Q3 2025 Karat Packaging Inc Earnings Call
Speaker #3: Good day . And welcome to the Karat Packaging Inc. . Third quarter 2020 Earnings Conference call . All participants will be in a listen only mode .
Speaker #3: Should you need assistance , please signal a conference specialist by pressing the star key , followed by zero . After today's presentation , there will be an opportunity to ask questions , to ask a question , you may press star , then one on your touchtone phone and withdraw your question .
Speaker #3: Please press star , then two . Please note this event is being recorded . I would now like to turn the conference over to Mr. Roger Pondel .
Speaker #3: Please go ahead , sir .
Speaker #4: Thank you . Operator . Good afternoon , everyone , and welcome to Karat Packaging Inc. 2025 , Third Quarter Conference Call . I'm Roger Pondel with Pondel Wilkinson .
Speaker #4: Karat Packaging Inc. Investor relations firm . It will be my pleasure momentarily to introduce the company's chief executive officer . Alan , Liu , and his chief financial officer , Jan Gao .
Speaker #4: Before I turn the call over to Alan , I want to remind our that today's call may include forward looking statements within the meaning of the listeners private securities Litigation Reform Act of 1995 , such forward looking statements are subject to numerous conditions , many of which are beyond the company's control , including those set forth in the risk Factors section of the of the company's most recent form 10-K .
Speaker #4: As filed with the Securities and Exchange Commission . Copies of which are available on the SEC's website at . Along with other company filings made with the SEC from time to time .
Speaker #4: Actual results could differ materially from these forward looking statements and Karat Packaging Inc. undertakes no obligation to update any forward looking statements except as required by law .
Speaker #4: Please also note that during this call , we will be discussing adjusted EBITDA , adjusted EBITDA margin , adjusted diluted , diluted earnings per share and free cash flow , which are non-GAAP financial measures as defined by SEC regulation G .
Speaker #4: 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 .
Speaker #4: And with that , I will turn the call over to CEO Alan Yu . Alan .
Speaker #5: Thank you . Roger . Good afternoon everyone . Despite ongoing trade volatility , Cara achieved another quarter of record net sales , up over 10% year over year , fueled by solid volume expansion .
Speaker #5: A favorable product mix , and effective pricing initiatives . We've experienced double digit growth across all major markets , especially in Texas and California .
Speaker #5: Even with significant higher import costs due to increased duties and tariffs . We successfully sustained a gross margin of 34.5% for the third quarter .
Speaker #5: We remain committed to our sourcing diversification strategy and our nimble and flexible operating model continues to enable us to effectively manage ongoing supply chain challenges .
Speaker #5: During the third quarter , we increased domestic sourcing to approximately 20% from about 15% in the second quarter , and we reduced imports from Taiwan to approximately 42% from 58% .
Speaker #5: We continue to closely monitor tariff developments and are ready to quickly adjust our sourcing strategy accordingly , as we have done in the past to maintain competitive advantage .
Speaker #5: Additionally , foreign currency exchange rate between the US dollar and the New Taiwan dollar have shown increased stability since August , which is expected to help improve our operating performance for the current quarter .
Speaker #5: Earlier this year, we secured a major add-on of business to supply paper bags, a new product category for Karat, to one of our largest national chain accounts.
Speaker #5: Initial shipments to select distribution centers started in the third quarter , and we expect the volume to accelerate in the fourth quarter with fulfillment expected during Q1 of 2026 .
Speaker #5: This new category of business with a chain account is for a two year term and expected to contribute approximately $20 million in additional annual revenue over the next 2 to 3 years .
Speaker #5: We aim to scale our paper business to more than $100 million in additional annual revenue . The anticipated growth from this new category is being driven by national and regional restaurant chains that are transitioning to paper bags from plastic bags .
Speaker #5: This shift is influenced by evolving state and municipal regulations , as well as a growing emphasis on enhancing customer experience and brand images .
Speaker #5: We expect continued market share growth in this segment . Further solidifying our position as leader in providing sustainable , eco friendly , disposable food service products .
Speaker #5: In late May and June this year , we implemented broad pricing increases across most product lines to offset rising import costs . Heading to the fourth quarter and 2026 , business trends remain strong .
Speaker #5: We continue to make disciplined pricing approach and partner with our customers while focusing on operating efficiencies . We are actively integrating several meaningful new customer accounts and focusing on increasing online marketing , which will strengthen our 2026 pipeline .
Speaker #5: Building a strong foundation for what we expect to be another record setting year in sales , Kerry's announced a first ever stock repurchase program this week .
Speaker #5: In addition to the regular quarterly dividend , the announcement underscores our broad confidence in the company's future growth prospects and financial strength , and I will now turn the call over to Jian Guo , our chief financial officer , to discuss the company's financial results in greater detail .
Speaker #5: John .
Speaker #6: Thank you . Alan . I'll begin with a summary of our Q3 performance , followed by an update on our guidance . Net sales for the 2025 third quarter were $124.5 million , up 10.4% from $112.8 million in the prior year quarter .
Speaker #6: The increase was primarily driven by an increase of $9.4 million in volume and a $3.5 million favorable impact from product mix , partially offset by a $0.7 million unfavorable year over year pricing comparison .
Speaker #6: Self to change accounts and distributors were up by 13.7% . Online sales increased 3.1% over the prior year quarter , and sales to the retail channel were down 12.5% over the prior year quarter , reflecting the softness of the overall retail sector .
Speaker #6: Cost of goods sold for the 2025 third quarter increased 17.8% to $81.6 million , from $69.3 million in the prior year quarter . Product costs increased $5.0 million due to sales growth , partially offset by more favorable vendor pricing and product mix .
Speaker #6: Additionally , import costs increased $8.2 million due to higher import duty and tariffs , coupled with a 21.0% increase in import volume . As we purchased more inventory ahead of expected business expansion , partially offset by a 13.4% decrease in average freight container rates .
Speaker #6: Gross profit for the 2025 third quarter was $42.9 million , compared with $43.5 million in the prior year quarter . Gross margin for the 2025 third quarter was 34.5% , compared with 38.6% in the prior year quarter .
Speaker #6: Gross margin was negatively impacted by higher import costs , which as a percentage of net sales increased to 14.4% compared with 8.6% in the prior year quarter .
Speaker #6: The decrease in margin was partially offset by a decrease in product costs as a percentage of net sales due to more favorable vendor pricing and product mix , as well as a reduction in inventory write offs and adjustments .
Speaker #6: As a percentage of net sales . Operating expenses in the 2025 third quarter were $34.3 million , compared with $32.2 million in the prior year quarter .
Speaker #6: The increase was mainly driven by $2.1 million of higher shipping costs due to higher sales volume , $0.7 million of higher rent expense due to a higher rate on our Chino , California facility lease extension , plus the opening of a new Chino distribution center and oh point $6 million of higher salaries and benefit expenses .
Speaker #6: These increases were partially offset by a $1.4 million reduction in online platform fees . Operating income in the 2025 third quarter was $8.6 million , versus $11.3 million in the prior year quarter .
Speaker #6: Total other income , net , was $1.3 million for the 2025 third quarter , compared with $0.6 million in the prior year quarter .
Speaker #6: The increase was primarily from foreign currency transaction gain of $0.7 million , driven by the strengthening of the United States dollar against the New Taiwan dollar .
Speaker #6: During the 2025 third quarter , compared with a loss of $0.3 million on foreign currency transactions during the 2024 third quarter . Net income for the 2025 third quarter was $7.6 million , compared with $9.3 million for the prior year quarter .
Speaker #6: Net income margin was 6.1% in the 2025 third quarter , compared with 8.2% in the prior year quarter . Net income attributable to carrot for the 2025 third quarter was $7.3 million , $0.36 per diluted share , compared with $9.1 million , or $0.45 per diluted share , in the prior year quarter .
Speaker #6: Adjusted EBITDA for the 2025 third quarter was $13.1 million , compared with $14.7 million for the prior year quarter . Adjusted EBITDA margin was 10.5% of net sales for the 2025 third quarter , compared with 13.0% for the prior year quarter .
Speaker #6: Adjusted diluted earnings per common share was $0.37 for the 2025 third quarter , compared with $0.47 for the prior year quarter . We generated operating cash flow of $1.0 million in the third quarter , compared with $19.5 million in the prior year quarter .
Speaker #6: Duty and tariff payments , as well as the inventory purchase payments , increased . However , such increases were offset by strong collections and as you'll see described in the form 10-q filed tomorrow .
Speaker #6: Despite the significant cash outlays for operations and a $3.5 million early loan repayment on one of our consolidated variable interest entities term loans , we ended the quarter with $91.1 million in working capital as of September 30th , 2025 , we maintain financial liquidity of $34.7 million with another $19.9 million in short term investments as of September 30th , 2025 .
Speaker #6: We reclassified one of our consolidated variable interest entities term loans into current liabilities as the maturity is within 12 months , totaling $20.4 million .
Speaker #6: We intend to pay down the loan upon maturity with our cash on hand on November 4th , 2025 , our Board of Directors approved the quarterly dividend of $0.45 per share , payable November 28th , 2025 , to stockholders of record as of November 21st , 2025 .
Speaker #6: Additionally , our Board of Directors approved our first ever share repurchase program of up to $15.0 million , under which carrot is authorized to repurchase shares of its outstanding common stock from time to time through open market purchases .
Speaker #6: Looking ahead to the 2025 fourth quarter , we expect net sales to increase by approximately 10 to 14% over the prior year quarter , with gross margin projected to be within 33 to 35% and adjusted EBITDA margin to be within 8 to 10% .
Speaker #6: As Adam mentioned earlier , our new business pipeline for 2026 is robust , supported by the new paperback category offering and the addition of several key customer accounts .
Speaker #6: We remain focused on accelerating top line growth with disciplined pricing while continuing to enhance operational efficiency and cost management . Alan and I will happy to answer your questions , and I'll turn the call back to the operator .
Speaker #3: Thank you . We will now begin the question and answer session . To ask a question , you may press star , then one on your touch
Speaker #3: tone phone . If you're using a now be speakerphone , please pick up your handset before pressing the keys . If at any time your question has been addressed and you would like to withdraw your question , please press star then two .
Speaker #3: And at this time , we'll pause momentarily , momentarily , to assemble our roster . And the first question will come from Michael Francis with William Blair .
Speaker #3: Please go ahead .
Speaker #7: Alan . James . Mike on for Ryan . Nice quarter . I wanted to start on paper bags . Did I hear you right ?
Speaker #7: That you aim to scale that to 100 million over the next two years ?
Speaker #8: Yes , that is correct .
Speaker #7: And what gives you confidence in that number ?
Speaker #8: It's because there's a lot of chains are moving away from plastic bags into paper bag . And this is a segment that we're seeing that it's , you know , as one of the large chains in the US move towards this area more and more similar chain will follow through that .
Speaker #8: And they're basically that we feel that there is a organic growth in that segment . And also at the same time , it is not just a paper bag with handles .
Speaker #8: There's different types of bags . There's S.O.S bag that which every fast food restaurant will need and what the growth of the the fast food chain that is growing , the number of stores that is growing .
Speaker #8: We feel that we're competitive . We can be competitive enough to to gain market share in that segment . And as more and more people are looking toward that area , and also there's there's other bakery bag as well .
Speaker #8: There's just too many items in that segment that that make us feel that we can grow immediately . I mean , as I said , we mentioned in our announcement that one chain , the annual sales of that number would be 20 to $25 million per year , just for one chain .
Speaker #8: And we do have 2 or 3 other chains already working in testing our paper bag . And S.O.S bag . That's why we're feel confident that this will grow quickly into an annual sales of additional $100 million a year .
Speaker #7: That's all good to hear . And then I wanted to ask on gross margins went lower . I think , as we were expecting , and for Q is a little lower than we were expecting .
Speaker #7: But would like to know long , longer term . Do you think that there's an opportunity for you to get back into that high 30% range on the gross margin number , or is that going to be difficult while tariffs are in the in the market ?
Speaker #8: Well , we're trying to be conservative right now at this point because there's still uncertainty . But the good thing is we feel that there's a tailwind .
Speaker #8: One of the things that one of the issues that reduces our our gross margin drastically in the second quarter was their sudden drop in the Taiwanese sudden increase in the Taiwanese dollar versus the US dollar , that it was a drop of 11% in just three days alone .
Speaker #8: And that 11% has come back to just about a increase of 4.5% , 5% . So basically , it's more of a stabilization in the US dollar against Asian currencies .
Speaker #8: And this is actually enabling us to go back to our vendors to negotiate a better pricing . This past few months . Basically .
Speaker #8: So we're seeing that there's more tailwind in terms of the gross margin . But we do want to be conservative in terms of how we look at in terms of the numbers .
Speaker #8: In September and giving us a number that we see in October . We already seen some improvement in October versus September . September was better than August , so we want to see more of the positive trend before we can issue a higher increase .
Speaker #8: Our gross margin numbers basically .
Speaker #7: Okay . And last one for me , it's good to see the share buybacks . Would love to get an update on your capital allocation priorities between debt pay down buybacks and the dividend and any potential M&A .
Speaker #8: Well , we we we our strategy is that if we have more than $20 million in the short term deposit that we can allocate it to the dividend .
Speaker #8: Special dividend , regular dividend or use it for other investment . At this point , even with . With the increase in tariff increase in inventory wise in the second quarter , we are deposit amount is still the same , remain the same .
Speaker #8: So we're still strong in cash and lately we're seeing that we're bringing we have been bringing down our inventory to reduce our liability , reduce our costs in terms of the the tariffs as well as importation costs .
Speaker #8: So we're seeing cash flowing back into our accounts . And that's why we feel like it's it's good for us to do some type of a short repurchase .
Speaker #8: While our stock is kind of low right now , I think it's a value to repurchase . Stare back at the same time we are still looking to merger and acquisition .
Speaker #8: We we do have a few in the pipeline investment partnership , joint venture , and also acquisition . We don't feel that this will deter us in terms of deter us in terms of moving towards this direction .
Speaker #7: Okay , well good to hear . I'll pass it on .
Speaker #8: Thank you . Michael .
Speaker #3: The next question will come from George Staphos with Bank of America . Please go ahead .
Speaker #2: Hi everyone . Good afternoon . Thanks for taking my question . Can you hear me ? Okay . Alan .
Speaker #8: Yes , I can , George .
Speaker #2: Hey . How are you ? So , listen , maybe piggybacking on the question on capital allocation . I want to take it from a different approach .
Speaker #2: I mean , you're you're dividend basically represents the majority of your earnings per share . You know , why would you consider or contemplate doing more buyback in light of that ?
Speaker #2: Would you consider borrowing to buy back more stock ? It would seem like , you know , deleveraging and taking care of your incoming debt .
Speaker #2: Needs would be probably more prudent . But how do you think about that ?
Speaker #8: Well , here's the thing that we don't have any debt on our books right now at this point , the debt that you're seeing is VI .
Speaker #8: That's on a real estate side of the ventures .
Speaker #2: , that $20 million , that current liability . You said you're going to pay that down in the upcoming year .
Speaker #8: We we can pay it down . We can pay either with our current CD that we have in our short term deposit to utilize some of the cash on that .
Speaker #8: And at the same time , we can have third party . We can also continue to borrow with different banks . It depends on how what the cash flow situation is .
Speaker #8: If there's a need to do that , because right now , like I said , we don't have any debt in our lollicup or Karat Packaging Inc. book right now .
Speaker #8: So we're we're this is one of the things that we , we , we still have time to think what we want to do , allocate our capital .
Speaker #8: If there's other things that we can do better , then we will do that . But at this currently , the rate of CD income is dropping as the interest rate reduces , so we have to figure out which is better .
Speaker #8: If we were to pay down the debt , we actually would be making generating additional income . You know , it'd be a inter-department intercompany loan to the VI company in paying down that debt .
Speaker #8: So it wouldn't be like really just paying . It'll be paying down the debt for the company . But at the same time , for Lollicup , it will be income .
Speaker #8: Additional income . Instead of getting a deposit from . Yeah , from the bank , it will be actually more income from the company .
Speaker #6: And George , this is Jen . I just wanted to add on . Hi , George . I just wanted to add on to what Alan was talking about to answer your question , the main purpose really is to have one additional tool in our toolbox to further enhance our shareholder return while we continue to focus on growing the company , either organic or inorganically as we previously announced .
Speaker #6: As you probably saw yesterday in the in the announcement , the total amount of the board approved of the share repurchase program is 15 million .
Speaker #6: So it is a fairly small program at management's total discretionary . So this this will be something that management will continue to evaluate in terms of a lot of the different factors , right .
Speaker #6: The price , the pricing , the the performance , the the liquidity , the strength of the balance sheet . Quite a few factors .
Speaker #6: Just just another tool in our toolbox to further enhance our shareholder return . You're right . I mean , obviously our dividend yield is already pretty rich .
Speaker #6: So that definitely is something that we consider as as we move forward with the potential execution under this program as well .
Speaker #2: Okay . I appreciate the thoughts on that . And thanks for the , the the reminder on on the V . One question back to the question .
Speaker #2: I think Mike teed up on on the bag . So let's assume you have . Perfect accuracy on the revenue side on bags .
Speaker #2: And that's $100 million in whatever time period you said . What kind of margin do you think you're going to get on that business .
Speaker #2: And you're already starting to see some of that show up in the fourth quarter ? You said . Correct . So two questions there .
Speaker #8: It'll be it will be a mix more of a mix margin . The higher volume will be in the could be in the the high teens margin size and the SOS bag could be in the high 30s .
Speaker #8: So it depends on the product line . There's also bakery bags that could be in the high 50s . So and also at the same time we are selling online on these new bag that we're bringing in .
Speaker #8: The online will be even higher margin range . So it will be more of a balancing mixture of each . Just like as we are doing right now .
Speaker #8: So and also we are actually working heavily toward in terms of getting our back to manufacture more efficiently to increase margin from there , better sourcing of raw materials from our vendors and also moving , shifting the manufacturing site locations , possibly potentially moving some into domestic US production .
Speaker #8: That might save some costs , even enhancing more margin . So this is these these are the things that we can do once as a volume increase in the next 12 months .
Speaker #2: All right . So two quickies for me and I'll turn it over to Alan . So with that being the case and we're already in November .
Speaker #2: So you know , almost halfway through the quarter yet , you know , the range on on revenue growth , range on , on margin is , is fairly wide .
Speaker #2: And I realize you're trying to be prudent . I realize there are a lot of vagaries in the market , especially with tariffs and sourcing .
Speaker #2: But I find the range is maybe a little bit wider than I would expect at this juncture in the year . What's giving you pause in terms of maybe , perhaps having a little bit narrower ?
Speaker #2: Both growth rate range and margin range for the quarter . And then did I hear you say my last question ? I'll turn it over .
Speaker #2: Did you say there was an inventory write off ? I apologize , I'm on the road right now , so I don't have your materials in front of me .
Speaker #8: I wasn't I don't I'm not sure what the inventory write off was , but I know that we're reducing inventory at this current rate toward the year end .
Speaker #8: Our actually , our sales have been very robust . As we've said , that we we are in the middle of the fourth quarter already .
Speaker #8: So we're seeing our sales almost in the mid range , but we just want to be conservative and basically at the Mid-teen range , this is a sales increase organically that we haven't seen for actually for the past three years .
Speaker #2: Okay . So so .
Speaker #8: You're saying that 12 to 14 . But we are seeing numbers very close to the mid-teens . But we just want to be prudent in terms of 12 to 14 .
Speaker #8: That's where we're we're trying to this is where we we being conservative . But we're seeing in the mid-teens right now in the growth numbers after the sales numbers and basically in our industry , this is kind of the a very good numbers in terms of well above our industry right now .
Speaker #2: Understood , understood . Thanks . I'll turn it over . Thank you Jen .
Speaker #9: Thank you .
Speaker #3: And this will conclude our question and answer session . I would like to turn the conference back over to Mr. Alan Yu , CEO , for any closing remarks .
Speaker #3: Please go ahead .
Speaker #8: Thank you . Thank you , everyone , for joining our third quarter Karat Packaging Inc. conference call . I'd like to say thank you again and have a nice day .
Speaker #8: Goodbye .