Karat Packaging Inc (KRT) 2022 Q4 法說會逐字稿

Good day, and welcome to the Karat Packaging Inc. Fourth Quarter and Full Year 2022 Earnings Conference Call. (Operator Instructions)

Phone note this event is being recorded. I would now like to turn the conference over to Roger Pondel, Investor Relations. Please go ahead.

Thank you, operator. Good afternoon, everyone, and welcome to Karat Packaging's 2022 Fourth 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 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 Factors 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 today's call, we will be discussing adjusted EBITDA, adjusted EBITDA margin and adjusted diluting -- diluted earnings per share, which are non-GAAP financial measures as defined by SEC Regulation G. A reconciliation of the most 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'll turn the call over to CEO, Alan Yu. Alan?

Thank you, Roger, and hello, everyone.

We were able to grow our top line during the fourth quarter of 2022 against a very strong prior year quarter despite an overall challenging deflationary environment in our industry and multiple price reduction that we've implemented. Additionally, thanks to our continued margin improvement of efforts, we achieved record full year gross margin of 31.2% despite a negative out-of-period inventory write-off of approximately $900,000 and generated a record full year operating cash flow of $29.5 million.

With the stabilization of ocean freight costs and the supply chain issues caused by the pandemic now essentially behind us, we are focusing on operating cost containment and eliminating inventory redundancies built during the supply chain disruption period. During the fourth quarter, we added a number of contracts with new national and regional chain accounts, and we expanded product offering to existing customers. We are expecting these new agreements to materialize and add to our top line starting mid-2023. And we are continuing the strong momentum in building our pipeline.

In the near term, Revenue for the 2023 first quarter will likely to be down about 10% compared to our prior year period. We are anticipating revenue to pick up again toward the end of second quarter. For the full 2023, we are expecting revenue growth to be at the high single digits year-over-year.

As a reminder, year-over-year comparisons were impacted by pricing for inventory sold during most of the first half of 2022, which was near peak level. Also, order volumes in that time period last year were unusually high due to supply shortages. We continue to see solid growth in our environmentally-friendly products. This category grew 24% in the fourth quarter over the prior year quarter, and demand remains strong into 2023.

Our joint venture in Taiwan building a state-of-the-art bagasse factory for manufacturing 100% of compostable food service products is progressing well. We are continuing to receive orders and many increase that fulfill capacity quite quickly, which will be a good problem to have.

However, construction of the plant is behind schedule because of power supply issue, which now have been resolved. We currently expect initial shipments to begin in the second quarter.

We are implementing a number of growth strategies in 2023, and we are confident we'll provide solid long-term returns. In London, we are improving our fill rate and inventory management and monetizing our model to be more asset-light by scaling back manufacturing production in California, while expanding import products, which carry higher margins.

To accommodate future growth, we are working on increasing our distribution space. In February, we signed a new lease for the approximately 52,000 square foot distribution facility in Chicago and expect to move in by end of April. We are also getting close to sign a lease for another distribution facility, similar in size, in Houston.

Additionally, we are working on expanding our existing warehouses by adding approximately [50%] of the new rack space. As part of this initiative, we are targeting geographical expansion in the East Coast and Midwest regions. To do so, we are increasing the size of our sales team by approximately 35%.

Lastly, we are in the process of upgrading our e-commerce platform and expanding online support team. As well, we are excited to begin offering online sales in Canada and Hawaii. We expect to again generate strong operating cash flow and continuing to scale back our CapEx this year, which will give the company flexibility to consider returning excess capital to our shareholders as we continue to look for strategic growth opportunities.

I will now turn the call over to Jian Guo, our Chief Financial Officer, to discuss our financial results in greater detail. Jian?

Thank you, Alan. Our 2022 fourth quarter results reflect continued top line growth despite a challenging year-over-year comparison, improved margin and continued strengthening of our liquidity position.

Now let me provide more color on our operating results, starting with revenue. Net sales for the 2022 fourth quarter increased 1.5% to $92.7 million from $91.3 million a year ago. The 2021 fourth quarter was a particularly strong revenue quarter with COVID reopenings and price increases implemented due to extraordinarily higher ocean freight and other costs.

By channel, sales to distributors, our largest channel grew 3.1% for the 2022 fourth quarter. Sales to the retail channel increased 4.6%. Sales from the online channel increased 1%, and sales to national and regional chains decreased 3% for the quarter.

The decrease in the chain accounts was due to certain operational issues, which have been essentially resolved. Sales of our ecofriendly products increased 24% for the fourth quarter. During the fourth quarter, we completed a project to reevaluate and classify our inventory to be more aligned with a variety of product categories offered to customers.

As a result, some of the product category data, including ecofriendly products in the prior period was recast to allow for a more meaningful comparison. We continue to see accelerated growth from these products as we strengthen our market leadership position and expand our product offering in this category to meet the needs of our customers and evolving regulatory landscape. Ecofriendly products represented 27% of our total sales in 2022 compared with 21% in 2021. Gross profit increased 4.8% to $29.7 million for the 2022 fourth quarter from $28.3 million last year.

Gross margin expanded 100 basis points to 32.0% from 31.0% in the prior year quarter. Gross margin was favorably impacted by lower and stabilized ocean freight costs for the 2022 fourth quarter and 9.8% of net sales compared with 12.3% of net sales in the 2021 fourth quarter.

The gross margin was negatively impacted by a $1.7 million inventory write-off, which represented an out-of-period adjustment for certain inventory items in the previously issued quarterly and annual financial statements as well as an impact of $2.4 million from freight and duty capitalization.

Based on current cost factors, we are expanding our 2023 full year margin goals to be in the range of 32% to 33%. Operating expenses in the 2022 fourth quarter were $24.9 million or 26.8% of net sales compared with $21.2 million or 23.2% of net sales in the prior year quarter. The increase primarily reflected higher labor costs of $1.5 million due to workforce expansion, higher production costs of $1 million due to unexpected machinery repair and about $600,000 due to an increase in rental expense from the 2 additional warehouses added in May 2022.

Operating expenses in the 2022 fourth quarter also included a CapEx deposit write-off of approximately $500,000 related to pre-pandemic capital investment project. Net income for the 2022 fourth quarter decreased to $4.5 million from $6.0 million for the same quarter last year. Net income margin was 4.9% for the 2022 fourth quarter versus 6.5% in the prior year quarter. Net income attributable to Karat for the 2022 fourth quarter was $4.5 million or $0.23 per diluted share compared with $5.6 million or $0.28 per diluted share in the prior year quarter.

Adjusted EBITDA, a non-GAAP measure, was $9.9 million for the fourth quarter versus $10.9 million in the prior year quarter. Consolidated adjusted EBITDA margin was 10.7% sales versus 11.9% in the prior year quarter. Adjusted diluted earnings per common share was $0.30 per share for the 2022 fourth quarter versus $0.32 per share in the prior year quarter.

During the 2022 fourth quarter, we generated operating cash flow of $17 million and continue to expect strong cash flow in 2023. We believe Karat is well positioned to execute on its future growth strategy. We finished 2022 with $84.5 million in working capital compared with $72.1 million at the end of 2021. We have financial liquidity of $63.0 million as of December 31, 2022, and declared and paid a special cash dividend of $0.35 per share on our common stock.

Lastly, we just completed the extension of our $40 million credit line, extending the maturity to March 2025. We expect to continue to further strengthen our financial and liquidity position in 2023. Alan and I will now be happy to answer your questions, and I'll turn the call back to the operator.

(Operator Instructions) Our first question comes from Jake Bartlett with Truist Securities.

My first one is on the 2023 sales growth. And Alan or Jian, can you talk about what the drivers are, so high single digits. Does that include negative impact from pricing. So pricing would be a headwind. Just if you could give us the components of that high single digits growth, that would be helpful.

Sure, Jake. Well, first of all, we believe that right now, we're seeing that price contraction due to deflationary, especially from ocean freight, pricing coming down to back to pre-pandemic. So we have been adjusting our prices ever since September of last year ['20] and then October, November, December, even in January, we do see that pricing to be a little bit deep -- basically stabilized as well as ocean freight has been stabilized. So our growth are part of seeing several factors: one, online sales. We're seeing strong online sales. Also, we added -- we're looking to start in Canada for online sales in Canada.

We never really tried to approach it in the past years. And this is because we actually modify our platforms and increase our warehouse spaces. And of course, second is national chain account and regional chain account. As mentioned in the previous discussion that we actually sign in several over a dozen different regional and national chain account that is expected to start shipping starting April, May, June, July of this year, and they will add to our existing volume.

Right now, the obstacle headwind to service these national chain account that we just added is warehouse spaces. We have been shortest warehouse basis ever since end of last year. So we added some spaces that was not -- still not adequate. So that's why we continue to seek for new spaces. And that -- this is an area that we are looking to really expect that speeding up the process of getting additional warehouse spaces in different areas.

Even in California, we are actually looking for additional spaces in California. On New Jersey, [South Carolina] -- we just expanded additional 50,000 square feet in South Carolina, and we're racking up the entire warehouse in New Jersey, and we're moving some of the equipment out of California and we'll be using that space to -- racking space for product that were coming in to service each account that we sign up.

Also another factor is that, we'll actually -- the growth will be the ecofriendly product. We're seeing more and more states. Cities are banning styrofoam, the plastics and the straws. So we're bringing more higher margin, higher revenue-wise product from overseas to sell to our customers and because [of need] on that part.

Great. Just kind of really just narrowing back on the pricing side because that seems to be -- obviously, it was a headwind in the fourth quarter here. And so I think you mentioned it, Alan, that you thought that the pricing level, the absolute level of pricing has stabilized. I just wanted to get your confidence on that, that we're not going to just see continuing decrease in pricing, which is going to kind of squeeze margins, but also limit the sales growth. So in the 10-K, as you disclosed kind of the drivers to the change in revenue.

I think the implication here if I did the math is that pricing was a negative 4% drag in the fourth quarter. And so the question is, if you kept prices where they are now, how much of a drag would that be for 2023 as a whole? Should we assume that pricing is going to be a negative impact on growth for '23 as a whole?

Well, earlier, Jake, we mentioned in our -- earlier in the conference call that the 2022 first quarter was the biggest -- the highest ever in history of ocean freight. And that's what we're seeing, and also as well as supply chain disruption was all in the first quarter, mainly in the first quarter of last year that everyone is rushing to buy whatever they can and stocking up everything and then at the higher price, even ourselves, we did that, too. And this year, we're seeing that first quarter, we're seeing everything is coming down. All the prices coming down. Ocean freight is coming down right now -- ocean freight is stabilized. It has been continued to come down since July of last year to -- even until the end of the last year.

So in January, this -- the ocean freight started to stabilize. And I do see that there's not much of a price difference anymore in the future for 2023, unless we have sufficient spaces that we're going after even more accounts that we're looking to sacrifice our margin and prices to obtain new accounts, which we already have enough pipelines and also agreements that basically it's going to fill our capacity in terms of warehouse space.

Again, we still have capacity in bringing more additional product and manufacturing capacity, but we're lacking in warehouse spaces. So that is the key components. We can grow as long as we add more warehouses at a -- not increasing too much facility costs.

Okay. Great. And then I just want to -- sorry, continue.

Jake, this is Jian. If I can just add on to Alan's comments real quick. I think Alan provided a lot of great color on pricing. So hopefully, that answers your questions about pricing just as far as what the trend is going to be for 2023. I also just wanted to add that we are continue -- we do expect to continue to be able to expand our gross margin even when pricing starts to stabilize, right? As Alan mentioned, pricing as of last year, if you're looking at earlier quarter of 2022, it was at peak level.

A lot of that was because of the significantly higher ocean fleet cost. Now even as we start to take actions to be proactive to pass on savings to our customers because of the significant drop in ocean freight and because of a lot of the other margin improvement sort of initiatives that we are implementing, we're actually guiding higher gross margin on a full year basis for 2023, and we're very confident that we can continue to expand our gross margin even with the price action that we're talking about.

Great. And my other question...

Let me add one more thing to price margin wise. Jian mentioned that we are able to keep -- well actually increase our gross margin even with the price decrease. That is correct because we're actually looking to have a full year guidance of 32% to 33% gross margin. And if you look at -- if we take a look at it back in the fourth quarter, we actually took almost over -- around $2.4 million freight duty capitalization. Same thing with the third quarter, it was like more than about -- around the same area freight duty capitalization. But starting the first quarter of 2023, we -- I don't believe we'll see any more of the freight duty capitalization that will take down on our margin wise, gross margin-wise and revenue-wise. So we're seeing that it's going to be a favorable thing which ocean freight stabilize for this year.

Great. And then my other question was just on manufacturing and the decision to, I guess, take away the manufacturing of the Chino facility. One question is, are you keeping the manufacturing in Texas facility, and what is -- just maybe a little more detail on the decision to make that change. There were some reasons why you did -- you had manufacturing capabilities before. So I'm wondering kind of what changed to kind of drive that decision?

Yes. We're actually going -- we actually have started increasing our equipment and moving some of the equipment from California into Texas. So we're increasing our Texas manufacturing capability because it has more space and also the warehouse spaces, it's -- costs less. The manufacturing cost is much lesser in Texas versus California, finding skilled mechanic, labors. It's much easier in Texas versus California.

California, the warehouse facility cost has gone up, tripled since 2 years ago. So in terms of -- as well as labor cost has gone up a lot tremendously. And we're seeing that. And that has been one of our key headwinds in the third and fourth quarter of last year as labor continue to go up, different loss changes in California. So we see California as more as a cup that can facilitate product manufacturer overseas into California. And for us to manufacture more in Texas, it's more favorable for us because it's more in the inland area. And also most of our new accounts, new customers, are actually out of the Midwest and Texas, Midwest and East Coast now. We're seeing most of our growth in the Midwest and East Coast versus a decline in the West Coast area market.

The next question comes from Ryan Meyers with Lake Street.

First one for me, some of like revenue in national and regional chain accounts was negatively impacted by some operational issues that you said have since been resolved. Just wondering if we can get some more detail on that and what went on there?

Well, Brian (sic) [Ryan] , in the fourth quarter, we had some issue -- actually some issues with our equipment, they were shutting down, they were broken. So we had kind of a decline in production output. And we then actually had to turn over to our overseas partners to have them start producing for us. And basically, it was a bit of a delay because we have to ship them overseas into California versus it was made in California. This product has come in and we see that this is actually pretty good in terms of -- it will cost us less to bring the product from overseas versus us continue to maintain the CapEx expenditures to fix these equipments, to maintain these equipment, to continue to purchase these equipment.

So that's one of the decisions that we made in January that we want to reduce manufacturing in California because we're losing mechanics, skilled mechanic in California. It's a challenge to find new ones to replace them. So we might as well just start to move our equipment into Texas and also for the West Coast relying on overseas partners.

Got it. That's helpful. And then just kind of switching gears. When we think about the ecofriendly products, you said it was 27% of the mix here in 2022. How would you expect that business to grow? And what percentage of mix would you expect that to represent in 2023?

Jian, do you have a number -- the actual numbers on that part? I can explain to you the part that -- what I'll do is explain the part that the growth part, the growth aspect is that we see that 2023, more and more city and states are going to push, force the law into effect especially like in California, were banning the styrofoam completely in California in some of the cities. And also, we're adding the -- like in May, there's no more styrofoam in the city of Los Angeles County. So everyone have to go into paper, or something more to ecofriendly.

And more and more [cities] are actually after -- now that we're -- the COVID pandemic is behind us, they're going back and start looking at ecofriendly packagings, and that's where we see the growth is as well as our online channels.

We're seeing more sales in the ecofriendly aspect of the product through our online channels. And with the new sales that we're moving into Canada. Canada has completely gone into ecofriendly. And that's where we see the major huge market in terms of ecofriendly products in the Northern state of Canada.

Got it. And then last question... Go ahead, Jian.

Yes. If I can also add on just from the numbers perspective, I think, as you pointed out, over the -- on average for the entire full year of 2022, ecofriendly products represented about 27% of total sales. This is based on the updated product category that we talked about in our prepared remarks, just to give you an idea about the sort of the trajectory here. So when we look at Q1 2022, that percentage was 25%. Q4 2022, that percentage was 31%. So you can clearly obviously see the momentum in the growth of our ecofriendly products. And as Alan mentioned, with all the strong demand, the regulatory -- the change in the regulatory environment and our continued expansion of the products that we are offering in this category, we do see that this momentum is going to continue into 2023.

Got it. That's super helpful. And then last question for me. I appreciate the commentary on building up a sales force there. Obviously, you're targeting some new geographies. But I'm curious, are you guys targeting any industries side of food service?

I'm sorry, what was the food service area because we are targeting. With the additional sales take force, we're targeting geographic location as well as we're adding new food product. Yes, more beverage items, bubble tea i.e. the boba product supplies. We do see that the demand for boba supply has come back up this year. So that's the area that we're targeting, but mainly geographic area in the Midwest and the East Coast and Southeast, that's where we see the biggest driver of our growth for 2023.

The next question comes from Michael Hoffman with Stifel.

Can we speak to -- I want to get to the sales growth thing a little. Can you walk us through what we should assume for cadence 1, 2, 3, 4Q to get to 7% to 9%, so midpoint 8%, that's high single sales growth for the year. What's the cadence look like over the 4 quarters?

Jian, do you have like a breakdown, the forecast on that number? Because I can go over the process and the strategy but the actual numbers, I think you have the projected numbers.

So Michael, let me go over the strategy in that part. The first quarter of 2023 versus 2022, we see a decline because the first quarter, we -- that was when the market was short of everything. So everyone is trying to grab a food container and they were stocking up, they were worried about everything.

So I think we're selling out everything that we had on the floor. So we started to really increase our inventory, which all came in, in the second quarter of 2022, which really bought kind of actually that decreased our operationals because we were -- we couldn't move anything in our warehouses. We are immediately -- we added a new warehouse facility in California. And that didn't -- that helped a lot for third and fourth quarter, so we eliminated the warehouse space issues. And in second quarter -- that's why we're seeing a decline year-over-year decline because we actually normalize this year. We're also with the price coming down. But we see that this is a continued issue for 2023.

That's why we started to look for additional spaces early in the last year. In January, if we finalize the Chicago and we're looking to finalize Houston. So we want to make sure we have been operational by May of this year because we see a bulk of our new accounts that are coming on board, they need the product, we need to stock for them by April, May of this year. And that's where we will see the increasing need of South Carolina space to increase. New Jersey warehouse need to increase the space. Texas needs to increase the space, Seattle. Every one of our facility need to increase our existing space by racking up the entire warehouse adding additional 15% to 25% additional spaces, plus the 2 additional warehouses that will help us for the growth of -- facilitating the growth of the new account that we're signing up, which we already signed up, it's just that the product [will] [can be start] to coming in from overseas and also domestic, we have to increase stockpiles to 60 to -- 30 to 60 days inventory on the floor for them to start to take on the product, and that's where we see the number is.

And then, Michael... This is Jian -- no, you're fine. Just maybe to provide a little more color on the -- from the numbers perspective, to answer your question on the breakdown by quarter in 2023. So this is what we have in mind. For Q1 '23, we already discussed in the previous prepared remarks that we are currently expecting the revenue to be down about 10%. And I think Alan provided a lot of great color on operationally what's driving that. From overall, the expense perspective, I think that's going to -- we talked about that, that trend is going to reverse. And then we're going to see that revenue growth is going to accelerate towards the end of the year. So we do currently expect continued momentum in our revenue growth, primarily in the second half of 2023, probably around 20% or above in the fourth quarter. So over when we're looking at the full year 2023, that's how we come up with high single digit year-over-year growth.

So if I'm playing this out, negative 10 in the first, low to mid-single digits in 2Q, teens in 3Q over 20% in 4Q, and that's how you get a blend to about 8%.

That's just the overall trend is we're going to start a little, but it's going to continue to accelerate throughout the year, yes.

Right. Right. And the way I sort of characterize it, 1Q negative 10, sort of up 5% to 10%, 3Q up 10% to 15%, 4Q up 20% to 25%, that blends you into, call it, an 8% number. That's a high single digit. Would you discourage us from thinking about it that way?

No, I would. I think the overall trend makes sense. Obviously, part of that depends on the timing of the shipments, especially as we think about quarter end. But I think overall, the trend is -- makes sense.

Okay. And then I mean your margin outlook, 32% to 33% straddles the 32.2% for the year. So it's a slight down to and up 80 basis points and you're dealing with a negative in the first quarter. So the nature of this question is, are we looking for increased number of SKUs and better quality of what's being sold is what helps overcome a headwind in margins in 1Q and then an improving trend to get you to, call it, the midpoint 32.5%, which should be up modestly year-over-year on a full year basis at the midpoint. Is that the right assumptions about how that's happening?

Michael, Michael, let me answer that question. We're going to see more of a higher margin in the first quarter and second quarter, and then we want to see a lesser margin in the second half of the 2023. That's one of the strategies that we're seeing is because we are going to go through ahead in terms of competing the market starting the second quarter -- second half of the year as we have more capacity in terms of facility space.

And yes, and earlier, Jian mentioned that in the fourth quarter, we're going to see -- actually starting third quarter, fourth quarters, we're going to see more of an increase because historically, our increase year-over-year has been around 15% to 22% year-over-year growth, and that's where we're going to see the momentum on that part mainly because of our additional sales reps that we've hired as well as the additional warehouse space that we have to service the new geographic area customers.

We mentioned that in the past years, our goal is to continue to grow into the area that we have not touched that is the Southeast, Midwest and the East Coast. And finally, we are -- with the additional space that we added, we'll be able to accommodate the growth in that area.

Okay. And just so I make sure I've heard this correctly. If I'm looking at the margin trend you're higher in the first half than you are in the second half, which means you have a sequential improvement from the year-end 4Q into the first half in order to land at a midpoint of 32.5% for the full year, which is your guide 32% to 33%.

Correct. Correct.

Okay. Okay. And then I don't want to belabor the fourth quarter much. I get some of the dynamics that are happening that were out of your control between down equipment and getting product from overseas, but if you -- and I haven't had a chance to do this because I'm on the road and so I confessed I should have done it myself, but I haven't, so I'm asking you.

If you account for -- well, let me ask it a different way. You gave guidance that would have landed us at about 33.2% for the margin for the quarter, and we came in at 32%. So what accounts for that 120 basis points? I'm assuming some of it's the write-offs and some of it's the timing of product that got disrupted because of the equipment failures, But I would like to hear sort of what's -- what made up some of that 120 basis points.

Jian, would you -- my understanding is to write-off, but Jian can go into detail on that part.

Yes, I can take that question. So the biggest impact in terms of the margin in the fourth quarter, you're right, it is the write-off. The out-of-period, which we talked about in the prepared remarks, the impact is $1.7 million for Q4 2022.

All right. I can do the math on that. So what's really important is you would have hit your margin target even if the sales were down because of the pricing givebacks related to freight. That's the real important message as margins are on track ex the write-off.

Yes. Margin is actually on track to grow.

But I'm specifically in the fourth quarter, margins were okay ex the write-off. I get the dollar amount is lower because of starting on a smaller sales base because you had to get price back. But the margin went actually was -- the margin trend actually right off for the fourth quarter was on budget or better.

I can take -- Michael, I can take that question. So it actually is going to be better. So without the impact of the $1.7 million out-of-period adjustment, our fourth quarter margin would have been 33.8%. So it would have been better. And then in Q1, we are seeing that operationally that some of the actions that we are taking to improve the margin is actually -- we're starting to see some of those translating into numbers. So we do expect margin to continue to expand from that number into Q1 2023.

Okay. I wanted to make sure we had that clarity because I think that's important for everybody to understand. You had a good margin quarter. You had to give back some price but you had a good margin quarter. Okay. That's -- last question for me. Capital spending, you said it was going to be down, but what's the dollar amount you're budgeting.

Jian, can you take that question for the capital side. I know my understanding that it will be much lower than the previous years. I believe the 2022 and 2021 where you spend over [$15 million] in capital expenditures. But in 2023, I think we're looking to spend under $4 million for capital expenditures as we decreased manufacturing in California. So we will reduce the CapEx expenditure for the maintenance expenses. But in terms of -- yes.

Yes, that's absolutely right. So I would say our run rate CapEx is going to be significantly lower, as Alan talked about. That number is excluding -- for example, the continued investment that we are making into the joint venture or if we were to expand to continue to invest into the joint venture. But that's absolutely right. The run rate CapEx is at a much lower level.

Okay. So about $4 million is what I'm hearing?

That is correct.

Correct.

The next question comes from Paul Dircks with William Blair.

First 1 for me is -- and forgive me if this was covered earlier, but on the destocking behavior, obviously, I think the thinking was that it would end here in the fourth quarter, it's obviously continuing into 2023. Can you help us parse out if there are certain customer segments, certain product categories or any other certain labeling of what actually is being destocked? And how much confidence do you have that it will wane over the next quarter or two.

I believe the destocking part for most of our clients that we service has ended in the end of last year. We continue to emphasize to our customers do not overstock we will bring product in. There's no shortages. There's no supply chain issue in most cases. Ocean freight are better than last year in terms of the arrival time they're more clear, the easier to get the container out of the port. It's less congested. And the domestic local carriers are actually faster than before.

So there is less of an issue of supply chain disruption only in certain case that some of the container might get delayed. But in most cases, it's not going to be delayed and also as well as the price. We actually kind of alerted our -- most of our customers that price was -- has started to come down since last August, September and October, and they continue to come down, and we will continue to let them know what is the market price on that part. So our client has been a [educated advice] on that part. So I don't see any more of destocking. That's where I mentioned earlier that everything should be normalized in 2023.

Okay. So just to be clear, no more destocking here in the first quarter?

Correct.

Okay. Got it. Next question for me. In 2022, price was up about 12% for the company. Can you let us know what was price up for the Karat Earth products? Or maybe if you have it in this way, how much did Karat Earth products contribute to your overall price increase?

Jian, do you have the numbers?

Karat Earth in itself in terms of the percentage of the overall price increase is actually not a super significant percent, it should be below 10%.

Okay. So -- And then maybe into 2023, are we seeing any price deflation on Karat Earth products? Or are those somewhat saved given the fact that there's so much of a push globally into ecofriendly products.

Yes, Paul. I am seeing some deflationary pricing on the -- including the Karat Earth. They're broadening for overseas when they -- when the price increase in ocean freight, it was also added to the Karat Earth. Basically all category lines were added on the ocean freight lines. So we also have announced a price decrease on the Karat Earth product in the fourth quarter and also January of this year as well.

Got it. That's helpful. And then last one for me. Into 2023, what are your expectations for being able to leverage your SG&A, do you expect that you'll be able to do that for the full year? Or is this something that we should think about only when revenue is growing in the back half of the year?

I do believe -- I'm sure Jian can go -- elaborate more, but my understanding that for SG&A is coming down. In second part of last year, SG&A were up sharply, facility costs, labor costs and also production manufacturing expenses, but SG&A should be starting to come down in terms of 2023 as we reduce manufacturing in California, mainly the SG&A increase was due to manufacturing in California, trying to repair the equipment and also the hiring the people or skilled labor for -- to maintain this equipment. That was one of the biggest challenge for the past 3 quarters. We do see that moving into Texas. That will have give us more of a leverage in terms of balancing out and reducing the expenditure in SG&A in the part.

The next question is a follow-up from Jake Bartlett with True Securities.

I had just a couple of follow-ups. One was on the CapEx and what you're talking about kind of for expectations for '23. But if I include just CapEx plus deposits, which I think seems to be the best way to do it, but it was $14.7 million in '22, what should that number be in '23? You mentioned $4 million in CapEx, but that's not kind of the -- maybe the whole picture and especially with what you're investing into the JV. So what should we -- if we think about kind of free cash flow is a combination of CapEx and deposits, what should that number be?

Well, Jake, for the year 2022 and 2023, the equipment that we order is in 2022 that will -- we pay most of deposit, and we actually accounted for that as a CapEx expenditure already in 2022. They're coming in basically, there's not much coming in into 2023. And basically, all we have to do is pay the remaining balance of those equipment that we paid for already in 2022.

As far as JV, we actually pay majority of it in 2022 already in terms of CapEx deposit on that part. 2023, as we mentioned that we want to see first how the joint venture in terms of the sales growing and growth and everything and to see if we do increase the CapEx, the additional investment. Or actually, we're looking to having -- actually having additional party to join the joint ventures in terms of selling their shares and having more shareholders for the company. So there's different areas that we're actually looking to right now on that part. So we don't see much of an increase in CapEx for deposit in 2023 for the joint venture, but for -- as well as for the equipment-wise.

So that's why we're saying that we're pretty safe in terms of $4 million in terms of maintenance and some of the capital expenditure, where you're actually looking to spend is on new trucks, new trailers, warehousing, racking and those are the things that we're spending in terms of the 2023, more on the logistics side.

Okay. Now in the Chicago or Illinois factory in Houston warehouse, those wouldn't be big CapEx expenses, the $4 million includes those.

Yes, that would not be a big expenditure for CapEx.

And then my other question is about you're back to pricing. And in my other coverage, covering restaurants and their guidance for costs in '23? And all of them have packaging costs being up year-over-year, so they're not seeing this at least telling us yet about deflation on that line. Is there any nuance that maybe the -- what restaurants order for to-go packaging is not going to be deflationary, but other items are? Just maybe a little more detail because I'm seeing a little bit of a disconnect in terms of what the restaurants I cover are talking about and then your kind of commentary on pricing. And maybe if you could just -- maybe it's a factor of what is coming down.

I know in the past, you've talked about the plastics, plastic-based products that are really what's driving the deflation on your pricing. So any more detail there would be helpful.

Sure. Plastic actually dropped more than anything. Paper has not dropped at all. Paper costs in the U.S. has been -- actually has gone up a lot in 2022, even toward the end of the year. I've even seen a price increase in January of 2023 on the paper side. But on the plastics side, it has dropped a lot about more than 40% in terms of resin costs. And that's basically -- it's known to everyone.

One thing about the restaurant industry. Restaurant doesn't really -- even though they orders, they buy direct from manufacturer like us, they actually have to have a third-party logistics such as Sysco, SYGMA or other national distribution company. They would do to mark up and in terms of what is the landed cost, the actual cost is determined not just by buying from the product from us, but also from the logistics side of the business. Now in that part of the segment of business, I've seen that increase a lot in terms of facility and labor. So that might be in the case that the actual landed cost has gone up versus the product cost has come down.

This concludes our question-and-answer session. I would like to turn the conference back over to Alan Yu for any closing remarks.

Well, thank you for everyone for joining the conference call of Karat Packaging, and I look forward to the future conference call. Again, thank you all, everyone. Goodbye.

The conference has now concluded. Thank you for attending today's presentation. You may all now disconnect.