Well, good afternoon, everyone. Thank you for joining us today for the Karat Packaging Fireside Chat. I'm Michael Lu, a managing director with Wells Fargo here. We're very fortunate to have Alan Yu, the Chairman, CEO, and Co-founder of Karat Packaging here with us. Really appreciate you, first of all, taking the time to share all the exciting things that are happening at the company. Obviously, a lot of growth happening at Karat. Four consecutive quarters of growth now, double-digit growth, very exciting. I guess really without further ado, I want to just really dive into it. Especially for folks who are new to the Karat story, I wanted to just see if you could maybe provide a snapshot of the company, where we are, overview of the products, the customers, and really kind of start with that.
Great. Thank you, Michael. Thank you for inviting me to this Fireside Chat. Well, first of all, Karat Packaging, we specialize in all the food service packaging out in the marketplace. If you dine out and you go to any of these fast food restaurant, most likely on your daily basis, you'll be using our product. Like for instance, if you go to In-N-Out Burger, we sell them their straws, their portion cup, their cups, and other items if they're short. If you go to Chipotle, we sell them portion cup, paper straws, and some other items. If you go to Chili's, basically, we sell them 70% of the packaging good, from paper shopping bag, to the food containers, to the takeout containers, to the portion cup, to their back of the house grease trap tray, modified tray.
If you go to Texas Roadhouse, Chick-fil-A, if you go to Jack in the Box, you name it. Basically, we sell over 150 QSR chains out in the U.S. Basically, our volume is pretty big in terms of in the food service sector. Now, we also sell through online channel. Online channel has been one of our biggest growth area. A lot of companies, people don't realize that how lucrative, how profitable this online business is, and also, less cost, less operation-wise. 18% of overall revenue derive from our online sales. Last year, we did about $75 million online sales. This year, we're looking to hit over $100 million in revenue online sales. We are targeting $130 million-$150 million online sales. The number is growing faster and faster, and the amount of customer we can reach is just unimaginable. Yeah.
Very good. The company has been around for over 25 years now, right?
Yes.
Obviously, it's evolved quite a bit over the years, and you guys have stayed very nimble. Maybe could you speak a little bit to Karat's kind of competitive differentiation, right? Whether it's the products, the global sourcing, the customer relationships. What's really supported the kind of defensible moat of the business over all these cycles and over the years?
We see our competitor in the marketplace. They're either a distributor or a manufacturer that does some of the imports. For the manufacturer that does some of the imports, they're still in the old school mentality that they only have one channel of sales, which is selling to distribution. Okay? They have limited growth capacity. If they don't invest more CapEx into their equipment, they can't grow. We see that that segment is growing either negative in the past two years or low single digit. That's how our competitors are doing. Distribution-wise, that's different. They don't have any CapEx expenditures, so less leverage and lower leverage on that, and they can grow faster. But still, they're growing single digit as well. Margin, I would say that if you're an importer distributor, your margin will be higher than the manufacturer on that part.
For Karat, our advantage is we do everything. We sell to a small channel restaurant down the street. We can sell to a gas station. They're online. We have a bubble tea supply that we also carry. That's $40 million plus revenue from our overall revenue source. Karat has a higher profit margin, which none of our competitors does. That was one of our bread and butter when we first started the business, and we continue to grow on that as well. For the segment, we have manufacturer. It's very small manufacturing. Right now, manufacturer generates 9% of our overall revenue. We stopped investing in CapEx on manufacturing equipment in 2022. Ever since 2022, after we stopped expenditure on CapEx on manufacturing equipments, we were able to issue dividend, reserve a lot of our cash, and pay back to our shareholder.
As well increase our gross margin from a low 20-ish to the high 30s margin profile. These are some of the advantage that we have versus our competitor. Also our competitor grow at single digit mainly by acquisition. We grow organically for the past 25 years, except for one small acquisition out of Hawaii that we spent $1 million back in 2020, and that was it.
Yeah. The organic growth has certainly been impressive. Maybe talking a little bit more about kind of supply chain. The sector as a whole has obviously seen a lot of disruption, right? Tariffs, weakened consumer, restaurant softness, right? Supply chain volatility overall. I guess, how have these periods of disruption, and you've kind of seen it all, Alan, how have they actually worked to kind of Karat's advantage in terms of new customer acquisitions and winning new business?
Well, because Karat is nimble, and that's one of our strength. We feel that we grow better during a bad economy, during a supply chain disruption. One of the things that is helping us, like for instance, 2020 was one of our best year ever because of the COVID. People were shut down, hard to get product from overseas. You can't open your restaurant without having a face mask for your employee. We imported face masks, air cargo. We were able to help a lot of our clients who are non-client, future potential clients, with their face mask need. In 2022, there was a major supply chain issue with the ocean freight, has gone up over $15,000 from $3,000 on per container. That time, we actually gained a lot of new business as well, and our revenue was the highest ever.
Then after the supply chain disruption ended in 2024, 2023, 2024, our revenue dropped a little bit because we had to lower the price that was inflated back in 2022. Now last year, 2025, we saw a tailwind for the tariff hitting because the tariff actually helped us. We were not heavily in debt. We can afford to pay up the high tariff versus a lot of smaller importers that were competing against us, they were out of business.
They couldn't afford to import product for themself. There was a lot of tariff involved and because of that, also the U.S. Customs has been examining more containers, and each time they hold the container for examination, it costs the importer a lot of money, which the small importer can't afford. That helped us a little bit. Now this year, the increase in the oil prices, the spike, also help us a little bit, somewhat because we have the capability to buy in bulk. We have the capability to diversify our vendors that we source our product from. Our cost increase was minimum compared to some of our competitors on that part. Every time we see a supply chain disruption, a spike in prices, a bad economy, our business do better. Our company does better in that sense.
It's very impressive. I guess talking more about winning new business and commercial momentum, looking at your sales pipeline, really what are the biggest drivers of growth that give you guys confidence? You guys have guided kind of a low teens annual growth rate on top line. What are these biggest drivers? I think you alluded to some of it earlier, online, product innovation, and just overall nimbleness, right? Really how much of that is volume versus price?
Our pipeline is built based on two things. One is our existing wallet share. How can we grow with our existing wallet share? We are continually doing that right now. Like you mentioned earlier, are there any more business opportunity with the existing chain that we're doing? Yes, there are. There is. Also new potential clients that basically have not started doing business with us. A lot of time it takes us over a year to convert them. Testing, testing, confirmation, the artwork design, everything, initial ramp-up period. They take time. We feel that we have those booked. New SKU is one of the key to our growth driver. This year we're focusing on paper shopping bag, SOS bag, grease bag, bread bag, all type of bag business and paper board business. A lot of bakeries, instead of using plastic containers, they want to use paper board now.
We're focusing on that segment as well. Also that segment has a higher margin versus the traditional plastic and paper boxes on that part. These are the segment that we're seeing that we're growing. In region, we're growing in Chicago, here in this area. So far our warehouse was set up about two years ago. Today versus last year-over-year growth comparison, it's over 100% growth. We're adding more trucks in this area. We're looking to expand our existing warehouse, double the size. We're looking to see if we can sublease another warehouse or add another warehouse nearby our current existing location. Also we can make it more delivery in this area. This is a very area that we see an expansion potential. We're looking to add another warehouse in Orlando, Florida. That's our fourth largest online channel area sales. That's where our customers are.
We're looking to do that so the customer can receive their product the next day versus three days after. That's one of the key to our success is making sure the customer can get their product immediate, quickly, faster when they order it versus later.
Very good. You alluded to it just now around kind of sales growth. You guys have picked up a lot of new national chain wins recently. Maybe walk us a little bit more through kind of typically how long it takes to convert this from initial contact to kind of the first orders and really maybe more importantly, how does Karat really kind of grow these longer terms and strategic partnerships? Really how do you guys kind of build that kind of share of wallet and kind of really kind of get into that share of wallet more?
Well, in a normal environment, it would take about two years to convert a national chain account. In an environment that is very hostile or very competitive environment like today, where there's so many issues on pricing, on supply chain, it may be just three month to convert a national chain account. They expedite it, speed up the process. They skip all these protocols just because they want to get the product in.
Like for instance, McDonald's, they said normally it would take two years to get a vendor into our system, right now because some of the shortage, we might be able to get in our foot in the door very quickly.
Are there any recent examples, kind of anecdotes basically, of new customer wins where you've grown the relationship in kind of similar manner to the McDonald's kind of anecdote? Are there recent chains or any examples you may want to kind of speak to and highlight?
For like what?
For any sort of new customer wins, right? To kind of demonstrate the expansion, like once you kind of get in and kind of land the account to grow that, have there been recent successes you want to kind of highlight?
Yeah, there's a lot. Like for instance, Chili's was one of them.
We first got into Chili's by selling them the food container. There's two, four, actually three SKU, about seven years ago. From there on, we sold them the takeout container nine by nine, because our competitor didn't want to do it, or was taking too long to do it. The competitor was telling them it takes 12 months to ramp up. We told them four months, so we got the business. From there on, adding new SKU, been much faster. That's one Chili's example. For Panda Express, same thing. We started with them with bubble tea supply.
From there on, when there's a shortage, the owner says to the buyers that, "Hey, why don't you check out Lollicup, see if they have the product?" It's every time that we can come up in product solution faster than our competitor, we immediately get our foot in the door. That's one of the key thing. Karat Packaging, we're nimble and fast. We can move fast, we can bring things fast, we're making decision quick. Our sourcing team, keys to our success is we have a great sourcing team that move fast as well.
Fantastic. Yeah, I think the integrated kind of production and the ability to design and customize all these really rapidly obviously kind of helps with that acquisition process and that ramp-up time as well.
Correct. Yes.
You alluded to earlier as well on the online growth piece, obviously a big driver of growth for the overall business. I think it's slated to go to $100 million by end of this year. What are really kind of some of the drivers of that 30+%? I mean, it's obviously a big number. Is it new customer acquisition, new partnerships? Is it really, as you mentioned earlier, pushing more volume to existing wallet I guess. What are the various levers there?
There are a few drivers to our online growth right now that we're seeing. One is adding additional platform, bringing our product into different platform. Like for example, Sysco, last year they just started the sysco.com, made it available to all their customers. They can order our product through sysco.com. We first started last year with just $50,000 revenue a month. Now we're doing $700,000 a month, which is about $8.4 million a year, and it's still growing. How we grow from there, we initially started with just 15 SKUs, and then right now I think we have over 2,000 SKU out of 8,000 SKU on the sysco.com website. Once we load up more SKUs, our revenue will grow faster. Second, for online growth, we used to sell online with one cases to two cases to the customers, single cases.
Now we've enabled customer to buy full pallet, 20 cases- 40 cases with volume discount. We're seeing more and more customer not buying one case, two case, they're buying 20 or 40 cases, which is taking up a lot of our inventory immediately. That's causing shortages for the short term. We're ramping up our inventory in some of the warehouses right now. Instead of having them carry just not enough inventory, but we're carrying more inventory. We're seeing that within the next few weeks later, once our inventory restock, our revenue can grow even more with the online.
That then comes at a higher margin as well.
Very, yes.
Maybe talking a little bit more about margins. Your gross margin guidance for the year kind of 34%-36%. Despite some of the kind of rising cost elements you talked about earlier, oil input costs, how do you feel comfortable supporting that level of margin? Could there be incremental upside even, right? As you kind of think about the year ahead.
Sure. Prior to the tariff, initiation of the tariff, our margin was around high 30s. When the tariff hit, our margin dropped to the mid-30s. With the tariff refund on the way, we see that adding that back to the past 12 months, we see that the past 12 months regaining back to the high 30s. In our second quarter, our last quarter guidance, we mentioned that our expectation was $26 million to be refunded to our company. Now that the tariff is down from 20% to 10%, we feel that we can confidently say that we should be able to accelerate and advance our current margins more. We feel that there's more room to expand our current margin versus how we guided it.
That's certainly a very strong margin profile relative to the sector. Maybe a little bit more on supply chain, right? You talked about it a little bit earlier, but the evolution of your sourcing strategy. How have you really adapted over the years, right? This company had a lot of manufacturing earlier, over time it's shifted. I think you mentioned 9% manufacturing now, largely an import distribution business. Really how have you adapted and really what is your process, if you could speak to it, to help onboard new suppliers, really efficiently, right? While ensuring product quality, availability and consistency for your customers.
Initially when we first started getting new vendor is a lot of these vendors, they don't have the exact same product that we need. What we have to do is we may have to purchase the equipment for them, train them, having our staff go over there and train them to run the business, run the equipment for us. That way, we can ensure the quality and the spec are the same. That's how we started initially. As they grew, they continued to evolve, they excelled in that segment. They can actually buy more equipment themselves, support us in terms of our growth. Adding new vendors, same thing. We sold recently a couple of our equipment to a Latin American manufacturer, they just started supplying our product about last month.
This was good because when we sold them the equipment, we didn't realize there was a war going on. The raw materials were going to skyrocket, and that manufacturer can actually stock up, load it up, pre-load it, actually the lower cost, the raw material reason. We're able to receive product at a lower cost.
That's one of the things that we're able to keep our costs lower than our competitors is diversifying manufacturer vendors. When you have different vendors competing for our business with a higher volume business like ours, we can negotiate better pricing versus our competitor.
Where is the manufacturing footprint now? I know there was a lot of China exposure before. How has that evolved and what does it look like? What does the map look like now?
If it was seven, eight years ago, China was 55% of all of our imports. Today, China is only less than 9% of our overall import. We shifted our imports from China to Taiwan, Indonesia, Malaysia, Vietnam, and now Latin America. We were thinking of Turkey, but with this war going on, we scrapped the idea of Middle East. Too much issue going on over there. I know that some of our competitors are still buying from Middle East. They're getting screwed right now. They can't get their product out. The container cost is over ridiculous. It's a good thing that we kind of diversify our risk. Right now, we have over 145 vendors that's supplying our product. There's not a single concentration of vendors.
Very good. Switching gears a little bit, this question gets asked a lot these days, but I guess, thinking about AI and technology, and really long-term productivity, how is Karat Packaging utilizing AI in your back office to support your growth and really to drive long-term productivity gains as we think about SG&A and some of the operating leverage you guys might get?
Well, one of the biggest costs for all companies is labor cost. Labor cost is one operational expense that everyone is looking to see if they can reduce. Our company basically had over 1,000 employees four years ago. Today, we're looking at less than 650 headcounts. We are reducing headcount by utilizing automation, paperless work, more data in the cloud, and of course, I've asked all of our team to look into AI to reduce work from anywhere from accounting to purchasing to customer service. For instance, our online team. We have over 7,000 orders a day. Before, we had to hire four or five people to handle customer service calls, over thousands of calls a day. Right now, 99% of our customer service online call questions are answered by AI. We have much less work to do right now with the assist of AI.
That's very good to hear. You guys are implementing it and integrating it into your business already. Maybe taking a step back a little bit, how do you, Alan Yu, think about, or I guess, what metrics do you look at from the broader sector? The feedback from your clients in the foodservice sector, what metrics do you look at to monitor the health and the growth aspect and really where to invest? Obviously, investing in AI was a major investment, but how do you think about metrics and broader industry trends as you make these strategic decisions?
Well, we do listen to market intel. A customer tells us, "Hey, this item, Alan Yu, you guys don't carry it. Would you consider bringing that item?" Then we would ask our sales rep to check in the market. Is there a demand for this product? Is there someone willing to make a commitment if we were to bring in this item? Who would do? How much commitment can we get? If we have people committing to a certain item, a certain quantity on the new item, we'll definitely bring it in because we can bring it not only for that customer, we can also bring it for other customers. Just like for example, one item that we recently brought in, it's a multi-fiber grease saver for the back of the house.
After you've deep-fried chicken or french fry, you bring the product up, you have a multi-fiber tray to absorb the grease first, then you put it into the takeout containers. We didn't have that item before. It was not because it's Chili's that they needed that. There's really no one else having that product. We brought it in, and we made it available for other customers as well as online. That's one best way to bring in new SKUs, where a demand, not just blindly bringing some item in and maybe we can't sell it. Yeah.
Got it. Well, as we conclude, I guess, looking two, three years out, what does success look like for Karat Packaging? What would you like investors to understand about the long-term opportunity that you don't feel like is reflected in the value of the business today?
Well, Karat in the past year, prior to 2020, when we were still a smaller company, our revenue was growing 25% plus year-over-year. We double our revenue every three, four years. Right now, I think that we're in the path to also double our revenue organically in three to four years. If we have any new acquisition, that might speed up the revenue growth. At the same time, other companies grew by acquisition, but also they took on heavily leverage and also reduced their profit margin, which reduces their ability to make profit, and then their stock price suffers. Our goal is not to do that. Our goal is making sure that if we have any merger acquisition, it will not hurt our current trajectory, our current EPS or EBITDA. It will only help us have a better synergy to grow even faster and better on that part.
That's where I see in the next three to five years. Very likely, we will grow double digits and maintain a current margin. That's our goal. Our EBITDA, increase our EBITDA on that part.
Very good. It sounds like you guys want to remain disciplined in how you approach M&A, and the basis for it is now this very solid foundation for you, for which you guys can now execute M&A more so in the next three to five years.
Yes, we're very conservative. That's why right now our dividend is paying out more than 6%, and we're pretty confident we can maintain that level.
We want to continue that as well.
Oh, very good. Well, that wraps up all the questions I had for you. Look, we really appreciate your time.
Thank you, Michael.
The audience. We'll probably have to give you guys a little bit of your time back, which I'm sure folks don't mind.