Karat Packaging Inc. (NASDAQ:KRT) Q4 2022 Earnings Call Transcript

Karat Packaging Inc. (NASDAQ:KRT) Q4 2022 Earnings Call Transcript March 16, 2023

Operator: Good day! And welcome to the Karat Packaging Inc. Fourth Quarter and Full Year 2022 Earnings Conference Call. All participants will be in listen-only mode. . After today’s presentation there will be an opportunity to ask questions. . Please note, this event is being recorded. I would now like to turn the conference over to Roger Pondel, Investor Relations. Please go ahead.

Roger Pondel: Thank you, operator. Good afternoon, everyone and welcome to Karat Packaging’s 2022 fourth 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 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-K as filed with the Securities and Exchange Commission, and copies of which are available on the SEC’s website at www.sec.gov, along with other company filings made with the SEC from time-to-time.

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 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, I’ll turn the call over to CEO, Alan Yu. Alan?

Alan Yu: Thank you, Roger, and hello everyone. We were able to grow our top line during the fourth quarter of 2022 against a very strong prior year quarter, despite an overall challenging deflationary environment in our industry and multiple price reduction that we’ve implemented. Additionally, thanks to our continued margin improvement efforts, we achieved record full year gross margin of 31.2%, despite a negative out of period inventory write-off of approximately $900,000 and generated a record full year operating cash flow of $29.5 million. With the stabilization of ocean freight costs and the supply chain issues caused by the pandemic now essentially behind us, we are focusing on operating costs, containment and eliminating inventory (ph) built during the supply chain disruption period.

Photo by Tarah Dane on Unsplash

During the fourth quarter we added a number of contract with new national and regional chain accounts, and we expanded product offering to existing customers. We are expecting these new agreements to materialize and add to our top line starting mid-2023, and we are continuing the strong momentum in building our pipelines. In the near term revenue for the 2023 first quarter were likely to be down about 10% compared with our prior year period. We are anticipating revenue to pick up again toward the end of the second quarter. For the full 2023 we are expecting revenue growth to be at the high single digit year-over-year. As a reminder, year-over-year comparisons were impacted by pricing for inventories sold during most of the first half of 2022, which was near peak level.

Also, order volumes during that time period last year were unusually high due to supply shortages. We continue to see solid growth in our environmentally friendly products. This category grew 24% in the fourth quarter over the prior year quarters, and demand remains strong into 2023. Our joint venture in Taiwan, building a state of the art bagasse factory for manufacturing 100% composable food service products is progressing well. We are continuing to receive orders and (ph) an increase that would fill capacity quite quickly, which would be a good problem to have. However, construction of the plan is behind schedule because of power supply issue, which now have been resolved. We currently expect initial shipment to begin in the second quarter.

We are implementing a number of growth strategies in 2023 that we are confident will provide solid long term returns. Among them, we are improving our fill-rate and inventory management and modifying our model to be more asset-light by scaling back manufacturing production in California, while expanding import products which carry higher margins. To accommodate future growth, we are working on increasing our distribution space. In February, we signed a new lease for the approximately 52,000 square foot distribution facility in Chicago and expect to move in by the end of April. We are also getting closer to sign the lease for another distribution facility similar in size in Houston. Additionally, we are working on expanding our existing warehouses by adding approximately 15% of the new rack space.

As part of this initiative, we are targeting geographical expansion in the East Coast and Midwest Regions. To do so, we are increasing the size of our sales team by approximately 35%. Lastly, we are in the process of upgrading our e-commerce platform and expanding online support teams. As well, we are excited to begin offering online sales in Canada and Hawaii. We expect to again generate strong operating cash flow and continue to scale back our CapEx this year, which will give the company flexibility to consider returning excess capital to our shareholders, as we continue to look for strategic growth opportunities. I will now turn the call over to Jian Guo, our Chief Financial Officer to discuss our financial results in greater detail. Jian.

Jian Guo: Thank you, Alan. Our 2022 fourth quarter results reflect continued top line growth, despite a challenging year-over-year comparison, improved margin and continued strengthening of our liquidity position. Now, let me provide more color on our operating results starting with revenue. Net sales for the 2022 fourth quarter increased 1.5% to $92.7 million from $91.3 million a year ago. The 2021 fourth quarter was a particularly strong revenue quarter with COVID re-openings and price increases implemented due to extraordinarily higher ocean freight and other costs. By channel sales to distributors, our largest channel grew 3.1% for the 2022 fourth quarter. Sales to the retail channel increased 4.6%. Sales from the online channel increased 1% and sales to national and regional chains decreased 3% for the quarter.

The decrease in the chain account was due to certain operational issues, which have been essentially resolved. Sales of our eco-friendly products increased 24% for the fourth quarter. During the fourth quarter, we completed a project to reevaluate and classify our inventory to be more aligned with a variety of product categories offered to customers. As a result, some of the product category data, including eco-friendly products in the prior period was recast to allow for a more meaningful comparison. We continue to see accelerated growth from these products as we strengthen our market leadership position and expand our product offering in this category to meet the needs of our customers and the evolving regulatory landscape. Eco-friendly products represented 27% of our total sales in 2022, compared with 21% in 2021.

Gross profit increased 4.8% to $29.7 million for the 2022 fourth quarter from $28.3 million last year. Gross margin expanded 100 basis points to 32.0% from 31.0% in the prior year quarter. Gross margin was favorably impacted by lower and stabilized ocean freight cost for the 2022 fourth quarter and 9.8% of net sales compared with 12.3% of net sales in the 2021 fourth quarter. The gross margin was negatively impacted by a $1.7 million inventory write-off, which represented an out-of-period adjustment for certain inventory items in the previously issued quarterly and annual financial statements, as well as an impact of $2.4 million from freight and duty capitalization. Based on current cost factors, we are expanding our 2023 full year margin goals to be in a range of 32% to 33%.

Operating expenses in the 2022 fourth quarter were $24.9 million or 26.8% of net sales, compared with $21.2 million or 23.2% of net sales in the prior year quarter. The increase primarily reflected higher labor costs of $1.5 million due to workforce expansion, higher production costs of $1 million due to unexpected machinery repair and about $600,000 due to an increase in rental expense from the two additional warehouses added in May 2022. Operating expenses in the 2022 fourth quarter also included a CapEx deposit write-off of approximately $500,000 related to pre-pandemic capital investment project. Net income for the 2022 fourth quarter decreased to $4.5 million from $6.0 million for the same quarter last year. Net income margin was 4.9% for the 2022 fourth quarter versus 6.5% in the prior year quarter.

Net income attributable to Karat for the 2022 fourth quarter was $4.5 million or $0.23 per diluted share compared with $5.6 million or $0.28 per diluted share in the prior year quarter. Adjusted EBITDA, a non-GAAP measure was $9.9 million for the fourth quarter versus $10.9 million in the prior year quarter. Consolidated adjusted EBITDA margin was 10.7% of net sales versus 11.9% in the prior year quarter. Adjusted diluted earnings per common share was $0.30 per share for the 2022 fourth quarter versus $0.32 per share in the prior year quarter. During the 2022 fourth quarter, we generated operating cash flow of $17 million and continue to expect strong cash flow in 2023. We believe Karat is well positioned to execute on its future growth strategies.

We finished 2022 with $84.5 million in working capital, compared with $72.1 million at the end of 2021. We have financial liquidity of $63.0 million as of December 31, 2022 and declared and paid a special cash dividend of $0.35 per share on our common stock. Lastly, we just considered the extension of our $40 million credit line, extending the maturity to March 2025. We expect to continue to further strengthen our financial and liquidity position in 2023. Alan and I will now be happy to answer your questions and I’ll turn the call back to the operator.

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Q&A Session

Operator: Thank you. . Our first question comes from Jake Bartlett with Truist Securities. Please go ahead.

Jake Bartlett: Great. Thanks for taking the question. My first one is on the 2023 sales growth, and Alan or Jian can you talk about what the drivers are, so you know high single digits. Does that include negative impact from pricing, so pricing would be a headwind. Just, if you could give us components of that high single digits growth, that would be helpful?

Alan Yu: Sure, Jake. Well first of all, we believe that right now we’re seeing that price construction due to deflationary, especially from ocean freight pricing coming down to back to pre-pandemic. So we have been adjusting our prices ever since September of last year ’20, and then October, November, December, even January. We do see that pricing to be a little bit basically stabilized as well as ocean freights been stabilized. So our growth are part of these several factors. One, our online sales, we’re seeing strong online sales. Also we added, we’re looking to start in Canada. For online sales in Canada we never really tried to approach it in the past years, and this is because we actually modify our platforms and increase our warehouse spaces.

And of course, second is national chain account and regional chain account. As mentioned in the previous discussion that we actually signed in several, over a dozen different regional and national chain accounts that is expected to start shipping starting April, May, June, July of this year and they will add to our existing volume. Right now the obstacle headwinds to service these national chain accounts that we just added is warehouse spaces. We have been short of warehouse spaces ever since the end of last year. So we’ve added some spaces that was still not adequate. So that’s why we have continued to seek for new space, and this is an area that we’re looking to really expedite €“ speeding up the process of getting additional warehouse spaces in different areas.

Even in California we are actually looking for additional space in California. New Jersey – South Carolina, we just expanded an additional 50,000 square feet in South Carolina and we’re racking up the entire warehouse in New Jersey, and we’re moving some of the equipment out of California and using that space, racking space for product that were coming in to service these accounts that we sign up. Also another factor is that we’ll actually be €“ growth will be the eco-friendly product. We’re seeing more and more states, cities are banning Styrofoam, the plastic and the straws. So we’re bringing more higher margin, higher revenue wise product from overseas to sell to our customers and the (ph) on that part.

Jake Bartlett: Great. You know just kind of really just narrowing back on the pricing side, because that seems to be €“ you know obviously it was a headwind in the fourth quarter here. And so I think you mentioned Alan that you thought that the pricing level, the absolute level of pricing has stabilized. I just want to get your confidence on that, that we’re not going to just see continuing decrease in pricing, which is going to kind of squeeze margins, but also limit the sales growth. So in the 10-K as you disclosed kind of the drivers to the change in revenue, I think the implication here if I did the math right, is that pricing was a negative 4% drag in the fourth quarter and so the question is, if you kept prices where they are now, how much of a drag would that be for 2023 as a whole? Should we assume that pricing is going to be a negative impact on growth for ’23 as a whole?