Karat Packaging Inc. — Q1 2023 Form 10-Q
Business and period: Unaudited results for the three months ended March 31, 2023, compared with Q1 2022. Karat manufactures and distributes disposable foodservice products and related goods, including compostable options, in one reportable segment.
Financial performance
| Metric | Q1 2023 | Q1 2022 | Change |
|---|---|---|---|
| Net sales | $95.8m | $105.4m | Down 9% |
| Gross profit / margin | $38.1m / 39.8% | $34.3m / 32.5% | Profit up 11%; margin up 7.3 percentage points |
| Operating income | $12.7m | $9.5m | Up 34% |
| Net income | $9.2m | $7.9m | Up 16% |
| Net income attributable to Karat | $9.0m; diluted EPS $0.45 | $6.7m; diluted EPS $0.34 | |
| Adjusted EBITDA (non-GAAP) | $15.3m; 15.9% margin | $13.0m; 12.3% margin | Up 18% |
| Operating cash flow | $14.2m provided | $11.4m used |
Drivers and comparisons: Sales fell primarily due to $2.4m of price reductions passed through as freight and raw-material costs eased, $5.0m from lower volume and product-mix changes, and $2.2m from lower logistics and shipping revenue. Cost of goods sold fell 19%, including a $9.5m reduction in freight and duty costs. Management attributed margin expansion to lower ocean freight costs, product and sourcing mix, and operating efficiencies. Operating expenses rose 2%, reflecting payroll, rent, and marketing increases, partly offset by lower shipping costs and bad-debt expense. Q1 2022 other income included a $1.3m interest-rate-swap fair-value gain; the swap was terminated in June 2022. Q1 2023 instead recorded a $0.4m foreign-currency loss, contributing to the year-over-year decline in other income.
Financial position and liquidity
- At March 31, 2023, cash and cash equivalents were $23.2m and short-term investments were $10.0m; cash included $14.4m associated with consolidated VIE Global Wells.
- Working capital was $97.4m, versus $84.5m at December 31, 2022. Current assets were $141.6m and current liabilities $44.2m.
- Long-term debt, including current maturities, was $50.5m, up from $42.7m at year-end, principally after an $8.0m advance under the 2027 Term Loan. No line-of-credit borrowings were outstanding; $38.9m remained available, subject to facility terms. A $1.1m standby letter of credit was outstanding.
- The term loans bear fixed rates of 3.50% and 4.375% and mature in 2026 and 2027. The $40m revolving credit facility was amended to mature in March 2025, with borrowings priced at one-month SOFR plus 2.50% and a 1.0% SOFR floor. The company reported compliance with loan covenants.
- Investing cash outflow was $14.7m, including $10.0m of short-term investments, net JV deposits, and property-and-equipment spending. Financing cash inflow was $7.7m, primarily the $8.0m term-loan advance. Cash increased $7.2m during the quarter.
Outlook, risks, and notable items
- No quantified revenue or earnings guidance was provided. Management said cash, operating cash flows, and available borrowing capacity should meet working-capital, debt-service, lease, and capital-spending needs for at least the next 12 months, while noting macroeconomic and geopolitical uncertainty and possible future financing needs.
- Management cited demand for takeout and delivery and eco-friendly products as potential supports, while identifying freight, raw-material prices, tariffs, foreign exchange, supply-chain effectiveness, demand forecasting, competition, and shipping disruptions as risks.
- On May 8, 2023, the board declared a special cash dividend of $0.35 per share, payable on or around May 31 to holders of record May 23.
- After quarter-end, Karat agreed to sell its Bio Earth JV interest to Keary Global for approximately $6.038m, subject to Taiwanese regulatory approval. Keary Global and affiliate Keary International are controlled by the CEO’s brother. The company had recorded $5.952m of JV investment deposits at quarter-end. Karat also disclosed $11.4m of Q1 purchases from these related-party suppliers and $9.9m payable to them at quarter-end.
- Management identified manufacturing machines and related inventory as held for sale after quarter-end. The machines’ net book value was $0.864m, associated inventory was $0.194m, and estimated sale proceeds were $0.400m; an estimated $0.858m impairment was expected in Q2 2023.
- A new 83,000-square-foot Houston distribution-center lease begins June 1, 2023, with a 62-month term and monthly base rent of $45,000–$54,000 after an initial abatement period.
- Disclosure controls and procedures were deemed ineffective as of March 31, 2023 because of material weaknesses in the control environment, IT controls, review controls, and revenue, inventory, and procurement processes. Management said the weaknesses had not caused a restatement and described remediation efforts; they were not yet considered remediated.
- Ordinary-course legal proceedings were not believed likely to have a material adverse effect. The filing reported no material changes to previously disclosed risk factors.
Investor verification points
- Track whether margin gains persist as freight costs, pricing, product mix, and raw-material costs change.
- Verify sales-volume trends and the cash conversion of receivables and inventory, given lower sales and increased receivables.
- Monitor debt, term-loan maturities, covenant compliance, and liquidity after the dividend and planned investments.
- Review completion, regulatory approval, proceeds, and related-party terms of the Bio Earth transfer.
- Confirm the timing and actual loss on the equipment disposal, and the cost and utilization of the Houston facility.
- Assess progress in remediating the disclosed material weaknesses and whether new controls operate effectively over time.