Participants

B. John Lindeman; Chief Financial Officer; Hydrofarm Holdings Group Inc

William Toler; Chairman of the Board, Chief Executive Officer; Hydrofarm Holdings Group Inc

Presentation

B. John Lindeman

Consumable products. Once again, made up more than three quarters of our total sales, outperforming durables, consumable products comprised approximately 79% of our total sales in Q3. An increase compared to last year overall brand mix with solid during Q3 as our proprietary brands represented 56% of our total net sales compared to 54% in the prior year period.
Importantly, even with our proprietary, even within our proprietary brand bucket, we sold a greater mix of our higher margin brands compared to last year.
Gross profit in the third quarter was $8.5 million or 19.4% of net sales compared to $3.3 million or 6.1% of net sales in the year ago period, adjusted gross profit was $10.7 million or 24.3% of net sales compared to $12.5 million or 23% of net sales last year.
The 130 basis point increase is primarily due to a better mix of our higher margin, proprietary branded sales in the quarter and increased productivity within select manufacturing facilities.
We also recorded no significant inventory write downs during the quarter. As Bill mentioned, this was our sixth consecutive quarter with the just the gross profit margins at or above 23%.
That said there continues to be room for improvement if we continue to execute on our strategic priorities, including our focus on proprietary brand sales and further improving our operational productivity.
A quick update here on some of our recent restructuring, cost saving actions. As we mentioned last quarter in June, we consolidated our grow media manufacturing by closing our smallest facility followed by a greater than 30% reduction in our Northern California facility in July.
Our manufacturing is now concentrated in two US locations plus our peat moss harvesting and processing facility in Canada.
During the quarter, we began to realize small but incremental efficiencies and cost savings from these consolidations. We are currently evaluating opportunities to optimize our distribution center network including potential third party logistics partnerships for one or more of our dcs in the US and Canada lastly, we successfully integrated one of our Canadian entities into our main ERP system during the quarter. Building on these achievements and our previously consolidated back office functions. We now intend to fully integrate our US and Canadian front office and operating teams over the next two quarters, we expect these actions to drive operation, operating efficiencies and potential revenue synergies on both sides of the border.
We look forward to sharing more details next quarter as we further streamline our business into one cohesive team.
Moving on to our selling general administrative expense where we continue to realize significant savings in the third quarter. Our SG&A and a expense was $17.6 million compared to $19.5 million last year adjusted SG& A expenses were $10.7 million. A nearly 11% reduction when compared to $12 million last year.
These savings are due to reductions across a wide range of items including facility expenses, head count reductions, professional fees and insurance costs.
Year-to-date, we have achieved a 19% reduction on the adjusted SG&A line compared to last year adjusted EBITA was slightly positive in the third quarter and year-to-date our adjusted EBITA of 2.1 million has more than doubled compared to 2023. Demonstrating the success of our restructuring and cost saving initiatives and our ability to operate profitably on lower sales levels.
Moving on to our balance sheet and overall liquidity position our cash balance as of September 30th was $24.4 million down from our balance of $30.3 million. At the end of the second quarter. Last year, we ended the third quarter with $119.6 million of term debt and approximately $128 million of total debt inclusive of financial lease liabilities.
Our net debt at the end of the quarter was approximately $104 million.
As a reminder, our term loan facility has no financial maintenance covenant does not mature until October 2028. We continue to maintain a zero balance in our revolving credit facility with our cash on hand and over $17 million of availability on our untapped revolving line of credit. We have over $41 million of total liquidity. A comfortable position for us.
In the third quarter, we reported cash flow from operating activities of negative $4.5 million with capital expenditures of $ 0.8 million yielding free cash flow of negative$ 5.3 million cash flow in the quarter was impacted by our investment in new partner brands that bill referenced earlier and temporary working capital delays from our US, Canadian ERP and related people integration.
While these impacts have put pressure on free cash flow. We are reaffirming our expectations to achieve positive free cash flow for both the fourth quarter and the full year.
With that. Let me turn now to our full year 2024 outlook.
We are reaffirming our 2024 guidance on key metrics. Net sales are tracking towards the middle of our outlook range which calls for a decline of low to high 10s on a percentage basis. We are also reaffirming our expectation for adjust but now that is positive for the full year 2024 and positive free cash flow for the full year as well, which includes an updated expectation of $2.5 million to $3.5 million of capital expenditures.
We also included a couple of updates to our full year assumptions in today's earnings release.
We are confident in the long term potential of this business. We continue to successfully execute on our cost saving initiatives and have proven the ability to operate profitably at lower sales levels.
We remain committed to our strategic priorities including diversifying our revenue streams and further improving our sales mix via our proprietary brands. We are also optimistic about an eventual industry turnaround and believe we are well positioned to capture any incremental demand profitably. I will now turn the call back over to Bill.

William Toler

Thanks John. And before we take questions, as we announced last month, I am retiring from the CEO role in transitioning to executive Chairman effective on January 1st of 2025. When John will take over as the CEO having turned 65 earlier this year.
This is the right time for me to make change. That said I'm not really going anywhere. I'm just just as committed now to the success of the company will be closely involved as executive Chairman and as one of the company's largest shareholders, I strongly believe in the long term fundamentals and the growth opportunity for hydrofarm.
This is a very natural progression. John is a proven leader who's been an integral part of this business for the last five years helping drive us through numerous complex industry environments. The transition to John and the team will be seamless and provide the necessary continuity of leadership the board and I could not be more confident in John and the deep leadership team we already have in place around him and I'll support them as necessary as we seek to realize the potential for hydroforming.
Thank you all for joining us this morning. We're now happy to answer your questions. Operator. Please open the line.

Question and Answer Session

Operator

(Operator Instructions)
Andrew Carter , Stifel Nicolaus and Company, Incorporated. Please go ahead.

Hey, thank you. Good morning. First question I wanted to ask is around the kind of distributed brands you signed up some new partners, which you mentioned, it does weigh on cash flow. Could you, could you kind of quantify what the outlook is for for partners out there? Obviously, Hawthorne is no longer distributing third party, but they've kind of helped cement the FGS position. Is there a lot out there that's profitable or are the demands out there of anyone looking to distribute a lot of times not worth it either on a profit basis or just the incremental working capital demands? Thanks.

William Toler

Yeah, the partner brands work for us and they work for us particularly well, when we have scale, right? Obviously, with the demand trends scale has been a challenge for us and for the whole entire industry.
So there are a handful of the partner ones that are, that have come our way that we think have really, really good, good long term potential. The ones I just mentioned are at the top of that list, right, the Quest and Mills and Hurricane are certainly really good brands for that.
There's also been some further consolidation of some very large lawn and garden brands, you know, on the on the grow media and nutrient side who have consolidated down to, you know, taken certain distributors out of the mix. And they've kind of come to us in a, in a, in an interesting way. So that's actually provided us some opportunity really that won't be realized until 2025.
But we're clearly lining up to where that we are a big part of the distribution industry today. And we think that's a viable business for us, especially once the industry comes back. You know, that being said, we are also making sure that we have the right distribution footprint that we have the right SKU CAL and the right viable levels of service to our customers.
So, you know, distribution can be a good business at scale. We've all struggled to get to that scale in the last, in the last few years, but we think that hopefully we're close to that coming back to being a positive force.

Got it. And then a second question, I know you mentioned that the independent retail closures are out there. You've got two kind of customer sets, you have independent retail and then you have a commercial business.
We understand on the independent retail. Are you seeing stability on your kind of on your commercial customers or are you seeing churn from either just exiting the industry or just anything on kind of the underlying trends there? Thanks.

William Toler

Yeah, the you're right, the retailer, the brick and mortar retailers have been consolidated. I think that's largely over now. But what happens is you have two step dynamic, right? They close the stores and that means those stores stop buying, but then they also have to sort of eat their own inventory and consolidate that inventory back into their other stores.
So there's really kind of a delayed effect on us because as they're consolidating inventory from one store to another and really consuming their own pipe, if you will, it takes longer for it to come back to us. So we certainly felt that in Q3, we've kind of felt that all year, right? On the other side of things, commercial has been, it has been okay, but certainly way below the levels.
It was a few years ago, there was a lot of people that have been kind of waiting for these regulatory changes to come through. Obviously, we all saw that Florida did not pass. You know, the majority of people of Florida wanted to, you know wanted to have it pass, but it didn't get to the 60% threshold. It's not really that surprising.
It usually takes one or two times for these things to pass and hopefully it will soon. And we've got the big DEA meeting coming up in early December. I think that will be the catalyst that gets commercial going again. Another channel that's been very viable for us in the last, you know this year and certainly the last couple of years is Ecommerce.
So Ecommerce now is a big, bigger part of the business than it had been over the last few years as people are more in ordering, you know, from Ecommerce and getting products delivered that way. So really, you've got weakness in brick and mortar. You've got kind of commercial that's been a bit on hold. But I think it's going to pick back up, especially if there's a rescheduling event. And you've got ecommerce that's probably emerging as a strong ongoing channel for the industry.
Thanks, Andrew.

Thanks. Passed on.

William Toler

Appreciate it.

Operator

Jesse Redmond, water tower research. Please go ahead.

Good morning,
I was curious to know if you could talk a little bit more about, Florida because that's a couple of billion dollar medical market that we were hoping would more than double over time. I know you're not specifically super leverage that market but curious if you could talk about what, what specific implications that not passing would have for hydrofarm.

William Toler

Yeah. It certainly was a, you know, a setback for the progression that we know is ultimately going to take place here. The fact that, you know, almost 57% voted. Yes. Say that people want it and they'll eventually get it. These things generally take, you know, more than one time before they do pass Floridas setting the bar at 60. The fact that the very popular governor was not for this is probably the reason that it didn't get through.
I am encouraged that, you know, Trump came out and said he's in far in favor of it. So that kind of leads me to believe that, you know, good things can and should happen going forward.
But you're right, we don't have a huge footprint in, in Florida. We don't have any distribution centers, really the closest distribution center we have here is Pennsylvania. So we don't have a lot of infrastructure in the state. We obviously don't operate any brick and mortar. So our, you know, our opportunity here was for the consumption growth and for the growth in infrastructure and the growth in consumables and, and things.
But we don't really have the sort of cost leverage or the cost challenges down here like some other people might. So we think that, you know, while a setback it is headed our direction and we are going to have other macro things. Hopefully, the rescheduling that, that far outweigh the benefit of what can, what might have happened down here in Florida.

And with your strong balance sheet and cash position, you're operating from a position of relative strength. Can you talk a little bit more about opportunities you're seeing on the M&A front to perhaps do some consolidation?

William Toler

Yeah, I think that the, the M&A front really has a couple of different things. There's there. We've been continuing to have dialogue and you know admittedly with our you know preservation of cash for all the right reasons and with our current, you know, equity price, we're not going to go out and do a lot of M&A but there's a couple of things that are going on if not M&A then perhaps people are looking at you know, outsourcing their volume to us, meaning a smaller player can't, can no longer afford to keep his own plant operating.
So with that kind of consolidation, perhaps we pick up volume that way, those kind of opportunities while they haven't come to us fully yet have also been discussed with a number of different people. So we may pick up some, some volume that way as we're looking to help other people, you know, get through this downturn on that same front we still remain having multiple dialogues with people about potential, you know, combinations and different strategic approaches that make sense for us and for the industry.
And we do have kind of a, a lot of good brands to leverage. We have a lot of good distributor partners to leverage. We have a lot of good things that can ultimately lead to the right solution. But we have been prudent in not rushing into anything that wasn't the right situation for us or what didn't create long term value for our shareholders because we know that like you said, our balance sheet is in good shape and we've got an undrawn revolver.
We've got debt that's still not due for four more years. We've got all kinds of things that protect where we are. We've been making money in five out of the last six quarters and so we, we get where we stand. We want to change that position over time. But we also know we got to do it in a disciplined and prudent way.

That's helpful. Thanks. And finally, congratulations on the continued cost controls. Can you talk a little bit about how we might be thinking about SG &A and a moving forward in ' 25? How much more room you have to cut there?

B. John Lindeman

Yeah, thanks, Jesse. I'll, jump in on that one. Yeah, there is a little bit more room. I mean, look, we've, I think proven over time now that we find ways to you know, Nip and Tuck where we can to continue to bring that down. I mean, we are at pre IPO levels as Bill mentioned in our comments earlier. So, you know, it does get a little bit tougher, but there's some more opportunity there for us in '25.

Great. That's all for me. Thank you.

William Toler

Great, Jessie. Thank you.

Operator

Thank you. I'd like to turn the call back over to Will Toler for any final or closing remarks.

William Toler

Great. Thanks Marjorie and thanks everyone on the call for the support and continued interest in hydroforming. And we look forward to speaking to you soon. Take care.

Operator

Thank you, ladies and gentlemen, that does conclude today's conference. We thank you for your participation. You may now disconnect.