This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.
spk00: Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Hydro Farm Holdings Group's second quarter 2022 earnings conference call. At this time, all participants have been placed in a listen-only mode, and the lines will be open for your questions following the presentation. Please note that this conference is being recorded today, August 9, 2022. I would now like to turn the call over to Mr. Fitzhugh Taylor, Managing Director at ICR, to begin.
spk04: Thank you, Anthony, and good afternoon. With me on the call today is Bill Toller, HydroFarm's Chairman, Chief Executive Officer, and John Lindemann, the company's Chief Financial Officer. By now, everyone should have access to our second quarter 2022 earnings release, Inform 8K, issued today after market close. These documents are available on the Investors section of HydroFarm's website at www.hydrofarm.com. Before we begin our formal remarks, please note that our discussion today will include forward-looking statements. These forward-looking statements are not guarantees of future performance, and therefore you should not put undue reliance on them. These statements are also subject to numerous risks and uncertainties that could cause actual results to differ materially from our current expectations. We refer all of you to our recent SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial condition. During today's call, we will discuss non-GAAP measures, which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP, and reconciliations to comparable GAAP measures are available in our earnings release. With that, I'd like to turn the call over to Bill Teller. Bill?
spk02: Thank you, Fitzhugh, and good afternoon, everyone. As we announced in our press release last week, our second quarter results continued to feel the impact of the hydroponics industry recession in the US and Canada. Initially in the quarter, we were encouraged by our results early in Q2 as sales trends displayed signs of stabilizing. However, these trends weakened as the quarter progressed and our mix shifts to less profitable products, impacting our results for Q2 and our expectations for the remainder of the year. More specifically, originally our business plan for 2022 had always expected a seasonal improvement in the spring and summer months, with sales volume continuing to build from there. Once we did not get the expected improvement in Q2, we have now assumed the current trends will continue through the third quarter, and that Q4 will have its normally lower volumes, but off again a lower base. Now, we didn't get the build in Q2, so we took the volume out for the entire year. While the industry recession has lasted longer than expected, we remain confident in the long-term opportunities ahead of us. According to headset data, which is the best measurement of volume sold through dispensaries, units sold continues to grow, albeit at lower prices. Furthermore, with cannabis consumption growing in the US and Canada, ultimately supply and demand will balance and pricing should strengthen. This should invite many growers back to the category and give MSOs, the multi-state operators, the expansion signals they are looking for. When that occurs, we are well positioned for the rebound. The strength of Hydrofarm is, of course, in our brands and people, in our unique customer relationships, and in our manufacturing and distribution footprint. This has not changed. As a reminder, we drive over 50% of our sales in our own brands, and we also proudly represent many of the industries top distributed brands. Just last month, we added Emerald Harvest, a leading nutrient to our preferred brand lineup. This new addition will further strengthen our consumables portfolio, which is currently about 66% of our sales, which we believe provides us even more insulation against weakness in the industry. Another important measure of Hydroform's competitive position is our relative market share. Our sales declines, while disappointing, are less than the decline seen by other public reporting entities, suggesting that we are building market share. During this difficult time, we continue to focus our efforts on leveraging and strengthening our core assets, while right-sizing where necessary in order to maintain the long-term health of our business. In fact, during the second quarter, through our team's networking capital management, we increased our cash position, lowered our net debt, and maintained a solid liquidity position, which John will talk about in more detail. Aiding this effort were the positive steps we've taken to lower our cost structure. As we did in the first quarter, during the second quarter, we continued to take strategic price increases, further increased freight surcharges, reduced our employee base, and took steps to capture cost synergies from our 2021 acquisitions. More specifically, we enacted further expense cutting measures, including Continued headcount optimization. Since the end of last year, we've reduced headcount by about 25%. We've also reduced shifts at our plants to increase efficiency and protect inventory levels. And finally, we've cut select outside services and expenses to tighten our belts across the board. All in all, we estimate we've reduced our costs by about $14 or $15 million on an annualized basis. and we'll continue to find efficiencies and further streamline our business as the business conditions dictate. As we look ahead, we believe we have appropriately reset the full year expectations and can successfully build back from here. Additionally, we remain confident the industry will eventually return to historical growth rates and the actions we're taking to refine and optimize our organization will leave us leaner and stronger and as a result, better positioned to take advantage of future growth opportunities. With that, let me turn it over to John, who will further discuss the details of our second quarter financial results and provide comments on the updated full year 2022 outlook. John?
spk05: Thanks, Bill, and good afternoon, everyone. Net sales for the second quarter were $97.5 million compared to $133.8 million in the prior year period, Our 2021 acquisitions added 13.5% to our top line in the second quarter of 2022 relative to the prior year period. But this M&A benefit was more than offset by a 43.4% decline in organic sales volume. We did realize a 3.1% price mixed benefit in the quarter as we continue to pass through higher costs. While we saw encouraging results in March and April, Sales trends in the second half of the quarter tailed off and continued through the remainder of Q2. Furthermore, these sluggish sales trends have continued into the third quarter to date period. We did experience year-over-year growth in select U.S. states, but the growing demand in these states was not yet sizable enough to offset the overall oversupply dynamic in many key U.S. markets. We also experienced a notable sales mix shift in the quarter. On a sequential basis, sales of our proprietary branded products in Q2 were outpaced by sales of distributed and preferred brands relative to Q1. We believe this was caused by the change in relative performance of select product categories and primarily the relative outperformance of Grow Media, which is largely composed of distributed preferred brands for us, and the relative underperformance in lighting, which includes several of our proprietary brands. I should note that on a year-over-year basis, we experienced a sales mixed benefit as our proprietary brands represented a much higher proportion of our total sales than they did in the prior year period. This positive year-over-year sales mix largely relates to the full quarter benefit we received from all of the acquired proprietary brands in Q2 2022 relative to only a partial benefit for select brands, namely Heavy 16 and House and Garden in Q2 2021. Gross profit during the second quarter decreased to $7.3 million compared to $29.6 million in the year-ago period. Similar to last quarter, we included in the press release a calculation of adjusted gross profit, which excludes certain items largely related to our acquisitions, which impact comparability. On this basis, adjusted gross profit was $9.1 million, or 9.3% of net sales in the second quarter, down from $30.2 million, or 22.5% of net sales last year. The decrease in adjusted gross profit is mainly due to the negative impact of the 10.2 million increase in inventory reserves that we recorded at the end of Q2. Excluding the increase in inventory reserve, adjusted gross profit margin would have been much higher than disclosed, albeit lower than 22.5% last year. This margin difference was due to proportionally higher freight and labor costs, which were impacted by the lower total sales volume and the altered sales mix. Selling general administrative expense decreased to $26 million in the second quarter of 22 compared to $27.3 million in the year-ago period. The decrease in SG&A was primarily due to an $8.4 million decrease in acquisition-related expenses. Adjusted SG&A expenses, which adjust for this acquisition-related expense as well as certain other items impacting comparability, was $15.9 million, or 16.3% of net sales in the quarter, versus 14 million or 10.5% last year. This was primarily driven by an increase in facility costs, compensation costs, and insurance expenses. As a reminder, these added costs primarily emanate from our distribution center expansions and the five acquisitions we completed last year, which increased our headcount and the size and scope of our operations. And while this positions us well for future growth, we remain diligent in mitigating costs in the near term in right-sizing our overall cost structure for the sales demand that we see today. Along these lines, we estimate that we've reduced our costs by approximately $14 million on an annualized basis. This reduction has come mostly in the form of headcount reductions conducted primarily over the last two quarters, during which we reduced our headcount by nearly 25%. The impact of these reductions is most visible in our adjusted SG&A expense, which has come down 17% from $19.2 million in our fiscal first quarter to approximately $15.9 million in Q2. And then we will diligently pursue additional cost savings and productivity initiatives on top of those already achieved. We are currently estimating $15 to $16 million in adjusted SG&A for the next two quarters. As noted in our August 2nd press release, declining valuation trends within the industry and its impact on the company's market valuation triggered a full evaluation of the goodwill arising from prior acquisitions. As a result, our second quarter included an impairment of goodwill of approximately 189.6 million. Reported net loss for the quarter was heavily impacted by the impairment, as well as the 10.2 million inventory write-down recorded in the quarter. As a result, reported net loss was 203.3 million, or $4.53 per diluted share in the second quarter, compared to net income of 2.3 million, or 5 cents per diluted share last year. Adjusted net loss for the quarter was $8.4 million, or $0.19 per diluted share, compared to adjusted net income of $12.9 or $0.31 per diluted share in the year-ago period. Lastly, adjusted EBITDA decreased to a loss of $6.8 million in the second quarter from a $16.2 million profit in the prior year period. The decrease in adjusted EBITDA was driven primarily by the decline in net sales, and its impact on our current cost structure, as well as the $10.2 million inventory reserve for which we did not adjust in our EBITDA calculation. Moving on to the balance sheet and overall liquidity position, as of June 30, 2022, we had $27.4 million in cash, cash equivalents, and restricted cash, and an aggregate principal amount of debt outstanding of $126.7 million. And I should note that we had zero drawn on the company's revolving credit facility. At the end of the quarter, we also had approximately $15.3 million in contingent payments, composed of an earn-out on the 2021 Aurora acquisition, which was subsequently paid out last month using cash on hand. We estimate total liquidity of approximately $97 million as of June 30th, composed of the $27.4 million in cash and cash equivalents at the end of the period, plus approximately $70 million of available borrowing capacity under our evolving credit agreement. We made significant progress in the second quarter managing network and capital, and even more specifically our inventory position. We sold through and thereby reduced our inventory by approximately $22 million, while also making necessary capital investments in the quarter. Together through these actions, we generated significant free cash flow, which in turn helped us increase our cash position. We believe that as of the end of the second quarter, we still have strong inventory levels, which gives us the opportunity to further manage down our investment network and capital and further aid our liquidity position. However, in the context of our current forecast, which I will highlight in a moment, we feel it prudent to suggest that driving further free cash flow in the second half of 2022 will be a challenge. I know this is a question many will ask, and so figure best to cover now. But let me be clear, and given all that we know now regarding our 2022 outlook, we feel that we can and will maintain a strong liquidity position for the duration of the year. With that, let me highlight our updated full year 2022 outlook. We expect total company net sales of approximately $330 million to $347 million, which assumes sales levels similar to those experienced from late second quarter through July continue over the remaining months of the year, with some further reduction to account for holiday-shortened months in the fourth quarter. We also expect an adjusted EBITDA loss of between $25 million to $16 million. This range includes $13.4 million of the inventory reserves taken year-to-date. In closing, we believe we've put in place the necessary steps to weather the current industry headwinds. While it's prudent to lower our expectation for the full year, we remain optimistic about our long-term business fundamentals and our ability to capitalize on the growth opportunities in the CEA industry. This concludes our prepared remarks, and we are now happy to answer any questions you might have. Operator, please open the lines for questions.
spk00: We will now begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. At this time, we'll pause momentarily to assemble our roster. Our first question will come from Andrew Carter with Stifel. You may now go ahead. Hey, good afternoon.
spk06: First question I wanted to ask is – hey, Bill. First question I want to ask is I appreciate the kind of commentary around the liquidity for the remainder of the year, incremental cost savings. But can you remind us kind of what the parameters are of your term debt and kind of your ability to use kind of the incremental kind of capacity you have left it?
spk05: Certainly. Thanks, Andrew. Let me start with the ADL facility. So I think, as you know, we have $100 million credit facility with JPMorgan Chase. And as we noted in the quarter, we had availability of $70 million roughly on that facility, zero drawn against it at the end of the quarter and $70 million available to us. We really only have one financial covenant of note in that particular facility, and it's a spring fixed charge coverage ratio that only comes into play when our excess availability on the facility is less than $10 million. And as I noted, zero drawn at the end of the quarter, it's $70 million available. So not near that at this time. On the term debt facility, we have $125 million using round number terms, a little bit less than that actually, borrowed currently. and it was a covenant light structure that has no meaningful financial covenant ratio. We did actually put in the 10Q additional details on this matter, and so you can see that there.
spk06: Thank you. That's helpful to get that out of the way. I guess a question I wanted to ask in terms of the operating environment, you said 3% kind of pricing, and I believe the release stated that You had cost ahead of pricing for the quarter. I guess one question I would ask is, if you stripped out lighting from that where there's deflation, would you be pricing ahead of your cost, just kind of looking for any indicator out there that there's still some rationality left in this category?
spk02: Yeah, you're right. Lighting is the one that's kind of going the other way, right? But the other categories – We are taking all the price that has come through to us from either raw material increases or packaging increases on our direct brand or our own brands and anything that's come through our distributed brands. We are passing all that on. And so far, the elasticities haven't been, you know, too exaggerated, and the competition has been pretty rational. Again, lighting being the exception, which is kind of going the other way on high-pressure sodium and other things. But, yeah, it's still – We're taking the pricing that's coming through to us, and it's working out okay.
spk06: Thanks. I'll pass it on.
spk02: Thanks, Andrew.
spk00: Our next question will come from Andrea Tashara with JP Morgan. You may now go ahead.
spk02: Andrea, I'm not hearing you.
spk00: Pardon me, Andrea. We will move on to the next question. Our next question will come from David Shacknell with William Blair. You may now go ahead.
spk03: Hi, this is David Shacknell stepping in for John Anderson. Two questions for you. The first, I just wanted to clarify from the prepared remarks, did you say you expect 15 to 16 million in adjusted SG&A for the next two quarters, 15 to 16 million each? Correct. Okay, great. And then the second thing, what states do you think still require the most consolidation right now? Is it Oklahoma, Michigan, or somewhere else? And where do you feel they are in that process?
spk02: Yeah, I think Oklahoma kind of stands out. I think If there's rough numbers, 15,000 commercial licenses in the U.S., I think Oklahoma literally has half of them, which is a bit overbuilt for a 4 million population state. So that one is the one that I think we're seeing the most consolidation and kind of roll-up strategy, if you will. Michigan has had some issues, although it's not over the longer term going to be as severe as what you're seeing in Oklahoma. California... It's still going through some pain, but honestly, I think California will find its normalized sea level here hopefully in the next couple of quarters, but we hope to see it sooner than that, but we haven't yet, so we're not going to call it. But specifically to your question, Oklahoma is the one that's the most overbuilt, if you will, and needs the most work to get it back to kind of supplying demand on its consumption level.
spk03: Got it. That helps. Great. Thank you very much.
spk02: Thank you.
spk00: Again, if you have a question, please press star then one. Our next question will come from Bill Chappell with Truist Securities. You may now go ahead.
spk01: Good afternoon. This is Steven Lange on for Bill Chappell. How are the newer markets sort of progressing through the year and where should we expect the meaningful step up in growth as we move through? I've moved to or through 23. Thank you.
spk02: Yeah, hi, Stephen. Thanks. Good to hear from you. We've got, I think, 18 out of 50 states showed growth. A lot of those kind of Midwest and East, as you would expect. Some of the smaller ones, places like Montana, obviously not in the East, but Montana, Louisiana, Mississippi, Florida has actually been a pretty good market. New Jersey has had a lot of dispensary growth and has had some growth of the hydroponic level as well. So you're finally starting to see a little bit of traction in these states that many of them passed in 2020 and 2000, even some of them are before that. So you're starting to get a little momentum there. Virginia has shown a little bit as well. So the wave is coming east, if you will. It's just simply that the California, Michigan, Oklahoma, Colorado, Oregon, triumvirate or five-state area is just so large relative to these new ones, any decline there can't be offset by these newer states. But you are seeing that traction. We are seeing that traction and think it's going to continue to be fun to watch as we go forward.
spk01: Great. Thank you very much.
spk02: Thank you.
spk00: This concludes our question and answer session. I'd like to turn the conference back over to Bill Toler for any closing remarks.
spk02: Great. Thank you, operator, and I appreciate your interest in following Hydropon today, and we all look forward to speaking with you in greater detail soon. Take care. Thank you.
spk00: The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
Disclaimer