Q3 2022 Hydrofarm Holdings Group Inc Earnings Call
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Good day, ladies and gentlemen, and thank you for standing by.
Welcome to the Hydro farm holdings third to third.
Third 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 questions. Following the presentation.
Please note that this conference is being recorded today November nine but.
Finally 22.
I would now like to turn the call over to Mr. Fitzgerald tailor managing director at ICR to begin. Please go ahead.
Thank you Victoria and good afternoon with me on the call today is Bill Toler How'd, you farm, Chairman and Chief Executive Officer, and John London, The company's Chief Financial Officer.
By now everyone should have access to our third quarter 2022 earnings release and form 8-K issued after market close. These documents are available on the investors section of hydro farms website at Www Dot Hydra farm Dot 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.
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'd like to turn the call over to Bill Taylor Bill.
Thank you fits you and good afternoon, everyone. As you saw in today's press release, our Q3 results continue to reflect an industry under pressure from the oversupply dynamics than lack of consistent legislative support.
Net sales for the quarter were in line with our own internal expectations and though our reported adjusted EBITDA was heavily impacted by inventory and accounts receivable reserves and related charges. Our underlying profit performance was generally in line with our internal estimates. Additionally, our free cash flow performance exceed.
Our expectations as we generated positive free cash flow for the second straight quarter.
As the industry evolves, we are adapting and moving with it and this was demonstrated during our third core even though our product sales through our specialty retail channel remained challenged in the current industry environment, particularly in the mature states. Our commercial sales have been a bright spot our commercial effort has been led by our associates.
The integrated growers equipment, or Iga company or a part of our country, which we acquired in November of 2021.
Currently our commercial sales make up 35% of our year to date 2022 sales through the end of the third quarter, an increase from only 19% of company sales in the same year to date periods last year.
Now I'll take a moment to talk about the impact of legislation the improvement in our commercial sales percentage is due in part to the benefit of Iga as I noted, but it's also a result of winning bids with growers around the country, particularly in states that have more recently adopted and implemented favorable cannabis legislation.
For example, the example, nearly half the sales of our <unk> branded products were sold in states largely along the eastern seaboard.
So difficult to predict in the short term over the long term, we expect continued growth from our commercial operations in new states as legislation becomes more favorable to cannabis on a state by state basis.
We continue to be pleased with our peak business, which serves a diverse customer base that includes both food floral grow operations.
Less reliant on North American cannabis trends, we believe the relative success in our peak business points to the benefits of our consumable portfolio and our ability to more broadly to adapt during a period of supply imbalance in the cannabis sector.
As we look ahead, we remain confident in our long term opportunities of our business. In addition to some of the recent positives I just discussed we believe we have several reasons to be confident about our long term opportunity.
First we believe the industry's supply demand imbalance brought on by the Covid overhang and uneven state Legislative Rollouts has been inching the industry closer to a rebound.
Additionally, recent legislative activity at both the state and national level, including yesterday's adult use passage in Missouri, and Maryland continue to point towards greater consumer access and awareness of legal cannabis and ultimately even higher legal cannabis consumption in the years ahead.
Next our consumable driven portfolio has provided us with a more tempered decline compared to some of our industry peers and we believe this fact, coupled with our strong financial position sets us up well to grow market share and we're engaged in consolidation opportunities in the future.
Finally, as we've discussed previously we've taken a number of actions this year to better position our organization for future growth, we have right sized where necessary with an overall impact of reducing our head count by over 25%. We continue to remain focused on mitigating cost streamlining our manufacturing and distribution operations.
Further diversifying our revenue streams in closing, we believe our actions thus far in 2022 and those yet to come but it's in a healthy position heading into 2023 and beyond.
Furthermore, we remain confident in the industry have returned to growth and we'll be better positioned than ever take advantage of these opportunities ahead as we have shaped our business into a leaner and stronger organization with that I'll turn it over to John to discuss the details of our third quarter financial results and our outlook for 2022 John .
Thank you Bill and good afternoon, everyone net sales for the third quarter were $74 2 million compared to $123 8 million in the prior year period.
Our 2021 acquisitions added nine 5% to our topline in the third quarter of 2022 relative to the prior year period, but this M&A benefit was more than offset by a 52, 1% decline in organic sales volumes.
We realized a two 7% price mix benefit in the quarter as we continue to pass through higher costs, but the magnitude of our pricing benefit has been tempered in the second half by the need to reduce price and the lighting category, which is the category that's been hardest hit by the industry downturn.
Commercial sales as a percentage of our total have strengthened in spite of the industry weakness in the lighting category.
A proportional increase in commercial sales is due in part to our acquisitions, namely E, which continues to drive relatively strong demand in this otherwise challenged industry environment.
Bill earlier noted the magnitude of <unk> business, along the eastern Seaboard.
No strength in several states, particularly, Massachusetts, Mississippi, Florida, Louisiana, Pennsylvania, and New Jersey, all of which are among our top 10 commercial states.
As we noted last quarter the industry recession is having an impact on our sales mix. This is primarily due to the relatively strong performance of distributed brands on a sequential basis relative to our proprietary and preferred brands.
While our proprietary brands continued to drive over 50% of our total sales in Q3.
Current industry environment is resulting in weak volumes in our lighting product sales, which in our portfolio are dominantly proprietary branded while Conversely, we're experiencing stronger demand for grow media products, which are primarily composed of distributed in preferred brands.
We expect this trend to continue into our fiscal fourth quarter.
Gross profit in the third quarter decreased to $5 9 million compared to $30 million in the year ago period.
Excluding certain items largely related to our acquisitions adjusted gross profit was $7 8 million or 10, 5% of net sales in the third quarter compared to $33 million or 26, 6% of net sales last year.
The decrease in adjusted gross profit margin is largely due to the negative impact of the $4 4 million increase in inventory reserves and related charges that we recorded at the end of Q3.
Excluding these inventory charges.
Adjusted gross profit margin would have been much higher than disclosed, albeit still lower than last year.
This margin difference was due to the lowest total sales volume the altered sales mix as well as proportionately higher freight and labor costs.
Selling general administrative expense decreased to $26 2 million in the third quarter of 2022 compared to $32 4 million in the year ago period.
The decrease in SG&A was primarily due to an eight 2% reduction in acquisition related expenses compared to last year's third quarter.
Adjusted SG&A expenses, which adjust for this for these acquisition related expense as well as certain other items impacting comparability was $16 8 million or 22% 22, 7% of net sales in the quarter versus $16 nine or 13, 6% last year.
This was primarily driven by decreases in marketing and employee compensation costs, partially offset by an increase in insurance expenses.
I would like to note two items inside of adjusted SG&A in the period first our Q3 compensation expense was lower on a year over year basis for the first time since we began acquiring businesses in 2021, we.
We believe this is a positive sign pointing to our successful M&A integration efforts as well as our aggressive cost reduction plans instituted across the year.
Second I wanted to point out that adjusted SG&A was negatively impacted by $1 1 million and higher than anticipated accounts receivable reserves. This largely relates to a single international customer and so while we continue to keep close tabs on our collection efforts, we have not seen any broad based deterioration in this area.
Reported net loss for the quarter was $23 5 million or <unk> 52 per diluted share compared to net income of $17 3 million or 37 cents per diluted share last year.
<unk> net loss for the quarter was approximately $15 million or $3 33 per diluted share.
The adjusted net income of $31 8 million or <unk> 69 per diluted share in the year ago period.
Finally, adjusted EBITDA decreased to a loss of $9 million in the third quarter from $16 1 million profit in the prior year period.
The decrease in adjusted EBITDA was driven primarily by lower net sales lower adjusted gross profit margin as well as the $5 5 million in inventory and accounts receivable reserves related charges for which we did not adjust in our EBITDA calculation.
Moving onto our balance sheet and overall liquidity position as of September 32022, we had $16 5 million in cash and cash equivalents in an aggregate principal amount of debt outstanding of $126 3 million.
And as has been the case for the entirety of 2022, we have zero drawn on the company's revolving credit facility.
We estimate total liquidity of approximately $78 million as of September 30th composed of the $16 5 million in cash and cash equivalents.
Approximately $62 million of available borrowing capacity under our revolving credit agreement.
As Bill noted earlier, we generated positive free cash flow for the second quarter in a row and now have generated over $8 million in total free cash flow in the year to date period.
We continue to aggressively convert our working capital and the cash helping us to generate positive operating cash flow and enabling growth oriented capital investments, namely in our more diverse Pete and <unk> businesses.
And while we have opportunity to further reduce our investment in working capital, we feel that generating positive free cash flow in the fourth quarter will be a challenge. However, we do expect that with the level of free cash flow already generated in the year to date period that we will finish the full year on a positive basis, and we expect to maintain a strong liquidity position.
Finally, you will see us file a shelf S. Three registration statement later today the filing is a universal shelf, which covers a range of capital market securities both on the debt and equity side.
We view this as proper corporate housekeeping that will provide maximum flexibility and allow us to access the markets if and when appropriate.
I will note that we have no immediate plans to raise debt or equity.
With that let me turn to our full year 2022 outlook, we are reaffirming expectations of net sales in the range of 330 million to $347 million.
I would add that given fourth quarter to date sales trends. It is likely the net sales come in at the lower end of our range.
Similarly, we expect to finish on the lower end of our previously estimated range of an adjusted EBITDA loss of $25 million to $60 million.
This range now includes the negative impact of approximately $19 million of inventory and accounts receivable reserves and related charges realized today and assumes no further material increase to these amounts.
Naturally we will go through a reassessment of our reserves at year end and we'll update you accordingly.
In closing, we believe we've put in place the necessary steps to weather. The current industry headwinds, we remain optimistic about our long term business fundamentals and our ability to capitalize on the growth opportunities ahead.
This concludes our prepared remarks and are now happy to answer your questions. Operator. Please open the line for questions.
Thank you we will now be conducting a question and I think also if you.
Would like to ask a question please.
One on your telephone keypad.
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One moment, please labor pool for questions.
Yeah.
Our first question comes from Andrew Carter with Stifel. Please go ahead.
Thanks, Good evening I wanted to ask so obviously the drawdown of the inventory has been a good source of funds.
Funds here how much farther can this go I mean, if I did my math right and I, probably didn't but I have your purchases down 58% in the quarter. That's behind the organic growth of 47 can it be like that or do you expect some kind of a big catch up here any how much more could you how much more is there a target working capital.
Sara I'll stop there finally.
Yes, we've got I think roughly 140 $550 million of total inventory now on a business doing $3 30 to $3 40 and sales do you still got in terms of days of supply good bit of inventory right.
Think of it in two buckets. One is our finished goods in our in our D. C that we buy from others and the other is of course, our own direct materials that we produce our own brands with I would say right now because of that.
You saw that we're all familiar with Andrew on the volume we've got more inventory on the direct material.
Brands that we own side and that can continue to come down and we can always continue to tighten on the finished goods side as well as a part of one of the things we're doing to strengthen the company, we're going through aggressive SKU and brand rationalization processes as well so taking out more skus taking out brands.
Cutting down on all of that inventory of course, that's going to give us even more room to take more inventory out so while I'm not going to give you a specific number of how much. We can take out we think we've got a good amount of room to keep working inventories down on both sides.
Of the aisle. If you will finished goods that we buy from others and all the direct materials.
Okay, and then thinking about like usually typically kind of on the same topic. One key was your kind of big purchase for the season I guess as you've gone through this cycle and you go into next year I mean, how confident are you you can plan for next year make the right decision, maybe that's something you have to use the credit facility for about knowing the season annoying.
How much you do have to purchase when you actually have to have to do that going and going into next year. I mean, we're thinking like <unk> early next year, but just how are you approaching that potential next kind of big decision for the company.
Yeah generally the area that involves the most kind of buying ahead is around the <unk>.
Media businesses right is generally a lot of kind of pre booking of that in the fall, but I would say as an industry. There's been a lot less of that this year and people are not really making these big early buys to get ahead on inventory I think it's going to be more.
Kind of hand to mouth, I mean, there's going to be a lot of pure Packer you need to back that that grow media up because you can't catch up if the if the volume takes off in Q2, but on our side of things I think many other distributors and other industry players are not really leaning into these big buys. So I don't think it's going to be the same draw that it has been in prior years.
We're gonna be cautious, we're not going to lean into it and like you suggest to tap the credit facility simply for inventory, we want to be careful not to do that and manage it as tightly as we can well it doesn't mean, we won't touch the credit facility, but it certainly means that we're going to be very cautious in how we buy in.
And I'll just ask kind of one final question just kind of on the pricing I know you mentioned, Nick you mentioned in the lighting isn't deflation.
Or can you give anything on what the the pricing ex lighting would be and then kind of separately like a are you actually expanding product margins on products outside of lightning just through the pricing you're getting thanks.
Yeah, you're right lighting is the one that's under the most pressure there's a pretty aggressive.
Promotion scheme up there, although our overall trade spending is pretty much in line with what we expected there is a promotional environment out there right now not anything ridiculous.
And on the product margins I would say other than grow media, we've been doing fairly well, but grow media, it's been tough on us this year.
Course lighting has been the one that under the most pressure.
Thanks, I'll pass it on.
Thanks, a lot.
Next question comes from Bill Chappell with true Okay great.
Please go ahead.
Hey, Good evening guys. This is even lengel on for Bill Chappell. Thank you for taking my question I guess kind of as a little bit of a follow up to Andrew's question on the.
On the lighting inventory, we kind of heard from Hawthorne that they seem to be exiting the OLED lighting can you kind of provide more color.
Under this as an opportunity to kind of gain some share over the long term or do you kind of expecting to exit the category as well. Thank you.
Yeah, we're not exiting it we are taking out I think 85% or 80 plus percent of our skus in high pressure sodium double-ended lights and also obviously florescence long pass now we're going to stay in that business I think some other industry folks are as well.
The word is getting out of it and that's fine that's their choice.
So we're going to offer that to folks who feel like that high pressure sodium is a tried and true and long proven.
Technology that still run by an awful lot of growers and so we want to offer that to our customer base and obviously, we still sell Leds very aggressively and we will continue to do that and compete on that front, but that work, we're going to stay in it but it'll be with a limited number of skus.
Great. Thank you and you guys kind of mentioned that you were performing well in the Pes business, what kind of color can you provide on some of the progress we've made in the category and where do you see some maybe further opportunity as we look ahead to 'twenty three.
Yes, we've got a unique.
Business in Edmonton or north of Edmonton, Canada.
It came as a part of the Aurora innovations acquisition, it's called a P. P. P products and we've actually been granted last year. Some additional acreage in bogs. So it's becoming a very nice business for us and importantly, it it sells outside of.
Just an ingredient going into cannabis already integral mixes right. So it sells into different kind of food and floral and outdoor grows in cells in the mushroom farmers in a number of different places. So theres. Many channels. There that we can develop it does require capital to develop those new box and where I think we spent over half of our capital between AG.
And our repeat this year, which is appropriate because those are probably our two best performing businesses on the topline side, but Pete we think is a place that unique commodity that's differentiated and it's.
It's sourcing it's you know, it's very tightly controlled by the Canadian government and gives us an angle that we like.
As a provider of ingredients and products to other other grow mixed providers and sellers. So we think it's a good business for us.
Awesome. Thank you so much guys I'll pass it on.
Again, if you would like to ask a question. Please press star one on your telephone keypad.
Next question comes from Andrea <unk> J P. Morgan. Please go ahead.
Thank you operator.
Good afternoon, everyone. So my question is how are you.
So bill John I like just just on.
It sounds kind of like going back to to your point about getting into the EBITDA guidance, but more on the land. So I'm assuming that implies gross margin Sui in the high single digits for the fourth quarter.
And then I'm, assuming the topline is this too I think top line is still coming okay. Given that you are you are kind of being tactical.
Tactical about how you you you get rid of the inventory.
But thinking of thinking off profitability from here I'm, assuming you did mention that you don't see any other write downs from here.
How should we be thinking as we move forward into 'twenty three do you think most of it is.
Behind Us and then why getting this shelf registration is that to avoid alloy to just being tactical about having the ability to tackle watch it to drop back in some of the other alternatives and thought that they had to pay for Oliver.
Yeah Andrea.
Good afternoon catch up.
With respect to.
Q4, and what's implied out of our guidance from a margin standpoint, I think you're you're generally thinking about it correctly.
Number of the things that we saw occurring in Q3 from a mix and sales volume perspective are what we expect to continue to emerge in the Q4, obviously, there's some seasonality that brings the sales level down I think that was kind of already implicit in sort of a lot of the numbers I saw floating around out there for us for Q4 going before the call.
All.
I think directionally. The that's all that's all right with respect to 2023, we've got some planning to do for sure over the next couple of months and I think we will have more to say about like formal thoughts for 2023 as we prepare to report the Q4 results here in the coming period.
With respect to the shelf registration I think it is just for companies like US I mean, typically you have a shelf out there available.
For access if and when needed right now I think as you know we've got cash on the balance sheet. We've got a fair amount of liquidity available in the line of credit.
It is completely untapped at this point so obviously it would be the first places we would go for cash.
And then b.
Although we've.
Got it and are offered an outlook that suggests you know generating free cash flow in the fourth quarter will be a challenge.
We are cautiously optimistic there are some opportunities for us to to continue to do that in the future in our last call suggested there's still some opportunity or last question rather suggested there's still opportunity in the inventory area.
We feel that way.
Mhm.
Many of you you can continue to.
You know, where you get I mean, I don't know what it means in terms of like what that means in terms of the retail inventory right well, how their house and how much visibility you have in some of your retail partners.
If they still are running high levels of inventory that may he too is to in the following quarters or are you have some good visibility there.
We don't have certainly it's not we don't have great.
But go ahead John .
No I was just going to make the same comment I mean visibility and in the specialty retail.
Retailers that we sell into as well.
Not perfect because you know, it's a very fragmented customer base for us.
But I think it's safe to say that many cases, probably still a pretty robust inventory levels. That's part of the reason I think our sales levels were down.
But having said that commercial as I think we pointed out in our earlier comments is a growing part of our business from a mixed standpoint, I mean, it's a 35% of our sales on a year to date basis up from 19 last year. So the commercial part of our business.
It's something we've been leaning into.
Okay. Thank you.
Thanks Andrea.
Next question comes from Chris Terry with Wells Fargo Securities. Please go ahead.
Hi.
Good evening.
Or afternoon.
Wherever you are [laughter].
Just on the Q4 cash flow assumptions.
Can you be a bit more specific perhaps about you know what the trade and it's gonna look like.
I may have missed that number if you had given us.
Oh I'm sorry.
I think that on free cash flow, but.
So in Q4, you're saying that generating cash flow will be difficult is there a way to frame that.
Yes, I think.
Look I mean, obviously Q4 from a seasonal perspective.
Sort of a slow for us and others in the industry and just as a result quite naturally the sell through will be a little bit.
Less dramatic maybe than what we've seen in the last couple of quarters at the same time.
There is a little bit of it.
Inventory build seasonally that happens, particularly with respect to our lawn and garden business up in Canada.
So those things are some of the things we're thinking about when we sort of error on the side of caution with respect to free cash in Q4.
Got it.
Just on the comment around the commercial grower versus you know.
Hobbyist or <unk>.
Small grower.
Are you seeing a.
Noticeable differences in health of these these.
These types of customers say you know I. Appreciate you no one has our balance sheet and maybe some cash reserves and the other is kind of you know.
Living day to day right from a from a cash perspective.
But is this something where there's actually a maybe unappreciated you know part of this channel, which is which is a lot healthier, which maybe is taking share even despite the macro headwinds of the category and you can really go after that customer take market share and perhaps deliver.
As you know a bit healthier financial results over the next 12 months, even if even if the category remains under pressure can you just talk to that dynamic. Please.
Yes, that's exactly how we look at it which is the.
The commercial multi state operator will commercial operators are generally better funded.
And have either a new bill going in or large scale grow and they are obviously able to support that and so we've been successful theyre building our percent of total in commercial up to the 35% that we quoted a few moments ago a lot of that's been driven by the team that we acquired as a part of the Iga business we have.
Several of our own folks were focused on commercial we integrated that with the GE team and now we have very strong presence and that's in that space. So that is an area. We expect to continue to grow and certainly think that we can gain market share and expand our footprint in that area.
Okay.
Yeah.
Thanks, Chris.
There are no further questions I.
I would like to turn the floor back over to Bill Toler to CEO for closing comments. Please go ahead.
Great. Thank you operator, and we want to thank everyone for joining us today to hear our Q3 results and we appreciate your support and following of Hydrophone. Thank you very much have a good day.
This conference has now concluded. Thank you for attending today's presentation you may now disconnect.
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