GrowGeneration Corp.

Hello and welcome to Grow Generation's fourth quarter and full year 2022 earnings conference call. My name is JP and I'll be coordinating your call today. Following the prepared remarks, we will open the call to question from analysts with instructions to be given at that time. I'll now hand the call over to Clay Karambliss with ICR.

Thank you and welcome everyone to the Grow Generation fourth quarter and full year 2022 earnings results conference call. Today's call is being recorded. With us today are Darren Lampert, co-founder and chief executive officer, and Greg Sanders, chief financial officer of Grow Generation Corp. You should have access to the company's fourth quarter earnings press release issued after the market closed today. This information is available on the investor relations section of Grow Generation's website at ir.growgeneration.com. Certain comments made on this call include forward-looking statements which are subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on management's current expectations and beliefs concerning future events and are subject to several risks and uncertainties that could cause actual results to differ materially from those described in these forward-looking statements. Please refer to today's press release and other filings with the SEC for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. During the call, we'll use some non-GAAP financial measures as we describe business performance. The SEC filings, as well as the earnings press release, which provide reconciliations of non-GAAP financial measures to the most directly comparable GAAP measures, are all available on our website. Following our prepared remarks, we will take questions from research analysts. We ask that you please limit yourself to one question and one follow-up. If you have additional questions, please re-enter the queue, and we'll take them as time allows. Now, I will turn the call over to our co-founder and CEO, Darren Lampert.

Thank you, Clay. Good afternoon, everyone. Thank you for joining us today to discuss our fourth quarter and full year 2022 financial results and our full year 2023 guidance. As always, I want to thank each one of our employees across our company for your continued support of ProGen. The last year has been extremely challenging, but I, along with the rest of the executive team, appreciate your continued hard work and dedication to our vision and strategic plan. Regardless of the market challenges throughout the year, and really over the last three years since we entered the pandemic, the team has been steadfast in executing our business model. I commend our entire team for stepping up to every challenge that has come at us over this time period.

We are pleased that our full year 2022

net revenue, $278 million, was in line with our previously communicated guidance range. We are also encouraged that our efforts in 2022 to right-size the business are starting to show in our financial results. And we are optimistic that the work we are doing is putting GrowGen in a significantly better position going into 2023. Further, For the first time in seven quarters, we believe GrowGen will see sequential revenue growth in Q1 2023 versus Q4 2022. In addition, we believe that growth margins will normalize in the mid to high 20s beginning in Q1 of 2023. In 2022, we invested in our storage product portfolio supply chain, technology, and other strategic initiatives as part of our long-term strategy to enhance profitability. In the fourth quarter, we added three members of senior management in the hydroponics industry in the areas of commercial sales, supply chain, and product development. We also significantly increased our volume of our private label products, driven by our drip hydro and charcoer brands. Private Label accounted for $26 million of retail and e-commerce sales in the full year 2022, which is around 12% of our overall retail and e-commerce sales, growing 6% year-over-year as a percent of sales. Our team also continued to make advances in our supply chain through the expansion of our distribution centers and fulfillment hubs, which now total eight locations. with our newest center in Columbus, Ohio, expected to be operational the fourth summer. With that as the backdrop, our day-to-day strategy is generally the same since we last spoke. We remain hyper-focused on controlling costs and generating cash, and we made significant progress in 2022. While some of these efforts have come at the short-term expense of our gross margins, especially in the fourth quarter,

We firmly believe these decisions are putting GrowGen in a better place to be stronger and more nimble than ever before.

It's important to reiterate that GrowGen remains on solid financial footing. We have a strong balance sheet, and we don't anticipate the need for external debt or equity issuance. We ended the 2022 fiscal year with $72 million of cash and cash equivalents and marketable securities, and no debt on our balance sheet, representing a sequential increase of $1 million in our net cash position since the end of the third quarter of 2022. This marks the second consecutive quarter that we have grown our cash balance, despite the incredibly challenging industry conditions. Now, I'd like to provide a brief overview on some of our key business initiatives throughout 2022, how we see those going forward in 2023. We recognized the need early last year to focus our organization on cost control, store consolidation, inventory reduction, and cash generation. In 2022, we reduced inventory by 28 million compared to the end of 2021. including a sequential $12 million reduction in the fourth quarter from the end of the third quarter. These inventory reductions have generally occurred at discounted prices, which clearly pressured our gross margin in 2022. But we believe it was the prudent thing to do as we optimized our working capital base and prioritized cash generation and balance sheet preservation. Partially upsetting the negative impact of our gross margin contraction, we made significant progress right-sizing our expense structure in 2022. We made the difficult decision to reduce our payroll base by a total of $12 million throughout 2022. In terms of our store footprint, we made considerable progress eliminating market redundancies, and overlapped by closing eight stores in total for 2022. We also continue to expand into markets where we see long-term value, opening five new stores and including four new states where we didn't previously have retail operations. These new locations, including Virginia and New Jersey stores, branded as Grow Generation, Hydroponics, and Garden Center, which we think represents an opportunity and provide a broader in-store product assortment that should allow us to increase store traffic and productivity by attracting new customers. Next, we reduced our store count by three stores and ended the year on December 31st with 59 locations in operation. We expect these initiatives in 2022 to continue benefiting our company well into 2023, including cost savings flow through from store consolidation, reduced payroll expenses, improved shipping costs and declining ocean freight rates, reduced headwinds from inventory discounting on our margins, and a greater percentage of private label sales. This will all have a positive impact on adjusted EBITDA dollar generation and margins. Going forward, we expect to continue seeking out acquisitions in white space markets, where we think it makes sense. We will also continue product development around our key brands and private label offerings. We're focused on monetization of our 1 million square feet of retail space, including merchandising and product education with key partners and a laser focus on execution of the various business transformation initiatives centered around supply chain and enhancing our customer journey. Progen is a unique, highly differentiated retailer. We are the leader in a large, fragmented market. Our customers have a passion for a grow pro lifestyle. Progen is more than just a retailer. We are a developer of market-leading brands and private label products. We are a distributor supporting the entire hydroponic growing community. And we are above all a passionate and dedicated partner to our customers. We live our mission and values, and our culture defines our relationship with our customers. We'll be celebrating our 10th anniversary in a year. As we begin the new year ahead, we take great pride in our past, and we're equally excited about our future. Turning to guidance for full year 2023, we expect next revenue in the range of $250 million to $270 million, translating into adjusted EBITDA. in the range of a $4 million loss to a $1 million profit. As part of that, in the first quarter of 2023, we expect net revenue in the range of $55 million to $57 million, translating into adjusted EBITDA in the range of a $2 million loss to a $4 million loss. With that, I will turn the call over to our CFO, Greg Sanders.

Thank you, Darren, and good afternoon, everyone. First, I will address our fourth quarter and full year 2022 financial results, and then I will discuss our preliminary outlook for the 2023 fiscal year. Starting with our fourth quarter results, growth generation generated revenue of $54.5 million versus $90.6 million in the fourth quarter of 2021, representing a decline of approximately 40% Our same-store sales for the fourth quarter 2022 were 34.3 million compared to prior year sales of 71.4 million, representing a 51.9% decline against the comparable year-ago quarter. Our e-commerce revenue declined on a comparable base from 7.7 million to 3 million. Our distribution and other revenue was 13.5 million for the quarter, report compared to 4.6 million in the year-ago period, representing an improvement of 195%. Growth profit margin was 17.6% for the fourth quarter of 2022, down approximately 830 basis points sequentially from the third quarter of 2022. Growth profit dollar generation in the fourth quarter decreased 7.9% from the prior year which includes the addition of gross profit from acquisitions of HRG, MMI, and St. Louis Hydro in the trailing 12 months. The company sold over $12 million of overstocked and aged inventory in Q4 clearance events that we estimate resulted in a total gross margin degradation of 332 basis points. Further, the company increased its inventory reserves by over $2 million in the quarter, which had a 379 basis point impact. The combination of these two strategic initiatives resulted in a one-time margin reduction of 7.1%. Our Q4 strategic initiatives to further right-size the inventory of the business are largely complete as of December 31st, 2022, and better position the company as we move into 2023. Store operating costs and other operational expenses declined sequentially from the third quarter. Overall, store operating expense declined from $14.5 million in Q1 to $13.8 million in Q2 to $13.6 million in Q3, finally to $12.8 million in Q4. The savings recognized throughout 2022 were primarily attributed to payroll reductions. We anticipate further cost decreases to continue into 2023, resulting from the execution of store consolidations in the latter half of 2022. Selling, general, and administrative, or SG&A, costs were $8.6 million in the fourth quarter, of which $1 million was derived from stock-based compensation. This compares to $8.8 million in the third quarter, with $1.3 million of stock-based compensation. This represents a 2.3% improvement quarter over quarter to SG&A. Depreciation and amortization of intangibles was $4 million in the fourth quarter of 2022, compared to $4.1 million in the year-ago period. Compared to the fourth quarter last year, SG&A expense decreased $2.8 million in the same period of 2022, with overall savings driven from payroll reduction and increased cost controls over a broad range of categories. Income tax in the fourth quarter was a benefit of $248,000 for tax purposes, but with a full valuation allowance, we did not observe a significant income tax provision benefit or expense in the period. Net loss for the fourth quarter was $15 million or negative $0.25 per share, compared to a net loss of $4.1 million or negative $0.07 per share for the comparable year-ago quarter. Adjusted EBITDA, which excludes interest, taxes, depreciation, amortization, and share-based compensation, was a loss of $10.2 million for the fourth quarter of 2022 compared to a loss of $1.7 million in the fourth quarter of 2021. We estimate this quarter's adjusted EBITDA loss includes roughly $1 million in expense associated with the closure and consolidation of our Las Vegas, Compton, and Cotati locations, and nearly $4 million associated with the inventory cleanup measures taken in the fourth quarter. These areas of execution were strategic initiatives taken to position the company for 2023. Cash generated from operations in the quarter was $2.6 million, primarily attributed to the reduction in inventory and additional measures taking to strengthen the balance sheet. Now, I will provide a quick overview of our results for the full year 2022. Net sales were down $144 million for 34%, $278 million and $422 million in the full year 2021. Gross profit for the full year 2022 decreased by $48 million to $70.2 million and gross profit margin was 25.3% in 2022 compared to 28% in the full year 2021. As Darren mentioned earlier, we have taken a number of steps throughout the year to right-size operating expenses and reduce our selling, general, and administrative expenses based by roughly 20.7 million through operational rationalization, workforce reduction, and tighter day-to-day expense controls. Related to the balance sheet, as of December 31, 2022, the company had total cash, cash equivalents, and marketable securities of $71.9 million. Within working capital, the company reduced inventory by $28.4 million, partially offset by a $2.6 million increase in high credit-worthy accounts receivable. We also invested approximately $9 million for payments associated with technology and distribution investments. On a full year basis, the company generated $12.5 million in cash from operating activities, primarily driven by the reduction of inventory and prepaid accounts payable. I will now discuss our guidance for the full year 2023. We expect full-year 2023 revenue to be between $250 and $270 million and full-year adjusted EBITDA to be in the range of a $4 million loss to a positive $1 million profit. Our updated guidance assumes quarter-over-quarter improvements in Q1 of 2023 and further revenue and profitability improvements continuing into the second and third quarters of 2023. The improvement in adjusted EBITDA expectations is primarily driven from the execution of our 2022 reductions to payroll, our eight store closures, and our inventory optimization efforts. We expect gross margins to normalize into the mid to high 20s in the first quarter of 2023. On a comparative basis to the fourth quarter, management expects modest improvements in revenue in Q1 of 2023 which would be the first quarter of a quarter improvement to revenue since the second quarter of 2021. We expect operating expenses to be controlled and sequentially down in the first quarter as we recognize additional cost improvements from our strategic initiatives. We are positioning the company and executing our business strategy to focus on cash from operations and EBITDA improvement. As we mentioned earlier, we expect that our headcount reductions are largely complete and the heavy lifting to correct our inventory position was mostly concluded in the last two quarters of 2022. With that, I will turn the call back over to Darren for closing remarks.

Thank you, Greg. Before we open the line for your questions, I want to reiterate that while 2022 was a challenging year for everyone in the cannabis value chain, ProGen remains focused on the areas of the business that we can control. We continue to make strong gains against our priorities, drive cost control, consolidate stores, reduce inventories, and improve profitability while preparing to capture the many growth opportunities that lie ahead, all of which we expect to drive incremental benefits in 2023. We remain committed to the expansion of our proprietary and distributed brands. We are very satisfied with the results of our private label products, including Char-Port and Drip Hydro. The addition of MMI strengthens our position to gain indoor vertical cultivation projects with their leading benching and racking systems. Controlled environmental agriculture and sustainable ag are only in the development stage, and we believe that more companies will invest in sustainable indoor vertical farms for local production of leafy greens, tomatoes, fruits, and other food products. To close, while we expect a degree of continued uncertainty in 2023, and we are not planning for an imminent turn in the cannabis cycle, we remain nimble and well prepared for a turnaround when it happens. Thanks to proactive management of the business in 2022, We believe GrowGen is on solid financial footing with a solid balance sheet, healthy liquidity, and a solid cash position. Thank you for your time today, and thank you for your interest in GrowGeneration. We will now take your questions. Operator?

Thank you. Ladies and gentlemen, we will now conduct the question and answer session. If you have a question, please press star followed by the number one on your touchtone phone. you will hear a one-tone prompt acknowledging your request. Your first question comes from the line of Mark Smith from Lake Street Capital. Your line is now open.

Hi, guys. First question is really around inventory. You did a good job getting those levels down, but it sounds like you had to clear some stuff out to kind of get there. Can you just talk about your comfort with inventory levels today? Do you still have any inventory that you think still needs to maybe be cleared out here in 2023? Hey, Mark. This is Greg.

We reduced inventory $28 million in the year, $22 million in the last two quarters of the year. At this point in time, we're carrying $77 million in inventory as we concluded the year. We believe that the volume of inventory that we have is appropriate for the business on a forward-looking basis. Our inventory isn't completely perfect, but we think it's in a very good position at this point with all of the efforts that we've taken, primarily over the last two quarters. We don't expect any major changes in our inventory volume as we move forward.

Excellent. And then just following up on that, can you talk a little bit about kind of the mix of consumables versus more capital equipment? You know, and Darren, at the end, you talked a little bit about, you know, we're maybe not, you know, seeing improvement yet in the industry. But, you know, are you seeing signs of that and, you know, your guidance for the year? Does that include, you know, the beginning of more build outs of kind of new growth facilities?

Yeah, Mark, I'll start at the beginning. When you look at the mix of our inventory right now, we've moved through a tremendous amount of non-consumable inventory in in 2022 so when you look at the tremendous reduction you're really looking at the lighting side the du side and and and the products that we use in build outs and we've kept our our inventory up on the consumable side those are products that our customers need on the day on a weekly daily basis so we've kept that to a point where we're very comfortable um when you when you unpack you know the second parts of the question You know, we have been grinding around the bottom for the last, you know, probably for the last three to four months. And March is the first month that we are starting to see some upticks. We're starting to see more bidding out there on commercial products back east. And we are seeing stabilization. You know, we have consolidated some of our stores around the country. We consolidated eight of our stores. And we feel that we're in a very good position right now going into 2023. Okay. We're seeing stabilization on pricing on cannabis out in California. That's what we're hearing from our customers. We're also, you know, we're also hearing out in the California markets that you are seeing, starting to see, you know, the large amounts of supply starting to dwindle. So we're keeping a, you know, an eye on the outdoor season right now that's coming up in April, but we have seen a little stabilization in our business.

Excellent. Good to hear. Thank you.

Your next question comes from the line of Brian Nagel from Oppenheimer. Your line is now open.

Hey, guys.

Good afternoon. So I want to – my first question, and this is basically the follow-up on that question, the prior question, just with respect to the overall industry. So, Darren, you're saying you're seeing – we've been kind of grinding along the bottom, maybe treating some signs of stabilization here and So as you look, and I know we've been talking about the factors that have weighed upon the industry now for a while, with oversupply and slower licensing. As you look at the business now and you look at some of the stabilization, is it becoming clearer whether those factors we discussed were more transitory in nature, or has there been a recent lower in the underlying growth potential from an industry perspective within the space?

Yeah, Brian, my belief is that on a go-forward basis, you will see much slower growth in the hydroponic and cannabis industries. I think the hypergrowth, the 20% year-over-year compounded growth that people are expecting through the 20s, I don't believe that to be true any longer. I think what you're seeing right now is an industry that has tremendous potential. But I do believe that you will see slower growth in this industry. You'll see tremendous consolidation in this industry. And I do believe that what you've seen over the last 20 months, you know, there was many reasons for it coming out of COVID. There was a tremendous amount of capital coming into the cannabis industry that has slowed in the last 20 months. And like most industries in the early stages, you do run into these issues. And I think what you're seeing right now is inventories coming down, both on the cannabis side of it, but also more importantly on the hydroponic side of it. There was a tremendous amount of hydroponic equipment that was brought into this market to fuel the build-outs and the feverish build-outs that you've seen. And that has slowed to a much more normalized base. And forecasting is going to become much easier for GrowGen as we build out our distribution centers. So we believe that you will see growth in this industry. But I think the hypergrowth that people thought you will not see in the future.

That's really helpful. And then I guess to follow up on that, if you look at some of the new markets where you've seen, I guess, legalization and then subsequent licensing, how would you characterize that initial build out in those markets versus what you saw in some like the Michigans or Oklahoma's?

You're seeing a much slower ramp back east. In Virginia markets, it's taken an enormous amount of time to get regulations passed, but it's also taken an enormous amount of time to get properties built. And one of the issues that you're seeing, Brian, is with the slowdown in the Oklahoma markets and the Michigan markets and the California markets, the capital has dried up. And with the dry up of capital, you're seeing much less building and you're not seeing the race to the start. what you've seen years ago. So you're seeing a much more controlled build-out environment, and I do believe that's what you will see in the future. And we're seeing that in the stores that we've opened. We opened five new stores in four states last year, Virginia, New Jersey, Missouri, and Mississippi. And we were seeing stores go profitable first month into builds, and we're not seeing that right now. Albeit we are seeing ramps in all our stores that we've built, but not the ramps that we've seen back in 18, 19, and 20. Got it.

And then one more, if I could flip it back, just more specific to your business. So you closed a number of stores. As you look at the base now, would there be additional closures, or is it basically cleaned out and poised to grow here? And then a follow-up to that, in the stores you closed, I assume that those were acquired stores, not stores that GrowJet opened organically, correct?

That is correct, Brian. On the other side of that, we still do believe you will see a few more store closures from GrowJet this year, but not anywhere near the pace last year. We're targeting anywhere from one to four store closures this year. And just so you do know, most of our store closures come when leases are up and we're not renewing leases. So, you know, the costs have been, you know, pretty tame for store closings. And we have kept, you know, a good portion of business, but not as much as we would have liked from these store closures.

I appreciate the call. Thanks, sir.

Thank you, Brian. Our next question comes from the line of Chris Terry from Wells Fargo. Your line is now open.

Hey, guys.

Why do you expect revenue to increase quarter to quarter? Are you seeing something? Can you expand on March? I think you highlighted that. Secondly, you know, this acquisition you did, is that material?

The acquisition that we've done in March was not material. They're very small acquisitions. But we are seeing a little pickup in business in March, you know, over fourth quarter of last year. we are going into our seasonally strongest period which is the second and third quarters um and what we're hearing from our commercial team our store team and our customers is you know that that business is starting to pick up and we're starting to see in our consumable side of it and we are starting to see much more quoting on the commercial side of it back east and then new markets okay so so this is what you're seeing not necessarily what you're what you're projecting

It's what we are. Well, you are, but you're seeing this currently is the point.

Yeah, Chris, and I'll jump in as well here. One of the key reports that we use on a daily basis is our daily sales report. And we've seen revenue pick up across the country in Q1 on a comparative basis in our retail markets. And that's part of the optimism that we have around the Q1 numbers and improvements. in the first quarter sales in comparison to Q4.

Okay, great. That makes total sense. Just on the daily sales comment that you just made, are you seeing daily sales stabilize and start to pick back up? Is that what you're kind of referring to with the daily sales on a comparative basis? Yeah, exactly. We are seeing improvement in Q1 versus last quarter. Okay, got it. And then just the final question is, you know, if you could put it all together, you know, why you think this is happening. Is it just because, you know, at some point the market has to bottom and stabilize? You know, pricing seems to be normalizing. You know, inventories seem to be normalizing. Do you have any theories about why this is happening? Just an aggregate. That's it for me.

You know, Chris, we're 20 months into a downturn into a market that, You know, we still do believe like many has, has tremendous potential. Um, 20 months is a long downturn for any cycle. Um, and we are starting to see, you know, a pickup in business in March and the, as we saw in the last couple months. Um, so we're starting to feel a little better about, about, about the industry. Uh, when you start taking a look and talking with our customers, when we have thousands of them, uh, they're starting to see price stability in the California markets to increasing pricing. they're starting to see some of the illegal mark some of the illegal growers have gone out of business and we're hearing up to 15 of the market in california uh has closed so you're seeing you know a smaller base of growers out there uh which brings down as you probably know um you know supply on the cannabis side of it so we are starting to see that we've also seen the same in michigan we've seen closures in michigan um so With that, you're going to see strengthening from the individuals that are still in business. But one thing that we haven't seen as of yet, you're not seeing money come back into the markets. And we have been extremely diligent on lending money to customers ours as we continue to keep our balance sheet in tremendously good condition. But we do see right now, as our side of the industry consolidates, we see tremendous acquisitions out there. And we do believe that, you know, you will see some at GrowGen this year. We don't think there'll be any material acquisitions this year. There'll be some smaller ones filling in white space around the country. But we will keep Wall Street New posted on those.

Okay. Sounds good. Good luck.

Your next question comes from the line of Eric DeLaurier from Craig Hallam Capital Group. Your line is now open.

Great. Thank you for taking my questions, and congrats on the strong balance sheet management here. Pretty impressive. My question is kind of following up on some of these trends that you're seeing. And if I'm understanding correctly, you're seeing, you know, sort of continued weakness in the more durable CapEx products in your business, but seeing, you know, overall, I guess, consumable stabilization, or maybe even quarter-over-the-quarter growth in consumables in Q1. My question is what, in terms of same-store sales growth, your guidance assumes, I guess mostly with respect to consumables. I mean, are you expecting to see sort of year-over-year growth kind of starting sometime midpoint in the year? I guess if you could just sort of flesh out what your guidance implies from a same-store sales perspective, and then I guess maybe any color between durables and consumables. within that would be great. Thanks.

You know, to start with, Eric, we don't break down, you know, the future of both consumables and non-consumables. You know, consumables is our everyday business. That's what we guide to. We also do guide to some non-consumable build-out projects, which we saw very little of in 2022. So, when you look at guidance right now for 2023, it embeds, you know, three different divisions of GrowGen. We do believe we will see growth in our online division this year versus last year. We also do believe you'll see growth in our commercial division year over year. And we do believe you'll see growth in our underlying stores, you know, starting in the second quarter of this year. We're still going against some decent comps out of January, you know, out of the first part of last year, which really slows down going into the second quarter of 2022. So we do believe you'll see a steady rise in decreasing same source sales. And, you know, we still do hope that you will see a positive same source sales number from GrowJet going into the latter part of this year. But at this point, it's just too early to forecast that. And if you look at our forecast for 2023, we're forecasting increased sales going into the second and third quarter coming off guidance what you're seeing at that $55 to $57 million mark in the first quarter. So you will see continued increases both on an EBITDA basis and also on a sales basis going into the second and third quarters.

And that actually segues nicely into my second question here. So obviously you guys have talked about guidance kind of assuming a quarter over quarter increase in revenues in EBITDA. I'm wondering if that does extend from sort of Q3 into Q4. In other words, if you're not expecting to see the sort of normal Q4 seasonality that you have in the past. And if not, could you just kind of expand on perhaps why you do not expect to see that seasonality this year? And then I guess it's just kind of a final one. Does your guidance assume any contribution from this M&A that you've said is potentially likely this year?

Yeah, Eric, right now, none of our guidance, I mean, our guidance does include any M&A we're doing this year. We also will have a few store closures this year. So basically, we look at that as kind of a zero-out sum. If we do any material acquisitions, which we are not expecting right now, that is not filtered into guidance. When it comes to the fourth quarter of this year, it's just too early to really forecast on that. But the one thing we feel comfortable with, that our fourth quarter same-store sales and sales number will be higher than what you're seeing in the fourth quarter of 2022. Again, right now, a little hard to see if we'll see quarter-over-quarter growth in the fourth quarter versus the second and the third.

Okay, that's very helpful. Thank you.

Your next question comes from the line of Aaron Gray from Alliance Global Partners. Your line is now open.

Hey, good evening, guys, and thank you for the question. So first one for me, I just want to dive a little bit deeper into California. Thanks for some of the remarks that you've had, Darren. So we've seen a number of active cultivators kind of come down meaningfully as they opted not to renew over the past six months or so, you know, down about 1,200 about or so. So I want to ask if you had any insight in terms of the outlook on that. It looks like there are a lot more most coming up in the next six months we talked about some stabilization of pricing in the state uh do you think there could still be some more trimming of the number of active cultivation licenses you think that has stabilized as people are seeing uh some more stabilization within the pricing thank you you know again it's a very difficult question aaron i think a lot of it has to do with financing and really the state of some of the balance sheets of some of these california growers

I think we all know that California is the epicenter of cannabis and always will be. And I think it's that delicate balance between the legal and illegal markets that you're seeing right now. But with companies taking a very hard look at their operations right now, their balance sheets and their income statements, some of the larger companies that aren't making money in California have made that decision right now that They'd rather look a couple years down the road opposed to sustaining right now just difficult margins and a difficult sales environment in California. We are seeing some of our California stores outperforming right now. Our downtown L.A. store has been growing. Our Santa Rosa store right now is starting to grow again also. We have seen, when you look at California, much more trouble in the outdoor markets in California. So something that we're keeping a very close eye on going into the spring this year. And we'll make some decisions after we see some of our stores that are very, very second and third quarter oriented.

Okay, all right, great. That was really helpful. And then the second question for me is just on private label. In case I missed it, could you give me a target you might have for this year in terms of private label sales? and then how that might impact you guys reaching the higher low end of the mid to high 20s gross margin guidance? Thank you.

You know, as we said earlier, our private label penetration in our stores online was up from 6% to 12% of sales this year. And, you know, we believe that will continue into 2023. One of the interesting parts, we launched Drip Hydro, you know, in the summer of 2022, and So you'll have a full year of growth on drip hydro, which is, we believe, one of the fastest growing, if not the fastest growing nutrient line in the country right now. So we have extremely high hopes for that. We're also doing line extensions on drip and power SI. So you see some new products coming out of these brands that we're very excited about. And the same thing with Charcor. You know, the biggest issue we had with Charcor a couple of years ago was really pricing coming in from India on freight. And we're seeing freight pricing come down, you know, probably 70% in the last year. So Charcor, which we believe is the premium brand in the market right now on the cocoa side, is becoming much more competitive on pricing. And we're starting to see a tremendous ramp in our Charcor brand right now. And we are coming out with new products continually right now. And we just brought in an extremely talented team. individual on the R&D side of it. That's going to help our private label penetration in 23 in the future. So, again, we do expect a nice bump, a number we're not sure right now, but we will keep you posted on a quarter-over-quarter basis.

Okay, great. Thank you very much for the call, and I'll jump back in the queue.

Your next question comes from the line of Scott Fortune from Roth MKM. Your line is now open.

Good afternoon. Thanks for the question. I appreciate all the color and the pricing kind of overall for the industry, but can you focus a little bit more on your ability to continue, you know, whether it's being the price leader in your markets or continuing to kind of give us a little color on the pricing with the input cost that's going on? And then what's the kind of landscape? I'm sure there's a lot of pressure from the competitors on your side and potential pricing pressure there. Just kind of sense for the pricing within your own stores and that ability right now.

You know, I think, Scott, what you're seeing is similar to the, you know, our underlying business, which is the cannabis space. There was an abundance of oversupply on the product side. And with this tremendous slowdown in our industry, And when you look at growth generation, you know, our same-store sales were down 51% last year. And I think it was quite a feat when same-store sales were down 51%. And, you know, you cut inventory $28 million. So we did a tremendous job moving through inventory, skew rationalization. And I think you're seeing that around the country right now. But on the other side, we're seeing many store closures out there as you're seeing on the cannabis side of it. So, you know, When industries usually hit bottom, you see consolidation, and we're starting to see that right now. And, again, pricing at GrowGen has been pretty normalized this year. If you were to take out the tremendous amount of discounting we did on SKU rationalization and certain SKUs that we needed to bring down, and it was really on the non-consumable side of it, that GrowGen, along with many companies, brought levels up when shipping went was so difficult coming out of China back, you know, back during COVID. And many products came in, you know, three to six months later and kind of came in at that downturn of the market. I think you heard similar comments from Bill Toler over at Hydrofarm the other day. And I think you also heard it from Orthon. So as we all work through inventory, you know, we believe pricing will normalize. But when you look at GroGen, our private label products and some of our higher margin products, have been doing a tremendous job really masking the tremendous aggregation and margins that you're seeing on our sale products to bring inventory down the way we did.

I appreciate that. And then, Darren, you know, you've been through a few cycles here, and we understand the CapEx equipment side, right? That's been obviously down, and there's very limited capital or production capacity being added here. Outside of the new states, obviously, those build-ups will continue. Help us understand, at some point, there's going to be a refresh cycle for a lot of the spin that's going on. A lot of the operators are looking to become more efficient operating on their production side of things. How do you look at the capex spin? What happens? Is there an aftermarket for a lot of these equipment like lights and such that you guys can see some growth from. Just kind of step us through that, the refresh cycle, probably not factoring much in there, but the potential there.

Yeah, we believe you will see a refresh cycle, you know, coming up, maybe not this year, but maybe the following year. I mean, you still are seeing facilities that are using double-ended bolts and fixtures as opposed to LEDs. And again, it's all a matter of capital, Scott. You know, Wall Street is shut down. Wall Street is shut down, you know, the cannabis space and You know, I do believe, you know, you will see a resurgence. You're starting to even see right now, you know, certain comments that they may be opening up the Toronto Exchange up in Canada to get some more liquidity and capital into these companies. So, you know, there's a lot of ifs. You know, the one thing that we do know when we look into our 2022 sales, you know, the biggest degradation in sales that we saw was on the capital equipment side, and we've been pretty vocal about that. We feel tremendously comfortable with the other side of our business, and that's the higher margin side of the business. So where we stand right now, you know, with our private label products coming out and, you know, with Drip Hydro Charcoal and some of the other brands that we're launching into the markets, you know, we believe that our margin profile will be very advantageous going forward into the future. And we have stayed away from selling used equipment from GrowGen. um we've stayed away from the junkyard and it's just not in our business model right now um it's much more on the lower cost illegal side of it we're not seeing it going into these legal grows so it's something that you know it's it's it's it's it's a wonderful you know like anything else marketplace but it's not something that we're going to get involved with right now okay thanks i'll jump back in the queue

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.