Hello, and welcome to GrowGeneration's Second Quarter 2023 Earnings Conference Call. My name is Chris, I'll be coordinating your call today. Following prepared remarks, we will open the call to questions from analysts and with instructions to be given at that time. I'll now hand the call over to Clay Crumbliss with ICR. Clay, please go ahead.

Good afternoon and welcome, everyone to the GrowGeneration second quarter 2023 earnings results conference call. Today's call is being recorded. With us today are Darren Lampert, Co-Founder and Chief Executive Officer; and Greg Sanders, Chief Financial Officer of GrowGeneration Corp. You should have access to the company's second quarter earnings press release issued after the market closed today. This information is available on the Investor Relations section of GrowGeneration's website at ir.growgeneration.com. Certain comments made on this call include forward-looking statements, which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on management's current expectations and beliefs concerning future events and are subject to several risks and uncertainties that could cause actual results to differ materially from those described in these forward-looking statements. Please refer to today's press release and other filings with the SEC for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any of the forward-looking statements made today. During the call, we will use some non-GAAP financial measures as we describe business performance. The SEC filings as well as the earnings press release, which provide reconciliations of the non-GAAP financial measures to the most directly comparable GAAP measures are all available on our website. Following our prepared remarks, we will take questions from research analysts. We ask that you please limit yourself to one question and one follow-up. If you have additional questions, please reenter the queue and we will take them as time allows. Now, I will turn the call over to our Co-Founder and CEO, Darren Lampert. Darren?

Thanks Clay and good afternoon everyone. Thank you for joining us today to discuss our second quarter 2023 financial results and our full year 2023 guidance. As always, I want to thank each one of our employees across our company for their continued support of GrowGen. I'm grateful to our entire team for stepping up to every challenge and for being steadfast in executing our company's strategy. I am pleased with GrowGen's second quarter results. I'm happy to discuss the great progress we have made against some of our key initiatives to drive future growth and profitability, including the official launch of our new ERP system on July 1st. In the second quarter of 2023, we generated net revenue of $63.9 million, which represents a 12% sequential improvement over the first quarter of 2023, consistent with the expectations we communicated earlier this year. Recall that historically the second quarter is the strongest quarter of the year due to seasonality of the planting and growing cycle. I'm especially pleased that we generated positive adjusted EBITDA of $856,000 in the quarter, which represents a significant improvement versus the prior quarter's adjusted EBITDA loss of $1.8 million. As we've detailed on previous calls, we made significant progress rightsizing our cost structure over the last year, and we're encouraged that those efforts are now bearing tangible results in our P&L. Additionally, we ended the second quarter with $71 million of cash, cash equivalents, and marketable securities, no debt and $77 million of inventory on our balance sheet. And year-to-date, we have generated more than $7 million of operating cash flow. All this to say, despite the ongoing challenges in our industry, GrowGen remains in a strong financial position to continue investing for growth, while putting profitability at the forefront. I'll reiterate that we are…

Thank you, Darren, and good afternoon, everyone. First, I will address our second quarter 2023 financial results and then I will discuss our updated full year 2023 guidance. For the second quarter, GrowGeneration generated revenue of $63.9 million versus $71 million in the second quarter of 2022, representing a decline of approximately 10.1%. Our same-store sales for the second quarter of 2023 were $44.7 million compared to prior year sales of $52.6 million, representing a 15.1% decline against the comparable year ago quarter. The decline in same-store sales in the second quarter represents a significant sequential improvement over prior quarters. Specifically, we observed a 21.5% sequential improvement in the second quarter compared to the first quarter year-over-year same-store sales percentage. Our e-commerce revenue showed a 9 basis point increase year-over-year and remain normalized at $3.7 million. Our distribution and other revenue was $13.3 million for the quarter compared to $12 million in the year ago period, representing an improvement of 10%. Gross profit margin was 26.8% for the second quarter of 2023, down approximately 185 basis points from the first quarter of 2023. The decrease in gross margin in the second quarter of 2023 was largely attributed to a 133 basis point impact from shrink and obsolescence expense, primarily driven from the restructuring of our distribution facilities, as well as a 32 basis point impact from margin pressure on lighting, primarily driven from vendor price reductions. The restructuring was a one-time event and related to the closure of our Ogden distribution facility and set-up costs associated to preopening of our Columbus, Ohio distribution facility. Store operating costs and other operational expenses declined from $13.8 million in the second quarter of 2022 to $12.3 million in the second quarter of 2023, representing a 10.9% reduction. The savings year-over-year were primarily attributed…

Thank you, Greg. Before we open the line for your questions, I want to reiterate that GrowGen is on solid financial footing with a strong balance sheet healthy liquidity and a solid cash position. We continue to manage our business prudently through the current industry landscape with an emphasis on sustainable growth, margin expansion and profitability. We are encouraged by our continued progress and remain laser-focused on controlling what we can control and ultimately emerge as a stronger, nimbler and more profitable company. Thank you for your time today and thank you for your interest in GrowGeneration. We will now take your questions. Operator?

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Aaron Grey, Alliance Global Partners. Aaron, please go ahead.

Hi, good evening, and thank you very much for the questions. First one for me, I want to talk about the guidance as it relates to maybe the embedded gross margin expectations. So you talked about for this quarter, 130 basis points from the shrinkage restructuring. So imagine that's more the onetime event. So just how best to think about gross margin in the back half, you get that 130 back, that lighting reduction of 32 basis points. Is that going to remain within that? So just any of the gross margin expectations have the back half embedded in the guidance would be very helpful? Thank you.

Greg, do you want to take that?

Yeah. So, hey, Aaron, as far as the back half of 2023, we're anticipating gross margin to normalize in the mid- to upper 20s. And what does that mean for our business generally. We're looking at a gross margin profile in that 27%, 28% range. And we're continuing to focus on private label penetration as a long-term strategy to continue to expand our gross profit margin on a long-term perspective.

Yes. Aaron, with that, what we are seeing and what we saw in the second quarter is tremendous discounting coming out of some of the vendors in the industry to move inventory. And with that, we've taken some onetime lumps on certain products that we're holding in inventory. And we do believe that will alleviate through the back half of the year. But on a normalized basis, we still do believe that you will see margins normalizing in the high 20s. And we do believe when this all shakes out, you will see margins that GrowGen in the low 30s, but certainly not in the back half of this year?

Thanks. I really appreciate that detail. And then going more towards the top line lowering the back half expectations like 2Q, it sounds like it came roughly in line with what you were expecting and certainly Wall Street was. So looking towards the back half and what you're seeing, are you seeing just more of a shakeout maybe within the cultivators and you might have been expecting less managers is just same clients, but then they're buying less? Maybe some more color in terms of what's driving that and what you're seeing out there and then whether or not you think that might be protracted being more of a shakeout or if it's just the current customer base buying less and maybe it rebounds more in 2024. So more of what you're seeing in terms of that outlook would be appreciated. Thank you.

Right now, Aaron, we just -- we're not seeing a pickup in CapEx as most of the cultivators are managing our balance sheets and waiting out the industry downturn. I think you've heard it from most of the MSOs and single state operators. They're not building unless they have to right now. And I think the name of the game right now is just wait and see. And what you're seeing is a very slow adoption in new states coming aboard. And in all states, a lot of the cultivators are happy with their positions right now, and they're not taking shots at adding to the physicians. They're adding to dispensaries, but certainly not the cultivation right now. And I think what you're going to need right now in the industry is whether it's the SAFE Act, whether it's legalization, whether it's something to get a shot in the arm. But what you're also hearing from the cultivators around the country and the large operators is there's just no capital coming in. And I think you see that also from your vantage point. And I do believe that the industry needs capital right now. There was a tremendous amount of facilities built in 2020 and 2021, and you'll start just seeing that people are just optimizing their facilities right now. But most of the sea changes you've seen in lighting and modification came in 2020 and 2021. And there will be a refresh cycle coming in the next couple of years with the products that have been bought, but we still do believe that it's going to take time. Our business was up 12% quarter-over-quarter, which we couldn't be happier with. But right now, we're just not seeing the enthusiasm from our customers right now on the build side of it. But like anything else, they're still managing their cultivation facilities and buying products from us every day.

Really appreciate that color. I’ll go back in the queue.

Thank you. Your next question comes from Brian Nagel, Oppenheimer. Brian, please go ahead.

Hi, good afternoon.

Good morning, Brian.

So just -- I guess to follow-up on that, the question, Darren. I know, we've talked a lot about the impacts of your partners, not as aggressively, you're not building out infrastructure. But as you look across the chain, and I guess you see some of these states are probably more legal, or have legalized more recently. Are you seeing a different trend there, or is it really across the board?

I think what we're seeing is a much slower trend in new legalized states, this late in the game, there are plenty of individuals that are still buying from the illegal markets. That's what they've done their whole lives. So it's just taking time to convert them over to the legal markets. But you're also seeing a lack of capital. Wall Street has not raised money for any of the MSOs recently, what you're starting to do seeing sale leasebacks here and there. But you're hearing it from the whole group. Everyone's optimizing their balance sheets and waiting it out and that's not necessarily bad for GrowGen. And again, we had a profitable quarter. We were up 12% quarter-over-quarter. And we've made tremendous strides in our private label brands, and we still do believe that you will see from GrowGen next year is us getting into the gardening space. We attended our first gardening show a few weeks ago, and we had tremendous interest in GrowGen products. We believe a lot of the products that we're selling into the cannabis space are changeable into gardening. And through customer segmentation and just what we're hearing and seeing from speaking with stores out there, that we believe the distribution centers that we're setting up right now, the leading ERP system that we just set-up will give us the ability to sell GrowGen products into thousands of independent garden stores around the country.

And then my second question, you mentioned you talked more about the acquisitions here. So just given the ongoing struggles of the sector, are you seeing more acquisition opportunities emerge. And then I guess related to that, is the pricing for these targets becoming more advantageous for you?

The answer to that is yes and yes, Brian. But on the other side of it right now, we certainly are taking a cautious stance in a lot of ways, and we will only buy best-of-breed right now. So we've turned down a lot of acquisitions in the last couple of months. We're happy with our portfolio around the country right now. There still are some states that GrowGen needs to be in. We'd like to be in Maryland. We'd like to be in Ohio right now. We'd like to be in New York. So you will see stores in those states. But we don't believe right now that we need to go much deeper in the states that we're in.

I appreciate the color. Thanks, Darren.

You’re welcome.

Thank you. Your next question comes from Andrew Carter, Stifel. Andrew, please go ahead.

Hey, thanks. Good evening. What I wanted to ask is kind of looking in the back half guide, you're applying kind of actually flat with the first half of the year. Store base was 64% at the end of the quarter, if I caught that. Is it -- are you closing more stores are the stores that you build that are greenfield in line with your projection? Kind of just -- yeah, what's the store closure target for the second half?

No, I'll start with the stores that we purchased this year, Andrew, are in line with our targets and performing well. We have no issues with any of the purchases that we've made this year. As we said, I think in our in our script today and press release, we will be closing some more stores. With distribution that we've built out in our new ERP system, there are certain stores that are close to other locations. I mean with the industry where it is right now, that we believe there is room for optimization both on -- right around GrowGen and costs, and we will be working on cost structures over the next six months.

Second question I ask about how -- you mentioned discounting. You mentioned lighting in particular. So number one, how much more do you have? How much inventory is kind of upside down or was that all taken, and how pervasive is the discounting? Is it isolated the lighting, or are you seeing it in other product categories as well?

I think in the second quarter, Brian, it was isolated mostly to lighting. There was lighting inventory that we had from some major vendors of ours that discontinued certain models and brought pricing down up to 80% on certain of those models, and GrowGen was holding inventory and it also did bring down pricing for the rest of the industry during those sales. Most of that inventory has been moved through. So we don't see it continuing. And again, we took our lumps in the second quarter because of it. You're seeing sporadic discounting. You're seeing stores going out of business around the country. So there's always -- if it's not one thing, it's another, but like anything else, as you've heard, our private label brands are performing well, 15% of sales within our stores right now, and that's not within our distribution channels. We're selling into 500 stores around the country. So we do believe as we continue to bring out best-of-breed products that margins will go higher and sales will go higher. We're working through a tremendously difficult time in this industry. And our team has done a tremendous job navigating the waters

Thanks. I'll pass it on.

Thank you.

Thank you. Your next question comes from Eric Des Lauriers, Craig-Hallum Capital Group. Eric, please go ahead.

Thank you for taking my questions. So, my first one, it sounds like the guide is mostly resulting from the sort of lower-than-expected durable sales. So, my question is, how consumable sales are sort of trending so far this year and sort of what's embedded in the guide here? You're commenting on private label sales, which are mostly in the consumable area that you're considering -- continuing to see some strength there. So, I was just kind of wondering if you can sort of shape the second half outlook sort of between durables and consumables, that would be great? Thanks.

Greg, do you want to try to unpack that for us?

Yes. Yes. So, Eric, for the back half of the year, we're looking at total revenue of somewhere in the range of $100 million to $105 million. We traditionally see more strength in the third quarter, of course, in the fourth. In terms of what does that mean for CapEx or consumables? And what we've been seeing from a trending perspective over the last several quarters, is it mix of about 70/30 even as high as 75/25 on consumables versus CapEx. And like Darren alluded to earlier, we're just not seeing the build activity that we expected into many of the newer states that have come online recently. So, we're hitting the brakes a little bit on expectations in the back half and focusing on driving profitability from the base of revenue that we expect now in the back half. So, hopefully, that helps answer the question.

Yes. No, that does. And could you just kind of help us frame it a bit. So, currently, 70/30-ish consumable durable split, how has that changed from like the hay days of 2021 and 2022? And just kind of wondering where you see durables kind of bottoming out? I mean is it reasonable to assume that consumable sales are kind of continuing to grow nicely and you just have this -- that's just being kind of more than offset by durables here and that eventually durables will start to bottom and you'll kind of return to growth just on consumables. Is that sort of the right way to think about it, or is there anything else that you would add to that?

Yes, I can take that, Greg. One, the consumable part of our business is and always will be the stronger part of our business is the recurring part of our business. When you look at the durable business, sometimes it's a one-time sale of a big build-out of low margins. So, when you look at GrowGen, we will continue to build our consumable brands and we do believe our consumable brands have access into other parts of the industry into the gardening space. And that's really what excites us today. We believe right now that, that 70/30, 75/25 mix will set, you may have certain quarters of pockets of strength on the build side. But most of it does go away when you find saturation on the building. It just depends how this industry continues to grow. When you look a few years ago, forecasts were to go to $100 billion by 2030 on the legal side of it. And right now, I think you're still under $30 billion. So, the industry has slowed. So, I would tell you that dependent upon the growth of the industry from the cultivator side -- from the cultivation side is really how large our durable business will grow. But we feel quite comfortable that the other part of the business, the consumable part of the business does pay the bills. And during the hay day was probably 60-40 and right now, it's probably running 75-25 if you took a hard look at it. And -- but we do believe there'll be refresh cycles coming online. So you will see pockets of strength in the future.

Okay. Great. That's very helpful. But it sounds like this 70-30, 75-25 is kind of sustainable for the status quo, which is good to hear. My last question is just on how to think about OpEx in the second half of the year. Obviously, there was some commentary on continued rationalize expenses and more store closings. But I just wanted to see if perhaps there will be any impact from the ERP implementation. I may have missed a comment there. So just wondering, if you could kind of flush out the OpEx implication for the second half of the year? Thanks.

Yes. Eric, I think what you saw from us in the second quarter is we took down total expense, $600,000 compared to the first quarter. So we did see some improvements in the second quarter itself. And we believe that we'll continue to see expense improvements, both in SG&A and operating expense in the back half of the year. We're continuing to execute on store consolidations, so where we'll see improvements directly in operating expense. And we have some improvements in SG&A that we expect as well in Q3 and Q4. So you'll see continued improvement from us from a cost perspective as we get through the remainder of the year. And that's important to us as we look at profitability against a lower base or aiming for that metric against a lower base.

Thank you for taking my questions.

Thank you. Your next question comes from Scott Fortune, ROTH MKM. Scott, please go ahead.

Yes, good afternoon, and thanks for the questions. Just want to follow up on, I guess, a couple of your bigger markets, California, Michigan, Obviously, you've seen weakness across the -- or you're expecting weakness across the board in the second half. But just speak to those states more where we have higher exposure, what are you kind of seeing and kind of the turnaround efficiency in California or kind of lumping all these things together here?

Yes, I think when you look at California right now, Scott, we're seeing more strength in the Northern California than we are in Southern California right now, even though our store is growing in downtown L.A. when you go out to the -- out to the coast and out to Temecula in that area, Anza Lake Elsinore we're seeing tremendous weakness out there. So I guess it seems to be that it's scattered. And I think it's scattered more with the outdoor growers, our Santa Rosa store is performing well. So we are seeing some strength in California, and we are seeing some weakness in California. And we are -- we do believe that we'll be closing probably another two to three stores in California in the third and fourth quarters. We're also seeing weakness in the San Diego area. So I think it's case by case just dependent upon where the customers are and where they feel comfortable growing right now. But some of the old, very strong areas in California have become very weak, and it's mostly outdoor growing out there. Michigan right now for us is pretty steady. We're not seeing a lift in Michigan, but we're not seeing further degradation in the business in Michigan right now. Back east, again back east still remains -- it remains flowing for us. So business right now, you saw same-store sales were down 15% in the second quarter and that was versus 37% in the first quarter and 50% or something a year earlier. So you're seeing certainly that we're getting to that breakeven on same-store sales point, so we definitely have seen an uptick, but not like we would like to. We were certainly expecting much more pickup going into the third and fourth quarters. And one of the reasons we're bringing numbers down today is we speak to cultivators every day. Our guys are on the street. We have over 600 employees out there. And they're just not seeing -- they're not seeing the work coming in on the build side right now. But again, on the other side of it, people are buying soils every day. People are buying new seeds to feed the plants every day. So we still have 75,000 customers a month coming into GrowGen.

Got it. I appreciate the color there. And then just real quick, obviously, one of your peers or supplier or you call them as mentioned in quarterly earnings, maybe it's time for the hydroponic market to kind of start getting more combinations together strategically, I know you can't really talk about it specifically, but how are you looking at the competitive or kind of the partnership opportunity in the hydroponic market kind of going forward here overall?

So the one thing I could tell you is we built this business from zero revenues in 2014, $30 million of revenue in 2018. Our balance sheet remains the strongest in the industry, which gives us tremendous flexibility really to do basically to build out the business model that we've set forth. We're tremendously excited about bringing our products into the home and garden space. As I said earlier, we were at our first Garden Show and had tremendous interest from the independent garden arena. So we're very excited. We're bringing best of breed products to market. Does GrowGen need to consolidate? The answer is definitely not. But like always, Scott, as I say, whatever is in the best -- whatever best for our shareholders, we will always entertain. But we've built quite a business. We just built out our ERP system that's taken us two years and a tremendous amount of money. We built out distribution, so we have distribution of leading products that can go anywhere from cannabis to gardening. And what this world lacks right now is really an independent gardening chain that has been -- that has the knowledge of GrowGen.

Got it. I appreciate the color. Thanks, Darren.

Thank you. [Operator Instructions] Your next question comes from Mark Smith, Lake Street Capital Markets. Mark, please go ahead.

Hi, guys. My question is really just first off around the comfort with the current inventory. You talked about some tough weakness with Lighting? Is there anything out there that you've got an inventory that you're a little nervous about, or how do you guys feel about it today?

Yes, Mark…

Go ahead, Greg. I'm sorry.

No, you're good. Yes, Mark, I think when you look at our inventory, we ramped up inventory slightly in the quarter, largely due to some risk associated with the ERP launch. I think the ERP launch from an all practical standpoint for us went pretty well at the beginning of July here. So we're working on bringing inventory back down a bit in the second half now that we're comfortable with kind of where we're at on that initiative. In terms of our inventory itself, we look at it from an obsolescence lower cost of market, overstock position frequently every single quarter at a minimum. So we feel good about our reserves and how we look at our inventory. But we're certainly looking to make some incremental improvements through the back half of the year, particularly as it relates to the updated sales forecast that we have. Hopefully, that helps.

That's helpful. Other question is just as we think about the store count and kind of big picture here, Darren, it sounds like a couple of more closures coming probably in some of the more mature bigger states for you. Can you talk two things, which states you really like? I think you mentioned New York, Ohio, where you really want to expand. And then also, as you look at peers, you'd mentioned some peers going out of business were hurt just as they kind of liquidate their inventory. Does that present a good long-term opportunity as you move into the market somebody else kind of goes out of business and then it gives you opportunity to really take share over time. Maybe talk about where you're seeing opportunities, whether it's from closures from peers or states where you really want to expand?

It goes both ways. I mean, we've done that. When we moved into the Missouri market, we built a store out in St. Louis. And prior to opening our store in St. Muller's a competitor went out of business. We bought their inventory, took their staff and moved it into the GrowGen store. So it's a -- it gives you a tremendous leg up opposed to building a store slowly, if you can -- again, if you can take a store that makes sense in a place you want to be, it's always easier than building right now. So we do look at that. And even looking at stores that could be close to our taking their inventory and customer list -- in this industry, it's quite fickle. Many customers still like to shop at their old hydro products or from 10 years ago. They have friends that work there. So we are very careful when it comes to that, and we've turned down a lot of purchases that just weren't where we wanted to be. And we do believe with distribution and GrowGen private label products there are places that we have good customers that we sell to that we'd rather not compete with right now. So we weigh everything and whatever is in the best interest of our company, we will do. So right now, it's not a rush to build 100 stores. That rush was a couple of years ago, three years ago when the industry was booming. Right now, we're solely focused on, on managing our footprint, managing our balance sheet, managing our private-label initiatives and distribution right now. So we will be adding stores much slower than we thought. And waiting really to see where this industry goes. But we are focusing, so as I said, really on getting distribution up and getting private label into other locations.

Excellent. Thank you.

Thank you. Your next question comes from Glenn Mattson, Ladenburg. Glenn, please go ahead.

Yes. So private label, I saw 15%. I know that's kind of like flat line from last quarter. I think last quarter was around that same level, up big year-over-year. Can you just talk about what do you do to push that a little higher over the medium term. You've talked about it a little bit, but just some detail maybe on like new product innovation. I mean, you talked about the gardening space that's interesting, but I imagine it's going to take some time to build progress there? And where you touched on that also in the gardening space, could you hit on what kind of investment you need to make to go after that space given that there's other incumbents and all that kind of thing? Thanks.

Good question, Glenn. To start with, we have many line extensions coming out with brands that we do have. So you will see line extensions within our Drip Hydro brands within our Char Coir brands. So we continue to innovate. We have another line extension shortly, hopefully coming on the Drip on the powder side of our liquid brands. So like anything else, private label is growing. It started at zero a couple of years ago. We'll have certain quarters of stagnation within it as new products come to market. So again, we're very happy with that. The gardening space right now, Glenn, we're not -- that is -- that's a work in progress at the second quarter event next year that we're putting together a plan that we will update Wall Street on probably in the fourth quarter.

Okay. And any other comments you can make on the top line in terms of seasonality in the back half? Because I'm just going back historical like in 2022, which was not necessarily a banner year, it was flat Q2 to Q3 2021, which is a different environment. Obviously, it was down maybe 10% or something Q2 to Q3. Is that Obviously, Q4 is the weakest, but can you just give us any sense of the magnitude from one quarter to the next?

I think what you've also seen in prior years was us adding stores during the second and third quarter, which helped sales in the latter part of the year. But the second quarter was planting season, third quarter was harvest season for outdoor. So we usually see the strongest part of the season is in the second quarter. And third quarter usually does remain strong. As Greg said a little -- as we said a little earlier, we're still assessing our ERP system. The rollout was like anything else, it’s always challenging. So we're still assessing, there were certain sales loss because of it, but we do believe that it's moving in the right direction. We're just not seeing right now the CapEx building we would like in the third quarter, and it's quite early and we thought it was prudent to bring numbers down. Certainly, we hope we beat them. But right now, third quarter appears to be slower than the second and the fourth quarter usually is the slowest quarter of the year.

Okay. Great. Thanks.

Thank you. There are no further questions at this time. I will now turn it back to Clay Crumbliss for closing remarks.

Great. Thank you for joining our second quarter earnings call today, and thank you for your interest in GrowGeneration. That concludes the call, and we'll speak to you again in November. You may disconnect.

Thank you. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.