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Thank you. to the Carrot Packaging second quarter 2026 Financial Results Conference call. All participants will be in a listen-only mode. Should you need assistance, please signal 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 then 1 on a touchtone phone. withdraw your question please press star then to please note this event is being recorded I would now like to turn the conference over to Roger Pondell. Please go ahead.

Good afternoon, everyone, and welcome to Cured Packaging's 2026 second quarter conference call. I'm Roger Pondell with Pondell Wilkinson, Cured Packaging'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, Jan Gow. 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 factor section of the company's most recent Form 10-K, as filed with the Securities and Exchange Commission. and 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 CARE packaging undertakes no obligation to update any forward-looking statements except as required by law. Please also note that during this call, we will be discussing adjusted EBITDA, adjusted EBITDA margin, and the following. 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 directly comparable GAAP measures to the non-GAAP financial measures is included into today's press release, which is now posted on the company's website. And with that, I will turn the call over to CEO Alan Yu. Alan?.

Thank you, Roger. Good afternoon, everyone. We deliver record quarterly net sales of more than $136 million, reflecting the strength of our customers' demand and accelerated momentum in our online business growth. the quarter, our sales pipeline expanded, adding four new chain accounts, which further broadened our market reach and created additional opportunities for future revenue growth. We continue to experience encouraging momentum across our business, and highlighted by the strong performance of our online channel, where net sales increased 23.6% year over year. Our eco-friendly product portfolio also continued to gain traction, benefiting from the continued expansion of SKUs and growth in the paperback categories. As a result, eco-friendly products represented 33.8% of total sales during the quarter, compared with 31.8% in the prior year period. Our results also benefited from IEPA tariff refunds, which refers higher tariff costs absorbed in the prior periods, and further contributed to the strong reported profitabilities. While we were pleased to capture this benefit in the quarter, our focus remains on the fundamental drivers of the business and sustaining strong long-term financial performances.

To support our long-term growth strategy, we are currently finalizing a lease for a 47,000 square foot warehouse for a new distribution center in Orlando, Florida, which we expect to be operational by the third quarter of this year. The new facility is expected to enhance CARES' ability to better service customers throughout the Southeast, improve fulfillment capability for our growing e-commerce business, reduce delivery time, and provide additional infrastructure to support At the same time, we remain focused on driving operational excellence. We are continuing to execute initiatives designed to enhance efficiency across the organizations, while carefully managing costs, aiming to support sustainable profitability, and position the company's the company for continued success. During this quarter, we achieved gross margin of 56.6%, including the benefit from the IEPA tariff refund of 1,890 basis points. far higher product costs and ocean freight rates, the performance underscores the strength of our sourcing capabilities. Our sourcing diversification initiative continues to deliver tangible benefits. strengthening care competitive advantage through reliable product availability and cost competitiveness. In the second quarter, domestic purchase increased to nearly 20% of total sourcing, while importing from Taiwan represented 46%, China represented 11%, and sourcing from Indonesia, Singapore, and South America represented an aggregate of 12%. Overall, we are pleased with the progress we are making with the expanding sales pipeline. new customer wins, strong e-commerce growth, and a continued focus on the operational discipline.

We believe Carrot is well positioned to advance profitability and long-term growth. I will now turn the call over to Jan Wo, our Chief Financial Officer, to discuss the company financial results in greater detail. Jan? Jan?.

Thank you, Alan. I'll begin with a summary of our second quarter performance, followed by an update on our guidance. Net sales for the 2026 second quarter increased to $136.3 million, up 9.9% from $124.0 million in the prior year quarter. The increase primarily reflected $13.1 million in volume growth. and product mix, and a $0.4 million favorable impact from pricing, partially offset by a decrease of $1.1 million in shipping and logistics revenue. Sales to chain accounts and distributors, our biggest sales channel, were up by 9.0% in the 2026 second quarter. Online sales, as Alan discussed earlier, rose 23.6% over the prior year quarter, and sales to the retail channel increased. declined 23.4% from the 2025 second quarter, primarily from the decrease in shipping and logistics revenue. Costs of goods sold for the 2026 second quarter, including the benefit of $25.8 million from AEPA tariff refunds, decreased 21.0% to $59.1 million from $74.9 million in the prior year. year quarter. This benefit was partially offset by higher product costs of $6.9 million and increased import costs of $3.5 million, including an 8.9% increase in average container rates and a 4.3% increase in the number of containers in imported versus the prior year quarter.

Gross profit for the 2026 second quarter increased to $77.2 million from $49.1 million in the prior year quarter. Gross margin increased to 56.6% in the second quarter of 2026 from 39.6% a year ago, reflecting that 1,890 basis point contribution from AIPA tariff refunds. Product costs represented 49.2% of net sales, up from 48.5% in the three-year quarter, while import costs increased to 11.1% of net sales, from 9.5% primarily to 10.5%. freight and import related expenses. Operating expenses in the 2026 second quarter increased to $39.6 million from $32.6 million last year. The increase was primarily driven by higher shipping and transportation costs of $3.1 million, along with increases in online platforms. of $0.6 million and marketing expenses of $0.5 million. also incurred higher costs of $1.1 million in salaries and benefits, while bed debt expense and warehouse expenses increased by $0.6 million and $0.4 million, respectively. Additionally, the second quarter included a $0.1 million loss on the disposal of machinery compared with a $0.3 million gain recognized in the prior year quarter from routine asset disposals. Operating income in the 2026 second quarter increased 127.2% to $37.6 million from $16.6 million in the prior year quarter.

Other income net for the 2026 second quarter was $1.4 million compared to other expenses net of $2.0 million in the prior year quarter. The year-over-year improvement was primarily driven by significantly lower foreign currency transactions. losses, which were $1 million in the current quarter compared with $2.9 million in the same period last year. In addition, interest income increased by $0.5 million, reflecting $0.9 million of interest income associated with IEPA tariff refund, partially offset by a $0.4 million decline in interest income earned on investments in cities. certificates of deposit. Net income for the 2026 second quarter increased 168.3% to $29.6 million from $11.1 million for the prior year quarter. Net income margin was 21.8% in the 2026 second quarter, reflecting the benefit from IEPA tariff refunds of 1,480 basis points versus 8.9% last year. Net income attributable to Carrot for the 2026 second quarter was $29.3 million, or $1.46 per diluted share, reflecting the benefit from AEPA tariff refunds of $1 per diluted share compared with 2020. $10.9 million of $0.54 per diluted share in the prior year quarter. Adjusted EBITDA for the 2026 second quarter rose to $41.6 million, reflecting the benefit from AEPA tariff refunds of $25.8 million from $17.7 million for the prior year quarter.

Adjusted EBITDA margin was 30.5%, reflecting the benefit from AEPA tariff refunds of 1,890 basis points compared with 14.3% for the 2025 second quarter. Adjusted diluted earnings per common share increased to $1.48 for the 2026 second quarter, reflecting the benefit from a per-tariff refund of $1 per diluted share. from $0.57 per share in a comparable prior year period. As of June 30, 2026, we had working capital of $110.8 million and $42 million in financial liquidity, with another $15.7 million in short-term investments. During the second quarter, we generated operating cash flow of $33.2 million and free cash flow of $31.8 million, both of which reflected the benefit from AEPA tariff refunds received of $25.2 million during the second quarter of 2020. We paid out a regular quarterly dividend of 45 cents per share to shareholders on May 28, 2026. During the second quarter, we repurchased 73,510 shares of our common stock for a total of $2 million under our share repurchase program. As of June 30th, approximately $10 million remained available under the program.

On August 4th, 2026, our board of directors approved an increase of regular quarterly dividend to 47 cents per share, payable on August 28th, 2026 to $1. stockholders of record as of August 21st, 2026. Now, let me provide an update to our guidance. For the 2026 third quarter, we expect net sales to grow in the low double digit range from the prior year quarter. We expect growth margin for the 2026 third quarter to be within 35 to 37% and adjusted EBITDA margin to be within 9% to 11%, both including insignificant AEPA tariff refunds anticipated during the quarter. For full year 2026, we expect net sales to grow in the low double-digit range over the prior year. with more clarity around the IEPA tariff refund process, now expect gross margin for the full year 2026 to be in the low 40% and adjusted EBITDA margin to approximately mid-teens, both including AEPA tariff refunds recorded during the first half of 2026. As Alan mentioned earlier, we are experiencing what we believe is accelerated growth in our sales pipeline, reflecting current strong market position and ongoing initiatives to gain market share. Looking ahead, we expect to continue driving top-line growth, sustaining healthy growth moments through our diverse solar strategy and reduced tariffs.

We're also confident that the actions we're taking to manage operating costs will further improve operating leverage and drive sustainable profitability. Alan and I now will be happy to answer your questions, and I'll turn the call back to the operator.

We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. The first question today comes from Michael Francis with William Blair. Please go ahead.

Hi, Alan, Jan. Good quarter. This is Mike on for Ryan here. I want to start on the SG&A. That seemed to be the big surprise for us in the quarter to the downside. You mentioned you have some actions that you're taking to improve that. Can you talk a bit more about, A, what surprised you there, and then, B, what you're doing to offset some of the higher costs?.

Yes, sure. Let me start and then Alan, please feel free to add some additional colors there. So in terms of the SG&A, I know you mentioned some surprises. I think really the way that we think about it is just consistent with the trend that we are observing with the micro environment, right? Just the biggest opportunities item that we are focusing on for the third quarter as far as the cost management is really the shipping cost. So shipping costs, a lot of the orders that we ship out to the customers, we utilize the third-party carriers. We partner with our third-party carriers. That's an area that we're focusing on in the third quarter to try to manage the cost. Just to give you a high-level idea, so the second quarter in in terms of the offline shipping cost.

In total, we incurred about $6.1 million on the year-over-year basis that's a 1.4 uh a sequent I'm sorry sequential that's a 1.4 million dollars increase right there so that's that's one area that in this in the third quarter really we're focusing on utilizing our internal fleet to try to minimize to get more efficiency out of the offline shipping cost to the customers by as I mentioned, utilizing the internal fleet. We're delivering oil local orders to our local customers with our own employees. And we're also performing the inter warehouse inventory transfers with some of our internal fleet as well. So that's the biggest area. Another area is we're continuing to try to get savings on the online order as well, online. line order delivery cost the shipping cost is one area that we talked about previously on the call is we have a service agreement with one of the carriers so that's one area that work we're continuing to to focus on in terms of realizing cost savings there. So that's the biggest kind of in terms of the offline and online shipping costs, really. I think it's probably fairly consistent with some of the other companies just as we approach, as we're thinking about the overall higher oil, the gas price there. One other area that we're focusing on in the third quarter is our salary and benefit expenses.

That's really to utilize our labor force more efficiently. So those are the two biggest areas I would call out.

I want to add a little bit of color to that, what Jan just mentioned. The second quarter was the highest fuel cost that we ever seen in the past year due to the crisis in the Middle East. And in the third quarter, we are actually seeing the cost coming down in the third quarter already. Like for instance, we were paying $5.40 gallon diesel gas. In the third quarter, we're looking at around four something, twenty-five percent discount on the diesel gas alone. On the the carrier fuel surcharge also we're seeing a declining rate from the second quarter to third quarters so this is where we're seeing that more of a decline in not only on the ocean freight declines and also as well as the shipping all because oil prices everyone knows that the second quarter oil price was the highest ever but it started to drop in July so or we'll see if it's a continued drop or even at this point it is still lower than the second quarter.

Yes, that's not surprising. I figured that was the case. And then... to the pause of your online sales are continuing to trend quite well. What drove the strength there and then across the category? Should we expect the similar growth trajectory to the.

in the second half that we saw in the first. Well, let me add to this online growth. Doing our last quarter earning call, I mentioned that we are our target for this year's online revenue. It's $100 million. As we see July's number, we were looking at the second quarter, we're looking at 20%, 24%, 25%. I think the online growth year-over-year just in July we're seeing Amazon growth around 49 percent year-over-year growth just in Amazon our old growth in July in the month of July we just finished a number we're at 37% plus just the online sales growth so right now I can confidently say that a hundred million dollars is on track for this year's revenue goal just for online it may be higher but I'm not sure how much higher so we're still pushing even more online sales right now that's where we are.

That's good to hear. One last one for me. Florida, DC, coming online, you continue to add capacity there. Do you still think you have any gaps in your current coverage where you could add more DCs and sellers, and if so, where?.

Well, Orlando, Florida, it's on the, basically we're finalizing the agreement and that's going to help because that is our fourth largest online customer base. And we have been shipping from South Carolina and Houston into Orlando. Once we have the Orlando, D.C. ready, our customer can receive their product. the next day, if not the following day, instead of waiting three or five days. So that would definitely improve our sales number online in just the southeast area, which is our fourth largest. Now the other area that we're seeing that we might need some support, definitely it would be in the Colorado area, which can support the Utah area. But we're still We're still looking at that because Colorado is, the shipping, anything shipping to Colorado is actually more into Texas. That's what we see. So currently we're shipping to Colorado from Texas into Colorado, which is two to three days for online.

And, of course, we have been looking to the North America area, the Vancouver, Toronto. These are the areas we have been trying to figure out how we can get the logistic part of the issues resolved because we do see a very wide open market in that part of the segment.

is North America. Okay, that's all understood. I'll pass it on.

The next question comes from Ryan Myers with Lake Street. Please go ahead.

Hey guys, thanks for taking my questions. You know, if we exclude the tariff refund during the quarter, I'm just curious, how would you characterize just the underlying gross margin and performance of the business? Was it relatively as you expected?.

Let me start and then, Ellen, please feel free to add colors on there as well. Hi Ryan, that's a great question. So as we reported our gross margin is 56.6% for the quarter. If you do the math, if you include the contribution, our gross margin without the refund, the tariff refund would have been 37.7%, which I think is still really strong. We're talking about high, close to 40% growth margin. And I think we talked about the underlying drivers, right? Our sourcing diversification, our sourcing capabilities. And I think we do expect growth to continue to navigate this environment really well with the pricing dynamics, with the sourcing, the changing kind of the trade landscape.

We did provide the guidance for the third quarter gross margin to continue continue to be in the high 30s, so 35 to 37 percent. Does that answer your question?.

Yes, Ryan, I want to add something to this. During the second quarter, we did see our, like Jen mentioned, a 37.7%. And in the third quarter, we're seeing a stronger U.S. dollar versus other currency in Asia, especially against Taiwan dollars. Last year, if you saw... The second quarter, we had a $2.9 million currency loss due to the currency devaluation of U.S. dollars against Taiwan dollars. Now we're seeing a strong tailwind, which is the currency gain. We're seeing one of the highest gains in the third quarter that we're looking at. as we stay at the same current level right now. So there's going to be some pretty positive things in the third quarter, like the ocean freight.

There might be some reduction in ocean freight, because we're about to end the peak season. might be a lot but it's definitely going to help. I think everything helps in terms of helping the gross margin and also we're looking at not only on that part we're looking at into the.

in terms of savings, in terms of operating expense as well. Got it. Now, that's great to hear. That's awesome. And then, you know, lastly, you mentioned in the press release that you guys added four new chain accounts during the quarter. You know, how should we think about the timing and potential contribution from those wins?.

We're thinking about the fourth quarter. Okay. Got it. So we start to ship the product. Yes, it takes us two to three months to wrap up the inventory and then start the – so we promise the customers fourth quarter we'll start shipping the product. Okay.

Okay, got it. No, that's helpful. Thanks for taking my questions. Thank you, Ryan.

This concludes our question and answer session. I would like to turn the conference back over to Alan Yu for any closing remarks.

Thank you, Operator, and thank you to everyone for joining us today. CARE is built on a strong business foundation, and we are encouraged by the positive momentum across our business. We remain focused on executing our growth strategy and look forward to keeping you updated on our continued progress. Have a nice day, everyone. Thank you. Bye-bye.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

This live transcript is auto-generated without human intervention or review.

[Call has ended.]

Thank you for standing by. My name is Carla, and I will be your conference operator today. At this time, I would like to welcome everyone to the Karat Packaging First Quarter 2026 Financial Results Conference Call. [Operator Instructions] I would now like to hand the conference over to Roger Pondel. Please go ahead.

Thank you, operator. Good afternoon, everyone, and welcome to Karat Packaging's 2026 First Quarter Conference Call. I'm Roger Pondel with PondelWilkinson, Karat Packaging'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. But 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 the company's most recent Form 10-K as filed with the Securities and Exchange Commission and 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 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, all of which are non-GAAP financial measures, as defined by SEC Regulation G. A reconciliation of the most directly 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. And with that, I will turn the call over to CEO, Alan Yu. Alan?

Thank you, Roger. Good afternoon, everyone. We began 2026 with a robust first quarter. Year-over-year sales increased almost 13% with momentum building throughout the quarter. Our performance during the quarter accelerated significantly, starting with modest weather impacted growth in January to growth exceeding 20% in March, which included some pull forward of orders. The acceleration reflected improving demand, strong execution across the organization and continued gain in the market share. Notably, our online sales, which are typically at a higher contribution margin, returned to robust growth this quarter after we pivoted to grow and fulfill our own online sales on our company storefront and third-party platforms. Compared to the prior year quarter, online sales increased almost 10% to $19.5 million in the first quarter of 2026 from $17.8 million in the prior year quarter, with momentum building steadily throughout the first quarter, achieving 19% year-over-year growth in March 2026. Gross margin remained resilient at 35.5% despite the continued impact of higher tariffs. This performance demonstrates the effectiveness of our diversified sourcing strategy and was further supported by a favorable product mix and pricing. As we look ahead, we are closely managing a dynamic cost environment given the sharp increase in oil prices and the resulting impact on product costs, we are implementing price increases on select plastic items beginning in the middle of this month. While certain sourced product costs are rising, we expect tariff saving under the current trade policy to begin reducing cost of goods sold this month. These savings should partially offset inflationary pressure and together with our pricing action, we expect to support gross margin stability. Importantly, we are well positioned to continue gaining market share amid ongoing rising supply challenges. Our strong inventory position and disciplined supply chain execution give us confidence in our ability to consistently serve customers and meet demand. Turning to innovation and sustainability. Our paper bag product category continued to expand steadily, driving a year-over-year increase in eco-friendly product sales of 16.9% in the first quarter. We also successfully closed another national chain account for paper bag during this quarter, further strengthening our leadership position and reinforcing our long-term strategy in sustainable packaging solutions. Our sourcing diversification initiative continues to deliver tangible benefits. We have proactively rebalanced import volumes across geographies in response to evolving tariff structures, strengthening our cost competitiveness and consistent product availability. In this quarter, we increased domestic purchase to 18% compared to 14% in the prior year quarter and increased sourcing from Malaysia and Vietnam to an aggregate of 17% from 12% in the prior year quarter. At the same time, we reduced purchase from Taiwan in the current quarter to 46% compared to 54% in the prior year quarter and reduced sourcing from China to 11% compared to 18% in the prior year quarter. Additionally, we expanded our sourcing footprint by adding a new supplier in South America, which further reduces geographic risk and enhanced supply chain flexibility. We remain focused on providing responsive customer service and disciplined execution, which are a hallmark of Karat Packaging while advancing Karat's operational efficiencies. These efforts are reflected in better operating cost leverage, which decreased to 28.3% in the first quarter of 2026 from 31.8% in the prior year quarter. In summary, we delivered a strong start to the year, maintained margin resilience in a challenging environment and continue to invest in growth areas that align with our customer demand and long-term industry trend. I will now turn the call over to Jian Guo, our Chief Financial Officer, to discuss the company financial results in greater detail. Jian?

Thank you, Alan. I'll begin with a summary of our Q1 performance, followed by an update on our guidance. Net sales for the 2026 first quarter increased to $116.9 million, up 12.9% from $103.6 million in the prior year quarter. The increase primarily reflected $12.1 million in volume and mix and a $2.0 million favorable impact from pricing. Sales to chain accounts and distributors, our biggest sales channel were up by 15.1% in the 2026 first quarter. Online sales, as Alan discussed earlier, rose almost 10% over the prior year quarter and sales to the retail channel declined 12% from the 2025 first quarter. Cost of goods sold for the 2026 first quarter increased 20% to $75.4 million from $62.9 million in the prior year quarter. The increase was driven primarily by sales growth and higher import costs of $7.3 million, primarily as a result of higher import duty and tariffs, which increased from $3.4 million for the 3 months ended March 31, 2025, to $10.5 million for the 3 months ended March 31, 2026. Gross profit for the 2026 first quarter increased to $41.5 million from $40.8 million in the prior year quarter. Gross margin for the 2026 first quarter was 35.5% compared with 39.3% a year ago. The year-over-year decline in gross margin reflects the expected impact from higher input costs, which increased to 13.8% of net sales from 8.6% in the prior year quarter as well as elevated inventory adjustments as a percentage of net sales. These impacts were partially offset by lower product costs as a percentage of net sales. Operating expenses in the 2026 first quarter increased to $33.1 million from $32.9 million last year. The increase was primarily driven by higher rent expense of $0.6 million associated with the opening of the company's new Chino distribution center in March 2025, along with a $0.6 million increase in salaries and benefits. These increases were partially offset by a $0.7 million reduction in online platform fees resulting from a shift away from third-party fulfillment of online orders as well as a $0.4 million decrease in shipping and transportation costs due to lower online shipping rates. Operating income in the 2026 first quarter increased 8.2% to $8.5 million from $7.8 million in the prior year quarter. Total other income net decreased $2.9 million for the 2026 first quarter from $1.1 million in the prior year quarter. Net income for the 2026 first quarter increased 4.8% to $7.1 million from $6.8 million for the prior year quarter. Net income margin was 6.1% in the 2026 first quarter compared with 6.6% last year. Net income attributable to KARAT for the 2026 first quarter increased 5.2% to $6.7 million or $0.34 per diluted share from $6.4 million or $0.32 per diluted share in the prior year quarter. Adjusted EBITDA for the 2026 first quarter rose to $12.5 million from $11.9 million for the prior year quarter. Adjusted EBITDA margin was 10.7% compared with 11.5% for the 2025 first quarter. Adjusted diluted earnings per common share increased to $0.34 for the 2026 first quarter from $0.33 per share in the comparable prior year period. We executed strong working capital management during the first quarter, generating operating cash flow of $7.2 million and free cash flow of $6.3 million despite continued heavy duty and tariff payments as discussed earlier. We paid out a regular quarterly dividend of $0.45 per share to shareholders on February 27, 2026. As of March 31, 2026, we had $90.7 million in working capital and $36.4 million in financial liquidity with another $5.7 million in short-term investments. On May 5, 2026, our Board of Directors approved a regular quarterly dividend of $0.45 per share payable May 28, 2026, to stockholders of record as of May 21, 2026. Looking ahead to the 2026 second quarter, we expect net sales to increase by approximately 8% to 10% from the prior year quarter. As Alan noted earlier, some timing shift of orders in March contributed to a softer start in April. Since then, we have replenished inventory, and we're confident in our ability to achieve our sales target. We expect gross margin for the 2026 second quarter to be within 35% to 37% and adjusted EBITDA margin to be within 11% to 13%, excluding potential tariff refund impact under the current trade policy. For the full year 2026, we expect net sales to grow in the low double-digit range over the prior year. We expect gross margin for the full year 2026 to be within 34% to 36% and adjusted EBITDA margin to be within 11% to 13%, excluding potential tariff refund impact under the current trade policy. As Alan mentioned earlier, we are seeing accelerated growth in our pipeline, reflecting our strong market positioning and initiative to continue gaining market share in a dynamic trade and supply chain environment. We expect to continue to drive top line growth sustain our gross margin and continue to deliver strong profitability with enhanced operational efficiency and disciplined cost management. Alan and I will now be happy to answer your questions, and I'll turn the call back to the operator.

[Operator Instructions] Our first question comes from the line of George Staphos with Bank of America.

This is Kyle Benvenuto on for George. You noted the sharp increase in oil prices is pressuring costs across sourced products and plastics. Within both your 2Q and 2026 margin guidance ranges, what oil price assumptions are embedded? And at what point would the mid-May plastic price increases no longer be sufficient to protect the 34% margin floor for the year?

Well, here's what we see on the oil prices. Yes, you're correct. Oil price has gone up and raw material has gone up sharply. But the issue is we were able to negotiate with our vendor to support a less increase versus the full increase impact of the oil prices. So majority of our partner vendors overseas have absorbed majority of the increases. So that's -- and also, that's where we're seeing that -- we're giving minimum increase in the May 15 to June area. That's how I see it. Is there going to be escalating -- is this tension going to escalate more? Right now, we see that the resin price has stabilized in Asia. It has come down a little bit also. So we do not see at this point that the raw material prices will go up even higher from this point.

Thank you Alan. And then one more question for you, and I'll turn it over. Your guidance points to 8% to 10% sales growth for 2Q. How much of this is driven by the expansion of new national accounts versus organic volume growth from your existing customer base?

We're seeing a sharp increase in our online sales portion of our business. For example, last month, April, we topped our record over double digit in terms of online sales. And we do foresee that this quarter, we will have a record sales online as well. Last year, we did about $72 million to $73 million online revenue. And this year, we are on track for $100-plus million on online revenues. So majority of the growth -- actually, a big chunk of the growth is from online sales revenue. From our national chain accounts, yes, we do see some of the national chain pipeline converting to revenues. So that is also a segment that we do see a growth in the national chain account, especially its summer season, most of these chains are going to increase their order for their drink cups and carriers as well as the deli part of our food segment of our business is we will expect an increase in that segment as well. So these are all organic growth, by the way.

The next question comes from the line of Ryan Meyers with Lake Street Capital Markets.

First one for me, I just want to make sure I understand this dynamic correctly. And Alan, you had called out the 20% growth that you saw in the month of March. And then obviously, the second quarter guidance is only 8% to 10% revenue growth. So it sounds like you guys saw some pull forward in order demand that drove the strength in March and then things kind of stabilize a little bit in the second quarter. That's where that delta is between that 20% and that 8% to 10% growth is. It's not necessarily the business is slowing...

No, it's not. And also, we want to be conservative in terms of our growth numbers. We do expect our full year guidance to be in range with what we have guided earlier this year. So second quarter, we're seeing some softening in April because of the pull forward from March. And in this month, so far, we're seeing a very positive revenue growth in terms of May. But that -- then we want to be conservative and cautious in terms of making sure that we meet the guidance or exceed the guidance.

Yes. Fair enough. No, that makes sense. And then just thinking in terms of pricing, you called out that in the prepared remarks and talked a little bit about that. But how much price do you feel like needs to be taken for you guys to preserve your gross margins? And then thinking about that, industry-wide, what does your price increases look like compared to competitors? Are you still feeling like you're priced below where the market is and that's allowing for some of those share gains?

Yes. We're hearing that our price announcement was 5% to 15% depending on category-wise. And our peer group are seeing to have a price increase of 8% to 12%. So we are in the lower range of the price increase among our peer group because we do want to -- we understand that this is a difficult environment that foodservice is having a challenging year and all the beef prices are up. So we do want to support our partners in this term. So basically, we're actually announcing a lower price increase. But because of some help with the tariff that in the past, past 6 or 9 months, we were paying 20% tariff. Now we're down to 10% tariff. There may be changes in July and August. But at least for now, we're seeing a 10% tariff reduction is helping our gross margin a lot. So that's where we see that. We do see a stronger gross margin for this quarter versus the prior quarters. That's why we're saying that our net sales should be -- we should be on track with our net sales.

And the next question comes from the line of Ryan Merkel with William Blair.

This is Ben Schmid on for Ryan. First question here, just to put a finer point on March and April. Is there any way to size the pull-forward impact in March? It sounds like April might have been down. So just a finer point there would be great.

I would say that about $2 million were pulled forward from April to March.

Okay. Got it. And then last one for me. So I know you guys mentioned a win this quarter, but any other updates on the pipeline of potential wins you guys discussed last quarter?

We are working with very large chains, actually a few large chains that might be converting in this quarter or at least next quarter. But this quarter, we are converting some of the existing customers, adding additional SKUs to the existing customers, such as -- their eco-friendly product line and paper bags. So that's what we're seeing right now.

And we have no further questions at this time. I would like to turn it back to Alan Yu for closing remarks.

Thank you, everybody, for joining our conference call on first quarter Karat Packaging earnings. We look forward to seeing you next time. Thank you very much. Have a wonderful day. Bye-bye.

Thank you. Ladies and gentlemen, this now concludes today's conference call. You may now disconnect.

Good afternoon, and welcome to the Karat Packaging Fourth Quarter 2025 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Roger Pondel, Investor Relations. Please go ahead.

Thank you, operator. Good afternoon, everyone, and welcome to Karat Packaging's Fourth Quarter and Full Year 2025 Conference Call. I'm Roger Pondel with PondelWilkinson, Karat Packaging'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 the company'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 undertakes no obligation to update any forward-looking statements, except as required by law.

Please also note that during this 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 directly 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.

And with that, I will turn the call over to CEO, Alan Yu. Alan?

Thank you, Roger. Good afternoon, everyone. Despite ongoing trade volatility, Karat continues to deliver profitable growth demonstrating the strength and resilience of our business model. We closed 2025 with an increase of 13.7% net sales in the fourth quarter, fueled by strong double-digit volume growth across all major markets. Notably, pricing also turned positive for the first time since early 2023, adding further momentum to our performance.

Our ongoing effort to diversify sourcing continued to deliver positive results. We have adjusted our import volume across sourcing countries following tariff and foreign currency development. During the fourth quarter, our import mix consisted of 46% from Taiwan, 14% from China, 13% from the United States, and 11% each from Vietnam and Malaysia. Our resilient global supply chain enabled us to maintain a solid 34% gross margin despite significantly higher tariff and duty costs during the quarter. Following the recent favorable global tariff developments and destabilization of favorable U.S. dollar and new Taiwan dollar exchange rates, we expect tailwinds on the margin to be realizing beginning in the second quarter of this year.

Our new paper bag business product category continues to gain strong momentum, expanding steadily and driving meaningful revenue growth. In addition to supplying one of our largest national chain accounts, we are actively pursuing additional opportunities, some of which are at the final confirmation stage. We are also strengthening this category by supplying generic paper bags to smaller customer accounts in addition to custom paper bags, and we expect to continue gaining market shares in this category in the years ahead.

Our eco-friendly product sales boosted in part by paper bags grew to 37.3% of total revenue in the fourth quarter of 2025, up from 34.5% in the same quarter of 2024. As our paper bag category business continued to expand, we are further strengthening our position as a leading provider of sustainable, eco-friendly disposable foodservice product.

In today's consistently shifting trade environment, we believe that Karat global sourcing flexibility and efficient logistic capabilities position us well to support continued growth and the margin improvement. We are also maintaining our focus on operating efficiency reflected in the improvement of our operating cost leverage to 26.7% in the fourth quarter of 2025 from 32% in the prior year quarter. Together, these efforts provide a solid foundation as we look forward to another strong year.

I will now turn the call to Jian Guo, our Chief Financial Officer, to discuss the company's financial results in greater detail. Jian?

Thank you, Alan. I'll begin with a summary of our fourth quarter performance followed by an update on our guidance. Net sales for the 2025 4th quarter increased to $115.6 million, up 13.7% from $101.6 million in the prior year quarter. The increase primarily reflected $8.2 million in volume and a $6.3 million favorable impact from pricing and product mix. Sales to chain accounts and distributors, our biggest sales channel, were up by 17.5% in the 2025 4th quarter. Online sales rose 1.9% over the prior year quarter, and sales to the retail channel declined 4.8% from the 2024 4th quarter.

As part of our initiative to optimize margin, we continued to shift away from online sales fulfilled by Amazon and focused more on driving traffic through our own Lollicup store and fulfilling our own orders on third-party platforms. We achieved significantly higher contribution margin in our online sales with reduced online platform fees and market costs.

Cost of goods sold for the 2025 4th quarter increased 23.4% to $76.3 million from $61.8 million in the prior year quarter. Product costs increased $6.1 million due to sales growth, partially offset by more favorable vendor pricing and product mix. Within import costs, duty and tariff costs increased $8.4 million due to higher tariff rates and a $0.4 million adjustment to the duty reserve previously recorded on certain imports.

Gross profit for the 2025 4th quarter was $39.3 million compared with $39.8 million in the prior year quarter. Gross margin for the 2025 4th quarter was 34.0% compared with 39.2% in the prior year quarter. Gross margin was impacted by higher import costs, which included ocean freight and import duty and tariffs. As a percentage of net sales, import costs increased to 14.5% from 8.3% in the prior year quarter. However, we were able to partially offset the headwind on margin by reducing product costs as a percentage of net sales due to more favorable vendor pricing and product mix as well as lower logistics expenses as a percentage of net sales.

Operating expenses in the 2025 4th quarter decreased to $30.9 million from $32.5 million in the prior year quarter. As Alan mentioned, our focus on cost containment yield significant results here. Compared to the prior year quarter, we reduced online platform fees by $1.6 million while maintaining our sales growth trajectory, lower marketing expense by $0.5 million and reduced professional services expense by $0.4 million. At the same time, our rent expense increased $0.5 million primarily due to the opening of a new Chino distribution center in 2025.

Operating income in the 2025 4th quarter increased 16.0% to $8.5 million from $7.3 million in the prior year quarter. Total other income net increased 17.7% to $1.2 million for the 2025 4th quarter from $1.0 million in the prior year quarter. Net income for the 2025 4th quarter increased 22.8% to $7.2 million from $5.9 million for the prior year quarter. Net income margin rose to 6.2% in the 2025 4th quarter from 5.8% in the prior year quarter.

Net income attributable to Karat for the 2025 4th quarter increased 21.3% to $6.8 million or $0.34 per diluted share from $5.6 million or $0.28 per diluted share in the prior year quarter. Adjusted EBITDA for the 2025 4th quarter rose to $12.5 million from $11.3 million for the prior year quarter. Adjusted EBITDA margin was 10.8% compared with 11.1% for the prior year quarter. Adjusted diluted earnings per common share increased to $0.34 a per share for the 2025 4th quarter from $0.29 per share in the prior year quarter.

We executed strong working capital management during the fourth quarter, generating operating cash flow of $15.4 million and free cash flow of $14.6 million despite continued heavy duty and tariff payments. During the fourth quarter, we also made an early loan repayment of $8.0 million for our consolidated variable interest entities term loan.

In addition to our regular quarterly dividend of $0.45 per share paid to shareholders on November 28, 2025, we further utilized our newly approved share repurchase program and repurchased 137,374 shares of our common stock at an average share price of $21.74 per share for a total amount of $3.0 million. As of March 11, 2026, approximately $12.0 million remained available for repurchase under the authorized repurchase program.

We ended 2025 with $91.0 million in working capital and maintained financial liquidity of $45.6 million. On February 5, 2026, our Board of Directors approved a regular quarterly dividend of $0.45 per share payable February 27, 2026, to shareholders of record as of February 20, 2026.

Looking ahead to the 2026 1st quarter, we expect net sales to increase by approximately 8% to 10% from the prior year quarter. Sales for the first quarter are typically subject to weather conditions. Although we experienced facility shutdowns due to inclement weather this January and February, we are seeing strong sales growth momentum.

We expect gross margin for the 2026 1st quarter to be within 34% to 36% and adjusted EBITDA margin to be within 9% to 11%. For the full year 2026, we expect net sales to grow in the low double-digit range over the prior year, and we anticipate continued improvements in both gross margin and adjusted EBITDA margin compared with the prior year under the current global tariff import environment.

As Alan mentioned earlier, we are seeing accelerated growth in our pipeline, supported by the continued expansion of our paper bags category and the addition of several key customer accounts. We remain committed to accelerating top line growth while continuing to improve operational efficiency and cost management.

Alan and I will now be happy to answer your questions, and I'll turn the call back to the operator.

[Operator Instructions] Our first question today comes from Ryan Merkel with William Blair.

I wanted to start with the outlook for '26, the up double digits. Alan, what are you assuming for the market in that outlook? I was thinking something like flat in that most of your sales growth is going to be market share gains, but tell me how you're thinking about that.

Well, I do see the environment for our competitive -- it's a very competitive environment right now. And I see numbers coming out from our competitors are negative growth to maybe low single-digit growth. While we are seeing -- foreseeing our company to have a low double-digit growth, I think that has been conservative. The way I see that is, yes, market share gain, mainly on the new categories that we're offering on the paper bag, the SOS back, we're adding -- for example, we have about maybe perhaps 40 SKUs on the paper bag. We're going to add additional 50 or more SKUs just on the paper bag category. Maybe we can have a complete line of SOS bags. We're adding all of it. Paper shopping bag, we're adding more of that, and we're adding more custom printing. We're doing a lot of things to add -- addition to the -- our line offering to increase our revenue.

Got it. Okay. That's great. And then I wanted to ask on 1Q. Kind of up 9% year-over-year for revenue, that's a bit of a slowdown from the up 14% this quarter. Jian, you mentioned weather. So I guess my question is, is it just weather that's causing the slowdown in 1Q. And now that the weather has cleared a bit, have you seen the trends pick back up?

Yes. Texas is one of our major hub. We had a shutdown over a week. We couldn't work in -- it was like a snowstorm. And also East Coast had several weather issues, New Jersey and South Carolina, but mainly it was Texas that we had entire week that we couldn't do anything. So that really slowed us down for the month of January, some part of February. But we do see that, whether it's getting better now in March, so we're seeing strong momentum coming back from the March and onward.

[Operator Instructions] The next question is from Ryan Meyers with Lake Street Capital Markets.

Congrats on a solid fourth quarter. First question for me, just thinking about the full year revenue guidance, do you guys factor in any of these business opportunities that you commented on that are in the final confirmation stages? Or is this full year revenue guidance just based on the business that you guys have already signed and visibility to already?

Well, a part of it. The one that we're adding in is that we know we have a lot of pipeline that we are confirming on the final stages. The key part is, in most cases, it is chain account, even with their -- after they confirm, there's a testing phase, and they might just delay and drag for 6 months to 9 months. So we want to be conservative. Of course, we don't just have 1 or 2 or 3 or maybe -- we have more than a dozen -- several dozen potentially accounts that we're adding in. They're either existing customer or the new accounts. So we're adding that, and that's why we're forecasting single digit -- single double -- low double-digit growth, but my goal is actually mid or higher -- high double-digit growth. That's our ultimate goal.

Okay. Got it. That's helpful.

So upside if we can -- if some of those opportunities can materialize.

Yes. Okay. Makes sense. And then I just want to make sure I'm understanding the gross margin guidance correctly. So Jian, are you expecting an increase from the 36.8% full year 2025 number in 2026? Or are you expecting an increase from what you guys reported in the fourth quarter? Just one clarification there.

We are expecting year-over-year increase under the current tariff environment.

The next question is from George Staphos with Bank of America.

Got it. This is Kyle Benvenuto stepping in for George. Quick question for you. You discussed tariffs, FX and logistics as key margin drivers, and in the past, you've talked about transportation. Can you comment on whether energy costs are baked into your margin outlook, your margin guidance?

Yes, we have because this is not the first time we've seen the energy crisis like the oil crisis. We've seen the -- in 2022, the ocean freightliner, the shipping ocean freight skyrocketed from $1,500 to $10,000 containers. But we do not foresee the price will be incrementally high. We are foreseeing a little bit of an increase. And I mean, the past 3 months, basically, the ocean freight carrier, they tried to increase the prices of the ocean freight cost. And for the past 3 times, they failed. It went up for just merely 2 or 3 weeks and they dropped back down. But mainly, we normally sign in the full year agreement, which normally are signed in the month of April, which is, next month, we'll be able to sign that. And so far, the guidance is just about 10%, 15% increase year-over-year on the ocean freight shipping costs. And for locally, domestic diesel gases, it's been up and down throughout the year. So these have been accounted for.

And then just one more question. In regard to the online sales, we saw some positive growth this quarter. Back in Q2, I believe you mentioned double-digit growth potentially in the back half of this year. I guess I was just wondering what's the progress on that maybe going forward into '26 and how -- a little bit more detail about how that's evolving.

Yes. No problem. We -- I do -- we do foresee 2026, we will have a double-digit growth online because we're adding additional platform where, currently, we have our own Shopify store. We have Amazon. We added sysco.com platform. We'll be adding target.com, and there's a cheneybrothers.com. And there's other platform we're adding our product into those platforms. That will increase our sales. And also, we're driving our sales by increasing bulk sale from our own stores and our Amazon stores. What I mean bulk sales is we're encouraging customers to buy not just 1 cases, 1 pieces but like 5 cases and 10 cases. That increases our volume. Not only volume, it increases our revenue and also profit margin because we do get a bulk discount from the carrier. If we ship more product to the same location, our shipping costs come down. So we're optimizing that and passing that savings to the customer to increase revenue. So we do foresee that our 2026 online growth will be double digit.

Next question is from Joshua Axel with KTF Investments.

I have a question for you on -- really 2 questions. Number one, can you expand a little bit on the demand you're seeing for the eco-friendly business maybe outside of the paper bag? Just curious as if you're still seeing high demand with the current environment. And then secondly, can you comment a little bit on what you're seeing in the California market?

Sure. The first question, demand in eco products has never dropped and mainly on the molded fiber product and on the paper bag due to regulatory regulation. And we're seeing more and more chains are moving away from Styrofoam into paper products. So we're seeing more of that.

On the compostable product, PLA items, we also see a growth of that due to the price decrease. They used to be pretty expensive to buy a compostable PLA cup. But now as price comes down, it's become more affordable, and more and more customers are actually looking to that. We're seeing newly opened restaurants are trying out with eco-friendly products because they want to perceive themselves with the consumer as being part of the initiative to save the environment. So I would say that more and more going to that. That's driving the demand from the consumer perspective.

Now in California market, we're seeing a slowdown in the California market overall. In general, restaurants are shutting down, and it's becoming a very competitive environment. But in our aspect, our company, we're seeing a double -- we have seen recently a double-digit growth in our companies. We're seeing, due to the tariff containment, some of the importers stopped importing product because they went out of business, and so it's definitely driving the business to our company as well as other larger companies with more inventory on hand. That's what we're seeing in the California market.

This concludes our question-and-answer session. I would like to turn the conference back over to Alan Yu for any closing remarks.

Thank you, operator. Thank you, everyone. It has been a wonderful quarter, and I look forward to hearing from you all in the next quarter. Thank you all. Bye-bye.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

Good day, and welcome to the Karat Packaging Third Quarter 2025 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Mr. Roger Pondel. Please go ahead, sir.

Thank you, operator. Good afternoon, everyone, and welcome to Karat Packaging's 2025 Third Quarter Conference Call. I'm Roger Pondel with PondelWilkinson, Karat Packaging'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 the company'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 undertakes no obligation to update any forward-looking statements, except as required by law. Please also note that during this 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 directly 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.

And with that, I will turn the call over to CEO, Alan Yu. Alan?

Thank you, Roger. Good afternoon, everyone. Despite ongoing trade volatility, Karat achieved another quarter of record net sales, up over 10% year-over-year, fueled by solid volume expansion, a favorable product mix and effective pricing initiatives. We've experienced double-digit growth across all major markets, especially in Texas and California. Even with significant higher import costs due to increased duties and tariffs, we successfully sustained a gross margin of 34.5% for the third quarter.

We remain committed to our sourcing diversification strategy, and our nimble and flexible operating model continues to enable us to effectively manage ongoing supply chain challenges. During the third quarter, we increased domestic sourcing to approximately 20% from about 15% in the second quarter, and we reduced imports from Taiwan to approximately 42% from 58%. We continue to closely monitor tariff developments and are ready to quickly adjust our sourcing strategy accordingly as we have done in the past to maintain Karat's competitive advantage.

Additionally, foreign currency exchange rate between the U.S. dollar and the new Taiwan dollar have shown increased stability since August, which is expected to help improve our operating performance for the current quarter. Earlier this year, we secured a major add-on of business to supply paper bag, a new product category for Karat to one of our largest national chain accounts. Initial shipments to select distribution centers started in the third quarter, and we expect the volume to accelerate in the fourth quarter. With fulfillment expected during Q1 of 2026, this new category of business with this chain account is for a 2-year term and expected to contribute approximately $20 million in additional annual revenue.

Over the next 2 to 3 years, we aim to scale our paper bag business to more than $100 million in additional annual revenue. The anticipated growth from this new category is being driven by national and regional restaurant chains that are transitioning to paper bags from plastic bags. This shift is influenced by evolving state and municipal regulations as well as a growing emphasis on enhancing customer experience and brand images. We expect continued market share growth in this segment, further solidifying our position as a leader in providing sustainable, eco-friendly disposable food service products.

In late May and June this year, we implemented broad pricing increases across most product lines to offset rising import costs. Heading into the fourth quarter and 2026, business trends remain strong. We continue to make disciplined pricing approach and partner with our customers while focusing on operating efficiencies. We are actively integrating several meaningful new customer accounts and focusing on increasing online marketing, which will strengthen our 2026 pipeline, building a strong foundation for what we expect to be another record-setting year in sales. Karat announced a first-ever stock repurchase program this week. In addition to the regular quarterly dividend, the announcement underscores our Board confidence in the company's future growth prospects and financial strength.

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?

Thank you, Alan. I'll begin with a summary of our Q3 performance, followed by an update on our guidance. Net sales for the 2025 third quarter were $124.5 million, up 10.4% from $112.8 million in the prior year quarter. The increase was primarily driven by an increase of $9.4 million in volume and a $3.5 million favorable impact from product mix, partially offset by a $0.7 million unfavorable year-over-year pricing comparison. Sales to chain accounts and distributors were up by 13.7%. Online sales increased 3.1% over the prior year quarter and sales to the retail channel were down 12.5% over the prior year quarter, reflecting the softness of the overall retail sector.

Cost of goods sold for the 2025 third quarter increased 17.8% to $81.6 million from $69.3 million in the prior year quarter. Product costs increased $5.0 million due to sales growth, partially offset by more favorable vendor pricing and product mix. Additionally, import costs increased $8.2 million due to higher import duty and tariffs, coupled with a 21.0% increase in import volume as we purchased more inventory ahead of expected business expansion, partially offset by a 13.4% decrease in average freight container rates.

Gross profit for the 2025 third quarter was $42.9 million compared with $43.5 million in the prior year quarter. Gross margin for the 2025 third quarter was 34.5% compared with 38.6% in the prior year quarter. Gross margin was negatively impacted by higher import costs, which as a percentage of net sales increased to 14.4% compared with 8.6% in the prior year quarter. The decrease in margin was partially offset by a decrease in product costs as a percentage of net sales due to more favorable vendor pricing and product mix as well as a reduction in inventory write-offs and adjustments as a percentage of net sales.

Operating expenses in the 2025 third quarter were $34.3 million compared with $32.2 million in the prior year quarter. The increase was mainly driven by $2.1 million of higher shipping costs due to higher sales volume, $0.7 million of higher rent expense due to a higher rate on our Chino, California facility lease extension plus the opening of a new Chino distribution center and $0.6 million of higher salaries and benefit expenses. These increases were partially offset by a $1.4 million reduction in online platform fees.

Operating income in the 2025 third quarter was $8.6 million versus $11.3 million in the prior year quarter. Total other income net was $1.3 million for the 2025 third quarter compared with $0.6 million in the prior year quarter. The increase was primarily from foreign currency transaction gain of $0.7 million, driven by the strengthening of the United States dollar against the new Taiwan dollar during the 2025 third quarter compared with a loss of $0.3 million on foreign currency transactions during the 2024 third quarter.

Net income for the 2025 third quarter was $7.6 million compared with $9.3 million for the prior year quarter. Net income margin was 6.1% in the 2025 third quarter compared with 8.2% in the prior year quarter. Net income attributable to Karat for the 2025 third quarter was $7.3 million, $0.36 per diluted share compared with $9.1 million or $0.45 per diluted share in the prior year quarter. Adjusted EBITDA for the 2025 third quarter was $13.1 million compared with $14.7 million for the prior year quarter. Adjusted EBITDA margin was 10.5% of net sales for the 2025 third quarter compared with 13.0% for the prior year quarter. Adjusted diluted earnings per common share was $0.37 for the 2025 third quarter compared with $0.47 for the prior year quarter.

We generated operating cash flow of $1.0 million in the third quarter compared with $19.5 million in the prior year quarter. Duty and tariff payments as well as the inventory purchase payments increased. However, such increases were offset by strong collections and as you will see described in the Form 10-Q filed tomorrow. Despite the significant cash outlays for operations and a $3.5 million early loan repayment on one of our consolidated variable interest entities term loans, we ended the quarter with $91.1 million in working capital.

As of September 30, 2025, we maintained financial liquidity of $34.7 million with another $19.9 million in short-term investments. As of September 30, 2025, we reclassified one of our consolidated variable interest entities term loans into current liabilities as the maturity is within 12 months, totaling $20.4 million. We intend to pay down the loan upon maturity with our cash on hand. On November 4, 2025, our Board of Directors approved the quarterly dividend of $0.45 per share payable November 28, 2025, to stockholders of record as of November 21, 2025.

Additionally, our Board of Directors approved our first-ever share repurchase program of up to $15.0 million, under which Karat is authorized to repurchase shares of its outstanding common stock from time to time through open market purchases. Looking ahead to the 2025 fourth quarter, we expect net sales to increase by approximately 10% to 14% over the prior year quarter with gross margin projected to be within 33% to 35% and adjusted EBITDA margin to be within 8% to 10%. As Alan mentioned earlier, our new business pipeline for 2026 is robust, supported by the new paper bag category offering and the addition of several key customer accounts. We remain focused on accelerating top line growth with disciplined pricing while continuing to enhance operational efficiency and cost management.

Alan and I will now be happy to answer your questions, and I'll turn the call back to the operator.

[Operator Instructions] And the first question will come from Michael Francis with William Blair.

Alan and Jian, it's Mike on for Ryan. Nice quarter. I wanted to start on paper bags. Did I hear you right that you aim to scale that to $100 million over the next 2 years?

Yes, that is correct.

And what gives you confidence in that number?

It's because there's a lot of chains are moving away from plastic bag into paper bag. And this is a segment that we're seeing that it's -- as one of the large chains in the U.S. move towards this area, more and more similar chain will follow through that. And there -- basically, that -- we feel that there is an organic growth in that segment. And also at the same time, it is not just the paper bag was handled, there's different type of bag. There's SOS bag, which every fast food restaurant will need.

And I mean with the growth of the fast food chain that is growing, the number of stores that is growing, we feel that we're competitive -- we can be competitive enough to gain market share in that segment as more and more people looking toward that area. And also, there's other bakery bag as well. There's just too many items in that segment, that make us feel that we can grow immediately. I mean, as we mentioned in our announcement that one chain, the annual sales of that number will be $20 million to $25 million per year just for one chain. And we do have 2 or 3 other chains already working in testing our paper bag and SOS bag. That's why it's -- we feel confident that this will grow quickly into an annual sales of additional $100 million a year.

That's all good to hear. And then I wanted to ask on gross margins, went lower, I think, as we were expecting and 4Q is a little lower than we were expecting. Would like to know longer term, do you think that there's an opportunity for you to get back into that high 30% range on the gross margin number? Or is that going to be difficult while tariffs are in the market?

Well, we're trying to be conservative right now at this point because there's still uncertainty. But the good thing is we feel there's a tailwind. One of the things that -- one of the issues that reduces our gross margin drastically in the second quarter was the sudden drop in the Taiwanese -- sudden increase in the Taiwanese dollar versus the U.S. dollar that it was a drop of 11% in just 3 days alone. And that 11% has come back to just about an increase of 4.5%, 5%. So basically, it's more of a stabilization in the U.S. dollars against Asian currencies.

And this is actually enabling us to go back to our vendors to negotiate a better pricing this past 2 months basically. So we're seeing that there's more tailwind in terms of the gross margin. But we do want to be conservative in terms of how we look at in terms of the numbers in September and giving us the number that we see in October, we already see some improvement in October versus September. September was better than August. So we want to see more of the positive trend before we can issue a -- increase our gross margin numbers basically.

Okay. And lastly for me, it's good to see the share buybacks. Would love to get an update on your capital allocation priorities between debt paydown, buybacks and the dividend and any potential M&A.

Well, we -- our strategy is that if we have more than $20 million in short-term deposit that we can allocate it to the dividend, special dividend, regular dividend or use it for other investment. At this point, even with the increase in tariff, increase in -- inventory-wise in the second quarter, our deposit amount is still the same, remains the same. So we're still strong in cash. And lately, we're seeing that we're bringing -- we have been bringing down our inventory to reduce our cost in terms of the tariff as well as implication costs. So we're seeing cash flowing back into our accounts. And that's why we feel like it's good for us to do some type of a share repurchase. While our stock is kind of low right now, I think it's a value to repurchase share back. At the same time, we are still looking to merger and acquisition. We do have a few in the pipeline, investment, partnership, joint venture and also acquisition. We don't feel that this will deter us in terms of moving towards this direction.

The next question will come from George Staphos with Bank of America.

Can you hear me okay, Alan?

Yes, I can, George.

So listen, maybe just piggybacking on the question on capital allocation. I want to take it from a different approach. I mean your dividend basically represents the majority of your earnings per share. Why would you consider or contemplate doing more buyback in light of that? Would you consider borrowing to buy back more stock? It would seem like deleveraging and taking care of your incoming debt paydown needs would be probably more prudent. But how do you think about that?

Well, here's the thing. The debt -- we don't have any debt on our book right now at this point. The debt that you're seeing VIE, that's on the real estate [ side -- part ] of the ventures.

That $20 million, that current liability, you said you're going to pay that down in the upcoming year?

We can pay it down. We can pay either with our current CD that we have in our short-term deposit, to utilize some of the cash on that. And at the same time, we can have third party -- we can also continue to borrow with different banks. It depends on how -- what the cash flow situation is, if there's a need to do that because right now, like I said, we don't have any debt in our Lollicup or Karat Packaging book right now. So we're -- this is one of the things that we still have time to think what we want to do, allocate our capital.

If there's other things that we can do better, then we will do that. But at this currently, the rate of CD income is dropping as the interest rate reduces. So we have to figure out which is better. If we were to pay down the debt, we actually will be making -- generating additional income. It will be an interdepartment -- intercompany loan to the VIE company in paying down that debt. So it won't be like really just paying, it will be paying down the debt for the VIE company, but at the same time, for Lollicup, it will be income -- additional income. Instead of [indiscernible] us for deposits from -- yes, deposits from the banks, there will be actually more income from the VIE company.

And George, this is Jian. I just wanted to add on to what Alan was talking about to answer your question. The main purpose really is to have one additional tool in our toolbox to further enhance our shareholder return while we continue to focus on growing the company either organically or inorganically. As we previously announced, as you probably saw yesterday in the announcement, the total amount of the Board approved of the share repurchase program is $15 million. So it is a fairly small program at management's total discretionary.

So this will be something that management will continue to evaluate in terms of a lot of the different factors, right, the pricing, the performance, the liquidity, the strength of the balance sheet, quite a few factors, just another tool in our toolbox to further enhance our shareholder return. You're right. I mean, obviously, our dividend yield is already pretty rich. So that definitely is something that we consider as we move forward with the potential execution under this program as well.

Okay. I appreciate the thoughts on that, and thanks for the reminder on the VIE. One question, back to the question, I think Mike teed up on the bag business. So let's assume you have perfect accuracy on the revenue side on bags, and that's $100 million in whatever time period you said. What kind of margin do you think you're going to get on that business? And you're already starting to see some of that show up in the fourth quarter, you said, correct? So 2 questions there.

It will be a mix -- more of a mix margin. The higher volume will be in the -- could be in the high teens on margin side, and the SOS bag could be in the high 30s. So it depends on the product line. There's also bakery bag that could be in the high 50s. So -- and also at the same time, we are selling online on these new bags that we're bringing in. The online will be even in a higher margin range. So it will be more of a balancing mixture of each, just like as we are doing right now.

So -- and also, we are actually working heavily toward in terms of getting our bags to manufacture more efficiently to increase margin from there, better sourcing of raw material from our vendors and also moving -- shifting the manufacturing site locations, potentially moving some into domestic U.S. production, that might save some costs, even enhancing more margin. So this is -- these are the things that we can do once -- as the volume increase in the next 12 months.

All right. So 2 quickies for me, and I'll turn it over to Alan. So with that being the case, and we're already in November, so almost halfway through the quarter, the range on revenue growth, the range on margin is fairly wide. And I realize you're trying to be prudent. I realize there are a lot of vagaries in the market, especially with tariffs and sourcing. But I find the range is maybe a little bit wider than I would expect at this juncture in the year. What's giving you pause in terms of maybe perhaps having a little bit narrower both growth rate range and margin range for the quarter? And then did I hear you say -- and my last question, I'll turn it over. Did you say there was an inventory write-off? I apologize, I'm on the road right now, so I don't have your materials in front of me.

I wasn't -- I'm not sure what the inventory write-off was, but I know that we're reducing inventory at this currently for the year-end. Actually, our sales have been very robust. As you said that we are in the middle of the fourth quarter already. So we're seeing our sales almost in the mid-teen range, but we just want to be conservative. And basically, at the mid-teen range, this is a sales increase organically that we haven't seen for actually for the past 3 years. That's where -- we're seeing that 12% to 14%, but we are seeing numbers very close to the mid-teens. But we just want to be prudent in terms of 12% to 14%, that's where we're trying to -- this is where we're being conservative, but we're seeing in the mid-teens right now in the growth of numbers -- actually, the sales numbers. And basically, in our industry, this is kind of very good numbers in terms of -- well above our industry right now.

And this will conclude our question-and-answer session. I would like to turn the conference back over to Mr. Alan Yu, CEO, for any closing remarks. Please go ahead.

Thank you. Thank you, everyone, for joining our third quarter Karat Packaging earnings conference call. I'd like to say thank you again, and have a nice day. Goodbye.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.