Karat Packaging Inc. — Q3 2023 Form 10-Q
Business context and period. Karat Packaging manufactures and distributes disposable foodservice products, including compostable and other environmentally oriented products, and provides related customization and logistics services. This unaudited report covers the quarter and nine months ended September 30, 2023; comparisons are to the same 2022 periods unless noted. Amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Net sales | $105.5 million | $110.0 million | $310.1 million | $330.3 million |
| Gross profit / margin | $38.9 million / 36.9% | $34.2 million / 31.1% | $118.9 million / 38.4% | $102.4 million / 31.0% |
| Operating income | $11.4 million | $7.9 million | $37.5 million | $25.2 million |
| Net income | $9.1 million | $6.2 million | $29.0 million | $21.3 million |
| Net income attributable to Karat | $9.1 million | $6.1 million | $28.6 million | $19.1 million |
| Diluted EPS | $0.45 | $0.31 | $1.43 | $0.96 |
- Sales declined 4% in Q3 and 6% year to date. Management attributed the decreases mainly to lower year-over-year pricing as freight and raw-material savings were passed to customers, plus lower logistics and shipping revenue; higher volume and product-mix changes partly offset the declines.
- Gross margin increased 580 basis points in Q3 and 740 basis points year to date. Management cited lower ocean freight costs, favorable currency effects, and a shift toward imported finished goods. Nine-month margin includes a 60-basis-point impact from a raw-material write-off.
- Operating expenses rose 5% in Q3 and 6% year to date. Nine-month expenses included $2.2 million of impairment and net disposal losses related to the manufacturing scale-back. Nine-month cost of goods sold also included a $1.7 million raw-material write-off.
- Adjusted EBITDA, a non-GAAP measure, was $15.2 million for Q3 and $51.6 million for the first nine months, versus $11.7 million and $36.6 million, respectively. Adjusted EBITDA margin was 14.4% and 16.6%, respectively; the company cautions these measures are not substitutes for GAAP results.
Cash, liquidity and debt
- At September 30, 2023, cash and cash equivalents were $28.2 million and short-term investments were $18.1 million. Working capital was $113.0 million, up from $84.5 million at December 31, 2022.
- For the first nine months, operating cash flow was $43.1 million versus $12.5 million in 2022; investing cash outflow was $21.3 million and financing cash outflow was $9.6 million. Financing uses included $16.9 million of dividends; cash flow benefited from $8.0 million of deferred tax payments, subsequently paid in October.
- Long-term debt totaled approximately $50.0 million before unamortized fees, consisting of fixed-rate term loans maturing in 2026 and 2027. There were no borrowings on the $40.0 million revolving credit facility; $3.7 million of its $5.0 million letter-of-credit sublimit was in use, leaving $36.3 million available to borrow. The company reported covenant compliance.
- Management stated that cash, operating cash flow, and available borrowing capacity should be sufficient for working capital, debt service, leases, and planned capital expenditures for at least the next 12 months. It also noted future growth or acquisitions could require additional financing, which may not be available on acceptable terms.
Material changes, outlook and risks
- Operating strategy: Beginning in February 2023, the company pivoted toward a more asset-light model by increasing imports and scaling back manufacturing at certain U.S. locations. It expects this to help margins and efficiency if imported goods can be sourced cost-effectively and manufacturing reductions produce savings. It expects approximately $1.9 million of additional net proceeds from equipment sales over the next 12 months.
- Product mix: Eco-friendly products were approximately 33% of Q3 sales, compared with 27% a year earlier. Management sees potential support from demand for compostable products, while noting regulatory changes and consumer preferences can affect demand.
- Other events: The company completed the sale of its 49% Bio Earth joint-venture interest to Keary Global for approximately $6.1 million, including accrued interest. Keary Global is affiliated with the CEO’s brother, is a shareholder and supplier, and purchases from related parties totaled $32.4 million in the first nine months. A September secondary offering was made by selling stockholders; the company received no proceeds and recorded $453,000 of transaction costs.
- Dividends: The company paid $16.9 million in dividends during the first nine months. On November 6, 2023, the board declared a quarterly dividend of $0.20 per share, payable around November 30.
- Risks and contingencies: Disclosed risks include demand and pricing changes, raw-material and freight-cost volatility, supply-chain and shipping disruption, tariffs, foreign-exchange movements, competition, and execution of the asset-light strategy. Management said routine legal proceedings were not expected to have a material adverse effect. Tax returns for specified years remain subject to IRS and state/local examinations; no unrecognized tax benefits were reported.
- Controls: Management concluded disclosure controls were not effective at September 30 because the material weaknesses reported in the 2022 Form 10-K remained. Remediation was ongoing; management said the weaknesses had not caused a restatement and did not affect the accuracy of the current-period financial statements, but they remain a financial-reporting risk until remediation is tested over time.
Important facts for investors to verify
- Whether sales volumes and product mix continue to offset lower pricing, and whether expanded gross margins persist as freight and input costs change.
- Whether the move toward imports and reduced U.S. manufacturing delivers expected savings without weakening supply reliability or customer service.
- The cash-flow impact of taxes deferred under storm relief, dividends, capital spending, and the planned distribution-facility lease.
- Related-party purchasing and the completed Bio Earth transaction, including the ongoing business relationship with Keary Global.
- Progress in remediating the disclosed material weaknesses and evidence that new controls operate effectively.
- Loan covenant compliance, debt repayment requirements, and the company’s ability to maintain liquidity if operating conditions or financing availability deteriorate.