Karat Packaging Inc. Price & Performance (KRT)

Thank you, operator, and good afternoon, everyone. Welcome to Karat Packaging's twenty twenty four fourth quarter conference call. I'm Roger Pondell with Pondell Wilkinson. 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 Gu. 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 Factors section of the company's most recent Form 10 ks as filed with the Securities and Exchange Commission and copies of which are available on the SEC 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 this call, we will be discussing adjusted EBITDA [indiscernible] adjusted EBITDA margin, adjusted diluted earnings per share and free cash flow, which are non GAAP financial measures as defined by SEC Reg 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's my pleasure to turn the call over to CEO, Alan Yu. Alan? Thank you, Roger. Good afternoon, everyone.

We ended 2024 with a strong fourth quarter as sales volume grew 14% and net sales grew 6.3% over the prior year quarter. Despite a $4,800,000 out of period benefit included in the prior year quarter from online sales platform We achieved gross margin of 39.2% in the fourth quarter versus 35.7% in the prior year period. As positive momentum continues in 2025, we are prioritizing to further strengthen our supply chain resilience in preparation for tariff uncertainties. We have reduced our reliance on China for imported goods to approximately 20% shifting our sourcing to countries with more favorable trade conditions and minimum tariffs like Taiwan. In 2024, we imported over 50% of our global purchases from Taiwan We continue to actively work on further diversifying our supply chain out outside of China and securing additional vendor discounts to mitigate pricing and margin pressures.

While we try to protect pricing, we are evaluating product pricing holistically and have implemented pricing increases in certain categories to be affected in March and April. With a strong U. S. Dollar, and expected stable ocean freight rates this year, we expect the reason imposed tariffs to have minimum long term impact on margin. Geographically, for the quarter, we experienced the strongest growth in the Midwest and we continue to market in other regions, including the Pacific Northwest and East Coast. Sales in California, our biggest market, began to stabilize in the preceding third quarter and I'm happy to report that the positive trend continued in the fourth quarter. When sales began to grow modestly in December. Sales of our Eco Friendly product in the fourth quarter increased 11% year over year and represented 34.5% of total sales. We continue to observe more state and local government legislation requiring recyclable or compostable foodservice product. For example, California's ban on styrofoam went into effect on 01/01/2025, we expect demand for our Eco Friendly product lines will accelerate we continue to actively developing new and innovative products to enhance our competitive position. Our strategic focus for 2025 are to drive sales growth and improve our operational efficiencies.

In January and February twenty twenty five, we are seeing robust sales growth and continued strength in our pipeline. We expect the positive momentum to continue into the rest of 2025 and we are closing new businesses expected to convert into revenue in the second half of the year. To support our anticipated growth, as recently announced, we signed a new lease on a 187,000 square foot distribution center near our headquarters in Chino. California. This facility almost doubles our current distribution capability in California and provides much needed capacities to support our anticipated growth [indiscernible] approximately 500 new SKU of paper products. Ahead of the peak summer season. We anticipate the new distribution center to be fully operational by about this May We are also reevaluating our operating processes and investing in automation and AI support to enhance productivity and maximize operation efficiency with a lean team.

As part of our long term growth strategy, we will continue to explore sales opportunity outside of our traditional channels, such as the supermarket sector, we are in the product testing stage with some of our large supermarket customers to further expand our relationship with them.

And we are working on expanding our sales team with experienced representative focused on this sector. [indiscernible] With our strong operating cash flow as well as liquidity and balance sheet and positive long term outlook, our Board of Directors again approving the increase in the quarterly cash dividend payment to $45 per share paid on February 28. 2025. To stockholder of record as of February 24, 2025. I will now turn the call over to Jian Guo, our Chief Financial Officer, to discuss the company's financial results in greater detail. Jan?

Thank you, Alan. Let me provide an overview of our Q4 performance and I'll close with our guidance for 2025. Net sales were $101,600,000 up 6.3% from $95,600,000 in the prior year quarter which included a benefit of $4,800,000 from the adjustments of online platform fees for the first nine months of 2023. As Alan mentioned, our volume grew 13.9% year over year. Pricing was unfavorable by $5,400,000 year over year. Online platform fees decreased $3,400,000 from the prior year quarter reflecting the impact of the prior year out of period adjustment.

By channel, compared with the prior year quarter, sales to our distributor channel the twenty twenty four fourth quarter were up 13.8% Sales to the national and regional chains were up by 1.7%. And sales to retail channel decreased 1.4%. Online sales were down 6.1% or $1,100,000 reflecting the impact of the prior year out of period adjustment. Cost of goods sold for the twenty twenty four fourth quarter was $61,800,000 which included an additional import duty charge of $600,000 on paper shopping bags. Cost of goods sold for the twenty twenty three fourth quarter was $61,500,000 which included an additional import duty reserve of $2,300,000 and the adjustments of $3,400,000 of certain production for the first nine months of 2023. Product costs increased $4,200,000 year over year primarily as a result of volume growth partially offset by a favorable impact from reduced vendor pricing a stronger U. S. Dollar and an increase in imports as a percentage of total product mix. Gross profit for the twenty twenty four fourth quarter increased 16.8% to $39,800,000 from $34,100,000 in the prior year quarter. Gross margin expanded by three fifty basis points to 39.2% in the twenty twenty four fourth quarter from 35.7% in the prior year quarter.

The twenty twenty three fourth quarter included a net unfavorable impact of two ninety basis points from the out of period adjustments related to online platform fees and production expenses as well as additional import duty reserves. Gross margin benefited from lower vendor pricing, favorable foreign currency impact and product mix. Partially offset by higher freight and duty costs.

Operating expenses for the twenty twenty four fourth quarter increased 10.4% to $32,500,000 from $29,500,000 in the prior year quarter. Selling expenses for the twenty twenty four fourth quarter was $13,900,000 compared with $16,000,000 in the same quarter last year. Which included the impact from the adjustment of $4,800,000 of online platform fees for the first nine months in 2023 and an adjustment of $1,500,000 of sales team labor costs for the first nine months in 2023. General and administrative expenses were $18,300,000 General and administrative expenses were $18,300,000 General and administrative expenses were $18,300,000 General and administrative expenses were $18,300,000 General and administrative expenses were $18,400,000 compared with $13,200,000 in the prior year quarter which included a favorable impact from the adjustment of $3,400,000 of certain production expenses for the first nine months in 2023 into cost of goods sold and an unfavorable impact of $1,100,000 in write off of a vendor prepayment upon the resolution of a legal Additionally, the year over year increase in general and administrative expenses was driven by an increase in labor costs and rent expense from workforce expansion and additional leased warehouses and higher stock based compensation and transportation costs. Operating income for the twenty twenty four fourth quarter increased 57.8% to $7,300,000 from $4,600,000 in the prior year quarter.

Net income for the twenty twenty four fourth quarter increased 40.3% to $5,900,000 from $4,200,000 in the prior year quarter.

Net income margin was 5.8% in the twenty twenty four fourth quarter compared with 4.4% in the prior year quarter. Net income attributable to tariffs for the twenty twenty four fourth quarter increased 44% to $5,600,000 or $0.28 per diluted share from $3,900,000 in the prior year quarter or $0.19 per diluted share.

Adjusted EBITDA increased to $11,300,000 for the twenty twenty four fourth quarter from $8,600,000 for the prior year quarter.

Adjusted EBITDA margin was 11.1% of net sales for the twenty twenty four fourth quarter compared with 9% for the prior year quarter.

Adjusted diluted earnings per common share rose to $0.29 for the twenty twenty four fourth quarter from $0.24 for the same quarter last year. We generated operating cash flow of $8,300,000 in the fourth quarter and ended 2024 with $114,600,000 in working capital compared with $110,500,000 at at the end of twenty twenty three.

Our free cash flow was $7,500,000 in the fourth quarter. As of 12/31/2024, we have financial liquidity of $67,800,000 with another $28,300,000 in short term As Alan mentioned earlier, our Board of Directors approved another increase of our quarterly dividend to $0.45 per share. We remain committed to a balanced capital allocation strategy between shareholder return and long term growth We expect net sales for the twenty twenty five first quarter to increase by 6% to 8% over the prior year quarter. Our gross margin goal for the twenty twenty five first quarter is approximately 37% to 39%, We expect adjusted EBITDA margin to be between 911%. On a full year basis, we expect year over year revenue to grow 9% to 11% in 2025. And gross margin to be in the range of 36% to 38%. Expect adjusted EBITDA margin to be in the low to mid double digits. Alan and I will now be happy to answer your questions And I'll turn the call back to the operator. Hi, everyone, and welcome to Carrot Packaging Inc.

Fourth Quarter twenty twenty four Earnings Conference Call. Please note that this call is being recorded. At this time, I would like to remind everyone Your first question comes from the line of Ryan Meyers from Lake Street Capital Markets. Your line is now open. Hey guys. Thanks for taking my question. So just thinking about what you gave for the first quarter revenue growth guidance, walk me through kind of what you guys are expecting as far as an acceleration of growth goes? Because if you look at the full year guide, obviously, it implies that sequentially throughout the year, the growth is going to accelerate.

Just wondering if there's anything to call out there or anything we should be aware of? Well, first of all, we're seeing already seeing California has in the past two years, California market has been basically a market that we started we have seen decline until the fourth quarter. That is one of our biggest market. And we're now seeing the California market stabilize in growing modestly. And our our largest market in Texas we're seeing that market growing big time in the Midwest. That's where we're seeing that more people are switching out of plastics that are into other type of material, could be plastic, it could be composed of iron. And also plastic bag into paper shopping bags. So we're seeing more and more of that in Midwest. Midwest has been a market with a lot of heavily on styrofoam. And now there's finally moving away from Styrofoam. And basically, if the Trump tariff goes through with the Mexico 25% and also 25% in Canada, we're going to see a major run on our product in the second quarter. So we're ready for the Karat basically. That's why we we leased double the size of our California warehouse and we're actually shipping not only before previous year we normally shipped 25%, 20% increases from our volume normal volume in summer peak season.

This time of year, we're asking our overseas production manufacturers to ship 200%, 300% of what we used to sell in the past year. So we're ramping up our inventory as the ocean phrase is kind of in a good pricing right now. And we know that there's still been uncertainties, but we know for sure anything coming out of China, it's basically like paper product is now being taxed 45%, which whoever is importing from China will stop immediately. There's no way they can afford that. And the reason import is really helping us basically. It's not a tailwind. It's It's actually not a headwind for us to turf. It's actually we're seeing as a tailwind for us.

Okay. And Ryan, this is Jen.

If I can just add on real quick to what Alan was talking about. Also what we build in this model behind the guidance for full year revenue growth is we are taking into consideration what we are seeing in our pipeline, the new deals that we signed or are very close to get signed. That we expect to convert into revenue around mid part of this year.

Okay, got it. And then just as a follow-up that I will ask similar question on the adjusted EBITDA margins, obviously guided 9% to 11% in the first quarter. Expect to end the year low to mid double digit. Is that just a function of you guys are gaining scale kind of on the operating expense lines as you ramp revenue or is there anything else to to think about there as far as the difference between the first quarter and the full year? Yes. One thing that we're seeing with us in the fourth quarter we ramp up online sales and we also sell online shipping and also the local shipping cost has gone up. So immediately, starting next week, we're actually following week, we're actually we found actually a different carrier shipper that would save almost a big time basically. Looking at all these operational savings that we can find in terms of shipping our product, not only the online shipping but also offline shipping. Recently, the truckload shipping from California to everywhere in The U. S. Has dropped by 35% as well as the, I would say, the rent [indiscernible] the operational the newly leased warehouse in California is actually down nearly half of what it was a year and a half ago.

The lease rate. Got it. Thank you for taking my questions.

Your next question comes from the line of Jake Bartlett from Truist Securities. Your line is now open. Great. Thank you so much for taking the question. My line was about the composition of revenue growth or the drivers of revenue [indiscernible] much is volume, how much is price, And then I have some follow ups from that. I'm going to say the volume is going to be double digit in terms of growth. We're already I would say that anywhere from 10%, 20% volume growth Pricing, because of tariff, we already announced price increase. So there's going to be some type of growth in revenue, but I won't say a lot. Because we're trying to help our customers, not trying to increase as minimum as possible and reduce our operational expense and with the savings in ocean freight. So we got to work with our client and that's why our clients trust us and continue to give us more business because we're seeing a lot of these existing customer virus chain accounts giving us more businesses in terms of the way that we can offer their savings and also different type of savings and also creativity in terms of different type of packaging.

Many of them want to switch out of their plastic bag into paper bag. Many of them want to switch out of their plastic container into paper corrugated boards. So we're doing a lot of things on that part.

Got it. So just maybe to dial in on on the pricing Karat, it has been negative. It's been a headwind for a little over two years now. And it sounds like maybe pricing could remain a bit of something that you kind of used to help drive volumes, right? Is that the right way to think about that we should maybe think about slightly negative pricing in 2025?

I don't see any negative pricing in 2025. There will be price increase into for sure. That's a guarantee 2025, there's some price increases. We already announced it and it's just that if there's going to be more announcement of price increase due to tariff?

Okay.

Great. And if you can just build on those the comments you just made about the tariffs on Canada and Mexico. Just remind us how though what the dynamic is there? Why is that so from those two markets specifically, why would that be a a tailwind for your business?

Well, there is some manufacturers of plastic materials and aluminum items out of Canada. And if the 25% goal in place, basically their existing clients, they will not be able to accept that increase. Same with Mexico. Mexico use has been a lot of these distributors are ordering from Mexico on paper product. Not necessarily plastic, more of a paper items, paper portion cup, paper bag and paper other items, paper goods. And Janitorial Items. Now If U. S. Tax Mexico 25% basically the importer will have to raise the price. And basically, I mean with us, we're like I said, we have been very nimble. We have been very importing from different Karat of the world. They could be from not just we move a lot out of China, right? [indiscernible] only 10% of the product out of China. That's our goal. Remember, we were fifty percent two years ago. Now in June, we already know it's 10% or less out of China. So basically, these new tariffs are not going to hit us at at all, basically. There's not a major impact. So we're moving to different part of the the country in Southeast Asia. And that's the only thing item that's basically it's unavoidable.

Everybody have to increase its aluminum because the announcement was that the 25% tariff is globally, including Japan, including Turkey, anywhere. So that basically is a given that aluminum product has to go up.

Okay. And then the last question is on the freight We were looking at the it looks like the kind of the spot market or the the open market here for freight has come down a ton in the last month. What do you have baked into for freight costs in 2025? And is it potential to see some up side to that or what's the story? Is that a kind of a lever point where could really help your margins or not?

Well, freight started to drop in the fourth quarter last year, ocean freight. And there were some additional charges peak season surcharge up until end of, I believe, February. So starting March, the ocean freight dropped about I would say, about 20% on that Karat. And has stayed up there down there for a while. And we don't expect the twenty twenty five year contract just going to be increased because the shippers are actually seeing the decline in shipping product from Asia. And for the domestic trucking. Because economy seem to be slowing down a lot So an oil price has come down. So all these truckers are actually looking for businesses. And that's giving us an opportunity to save on the operational side. So as Jan mentioned, fourth quarter, our operational expense was higher And we're seeing that starting in March, our operational expenses coming down. In second quarter, going to come down even lower than versus compared to fourth quarter and first quarter of this year?

Great. All right. Thank you so much. I appreciate it. Thank you.

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

Good afternoon. Thanks for taking the questions. Hi Ryan.

First question, just maybe can we talk about the segments across the national accounts, distributors, online and retail? How should we think about that in 2025 and what's driving considering yet such a big outlay or a big performance in distributors in the fourth quarter.

Well, for the distribution channels, we're seeing California distributor distribution, the major distributors coming to us, tore us to sign agreement because they had to substitute out styrofoam.

So they're buying more of the plastic hinge containers And we actually forecasted 400% increase in the sales of our plastic container in replacement of styrofoam. This is from the distribution. Also on the paper backside, we're seeing a major sharp increase approximately 100% to 200% increase in the paper bag because there replaces bending plastic bag and some natural chain account is actually switching entirely out of the plastic bag into paper bag. And that's where we're seeing the growth in distribution also on the chain account. This is for the chain account on the paperback side. And also for the chain account, we're some of the chain account moving away from styrofoam into plastic containers as well as some jump into the corrugated boxes like these pizza boxes. They used to just put pizza in them. Now they're putting tacos, they're putting actually entree [indiscernible] distribution channels. And some of these channel accounts are coming toward us because they want to consolidate vendor. Here's the thing with the the challenge of having multiple vendors. They have they can't get a full truckload per item, so their shipping cost is expensive. And so they want to reduce not their FOB pricing on the cost of goods itself, they want to actually see a overall saving in the landed cost.

So that's something that we're offering to our customers that we can provide a landed cost. So this year actually we're going to be purchasing around 15 to 20 additional trucks and trailers, not just increasing our size of our warehouse, we're actually actually increasing our fleet. So we can do more delivery ourselves into these chain accounts, distributors, retail accounts. We're seeing that that Karat, we're going to see we can enjoy more saving in the operational side. Okay.

And following up, I guess, on that kind of vendor consolidation when you think of your revenue growth, that double digit, which is impressive, maybe break that down. What's the market growing at? And then where are you taking share Clearly some of that's vendor consolidation, but is there other places you're taking share in 2025? And is supermarket is there any growth built in there on on those trials that you're kind of in there? Is that part of your 2025 guidance as well?

Yes. Supermarket growth is our part of our guidance. National chain account is hard part of our guidance and also introducing new paper products additional 500 SKU on the paper product that is in the bakery bag in the deli wraps, in the sandwich bag. So these are the sectors that we have never been into In the past two months, we've seen a couple of our competitors being acquired by our competitor also. The acquisition actually caused more of a disruption in that industry. And which is favorable to us as well. So we're one company that can ship all product in one location versus you have to ship multiple locations. And like I mentioned earlier, customers switching out of plastic bag into paper, that's basically a market share we're taking from plastic bag.

And also, we're seeing this is a major issue with the importers. The tariff increase, a lot of these smaller importer without the cash flow they will run into trouble of being able to import product in because of the cash flow. Now that you have to put in more money on the tariff side versus on the just on the ocean freight on the product itself. I mean at Carrier Pack Lalica, we're strong, robust in terms of our cash flow. We can utilize this cash flow to bring in more product well as having increased storage, investing trucking. So I mean, have that leverage now.

Okay, great. And actually on cash flow, how should we think about that? I mean, you talked about building up inventories in the first quarter. How should we think about cash flow through 2025? And what kind of capital capital spending are you looking at? You talked about adding trucks. So maybe how do we think about free cash flow sequentially through the quarters and a total for kind of where $25,000,000 to come out?

We're looking at the we actually in the past year for the past twenty four months, we've reduced our manufacturing in U. S. And that also with that reduction, we've reduced our maintenance costs. CapEx on that as well. So our maintenance CapEx is down very low to approximately maybe $1,000,000 or less a year. Our major capital investment will be on the truck brand new truck and fleet. That reduces our expenses and operational costs because we wouldn't have to lease the truck and maintenance costs. But the thing is, will increase our EBITDA because that's back on depreciation. I would anticipate our capital expenditure to be around $5,000,000 this year.

Which is Yes.

Brian, this is Jan. Just to answer your question about the free cash flow, the way to think about kind of the free cash flow is obviously as you're aware, we will just talking and giving guidance at the adjusted EBITDA margin level. For free cash flow, I would expect the free cash flow conversion rate twenty twenty twenty four?

Terms of the cadence.

Okay, great.

Thank you for taking the questions.

Thank you. Thanks, Brian.

Next question comes from the line of Michael Francis from William Blair. Your line is now Hey, guys. This is Michael for Ryan. Thanks for taking the questions.

First one for me and you talked about sort of that good growth in the Midwest and some stabilization in California and the new DC there. So I was wondering looking at 25 sort of geographies you feel you have the most opportunity in?

I am going to bank on the Midwest.

That is where we see the most opportunity. In Texas, especially in Texas.

Okay. Any reason why in Texas?

Well, our largest manufacturing facility is located in Texas. And a lot of our chain accounts are moving into Texas. Texas. And we're seeing I mean, I myself moved to Dallas myself last year And I'm there all the time and see that the growth are growing, people are moving to Dallas and Texas everywhere. And restaurants are booming. They're opening restaurants everywhere. So basically we're seeing business I mean, if you see if you people see that business is slowing down in California, it's growing greatly in Texas. [indiscernible] [indiscernible] And then looking at gross margins for next year, the guidance is down about 200 basis points at the midpoint from where you finished this year at. Can you talk about what's sort of driving that decline? And then are there any sort of positives or offsets that could help there?

Well, right now, we the tariff is very uncertain. So for us to set the entire year of gross margin, it's hard to really to anticipate. We don't know if the tariffs is going to increase Vietnam or if there's going to be additional Karat on Malaysia or additional tariff on Thailand or is it going to be globally? So we kind of wanted to anticipate forecast a little bit into it. For now, because it's a lot of things are uncertain right now. But for 1Q for sure, the strong dollars, the the lower ocean freight, it's helping us a lot in terms of the gross margin. But we'll see after I would say it should stabilize. We There should be more clarity after May of this year because right now this month we're still seeing one day there's a increase of 10%, 20% and next two days later there's a withdrawal or a pushback. So So right now, we're just waiting to see what's going to happen. Yes.

Okay. And then last one for me. You mentioned your operating expenses coming down to the second quarter from the fourth. Can you talk a little bit about what you're assuming on the OpEx side in 2025?

Jack, can you go over that with the Michael?

Yes. So Michael, just to make sure I'm hearing your question correct, your question is about what we build in the model for operating expenses for 2025. Is that correct?

Yes, that's correct.

Okay. Yes, sure. So happy to provide a little more in our model for 2025, we considered a few things at the saving opportunities as Alan talked about to be more to drive operating efficiency, primarily in the operations, in our operations, Alan talked about potential savings on the shipping side, that's primarily the truckings and shipping of our online orders The other component of that really also is as we're gaining efficiency, we're trying to to we're exploring kind of opportunities to get more savings on the labor side. The third area that we're building kind of in the on the operation side just in terms of seeing opportunities is to look at our online sales. Online has been a great one of our our most significant drivers of growth as we in the past made significant investments on the marketing side, on the platforms to really drive that that growth. We also have opportunities to potentially scale back on some of the investments and maintain that momentum on the online sales growth. So those are the major areas that we've considered in terms of building the model for 2025.

Okay. That's all for me. Thank you to Pat Assalam.

Thank you.

I'd now like to hand back the call over to Alan Yu, [indiscernible] Go ahead, sir.

Thank you, operator, and thanks to all of you for joining us today. We appreciate your continued support. We remain confident about KARET's future and we look forward to keeping you appraised of our progress. You very much. Have a nice day. Bye bye.

Thank you for attending today's call. You may now disconnect. Goodbye. [indiscernible] [indiscernible]