Karat Packaging Inc. (KRT) Q3 2021 Earnings Call Transcript

Karat Packaging Inc. (KRT -0.52%)
Q3 2021 Earnings Call
Nov 11, 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 third quarter 2021 earnings conference call. [Operator instructions] After today's presentation, there will be an opportunity to ask questions. [Operator instructions] Please note, this event is being recorded. I would now like to turn the conference over to Roger Pondel with PondelWilkinson, investor relations for Karat Packaging.

Please go ahead.

Roger Pondel -- Investor Relations

Thank you, Andrea, and good afternoon, everyone. Welcome to Karat Packaging's 2021 third quarter earnings call. I'm Roger Pondel with PondelWilkinson. We're Karat Packaging's investor relations firm.

It will be my pleasure momentarily to introduce the company's chief executive officer, Alan Yu; and its interim chief financial officer, Peter Lee. But before I turn the call over to Alan, I need to remind everyone today that our 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 IPO registration statement and in its most recent Form 10-Q as filed with the Securities and Exchange Commission. 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, management will be discussing adjusted EBITDA and adjusted EBITDA margin, which are non-GAAP financial measures as defined by SEC Regulation G. And a reconciliation of non-GAAP financial measures to the most recently or the most directly comparable GAAP measures is included in today's press release, which is now posted on the company's website. And with that, it is my pleasure to turn the call over to CEO, Alan Yu.

Alan.

Alan Yu -- Chief Executive 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 a solid third quarter net sales growth that reflects exceptionally strong demand for our products and continued expansion in our customer base. Market trend remains favorable, particularly for the environmentally friendly product and solution that Karat Packaging provides. For the third quarter, net sales were in line with the guidance range that we have increased just last month, growing at a pace of 35% year over year. Sales in our distributor, online, and national channels were particularly strong.

Excluding the personal protective equipment products that we sold in the third quarter last year during the height of COVID-19 pandemic, our rate compared to sales growth for the third quarter was 43%. Online sales rose 64% year over year in the third quarter as we continue to shift our sales mix toward these high-margin channels. Sales through national and distributor channels have also increased at a double-digit pace. Our sales were somewhat constrained by inventory shortages, resulting from tight labor conditions and port delays in the third quarter.

We are managing the labor environment through increased recruiting effort, the use of temporary labor, and targeted overtime, and shifted distributions to other facility in our supply chain. Gross margin in the fiscal 2021 third quarter declined year over year, primarily due to the increasing freight costs, which every company is experiencing. Ocean freight rates again rose in the third quarter relative to the last year, although they have begun to ease and stabilize reasonably. Despite this sequential improvement, we expect this raise to remain at the current high level compared with last year.

In addition, gross margin was affected by increased landed costs, which include freight and duty and custom brokers fee, of approximately 1.8 million versus a benefit in the same quarter last year and in preceding 2021 second quarter. These increased fees were capitalized into inventory in the prior quarter, resulting in a higher inventory cost in the third quarter. Subsequently, as the company saw its higher cost inventory resulting from increased landed costs capitalized from the second quarter, it negatively affected gross margin. The landed costs vary from month to month, especially due to the extreme cost fluctuation of ocean freight this year.

We will likely see a benefit for the fourth quarter based on the current inventory being sold that carries a lower landed costs. To respond to the current inflationary pressures and product shortages and to protect our margins, we instituted multiple price increases in September, and again, in November without any push back. As a result, we expect our gross margin to improve sequentially in the fourth quarter. Our positive business momentum is continuing into the fourth quarter, with the secular tailwind we've seen this year in consumer spending for services and adoption of environmentally friendly products helping to drive demand and support for our business.

Now, as a result, we're currently targeting net sales to be in the range of 93 million to 96 million in 2021 fourth quarter, up about 30.4% at the midpoint of the range compared with the same period last year. This sequential decline is consistent with normal seasonality. We expect our sales to result for the full 2021 year in the range of 366 million to 369 million. Growth in high-margin online sales and actions we've taken to pass on higher freight costs also give us confidence in our ability to improve our gross margin in the fourth quarter.

We want to leave adequate time for questions, so I'll stop here and turn the call over to Peter to discuss our third quarter results in detail. Peter.

Peter Lee -- Chief Financial Officer

Thank you, Alan. Our 2021 third quarter results reflect strong top-line growth, although gross margin declined and expenses increased, primarily due to higher freight, shipping, and labor costs. Net sales increased 35% over the prior year to 103 million in 2021 third quarter. During the height of the pandemic last year, we shifted quickly to import PPE products to meet a critical need.

Sales of these products in the last year's third quarter totaled 5 million. Since they peaked in the second quarter of last year, PPE sales, as expected, have declined and represented less than 1% of total sales in this year's third quarter. Excluding the PPE product, sales for the 2021 third quarter rose 43% year over year. First, the distributors, our largest channel, grew 44%, and sales to national chains expanded 24%, primarily due to more business with existing customers.

Online sales rose 64% for the quarter, reflecting strong demand and our continued investment in this critical channel. Sales to retail channel fell 14% from a year ago, with some sales shifted from retail to online channel. We also increased minimum shipping requirements to better manage our tight labor conditions, which shifted a portion of our sales mix from retail to distributors, which enabled us to better utilize staffing and resources. For reference, the tables in our earnings release issued earlier this afternoon break out sales of our traditional products, excluding PPE, by channel.

Gross profit increased 29% to 30 million for 2021 third quarter, primarily due to the strong sales growth with the quarter, partially offset by a decline in gross margin. Our gross margin was 29% for 2021 third quarter, a decline of 120 basis points, compared to 30.2% for the same period last year. The gross margin decline primarily reflects higher freight costs, which have begun to ease and stabilize in the fourth quarter even as we continue to take actions to pass through our higher costs through a series of price increases. Although our gross margin was slightly lower sequentially for the third quarter, we expect to see improvement in the fourth quarter and likely to see additional benefit from the freight and duty capitalization as Alan mentioned earlier.

Operating expenses for the third quarter increased 53% year over year to 24 million, principally reflecting higher shipping costs, payroll expenses associated with the workforce expansion, increase in facility and transportation costs, higher professional fees, and stock-based compensation of 0.8 million. Operating income declined 24% to 5 million for the 2021 third quarter. Operating margin was 5.2%, compared with 9.2% for the same period last year. This is primarily due to pressure from higher freight and shipping costs.

Provision for income tax expense was 1 million for 2021 third quarter, slightly lower than our provision for the same period last year. Our effective tax rate was 24% for both periods, and we continue to expect our effective tax rate for 2021 to be in the mid-20% range. Net income amounted to 4.1 million for the 2021 third quarter, compared with 4.6 million for the same period last year. Net income attributable to Karat Packaging was 3.8 million, or $0.19 per diluted share for the 2021 third quarter, compared to 4.1 million or 0.26 -- or $0.26 per diluted share last year.

Adjusted EBITDA on a consolidated basis was 8.2 million for the 2021 third quarter, compared with 9.1 million a year ago. Consolidated adjusted EBITDA margin was 8% in the third quarter, compared with 11.9% for the same period last year. Adjusted EBITDA attributable to Karat Packaging was 7.3 million for 2021 third quarter. Adjusted EBITDA attributable to Karat Packaging was 7.1%.

Net cash used in operating activities was 3.6 million for the 2021 third quarter, compared with net cash provided by operating activities of 3.6 million for the same period last year. The decline primary was due to a change in working capital, in particular, a decrease in accounts receivable and our line of credit balance. I will now turn the call back to Alan for closing remarks, and then we'll be happy to answer any questions you may have. Alan.

Alan Yu -- Chief Executive Officer

Thank you, Peter. Our business continues to thrive as we capture positive secular trend in the foodservice industry. As a nimble supplier of a wide range of products, Karat Packaging is able to respond more quickly to market conditions than the competition, which we believe gave us a tremendous advantage. Our 2021 third quarter delivered 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 fourth quarter. With that, I'll turn the call over to the operator. Operator, for Q&A.

Questions & Answers:

Operator

We will now begin the question-and-answer session. [Operator instructions] And our first question comes from Jake Bartlett of Truist. Please go ahead.

Jake Bartlett -- Truist Securities -- Analyst

Great. Thanks for taking the question. Alan, my first question was on the supply constraints, it's -- or the ability to kind of to service customers. It sounds like demand is higher than really you can accommodate right now.

So, I'm wondering -- two questions in that. One, whether that makes the seasonality less? So, demand goes down in the fourth quarter, but demand should be -- it sounds like it's higher than you can even supply now. So, shouldn't kind of -- if your ability to supply stays the same, shouldn't -- and demand is kind of higher in the third quarter than you could -- you can meet, you know, shouldn't that lessen the impact of seasonality in the fourth quarter? 

Alan Yu -- Chief Executive Officer

Jake, that is correct, and that's why I mentioned that we're not going to see, in large, seasonality in the fourth quarter. Normally, in the past -- historically, the company's sales has been -- has dropped in the fourth quarter, starting in October and November and December. Primary reason for that is toward the end of December, most of the distributors stop purchasing products. They stopped taking out inventory due to inventory tax purposes or adjusting their inventory or year-end inventory count.

So, they will stop reducing inventory. And most likely toward the end of the year, the last week basically, it's really hard to find any distributor -- buyers that is actually working. Most of them are on vacation, except for the national chain account, they've already stocked up. So, in the past, we see a bigger change in the -- bigger in terms of difference in seasonalities.

But this year, due to the lack of supply, we are having just hard -- enough hard time to catch up with the demand. It's like every single case of cup that we offload the container, it's gone the next day. Every single case of product that we produce in our -- all of our facilities are basically purchased, bought out. We even have to ship product from Hawaii to Chino at our high ship -- at a pretty high shipping freight, and they're gone immediately by the time they land in California.

That's how the demand is right now in the market. And even with that, every -- I was -- every manufacturer in the marketplace is having -- is experiencing the same thing. And I was -- and anywhere you go in the U.S., you'll find people that, hey, sorry, we might not have a lid. We might not have a straw.

We might not have a cup. We'll use a substitution cup. And you won't be surprised, if you go to any national chain, and they're using a plain white clear cup, not a branded cup anymore. I mean, I was on -- even on the plane, you probably see people substituting the traditionally airline local cups versus a clear cup.

This is how high the demand is in the market right now. And it's very strong. It has been strong in the third quarter. And we see this not -- hasn't stopped, and it's gotten even worse now.

Jake Bartlett -- Truist Securities -- Analyst

Got it. Great, that's helpful. And, you know, Alan, if you think forward to 2022, you know, it sounds like demand should remain strong. But how do you -- how comfortable are you that supply is going to improve so that your sales can grow with that demand? Or do you think that, you know, really, sales growth, this is going to be constrained just because of all the challenges you just mentioned?

Alan Yu -- Chief Executive Officer

I have been -- we have been informed by the supply manufacturer, raw material manufacturer, the supply will be even tighter in the year 2022, especially with paper products because more and more cities and states are requiring company to go ESG. And the only way to go that is either bagasse or molded fiber product or paper. And there is going to be -- there has already been an allocation of paper, a raw material, and we've been told that 2022, it's going to get even worse. And as well as the compostable raw material.

Due 2020, there is -- there was more supply in 2020 during the COVID period. But starting now, it has tightened up. Their demand has -- they -- there -- even until 2024, the PLA resin has been basically prepurchased already.

Jake Bartlett -- Truist Securities -- Analyst

Got it. So, just the implication if I'm hearing that right is that you would expect that the supply constraints, you know, to crimp the sales growth for you in 2022?

Alan Yu -- Chief Executive Officer

What we've done is we import -- we're actually ordering more product from overseas or supply more inventory from overseas. And to reduce our -- basically, increase our sales revenue because there's a demand out there. And we've seen that more and more customers are coming toward us. So, to mitigate that, we have actually found more vendors in overseas in different countries to bring products in so that we can protect our revenues for the year 2022. 

Jake Bartlett -- Truist Securities -- Analyst

Got it. Great. Great. That's helpful.

And then just last question on gross margins for the fourth quarter, you know, specifically, and then going forward. But quantify, you know, the impact of 1.8 million, you know, gain that you had in the third quarter and you expected that to reverse in the fourth. Can you help us by quantifying what that could -- what that portion could be? And then, you know, separately, as you think about gross margins, you're referring to assume that freight costs, you know, could stay where they are now in the fourth quarter into '22, and then you think about the pricing that you just took. What would gross margins look like in that scenario? So, given your pricing and then just assuming that freight costs stay where they are.

Alan Yu -- Chief Executive Officer

Well, here's the thing. Our gross margin is 29%. That's the part of the reason -- main reason is because we have a freight and duty capitalization, that 1.82 million that we basically booked in the third quarter. And during the second quarter, we had actually had a freight and duty capitalization of gain of more than $1.8 million.

It's actually north of $1.8 million. So, we actually enjoyed the benefit of the freight and duty capitalization when we imported more products in -- at a higher ocean freight rates in the second quarter. So, now, in third quarter, when we reduce our inventories and lowered our freight costs from the second quarter's, we -- we're actually booking negatively on the $1.8 million. In the fourth quarter, we've already seen that.

We won't see that $1.8 million negative affecting our gross margin. And we're actually looking at a potentially increase, a gain of the freight and duty capitalization in the fourth quarter. Of how much? I wouldn't say, but we are expecting a gain in the freight and duty capitalization in the fourth quarter. But for sure, it's not going to be a negative $1.8 million like in the second quarter's.

So, with that said, it definitely will be in north of 29.5%, just like we did in the third quarter at 29.7% because of the favorable gain that will be booked in fourth quarter, plus the increase that we had September 15, which had a very -- pretty fairly large increase September 15, and some of the customer requested an extra one week to take in the effect of pricing because they had the purchase orders in. So, those increases are not fully reflected in this third quarter. And on top of that, the September 15 increase, we instituted another large increase in November 1 across almost all the most hot -- basically, the hottest item that we're selling, carrying, including the cups basically. That is going to help us pretty nicely on the fourth quarter gross margin.

Reduction in the freight and duty cost, improvement in sales. We do see a very healthy fourth quarter. That, potentially, helping us to reach our goal of 31%. I mean, that's our goal we set in the beginning of the year.

So, basically, we're hoping to see that goal basically.

Jake Bartlett -- Truist Securities -- Analyst

Great. Thank you very much. I appreciate it. 

Operator

The next question comes from Ryan Merkel of William Blair. Please go ahead.

Ryan Merkel -- William Blair -- Analyst

Hey, thanks. So, first off, Alan, I just wanted to get your view, high level, what are you hearing from restaurant customers, how were traffic levels, and then are they -- are you still seeing the delivery and takeout at a very high rate?

Alan Yu -- Chief Executive Officer

Yes, that is -- I do see the restaurant delivery and takeout rate as a high rate because our -- the demand for our nine-by-nine takeout food containers from all of our restaurant chain customers. And not only that, on the new customers and some of our national chain account are telling us, they are seeing a 30% to 40% increase in the holiday season for the takeout. Mainly, they're doing -- most of them are doing promotions, adding -- it's -- one of my -- some -- one of my chains -- a large chain that we've been working with, they only -- they were working with only with DoorDash. Now, they're adding Uber Eats and other channels of selling the product.

And it's seasonality for the chains. I would say that the best month will be there -- the holiday season for most of these chains that we work with and also this time of the year. Recently, we added half -- actually, half a dozen or more new chain customers accounts that came aboard to us -- with us. And I'm seeing that the restaurant is still robust, especially takeout.

One of the main reason that they're focusing on takeout is they're lacking staff to service the dine-in area. So, it's -- it costs them less to -- just to serve as takeout. And by the way, they don't have people to actually work on the floor for the indoor dining. 

Ryan Merkel -- William Blair -- Analyst

Yeah, that's interesting. Makes sense. OK. Good to hear.

And then second question, you've had a lot of price increases this year. Can you just give us a sense of where is year-over-year price inflation right now? And I got to think there's a lot that carryovers next year. If you could just help us with, you know, maybe a range and what that might be. 

Alan Yu -- Chief Executive Officer

Yes. We instituted at least five price increases this year. And then most of them are from the last six months -- from past six months basically. Primary reason, inflation really shot up.

Labor costs really skyrocketed. It's really tough to get people -- employee -- to retain employees nowadays. And not only -- not to mention, ocean freight, domestic logistic freight costs has also nearly doubled in the past 12 months versus last year. And are we seeing a new price like stability? No, we have not seen price stability.

Primarily, there is a major factor that we're waiting to see how that's going to play into our costs for every importer in the U.S. We've been notified by all of our shipping carriers, starting November 15, the Port of Los Angeles will be penalizing shipper if there is a container that's not pulled out of the shipyard. But the problem is the shipper are telling the importers they will pass on these penalties into the importers. And of course, the importer will pass on these penalties to the consumers.

And in the past, we were told that -- right now, it's not that the importer doesn't want to get these containers out of the port. It's the port issue. The port doesn't have enough employees to get these containers onto the chassis to get to the truck. I mean, there's truckers.

Basically, these truckers, they want to take these containers out. So, there is no such thing as a shortage of truckers. The only reason that there's a shortage of truckers is because it's taking three-time amount of time to get a container out of the port due to shortage of labor in the port. So, ultimately, we're just waiting if this penalty is really going to go through because if it goes through, we're going to see an even larger inflation because all these penalties is going to pass on to the consumer immediately.

Ryan Merkel -- William Blair -- Analyst

Yeah, it's definitely an interesting situation with the penalties there. OK. Thanks. I'll pass it on.

Operator

[Operator instructions] And our next question will come from Michael Hoffman of Stifel. Please go ahead.

Michael Hoffman -- Stifel Financial Corp. -- Analyst

Hey, Alan, Peter. Thank you. Alan, you began this year going public with a guide that was 9 to 11 EBITDA margins. Based on how you're framing the fourth quarter, how do I -- how does that -- how do we stand there? I'm assuming you're at the low end, but are we going to still be inside 9 to 11?

Alan Yu -- Chief Executive Officer

We are still projecting a 9 to 11 EBITDA margin. I think we mentioned that the fourth quarter, we do see a strong margin due to the favorable aspect that we're going to see that we already took a hit. Actually, we subtracted in third quarter the freight and duty capitalization, and we're going to see a favorable freight and duty capitalization, which going to -- also with the price increases and improving the sales, we -- that 9 to 11 is still our target for the year-end.

Michael Hoffman -- Stifel Financial Corp. -- Analyst

OK. And you're expecting both margin and dollars of EBITDA to be better sequentially?

Alan Yu -- Chief Executive Officer

Yes.

Michael Hoffman -- Stifel Financial Corp. -- Analyst

Right. OK. And just to be clear for everybody, so your freight and duty was high in 2Q, got buried in your inventory, hurt your sales in 3Q. You've worked all of that inventory out, so it's all gone or most of it's gone, or how much of it's gone?

Alan Yu -- Chief Executive Officer

Our inventory level is at the lowest I've seen in this year, currently.

Michael Hoffman -- Stifel Financial Corp. -- Analyst

OK. So -- all right. So, that one eight that was built into inventory that put pressure on the gross margin in 3Q is now out. So, unless there is incremental freight, duty, and customs fees costs in over above what you're thinking, doing the same thing on short-term or inventory turns, I'm going to be OK, we're going to be OK?

Alan Yu -- Chief Executive Officer

Yes. 

Peter Lee -- Chief Financial Officer

Alan, if I may. So, our inventory turns a little bit above 60 days. Following that guideline, to answer your question, yes, it would have all turned. But there are different degrees of turns for each different SKUs.

So -- but on average, yes, it would have turned, and then your assumption would be correct in that the sales in the fourth quarter would have a lower cost inventory. 

Michael Hoffman -- Stifel Financial Corp. -- Analyst

Got it. You have talked numerous times of moving more and more supply out of China into other vendors, and you were being aggressive about doing that given some of the rolling blackouts that are going on in China. What progress did you make on that? Can you share that with us?

Alan Yu -- Chief Executive Officer

Sure. We -- I would say that, right now, we're getting a lot more product out of China into Taiwan. Earlier in my conference call, I mentioned that we added several new vendors, and most of these vendors are in Taiwan vendors on the cup side, on the lid side, on some of these -- on most of our items that we added; and from Vietnam. Particularly, we wanted to really move away.

We don't -- the political stability of China, it's really uncertain, especially right now with the COVID. That basically -- there are a lot of actually increasing COVID cases in China, and more and more provinces are shutting their city down for -- and many interstate, intercity travels and telling their citizens and residents to stay put. Restaurants are doing bad because they're only doing takeout, and most of the restaurants are shutting down due to COVID. And we're concerned that if this continues -- I mean, it just started last two weeks -- two, three weeks ago, this escalation of COVID cases spiking.

We're just concerned that during the wintertime, it will escalate even more into the -- more people will catch COVID in China, and there'll be more shutdown in that state area. And also, the blackout periods. Even though the -- most of the factories that we work with are back to 80%, we don't know if -- anytime, it could -- they could shut them down, and we don't want to take that risk. So, by doing so, we move more products into Taiwan and also Vietnam.

Michael Hoffman -- Stifel Financial Corp. -- Analyst

OK. So, you were about, I think if I remember correctly, about 20% out of China. So, we're below 20 now?

Alan Yu -- Chief Executive Officer

I don't have that number, but definitely, I can give you after we -- after the call, we can look into the numbers, see how much we are actually importing from China versus other countries or how much we reduced.

Michael Hoffman -- Stifel Financial Corp. -- Analyst

OK. That would be helpful. And then you've been giving us all on through the year the percent of total revs that were eco-friendly and the trends have been very favorable. What was it in the third quarter?

Alan Yu -- Chief Executive Officer

Peter said -- do you have the number? I think I saw the number was 18% for eco-friendly products.

Peter Lee -- Chief Financial Officer

Yes. Sorry.

Alan Yu -- Chief Executive Officer

On the overall.

Peter Lee -- Chief Financial Officer

Sorry, I was on mute. It's 18.7 million, which takes about 18.2% of the total revenue.

Michael Hoffman -- Stifel Financial Corp. -- Analyst

OK. And so, that's -- I think I'm doing it off from memory, and sound sequential on a percentage basis. Is that correct?

Peter Lee -- Chief Financial Officer

0.2%, yes. So, Q2 was 72 million, 18% of current revenue, increased to [Inaudible]

Michael Hoffman -- Stifel Financial Corp. -- Analyst

So, it's better -- OK, better on total dollars for a little less 1%. So, leveling off a little bit. And is that mostly a supply issue? Is -- you could have sold more if you could have gotten it?

Alan Yu -- Chief Executive Officer

It's -- actually, it is true. It's more -- and mostly a supply issue. And also, we are stocking up more on the compostable product line right now. Right now, we're doing a stocking up in our Hawaii facility and our Chino facility mainly to -- we know that January 1, Bill 40 will continue -- will pass through.

We already stocking up for all of our national chain accounts on their compostable lids, on their compostable clear cup basically, and our takeout containers. That's something that will start to turn on. Basically, Hawaii will force every restaurant, every national chain to start using compostable takeout products. So, we should start moving those out mid-December in Hawaii. 

Michael Hoffman -- Stifel Financial Corp. -- Analyst

OK. OK. And if my memory serves and I'm going to [Technical difficulty] I always forget the A B, whatever it is, but there's a new content rule coming in in California. How is that disrupting the whole model at this point? And disrupting might be positive, but how was it impacting the model?

Alan Yu -- Chief Executive Officer

I'm sorry, what was it that you mentioned that was a new something that's coming out?

Michael Hoffman -- Stifel Financial Corp. -- Analyst

California has got a content -- a recycling content, packaging -- food packaging content will be coming in I believe in 2022, and I was wondering how that is influencing buying behavior of your customers or your, you know, ability to meet the demand side given what the content will change.

Alan Yu -- Chief Executive Officer

I am not sure which content you're referring to -- recycling content you're referring to. I know that California is actually asking people not to serve straws or utensils in open public. They're asking them to put behind the bar in the restaurants to be -- they may upon request. And I know that -- I believe that some of the cities are actually putting more pressure in terms of for the restaurant operators to use the compostable product versus paper and plastic.

That's what I know. It's been going on, and there's just actually tightening up the rules and adding more products to the list that they've already stated in the past. And that's -- that, basically, it's going to really push more customer restaurants and starts forcing for compostable products. And we -- just the past three -- past quarter, we actually created or actually brought in more compostable product line so that we could serve additional customers.

Michael Hoffman -- Stifel Financial Corp. -- Analyst

Got it. Last two from me. Where are you in adding manufacturing capacity, either in California or in Texas? And then I want to come back to this November 15 freight duty -- freight fines.

Alan Yu -- Chief Executive Officer

Well, when we noticed the freight and ocean freight and everything really began to rise and the demand of these cups began to rise, as well as the demand for compostable straws as we're getting an increase on that part, we purchased based on our -- what we mentioned in our IPO, that we're using, I believe, was a certain percentage of our revenue to purchase -- or 5% or something on the -- $5 million I would say to purchase equipment. We already ordered several paper machines, plastic machines, straw -- additional straw machines, and takeout container machines. And on top of that, we are looking to order some automated robotic packaging machines. They will start to come in December, which is next month, and January and February, all the way until the end of next year.

We are looking to add additional -- much more capacity. I would say an additional 20%, 30% of our existing capacity. The biggest challenge right now is training the people. I mean, buying the equipment, it's not that hard.

Getting it in, it's not that hard. The hardest thing is getting the people trained and getting people staffed. And that's why we've hired -- we've actually changed our policy in terms of a full-time only. We're taking the flexibility of the employees' schedule hours, so we're making it available for people to interview newly hired or newly interviewed staff, they can work part-time based on their flexible schedules.

And then we can call them because we know during the holiday, there's going to be a lot of employees calling out for a sick or calling on vacation and take on their annual leave. We want to make sure that it doesn't disrupt our service and shipping products out. So, we're hiring more part-time, seasonal workers in that part, also seasonal drivers. And most -- very importantly, we will start working on Saturday, adding one extra day each week as a working day, not for the -- only for the production because our production is 24/7, but our warehouse facility shipping, it used to be five days.

We're adding an extra day so that we can catch up with the orders and shipping our product starting -- I believe starting this November -- third quarter -- third week of November. 

Michael Hoffman -- Stifel Financial Corp. -- Analyst

OK. And then on this November 15 fine that's coming from the ports, have you looked back at 3Q and said if that fine had existed during the quarter, what that would have been as an incremental cost?

Alan Yu -- Chief Executive Officer

I would estimate, minimum, $0.5 million a month.

Michael Hoffman -- Stifel Financial Corp. -- Analyst

Half a million a month. OK. And are you hearing of other distributors and vendors and, you know, companies talking about any kind of legal action against the ports because, you know, this feels like a gouging issue when you think about it? And certainly, I can't understand how adding a compounding $100 where the second day it's 200, the third day it's 300, the fourth day it's 400 is going to influence moving containers faster if they're the bottleneck. So, what's the legal sort of ramifications that all of the people like you who are sitting there on the gate, waiting to get their containers out and the port is the bottleneck?

Alan Yu -- Chief Executive Officer

Well, I -- this is how I feel. We're a small importer compared to Target, Walmart, or Costco. And if we're going to be hit with $0.5 million a month, these large companies are going to be hit with millions. And basically -- ultimately, they're going to be passing on to the consumers.

I'm just sitting on the sidelines to wait how is this going to play out because like you said, the money will be made by the Port of Los Angeles. I mean, the port is already making tons of money. They're paying these union workers a lot of money already to move these -- to call sick or to -- I mean, whatever is happening right now. And like you said, it's not going to help moving these containers because they just need to get more people into working.

I mean, President Biden said we're asking them to work 24 hour, seven. Yes, we're asking them to work 24 hour, seven, but they don't have people to manage to work 24/7. So, no, you're requesting them to do it. They don't have people to do it.

And that's the issue. And fining the shipper, and ultimately, fining the consumer, that is not going to help. We've already seen the highest inflation in the past month. Once this fine goes through, we're going to see even higher inflation down the road.

And -- 

Michael Hoffman -- Stifel Financial Corp. -- Analyst

Got it. 

Alan Yu -- Chief Executive Officer

And some of these will might just abandon the containers. If my containers is costing me already $15,000 for a container, if I'm going to be fined another $10,000 container, if I'm the importer, I'll just abandon it. I don't want to get it. It's not worth it.

Michael Hoffman -- Stifel Financial Corp. -- Analyst

Right.

Alan Yu -- Chief Executive Officer

And that's going to create more bottleneck when people started abandoning containers. Where is the port going to put those abandoned containers at?

Michael Hoffman -- Stifel Financial Corp. -- Analyst

Right. Yup, that's what I've been hearing from other distributors. All right, Alan. Good luck.

Interesting environment.

Alan Yu -- Chief Executive Officer

It's challenging. Never been before.

Michael Hoffman -- Stifel Financial Corp. -- Analyst

Yeah. Thank you.

Alan Yu -- Chief Executive Officer

Thank you. Thank you all. Thank you, everyone. Well --

Operator

The next question is a follow-up from Jake Bartlett of Truist. Please go ahead.

Jake Bartlett -- Truist Securities -- Analyst

Hi, thanks for the follow-up. Just a couple of quick ones. Alan, your -- the comment about kind of being able to hit, you know, at least the low end of that 9% to 11% EBITDA margins. One, I just want to confirm that that's the kind of the X global wealth EBITDA as you think about it.

You know, just doing some rough math, if you assume that you're at, you know, 31% gross margins behind of the revenue guidance, it would seem that some of the other costs would have to come down to hit, you know, the 9% for the year. And so, you know, those include shipping costs. You know, even if they come down and stayed constant as a percentage of sales, so you'd be challenged to get there. So, the other, you know, missing piece is or the other piece of the puzzle is recurring G&A or operating costs, which have been going up pretty heavily every quarter.

Is there any reason to think that that cost might be coming down? Anything abnormal that's been in the third quarter, in the second quarter that would ease in the fourth?

Alan Yu -- Chief Executive Officer

Jake, you are correct. We are seeing the shipping costs coming down, as well as labor costs coming down. One of the things that really hit us in the second quarter is that due to labor shortages, we had to hire third-party lump of services, which was much higher than our normal services. We had to hire out temp agencies, which we had to pay a premium for the temp agency staffing.

So, we've managed to hire direct -- more direct people, employees. And also, during the second quarter, we had to spend a lot of -- actually, I would say almost 70% more just to ship products over the road from California into Texas because there were so much product coming in, we overwhelmed the California warehouse, in which we had to spend more money to transfer it into the other warehouse location, which we mitigated that and we effectively reduced that in the -- near the end of the third quarter and continuing to fourth quarter. So, yes, we will see shipping -- domestic shipping coming down. We will see labor costs coming down.

We will also see a major freight coming down because of us utilizing more of our contracted freight rate -- ocean freight rate versus the higher broker's freight rate that we have to use in the third quarter -- the second quarter.

Jake Bartlett -- Truist Securities -- Analyst

Got it. Got it. That's very helpful. And then you're just -- another question on sales.

And the national sales revenue, you know, is up solidly year over year, but it didn't accelerate much from the second quarter into the third, you know, whereas -- where it certainly accelerated a bunch all the other, you know, channels accelerated I think more. So, just what is going on with national? Is there some reason why the sales there would be constrained, you know, in this environment, maybe they're less likely to kind of look outside there, you know, maybe it's harder to get incremental customers for you? Just why isn't that channel growing, you know, quicker in this environment?

Alan Yu -- Chief Executive Officer

We have a lot of increase on these -- on new national chain accounts. We've told them we don't have enough capacity. So, we're asking them to give us more time to get ready to service them. One of the national chain that's well known in Texas, we told them that we could start maybe in December once we stock up more in our inventory because we do have to service the existing national chain account first before we can take on new ones.

On the distribution side, basically, we're selling whatever we have inventory. There's no commitment to really have to fulfill the order of 100%. So -- and because there's shortage in the entire market, we're getting distributors buying from everywhere, anywhere they can find products to service their retail customers. But for national chain account, we can't just take our national chain account, I mean, knowing that we're going to be out of products.

Jake Bartlett -- Truist Securities -- Analyst

Got it. That makes a lot of sense. I appreciate it.

Alan Yu -- Chief Executive Officer

Thank you, Jake.

Operator

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 Executive Officer

Thank you, operator, and thanks to everyone who joined us today. We appreciate your support and interest in our company. You have our commitment to working hard and working smart toward achieving our collective goals of enhancing shareholder value. We look forward to speaking with you again soon.

Goodbye.

Operator

[Operator signoff]

Duration: 48 minutes

Call participants:

Roger Pondel -- Investor Relations

Alan Yu -- Chief Executive Officer

Peter Lee -- Chief Financial Officer

Jake Bartlett -- Truist Securities -- Analyst

Ryan Merkel -- William Blair -- Analyst

Michael Hoffman -- Stifel Financial Corp. -- Analyst

More KRT analysis

All earnings call transcripts