Karat Packaging Inc. — Q1 2022 Form 10-Q
Reporting period: Three months ended March 31, 2022; unaudited. Karat manufactures and distributes disposable foodservice products, including environmentally friendly and compostable options. It reports one operating segment.
Financial performance
| Metric | Q1 2022 | Q1 2021 | Change |
|---|---|---|---|
| Net sales | $105.4 million | $75.7 million | +39.3% |
| Gross profit / margin | $34.3 million / 32.5% | $21.6 million / 28.6% | Margin +3.9 percentage points |
| Operating income | $9.5 million | $3.8 million | +154.3% |
| Net income | $7.9 million | $3.1 million | +160.4% |
| Net income attributable to Karat | $6.7 million; $0.34 diluted EPS | $1.8 million; $0.12 diluted EPS | |
| Adjusted EBITDA (non-GAAP) | $13.0 million; 12.3% margin | $6.8 million; 9.0% margin | +90.3% |
| Operating cash flow | $(11.4) million | $4.5 million |
Sales growth reflected higher sales to existing customers, more than 5,000 new customers, new SKUs, price increases, volume and logistics revenue. Management attributed gross-margin expansion to product mix, price increases, favorable foreign exchange and operating efficiencies. These benefits were partly offset by freight and duty costs, which rose to 14.4% of sales from 6.2%.
Operating expenses increased 38.9% to $24.8 million, principally from higher delivery costs, workforce expansion, production expense and stock-based compensation. The effective tax rate was 25.2%, versus 28.0%.
Liquidity, cash flow and debt
- At March 31, cash and equivalents were $6.8 million; working capital was $93.7 million, compared with $72.1 million at December 31, 2021. Current assets were $133.5 million and current liabilities $39.8 million.
- Operating cash use of $11.4 million mainly reflected working-capital investment: inventory increased $19.3 million and receivables increased $11.1 million, partly offset by higher payables and other liabilities. Investing cash use was $4.8 million, including $4.0 million of equipment deposits. Financing provided $16.6 million.
- Debt at quarter-end included $10.2 million drawn on a $40 million revolving line (3.25% rate; $29.8 million available) and $43.3 million of term loans, before the current portion and debt discounts. The term loans carry stated rates of 3.25% variable and 3.5% fixed. The company reported covenant compliance.
- Global Wells, a consolidated variable interest entity in which Karat has a 13.5% ownership interest, held $56.6 million of assets and $44.9 million of liabilities. Karat guaranteed Global Wells loans totaling approximately $43.1 million.
Material changes and outlook
- Freight and duty expense increased by $8.7 million year over year; management cited elevated ocean freight rates, raw-material inflation, labor constraints and supply-chain disruptions. Price increases helped offset cost inflation, but management cautioned that pricing can lag cost increases.
- Management said cash, operating cash flow and available borrowing were expected to cover working capital, debt service, leases and planned investment for at least the next 12 months. No formal revenue or earnings guidance was provided.
- On April 6, 2022, the company agreed to invest approximately $6.0 million for a 49% interest in a Taiwan joint venture to build a bagasse-based compostable-products facility. Contributions are planned in three tranches; the agreement provides a 20% investment-return guarantee and specified termination and repayment terms.
- After quarter-end, the company signed leases for distribution facilities in California and Hawaii, commencing May 1, 2022. From April 1 through May 6, it repaid $2.0 million and drew $4.3 million on its line of credit, bringing borrowings to $12.5 million.
- COVID-related disruptions, China lockdowns, the Russia-Ukraine conflict, freight costs, tariffs, demand forecasting and raw-material availability were identified as potential risks. Management noted that worsening global conditions could adversely affect liquidity and capital needs.
Other notable matters
- Disclosure controls and procedures were deemed ineffective at March 31, 2022 because previously reported material weaknesses remained under remediation. Deficiencies included control environment and risk assessment, data accuracy, and review controls over areas including taxes, receivables and inventory. Management described remediation steps, but weaknesses were not yet considered remediated.
- Purchases from related-party suppliers Keary Global and its affiliate were $11.9 million in Q1 2022, compared with $5.1 million a year earlier; quarter-end related-party payables were $1.3 million.
- Interest-rate-swap fair-value changes contributed approximately $1.3 million of interest income in each comparative quarter. Management also cited lower average debt as contributing to improved other income.
- The company reported no material legal proceedings. It remained subject to federal and state tax examinations for specified prior years.
Most important facts for investors to verify
- Whether price increases and favorable product mix can continue to offset freight, materials and labor inflation, and whether gross margin holds as freight costs fluctuate.
- How quickly inventory and receivables convert to cash after the substantial Q1 working-capital build.
- Use of the revolving facility, debt covenants and guarantees, including Global Wells’ obligations and the post-quarter increase in line borrowings.
- The Taiwan joint venture’s funding schedule, construction and production milestones, and enforceability and conditions of its return guarantee.
- Progress in remediating material weaknesses and evidence that new financial-reporting controls operate effectively.
- Whether Q1 earnings benefited materially from non-recurring swap fair-value movements; compare GAAP results with the company’s non-GAAP Adjusted EBITDA reconciliation.