Hydrofarm Holdings Group Q2 2024 Earnings Call Transcript

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August 8, 2024

There are 6 speakers on the call.

Operator

Good morning, and welcome to Hydrofarm Second Quarter Earnings Call. Today's call is being recorded. 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.

Operator

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 Q2 2024 earnings release and Form 8 ks issued this morning as well as an investor presentation available for reference. These documents are available on the Investors section of Hydrofarm's website athydrapharm.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.

Operator

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 Bill Tolar.

Speaker 1

Thank you, Anna Kate, and good morning, everyone. In the Q2, we experienced sequential improvement in our adjusted gross profit margin over our 1st quarter levels and also delivered positive adjusted EBITDA for the 4th time in the last 5 quarters. We realized further favorability on our adjusted SG and A line with substantial savings year on year. For the 6 months year to date, we've delivered over $2,000,000 of adjusted EBITDA, up from approximately $300,000 in 2023, and we had the smallest year over year net sales decline in the last 3 years. We maintained relatively consistent results across the first 2 quarters of 2024, despite the Q2 of 2023 being a difficult quarter to lap.

Speaker 1

We remain laser focused on driving profitability in the business, and we took additional steps in the Q2 to further integrate and optimize our manufacturing operations, which should produce improved efficiencies and reduce cost 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 Q2 net sales were relatively in line with our expectations, and the month of May marked our 7th consecutive month of sequential net sales growth. That was the longest streak of sequential net sales growth for HydroPharm since going public back in 2020.

Speaker 1

I'll now highlight some of the areas of strength in the Q2. Our proprietary brands, including Active Aqua, Photo Bio and Roots Organic all performed well, growing year on year. Notably, the strong Photo Bio brand performance is a result of recent innovation in lighting. We are having success with the new generation of lighting products, including our photo bio 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.

Speaker 1

In Q2, our non cannabis and non U. S. 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 U. S.

Speaker 1

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 photo bio lighting that I mentioned earlier.

Speaker 1

We are investing significantly in several of our proprietary consumable 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.

Speaker 1

Following the proposal, there has been a 60 day period for comments, which ended on July 22. 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 will 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 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.

Speaker 1

To wrap up my remarks today, we are reaffirming our full year guidance for net sales, adjusted EBITDA and free 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 Q2 financial results and our outlook for the balance of 2024. John?

Speaker 2

Thanks, Bill, and good morning, everyone. Net sales for the 2nd quarter were $54,800,000 down 13.1% year over year, driven primarily by a 10.3 percent 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 3 quarters of our total sales, representing approximately 76% of our total sales in Q2, which is roughly the same amount when compared to the Q2 of 2023.

Speaker 2

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 the 2nd quarter was $10,900,000 compared to $14,500,000 in the year ago period. Adjusted gross profit was $13,300,000 or 24.4 percent of net sales compared to $17,000,000 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.

Speaker 2

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 3rd highest level we have recorded in any quarter since our IPO. And this quarter marked the 5th 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 base.

Speaker 2

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 31, 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 grade products.

Speaker 2

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 rightsized 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 2 U. S.

Speaker 2

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 we'll 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 and administrative expense, which continues to be a good story for us as we continue to take cost out of the business.

Speaker 2

In the Q2, our SG and A expense was $18,700,000 compared to $23,500,000 last year. Adjusted SG and A expenses were $11,600,000 more than 20% reduction when compared to $14,600,000 in the Q2 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 $1,700,000 in the 2nd quarter compared to $2,500,000 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 and A expenses.

Speaker 2

This quarter marks the 4th time in the last 5 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 30,300,000 dollars up significantly compared to our balance of $24,200,000 at the end of the Q1. The increase was primarily related to the net proceeds from the sale of the IGE assets of about $6,300,000 We ended the 2nd quarter with $120,200,000 of term debt and approximately $129,000,000 of total debt inclusive of financial lease liabilities. Our net debt at the end of the quarter decreased to approximately $99,000,000 dollars from approximately $107,000,000 last year.

Speaker 2

As a reminder, our term loan facility has no financial maintenance covenant, 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 30,000,000 dollars plus the availability of our on our revolving line of credit of approximately $20,000,000 results in total liquidity of $50,000,000 Lastly, on this point, we continue to make progress towards monetizing non operating excess land that we own in Upstate New York, 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 Q2, we reported cash flow from operating activities of $3,800,000 with capital expenditures of 400,000 yielding free cash flow of $3,400,000 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 2nd quarter despite investing in inventory for new distribution relationships and innovative lighting products, which Bill mentioned earlier.

Speaker 2

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 $3,500,000 to 4,500,000 dollars for the full year 2024, down slightly from $4,000,000 to $5,000,000 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.

Speaker 2

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. We're now happy to answer your questions. Operator, please open the line. Thank

Operator

And we'll take our first question from Andrew Carter from Stifel.

Speaker 3

Thank you. Good morning. I wanted to ask about you mentioned the demand trends in the quarter. I think you or you meant sorry, demand trends, I mean the revenue in the quarter. You mentioned May was the 7th highest month of sequential growth.

Speaker 3

I think that there's usually a seasonal build during the quarter. So could you talk about what underlying revenue did as you progressed through the quarter? And do you think the industry held steady or deteriorated during 2Q? Thanks.

Speaker 1

Thanks, Andrew. Appreciate the question. Yes, what specifically what I had said is that May was the 7th consecutive month of sequential growth going back to October, right? That did not continue in June or I probably would have said June, right? So May was sort of the peak of that 7 month trend.

Speaker 1

I think that we saw some encouraging signs on in the fact that some of our durable products, you heard me mention active aqua, there for healing and you heard me mention photo bio, which of course is lighting, showed year over year growth. So the mix has changed a little bit. I think it's an encouraging sign for the industry when durable products are starting to do a little bit better than what it says is people are either replenishing or rebuilding or building new, right? So I think that's an overall positive, right? We were lapping some really strong international shipments on our consumable brands in June as we opened up pipeline into new countries last year.

Speaker 1

So year on year on consumables didn't look quite as good, as we had hoped. But I think overall, the demand signs are stable, let's call them, with a little bit of a mix change toward durables, which is encouraging. And then we think that onward from here, we're maintaining the ability to make a little bit of money in some lower demand levels and then waiting for things to improve as the scheduling happens and as new states begin to open up.

Speaker 3

And then the second question I'd ask is like kind of thinking about where your mix is today from a geographical perspective, mature states, licensed cannabis sales still under pressure, cannabis pricing metrics still under pressure. But how about kind of the new states as a percentage of your mix, New York, obviously Ohio just opened, Missouri, are those big have those kind of achieved any kind of Yes.

Speaker 1

Yes, good question. They have started to achieve some level of critical mass. It's not enough to move the needle. We're still I think the whole industry is kind of held back by the size and scale of California, Oklahoma, Michigan, a little bit of Colorado, Oregon and Washington. But it has been very encouraging seeing what places like Minnesota and Missouri and New York, the ones you mentioned, Virginia is doing pretty well.

Speaker 1

Ohio has stepped up. So they are starting to shift that kind of balance of consumption and balance of volume towards the Midwest and the East. But we still got California that's under a lot of pressure until that one at least stops declining. We're going to not be able to get over the growth hump, but we are seeing that mix shift. We are seeing that come toward the Midwest, the Mid Atlantic and so on.

Speaker 1

Of course, the other big one is what's going to happen in Florida. A lot of people are waiting and watching to see how the voting turns out in November. We think that one could have a huge impact on everybody's opportunity to grow. Thanks, Andrew.

Speaker 4

Thanks. I'll pass it on.

Speaker 1

Thanks, Andrew.

Operator

And we'll take our next question from Peter Grom, UBS.

Speaker 4

Thanks, operator. Good morning, everyone. I wanted to follow-up on Mr. Carter's question a little bit just on the top line progression. I guess just in the context of the guidance, still a decently wide range for the balance of the year, but you're kind of trending at the better half of that year to date.

Speaker 4

So can you maybe just talk through how we should be thinking about the puts and takes as to what will put you towards the better end versus maybe towards the lower end of that guidance range? And maybe any thoughts in terms of how you would be thinking about the phasing of that 3Q versus 4Q?

Speaker 1

Thanks, Peter. And with the first half, it's sort of right at 13% and you got just above 13% in Q2 and right under 13% in Q1. Obviously, we are trending at the better end of our range. We talked about tightening it, but honestly felt like that with the uncertainties of things that go on in our industry in Q3 and Q4, we didn't want to get out ahead of ourselves. So we thought about, look, we are at the better end right now.

Speaker 1

We hope to stay there. But it's been a hard nut to call and a hard nut to find. And so we're encouraged by overall macro things that I mentioned in answering Andrew's call, but we still want to see further stabilization before we tighten anymore or call the range any better. But we are glad to be at the better side of that range right now.

Speaker 4

Okay. And then I guess if I were to just like thinking about it and just kind of getting back to stabilization, just going back to that point on the monthly sales trends, obviously, June maybe wasn't that as you mentioned. But not to call about not to talk about 2025 now, but because it's been you're still having a harder time figuring out where to

Speaker 2

be within the range of

Speaker 4

the back half of this year. But I guess just like would you anticipate like just I don't know like do you think we could see better stabilization and just in terms of top line growth? And so said another way, the stabilization in top line growth, will that allow some of the cost savings and restructuring that you're doing to kind of allow some of the better profitability to flow through. So just trying to think about a bigger picture how you think about maybe the puts and takes of 25 at this point in time.

Speaker 1

It's something we've begun to talk about, but we're certainly not ready to call anything in 2025. But I think that the momentum is such that the shifting to the middle of the country states and the Northeast states, plus the potential for rescheduling. All those things should lead us to a growth year in 2025, not really ready to put a number on that yet. But I think that we certainly paid our dues longer than we thought we had to across the entire industry with a couple of years here of declines. So we should be ready to go.

Speaker 1

And I think now that our cost structure is as tight as it is, we will start seeing those much higher profitability numbers popping through with the controlling costs, the restructuring done, the shutting of facilities, the selling of assets, all of that puts us in a great spot that when a little bit of growth does return, it's much more of it's going to stick to the bottom line as it flows through.

Speaker 4

Great. And then maybe just one quick follow-up for John. Gross margin expansion is still expected for the year. Just any thoughts on phasing for gross margin as well as kind of adjusted EBITDA just as we think about calibrating our models for 3Q and kind of 4Q?

Speaker 2

Yes. Typically, we see, as you know, Peter, a little bit stronger profitability in Q3 than we do in Q4, just because we typically see what the seasonality trends that exists in our business, particularly up in Canada and elsewhere that sort of top line in Q4 is typically a wee bit lower than it is in Q3 and sort of that effect has a little bit of an implication on our margin. But overall, as we said, we're expecting stronger margin in the second half and hopefully that gives you a little bit of insight on sort of the Q3, Q4 aspects of it.

Speaker 4

Awesome. Thank you both. I'll pass it

Speaker 1

on. Thanks, Peter.

Operator

And we'll take our next question from Jesse Redmond, Water Tower Research.

Speaker 5

Good morning, guys, and congratulations on the quarter. Had a question on Ohio. I know we saw a pretty strong production ramp heading into launching sales just a few days ago. Can you talk about how you may have benefited from that production ramp and how much of that you expect to persist, which I guess maybe speaks to a little bit about the consumables versus durables?

Speaker 1

Yes. Thanks, Jesse. Ohio has been trending well as you get kind of these burst of opportunities with new things happening. That's been a strong state for us for a while. We've got good people on the ground there and good relationships with key customers in that area.

Speaker 1

So that has been a good one. But there have been others. I mean, Missouri has been strong as well. Some of this stuff finally, Virginia has come around after a couple of years to get it fully implemented. A number of these states that have been slow to implement and slow to start, they have happened.

Speaker 1

And with that 75% to 78% of our business now in consumables, generally at New States is going to benefit the durable side a little bit first. And then consumables, of course, you got to build the facility before you can run it. And part of that is why that our durable business has done a bit better, driven by the innovation of photo bio, the innovation of Phantom and of course these new states are rolling out. The challenge for all of us has been that the size and scale of the California, Michigan and Oklahoma until the country kind of adjust to absorb the new business in each of the newer states, which by definition are smaller until they scale up. Until that shift happens, we're not going to see an Ohio or any state really big enough to drive growth.

Speaker 1

But it is good to see that shift. It is good to see it spreading out a little bit and not being nearly as concentrated as it was a couple of years ago.

Speaker 2

That's helpful. Thank you. And also

Speaker 5

I was wondering if you had any we talk a lot about what's going on in the cannabis space, obviously, because that drives most of the revenue and there's a lot of exciting catalysts on the state and federal level. But also curious what's going on in the non cannabis world and maybe added the insights to the kind of the foods, florals, lawn and garden area of the business?

Speaker 1

Yes, that industry, while we've got a pretty good business in the lawn and garden side up in Canada, we spent a good bit of time in the U. S. Developing lawn and garden relationships. That business I would call it while cannabis has been declining, that's usually a pretty stable and flattish business. Lawn and Garden can grow a couple of percentage points a year and it has shown those kind of trends here over the last few quarters.

Speaker 1

So we're getting deeper into that. We are seeing that to be a much slower business to adopt change and we've been working now for a better part of a year or more in getting into new stores and new areas. One of the things we've done is we're selling kind of integrated planograms into some of these lawn and garden retailers and that's had some nice traction working with good partners and in some of the lawn and garden distributors that are working with us to help get volume out into these stores. And so those partnerships are developing, but it's a slower burn and it takes a while to develop significant volume there. But we think that will continue to help us a little more into 'twenty four and on into 'twenty five.

Speaker 2

And just to add on to that too, Jesse, our peat business, which tends to skew much more food and floral than it does cannabis has generally been very steady business for us and we expect that to continue. And then as I think we've noted on prior calls from an international standpoint, which we sort of consider outside of the U. S. And Canada, we had very strong growth last year. Numbers are still small in absolute dollar terms, but very strong growth percentage terms last year.

Speaker 2

A little sort of flattish in the first half of this year, but with words we can see and expectations with new distributions and geographies, we are expecting growth in the back half and that side of the business as well. So So all these things are sort of combining to help us diversify.

Speaker 5

That's great. And if I could just get one more quick one maybe for you, John. It looks like you're getting making continued progress on the cost cutting side. Any comments on where you are in that cycle and how much room you might be able to squeeze more out of SG and A or other areas?

Speaker 2

Yes, great question. I was looking at it this morning. If you look on a trailing 12 month basis, as we ended this Q2 and compare that to a trailing 12 month basis, Q2 1 year ago, our adjusted gross profit margin is up 5.40 basis points year over year, so substantial improvement. And we've taken $17,100,000 out of adjusted SG and A expense. So really big movements in connection with the restructuring cost saving actions we've taken.

Speaker 2

I think as we said before and it's kind of alluded to in the response we gave to Peter's question, if we get any energy on the top line across the category and continue to make progress on our own initiative to continue to drive more proprietary brands, in particular in some of our consumable products that are fairly profitable for us and higher margin. We have the opportunity to see our adjusted gross profit margin expand into sort of a couple of 100 basis points higher than where we've been here the last couple of quarters. And we're excited to see that prospect come to fruition.

Speaker 5

Great. Thanks very much for the comments.

Speaker 1

Thanks, Jesse.

Operator

And with no further questions in the queue, I will turn the program back over to your presenters for any additional or closing remarks.

Speaker 1

Great. Thank you, operator and everyone. We appreciate your support of Hydrofarm and look forward to speaking with you soon. Take care.

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Key Takeaways

  • Profitability Improvement: Hydrofarm reported sequential increase in adjusted gross profit margin and positive adjusted EBITDA for the fourth time in five quarters, with over $2 million of adjusted EBITDA in the first six months of 2024.
  • Restructuring and Cost Savings: The company closed underperforming facilities, sold IGE manufacturing assets, and consolidated operations into two U.S. sites plus a Canadian peat facility, resulting in over 20% reduction in adjusted SG&A year-over-year.
  • Sales Stabilization and Brand Growth: Net sales of $54.8 million in Q2 declined 13.1% year-over-year, but May marked the seventh consecutive month of sequential sales growth; proprietary brands now represent 58% of net sales, driven by strong performance from Active Aqua, Photo Bio, and Phantom lighting.
  • Revenue Diversification: Hydrofarm is expanding international and non-cannabis channels—food, floral, lawn & garden—and added distribution partners like Quest, Hurricane Fans, and Mills Nutrients to broaden its product portfolio and customer reach.
  • Reaffirmed Full-Year Guidance and Liquidity: The company reaffirmed its 2024 outlook for low-to-high-teens net sales decline, positive adjusted EBITDA, and free cash flow, supported by a strong liquidity position of approximately $50 million and potential tailwinds from cannabis rescheduling.
A.I. generated. May contain errors.
Earnings Conference Call
Hydrofarm Holdings Group Q2 2024
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