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Karat Packaging (KRT) Q2 2021 Earnings Call Transcript

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KRT earnings call for the period ending June 30, 2021.

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Karat Packaging (NASDAQ: KRT)
Q2 2021 Earnings Call
Aug 12, 2021, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon, and welcome to the Karat Packaging second-quarter 2021 earnings conference call. All participants will be in a listen-only mode. [Operator instructions] I would now like to turn the conference over to Roger Pondel. Please go ahead.

Roger Pondel -- Investor Relations

Good afternoon, everyone, and welcome to Karat Packaging's 2021 second-quarter earnings call. I'm Roger Pondel with PondelWilkinson, Karat Packaging's investor relations firm. It is my pleasure, momentarily, to introduce the company's chief executive officer, Alan Yu; and its chief financial officer, Ann Sabahat. 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 IPO registration statements 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 and adjusted EBITDA margin, which are non-GAAP financial measures as defined by SEC Regulation G. A reconciliation of non-GAAP financial measure to the most directly comparable GAAP measure 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?

Alan Yu -- Chief Financial Officer

Thank you, Roger. Good afternoon, everyone. We're pleased to be here with all of you today. Our business continued to grow at a robust pace.

Earlier today, we reported solid second-quarter financial results that reflect strong demands and the company's prowess and its nimbleness as a leading supplier of customized solutions for a diverse and expanding customer base. In addition, increasing adaptation of environmentally friendly products and solutions continue to drive demand for the food service industry, and particularly for Karat Packaging. For the second quarter, net sales were ahead of the expectation, increasing 12% year over year with a strong performance in our national, online, and distribution channel. Excluding the personal protective equipment products that we primarily sow in the second quarter last year during the height of the COVID-19 pandemic, our rate of comparative sales growth for the second quarter on our core business was nearly 70%. Online sales rose 22% year over year in the second quarter, and we continue to shift our sales mix toward these high-margin channels. Sales through national and distributor channels also increased at a double-digit pace. Retail sales were lower year over year in the most recent second quarter.

Primarily due to PPE sales in the last period -- in the prior period. Gross margin in this fiscal 2021 second quarter decline year over year. Primarily due to increases in freight and material costs, as well as a comparison to the higher-margin PPE products that we saw last year. As Ann will explain shortly in more detail, we saw a significant number of PPE products in last year's second quarter.

These products carry a higher margin close to 50%, which is higher than what -- higher the margins on our traditional products. Ocean freight rates have risen to the highest rate we've ever seen, and we expect this rate to remain at a high level until early next year. To respond to the current and anticipated increases in freight rates and to protect our margin, we instituted multiple price increases in the second quarter. As a result, gross margin increased 110 basis points sequentially over the 2021 first quarter.

Despite higher freight costs, we continue to take action to pass on higher costs in July with the largest price increase in our company's history. Our positive momentum has continued into the third quarter with a secular tailwind we're seeing in the restaurant opening, consumer spending services, and adaptation of environmentally friendly products helping to drive the demand in support of our business. We're also seeing high demand for our beverage line of higher-margin bubble tea supplies, which is adding to our growth and profitability. As a result, we're currently targeting net sales to be in the range of 100 million to 102 million in the 2021 third quarter. Moreover, growth in high-margin online sales and the actions we've taken to pass on higher freight cost has given us confident in our ability to improve our gross margin in the third quarter relative to the first half of 2021.

At the same time, we are also are driving greater efficiency in our operation. We're better leveraging our cost base at our largest facility in Texas. Wile increase also increasing output, we are also regionally expanding our network through the acquisition of a warehouse building and the addition of a distribution facility in South Carolina. We want to leave adequate time for questions so I will stop here and turn the call over to Ann to discuss our first-quarter results in detail.

Ann?

Ann Sabahat -- Chief Financial Officer

Thank you, Alan. Our 2021 second-quarter results reflect strong top-line growth offset by a decline in gross margin and an increase in operating expenses. Net sales increased 12% to 95 million in the second quarter In last year's second quarter, we shifted to import PPE products to meet a critical need during the height of the pandemic and support our growth. Sales of this product peaked in last year's June quarter at 29 million. Since then, PPE sales as expected have declined and represented less than 1% of total sales in this year's second quarter. Excluding PPE products, sales in the 2021 second quarter rose 69% year over year.

Sales to distributors, our largest channel, grew 14%, and sales to a national chain expanded 38%. Primarily due to more business with existing customers. Online sales rose 22% in the quarter as we continue to make significant investments in this channel. Sales to the retail channel sell 41% from a year ago. Primarily due to sales of PPE products in last year's second quarter.

Excluding PPE products, our sales in our retail channel were up slightly year over year. We also increased minimum shipping requirements to better manage tight labor conditions, which shifted a portion of our sales mix from retail to distributors and enabled us to better utilize staff and resources. For reference, the tables in our earnings release issued earlier this afternoon breakout sales of our traditional products excluding PPE by channel. Gross profit decreased 3% to 28 million in the 2021 second quarter.

Primarily due to a decline in gross margin partially offset by higher sales. Gross margin was 29.7% in the 2021 second quarter. A decline of 440 basis points, compared with 34.1% in the same period of last year. The gross margin declined primarily reflects higher freight and material costs, as well as the high margin PPE products sold in the last year second quarter.

As Alan mentioned, we've taken action to pass through higher costs in a series of price increases. Our progress to date is evident with our gross margin trend, which was improved from 27.4% in the fourth quarter of 2020, and 28.6% in the 2021 first quarter to 29.7% just reported in the second quarter. Operating expenses in the most recent second quarter increased from 47% to 21 million. Principally reflecting higher shipping costs, payroll expenses associated with workforce expansion and temporary labor, an increase in facility costs, and higher professional fees.

Costs related to our public offering were approximately 600,000 in the 2021 second quarter. Operating income declined 53% to 7 million in the 2021 second quarter. Operating margin was 7.3%, compared with 17.1% in the same period of last year. Primarily due to the pressure from higher freight and shipping costs.

Other income increased approximately 5 million year over year in the second quarter due to a gain on PPE loan forgiveness, which we borrowed last year. Provision for income tax expense decreased to 2 million in the 2021 second quarter from 4 million in the same period last year. Our effective tax rate was 14% in the second quarter, compared with 28% in the same period last year. Primarily because the 5 million gain recorded on the forgiveness of the PPP loan is not subject to federal income tax.

Excluding the gain on debt forgiveness, our effective tax rate in the 2021 second quarter would have been 23%. We expect our effective tax rate for 2021 to be in the mid-20% range. Net income amounted to 9 million for the 2021 second quarter, compared with 10 million in the same period last year. Net income attributable to Karat Packaging Inc.

was 9.6 million, or $0.50 per diluted share in the second quarter, compared with 10.1 million, or $0.65 per diluted share last year. Adjusted EBITDA on a consolidated basis was 10.1 million for the 2021 second quarter, compared with 16.5 million a year ago, and 6.8 million in the 2021 first quarter. Consolidated adjusted EBITDA margin was 10.7% in the second quarter, compared with 19.4% a year ago, and 9% in the 2021 first quarter. Adjusted EBITDA attributable to Karat Packaging was 9.2 million in the 2021 second quarter.

Adjusted EBITDA margin attributable to  Karat Packaging was 9.7%. Net cash used in operating activities was 2 million in the 2021 second quarter, compared with net cash provided by operating activities of 7 million in the same period last year. The decline, primarily, was due to changes in working capital, in particular, increases in inventory and accounts receivable that principally reflect our growth. Capital expenditures were significantly lower year over year. Primarily as a result of the purchase of manufacturing equipment and construction of our facility in New Jersey last year.

I'll now turn the call back to Alan for closing remarks, then we'll be happy to answer any questions you may have. Alan?

Alan Yu -- Chief Financial Officer

Thank you, Ann. Our business continues to grow as we capture positive secular trends in the food service industry. As a nimble supplier of a wide range of products, Karat Packaging is able to respond more quickly to market conditions than our competitors, which we believe gives us a tremendous advantage. Our 2021 second quarter delivers solid growth in sales as we proactively work through our cost pressures. We're pleased that demand continued to be strong, which we believe will contribute to another solid sales performance in the third quarter.

With that, I'll turn the call over to the operator for Q&A.

Questions & Answers:

Operator

Thank you. We will now begin the question-and-answer session. [Operator instructions] And the first question will come from Jake Bartlett with Truist. Please go ahead.

Jake Bartlett -- Truist Securities -- Analyst

Great. Thanks for taking the questions and congrats on to some great top-line growth here. You know, Alan, my first question is about the upside to sales that you saw in the second quarter and the strong guidance for the third. You know, are there any particular channels that are driving the upside, or is it pretty broad-based?

Alan Yu -- Chief Financial Officer

I do see -- Jake, well, if you can hear me well --

Jake Bartlett -- Truist Securities -- Analyst

I can.

Alan Yu -- Chief Financial Officer

I do you see -- can you hear me, Jake?

Jake Bartlett -- Truist Securities -- Analyst

Yes.

Alan Yu -- Chief Financial Officer

OK. Well, this is why I see the catalyst of the -- what I see in the second quarter is the online sales. I've seen more and more people ordered online. I've seen there's a disruption of the supply chain throughout the U.S., especially in the cup market.

Everyone -- if you go out to a national chain account, it could be any national chain account, you asked them for a cup. Normally, they have a printed cup. Now, they probably tell you that we're out of cups. We have a Styrofoam cup.

In some places, they don't even have Styrofoam cups. Well, I heard in the market is that every manufacturer is struggling -- having a challenge in terms of producing regardless of a Styrofoam cup or a paper cup or plastic cup. This is where we see everyone -- when people can't find a product in a normal distribution channel or the ration people, they go online. We see a lot of people going online buying our straws, our bubble tea supplies, and our cups. So what Ann just mentioned earlier in the conference, that she described one of our biggest sales growth as we've seen, almost a double like 100% growth in a bubble tea supply demand.

This is something that we have never seen in the past year. The boba's double-digit -- actually, triple-digit growth year over year. Cup demand, upside increase. I guess what -- when people like -- I was talking to customers in Las Vegas and Florida.

People are traveling now. They're going everywhere. They're taking flights. And they're using cups and going to their favorite restaurant. They're going to the hotels.

Hotels are buying cups like crazy. In Las Vegas, everywhere you go is packed with people, and they're holding a plastic cup or paper cup. So, the demand has really gone up, and especially in the second quarter when the economy opens up. So, just the way I see all these -- the panelists of the growth and it's actually -- it's carry over to the third quarter. Why? Just on our backorders, we're behind three weeks in a shipping product.

Imagine if we're caught up, this is -- it is -- we just don't have enough people to pack the orders and a ship right now. We're at this challenge that I do see everywhere in the market is facing. And regardless it's Sysco, US Foods, or Bonzo, or anybody. That's Amazon -- even Amazon is having challenges hiring people to get the product shipped in a timely manner.

Jake Bartlett -- Truist Securities -- Analyst

Great.

Ann Sabahat -- Chief Financial Officer

Jake, let me follow up with what Alan just shared. In Q2 2021, we saw food products grew to 21 million, or 22% of revenue for Q2 of 2021, which is over 200% year over year, and over 60% Q per Q. The main food growth drivers were syrup, boba, popping pearls, and powder. In terms of cups, revenue for cups, couplet holders, and cup jackets came in at a robust approximately 20 million, or 27% of total revenue in Q2 of 2021. And this has been up about 30% for us compared to Q1 of this year and, significantly, up over 200% from the pandemic glow of Q2 of 2020.

Another trend that we are seeing is your -- the food containers for us remain roughly at about 15%, and custom printouts remain approximately at 19% for the company in Q2.

Jake Bartlett -- Truist Securities -- Analyst

Great. That's really helpful. It's actually my next question but just build on that. What percentage was environmentally friendly, you know, whether it's Karat Earth, or just how else you define it and maybe you could share both as a percentage of sales in the second quarter?

Ann Sabahat -- Chief Financial Officer

Yes. Eco-friendly sales approximated 17 million in Q2 of 2021 or roughly 18% of total revenue. An increase from about 14 million in Q1 of 2021 and 8 million in Q2 of 2020. The company continues to see strong demand for paper food containers, hot cups, cold paper cups, and food-to-go containers. In terms of Karat Earth, as a percentage of sales, we continue to see it at steady at about 5% of total revenue for Q2 of 2021.

Jake Bartlett -- Truist Securities -- Analyst

Great. And then my last -- my next question is SG&A. It was up fairly consistently in the second quarter from the first quarter. How should we think about the back half of the year in '21? Is the second quarter a good run rate or should we expect a similar kind of growth quarter to quarter as we move throughout the year? Just, you know, any help on what we should expect from SG&A going forward.

Ann Sabahat -- Chief Financial Officer

Yes. So, we should expect Q3 to be similar to that of Q2 of this year.

Jake Bartlett -- Truist Securities -- Analyst

OK. And for the fourth quarter, kind of a similar as well, or any reason that should deviate?

Ann Sabahat -- Chief Financial Officer

That should be a similar expectation as well in Q4.

Jake Bartlett -- Truist Securities -- Analyst

OK. And then last question --

Alan Yu -- Chief Financial Officer

Now, Jake, I want to have --

Jake Bartlett -- Truist Securities -- Analyst

Yeah, go ahead.

Alan Yu -- Chief Financial Officer

Jake, I want to add to what Ann mentioned earlier in Q3. In our conference call, we did mention that our Q3 earning is going to be around 100 million to 102 million, which is 30% to 33% year-over-year growth. I would think that is -- it's going to be higher than our Q2 numbers. And this is the one reason we see a strong headwind continue into the third quarter based on the second-quarter numbers.

Jake Bartlett -- Truist Securities -- Analyst

Headwind of what? You mean a --

Alan Yu -- Chief Financial Officer

Oh, tailwind. That's it, tailwind. 

Jake Bartlett -- Truist Securities -- Analyst

Tailwind. Yeah, got it. Great. And then just -- if you could frame up, you know, what kind of pricing is in the system in the third quarter versus the second quarter. How much has that -- you mentioned it is the largest increase from July in the company's history.

If you could help us just frame, you know, what the year-over-year pricing is at this point and what it was in the second quarter that would be great.

Alan Yu -- Chief Financial Officer

Sure. In the second quarter, we took some price increase in April and also in June in different categories. But in July -- end of July, we actually imposing a 10% to 18% price increase nearly across the board with the exception of some national chain accounts. But this is like our largest price ever increase because we've seen the ocean trade has gone up tremendously since June and July, and even August.

This month, we've seen ocean freight continues to go up, and it's actually deterring a lot of our competitors from stop importing the product. And even with the high cost of the ocean freight, most of our -- are still unable to get enough container space to bring their product here. This is what costing a supply chain disruption in the U.S. is that even if you pay more like almost triple the amount of money that you used to pay last year, there is no guarantee of getting a container space.

Jake Bartlett -- Truist Securities -- Analyst

Got it. Great. I appreciate it. This is all very helpful.

Operator

And the next question comes from Michael Hoffman with Stifel. Please go ahead.

Michael Hoffman -- Stifel Financial Corp. -- Analyst

Hi, Alan, Ann, thanks for making time for me this morning or this afternoon. I mean, my questions center around the cadence for the remainder of the year. So, we've got a meaningful improvement in revs, EBITDA actually came in about where you all thought it was at the time of the IPO. I guess, maybe we, as sell-side analysts, were a little more ambitious but it came more or less in line with your thinking. So, how do you feel about that original IPO, EBITDA, net of global sales that was about 38 million? Are we still on a pace to be able to do that accounting for the challenges with freight and labor but really good demand and sort of balancing all that out?

Ann Sabahat -- Chief Financial Officer

Michael, that is a great question. So, in terms of our EBITDA margin, we continue to have confidence that our EBITDA margin will be between 9% to 12%. In terms of -- yes, and so, that should lead us on the trend to be between 36 million to 38 million roughly for the remainder of -- for the rest of the year. 

Michael Hoffman -- Stifel Financial Corp. -- Analyst

OK. So, a little bit low on the -- lower on the low end. The high end still sorts of reflects where we're starting, and in fairness, you know, there's been some unprecedented inflation pressures and you're working hard to price it through and manage cost.

Ann Sabahat -- Chief Financial Officer

Yes, I mean, absolutely. I mean, what we have seen is that in spite of the rising freight and freight costs, what we have been able to do is we have been able to protect our growth margin. We went from 37.4% in Q4 2020 to 28% in Q1 of this year, and then 29.% in Q2 of this year. So, we have been very proactive in protecting and also expanding our margin in a very tight market the past few quarters, right? And so, we do continue to expect again our EBITDA margin to be within that 9% to 12% range, which would lead us to be about 36% to 38% total EBITDA for 2021.

Michael Hoffman -- Stifel Financial Corp. -- Analyst

And, you know, again, speaking about gross margins, you've always talked about that approximately this is a 30% gross margin business. So, would we -- given the pricing initiative, some mix trends, the strong demand would -- are we headed toward a 30 for the remainder of the year so -- with further sequential improvement?

Ann Sabahat -- Chief Financial Officer

That is our expectation, Michael. In the remainder of the year for Q3 and Q4, our expectation is we're going to be at that 30% gross margin range.

Michael Hoffman -- Stifel Financial Corp. -- Analyst

OK. That's terrific to hear.

Alan Yu -- Chief Financial Officer

And I believe that -- I believe, Michael, as mentioned in the last quarter, our goal for 2021 is 29% to 31%. And also -- we've already seen the second quarter at 29.7%, 29.8% already. So, we're already near the 30% already. So, we are still shooting for the 31%.

You know, that's our goal, basically, when we first started discussing the IPO, yes.

Michael Hoffman -- Stifel Financial Corp. -- Analyst

OK. Terrific. So, lots of restaurants have been able to get opened. You know, we've all heard the same stories of challenges with labor and all of those things.

But the interesting question I have is, moving from takeout to on the curb to indoor dining menu started changing, and how are some of those menu changes been showing up in your business? That's sort of part one. And then, there's this increasing announcement of expanding the number of ghosts -- I was going to say ghost chickens but I mean to say ghost kitchens also impacting the business.

Alan Yu -- Chief Financial Officer

Well, here's the thing, when restaurants were shut down but most were using takeout, we've seen a rise in demand on the takeout containers. Every restaurant will have takeout containers -- a sharp drop in the cup business, in the napkin, and the unwrapped utensils, and the disposables line of product. But when the restaurant started to open up, we saw an even larger increase than that in the cup. When the fountain drink, when they were closed, people are using less cup now.

But the -- when they open up the fountain, everyone starts scrambling to restock the cup that they use, as well as napkins, utensils. The items that we -- basically, we're not moving during the pandemic and started to really move when restaurants started opening up. And we've seen one of our customers was telling us that when the pandemic -- when there was a pandemic -- when they shut down the indoor dining, the takeout, the drive-thru was -- basically, cars were wrapped around their seat in the shopping mall for the drive-thru. When they open up the indoor dining, they basically added double the store size of their business. So, most of these high-volume stores where there are more drive-thrus and when they open the indoor dining, in fact, they could open two more or new stores for everyone in the locations that they have.

That's not some distant era that customer has been telling us. And, I guess, like I said earlier, when restaurants opened up, when the hotels opened up, when the resorts opened it up, and also the stores inside opened up, the demand just skyrocketed.

Michael Hoffman -- Stifel Financial Corp. -- Analyst

OK. Last one for me. M&A is something we've, you know, you've talked about. That was one of the purposes of the IPO was to create a balance sheet that would allow you to start looking at M&A, and Pacific packaging you let off with.

What it was -- how would you frame where your pipeline is, the prospects of possibly finding another opportunity like Pacific packaging or even something different? Can you talk to us about that?

Alan Yu -- Chief Financial Officer

Yes. We are -- we have -- we see some -- Ann and I have been looking and discussing with several companies and we're looking -- we're doing the due diligence. And also, we want to do the right thing and make sure that there's a bright mix. As we mentioned in the IPO, we're looking for a company with synergy, leadership, the management team, and also the product offering, and another thing is the location.

So, these are the things that we're looking at. And we have been in discussion with a couple of these companies. We're just on -- we're gathering more information on that part.

Michael Hoffman -- Stifel Financial Corp. -- Analyst

All right. Terrific. Thank you for taking my questions. Good luck for the rest of the year.

It's an interesting operating environment.

Alan Yu -- Chief Financial Officer

Thank you, Michael.

Ann Sabahat -- Chief Financial Officer

Great. Thank you.

Operator

And the next question will be from Ryan Merkel with William Blair. Please go ahead.

Ryan Merkel -- William Blair & Company-- Analyst

Hey, thanks for taking the questions. So, first off, Alan, in this market with major shortages is your import model winning in the marketplace? Are your fill rates better than your competitors?

Alan Yu -- Chief Financial Officer

I have to say, yes. I -- if you covered the industry well and I'm sure you can talk to any one of our industry sector manufacturers, everyone is having shortages. And there's one -- the main reason for the shortage is it could be a supply issue, raw material supply issue. And mainly, it's a labor issue. The major shortage of laborers.

That is one of the main reasons that there's a supply shortage in the market. It's just really hard to get people to come to work in this environment. Everyone is hiring but it's really tough. It's a challenging market in labor. It's not just for the manufacturer.

It's for the restaurants. I've spoken to a lot of restaurants. They had to shut down their dining -- indoor dining because they can't find people to work and clean the indoor area -- dining area. Some of the managers in our distributors have to drive the forklift and load the truck and they all make deliveries. I think everyone has that same challenge.

So, basically, the only alternative is importing. Now, when we saw the -- actually, we had kind of knew every year that when the summer comes, there's a short -- always a shortage. So, we had a month and a half a shortage in our product. So, we -- our fill rates were slow. And then we started ramping up on import in June and July.

So, right now, our warehouse is packed and, I believe, our fill rate is better in California, but we're trying to get the product into Texas and New Jersey area. And that's one of the challenges everyone is facing. There are more supply issues on the East Coast than the West Coast because the ocean line -- the ocean freight container freight is unable to get to the New York area, the East Coast area. So, everything is coming to the West Coast and rail with the truck into the East Coast, which is there -- that's why -- that's causing great congestion in the logistic.

Also, I would say that every logistic including UPS, FedEx, or the ground carriers, they are maxed out at their capacity. There are major delays. You can see that every website is telling you that there's a delay in shipping, there's a delay in delivering, just expect delays. But I would say our fill rate today is definitely better than most of our competitors right now.

Ryan Merkel -- William Blair & Company-- Analyst

OK. And you sort of hit on my follow-up, which is you've got ocean freight rates, you know, going crazy. You've got the congestion, you got, you know, containers coming in late and delayed. How are you managing that? How are you importing product effectively and having these high fill rates when there's a lot of other people that are facing challenges?

Alan Yu -- Chief Financial Officer

Well, we actually took the initiative of placing the order in a van. So, we actually -- like in our conference call, we're nimble. That's how we're able to compete in the marketplace. We're small and we're nimble, so we move fast.

And when we saw there's a height of peak or rising demand in the bubble tea line product, with the cup business, we immediately placed additional orders with our overseas partners and manufacturers and they started shipping. And we actually order more than twice the amount of what we normally would order. And also, at that time, basically, they all actually arriving now. And that's one of the reasons we're able to fulfill a lot more of our customers. And actually, we're helping out a lot of these national chain accounts that ran out of cups, that ran out of straws, that ran out of two containers.

We're basically helping a lot of people out. You -- if you cover the restaurant industry and you would talk to these national chains, you would -- the people would actually tell them, come to Lollicup, they might be able to help you. I mean, that's what's going on out there. 

Ryan Merkel -- William Blair & Company-- Analyst

Yeah, that's great. OK. That helps. And then just lastly, we had on this a little bit but just want to be clear, in the quarter for gross margins, did your price increases cover your, you know, raw material cost increases and freight increases?

Alan Yu -- Chief Financial Officer

I believe it did. As Ann mentioned, our second-quarter gross margin was actually higher than our first quarter.

Ryan Merkel -- William Blair & Company-- Analyst

Right. 

Alan Yu -- Chief Financial Officer

Because the largest increase in the raw material was in April and May. There was -- the largest increase in the raw materials is not in the first quarter. That was in the second quarter. So, basically, if we have not implemented the price increases, our gross margin will fall below the first-quarter number.

But, in essence, we actually were able to increase it from 29.2 to 29.7, I believe, And that's due to the fact that we were proactively passing on the increase to our customers onto our products.

Ryan Merkel -- William Blair & Company-- Analyst

Right.

Ann Sabahat -- Chief Financial Officer

Yes. And to clarify, you know, we went from 27.4% Q4 to 28.6% in Q1, and then to 29.7% in Q2. So, to Alan's point, yes, we have been able to increase cost sufficient to cover the rising ocean freight and the higher material cost, and then, you know, contribute to the additional margin expansion sequentially over the past few quarters.

Ryan Merkel -- William Blair & Company-- Analyst

Perfect. Very helpful. Thanks a lot.

Ann Sabahat -- Chief Financial Officer

Absolutely. 

Operator

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

Alan Yu -- Chief Financial Officer

Well, thank you all for joining our conference call. We will definitely continue to work hard to increase our shareholder value and we'll look forward to a better next quarter. Thank you all. Have a nice day.

Operator

[Operator signoff]

Duration: 38 minutes

Call participants:

Roger Pondel -- Investor Relations

Alan Yu -- Chief Financial Officer

Ann Sabahat -- Chief Financial Officer

Jake Bartlett -- Truist Securities -- Analyst

Michael Hoffman -- Stifel Financial Corp. -- Analyst

Ryan Merkel -- William Blair & Company-- Analyst

All earnings call transcripts

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