Karat Packaging Inc

NASDAQ:KRT

Thank you, Roger. Good afternoon, everyone. We delivered solid top line growth in the third quarter with net sales increasing more than 8% to about $135 million. We experienced continued strong momentum in our e-commerce business, where online sales grew nearly 38% compared with the prior year quarter. While increased import costs, higher domestic shipping costs and elevated resin prices pressured margins and contributed to the result below our expectation, we remain encouraged by the resilience of demand across our business. We continued success in new account wins and the strength in our pipeline. We are confident in our long-term growth prospects.

In October, we began shipping select products to the 4 new chain accounts that we secured in the second quarter. Notably, we expanded these relationships during the third quarter, winning additional business across multiple product lines such as paper bags, bagasse trays and others, with shipment expected to begin in early 2027. Building on these wins, we recently secured 4 additional chain accounts, further expanding our distribution footprint. We believe these new relationships underscore the appeal of our broad product offering, flexibility and outstanding service as well as our reliability as a value supplier.

These new business wins support our continued focus on deepening Karat's market penetration on the East Coast and Midwest. Sales on the East Coast grew 19% year-over-year, while Midwest sales increased 22% compared to the prior year quarter. Beyond these new accounts, we are testing phases with other large chains across different product categories. We are also building inventory to prepare the shipments in the first and second quarter of 2027. Our new 47,000 square foot distribution center in Orlando, Florida is expected to be fully operational in November 2026 to serve customers throughout the Southeast.

The facility is expected to strengthen fulfillment capabilities for our growing e-commerce business, help reduce delivery time and provide additional infrastructure to support future growth. To address elevated oil prices and ongoing cost pressures, we continue to realign and optimize Karat's global supply chain and diversify sourcing for regions with more favorable trade conditions and freight costs, including Indonesia, Malaysia and South America. We have also implemented price increases on select items this month, and we expect to implement additional price increases early next year to help offset higher costs.

Aggregated purchases from Indonesia, South America and Malaysia increased to 19.4% of total sourcing, while sourcing from Taiwan, China and the U.S. accounted for 39.1%, 14.4% and 16.7%, respectively, of total purchases. We believe our expanded distribution capacities, together with our supply chain and pricing initiatives, along with the continued strength of our online channel and new chain account wins will position Karat to accelerate revenue growth and improve operating performances and profitability in the quarters ahead. I will now turn the call over to Jian Guo, our Chief Financial Officer, to discuss the company's financial results in greater detail. Jian?

Thank you, Alan. I'll begin with a summary of our Q3 performance, followed by an update on our guidance. Net sales for the 2026 third quarter increased to $134.7 million, up 8.2% from $124.5 million in the prior year quarter. The increase primarily reflected $10.7 million in volume growth and product mix and a $0.4 million favorable impact from pricing, partially offset by a decrease of $0.8 million in shipping and logistics revenue. As Alan mentioned earlier, online sales rose 37.7% in the third quarter of 2026 compared with the prior year quarter. Sales to chains and distributors, our largest sales channel increased 3.9% year-over-year and retail channel sales declined 18.4% from the third quarter of 2025, primarily due to lower logistics service revenue.

Cost of goods sold for the 2026 third quarter increased 9.8% to $89.6 million from $81.6 million in the prior year quarter. This increase was primarily driven by higher product costs of $7.2 million due to higher sales volume and resin prices as well as higher import costs. Ocean freight costs increased $2.4 million, including a 17.0% increase in average container rates and an 11.7% increase in the number of containers imported versus the prior year quarter, partially offset by a decrease in duty and tariff costs of $1.1 million compared with the prior year quarter.

Gross margin for the 2026 third quarter increased 5.2% to $45.1 million from $42.9 million in the prior year quarter. Gross margin was 33.5% in the 2026 third quarter compared with 34.5% in the prior year quarter. The decrease was primarily driven by higher product costs, which represented 60.6% of net sales compared with 48.9% in the prior year quarter. The increase in product costs was partially offset by lower depreciation expense to 1.0% as a percentage of net sales from 1.3% in the prior year quarter.

Operating expenses in the 2026 third quarter increased 17.2% to $40.3 million from $34.3 million last year. The increase primarily reflected higher shipping and transportation costs of $2.8 million, mainly due to the increase in online shipping costs of [indiscernible] of $0.9 million and online marketing expenses of $0.7 million. Additionally, salaries and benefits increased $0.9 million, warehouse expenses increased to $0.4 million and stock-based compensation expense increased to $0.4 million. Operating income in the 2026 third quarter was $4.9 million compared with $8.6 million in the prior year quarter.

Other income net for the 2026 third quarter was approximately $1.0 million compared with $1.3 million in the prior year quarter. The decrease was primarily due to a $0.5 million decline in the gain on foreign currency transactions. Net income for the 2026 third quarter was $4.7 million compared with $7.6 million for the prior year quarter. Net income margin was 3.5% in the 2026 third quarter compared with 6.1% for the prior year quarter. Net income attributable to Karat for the 2026 third quarter was $4.4 million or $0.22 per diluted share compared with $7.3 million or $0.36 per diluted share in the prior year quarter.

Adjusted EBITDA for the 2026 third quarter was $8.9 million compared with $13.1 million for the prior year quarter. Adjusted EBITDA margin was 6.6% of net sales for the 2026 third quarter compared with 10.5% for the prior year quarter. Adjusted diluted earnings per common share was $0.24 for the 2026 third quarter compared with $0.37 per share in the prior year quarter. As of September 30, 2026, we had working capital of $87.0 million and $37.0 million in financial liquidity with another $10.0 million in short-term investments. During the third quarter, we generated operating cash flow of $9.7 million and free cash flow of $9.1 million.

We paid a regular quarterly dividend of $0.47 per share to shareholders on August 28, 2026. Additionally, Global Wells, our consolidated variable interest entity, fully repaid the remaining balance of $11.2 million on one of its term loans that matured on September 30, 2026, further reducing our consolidated leverage ratio going forward. During the third quarter of 2026, the company did not repurchase any of its common stock under its previously announced share repurchase program. For the first 3 quarters of 2026, the company repurchased a total of $2.0 million of its common stock. As of September 30, 2026, approximately $10.0 million remained available for future repurchases under the program.

On November 3, 2026, our Board of Directors approved a regular quarterly dividend of $0.47 per share payable on or about November 27, 2026, to stockholders of record as of November 19, 2026. Alan outlined the initiatives that we are implementing to support our long-term growth and enhance profitability in the quarters ahead while navigating significant pressure from resin products and oil prices. Against this backdrop, I'll provide an update to our guidance. For the 2026 fourth quarter, we expect net sales to grow by 9% to 11% from the prior year quarter. We expect gross margin for the 2026 fourth quarter to be within 33% to 35% and adjusted EBITDA margin to be in the high single digits.

For the full year of 2026, we expect net sales to grow by 9% to 11% over the prior year. We expect gross margin for the full year 2026 to be between 39% and 41% and adjusted EBITDA margin to be in the mid-teens. Both margin expectations include IEEPA tariff refunds recorded during the first half of 2026.

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

Sure. For the third quarter, we missed our revenue by $2.5 million, fundamentally by -- one thing is we expected some of the chain accounts to start pulling the orders. They have been delaying for testing purposes. So they will be pushed forward into the fourth quarter. That's why we're looking at guiding the fourth quarter to be in the 9% to 11% because they were supposed to take in the third quarter, they moved toward in the fourth quarter.

And at the same time, we have been adding additional new chain accounts that have signed up to start in the first quarter of 2027. So we will be ramping up inventory in the fourth quarter for them to start taking in the first quarter. One of the common practices for the chain accounts is they -- even though they committed to buy from us, pull from us, they have to deplete their inventory from the previous vendors. So often that kind of pushes us away in terms of guidance.

I can give a kind of an idea what's on the ocean freight side first. Ocean freight, our contracted rate is about $2,500 that we signed in the second quarter. That was also started on May 1. But during the third quarter of the year, because of the oil price increase, and the Iran war issues. The carrier has been raising their peak season charge, adding bunker fees and additional fees and shorting on the containers, so we have to pull additional containers not from the traditional contract.

So our rate has been basically averaging about $4,500 to $6,000 containers. We were expecting about $3,500 based on normal peak season surcharge. And normally, these containers post like the peak season is for a couple of months only. And this year, they extended even longer period of time. And also, the carriers did remove the peak season and the bunker added additional fees claiming that the war has raised the price of the oil and gas and delaying the shipment, delaying -- there's over demand.

So I mean, we're fortunate paying $4,500 to $6,000. We're seeing other noncontracted people paying -- our competitors have been paying $7,000 to $10,000 for the East Coast. So for us, we have been competitive on the ocean freight compared to other people. Now looking going forward, we're seeing that the containers cost did not reduce during the month of October. It kind of slowly dropped a little bit, but we -- we're hearing that the cost should be coming down in the fourth quarter, the last month, December of this year. As yesterday, we knew that the midterm election was over and a lot of these carriers are looking to reduce the -- looking like they will reduce the bunker fee and peak season earlier. So we're waiting to see when they will start.

Sure, George. Now first to go to your question after the election. Now with the election, first of all, originally that we were wondering if the Iran war was going to continue because there was stress from the President that after the election, he was going to go all out with the war and bomb Iran, which we -- I would expect -- we would expect the oil price to go even higher, that will basically raise the price of all the resin and cost. So we actually -- in the third quarter, we did not actually take any step into raising prices to our customer -- passing the cost to our customer.

We were anticipating the war to end because every time there's a peace talk -- I'm sure you heard the peace in the second -- the third quarter that it was going to end, it was going to end. So we thought that it was going to end, but it didn't. And after the election, it seems like the war is going to end. And right now -- but we did not account for the war to be ended a week ago. So we actually made a price increase announcement in October, we added a fuel surcharge to kind of offset some of the costs on delivery.

In November, we actually announced a price increase, which we started 2 days ago, a price increase across the board to all of our -- most of our clients, except for some chain accounts and some chain accounts, we did have a price increase. And we also -- just last Friday, we announced another price increase, a bigger price increase January 1, 2027, 3% to 13% price increase because we feel that we don't -- we can't rely on the fact that the war is going to be over, that the resin cost is going to come down, the cost of delivery. I mean one key thing that impacted our margin is online shipping. We use UPS for online shipping. Actually, it was FedEx, okay? We use FedEx for online shipping.

They have a fuel surcharge that goes up and down. With the diesel price going up, the fuel surcharge went up as much as 40%. So we're paying more. The more we sell online, we're paying more, but we can't charge this to pass on this to online customers because this is -- a lot of these are -- they prepay online orders or we actually have a fee to it. So with the anticipation now that the war is going to end and the gas prices come down earlier in the fourth quarter, we feel that with our price increase and the decrease in the diesel prices and delivery costs, that is definitely going to help our margin to normalize, and we see our margin not deteriorating even further down.

So I feel that with the election, the midterm election, the result is going to have a favorable effect on the cost of the oil prices. That's one. Second, with the Democratic party winning the election, there will be most likely the states will be pushing more further into compostable, more biodegradable product, eco-friendly items, which we have been gaining traction in terms of the [indiscernible] product and also the paper product.

As I mentioned earlier in our calls that we have a few additional pipelines. Most of these additional pipelines are related to the fiber product and the paper-related product. Some are plastic cups, but mostly are the fiber products that we wanted to push forward. So we feel that in 2027, our fiber paper growth can grow as much as double. That's how we feel for the 2027 year. And the margins are actually a little bit higher on the fiber side because our competitors have been enjoying a higher margin. As we come in, even though we're being competitive, we're still seeing a better margin than selling the traditional paper plastic, okay? Does that answer the 2 of your questions?

Right now, currently, we basically have a revenue in terms of calculating like the bag sales monthly, it's around $850,000. So it's not a huge -- we only have a big base of the fiber product line. Now doubling that will be $1.6 million, $1.7 million total in revenue per month, basically looking at that. Our paper shopping bag business, I think Jian might have a better idea in terms of what is our current paper shopping bag in terms of winning additional -- because on our pipeline, we have -- we're seeing more and more companies coming to us for the paper shopping bag, mainly chain accounts.

So when we mentioned about the 4 pipeline, 5 pipeline, these are all national chain accounts that we're converting into the fiber and also paper product. That's why we're seeing -- we are more confident in terms of 2027. This is -- actually, this election is going to be -- and also this war, the ending of the war. And also recently, there will be a shortage -- a major shortage of the product that I'm seeing just as bad as 2022 right now for the next couple of months. Inventory-wise, yes.

Everything. Because the container -- one of the ways that the shipping companies have been able to raise their prices and gouge all these importers is by reducing shipping space. So they cancelled almost 40% of the shipping coming to North America. So they can create a kind of a shortage and raise the price. And containers coming out of Indonesia, most of the importers can get 50% out of the 100%, 550 out of 100 containers they want. Out of Vietnam right now, they can probably get 30 containers out of 100 containers they need.

We -- fortunately, we have more of the experience in terms of dealing with the situation. So we're getting about 70% to 80% of what we need for our product. So we will at least have product in our warehouse. But we have been seeing shortages -- we have been shorting customers. I mean we try to fulfill as much as we can. But during the latter part of the third quarter, we have started shorting customers.

In the fourth quarter, we're seeing shortages. That's why the price increase is necessary.

No problem. Jian, can you answer that question because I know that the online sales is up, but the retail side down 18%, I wasn't worried about.

Yes. Retail -- sure, I'll take that question. George, on the retail side, the decline was primarily in the logistics services. That's a really small piece of our revenue stream is we have our own fleet to provide logistics services to some of our customers. So almost the entire amount of the decline in the retail channel is logistics sales revenue.

Some of the chain accounts, they would actually do a regional test and then full-blown. But majority of the chains that we deal with, they would actually start when we have all the inventory available to ship in all of our distribution centers. So what we normally do with the chain is they have -- for example, a chain with 500 stores, they need us to ship to 8 of their different locations, the distribution centers. So we have to put the product into California, Texas, South Carolina or Washington.

So a lot of times, we get our product into California, then we transfer them into Texas and other places. At the same time, we ship the resin from overseas into Washington and New Jersey and South Carolina. So as it ramps up first to tell them, we have the inventory approximately when and when will they be depleting the inventory from the previous vendor. Sometimes they're accurate, sometimes they're a little bit off. Sometimes the previous vendor would tell them, hey, they found an extra 1 month inventory. So they ask us to wait for an extra month. But normally, it will be 90 days to start shipping for the first shipment into the DCs if basically everything is okay.

The resin costs increased the most. And in most years, most cases, resin costs, the raw material costs spike up for a couple of months, they come back down. But this year, we anticipated -- everybody, not just ourselves, anticipated the war to be ended quickly, no more than 3 months. But this war has started since March. And basically, it didn't end until the day of midterm election. So that part of it was the biggest part that caught us off guard because when we thought that the war ends, the oil price comes down sharply as well as the raw material. That's one thing.

But also with the war going on, the oil prices continue to rise with the diesel price going beyond $6.50, $7.50 per gallon, our delivery costs went up. Most majority of our contracts are delivered price. We actually added the cost of the delivery into the product itself. So when the oil price is high, we have to absorb that cost. And we -- once we began to realize this war is not ending, we started -- we finally announced a price increase and fuel surcharge on October 1, November 1.

That's where we see that we have -- we cannot rely on the -- what we're hearing from the government that the war is ending. And basically, we just -- we wanted to help our customer to see that if this is going to end, we -- we wouldn't have to raise the price. But it was to a point that we had to raise our prices for our customer. And initially, we raised a nominal number basically in October and a different number in November.

But then we just made an announcement that we have to go even higher on January 1 because now it's not only the oil prices is causing the price to go up, the disruption in ocean freight is going to cause a disruption in the supply chain throughout, not just us, but every importer manufacturer that purchases from overseas in Asia is going to see a major supply chain disruption in the upcoming months. But we are prepared for it basically. So I'm sure that we will be benefiting additional revenue. At the same time, without raising the prices, our customers are not going to be complaining because you can't find product out there in the market in the next 2 months.

Well, the chain accounts like to have the stability in prices. They don't -- they -- it's more of a kind of a business relationship that if we can absorb the price cost, but passing the chain price mainly on a yearly basis, unless there's a major issue. In this case, we did kind of tell the chain that, hey, the war is more like a force majeure situation. So we did increase a nominal increase in the fourth quarter. But the latter part of the third quarter is starting in some chains, some of the chains in the first part of the first -- fourth quarter.

Other chains, we made announcements that the first month of the year, January 1 is when the price increase takes place because we know that now that basically the raw material might not come back down to normalization anytime soon. So we -- the chains understood because they know themselves are getting the price increase notice from every vendor out there from the food supplier, from the distribution center that help them distribute the product to the store like Sysco and US Foods. Everyone is putting a fuel surcharge, not 5%, but more like 15%, 20% fuel surcharge on top of the normal delivery fees. So it's become a norm that if you don't raise the price, you're just taking a hit on the margin side. So we are taking action in terms of protecting our margin in the fourth quarter and first quarter ongoing.

So on that, I just want to also add a couple of data points just maybe to help quantify -- help us quantify thinking about really the pressure on the margin side. I know we talked about -- Alan talked about the resin price, the ocean freight, just some additional data points here is over the past couple of years, our average product cost as a percentage of total net sales is about 47% -- that's an average. Q3 2026 at just a little over 50%. So that's -- so obviously, just the majority of our product cost is our imported finished goods. So very closely correlated to resin price.

And then on the ocean freight, our average is about 11% over the past couple of years. Q3 2026, we were at 14.2%. So just want to add some data points -- so I know Alan also talked about the price increases that we implemented in Q3 -- sorry, in Q4 as well as the increases we're planning to implement in Q1 2027 to help offset some of the pressure that we're facing on the margin.

Thank you, operator, and thanks to everyone for joining us today. We're encouraged by the positive sales momentum and geographic expansion. We remain focused on executing our growth strategy and look forward to keeping you updated on our continued progress. Have a nice day.