Hydrofarm Holdings Group, Inc.

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Hydrofarm Holdings Group Second Quarter 2025 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 12, 2025. I would now like to turn the call over to John DiDomenico at ICR to begin.

Thank you, and good morning. With me on the call today is John Lindeman, Hydrofarm's Chief Executive Officer, and Kevin O'Brien, the company's Chief Financial Officer. By now, everyone should have access to our second quarter 2025 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 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. 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 John Lindeman.

John, and good morning, everyone. During the second quarter, we delivered our 12th consecutive quarter of year-over-year adjusted SG&A savings. with a nearly 16% reduction in expenses compared to 2024. These substantial savings helped drive a small sequential improvement in adjusted EBITDA compared to the first quarter of this year, despite the tariff environment. Our disciplined approach to working capital management and inventory optimization also allowed us to deliver positive free cash flow for the quarter. We also took a significant step in the quarter with the initiation of a new restructuring plan to enhance our focus on higher margin brands and to further optimize our distribution and manufacturing network. We expect this initiative over the next several quarters to drive higher quality revenue streams and improve our level of profitability. Second quarter sales and sales mix came in softer than anticipated as industry headwinds continued to impact our top line performance. in particular on the durable side of our business. There continues to be oversupply challenges in the market, consolidation across the retail customer base, and minimal real progress made by the government on rescheduling and safer banking. These dynamics have led to inconsistent demand, most notably on the lighting and durable side of our business, which is heavily weighted towards proprietary brands. With that said, there are several positives to call out from a performance within the quarter. To start, we saw solid year-on-year performances on a relative basis from several of our proprietary consumable brands in the nutrients and grow media categories. And while the lighting and durable side of the business overall was very soft in Q2, we did see strong performance from our SunBlaster brand behind early results from our innovative and award-winning Nano and Halo plant lights. As part of this initiative to drive high-quality sales, We also have additional new branded products launching later this year. During the quarter, we also experienced positive performance in some of our newer distributed brands. Our team is excited to work with our distributed brand partners who are committed to aligning closely with us and investing behind their brands to support growth and deliver strong margin and cash flow characteristics. However, we are becoming increasingly selective And in our restructuring program announced today, we took the step to rationalize several distributed brands that do not fit those characteristics. We saw further progress in our non-cannabis and non-US Canadian sales mix during the quarter. Our international sales in particular performed well, improving year on year with nice results in select European and Asian countries. We remain on pace to improve upon the full year metric we achieved last year and continue to seek ways to diversify our revenue streams. Under our fully integrated ERP system, we have begun to realize improved working capital management, which helped to deliver positive free cash flow. Managing our free cash flow and our overall financial position remains a key area of focus for us, and we remain on pace to deliver positive free cash flow for the last nine months of 2025. We have made it clear that our top strategic priority is to drive diverse, high-quality revenue streams. After positive momentum in the first quarter of this year, which saw our proprietary brand sales mix improve to 55%, our mix softened in the second quarter due in large part to poor industry demand levels in the durables category. Behind our restructuring initiatives and select planned investments in the second half, We still expect to improve our proprietary mix and adjust the gross profit margin for the full year. Last quarter, we indicated that we would conduct a thorough review of our product portfolio and distribution network to better align with estimated sales demand in the current industry and tariff environment. In Q2, we completed that process and, as a result, initiated our new 2025 restructuring plan. This plan further streamlines our product portfolio and our manufacturing and distribution footprint. These actions include a large reduction in the number of SKUs and distributed brands that we will carry going forward. By trimming these underperforming products, we reduce our purchasing and warehousing complexity, reduce our space and personnel requirements, limit our working capital investment, and enable our sales team to focus their efforts on higher value brands. We estimate these actions collectively will result in annual cost savings in excess of $3 million, plus incremental improvements in working capital. And importantly, we expect approximately one-third of the total benefit to start showing through in the second half of 2025. Our strong history of impactful restructuring and cost-saving measures gives us confidence that we will, over time, realize these benefits. In the second half of 2025, we also plan to invest more in marketing behind new innovations, improve our brand websites, and further refine our internal CRM capabilities. All of these actions are oriented to drive higher quality revenue streams. I would like to give an update on the ongoing uncertain tariff environment. As a reminder, our primary tariff exposure is in our durables business, as we source certain lighting and equipment products from China. We typically maintain larger inventory positions and products sourced from overseas, and as such, we have not yet realized a dramatic impact from tariffs outside of approximately 300K of incremental costs year to date. We are managing our business to minimize the impacts from tariffs and are carefully purchasing from vendors abroad in situations where the incremental tariff costs can either be shared with our suppliers or passed on to customers in a limited manner. In addition, we have and will continue to enact pricing actions when necessary and where possible in an effort to preserve our margins. With all of that said, it's important to note that the largest part of our business is our consumables portfolio. and this business is mainly sourced from within the U.S. and Canada, albeit there is a portion sourced from other countries. We are increasingly focused on a proprietary consumables business, and with tariffs primarily affecting durables, it is logical for us to maintain that focus. We are executing what is within our control. We believe that by concentrating our efforts on a more optimized product portfolio and manufacturing and distribution footprint, we are positioned much better to drive diverse, high-quality revenue streams, improve profit margins, and strengthen our financial position. With that, I'll hand it over to Kevin to further discuss the details of our second quarter financial results and our new 2025 restructuring plan.

Thanks, John, and good morning, everyone. Net sales for the second quarter were $39.2 million. down 28.4% year over year, driven primarily by a 27.9% decline in volume mix and a 0.4% decline in pricing. The declines were primarily related to industry oversupply. While we were successful at driving improvements in our higher margin proprietary brands during the first quarter, continued industry headwinds and lower performance in our durable lighting and equipment products led to a decline in Q2. We are focused on improving our proprietary brand mix in the second half of 2025 and are planning increased investments behind our key brands, along with executing our restructuring plan, as John discussed earlier. Consumable products outperformed durable products on a relative basis, and as a result, our consumables mix ticked up to approximately 80% of sales in the second quarter. Gross profit in the second quarter was 2.8 million or 7.1% of net sales compared to 10.9 million or 19.8% of net sales in the year ago period. Second quarter 2025 gross profit was negatively impacted by 3.3 million of restructuring charges we incurred during the quarter related to non-cash inventory write downs. Adjusted gross profit was 7.5 million or 19.2% of net sales compared to 13.3 million or 24.4% of net sales last year. The decrease was due to lower net sales and a decline in proprietary brand sales mix. As John said, we continue to expect improvement and adjusted gross profit margins for the full year 2025 as we improve our mix and reduce costs. I'll now provide further detail on our new restructuring plan and cost saving initiatives. In response to the prolonged industry headwinds, as well as the evolving tariff situation, during the second quarter we initiated a restructuring plan to narrow and optimize the size and scope of our product portfolio and related footprint. The restructuring plan entails rationalizing over one-third of SKUs and brands in our product portfolio across the US and in Canada, where our portfolio is much larger, given the nature of our garden center business. The restructuring is intended to simplify our offering and optimize how we manage our inventory as one operating segment. In connection with the product portfolio optimization, we are reducing our footprint, including in our distribution center and manufacturing facilities. We estimate annual cost savings in excess of $3 million and working capital benefits from the restructuring, primarily from a reduction in inventory. We also believe this restructuring will improve efficiency, tighten our focus on our key proprietary brands, and help deliver improved profitability. Moving on to our selling general and administrative expense. In the second quarter, our SG&A expense was $16.1 million compared to $18.7 million last year. Adjusted SG&A expenses were $9.8 million, a 16% reduction when compared to $11.6 million last year. This was our 12th consecutive quarter of meaningful year-over-year adjusted SG&A savings. We are now operating well below our pre-IPO quarterly adjusted SG&A levels from 2020, a testament to the effectiveness of our cost savings initiatives. Adjusted EBITDA was a loss of 2.3 million in the second quarter. The decline from the prior year was due to lower net sales and adjusted gross profit margin, partially offset by adjusted SG&A savings. While the year-over-year comparison was unfavorable, we did improve sequentially compared to the first quarter while also covering incremental tariff costs. Moving on to the balance sheet and overall liquidity position. Our cash balance as of June 30, 2025 was $11 million. During the quarter, we made a $4.5 million prepayment on our term loan and ended the second quarter with $114.5 million of principal balance on the term loan and approximately 122.6 million of total debt, inclusive of financial lease liabilities. Our net debt at the end of the second quarter was approximately 111.6 million. As a reminder, our term loan facility has no financial maintenance covenant and does not mature until October 2028. We also continue to maintain a zero balance on our revolving credit facility. As a reminder, in May, we entered into a seventh amendment to our revolving credit facility, which extended the maturity date to June 30th, 2027, and reduced the maximum commitment amount to 22 million. With cash on hand and approximately 9 million of availability on our revolving line of credit, we had 20 million of total liquidity as of June 30th, 2025. In the second quarter, cash from operating activities was 1.7 million and capital expenditures were 0.3 million, yielding free cash flow of 1.4 million. Working capital benefits helped to deliver sequential improvements in free cash flow. We believe that we will deliver positive free cash flow for the last nine months of 2025. To close, during the second quarter of 2025, We took significant steps to better position our business for improved performance as we move forward. We are committed to executing our strategic priorities and remain optimistic for an eventual demand turnaround in the industry. Thank you for joining us today, and we look forward to providing another update in November on our third quarter call. We are now happy to answer your questions. Operator, please open the line.

Thank you. And at this time, if you would like to ask a question, please press the star and one on your telephone keypad. You may withdraw your question at any time by pressing star two. Once again, to ask a question, please press the star and one on your telephone keypad. We'll take our first question from Dimitri Silverstein with Water Tower Research. Please go ahead. Your line is open.

Good morning, guys. Thank you for taking my question. I want to revisit the tariff impact you mentioned. We've gotten a little bit more of a clarity here as we ended the second quarter with respect of, you know, EU and UK, some of the Asian countries where you're trying to grow China. Excuse me, tariff deadline has been extended here by another three months while negotiations are going on. So can you talk a little bit more about sort of what you expect, what you're seeing currently in terms of tariffs and what you expect to see Should these negotiations with China not deliver the results that people expect?

Yeah, good morning, Dimitri, and thanks for the question. Yeah, I mean, look, tariffs are certainly hard to track with the news coming out daily. But given how the size, scope, and speed of tariff changes have been occurring, it's certainly hard to predict the exact impact on the gross margin going forward. I would say thus far in the first half of 2025, I think we've been reasonably successful in covering the incremental cost of tariffs that were incurred on products that mostly for us were sourced out of China during that time period. Going forward in the second half, we'll continue to manage within our control with respect to tariffs. We're doing this by very carefully purchasing from vendors abroad. in situations where the incremental tariff costs can be shared or passed on to our customers in a limited manner. You know, we're also continuing to review alternative sourcing arrangements from abroad and domestically. And we're also focusing our business on proprietary manufactured brands, which are, at least on the manufactured side, for us, predominantly consumable products that we make here in the U.S. and Canada. These have the smallest exposure to tariffs and you know, related durable products, which are more heavily impacted by industry conditions right now. So hopefully that gives you some broad perspective on sort of how we're thinking about going into the second half.

Yes, it does, John. Thank you. You kind of segued into my next question, and that's your product portfolio optimization and changes. You talk about growing your proprietary business and kind of weeding out the third-party non-propriety, I guess, which you distribute for other people. What I will ask there is the reason you are distributing third-party products through your channels, is it just to expand your portfolio offering, or is it sort of offering a generic lower-cost alternative to your proprietary products? In other words, as you continue to weed out third-party distribution or distributing third-party products, What impact will it have on your portfolio overall and your ability to be a, you know, kind of a one-stop shop for your customers?

Yeah, look, I appreciate the question for sure. Look, we historically and continue to have had many great long-term relationships with distributed brand partners. Many of these partners have really helped us form a diverse and broad portfolio of products which we offer. You know, and this is not going to change for us. You know, our team continues to be excited to establish new partnerships where there's an innovative product with growth potential and, you know, the brand partner is willing to offer sort of fair margin and cash flow characteristics. But as we've talked about, you know, the industry remains challenging and it makes sense for us to reduce the offering where there are significant redundancies, let's sort of underscore that, and or sort of underperforming products. And we took those steps, you know, to make changes in their portfolio, you know, as we just reported. We did this just to kind of rehash a little bit so there's clarity on this. You know, we rationalized over a third of the SKUs and brands in our product portfolio across both the U.S. and in Canada. And although, you know, the rationalization of these SKUs and brands were across all the product and brand categories, and I want to be clear, it was across all product and brand categories. the largest proportion of underperforming SKUs and brands that we rationalize were found in the durable products and distributed brand areas. And because, in general, these are underperforming products that have not been selling well and carrying below-average margins, the impact to our net sales is much less than the one-third callout. And from a gross profit margin perspective, we actually expect to see our adjusted gross profit margin improve over time. So again, we expect to continue to have a broad offering across all the product categories as we do today. But frankly, during the go-go times of the industry, I think our portfolio probably became a little bit bloated and we need to continue to trim in spots that it makes sense.

It makes sense, John. Thank you for that granularity. Just switching gears here a little bit, talk about the non-cannabis part of your business. From what I understand that your loan and garden focus, your focus on e-commerce and distribution through that channel is aiding you a little bit here to sort of navigate the difficult times in the cannabis industry. Is there any sort of incremental effort that you're putting behind growing that part of your business? And is there anything that we should look forward to in the balance of 2025 on that front?

Yeah, sure. You know, as we sort of talked about in descriptive remarks, you know, our international sales had performed well, certainly on a relative basis, and they actually grew in the quarter on a year-over-year perspective with nice results in select European and Asian countries. You know, we continue to press in that area with our team, and, you know, we remain on pace to improve upon sort of the full-year diversification metric that we've typically reported. which is this non cannabis and non us Canadian sales metric. Um, and you know, how are we doing that? We're doing that with the international piece, which I just mentioned, we're doing that with food and floral sales in the U S and Canada. Um, you know, we're doing that with garden center in the U S and Canada, and we're doing that with e-commerce. Um, you know, we've had some success, you know, We're modifying some of our products to better appeal to non cannabis markets. You know, we've done that in the chiller space. Um, we've done that with some of our rotators. We've done that with our some blaster lighting products. And, uh, you know, we're continuing to look at some areas in the nutrient category. Um, along those lines, so lots of things that we're doing to focus our diversification efforts.

Understood understood. And then final question, um, you know, president Trump was, uh, recently, you know, speaking publicly talking about the fact that, that he is considering, um, we, uh, re, uh, classifying, uh, cannabis. Um, what have you heard from, from DC and, and, you know, what are the chances of that's actually gonna happen as opposed to be talked about again?

Yeah, I, I just simply say maybe unlike some others, I'm not sure I have a direct line to, uh, to Trump. But certainly we've seen the news, the news yesterday, some of the news we saw even the week before at the Wall Street Journal and Fox Business. And it certainly sounds like, you know, he's privately or his administration, perhaps I should say, is privately considering rescheduling cannabis. You know, look, we're certainly encouraged by these reports and hope the Trump administration sees it through in a positive, with a positive outcome. But, you know, we'll wait and see. for judgment until we actually see something. You know, there's been a lot of stops and starts in the past in this area, but certainly the latest development seems really encouraging. And, you know, we do think that, you know, this would be a positive, you know, for the overall industry as it frees up capital and cash flow, you know, for a lot of our end users of our products. So we're certainly excited to see a positive outcome here.

Very good, John. Thank you. That's all the questions I have for right now. Thanks, Dimitri.

Thank you. And this does conclude our Q&A session, as well as the conference call. Thank you all for your participation, and you may disconnect at any time.