HYDROFARM HOLDINGS GROUP, INC. Q1 FY2024 earnings call

• Bill Toler noted better profitability metrics in Q1, including adjusted gross profit margin, adjusted EBITDA, etc., and March 2024 marked the fifth consecutive month of sequential net sales growth since IPO.
• Adjusted gross profit margin increased for 5 consecutive quarters, and positive adjusted EBITDA was achieved in 3 of the past 4 quarters.
• Launched a new PHOTOBIO LED light for commercial growing, which saw year-on-year growth for the PHOTOBIO brand.
• Diversified revenue by increasing noncannabis and non-North American sales to 32% of sales, up 360 basis points YOY.
• Regulatory environment improving for U.S. cannabis growers, e.g., DEA proposing reclassification of marijuana.
• Proprietary brands grew in Q1, and adjusted SG&A was 24% lower YOY.

Net sales for the first quarter were $54.2 million, down 12.9% year-over-year, driven primarily by a 12.6% decrease in volume/mix. Consumable products represented approximately 76% of sales in Q1 2024 compared to 72% in Q1 2023, led by growth in Grow Media products. Proprietary brands made up approximately 57% of total net sales. Gross profit in Q1 was $10.9 million vs. $11.4 million YOY. Adjusted gross profit was $12.7 million or 23.4% of net sales, an 80-basis-point increase year-over-year due to improved productivity in manufacturing plants.

• Reaffirmed full year guidance: net sales to decline low to high teens, adjusted EBITDA positive for full year 2024, positive free cash flow for full year, with continued expectation of $4 million to $5 million of capital expenditures.
• March 2024 marked the fifth consecutive month of sequential net sales growth.

• Forward-looking statements subject to numerous risks and uncertainties; refer to recent SEC filings for detailed risks impacting future operating results and financial condition.
• Industry oversupply in the cannabis sector could impact volume/mix.

Q: Maybe just a couple of quick ones from me. Just first on the guidance from the revenue perspective. Maybe first -- can you maybe just remind us -- I might have misheard you, but you talked about some monthly improvements, some of the best you've seen since the IPO. So maybe just can you just repeat that for us? And then taking a bigger picture and looking at kind of the reported numbers here, you've had some sequential improvement in sales trends over the last 5 quarters or so. You started the year kind of at the better end of your top line guidance range. Can you maybe just help us understand what you're seeing from a top line progression or what you expect from a top line progression from here? Is there a reason that it could potentially step back from kind of this low double-digit decline we saw? Or should we expect sequential continued improvement? And I guess within that, are you simply just kind of keeping this range to kind of be cautious given we're still very early in the year?

A: No. Thanks, Peter, and good question. So the first one for clarification. We've seen sequential improvements in revenue really from last October through March. So each month, it's stepped up just a bit. October through March, that's 5 consecutive months there, and that's the longest string of those since our IPO back in the end of 2020, which, of course, you remember. So on that. Now the other question is around kind of guidance, and we sort of are at the better end of the range now. Why not move it up there and what can we expect to see, I think, is where you're headed with that one. The -- we are being conservative here. It is early in the year. We think things are looking pretty good. But we also had a very large quarter last Q2. So we're lapping up against some big numbers there. And we just don't want to get ahead of ourselves. We've got such an important period here in, really, May, June, July going to the kind of the core of the outdoor season and the late spring, early summer stuff. We just really don't want to get ahead of ourselves and try and take up numbers too quickly. We want to see that traction going on for a few more months and other things, but we are encouraged by recent trends. We're not overly giddy or optimistic yet, but we do think that things are certainly firming up, as you probably heard from some others. And we're seeing some overall sales trends that finished up Q1, and then we even start in Q2 that are encouraging for us as we go forward. But much like you suggested, it is early in the year. We don't want to get ahead of ourselves.

Q: I guess the first thing I wanted to ask is kind of within the sale of IGE, I know that last quarter, there was kind of a message, either shrink to profitability or grow. I guess have you picked a firm path? Does IGE signal that exactly? And has kind of the landscaping or your thinking about the world changed following Hawthorne's announcement to partner with BFG?

A: No, not really. I think IGE is a step that, as John mentioned, kind of assures more better profitability from that smaller business, positions us really more cleanly now as a manufacturer of brands in the consumable space and really gets us out of that durable piece. IGE was the only durable piece we had. It's not an area where we spend a lot of time or have a lot of synergy on. So we don't -- we didn't think being there was a good fit. And also, the previous owner who we sold the assets back to -- and it's important to recognize, we didn't sell the business back to him. We still own the brand. We still have the business. So this should have little to no effect on our revenue through IGE, and we'll improve our profit margin. So back to your larger question, this does not sort of cast our direction in terms of either getting smaller or getting bigger. This is really just kind of a tactical step to clean up the portfolio and make this more focused on the consumables, where we're now doing 75% of our business in total or so. So we still are looking for options to expand our footprint and to get kind of to what I would call that Hydrofarm 2.0, which we're not there yet. So ideas out there include different kinds of combinations, different kinds of ideas. So we're still working on that. And know that, that is an important step for us to be ready for the industry, which does feel like it's starting to strengthen a bit.

Q: Congratulations on the quarter. I had a question about the improving macro environment that you referenced. One of the big things going on is potentially finally seeing some political progress. Although you're not explicitly impacted by 2(ee) removal, can you talk about how Schedule III may benefit your business? And do you expect to see the purse strings loosening at some of the bigger MSOs as they start to get more cash flow?

A: Yes. I think that there are numbers out there to say there could be up to couple of billion dollars that used to be paid in taxes that now can be reinvested back in the industry. And obviously, that's kind of good news for everybody, right? And we all can even go out and fight for our share of that. So that's the impact that we expect, which is terrific. But the reality is this is still a long process, right? It's still now been recommended. Then there's going to be hearings, and there's going to be this, and there's going to be that. All this stuff is going to take time. And I think that it's important to recognize that we're focused on operating today and finding the right solution for our company today. And all those things will happen down the road, we believe. But we're not sitting around waiting for the government to solve our problems or the government to fix our business. We're making sure that we're operating profitably and figuring out the right long-term solution for Hydrofarm as these things get implemented over the next, let's call it, 6, 12, 18, 24 months.

Q: And my second question is at the state level, we obviously have some good opportunities ahead of us with potentially Florida and maybe Pennsylvania. But this summer, we have Ohio rolling out, which is happening more quickly and in a manner that looks like it should be a pretty good market for most operators. Can you talk a little bit about Ohio and what that market potentially represents for you?

A: Yes. Ohio has started to show some vibrance, and we're growing very nicely on a small base in Ohio, just as we are in Florida and some of the other rollout states like Missouri and other places. So we are seeing that start to pick into the industry, which is really encouraging. The other thing we're seeing across the pond, if you will, is with Germany passing 90 million people that are very cannabis friendly, and it's a highly consumed product in Germany, we are well positioned over there with all of our brands that we've rolled out. We had a business in Spain that's positioned across all of Europe for a number of years. So we are moving resources and people and assets into Germany to be ready to take advantage of that. And importantly, the way that Germany laws work, it's going to be a very favorable home market. It's not going to be driven by LPs or MSOs or large entities, can be driven much more by the at-home grower, which is a terrific thing for a company like ours and brands that people can use at home and know and trust. And so we think that while there's some states that are popping here in the U.S. that are showing some nice vibrance, we also think that the Germany opportunity really opens us up to, call it, another 100 million consumers, if you will, of people that are very cannabis friendly and a culture that we think is going to be right for us to grow in.