Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Hydrofarm Holdings Group’s 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 10, 2023. I would now like to turn the conference 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 more detailed discussion of the risks that could impact our future operating results and financial condition. Lastly, during today’s call we will 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.

Great. Thank you, Anna Kate, and good afternoon, everyone. During the first quarter, we continued to see signs of stabilization in the industry as we saw our first quarter sales increased sequentially from Q4 2022 to Q1 2023. We remain focused on controlling and cutting costs to Hydrofarm, including rightsizing 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 and 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 initiatives. 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, 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…

Thanks, Bill, and 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. For example, our total 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. Second, our international sales outside of the U.S. and Canada grew sequentially and then on a year-over-year basis. While international sales make up less than 2% of total sales, the significance was 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% in net sales in the first quarter, compared to $22.3 million or 20% in net sales last year. The increase in adjusted gross profit margin is largely due to improved brand mix, improved productivity, primarily in…

[Operator Instructions] Our first question comes from Andrew Carter with Stifel. Please go ahead.

Yes. Thank you. I just want 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. But could you help us understand right now kind of what the April trends are looking like 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.

Yes. Hey, Andrew. Thanks. I’ll start and John can fill in the blanks, if I leave some there. Yes. I think in simple terms, April was a little weaker than we’d hoped and May has started to pick -- has really picked it up a bit, which is great to see. So, we’re not quite sure if the delay was holiday timing or weather or what it was in April. But we think that 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. And your right, it’s sort of in that low-teens kind of area, which is kind of the average of what we’ve seen over the last four out of the last five years. So, we think it’s a reasonable assumption, although the industry has been through a tough time over the last six quarters. But yes, the May numbers have given us some encouragement, but we’re only a third of the way through the months. I hate to put too much credence into that. And that’s why we thought it was prudent to stay within the guide, but kind of recognize that we’re probably on that lower end of the guide at this point.

Second question is in terms of the pricing, you kind of highlighted last quarter that you were going to have kind of a negative pricing because of the lighting. Could you quantify how much that weighed? And I believe for your expectations are positive price mix, do we see positive price mix come through in this up -- in 2Q? Thanks.

Yes. Thanks, Andrew. I’ll jump in on that one. Yes. We did, as you point out, expect to have negative price next in Q1. And indeed, it was due to the lighting sales, which was also what we had suggested. When we look at the math, if you exclude the discounted lighting sales that we had in Q1, we do see positive price mix beneath that. So, 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.

Our next question comes from Bill Chappell with Truist Securities. Please go ahead.

I just want to follow-up just -- 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, if that’s just product mix or geographic or anything else, we should be thinking about, or are you seeing the whole category getting -- get a lift?

Yes. Good question. Because really, what we’re seeing is we’re seeing the consumables lift, right? And 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. And the reason is that right now we’re getting people back into the repeat purchase of consumables, but the delays in builds and the delays in refurbishments and delays in all the issues and new states and stuff has cost us on the commercial side, which is more durable for us. So yes, it is more about portfolio than it is about -- differently.

Sorry. You cut off there for a second. And then, in terms of [Technical Difficulty] reported six weeks ago, not sure how much has changed in terms of the opening up front. But trying to understand, if in New York, Connecticut, stuff like that, if you’ve seen any kind of further brigs -- further opening up, any regulations start to fall, things that are moving any faster, or it’s still kind of all in line with expectations?

Yes. It’s still kind of moving slowly, in spite of Delaware saying yes, and Minnesota moving, the North Carolina being rumored to be closer. We’re in the states that kind of have these big legislative quagmires going on, we haven’t seen much progress in all. And a number of our projects that we thought would come in and Q1 had been delayed and push to Q2, Q3 and onward. And so, that’s been part of the slowness of the commercial business, has been these, these delays. So no, we have not seen a lot of progress in those key states.

Our next question comes from Andrea Teixeira with JPMorgan. Please go ahead.

I just want to kind of go back a bit with what’s happening to the end consumer, if you’re sitting down-trading. And I know you don’t touch the plants, but perhaps talk about what’s happening in the most recent legalized state. I mean, it sounds recent, but it was not recent, but just says, as we see the last mature states, if like the whole dynamic between black markets and legalized or dispensaries have changed, if there’s any down-trade helping the non-commercial producers? And in that vein, if you think that there’s inventory buildups to working through outside of lightning, or in lightning, you are seeing also that kind of like being worked out already? Hopefully.

I’ll start and then John can speak to inventory, which I think is largely what you said lighting. But 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. And so, 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 -- our businesses still dominantly retail oriented. So, we’re starting to see that picking up a bit. And on the flip side of that, the MSO, the commercial side of things, those builds and those refurbishments are going much slower. So, 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, and 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 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. I think that’s part of we are, what we are. And relative strength in that retail 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 volume moving through retail stores, which is our predominant business, volume moving into these craft growers, to smaller growers, and volume going into the hobbyist, the home grower in the gray market, if you will. John, do you want to cover the inventory piece of Andrea’s question.

Yes. 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. And 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. 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. And 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. So, as we work our way through the rest of the year, 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.

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 and to the final consumer. So, you said that this commercial delaying because of the legislation other the factors. How much visibility do you have? Because it kind of like, to your point, it might be anecdotal here and there, you don’t know how much inventory of media and/or nutrients people have in their garages. And so, how do you know the level of inventory? And 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. But what if -- what needs to happen, not a lot needs to happen, not to hit that low end of guide, it seems.

Yes. As we try to be clear, we need that lift to continue and to pick up a little bit. And we need to close some of these commercial opportunities that have been pushed out. If we get those things then we’re back -- we’re in the guide and we’re back to the numbers we started the year with and the range that we started the year with. We’re still within that range, but 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 profitability to be just fine. We expect the free cash flow to be just fine. But, to your point on the visibility, you actually have better visibility on the new builds when somebody says they’re going to start a build on May 1st, and then they delay it, you find that out pretty clearly. When they -- it’s a little tougher to tie it to inventories, I don’t think it necessarily is. These are oftentimes new builds and new states. And in those situations, that’s a new grow and a new opportunity for an MSO or for a craft grower to go into those areas. So, it’s a little clearer on the on the commercial side, the pipeline and the backlog are sometimes pretty clear, because 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.

[Operator Instructions] There are no further questions at this time. I would like to turn the floor back over to Bill Toler, CEO, for closing comments.

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.