Q2 2022 Karat Packaging Inc Earnings Call
Ladies and gentlemen, thank you for standing by and welcome to the Carrick Packaging second quarter 2022
I would now like to turn the call over to Roger Pondell, Investor Relations for Carrot Packaging. Please go ahead.
Thank you, operator, and good afternoon, everyone. Welcome to Caret Packaging's 2022 second quarter earnings call. I'm Roger Pundell with Pundell Wilkinson, Caret Packaging's investor relations firm, and it will be my pleasure momentarily to introduce the company's chief executive officer, Allen Yu, and chief financial officer, Jen Goh.
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 as a result of the
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 CARET 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, and
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 Yoo. Alan?
Thank you, Roger. Good afternoon, everyone. Our second quarter 2022 results continue to reflect strong demand for our products, particularly our environmentally friendly offering, which grew 50% over the comparable prior year period. The positive sales performance was broad-based across all categories, paced by 30% growth in the distributor channels. We continued to gain wallet share with our existing customers, and we added several new wholesale distributors to our customer roster.
Sales were negatively impacted by approximately $2 million of fewer order fulfillment, caused by shipping delays between our Chino manufacturing plant and other carrot warehouses, including two new facilities in Southern California and Hawaii that we lease in May. The shipping delay issues were transitional due to inventory overflow received in May and June , and have been resolved. I thank the entire carrot team for working diligently through it.
As more cities and states in the United States and around the world enact new regulation to ban styrofoam and single-use plastics, demand for a composable and biodegradable product is rapidly growing. We are experiencing increase from national change in grocery accounts for a composable product. Carrot is committed to its leadership position in eco-friendly disposable food service products. As we continue to provide new and innovative offerings, our joint venture announcing April 2018th as an opportunity to support New Mexican
Green Earth technology in Taiwan is progressing well. The 180,000 square foot state-of-the-art automated bagasse factory to manufacture 100% composable food service product is expected to be completed ahead of schedule.
With production and shipment to begin before the end of this year, the plant is expected to produce approximately 648 containers of product annually.
We are in discussion with our Taiwan partners to expand production lines to double the manufacturing capacity by mid-2023.
Additionally, we plan to accelerate our initiative to build a Bogus plant in the U.S. in 2023.
using the proprietary manufacturing processes of the new Taiwan facilities.
As we proceed further into 2022, we believe we expect continued growth from our eco-friendly product lines, improvement in our fulfillment rates with the recent warehouse expansion, and continued operating efficiencies. We are currently targeting net sales for the 2022 third quarter to be in the range of $117 million to $120 million, up from the $102.7 million for the 2021 third quarter.
For the full 2022 years, we are reiterating our guidance with net sales expected to be in the range of $445 million to $449 million versus the $364 million in 2021. Despite the significant increase in total freight and duty capitalization costs in the 2022 second quarters, we've achieved a gross margin of 29.6% consistent with the 29.7% in the same period last year.
Gross margin benefited from higher margin eco-friendly products, as well as favorable foreign currency exchange rate.
Our gross margin goal for the 2022 full year remains 31% to 32% on average. We are currently seeing some meaningful drop in ocean freight rates. As we absorb the higher ocean freight costs, we are confident that we can still accomplish our full year average gross margin of 31% to 32%. I want to leave adequate time for questions, so with that I will turn the call over to Zhang Gao.
our Chief Financial Officer to discuss our financial results in greater detail. Jan?
Thank you, Alan. As Alan mentioned, we delivered another quarter of solid sales growth and increase in adjusted EBITDA on top of the exceptional growth achieved last year due to post-COVID reopening.
We reported record quarterly net sales for the 2022 second quarter, rising 22% to $114.9 million from $94.5 million in the same period last year, reflecting strong growth from existing and new customers.
The increase was driven by our eco-friendly products and price increases implemented to partially offset higher product, freight and label costs as well as increased revenue from our expended logistics services.
By channel, sales to distributors or largest channels grew 30%.
for the 2022 second quarter. Sales from the online channel increased 13%.
Sales to national and regional chains increased 12 percent and sales to the retail channel increased 5 percent for the quarter.
Gross profit increased 21% to $34.0 million.
for the 2022 second quarter from $28.1 million last year.
Growth margin was 29.6% consistent with 29.7% in the same period last year, despite the significant increase in total freight and duty costs.
Overall freight costs as a percentage of net sales increased to 18% in the second quarter of 2022, from 10.3% in the second quarter of 2021.
Gross margin benefited from a shift to higher-margin eco-friendly products and favorable foreign currency exchange rate along with improved operating efficiencies and leverage.
With some abatement in the current ocean freight rates, we expect total freight and duty costs to continue to decrease as a percentage of net sales in the second half of 2022.
We also continue to focus on optimizing our product mix and improving our operating efficiencies, and we are confident to deliver on our gross margin goal for the full year.
Operating expenses in the 2022 second quarter were $26.2 million or 23% of net sales, compared with $21.2 million, also about 23% of net sales in the same period last year.
The increase included incremental warehouse transfer costs.
To manage inventory overflow,
higher demerit fees, additional temporary labor costs, including for COVID-related illness, and higher rent and stock-based compensation expense.
Other income net was $1.1 million for the 2022 second quarter, including a gain on foreign currency transactions of $850,000 compared with $4 million in the same period last year. The decrease primarily reflects a gain of $5 million from the PPP loan forgiveness partially offset by interest expense of $1.1 million in the 2021 second quarter.
Provision for income taxes was $1.7 million, or 20%, for the 2022 second quarter, compared with $1.5 million, or 14%, for the prior year quarter.
The lower text rate last year
was primarily attributable to the gain of $5 million.
forgiveness of death.
Net income for the 2022 second quarter was $7.2 million, compared with $9.3 million for the same quarter last year, which included the gain on debt forgiveness.
Net income attributable to tariff packaging for the 2022 second quarter was $6.3 million.
All 32 cents per diluted share compared with $9.6 million.
All 50 cents per diluted share a year ago.
Adjusted diluted earnings per common share increased.
17% to $0.34 from $0.29 in the prior year quarter.
Adjusted EVDA for the second quarter was $11.8 million, an increase of 15% from $10.3 million a year ago. Consolidated adjusted EVDA margin was 10.3% in the second quarter versus 10.9% in the year
for the same quarter last year.
Net cash provided by operating activities was $3.7 million for the three months ended June 30, 2022, compared with net cash used in operating activities of $7.2 million for the same quarter last year.
The difference primarily reflected the increase in net income year over year, excluding the one-time gain of $5 million from debt forgiveness included in the prior year quarter, and more effect of working capital management.
During the 2022 second quarter, we invested $4.4 million in regular capex.
principally for manufacturing machinery and another $4 million to set up our joint venture in Taiwan.
We finished the quarter with $96.7 million in working capital.
compared with $72.1 million at the end of 2021. We believe Carrot is well positioned to execute on its future growth strategies.
As of June 30, 2022, the company had $11.6 million of borrowing outstanding under the line of credit and additional availability of $28.4 million under this line.
With global wealth refinancing of one of its term loans in June 2022, we gained additional liquidity of 8 million.
We continue to explore other options to further expand our liquidity to support the business growth and enhance shareholder value.
Alan and I will now be happy to answer your questions, and I'll turn the call back to the operator.
The floor is now open for your questions. To ask a question at this time, please press star 1 on your telephone keypad. If at any point you would like to withdraw from the queue, please press star 1 again. We will take a moment to render our roster.
Our first question comes from Jake Bartlett from Truist Securities.
Great. Thanks for taking the question. Alan, my first question is on fill rates. You talked about improving fill rates, helping sales, but can you give us an update on how the fill rate has improved or changed from the first quarter and how you think that should trend for the rest of the year? And then also if you could kind of confirm or...
talk to whether fill rates are really the limitation on your sales growth right now or whether you're seeing any sort of softness in demand. I get the picture that demand is much higher than really than you can meet so falling demand is a pretty low risk but if you can kind of help frame that for us that would be helpful.
Sure, Jake. Well, thank you. First of all, the fill rates. We are seeing our fill rate out of our Texas facility, which is one of our largest facilities. We're still at most of the purchase order that we received. The second quarter was at 50%. So we had to short customers almost 50% of the item they needed to order. But in California, it was much better. California fill rate was up to 85%.
to South Carolina, New Jersey, and Washington to stock up other warehouses because we have a lot of customers in different parts of the states that also need our products. So that's what we have been doing right now. Is there a softness in the market? No, I do not see a softness in the market. Actually, I've seen it. The market is growing even stronger and the demand, especially the demand for a composable eco-friendly product, basically it's growing faster than ever. For example, I've seen that the San Mateo County is requiring...
every restaurant to be using compostable products starting October 1st, Hawaii starting September 1st. So everyone is clearing up with eco-friendly product line right now. And we spoke to a national chain account last week, and they were saying that prior to pandemic, their take-out was 15% of their overall volume. As of today, they're at 40% of their entire volume. And not to mention that they even added 4 different brands of virtual kitchen.
that increase the volume, the usage of the packaging. And this is where we've seen that the entire industry is looking to grow with the disposal packaging.
with this trend moving into more ghost kitchens and virtual kitchens from existing chain accounts.
Great. Thank you. That's really helpful. And I wanted just to focus in on gross margins for a moment. One is I know in the first quarter there was that big impact of capitalization of freight and duty. Was there any impact in the second quarter? I might have missed that but whatever impact was in the second quarter. And then we've been tracking weekly...
spot ocean freight rates from you know East Asia to the West Coast and they're down about 60% you know currently is from what I'm seeing year over year. So the question is you know when do you see that sort of benefit flowing through I mean is there a quarter or two delay and what should we see the the benefit of really dramatically falling ocean freight rates you know coming through the gross margin.
Octavio?sh
The ocean freight started to increase last year. So in last year's fourth quarter, when we had our earning conference call, we were mentioning that everyone was saying that there's going to be a headwind because the ocean freight is growing. And the peak of the ocean freight was the first quarter. And that's where we see a, we had a, in the first quarter earning, we had a favorable capitalization, freight duty capitalization in the first quarter because we brought in a lot of product using the higher freight rate.
And the freight rate started to drop. When it started to drop, it dropped from early, I would say early June . That's when it first started to drop, not in May. So basically June , we wouldn't see a much favorable freight doing capitalization gain the second quarter, but we will see a tailwind starting the end of third quarter into the fourth quarter. And yes, the freight has dropped tremendously from...
I would say $21,000 spot rate to currently at $5,700 today.
Okay, great. And just to add on to Alan's comments to answer your question, during the second quarter, we did have an unfavorable impact.
from the freight and duty capitalization of about 2.3 million. So it did have a fairly significant impact on our gross margin. And now also to what Alan was talking about, we expect to start to see the benefit from the decrease in ocean freight rate in the third quarter, the later part of the third quarter, and then probably more so in the fourth quarter of 2022.
Great. And then my last question, the Taiwan, the JV, my impression was that you were going to, that was going to be, you know, a way you could prove the automations to produce BAGAS in an effective way. I know it's typically a very labor-intensive process so you're going to try to see how that automation—
works and whether it's cost effective and then if successful you might bring it to the US but sounds like you're kind of making the decision to bring it to the US but I'm not sure if you've kind of you know do you feel like you've proven out the automation at this point?
Well, yes.
Last or earlier this year, our thought was to start in Taiwan and see if it's workable and bring it to the U.S. But at this point, we are seeing progressing very well, the production basically set up and everything. So we are confident that we should be able to train and hire people in Taiwan and get it operational. That's why we are already jumping into the second phase of the Taiwan investment.
Basically, we know that the demand for composable product is going to be widespread in the US and there has been already other larger manufacturers that have tried to bring in bagasse manufacturing domestically and so far I haven't seen it done very well. I always think that our manufacturing facility and our equipment, we compare with different types of other equipment that are out there in the market, we would say that the equipment that are
accounts in the market that are buying these, using these per-gauge products are mainly, I would say 80% are from China. And that's where we want to reduce our reliance from Chinese manufacturer into other part of the world, especially if we can manufacture domestically. I would think that I've already spoken to a lot of chain and we are gaining a lot of support that if the price is not too much more, they would actually support the domestic manufacturer like us.
Great, thank you very much.
Our next question comes from Michael Hoffman from Stevell.
Hi, Ellen, Jen, thank you very much for taking the questions. On the freight side...
Can we follow through in the commentary of so there was a couple million dollar headwind
and to queue if rates are falling
And given the inventory turns you've added 27 million dollars of inventory sequentially we're going to see
Probably not as great but I still have pressure in 3Q and then a fairly significant reversal is the way to think about that, that capitalized number.
Yes, we have increased our inventory in Q2 and we are looking to significantly decrease our inventory in Q3 compared to Q2. And at the same time, we are going to see some favorable freight duty capitalization gain in Q3. That's where we're seeing that right at this point because the ocean freight has dropped significantly.
Okay, just to be clear though, you've got a whole bunch of inventory that's sitting on a freight and duty that's higher.
than the current market is. So I'm.
I mean that's a drag isn't it in the third quarter until you get more inventory turns? You got to turn this inventory and get the whole stuff coming in at lower rates.
Yes, Michael. I wouldn't say it's a drag, and I wouldn't say a lot of inventory at a higher cost. The higher cost came in in the first quarter, not necessarily in the second quarter. The second quarter freight has already dropped. The product that we brought in the first quarter at a much higher rate has already been depleted. And it's reflecting in the second quarters. Basically, right now, the reason I said that our inventory is going to drop significantly is just now TikTok
especially by the end of the third quarter, is that we have already seen a reduction in terms of ocean freight coming in. And basically, all these new inventory that we brought in are at lower cost freight rates. And that's where we see that. And also, starting next month, we'll be – we reduce our inventory for a six-week period, and we're adding the inventory back starting this week. And –
basically by the end of the quarter, most of our product will be at the normal market rates. And currently, we have not shown any decrease in prices in the market, so it wouldn't be a market drag on our segment at this point.
So just to be clear, the 2.3 million freight and duty Dragon 2Q should not repeat. It should be neutral to positive in 3Q.
I would say that it will be neutral in Q3.
Okay and then it should turn positive.
Hi Michael, thank you for the question. I just wanted to provide a little color there. So I think Alan is exactly right. If you look at our inventory turn, our average inventory turn is about a little over 60 days.
As far as...
total ocean freight and duty cost including
sort of the cash base cost as well as the capitalization piece. If you look at the second quarter, the total ocean freight represented about 18% of net sales.
which as I said included the unfavorable impact of a little over 2 million already from this capitalization. When we look at the third quarter our current expectation for the total ocean fate.
including the impact from the capitalization, we expect to
to see that percentage to decrease to mid-teens. So we do expect probably 200 basis points to 400, roughly, basis point decrease in our total ocean freight and duty as a set of net sales in the third quarter, if that answers your question.
Perfect. That's what I was trying to get at.
What are you, did you end up with signing a contract and having to you know take a contract rate in May like lots of the world did and and if you did where are you on a on the mix of spot versus contract in your containers?
Well, that's a very good question. Yes, everybody signed a contract at the end of April , starting in May, and as Shipper realized, the spot rate is much lower than the contract rate. All the ocean freightliners have agreed to reduce the contract rate to match the spot rate.
So ear mix would have been really high contract in earlier in the year, now it's more spot, is what I'm hearing.
Everyone is on spot now, yes. Okay. And then what percent of sales was eco-friendly? If you said that in the prepared remarks, I'm sorry I missed it.
Jane, do you have the number? Yes, it's still in the high teens. As a percentage of total net sales, we are seeing year over year, it increased by roughly 1%, it's still in the high teens as a percentage of total sales.
So basically flat sequentially but up year over year. So we've settled in sort of a current level of demand based on access to the product and things of that nature but the trend is still to drive it higher.
Yes, that is the other time.
Yes
Right, and the limit to... And that trend is going to be boosted obviously by, as Alan talked about, the joint venture in Taiwan once the manufacturing starts to, once we start to get the products out of the joint venture in Taiwan.
Right and if I remember hearing it correctly this should...
be in production in 4Q, but what am I looking at? It's really a 1Q before anything gets onshore USA.
That is correct. Okay and then the two million fulfillment issue this was this a function of some of the labor challenges you've been dealing with and you just didn't have enough people to move all of the goods out of.
Chino to be able to redistribute it into the other distribution centers in order to be able to then deliver it to the customers.
Yes, actually in California, during the second quarter, end of May and June , we've seen a much higher increase in COVID-related cases. We've never seen so many staff that are calling us sick for five to seven or eight even more days. And there's short staff getting product out. There were some challenges. And also we have to call in temp agency people.
that also increased operation costs. But second quarter, we had to face a lot of shortage in labors, and that was one of the challenges. And that's one of the things that we did at open house at the end of the second, actually early July , and we actually added 5% of our, we hired 5% additional labor force just to cover those shortages.
And is it fair to say that 2 million is not a recoverable revenue somebody else fulfilled it ultimately or do you think you might actually get that 2 million back?
We will probably get half of that back because of the shortage of everyone out there. We now know that if a restaurant needs a product or they can't find it from us, they'll find it from someone else. But one thing is, of course, for the item that we didn't ship out, we had a delay in shipment. That's another thing. We were delaying about 10 days in some of the shipment out of California. So now we're pretty much caught up in terms of shipping product. Even online order, we were delayed for Amazon ordering online orders.
after today were pretty much caught up. So, and we're looking to increase more fuel rates. So I would say that we recover 50% of that, 2 million shortages.
So last quarter and based on the comments you made in the in your opening remarks about moving product into, Texas South Carolina, New Jersey He would expect in 3q those fulfillment rates out of those distribution centers to be better than they were in 2q
Yes, that's our goal. Okay. Great. Thank you. Thank you, Michael.
Our next question comes from Paul Dirks from William Blair.
Thank you. Good afternoon, everyone.
So my first question is on price. Could you maybe quantify for us what price contributed in the quarter? and looking forward
Do you expect to see any price deflation?
in particular on the plastic product side of the business.
will lead the price in terms of the effect on the quarter. But on the question on the remark on the price deflation, we do not see a price deflation in the paper. So I guess you already know that paper product is actually looking to go even higher potentially next year, actually early next year, possibly end of this year. That's what everyone is seeing is shortage of paper supply.
plastic on the other end, are we looking at a price drop in the plastic. At this moment, I haven't seen any price drop. Domestically, the raw material did drop about 10% in terms of raw material, but all of our manufacturers out there are seeing a higher operation cost in terms of warehouse storage fee, the labor costs have increased, the operational costs, the transportation of the movement of the raw materials.
So that we haven't seen the softness in terms of demand for plastic. And especially when right now we're in the summer season, everyone's still looking to getting plastic cups and also everyone's looking to switch their styrofoam into plastic containers. So, so far the demand still outgrow the availability of the product. So, I haven't seen much of that softness in that part of the area.
Would that continue forward? We'll see how it moves. But the thing is right now, as I mentioned, the growth in takeout is 40%. There is still some supply issues in the market for most of the products, not all the products, but that's what we're seeing right now. That's helpful. I guess.
My next question is
you know, sequentially, could you maybe talk, Alan, about your conversations with the national chains and also your retail customers? You know, on a sequential basis, sales were only up modestly, and you know, thinking about how sales progressed last year, it's quite a bit of a lower growth rate than what we saw moving seasonally into the summer months last year. Can you maybe talk about those conversations that you had? Did the...
tone of those conversations change or perhaps get a little bit more cautious as we got into June and into July .
Sure. One of the softness we've seen is our T-Zone product, our boba supply product. Now we've seen it drop in terms of the sales volume. As last year when the economy opened up, everyone was craving for a drink or high-end or expensive drink in terms of boba supplies. That we saw as softness this year, but we do see that trend might continue to go upward, trending up as more national chain accounts are looking to.
incorporate boba supply into their offering. Now in terms of discussion with the national chain account, now that we are open and we are able to travel and meet our national chain account, we are in discussion with most of our national chain account to increase what they have been purchasing. That's one of our strategies to increase our wallet share for the existing customer's national chains. And we are talking to some meaningful large chain account. We are looking to add.
additional product line into their current usage and in that part sense. We will be announcing in the third quarter letting everyone know which chains actually we've added new chains or which distributor we have added in the third quarters and also at the same time displaying how our growth with the National Chain Account will be growing because with the National Chain Account it does take a long time.
to get approval, get a mock-up, get sample testing. And we've done all that in the, doing the second quarters, and we are looking to close most of the majority of the deal in the third and fourth quarter of this year. So that will trend into an increase in sales for the 2023.
Very good. And my final question is, you know, on the Bagaas facility in Taiwan, can you share with us how did those product margins compare to the other eco-friendly products that current currently offers and how would those margins be affected with the introduction of the new US facility? Could those US facility margins be...
yet the most rich that you guys would have in your portfolio? Can you help us understand the profitability of these products?
Well, the key aspect of having a bagasse product is there's a need for it. Regulations in most places are banning plastic, so they're not even allowing the polypropylene or the reusable plastic. So basically all the restaurant has to change into the composable products such as bagasse or sugarcane product line. In terms of margin wise, I would think that the operational expense in US is going to be definitely higher than oversea.
But the benefit is that it is made in the USA. It is reliable. It is domestic. Our customer can actually come and visit this facility to see how it is made versus if it's made in the oversea, what if there is a supply chain disruption? What if there is a ship down or a blockade in the certain part of the port in China? So that aspect people will see the benefit in terms of not necessarily looking for pricing wise.
as long as the price is not too far off compared to the products that are coming overseas. That's where we see it. In terms of margin wise, I'm not going to say that there's going to be a higher margin because we have to see how the operational expense will be when we first start in domestic US. Part of the raw material that we'll be receiving will be from our existing paper plans.
that we can recycle the paper pulp into the existing material, sugar cane or wheat, and blend it in, that will reduce our raw material cost. So this is where we see how effective we are able to use our raw material, recycle raw material to produce a product.
I appreciate the color. Thank you.
Thank you. Thank you, Paul.
That does conclude today's questions.
I would now like to turn the call over to Alan Yu for closing remarks.
Thank you everyone. Well, thank you all for joining the conference call for query packaging in the second quarter. We look forward to speaking with you again in the third quarter. Again, thank you very much and have a nice wonderful day.
Operator. Thank you ladies and gentlemen. This does conclude today's call. Thank you for your participation. You may now disconnect.
Good afternoon. May I please have the name of the conference you're calling to join? Hello? Hi. I'm trying to connect to a Carrot Packaging. Yes. Thank you. May I please have your first and last names with spelling? Rachel or A-C-H-E-L. S-M-I-T-H. Thank you. And the name of the company you're calling from, please? A-Y-E-R-A. Thank you so much. I'm sending you through now. Thank you. Thank you. Extra!!!