Hydrofarm Holdings Group, Inc. (NASDAQ:HYFM) Q2 2023 Earnings Call Transcript

Hydrofarm Holdings Group, Inc. (NASDAQ:HYFM) Q2 2023 Earnings Call Transcript August 9, 2023

Hydrofarm Holdings Group, Inc. reports earnings inline with expectations. Reported EPS is $-0.21 EPS, expectations were $-0.21.

Operator: Good day, ladies and gentlemen and thank you for standing by. Welcome to the Hydrofarm Holdings Group Second Quarter 2023 Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded today, August 9, 2022. I would now like to turn the call over to Anna Kate Heller at 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 second 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.hydropharm.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 Bill Toler.

Bill Toler: Thank you, Anna Kate and good afternoon everyone. While we experienced some sequential growth in 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 9 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 are 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 6 distribution centers here in the U.S., 2 up in Canada and 1 in Spain, just as we did 2 years ago. And we are pleased to be delivering at a high level of service to our customers with fast turnaround times. Overall, we are 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 were 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 outperformed 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 experienced 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 and 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 cost, which may include a second phase of our restructuring. We are also seeing some positive industry signals and we remain confident that the industry will return to growth.

I am 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 will turn it over to John who will discuss the second quarter financials and our outlook for 2023. John?

John Lindeman: 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.

Image by BrightAgrotech from Pixabay

This largely relates to strong performance in the Nutrient and 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 recognized 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 performed 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% of 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 rightsizing 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 rightsizing the elements of our business associated with durable products. Selling, general and 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 profit 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 6 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 at only 1% annually, and our debt facility does not mature for another 5 years, not until October 2028.

We continue to maintain a zero balance on 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 to 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 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.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question is coming from the line of Andrew Carter with Stifel. Please proceed with your question.

Andrew Carter: Hi, 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 in in there? Kind of just tell us what’s in hand at this point?

Bill Toler: I’ll start and John can pick it up. But yes, it’s exactly that. It’s a stronger gross margin profile based on the better mix that we’re selling. The house spring 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 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 and 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 in 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.

Andrew Carter: And then the second question is your commentary around durables is counter noted. And obviously, there’s –Grow talked about pricing pressure yesterday. Author talked about it as well and leaning in, how strategic is durables for you? And what I mean by that is in this world where there aren’t any builds and when you were looking at the world 3 years ago, you probably thought about durables is get that initial sale own the customer for a lifetime. How strategic is could you window this portfolio down to consumables and be profitable?

Bill Toler: 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% durables and some nice high-priced tickets on that that ship pretty efficiently. So that’s – it is strategic in that you’re in the early part of the sale. You don’t want to be behind on that. So you want to get in on the MSO or the growers starting to make those decisions. So you really view it as more of a full-service partner. And that’s really what we’ve always been as kind of an end-to-end partner. So 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 and some other airwor-handling equipment.

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.

Andrew Carter: Thanks, I will pass it on.

Bill Toler: Thanks, Andrew.

Operator: Thank you. Our next question is coming from the line of Peter Grom with UBS. Please proceed with your question.

Peter Grom: Thanks, operator. Good afternoon, guys. Maybe just one point of – maybe I just want to start with the top line and another call down here. 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 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 and what we saw 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.