Hello, and welcome to GrowGeneration's First Quarter 2023 Earnings Conference Call. My name is Joelle, and I'll be coordinating your call today. Following prepared remarks, we will open the call to questions from analysts and with instructions to be given at that time. I'll now hand the call over to Clay Crumbliss with IR.

Thank you, and welcome, everyone to the GrowGeneration First Quarter 2023 Earnings Results Conference Call. Today's call is being recorded. With us today are Darren Lampert, Co-Founder and Chief Executive Officer; and Greg Sanders, 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 of the forward-looking statements made today. During the call, we will use some non-GAAP financial measures as we describe business performance. The SEC filings as well as the earnings press release, which provide reconciliations of the 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 reenter the queue and we will take them as time allows. Now I will turn the call over to our Co-Founder and CEO, Darren Lampert.

Thanks, Clay, and good afternoon, everyone. Thank you for joining us today to discuss our first quarter 2023 financial results and our full year 2023 guidance. As always, I want to thank each one of our employees across our company for their continued support of GrowGen. I'm grateful to our entire team for stepping up to every challenge and for being steadfast in executing our company's strategy. GrowGen is more than just a retailer. We are a developer of market-leading brands and private label products. We are a distributor supporting the entire hydroponics growing community, and we are above all a passionate and dedicated partner to our customers. As we mentioned last quarter, we celebrate our 10th anniversary this year. As we continue into the year ahead, we take great pride in our past, and we are equally excited about our future. I'm pleased to report that GrowGen's first quarter results performed at the high end of our expectations, which further increases our optimism for 2023. In the first quarter, we generated net revenue of $56.8 million at the high end of our guidance, which, as expected, represents a sequential improvement over the fourth quarter of 2022. Furthermore, gross margins in the first quarter of 2023 were 28.7%, above our expectations. We generated an adjusted EBITDA loss in the first quarter of $1.8 million, which represents significant improvement versus the prior quarter, which had an adjusted EBITDA loss of $10.2 million and outperformed our previously issued first quarter guidance. We also ended the first quarter with $72 million of cash, cash equivalents, and marketable securities, no debt, and $75 million of inventory on our balance sheet. We've spoken about it extensively in previous quarters, so I won't dwell on the challenges of the past other than to say this, last year was a transition year for GrowGen. As we detailed on our fourth quarter earnings call, nearly two short months ago, we have made significant progress transforming our business to be more nimble, efficient, and better positioned for profitable growth in 2023 and beyond. On the legislative side, state momentum has continued, with Delaware becoming the 22nd state to legalize adult-use cannabis. Minnesota is another state that could legalize adult-use cannabis this year, with state house and senate versions of the bill passing last month. Additionally, Georgia issued its first dispensary licenses and Texas, North Carolina, and Ohio could add to their medical cannabis programs, with Maryland adult-use sales planned to begin July 1. At the federal level, the reintroduction of the SAFE Act last month has renewed hope for federal reform. As a result, I'm more excited today than I've been in a while about the opportunities that lie ahead. We are entering a new chapter of the GrowGen story, and we're significantly focused on managing our business despite the ongoing challenges in the broader industry. Those challenges do impact us, but they certainly don't define us. So while we maintain a degree of cautious optimism, we expect to invest for growth in 2023, searching for opportunities where they exist and putting resources behind them in an appropriate and disciplined manner. What that means in practical terms is, one, we will continue building and growing our private label brands. Two, we are back on the acquisition front, as you have seen from our recent press releases. And three, we are putting profitability at the forefront, focusing on margin expansion and profitable growth. Briefly on each of these. First, we remain committed to the expansion of our proprietary and distributor brands, and we are very satisfied with the results of our private label products. Private label accounted for $6.9 million of retail and e-commerce sales in the first quarter of 2023, which is around 16.1% of our overall retail and e-commerce sales, up from 10.8% in the first quarter of 2022. Second, GrowGen will continue actively seeking accretive acquisitions where we believe they are complementary to our current business. We believe we're one of the few companies that is well positioned with an attractive valuation in the hydroponics and garden center space. So far this year, we acquired a store in Traverse, Michigan in January. We entered our 17th state with the acquisition of a store in Bozeman, Montana in early April. And most recently, we acquired a retail store in Jackson, Michigan, a few weeks ago. As part of these efforts, we continue to analyze the performance of our current stores concerning redundancies in the footprint. We don't expect many additional store closures this year, which was a major focus for us last year. We're focused on monetization of our nearly one million square feet of retail space, which includes merchandising, product education with key partners, and a laser focus on execution of the various business transformation initiatives centered around technology and supply chain. We are pleased to announce that our third distribution center, approximately 100,000 square feet located in Columbus, Ohio, is now operational and serving our Midwest and East Coast customers. Third, we are prioritizing profitable growth, which we believe we will attain through our continued efforts to expand revenue and execute our margin expansion strategies. We think we are past the vast majority of our cost-cutting initiatives, the benefit of which will continue to flow through our margins in 2023. In addition, we feel our inventory is in a much better position today, as reflected in our first quarter gross margins that expanded 1,100 basis points over the fourth quarter margin, and we don't see the need for significant inventory discounting going forward. Turning to guidance for full year 2023, we are maintaining our net revenue in the range of $250 million to $270 million, translating into adjusted EBITDA in the range of a $4 million loss to a $1 million profit. We are seeing incremental signs of stabilization in our business, and we expect sequential quarter-over-quarter improvements in net revenue and adjusted EBITDA to continue through the second quarter. With that, I will turn the call over to our CFO, Greg Sanders.

Thank you, Darren, and good afternoon, everyone. First, I will address our first quarter 2023 financial results, and then I will discuss our full year 2023 guidance. For the first quarter, GrowGeneration generated revenue of $56.8 million versus $81.8 million in the first quarter of 2022, representing a decline of approximately 31%. Our same-store sales for the first quarter of 2023 were $37.7 million compared to prior year sales of $59.5 million, representing a 36.6% decline against the comparable year-ago quarter. Our e-commerce revenue declined on a comparable basis from $5.3 million to $3.3 million, representing a decline of 37.7%. Our distribution and other revenue was $14.2 million for the quarter compared to $12.2 million in the year-ago period, representing an improvement of 17%. Gross margin was 28.7% for the first quarter of 2023, up approximately 1,110 basis points sequentially from the fourth quarter of 2022. Gross profit percent in the first quarter increased 160 basis points from the comparable year-ago quarter. The improvements in gross margin in the first quarter of 2023 are largely attributed to the completion of our 2022 inventory rationalization initiatives in the retail segment and a healthy margin contribution from our distribution and other segments. Store operating costs and other operational expenses declined from $14.5 million in the first quarter of 2022 to $12.9 million in the first quarter of 2023, representing an 11% reduction. The savings year-over-year were primarily attributed to payroll reductions. Further, we expect that the reductions executed over the prior year are sustainable as we move forward into future reporting periods. Selling, general and administrative or SG&A costs were $6.8 million in the first quarter, of which $600,000 were derived from stock-based compensation. This compares to $8.6 million in the fourth quarter with $1 million of stock-based compensation. This represents a 20% improvement quarter-over-quarter to SG&A. Compared to the first quarter last year, SG&A expense decreased by $2.8 million in 2023, with overall savings driven from payroll reductions and increased cost controls over a broad range of categories. Depreciation and amortization of intangibles were $3.9 million in the first quarter of 2023 compared to $4.5 million in the year-ago period. In the first quarter of 2023, the company did not recognize an income tax benefit or expense. GrowGeneration is using a 0% tax rate as its deferred tax assets are not expected to be realizable. As such, the company has established a full valuation allowance primarily resulting from the 2022 impairment of goodwill. Net loss for the first quarter was $6.1 million or negative $0.10 per share compared to a net loss of $5.2 million or negative $0.09 per share in the year-ago period. Compared to the fourth quarter of 2022, the company improved net income from a net loss of $15 million to a net loss of $6.1 million. Adjusted EBITDA, which excludes interest, taxes, depreciation, amortization, restructuring charges, and share-based compensation, was a loss of $1.8 million for the first quarter of 2023 compared to a loss of $800,000 in the first quarter of 2022. Compared to the fourth quarter of 2022, the company improved adjusted EBITDA from a loss of $10.2 million to a loss of $1.8 million, primarily resulting from increased revenue, improvements in gross margin, as well as sustainable reductions in expense. In the first quarter, the company included one-time restructuring charges or severances and consolidation expenses into adjusted EBITDA, which had a $278,000 favorable impact. Related to the balance sheet, as of March 31, 2023, the company had total cash, cash equivalents, and marketable securities of $71.9 million, which was sequentially flat to the fourth quarter of 2022. From a year-over-year perspective, cash and cash equivalents increased by $5.5 million, mainly due to inventory rationalization measures and other strategic initiatives. Within working capital, the company collected a $4.9 million income tax receivable as well as reduced total accounts and notes receivable by $1.7 million. As such, the company generated positive cash from operations of $3.4 million in the quarter. In the first quarter, the company reduced inventory compared to year-end. We believe that the outcome of our inventory reduction efforts in 2022 positions the company with sufficient inventory levels and product mix for 2023. We will continue to make incremental improvements to lower inventory where needed while ensuring that we continue to meet the procurement needs of our customers just-in-time inventory. Now moving on to our full 2023 outlook. As Darren mentioned earlier, we are maintaining our previously communicated guidance with full year 2023 revenue to be between $250 million and $270 million and full year adjusted EBITDA to be in the range of a $4 million loss to a positive $1 million profit. We have observed stabilization in our expense structure and believe that we have sufficient alignments on the cost of sales based on our first quarter results. As the company reduced its expense base by over $20 million in 2022, we are not forecasting further significant reductions in 2023. We expect that both sales and adjusted EBITDA will show incremental improvements in the second quarter compared to our first quarter results, but we are optimistic about 2023 and remain confident in our ability to navigate the industry. We will continue to stay focused on cost controls in our efforts to return the business to profitability. As Darren's remarks indicated earlier, profitability is the forefront goal of the business in 2023. Our approach to capital allocation is shifting from a focus on preservation to a disciplined approach centered on return on invested capital. We will execute on the right M&A opportunities that fill white space. We will also invest capital in our deployment of private label products where the return is appropriate. We are positioning the company and executing our business strategy to focus on business and profitability improvement.

Thank you, Greg. Before we open the line for your questions, I want to reiterate that GrowGen is on solid financial footing with a strong balance sheet, healthy liquidity, and a solid cash position. In 2023, we are putting profitability at the forefront, focusing on margin expansion and profitable growth. We are encouraged that we made significant progress during a year of transition to right-size our business, and we're ready to move forward as a stronger, nimbler, and more profitable company. Thank you for your time today, and thank you for your interest in GrowGeneration. We will now take your questions.

Your first question comes from Brian Nagel with Oppenheimer.

I just want to start by mentioning that we've discussed a lot about the current situation for GrowGen. Your comments on sales indicate that I might be feeling a bit more optimistic. So my question is, what are you observing on the ground level? Have there been any significant changes in how you interact with your customers? Are you noticing different trends in various regions?

Yes. I think to start with, Brian, as you probably know, we've had six sequential quarters of down revenue, which was certainly out of the ordinary for GrowGen, at least for the first six quarters since we started back in 2014. What we're starting to see is a pickup from our customers. We're starting to see consolidation and price stabilization in mature markets. The supply/demand is normalizing out West. New states are starting to roll out, and CapEx is increasing in new states. We're also seeing activity in the outdoor markets, which we didn't see in 2022, which should be a positive boost in sales for GrowGen in both the second and third quarters. So again, this is really the first time we've seen it. We saw back in 2018, there was about a six-month downturn. This has lasted six quarters. So we're seeing stabilization, Brian, albeit off a very low number. You saw same-store sales, which were down in the mid-50s during 2022. They were down 36% in the first quarter of '23. And we certainly look for that to be much better in the second quarter going forward.

Got it. That's helpful. Regarding gross margins and inventory, you took significant corrective actions last year with your inventories, and you entered 2023 in a strong position. Consequently, you experienced improved gross margin performance in Q1. How should we view the future trajectory of gross margins and inventories from this point onward?

I'm going to send it over to Greg. Greg?

Yes. So I think the impact of the last two quarters in '22, as you mentioned, had a significant impact on the overall gross margin in those periods. We reduced inventory by $20 million in the last two quarters of 2022. And we felt that inventory was in a much better position coming into 2023. We did make sequential improvements to inventory in the quarter, but nothing of significance. We reduced our inventory balance by $1.5 million in the quarter. I think what you saw in our results for the first quarter was a gross margin profile of 28.7%, which we believe is in the more normalized range as we look forward at the business in the future reporting periods. We're still continuing to communicate that our expected gross margin profile for 2023 will be in the mid- to upper 20s on a normalized basis.

Brian, you also saw a bump in our private label division from 10% up into that 16% range. Our private label products carry a much higher margin than our normal products. And we are buying better right now also. So I think it's all factoring into what you're seeing normalization of our margins in that mid- to high 20s.

My first question is about valuations on M&A transactions. You've been busier over the past few months. Can you discuss what you're observing in terms of pricing for acquiring new stores?

Yes, I can’t share exact pricing with you, Mark. However, I can say that if you examine GrowGen's balance sheet, our inventory, cash position, asset value, and fixed assets show that GrowGen is trading with minimal goodwill on our balance sheet at this time. When we approach the market, we evaluate the same for the individuals we are considering acquiring right now. Therefore, the goodwill aspect of these transactions is quite minor at the moment.

Okay. And then you spent some time talking about private label goods. It seems like that's certainly a push for you. Any additional insight into kind of how you feel about the brands that you have now? Is this something where you still want to be active and maybe acquire new things and what it takes to continue ramping sales of these private label goods?

I feel that we have the right team in place right now to continue ramping our private label products on both Char Coir and dripper are performing above our expectations. We do have product extensions coming out on both lines as we speak. So our private label products are taking hold in the industry, and we're having wonderful results. And we will continue with our private label penetration, and we feel very good where we are right now with our private label products and the increase in sales that we're seeing from them and margins.

Okay. And then the last question, similar here, as we look at e-commerce, sales are sitting today, is that just really a function of kind of where the cannabis industry is? And are there any levers you can pull to turn on a little more digital sales?

We are making progress. We feel more confident about increasing our advertising budget for our online division. One encouraging sign, Mark, is that our online division saw a quarter-over-quarter increase. We experienced a 7% rise from the fourth quarter to the first quarter, marking the first positive change we’ve observed in a while within our online division.

I wanted to ask about the two-year same-store sales comparison. In the first quarter, you were down 61.6%, but this was the first time you saw a two-year improvement from the fourth quarter. Looking at the second quarter of 2023 compared to the second quarter of 2022, which is down 57%, are you expecting a low single-digit decline in sales? Can we anticipate that level of improvement, or is it too uncertain to expect such a significant change in same-store sales for the second quarter?

I'm going to have Greg start with that, and I'll finish it.

Yes. Andrew, it's good to speak with you. We are anticipating an improvement in our comparable sales for the second quarter. However, at this moment, we cannot confidently specify whether that improvement will be in single digits. Nonetheless, we do expect a better performance in Q2 compared to our first quarter. Additionally, we are facing better comparisons in the second quarter compared to the first quarter of last year, which should help us perform better against last year's numbers.

Andrew, on the other side of that, when you look at comps from our first quarter, we had a pretty strong first couple of months of our first quarter. We started sales deteriorating probably in that February-March trend. So we do feel pretty comfortable on a go-forward basis with same-store sales.

Fair enough. The second thing I wanted to ask is, obviously, one of your peers or suppliers reported last week and made several comments about considering industry combinations. I know you're not going to address anything specific, but how do you see your position in light of potential changes in the industry? Do you feel the need to participate, or can you simply pursue your own strategy? It seems like you're focused on acquiring assets for inventory in a more incremental way. Any comments on this would be appreciated.

The other thing, Andrew, when you look at GrowGen, we have built tremendous brand recognition in this industry over the 10 years that we've been here. We're doing over 2,500 transactions a day with investors, and we're building out a wonderful private label division at GrowGen. GrowGen is an acquirer; we're back on the acquisition front. We've acquired three stores already this year, and the year is just beginning. So for us, we'll always do what's in the best interest of our shareholders. But right now, it's $75 million cash in the bank and $75 million of inventory, we believe we're in a wonderful position. And I still say if you were to close your eyes and look in 10 years, GrowGen will be the dominant force in both hydroponic and indoor gardening in the country we live in. So we're 100% comfortable with the position we're in right now.

I'll go ahead and jump off the back of that last question first. Just on the M&A front. So there's been some store acquisitions at the beginning part of this year, strong balance sheet. Are you looking at different verticals as well? Or what are you kind of seeing out there? Is it primarily the storefront when we see appealing acquisitions? Do you think there's something more on the vertical front, either via hydroponics or indoor gardening? Just any further commentary you can give on that would be helpful.

Yes. To begin with, the primary focus for GrowGen right now is to restore profitability, particularly in the hydroponics and controlled environment agriculture sectors. We believe there are significant opportunities in indoor gardening and product offerings, but until we achieve profitability and growth, pursuing acquisitions outside our core areas would be challenging. Nonetheless, we are observing many acquisition opportunities within the hydroponics sector, especially from source suppliers. The industry has faced tough times recently, resulting in many companies exiting the market, making it more difficult to serve our customers. However, GrowGen has the expertise and the financial resources to navigate these challenges. We have just completed the construction of a 100,000 square feet distribution center in Ohio to better serve our Midwest and East Coast customers. Additionally, we are set to implement our ERP system at the beginning of July, enhancing our operations from end to end for our customers. While we may explore other opportunities, I want to emphasize that this focus will be evident in our strategy this year.

Okay. Great. Thanks for that detail. That's helpful. Second question for me. You talked about being a rebound in some of the outdoor states, so I just want to get some further color on California, what you're seeing there, those number of licenses that are coming from renewal that were not renewed at the end of last year, and those are numbers that were also for renewal in the first half of this year. So just any further color in terms of what you're specifically seeing in California and some stabilization in your outlook there?

Yes, we are observing stabilization in California. It's important to note that when we see closures affecting growth, similar closures are also happening in the hydroponics sector. We are capturing business from stores that are shutting down, as well as from other retailers in California. Our outdoor stores in California are experiencing a boost, and some of our California locations have reported positive same-store sales compared to last year. Overall, our California stores are performing better than we anticipated, which is a pleasant surprise. Additionally, we are receiving feedback from customers indicating an increase in growing activity, reflected in the sales of our products.

First, I want to focus on same-store sales. You mentioned that there is beginning to be some positive movement in California, which suggests we might see a nice improvement in same-store sales in Q2 as well. Could you provide some insights into the differentiation between durable goods and consumable goods? I’m not looking for exact figures, but anecdotally, when did we see a significant drop in sales of durable goods like lighting and HVAC last year? When do you anticipate we’ll see some easier comparisons? Any insights on the trends between durables and consumables regarding same-store sales would be appreciated. Additionally, since you brought up California, are there any notable geographic trends in same-store sales worth mentioning?

Yes. Right now, we're seeing about 70% on the consumable side, 30% on the durable side. It used to be 60-40 during our crazy growth periods. But we are starting to see on the East Coast build-outs in New Jersey and some other states. And we are starting to see, again, some refresh cycles. There's tremendous, tremendous rebates going on in the LED markets right now from the electric companies. So we're starting to see a pickup on LED lighting right now even. So it's kind of across the board. We did very little, again, build-out last year. So we're comping against a very small number right now. But the more important part of our business, we always look at it as 70% of consumables. Those are repeat customers every weekend on a weekly, monthly basis. So that's the more important part of our business, a higher margin part of our business. So we do believe that pickup going through this year with new states rolling out and always that hope of legislation. And you will start seeing refresh cycles on some of the legacy farms out there and cultivators that need new equipment. So it's kind of an ongoing situation, but we see it as getting better.

That's great to hear. My next question is on private label as well. I guess it's kind of a state of the union overall on the different sort of brands that you're seeing in different categories? I guess what I'm getting at is if you can kind of talk about how your private label brands are performing in different categories. And if there are other categories where you're seeing significant brand turnover where it might present a private label opportunity versus maybe some other categories where there just continues to be sort of dominant brands there. So I guess it's kind of an overall kind of state of the union on the different brands within categories and then your ability to kind of attack that with private label?

Yes. I think it's highly competitive in nature, unfortunately. Our private label division, we don't usually break down sales for categories for Wall Street. But suffice it to say that our sales are up from 10% to 16% from 2022 to 2023. And we will continue to bring products to our customers as they want them. We have a tremendous R&D group at GrowGen, and we work with a lot of the firms out in California that do R&D for us. So again, we look to bring new options to our customers and always their choice, what brands they choose to grow. The one thing with GrowGen, as we always say, we're product agnostic in a lot of ways. We sell what our customers want, and we will continue to.

Okay. Great. And I guess if I could just kind of simplify the private label question. Should we expect GrowGeneration to kind of just put more weight behind its existing private label brands? Or should we expect new brands and new categories for this year?

You will see continued rollout of new products from GrowGen. That's what we do. So again, we service our customers to the best of our ability, and we have a wonderful relationship with our vendors. But we do have a private label division at GrowGen, and we will continue to hopefully roll out innovative products that the growers want.

Darren, you mentioned last quarter that you saw an uptick kind of in March in biddings and commercial projects back east. Just want to get a sense for how that's continuing to trend through here in April and kind of these new states coming on board in back east from that standpoint. And with that in mind, kind of do you expect the subsequential growth here in the first quarter, but you expect a little bit more of a pickup in the second half. How do you look at this kind of going forward for us?

I think right now, Scott, it's really hard to forecast this industry. We're one and a half months into the second quarter. So the second quarter becomes much easier. So we're looking at comps of April and half of May. So it's kind of easy for us to get an understanding of where we are right now and make a call that you'll see sequential growth in the second quarter. We'd much rather give it a couple of months before calling the third and fourth quarters. We've heard from certain of the other public companies in this industry that they believe that you're going to see a very strong back half to the year. We're not endorsing that as of yet, but we're certainly not saying it's not true. We shall see how it goes. It's just too early for us to call. We want to see a turn and really see that turn before I can tell you again that the year is going to continue to get stronger. I certainly do believe that you'll see positive same-store sales going into the end of the year. We're comping against very minimal sales. So we feel confident right now. But you'll hear us guide probably on our second quarter call in August.

Got it. And just kind of a follow-up on the kind of what are you hearing as far as commercial projects back east. And I take it kind of as you look at any new store opportunities, you'll be focusing on the Midwest — Maryland, Connecticut, Georgia, Missouri have all come on board, right? And kind of your sense of building out that area, geographic area, if there are new store adds?

Again, we are quoting deals. We are working on deals in Jersey and back east. It's all incremental business to GrowGen because it wasn't there last year. So with that, we also get the consumable products once these facilities are built. So we are seeing a pickup in our commercial division. It's picking up every day. And we also are starting to see rebuilds. We are seeing, again, rebuilds in Washington, Oregon, and in California also. So we are seeing business pick up. We saw very little durable business last year. We're seeing much more right now. We're seeing more month by month. So we are — again, we are excited, but too early to get that too excited.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.