Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Hydrofarm Holdings Group Fourth Quarter and Fiscal Year 2024 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, March 5, 2025. I would now like to turn the call over to Anna Kate Heller at ICR to begin. Please go ahead.

Thank you, and good morning. With me on the call today is John Lindeman, Hydrofarm's Chief Executive Officer; and Kevin O'Brien, the company's Chief Financial Officer. Bill Toler, Executive Chairman of the Board, is also on the call. By now, everyone should have access to our fourth quarter and full year 2024 earnings release and Form 8-K issued this morning, as well as an investor presentation available for reference. These documents are available on the Investor section of HydroFarm's website at www.hydrofarm.com. Before we begin our formal remarks, please note that our discussion today will include forward-looking statements. These forward-looking statements are not guarantees of future performance, and therefore, you should not put undue reliance on them. These statements are also subject to numerous risks and uncertainties that could cause actual results to differ materially from our current expectations. We refer all of you to our recent SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial condition. Lastly, during today's call, we 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 John Lindeman.

Thank you, Anna Kate. Good morning, everyone. I'm pleased to be speaking with you on my first call on the capacity of CEO, the transition that occurred on January 1st of this year. And before I begin, I want to thank Bill for his leadership over the past five years and his continued support in his role as Executive Chairman. Now, let me begin by stating that we made some notable improvements across the business in 2024. Though the benefits from some of these improvements were massed by a challenging second half, particularly in the fourth quarter, industry conditions weaken in the second half of 2024, marked by persistent oversupply challenges and further retail store closings across the sector. This has resulted in lower sales across the supply chain, a trend we are seeing echoed across our industry peers. That said, I'm pleased to report that we finished the year with sales comfortably within our full year outlook and successfully completed reductions in adjusted SG&A to our effective cost saving and restructuring actions. Having said that, our 2024 adjusted EBITDA and free cash flow fell short of guidance due primarily to our fourth quarter performance. While it is seasonally our smallest quarter, fourth quarter sales came in softer than expected due to industry conditions. For quite some time, we have been clear that our strategic priority is driving the sales of our higher margin proprietary brands. This strategy has yielded positive results as we have improved our proprietary brand sales mix from approximately 35% in 2020 to 56% in 2024. This strategy has allowed us to operate profitably for the majority of quarters over the past two years, even as industry sales levels have compressed. In October and November, we saw our proprietary sales mix slip, which significantly pressured our…

Thanks, John. And good morning, everyone. I am excited to be here on my first earnings call as CFO at Hydrofarm. Net sales for the fourth quarter were $37.3 million, down 20.9% year-over-year, driven primarily by a 16.8% decrease in volume mix and 3.9% decline in pricing. The decrease in volume mix was mainly related to an oversupply in the cannabis industry. As we had indicated last quarter, the pricing decline was driven largely by promotional activity in the period. As John discussed before, overall brand mix slipped during Q4. Our proprietary brands represented approximately 52% of our total net sales a decrease compared to the prior year period. We started Q4 2024 with weaker proprietary brand mix performance compared to our expectations. As John noted, we began implementing several corrective actions and have achieved some recovery and proprietary brand mix over the past few months. The negative impact on profitability made clear our strategic priorities for 2025. We are focused on driving performance of our higher margin e-proprietary brands, and we'll be investing in them to approve this mix in 2025. For the fourth quarter and full year 2024, consumable products continued to account for approximately three quarters of our total sales, which was similar to 2023. Gross profit in the fourth quarter was $1.8 million or 4.9% in net sales compared to $8.4 million or 17.9% in net sales in the year ago period. Adjusted gross profit was $3.6 million or 9.6% in net sales, compared to $11.5 million or 24.3% in net sales last year. The decrease was due to lower overall sales and a decreased mix of our higher margin proprietary branded sales in the quarter. We also incurred approximately $1.4 million of inventory related charges that were not associated with our restructuring plans. During the…

[Operator Instructions] We'll take our first question from Dmitry Silversteyn from Water Tower Research.

My question, I should say. You mentioned that a lot of your fourth quarter performance was driven by what's going on generally in the market and the industry. Can you talk a little bit more about the -- what the dynamics look like for the broader environment in your categories as you look forward to 2025 and maybe provide some granularity on when you think oversupply in the channel will be worked off?

Thanks for joining. Yes, sure. I think for starters, you need to look back to early last year in 2024. There was a lot of optimism in the category about rescheduling happening, about Florida passing about the Safer Banking Act kind of coming into its own finally. And that helps spur a lot of sequential improvement in spending for a period of time wasn't a lot, but it was a sequential improvement from towards the end of '23 into the spring of '24. As it became more clear that there was going to be a presidential administration change and then Florida not passing, I think expectations and time lines were reset or prolonged. We could see a return to growth in the second half of the year. Who knows maybe increased U.S. border security will have some positive impact on U.S. cannabis pricing, which would be a good thing for growers. Paris are also a little bit of a wildcard right now, at least for supplies coming from China, Canada or maybe even Europe. We'll just have to see. I mean, our -- as for our internal models, we're expecting double-digit sales declines early in the year that moderate as the year unfolds. Regardless, we will be focusing on our key initiatives that I mentioned earlier, we're going to focus on improving our proprietary brand mix driving more diverse revenue streams, both outside the U.S. and Canada, and outside of the cannabis industry, improving our profit margins. We have an opportunity to further optimize our distribution center network we could extract some decent savings there and the opportunity to drive more SG&A savings, those things also certainly -- both of those will have an opportunity to help our free cash flow. We also have an opportunity, we believe, to continue to manage down our inventory levels given the current demand environment, and manage our working capital and free cash flow. As you heard Kevin mentioned, we completed a few ERP integrations this past year. it opens up and gives us a little bit better line of sight on some of our working capital in a way that we think there's opportunity. So in general, hopefully, that helps to give you a little bit more perspective on that and now.

It does. I want to follow up, if I may, on your cost-cutting initiatives. You talked about rationalizing your manufacturing infrastructure and your warehouse and distribution. The cost savings that you're getting out of the SG&A, thanks to the ERP going live. What can we look forward to in 2025 in terms of incremental benefits of the actions that you've taken? How much more can you improve your operations and improve your efficiencies as you move through 2025?

Yes. Great question. Yes, I mean, look, there's an opportunity for sure to continue to extract some additional savings, and we have a series of actions lined up. I would say, certainly, I mentioned it earlier, but optimizing our DC network further to something we could do, and we could do it a couple of different ways. We can expand our sublease 3PL relationships or add new ones to effectively reduce our already actively operated space, and reduce our net facility costs. We may have an opportunity to completely consolidate one or more of our DCs into other DCs. We've done that once before. We actually saw really good inventory level savings by affecting that trade. And so we're looking at both of these options right now. And there's an opportunity in front of us, perhaps in the Western U.S. There's also an opportunity to further reduce our SG&A cost. I mean we've taken a lot out already to be fair, but we do have line of sight currently on over $2 million to $3 million savings, and we think there's opportunity for more. Lastly, maybe on this point is within our working manufacturing centers, we also have an opportunity to get some lab benefit productivity initiatives that went into place last year. Now remember, we consolidated 2 manufacturing facilities, actually 3, into the remaining 2 here in the U.S. around midyear last year, and then we still have our facility up in Canada. Now some of those benefits may be masked by just depending on how much demand pull-through we ultimately get this year. But our models do suggest that if we hit sort of the mid favorable end of our range, we should see some manufacturing benefit this year, too. So and also in light of the things I mentioned on working capital, consolidating DCs just to underscore that, really do have a positive impact on our inventory reductions. And so good opportunity from a working capital standpoint there. I think those are the main points, I think.

That's helpful. If I can ask maybe kind of a 30,000 foot view question. Investors many industries are concerned or at least talking about the potential impact of tariffs, whether already announced or potentially announced. We also have, obviously, you mentioned the new administration, new HHS Secretary, this focus on cutting regulations and perhaps doing something with the classification of cannabis. If you look at sort of these things that are beyond your control, but do you have a view on how this may impact you either positively or negatively, whether the industry overall or used specifically?

Yes, sure. I mean for sure, there's a lot of moving parts in tariffs these days, but I totally get that it's on investors' minds. It's on our mind, right? I mean we've got a lot of things in place that we're working on against this. I would say, first, it's important to kind of understand the historical balance of trade for us here at Hydrofarm. Between the U.S. and Canada, we actually send some product up into Canada and we received some product in the United States reciprocal from Canada. But when you match those 2 together, we're effectively a net importer from Canada. If you look back to 2024, roughly 5% of our total sales came from Canada. And in a meaningful way, it is applicable to our peat business up in Edmonton. And as it stands now, we see competitors passing along to customers, the incremental cost of tariffs -- and in that instance, we intend to do the same. But it's a very fluid situation. I think there are customers and frankly, people across the broad population that still think there's some chance that these may be somewhat temporary if the administration to the North sort of meets the expectations of the administration here. So we'll just have to see. But as it stands now, we're intending to sort of follow what we're seeing in this respect and pass along these incremental costs. We're not expecting currently any significant volume impact, but we certainly could see some customers making choices in how they speculate about tariffs, which are obviously in play now. But kind they think they last, we could see some drawdowns on allocation of product that they have with us from one quarter to the next. And certainly, all of this could change our…

John, thank you for that level of detail. I appreciate it. And then one final question, if I may. You mentioned that you may become a little bit more or not become, but be a little bit more active, if you will, or have some thoughts on the M&A side of the business, whether partnering or perhaps an acquisition. Can you talk a little bit more about specifically what is it that you're looking for? What are you going to look out for? And what are some of the things that you may be considering when it comes to strategic moves for the company.

Yes, I probably need to be a little bit careful here and specificity. But look, I can certainly say, we can imagine that this is on the minds of all of our stakeholders. Frankly, it's on our minds. And so I'm really glad you asked. If you look at sort of all the key players across the category, we've all been experiencing the same thing. I mean revenue declines and demand declines have quite simply been pervasive now for 2 years plus and has been prolonged and taking longer for a turnaround than all of us would have wanted or expected. And so usually, when you see that kind of thing in an industry there tends to be a fair amount of real consolidation in our industry, at least among sort of the more meaningful players in the supply chain there really just hasn't been a lot of consolidation. And so we just wanted to be very clear about it, that we can control what we can control and Bill and I have been consistent on this. We continue to monitor very aggressively opportunities that could enhance shareholder value. That could be -- we could possibly pull up a tuck-in acquisition that helps us diversify either geographically or quite possibly outside of the cannabis space altogether. We've also looked at some opportunities. We know there's some assets inside of our business that have real attraction to some folks. And so we've at least given some of those things, some real consideration. And then lastly, complete strategic combination is something that in a couple of instances, we think could be really helpful for the industry overall and frankly, make it a little bit of a healthier place but also good for our shareholders under the right set of conditions. And so Bill and I and others here, we continue to work this. So along with some partners of ours. We'll just have to say.

Understood. I appreciate that, and I understand you can be more specific, but I wish you the granularity on that. Well, I'm going to get back into the queue and just wish you luck in 2025. It sounds like we're going to start the year a little bit slower, but hopefully, the momentum will build as the year unfolds.

And at this time, we have no further questions. That will end today's presentation. We thank you for your participation. You may disconnect.