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spk08: Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Hydro Farm Holdings Group second quarter 2023 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 9th, 2023. I would now like to turn the call over to Anna Kate Heller at ICR to begin.
spk07: Thank you, and good afternoon. With me on the call today is Bill Toler, Hydrofarm's Chairman and Chief Executive Officer, and John Lindeman, the company's Chief Financial Officer. By now, everyone should have access to our second quarter 2023 earnings release and Form 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 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 conditions. Lastly, 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 an 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 would like to turn the call over to Bill Toller.
spk01: Thank you, Anne and Kate, and good afternoon, everyone. While we experienced some sequential growth the second quarter in a row, the reality is the growth was very modest, and overall demand levels have remained relatively stable over the last nine months. We are pleased, though, that in the second quarter, we have returned to adjusted EBITDA profitability for the first time since Q1 of 2022. as we generated $2.5 million of adjusted EBITDA this past quarter. We're also proud of how we got there, with significant improvements in gross profit driven by a higher margin mix of products sold and by cutting down on costs that we incurred in 2022. Our Q2 SG&A was the lowest since the second quarter of 2021, before we began acquiring and integrating five companies. While we have reduced costs, we have not compromised our commitment to excellent customer service and to on-time delivery. We still operate six distribution centers here in the U.S., two up in Canada, and one in Spain, just as we did two years ago. And we are pleased to be delivering at a high level of service to our customers with fast turnaround times. Overall, we're very encouraged that even at the current sales level, we have made significant progress on key metrics. like delivering positive adjusted EBITDA and free cash flow in the quarter. We remain focused on controlling our costs, improving productivity, and driving results here at Hydrofarm. There are a number of bright spots on the top and bottom line in Q2. Our consumable business performed well, as we saw strong performance in several key house brands, and those are in our core nutrient and grow media businesses, which those outperform the overall business significantly. We also saw continued improvement in revenue stream diversity, with an increased proportion of our sales coming from outside North American customers and from non-cannabis CEA applications, which include food, floral, lawn, and garden. We told you that in order for us to achieve our previously provided top-line guidance for the year, we needed to see a seasonal lift in the spring. While we did get and experience some of that lift in May and June, particularly in our consumable brands, The seasonal uptick was not enough to offset the softness in our durables business. This has affected our sales outlook for the year, which John will discuss in a few moments. Our profitability improvements demonstrate the success of our previously announced restructuring and related cost savings initiatives. We continue to execute select ongoing initiatives, many of which are working well, including continued inventory and overall working capital management, cost reductions in our transportation and logistics activity, and more recently, increased production efficiencies in selected manufacturing operations. In summary, we remain laser focused on being profitable in a lower demand market. The first phase of our restructuring has been successful, as evidenced by our sequential and year-over-year improvement in adjusted gross profit and adjusted EBITDA margin. We will continue to execute on these key initiatives to find more ways to reduce costs. which may include a second phase of a restructuring. We're also seeing some positive industry signals, and we remain confident that the industry will return to growth. I'm proud of our team at Hydrofarm for returning to adjusted EBITDA profitability in the second quarter at the lower sales levels. Our team's execution demonstrates that Hydrofarm is better positioned than ever to more consistently generate positive adjusted EBITDA in future periods. With that, I'll turn it over to John, who will discuss the second quarter financials. and our outlook for 2023. John?
spk04: Thanks, Bill, and good afternoon, everyone. Net sales for the second quarter were 63.1 million, up slightly from 62.2 million we realized in Q1. And though the sequential growth was very modest, we are pleased to see it trending in the right direction over the last two consecutive quarters. On a year-over-year basis, our second quarter net sales were down 35.3%, driven primarily by a 32.5% decrease in sales volume. We also realized a 2.3% price mix decline in the quarter, resulting from the sell-through of discounted lighting products and a higher mix of lower-priced consumable products relative to higher-priced durable products. It is worth noting that our sales mix of consumables to durables has evolved significantly this year, with consumable products now comprising approximately 75% of our year-to-date sales up from 64% in the year-ago period. This largely relates to strong performance in the nutrient grow media product categories and relative weakness in equipment as there are fewer new construction and expansion projects across the industry. As a result of these trends, we now expect price mix to remain slightly negative for the full year 2023. Our overall brand mix improved in the quarter. proprietary brands increased as a percentage of total sales to approximately 55% from 53% in the prior year, driven primarily by proprietary branded nutrient and grow media sales that were higher year over year on a relative basis, partially offset by lower proprietary branded commercial equipment sales. In addition to the favorable brand mix, we recognize sales improvements in a few key geographies this quarter. In California, our highest volume state, we saw a solid sequential sales improvement for the second quarter in a row and are now up 34% since Q4, 2022. We also perform well sequentially in a few other states, including Oregon, another one of our larger volume states. Gross profit in the second quarter was 14.5 million compared to 7.3 million in the year ago period. Adjusted gross profit was 17 million or 27% of net sales in the second quarter. compared to 9.1 million or 9.3% in net sales in the year-ago period. The strong margin growth is a result of the improved brand mix, reduced freight and labor costs, improved productivity, and a significant reduction in our inventory provision versus this time last year. Our team has been focused on right-sizing our business, and I'm encouraged that the nearly complete first phase of our restructuring has been successful. We are actively considering a second phase to our restructuring initiatives, We will update you on our November earnings call, but we can tell you that any further restructuring actions would likely focus on right-sizing the elements of our business associated with durable products. Selling general administrative expense was $23.5 million in the second quarter compared to $26 million in the year-ago period. Adjusted SG&A was $14.6 million, down from $15.9 million last year, and our lowest quarterly total since Q2 of 2021. The $1.4 million or 9% decrease was primarily due to reductions in compensation costs, professional fees, insurance, and facility expenses as a result of the restructuring plan and related cost-saving initiatives. Finally, adjusted EBITDA was $2.5 million in the second quarter compared to a loss of $6.8 million in the prior year period. The $9.3 million increase was driven primarily by higher adjusted gross profits and lower adjusted SG&A expense, partially offset by lower sales volume. This now marks our third consecutive quarter of sequential improvement. I should also note that we are adjusted EBITDA positive for the six months year to date through June 30. This is a testament to the effectiveness of our restructuring and cost saving initiatives, and we are excited to have demonstrated that we can achieve positive EBITDA even at lower sales levels. Moving on to our balance sheet and overall liquidity position, Our cash balance at June 30, 2023 increased by approximately $8 million during the quarter to $26.7 million. We ended the quarter with $123.1 million of term debt. As a reminder, our term loan facility has no financial maintenance covenant. Principal amortizes it only 1% annually, and our debt facility does not mature for another five years, not until October 20, 2018. We continue to maintain a zero balance in the company's revolving credit facility throughout the second quarter. Our free cash flow improved considerably in the second quarter versus the first quarter. We generated net cash from operating activities of $9.9 million, with capital investments of $1.7 million, yielding strong positive free cash flow of $8.3 million. Our positive adjusted EBITDA and continued strong working capital conversion served us well during the period and helped us sequentially increase our liquidity and lower our net debt in Q2. With that, let me turn to our updated full year 2023 outlook. As Bill discussed, while our consumables business is performing well, our sales in the first half of this year on the durables commercial side of the business are not where we expected them to be. And because of this, we now expect net sales in the range of $230 million to $240 million for the full year 2023. While we are reducing our sales expectations due primarily to the current softness in our commercial business, we are pleased to reaffirm our expectation for modestly positive adjusted EBITDA for the full year of 2023. Our outlook assumes improved adjusted gross profit and adjusted gross profit margin on a year-over-year basis, resulting primarily from the restructuring related cost saving initiatives we already put in place, as well as any additional cost saving actions we may take across the remainder of the year. Our outlook also assumes minimal inventory and accounts receivable, reserves, or related charges. We are also reaffirming our expectation for positive free cash flow for the full year, which we expect will be aided by further reducing our inventory levels across the second half of the year. In closing, we are very encouraged by our continued profitability improvement, and we continue to be impressed by the resilience of our entire team and are thankful for all their hard work and effort, particularly over the last few quarters, during which we inserted significant cost reduction efforts. We also continue to believe the industry will return to growth and remain confident in the long-term fundamentals of our business. We will continue to control what we can and look forward to providing further updates on our progress next quarter. With that, let me ask the operator to open the line for any questions you may have.
spk08: Thank you. Ladies and gentlemen, we will now be conducting our question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. The confirmation tone will indicate that your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question is coming from the line of Andrew Carter with Stiefel. Please proceed with your question.
spk00: Hey, good afternoon. I'm just a little bit confused. So in terms of dropping the revenue guidance for the year, maintaining EBITDA, I wanted to make sure I fully understand kind of the source of kind of the resilience there. Number one, a stronger gross margin profile coming through in the quarter. Maybe that's it, but the other side of it is cost savings. I believe you've taken some, and then there's some contemplated. Is there an if-then in there? Kind of just tell us what's in hand at this point.
spk01: I'll start and John can pick it up, but yeah, it's exactly that. It's a stronger gross margin profile based on the better mix that we're selling. The house frame consumables are on the highest part of the margin chart, if you will, and we're doing better in that part of the business than we originally planned, so that's a positive. Also, the SG&A, we've taken it out during really over the last couple of years, but in Q1 and in Q2, we took it out. We should get benefits from that in Q3 and Q4. the full effect of our transportation changes that we've made in terms of a new provider and also some work we've done on our DCs to make them more efficient and actually offset some of the costs there with some revenue, doing 3PL for other parties. All that kind of plays into what we think is going to be a strong margin second half, even on lower volumes.
spk00: The second question is, your commentary around durables is kind of noted, and obviously there's Grogin talked about pricing pressure yesterday. Hawthorne talked about it as well and quote-unquote leaning in. How strategic is durables for you? And what I mean by that is in this world where there aren't many builds and when you were looking at the world three years ago, you probably thought about durables as get that initial sale, own the customer for a lifetime. How strategic is – could you winnow this portfolio down to consumables and be profitable?
spk01: It's tough with the same infrastructure to do that. You need that scale, even at the reduced levels. Today, we're still probably 20-25% durable and some nice high-priced tickets on that that ship pretty efficiently. It is strategic in that you're in the early part of the sale. You don't want to be behind on that. You want to get in when the MSO or the grower is starting to make those decisions. You're really viewed as more of a full-service partner. That's really what we've always been. It's kind of an end-to-end partner. Right now, while the durable side hasn't performed for anybody in the industry, we still think over time it's important to have good, strong brands, and in many cases your house brands in that space, like we do in lighting, like we do in some other air and water handling equipments. All of that is important to be a part of the offering in the mix, but right now the margin bus is being driven by our consumable brands, particularly on our nutrient side.
spk02: Thanks. I'll pass it on. Thanks, Andrew.
spk08: Thank you. Our next question is coming from the line of Peter Grom with UBS. Please proceed with your question.
spk06: Thanks, operator. Good afternoon, guys. Maybe just one point of, you know, maybe I just kind of want to start with the top line and, you know, another call down here. And I know this is probably going to be hard to answer, but you did mention that you remain confident that the industry will return to growth. So just, you know, any thoughts on when this could happen? What will it take to really get there? And then within the updated guidance, is there any sort of underlying improvement embedded in the category outlook similar to what we saw in last quarter? Or do you kind of assume that the current run rate continues? In other words, just trying to understand if you've taken more of a prudent approach to the top line outlook at this point.
spk01: I mean, when we go back and look at our monthly financial report, you look over there, it goes month by month, of course. We've seen... you know, plus or minus a million bucks for nine straight months. So like, why are we going to think we're going to get a whole lot more than that? Right. And so we, we basically just straight lined it and actually seasonally adjusted down a bit for Q4. Cause that's always the weakest quarter of the year, but you know, we've been reporting last Q4 last year was 61 million. Q1 this year was 62 million. Q2 was 63 million. So there it is 20 million a month for nine months. And it's like, Let's not expect a whole lot more than that because the industry is not producing it right now. And we think we're picking up share versus some other folks. So it's not like we're losing battles in the field. We're just in a smaller industry and the industry is consolidated. So back to your first question, which is when and how is it going to come back to growth? You still look at headset data and look at what's selling out of dispensaries month in and month out. More pounds are going out almost every month than went out the month before. And so you're still seeing sequential growth in in-product consumption. So there has to be a point of balance here that comes into the market at some point. We all have expected it a lot sooner, and we've all been surprised and disappointed by it, but we've got to be getting near the end of that at some point here, you know, fairly soon. There's just no way you can have that consumption keep on going out and not ultimately get supply and demand back into balance.
spk06: No, that makes a lot of sense. And then I guess my second question, you know, Bill, you're one of your largest competitors, you know, talked about partnering with other players in the industry or potentially spinning the asset entirely. I'm just loving your perspective on how you kind of see the competitive landscape evolving. And do you kind of see merits in partnering with other industry players at this stage as we move forward here?
spk01: Yeah, I think that with this prolonged protraction and contraction of volume, that scale would help us all, right? There's too many of us out there with sort of substandard scale now, and infrastructure is built for potentially bigger businesses. But I'm really pleased that we're standing on our own, making money at these sales levels, and we don't have to do it. So that's important to comment on, that it's not something we feel like we have to do. But sure, I'd love to have more scale, and we have been involved in a number of different partnering conversations, not specifically to the point you necessarily raised, but we've been involved with folks that are interested in Finding ways to help each other sell more product, right, whether that's getting into other channels like Lawn and Garden or whether that's getting into, you know, consolidating more hydro or taking some of the gas that's still direct and bringing them into our distribution network. All of those are discussions that I would expect everybody in the industry is having right now to try and build scale. We all need it, and it's important to build over time. But as I said, I'm glad to say we don't have to have it because we are making money on our own, even at these tepid sales levels.
spk02: Super helpful. I'll pass it on. No, thanks, Peter.
spk08: Thank you. Our next question is coming from Bill Chappell with Truist Securities. Please proceed with your question.
spk03: Thanks. Good afternoon. Hey, Bill. Just on your outlook as we move to the back half in light of kind of what Scott or Hawthorne had said in terms of, I know they're mainly talking about lawn and garden, but they're going to step up promotion, step up, basically trying to clean up inventory now that they've gotten a little bit of a waiver on their debt covenants. Does that lead to greater downward pricing, especially on the durable side over the next four or five months where the growth actually gets a little bit worse? Or is that not really any different from what you've already been seeing here today?
spk01: Yeah, the overlap we have with Hawthorne is actually very small, right? They are a very big lighting business. We have a small lighting business. We've gotten our inventory now into a place where it's about the same percentage of sales as it is percentage of our inventory, which is helpful. We've also taken a number of inventory reserves on lighting, which positions it a little differently in the portfolio. We think we have gotten our lighting position to be able to sell through at the position where we are now. We're not relying a lot on that durable side of the business. They are much more so than we are. And so we don't really go head-to-head like that, like you might think, except for on those few products I mentioned. John, any thoughts on that you want to add? No, I think you covered it well. Thanks.
spk03: And I guess within the industry, do you feel like the industry where you do compete, inventory levels are getting to the point where they match kind of sales in terms of shipments to sales, or is there still some, some D stock, if you will, throughout the industry in this back half?
spk01: I, I think most industry players have gone through similar efforts like we have, which is to get inventories much more in line with current sales levels. It's been, you know, a year plus a year and a half that people have been getting readjusted to the new volume levels. Remember all this, the heyday started in late mid 20 and went through 21 and, We've kind of all had now 18 months to get it back in adjustment. So I think the industry is much more in balance now than it probably has been in a good while. There's certainly going to be pockets of things that might need to be moved here and there, but I think we're much more in balance than we have been in quite a while.
spk03: Got it. And then just one other, you know, when you talk about we believe that the industry will return to growth, like where are you seeing that? Where do you expect that to come? Is that a California market? stabilizing at some point? Is that New York or new states now finally coming on? As we move into 24, where do you expect that growth to what the drivers are?
spk01: I think it's a lot of what you just said. I mean, look at what a note John made, which was plus 34%, I think it was, from Q4 to Q2 in just California. That's some pretty good sequential show of strength. you know, Oregon and Washington, which have been very, very weak for a long time are now getting more stable. Even Michigan is starting to show some resilience. Then you couple in with places like Missouri, which have come back nicely. And, you know, New York, New Jersey, we've still been a huge disappointment, very slow, not a lot of legislative help, all that stuff that we all know about. But there's little pockets of things that are going on. And we see things in our, even in our durable pipeline that are, that are coming up for later in the year in New Jersey. But that, that part of the industry is very stagnant right now. There's not a lot of building going on, and you see it really show up in all of our numbers, all the industry numbers on the durable side, and particularly on the durable manufacturers that have that much more exposure. But, yeah, I think we are going to get kind of a normalization in the legacy states, if you will, and you will get new adapters in these new states eventually. It's just been a lot slower than we all hoped and we all thought would happen back two years ago.
spk02: Absolutely. Thanks so much. Thank you, Bill.
spk08: Thank you. Our next question is coming from the line of Jesse Redman with Water Tower Research. Please proceed with your question.
spk05: Hey, guys. Congrats on the progress this quarter. My question was also on growth opportunities, specifically as it relates to new states opening and what impact you see that happening. For example, this year we saw Missouri earlier this year, and now with Maryland on July 1st, you saw a lot of the MSOs ramping up production. in anticipation of that. So curious how helpful that has been and also looking forward into like a 24. It looked like there may be some good opportunities with big states like Ohio and Pennsylvania moving to adult use. So just curious what kind of impact you've been seeing in 23 with new states opening and any thoughts on how the landscape might look in 24 and how that might impact you.
spk01: Yeah, thanks, Jesse, and appreciate the question. Yeah, you're kind of on the right track there. Those new states are nice parts of the opportunity and parts of the upside and the green shoots that we're seeing. The challenge is that we used to call it Detroit, California, Michigan, and Oklahoma. Those three were doing 50, 60 plus percent of the industry at one point. And it doesn't matter what happened in Missouri and Pennsylvania and even Vermont if those three don't come along with you that the scale of numbers never work. And so what's happened is at least finally now the legacy, the older states, which always go to California, Oregon, Washington, Colorado, you know, the kind of that core group, they're not in as bad a shape as they were. So they're not in the drain they were. And a few of the newer ones are coming on. We used to use a rule of thumb that a state would legalize. And about nine months later, you'd start getting, you know, some volume from it. Now it's getting pushed out with all the, you know, the legislative bureaucracy that's going on, the lack of alignment on how these things need to get rolled out and how they get licensed, that's really creating this delay. So places like New York, New Jersey, been a couple of years now, in some cases three years, they really haven't seen a lot of the benefit from that. And so you're going to see more of that. I think that people have learned and watched and realized that these people that implement it slowly, all they've learned is hurt the tax base and hurt what the citizens want. And so let's get on with it. And so Places are going to get smarter, like Missouri is doing a pretty good job on it. I think Pennsylvania and others are going to come along if they get it all that straightened out. But New York and New Jersey have been the ones that really kind of drag your feet and hurt us. But we think there's a little bit of signs of hope there as well.
spk05: Any read on how California is looking? I'm in California and it still feels miserable here, cannabis wise, maybe on the margins, not getting as miserable. It seems like we had a pretty significant reduction in canopy, which I'm guessing wasn't helpful for you guys. We're just curious if you're seeing any stabilization or potential green shoots here.
spk01: Yeah, it's funny. We see it almost as a bifurcated state in the sense that NorCal is doing okay and Southern Cal is really doing much worse than most other areas. So it's a bit of that spread, right? And so I would say NorCal is slightly healthier and Southern is not as good. And so those are things that we're seeing. And we think that a lot of people left the market in California and went to other states to do things. And I think now it's at least settled out, so we're not lapping the monster numbers that we were back in 21. So we've got a little bit of an easier lap, which helps, but also maybe some stabilization in some of these markets. Because pricing is – it moves around a lot, but it's overall starting to stabilize on the cannabis side, but it hasn't really gotten back to any kind of a healthy level yet.
spk02: I appreciate the thoughts. Thank you. Thanks, Jesse.
spk08: Thank you. There are no additional questions at this time, so I would like to pass the floor back over to Mr. Toller for an additional closing remarks.
spk01: Great. Thank you all very much for your support of Hydroprom. We appreciate you being on the call with us and look forward to further discussions. Take care. Have a good afternoon.
spk08: Ladies and gentlemen, this does conclude today's teleconference. Once again, we thank you for your participation, and you may disconnect your lines at this time.
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