Prepared remarks
Good day, and welcome to the Karat Packaging Second Quarter 2026 Financial Results Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Roger Pondel.
Good afternoon, everyone, and welcome to Karat Packaging's 2026 second quarter conference call. I'm Roger Pondel with PondelWilkinson, Karat Packaging's investor relations firm. It will be my pleasure momentarily to introduce the company's Chief Executive Officer, Alan Yu; and its Chief Financial Officer, Jian Guo. Before I turn the call over to Alan, I want to remind our listeners that today's call may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to numerous conditions, many of which are beyond the company's control, including those set forth in the risk factor section of the company's most recent Form 10-K, as filed with the Securities and Exchange Commission, and copies of which are available on the SEC's website at www.sec.gov, along with other company filings made with the SEC from time to time. Actual results could differ materially from these forward-looking statements, and Karat Packaging undertakes no obligation to update any forward-looking statements except as required by law. Please also note that during this call, we will be discussing adjusted EBITDA, adjusted EBITDA margin, adjusted diluted earnings per share, and free cash flow, which are non-GAAP financial measures as defined by SEC Regulation G. A reconciliation of the most directly comparable GAAP measures to the non-GAAP financial measures is included in today's press release, which is now posted on the company's website. And with that, I will turn the call over to CEO Alan Yu. Alan?
Thank you, Roger. Good afternoon, everyone. We delivered record quarterly net sales of more than $136 million, reflecting the strength of our customers' demand and accelerated momentum in our online business growth. During the quarter, our sales pipeline expanded, adding four new chain accounts, which further broadened our market reach and created additional opportunities for future revenue growth. We continue to experience encouraging momentum across our business, highlighted by the strong performance of our online channel, where net sales increased 23.6% year over year. Our eco-friendly product portfolio also continued to gain traction, benefiting from the continued expansion of SKUs and growth in the paper bag categories. As a result, eco-friendly products represented 33.8% of total sales during the quarter, compared with 31.8% in the prior-year period. Our results also benefited from IEEPA tariff refunds, which reverse higher tariff costs absorbed in the prior periods, and further contributed to the strong reported profitability. While we were pleased to capture this benefit in the quarter, our focus remains on the fundamental drivers of the business and sustaining strong long-term financial performance. To support our long-term growth strategy, we are currently finalizing a lease for a 47,000-square-foot warehouse for a new distribution center in Orlando, Florida, which we expect to be operational by the third quarter of this year. The new facility is expected to enhance Karat's ability to better service customers throughout the Southeast, improve fulfillment capability for our growing e-commerce business, reduce delivery time, and provide additional infrastructure to support future growth. At the same time, we remain focused on driving operational excellence. We are continuing to execute initiatives designed to enhance efficiency across the organization, while carefully managing costs, aiming to support sustainable profitability, and position the company for continued success. During this quarter, we achieved gross margin of 56.6%, including the benefit from the IEEPA tariff refund of 1,890 basis points. Despite higher product costs and ocean freight rates, the performance underscores the strength of our sourcing capabilities. Our sourcing diversification initiative continues to deliver tangible benefits, strengthening Karat's competitive advantage through reliable product availability and cost competitiveness. In the second quarter, domestic purchase increased to nearly 20% of total sourcing, while importing from Taiwan represented 46%, China represented 11%, and sourcing from Indonesia, Singapore, and South America represented an aggregate of 12%. Overall, we are pleased with the progress we are making with the expanding sales pipeline, new customer wins, strong e-commerce growth, and a continued focus on the operational discipline. We believe Karat is well positioned to advance profitability and long-term growth. I will now turn the call over to Jian Guo, our Chief Financial Officer, to discuss the company financial results in greater detail. Jian?
Thank you, Alan. I'll begin with a summary of our second quarter performance, followed by an update on our guidance. Net sales for the 2026 second quarter increased to $136.3 million, up 9.9% from $124.0 million in the prior-year quarter. The increase primarily reflected $13.1 million in volume growth and product mix, and a $0.4 million favorable impact from pricing, partially offset by a decrease of $1.1 million in shipping and logistics revenue. Sales to chain accounts and distributors, our biggest sales channel, were up by 9.0% in the 2026 second quarter. Online sales, as Alan discussed earlier, rose 23.6% over the prior-year quarter, and sales to the retail channel declined 23.4% from the 2025 second quarter, primarily from the decrease in shipping and logistics revenue. Costs of goods sold for the 2026 second quarter, including the benefit of $25.8 million from IEEPA tariff refunds, decreased 21.0% to $59.1 million from $74.9 million in the prior-year quarter. This benefit was partially offset by higher product costs of $6.9 million and increased import costs of $3.5 million, including an 8.9% increase in average container rates and a 4.3% increase in the number of containers imported versus the prior-year quarter. Gross profit for the 2026 second quarter increased to $77.2 million from $49.1 million in the prior-year quarter. Gross margin increased to 56.6% in the second quarter of 2026 from 39.6% a year ago, reflecting that 1,890 basis point contribution from IEEPA tariff refunds. Product costs represented 49.2% of net sales, up from 48.5% in the prior-year quarter, while import costs increased to 11.1% of net sales from 9.5%, primarily due to higher freight and import-related expenses. Operating expenses in the 2026 second quarter increased to $39.6 million from $32.6 million last year. The increase was primarily driven by higher shipping and transportation costs of $3.1 million, along with increases in online platform expenses of $0.6 million and marketing expenses of $0.5 million. We also incurred higher costs of $1.1 million in salaries and benefits, while bad debt expense and warehouse expenses increased by $0.6 million and $0.4 million, respectively. Additionally, the second quarter included a $0.1 million loss on the disposal of machinery compared with a $0.3 million gain recognized in the prior-year quarter from routine asset disposals. Operating income in the 2026 second quarter increased 127.2% to $37.6 million from $16.6 million in the prior-year quarter. Other income net for the 2026 second quarter was $1.4 million compared to other expenses net of $2.0 million in the prior-year quarter. The year-over-year improvement was primarily driven by significantly lower foreign currency transaction losses, which were $0.1 million in the current quarter compared with $2.9 million in the same period last year. In addition, interest income increased by $0.5 million, reflecting $0.9 million of interest income associated with IEEPA tariff refund, partially offset by a $0.4 million decline in interest income earned on investments in certificates of deposit. Net income for the 2026 second quarter increased 168.3% to $29.6 million from $11.1 million for the prior-year quarter. Net income margin was 21.8% in the 2026 second quarter, reflecting the benefit from IEEPA tariff refunds of 1,480 basis points versus 8.9% last year. Net income attributable to Karat for the 2026 second quarter was $29.3 million, or $1.46 per diluted share, reflecting the benefit from IEEPA tariff refunds of $1 per diluted share compared with $10.9 million, or $0.54 per diluted share in the prior-year quarter. Adjusted EBITDA for the 2026 second quarter rose to $41.6 million, reflecting the benefit from IEEPA tariff refunds of $25.8 million from $17.7 million for the prior-year quarter. Adjusted EBITDA margin was 30.5%, reflecting the benefit from IEEPA tariff refunds of 1,890 basis points compared with 14.3% for the 2025 second quarter. Adjusted diluted earnings per common share increased to $1.48 for the 2026 second quarter, reflecting the benefit from IEEPA tariff refunds of $1 per diluted share from $0.57 per share in a comparable prior-year period. As of June 30, 2026, we had working capital of $110.8 million and $42 million in financial liquidity, with another $15.7 million in short-term investments. During the second quarter, we generated operating cash flow of $33.2 million and free cash flow of $31.8 million, both of which reflected the benefit from IEEPA tariff refunds received of $25.2 million during the second quarter of 2026. We paid out a regular quarterly dividend of $0.45 per share to shareholders on May 28, 2026. During the second quarter, we repurchased 73,510 shares of our common stock for a total of $2 million under our share repurchase program. As of June 30, approximately $10 million remained available under the program. On August 4, 2026, our board of directors approved an increase of regular quarterly dividend to $0.47 per share, payable on August 28, 2026, to stockholders of record as of August 21, 2026. Now, let me provide an update to our guidance. For the 2026 third quarter, we expect net sales to grow in the low double-digit range from the prior-year quarter. We expect gross margin for the 2026 third quarter to be within 35% to 37% and adjusted EBITDA margin to be within 9% to 11%, both including insignificant IEEPA tariff refunds anticipated during the quarter. For full year 2026, we expect net sales to grow in the low double-digit range over the prior year. With more clarity around the IEEPA tariff refund process, we now expect gross margin for the full year 2026 to be in the low 40% and adjusted EBITDA margin to be approximately mid-teens, both including IEEPA tariff refunds recorded during the first half of 2026. As Alan mentioned earlier, we are experiencing what we believe is accelerated growth in our sales pipeline, reflecting current strong market position and ongoing initiatives to gain market share. Looking ahead, we expect to continue driving top-line growth, sustaining healthy growth momentum through our diverse sourcing strategy and reduced tariffs. We're also confident that the actions we're taking to manage operating costs will further improve operating leverage and drive sustainable profitability. Alan and I will now be happy to answer your questions, and I'll turn the call back to the operator.
Questions and answers
The first question today comes from Michael Francis with William Blair.
I want to start on the SG&A. That seemed to be the big surprise for us in the quarter to the downside. You mentioned you have some actions that you're taking to improve that. Can you talk a bit more about, A, what surprised you there, and then, B, what you're doing to offset some of the higher costs?
Yes, sure. Let me start and then Alan, please feel free to add some additional color there. So in terms of the SG&A, I know you mentioned some surprises. I think really the way that we think about it is just consistent with the trend that we are observing with the macro environment. The biggest item that we are focusing on for the third quarter as far as cost management is really the shipping cost. For many of the orders that we ship out to customers, we utilize third-party carriers. That is an area that we're focusing on in the third quarter to try to manage the cost. Just to give you a high-level idea, in the second quarter in terms of the offline shipping cost, in total, we incurred about $6.1 million on a year-over-year basis, which was a sequential $1.4 million increase. So that's one area that in the third quarter we're focusing on by utilizing our internal fleet to try to minimize costs and get more efficiency out of offline shipping to customers by delivering local orders to our local customers with our own employees. We're also performing inter-warehouse inventory transfers with some of our internal fleet as well. Another area is we're continuing to try to get savings on online order delivery cost. We have a service agreement with one of the carriers, so that's an area that we're continuing to focus on to realize cost savings. So those are the biggest areas in terms of both offline and online shipping costs. I think it's probably fairly consistent with some of the other companies as we approach the environment with higher oil and gas prices. One other area that we're focusing on in the third quarter is our salary and benefits expense, where we're working to utilize our labor force more efficiently. So those are the two biggest areas I would call out.
I want to add a little bit of color to what Jian just mentioned. The second quarter had the highest fuel costs we've seen in the past year due to the crisis in the Middle East. In the third quarter, we are actually seeing the cost coming down already. For instance, we were paying $5.40 per gallon for diesel. In the third quarter, we're seeing prices around $4.00-something — roughly a 25% discount on diesel alone. On the carrier fuel surcharge, we're also seeing a declining rate from the second quarter to the third quarter. So this is where we're seeing more of a decline not only in ocean freight but also in shipping, all tied to oil prices. Everyone knows that the second quarter oil price was the highest, but it started to drop in July, so we'll see if it continues. At this point it is still lower than the second quarter.
Yes, that's not surprising. I figured that was the case. And then the pause of your online sales are continuing to trend quite well. What drove the strength there and then across the category? Should we expect a similar growth trajectory in the second half as we saw in the first?
Let me add to the online growth. During our last quarter earnings call, I mentioned that our target for this year's online revenue is $100 million. As we see July's numbers, for the second quarter we were looking at 20%, 24%, 25% year-over-year growth. In July specifically we're seeing Amazon growth around 49% year over year just on Amazon. Our overall online sales growth in July was over 37%. Right now I can confidently say that $100 million is on track for this year's revenue goal just for online. It could be higher, but I'm not sure by how much, so we're still pushing for more online sales — that's where we are.
That's good to hear. One last one for me. Florida D.C. coming online, you continue to add capacity there. Do you still think you have any sort of gaps in your current coverage where you could add more distribution centers and sellers, and if so, where?
Orlando, Florida — we are finalizing the agreement and that will help because the Southeast is our fourth largest online customer base. We have been shipping from South Carolina and Houston into Orlando. Once we have the Orlando distribution center ready, our customers can receive their product the next day, if not the following day, instead of waiting three to five days. That should improve our online sales in the Southeast area. Another area where we might need support is the Colorado area, which can also support Utah. Currently we're shipping to Colorado from Texas, which is two to three days for online. We have also been looking at North America — Vancouver and Toronto — and are trying to resolve logistics for those areas because we see a very wide open market there.
Okay, that's all understood. I'll pass it on.
The next question comes from Ryan Meyers with Lake Street.
If we exclude the tariff refund during the quarter, I'm just curious how you would characterize the underlying gross margin and performance of the business? Was it relatively as you expected?
Let me start and then Alan, please feel free to add color as well. Hi Ryan, that's a great question. As we reported, our gross margin is 56.6% for the quarter. If you do the math, excluding the tariff refund contribution, our gross margin without the tariff refund would have been 37.7%, which I think is still really strong — close to a 40% gross margin. The underlying drivers are our sourcing diversification and sourcing capabilities. We expect to continue to navigate this environment well with pricing dynamics and changes in the trade landscape. We provided guidance for the third quarter gross margin to continue to be in the mid-to-high 30s, specifically 35% to 37%. Does that answer your question?
Ryan, I want to add that during the second quarter we saw a positive shift on the currency front. Last year in the second quarter we experienced a $2.9 million currency loss. Now we're seeing a stronger U.S. dollar versus some Asian currencies, especially the Taiwan dollar, which provides a tailwind. We are also seeing some reduction in ocean freight as peak season ends, which will help. All of these factors can help gross margin, and we're also focused on savings in operating expenses.
Got it. That's great to hear. Lastly, you mentioned in the press release that you added four new chain accounts during the quarter. How should we think about the timing and potential contribution from those wins?
We're thinking about the fourth quarter for those accounts. It takes two to three months to ramp up inventory and start shipping the product, so we expect to begin shipping in the fourth quarter.
Okay, got it. No, that's helpful. Thanks for taking my questions.
This concludes our question and answer session. I would like to turn the conference back over to Alan Yu for any closing remarks.
Thank you, Operator, and thank you to everyone for joining us today. Karat is built on a strong business foundation, and we are encouraged by the positive momentum across our business. We remain focused on executing our growth strategy and look forward to keeping you updated on our continued progress. Have a nice day, everyone. Thank you. Bye-bye.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.