Hydrofarm Holdings Group, Inc. (NASDAQ:HYFM) Q4 2023 Earnings Call Transcript February 29, 2024
Hydrofarm Holdings Group, Inc. isn't one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Hydrofarm Holdings Group fourth 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, February 29, 2024. I would now like to turn the call over to Anna Heller of ICR to begin. Please go ahead.
Anna Heller: Thank you and good morning. 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 fourth quarter and full year 2023 earnings release and Form 8-K issued this morning. These documents are available on the Investors section of Hydrofarm's website at www.hydrofarm.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'll 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.
William Toler: Thank you again, and good morning, everyone. We achieved positive adjusted EBITDA and positive free cash flow for the full year 2023 as we had provided in our outlook, even at lower sales levels. Throughout 2023, our team worked very hard to execute our restructuring and related cost savings initiatives, which allowed us to achieve the improvement in several profitability metrics that we are reporting today, including adjusted gross profit, adjusted gross profit margin in '23 for both the fourth quarter and the full year. Our initiatives included streamlining our product portfolio to enable greater emphasis on our higher-margin proprietary brands, continued focus on inventory reduction overall working capital management, better space utilization in our distribution centers, and cost reductions in our transportation and logistics.
Our cash balance, overall liquidity, and ability to generate positive free cash flow, as we have demonstrated in the last two fiscal years, gives me confidence about where we are from a balance sheet perspective. On the top line, our 2023 sales fell short of our guidance range due to several key factors. Fourth quarter sales were lower primarily due to industry softness in the US specialty retail channel. You may hear from others in the industry that retail stores and cultivation facilities have been closing as the US cannabis industry remains bogged down in regulatory challenges. These issues have led to an overall reduction in demand from retail stores and cultivation facilities. For example, regulators are enacting stronger enforcement in Oklahoma and many facilities and stores are closing down as a result.
We believe these changes will ultimately be good for the long-term health of our industry as the stronger players will consolidate and create a more stable market environment. There are a number of bright spots in 2023 that we will carry into 24 and continue to build on which I'd like to highlight. Our proprietary nutrient brands continue to perform well. In fact, sales grew in the fourth quarter and for the full year of 2023, when you compare them to 2022. Because proprietary nutrient brands is one of our higher margin product lines, the increased portion of sales mix helped to support margin improvement and also helped us to achieve positive adjusted EBITDA for 2023. An other area of focus in 2023 was to diversify our revenue streams. We have made progress in this area through both geographic and product diversity.
Our international sales which are to customers outside the US and Canada and non cannabis sales of CEA products sold into food, floral, lawn and garden, and certain other customers increased to about 25% of our total 2023 sales, up from 22% in the prior year. In 2024, we will continue to develop geographic and sales channel diversity. Hydroponic sales in the US and Canada are still our core business, but the revenue diversity will help support us as we are navigating challenging industry dynamics. Several potential catalysts are on the horizon for the cannabis industry. The first is the possibility of federal deschedule, which should inject new life into the industry by reducing taxes on legal plant-touching businesses, enabling them to reinvest.
The should attract renewed investment from both institutional and retail players. And importantly, since the beginning of 2023, there are an additional seven US states that have legalized adult use cannabis, which means now there's an estimated 54% of US adults who live in a legalized state. Momentum is beginning to swing positively internationally as well, as Germany just legalized recreational cannabis use last week. We are confident that Hydrofarm will continue to navigate our path forward, and we are well positioned when the industry returns to growth. I'm very proud of the entire team at Hydrofarm for all their hard work this year in delivering a positive adjusted EBITDA and free cash flow in 2023. With that, I'll turn it over to John to discuss further details of the fourth quarter financial results and our outlook for 2024.
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John?
John Lindeman: Thanks, Phil, and good morning, everyone. Net sales for the fourth quarter were $47.2 million, down 23.2% year over year, driven primarily by an 18.7% decrease in sales volume and a 4.5% price mix decline. While we anticipated softer sales volumes in Q4 with a standard cadence for the business, the softness was larger than we had expected. Our price mix decline in the quarter was primarily driven by promotional activity in our durable products as well as a higher mix of lower priced consumer products relative to our higher price durables. Our sales mix continues to evolve, and for the full year, consumable products represented approximately 74% of our sales compared to 65% in 2022. Our proprietary brands continued to mix higher on a year-over-year basis and approached 60% of our total net sales in the fourth quarter, our highest ever quarterly level since our IPO.
Some of this mix shift was a reflection of the encouraging demand for our proprietary nutrient brands. Accompanying our favorable brand mix for the quarter was continued sales diversification. As Bill noted, our international and non-cannabis sales increased from a sales mix perspective in Q4 '23 and for the full year, and now represent approximately a quarter of our total sales. In 2024, we will look to further capitalize on what is working today, focusing on improving our mix of proprietary brands, most notably our proprietary nutrients, as well as driving further momentum in our international and non-cannabis sales. Gross profit in the fourth quarter was $8.4 million compared to a gross loss of $0.5 million in the year ago period. Adjusted gross profit was $11.5 million or 24.3% of net sales compared to $9 million or 14.7% of net sales in the year ago period.
This represents a significant adjusted gross profit margin expansion when compared to the fourth quarter of 2022 and 130 basis point expansion when compared to our vastly improved third quarter margin. This margin expansion demonstrates continued progress on more favorable brand mix, lower freight costs, and improved productivity. As you may recall from our Q3 call, we initiated a second phase of our restructuring plan, which includes US manufacturing facility consolidations intended to improve efficiency and further right size our footprint. This second phase is primarily focused on our durable products manufacturing operations. In the fourth quarter, we recorded $1.3 million of restructuring expenses, which included noncash inventory write-downs associated with the reduction in durable manufacturing and warehousing space.
In total, when you combine our phase one and phase two restructuring initiatives, along with our sublease cost saving activities, we expect that by the end of 2024, we hope will have reduced our company-wide manufacturing and distribution footprint a little over 25% since the start of 2023. Selling, general and administrative expense was $19.9 million in the fourth quarter compared to $26.2 million in the year ago period. Adjusted SG&A expenses were $12 million, a significant 31% reduction when compared to $17.4 million in the year ago period. The decrease was primarily driven by reductions in headcount, professional fees, lower accounts receivable reserves, distribution center facility costs, and insurance costs. Our Q4 adjusted SG&A expense remained in line with our third quarter, which was our lowest quarterly total since before going public.
Adjusted EBITDA was a loss of $0.6 million in the fourth quarter compared to a loss of $8.4 million in the prior year period. The $7.8 million improvement was driven by our lower adjusted SG&A expenses and our higher adjusted gross profits. Most notably, for the full year, we achieved positive adjusted EBITDA which delivered on our expectations and demonstrates the effectiveness of our improved proprietary brand mix and our restructuring, productivity, and cost-saving initiatives. Moving onto our balance sheet and overall liquidity position. Our cash balance as of December 31, 2023, was $30.3 million, an improvement by $9 million compared to the end of 2022. We ended the year with approximately $123 million of term debt, approximately $132 million of total debt when you include finance lease liabilities, and approximately $102 million of net debt.
As a continued reminder, our term loan facility has no financial maintenance covenants and our debt facility does not mature until October 2028. We continued to maintain a zero balance on our revolving credit facility throughout the fourth quarter and across the entire 2023 fiscal year. In the fourth quarter, we reported a loss from operating activities of $1.6 million with capital investment of $0.2 million, yielding negative free cash flow of $1.7 million. However, our positive adjusted EBITDA and our disciplined management of working capital throughout the year helped us generate positive free cash flow as expected for the full year of 2023. With that, let me turn to our full year 2024 outlook. We expect net sales to decline low to high teens on a percentage basis for the full year 2024.
As we have seen each sequential quarter since Q4 2022, we expect the quarterly declines to decelerate over the coming year. We also expect to see an increase in adjusted gross profit margin, primarily due to improved sales mix and our restructuring and related cost-saving initiatives. We expect adjusted EBITDA that is positive for the full year 2024. This assumes improved adjusted gross profit margin and adjusted SG&A expense savings to more than offset some limited productivity investments. We also do not expect any significant charges related to non-restructuring inventory write-downs or accounts receivable for the full year. Finally, we expect to generate positive free cash flow in 2024. We will continue to reduce our working capital inventory levels.
I will note that we do expect capital expenditures of approximately $4 million to $5 million in the year. In closing, we remain optimistic about the future of the industry and the future of Hydrofarm. This year, we proved we can operate profitably despite lower sales levels as we deliver positive adjusted EBITDA and positive free cash flow. And we look forward to continuing to deliver the results in 2024. Thank you all for joining us, and we are now happy to answer any questions. Operator, please open the line.
