Good day, and welcome to the Karat Packaging Inc. first quarter 2022 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Roger Pondel. Please go ahead.
Good afternoon, everyone, and welcome to Karat Packaging's 2022 first quarter earnings 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 his Chief Financial Officer, Jian Guo. Before I turn the call over to Alan, I wanna remind all 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 recently filed 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, and adjusted diluted earnings per share, 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. With that, it is my pleasure to turn the call over to CEO, Alan Yu. Alan?
Thank you, Roger. Good afternoon, everyone. We're pleased to be here with all of you today. Our first quarter 2022 result again demonstrated excellent operational execution, achieving record sales and strong margin expansion. Our positive sales performance was broad-based across all categories, including national and regional chain account, distributors, online and retail channels. Sales were boosted to some extent by Karat's Tea Zone branded products, particularly bubble tea supply and our newly expanded logistics services. We continue to gain wallet share with our existing customers, and we added many new customers through wholesale distribution and through e-commerce, direct-to-consumer channels. Our online presence continued to be an important initiative. In addition to selling Karat product, we plan to expand the selling platform on our site, enable other food service purveyor to showcase and sell their product, and creating a convenient one-stop shopping option for our customers.
The company achieved gross margin of 32.5% in the year 2022 first quarter, increasing 390 basis points over the same quarter last year. Despite continued supply chain challenges and higher freight costs, this demonstrated our ability to improve operational efficiencies and cost leverage. Gross margin also benefited from freight and duty capitalization. Demand for compostable and biodegradable products is on the rise as more cities and states are beginning to enact regulations to ban single-use plastic and styrofoam products. Karat's longstanding commitment to providing environmentally friendly disposable products has empowered us to grow into a leader in the industry.
As we continue to provide new and innovative offerings, just subsequent to the close of the quarter, we enter into a joint venture agreement to build a 180,000 sq ft state-of-the-art automated factory in Taiwan to manufacture 100% compostable foodservice products from bagasse, which is a derivative of sugarcane pulp. The new plant, which will feature state-of-the-art robotics, is expected to produce approximately 7,600 tons or 650 containers of takeout boxes, plates, bowls, tableware, and other bagasse products in the year 2023. About half of the product produced at this plant will be earmarked for Karat customers. This will further enhance Karat's vertical integration in its supply chain and minimize dependence on imported goods from China, which is where most bagasse products in the United States are currently imported from.
Longer term, it is our objective to build a similar plant in the United States and become a dominant domestic manufacturer in the near future. I'm also happy to mention that as of this month, we've expanded our warehouse capacity, adding total of 90,000 sq ft of new leased warehouse space in California and Hawaii. We also expanded our South Carolina warehouse space by 50,000 sq ft to meet continuing increasing demand. This much needed additional warehouse space will give us more growing room and allow us to further increase our fulfillment rates and support additional sales growth. As we proceed into 2022, we believe we will see continued business growth further accelerated by the expansion of our warehouse base and continued operating efficiencies.
We are currently targeting net sales for the 2022 second quarter to be in the range of $116 million-$118 million, up about 24% at the midpoint of the range over the same period last year. Accordingly, for the full 2022 year, we are increasing our guidance with net sales expected to be in the range of $445 million-$449 million versus $360 million in the year 2021. Up from last quarter forecast a full year growth guidance of 17%-19% or $426 million-$433 million. Our gross margin goal for the 2022 full year remains 31%-32% on average.
The ocean freight costs are challenging to predict. We currently expect the freight rate to remain elevated for the remainder of 2022. While some of our higher first quarter ocean freight costs will be absorbed in the second and possibly the third quarter of 2022, we reiterate the full year average gross margin goal of 31%-32%. We currently expect some tailwind from foreign currency gains and continued operating efficiencies to offset most of our expected unfavorable impact on freight and duty capitalization in the second quarters. I want to leave adequate time for questions. With that said, I will turn over the call to Jian Guo, our Chief Financial Officer, to discuss our financial results in greater detail. Jian.
Thank you, Alan. As Alan mentioned, we delivered another quarter of impressive sales growth and a significant increase in adjusted EBITDA. We reported record quarterly net sales in the 2022 first quarter, rising 39% to $105.4 million from $75.7 million in the same period last year, reflecting strong growth from existing and new customers. Our new product offerings, greater product penetration and price increases implemented throughout the second half of 2021 and the first three months of 2022 all contributed to the strong sales growth. By channel, sales to distributors, our largest channel, grew 48% for the 2022 first quarter. Sales to national and regional chains advanced 36% and online sales increased 18%. Sales to the retail channel rose 32% for the quarter fueled by our bubble tea suppliers.
Gross profit increased 59% to $34.3 million for the 2022 first quarter. Gross margin for the 2022 first quarter rose to 32.5% from 28.6% for the same quarter last year. The margin expansion was primarily a result of the strong sales growth in our higher margin products, improved operating efficiencies and fixed cost leverage along with favorable foreign currency impacts. Also benefiting gross margin was strong pricing to offset increased product, ocean freight and labor costs. Although some of the higher first quarter freight costs will not be absorbed in cost of goods sold until the second or possibly the third quarter of 2022, overall freight costs as a percentage of net sales increased from 8.6% in Q1 2021 to 14.4% in Q1 2022.
While we currently expect the ocean freight rates to remain elevated for the remainder of 2022, as Alan mentioned, we are confident that we will continue to effectively manage the freight costs and deliver on our growth margin goal for the full year. Operating expenses for the 2022 first quarter were $24.8 million or 24% of net sales, compared with $17.9 million, also 24% of net sales in the prior year quarter. Our operating cost leverage remained consistent with the prior year quarter as the operating efficiencies achieved were offset by higher shipping, transportation and production costs and stock-based compensation. Heading into the second quarter of 2022, we are seeing some abatement in the shipping cost increases and expect stock-based compensation to be more comparable year-over-year.
Other income net was $1.1 million for the 2022 first quarter, compared with $465,000 in the prior year quarter. We recognized an interest income of $1.3 million in both quarters from the change in the fair value of our interest rate swaps. The interest expense on our line of credit and term loans decreased $572,000 year over year, primarily due to the decrease in our average debt outstanding from the first quarter of 2021 to the first quarter of 2022. Provision for income taxes was $2.7 million, or 25%, for the 2022 first quarter, compared with $1.2 million or 28% for the prior year quarter.
The higher tax rate in the prior year quarter was attributable in part to inclusion of certain non-deductible costs related to Karat's initial public offering, which was completed in April 2021. Net income more than doubled to $7.9 million for the 2022 first quarter from $3.1 million for the same quarter last year. Net income attributable to Karat Packaging Inc. was $6.7 million or $0.34 per diluted share for the 2022 first quarter, compared with $1.8 million or $0.12 per diluted share for the same quarter last year. We delivered record first quarter consolidated adjusted EBITDA of $13.0 million, an increase of 90% from $6.8 million a year ago.
Consolidated adjusted EBITDA margin improved 330 basis points to 12.3% in the first quarter, from 9.0% for the same quarter last year. Adjusted diluted earnings per common share more than doubled to $0.36 from $0.15 in the prior year quarter. Net cash used in operating activities was $11.4 million for the 2022 first quarter versus net cash provided by operating activity of $4.5 million for the same quarter last year. The difference primarily reflected changes in working capital, including inventory build-up, to accommodate higher demand in our peak season and an increase in accounts receivable from higher sales, partially offset by higher account payables and accrued expenses.
We finished the quarter with $93.7 million in working capital compared with $72.1 million at the end of 2021. We believe Karat is well-positioned to execute on its future growth strategies. As of March 31, 2022, the company had $10.2 million of borrowing outstanding under the line of credit, an additional availability of $29.8 million under this line. We invested $4.8 million in CapEx during the 2022 first quarter, principally for manufacturing automation. Alan and I will now be happy to answer your questions, and I'll turn the call back to the operator.
Thank you. We will now begin the question-and-answer session. To ask a question, you may press star then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Once again, pressing star then one will allow you to ask a question. At this time, we will pause momentarily to assemble our roster. The first question will be from Jake Bartlett from Truist Securities. Please go ahead.
Great. Thanks for taking my questions and congrats on a great quarter. Good start to the year. My first question is on the increased guidance for sales in 2022. If you could maybe just give us some details to what the main drivers of the increased guidance is. It seems like demand for a while now has been really kind of stronger than you can accommodate, so it feels like it's you know demand has already been strong. I'm wondering, is it the increased capacity that you've added you know in the quarter? Is it just the increased staffing that you're seeing? Then also, if you can touch on whether you know there's more pricing assumed in that guidance.
I think the pricing, at least what I had, was about 5%-7% was gonna be running through in 2022. Maybe any update there?
Sure, Jake. Well, one thing that we've seen that the increase is coming from demand. For example, you heard that we are adding additional warehousing space both in California and Hawaii. It's because we've seen the demand in Hawaii has actually explosively grew a lot than what we anticipated it was going to be. There's more tourists going to Hawaii and there's basically everywhere there's a demand for packaging. Same thing in California, that we're shipping to Las Vegas and Arizona. There's a really strong demand increase on the packaging side for the state of Arizona and Las Vegas. More and more tourists are coming into Vegas and more and more tourists are coming to California.
Another thing is, our boba tea supply. We are seeing a huge demand in the growth of boba tea supply this first quarter already that we're entering into our peak season in the second quarters. That has contributed to a large sum of growth in our overall revenue-wise. Lastly, of course, more and more people looking to go into the eco-friendly lines. We're seeing a high demand in the bagasse products, in the compostable utensils categories, and our foil line's growing. I would say it's particularly there's two categories growing really strong, but other categories are growing as well. Another thing is our fill rates are going up.
That's automatic. Last quarter, I mentioned that our fill rate was only 60%, but we actually increased our fill rate to approximately 70%-75% now. It automatically increases our revenue. I wouldn't attribute much of the increase in guidance toward the price increase on that part.
Great. That's really helpful. Then, you know, on gross margins, if you could just give us how much the first quarter was helped by the capitalization of freight and duty, that would be helpful. You mentioned in the guidance in the press release that that includes, you know, that moving piece. Maybe just help us understand how that might flow through the rest of the year. It was a help in the first quarter. Does it hurt in subsequent quarters? Just help us understand how to model the quarterly progression there.
Jian, I'll let you answer that question for Jake.
Sure. Hi, Jake. Thank you so much for the question. In terms of the impact from the CapEx capitalization in Q1, the total dollar amount of the impact was about approximately $6 million. As we mentioned in our remarks, even with the $6 million in benefit in our cost of goods sold in the first quarter, overall, ocean freight costs remained as a % of sales much higher year-over-year. Last year, Q1, we were at 8.6% of sales versus Q1 this quarter, it was 14.4%. A lot of that was primarily because we were really stocking up. We brought a lot of the shipments from Asia to stock up our inventory in anticipation of our peak season starting with the second quarter.
To answer the second part of your question in terms of expectation for the remaining quarters in 2022. In Q2, we expect we'll absorb probably a good chunk of the benefit that we realized in Q1 in terms of the capitalized ocean freight cost. That said, I will highlight a few factors as we think about our gross margin for the second quarter as well as for the full year 2022 holistically. Even with a little bit of a headwind, if you will, from the ocean freight capitalization in Q2, we are seeing some favorable impacts and we do expect to be able to offset at least partially or mostly some of the negative impacts from the ocean freight capitalization in Q2. Just to name a few.
One, we are seeing a fairly significant positive impact from foreign currency impact, just really strong USD against some of the currencies in Asia. We continue to see improvement in our product mix, as we continue to shift into higher margin products, as well as continue to improve on some of our on the operating efficiency. We are seeing quite a few positive factors that are trending towards basically offsetting the expected negative impacts in Q2, and that's the reason why we reiterated that for the full year 2022, we still expect to deliver on the growth margin goal of 31%-32% on average.
Great. Thank you. That's really helpful. My next question is on the JV that you're entering into in the facility. You mentioned, Alan, you know, some tons of packaging and some you know, containers. Could you help us understand what that might mean for sales in 2023? You expect that facility to be you know, open kind of early in the year and that this could be a benefit for the whole year? That's my next question. I have one more quick follow-up.
Sure. Well, as you said, we expect 2023 to be the year. Well, actually, the year that many states and cities will be transforming from Styrofoam or paper and plastic into 100% compostable packaging product. We've already received the news that the County of Los Angeles, starting May 1, is gonna ban all single-use plastic, such as Styrofoam and plastic utensils, plastic straws, and plastic takeout containers. Hawaii already did that last year, and New Jersey is banning that too. More and more states are gonna do the same thing. Plus, as we all know, most of the bagasse products still coming out of China.
This is what we've been telling our investors and same with anyone that we're trying to move away from China into other parts of the world, Asia world. Perhaps possibly with the JV that we started in Taiwan, our goal is to test out the automation of the robotic system. Can we bring it into Texas to manufacture domestically? Yes, you know, what our goal is basically see if we can produce these domestically, and that is our goal. What kind of impact would it have on our revenue side? Definitely it will have a favorable impact on our revenue side. Now we can actually control the cost of our product that we produce versus basically in terms of ocean freight. We don't have to worry about ocean freight.
All we have to worry about is the raw material, which domestically can be found. Some of the raw materials can actually be contributed to from our paper manufacturing into the bagasse production of the bagasse product. I mentioned we can produce 650 containers out of that first part of the joint ventures. We do have a second part of joint venture, which will also be able to produce another 650 containers out of the same location on that part. What exactly the total revenue of 2023 that we're still figuring out right now.
Got it. Real quickly, is that more of a certainty of supply and of costs move or is that more of a driver of sales, you think with that JV?
I would say it's driving the sales, and also the ability to test out the new equipment, see if they are suitable for domestic manufacture in the U.S.
Great. Thanks a lot. I'll pass it on.
Again, if you have a question, please press star then one. The next question is from Brian Butler with Stifel. Please go ahead.
Hi. Thanks for taking my questions. Let's just start on the eco and environmental products. Can you just update everyone kind of what % of revenue that is now, and then kind of the expectation of what that % for 2020, for 2022 guidance and where it could go once the new facility is kinda ramped up in 2023?
Jian Guo, can you actually give Brian the current numbers and also where, with the future goals of the company on that part?
Yeah. Sure. I can take that question. Hi, Brian. In terms of eco-friendly products, overall, the percentage of total sales, it went up just a little bit from Q4. It remained in the high teens. I think Q4 we said close to 20 high teens, so it's still in that range. Went up just a little bit, less than 1% in terms for. That is for obviously the current quarter.
As we think about sort of the rest of 2022 and 2023, we think the percentage will continue to increase throughout 2022, especially as we are seeing some of the regulatory development in some of the regions, counties, cities where there were some recent developments pushed towards the use of eco-friendly products and some of the, and definitely also the continued shift on the consumer's preference side towards the eco-friendly products as well. We do expect the trend to continue into 2023, to answer the second part of your question. It's especially with additional capacities on our end as the JV, the joint venture, production starts in the second half of this year.
Brian, our goal for 2023 is shooting for the 30% of overall revenue to be eco-friendly product line, ESG, the green products. That is our goal.
Can you remind me, is the eco-friendly product materially higher in margins or is it pretty similar to your other products?
It carries higher margins than our traditional products.
It is higher margin. Okay.
It is.
My next question was on the overall growth. Can you break that down between price and volume , the strong growth you saw? Then maybe are you getting price at a level that's offsetting the inflation in each business line?
Can you rephrase that question?
Well, I guess just at the very highest level, can you break down the organic growth between price and volume?
Jian Guo, the assessment that you had in your hand?
Yeah, I can take that question. When you look at the overall revenue growth year-over-year, I would say, roughly, approximately half of that came from pricing and then the remaining came primarily out of, you know, volume and mix. In terms of the pricing, the additional color I'll add here is, as you're aware, we implemented multiple price increases in the second half, primarily in the second half of 2021, also a little bit in the first quarter of this year. That's really when we're looking at the year-over-year comparison that's giving us the benefit there. About.
If I heard that correctly, about 50% of the growth was from the increased pricing that you had put in place. Correct. A little over 50%. Okay. On the cash flow side, on the inventory build, how should we think about that inventory through the remainder of the year? Does that come back down and we end up with a working capital number that's either flat or slightly negative? Or is that gonna remain at an elevated level for a while?
I would think the inventory will remain at an elevated level for a while because to support our growth, because we do expect our growth to continue to be strong.
In the last year, there was a lot of shortages in our product, and that's one of the thing causing a fulfillment rate to be at 60%. We realized that we can't, it takes us 2 months or 3 months to get a product in from overseas to U.S., and we can't have. A customer want the product, they want it now, so we had to have, we have to have product in place sitting in our warehouse. This is one of the reasons that we increased our warehousing space in California and Hawaii, understanding that if we have the product in place, there's a demand for it, then that will definitely automatically increase our sales. We are actually looking for more warehousing space in Texas, and in California to grow that.
With that said, we'll be bringing more inventory in to support our growth.
Okay. With that kind of change in the higher inventory to support the growth, I mean, is the expectation that free cash flow is gonna be flat to negative this year?
I would say free cash flow will be positive this year with us generating more net profit from the operation.
Okay. Even with the additional investment in the inventory, you expect free cash flow will be positive for 2022, that's fair?
That is fair.
Okay. Last one for me. Any color on or update kind of on the M&A environment and outlook for 2022 and 2023?
Well, last year it was challenging in terms of when the market was booming, everyone was doing well. The last result has been, we've seen a lot of M&A activity in the market. I guess now with the market coming down, there's actually less M&A activities in the recent months. I would think that this will be a good opportunities for us to really look into who actually what partnership or which company that will be suitable to partner up with in terms of in the next 6-9 months as economy shift downward in most cases. I would say that there's to us, I think that there's more opportunity down the road than it was 6 months ago.
Okay, great. Thank you for taking my questions.
Thank you, Brian.
The next question will be from Paul Dircks, from William Blair. Please go ahead.
Hi, good afternoon, and thank you for taking my questions. First one for me. Just wanted to ask Alan, over the last 30-60 days, how has the tone of the conversations that you've had with national account customers changed as we've seen the rapid inflationary pressures across the economy take greater hold?
Well, the past 30 to 90 days, we've seen our most of our national account customers are still looking to work even closer with us. They're seeing that there's still concern that there's a supply chain you know disruption in the marketplace, primarily on the paper side. There's still I mean the paper shortage is still ongoing. Not necessarily on the plastic side, but on the paper side there is a shortage of paper raw material. It could be from paper food container, a paper cup or a paper tray or something else. But mostly on the paper side, there is a shortage in the domestic marketplace. We talked to a lot of the national chain account.
They do wanna work with us even closer in terms of if we can be a secondary supplier to them, just in case that their primary supplier would not be able to accommodate them. Which I think is a good idea that during the pandemic that it changed everyone's perception of having a single source, of vendors versus not only a secondary but third backup source, in order to make sure that there's no supply chain disruption, which we are still seeing right now.
Got it. Maybe said differently, I'm implying or I guess your answer implies that we're not really seeing much of a change from a demand standpoint from those national account customers, if for no other reason than they're looking to carry it as a solution for some of their own supply chain challenges. We're not really seeing an economic impact here as far as the demand goes and as it relates to you. That would be a fair assumption?
No. Yes. I haven't heard much of a demand increase on that part. Yeah.
Okay. Thank you. No, I appreciate that. You know, switching to the online channel, you mentioned during the prepared remarks that you guys were planning to open up the website to become more of a one-stop shop. Can you maybe talk about, you know, one, does this require a step up in expenditure? And two, how would this change the growth potential and maybe even the margin profile of the online channel, which as we know is, your highest margin channel for your business?
Well, I don't see any change in margin in our online sales. One thing is we've been utilizing Amazon to sell our products. We've been utilizing our Lollicup store, our own website, to sell directly to the end user. At the same time, we feel that we need to expand our product offering, not just to what we carry ourselves, but in terms of it could be a sauce, it could be a sriracha, a flavoring sauce, it could be a chili sauce, it could be other items that is basically needed by our customers. What we're looking at is partnering with different vendors that they can use us as a platform, use our clientele as their base and to sell their product.
That's where we can earn commission or affiliate commission on that part as a revenue stream, just like some of these platforms out there. We do see that we wanna better utilize our 40,000 customers online to see what else we can offer them as a one-stop shop.
That's helpful. I guess maybe quickly to follow up on that. Is it your expectation that there would be a major step up in your expenditure in terms of your website, or how quickly should we expect to see some of these new ideas implemented online?
I don't see much of an expenditure now because most of our expenditure has been spent last year and the year before. In the past two years, operational expense has been higher than I would say this year, is that we spend more money on the technology, warehouse management system, within the last two years, as well as our online upgrades that we mentioned in the past quarter earnings calls, that we spend millions of dollars on the upgrading of our online system. Right now, I would say that what we need to spend, we will be spending, is on people. The people to manage bringing new product, the people to manage how to find partners that we, that would like to use our platform to sell their product as well.
That's where we're gonna be investing, it's people versus the website this year.
That's helpful. Last one from me. You had mentioned that you expect ocean freight rates to remain elevated over the course of 2022. But you know, recently here we're starting to see rates come down a bit. My question is, can you remind us if those rates do continue to come down, how quickly we should see those affect your PNL? Could we perhaps see some margin tailwind from this later in the year, if we continue to see the current change persist over the course of the year?
Sure. The reason I said we expect the ocean freight to remain elevated is that same thing with last year, we saw it came down for a brief period of 3-week, 4-week, 5-week, and it went back again. Right now we see that, yes, the ocean freight has come down in the past 4 and 5 weeks, mainly due to the lockdown in the port of China. Now, what happens when the port opens, reopens? Are we gonna see the rate go up again? We're not. Right now we're just not changing our stance in terms of how the rate is gonna drop tremendously, majorly. We're gonna wait and see until the port opens from China and see how it goes.
Because I'm sure once the ports open, there's gonna be a lot of factories in China who wanna ship their product to the U.S. With that said, they might raise the price again. Or if the economy still continues to stay at this low end, that perhaps the ocean freight will come down. That would, like you said, with that said, it will help for margin in terms of the third quarter, not the second quarter. One thing I would mention that it's helping the margin is the domestic freight truckload rate has come down due to the lack of product coming from overseas. We've seen the truckload rate coming down, but at the same time, offsetting by the LTL carriers have raised their domestic shipping by nearly double.
Where we used to ship $400, now we're being told that it's gonna be $800. Of course, a lot of these are actually paid for by the customers. We're seeing the market is still not in a normal mode right now. There's a lot of changes up in the market for shipping.
Understood. Appreciate the color. Thank you.
Thank you.
The next question will be from Michael Hoffman from Stifel. Please go ahead.
Hi. Thank you. You can basically tell from my voice that's why Brian asked the questions, but we have some follow-up, if I could. With regards to the ocean freight, how much is your freight cost a contracted rate versus a spot rate?
Yes, we have contract rate, which last year our contract rate were average about $4,500. Our current year contract rate is now $10,000. That is one of the reasons that we mentioned that we expect the high end the ocean freight to be elevated at the same time. Because if you look at it, actually, double, more than double this year's contract versus last year. The good thing is, we're able to get the non-contract rate from the freight forwarders at about $9,000. Even with that, it's still higher than the contract rate from last year.
Excuse me. What % of total freight is contracted versus spot?
Last year I would say 40%-50% were contracted rate versus the spot rate. This year so far, the new contracts start May first. So far in May first, we only took on maybe 20% of our contract rate. The remaining 80% will be using market rates.
Okay. If the trend is favorable, you might actually get the freight back as a tailwind because you can lean on the spot rate for some of that.
Yeah.
The next question is about capitalizing freight costs within the full year guidance. How much have you assumed you're capitalizing freight as a dollar amount versus the $6 million in Q1 Q2? Within the capitalization, what's the timeline to amortize that off?
Jian Guo, answer that question.
How about it. Yeah, I can probably take that question. Hi, Michael. If I'm hearing you correctly, your first question about how much of a benefit we got out of the capitalized capitalization of ocean freight cost in Q1. To answer that question, we capitalized approximately roughly $6 million in Q1. As I previously mentioned in my prepared remarks, even with the benefit of roughly the $6 million, the total ocean freight cost was about $15.2 million or 14.4% of net sales in Q1.
In terms of how quickly that we expect to amortize, if you will, the benefit over the on the P&L, our current estimate, and this depends on the volume of the purchase that we're making in the second quarter as well as the third quarter. Based on our current estimate, we do expect that we'll absorb the majority of the benefit from Q1 in the second quarter. There might be, there probably will be just a little bit over that we would recognize over the third quarter this year as well. I mentioned previously, I just wanted to provide a little bit more color on some of the expectations for the second quarter gross margin.
Even with the expected hit, if you will, from the ocean freight capitalization, we still reiterated the full year gross margin goal of 31%-32% on average. That's because we are seeing some favorable impacts that we believe will pretty much offset the negative impact from the ocean freight capitalization in Q2. To name a few, the continued shift towards the higher margin products, operating efficiencies, some of the gains from the foreign currencies. I mean, we are seeing continued favorable impacts from quite a few factors.
Okay. Just to make a little bit of a finer point, which I think is important, is the full year guidance is not predicated on having capitalized freight for the full year. You're gonna basically reabsorb it. This is more of a timing difference on when that expense, that portion, some portion of that expense was being recognized in the context of thinking of capitalization being, you know, 5- and 10-year amortization type cycle. I think that's an important observation. Am I wrong about that?
The full year, if I'm understanding your question correctly, Michael, our full year guidance on the gross margin is with the expected impact from ocean freight capitalization from all quarters.
Yeah.
being 25 years.
If I understood you correctly, you're saying that you capitalize in 1Q, you're gonna reabsorb most of it in 2, a little bit in 3, so that you fully absorb it within the P&L, and you're still gonna make your numbers.
What numbers? I'm sorry, I didn't get the last part.
Yeah, sorry. That's me losing my voice. You've given a margin guidance for gross margin, and what I'm hearing, and correct me if I'm wrong, is that gross margin is not going to be dependent on you having capitalized an expense. You will have reabsorbed the timing of that capitalization in one Q by the time the full year is over.
That's correct.
Yeah. I think that's an important point, is you're not getting to your numbers by capitalizing an expense for the full year. It's more of a timing issue.
You're absolutely right. Obviously we touched on the improvement, right? That we're making, that really was driving the margin expansion. The margin expansion was not really driven by the capitalization. The capitalization just caused a little bit of fluctuation between the quarters, if you will.
Yeah, I mean, it did help your reported number, I mean, one and two, but for the full year, you're not making your number by capitalizing expenses.
Yeah. You, you're absolutely right.
Right. I think that's an important comment. Given the inventory build, has that improved your fulfillment? Because, Alan, you alluded to fulfillment dipped pretty meaningfully in Q4 2022. Has fulfillment rebounded?
Yes, our fulfillment is definitely better than last quarter and also last year's same quarters. We had a major fulfillment issue last year, all the way till the entire year, I would say. I would say first quarter is better, and second quarter will be even better.
Okay. Lastly, labor has been a challenge for you, but you didn't really bring it up this time. Is making decisions like adding warehousing or what have you can staff that? You're feeling better about labor availability on a relative basis?
I would say labor is definitely better than the beginning of the year. More people are looking for job now and I would say that it's, I mean, that's one thing that can help us ship the product and grow the business, is making sure that we have sufficient labors. Yes, I think it's better now. Labor better, situation is better than previous quarter and last year also.
Okay. That's the rest of my questions. I apologize for my rusty voice.
Thank you, Michael.
The next question is a follow-up question from Jake Bartlett from Truist Securities. Please go ahead.
Great. Thanks for taking the follow-up. My question is on the pricing. You mentioned that essentially the pricing was about 20% in the first quarter, you know, half of the roughly 40% revenue growth, you know. That kind of was implemented throughout 2021. You've taken a little bit more in 2022 already. How much of pricing is contributing to the 22%-23% revenue growth that you expect in 2022?
I believe Jian Guo mentioned, 50% of that 23% is contributed to the price increase that we had last year, especially toward the end of last year. You know, we are seeing the price increase. We're using the new price now that we raised back in October, November, and of course, January this year. This is what we're seeing that the benefit is that you know, that 23%, 50% of that is the price increase. Is there gonna be more price increases down the road? I would say yes, particularly on the paper product, because we have just received additional price increase from our source that is telling us that there is still challenge in terms of paper raw material.
There's gonna be more additional price increase down the road on the paper side. Not necessarily on the overall product line, but on certain products, there's gonna be a price increase.
Just to clarify, 'cause I had understood the first question about pricing to be about the first quarter specifically, but that it wasn't. You're saying that about, you know, 11-12% pricing is what you expect on average for the whole year of 2022?
If we're saying that our growth this year will be 25, 23% year-over-year growth, about 10% of that is from price increase.
Okay. Maybe just to ask the question about what in the first quarter, how much of the you know 39% revenue growth was from pricing?
Jian Guo, do you have that number?
Yeah. As we were just talking about, Jake, the total first quarter year-over-year growth, a little over 50% was from the pricing increase. Maybe just also to add on to Alan's point, as we think about the impact from the pricing increase for the full year 2022, I would agree with Allen that it's probably going to be roughly half of the total revenue growth, or maybe just a little bit less. Because obviously when we're comparing year-over-year, the first quarter last year, we...
I mean, this is what we're comparing year-over-year a lot because most of the price increases that we implement last year was from the second half of 2021. As we head into the second half of this year, the year-over-year impact on the pricing will be a little bit less. Overall, I would agree with Alan's comments for the full year.
Great. That's helpful. I got a cough now too. The other question was on CapEx for the year. You know, I think that includes the deposits paid for property and equipment. You know, how much do you expect to spend on CapEx in 2022? You know, and does that include the investments related to the JV? If not, maybe just kind of break that out as well.
I would say that majority of spending that we're seeing in 2022 were actually spent in 2021. We've been using our 2021 funds, because we have to pay a deposit down last year to get the product in this year. Over 50% of that was already paid for last year and moving forward this year that we're receiving the product such as the automated robots and as you mentioned, the JV, the investment. I would say that's part of the CapEx that we're looking to spend in terms of no more than 5% of our revenue. That's still our goal.
Okay. Thanks a lot. Appreciate it.
Thank you.
Just with the JV, I mean, how does the JV work in terms of your investment in the JV?
JV, we're investing approximately $60 million in the first phase. Basically, the production should be starting later this year, about around the fourth quarter of this year into full production in 2023. Clario will take over 50% of the product that produced out of that manufacturing plant, and the other 50% will be sold to other clients. Could be in Australia, could be Japan, could be other customers in the U.S., private label branding for other manufacturers. That's what the goal is on that JV.
Great. Thanks a lot. Appreciate it.
Ladies and gentlemen, this concludes our question and answer session. I would like to turn the conference back over to Mr. Alan Yu for any closing remarks.
Thank you, operator, and thank you all for joining us today. We appreciate your support, interest in our company, and I look forward to speaking with you again. Thank you very much. Have a nice day.
Thank you, sir. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.