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Kevin O'Brien

Thanks, John, and good morning, everyone. I'm excited to be here on my first earnings call as CFO at Hydrofarm. Net sales for the fourth quarter were $37.3 million, down 20.9% year over year, driven primarily by a 16.8% decrease in volume mix and 3.9% decline in pricing. The decrease in volume mix was mainly related to an oversupply in the cannabis industry. As we had indicated last quarter, the pricing decline was driven largely by promotional activity in the period.
As John discussed before, overall brand mix slipped during Q4. Our proprietary brands represented approximately 52% of our total net sales but decreased compared to the prior year period. We started Q4 2024 with weaker proprietary brand mix performance compared to our expectations.
As John noted, we began implementing several corrective actions and have achieved some recovery in proprietary brand mix over the past few months. The negative impact on profitability made clear our strategic priorities for 2025. We are focused on driving performance of our higher margin be proprietary brands, and we'll be investing in them to approve this mix in 2025.
For the fourth-quarter and full-year 2024, consumable products continued to account for approximately three-quarters of our total sales, which was similar to 2023. Gross profit in the fourth quarter was $1.8 million or 4.9% of net sales compared to $8.4 million or 17.9% of net sales in the year ago period.
Adjusted gross profit was $3.6 million or 9.6% of net sales compared to $11.5 million or 24.3% of net sales last year. The decrease was due to lower overall sales and a decreased mix of our higher-margin proprietary branded sales in the quarter. We also incurred approximately $1.4 million of inventory-related charges that were not associated with our restructuring plans.
During the fourth quarter, we substantially completed the second phase of our restructuring plan, which included significant reductions to our manufacturing and distribution center footprint. Our manufacturing operations are now concentrated in two US locations plus our Canadian Peat Moss harvesting and processing facility.
We successfully integrated our Canadian entities into our main ERP system and reorganized business activities and reporting into a single operating segment effective in the fourth quarter. These integrations were important to reduce costs and are expected to improve operating efficiencies and drive synergies.
And given the ongoing challenges in the industry, we will continue to evaluate opportunities to drive further efficiencies and cost reductions. Moving on to our selling, general, and administrative expense. In the fourth quarter, our SG&A expense was $17 million compared to $19.9 million last year. Adjusted SG&A expenses were $10.8 million, a 10% reduction when compared to $12 million last year.
For the full year, we achieved a 17% reduction in adjusted SG&A due to lower expenses in several areas, including facility expenses, headcount reductions, professional fees and insurance costs. This marks 10 consecutive quarters of significant year-on-year adjusted SG&A savings and we have line of sight into further cost savings in 2025, net of our plans to invest in proprietary brand marketing.
As previously stated, in connection with our restructuring and related cost saving initiatives, we significantly reduced our distribution center facility footprint through sublease and third-party logistics agreements for several of our U.S. and Canadian locations. In 2025, we will continue to review opportunities to reduce facility space and our overall inventory levels in connection with distribution center consolidations.
Adjusted EBITDA was a loss of $7.3 million in the fourth quarter. The loss was due to lower sales and adjusted gross profit, partially offset by adjusted SG&A savings.
Moving on to our balance sheet and overall liquidity position. Our cash balance as of December 31, 2024, was $26.1 million, up from $24.4 million at the end of the third quarter. We ended the year with $118.3 million of term debt, and approximately $128 million of total debt, inclusive of financial lease liabilities. Our net debt at the end of the year was approximately $102 million.
As a reminder, our term loan facility has no financial maintenance covenants and does not mature until October 2028 and we continue to maintain a 0 balance on our revolving credit facility. With our cash on hand and approximately $13 million of availability on our untapped revolving line of credit, we have $39 million of total liquidity, a comfortable position for us.
In the fourth quarter, we generated cash flow from operating activities of $2.7 million and capital expenditures of $0.3 million, yielding free cash flow of $2.4 million. With that, let me turn to our full-year 2025 outlook. The outlook we are providing today is based on our current industry view for 2025. We expect net sales to decline between 10% and 20% compared to 2024 levels.
We also expect an increase in adjusted gross profit margin primarily due to improved proprietary brand mix, and our restructuring and related cost savings initiatives. We expect adjusted [EBIT] to be negative but an improvement compared to full-year 2024. To accomplish improved adjusted EBITDA on lower sales, we are assuming improvements in our proprietary brand mix and operational efficiencies, leading to higher adjusted gross profit margin.
We also anticipate further reducing our adjusted SG&A in 2025. As John noted, we plan to make some targeted investments to drive sales. We are also assuming no significant charges related to non-restructuring inventory write-downs or accounts receivable for the full year.
Lastly, we believe we can continue to drive inventory reductions through our facility consolidations and improved execution on working capital management, generating an improvement in free cash flow compared to our 2024 level.
To close, we remain optimistic about the long-term prospects for our industry and the future of Hydrofarm. In 2025, we will continue to invest behind our key higher-margin proprietary brands and further diversify our revenue streams and better position ourselves for an eventual demand turnaround in the industry.
Thank you all for joining us, and we are now happy to answer any questions. Operator, please open up the line.

Question and Answer Session

Operator

(Operator Instructions) Dmitry Silversteyn, Water Tower Research.

Dmitry Silversteyn

Thank you for taking my call -- my question, I should say. You mentioned that a lot of your fourth-quarter performance was driven by what's going on generally in the market and the industry. Can you talk a little bit more about the -- what the dynamics look like for the broader environment in your categories as you look forward to 2025 and maybe provide some granularity on when you think the oversupply in the channel will be worked off?

B. John Lindeman

Dmitry, thanks for joining. Yeah, sure. I think, for starters, you need to look back to early last year in 2024. There was a lot of optimism in the category about rescheduling happening, about Florida passing about the Safer Banking Act kind of coming into its own finally. And that helps spur a lot of sequential improvement in spending for a period of time. Wasn't a lot, but it was a sequential improvement from -- towards the end of '23 into the spring of '24.
It became more clear that there was going to be a presidential administration change and then Florida not passing, I think expectations and timelines were reset or prolonged. We could see a return to growth in the second half of the year. Who knows maybe increased US border security will have some positive impact on US cannabis pricing, which would be a good thing for growers.
[Paris] are also a little bit of a wildcard right now, at least for supplies coming from China, Canada, or maybe even Europe. We'll just have to see. I mean, our -- as for our internal models, we're expecting double-digit sales declines early in the year that moderate as the year unfolds.
Regardless, we will be focusing on our key initiatives that I mentioned earlier, we're going to focus on improving our proprietary brand mix driving more diverse revenue streams, both outside the US and Canada, and outside of the cannabis industry. Improving our profit margins, we have an opportunity to further optimize our distribution center network could extract some decent savings there and the opportunity to drive more SG&A savings, those things also certainly -- both of those will have an opportunity to help our free cash flow.
We also have an opportunity, we believe, to continue to manage down our inventory levels given the current demand environment and manage our working capital and free cash flow. As you heard Kevin mentioned, we completed a few ERP integrations this past year. It opens up and gives us a little bit better line of sight on some of our working capital in a way that we think there's opportunity. So in general, hopefully, that helps to give you a little bit more perspective on that and now.

Dmitry Silversteyn

It does. Thank you very much. I want to follow up, if I may, on your cost-cutting initiatives. You talked about rationalizing your manufacturing infrastructure and your warehouse and distribution. The cost savings that you're getting out of the SG&A, thanks to the ERP going live. What can we look forward to in 2025 in terms of incremental benefits of the actions that you've taken. How much more can you improve your operations and improve your efficiencies as you move through 2025?

B. John Lindeman

Yeah. Great question. Yes, I mean, look, there's an opportunity for sure to continue to extract some additional savings, and we have a series of actions lined up. I would say, certainly, I mentioned it earlier, but optimizing our DC network further to something we could do, and we could do it a couple of different ways. We can expand our sublease 3PL relationships or add new ones to effectively reduce our already actively operated space and reduce our net facility costs.
We may have an opportunity to completely consolidate one or more of our DCs into other DCs. We've done that once before. We actually saw really good inventory level savings by affecting that trade. And so we're looking at both of these options right now. And there's an opportunity in front of us, perhaps in the Western US.
There's also an opportunity to further reduce our SG&A cost. I mean we've taken a lot out already to be fair, but we do have line of sight currently on over $2 million to $3 million savings, and we think there's opportunity for more.
Lastly, maybe on this point is within our working manufacturing centers, we also have an opportunity to get some lab benefit productivity initiatives that went into place last year. Now remember, we consolidated two manufacturing facilities, actually three, into the remaining two here in the US around midyear last year, and then we still have our facility up in Canada.
Now some of those benefits may be masked by just depending on how much demand pull-through we ultimately get this year. But our models do suggest that if we hit sort of the mid favorable end of our range, we should see some manufacturing benefit this year, too.
So and also in light of the things I mentioned on working capital, consolidating DCs just to underscore that, really do have a positive impact on our inventory reductions. And so good opportunity from a working capital standpoint there. I think those are the main points, I think.

Dmitry Silversteyn

That's helpful. Thank you for that. If I can ask maybe kind of a 30,000-foot view question. Investors many industries are concerned or at least talking about the potential impact of tariffs, whether already announced or potentially announced. We also have, obviously, you mentioned the new administration, new HHS Secretary, this focus on cutting regulations and perhaps doing something with the classification of cannabis.
If you look at sort of these things that are beyond your control, but do you have a view on how this may impact you either positively or negatively, whether the industry overall or you specifically?

B. John Lindeman

Yeah, sure. I mean for sure, there's a lot of moving parts in tariffs these days, but I totally get that it's on investors' minds. It's on our mind, right? I mean we've got a lot of things in place that we're working on against this. I would say, first, it's important to kind of understand the historical balance of trade for us here at Hydrofarm.
Between the US and Canada, we actually send some product up into Canada and we received some product in the United States reciprocal from Canada. But when you match those two together, we're effectively a net importer from Canada.
If you look back to 2024, roughly 5% of our total sales came from Canada. And in a meaningful way, it is applicable to our peat business up in Edmonton. And as it stands now, we see competitors passing along to customers, the incremental cost of tariffs -- and in that instance, we intend to do the same. But it's a very fluid situation. I think there are customers and frankly, people across the broad population that still think there's some chance that these may be somewhat temporary if the administration to the North sort of meets the expectations of the administration here. So we'll just have to see.
But as it stands now, we're intending to sort of follow what we're seeing in this respect and pass along these incremental costs. We're not expecting currently any significant volume impact, but we certainly could see some customers making choices in how they speculate about tariffs, which are obviously in play now.
But it -- [depending on] they think they last, we could see some drawdowns on allocation of product that they have with us from 1 quarter to the next. And certainly, all of this could change our net pricing models internally already is beginning to with the changes we're putting in place right now. We could see some shifts. As a result of what I've said, just to be very clear, we could see some sales shift from one and quarter to the next. We'll just have to see.
I guess the last thing to mention as it pertains to us in this area, is just sourcing from China. I mean there's obviously been tariffs in place on China since from first administration. They're obviously increasing now. If you look at us, when we went public, we had a more significant -- much more actually significant presence in how we source from China. Over the years, we've tweaked that and changed that.
And now we're sort of in a -- about low- to mid-teens percentage of our sales are products that initiate from China. Those products tend to have longer lead times which is an important notation because as a result of that, in this area specifically, we tend to carry a little bit more inventory than we would in other areas because of those longer lead times. That's always been the case for us. And we've tried to minimize it, but the reality is it just takes a while. And so we maintain a more inventory level.
So in that respect, the good news here in that instance is that obviously, we've got some landed inventory that's usually measured in several months kind of time frame here on the ground in general in most product areas. Obviously, it's different from SKU to SKU, but generally speaking, several months.
So we'll have to see. But once again, the intention will be as we see currently, to pass these along. And obviously, if we see that dynamic change, we'll be prepared and move swiftly. So overall, hopefully, that gives you at least a little some background on this.

Dmitry Silversteyn

It does, John, thank you for that level of detail. I appreciate it. And then one final question, if I may. You mentioned that you may become a little bit more or not become, but be a little bit more active, if you will, or have some thoughts on the M&A side of the business, whether partnering or perhaps an acquisition.
Can you talk a little bit more about specifically what is it that you're looking for? What are you going to look out for? And what are some of the things that you may be considering when it comes to strategic moves for the company.

B. John Lindeman

Yeah, I probably need to be a little bit careful here and specificity. But look, I can certainly say, we can imagine that this is on the minds of all of our stakeholders. Frankly, it's on our minds. And so I'm really glad you asked. If you look at sort of all the key players across the category, we've all been experiencing the same thing.
I mean revenue declines and demand declines have quite simply been pervasive now for two years plus and has been prolonged and taking longer for a turnaround than all of us would have wanted or expected. And so usually, when you see that kind of thing in an industry there tends to be a fair amount of real consolidation. In our industry, at least among sort of the more meaningful players in the supply chain, there really just hasn't been a lot of consolidation.
And so we just wanted to be very clear about it, that we can control what we can control and Bill and I have been consistent on this. We continue to monitor very aggressively opportunities that could enhance shareholder value. That could be -- we could possibly pull up a tuck-in acquisition that helps us diversify either geographically or quite possibly outside of the cannabis space altogether.
We've also looked at some opportunities. We know there's some assets inside of our business that have real attraction to some folks. And so, we've at least given some of those things, some real consideration. And then lastly, complete strategic combination is something that in a couple of instances, we think could be really helpful for the industry overall and frankly, make it a little bit of a healthier place, but also good for our shareholders under the right set of conditions.
And so, Bill and I, and others here, we continue to work this, so -- along with some partners of ours. We'll just have to see.

Dmitry Silversteyn

Understood. I appreciate that, and I understand you can't be more specific, but I appreciate the granularity on that. Well, I'm going to get back into the queue and just wish you luck in 2025. It sounds like we're going to start the year a little bit slower, but hopefully, the momentum will build as the year unfolds.

B. John Lindeman

Thanks, Dmitry. Appreciate that.

Operator

Thank you. And at this time, we have no further questions. That will end today's presentation. We thank you for your participation. You may disconnect.