Good day, ladies and gentlemen, thank you for standing by. Welcome to the Hydrofarm Holdings Group Second Quarter 2021 Earnings Conference Call. At this time, all participants have been placed in a listen-only mode and the lines will be opened for your questions following the presentation. Please note that this conference is being recorded today, August 12, 2021. I would now like to turn the call over to Mr. Fitzhugh Taylor; Managing Director at ICR to begin.

Thank you, Stacey 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 second quarter 2021 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 what we expect. We refer all of you to our recent SEC filings for more detailed discussions, 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'd like to turn the call over to Bill Toler. Bill?

Thank you, Fitzhugh and good afternoon everyone. I'm pleased to report another quarter of strong growth in our business. We enjoyed growth across virtually all of our products lines, all of our geographies, including both new and mature markets. To briefly touch on this we grew our topline by almost 47% and improved gross profit by over 65% year-over-year. More importantly, as our proprietary brands are becoming a larger part of our total sales we benefited from this favorable sales mix and posted over 127% improvement in adjusted EBITDA and 430 basis point increase in adjusted EBITDA margin to a very solid 12.1% in the quarter. We believe this result is evidence of our unique positioning as a leader in manufacturing and distributing differentiated branded hydroponics equipment supplies in the controlled environment agriculture market. To maintain our momentum going forward, we'll remain focused on our four key growth drivers. First drive and increase the penetration of our proprietary brands inside of our company. Again, these are the brands that we own and represent a key growth opportunity for us due to their higher margin profile. Second develop strategic relationships to convert more brands in the preferred brand status. These are brands that are primarily sold into the hydroponic channel through Hydrofarm. Third, drive our commercial presence by working with our MSOs and large commercial growers. And lastly, which is what I want to focus most of my comments on today is our M&A strategy that we believe will continue to create more opportunity to refine our portfolio and improve margin growth and innovation. Following our IPO in December of 2020, we begun to reconfigure our portfolio to become a brand owner, using our established distribution platform to reach customers. In Q2, we took our first steps toward this goal. But…

Thank you, Bill, and good afternoon everyone. Net sales for the second quarter increased 46.7% to $133.8 million from $91.2 million in the prior year period. The increase in net sales was dominantly organic volume-driven growth though the two acquisitions completed in the quarter HEAVY 16 and House & Garden had a positive impact as did one notable preferred brand. Once again, we experienced increased demand throughout all of our end markets and faster growth across our Proprietary Preferred Brands, which continue to outpace our peer distributed brands. Gross profit during the second quarter also increased by 65.5% to $29.6 million as, compared to the year-ago period while gross profit margin improved by 250 basis points to 22.1%. This was driven primarily due to a favorable mix shift towards Proprietary and Preferred branded products which typically carry a higher natural profit margin than pure distributed brands. Selling, general administrative expense increased to $27.3 million in the second quarter of 2021 compared to $12.8 million in the year-ago period. The increase in SG&A was primarily due to increased costs associated with the recent acquisition integration activities, which accounted for approximately 70% of the total increase while higher costs associated with supporting our public company status and long-term growth strategy, made up the difference. Excluding acquisition and integration costs, share-based comp costs and depreciation and amortization, SG&A was $14.5 million or 10.8% of net sales in the quarter versus 11.1% or 12.1% last year. So on this comparative basis, we realized operating leverage in the quarter once again. Reported net income attributable to common stockholders was $2.3 million or $0.05 per diluted share in the second quarter compared to $1.9 million or $0.08 per diluted share last year. Weighted average diluted shares outstanding were approximately $42 million for the second quarter of…

Your first question comes from Andrew Carter with Stifel.

I have a first thing, hey I appreciate the guidance update today and maybe I'm not sure if I had the acquisition contribution, right in the quarter, but for the second half I'm getting kind of at the midpoint kind of 5% kind of underlying organic growth. So I guess could you kind of talk about kind of that step down and maybe what you're seeing to this first I guess we're six weeks into the quarter, anything you can help us - with there. I'll stop there? Thanks.

Yes, as we've been saying, as you start lapping the plus 60% growth numbers from Q3 and Q4 of last year the percent changes are obviously going to get a little tighter. I think your 5% is way conservative there and part of the challenge for us is when an M&A comes in like a HEAVY 16 or House & Garden and it's fully incremental to us, and we never distribute it before it's easier to capture that. When an M&A like Greenstar or Aurora comes in, where we already distributed the brand and essentially is really organic to our company. So it's not the same sort of, it's harder to tease that apart right, we might pick-up some sales outside of stuff that we didn't distribute for them before, but it's very difficult to pull all that apart. I think your 5% number is very conservative there. As far as how the quarter is progressing we're pleased with where we sit as of Q3. I think there is a number of sort of overall factors that are going on in the industry that have caused things to change the trajectory a little bit, but we think it's primarily an isolated situation in a couple of places and we already starting to see things bounce back to the levels that we had been seeing back earlier in Q2. So overall, we feel good. Think we are a little tight on the 5% for sure and again, we've got that difficulty of peeling apart these brands that are already ours.

Fair enough. And I guess the second question I appreciate the update on the portfolio of transformation. A big aspect of the story has been the inventory demands, 95 days. But through the acquisitions you've bought a lot of higher margin businesses that were - now you don't have to have that margin sitting there and inventory more? Can you kind of give us an update on kind of the, how the working capital demands have changed for the business because obviously there is more capital intensity on the CapEx side? Thanks.

Yes, working capital has been interesting for the whole industry as everybody has struggled to get reliable supply from all over the world, right. Most of the soil and grow media suppliers are behind many of the equipment suppliers in China behind. Their lead times have been extending from what used to be six weeks or eight weeks to now what are up to several months. So we've taken the strategy of lean into inventory, leverage the balance sheet towards inventory to be able to service the customers, right. And we didn't have a whole lot of control and a lot of the M&As as to what their inventories are level - what their inventory levels were, couple are more higher, couple are more lower, so it's not exactly a normalized time to evaluate inventory days. I think with the worldwide supply chain still being a bit altered from all the challenges over the last 18 months. We're still coming to what I would call to be a normalized level, John do you want to add to that?

Yes, sure. I'll just chime in as well. Andrew, you're right, I mean with the pickup of four manufacturing businesses, there is going to be a little bit of an incremental spend behind it, you see that to some extent in our call out in the press release of a step up in the CapEx that we're intending for this year to $8 million to $10 million. But with respect to inventory and inventory turns. I think we might see a step up, a tick or two. Just in terms of a couple of days relative to maybe what you've seen historically really to enable sort of that raw material component of the overall manufacturing process, which we really didn't have in our present in our business before.

Your next question Jon Andersen with William Blair.

Congratulations on the quarter and the acquisition.

Thanks Jon.

Thank you.

The question on the acquisitions themselves you've handpicked certain businesses and brands here and made a series of acquisitions since the start of the second quarter. How should we think kind of in aggregate about the growth rate of these businesses going forward, is the right way to think about it? These were brands that you saw as particularly attractive with higher than average growth rates in the marketplace, but you wanted to own them and make them proprietary? And then the second part of this acquisition question is as you take on more proprietary brands or own brands. Do you need to also maybe invest more in innovation and demand generation activities relative to doing business in a preferred or distributed way? Thank you. I know there's a lot there. Appreciate it.

That's right, thanks. Yes, to answer your last question first. We are investing in innovation and marketing at the same time we're buying businesses. Right, it's a lot quicker payback to drive innovation on your own products than it is to go out and buy companies, all the time. So we're doing both, we're dialing up our marketing efforts, frankly to levels that we've never seen before and historically we weren't a huge marketing company and still as a percent of sales. It's still going to be a fairly small number, but we believe strongly. I mean my whole history, John's whole history many of our leader's histories have been around brand-building through innovation and marketing. So yes, that's a key part of what we're doing. As to how we targeted the businesses that we've acquired, frankly we had a profile of - we always wanted to get more into consumable categories. We didn't have brand representation in grow media or nutrients. So that was a target. Then we want to find sort of the best available quality products that we thought had a role in the marketplace and play different roles in the marketplaces and these brands all kind of fit together like that. And so then - and then of course the third opportunity has to be these brands are willing and interested to sell at a particular time. And so those three things all came together on these first four businesses, and we feel very good about the portfolio that we've built, we've been heavily consumable oriented so far. It doesn't mean we wouldn't look at a capital type business or a durable-type business that could be our future as well. But right now, we're pleased to get our consumable side and our consumable brand portfolio built up.

One quick follow-up, I think at the time of the IPO, you had eight distribution centers across North America could you and I can't recall how many manufacturing facilities, but could you refresh, those numbers today with the acquisitions, what the manufacturing and DC footprint look like and why the investments - what kind of investments you made?

Yes, on the DC side eight was the number at the IPO. It is still eight, we've enlarged one Portland, Oregon and we are enlarging two more Southern Cal and Northern Cal. We are looking for another facility or looking to open a facility in the Southeast, Southwest type of area to cover the demand down there. The two in Canada are still the two in Canada for now. As far as manufacturing we did somewhat I would call light-assembly work in one of our facilities in the U.S., but really our manufacturing acquisitions have been the HEAVY, House, Aurora and the Greenstar so now it gives us a cat way four nutrient plants, two soil plants, couple of warm casting facilities, and a peat manufacturing facility up in Canada.

Next question Peter Grom with UBS.

So I just wanted to follow-up I’ll follow-up to Andrew's question because I think it's pretty important. But could you maybe help us tease out what M&A contributed to the top line in both the quarter and in your guidance, I mean, at least directionally? Because I think last quarter the math implied like 26% to 36% organic revenue growth rate. So I think investors are trying to understand how much of a slowdown versus last quarter and actually embedded in this guidance if at all?

Yes, now let me chime in on that. Yes with respect to Q2, the quarter, we just completed. We had top line growth as we mentioned just using round numbers around 47%. I think I'd tell you about 900 basis points, about 9% of that 47 was M&A growth so contribution from House & Garden, HEAVY 16 in the quarter. As we think about our guidance or maybe as you should think about our guidance of 45% to 50% year-over-year which is an update from our prior quarter guidance really inside of that is roughly 25% to 35% year-over-year growth. Again this is annual guidance, year-over-year growth for whatever maybe call our legacy business and approximately 15% to 20% of M&A growth. And I think if you kind of walk through the press releases for each of the acquisitions that we've completed up to this point and I think and maybe all of those press releases we may have had a 2021 full year estimate. Obviously, we don't own these businesses for the full year. But I think if you work that math. It should roughly tell you and walk you through exactly what I just explained. And by the way, I think I would just comment to that that 25% to 30% year-over-year growth is pretty comparable to kind of what we've called last quarter as well.

Okay that's incredibly helpful. And then I had a bit of a longer-term question on the margin opportunity. I think those that are listening to this call as the press release has kind of come out this quarter. I would say I have been surprised at how high the implied EBITDA margins were in some of the assets you've acquired. And then in the release and pro forma EBITDA margin in the mid-teens isn’t far greater than I think most anticipated? Particularly more to think about 2022, so given you still have room for future acquisitions and likely operational efficiencies. I guess how should investors really think about the long-term margin opportunity for this business and how quickly can you get there given what you've delivered so far?

Yes thank you - last year was six, this year's pro forma we just gave you is 15.2 and we think we are well on our way to having a solid mid-teens kind of business year for the foreseeable future with upside. I mean we now own four nutrient plants we just hired a leader of manufacturing to help us think about productivity and optimization. We are getting scale out of our distribution centers. We've been growing and the growing challenges of becoming a new public company. We spent a lot of money to do all of that. So we think there is you know we haven't even gotten to the productivity side of business. We're just trying to capture all the growth that's out there and that's what's exciting for us is that we are showing the kind of mid-teens type of profitability with incredible upside to go. So it's become I don't - I won't say it's a surprise to us. I think it happened quicker than we might have thought, nine months ago or eight months ago when we did the IPO. But we clearly saw and felt like we could get to the mid-teens. We just didn't want all you guys to get ahead of us and try and run us out there too fast but. So we were pleased with where it looks right now, and think that we can keep going from here both on top-line and the bottom line.

Next question comes from Kevin Marek with Deutsche Bank.

Maybe just another deal question sitting here after four years completed in a matter of months, is there a point at which you need to slowdown and ensure the deals you've done are performing well and are effectively a part of the Hydrofarm entity or do you have the bandwidth to kind of continue to go after deals?

Yes, very fair question. We talk a lot about this right. It's particularly a bandwidth question around the financial integration, many times we're buying family businesses that aren't up to the sophistication that we are, we've been able to put in external resources, internal resources, we've been hiring and adding things there. We aren't going to keep the pace of one a month. I'll promise you that. That's a bit - that's a bit aggressive but also you can't time M&A when it - when it becomes available right. And we want to become aggressive, but not overly aggressive to do things. So you can expect us to stay on this track to doing more and more and more, but yes, I think that one a month pace is a little quick. And we've been able to absorb it so far and get everything filed on time and feeling comfortable that we've got the right information and numbers. But it will slow some, but we're still going to become an acquirer of choice and a person that rolls up this business and rolls up this industry hopefully quite successfully.

Understood that's helpful. Thank you maybe just one more.

Sure.

Realizing it's a bit early to be talking about 2022, but just thinking about your guidance. Some of the comp issues in the back half of this year. I'm curious if you have any first plus thoughts about the industry or company growth prospects in 2022 given some of those dynamics legalization that are taking time to play out, et cetera.

Yes, it's been - interesting to watch because that number I quoted is 60% of people that can't buy today. Well, a year ago that number was over 70% so a bunch of legislation has happened, but not much implementation has happened. So it's tricky to get ahead of this because the states have been very unpredictable in implementing right and we had a clear path on what New York, New Jersey, Virginia, Connecticut, we're going to do it be easier to know. But right now, they're all sort of playing politics with each other and not really sure where it's going. And so we're cagey there, so we don't have a number, yes this is only halfway through our year as you know. And so we're really focused on getting the M&As integrated, continue to drive innovation, and organic growth and will be out later this fall or in the fall with sort of our look for 2022.

And maybe the only thing I would add to reinforce is just, I mean for sure, the long-term math in this category is something that we remain very excited about. I mean we're still we believe very much in the early innings, we'll get a full year contribution from acquisitions next year. Hopefully, we'll find a way to get another deal or two done over the next six months to 12 months. And so I think we're going to be quite excited about 2022, but no numbers just yet for you.

Next question, Bill Chappell with Truist Securities.

Bill, you kind of alluded there were some kind of hiccups but some issues in certain areas in the quarter kind of implying that maybe revenue could have been even better and things have kind of ramped back up since we've started 3Q, can you give us a little more color on that?

Yes, I would say that Q2 was pretty solid. We came into July a little slower than we hope, but there's all kinds of external factors that are going on. Its - heat waves in Oregon and big fires in California that caused these little blips, but we think that those are largely going to be a few week thing and not really matter too much. But we think overall that we're still in a really good spot and the growth will be there.

Got it. And then one thing kind of struck is, I think you said in the release that pricing only added about 3% to 4% to top-line growth. Would you expect, are you taking pricing with higher costs for your own brands, where you would see that would be a much bigger number in the back half?

Yes, I mean look Bill, we continue to reassess pricing on a quarterly basis and obviously, right now, just the overall supply environment, not just for us, but the whole industry and frankly other industries is very dynamic. So it's a little hard for us to take too much of a long game view on it right now. I think we're trying to manage a quarter-to-quarter. We've basically taken pricing in each of the last two or three quarters now with the intent of really lifting margins from a pricing mechanism, but really maintaining margins and finding productivity and our portfolio shift is a way to drive margins. So I think we'll continue to drive in that sort of quarterly cadence from here.

Got it. And then last one, just on the M&A front, I mean I understand all the Nutrient businesses are different, but is there a point where you've filled out the nutrient side of the portfolio or you don't need more and do you at some point do you start to get negative reactions from the company's you're not acquiring and that are you're distributing for?

No, it's certainly a conversation we have with them, but all of them know kind of how we fit. I think our share in nutrients if you add all of our distribution, our proprietary brands, even our distributed brands we're probably still only 15-share so it's a very large and fragmented category. So we think we've got some room to go there. But also we want to make sure we have good balance in the portfolio. So we don't do a Nutrient one next that would make sense. But after that, we certainly look at some if they are the right ones and fit in a nutrient role that we could expand.

I will now turn the floor over to Bill Toler for closing.

Terrific thank you, Stacey and thank you all for being on the call today, we appreciate your interest in Hydrofarm and look forward to speaking to you down the road. Thanks a lot.

This concludes the teleconference. You may disconnect your lines at this time and thank you for your participation.