GrowGeneration Corp. Q1 FY2022 Earnings Call

Thank you and welcome everyone to the GrowGeneration first quarter 2022 earnings results conference call. Today's call is being recorded. With us today are Mr. Darren Lampert, Co-Founder and Chief Executive Officer; and Jeff Lasher, Chief Financial Officer of GrowGeneration Corp. You should have access to the company's first quarter earnings press release issued after the market close 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 forward-looking statements made today. During the call, we will use some non-GAAP financial measures as we describe business performance. The SEC filing as well as the earnings press release provides reconciliations of non-GAAP financial measures to the most directly comparable GAAP measures are all available on our website. Following prepared remarks, we will take questions from research analysts. We ask that you limit yourself to one question and one follow-up. If you have additional questions, please re-enter the queue and we'll take them as time allows. Now, I will turn the call over to our Co-Founder and CEO, Darren Lampert. Darren?

Thank you, Clay, and good afternoon everyone. Thank you for joining us today to discuss our first quarter 2022 financial results and full year guidance. I will begin with a brief discussion of our challenging start to the year, which has been slower than we hope; followed by a summary of what we're currently seeing in the U.S. cannabis market. And I'll finish by reiterating our confidence in the longer term strategic vision for GrowGeneration, highlighting some positive developments in the quarter against that strategy. I will then turn the call over to our CFO, Jeff Lasher, who will take you through the details for our first quarter results and our updated full year 2022 guidance. I'd like to start by thanking each one of our employees across our corporate center and 63 retail locations through a continued support of GrowGen and your dedication to our vision and strategic plan. While 2022 is off to a slower start than any of us would prefer, we remain confident in the longer term opportunity that exists within the hydroponic industry. We entered the quarter with excess inventory, and we didn't anticipate that demand for hydroponics would remain as slow as it has for as long as it has. As a result, we saw fewer vendor rebates and more obsolescence in the first quarter, which consequently had a negative impact on our gross profit from a lower sales base than we originally planned. As I can tell you firsthand, this isn't the first time the industry has experienced a downturn. And as it did last time, we expect this one to pass in the near future. In the meantime, I want to reassure you GrowGen is on solid financial footing to weather this trough in the cannabis cycle. And we are focused on controlling the areas of the business that are fully under our control. As a result, we firmly believe we are well-positioned to emerge stronger when the market eventually turns, which it will. We have a strong balance sheet and we don't anticipate the need for external debt or equity issuance. We currently have $66 million of cash and cash equivalents with zero debt. In other words, the company has the ability to meet the operational needs of the business without additional capital. While our cash from operations was negative in the quarter due to inventory purchases and payment of customer deposits after the HRG acquisition, our underlying business generated positive cash flow from operations. I mentioned this to say, we feel very good about the liquidity position well into the foreseeable future, even if the current market conditions persist throughout this calendar year. We're taking an active approach to managing the business in a way that preserves cash to working capital optimization, which Jeff will discuss in more detail later. And we're more aggressively right-sizing our cost structure in light of the current demand in the space. Now, I'd like to say a few words about the broader industry. Demand for hydroponics remains soft, as we see a large oversupply of cannabis in the consumer marketplace. That is all but halted grower CapEx projects. This is most pronounced in markets such as California, Oklahoma, and Michigan, which represent in the aggregate over 55% of our sales. I can't tell you exactly when this dynamic will shift, but I can tell you that GrowGen remains poised to capitalize on the rebalance when it does. On a positive note, we do see opportunities for cultivation growth in emerging states and regions, including the Northeast, Midwest, and New England, which is where we will focus our greenfield and commercial efforts. More specifically on our business, I want to reiterate our five strategic initiatives this year, which we believe will better position us for growth in 2023. First, we're focusing our growth prospects on opening greenfield retail locations in places where we think there is the most potential opportunity. As we've outlined before, this includes our plans to open new first-time retail locations in Mississippi, Missouri, New Jersey, New York, and Virginia this year. While we are reassessing our goal of adding 15 to 20 new stores this year, our new 10 to 15 store goal reflects our strategic decision not to open new stores in existing markets where oversupply is most pronounced. We plan to open our Mississippi retail location in June. In addition, Missouri, New Jersey, and Virginia are all at the lease signing stage. And we plan to have these locations opened in the second half of 2022. We also plan to have New York locations operational by the end of 2022. Second, we are investing in companywide technology to drive operational excellence and to deliver our omnichannel strategy. Our enterprise resource planning platform will speed transactions at the cash register in store, unify our customer databases, and create a more efficient inventory demand planning and purchasing system. Third, we're establishing a network of five distribution centers in key locations to serve our retail stores, e-commerce, and commercial customers. Our fifth distribution center will open in June, adding an incremental 100,000 square feet of warehouse space to service the Midwest, New England and Mid-Atlantic regions. Having both East and West Coast distribution will allow us to lower our freight costs, mix our private label items with our distributed products, and better serve our customers on a national level. We now have over 1 million square feet of retail and warehouse space. Fourth, we are driving sales of proprietary brands and private label products. This includes investments in resources to provide customer service, product development, and distribution excellence. Private label and retail stores accounted for $3.6 million of retail sales, which is around 5% of our overall retail and e-commerce sales. Drip Hydro, a proprietary nutrient and additive line, launches in GrowGen stores later in the month of May. In our non-retail store segment, our recent acquisition of HRG will enable us to expand the distribution of some of our 400 private label skews into 750 hydroponic stores across the U.S. starting in the second quarter. Revenue from our non-retail distribution business, including HRG, MMI, Power Si, Char Coir, and other own brands, total 15% of sales. Fifth, in the first quarter, we combined the e-commerce operations and infrastructure to operate a site that generated $5.3 million in online sales in Q1. This results in long-term capabilities to service customers more efficiently with reduced freight and faster delivery times while maintaining competitive pricing, as well as the ability to leverage our operating expenses. In summary, our first quarter comparable sales declined 35% year-over-year, and comparable sales sequentially declined each month so far in 2022, and the revenue weakness has not abated in the second quarter. Our retail same-store sales remain under pressure from declining demand for durable goods, including lighting and HVAC products, as well as lower demand from large commercial accounts. We remain committed to these strategic and commercial initiatives, and we firmly believe these strategies will make us stronger in 2023. As Jeff will detail for you, we are reducing our guidance for both net revenue and adjusted EBITDA for the full year 2022 to essentially reflect the continuation of the current sales environment across the remainder of the year. While we hope the market improves, we think it's prudent to take this more cautious approach given where we stand today. And now I will turn the call over to Jeff Lasher, our Chief Financial Officer. Jeff?

Thank you, Darren. I will address our first quarter financial results and then I will discuss our updated full year 2022 guidance today. For the first quarter, GrowGeneration generated revenue of $81.8 million versus $90 million in the first quarter of 2021, representing a decline of approximately 9% or $8.2 million. The decrease in revenue was primarily attributed to a $25.1 million decrease in same-store sales revenue in stores, and a $1 million decline in e-commerce revenue for web stores opened in both periods. This was partially offset by $11.3 million of incremental revenue from non-com stores and stores opened or acquired last year. Sales in non-retail businesses, including the acquisition and integration of HRG and MMI, increased from $2.8 million in the same period 2021 to $12.2 million in the first quarter of 2022. Our same-store sales for the first quarter was $47.7 million compared to prior year sales of $74 million, representing a 35% decline against a comparable year ago quarter. Gross profit margin was 27.1% for the first quarter, down approximately 110 basis points from the prior year, but up from Q4. The year-over-year margin decrease in the first quarter was related to unrecaptured freight expense, diluted impact of pass-through freight charges to customers at cost, inventory write-downs, and discounting activities. Gross profit dollar generation in the first quarter decreased 12.8% from the prior year, including the impact of additions of acquisitions and retail stores, e-commerce, and our non-retail segment. Total operating expenses in retail stores and our e-commerce segment sequentially declined from the fourth quarter of 2021. However, the addition of HRG and MMI for the quarter resulted in an overall increase in operating expenses, which totaled $14.5 million compared to $8.2 million in the first quarter of 2021. On a year-over-year basis, we added 37 retail locations in several non-retail acquisitions, which contributed to the increase in first quarter store operating costs on an absolute basis versus the comparable year ago period. Selling, general and administrative costs were sequentially down in the first quarter of 2022 at $10.3 million compared to fourth quarter of 2021. Of the $12 million of SG&A in the quarter, $1.6 million was derived from stock-based compensation. Additionally, the recent acquisition of MMI and HRG added an incremental $1.6 million to SG&A expense in the quarter. We've taken a number of steps to decrease operating expenses, including resizing the payroll, consolidation of the e-commerce web stores that reduce marketing expenses and operational changes. For the quarter we had higher expenses, including an increase in bad debt reserve and expenses for the termination of office leases, that totaled about $1 million. Depreciation and amortization of intangibles was $4.5 million in the first quarter of 2022. The breakdown is $2.7 million of amortization and $1.8 million of depreciation for new store openings and technology. As we go forward, depreciation and amortization expense will continue, and we forecast that amortization will be about $12 million in 2022 associated with acquisitions over the last couple of years, including the 2022 acquisitions of HRG. Income tax provision was a credit of $1.6 million in the first quarter of 2022, following the net loss in the quarter. For 2022, we are forecasting a financial loss for tax purposes. Net loss for the first quarter was $5.2 million or $0.09 per diluted share compared to a net income of $6.1 million or $0.11 per diluted share for the comparable year ago quarter. Adjusted EBITDA, which excludes the expenses associated with interest, taxes, depreciation, amortization, and share-based compensation, was a loss of $700,000 for the first quarter of 2022 compared to income of $11.1 million in the first quarter of 2021. Related to the balance sheet, the company ended the quarter with $47.3 million of cash and $19 million of marketable securities on the balance sheet that are mature and available for sale, if needed. Total liquidity was $66.3 million at the end of March 2022. The company reduced ongoing legacy inventory and legacy company prepaid by about $13 million. However, including inventory purchased in the HRG acquisition and acquired shortly after the acquisition, total inventory was flat at $106 million. Prepaid inventory and other prepaid assets fell from $16.1 million to $7 million in the quarter. Total receivables increased from $8.2 million to $9.4 million with the addition of HRG activity. Quarterly used cash in operations to pay down accounts payable fell $17 million to $14.2 million at the end of the quarter, inclusive of HRG payables. We also consumed about $4 million for payments of accrued liabilities, including payroll-related items. Customer deposits fell from $11.7 million at the end of 2021 to $7.2 million at the end of March 2022, reflecting lower commitments of capital products that require deposits in advance of production. Overall, managing other working capital needs in the first quarter resulted in an underlying generation of $3 million of cash from operations despite these existing at the end of 2021. However, cash flow from operations in the first quarter was burdened by an inventory bill for HRG of $5 million, and the overall result was a usage of cash in the quarter of $2.3 million. We are now expecting and planning for an acceleration of the decline in comparable store sales across the country throughout 2022. The sales results in the later half of the first quarter in the month of April deteriorate sequentially since and have forced us to revise downward our sales projections for the year. Specifically, April was down more than 50% on a same-store basis and we have not seen any improvement in the beginning of May. As a result, we are now forecasting comparable sales declines at or below Q1 results for Q2 and for Q3. We are up against an easier comparison in Q4 of 2022 and presently forecast a high single digit decline in comparable store sales in Q4. We expect gross margins to remain pressured, moving into the second and third quarters followed by a projected margin expansion in the fourth quarter on a year-over-year basis. We are continuing to take steps in executing our business strategy to focus on generating cash from operations during the challenging industry environment. We are doing this with a focus on inventory reductions, tight management of credit authorization and modification of key vendor terms to shore up the company's balance sheet and cash position. As mentioned, the cash generated by legacy 2021 operations was positive in the first quarter. So we made a substantial investment in the wholesale hydroponic business, specifically the acquisition and inventory build of HRG. Total net cash used in the investment of HRG and the expansion of distributed brands inventory for that business after the acquisition was $12 million, which does not include the common stock issued in the course of the acquisition valued at $5.7 million. At the time of the acquisition on January 31, 2022, HRG had $4.2 million of inventory, and we acquired $5 million additional inventory to support expansion of product offerings into control systems and LED lighting. HRG contributed $3.4 million of revenue in the quarter, but did not materially contribute to EBITDA. We are planning for total capital investments outside of acquisitions, primarily for new store buildouts of $15 million to $20 million. Thus far, we have spent $4.5 million in 2022. The other addition to the enterprise that produced better than expected EBITDA and cash flow with MMI, a company specializing in manufacturing and selling of vertical benching and racking systems for both the retail and agricultural markets. The MMI business benefited from continued expansion of fulfillment center conversions in retail, as former retail-only locations are converted to multi-channel fulfillment centers across the country. We are now expecting full year 2022 revenue to be between $340 million and $400 million and full year adjusted EBITDA to be above breakeven, but less than $10 million, all including the recent acquisition. The low end of our guidance range embeds a continuation of current trends we are seeing today. As such, we are not expecting adjusted EBITDA in the second quarter of 2022 to be significantly different relative to first quarter results. We expect gross margins to remain under pressure throughout the balance of the year due to discounting and elevated freight cost. We expect operating expenses to be controlled and sequentially down in the second quarter before increasing on an absolute basis in the third and fourth quarters due to the expansion of retail store footprint. As we said on our last earnings call, we continue to expect for 2022 that our proprietary brands of Power Si and Charcoir will benefit from the industry focus on yield and quality and product, but other areas, including lighting control systems and HVAC will be under pressure. As a result, we have significantly constrained our inventory purchases as we focus on our brands and decrease working capital needs. We will add new stores in the latter portion of 2022 that should generate incremental sales as they come online throughout the balance of the year. So far in 2022, we have opened a new location in Ardmore, Oklahoma on the Texas border and relocated stores in Auburn, Maine and Redding, California. Our new Jackson, Mississippi location will open this summer, followed by more locations in the new markets throughout the East and Midwest before year-end. Just as importantly we believe that our additional investments in technology, distribution capacity and private label sales will increase EBITDA margins in future years. Total cash generated by the business will benefit from the companywide focus on inventory and management and balance sheet items including receivables. We have modified our tactical response to the market and changed inventory purchase plans substantially. We maintain a strong cash position without the immediate need for external debt and do not foresee a meaningful debt or equity issuance. We do anticipate that we will generate positive cash from operations this year in excess of our adjusted EBITDA. Before I close, I'd like to point out that the company has recently changed audit firm. As previously disclosed and as such, our Form 10-Q filing with the SEC will be filed at a later date and required given this recent change. For more information, please see our Form 12b-25 with the SEC filed earlier today. Our focus for 2022 is on execution to set up the company for a strong future with new retail locations, private label and proprietary brands, improved technology, superior distribution capabilities, and a strong e-commerce platform built to scale profitably. With that, I will turn the call back over to Darren for closing remarks.

Thank you, Jeff. Briefly, before we open lines for questions, I want to reiterate that we are not satisfied with our results in the first quarter. We acted quickly in January with cost reductions to prepare to weather the industry downturn. GrowGen is on solid financial footing with a strong balance sheet, a healthy liquidity position, and solid underlying cash generation. We are confident that when the cannabis cycle turns and the excess supply in the marketplace eventually normalizes, which we firmly believe it will, GrowGen will be well-positioned to recover quickly and fully. Our strategic acquisition of HRG accelerates our expansion of our proprietary and distributed brands outside of our retail locations into 750 independent locations. We are very satisfied with our results of both Charcoir and Power Si and are very excited to begin selling Drip Hydro, nutrient and additives. The addition of MMI strengthens our position to gain indoor vertical cultivation projects with our leading benching and racking systems; controlled environment agriculture and sustainable ag are only in the development stage, and we believe more local communities will invest in sustainable indoor vertical farms to local production of leafy greens, tomatoes, fruits, and other food products. We've taken the actions needed to reduce our expenses and drive cash generation, while focused on our growth plan. Thank you for your time today and thank you for your interest in GrowGeneration. We'll now take your questions.

Thank you. Our first question will come from Brian Nagel with Oppenheimer.

Hi, good afternoon.

Hey, Brian.

Good afternoon.

So, the first question I want to ask is directed at you, Darren. From a broader perspective, looking back at your initial comments, I'm trying to understand what is happening in the industry. We began discussing the headwinds of oversupply and, in some cases, slower licensing about halfway through last year. It seems these headwinds have continued, if not intensified, longer than many of us anticipated. Can you explain what's happening now? If I understood you correctly, it appears the oversupply is not just limited to the West Coast or California; it's affecting other markets as well. Could you clarify whether this is solely a supply issue? Are we also seeing a demand issue? Additionally, is it possible for a supply issue to persist for more than one year, or is there a natural self-correcting mechanism in place?

I can start, Brian. To begin, there is a certain level of licensing required in every state where GrowGen operates. From the outset, we believed we would expand from state to state. As these states matured, we anticipated a slowdown in capital expenditures, which we have observed. In states like California, Oklahoma, and Michigan, which are now fully developed, we see refresh cycles every three to five years, introducing new lights, control systems, and products. Initially, following the 2020 election and the democratic sweep, we expected new states to legalize at a faster pace, but the reality has been quite the opposite, with more regulations and obstacles appearing. Despite significant investment in existing markets, such as California and Michigan, we've encountered ongoing illegal markets in California, while states have excess product. Wall Street has also pulled back on funding new builds, contributing to oversupply and falling prices on the cannabis side. This creates a challenging environment for the hydroponics sector, as indicated in recent calls from industry leaders. Currently, many companies are not constructing new facilities, leading to declines in sales of LED lights and other systems. GrowGen has shifted its focus to selling everyday consumable products for plant growth, as larger projects have stalled. If the cannabis industry remains stagnant, it could face tougher times ahead. However, we believe the industry could reach $100 billion in this decade, currently valued around $20 billion. Therefore, while we are taking a cautious approach, we are optimistic about future growth, especially in new markets. We're focusing on building a 35,000 square foot store in Mississippi, set to open in June, alongside new stores in Virginia, New York, and New Jersey, anticipating these markets will foster industry growth. We expect the oversupply conditions in the West will eventually correct, leading to renewed growth in cultivation. The outdoor growing season on the West Coast has been pushed back nearly three weeks, and while we hope for an uptick in outdoor production, it hasn't materialized yet. We are being very conservative with our guidance until we observe a market turnaround.

That's really helpful, Darren. As a follow-up for Jeff, I would like to know more about the strategies you might consider to maintain financial stability during this challenging period. If results are weaker than expected, what options do you have to help stabilize the financial situation?

I think there are several factors that we are still incorporating into our guidance and will continue to address throughout the year. Our top priority is cash from operations, ensuring the strength of our balance sheet, focusing on inventory turnover, and enhancing our overall situation. You can observe this in our inventory figures as we release them over the course of the year, as we aim to improve that aspect. We have made progress so far this year, despite our investment in HRG, and our capability to expand our brand offerings for the distribution business. We have significantly reduced inventory from the end of last year to now in our legacy business, excluding MMI and HRG, and we are still assessing our turnover rates. We are examining our expense structure for potential efficiencies at various levels, including labor at the store, management, and administrative levels, as well as seeking efficiencies in external services and marketing costs. We are confident that the technology investments we have made, which will lead to the launch of our new ERP system in a few months, will greatly enhance our distribution efficiency and help us gain a clearer understanding of our operational metrics to drive better outcomes. Overall, we are committed to ensuring that our business matures quickly to position ourselves for our customers and to grow profitably in the future.

Okay. Thanks a lot. Appreciate it.

Thanks, Brian.

And our next question will come from Aaron Grey with Alliance Global Partners. Mr. Grey, your line is open for a question. Please go ahead.

Hi. Apologize, I was on mute. Hi. Thanks for the question. So, first question for me. I appreciate the call on the brighter dynamics. One of the other things you guys mentioned was lower demand from your larger customers, just as we think about these Northeast states kind of coming online and some of the license structures are going to be a little bit different than Michigan, California or Oklahoma. I think there's going to be a little bit more of a reliance on some of the larger players out there. So, can you talk about some of the initiatives you have with those players, because I think you're going to have more of reliance to capture some of the growth there? Yes. There'll be able to license. I believe, the New Jersey, New York, and Virginia markets, but less so than those other three markets from now see the downturn in which drove a lot of your growth last year. So, just your initiatives with some of those larger customers and how those have kind of evolved. Thank you.

Yeah. Aaron, we have a very talented commercial team at GrowGen that does represent many of the large cultivators around the country. They're in constant contact with them. We are rolling out new products constantly. We have an eye on 630 light right now that we believe is best to breed. We have a benching company doing vertical racking right now. So, we are certainly looking right now to be a one-stop shop for most of these larger cultivators around the country. But we do service most of them, and we have the best solution, best service, best supply in the country. And we also have dedicated reps that spend time in the cultivation centers around the country and they do work hand in hand with a lot of the large cultivators that do have licensing in these new states.

Thank you for your insights. Regarding the three to five-year reset cycle, do you believe it will apply to markets like California, Michigan, and Oklahoma? These states represent a significant portion of your revenue. With new states emerging and considering the current licensing structure, would positive regulatory developments be sufficient to counterbalance the reset cycle in these established markets as they undergo their buildout phases? Thank you.

Currently, approximately 65% of our sales come from consumable products, while about 35% are from non-consumable items. The consumable products are essential for daily or weekly use, so we are confident in that area. In terms of reset refresh cycles, we're typically observing the introduction of new or energy-efficient products, particularly in lighting, dehumidification, and control systems. Currently, we are in a wait-and-see phase, and we are already a year to a year and a half into this transition. We are optimistic that new products will be launched and that more capital will flow back into the markets, which we believe will be sufficient to balance declines in other areas. Non-consumable products yield our lowest margins, while consumable products provide a higher margin for us. We feel well-positioned to regain growth as the industry rebounds. We expect to capture significant shares in new states as they come online, and we are currently expanding in Mississippi and signing leases in Virginia, New Jersey, and Missouri. We anticipate growth ahead. Additionally, we have over 400 private label SKUs in our portfolio. We are in the process of launching Drip Hydro by mid to late May, which we expect to be a highly successful nutrient line, with early feedback indicating strong potential. We look forward to discussing this with Wall Street in our next earnings call.

All right. Great. Thanks for the comment. I'll go ahead and jump back into the queue.

Our next question will come from Andrew Carter with Stifel.

Thanks for the update. For the last part of the fiscal year, this suggests an increase ranging from $14 million to $74 million. First, could we get the same-store sales figures for each of the next three quarters to align our models? Secondly, what portion of the final nine includes M&A activity, and what is the revenue expected from new store relocations? Thank you.

To clarify your question, the mergers and acquisitions we've completed this year include the purchase of HRG, which operates as a distribution business, and the acquisition at the end of 2021 of the MMI business in New York that manufactures benches. These are factored into our guidance for 2022. We are not forecasting any new acquisitions for 2022 at this time, as we currently do not have any suitable targets identified. While we remain vigilant for opportunities to expand our network, we do not have any potential targets at this moment.

Yeah. But when…

You look at the no, go ahead, Andrew.

I want to know if you have a plan for the year that includes some incremental mergers and acquisitions from either the wrap or MMI, HRG. How much of that is factored into the final nine months? That's my question, in addition to the new store openings.

As we disclose at the end of the calendar year, the MMI business has total revenue in the low double-digit millions. The same goes for HRG after converting that business to distributor. For our new stores, we expect that with our reduced new store openings and a renewed focus on fresh markets, adding 10 to 15 retail stores will generate approximately $5 million to $10 million, around $10 million plus or minus, in revenue for the calendar year, depending on the openings, but that's our current outlook.

Okay. Thank you. Second question I would ask is, I mean, this is the second delayed filing you've had here and I know there's been a lot of guidance revisions. You're not alone. But I guess I would ask is, is there like an issue with the systems or something another round that you need to go, or something like another row of investment, anything you can help us out with? Thanks.

We have already been making those investments, and I appreciate your patience. We have matured as a business, and with that, we've added complexity which obviously requires more time, effort, and detail in the closing process. Moving to a large accelerated filer at the end of the calendar year significantly accelerated our timeline, particularly at year-end, with a marginal impact on the quarters. We don't expect any further delays in filing status in future quarters. This quarter, we needed a few extra days to finalize some items associated with 2022 and the complex business combinations we've undertaken over the past year and a half. However, we do not foresee any further delays, especially with the upcoming launch of NetSuite this summer, which we expect will greatly improve our ability to deliver results even earlier than we are currently able to.

Thanks. I'll pass it on.

We now take a question from Scott Fortune with ROTH Capital.

Good afternoon. Let's focus on California, especially considering the downturn we experienced in Colorado about four years ago. What is your perspective on the situation? There's currently no indication that California is correcting, but could you remind us how much of your sales are generated from that state? Additionally, you mentioned a return rate of 55%, which sounds positive, but could you elaborate on whether you are seeing customers going out of business? Are cultivators struggling in the challenging California market? Also, how does this compare to the decline you witnessed in Colorado when you reduced your store base? Do you think your current number of stores in California is appropriate, or is there a possibility of needing to adjust or reduce that further? What is your take on the 23 stores in California in light of the current market conditions?

Sure, I'll start. We have 23 stores in California that are distributed across both Northern and Southern regions. There are specific areas where we might consider consolidating some locations in 2023. Most of our California stores are still making a profit, and we review our performance closely each quarter. We've made significant cost reductions in California. As we approach the summer planting season, we will reevaluate after the spring to see how it unfolds. Many of our Northern California stores are focused on spring and outdoor growing, so we don't yet have a complete understanding of the outdoor season there. Currently, our California operations account for about 20% of our overall business, while the larger share comes from the Oklahoma and Michigan markets. At this point, it's still too early to make any decisions about consolidating our stores in California.

Got it. To provide some insights on the private label side, I understand there's still potential in some initiatives regarding nutrients. Are you noticing customers opting for lower-priced options, which might be benefiting your private label? How are customers responding to the current inflationary challenges? Are you observing any trends of customers trading down? Also, regarding mergers and acquisitions, do you see any ongoing opportunities in the private label sector?

Our private label brands are currently experiencing growth, primarily from in-house initiatives. We are in the process of launching Drip Hydro, a product developed by GrowGen. The brands Power Si and Charcoir, which we acquired last year, are performing well. Additionally, we purchased MMI this year. An exciting acquisition for GrowGen this year was HRG, which distributes Power Si and Charcoir to 750 hydroponic locations nationwide. We will leverage HRG to distribute GrowGen's private label products to various stores across the country, offering competitive pricing and high-quality products. This distribution is expected to begin in the latter part of the second quarter, and we will have more insights to share during the third-quarter call. Furthermore, we plan to start distributing Drip Hydro to other stores in the third quarter.

That's good. Are customers trading down, or how are you seeing their reactions to the current inflation pressures?

Our pricing on some of our private label products, including our Charcoir and Power Si products, remains at a premium level. Many GrowGen products currently fall into the premium category as well. Our Ion Lighting products are priced very competitively in the market. Ion had a strong performance in 2021 and has started 2022 decently. However, pricing for lighting has decreased from vendors, distributors, and retailers. As a result, lights that were previously priced at $1,100 are now being sold for $800, reflecting the competitive nature of the market in stores across the country.

Okay. I'll jump back in the queue. I really appreciate the color. Thanks, Darren.

Our next question will come from Glenn Mattson with Ladenburg Thalmann.

Hi. Yeah. Thanks for taking the question. So, I'm just thinking about inventory and the chance for any potential obsolescence and how comfortable you are with the inventory on the balance sheet. Can you go into that at all?

We review our obsolescence position every quarter, and we're comfortable with the reserves that we have in place on the lower of cost of market analysis that we do on a regular basis. We do have programs in place to address products that are starting to slow down. And we have specific programs from a marketing and promotional perspective to make sure that we continue to move the product, and no concerns on that front.

And is there a target number you want to get to by the end of the year in terms of days of inventory or an absolute dollar number in terms of working down that number over the course of the year?

Yeah. I'm hesitant to put our neck out there on a specific target of inventory numbers. I can say that internally we're focused on continuing to drive down our inventory levels and get back to a turnover that was similar to what we've seen in the past, which is four turns a year for our inventory. So, we're focused on improving our turns, but at the same time, making sure that we have product available for our customers, and that we have the selection and the service for the customers to make sure that we're competitive in the marketplace. So, it's a balance between those two issues and we want to make sure we're taking care of the customers on a long-term basis. We have the financial capabilities of being there for our customers, and we don't want to change that.

Darren, someone has already asked about the lower demand from your large commercial accounts. Considering the Northeast states, many of the major players there early on are not necessarily significant in markets like California or Oklahoma. Given this, as this part of the country begins to improve and the cannabis market starts to grow, how can you assure investors that you'll participate in that growth proportionally?

I think the straightforward answer is that we've consistently taken our fair share in every state we've operated in. We are recognized nationwide for our excellent service solutions, supply, and products, as well as having the top commercial team. Therefore, I see no reason why our strong presence in other states won't continue in the Northeast. We currently have a solid foothold in Maine, Rhode Island, and Massachusetts, and I believe that will extend into New York, New Jersey, and along the coast.

All right. So, to summarize, if you're comfortable with the inventory level, which is your largest asset in terms of cash, and with the recent reduction in your capital expenditures, you should end the year with a reasonable amount of cash as you manage your inventory. Additionally, you mentioned that cash from operations is expected to exceed EBITDA.

That's correct.

You will end the year with a decent level of cash. I usually don't ask this question since it's more for the Board, but Darren, what are your thoughts on potentially investing in the company given the stock's current position? Do you think there is an opportunity to show confidence in the company's ability to recover, maybe through a share buyback or something similar? That's all from me. Thank you.

I think it's a question for the Board. Everyone has their personal opinions on it, so I'd prefer not to discuss it right now. However, the Board at GrowGen will review the current stock situation and make a rational decision. There are many who believe that stock buybacks can represent a weakness and may not always be the best use of cash, particularly in uncertain markets. So, as I mentioned, it will be up to the Board, and we will see what happens.

We will now hear from Ryan Meyers with Lake Street Capital Markets. Everyone has their personal opinions on it. I'd rather not discuss it right now. But certainly a question for the Board and like anything else, the Board at GrowGen will always look at where the stock is right now and make a rational decision on it. However, there are plenty of people that view stock buybacks as a sign of weakness, and not always the best use of cash, especially in uncertain markets. So, like anything else, Glenn, it'll be a question for the Board, and we shall see.

Yes. Hi, guys. Thanks for taking my question. Just one for me. So, of the 10 to 15 stores that you guys look to open, how many of these do you already have specific geographies identified?

We have opened a store in Ardmore, Oklahoma. We have also completed reloads in Auburn and Redding, and we have a signed lease in Mississippi that will be operational in June, currently under construction. We are also finalizing lease agreements in Virginia, Missouri, and New Jersey. We have identified specific areas and are actively securing leases. Currently, we have completed three openings, and Mississippi will be our fourth. With an additional three lease signings upcoming, that brings us to a total of seven.

And it appears there are no further questions at this time. I'd like to turn the conference back over to our speakers for any additional or closing remarks.

I'd like to thank everyone on the call today. Thank you to our shareholders, and to each one of our employees. We appreciate everything you do for GrowGen every day. And we look forward to sharing hopefully some better news on our second quarter call coming up in August. Thank you.

And that does conclude today's conference. Once again, thanks everyone for joining us. You may now disconnect.