Karat Packaging Inc. (NASDAQ:KRT) Q1 2023 Earnings Call Transcript May 12, 2023

Operator: Good day and welcome to the Karat Packaging Inc. First Quarter 2023 Earnings Conference Call. Today, all participants will be in listen-only mode. [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Roger Pondel, Investor Relations. Please go ahead sir.

Roger Pondel : Thank you, operator, and good afternoon everyone. Welcome to Karat Packaging’s 2023 first quarter earnings 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 its Chief Financial Officer, Jian Guo. Before I turn the call over to Alan, I want to remind all 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 Factors section of the company’s most recently Form 10-K as filed with the Securities and Exchange Commission, 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 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: Thank you, Roger. Good afternoon everyone. Our first quarter performance reflects a strong execution of our 2023 business strategy. We were able to achieve a record gross margin of 39.8% and record adjusted EBITDA results since the company’s IPO in 2021; despite the industry-wide deflationary environment and multiple price reduction that we implemented. Moving ahead with our growth strategy on improving inventory management and fill rates, we recently signed a lease for an 83,000 square feet distribution center in Houston, following the addition of a Chicago warehouse earlier this year. Our plans for geographic expansion on the East Coast and the Midwest region are progressing well. With the recent expansion of the sales team and additional marketing activity together with the new contracts that were signed during the fourth quarter last year, we are expecting revenues to pick up again during the second half of this year.

As a reminder, revenue for the first half of 2023 is expected to be lower than the same period last year, when pricing for inventory sold was at the peak level. In addition, order volumes during that time period last year were unusually high due to supply shortages. We continue to execute our asset-light business plan, and are now scaling back manufacturing production in California, while increasing import items focusing on higher-margin products during the past few months we have significantly enlarged our sourcing network in Asia giving us greater flexibility without additional overhead. To me our growing demand for eco-friendly and compostable products this category grew 17% in the first quarter over the prior year quarter. And demand remains strong.

Our 2023 growth goals for the eco-friendly product category is to be around 35% of total sales. Due to the multiple construction and regulatory approval delays in Taiwan and our recent strategy to shift toward imports and diversifying eco-friendly product sourcing we decided to sell a proportion of the joint venture bagasse factory to Kerry [ph] Global Group. We are expecting the transaction to close within a three-month period or soon thereafter. With the selling price equal to our initial investment of about $6 million plus 5% interest. Lastly, we made a significant upgrade to our e-commerce platform and expanding our online support team. Sales to Canada and Hawaii are underway and proceeding well. We are now seeing some of the benefits of our online efforts with the business going in a positive direction.

We again generated strong operating cash flow during the first quarter and continue to project positive cash flow throughout 2023, which is allowing Karat to generate excess capital and seek new opportunities. Accordingly, as announced on Tuesday, our Board of Directors declared another special dividend of $0.35 per common share. I will now turn the call over to Jian Guo, our Chief Financial Officer to discuss the company’s financial results in greater detail. Jian?

Jian Guo: Thank you, Alan. Despite a challenging year-over-year comparison first quarter 2023 results demonstrated our ability to adapt to the external business environment as we were able to significantly enhance margins and strengthen the company’s liquidity position. Net sales for the 2023 first quarter as anticipated decreased 9.1% to $95.8 million from $105.4 million a year ago. This was slightly better than our original expectation. Last year’s first quarter was a particularly strong revenue quarter with inventory price increases at the peak due to extraordinarily higher ocean freight and other costs and strong volume resulting from overall supply shortage in the industry. By channel, sales to distributors our largest channel was lower by 7.6% for the 2023 first quarter.

Sales to national and regional chains decreased 14.2%, sales to retail channel decreased 21.7% and sales from the online channel increased almost 1%. As Alan mentioned earlier, our investment and marketing efforts to support our e-commerce platform have begun to bear fruit. Sales of our eco-friendly products increased 16.8% for the first quarter. We continue to further strengthen our leadership position as Karat experiencing strong growth from these products based in part on our enlarged sourcing network and expansion of our product offering as well as the evolving regulatory landscape. Eco-friendly products represented 33% of total sales in the 2023 first quarter compared with 25% a year ago. Gross profit increased 11.2% to $38.1 million for the 2023 first quarter from $34.3 million last year.

We achieved record gross margin of 39.8% in the first quarter, an improvement of 730 basis points over the prior year quarter. Gross margin expansion benefited by a significant decrease in ocean freight costs, which amounted to 5.9% of net sales in the 2023 first quarter compared with 14.4% of net sales last year. Also costs for certain raw materials were lower and operating efficiencies and productivity are continuing to improve. Operating expenses in the 2023 first quarter were $25.4 million or 26.5% of net sales compared with $24.8 million or 23.5% of net sales in the prior year quarter. The increase was primarily due to workforce expansion and increase in rental expense from the two additional warehouses added in May 2022 and higher marketing expense to support online sales growth.

The increase in operating expenses was partially offset by decreases in shipping and transportation costs and bad debt expenses. Net income for the 2023 first quarter increased 15.6% to $9.2 million from $7.9 million for the same quarter last year. Net income margin was 9.6% in the 2023 first quarter compared with 7.5% a year ago. Net income attributable to Karat for the 2023 first quarter was $9.0 million or $0.45 per diluted share compared with $6.7 million or $0.34 per diluted share in the prior year quarter. Adjusted EBITDA, a non-GAAP measure was $15.3 million for the 2023 first quarter compared with $13.0 million in the prior year quarter. Consolidated adjusted EBITDA margin expanded to 15.9% of net sales compared with 12.3% for the 2022 first quarter.

Adjusted diluted earnings per common share rose to $0.46 per share from $0.36 per share a year ago. Karat’s consistent solid growth has built a strong financial and liquidity position for the company. The company is well-positioned to execute on its future growth strategies. We finished the quarter with $97.4 million in working capital compared with $84.5 million at the end of 2022 and have financial liquidity of $62.1 million with another $10 million in short-term investments. Moving further into 2023, we are forecasting revenue for the second quarter to be down about 5% year-over-year. Moreover, we are reiterating net sales for the full year expected to increase by high single digits, from new contracts increased inventory fill rate with additional warehouse, space benefits from additional marketing efforts and better pricing comparisons.

As Alan mentioned, we are now scaling back manufacturing production in California, selling and disposing of equipment and raw materials that no longer will be needed, to create more warehouse space for import products and to further improve inventory management and efficiency. Accordingly, we’re currently expecting to record an impairment charge in the range of $2.7 million to $3.5 million in the second quarter of 2023, including approximately $1.5 million to $2 million write-off of inventory with the remaining write-off in operating expenses. We expect to benefit from this shift of strategy to more than offset the impairment charge. At the gross margin level, we believe the gross margin for the first quarter was exceptionally high and is not indicative of future quarters.

We are reaffirming our 2023 full year margin goal to be in the range of 32% to 33%, even with the expected impairment charge in the second quarter as we expect to continue to benefit from the stabilized ocean freight, and our efforts to increase import, shift towards high-margin items and improve operating efficiencies. Alan and I will now be happy to answer your questions, and I’ll turn the call back to the operator.

Q&A Session

Operator: We will now begin the question-and-answer session. [Operator Instructions] Today’s first question comes from Jake Bartlett with Truist Securities. Please proceed.

Operator: The next question comes from Ryan Meyers with Lake Street Capital Markets. Please proceed.

Operator: Our next question comes from Ryan Hoffman with Stifel. Please proceed.

Operator: The next question comes from Ryan Merkel with William Blair. Please proceed.

Operator: At this time, we are showing no further questioners in the queue and this does conclude our question-and-answer session. I would now like to turn the conference back over to Alan Yu for any closing remarks.

Alan Yu: Thank you everyone for joining the earnings call and Q&A session. And I look forward to all of you on the next earnings call. Thank you very much and have a wonderful day. Bye-bye.

Operator: The conference is now concluded. Thank you for attending today’s presentation and you may now disconnect.