Hydrofarm Holdings Group, Inc. (NASDAQ:HYFM) Q3 2023 Earnings Call Transcript
Hydrofarm Holdings Group, Inc. (NASDAQ:HYFM) Q3 2023 Earnings Call Transcript November 9, 2023
Hydrofarm Holdings Group, Inc. reports earnings inline with expectations. Reported EPS is $-0.16 EPS, expectations were $-0.16.
Operator: Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Hydrofarm 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 open for your questions following the presentation. Please note that this conference is being recorded today, November 9, 2023. I would now like to turn the call over to Anna Kate Heller at ICR to begin.
Anna Kate Heller: Thank you, and good afternoon. With me on the call today is Bill Toler, Hydrofarm’s Chairman and Chief Executive Officer and John Lindeman, the company’s Chief Financial Officer. By now, everyone should have access to our third quarter 2023 earnings release and Form 8-K issued today after market close. These documents are available on the Investors section of Hydrofarm’s website at www.hydropharm.com. Before we begin our formal remarks, please note that our discussion today will include forward-looking statements. These forward-looking statements are not guarantees of future performance, and therefore, you should not put undue reliance on them. These statements are also subject to numerous risks and uncertainties that could cause actual results to differ materially from our current expectations.
We refer all of you to our recent SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial condition. Lastly, during today’s call, we will discuss non-GAAP measures, which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP and reconciliations to comparable GAAP measures are available in our earnings release. With that, I would like to turn the call over to Bill Toler.
Bill Toler: Thank you, Anna Kate and good afternoon everyone. We're pleased that in the third quarter we achieved adjusted EBITDA profitability for the second quarter in a row. The successful execution of our restructuring and related cost-saving 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 laser focus on optimizing our business to drive profitability. We've maintained our dedication to excellent customer service and on-time deliveries, even as we reduce costs.
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 in many areas this quarter, delivering both adjusted -- positive adjusted EBITDA and strong free cash flow. Our primary focus at Hydrofarm continues to be diversifying our revenue stream and controlling costs, whether it's through right-sizing the company, improving operational efficiency or 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 highest 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 & Garden, Grotek and HEAVY 16. We also continue to enhance the diversity of our revenue streams with a growing proportion of sales originating from customers outside of the US and Canada. Additionally, we observed an uptick in sales year-to-date versus last year from non-cannabis CEA 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 of 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 initiated a second phase of restructuring, focused primarily on our durables 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, achieving adjusted EBITDA profitability of 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 to growth.
Several potential catalysts on the horizon for the cannabis industry, the first is the possibility of now the SAFER Banking Act and federal descheduling or rescheduling, which could inject new light into the industry by attracting renewed investment from both institutional and retail players. Another notable catalyst lives in the U.S. states where adult-use cannabis has been approved, but there's been a slow start, but now these states are starting to position themselves for significant growth. And Ohio, it's a recent addition to the list, having just legalized adult-use cannabis on November 7, making it the 24th state to do so. We are hopefully Ohio state legislator will follow the will of the people and approve this measure. Being the seventh most populated state in the U.S., this is certainly significant, and it actually pushes the total U.S. adult use population to over 50% for the first time.
There is 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 successful to 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 2023. John?
John Lindeman : 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 22% 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, it's 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.
In fact, 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 and equipment commonly used in new expansion projects or newly established grow operations. This mix change is also a reflection of the demand for several of our higher-margin proprietary nutrient brands. As Bill mentioned, our proprietary nutrient brand sales grew double digits in the quarter, compared to the same period last year. In an industry environment in which growth is hard to come by, we are 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 mix slightly higher on a year-over-year basis and remained above 50% of our total sales.
In addition to the favorable brand mix, we recognized sales improvements in a few key geographies this quarter. Sales to customers outside of the US 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 in hydroponic sales to our Canadian customers. And in the US, we experienced some pullback in the quarter in several key western states, namely California, but this was partially offset by relative strength in several states in the Midwest and in the Northeast. Gross profit in the third quarter was $3.3 million compared to $5.9 million in the 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 1,200 basis point improvement in adjusted gross margin as a result of continued reduction in inventory charges, improved brand mix, reduced 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 nonrestructuring inventory charge we took in the quarter. Though 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 nonrestructuring inventory charges for the remainder of the year.
Given the considerable progress we have made thus far on improving adjusted gross profit margin, we have initiated a second phase of restructuring. Phase 2 is centered on rightsizing the elements of our business associated with durable products. And so this has emerged as the most challenged segment during the industry slowdown. In the 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. And I should 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 1 and look forward to continuing to execute on Phase 2 to real 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 and our lowest quarterly total since before going public in late 2020. The $4.9 million reduction or a 29% decrease was primarily due to reductions in headcount, professional fees and lower accounts receivable reserves, primarily a 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 30. 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 on to our balance sheet and overall liquidity position. Our cash balance as of September 30, 2023, 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 covenants. Principal amortizes at only 1% annually, and our debt facility does not mature for another five years in October 2028. We continued 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 into cash, helping us to generate positive free cash flow in the full nine-month 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.
We now expect our top line 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 brands, 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 expectations for capital expenditures to $4.5 million 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 are finalizing our plans for the Phase 2 restructuring initiatives. With our Phase 2 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 improvement 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 Hydrofarm 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.
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