Karat Packaging - Earnings Call - Q2 2025

Executive Summary

• Record quarter: net sales $124.0M (+10.1% YoY), gross margin 39.6% (+110 bps YoY), and net income $11.1M (+19.8% YoY); adjusted diluted EPS $0.57 and adjusted EBITDA $17.7M.
• Versus Street: Revenue modestly beat ($123.5M* consensus), adjusted EPS modestly missed ($0.60* consensus), adjusted EBITDA roughly in line ($17.6M* consensus). Drivers were strong volume (+13% YoY) and favorable mix offset by FX losses and higher duties; we expect near-term estimate pressure on margins given Q3 guide to low–mid-30s gross margin and 10–12% adj. EBITDA margin.
• Guidance: Q3 2025 net sales expected to grow high single-digit to low double-digit YoY; gross margin low–mid 30s; adjusted EBITDA margin 10–12%; full-year 2025 guidance maintained pending tariff impacts.
• Strategic actions: Rapid supply chain diversification (China sourcing reduced to ~10% in Q2; expansion into other Asia and Latin America) and domestic manufacturing ramp underpin resilience and new national-chain wins shipping in H2.
• Key catalysts: Strong July demand (double-digit in California), national chain onboarding in Q3/Q4, and easing FX pressure entering Q3, versus near-term margin compression from inventory imported under elevated tariffs.

What Went Well and What Went Wrong

What Went Well

• Record quarterly net sales ($124.0M) and net income ($11.1M) on 13% volume growth and favorable mix; gross margin expanded to 39.6% (+110 bps YoY).
• CEO: “We are swiftly diversifying our sourcing footprint, reducing sourcing from China to just 10 percent in the second quarter... and further expand across other Asian countries and Latin America”.
• Operational wins: New Chino warehouse fully operational; logistics improved; inventory built ahead of expansion; online shipping/marketing savings by switching providers and shifting fulfillment toward owned storefronts.

What Went Wrong

• FX headwind: $2.9M loss on foreign currency transactions (USD vs. TWD), flipping other income to a $2.0M expense; Street EPS miss tied to FX and tariff/duty costs.
• Tariffs/duties: Ocean freight and duty costs up $2.1M; import volume +37% as inventory purchases were pulled forward, pressuring near-term margins.
• Sequential margin pressure expected: Q3 gross margin guided to low–mid 30s and adj. EBITDA margin to 10–12% as COGS reflects inventory brought in with elevated tariffs.

Transcript

Speaker 4

Good afternoon, everyone, and welcome to the Karat Packaging Inc. second quarter 2025 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please say no to 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 and then one on your touch-tone telephones. To withdraw your questions, you may press star and two. Please also note today's event is being recorded. At this time, I'd like to turn the floor over to Roger Pondel. Sir, please go ahead.

Speaker 5

Good afternoon, everyone, and welcome to Karat Packaging Inc.'s 2025 second quarter conference call. I'm Roger Pondel with PondelWilkinson Inc., Karat Packaging Inc.'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 Karat Packaging Inc.'s most recent 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 Inc. 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, adjusted diluted earnings per share, and free cash flow, which are non-GAAP financial measures as defined by SEC Regulation G. A reconciliation of the most recently 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. With that, I will turn the call over to CEO Alan Yu. Alan.

Speaker 1

Thank you, Roger. Good afternoon, everyone. We achieved a record second quarter performance marked by a 13% increase in sales volume, 10% growth in net sales, and 20% growth in net income year over year, despite a significant foreign currency headwind due to a sudden substantial weakening in the U.S. dollar against the New Taiwan dollar. Heading into the third quarter, we continue to diversify our global sourcing and expand into new countries and geographies, and we see the currency pressure starting to ease. Our record quarter performance is a testimony to Karat Packaging Inc.'s nimble business model and resilient global supply chain, which allow us to show early success in navigating the supply chain disruption and trade uncertainties.

We are swiftly diversifying our sourcing footprint, reducing reliance on China to just 10% in the second quarter, while implementing plans to further expand our sourcing across other Asian countries and Latin American countries to enhance supply chain resilience and flexibilities. In addition to the sourcing diversification, Karat Packaging Inc.'s ability to quickly ramp up existing domestic manufacturing operations enables us to respond rapidly to customers' needs. Together, these actions have further enhanced our agility and competitiveness and are helping us to secure new business and position the company well for sustained growth in a challenging external environment. Business trends remain strong as we proceed into the third quarter and the remainder of 2025 and continue double-digit sales growth across our major markets, including California, further, leading to new business wins from a number of large national chains scheduled to begin shipping in the third and fourth quarters.

Our new distribution center near our Chino headquarters is now fully operational, significantly strengthening our logistic capabilities and enabling even faster delivery times. This facility also supported inventory buildup during the second quarter, positioning us well to accommodate our anticipated growth in the second half of the year. As previously announced, we implemented price increases for select products on April 1, followed by a broader price adjustment across most of our product lines in late May. We continue to assess the impact of these changes, along with potential effects from the new tariffs effective in August. Karat remains focused on accelerating top-line growth and profitability through product innovation, strategic expansion, and a track record of being a dependable supplier to our customers. At the same time, we continue to drive operational efficiency through disciplined cost management.

In the second quarter, we improved our operating cost leverage, saving $1 million in online shipping and marketing by switching providers even as shipping volume increased. We also shifted our online sales focus from third-party platform fulfillment to our own e-commerce storefronts, lowering online selling costs and more effectively utilizing online marketing dollars. These efforts reflect our ongoing focus on balancing growth with profitability and building long-term operational resilience. We believe Karat is well-positioned for continued profitable growth, 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. Jian?

Speaker 0

Thank you, Alan. I'll begin with a summary of our Q2 performance, followed by an update on our guidance. Net sales for the 2025 second quarter were $124 million, up 10.1% from $112.6 million in the prior year quarter. The increase was primarily driven by year-over-year volume growth of 13%, partially offset by $3.3 million in unfavorable pricing as chains and distributors' growth outpaced online and retail channels. Sales to chain accounts and distributors were up by 11.4%. Online sales increased 6.8% over the prior year quarter, reflecting our continued focus on expanding this high-margin category. Sales to the retail channel turned positive with an increase of 1.9%. Cost of goods sold for the 2025 second quarter was $74.9 million, compared with $69.2 million in the 2024 second quarter. The increase primarily reflected $4.0 million of higher product costs resulting from increased sales volume.

This was partially offset by more favorable vendor pricing and product mix. Additionally, ocean freight and duty costs rose by $2.1 million due to higher import duty costs impacted by the recent tariffs, coupled with an increase in import volume of 37.0% as we increased inventory ahead of expected business expansion during the second half of 2025. At the same time, average ocean container rates during the 2025 second quarter decreased 4.0% year over year. Gross profit for the 2025 second quarter increased 13.1% to $49.1 million from $43.4 million in the prior year quarter. Gross margin increased 110 basis points to 39.6% compared with 38.5% in the prior year quarter. Gross margin benefited from lower product costs as a percentage of net sales, mainly due to more favorable vendor pricing and product mix, and a reduction in depreciation expense as a percentage of net sales.

These improvements were partially offset by higher ocean freight and duty costs, as a percentage of net sales increased to 9.5% during the 2025 second quarter versus 8.6% during the 2024 second quarter. Operating expenses for the 2025 second quarter were $32.6 million compared with $32.3 million in the prior year quarter. The increase was mainly due to higher shipping and transportation costs for offline orders from increased shipping volume, increased rent, and higher salaries and benefits. These increases were partially offset by a decrease in shipping costs for online orders despite the increase in online orders shipped. Online platform fees, lower marketing expense, stock-based compensation, and the gain recognized from the disposal of machinery and equipment. Operating income in the 2025 second quarter increased 48.9% to $16.6 million from $11.1 million in the prior year quarter.

Total other expense net was $2.0 million for the 2025 second quarter compared with other income net of $1.0 million in the prior year quarter. The difference was primarily due to a loss on foreign currency transactions of $2.9 million compared with a gain of $0.3 million during the 2024 second quarter. Net income for the 2025 second quarter increased 19.8% to $11.1 million from $9.2 million for the prior year quarter. Net income margin was 8.9% in the 2025 second quarter compared with 8.2% a year ago. Net income attributable to Karat Packaging Inc. for the 2025 second quarter was $10.9 million or $0.54 per diluted share compared with $9.1 million or $0.45 per diluted share in the prior year quarter. Adjusted EBITDA for the 2025 second quarter was $17.7 million compared with $15.7 million for the prior year quarter.

Adjusted EBITDA margin was 14.3% of net sales for the 2025 second quarter compared with 13.9% for the prior year quarter. Adjusted diluted earnings per common share was $0.57 for the 2025 second quarter compared with $0.49 for the same quarter last year. We generated operating cash flow of $9.8 million in the second quarter and ended the quarter with $116.8 million in working capital. Our free cash flow was $9.6 million in the second quarter. As of June 30, 2025, we had financial liquidity of $44.7 million with another $26.4 million in short-term investments. On August 5, 2025, our Board of Directors approved a quarterly dividend of $0.45 per share payable August 27, 2025, to stockholders of record as of August 20, 2025. Looking ahead, we expect net sales for the 2025 third quarter to increase by approximately 9% to 10% over the prior year quarter.

We expect our gross margin for the 2025 third quarter to be in the low to mid-30s and adjusted EBITDA margin to be within 10% to 12% as our cost of goods sold has begun to reflect inventory brought in with the elevated tariff. Currently, we are maintaining our full-year 2025 guidance for net sales, gross margin, and adjusted EBITDA margin pending potential impact related to additional tariff changes. Alan and I now will be happy to answer your questions, and I'll turn the call back to the operator.

Speaker 4

Ladies and gentlemen, at this time, we'll begin the question and answer session. To ask a question, please press star and one using a touch-tone telephone. To withdraw your questions, you may press star and two. If you've largely seen a speakerphone, we do ask that you please pick up the handset prior to pressing the keys to ensure the best sound quality. Once again, that is star and then one to join the question queue. We'll pause momentarily to assemble the roster. Our first question today comes from Michael Edward Francis from William Blair & Company L.L.C. Please go ahead with your question.

Hey, guys. This is Mike on for Ryan. Nice quarter. I wanted to unpack some stuff on the guide, but first, I want to start with prices. I was surprised to see price was negative on the quarter, especially with some of the tariff price increases. I guess two parts. Why was price negative on the quarter? What should we be expecting from the impact of price in the second half?

Speaker 1

We are currently holding on to the pricing with some minor increases in certain categories. That's it. We're seeing that there's more visibility in terms of every country that we import now on the pricing. One of the things is that we mitigated, we will be starting to mitigate our costs by moving some of the products that we've sourced from certain countries from Taiwan into other Asian and Latin American countries with lower tariffs, as well as our costs of goods purchase have been reducing. We have some new vendors and vendors that we work with looking to reduce our costs, and that's going to help us in terms of mitigating any potential tariff increase impact.

Okay. If I think about that, with your second-half guide that you referred to, should I be thinking sort of a similar volume growth and price impact that we saw in this quarter in the third quarter? Jian, would you be able to answer that question?

Speaker 0

Yeah, to answer your question, Michael, going forward, the second half of the year, we do expect pricing to be close to break even, compared to about a negative 3% in this quarter.

Okay. Understood. I noticed that there's an embedded in the guide, there's a sequential decline in gross margin. I wanted to know what the puts and takes of that is. Is it tariff coming through the P&L? Is it forward profitability sourcing from other countries? I just would love to unpack that.

Speaker 1

Currently, I would say that the impact, the positive impact of the new sourcing will be hitting, will be actually receiving that impact in the fourth quarter. Right now, third quarter, we are still seeing that some of the tariffs that we brought in in the second quarter, in the second quarters, we're seeing that with a higher tariff cost, and that should be mitigated in the fourth quarters. Right now, we're trying to see how much impact it will be. That's why we mentioned in the first quarter, during our first quarter earning conference call, we mentioned that the product brought in in the second quarter will be sold in the third quarters. Second quarter will have a higher gross margin, and third quarter will have a lower gross margin.

Also, the bigger impact was because many of the products we sourced from Taiwan had a currency FX loss in terms of devaluation into U.S. dollars. That's causing the increase in some of the costs to sell decreased our gross margin as well.

Okay, if I'm understanding you right, it should be down in the third quarter, but then gross margin should recover some in the fourth quarter?

Yes, that is my understanding.

Okay. The last one for me, I just wanted to know what you're seeing on July trends, and have you seen any sort of freebuy from your customers ahead of the August tariffs?

We are seeing, especially from some of our national chain accounts, their sales in July have been very strong. Due to the tariff, we've seen several, many of our smaller importer competitors reduce their inventory, and our volume has increased in terms of a certain category that people were sourcing from overseas. We're seeing strong demand in terms of July, especially in California. We're seeing more than double-digit sales increase in the California market. It started in June, and July basically followed the trend. We're pretty, we believe that the revenue volume double-digit is very, it's something that we know that we can definitely beat.

Okay, I'll pass it on. Thanks, guys.

Speaker 4

Once again, if you would like to ask a question, please press star and then one. To withdraw your questions, you may press star and two. Again, that is star and then one to join the question queue. Our next question comes from Joshua R. Axel from UBS. Please go ahead with your question.

Hi, guys. Hope all is well today.

Hi, Josh.

Hi. Question for you on the online sales. Can you give a little guidance on what you're thinking for the second half of the year as far as online sales, the kind of growth you're targeting, and what you're seeing in that area? I have one more question for you.

Speaker 1

Sure. No problem. We believe online sales will continue to grow, especially since we just added a new platform called Cisco Marketplace. That seems to be doing quite well for us, and it's basically fulfilled by our own logistics warehouse. We've moved away from Amazon FBA fulfillment by a third party because the cost was just too high, and there were a lot of issues in terms of inventory reconciliation. By moving away from Amazon FBA, our revenue dropped a little bit, but our margin has significantly gained a lot in terms of margin-wise. We have better control of the inventory as well. We do see our online sales to grow continuously, just like we have been in the past months, years.

Do you think you can get back to double-digit online growth in the second half of the year, or with losing Amazon, is that going to be a little more difficult?

I would think that in the fourth quarter, because we're the Cisco Marketplace, we started it just about three months ago, and it has built a lot of momentum. We're adding, we probably had about 500 SKUs in the Cisco Marketplace, and we're looking to add another 750 SKUs this month. These definitely will turn into revenue. We believe that in the fourth quarter, online revenue should be able to go back to double-digit growth, yes.

Great. Last question, can you just comment, Alan, on what you're seeing in the M&A landscape, if you're looking at anything, and if so, what, or if maybe prices just don't seem attractive or just where you are? Thanks.

Yes. We are still looking at M&A, and also we analyzed the current, the previous past six months. There has been a couple of mergers and acquisitions in our packaging space, and it seems like the sellers were not getting as much as they were hoping for. The price is still, I believe, it's not to where we believe it should be. Also, most of our competitors who bought these, the acquirer, it was just to gain the product line and market shares, which we can basically increase by bringing new SKUs, and that we can do ourselves. Our goal with M&A is basically strategically, it has to be either location or a client base or item that we do not currently carry. We are still looking at that segment. Also, of course, adding new product lines, that's what we've been doing.

In the past month, we've looked into partnership with other people. Discussion has been going on for over several months in the past with different kinds of vendors that we have to see if there's any potential that we can work together in terms of just like we had in the past with the bagasse manufacturer joint ventures. These are the things that we're looking at. We're not just saying that we're just looking at one segment. We're looking at different areas.

Great. Thank you very much, guys. Thank you, Josh.

Speaker 4

With that, ladies and gentlemen, we'll be concluding today's question and answer session. I'd like to turn the conference call back over to Alan Yu for any closing comments.

Speaker 1

Thank you, everyone, for joining our Karat Packaging second quarter earning conference call. I would like to say thank you all and have a nice day. Bye-bye.

Speaker 4

Ladies and gentlemen, with that, we'll conclude today's conference call and presentation. We do thank you for joining. You may now disconnect your line.