Hydrofarm Holdings Group, Inc. (NASDAQ:HYFM) Q1 2023 Earnings Call Transcript May 10, 2023

Operator: Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Hydrofarm Holdings Group’s First 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, May 10, 2023. I would now like to turn the conference call over to Anna Kate Heller of ICR to begin.

Anna Kate Heller: 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 first quarter 2023 earnings release and Form 8-K 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 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 Bill Toler.

Bill Toler: Great. Thank you, Anna Kate, and good afternoon, everyone. During the first quarter, we continued to see signs of stabilization in the industry as we saw our first quarter sales increased sequentially from Q4 2022 to Q1 2023. We remain focused on controlling and cutting costs to Hydrofarm, including rightsizing our business, making operations as efficient as possible, and managing for profitability. We are seeing positive industry signals, which I’ll talk about more shortly. And we’re confident that the industry will return to growth. I am proud of the hard work done by the entire team and Hydrofarm to shape our business into a leaner and stronger organization. We appreciate the work our team has done. These actions have us better positioned than ever to take advantage of growth opportunities that lie ahead.

I’ll point to a few of the key accomplishments during the quarter. I’ll discuss the positive signs as well as the challenges that we are currently seeing. We continue to execute on our previously announced restructuring initiatives. We completed the consolidation of our Canadian nutrient manufacturing facility, the closing of our regional office in China, as well as the relocation of our distribution center in Western Canada. In January, we completed the sale-leaseback of our property in Eugene, Oregon, which serves as a location for the manufacturing and processing for some of our grow media and nutrient brands. We received a little over $8 million in net proceeds from the transaction. Turning to a recent achievement regarding innovation, one of our core brands I’m really thrilled to talk about.

On April 20th, we officially launched our newest House & Garden powder product line. It is a dry nutrient lineup, aimed toward commercial growers that was built around our highly reputable premium brand, House & Garden, an early player in the industry and an industry leader in the nutrient category. Based on professional field trials in a controlled environment, our new House & Garden commercial powders produced more yield and higher plant quality than any of the other tested alternatives. We are excited about our team’s ability to innovate on our core brands, and offer value added solutions for our retail customers and our commercial customers. Turning to industry dynamics. In Q1, we experienced relative strength from our specialty retail customers, especially in the western states.

I’d like to note that in California, historically our largest ship to state, it was up sequentially in dollar sales when you compare Q4 of last year to Q1 of this year. We’re also seeing strength in APP, our Aurora Peat brand, which has a diverse customer base and also serves non-cannabis channels. This brand grew double digits on a year-on-year basis in the first quarter. We’re excited to see the improvement in APP and our specialty retail in the west. One of our challenges we faced in the quarter was that some commercial customers delayed builds in new projects. As a result, our commercial sales in Q1 fell short of expectations. This is primarily due to the ongoing legislative battles and frankly, lack of cohesive legislative support that has been slowing implementations in key states, like New York, New Jersey, Connecticut, Mississippi.

As we have previously said, for us to achieve our guidance — top-line guidance for the year, we need a modest seasonal lift in the spring, we also need to close some of those commercial opportunities in front of us. Now as we sit here in early May, we have just recently seen a lift in our daily sales. This seasonal uptick needs to continue and increase through the remainder of Q2 and into the back half in order for us to achieve our top-line guidance. In summary, we are laser focused on driving profitability and executing our strategy. As a result of our actions, we’re already seeing some benefits as evidenced by our sequential and year-over-year improvement in adjusted gross margin — profit margin. We will continue to execute on key initiatives which include driving a more favorable sales mix by selling and focusing on high margin products, diversifying revenue stream by further expanding our sales efforts in the non-cannabis channels, including CEA food and floral and lawn and garden, increasing productivity across all of our manufacturing and distribution centers, generating cost savings by continually reexamining the size and scope of organization relative to the current industry demand levels, and of course, reducing our working capital.

I’m encouraged by our team’s discipline and execution during the quarter. The margin improvement we saw in the first quarter is a testament to the success of the recent actions, which have put us in a stronger position in 2023 and beyond. With that, let me turn it over to John to discuss the details of our first quarter financial results and outlook for 2023. John?

John Lindeman: Thanks, Bill, and good afternoon, everyone. Net sales for the first quarter were $62.2 million compared to $111.4 million in the prior year period, driven primarily by a 42.5% decrease in sales volume. Note that this now marks the second consecutive quarter of reduced year-over-year organic sales declines, dating back to Q3 2022. We realized, as expected, a 1.1% price mix decline in the quarter, resulting primarily from the sell-through of discounted lighting products. Our overall brand mix improved in the quarter as proprietary brands increased as a percentage of total sales to 56% from 54% in the prior year, driven primarily by nutrient sales, partially offset by lower commercial equipment sales. We did see some other positive trends in the quarter too.

First, we saw sequential strength in several key western states. For example, our total dollar sales in California, Oklahoma, Washington and Oregon, all increased sequentially for the first time since mid-2021. This strength helped our specialty retail business outperform internal expectations for the quarter, albeit this outperformance in our specialty retail channel was mitigated by weaker than expected performance in our commercial channel. Second, our international sales outside of the U.S. and Canada grew sequentially and then on a year-over-year basis. While international sales make up less than 2% of total sales, the significance was the placement of some of our house nutrient brands into markets outside the U.S., which gives us something to build on.

Gross profit in the first quarter was $11.4 million compared to $16.6 million in the year-ago period. Adjusted gross profit was $14.1 million or 22.6% in net sales in the first quarter, compared to $22.3 million or 20% in net sales last year. The increase in adjusted gross profit margin is largely due to improved brand mix, improved productivity, primarily in our distribution centers, and the fact that we recorded lower inventory reserves than last year. Our Q1 adjusted gross profit margin improvement suggests that our restructuring and related cost saving initiatives are making an impact. Against these benefits, we realized $1.4 million in pre-tax charges in Q1 related to the closure and relocation of certain facilities in Canada and China.

We do expect to incur additional restructuring charges primarily in Q2 of 2023. Selling, general administrative expense was $24.4 million in the first quarter compared to $40.2 million in the year-ago period. Adjusted SG&A expenses were $16.2 million a quarter versus $19.2 million last year, this $3 million or 15% decrease was primarily due to lower compensation costs resulting from headcount reductions, as well as reduced spending with professional and outside service providers. Finally, adjusted EBITDA decreased to a loss of $2.1 million in the first quarter from a $3.1 million profit in the prior year period. The decrease in adjusted EBITDA was driven primarily by the lower organic cost of sales volume. Notably, this is the second consecutive quarter of sequential improvement in adjusted EBITDA.

We still have work to do, but the sequential improvement demonstrates the progress of our restructuring and related cost saving initiatives. We will continue to control what we can in an effort to drive increased profitability through improved brand mix, distribution center and manufacturing productivity and reduced SG&A. Moving on to our balance sheet and overall liquidity position. Our cash balance as of March 31, 2023, was $18.7 million. We ended the quarter with $123.4 million of term debt. As a reminder, our term debt facility has no financial maintenance covenant and does not mature until 2028. And as was also the case for the entirety of 2022, we maintained a zero balance in the Company’s revolving credit facility across the entire first quarter.

I would also like to note that in March, we extended the maturity of our revolving line of credit to June 2026. As you see in today’s earnings release, our free cash flow in the first quarter improved by approximately $2 million relative to the same period last year. This improvement is something we expect to build on as we move into what are typically the more seasonally favorable cash flow periods of the year. We estimate total liquidity of approximately $57.7 million as of March 31st, comprised of our cash position plus approximately $39 million of available borrowing capacity under our revolving credit agreement. With that, let me turn to our updated full year 2023 outlook. We continue to expect net sales in the range of $290 million to $310 million for the full year 2023.

As we discussed on our last earnings call, our sales guide assumed a modest seasonal lift in early Q2, and year-over-year top-line growth resuming in the second half of 2023. As you heard from Bill, we have not yet seen enough of the seasonal lift that we previously expected. And we now have a little bit of a gap in our commercial sales that we need to close across the remainder of the year. Our current 2023 sales guidance assumes that the pickup will occur mid to late Q2, and that year-over-year top line growth will resume in the second half of 2023. As a result, we expect top line for the second quarter to be modestly higher than the first quarter and we expect our full year sales to be at the lower end of our $290 million to $310 million range.

As noted earlier in the call our adjusted EBITDA and adjusted EBITDA margin has sequentially improved in each of the last two quarters, and today we are reaffirming our expectation for modestly positive adjusted EBITDA for the full year 2023. We are also reaffirming our expectation for positive free cash flow for the full year. In closing, we believe we remain on the right path to control the controllables, while weathering the industry headwinds. And we remain excited about our prospect for continued improvement and near-term profitability. And with that, let me ask the operator to open the line for any questions you may have.

Q&A Session

Operator: [Operator Instructions] Our first question comes from Andrew Carter with Stifel. Please go ahead.

Operator: Our next question comes from Bill Chappell with Truist Securities. Please go ahead.

Operator: Our next question comes from Andrea Teixeira with JPMorgan. Please go ahead.

Operator: [Operator Instructions] There are no further questions at this time. I would like to turn the floor back over to Bill Toler, CEO, for closing comments.

Bill Toler: Thank you, operator, and thank you all for your time and interest in Hydrofarm. And we look forward to speaking with you and working with you going forward. Thanks so much.

Operator: This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.