Karat Packaging Inc Aktie

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.

Good afternoon, everyone, and welcome to the Karat Packaging Inc. Second Quarter 2025 Earnings Conference Call. [Operator Instructions] Please also note, today's event is being recorded.

At this time, I'd like to turn the floor over to Roger Pondel. Sir, please go ahead.

Good afternoon, everyone, and welcome to Karat Packaging's 2025 Second 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 turning 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 Karat'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 today's 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 recently 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 achieved a record second quarter performance marked by a 13% increase in sales volume, 10% growth in net sales and 20% growth in net income year-over-year despite a significant foreign currency headwind due to a sudden substantial weakening in the U.S. dollar against New Taiwan dollar.

Heading into the third quarter, we continue to diversify our global sourcing and expand into new countries and geographies, and we see the currency pressure starting to ease.

Our record quarter performance is a testimony to Karat's nimble business model and resilient global supply chain, which allow us to early success in navigating the supply chain disruption and trade uncertainties.

We are swiftly diversifying our sourcing footprint, reducing reliance on China to just 10% in the second quarter while implementing plans to further expand our sourcing across other Asian countries and Latin America to enhance supply chain resilience and flexibility.

In addition to the sourcing diversification, Karat's ability to quickly ramp up existing domestic manufacturing operations enables us to respond rapidly to customers' needs. Together, these actions have further enhanced our agility and competitiveness and are helping us to secure new business and position the company well for sustained growth in a challenging external environment.

Business trend remains strong as we proceed into the third quarter and the remainder of the 2025 and continue double-digit sales growth across our major markets, including California. Further, recent new business wins from a number of large national chains are scheduled to begin shipping in the third and fourth quarters.

Our new distribution center near our Chino headquarters is now fully operational, significantly strengthening our logistic capabilities and enabling even faster delivery time. This facility also supported inventory buildup during the second quarter, positioning us well to accommodate our anticipated growth in the second half of the year.

As previously announced, we implemented price increases for select products on April 1, followed by broader price adjustment across most of our product lines in late May. We continue to assess the impact of these changes, along with potential effects from the new tariffs effected in August. Karat remains focused on accelerating top line growth and profitability through product innovation, strategic expansion and a track record of being a dependable supplier to our customers. At the same time, we continue to drive operational efficiency through disciplined cost management.

In the second quarter, we improved our operating cost leverage, saving $1 million in online shipping and marketing by switching provider even as shipping volume increased. We also shifted our online sales focus from third-party platform fulfillment through our own e-commerce storefront, lowering online selling costs and more effectively utilizing online marketing dollars.

These efforts reflect our ongoing focus on balancing growth with profitability and building long-term operational resilience. We believe Karat is well positioned for continued profitable growth.

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 Q2 performance, followed by an update on our guidance. Net sales for the 2025 second quarter were $124 million, up 10.1% from $112.6 million in the prior year quarter. The increase was primarily driven by year-over-year volume growth of 13%, partially offset by $3.3 million in unfavorable pricing as chains and distributors growth outpaced online and retail channels.

Sales to chain accounts and distributors were up by 11.4% Online sales increased 6.8% over the prior year quarter, reflecting our continued focus on expanding this high-margin category. Sales to the retail channel turned positive with an increase of 1.9%.

Cost of goods sold for the 2025 second quarter was $74.9 million compared with $69.2 million in the 2024 second quarter.

The increase primarily reflected $4.0 million of higher product costs resulting from increased sales volume. This was partially offset by more favorable vendor pricing and product mix.

Additionally, ocean freight and duty costs rose by $2.1 million due to higher import duty costs impacted by the recent tariffs, coupled with an increase in import volume of 37.0% as we increased inventory ahead of expected business expansion during the second half of 2025. At the same time, average ocean container rates during the 2025 second quarter decreased 4.0% year-over-year.

Gross profit for the 2025 second quarter increased 13.1% to $49.1 million from $43.4 million in the prior year quarter. Gross margin increased 110 basis points to 39.6% compared with 38.5% in the prior year quarter.

Gross margin benefited from lower product costs as a percentage of net sales, mainly due to more favorable vendor pricing and product mix and reduction in depreciation expense as a percentage of net sales.

These improvements were partially offset by higher ocean freight and duty costs as a percentage of net sales increased to 9.5% during the 2025 second quarter versus 8.6% during the 2024 second quarter.

Operating expenses for the 2025 second quarter were $32.6 million compared with $32.3 million in the prior year quarter.

The increase was mainly due to higher shipping and transportation costs for off-line orders from increased shipping volume, increased rent and higher salaries and benefits.

These increases were partially offset by a decrease in shipping costs for online orders despite the increase in online orders shipped, online platform fees, lower marketing expense, stock-based compensation and a gain recognized from disposal of machinery and equipment.

Operating income in the 2025 second quarter increased 48.9% to $16.6 million from $11.1 million in the prior year quarter.

Total other expense, net, was $2.0 million for the 2025 second quarter compared with other income, net, of $1.0 million in the prior year quarter. The difference was primarily due to a loss on foreign currency transactions of $2.9 million compared with a gain of $0.3 million during the 2024 second quarter.

Net income for the 2025 second quarter increased 19.8% to $11.1 million from $9.2 million for the prior year quarter. Net income margin was 8.9% in the 2025 second quarter compared with 8.2% a year ago.

Net income attributable to Karat for the 2025 second quarter was $10.9 million or $0.54 per diluted share compared with $9.1 million or $0.45 per diluted share in the prior year quarter.

Adjusted EBITDA for the 2025 second quarter was $17.7 million compared with $15.7 million for the prior year quarter. Adjusted EBITDA margin was 14.3% of net sales for the 2025 second quarter compared with 13.9% for the prior year quarter.

Adjusted diluted earnings per common share was $0.57 for the 2025 second quarter compared with $0.49 for the same quarter last year.

We generated operating cash flow of $9.8 million in the second quarter and ended the quarter with $116.8 million in working capital.

Our free cash flow was $9.6 million in the second quarter.

As of June 30, 2025, we had financial liquidity of $44.7 million with another $26.4 million in short-term investments.

On August 5, 2025, our Board of Directors approved a quarterly dividend of $0.45 per share payable August 27, 2025, to stockholders of record as of August 20, 2025.

Looking ahead, we expect net sales for the 2025 third quarter to increase by approximately 9% to 10% over the prior year quarter. We expect our gross margin for the 2025 third quarter to be in the low to mid-30s, and adjusted EBITDA margin to be within 10% to 12% as our cost of goods sold have begun to reflect inventory brought in with the elevated tariffs.

Currently, we are maintaining our full year 2025 guidance for net sales, gross margin and adjusted EBITDA margin pending potential impact related to additional tariff changes.

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

[Operator Instructions] Our first question today comes from Michael Francis from William Blair.

This is Mike on for Ryan. Nice quarter. I wanted to unpack some stuff on the guide, but first, let me start with prices. I was surprised to see price was negative on the quarter, especially with some of the tariff price increases.

So I guess 2 parts. Why was price negative on the quarter? And then what should we be expecting from the impact of price in the second half?

We are currently holding on to the pricing with some minor increases in certain category, that's it, because we're seeing that the -- there's more visibility in terms of every country that we import now on the pricing. And also one of the things is that we mitigated -- we will be starting to mitigate our costs by moving some of the product that we source from certain countries, from Taiwan, into other Asian and Latin American countries with lower tariff as well as the -- our cost of goods purchase has been reducing.

So we have some new vendors and vendors that we work with looking to reduce our costs, and that's going to help us in terms of mitigating any potential tariff increase -- impact.

Okay. So if I think about that right with your second half guide that you referred to, should I be thinking sort of a similar volume growth and price impact that we saw in this quarter in the third quarter?

Jian, would you be able to answer that question?

Yes. So to answer your question, Michael, going forward, second half of the year, we do expect pricing to be close to breakeven compared to about a negative 3% in this quarter.

Okay. Understood. And then with that, I noticed that there's -- embedded in the guide, there's a sequential decline in gross margin. So wanted to know what the puts and takes of that? Is it tariffs coming through the P&L? Is it just lower profitability, sourcing from other countries? I just would love to unpack that.

Well, currently, I would say that the impact -- the positive impact of the new sourcing will be hitting -- we'll be actually receiving that impact in the fourth quarter.

So right now, third quarter, we are still seeing that some of the tariffs that we brought in, in the second quarter, we're seeing that with a higher tariff costs and that should be mitigated in the fourth quarter.

So right now, we're trying to see where the -- how much impact it will be. That's why we mentioned in the second -- first quarter -- during our first quarter earnings conference call, we mentioned that the products brought in, in the second quarter will be sold in the third quarter. So second quarter will have a higher gross margin and third quarter will have a lower gross margin.

And also the bigger impact was because many of the products we source from Taiwan had a currency FX loss in terms of devaluation into U.S. dollars, that's causing the increase in some of the cost of goods sold. Decreased our gross margin as well.

Got it. So if I'm understanding you right, it should be down in the third quarter, but then gross margin should recover some in the fourth quarter?

Yes, that is my understanding.

Got it. And then last one for me. I just wanted to know what you're seeing on July trends? And have you seen any sort of prebuy from your customers ahead of the August tariffs?

We are seeing, especially from some of our national chain accounts, their sales in July have been very strong. And we have -- due to the tariff, we've seen several -- many of our smaller importer competitors gone -- reduce their inventory. And our volume has increased in terms of a certain category that people were sourcing from overseas. So we're seeing strong demand in terms of July.

Especially in California, we're seeing more than double-digit sales increase in California market. It started in June and July was basically follow the trend.

So we're pretty -- we believe that the revenue volume double digit is very -- it's something that we're -- we know that we can definitely beat it.

[Operator Instructions] And our next question comes from Josh Axel from UBS.

A question for you on the online sales. Can you give a little guidance on what you're thinking for the second half of the year as far as online sales, the kind of growth you're targeting and what you're seeing in that area? And then I have one more question for you.

Sure. No problem. We believe online sales will continue to grow, especially we just added a new platform called Sysco Marketplace (sic) [ Sysco Market ]. That seems to be doing quite well for us and it basically fulfilled by our own logistics warehouse.

We've moved away from Amazon FBA fulfillment by a third party because the cost was just too high, and there's a lot of issues in terms of inventory reconciliation. And by moving away from Amazon FBA, our margin -- our revenue dropped a little bit, but our margin has significantly gained a lot in terms of margin-wise. And we have better control of the inventory as well.

So we do see our online sales to grow continuously, just like we have been in the past months -- years.

Do you think you can get back to double-digit online growth in the second half of the year? Or with losing Amazon, is that going to be a little more difficult?

I would think that in the fourth quarter because we're -- the Sysco place -- marketplace (sic) [ Sysco Market ], we started it just about 3 months ago and it has built a lot of momentum. And we're adding -- we were -- we probably had about 500 SKUs in the Sysco Marketplace (sic) [ Sysco Market] and we're looking to add another 750 SKUs this month.

So these definitely will turn into revenue. So we believe that in the fourth quarter, online revenue should be able to go back to double-digit growth, yes.

Okay. Great. And then the last question, can you just comment, Alan, on what you're seeing in the M&A landscape, if you're looking at anything? And if so, what or if maybe prices are -- just don't seem attractive or just where you are?

Yes. We have -- we are still looking at M&A. And also we analyze the current -- the previous -- past 6 months. There has been some -- a couple of merger and acquisition in our packaging space and it seems like the sellers were not getting as much as they were hoping for. But the price is still, I believe, it's not to where we believe it should be.

And also most of our competitors who bought these, the acquirees, were just to gain the product line and market shares, which we can basically increase our -- bring in new SKUs and we can do it ourselves.

Our goal with M&A is basically strategically, it has to be either a location or a client base or items that we do not currently carry. So we are still looking in that segment.

And also, of course, adding new product lines, that's what we've been doing. In the past month, we're looking to partnership with other people. Discussion has been going on for over several months in the past with different kinds of vendors that we have to see if there's any potential that we can work together in terms of just like we had in the past with the bagasse manufacturer joint venture.

So these are the things that we're looking at. So we're not just saying that we're just looking at one segment, we're looking at different areas.

And with that, ladies and gentlemen, we'll be concluding today's question-and-answer session. I'd like to turn the conference call back over to Alan Yu for any closing comments.

Thank you, everyone, for joining our Karat Packaging second quarter earnings conference call.

And I would like to say thank you all, and have a nice day. Bye-bye.

Ladies and gentlemen, with that, we'll conclude today's conference call and presentation. We do thank you for joining. You may now disconnect your lines.