All right, we're gonna start up with our next session here. My name is Brian Butler. I'm the specialty distribution analyst at Stifel, and today I have the pleasure to introduce Karat Packaging. We have Alan Yu, the CEO, and Jian Guo, the CFO, to talk a little bit about their business, kind of the opportunities in that market.
Thank you, Brian.
Thank you very much for being here. Let's just maybe just start out, and we'll just kinda give everybody an idea of kind of where you fit into the overall U.S. fo od service disposable markets, 'cause that's what you guys do. Maybe give a little color on that, and talk about, you know, how you fit in there and where you compete.
Well, Karat Packaging, basically, we always pride ourself as a one-stop shop for all of our disposable product. Right now, if you go to some of the national brand chain accounts or a mom-and-pop, regional mom-and-pops, you'll find our product. When I say chain account, you can look at Chili's, Applebee's, Chipotle, Panda Express, and In-N-Out Burgers, regional ones, like in Texas, we have Pollo Campero, Pollo Regio, Jason's Deli, so we're almost everywhere in national chain. Also, we're getting to the supermarket business with their bakery hinged container, also meat tray, compartment trays, and we're getting to the paper shopping bag business. And very importantly, the past few years, we're growing heavily into ESG compostable product. Our last quarter, our 34% of our sales derive from the sales of our ESG product, compostable product line.
Our goal for next year is 50% of revenue derive from the sales of eco-friendly product. Another very important aspect of our company is that we're versus our competitors, we're the only company that has an online channel that sells our product online, and we're growing heavily on that part. Our revenue, by next year, we're looking at over $100 million in revenue, which right now composed of 16% of overall revenue as of this year and last year. But next year, we're looking at $100 million in revenue just on online. When I say online, we have our own LollicupStore.com that we operate. We also sell through Amazon stores. We also sell through Amazon FBA. We also sell through Walmart.com, and also, recently, we started TikTok e-commerce on that part.
Okay, and when you think of kind of that customer or the customer mix that you have out there from a perspective of most heavily weighted to restaurants, I mean, you talked about supermarket opportunities. Maybe talk about those growth opportunities, you know, kind of where you're heavily weighted right now, customer-wise, and then the opportunity growth-wise in some of the other areas that you're less focused or less in at the moment.
Sure. We basically have four channels of selling our product. One is the distribution channel, which is the most heavily concentrated one, like around 50%. Online channel is about 16%. Our national chain account's about 20-some percent, 25%, and our retail channel is about 20-some percent. Our highest gross margin are coming deriving from retail channel and online channels. Our lowest gross margin deriving from the distribution channel, but that channel have continued to grow with the supermarket chain, that we're seeing that there's a big push for our sales force going to the supermarket market channels. And also one of our growth, one of the catalysts for our growth is we've increased our sales team, sales force, almost double this year versus last year.
Continue to adding new sales force to push our product in different region, such as the Florida area, the Atlanta area, the Washington area, and also the Arizona area. So we're moving from the West Coast into the East Coast area, as we speak right now.
Right, and you're seeing very strong growth in, I guess, those kind of organic opportunities. And what gives you that, you know, I guess, competitive edge when you go to market in expanding that sales force? What are customers choosing you guys over competitors, and what's that opportunity in... versus, you know, how is the market overall just growing?
I think our customers are telling us one of our advantages, we're flexible. We're very flexible compared to our competitors. When I say flexible, meaning that if the customer says, "Hey, can I get a full truckload of 50 SKUs?" Most likely, yes. All of our warehouse, by adding new warehouses, distribution center, we're enabling ourself to stock product in area closer to our customers. Last year, we added a Chicago warehouse, Houston warehouse, and last month, we added Arizona warehouses. We're also looking to add a warehouse in Florida, in Atlanta, Georgia, and also Denver, Colorado. In doing so, basically, we can penetrate and be a one-stop shop for our customer. Also, reduces the time of transit time for our customer to order product.
They can get their product, like, instead of ordering a full truckload, they can do a will call in our warehouses the same day. That's something that we're flexible with. For a lot of our competitors, you might have to pre-order; they have to schedule an appointment. It might take them a week, or maybe at least 72 hours or even longer for them to prepare a product. For our company, we can order it right now and can probably pick up in three hours. Flexibility is very important nowadays in terms of customer service-wide for our customers.
Okay, and you mentioned the distribution centers. How should we think about those as opportunities from a perspective of, you know, you've been adding them as you've grown? You know, what can they support right now from a growth perspective, and do you need to add more down the road? What does that timeline investment maybe look like, like, you know, on the distributions, you know, helping you guys grow?
We're seeing adding a new distribution center from signing a lease agreement, because we don't build them, from signing a lease agreement to getting the product and racking up ready, it's about 4-5 months per distribution center. That's where we're seeing it. And currently, our distribution centers are almost 90% full. In California, it's 100% full. In Texas, it's 100% full. So we're looking to add additional Texas distribution center, but not in California. California has been an area that cost is growing exponentially, so we're trying to maintain as is in California, but expand outward, in like, just like we did in Arizona, okay? CapEx expenditure per warehouse D.C., adding new truck, adding new racking, it's about $500,000, adding new D.C., that part.
Okay
When you think about maybe how many do you have right now, distribution centers, and are you adding one or two a year? Is that the right way to think about growth, or is it bigger than that?
We currently have nine distribution centers, which three of them are currently manufacturing products. We're looking to add approximately, I would say, this year, additional two more distribution centers. And also this year, we're looking to grow our business by merger and acquisition, as we spoke. I mentioned that last quarter, quarter call, earnings call.
Right. And then I guess on the M&A, let's talk about that. I mean, that's an opportunity that you've talked about in the past. What does that market look like? Maybe kind of a little bit color on exactly, you know, what you guys are looking for, maybe either geographically or different product lines. You know, let's just talk about that.
Sure. Our competitor has been growing by acquisition, merger and acquisition. I can name a few, Sabert, Pactiv , and Graphic Packaging, and Genpak, and Anchor . They've grew by acquisition. Most of our growth are, actually, all of our growth has been organics, by adding new SKUs. Like this year, we're looking to add 500 new SKUs, new product line, such as the paper shopping bag, food container, food trays, and also meat trays, and the items that supermarket would need or a food processor would need. That's the kind of SKU that we're adding right now.
A couple years ago, we started looking at merger and acquisition when we first went IPO, but at that time, most of the company we looked at, they were looking for a higher valuation, a number that was not very reasonable. I see that this year, that the expectation had come down because the economy has softened, and we're seeing that more and more reasonable valuation ask in terms of a selling price. So currently, we're looking at food manufacturing that basically complement to our what we do right now. We're looking to expand cold storage. In terms of right now, we have all of our warehouses, it's basically normal temperatures. We're looking to add cold storage into our warehouse.
We're looking at refrigerator truck, so we can start moving our product from one warehouse to another, also distribute frozen. We actually, we started importing frozen mango, frozen strawberry, and also frozen fruit, diced fruits, that we can service our customers. We're looking to increase other fruit product line, frozen fruit line, basically, into our food offering. That's what we're looking at to do. So adding SKUs is one way of organic growth, but adding merger, buying, not buying our competition, competitors. I think buying our competitors is not worthy of it because most of our competitors are having, equipments are 20, maybe, 20 years old or older, older than that. And they have clientele, we have, clientele that are basically reciprocal, same, same clients, basically. So there's no need to add, buy our, competitors.
I would say that buying an industry that basically it's very similar to ours, because we want to get into supermarket. How to get into supermarket business? Is buying, buying our way into supermarket. And since supermarket, what do they sell? They sell frozen food, they sell other product. We feel that that's one way of getting into supermarket.
You're expanding beyond just the food disposables into more products?
Yes.
That kind of match with the food services. What does that market look like? Is that a lot of small players out of there, or are there some larger, chunky, kind of M&As that you're looking at from a... When you think about the amount of capital you can deploy, maybe talk about twofold there.
We feel that there's. I see that there's either a super gigantic large player or the smaller size players, which is a niche market. We're talking to the one that is smaller size in terms of $20 million revenue-wise, that has growth opportunity because they're more regional, though, that we can take them nationwide, that part. That's what we see. We see a lot of these small players. They're more regional ones, and we see the opportunity that there's a lot of opportunity that can go nationwide, basically. We see that supermarkets, more and more supermarkets are adding these specialty frozen food item into their stores, too.
When you think about the leverage and kind of capacity, I guess, you know, what do you think your liquidity capacity is to do? You know, what size deals can you do, and what leverage kind of are you comfortable with when, you know, once you complete one of these?
Sure. In the past years, from year 2000 to 2022, we invested heavily into equipment, manufacturing equipment. Just in two years, we spent over $40 million in buying the equipment, okay? But then we stopped buying equipment last year, and we resorted into a lot of cash flow. Right now we're sitting on over $30 million in CD deposit, generating interest income, and we're able to. We then started giving out dividends and increase our dividends since August of 2023. Even with the distribution dividend, we'll continue adding more money into our savings account, accumulating more. So we're comfortable in terms of buying a company that's about $20 million or somewhere around that area, $20 million.
But we did one small acquisition back in 2000, end of 2000, 2001. It was $1 million, a distribution manufacturing facility in Hawaii. That turned out to be a great investment. So right now, we're looking at anywhere from $10 million to $15 million, $20 million. On EBITDA, seven to 10 times, seven to 10 times EBITDA, which we feel that's the right range of EBITDA in that part. And also, we're looking at acquisition that has higher gross margin than currently we have. Right now, we have 37%-40%. We're projecting 37%-40% gross margin. We're looking at acquiring someone with over 50% in gross margin-wise.
Is there a large population with growth margins over 50%?
Actually, believe there are, there are.
All right. You mentioned the manufacturing facility. You know, you've kind of dialed back some of your, you know, or your own manufacturing with outsourcing that. How should we think about that? Is manufacturing still a meaningful or material, you know, part of the strategy going forward? Or is it really now more straight distribution in that piece of the business?
This is one of the strategy we are able to attract our chain account business. That we kind of sell to our chain account that we are nimble. We can manufacture domestically, or if there's an ocean freight disruption, we can do it immediately, turn on our equipment. We can reduce our manufacturing and depend on overseas. Either way, it all depends on what's going on in the part of the world. Like right now, recently, there has been, just starting this month, June first, a major supply chain disruption in the ocean freight arena. If you wanna get a container out of China, you probably won't get it for 30 days.
The ocean freight price has gone up from $1,400 to $7,000 over like over the week, basically. But we see that as a short term, basically, due to the geopolitical reason, basically. So for manufacturing-wise, yes, we resorting to reduce manufacturing, but like this week, we're asking our production line to increase capacity just for this month, to help make sure that we don't run out of our product for our customers. So basically, that ensures our customers that they just need to give us the business, and we'll handle the logistic part. Either we may produce it domestically, or we can produce it from overseas. But we ensure that we don't just raise the price because of the issue like this.
You're not necessarily increasing your manufacturing footprint, but you're gonna keep it to service everybody. Is that a fair way to look at it?
Yes.
All right. Then, maybe we'll, we'll switch gears a little bit and talk about, you mentioned the eco-friendly products. So what falls under that definition of eco-friendly? And when you talk about, you know, your percentage of 34% growing, you know, just let's understand what's included in that definition.
When people say about eco-friendly, it's more about an item, is it compostable? Is it 100% compostable, or is it just 90% compostable, okay? When we talk about eco-friendly, it's more of 100% compostable, such as bamboo straw, such as a paper shopping bag that is basically 100% made of paper without plastic lining. That's what when I say compostable. First, one thing is, we don't sell any Styrofoam product, so it's either paper or plastic. Plastic is not compostable. Plastic is not considered eco-friendly, so it has to be PLA material that is 100% compostable in a commercial compost site, or paper bag that is 100% paper without any plastic lining in it. That is eco-friendly. That's what I saw when I say compostable.
Okay, and when you think about that eco-friendly piece, that growth versus standard, how does that compare, or how has it maybe trended over the last, you know, four or five years? Obviously, sustainability, circular economy is continuing to pick up importance, and just what do you see there, growth opportunities?
Three, four years ago, our eco-friendly, compostable, revenues was about 25% or under of all our sales. Last quarter, 34%, and we're seeing that 50% by next year. Majority of that increase is by the push from local municipality. New state and city, new rules are forcing the banning the Styrofoam, banning the plastic. Like Hawaii, Bill 40 bans plastic in Hawaii starting April of last year. San Mateo County banned plastic completely. Malibu City banned plastic. Santa Monica City banned plastic. New Jersey banned plastic. So these... I mean, these push are mainly done so by the local city and states to do that, basically.
Is that mostly on the East Coast, West Coast, you know, kind of Hawaii? I mean, what... If you were to compare maybe the distribution of, you know, where those sales are happening, is it really just the East and West Coasts? Is that the biggest chunk, or?
Pretty much, yes, you're right. Also, even the coastal line of Mexico, like Los Cabos and other city in Mexico, like Puerto Rico, they're very eco-friendly conscious as well.
When you think about how big that can get, you know, it's gonna be 50%. Can that get to 75%? I mean, is that realistic, or is it really somewhat limited just by kind of those geographies?
At this point, I would say 50% is pretty high already, because there's still a lot of companies using Styrofoam. When people use Styrofoam, the next step they move up is paper and plastic, not really, really jumping to a compostable product. That's really odd. Yeah.
Is that an opportunity, or is that a selling point for you guys when you're winning new business, is that you can, you know, move people away from the Styrofoam to the compostable?
Well, even if we were to take 5% of the market share of the Styrofoam, that switch from Styrofoam to paper and plastic, that would be basically a big jump for our revenue-wise. Yes.
When you think of the cost of the eco-friendly, how does that compare to the other products that are out there? How big of a decision is that from a customer perspective to move from one to the other? Are there customers really asking for more eco-friendly products?
If you were, say, four or five years ago, or even three years ago, the price difference between a plastic and eco-friendly product was probably 50%-60% difference. Today, because more and more people are using eco-friendly product, it's more widely used, and also there's more players in terms of manufacturing these products. It used to be just Taiwan manufacturing these eco-friendly products. Now China is manufacturing these, Vietnam, Malaysia, Indonesia, they're all manufacturing these eco-friendly products. The cost has come down. So I would say right now the price difference, the gap, it's about 20%-25% difference. Really not much of difference. So it's for a, an operator to move from a plastic to eco-friendly, it's an easier decision to switch versus if it was a 50% difference in cost-wise.
When you think about that decision to switch, what kind of holds back customers at this point, as cost has kind of come down? Is there a performance difference between the eco-friendly products and some of the standard products that are out there?
Yes. I would say, what performs best? Styrofoam. Styrofoam performs best, and that's why you see some of the major chain, they just wanna hang on to Styrofoam as long as they can because they hold heat better, they're cheaper, they're lighter, and that's. Well, Styrofoam is the best, basically. Then next step is, okay, plastic. All right, so plastic is recyclable. It's actually better than eco-friendly product, because eco-friendly product, where do they go to? I mean, they're compostable, unless you put it in a commercial compost site, it goes to landfill anyway. So it's the same thing with paper and plastic, so that's the thing. Yeah.
All right, and then let's maybe touch a little bit on costs and think about how costs kind of have trended over the last year or so. And then you think about freight. Obviously, ocean freight always comes up as a big topic among investors with you guys. And how is that recently being set still higher, but not as high as some expectations? How should we think about that through the back half of the year? You know, how exposed are you to continuing ocean freight until the following year reset?
Well, I, we have recently signed a contract, an agreement with 5 different carriers in May, and basically, that's keeping our costs low. This is the ocean freight right now, last actually, up to May, was the lowest ever, in a decade, basically. It was not only just recently, last week to this week, they shot up. But the thing is that we're still able to get 40% of the contracted rate, and then the 60% that we might have to go out and source and for the higher rate. But what we're trying to do is reduce the amount of container we need at a higher rate, and by turning on the machine that we have in California and Texas, to reduce the exposure of the increase.
We know that this time, the increase, ocean freight increase is different than the COVID period. The increase in COVID periods, the rate increase was due to the demand increase. Overall demand in domestic usage in the U.S. skyrocketed. But this current increase is due to the fact that the U.S. just imposed a new tariff that is going to start in end of July on all the solar panels, on batteries, and other things. So all these manufacturing overseas and domestic importers, they're ramping up to ship as much as they can before the tariffs begin. Now, once these products are shipped, and once the tariffs start in August, there's nothing to ship. Basically, we're gonna go back to an even worse situation than it was actually two months ago.
Right.
This, everyone knows that this is a short-term increase spike because short-term increase in demand on that part.
When you think about that, right, so you're gonna have a short-term issue on shipping, but hopefully, you know, that's gonna ease in the back half of the year. But how should we think about shipping just in general? Are you able to pass those costs on in pricing, or is that something that you end up having to kind of maybe lags, and it takes a little bit of time to recoup some increased shipping costs?
Well, the good thing is we normally increase our inventory level in March and April. So we actually ramp up a lot of inventory to anticipate new businesses. We've discussed internally that we're gonna take this as an opportunity for other companies that are our competitor are shorting their customer the product. They can come to us for assistance. This will be an opportunity for us to gain new businesses by helping our competitor helping the customer out there, because our competitor will be running low or running out of product due to this issue. So right now, it's not only about the ocean freight price going up. You can't even get a container to ship out of Asia. That's a major problem.
And that's being addressed. How, I mean, you have, you have the inventory, but is that longer-term, structural problem, or is that more just short term?
It's a short term, but that chain account can't afford to have product run out for not even a week.
Right.
So they need somebody like us to support them. And this is how we actually got more business during the COVID versus prior to COVID. Prior to COVID, majority of our customer, they were doing single source. COVID, actually, they learned after COVID never to do single source. Always have dual sourcing, because you don't know what's gonna happen. And you want. You have your two source, basically, you ensure that they have both of the source have plenty of inventory for two months of stock. If one goes out, you have another one that can fill out, fulfill the other one. So basically, you limited yourself in terms of running out of product. Supply chain 101 , basically, just having multiple sources is always better.
Even for us, we source not only from one country, we source from seven, eight different countries. Similar product, we source from China, Vietnam, Malaysia. Now we're going even to Indonesia to get a product from there, from that part of the world.
Okay. And then on the cost side, the other piece, kind of labor, maybe talk about that and how is that from a perspective of kind of staffing up the distribution centers, as well as the addition of additional sales? How has labor cost trended in, you know, the last couple-
We're seeing our labor costs coming down. Primarily, you've all heard that California labor costs have skyrocketed. California oil price has gone up. They increased the price on the oil, the taxes on the oil, also raising the minimum wage for the fast food chain, which also caused an increase in other business as well. So we're moving... That's one of the reasons that we're moving to Arizona. Arizona labor cost is lower than California, and also we're focusing more in Texas. Texas labor cost is also less than California. We have less labor dispute issues, legal issue on the labor part. We have less workers' comp costs in Texas and Arizona. So that's why we're opening more regional centers versus focusing more in California.
Okay. And when you think, I guess, when you put it together, right, the organic growth that you have, you know, some of the operating leverage and then some of the cost, you know, lower costs on labor, how should we think about margins just, you know, on a, on an annual trend? I mean, are you able to raise those 20, 30 basis points each year, or what kind of operating leverage and, and, and, you know, opportunity is out there for the business?
Sure. In year 2019, our margin, gross margin were around 25%-26%, okay? Last year, our yearly, overall margin was about 36%, and this year, last quarter, doing our earnings call, conference call, we've raised our guidance to 37%-40%, the entire year of 2024. So actually, we're able to raise our margin versus the previous year on that part.
As you continue to get... I mean, is there a limit? I mean, how high do you think, you know, this business can, can really do from a margin perspective?
I think we're, we're pretty comfortable at the 37%-40%. That's pretty high already to, in our industry wise.
Right. I mean, you're already kind of... So that's, I guess that's what I was asking, is: Is that kind of industry near peak levels, and that's the rate to look at and maintain?
That's the rate. Our goal is to maintain that rate by increasing our revenue on the online business.
All right. And then when you think-
Oh, I was just gonna say, that's actually already way higher.
Yeah.
Our margin is much more superior than our competitors and that's just by the operating efficiency, the nimbleness that we have in the operations.
All right. And then when you think of that next step down to the cash flow, that conversion, how should, you know, investors think about converting that EBITDA or that margin into cash flow? What does that cash flow look like, especially when you consider some of the growth opportunity, you know, the capital spending? So maybe talk about capital spending for growth, and then what does that translate to free cash flow in our last minute and a half here?
I'll let Jian discuss about the cash flow.
Yeah. So in terms of the CapEx, so we talked about historically, just the past, past couple of quarters, that we're pivoting into an asset-light model, meaning we're importing more and manufacturing less in general, high level, domestically. Doing that allows us to increase our, to continue to build stronger cash flow. So I think, in, in terms of the overall, overall adjusted EBITDA margin, I think what we're projecting, roughly mid-teens, is probably a good level that we should be able to maintain, and we continue to generate pretty strong cash flow from our operations. Last year was actually the first year we started our, regular dividend program last August, and we've been continuing to increase the dividend payout to increase the return to our investors.
So our cash flow has been pretty strong. Right now, I think Alan mentioned this already, we have knocked off $30 million in our investment account, and we're ready to pull the trigger on some sort of M&A opportunities.
All right. Well, great. Well, thank you very much for being here. We're right on time.
Thank you.
Thank everybody here.
Thank you, all. Thank you.
Thank you.