Good day ladies and gentlemen and welcome to GrowGeneration Second Quarter 2022 Earnings Results Conference Call. Today's call is being recorded. For opening remarks, I will turn the call over to Clay Crumbliss from ICR. Please go ahead.

Welcome everyone to the GrowGeneration second 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 closed today. This information is available on the Investor Relations section of GrowGeneration's website. 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 which provide reconciliations of non-GAAP financial measures to the most directly comparable GAAP measures are all available on our website. Following our prepared remarks, we will take questions from research analysts. We ask that you please 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 second quarter 2022 financial results. I will begin with a brief discussion of the challenges that continue to pressure all aspects of the U.S. cannabis and hydroponic markets. I'll then provide an overview of how our GrowGen business is performing, and I'll highlight the aggressive, proactive steps we're taking to adapt. Then I'll finish by reiterating our confidence in the longer-term strategic plan for GrowGeneration. I would like to start by thanking each one of our employees across our Corporate Center and 62 retail locations for your continued support of GrowGen. It's been a challenging few months, but I, along with the rest of the executive team, appreciate your hard work and dedication to our vision and strategic plan. It will not come as a surprise to anyone on this call that the cannabis industry is currently experiencing an unprecedented and prolonged downturn that is negatively impacting all participants across the cannabis value chain, from growers, to suppliers, to retailers. For GrowGen, while our sales and profit generation in the first half of the year have clearly underperformed our original expectations, and while we're planning for the lull to continue into the second half, we remain dedicated to controlling the areas of the business we are able to control. We identified early the need to proactively make changes in our business, and we're shifting our priorities to put less focus on our five strategic imperatives and put even more emphasis on cost controls, inventory reduction, and cash generation. As a result of our actions over the last few months, which we will discuss in more detail later, I want to reassure you GrowGen is on solid financial footing. We have a strong balance sheet, and we don't anticipate the need for external debt or equity issuance. We currently have $65.6 million of cash and cash equivalents with zero debt. As we sit here today, we feel very good about our liquidity position well into the foreseeable future. The company has the ability to meet the operational needs of the business without additional capital, even if the current market conditions persist. As it relates to the broader industry, supply and demand remain out of equilibrium, with a large oversupply of cannabis in the marketplace. As a result, growers have slowed CapEx projects, which is directly pressuring hydroponic sales year-to-date. The trends are most pronounced in major markets such as California, Oklahoma, and Michigan, which represent an aggregate over 56% of our retail sales. In summary, we've seen cannabis demand and therefore hydroponic demand slow nationwide, and we're not able to accurately predict when the industry will get out of this rut. On a positive note, we do see continued opportunities for cultivation growth in emerging states and regions, including the northeast, Midwest, and New England, which over time, is where we will focus our store expansion and commercial efforts. In addition, there have been some positive developments on the legislative track. The state of California recently eliminated the cultivation tax, which will make legal cannabis more competitive in the marketplace for wholesale cannabis prices that remain well below year-ago levels. At the federal level, lawmakers in the United States Senate have introduced new legislation that, if passed, would pave the way to federal cannabis legalization. While the general consensus is that the bill faces an uphill battle to overcome a Republican filibuster, we were encouraged that the conversation on Capitol Hill seems to be gaining traction again. As we said before, we manage our day-to-day operations and planning for the future under the going assumption that cannabis is not federally legalized in the U.S. In other words, our business model does not depend on that outcome. That said, we think it's only a matter of time until lawmakers in Washington catch up with the American public who overwhelmingly support federal cannabis legalization. The first half of 2022 hasn't been easy, but we've made a lot of progress, strengthening our business over the last six months. As I mentioned earlier, our balance sheet is strong and healthy. We have $65.6 million of unencumbered cash, reduced inventory by $7 million from $106 million to $99 million in the second quarter, due to a combination of inventory management and selling out of close-out products. But there's a silver lining to this exceptionally difficult operating environment. We've used this opportunity to more closely evaluate our retail footprint and cost structure. Throughout the first half of the year, we reduced our expense base by roughly $1.5 million a quarter through a combination of labor management and tighter day-to-day expense controls. In the second half of the year, we're projecting a decrease of an additional $1 million in each quarter sequentially, primarily through store closures and expense control. In total, we estimate that our annual run rate expense will be down about $13 million by year-end 2022 when compared to Q4 2021 pace. That is $26 million in expenses in Q4 2021, down to $22.7 million in Q4 2022, not including annualized contributions from HRG and MMI. While reducing the workforce is never an easy decision, I'm confident we've made the right choices to strengthen the company and better position GrowGen to make a strong recovery. In terms of our store count, we've closed two stores in July and will be closing an additional three to five stores this year. The majority of these consolidations are simply eliminating redundancies in the footprint to unlock stranded costs. In fact, we expect very little, if any lost sales due to these closures, as most of the stores were within 20 miles of another GrowGen retail location. As a reminder, we recently opened our new Greenfield location in Jackson, Mississippi, and our new location in Ardmore, Oklahoma, that opened earlier this year, is performing as well as can be expected given the market conditions. As of now, we've scaled back store opening plans and only have two to four locations planned before year-end as we've shifted our priorities to manage through this downturn. Notwithstanding, we've signed leases that will be opening retail locations in Missouri, New Jersey, and Virginia. The takeaway is, we still believe there are compelling opportunities to acquire and build new stores in states where we don't yet have a physical presence throughout the eastern parts of the country and in the Midwest. As I hope you can see, we're actively prioritizing working capital optimization to preserve our capital base, and right-sizing our cost structure to reduce our breakeven and enhance our future margin structure. We believe that when the cannabis industry eventually recovers, these efforts will put GrowGen in a better place to emerge stronger, with an even more attractive financial algorithm as the leading hydroponics retailer and private label supplier. Our private label strategy remains one of the top imperatives this year. We're driving sales of proprietary brands and private label products and we're investing in resources to provide customer service, product development, and distribution excellence. Private label accounted for $6.5 million of retail sales, which is around 11% of our overall retail and ecommerce sales. Drip Hydro, our proprietary nutrient and additive line launched in GrowGen stores during the second quarter, is off to a strong start. In our non-retail store segment, our acquisition of HRG is enabling us to expand the distribution of some of our 400 private label SKUs to 750 hydroponic stores across the U.S. We made good progress against this goal during the second quarter. Revenue from our non-retail distribution business, including HRG, MMI, Power Si, Chart Coir and others, totaled 16% of sales in the second quarter, but contributed over 21% of gross profit. I want to make a few points about our performance in the quarter. Clearly, we are not satisfied with the current sales trends in the business. Our second quarter comparable sales declined 57% year-over-year, with generally equal distribution of dollar sales across April, May, and June. We did not see a seasonal increase in revenue in June, which historically shows an increase of over 10%. 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 have not seen any material improvement in July trends, which were down approximately 52% compared to last year on a same-store comp basis. On a positive note, private label sales and margins have held up relatively well, and we generated positive operating cash flow in the second quarter of $3.8 million through our concerted efforts to reduce inventory, optimize our working capital, and preserve cash. In terms of profitability, we had a GAAP net loss in the quarter, inclusive of goodwill and intangible impairment. We delivered an adjusted EBITDA loss in the second quarter of $2.9 million with a gross margin of 28.5%. These results in the second quarter included a few items worth noting. Freight transportation costs were $3.8 million in the quarter, which we estimate is roughly triple our volume-adjusted historical normal. We expect these elevated costs to continue in the back half of the year as we look to minimize procurement for rebalancing inventory and store closures. We incurred $500,000 of severance costs related to workforce reductions, and we incurred $800,000 of bad debt expense. The declining macro environment in the industry has adversely impacted the enterprise value since our last quarterly report. This triggered a review of goodwill and intangible assets acquired in business combinations over the last few years. The impairment expense is a result of declining enterprise values throughout the peer group. Net of these items, we estimate our adjusted EBITDA would have been more consistent with the first quarter, reflecting the difficult decisions we've made throughout the quarter to right-size our expense structure and ultimately reduce the company's breakeven point. As Jeff will detail for you shortly, we are reducing our guidance for both net revenue and adjusted EBITDA for the full year 2022. On the top-line, the revised guidance reflects a third and fourth quarter that closely resembles the trends we saw in the second quarter, which, as you will recall, was sequentially softer than the first quarter. From a margin perspective, we expect continued pressure from elevated freight costs to be at least partially offset by the ongoing benefit of reduced G&A expense and the mixed benefit from a higher proportion of private label sales. With that, I'll turn the call over to our CFO, Jeff Lasher.

Thank you, Darren. First, I will address our second quarter financial results. And then I will discuss our updated full year 2022 guidance. For the second quarter, GrowGeneration generated revenue of $71.1 million versus $125.9 million in the second quarter of 2021, representing a decline of approximately 44%. The decrease in revenues was primarily attributable to a 57% decrease in same-store sales revenue and an $8.3 million decline in ecommerce revenue. This was partially offset by a $7 million increase in non-retail businesses, including the acquisition and integration of HRG and MMI, which increased that segment sales to $12 million this quarter from $5 million a year ago. Our same-store sales for the second quarter of 2022 were $44.8 million, compared to prior year sales of $104.1 million, representing a 57% decline against the comparable year-ago quarter. This comp base includes ecommerce web stores that operated in both periods for 2021 and 2022. Gross profit margin was 28.5% for the second quarter of 2022, up approximately 140 basis points sequentially from the first quarter. Gross profit dollar generation in the second quarter decreased 43% from the prior year, including the impact of acquisitions and new stores in our retail stores, ecommerce and our non-retail segment. Our retail gross margins in the quarter were flat to last year, but aggregate gross margins benefited from the decline in ecommerce volume as a percentage of total sales from 10% revenue to 5% of revenue, as well as an increase in the mix of distribution and other segment revenue from 4% of revenue to 17% revenue. The distribution and other segment has meaningfully more favorable gross margins than the retail and ecommerce segments. We did have a significant headwind on a gross margin percentage basis from freight and shipping expense. On an absolute basis, freight expenses in line with last year. But as Darren mentioned, with the decline in sales volume, the percent of revenue spent on freight increased substantially in the second quarter. Core operating costs and other operational expenses declined sequentially from the first quarter. Overall, the expenses directly associated with revenue production declined from $14.5 million in Q1 to $13.8 million in Q2. Selling, general and administrative or SG&A costs were $10.6 million in the second quarter, of which $1.1 million was derived from stock-based compensation. This compares to $10.3 million in Q1 with $1.6 million of stock-based compensation expense. Total SG&A expenses were impacted by $500,000 of severance-related expenses and $800,000 of bad debt expense, more than double the amount of bad debt-related expense in Q1. Compared to the same period last year, SG&A expenses increased $100,000 in the second quarter of 2022, with overall savings offset by the addition of HRG and MMI and the previously mentioned increase in bad debt. On a year-over-year basis, we added six retail locations from 58 to 64 stores in the second quarter, which also contributed to the increase in second quarter store operating costs on an absolute basis versus the comparable period one year ago. As Darren outlined, we've taken a number of steps to right-size operating expenses, including resizing the payroll, consolidation of the ecommerce web stores, reducing marketing expenses, rationalizing our store count, and other operational changes. Depreciation and amortization of intangibles was $4.8 million in the second quarter of 2022. In addition, as Darren mentioned, the company had a one-time impairment of goodwill and intangibles associated with previous acquisitions. This $127.8 million will not impact the day-to-day operations of the business and is related to the contraction of the company's enterprise value. This one-time non-cash expense resulted in a valuation allowance expense of an additional $1 million associated with the temporary impairment of deferred tax assets, as we do not project the ability to use those operating loss credits in the foreseeable future. However, the loss generated will result in our tax refund of approximately $3 million later in 2022. Income tax was a benefit of $283,000 in the quarter, the income tax provision was impacted by the valuation allowance of $1 million. For 2022, we are forecasting a financial loss for tax purposes but with a valuation allowance, we do not expect significant income tax provision benefit or expense for the remainder of the year. Net loss for the second quarter was $136.4 million, or $2.24 per diluted share, compared to net income of $6.7 million or $0.11 per diluted share from the comparable year-ago quarter. Just a reminder that impairment income tax expense represents a preliminary amount and remains subject to change following the completion of normal quarter-end accounting procedures. Adjusted EBITDA, which excludes the expenses associated with interest, taxes, depreciation, amortization impairment, and share-based compensation expense, was a loss of $2.9 million for the second quarter of 2022, compared to income of $14.5 million in the second quarter of 2021. We estimate this quarter's adjusted EBITDA loss includes roughly $1.3 million of unusual items that we expect should either become less impactful or will not repeat going forward, including bad debt expense and cost cuts related to labor reductions. Related to the balance sheet, the company ended the quarter with $55.6 million of cash and $10 million in marketable securities that are mature and available for sale. Total liquidity was $65.6 million at the end of 2022. The company reduced inventory by $6.9 million, offset partially by a $2.2 million increase in prepaid inventory. We also consumed about $4.4 million for payments associated with technology and distribution investments. Cash generated from operations in the quarter was $3.8 million, primarily from the reduction in inventory. I will now discuss our updated expectations for the balance of the year. We saw an acceleration of declines from the first quarter sequentially into the second quarter. We have not seen an improvement in the third quarter to date through July from those two quarter lows. As such, we are now expecting and planning for comparable store sales across the country in the second half of the year to resemble the first half. Specifically, July was down 52% on a same-store sales basis. As a result, we are now forecasting comparable sales declines at or below Q2 results for Q3 and continued degradation in comparable store sales for the fourth quarter. Overall, we anticipate revenue to be down $30 million to $55 million in the second half of 2022 compared to first half revenue of $152.9 million. We are now expecting full year 2022 revenue to be between $250 million and $275 million and full year adjusted EBITDA to be a loss of $12 million to $50 million, all including the contribution from recent acquisitions. The middle of our guidance range embeds a continuation of the current trends we are seeing today. The low end contemplates a further deterioration in the operating environment. We expect gross margins to remain under pressure throughout the balance of the year due to lower sales volume that produces deleverage of the supply chain, as well as discounting and elevated freight costs. We expect adjusted EBITDA in the third quarter of 2022 to be a loss in the range of $3 million to $5 million weighed down by elevated gross margin pressures, additional employee separation and store closure costs, and other expenses. We expect operating expenses to be controlled and sequentially down in the third and fourth quarters, as we are now planning for fewer retail store openings than we previously expected to add to the absolute dollar expense in Q4. We are continuing to take steps in executing our business strategy, focusing on generating cash from operations during this challenging industry environment. We are planning for total capital investments outside of acquisitions, primarily for new store buildouts and technology investments of $69 million for the back half of 2022. Thus far, we have spent $8.8 million in 2022. We have opened a new location in Ardmore, Oklahoma, near the Texas border, and relocated stores in Auburn, Maine, as well as Riverside, California. Our new Jackson, Mississippi location opened in July. We have closed two stores and plan to close three to five additional locations, and we're in the process of reviewing additional store closures. We estimate year-end store count to be around 60. With that, I will turn the call back to Darren for closing remarks.

Before we open the line for your questions, I want to reiterate that while 2022 is not shaping up as we initially expected, we are making the tough decisions necessary to ensure we're in the best place possible to emerge stronger than ever when the industry eventually turns around. We're actively focused on the areas of the business that we can control and have acted quickly beginning back in January to reduce costs and prepare to weather the industry downturn. We accelerated those efforts even further during the second quarter by delaying a few of our strategic goals this year in favor of right-sizing our core structure with significant workforce reductions, including a couple of high-level executive positions and store count rationalization. As an update on our five key initiatives, our ecommerce sites have been combined, and we're actively working on efficient operation of profitable web stores. We've opened five new and relocated locations but scaled back near-term openings considering the industry-wide sales slowdown. Our technology improvements are delayed until later this year. We continue to expand private label penetration to 11% of retail sales from brands that we have control over, and our distribution and other segments continue to be an area that shows incremental revenue and beneficial margins. We have not changed investment activities in any segment. We remain committed to the expansion of our proprietary and distributed brands outside our own retail locations into 750 independent locations. We are very satisfied with the results of both Char Coir and Power Si and are very excited to have introduced Drip Hydro nutrients and additives. The addition of MMI strengthens our position to gain indoor vertical cultivation projects with their leading benching and racking systems. Controlled environmental agriculture and sustainable agriculture are only in a developmental stage, and we believe more local communities will invest in sustainable indoor vertical farms for the local production of leafy greens, tomatoes, fruits, and other food products. GrowGen remains on solid financial footing with a strong balance sheet, a healthy liquidity position, and solid cash generation. We're confident that when the cannabis cycle turns and the excess supply in the marketplace eventually normalizes, GrowGen will be well positioned to recover quickly with a more attractive expense structure on a lower G&A base from which to build. Thank you for your time today, and thank you for your support in GrowGeneration. We will now take your questions.

Thank you. We'll take our first question from Scott Fortune with ROTH Capital Partners. Please go ahead.

Good afternoon. Thanks for the question. I just wanted to focus, Darren, obviously on long exposure in California and how that plays into your store base there. We're seeing cultivation licenses up for renewal in October and sounds like maybe California cultivators are not planning this year or renewing licenses, resulting in ongoing pressure for a lot of the small growers. What's your sense of California and how that will play out for the rest of the year? And then your footprint in California from the store base side of things? Thanks.

Yes, Scott. As you know, California is the epicenter of cannabis and always will be. There is a tremendous base of cultivators in the state of California. There's also a significant illegal market coming out of California, and we believe you will see an equilibrium somewhere. You've seen positive events in California over the last few months with the state tax giving back almost $160 a pound for the cultivators out there. We've seen a very slow outdoor season in California, which usually bodes well for the indoor markets. Our bread and butter in California is the legal market, and it's the indoor growers. So we feel pretty comfortable with where the market is. We opened a store in LA last year that is progressing well. Our California stores, albeit down, have been stable over the last few months.

Got it. I appreciate the color there. Can you provide a little more touchpoints from the top customers on the commercial side versus small operators in terms of their ordering in California? What percentage of revenue is driven from recurring fertilizers and mediums now versus more the equipment purchases overall for your business?

Yes. I think what you've seen this year, Scott, with the downturn in the cannabis markets and the downturn in the capital builds, we've probably seen a shift to about 75% on consumable products and 25% on capital build products. We do believe, with the growth of this industry, you will see a resurgence of capital build projects in the future. When that occurs, we just don't know right now. I'm just seeing some positive talk right now on Capitol Hill, from Schumer and Booker. More articles were out today; I see you're starting to see that compromise going into the internal elections. And like anyone, we certainly have our fingers crossed. The cannabis markets right now are about a $20 billion market, and many experts project that to be $100 billion by the end of the year. When you compare it to the wine and spirits market, which is almost at that trillion-dollar mark, we think there's tremendous upside. But in the growth of any industry, you see ups and downs. Unfortunately, right now, Scott, you're seeing downs. You heard it from Hydrofarm and Hawthorne this week; the markets have been tremendously challenging. GrowGen has taken all steps to stabilize this business and bring it back to profitability.

Thanks for the color. I will jump back in the queue. Thanks, Darren.

We'll take our next question from Aaron Grey with Alliance Global Partners. Please go ahead.

Hi. Good evening and thank you for the questions. So first question for me, as we look at the broader cannabis landscape in your customer base. The capital markets environment is very difficult for them right now, which has always been given federal illegality. This creates difficulty in retaining an ROI, particularly when we think about the 280E headwinds that your customers face. So I guess my question is, as we're facing this reset now, oversupply in key markets, pricing pressure making it even more difficult to be profitable, especially cash flow with 280E, how do you think about the changes that are going to be needed at the federal level to get that shift back to where you might have been last year? Do you think SAFE is enough for that, if 280E was not being included, and it was more just out of the depository banking side? Thank you.

I think to start with, Aaron, the SAFE Act certainly brings legitimacy to the markets, which I think everyone is looking for. We all know that build-outs and new facilities cost a lot of money. What you're seeing right now is on the cultivator side, they're also preserving cash for the future. A tremendous number of individuals are simply happy with what they have right now. If the industry stays at its current level, there's enough facilities to handle that. The looming question is whether the cannabis industry is going to grow from where it is today to the future estimates. We still believe there will be a tremendous amount of business coming in from typical agriculture and indoor growing, which should boost the hydroponic and CEA industries moving forward. The SAFE Act will provide a boost to the markets and the capital equipment markets. As new states come on board, albeit much slower than expected, we are starting to see builds happening in New Jersey and New York. You're seeing them beginning in Mississippi, albeit slowly. Virginia and Missouri are also starting to witness developments. The builds are happening, albeit not at the same levels we observed a year ago.

Okay. Appreciate that color. It’s really helpful. You guys have strong cash distribution; you mentioned how you don't need to take on any more equity or debt. You’re taking your initiatives on the expense side. On the flip side of it, I'm sure you guys are better positioned than many of your competitors and even within the hydroponic supply chain. During these times, how do you think about getting more aggressive and finding M&A opportunities? Is that not something on the horizon, or do you see people becoming more cash constrained while dealing with fundamental headwinds that you guys are as well? I'd love your outlook in terms of whether or not M&A might be opportunistic right now for you guys. Thank you.

Aaron, I think you know me well enough and you know the company well enough. If there's a deal on the table that makes sense for GrowGen, we will look hard at it, whether it's on the product side or the store side. If it's accretive and at the right price, we're always looking. Right now, it has to be the right price, and we look at deals all the time. Fortunately, unfortunately, we haven't pulled the trigger. We pulled the trigger on two deals earlier this year. One was, I think, the last day of December; MMI, and we bought HRG this year. We're very satisfied with both of those acquisitions. It’s not that we've been that quiet this year; we have made some acquisitions and store openings. But for now, we are balancing both sides. If something comes across our desks that we believe makes sense and is at the right price, we certainly will take a hard look at it.

Okay. Great. Thank you very much for the detail. I will jump back in the queue.

We'll take our next question from Ryan Meyers, Lake Street Capital Markets. Please go ahead.

Hey, guys, thanks for taking my question. First one for me. So the three or four stores that you plan on opening, just kind of curious what your level of confidence is in generating some solid business out of these in the near term. Any color on those three to four openings would be helpful.

A couple of things. They are new markets, Ryan, and we do feel quite comfortable. We have business in those markets already. We have a very vibrant commercial team out there. These aren't new states for us; they're just new states with locations to better serve the cultivators and growers. The stores that we're building in New Jersey, Virginia, and Missouri are smaller than our average stores. We'll definitely supply them from our supply chain. We're quite confident they will become profitable, as we did with Ardmore, Oklahoma about six months ago.

Okay. That's helpful. And then, Darren, you alluded to this on the call, but given the tough cannabis market, what kind of opportunities are you seeing within CEA vertical growing, indoor growing for agriculture? Do you have anything in the pipeline there?

It's still been very slow. We see certain transactions on the hemp side. But on the other side, we're starting to see some products sold into colleges that are building greenhouses on premises. However, it's been a very, very slow uptake. We think it's going to be a 2023 project for GrowGen. We've been focused on our business this year, and 95% of what we do right now is still within the cannabis space. So we have plenty of work to do on that side of the business, but we believe that in the next couple of years, you'll see that industry starting to gain traction.

Got it. Thanks for taking my questions.

We'll take our next question from Andrew Carter with Stifel. Please go ahead.

Hey, thanks. Good evening. I guess the first thing I wanted to ask, and backing up on the initiatives, I want to have an understanding of where you are in terms of harmonizing. Number one, are all your stores and distribution centers integrated from a back office perspective, ERP where you have visibility? Then on the new distribution centers, are they in a place where they're starting to enable the company's supply chain, or is it still kind of test and learn and not really benefitting until kind of 2023? Thanks.

Yes, Andrew. On the store side, the 63 stores are connected together. There are a variety of systems that we use within the organization. The retail store side, all of the acquisitions that we have acquired over the last couple of years get plugged into our systems the same day we acquire them, and we start receiving data and information from them. We do have a technology investment that will go in next year that will supplant that and provide better efficiencies for us. We're still doing quality control and validation and some exercises on that technology investment. The distribution centers, we have one active and one that's still waiting on final development, which will be in Ohio; they will provide opportunities for us to be more efficient in the distribution of our private label business, as well as our own distributed brands business, which is their primary focus in the near term. Longer term, the capabilities to service the stores with a variety of different products, as well as ecommerce deliveries, is a goal we're looking forward to as we build out the network.

Okay. Yes. I'll be offline and will follow up on that. And second question I want to ask is, do you have visibility on the competition out there? Are competing private label retail hydroponics retailers starting to struggle? Is rationalization happening as the new states are opening? Are you seeing them start to open right alongside you where you're planting flags? What can you tell us about how the competitive landscape looks? Thanks.

Yes, I think what you're seeing from competition right now is diminishing. We haven't seen many new store groups pop up of late. We just opened a large store in Mississippi, and I think we're probably the only one in Mississippi right now. The doldrums seem to spread around the industry right now. Everyone is feeling it. You heard it from Hydrofarm; you heard it from Hawthorne. You’ve seen a degradation in their sales in 2022 from the individual stores, not mine. So we do believe that we hear from stores every day. We certainly have our ear to the ground and we understand what's going on in the industry, and I think the competitors are feeling it worse than GrowGen.

Thanks. I'll pass it on.

We'll take our next question from Eric Des Lauriers with Craig-Hallum. Please go ahead.

Great. Thank you for taking my question. So you've mentioned this increasing mix of private label. You also mentioned some of these newer stores are going to be a bit smaller than perhaps what we're used to seeing. Certainly you've gone through a bit of an evolution here, and it sounds like so far in '22, it's been sort of a cold hard assessment with some of these noticeable changes here. I was wondering if you could maybe just give us sort of an updated kind of North Star of what you guys are looking for, whether that's a mix of ecommerce versus retail, overall store sizes like, can you just give us a sort of high-level overview of how your North Star or strategy has shifted within the past six months?

Yes. A couple of things, Eric. One, I don't think we've shifted that much. We have been steadfast with our private label rollouts, looking to go from 2% a couple years ago to now 11%. We've slowed down store acquisitions as we told Wall Street we would and are moving to an opening platform this year, albeit much less than we originally thought, as we work through this downturn of the industry. Anytime you see a slowdown in an industry, you need to caution yourself, and I think that's what GrowGen is doing right now. Our margins this year at 28.5% in this quarter represent a phenomenal accomplishment during these times. As Jeff mentioned in his call, our shipping costs this quarter were over three times the norm compared to our historical norms. We've done a tremendous job managing supply chain by bringing inventory down and also decreasing payroll. We're looking at a $13 million drop in overall expenses this year. Our thesis hasn't changed. While we may have slowed down for the time being as Wall Street has backed out, we still believe that the industry – the federal government has slowed down the industry for the time being. But we believe you're in the first inning of a nine-inning game. This may be an early inning, and every once in a while, you’ll see slowdowns, which we are experiencing. However, we’ve kept our balance sheet strong. We’re bringing inventory levels down, and we continue to do business every day and help the cultivators and growers in the United States.

Okay. That's helpful. Specifically, on private label, ecommerce, and inventory, can you just kind of give me a sense of how you're envisioning all those sort of evolving throughout the year? Or maybe beyond as it relates to ecommerce and retail, and sort of what's your target mix of retail versus ecommerce? Are we going to see a bit more of a push toward ecommerce or omni-channel as you are looking to slow down some CapEx spending and conserve some costs? So maybe just kind of touch on how you're looking at your ideal mix of retail versus ecommerce and then Jeff, maybe you can just comment on how we should think about your ability to further wind down inventory throughout the year? Thank you.

We are in the process of remodeling our online site, and you will see a new rollout by year-end, hopefully sooner. As we stated earlier, we've integrated our sites, Agron and growgeneration.com. Agron was specifically a commercial ordering site, and most of the business was big build-down; it was lighting, dehumidification, control systems, and that part of the industry has slowed dramatically. We’ve pivoted and we're redoing our sites. I think they're in final development right now and will be two sites in one, both looking for business from individual growers and larger cultivators, but not as much weighted towards the large commercial builds. The stores maintain business as usual. Private label traction within our stores is at 11% of sales and going higher. We just launched Drip Hydro, which is off to a great start, and we believe will increase our private label sales going into the third and fourth quarters this year. We aim for our omnichannel presence to grow while we remain cautious about the environment.

As for the specific inventory actions we've taken and progress we've made, we ended the year with $106 million of inventory, which included the legacy business from 2021 as well as the acquired inventory when we acquired MMI. It went up to $106 million at the end of the first quarter but down to $99 million at the end of the second quarter. Our inventory in the retail business continues to decline, and we expect to progress through the third quarter while maintaining investments with HRG to expand that business. Our private label inventory has some timing issues as we bring it in throughout the year on a seasonal basis in preparation for peak seasons, which ends up with variances quarter-to-quarter. But our plan is to continue addressing inventory and focusing on it as an opportunity to generate cash in the near term.

We'll take our next question from Andrew Chasanoff with Oppenheimer. Please go ahead.

Hi, thank you for taking my question. Just in regards to the top line, amid all the current industry noise, is there anything that suggests potential rebound in sales once we get through the back half of 2022? And what gives you confidence that the current sales wall is more cyclical in nature rather than structural?

The answer to that is, Hawthorne's sales were down 63% in the quarter; I think Hydrofarm may be more so. You've heard from our suppliers, and we understand the state of the industry. We believe that GrowGen is holding up much better than our peers and the rest of the industry. Like anything else, if you believe in the forecast for the underlying industry, which is the cannabis side of it, and you believe in the growth forecasts. The cannabis industry is in a low right now, but it will come back. If cannabis sales decline and don't grow, like projected, you may see some more severe issues with this industry. But from everything you hear and from the American people, which shows over 75% acceptance of cannabis, there are still states that have not built out, and people are still unable to get cannabis, which we believe presents significant opportunities. I think you're hearing from most cultivators and the MSOs that this is still the early innings of an industry and its making, and like anything else, it takes more than a few years.

Okay. That's very helpful. I guess my second question is, do you consider further legalization necessary for the intermediate to longer-term growth of both GrowGen and the industry as a whole?

We don't. However, you certainly will need the SAFE Act with some other help from the federal government. If cultivators can't make money, it's difficult for them to stay in business. The situation with 280E, which presents tax ramifications to the growers, coupled with the lack of funding coming in from Wall Street, makes building facilities very expensive. Capital has to enter the industry. Without the SAFE Act, Wall Street has pulled back, but we believe there are several pending bills heading into the interim elections that could have significant impacts on the industry moving forward.

We'll take our final question from Glenn Mattson with Ladenburg. Please go ahead.

Hi, thanks for taking the question. Most of them have been asked already. But just one more on the inventory; can you talk about the possibility of any obsolescence? Is there a large portion of that made up of equipment that's just not moving right now that won't be as viable six or nine months down the road? And then, what would be the ideal days of inventory you are targeting as you plateau at this lower level, which might last for a little while?

So on the obsolescence opportunity or risk, we review that regularly and adjust our inventory based on lower cost to market analysis that we do. We try to position our inventory for accounting purposes to reflect those risks. We are looking at some opportunities to discount in order to move some inventory, but it's not to the point where we’re selling below cost—it's more about being aggressive in the marketplace to move product and gain market share over the back half of the calendar year. As far as improving our gross margin return on investment of inventory or inventory turns, we are always looking for opportunities to right-size our inventory. However, we also recognize the need to service our customers with a selection of products readily available in our stores. Therefore, there's a balance between maintaining inventory to sustain sales and market share versus the spreadsheet analysis on a lower inventory set. We constantly review that and adjust our inventory target levels based on that balance.

Okay. Thanks for that color. And then just quickly on the cost cuts, would you expect this to flow through rather quickly or just some cadence? Thanks.

We expect our Q3 cost structure to reflect the number of actions we took in Q2, and for our Q3 cost structure to be lower than Q2.

Ladies and gentlemen, this concludes today's question-and-answer session. I will now turn the call back to Clay Crumbliss for additional closing remarks.

Thanks, Steve. And thank you everyone for your interest in GrowGeneration. Please reach out to ICR with additional questions, and we look forward to updating you on our 3Q results later in the year. This concludes our call.

Ladies and gentlemen, we appreciate your participation. You may now disconnect.