Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Hydrofarm Holdings Group First 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, May 10th, 2023. I would now like to turn the call over to Anna Kate Heller of ICR to begin.
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 first 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.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 conditions.
Lastly, during today's call, we will discuss some 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 reconciliation to comparable GAAP measures are available in our earnings release. With that, I would like to turn the call over to Bill Toler.
Great. Thank you, Anna Kate, good afternoon, everyone. During the first quarter, we continued to see signs of stabilization in the industry as we saw our first quarter sales increase sequentially from Q4 2022 to Q1 2023. We remain focused on controlling and cutting costs at Hydrofarm, including right-sizing our business, making operations as efficient as possible, and managing for profitability. We are seeing positive industry signals, which I'll talk about more shortly, and we're confident that the industry will return to growth. I am proud of the hard work done by the entire team at Hydrofarm to shape our business into a leaner and stronger organization. We appreciate the work our team has done. These actions have us better positioned than ever to take advantage of growth opportunities that lie ahead. I'll point to a few of the key accomplishments during the quarter.
I'll discuss the positive signs as well as the challenges that we are currently seeing. We continue to execute on our previously announced restructuring initiative. We completed the consolidation of our Canadian nutrient manufacturing facility, the closing of our regional office in China, as well as the relocation of our distribution center in Western Canada. In January, we completed the sale-leaseback of our property in Eugene, Oregon, which serves as a location for the manufacturing and processing for some of our grow media and nutrient brands. We received a little over $8 million in net proceeds from the transaction. Turning to a recent achievement regarding innovation on one of our core brands I'm really thrilled to talk about. On April 20th, we officially launched our newest House & Garden powder product line.
It is a dry nutrient lineup aimed toward commercial growers that was built around our highly reputable premium brand, House & Garden, an early player in the industry and an industry leader in the nutrient category. Based on professional field trials in a controlled environment, our new House & Garden commercial powders produced more yield and higher plant quality than any of the other tested alternatives. We are excited about our team's ability to innovate on our core brands and offer value-added solutions for our retail customers and our commercial customers. Turning to industry dynamics. In Q1, we experienced relative strength from our specialty retail customers, especially in the Western states. I'd like to note that in California, historically our largest ship-to state, it was up sequentially in dollar sales when you compare Q4 of last year to Q1 of this year.
We're also seeing strength in APP, our Aurora Peat brand, which has a diverse customer base and also serves non-cannabis channels. This brand grew double digits on a year-on-year basis in the 1st quarter. We're excited to see the improvement in APP and our specialty retail in the West. One of our challenges we faced in the quarter was that some commercial customers delayed builds in new projects. As a result, our commercial sales in Q1 fell short of expectations. This is primarily due to the ongoing legislative battles and frankly, lack of cohesive legislative support that has been slowing implementations in key states like New York, New Jersey, Connecticut, Mississippi. As we have previously said, for us to achieve our guidance, top-line guidance for the year, we need a modest seasonal lift in the spring. We also need to close some of those commercial opportunities in front of us.
As we sit here in early May, we have just recently seen a lift in our daily sales. This seasonal uptick needs to continue and increase through the remainder of Q2 and into the back half in order for us to achieve our top-line guidance. In summary, we are laser-focused on driving profitability and executing our strategy. As a result of our actions, we're already seeing some benefits as evidenced by our sequential and year-over-year improvement in adjusted gross margin, profit margin. We will continue to execute on key initiatives, which include driving a more favorable sales mix by selling and focusing on high margin products. Diversifying revenue stream by further expanding our sales efforts into non-cannabis channels, including CEA food and floral and lawn and garden. Increasing productivity across all of our manufacturing and distribution centers.
Generating cost savings by continually reexamining the size and scope of our organization relative to the current industry demand levels, and of course, reducing our working capital. I'm encouraged by our team's discipline and execution during the quarter. The margin improvement we saw in the first quarter is a testament to the success of the recent actions, which have put us in a stronger position in 2023 and beyond. With that, let me turn it over to John, who will discuss the details of our first quarter financial results and outlook for 2023. John?
Thanks, Bill, good afternoon, everyone. Net sales for the first quarter were $62.2 million, compared to $111.4 million in the prior year period, driven primarily by a 42.5% decrease in sales volume. Note that this now marks the second consecutive quarter of reduced year-over-year organic sales declines dating back to Q3 2022. We realized, as expected, a 1.1% price mix decline in the quarter, resulting primarily from the sell-through of discounted lighting products. Our overall brand mix improved in the quarter as proprietary brands increased as a percentage of total sales to 56% from 54% in the prior year, driven primarily by nutrient sales, partially offset by lower commercial equipment sales. We did see some other positive trends in the quarter, too. First, we saw sequential strength in several key Western states.
Our total of dollar sales in California, Oklahoma, Washington, and Oregon all increased sequentially for the first time since mid-2021. This strength helped our specialty retail business outperform internal expectations for the quarter, albeit this outperformance in our specialty retail channel was mitigated by weaker than expected performance in our commercial channel. Our international sales outside of the U.S. and Canada grew sequentially and on a year-over-year basis. While international sales make up less than 2% of total sales, the significance is the placement of some of our house nutrient brands into markets outside the U.S., which gives us something to build on. Gross profit in the first quarter was $11.4 million, compared to $16.6 million in the year-ago period.
Adjusted gross profit was $14.1 million or 22.6% of net sales in the first quarter, compared to $22.3 million or 20% of net sales last year. The increase in adjusted gross profit margin is largely due to improved brand mix, improved productivity, primarily in our distribution centers, and the fact that we recorded lower inventory reserves than last year. Our Q1 adjusted gross profit margin improvement suggests that our restructuring and related cost-saving initiatives are making an impact. Against these benefits, we realized $1.4 million in pre-tax charges in Q1 related to the closure and relocation of certain facilities in Canada and China. We do expect to incur additional restructuring charges primarily in Q2 of 2023.
Selling, general, and administrative expense was $24.4 million in the first quarter, compared to $40.2 million in the year-ago period. adjusted SG&A expenses were $16.2 million in the quarter versus $19.2 million last year. This $3 million or 15% decrease was primarily due to lower compensation costs resulting from headcount reductions, as well as reduced spending with professional and outside service providers. Finally, Adjusted EBITDA decreased to a loss of $2.1 million in the first quarter from a $3.1 million profit in the prior year period. The decrease in Adjusted EBITDA was driven primarily by the lower organic sales volume. Notably, this is the second consecutive quarter of sequential improvement in Adjusted EBITDA. We still have work to do, but the sequential improvement demonstrates the progress of our restructuring and related cost-saving initiatives.
We will continue to control what we can in an effort to drive increased profitability through improved brand mix, distribution center, and manufacturing productivity, and reduced SG&A. Moving on to our balance sheet and overall liquidity position. Our cash balance as of March 31st, 2023, was $18.7 million. We ended the quarter with $123.4 million of term debt. As a reminder, our term debt facility has no financial maintenance covenant and does not mature until 2028. As was also the case for the entirety of 2022, we maintained a 0 balance in the company's revolving credit facility across the entire first quarter. I would also like to note that in March, we extended the maturity of our revolving line of credit to June 2026.
As you see in today's earnings release, our free cash flow in the first quarter improved by approximately $2 million relative to the same period last year. This improvement is something we expect to build on as we move into what are typically the more seasonally favorable cash flow periods of the year. We estimate total liquidity of approximately $57.7 million as of March 31st, comprised of our cash position, plus approximately $39 million of available borrowing capacity under our revolving credit agreement. With that, let me turn to our updated full year 2023 outlook. We continue to expect net sales in the range of $290 million-$310 million for the full year 2023.
As we discussed on our last earnings call, our sales guide assumed a modest seasonal lift in early Q2 and year-over-year top line growth resuming in the second half of 2023. As you heard from Bill, we have not yet seen enough of the seasonal lift that we previously expected, and we now have a little bit of a gap in our commercial sales that we need to close across the remainder of the year. Our current 2023 sales guidance assumes that the pickup will occur mid to late Q2 and that year-over-year top line growth will resume in the second half of 2023. As a result, we expect top line for the second quarter to be modestly higher than the first quarter, and we expect our full year sales to be at the lower end of our $290 million-$310 million range.
As noted earlier in the call, our Adjusted EBITDA and Adjusted EBITDA margin have sequentially improved in each of the last two quarters. Today we are reaffirming our expectation for modestly positive Adjusted EBITDA for the full year 2023. We are also reaffirming our expectation for positive free cash flow for the full year. In closing, we believe we remain on the right path to control the controllables while weathering the industry headwinds. We remain excited about our prospects for continued improvement in near-term profitability. With that, let me ask the operator to open the line for any questions you may have.
Thank you. We'll 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 you 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 keys. Our first question comes from Andrew Carter with Stifel. Please go ahead.
Yes. Thank you. I just wanted to drill down a little bit on kind of what you're seeing kind of through April, May. You say you're seeing a little bit of the seasonal pickup, but to be clear, not enough for your previous guidance. Could you help us understand right now kind of what the April trends are looking like at and how much of a change you need to see by June to kind of get to that back half, which I think is still implied kind of mid-teens growth? Thanks.
Hey, Andrew. Thanks. I'll start. John can fill in the blanks if I leave some there. I think, you know, in simple terms, April was a little weaker than we'd hoped. May has really picked it up a bit, which is great to see. You know, we're not quite sure if the delay was, you know, holiday timing or weather or what it was in April. We think that, you know, we've seen now in May the beginning of, and not all the way there, but the beginning of the seasonal lift that we had mentioned. You're right. It's sort of in that low teens percent kind of area, which is, you know, kind of the average of what we've seen over the last four out of the last five years.
We think it's a, it's a reasonable assumption, although the industry's been through a tough time in the last six quarters. Yeah, the May numbers have given us some encouragement, but we're only a third of the way through the month, so you hate to put too much credence into that. That's why we thought it was prudent to, you know, stay within the guide, but kind of recognize that we're probably on that lower end of the guide at this, at this point.
Second question is, in terms of the pricing, you kind of highlighted last quarter that you were gonna have kind of a negative pricing because of the lighting. Could you quantify how much that weighed? I believe full year expectations are positive price mix. Do we see positive price mix come through in the 2Q? Thanks.
Yeah. Thanks, Andrew. I'll jump in on that one. Yeah, we did, as you point out, expect to have negative price mix in Q1. Indeed, it was due to the lighting sales, which was also what we had suggested. You know, when we look at the math, if you exclude the discounting lighting sales that we had in Q1, we do see positive price mix beneath that. You know, as we're modeling the rest of the year, we are still modeling positive price mix for the full year, albeit we are a little bit cautious, a little bit more cautious than we were before just because of our call-out, as we noted today earlier, on the commercial side of our business.
Thanks. I'll pass it on.
Thanks, Andrew.
Our next question comes from Bill Chappell with Truist Securities. Please go ahead.
Yeah, good afternoon.
Hey, Bill.
Just wanna follow up. It's great that you're seeing kind of a spring lift and encouraging. Just trying to pair that with, I think Hawthorne Scotts kind of said they hadn't seen much of a change in kind of daily order patterns since the start of the year. I didn't know if that's competitive or if that's just product mix or geographic or anything else we should be thinking about it, or are you seeing the whole category getting a lift?
Yeah. Good question because really what we're seeing is we're seeing the consumables lift, right? That's where the strength of our portfolio is. It also is where most of our business is. Almost 70% is now consumables. I would say that our durables numbers are more like what you've seen from other people. The reason is that right now we're getting people back into the, you know, repeat purchase of consumables. The delays in builds and the delays in refurbishments and delays in all the issues in the new states and stuff has cost us on the commercial side, which is more durable for us. Yes, it is more about portfolio than it is about us seeing it differently than Sorry?
No, no, that helps.
Yeah.
Sorry, it cut out there for a sec. In terms of you all reported six weeks ago, not sure how much has changed in terms of the just the opening up front. Trying to understand, you know, if in New York, Connecticut, stuff like that, if you've seen any kind of further breaks, further opening up, any regulations start to fall, things that are moving any faster or it's still kinda all in line with expectations?
Yeah, it's still kind of moving slowly in spite of Delaware saying yes and Minnesota moving, you know, North Carolina being rumored to be closer. In the states that kind of have these big legislative quagmires going on, we haven't seen much progress at all. A number of our projects that we thought would come in in Q1 have been, you know, delayed and pushed to Q2, Q3 and onward. That's been, you know, part of the slowness of the commercial business, has been these delays. No, we have not seen a lot of progress in those key states.
Got it. Thanks so much.
Thanks, Bill.
Our next question comes from Andrea Teixeira with JP Morgan. Please go ahead.
Thank you, operator, good afternoon there. I just wanna kind of go back a bit with what's happening to the end consumer, if you're seeing downtrading. I know you don't touch the plans, but perhaps, you know, talk about what's happening in the most recent legalized state. I mean, it sounds recent, but it was not recent, but just as as we see the last mature states, if like the whole dynamic between black markets and legalized or dispensaries have changed, if there is any down trade helping the non-commercial producers? In that vein, if you think that there is inventory build-ups you're working through, outside of lighting, or-?
Yep.
If, you know, in lighting, you were seeing also that kind of like being worked out already, hopefully.
I'll start. Then John, you can speak to inventory, which I think is largely what you said, lighting. Anyway, what I think we're seeing in the short term, and I don't think this is a long-term thing, is that if you look at the big MSOs and the guys that are reporting right now, just like we are, you see a lot of them either shuttered or mothballed a lot of their capacity. In this window we're in right now, I think you're seeing a reemergence of your hobbyist and craft grower and gray market, and you see that primarily through retail stores and through, you know, our business is still dominantly retail oriented. You know, we're starting to see that picking up a bit.
On the flip side of that, the MSO, the commercial side of things, those builds and those, you know, refurbishments are going much slower. I think right now we're seeing a bit of a shift back to the old days, if you will, which is more, craft growers and hobbyists and such. The MSOs, the bigger ones, which will ultimately probably be certainly the dominant players in the industry, they're the ones caught up in a lot of this legal stuff, and I think that's.
Mm-hmm.
-happening kind of in the moment that we're in. I think it'll sort itself out in the next few months, but I think that's part of what's going on in the industry right now, and that's part of how we are where we are. The relative strength in that retail that we talked about, the strength in California we talked about, that Western block that John talked about now coming back to being more like they've been historically for us. All that speaks to, you know, volume moving through retail stores, which is our prominent or our predominant business, volume moving into these craft growers, the smaller growers, and volume going into the hobbyists, the home grower, and the gray market, if you will. John, you wanna co-cover the inventory piece of Andrea's question?
I mean, for sure we've continued to just overall talk about inventory. Overall, we've continued to work down our inventory levels. I think you see that in this quarter once again from where we stood at the end of last year. We're down another $7 million-$8 million in inventory. That number should continue to come down as we work our way through across the rest of the year if we're doing our jobs right here. You know, with respect to lighting specifically, I do think that for sure us internally here at Hydrofarm, feel like we've worked through a very good portion of sort of the lower technology, a little bit more older generation lighting products, which tend to carry the highest amount of discounting associated with them.
I think across the industry, I think we're starting to feel a little bit like that stuff is working its way through the system. You know, as we, you know, work our way through the rest of the year, and we're obviously paying attention to lighting category, but overall, we're starting to feel like we're getting a lot of the higher risk lighting products behind us, which is good.
That's helpful. One of the things like how much, and it's across CPG as you know, but especially in your industry because there's so many layers until the final consumer. You said that this commercial delaying because of the legislation, other factors, how much visibility do you have on that? Because it kind of like, to your point, it might be anecdotal here and there. You don't know how much inventory of media or nutrients people have in their, you know, in their garages or, you know, in the. How do you know the level of inventory? To your point earlier, Bill, like how can.
If the weather gets, in the exit rate that you had in April, like if the weather not the weather, sorry, if the trends continue to be that way, then you should be seeing, to hit the low end of guide. What if, you know, what needs to happen? Not a lot needs to happen not to hit that low end of guide, it seems.
Yeah. We, as we try to be clear, we need that lift to continue and to pick up a little bit. We need to close some of these commercial opportunities that have been pushed out. If we get those things, we're back at, we're in the guide and we're, you know, back to the numbers we started the year with and, you know, the range that we started the year with. We're still within that range. We're trying to be as transparent as we can be and say that we expect right now as we see it, to go to the lower end of that guide. We expect the profitability to be just fine. We expect the free cash flow to be just fine.
You know, to your point on the visibility, we actually have better visibility on the new builds. When somebody says they're gonna start a build on May first and then they delay it, you can find that out pretty clearly. You know, it's a little tougher to tie it to inventories. I don't think it necessarily is. These are oftentimes new builds in new states, and in those situations, that's a new grow and a new opportunity, you know, for an MSO or for a craft grower to go into those areas. It's a little clearer on the commercial side. The pipeline and the backlog are sometimes pretty clear 'cause we've been working these projects for months and months and months.
It's not necessarily tied to an inventory situation as much as it is to getting the legislative approvals and getting all the things done so that the grower can start building and start growing.
Mm-hmm. Okay. That's fair. Thank you.
Thank you.
Ladies and gentlemen, as a reminder, if you would like to ask a question, please press star one. There are no further questions at this time. I would like to turn the floor back over to Bill Toler, CEO, for closing comments.
Great. Thank you, operator, and thank you all for your time and interest in Hydrofarm, and we look forward to speaking with you and working with you going forward. Thanks so much.
This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.