Good afternoon, everyone. Today, I have with me Bill Toler, the CEO of Hydrofarm Holdings. Thanks for coming. So Bill, obviously, you know, 2023 was challenged in the cannabis industry. As we are now entering 2024, should we expect more of the same, or any key catalysts to watch out for in the industry this year?
Yeah, thanks, Anna Kate. Nice to be with you and ICR. Appreciate you guys doing what you do every year, and, you know, I look at, you know, Andrew Carter from Stifel was gonna do this, but he got COVID, and I get Anna Kate, so it's. I think COVID's the gift that keeps on giving, so that's great. We're all much better off today, so thanks for stepping in. You know, 2023 was obviously a difficult year. If you were here for Darren's discussion, he outlined it brilliantly in terms of where the industry has been. Been struggling now for a couple of years. I think we are all optimistic and hopeful that things are going to get better, and there are a few signs of it, right?
I still believe that Canada operates a bit as a precursor to what is probably gonna happen in the U.S., and our Canadian business, which is quite substantial, is much stronger than our US business. So we might have had a decline in the U.S. of, you know, greater than 20% or 25% in 2023. Canadian business was down single digits, and it was growing in the aggregate eight-month period in the last eight months of the year, so it's better. We think that's encouraging, and think that's a sign that maybe the U.S. is gonna have some strength as well. We have significant kind of pre-build programs for our grow media business, where customers buy out in the spring, and the size of that purchase this year is several times what it was a year ago.
So again, that gives us, you know, little, little bits of kind of hopes and green shoots that, that have been, you know, been there for a little bit, but we're starting to see them. Also, on a sequential basis, while, you know, Q1, Q2, and Q3, in an absolute dollar basis had been sequentially down, Q4 is always seasonally weaker, so that's certainly gonna be there. But within the quarter, we saw a move upward from October to November to December. So again, that's not necessarily the historical trend that you always see. So we think there's some stabilization on those fronts, and we think there's some reasons to believe that in 2024, while I don't think any of us are expecting wild, you know, great growth numbers, I think that there are reasons to believe that we're, you know, heading for a better place.
Thanks. And obviously, you have different sides of your business, your consumables and your durables business. So what should we expect in 2024? What are the different trends you're seeing on each different side?
Yeah, our company now is about 75% consumables, 25% durables. 3-4 years ago, that would've been closer to 50/50. Part of that is the nature of the industry and how it's changed. Part of it is a very conscious move we made in doing M&A in the consumable space. We bought five companies in 2021, all of which are now pretty much integrated into our business. Four of those were in the consumable space, one was a durable one. So we're looking at our businesses now. That mix, of course, has changed because of who we purchased and how, and the kind of products we purchased. But also, if you look at how the businesses are trending, our consumable businesses are doing much better than our durable business.
You could almost say the Durables are down kind of twice as badly or twice as weak as the consumables. And if you dig into that one more level down, our house brands, the brands that we own, grew in the second half, year-on-year, of 2023 versus 2022. So again, as you keep pulling it apart, and one of the themes that I want to communicate today is really the... You know, it's all about the brands, right? The house brands that we own, that drive 55%-60% of our sales, are really where the long-term strength, the long, long-term margin profile, and the long-term belief that Hydrofarm has not only a great opportunity to contribute, but a great opportunity to continue to expand in the industry.
Obviously, there's been softness in demand across the industry, but you've still managed to, you know, control costs where you can. How have you been able to do that, manage costs effectively?
Yeah, it's interesting. I've been doing businesses for a long time, over 40 years, and I was a part of leading four companies out of bankruptcy and going through the difficult choices you have to make there. And I would say that our team has probably done a better job managing the things in front of them than other places I've been, and I'm proud of the work we've done. The results, none of us are thrilled with, the numbers, the absolute numbers, but the work we've done underneath really positions us for the long haul. If you look at some of the specifics of what we've had to do, we've cut our SG&A substantially. We've cut our SG&A by about $20 million a year. We've done that through the very hard choices we made around headcount.
Our headcount peaked in the middle of 2021 at about 750, 760 people. We're down now to 360, so it's a tough cut to take. It's a hard cut to take. I wish we had done it all at once, but we did it in stages, which makes it more difficult on the organization and more difficult on the individuals. But, you know, we always hope that things are, were there to turn around, and they haven't yet. In addition to heads and outside services, we cut down our some of our costs. Fortunately, things like D&O insurance and other things have come down over the last couple of years, one of the few insurance areas that have gotten better. We've closed facilities. We closed two in Canada.
We're looking at closing 1-2 in the U.S. and perhaps another one into Canada. We did a sale-leaseback, which was more of a balance sheet move than it was a cost cut. But the point is that we've aggressively attacked all aspects of our P&L, and we've done that to make sure the company remains strong and remains viable. And, you know, our guide for 2023 is positive EBITDA for the whole year. We made a little money in Q2, made a little money in Q3. Obviously, Q4 is seasonally weaker in top line generally, so it's gonna be a challenge to hold all that together. But, you know, those are the things we're hoping to do. And very importantly, we are gonna create free cash flow. We've created a lot of free cash flow through Q3.
We hope to hold that Q4, we've done that primarily through managing working capital aggressively. Specifically on inventory, from February of 2022, so a year, you know, almost 23 months ago, we were at $190 million of inventory. We'll finish the year somewhere in the mid-80s. 80s, so almost over $100 million coming down. Some of that was inventory write-down, but a lot of that was just hard work, converting inventory into cash, not reordering items you didn't need, cutting SKUs that didn't sell, and managing very, very aggressively on the other side of things. So part of that question is always, okay, well, you can't take inventory from $80-ish million down to zero, so where are you going to continue to create, you know, free cash flow?
Well, hopefully through making money in 2024, but more importantly, we've still got to manage inventory. We believe we ought to be able to manage our company on a three-month inventory basis, right? If we, if we did kind of $60-ish million + or - a few, you know, each quarter for, for, you know, most of 2023, then we ought to be able to manage our inventory down into the 50s or 60-ish kind of number as a target. We'll get a lot that this year from our raw material inventory, so our bottles and caps and things that are actually used to make our own house brands. Most of our inventory reductions over the last 18 months have been through, you know, finished goods that we buy from other people. Now, we're getting tighter and closer on the raw material side.
All of those areas will continue to work, and all those areas will continue to find ways to save money, 'cause we believe that cost savings are never done. You're always in the process to find better ways to be smarter and more efficient and more effective in what you do.
Yeah. So you obviously executed the first phase of your restructuring initiative very well. You talked a lot about that last year, and you've recently initiated a second phase. How is that going so far?
Yeah, the second phase was primarily around reducing the footprint of our durables business. It may also include some other facilities later on, but right now, we've taken about a third of our durables business footprint down. We did that by getting out of some buildings, getting out of some capability on the warehousing side. We still can manufacture everything we manage there, but each business we have to look at as a standalone. Is it a viable business by itself? Does it, you know, operate profitably or have the potential to be profitable? And in the durables side, which has been the tougher side of the business for all of us, we felt like we could make some moves there.
So we did reduce that as a first part of that, and there are all other areas that we're considering as we look at overall footprint.
Bill, I think this week is your fifth-year anniversary at Hydrofarm, so congratulations on that milestone. How would you characterize the changes you've seen over your time?
Yeah, tomorrow is five years, which is kind of amazing, and Darren's talking about his 10th year with the company. It is, it is a fascinating time to reflect a bit back. If you think back five years ago when I came to Hydrofarm, the industry was sort of, call it 15 states legal on the, on the adult consumption side and 25 or so on the, on the medical side. Now, it's 25 to 26 on the, you know, rec side, if you will, and 38 on the medical side. So significant progress on that front. But if you look at it and say, "All right, what else should happen, right?" The other big sort of bogey in the room is the lack of consistent and planned, you know, federal and legal and legislative support.
So we haven't had the changes that should go on. We haven't had the descheduling or rescheduling. Maybe that's coming. Let's hope it is. We haven't had SAFER Banking or SAFE Banking. It's passed five or six times in the House, hasn't gotten through the Senate. So really, I think we've almost built an industry in spite of a lack of support from the government and a lack of support from people that don't really understand the impact of the actions that they haven't taken, and that is, now that capital is more constrained and interest rates are higher. Hundreds of millions of dollars have been invested in this industry that aren't being utilized properly, or hundreds of thousands of people are losing jobs.
The industry is not coming along like it should be, and that's been a real challenge for, for all of us to see, and I think we're going to see that day coming. I mean, the juggernaut is still there. The juggernaut of this category going to $100 billion, $200 billion, $500 billion is still going to happen underneath someday and somehow, and there's never been more momentum than there is right now. But until that day happens, the world really hasn't seen it appreciate and get to where it can be. Yeah, I look back on the supply side of the industry. Back five years ago, when I showed up, there were three of us, right? There was Hawthorne, there was Hydrofarm, obviously, and there was BWI.
Well, BWI went away and was largely consumed by GrowGeneration, at least on the inventory side, and then it was kind of us and Hawthorne for a while. Hawthorne, these are all public numbers, really did an incredible job for a few years and created a monster company of distribution and branded, and then, you know, we've had some success along the way. Got the company public in late 2020, had some really great early success behind 2020 and 2021, and then the industry changed a lot. You know, Hawthorne has changed now again to back more of a distributing their own brands, primarily, not distributing other people's products. We are still an industry distributor and distribute third-party products as well, and we've had new entrants come in, specifically BFG. BFG, being a lawn and garden supplier primarily, is now getting in the hydro space.
So like a lot of industries, the industry has morphed, right? You see, GrowGen and Hydrobuilder Holdings, the two largest retailers in the industry, have really developed kind of national or semi-national footprints that didn't exist five and 10 years ago, and they now have their own brands. We now have distribution capabilities directly into growers, and so everybody morphs to be a little bit like everybody else. That's not unusual. I came out of the food industry, and, you know, 40 years ago, it was just you had a drugstore, a food store, and a mass merchandiser. Then all of a sudden, mass merchandiser had a pharmacy, a drugstore had a food section, and a food store had a pharmacy as well. So industries morphing to look a little bit like each other is not unusual.
And so I think the key here is that where does this whole thing go? I think this whole thing goes to where we all continue to drive ourselves and differentiate by our brands. Our brands really set us apart. Our customers want our brands. Our customers grow with our brands. I looked back the other day in preparing for this talk and said, "All right. What were our biggest brands five years ago? Well, the biggest brands over the three, four, five years were Phantom high-pressure sodium lights, which barely exist today in that format. It's all LED now. Our other biggest brands were FoxFarm and Grodan, okay, over those three, four, five years. Those brands are products that we buy and distribute for someone else.
So as a company, you're gonna have a margin on that, you're gonna have revenue from that, but it's never gonna define you and make you a differentiated player in any industry. So our brands today, our largest brands today, are House & Garden, a brand we acquired, and Aurora Peat, a brand we acquired, acquired. So again, we've remorphed the business into driving it with our own brands, differentiating ourselves to our customers with brands that we make manufacturing margin on and that we distribute as well. That puts you in a very different position than it is if you're selling other people's products for them or distributing them for them.
So I look back over the industry and see the changes with the retail base and the distribution base, but most importantly, I'm most pleased with and proud of the work we've done in building a differentiated branded portfolio that we own, that we manufacture, and that we can drive for our own success. If you look at five years ago, we had about 20% of our sales in our own brands, and we manufactured zero of that. So we got no manufacturing margin for anything. It was all co-pack out of China. Today, we sell about 55%-60% of our products that are our brands, and we manufacture virtually all those.
Still a little bit coming out of China on the lighting side, but we manufacture the vast majority of those, and we manufacture essentially 100% of our house products on our consumable side. So again, the remorphing or the remaking of a company, the changing of an industry, and the way that the customers and suppliers have become kind of, you know, a little bit of a mirror image of each other, are things that I've thought about a lot over the last five years.
Yeah, and speaking of changing, I mean, you've obviously always risen to the occasion to adapt your business when needed, and you've talked a lot about pivoting from what was previously primarily a North American cannabis focus into more lawn and garden, food and floral, and other verticals. So, how has that been successful so far in working for Hydrofarm?
Yeah, it's been an interesting approach, and it's been successful in a sense that we now have much more lawn and garden presence than we had. We sell, you know, products like Gaia Green and others that go into the lawn and garden planograms. We sell modules that go into these stores. We have a presence there that we're working very hard to, and they're all doing extremely well. If you looked at the way we break down our business, we kind of talk about the retail segment, and then there's sort of commercial, e-commerce, international, lawn and garden, and others. Well, the non-retail segment has essentially doubled in sales over the last year or two, and then the retail segment, of course, has shifted away from that. The problem is, the retail segment's still the biggest piece.
Used to be kind of 85% of the business, now it's more like 75% of the business. We'd love for that strength of the core retail business, where we've always had the greatest strength and presence, to come back, of course. But just as any other retailer or supplier or anybody, when your core isn't delivering for you, and North American cannabis hasn't been, we had to pivot to other things. So we've been able to take our nutrient brands that we own and move them into Europe, and our business over there is up, you know, significantly. We've been able to get into lawn and garden, both in Canada, which we already had a presence in, but also now here in the U.S. We're selling more into food and floral. So we're selling the Grodan container type of operations for indoor growing.
So there's a lot of those pivots that have really helped us, and... But it hasn't offset the weakness in our core, you know, North American or Canadian cannabis business. So that's been the challenge, but we're pleased with those efforts. It just takes time to get those to be a meaningful part of the overall total.
Yeah, and thinking about the industry, and obviously, you operate all over the U.S., but are there any particular states or areas of the country that you've seen relative strength, and why is that the case?
Yeah, it's... You know, I wish that every time a state opened, you got a huge flush of business, right? Back in 2018, 2019, 2020, or 2019, 2020, 2021, I should say, when Oklahoma was fully building out, you're selling out 7,000 licenses, and everybody built, everybody built to grow. Michigan was tripling in size. This unbelievable amount of rush to each state. Now, the states are rolling out in a very constricted way, right? There's not. Oftentimes there's legalization, but there's not a corresponding at-home market, and that's a challenge for how the states are rolling out.
Or you get into, you know, the social equity issues that places like New York and New Jersey are trying to bundle all this together to make the legalization of cannabis solve, you know, 250 years of other kinds of problems, which makes it very, very difficult. So the states, the way they're rolling out now, it isn't really conducive to the, you know, okay, state rolls out in January, and by September, you've got all the grows starting, and by January, you've got all the consumables starting. We don't see that kind of a flow now. Every time I think what happens is you get a slower rollout and build, and you get a rebalancing there. Part of that's just the nature of the economy. The money's dried up from Wall Street. The interest rates are high if you can borrow it.
So it really makes people, you know, think twice. Back two, three years ago, money was essentially, you know, I won't say free, money's never free, but it's- it was incredibly cheap, and it was... People were able to get access to capital, especially when you were putting it into an industry that was growing as rapidly as we were in 2020 and 2021. So all those factors have caused for the rollouts to be more muted and more challenging. So there's not really an area right now that I can point to that I... Maybe Missouri's doing fine, that's great, but it's- that's not gonna move the whole needle. You know, the big states are still having the struggles, which create that gap for us to try and fill in with other markets and other ideas.
So this is very topical. There's been lots of speculation about consolidation within the industry. So what are you seeing, hearing? How are your conversations going, and how does Hydrofarm stand to benefit from this trend?
... Yeah, we think we, you know, offer a lot to any potential industry partner, right? And there have been a lot of people talking about industry combinations and scales, and obviously I'm not gonna share anything specific here, but specifically, the industry should consolidate. There needs to be greater scale across all the points of distribution, all the points of presence, whether that's like-minded manufacturers or complementary ones coming together, whether that's lawn and garden and hydro coming together, whether that's hydro retailers and suppliers coming together. All of those things should be considered and would benefit all of us because we're all subscale to where we were in 2021 by a 50%-80% margin, 80% being another competitor, not us, obviously.
And so it does create a challenge, and all of us built out for growth that was happening in 2020 and 2021, and now we've had to go out and do other things, like we're mitigating the cost of our DCs by subletting cost out to partners in our industry and partners outside of our industry, so we're cutting costs that way. So there are discussions, obviously, of lots of opportunity there. We think we're in position very well on a number of fronts, right? We have six very well-operated, mostly very pretty new distribution centers here in the U.S. We're the only major player in Canada with two distribution centers, east and west. So in terms of North American supply, we are very, very well positioned, right? And so we're able to do that and frankly can distribute...
You know, if your DC is in Denver, let's say, and Oklahoma is one of the states that you supply to, but Oklahoma goes way weaker, and then Arizona picks up, you just ship to Arizona. So that distribution center footprint works very, very well and puts us in a really good position to, you know, find a partner to scale with. And, as I have said on all calls, and many of industry players have said, you know, the scale here is a really good idea for the industry, and if it makes sense for us with another partner, we'll certainly pursue that.
Turning to inventory for a minute, I know you've been very aggressive with managing your inventory down. So now, where we sit, heading into 2024, how are your inventory levels, and how do they look for the year?
Yeah. Inventory levels are much improved, as I'd mentioned in one of the earlier answers, and so we're in the, call it $80-ish million, you know, probably coming out of the year, coming out of Q3, I guess I should say. And we still think there's more. There's more there because we believe we can tighten up the SKU count, we can tighten down our supply, we get better supply lines from our partners now. Some used to produce in Europe and now produce here in North America. We also have a much higher percentage of our business from our own products. Our own products don't need as much supply, so we have great response times to be able to do that.
The place we have the opportunity is on the raw material side, your bottles, caps, and, and other, other elements that go into your own direct products. They had bought ahead back in 2020 and 2021, as if the industry was gonna continue to grow, so that kind of what I call eating your pipeline, takes a long time when you've got inventory supplies and bottles sticking in warehouses. All that's kind of going away now, and we're starting to burn off a lot of that inventory. So the progress in 2024, I think, will be mostly around reducing that inventory, the raw materials for our, for our house brands.
Turning back to regulatory specifically for a minute, you mentioned how, you know, you've been waiting on things to pass, and it hasn't happened. As we're entering election year, which is top of mind for investors, what are kind of the key things from a regulatory standpoint to look out for, and what are you hearing?
It's still the basic things that we hope will happen, right? I mean, you see Ohio passed, you know, recently, but more importantly, it's around rescheduling, getting rid of 280E. That's the burden that's on the growers, that's costing billions in tax every year. If that money wasn't going to taxes, it could be reinvested in new grows. Obviously, you know, how, you know, DEA plays that, we'll see how it goes politically. I do think we'll get some action on that in the first half of the year, and I think that's gonna be a big trigger to restore confidence, to get people believing again that this category is finally going to achieve its potential, which it will.
It's just hard to see through the forest and get all the way out into the bright, bright sunlight, but it's going to happen hopefully a bit this year, and in the future, we'll see, we'll see it go even better.
Thanks. So I'll have one more, and then we'll wrap it up. So from the different industry segments, where is your demand coming from? There's, you know, we're operating in a lot of different areas now, so what are you seeing? What's driving demand?
Yeah, the core is still North American cannabis, no doubt. We've diversified ourselves to go further into, you know, other areas, but our still core business is driven by what happens in, you know, in North American cannabis. One thing I should get out about our company is, we have a very, very strong balance sheet. We do have debt on that balance sheet. It's not due until November of 2028, so a whole another presidential cycle to go, and we got a long way to go in this one. It's almost five years out. That's when our debt is due. It amortizes 1% a year. We've got an undrawn revolver of $40 million. We've got about $30 million in cash on the balance sheet coming out of Q3.
So we feel good about our balance sheet, and we're managing our debt appropriately. And it gives us a good position for... And we're scaled now down to a place where, on the headcount side and the DC side and the workers in the DC side, that as the industry revenue comes back even a little bit, the leverage going forward on that's gonna be really, really strong. So we're anxious for that to happen, working hard to make it happen, and think that it's gonna be a really, you know, positive outcome, once it does.
Well, that's all I had for you today, Bill. Thank you so much, and thanks, everyone, for joining us.
Thanks, Anna Kate.