Q1 2022 Hydrofarm Holdings Group Inc Earnings Call

May 10, 2022

[music].

Good day, ladies and gentlemen, and thank you for standing by welcome to the Hydro form Holdings group's first quarter 2022 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 2022.

Now I'd like to turn the conference over to Mr. Fitzhugh tailor managing director at ICR to begin.

Thank you Claudia and good afternoon.

With me on today's call is Bill Toler Hydro farms, Chairman and Chief Executive Officer, and John London, The company's Chief Financial Officer.

By now everyone should have access to our first quarter 2022 earnings release and form 8-K issued today after market close. These documents are available on the investors section of hydro farms website at Www Dot Hydro farm Dot com.

Before we begin our formal remarks. Please note that our discussions 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.

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.

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 Taylor Bill.

Thank you Sue and good afternoon, everyone.

Since our IPO in December 2020, we worked hard to strengthen our business and lay a foundation for long term success. We've completed five acquisitions that have reshaped our product portfolio with a focus on higher margin consumables, increasing both our proprietary and preferred brands. We've also expanded our distribution.

Tribunal and manufacturing footprint by over 70% and completed three financings to further solidify our balance sheet. We have added new skill to our management team here at Heidrick pharma as well.

With a long history of consistent growth combined with a strong tailwind I'm the CEO of hydroponic growth, we believe our optimism is grounded.

However, while optimistic about the future of our business and our long term potential recent volume trends across the industry have been impacted by the external environment due to the agriculture oversupply that has hampered cannabis growing activity across the U S and Canada.

Our sales in Q1 are essentially flat compared to last year's first quarter supported largely by our M&A volume.

With that in mind, we believe it's prudent to adjust our outlook for 2022, which John will discuss in further detail in a moment.

Nevertheless, beside these transient challenges, we should not lose sight of the fact that in consumption of cannabis continues to grow.

Best proxy we have for this is dispensary unit volume data measured by headset, which is showing increasing volume both sequentially and year over year. This end use consumption is leveling out Ken cannabis inventories, which should help the hydroponic industry return to a more normalized growth.

During this challenging time, we are working to control the controllable by taking additional actions to control costs increased prices and protect our business.

These include price increases passing on fuel surcharges, passing on higher freight costs. We have also reduced our employee base by about 11% by the end of the first quarter and continued to optimize our organization as we capture cost synergies from the acquisitions completed in 2021.

The results of these actions are helping to mitigate inflationary costs and beginning to positively impact our P&L.

We are using the short term volume challenges as a time to make us a better operator, and a stronger leaner company. So when growth returns, we will be more profitable and stronger business. In addition to these actions the growth drivers we laid out in prior communications are actually performing relatively well when you look at Iga.

And our commercial business. They both enjoyed a solid first quarter.

Several of the newer legalized states are doing pretty well and also our Pete we're seeing solid performance.

However, this has been offset by softness in our core retail business, including legacy markets, like California, Michigan and Oklahoma.

Lastly, we continue to believe that adult use legislation will provide us with significant growth opportunities in the future while the new states have been slow to implement we continue to see an opportunity for growth in cultivation activity in late 2022.

Ultimately, we expect an acceleration in the cannabis market growth, resulting from these.

These state legislative changes and increasing popular support.

In summary, the actions we've taken combined with our growth drivers have not only helped us refine and optimize our organization, but also equipped us to move past the near term challenges. Moreover, with strong product portfolio and a healthy balance sheet. We believe we are well positioned to capture the tremendous growth opportunities that lie ahead.

Is that I will turn it over to John to further discuss the details of our first quarter financials and provide comments on our updated full year 2022 outlook John .

Thanks, Bill and good afternoon, everyone.

Net sales for the first quarter held steady at $111 4 million compared to the prior year period.

Our 2021 acquisitions added 34, 6% to our topline in the first quarter of 2022 relative to the prior year period.

But this M&A growth was offset by a 34, 6% decline in organic sales due to softness we experienced in several U S States and in Canada.

In the U S. California remained challenged but we also experienced softness during the quarter and several of the historically larger state markets.

So not yet sizable enough to offset these historically larger states, we experienced year over year organic growth in Q1, and several other states and regions. For example in the southeastern U S States, such as Mississippi, Louisiana, and Florida, each experienced double digit or more year over year organic grew.

In Q1.

Similarly, several other states, most notably in Virginia, and New Jersey experienced significant growth in the quarter.

In Q1, we also realized a two 2% price mix benefit which is consistent with our intention to pass through higher costs and consistent with our own internal expectations for the quarter.

Gross profit during the fourth quarter decreased to $16 6 million as compared to $23 2 million in the year ago period during.

During the first quarter, we incurred $3 9 million in acquisition related expenses.

We also experienced a significant year over year increase in depreciation and amortization expense largely due to purchase accounting and the stepped up asset values that resulted from our 2021 acquisitions.

For comparability purposes, we included in the press release, the calculation of adjusted gross profit, which excludes these items on this basis adjusted gross profit was $22 3 million or 20% of net sales in the first quarter down slightly from $23 4 million or 21% of net sales last year.

And though we did not adjust for it adjusted gross profit was negatively impacted by a $3 $2 million increase in inventory reserves, primarily consisting of a write down of certain lighting products during the quarter.

Excluding the increase in inventory reserve adjusted gross profit margin would have been higher in the first quarter of 2022 than in the prior year period.

Should also note that while freight and labor costs were higher in the quarter on a year over year basis, our pricing actions create initiatives and favorable sales mix largely offset these items.

Selling general and administrative expense increased to $43 million in the first quarter of 2022 compared to $16 8 million in the year ago period.

The increase in SG&A was primarily due to $13 $5 million increase in amortization expense again due to stepped up asset values from the acquisitions distribution center relocation costs acquisition and integration related costs and certain other noncash expenses detailed in the back of today's earnings release.

Adjusted SG&A expense, which adjust for these items was $19 2 million.

Or 17, 2% of net sales in the quarter versus $13 5 million or 12, 1% last year, primarily driven by an increase in compensation costs facility costs and insurance expenses.

As a reminder, these added costs, primarily emanated from the five acquisitions that we did last year and the overall increase in the size and scope of our operations today, all of which helped to prepare us for future growth.

Reported net loss was $23 3 million or <unk> 52 cents per diluted share in the first quarter compared to income of $4 9 million or <unk> 13 per diluted share last year.

Weighted average diluted shares outstanding were approximately $44 7 million for the first quarter of 2022.

Adjusted net loss for the quarter was approximately $7 8 million or 17 cents per diluted share compared to an adjusted net income of $7 $2 million or <unk> 18 per diluted share in the year ago period.

Lastly, adjusted EBITDA decreased $3 1 million in the first quarter from $9 9 million in the prior year period.

Adjusted EBITDA margin decreased to two 8% from eight 9% in the prior year period, driven primarily by higher SG&A expenses relative to net sales in the period comparisons as well as the $3 2 million inventory reserve I mentioned earlier.

It is worth noting that if not for the inventory write down our Q1 adjusted EBITDA would have been in line with our commentary back in March even on lower than expected net sales. This suggests that the initiatives we put in place in Q1, R&D, having a positive impact on the P&L in spite of the continued revenue softness.

Moving on to our balance sheet and overall liquidity position as of March 31, 2022, we had over $111 million in total liquidity between $12 $2 million unrestricted cash and approximately $100 million available on our Undrawn ABL revolving credit facility.

We also maintained approximately $125 million in debt outstanding under our term loan.

Based on our Q1 results and recent sales trends, we are updating our full year 2022 outlook, providing you with some color around our current assumptions.

We now expect total company net sales growth of zero to 8%, which translates to approximately 104 hundred $80 million to $520 million in net sales, we expect a decline in full year organic sales offset by M&A growth.

While we expect total sales growth to resume in Q3 versus reported results a year ago, We now expect quarterly organic growth to resume in Q4.

Though difficult to make this call only for four months into our 2022 fiscal year based on the soft early spring sales, we felt updating our guidance was the prudent thing to do.

Our pricing and cost saving actions are yielding positive early results and are helping to counterbalance the margin impact of a softer than expected top line.

While we expect this relationship to continue our adjusted EBITA estimates imply a margin profile that is impacted somewhat by the reduction in full year net sales.

Lastly, and as Bill pointed out earlier, we've made many investments over the past year to prepare us for the <unk> growth expected in our future we.

We expanded our distribution footprint invested in inventory positions increase the size and scope of our proprietary brand offering and manufacturing capabilities and added key leadership roles.

Against this backdrop, we feel justified and reducing our capital expenditure plans slightly to $8 million to $10 million and inserting controls.

To reduce over time, our networking capital investments and further boost internally generated cash flow.

In closing, we believe we put in place the necessary steps to weather the current industry headwinds, while it was prudent to lower our expectations for the full year.

We remain optimistic about our business fundamentals and our ability to capitalize on the growth opportunities in the <unk> industry.

This concludes our prepared remarks, and we're now happy to answer any questions you might have operator, please open the lines for questions.

Thank you Sir.

Now be conducting a question and answer session.

You would like to ask a question Keith Please star one on your telephone.

Thank you Pat.

A confirmation tone will indicate your line is in the question queue.

You mean stocking too if you would like to remove yourself from the question queue.

For the participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key.

One moment, please while we poll for questions.

The first question comes from Andrew Carter from Stifel. Please proceed with your question.

Thanks. Good afternoon first question I wanted to ask who's taking the inventory parament about $3 million first part of that is as you review kind of the categories. How much more could there be I E. Like how much of your inventory right now is in deflation I would assume lighting is.

And then a separate part of that question is I think your purchases I did my math here quickly. We're still up do you think youll be able to generate free cash flow this year kind of working through inventory. Thanks.

Yes, Thanks, Andrew.

For sure our inventory levels remained pretty strong.

You know the $3 2 million inventory reserve, primarily relates to select lighting skus, particularly in the high pressure sodium area.

I would note we did not write those down to zero, but rather to a level. We think allows us to move those products efficiently.

We will continue to keep a watchful eye, but at this point, we think what we do.

It is that's what's warranted.

And with respect to I think to your question on free cash flow, Yes, I think with.

Our our capex assumptions working capital assumptions.

And assuming we continue to progress towards the guidance. We just outlined we do expect to generate free cash flow this year.

Thanks, and then the second question is you mentioned the pricing on that was a 2% hard to kind of read on books are you getting incremental pricing through and I'm not sure in this environment when volumes down 30, you can tell or not you get any pushback or senior roles in particular, I'm kind of asking about the promotional environment that you're seeing out there. Thanks.

Yes, the pricing is primarily on a list price basis.

Promotional activity Hasnt materially changed it across the categories as you suggested with volumes down in retail traffic down the effectiveness of propulsion.

It would be if you were getting more people into stores and more people buying so you haven't really seen a whole lot more investment on that side of it I think individual distributors and brand owners may have certain categories that are promoting John mentioned earlier that we are working to move through the HTS double-ended lighting that were working against under our.

<unk> brand.

But we haven't seen it go.

Over the top on promotion the pricing is it primarily on list pricing. We've also put in place a fuel surcharge and also increased freight requirements for our customers to buy again, helping solidify the costs that we're seeing.

Thanks, I'll pass it on.

Thanks, Andrew.

Thank you. The next question comes from Peter Grom from UBS. Please go ahead with your question Peter.

Hey, good afternoon, everyone. So just a couple of questions maybe person.

I don't mean to be too far here, but I guess I'm just trying to understand what happened this quarter I mean.

You reported in early March and the commentary was that sales are going to be down a little bit worse in <unk> on an organic basis.

And essentially more than doubled that decline and I totally understand the category has been challenged but yes more.

More than kind of doubled the decline that you were kind of expecting even though you had two months in the rearview here. So I'm just trying to understand the visibility you have in your business. When we think about your guidance, particularly as we as we look out.

For the balance of the year.

Yes, I think it's fair to say that visibility in the category has been difficult for everybody Alright, and we're certainly.

In that in that group that struggles to see where the demand is coming and when it's coming forward. We did have.

Some open thought that as we got into the spring months March and I think as you know 40% of the of the first quarter that March would sort of be that turned back to the positive and actually went the other way. It was a weaker time than we had than we had hoped so yes. It was a disappointing Alan we didn't give a specific number when we gave that sort of.

Callout in March we just said is going to be worse than it was in Q4 and.

It turned out to be a good bit worse as we are reporting now so the visibility is clearly a challenge. We're all working through that we're all trying to get better look some views into it but there's not a lot of magic meant a lot of third party data that gets US there. We're just trying to plan out and see what business, we can and work should work through it.

Get the best outcomes, we can but I certainly understand your question here.

Okay. That's helpful and then yeah.

You mentioned.

Sales trends as part of the reason as to why.

Our guidance is much easier and so maybe you could just speak to what.

Youre seeing kind of through April and May and how we should think about sales on an organic basis.

<unk> and then.

Maybe just layering on that I guess.

Looking at some of your peers right I mean, I totally understand the visibility has been a challenge for everybody, but the level.

Negative revision from a revenue perspective is far greater at this point in time are you simply being conservative or are you do you feel like this is.

You Shouldnt, we should expect to achieve I'm just trying to understand.

You know kind of the underlying assumptions here.

And youre kind of comfort in hitting this.

<unk> target.

Yes.

Back to your first part of that question, we have not seen.

We haven't seen any improvement in April may is too early to tell obviously April did not show us a whole lot and that certainly.

Influenced how we called down the whole year, because we haven't seen kind of that spring return that we had hoped for.

And so that's where we are.

That's the that's the part of it do you see other people I think our largest competitor hasnt really provided there.

Revised look.

<unk> just came out a few minutes ago I glanced at it quickly and that was pretty significant.

You can call them their same store sales decline is similar to what our organic number was in Q1, so we kind of track along with that.

And that's where we were seeing but we haven't seen a turn that's why we went ahead and called down and obviously, we give you the numbers. The best we can that we think we can achieve and we're not trying to be heroes sandbag or two.

Calling down multiple times, but we will give you the numbers that we can.

We can forecast and that's what we see.

Okay. So just if we if we were to kind of hold the current rate that youre seeing.

During the balance of the year would that kind of get you.

So what you're outlining in terms of revenue and EBITDA or is it do you think that.

I'm just trying to understand cause last quarter, you down I'm, saying in Montreal.

I mean the category.

Sure.

I'm sorry go ahead Peter.

No.

Want to make sure that that's what I was trying to understand is it.

I mean that the kind of current state of the category holds and that just as the comparisons get easier in the back half of the year that that's kind of when you would get the organic growth or does it cause bad debt. The category show some sort of signs of life here in the coming months.

Yes, we are expecting it to show some strength in Q4 versus perhaps earlier than we had thought maybe late Q2 early Q3.

And there is seasonality in the business as you well know the last six months have been the Russell just from a seasonality standpoint, Q2, and Q3 should be the stronger ones, we'll see how that plays through as we go through the year and yes, the easier comps in the back half do give us.

You know more confidence that we should be able to track with the better better outcomes.

Okay, great well best of luck and I'll pass it on.

Thanks Peter.

Thank you ladies and gentlemen, just another reminder, if you'd like to ask a question. Please press Star then one if you'd like to ask a question. Please press Star then one the next question comes from Andrea Teixeira from Jpmorgan. Please proceed with your question.

Good afternoon.

So if we can just deal.

If we can just think about like what is embedded in your guide going forward in terms of pricing or is just the pricing that you've put through so far.

You parsed out some of the impacts right I mean huge.

<unk> surcharge in some of the minimums.

Freight cost in all of that but I was.

<unk> also the mixed impact from having <unk>.

Sliding and all of this puts and takes and then when.

When you think about like Oh, that's happening to the industry and I could just discuss your cash flow not being still being able to to generate the cash.

But I was wondering if youre seeing youre, having to be more selective in your customers as well maybe potentially some accounts receivable issues ahead, given that it's taking longer than anticipated to see demand coming back or you are clear there.

In terms of that off that part of the equation.

And just to get a little bit of the <unk>.

What's happening given that everybody else in the industry has been impacted how you're seeing pricing in the rationality in the marketplace.

Yes, thanks, Andrea a lot of good questions here. So, let's just start at the top on the pricing question. So we had two 2%.

Pricing mix benefit in the quarter I think we had mentioned last time, but it is good to revisit here that we took several pricing actions in the first quarter.

First quarter does not reflect a full quarter of those pricing actions.

So we can get full benefit in the quarter.

We also put in place at the very end of the first quarter, some new freight initiatives, which include fuel surcharges or other freight surcharges.

Some changes to free minimums.

All of which are beneficial and helpful to our pricing mechanism or rather net price realization overall, we are expecting take additional actions in Q2 on pricing and as we plan and model across the course of the year, we do expect.

Our pricing realization to build over the course of the year as we begin together the full year benefit.

Oh, the pricing actions, we've taken both in Q1 and expect to take in Q2. The other thing that will happen for us that'll have an impact on price realization.

As our <unk>.

The acquisitions, we did in 2021 work their way into the 13th month, and then begin to fall into our organic sales.

We did take pricing actions on some of the M&A companies or companies will be acquired as well and right now that is not showing through in our net price realizations. We reported because they are all in the M&A growth bucket. If you will so that'll benefit.

The price until of course.

From a cash flow perspective.

Go ahead.

No I was just trying to round up your commentary on the pricing. So when you when you think about all in.

The 2% would you getting to like a mid single or is that aspirational.

No we still think that we wind up across the course of the year than the mid single.

By call it like end of the second quarter I'm assuming.

Okay.

You mean.

I don't know that we've called out by the end of the second quarter. If you mean for the first six months of the year I'm not sure that that would entirely because there is this expected to be a little bit more weighting to the back half.

As these pricing initiatives begin to gather steam and stack on top of each other and again a lot of the acquisitions. We did were really in the last seven or eight months of last year, when we pick up the pricing action benefits inside of those companies as they roll into organic so again, it waits a little bit more to the back half.

Okay.

Yeah.

And then on the cash flow side on our accounts receivable anything we should be aware of.

We haven't really seen a lot of pressure there yet I mean look we're obviously have our antenna up and.

Remaining cautious but.

So far so good on that front.

Okay. Thank you I'll pass it on.

Thank you.

Thank you. The next question comes from Bill Chappell from <unk> Securities. Please proceed with your question.

Thanks, Good afternoon.

Hey, Bill.

Hey, just trying to understand I guess the composition or.

If I think about it is it more durables and lighting or is it kind of.

Industry wide and the reason I ask that is it seems like there is partially a problem in terms of the glut of cannabis, but now with your competitor kind of building throughout and you maybe building throughout the past six nine months, there's a glut of lighting or.

Kind of hard goods or durables, and and I'm trying to understand if that's something that is now factored into your outlook with this glut theres going to be some pricing pressure and as people try to move these and it takes quite a while and so just to understand if that's the bigger issue or if it's still more just the.

Can't even with the agricultural side.

Yes. It is clearly still more on the cannabis agricultural side, but durables are down a few hundred basis points more than consumables for us and speak to anybody else, but I know for us if you break it apart durables are down more and that one is primarily targeted around the high pressure sodium double ended.

Lights, the Phantom lights, which had been the historical.

Way, we go to market and where the industry has gone to market. That's now shifting very quickly to Leds, we compete effectively in Leds, but they're high pressure sodium segment is dropping faster than Leds are picking up at least for us. So we have some pressure on inventory. There. That's why we took the write down that we did.

In Q1 to get that down to a promotional level that we think will move the product through.

But overall I still think the umbrella here as the agricultural supply and you see that and you'll see that in other retailers numbers and you see that in a lot of different places that retail traffic is down and growing overall, it's down but we all can't forget that if you use headset dispensary data then people are still buying more.

Cannabis through the dispensaries than they were last quarter and they were a year ago, which suggests that consumption is still growing and eventually that's going to balance out inventory and get demand and inventory and growing back back in balance and you'll you'll see growth returned to the category.

Okay.

And in terms of just.

The new states that you talked about some positive reads in New Jersey, Virginia.

Are those still on kind of the same path maybe more meaningful in the second half of this year and early next year is there any pull forward or any delay that you see out of those states and kind of contribution to the industry.

Yeah, all of them have been slower than we had hoped right remember many of these past in the 16 and 18 elections and some are not even implemented yet and you look at our New York, which is still kind of getting its sea legs in New Jersey, just opened up last week.

Virginia is still I think they moved from 'twenty four 'twenty three but there's a lot of moving slower than we hoped and what we're seeing broadly in the msos.

And our commercial World is nobody has canceled but we are seeing delays and I think you'd see that from a lot of people on the durable side that theyre getting delayed orders that people are pushing off projects and waiting for the industry and normalize a little bit and I think thats kind of cast a an overall shadow on everything that's going on.

Got it thanks for the color.

Thank you Bill.

Thank you at this time there are no further questions I'd like to turn the call back to Mr. Bill Thomas excuse me. Thank.

Thank you Sir.

Thank you folks we appreciate your interest and support of Hydro farm and look forward to updating you about the business down the road. Thank you so much.

This concludes today's conference you may now disconnect your lines at this time. Thank you very much for your participation.

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Good day, ladies and gentlemen, and thank you for standing by welcome to the Hydro form Holdings Group first quarter 2022 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 2022.

I'd now like to turn the conference over to.

But few tailor managing director at ICR to begin.

Thank you Claudia and good afternoon.

With me on today's call is Bill Toler Hydro farms, Chairman and Chief Executive Officer, and John Lindemann, The company's Chief Financial Officer.

By now everyone should have access to our first quarter 2022 earnings release and form 8-K issued today after market close eastern.

Documents are available on the investors section of Hydro farm to web site at Www Dot Hydro farm Dot com.

Before we begin our formal remarks. Please note that our discussions today will include forward looking statements.

<unk> looking statements are not guarantees of future performance and therefore, you should not put undue reliance on them.

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.

I would like to turn the call over to Bill Toler Bill.

Thank you fits you and good afternoon, everyone.

Since our IPO in December of 2020, we worked hard to strengthen our business and lay a foundation for long term success. We've completed five acquisitions that have reshaped our product portfolio with a focus on higher margin consumables, increasing both our proprietary and preferred brands. We are also expanding.

Our distribution and manufacturing footprint by over 70% and completed three financings to further solidify our balance sheet, we have added new skills to our management team here at Heidrick farm as well.

With a long history of consistent growth combined with a strong tailwind of the CEO of hydroponic growth. We believe our optimism is grounded however.

Our sales in Q1 are essentially flat compared to last year's first quarter supported largely by our M&A volume.

That in mind, we believe it's prudent to adjust our outlook for 2022, which John will discuss in further detail in a moment.

Nevertheless, beside these challenge transient challenges, we should not lose sight of the fact that in consumption of cannabis continues to grow.

The best proxy we have for this is dispensary unit volume data measured by headset, which is showing increasing volume both sequentially and year over year. This end use consumption is leveling out Ken cannabis inventories, which should help the hydroponic industry return to more normalized growth.

During this challenging time, we are working to control the controllable by taking additional actions to control cost increase prices and protect our business. These include price increases passing on fuel surcharges passing on higher freight cost.

Also reduced our employee base by about 11% by the end of the first quarter and continued to optimize our organization as we capture cost synergies from the acquisitions completed in 2021.

The results of these actions are helping to mitigate inflationary costs and beginning to positively impact our P&L.

We are using the short term volume challenges as a time to make us a better operator, and a stronger leaner company. So when growth returns, we will be more profitable and a stronger business. In addition, these actions the growth drivers we laid out in prior communications are actually performing relatively well when you look at Iga.

In our commercial business. They both enjoyed a solid first quarter.

Several of the newer legalized states are doing pretty well and also our peak business, we're seeing solid performance.

However, this has been offset by softness in our core retail business, including legacy markets, like California, Michigan and Oklahoma.

Ultimately, we expect an acceleration in the cannabis market growth, resulting from these.

These state legislative changes and increasing popular support.

In summary of the actions we've taken combined with our growth drivers have not only helped us refine and optimize our organization, but also equipped us to move past the near term challenges. Moreover, with strong product portfolio and a healthy balance sheet. We believe we are well positioned to capture the tremendous growth opportunities that lie ahead.

That I will turn it over to John to further discuss the details of our first quarter financials and provide comments on our updated full year 2022 outlook John .

Thanks, Bill and good afternoon, everyone.

Net sales for the first quarter held steady at $111 4 million compared to the prior year period.

Our 2021 acquisitions added 34, 6% to our top line in the first quarter of 2022 relative to the prior year period.

But this M&A growth was offset by a 34, 6% decline in organic sales due to softness we experienced in several U S States and in Canada.

In the U S. California remained challenged but we also experienced softness during the quarter and several of the historically larger state markets.

In Q1.

Similarly, several other states, most notably, Virginia, and New Jersey experienced significant growth in the quarter.

In Q1, we also realized a two 2% price mix benefit which is consistent with our intention to pass through higher costs and consistent with our own internal expectations for the quarter.

Gross profit during the fourth quarter decreased to $16 6 million as compared to $23 2 million in the year ago period during.

During the first quarter, we incurred $3 9 million in acquisition related expenses. We also experienced a significant year over year increase in depreciation and amortization expense largely due to purchase accounting and the stepped up asset values that resulted from our 2021 acquisitions.

So for comparability purposes, we included in the press release, the calculation of adjusted gross profit, which excludes these items.

On this basis adjusted gross profit was $22 3 million or 20% of net sales in the first quarter down slightly from $23 4 million or 21% of net sales last year.

Excluding the increase in inventory reserve adjusted gross profit margin would have been higher in the first quarter of 2022 than in the prior year period I.

I should also note that while freight and labor costs were higher in the quarter on a year over year basis, our pricing actions create initiatives and favorable sales mix largely offset these items.

Selling general and administrative expense increased to $43 million in the first quarter of 2022 compared to $16 8 million in the year ago period.

The increase in SG&A was primarily due to $13 $5 million increase in amortization expense again due to stepped up asset values from the acquisitions.

Distribution center relocation costs acquisition and integration related costs and certain other noncash expenses detailed in the back of today's earnings release.

Adjusted SG&A expense, which adjust for these items was $19 2 million.

Or 17, 2% of net sales in the quarter versus $13 5 million or 12, 1% last year, primarily driven by an increase in compensation costs facility costs and insurance expenses.

As a reminder, these added costs, primarily M&A from the five acquisitions that we did last year and the overall increase in the size and scope of our operations today, all of which helped to prepare us for future growth.

Reported net loss was $23 3 million or <unk> 52 per diluted share in the first quarter compared to income of $4 9 million or <unk> 13 per diluted share last year.

Weighted average diluted shares outstanding were approximately $44 7 million for the first quarter of 2022.

Adjusted net loss for the quarter was approximately $7 8 million or <unk> 17 per diluted share compared to an adjusted net income of $7 2 million or <unk> 18 per diluted share in the year ago period.

Lastly, adjusted EBITDA decreased $3 1 million in the first quarter from $9 9 million in the prior year period.

It is worth noting that if not for the inventory write down our Q1 adjusted EBITDA would have been in line with our commentary back in March even on lower than expected net sales.

This suggests that the initiatives we put in place in Q1, R&D, having a positive impact on the P&L in spite of the continued revenue softness.

Moving on to our balance sheet and overall liquidity position as of March 31, 2022, we had over $111 million in total liquidity between $12 2 million of unrestricted cash and approximately $100 million available on our Undrawn ABL revolving credit facility.

We also maintained approximately $125 million in debt outstanding under our term loan.

Based on our Q1 results and recent sales trends, we are updating our full year 2022 outlook and providing you with some color around our current assumptions.

We now expect total company net sales growth of zero to 8%, which translates to approximately 100 $480 million to $520 million in net sales, we expect a decline in full year organic sales offset by M&A growth.

And while we expect total sales growth to resume in Q3 versus reported results a year ago, We now expect quarterly organic growth to resume in Q4.

Though difficult to make this call only for four months into our 2022 fiscal year based on the soft early spring sales, we felt updating our guidance was the prudent thing to do.

Our pricing and cost saving actions are yielding positive early results and are helping to counterbalance the margin impact of a softer than expected top line.

While we expect this relationship to continue our adjusted EBITDA estimates imply a margin profile that is impacted somewhat by the reduction in full year net sales.

Lastly, and as Bill pointed out earlier, we've made many investments over the past year to prepare us for the <unk> growth expected in our future.

We expanded our distribution footprint invested in inventory positions increase the size and scope of our proprietary brand offering and manufacturing capabilities and added key leadership roles.

Against this backdrop, we feel justified and reducing our capital expenditure plan slightly to $8 million to $10 million and inserting controls.

To reduce over time, our networking capital investments and further boost internally generated cash flow.

In closing, we believe we put in place the necessary steps to weather the current industry headwinds, while it's prudent to lower our expectations for the full year.

We remain optimistic about our business fundamentals and our ability to capitalize on the growth opportunities in the <unk> industry.

This concludes our prepared remarks, and we're now happy to answer any questions you might have operator, please open the lines for questions.

Thank you, Sir we will now be conducting a question and answer session.

If you would like to ask a question Keith Please star one telephone keypad.

Formation tone will indicate your line is in the question queue.

You mean placed stocking too if you would like to remove yourself from the question queue.

For the participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key.

One moment, please while we poll for questions.

The first question comes from Andrew Carter from Stifel. Please proceed with your question Andrew.

Thanks. Good afternoon first question I wanted to ask who is taking the inventory parament about $3 million first part of that is as you review kind of the categories. How much more could there be I E. Like how much of your inventory right. Now is in deflation I would assume lighting is and then a separate part of that question is I think your purchases I did my math here quickly.

We're still up do you think youll be able to generate free cash flow this year kind of working through inventory.

Yeah. Thanks, Andrew.

For sure our inventory levels remained pretty strong.

The $3 $2 million inventory reserve, primarily relates to select <unk> skus, particularly in the high pressure sodium area.

I would note we did not write those down to zero, but rather to a level. We think allows us to move those products efficiently.

We'll continue to keep a watchful eye, but at this point, we think what we did is what's warranted.

Yeah.

And with respect to I think to your question on free cash flow, Yes, I think with.

Our our capex assumptions working capital assumptions and assuming we continue to progress towards the guidance, we've just outlined.

We do expect to generate free cash flow this year.

Thanks, and then the second question is you mentioned the pricing on that was 2% hard to kind of read on mix are you getting incremental pricing through and I'm not sure in this environment when volumes down 30, you can tell or not you get any pushback or senior roles in particular, I'm kind of asking about the promotional environment that youre seeing out there.

Yes, the pricing is primarily on a list price basis.

Promotional activity Hasnt materially changed it across the categories as you suggested with volumes down in retail traffic down the effectiveness of promotions.

It would be if youre getting more people into stores and more people buying so you haven't really seen a whole lot more investment on that side of it I think individual distributors and brand owners may have certain categories that are promoting John mentioned earlier that we are working to move through the hps that blended lighting that were working against under our <unk>.

<unk> brand.

But we haven't seen it go.

Over the top on promotion the pricing is it primarily on list pricing. We've also put in place fuel surcharge and also increased freight requirements for our customers to buy again, helping solidify the costs that we're seeing.

Thanks, I'll pass it on.

Thanks, Andrew.

Thank you. The next question comes from Peter Grom from UBS. Please go ahead with your question Peter.

Hey, good afternoon, everyone. So just a couple of questions maybe person.

I don't mean to be too forward here, but I guess I'm just trying to understand what happened this quarter I mean.

You reported in early March the commentary was that sales are going to be down a little bit worse in <unk> on an organic basis.

Essentially more than doubled that decline.

Totally understand the category has been challenged but yes more than doubled the decline that you were kind of expecting even though you had two months in the rearview here. So I'm just trying to understand the visibility you have in your business. When we think about your guidance, particularly as we as we look out.

For the balance of the year.

Yes, I think it's fair to say that visibility in the category has been difficult for everybody alright.

Certainly.

In that in that group that struggles to see where the demand is coming and when it's coming forward. We did have.

Some open thought that as we got into the spring months March and I think it's 40% of the of the first quarter that March would sort of be that turned back to the positive and actually it went the other way. It was a weaker time, when we had and we would hope so yes. It was a disappointing out like we didn't give a specific number when we gave that sort of.

Callout in March we just said is going to be worse than it was in Q4 and at.

It turned out to be a good bit worse as we are reporting now.

So the visibility is clearly a challenge we're all working through that we're all trying to get better.

Through the use into it but there's not a lot of magic in that a lot of third party data that gets us there.

Just trying to plan out and see what business, we can and work worked through it too.

Get the best outcomes, we can but I certainly understand your question Peter.

Okay. That's helpful and then.

You mentioned.

Sales trends as part of the reason as to why.

Our guidance is much easier and so maybe you could just speak.

Youre seeing kind of through April and May and how we should think about sales on an organic basis.

And then.

Maybe just layering on that I guess, you look at some of your peers right I mean, I totally understand the visibility has been a challenge for everybody, but the level.

Negative provision.

Revenue perspective is far greater at this point and so are you simply being conservative or do you feel like this is.

You should we should expect.

I'm just trying to understand.

Kind of the underlying assumptions here.

And youre kind of comfort in hitting this.

<unk> target.

Yes.

Back to your first part of that question, we have not seen.

We haven't seen any improvement in April may is too early to tell obviously April did not show us a whole lot and that certainly.

Influenced how we called down the whole year, because we haven't seen kind of that spring return that we'd hoped for.

And so that's where we are.

That's part.

Part of it do you see other people I think our largest competitor hasnt really provided their revised look.

Grow Jen just came out a few minutes ago I glanced at it quickly and that was pretty significant call them.

Same store sales decline is similar to what our organic number was in Q1, so we kind of track along with that.

That's where we see it but we haven't seen it turn that's why we went ahead and called down and obviously, we give you the numbers. The best we can that we think we can achieve and we're not trying to be heroes are to sandbag or to.

Calling down multiple times, but we give you the numbers that we can we can.

Can forecast and that's what we see.

Okay. So just if we if we were to kind of hold the current rate that youre seeing.

The balance of the year would that kind of get you.

So what you're outlining in terms of revenue and EBITDA or is it do you think that you know.

I'm just trying to understand is last quarter, you kind of thing and Marcelo.

I mean the category.

Sure.

I'm sorry go ahead Peter.

No.

Want to make sure Thats, what I was trying to understand is it I assume.

I mean that the kind of current state of the category holds and that just as the comparisons get easier in the back half of the year that thats kind of when you would get to organic growth or does it really bad debt. The category showed a some sort of signs of life here in the coming months.

Yes, we are expecting it to show some strength in Q4 versus perhaps earlier than we had thought maybe late Q2 early Q3.

And there is seasonality in the business as you well know the last six months have been the Russell just from a seasonality standpoint, Q2, and Q3 should be the stronger ones. We will see how that plays through as we go through the year and yes, the easier comps in the back half do give us.

More confidence that we should be able to track with better better outcomes.

Okay, great well best of luck and I'll pass it on.

Thanks Peter.

Good afternoon.

So if we can just.

If we can just think about like what is embedded in your guide going forward in terms of pricing or is just the pricing that you've put through so far.

You parsed out some of the impacts right I mean.

Surcharge and some of the minimums.

Freight cost in all of that but I was.

<unk> also been mixed impact from having <unk>.

<unk> and all of this puts and takes and then when.

When you think about it like all that's happening to the industry and I could just discuss your cash flow and not being still being able to generate cash.

In terms of that off that part of the equation.

And then just to get a little bit of what's happening given that everybody else in the industry has been impacted how you're seeing pricing in the rationality in the marketplace.

Yes, thanks, Andrea a lot of good questions here. So, let's just start at the top on the pricing question. So we had two 2%.

Pricing mix benefit in the quarter I think we had mentioned last time, but it is good to revisit here that we took several pricing actions in the first quarter.

First quarter does not reflect a full quarter of those pricing actions, we can get full benefit in the quarter.

We also put in place at the very end of the first quarter, some new freight initiatives, which include fuel surcharges or other freight surcharges.

Some changes to free minimums.

All of which are beneficial and helpful to our pricing mechanisms more rather net price realization overall, we are expecting take additional actions in Q2 on pricing and as we plan and model across the course of the year, we do expect.

Our pricing realization to build over the course of the year as we begin together the full year benefit.

Oh, the pricing actions, we've taken both in Q1 and expect to take in Q2. The other thing that will happen for us that will have an impact on price realization.

As our <unk>.

As the acquisitions, we did in 2021 worked their way into the 13th month, and then begin to fall into our organic sales.

We did take pricing actions on some of the M&A companies or companies will be acquired as well and right now that is not showing through in our net price realization as we reported because they are all in the M&A growth bucket. If you will so that'll benefit.

The price until of course.

From a cash flow perspective.

Go ahead.

No I was just trying to round up your commentary on the pricing. So when you. When you think about all in from the 2% would you getting to like a mid single or is that aspirational.

No we still think that we wind up across the course of the year mid single.

By call it like end of the second quarter Masami.

Okay.

You mean.

These pricing initiatives begin to gather steam and stack on top of each other and again a lot of the acquisitions. We did were really in the last seven to eight months of last year, when we pick up the pricing action benefits inside of those companies as they roll into organic so again, it waits a little bit more to the back half.

Okay.

Yeah.

And then on the cash flow size in our accounts receivable anything we should be aware of.

We haven't really seen a lot of pressure there yet I mean look we're obviously.

Our antenna up and.

Remaining cautious, but so far so good on that front.

Okay. Thank you I'll pass it on.

Thank you.

Thank you. The next question comes from Bill Chappell from <unk> Securities. Please proceed with your question Bill.

Thanks, Good afternoon.

Hey, Bill.

Hey, just trying to understand I guess the composition or.

If I think about it is it more durables and lighting or is it kind of.

Industry wide and the reason I ask that is it seems like there is partially a problem in terms of the glut of cannabis, but now with your competitor kind of building throughout and you may be building throughout the past six nine months, there's a glut of lighting or.

Kind of hard goods or durables and I'm trying to understand if that's something that is now factored into your outlook with this glut theres going to be some pricing pressure and as people try to move these and it takes quite a while and so just to understand if that's the bigger issue or if it's still more just.

<unk>.

Kenny with agricultural side.

Yes. It is clearly still more on the cannabis agricultural side, but durables are down a few hundred basis points more than consumables for us I can't speak to anybody else, but I know for us if you break it apart durables are down more and that one is primarily targeted around the high pressure sodium <unk>.

Lights, the Phantom lights, which had been the historical.

In Q1 to get that down to a promotional level that we think are moving the products through.

But overall I still think the umbrella here as the agricultural supply do you see that and you see that in other retailers numbers and you see that in a lot of different places that are.

Retail traffic is down and growing overall is down but we all can't forget that if you use headset dispensary data then people are still buying more cannabis through the dispensaries than they were last quarter and they were a year ago, which suggests that consumption is still growing and eventually that's going to balance out inventory and get.

Demand in inventory and growing back back in balance and you'll you'll see growth returned to the carrier.

Okay.

In terms of just.

The new states that you talked about some positive reads in New Jersey, Virginia.

Yes, all of them have been slower than we had hoped right remember many of these passed in the 2016 and 18 elections and some are not even implemented yet.

Look at our New York, which is still kind of getting its sea legs in New Jersey, just opened up last week in Virginia is still I think they moved from 'twenty four 'twenty three but there's a lot of moving slower than we hoped.

What we're seeing broadly in the <unk> world and our commercial World is nobody has canceled but we are seeing delays and I think youll see that from a lot of people on the durable side that theyre getting delayed orders are people pushing off projects and waiting for the industry to normalize a little bit and I think thats kind of cast a an overall shadow on everything that's gone.

Mt.

Got it thanks for the color.

Thank you Bill.

Thank you at this time they are no further questions I'd like to turn the call back to Mr. Bill Thomas.

Thank you Sir.

Thank you folks we appreciate your interest and support of Hydro farm and look forward to updating you about the business down the road. Thank you so much.

This concludes today's conference you may now disconnect your lines at this time. Thank you very much for your participation.

Q1 2022 Hydrofarm Holdings Group Inc Earnings Call

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