Karat Packaging Inc. — Q2 2023 Form 10-Q
Reporting period: Three and six months ended June 30, 2023. Karat manufactures and distributes disposable foodservice products, with operations in one reportable segment.
Financial performance
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Net sales | $108.7 million | $114.9 million | $204.5 million | $220.3 million |
| Gross profit / margin | $41.9 million / 38.5% | $34.0 million / 29.6% | $80.0 million / 39.1% | $68.3 million / 31.0% |
| Operating income | $13.3 million | $7.8 million | $26.1 million | $17.3 million |
| Net income | $10.7 million | $7.2 million | $19.9 million | $15.1 million |
| Diluted EPS | $0.53 | $0.32 | $0.98 | $0.65 |
Q2 sales declined 5%, while gross margin rose 8.9 percentage points and net income increased 48%. For the first half, sales fell 7%, while gross margin expanded 8.1 percentage points and net income increased 31%. Lower ocean freight and duty costs were the main driver of margin improvement; the company also cited lower input costs, product mix, and operating efficiencies. Lower selling prices, reflecting freight and raw-material savings passed to customers, weighed on revenue.
Six-month operating cash flow was $31.1 million, versus cash used of $7.7 million in the prior-year period. Investing activities used $29.3 million, including $28.0 million invested in short-term certificates of deposit; financing activities provided $0.5 million. Cash and cash equivalents were $18.3 million at June 30, and short-term investments were $28.0 million. Working capital was $110.3 million, up from $84.5 million at year-end 2022.
Gross debt was approximately $50.3 million: $21.9 million on the 2026 term loan and $28.4 million on the 2027 term loan. There were no line-of-credit borrowings; up to $37.8 million remained available, subject to the facility and its $2.2 million outstanding standby letter of credit. The company reported compliance with debt covenants.
Material changes and unusual items
- Management pivoted toward an asset-light model, increasing imports and scaling back manufacturing at certain locations. It recorded $2.5 million of impairment and machinery-disposal costs and a $1.7 million raw-material write-off in the first half. The write-off reduced gross margin by 0.8 percentage points for the half year.
- The company completed the sale of its Bio Earth joint-venture interest for approximately $6.1 million, recovering its deposits plus interest. The buyer, Keary Global, is owned or controlled by the CEO’s brother; Keary Global and its affiliate are also suppliers and purchasing agents. Purchases from these related parties were $25.0 million in the first half, and amounts payable were $7.1 million at June 30.
- In May, the company paid a $0.35-per-share special dividend, totaling $7.0 million. After quarter-end, the board declared another special dividend of $0.40 per share and adopted a quarterly dividend policy, declaring $0.10 per share for payment in August.
- Management expects approximately $2.5 million of additional net proceeds from machinery sales over the next 12 to 24 months and approximately $8.1 million of deferred estimated tax payments in October 2023.
Outlook, risks, and controls
The company provided no specific revenue or earnings guidance. Management said cash, operating cash flows, and available borrowing capacity should meet working-capital, debt-service, lease, and capital-expenditure needs for at least the next 12 months. It noted that future results depend on successfully sourcing imported goods at favorable prices and realizing savings from reduced manufacturing. Other cited risks include demand and product regulation changes, supply-chain and freight disruptions, raw-material cost fluctuations, tariffs, foreign exchange, and the ability to forecast demand and manage inventory.
Disclosure controls and procedures were deemed ineffective as of June 30, 2023 because previously reported material weaknesses in internal control over financial reporting remained. Management described remediation work underway and said the weaknesses would not be considered remediated until new controls had operated and been tested over time. The company said the weaknesses had not caused a restatement and management did not believe they affected the accuracy of current-period financial statements. Management did not expect pending ordinary-course legal matters to materially affect the company.
Investor verification points
- Assess whether higher margins and earnings can persist as freight costs normalize and price reductions continue.
- Track execution and financial effects of the shift toward imports and reduced in-house manufacturing, including equipment-sale proceeds and any further write-offs.
- Review the related-party Bio Earth sale and ongoing supplier relationships, including terms, governance, and payment balances.
- Confirm the cash impact of declared dividends, deferred tax payments, capital spending, and debt obligations.
- Monitor remediation and testing of the disclosed material weaknesses in internal controls.
- Note that Adjusted EBITDA is a non-GAAP measure: reported at $21.1 million for Q2 and $36.4 million for the first half, including add-backs for inventory write-offs and machinery impairment/disposal costs.