Hydrofarm Holdings Group, Inc.

Please stand by. Your program is about to begin. If you need assistance during your conference today, please press star zero. Good morning and welcome to Hydrofarm's second quarter earnings call. Today's call is being recorded. If you would like to ask a question, please press star one on your telephone keypad. To remove yourself from the queue, press star two. At this time, I'd like to turn the conference over to Anna Kate Heller, ICR. Please go ahead, ma'am. Thank you, and good morning. With me on the call today is Bill Toller, 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 2024 earnings release in Form 8K issued this morning, as well as an investor presentation available for reference. These documents are available on the investor section of Hydrofarm's website at 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 guaranteed the 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 S&P 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 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 would like to turn the call over to Bill Toller.

Thank you, Anna-Kate. Good morning, everyone. In the second quarter, we experienced sequential improvement in our adjusted gross profit margin over our first quarter levels and also delivered positive adjusted EBITDA for the fourth time in the last five quarters. We realized further favorability on our adjusted SG&A line with substantial savings year on year. For the six months year to date, we've delivered over $2 million of adjusted EBITDA up from approximately $300,000 in 2023. and we had the smallest year-over-year net sales decline in the last three years. We maintained relatively consistent results across the first two quarters of 2024, despite the second quarter of 2023 being a difficult quarter to lap. We remain laser-focused on driving profitability in the business, and we took additional steps in the second quarter to further integrate and optimize our manufacturing operations. which should produce improved efficiencies and reduce costs going forward. These include closing on the sale of the manufacturing equipment and inventory related to our IGE branded products, closing our Paramount California manufacturing facility, and ceasing production at our smallest Grow Media manufacturing facility in Goshen, New York. Our cost savings and restructuring actions have been very effective to date. And we have proven our ability to continue operating profitably at lower sales levels while delivering top-notch service to our customers. Our 2-2 net sales were relatively in line with our expectations. And the month of May marked our seventh consecutive month of sequential net sales growth. That was the longest streak of sequential net sales growth for hydro farms since going public back in 2020. I'll now highlight some of the areas of strength in the second quarter. Our proprietary brands, including Active Aqua, Photobio, and Roots Organic, all performed well, growing year on year. Notably, the strong Photobio brand performance is a result of recent innovation in lighting. We are having success with a new generation of lighting products, including our Photobio MX2 model for commercial use and our Phantom Cultivar lighting model for in-home use, both delivering exceptional value at affordable prices. We will continue to innovate and invest behind our key proprietary brands to address growers' needs as they evolve. In Q2, our non-cannabis and non-US and Canada revenue sources as a percentage of sales remained stable relative to Q2 last year. We do expect growth in our sales mix for full year 2024 as we continue diversifying our revenue sources by expanding our international presence to customers outside the US and Canada. and driving non-cannabis sales, including CEA products sold into food, floral, lawn and garden, and certain other customers. We entered into new distribution relationships with several vendors that have strong brand equity, including Quest dehumidifiers, Hurricane fans, and Mills nutrients. While our primary focus remains our proprietary brands, these new distributed brands complement our existing portfolio and bring us closer to customers who regularly purchase these branded products. The initial inventory investment into these brands in Q2 had a slightly negative impact on free cash flow in the quarter, but I expect them to yield very favorable returns in 2024. We are also investing behind several of our key proprietary brands, including innovation behind photobiolighting that I mentioned earlier. We are investing significantly in several of our proprietary consumer brands, and our team is excited to support several of our top brand offerings. We remain optimistic that the regulatory environment for U.S. cannabis growers will improve and deliver a tailwind to the industry in the near future. In May, the DEA proposed the reclassification of cannabis from a Schedule I to a Schedule III drug, which would loosen federal restrictions on cannabis. Following the proposal, there has been a 60-day period for comments, which ended on July 22nd. Encouragingly, over 90% of the comments received were in favor of rescheduling of cannabis, and the vast majority of those comments, more than 60%, advocated for a complete descheduling from the controlled substance list. We're not certain how long it'll take to get a ruling on the matter, but this represents another step forward in the process of legalizing cannabis in the U.S. We are seeing signs of encouragement on the macro level that give us optimism that growth will return. And we believe through the diversification of our revenue streams and our effective cost savings initiatives that we are well positioned to achieve further improvements in profitability as demand and volume increase. To wrap up my remarks today, we are reaffirming our full year of guidance for net sales, adjusted EBITDA, and pre-cash flow as we remain focused on our brands, diversification of revenue, improving our mix, and controlling and reducing costs. With that, I'll turn it over to John to further discuss the details of our second quarter financial results and our outlook for the balance of 2024. John? Thanks, Bill, and good morning, everyone.

Net sales for the second quarter were 54.8 million, down 13.1% year over year, driven primarily by a 10.3% decrease in volume mix and a 2.6% decline in pricing. The decrease in volume mix was mainly related to oversupply in the cannabis industry. The pricing decline was largely driven by promotional pricing activity and is something we expect to see for the remainder of 2024. Consumable products continue to make up more than three quarters of our total sales, representing approximately 76% of our total sales in Q2, which is roughly the same amount when compared to the second quarter of 23. Overall brand mix was solid in the quarter. with proprietary brands increasing to approximately 58% of our net sales compared to 55% last year. Gross profit in second quarter was 10.9 million compared to 14.5 million in the year-ago period. Adjusted gross profit was 13.3 million, or 24.4% of net sales, compared to 17 million, or 27% of net sales in the year-ago period. The decrease in margin is related to a very difficult lap. Typically, we expect to see a rise in our adjusted gross profit margin when we experience a rise in our proprietary brand mix. However, in Q2 of last year, we experienced particularly strong manufacturing productivity in certain consumable manufacturing facilities due primarily to an early harvest in our pea facility enabled by favorable early spring weather in Alberta, Canada. We also experienced relatively higher manufacturing throughput for select consumable products last year. With all that said, we are pleased with our overall adjusted gross profit margin trend, as Q2 represents the third highest level we have recorded in any quarter since our IPO. And this quarter marked the fifth consecutive quarter with adjusted gross profit margins of at least 23%. To put that into perspective, our 2021 full-year adjusted gross profit margin was 22.9%, and that was on much larger sales days. With the cost-saving actions we continue to execute and consistent with our full-year 2024 outlook, we expect our full-year 2024 adjusted gross profit margin to be higher than it was last year. I'll now provide an update on our most recent restructuring and cost-saving actions. Our second phase of restructuring is focused primarily on rightsizing our manufacturing footprint, particularly with respect to durable equipment products. In this quarter, we made great progress. On May 31st, we closed on the sale of the manufacturing equipment and inventory related to our IGE branded products and are now aligned with an exclusive contract manager to produce those same great products. In June, we closed our Paramount California manufacturing facility and consolidated those operations into our facility in Northern California. Also in June, we ceased production in our smallest grow media manufacturing facility and intend to consolidate some or all of those operations into our remaining facilities. In July, we further right-sized our Northern California manufacturing facility, reducing space approximately 31% in the building. After completing these actions, we have now consolidated all of our manufacturing activity into two U.S. locations, plus our single peat moss harvesting and processing facility up in Alberta, Canada. We have now fully integrated the ERP system in our peat business and will continue to make progress on system integration in other areas. Lastly, on the restructuring front, as we continue to evaluate opportunities to consolidate and become more efficient, we are now reassessing our distribution center network. We expect these actions collectively will help us operate more efficiently and cost-effectively going forward. Moving on to our selling general administrative expense, which continues to be a good story for us as we continue to take cost out of the business. In the second quarter, our SG&A expense was $18.7 million compared to $23.5 million last year. Adjusted SGN expenses were $11.6 million, more than 20% reduction when compared to $14.6 million in the second quarter of 2023. These savings resulted from reductions across a wide range of items, including headcount, facility expenses, professional fees, and insurance costs. Adjusted EBITDA was $1.7 million in the second quarter, compared to $2.5 million in the prior year period. The decrease was in large part due to the dynamics discussed earlier regarding our adjusted gross profit, partially offset by our reduced adjusted SG&A expenses. This quarter marks the fourth time in the last five quarters that we have realized positive adjusted EBITDA, further illustrating the success of our restructuring and cost-saving initiatives and our ability to drive profitability against lower sales levels. Moving on to our balance sheet and overall liquidity position. Our cash balance as of June 30, 2024 was $30.3 million, up significantly compared to our balance of $24.2 million at the end of the first quarter. The increase was primarily related to the net proceeds from the sale of the IGE assets of about $6.3 million. We ended the second quarter with $120.2 million of term debt and approximately $129 million of total debt, inclusive of financial lease liabilities. Our net debt at the end of the quarter decreased to approximately $99 million from approximately $107 million last year. As a reminder, our term loan facility has no financial maintenance covenant and does not mature until October 2028, and we continue to maintain a zero balance on our revolving credit facility. Our cash balance at the end of the quarter of approximately $30 million plus the availability on our revolving lot of credit of approximately $20 million results in total liquidity of $50 million. Lastly, on this point, we continue to make progress towards monetizing non-operating excess land that we own in upstate New York, which could further reduce net debt and or add to our liquidity when we complete the associated real estate sales. For all these reasons, we continue to feel good about our liquidity position. In the second quarter, we reported cash flow from operating activities of $3.8 million with capital expenditures of $0.4 million, yielding free cash flow of $3.4 million. Our free cash flow would have been about breakeven for the quarter without the impact of the IGE asset sale, as a portion of the net proceeds were required to be accounted for in operating activities. We achieved this cash flow position for the second quarter despite investing in inventory for new distribution relationships and innovative lighting products, which Bill mentioned earlier. With that, let me turn to our full year 2024 outlook. We are reaffirming the key metrics to our 2024 guidance, which includes net sales to decline low to high teens on a percentage basis, adjusted EBITDA that is positive for the full year 2024, and positive free cash flow for the full year. We also reaffirmed all other assumptions in today's earnings release, with the exception of capital expenditures, which is now 3.5 million to 4.5 million for the full year 2024, down slightly from 4 to 5 million previously. Before turning it over for questions, I would like to echo what Bill mentioned earlier, that we continue to control what we can and have set up our business to operate profitably with even lower sales. As we look ahead, we are excited about the future. When demand hopefully picks back up, we are in a great position to capitalize on it profitably. Thank you all for joining us this morning, and we're now happy to answer your questions. Operator, please open the line.