Q3 2023 Hydrofarm Holdings Group Inc Earnings Call
Good day, ladies and gentlemen, and thank you for standing by welcome to the Hydro arm Holdings Group third quarter 2023 earnings Conference call. At this time, all participants have been placed in a listen only mode and the lines will be opened for your questions. Following the presentation. Please note that this conference is being recorded today November nine 2023.
Hi.
I would now like to turn the call over to Ana Cade Helbert ICR to begin.
Thank you and good afternoon with me on the call today, they'll tell our hydrocarbons, chairman and Chief Executive Officer, and John London, I'm, The company's Chief Financial Officer by now everyone should have access to our third quarter 'twenty to 'twenty three earnings release and form 8-K issued today after market close. These documents are available on the investors section of Hydrophones last night.
How did you find 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 these.
These statements are also subject to numerous correcting those certainties that could cause actual results to differ materially from our current expectations.
For 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 here for 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 Taylor.
Thank you Anna and good afternoon, everyone. We're pleased that in the third quarter, we achieved adjusted EBITDA profitability for the second quarter in a row.
Accessible execution of our restructuring and related cost savings initiatives has driven significant improvement in our adjusted gross profit, which was also driven by greater emphasis on our own proprietary brands, which typically carry a higher margin.
Our quarter end cash balance is the highest it's been since the second quarter of 2021 putting us in a much stronger position as a result of our labor laser focus on optimizing our business to drive profitability.
Maintained our dedication to excellent customer service and on time deliveries, even as we reduce cost while we've implemented operational changes our distribution footprint remains customer centric and we maintain our commitment to providing top notch service. We're glad to report that even at current sales levels, we've achieved significant progress.
<unk> in many areas this quarter delivering both adjusted.
Positive adjusted EBITDA and strong free cash flow.
Our primary focus at hydro for them continues to be diversifying our revenue stream and controlling cost whether it's through right sizing the company improving operational efficiency are emphasizing profitability throughout everything we do.
I'll start by highlighting a few positives on the top and bottom line in Q3.
Our proprietary nutrient business, which is one of our higher margin product lines again delivered a strong performance. We saw excellent results in numerous key proprietary brands, which contributed nicely to this quarter's margin expansion our proprietary brand nutrient sales grew over 20% versus third quarter of last.
Year in large part to our great brands, including House and garden grow check and have your 16.
We also continue to enhance the diversity of our revenue streams with a growing proportion of sales originating from customers outside of the U S and Canada.
Additionally, we observed an uptick in sales year to date versus last year from non cannabis applications, including food floral lawn and garden, making our progress in diversifying revenue sources.
I'm pleased to announce that our restructuring and related cost savings actions have been successful as evidenced by our strong year over year improvement adjusted gross margin and adjusted SG&A as well as positive adjusted EBITDA for the second quarter in a row, we still have work to do but these improvements demonstrate significant progress given the current industry backdrop we.
Wait a second phase of restructuring focused primarily on our durable business, which John will talk about more in a moment.
We will continue to control what we can by driving improved brand mix distribution center and manufacturing productivity and reducing SG&A.
I am encouraged by our team's discipline and execution during the quarter.
<unk> adjusted EBITDA profitability at these lower sales rates and adjusted gross margin improvement that we saw in the third quarter versus last year is a testament to the success of our recent actions, which has put us in a stronger position heading into 2024 and beyond we are seeing positive momentum from a regulatory standpoint, and we remain confident the industry will return.
And to grow.
Several potential catalysts on the horizon for the cannabis industry. The first is the possibility of now the safe banking Act and federally federal D scheduling, a rescheduling, which could inject new life into the industry by attracting renewed investment from both institutional and retail players.
Another notable catalysts lives in the U S States, where adult use cannabis has been approved but theres been a slow start but now these states are starting to position themselves for significant growth in Ohio. It's a recent addition to the list having just legalized adult use cannabis on November the seven making it the 24th state to do so we have hoped.
The Ohio State Legislature will follow the will of the people and approved this Matt measure being the seventh most populated state in the U S is certainly significant and it actually pushes the total U S. Adult use population to over 50% for the first time.
There is an increasing momentum in additional states as well like Pennsylvania, Virginia, and Florida, where we believe we may have fully legalized adult use cannabis on the ballot in the near future and have successfully expand the industry's reach and present new growth opportunities with that I'll turn it over to John to further discuss the details of our third quarter financial results and our outlook for.
<unk> 2023, John.
Thanks, Bill and good afternoon, everyone.
Net sales for the third quarter were $54 2 million down 27% year over year, driven primarily by a 2% decrease in sales volume, we realized a price mix decline in the quarter much like we have for the last several quarters and as we expect for the full year.
Our 5% price mix decline in the quarter, primarily due to promotional activity in both durable and consumable products.
Our price mix decline in the period was also driven by a higher mix of lower priced consumable products relative to higher priced durables.
Despite some competitive pricing in the grow media category, we still experienced much stronger top line performance in our consumable products relative to durables consumables represented approximately 75% of total sales in the quarter up from 67% in Q3 last year.
Much of this shift was influenced by a broader industry trend of weakness in durable products in particular sales of lighting equipment, commonly used and new expansion projects were newly established grow operations.
This mix change is also a reflection of the demand for several of our higher margin proprietary nutrient brands.
Bill mentioned, our proprietary nutrient brand sales grew double digits in the quarter compared to the same period last year and an industry environment in which growth is hard to come by we were really pleased with our Q3 top line growth in our key proprietary nutrient brands.
In connection with our strong nutrient performance, our proprietary brands as a whole in Q3, maybe slightly higher on a year over year basis and remained above 50% of our total sales.
In addition to the favorable brand mix, we recognize sales improvements in a few key geographies this quarter.
Sales to customers outside of the U S and Canada increased over 20% in Q3, which now marks the third consecutive quarter of year over year growth.
In addition, during the quarter, we experienced good year over year momentum and hydroponics sales to our Canadian customers.
And then the U S. We experienced some pullback in the quarter and several key Western states, namely, California, but this was partially offset by relative strength in several states in the Midwest and the northeast.
Gross profit in the third quarter was $3 3 million compared to $5 9 million in year ago period.
Adjusted gross profit was $12 5 million or 23% of net sales in the third quarter compared to $7 8 million or 10, 5% of net sales in the year ago period.
This strong over 200 basis point improvement in adjusted gross margin as a result of continued reduction in inventory charges improved brand mix reduce freight costs and improve productivity.
And while we are relatively pleased with this improvement I should note that adjusted gross margin would have been another 200 basis points higher if not for an approximate $1 2 million non restructuring inventory charge, we took in the quarter.
So we assess inventory values each quarter, we do believe the inventory charge. We took in Q3 is a relatively isolated charge and as you read in the outlook section of our earnings release. This afternoon, we still expect minimal additional non restructuring inventory charges for the remainder of the year.
Given the considerable progress we've made thus far on improving adjusted gross profit margin, we have initiated a second phase of restructuring.
Phase two is centered on right sizing the elements of our business associated with durable products.
This has emerged as the most challenged segment during the industry slowdown in the <unk>.
Third quarter, we recorded $7 8 million of restructuring expenses associated with reducing our durable manufacturing footprint.
And writing down the value of raw material inventory in connection with vacating storage space.
Note that while we are reducing our manufacturing footprint, we are not eliminating any key manufacturing capabilities.
We expect the second phase of the restructuring to result in annual cost savings of approximately $1 5 million the bulk of which we will begin to realize in fiscal 2024.
Our team is working hard to improve the structure of our business. We are optimistic by the progress from phase one and look forward to continuing to execute on phase III trial for further cost savings in 2024.
I look forward to providing another update on our restructuring efforts on our year end call in the new year.
Selling general and administrative expense was $19 5 million in the third quarter compared to $26 2 million in the year ago period.
Adjusted SG&A expenses were 12 million down from $16 8 million last year, when our lowest quarterly total since before going public in late 2020.
The $4 9 million reduction or 29% decrease was primarily due to reductions in head count and professional fees.
And lower accounts receivable reserves, primarily result of the restructuring plan and related cost saving initiatives.
Adjusted EBITDA was 0.5 million in the third quarter compared to a loss of $9 million in the prior year period, representing positive EBITDA for the second quarter in a row.
The $9 5 million increase was driven primarily by our lower adjusted SG&A expenses and higher adjusted gross profit.
We are also now adjusted EBITDA positive for the nine months year to date through September 30th.
Our ability to generate positive EBITDA and lower sales levels is encouraging and is a testament to the effectiveness of the restructuring and cost saving initiatives.
Moving onto our balance sheet and overall liquidity position, our cash balance as of September 32023 increased by $5 8 million during the quarter to $32 5 million.
And while we ended the quarter with approximately $123 million of term debt and approximately $133 million of total debt inclusive of finance lease liabilities. The considerable increase in our cash balance over the last two quarters now has helped to drive our net debt down to approximately $100 million.
As a continued reminder, our term loan facility has no financial maintenance Kevin.
Principal amortized is that only 1% annually and our debt facility does not mature for another five years in October 2028.
We continue to maintain a zero balance on our revolving credit facility throughout the third quarter.
We had positive free cash flow again this quarter as we generated net cash from operating activities of $7 $7 million with capital investments of 0.8 million, yielding positive free cash flow of $6 9 million.
We continue to aggressively convert our working capital and cash helping us to generate positive free cash flow and a full nine months year to date period.
With that let me turn to our full year 2023 outlook, we are reaffirming expectations of net sales in the range of $230 million to $240 million.
Now expect our topline results to be around the lower end of that range.
With the strength of our cost saving efforts and the performance of our proprietary nutrient brass we are reaffirming modestly positive adjusted EBITDA for the full year.
We also still expect to generate positive free cash flow for the full year.
I should note that we did lower our expectation for capital expenditures to $4 five to $5 5 million for the full year down from $7 million to $9 million previously as we slowed our spend in Q3, while we were finalizing our plans for the phase two restructuring initiative.
With our phase III plan now established at the end of Q3, we do expect our capex spending to pick up in Q4 and into early next year.
In closing we are encouraged by the improvements in profitability that we achieved through the execution of our cost saving initiatives.
We remain optimistic about the future of the industry and the growth opportunities for hydro farm in 2024 and beyond.
We look forward to providing further updates next quarter. 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 answer session. If you would like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is in the question queue. You May press star two if he would like to remove your question from the queue for participants using speaker equipment. It may be necessary to pick up your handset before.
Pressing the star.
One moment please poll for questions.
Our first question comes from Peter Grom with UBS. Please proceed with your question.
Thanks, operator, good afternoon, guys hope you're doing well so you know bill specifically around your confidence.
You mentioned the industry returning to growth.
Obviously, it's been a.
A couple of years here, but you did touch on a lot of positive development. So is there something that you think can actually occur as we look out to 2024 over the next 12 to 18 months.
Or is kind of an exit rate, we're seeing in <unk> I think the implied guidance is call. It like a mid to high teens decline is that.
Fair run rate to kind of start the year at thanks.
Yeah, I think it's hey, Peter Good question I think it is a fair rate to start the year at but I think there are a number of signs that are pointing toward growth.
Growth in probably let's call it sometime in 'twenty for maybe the back half of 'twenty four.
Our backlog on our durables bids are starting to bid a little bit the commercial activity is picking up some you're seeing these states that had been woefully slow enrolling out starting to do some things, whether that's New York, New Jersey or <unk>.
Connecticut, they're all they're all starting to pick up Maryland has been pretty good in Missouri is getting better all those things are starting to turn a bit you know.
Youre going to see and we have seen that in addition to the legislative stuff that we talked about and those things can be a few months away. There can be a few longer than that away. We don't really know at this point, but all that is pointing in the right direction, but as you said, it's been elongated a difficult period of time for all of us and so we're hesitant to call anything.
Until we see it and we're kind of planning as if it's going to run at certain rates, it's running at now and keep getting costs under control keep managing the mix and keep looking at your assets to find ways to create a more profitable company.
Okay.
That's super helpful. And then I guess I was just maybe a follow up.
From a margin perspective, and maybe more of a long term.
Question right and it's obviously very encouraging to see two straight quarters of positive EBITDA on a lower sales base, but can you maybe frame in the context of the restructuring you. Don you know, it's a second restructuring today other cost saves like what really is achievable from a margin perspective, particularly if we start to get some stabilization or growth.
In the back half of next year, obviously several years ago, you had some more ambitious goals from a profit standpoint, but just where we are in today I think it'd be helpful to kind of frame.
What is really possible.
And how long you actually think it can take to get there.
Yeah I'll jump in on that one thanks Peter.
Great question, Yes, I mean, I think if you look at the past three quarters, our adjusted gross profit margins than running around 24% I mean, we've had sort of two quarters, where it was 23% on quarter was 27% frankly in the quarter. We just finished as you saw me call out in our prepared remarks.
We put up a 23% adjusted gross profit margin, but really sort of 200 basis points higher when you take into consideration all the charges will be incurred during the period. So I think if we were to get just a little bit of cooperation from the industry and a little bit of growth.
I think we could look at something in the <unk>.
<unk> 23 to 25, maybe a little bit better than that sort of adjusted gross profit margin and when we talk about adjusted SG&A.
We're kind of running right now around $12 million to $13 million kind of range and an adjusted level.
Which was down nearly $354 million from where we began the year. So as we go into 2024, we're going to get some lag benefit from that just quite simply from the savings that we've already instituted in already received some benefit from you also heard from the restructuring effort phase III that we're putting in place, we're expecting $1 $5 million.
Additional savings there.
I definitely feel like we've got some more opportunity in front of us with respect to you know.
Growing the margin to.
The EBITA level from here.
That's super helpful. Thank you so much on ethanol.
Thanks Peter.
Our next question comes from Jesse Redmond with water Tower Research. Please proceed with your question.
Hi, guys I had a question on the product side as we've chatted before I always enjoy using your products and personally like your roots organic lines and the things that I do in my backyard every season, but I know you've also been working on so proprietary nutrient brands and I'm. Just wondering if you had an update there if you could talk a little bit about how those are performing.
Yeah, Thanks, Jesse and you know probably the strength of our portfolio and embedded in all of this adjusted gross profit progress has really been the proprietary nutrient brands I mean, whether its Houston garden, which honestly over the last three years has been our most consistent business, whether it's have you 16, which had.
Had a tough year last year, but its come back gangbusters or finally grow tech, which was a business that we bought out of Canada. It's always been distributed by US in both Canada and the U S has a great presence in Europe as well grow Tech has always done well in the Asian community and we've really been able to tap back into that market. This year.
We've had you know kind of two quarters in a row of just outstanding growth on on that brand as well, but the proprietary nutrients are really the kind of the core of where we're making our money. If you will than better we're not making a ton of money yet, but it really is driving.
The higher adjusted gross profit results that we're seeing and it's been an important part of kind of how this year has held together for us on a on a on a.
Slightly above positive adjusted EBITDA and also creating free cash flow. So good progress on the nutrients out there, they're really the centerpiece of our of our entire our proprietary brands branded offering.
Did you see any trends in terms of I can see there's a couple of ways when I'm talking to operators. There's people that are interested in growing great flower and want to spend more money to get higher THC numbers and more turbines and maybe the more of the premium part of the markets and looking to spend more on.
On that side to create better products, but also we recognize there's a lot of margin pressure and one thing I've been hearing that some of the other so calls as people.
Consumers are shifting down and going more towards value lines, which makes me think that providing affordable solutions may be of more interest I'm curious what are you seeing the push and pull on that side. If you're seeing people that are looking for more value conscious solutions or if you're also seeing people that are looking for whatever it's going to push the plant to its maximum potential.
Yeah, I think youre right Theres, a wide spectrum of demand curve out there right and the margin pressure in the overall kind of glut of product over the last couple of years, just cause pricing to dropped way down and so people than the corresponding reaction to that is they want to get cheaper inputs and cheaper.
Cost of goods for growing and so we've seen some of that until we've launched as you know we've launched a house and garden dry product, which is a real value orientation instead of having the liquids, which of course, you shake the water and you shouldn't that dilution factor there.
So the dry product really gives people a value oriented way yet still have a high quality house and garden brand name on it so that's one.
One of the things, we're doing and we also offer a range of products both in our proprietary line and in our distributed whether it's the guy Green products, whether it's the Moab. The mother of all Bloom products are all of those that there really are a part of our portfolio that enable us to give people value enable us to get people.
<unk> and it does allow for folks to get that wide range of things you outlined which is some multi max chirping, some multi max THC. Some just want a consistent product than what they've had before and others play in that price market as well.
We began doing some work on sourcing kind of all the way back to the core raw materials to work with our growers on so that we're able to work with them and it gives them the access to the product today and perhaps even more of a mixed surround so we're really adjusting our approach to the market.
To reflect what each of our growers need and there's a wide range of them out there as you suggested Jesse.
Great. Thank you guys that's really helpful.
I appreciate it I appreciate the question.
There are no further questions at this time I would now like to turn the floor back over to Bill Taylor for closing comments.
Great. Thank you all for your interest in and Hydro farm. We appreciate you being on the call and look forward to updating you soon on other activity in the business. Thank you.
Okay.
This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.
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