Hydrofarm Holdings Group, Inc. (HYFM) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to the UBS Global Consumer and Retail Conference here in Boston. My name is Peter Grom, the U.S. household and personal care analyst here at UBS. We are very excited to have joining us today from Hydrofarm, Chief Executive Officer, Bill Toler. In terms of format for this morning, Bill plans to run through a presentation on Hydrofarm. After the presentation, we will then have Q&A. And for those in the audience, you should have received instructions on how to submit or text questions to me. And if not, I believe there are instructions around the room. I have a few questions prepared myself, but we'll also ask whatever questions come in on behalf of the audience. Before we start and turn this over to Bill, I'm required to read a legal disclaimer. As a research analyst, I'm required to provide certain disclosures relating to the nature of my own relationship and that of UBS with any company on which I express the view on this call today. These disclosures are available at www.ubs.com/disclosures. Alternatively, please reach out to me, and I can provide them to you after the call. So with that, Bill, thank you for joining us today. I'll turn it over to you.

Thanks, Peter. Hello, everyone. [indiscernible] information on Hydrofarm today. The company is a leading hydroponics company with a manufacturing and distribution platform, serving the controlled environment agriculture market. Our mission and vision really has been the same for over 40 years. We enable growers and farmers and cultivators to get greater yields, consistent quality, better efficiencies at their farms. And we do it by bringing innovative solutions, our preferred brands and gold standard service to the industry. Some results and numbers are important to keep track of. 40% net sales growth in 2021, important number there, similar number, actually a little better in 2020 versus the prior year. 78% of the sales we have are in products that are margin advantage. What we mean by that is either they are our own brands or they are preferred brands, brands you have to buy from us, you can't buy from our primary competitor in the space. Margins last year, 9.8%, up from 6.2% in the prior year. Importantly, we compete in a rapidly and consistently growing market over a long period of time, 19% CAGR projected over the next 5 years. Our company is not a start-up in this space. Our company has been in business for over 40 years. Eight distribution centers around North America: 3 in the West Coast; 1 in Denver; 1 in Michigan; 1 in Philadelphia; and 2 up in Canada. We cover our retail store base with 90% delivery coverage within 24 to 48 hours. The company has been growing at 19% compounded for the past 15-plus years. And if you follow this industry at all, you know there's a bit of a downturn over the last 6 or 8 months. And it's important to note that 19% compounded growth includes periods of downturn and up growth in the last 15 years. So overall, a very nice category of growth with a lot of tailwinds as well. We sell to 2,000 wholesale, primarily retail customers, 400 suppliers globally, and 68% of our sales come from consumables. We like that part of the industry because it gives you the recurring revenue you need to build a solid growing revenue base. We're well positioned for the future, some key highlights for us. We are the picks and shovels play in the controlled environment or indoor growing industry. Great tailwinds I will unpack here in a few minutes on how the category continues to grow as legalization for cannabis rolls across the country. Differentiated product offering, most of our sales come from our own brands or brands you have to buy from us, mostly consumables, 68%. Great platform of the supply chain and distribution to our customers and the growth algorithm we talked about of 15 years, 19% compounded growth. Our profitability is improved in 2021, facing the challenges of inflation, labor and freight and other things that many people are facing this year, and then we expect to get back to kind of low teens in 2023 and beyond. Consolidator of choice. We were very active in our first year as a public company, which was last year. We acquired 5 businesses, which I'll talk about here in a moment. And our management team brings deep public company experience that we think gives us a differentiated point of view in this category. There's the footprint of the company. And it's important to note, you can see the green with white circles, those are our distribution footprints. The dark green are all manufacturing plants. It's notable because if we did this feature a year ago, none of those manufacturing plants would have been on there. These are all part of the 5 acquisitions we've done in the last year, which really speaks to the fact we now have 7 plants, 8 distribution centers, and we've become more of a manufacturer than a distributor, which we think is an important strategy to pursue because it really allows us to control our own destiny. 1 million square feet of distribution space in North America, service 90% of our customers in 24 to 48 hours, 400 supply-base, 2,000 wholesale customers and a commercial team that goes out and sells to the multistate operators and commercial operators. There's our picture of our management team. John is here with me today. John comes from a public company as a CFO. I was a public company CEO, taking Hostess public back in 2016. I was also involved in private equity efforts that AdvancePierre with Oaktree, at Pinnacle with both Blackstone and prior ownership. And I grew up in the CPG world of P&G and Campbell's and Nabisco. A broad management team there, but I want to focus a little bit on our Board. Renah comes from Canada. She is the lead Director on Tilray. Susan is a retired Head of HR for General Electric, had 370,000 people working for her at GE. Rick Moss is the former CFO at Hanes and now a experienced Board member, Head of our Audit Committee. Patrick, a VP of Finance at a private equity firm in Canada. And Melisa Denis is our tax partner from -- retired tax partner from KPMG, joined our Board at the beginning of the IPO like all of these guys did. We operate in a very large and growing market. On the left, you can see that really the backdrop is sort of the $1 trillion ag market, $75 billion global CEA market, including the sale price of cannabis in there. On the right, you can see that our -- really, our competitive TAM that we operate in is about $9.5 billion, call it, $10 billion, if you will. The primary categories in that are HVAC, nutrients, equipment, supplies, lighting and grow media, and you'll see that we essentially have representation in all of those here in a moment. You can see the growth numbers at the bottom. Cannabis growth over 20%. Global CEA at 19%. Global vertical farming and other area we play in as well, which is the food side of indoor growing about 24%. All of these have enormous tailwinds as they're either emerging markets or markets that are emerging because of legalization. We've been busy since our IPO in December of 2020. 40% sales growth last year. Gross margin up about just under 300 basis points to 21.2%. Adjusted EBITDA up 350 basis points from 2020, all while doing 5 acquisitions and beginning the integrations and not yet really getting the full benefit of these integrations. We're executing on our strategic imperatives. Number one, revenue growth across broad product lines and categories, bringing our warehouse capacity up for the growth and the acquisitions. We've essentially more than doubled the size of the company in the last 2 years. So we're expanding warehouses to allow us to keep that going. Relocated 3 of our DCs to accommodate the growth that we expect over the next few years. The market remains strong while we're having a short-term downturn in volume, I'll talk about that in a moment. The legislative momentum continues with new states like New York, New Jersey, New Mexico, Connecticut, Virginia, Mississippi, are all legalizing and coming on. All these states need tax revenue and they're reaching out to cannabis to be a source of that tax revenue. We laid this chart out at our IPO and really talked about our 4 primary strategic growth strategies. Number one, expand our proprietary brand offering. When I got to the company in early 2019, we had about 31% of our sales in our own brands. That number is up near 60%. Again, the acquisitions, innovating on our own brands are all giving us more proprietary brands that we sell. Number two, adding strategic distribution relationships and preferred partners. We like being the industry distributor for all products or a lot of products, but we really prefer relationships. And by prefer what we mean is they sell primarily through us and not through our major competitor. What it enables us to do is that almost 80% of our sales in products that you have to buy from us. We've also been focused on the commercial growers. Historically, Hydrofarm was a retail-oriented company. We realized that the growth -- the big time growth in the industry is going to be in these wholesale growers, these multistate operators, these commercial growers, they're all going to be the larger part of the industry going forward. We've put a large team against that over the last couple of years and really gaining traction in that area. And strategy number four, the one that we probably spent the most time on in 2021, acquiring value-added businesses. Here's the tale of the tape of the 5 businesses that we bought last year. HEAVY 16, a regional nutrient business based in L.A. Bought in May, a $23 million revenue base nutrient products, very simple line, really 9 core products, about 16 or 17 core SKUs. House & Garden, a second nutrient line with a different approach to the category, much more of a bespoke broad number of SKUs used more for the grower who likes to kind of tinker more with his particular formula, $55 million in revenue. Aurora Innovations moved us over to the grow media side of things. Aurora $60 million revenue in July of 2021. Greenstar, a nutrient Canada company based in Canada, $26 million in revenue. And finally, Innovative Growers Equipment bought in November, $52 million in revenue. IGE does rolling benches and also does some LED lighting, an important category in which we compete. So that's the group of the businesses that we bought last year. How they fit into the portfolio? If you look at the boxes that are outlined in red and have the numbers, and that's the number of the order of the acquisitions I just gave you. But importantly, take all those boxes away, you see we do no nutrients. We barely own any grow media and our lighting and equipment business wouldn't have had as strong a presence. So our goal was to go out and fill the white space, bring brands in, in places where we didn't already own a lot of products, and we were successful in doing that in our first 5 acquisitions. When you look on the left, it really tells you why we do that. The bars are represented to show relative margin from our distributed products, products that we ship around that others own to our preferred brands, products that we ship around that are ours that you can't buy from our competitor, higher margin for us. Third is proprietary brands that we own. And the fourth kind of the new bar, if you will, from 2021, proprietary brands that we self-manufacture. So the highest margin for us comes in products that we own that we make. It certainly makes sense. And it's -- and it plays out in our overall P&L and how we mix our business together. The long-term growth drivers of the category are really around legalization and around the evolution of consumption in states that legalize, let me explain. In adult-use states, we sell about $3 to $3.75 per capita. In those states, about 30% of the population with 75% of our volume. And we're seeing about 20% compounded growth in those states over a few year period. Medicinal, which tends to be the first step states will make before they go to full adult use, we only sell about $0.60 per capita. There's 41% of the population that's in that middle stage you can assume that most states that are medicinal are probably going to go adult use. Right now, that's only 20% of our sales and 60% growth. So they're growing faster as you come up the curve. New adult-use states are even lower at $0.40; at 13% of the population, only 3% of our revenue, but large sales growth. So it's important to note in the bottom one where there's no growth or no legalization, you got 16% of the population, essentially none of our volume, and you see growth there as well. So that bottom 3 buckets more than likely are going to turn into that top bucket in terms of it's dynamic. The dollars per capita going up, the population penetration going up and, of course, the growth continue to expand. Important way to think about it. So we look at that and say, mid-teens double-digit growth seems like a compounded CAGR we can expect for years and years to come. This is my favorite chart. On the right there, the lines are a little hard to see, but what it says is, the 2 highest consuming areas, states in the country are D.C. and Vermont, 30% of population. Now I kind of call that my Bernie Sanders chart because [ he infects ] both of those D.C. and Vermont. But I'm not sure that's totally correlatable, but anyway. And so what you see is that mostly the higher consumption areas are in legalized states, and that you would certainly expect that. But it's important to note down the bottom left that as we have legalized states, fully adult use, 25% of the population using the products in new adults, you get 18% and additionally, you have 17% and now you have 15%. So think about it as things legalize, that people are going to move up that curve and essentially, the U.S. will probably be in the low 20s, mid-20s ultimately people using the category once it is fully legal, and you'll see this map of course change based on population. The cannabis market continues to grow. This is actually dispensary retail sales. So look at the 4 brown bars, that's Q4 -- I mean, I'm sorry, that is the most recent year 2021, Q4 -- I mean, Q1, Q2, Q3 and Q4 of last year. So each year and each quarter, the category continues to grow. So why are we going through a downturn? What's not on this chart is inventory that was growing ahead. We are simply lapping a onetime situation of COVID, where people were at home. People came home and did more at-home behaviors, and that's smoking unfortunately. And so smoking is a choice people make generally at home versus being where they're out. And you look at a lot of companies that have benefited from the COVID bump, if you will, the people like Peloton and Netflix and Amazon and others, all have seen a bit of a downturn. We certainly have seen it in our category. But importantly, consumption continues to grow month-on-month, quarter-on-quarter and year-on-year. So you can expect these tailwinds to continue, and inventories, we believe are starting to normalize and level out. The other part I alluded to it earlier is cannabis is only a certain part of the population, probably 20%, 25% are ever going to interact with controlled environment agriculture growing, but everybody is going to eat. And CEA is going to evolve in food, whether you see it in AppHarvest or AeroFarms or Plenty or Sustainitech or Freight Farms or Wonderful Nurseries, all of the village or any of the others are very important applications of CEA in food. We certainly play in that space and want to find more ways to get deeper into that as we go. We also believe there's targeted outside of the U.S. growth opportunities. In Canada, we're working in a couple of areas. We have a big business in Canada today. We're also looking into Europe as Europe is beginning to mirror the U.S. in terms of legalization especially when you think about Germany kind of being the bellwether for Europe, once Germany flips and turns you're going to see the rest fall in line pretty soon. And the new government over there as suggesting that might happen perhaps in the next year or so. So we think there's opportunity for us to grow and expand beyond North America as well. In our '22 outlook, it's important, we believe, to not just look at this quarter or next quarter. But to step back and say, what are we looking for over kind of a 4-year period? If you look in the top left, net sales growth, 2019, my first year here, the company was $235 million. The year before, we were about $200 million, so it grew about 11% that year. In a matter of a couple of short years, we've more than doubled the business to last year at $479 million and the midpoint of our outlook or our guidance for this year is just under $600 million in net sales. So essentially tripling the business since 2018, some of that's M&A, of course; some of that's organic growth. But importantly, the adjusted growth profit from a low of $27 million in '19, up to $140 million -- I don't know $140-ish million in 2022 in the mid point of our guidance. SG&A has been growing rapidly as we build capability to be a public company, take on all the costs you have to do for that and be able to do all the reporting you have to do, but also to build the infrastructure structure to support these 5 kind of undermanned, understaffed companies that we've acquired. SG&A has gone up in dollars, probably more than I would like. But at least as a percentage of sales, you see it leveling out there, '21 to '22. And then finally, on the EBITDA line, back in 2019, we lost about $10 million. And this year, our midpoint of our guidance is around $69 million or $70 million, let's call it, with a nice step up year-on-year-on-year. So this is a long-term story. It's not a short-term sort of quarter-to-quarter kind of story. It's a 4-year window of how we've done building the business and growing the company and taking the company public and doing acquisitions post IPO. We have some growth drivers that are a little unique to us, different than some of our competitors that we think give us confidence that we're going to have an okay year in 2022. Number one, the acquisitions. You're going to see a big part of the growth this year is sort of the benefit of having these 5 acquisitions for the full year, right? Last year, we started buying in May. We stopped in November. So we've got some rollover benefit that's going to help us and the full year benefit is going to be there. IGE, the equipment company we bought back in November is a little bit different kind of business where they actually have 50% deposits on all of their orders because they're pretty much custom orders. So IGE has a backlog with orders and cash written down and cash paid of $25-plus million coming into this year. What that suggests is they're going to be way beyond that or beyond that $52 million they did last year. Commercial channel. Our commercial channel had the best year ever in 2021. Essentially, at 3x what we did in 2020, and we see that momentum continuing, especially in the new states. The new states are going to be good for us because we don't have to fight the historical relationships that other companies might have had in those older states. In the new states, we kind of have a little bit of a jump ball opportunity to go out and get that new volume. Peat products. I was -- had the benefit of being in the cold dark North earlier this week with our Head of the peat business. And we think peat is a niche product. Peat is sort of farmed out of bogs and it's farmed out of bogs that primarily the Canadian government leases to you. And we were fortunate enough to get new leases in Canada late last year and early this year that have increased our acreage by about 70%. That's a great gain for us. And peat's already like a $15 million, $20 million -- $20 million business for us in Canada now. We've taken our acreage up about 70%. It's not automatically linear because it takes 1 year or 2 to prepare the bog and to really get the bag fully operational, and it's a weather-dependent category, so a lot of caveats in there. But peat's a really cool business because it's an amendment to soil, so it's good for an outdoor grower. It can be an ingredient and professional mix. So it's part of our own mixes that we make for our Aurora Innovation product. And it really sells to a lot of different channels. So it gives us a broader view than just CEA. So we kind of like that aspect of the peat business. The new states, I already mentioned, they're coming online pretty quickly, whether it's New York, Missouri, Arizona, Louisiana, Virginia, all of that starting to see a little bit of traction there. Unfortunately, in California and Oregon and Colorado are so big that the small -- large growth in small states is covering the overall volume yet, but we do think that the new part of the industry is going to help us. And then in Q1, we took some extra action on reducing headcount, taking more pricing, taking more freight that I'll talk about in a minute. But these are the reasons we believe we've got the growth drivers and the building blocks for a solid '22. We did take additional price in Q1. We've been pricing right along essentially every quarter we reflect through. But now we really stepped it up and installed freight initiatives, fuel charges on certain -- fuel surcharges on certain orders. We raised our minimum for free freight. This industry operates on a buy x amount of dollars and you get free freight. We took that number up by 40% to allow for free freight, and we cut down the amount of soil will allow a customer to put on that order. The soil's very hard and heavy to ship. We reduced our workforce. We've been getting the M&A integration synergies that we are enjoying from last year's M&As. We took a third round of SKU rationalization, taking out your low movers or low margin and slow movers. And we're really starting to offset some of the costs that we're expecting in inflation. We are feeling inflation like everybody else, whether it's on unit cost, whether it's on freight, whether it's on labor, whether it's on warehousing, it's certainly affecting us and it's affecting our margins and it's putting pressure on the business as it is pretty much everywhere in many industries. Top line is off to a slower start in Q1 of 2022, slower than we expected even 1 month or 2 ago. And so Q1 is going to be a struggle. We've said that for a while. We said it's probably going to be in the mid-single-digit kind of EBITDA margins. It will be on lower volume than we saw in -- lower volume versus 1 year ago than we saw in Q4 as the first part of the year hasn't gotten off to a great start. But we think still those growth drivers are coming into play in Q2, Q3 and Q4. So we expect our full year EBITDA margin to be in that 11% to 12% range, and that's reflected in the guidance that we have separately provided. We'll continue to price and go for the efficiencies necessary to keep up with the costs that are going on in the industry and beyond. We believe and we like our position. We are uniquely positioned to take this legislative momentum, really grab the support for that. We think we've got a unique position in the supply chain. This pure play, picks and shovels don't touch the plant, we think is still a very valuable part of who we are and what we do. Now we're consolidating the industry. We've said that 1.5 years ago, and people kind of looked at and said maybe, maybe not. Five deals in the first 8 -- really the first 11 months was a pretty good statement that we are the consolidator of choice. We've got that done with a good management team that we think brings the kind of skills to a category that frankly hasn't had that -- hasn't had that in the industry over the last x number of years. All right. With that, Peter, turn it back to you, and we'll go from there.

Thanks, Bill. So obviously, it's been a very tough 9 months or so for the industry, and I definitely want to get into some of the near-term pressures. But looking back over a longer time horizon, even with yours, there's slower growth or you've had declines in the past, right? But does anything that you're seeing today change your view around the company's long-term target of mid-teens organic sales growth?

No. If anything, I think it actually gets better, meaning my view gets better. I don't think any of us realize in this industry, in this category, how unique COVID was, right? One thing I intended to say that I didn't, the size of the COVID lap was certainly huge, right? We've got an incredible chart of dispensary sales, and you see it bubble with COVID, number one. But number two, you see a spike every time a government stimulus check went out. I'm not sure what that says about people in our culture, but what they did basically is they went on and used government stimulus checks to buy cannabis. And so you literally can see the chart just has an absolute spike 4 times for the 4 stimulus checks, but with that COVID. So the size of that lap is still unbelievably large. We've just got to get through it. And what happened was people grew ahead thinking the demand was never going to change. People didn't really think about at the time that it was COVID and stimulus checks that was driving the actual sales, but it was. And so I think that if you look at the 2-year stack on that sort of rubbing out the middle bubble, we're still at 31% compounded for the 2-year stack. So that says that we've been above kind of historical trends over the last couple of years, again, kind of rubbing out the COVID bump. So with that and with the momentum in the states because of tax revenue needs and because of, again, the COVID impact of what it did to the health care systems, these states now are pushing further and faster than they ever have. We get more pass but not implemented legislation in place right now than we ever had. We've got 50 million people who live in States that has passed adult use, but they haven't really implemented, of course, New York and New Jersey being the primary ones, but some other ones as well, Virginia, Connecticut and others. There's kind of -- they're sort of limping along doing the normal political wrangling before they get there. But all of that speaks to this category being just a continual evolution as the tailwinds continue. But with that, the fact that 70% of the population now says this should be approved whether people use it or not is their own choice, but 70% say it ought to be legal. And so that really speaks to me to those tailwinds that are -- that have been there for a long time and are now culturally much more acceptable.

Bill, I mean, having just reported last week, I can't imagine there's much to update on this front, but kind of just would be curious kind of what you're seeing sequentially. Your primary competitor earlier this week took down their guidance again. So are you seeing any signs of stabilization improvement sequentially?

Yes. It's been a tough first couple of months of the year. And I think you saw that reflected in our tone a week ago, in their tone or numbers this week, and what I just said earlier that, yes, Q1 is going to be a rough quarter. It's going to be more organic decline than we saw in Q4. And that's okay because it's still wrapping around and lapping through these things. We still think our margin targets are in place, and we believe the growth drivers that are getting get us there were largely going to affect Q2, Q3 and Q4 anyway. So we got to grind through Q1. And you're seeing that from not only our largest competitor, but our largest retailer as well has put out similar numbers, of course, GrowGen.

Okay. So I mean, just -- so Q1, just to clarify, Q1 organic worse than Q4 organic, correct?

Yes.

Okay. And then I guess beyond the state-by-state nuances, and I would love to kind of get your thoughts on that. But can you give us a sense of what you're seeing across your different -- from your 5 product categories, right? Is this more -- is the decline more concentrated in durables versus consumables? Is there any way to kind of frame the magnitude there?

Yes. Good question because it is different. You saw in Hawthorne's calendar Q4 last year, their Q1 fiscal of '22, but our Q4 of calendar '21 and fiscal '21. They reported a minus 38%, our organic is minus 14%. The reason is the decline is hitting harder in durables right now than it is in consumables. We're not pleased with where our numbers are in consumables, but we don't have the same exposure on the durables side. They've got public numbers. They've got a huge exposure and great brands in the lighting category. And so that's the one, I think, has gotten hit harder than most. We have exposure in lighting. We like our lighting brands, and so we're seeing declines there. But as a percent of total, it's not as large. So I think there is a difference. And just fundamentally, you kind of get it, if people aren't sure what category pricing is going to be, they're likely to push off new capital expansion. And so that would affect the durables side more readily and more quickly. On the consumable side, people are going to continue to reorder as they grow, they just might not expand as fast. We felt that in the progress of our commercial business even in the early part of this year. But we think that's still going to kick back in, in Q2, Q3 and Q4.

Okay. And then I guess, a question or a topic that I get a lot is just kind of the visibility on the industry, right? And with the end market still trying to find its footing and in many cases, you're still dealing with a largely enlisted market in a number of different states. So it's understandable. In my view that it's not as easy as traditional CPG to just have a handle on what's really going on. But it's also been a source of pushback, right, not the lack of visibility from investors. And so how do you improve that, right? I mean how do you get a better sense of what's going on in your end markets? Has it changed from maybe a year ago to where we are today?

It's a touch better. I mean the Headset data is decent. But John and I were talking about the other day, the Headset data, if you look at it in terms of its percentage of ACV, how much of the market it covers, it's maybe in the teens. So it's not really extrapolatable like an IRI or Nielsen, which would be in the 90s in the food industry as you referenced. So I would say that it's getting a bit better but it's not where it needs to be. And we're trying to do more work to pull together pricing as a leading indicator of volume to come and we're pulling it apart. It's not particularly easy. It's not necessarily directly correlatable right now, but because you do have that sort of -- you call it illicit, we call it hobbyists, but that's okay. We have the hobbyists who are a big part of our business, particularly in the retail side of our business, and we are a more retail unit company today, although most of our growth is coming from nonretail factors, the peat, the IGE, the commercial growth, that's all really nonretail. That's one of the reasons we see the growth a little clearer, but that retail factor, which is still 70%, 75% of our business, has some declines built in, it's just structurally and you see that from GrowGen and what they're saying. And so you're seeing that side of the business is very fuzzy and it's the harder one to get your arms around. So to specifically answer your question, getting a little better, but we're a long way away from having kind of a fully modelable kind of correlation of inventories and ACVs and pricing and all that.

Okay. That's helpful. And maybe just rounding out the top line. Maybe 2 quick questions or one near term or one kind of going back to that slide in terms of the $3 to $3.50. But maybe just first just walk us through what you're kind of seeing in your core markets? California, I think Oklahoma has recently mentioned. And then just -- any signs of life out of kind of the New York, New Jersey area right now?

Yes. New York, particularly when they decriminalized back in Q4, and then I think the governor signed a new bill that's going to be more helpful, we saw a little spike. I think when they decree, they said people say, towards more of a risk now because at least it's not a criminal problem. So more people are kind of getting into it. So we're encouraged by New York's recent progress. But again, it's a small state in our industry today. So even 100% growth there is nothing compared to 1% of California. California has been a -- Headset data is getting slightly better, but it's really kind of the end of a long slow decline, so it's starting to flatten and turn up on the pricing side. Our volume is still pretty tough there. And so that's not been what we'd hope to see. On Oklahoma, I think you're seeing what we all knew was going to happen, which is I believe it's some number, a crazy number like half the licenses in the U.S. are in Oklahoma. So it's probably a little overbuilt. And we knew it was going to be overbuilt and eventually that was going to slow down. It was sort of a -- it was kind of the wild, wild west for a while, and everybody ran to it and did great. And now people are running to the next one. Apparently, the next one is going to be Mississippi. Apparently Mississippi is going to approach Oklahoma -- approach licensing much like Oklahoma, so you could have an awful lot of growth there. Now per capita per population does make a whole lot of sense because a lot of that product gets grown in Oklahoma and gets shipped to other places. And so it's hard to correlate kind of heads and per capita and amount of sales that we can have. So overall, that's in kind of the market. Michigan has been missions second largest state for almost all the players in the category, and it's been hot and cold. It hasn't been all cold. There have been some caretaker laws that are going on that have been concern, but some of that's passed and things have picked back up a little bit. But again, we're -- the category broadly is still struggling.

That's helpful. And then going back to that slide, I mean, I think it was the newly legal states, it was like $0.40 per capita and then it was $3 to $3.50 for the full adult use. I mean what's the ramp look like? Like how quickly can that $0.40s per capita go to $3.

Yes. It does take a few years. I mean -- and it also depends on how they legalize, right? Like right now, Mississippi it passed, but they got a 90-day hold or moratorium to kind of think of it, I guess. It's passed but hasn't really started. Same thing in New York, New Jersey, passed a while ago, and it hasn't really kicked in to fully kick up and go. It all depends on kind of the political wrangling that goes on. And there's been a lot of it, obviously, in most areas of politics, but particularly in our industry, too.

Okay. And then I kind of want to shift gears to profitability here. I mean so back in November, the company provided a pro forma update for EBITDA margins that was kind of in the mid-teens. So how are you internally thinking about getting back to that margin percentage? And should we really expect that to occur in 2023? Or is it going to be a multiyear process?

Yes. It's a frustration for me and for John because we had kind of that 13%, 14% pro forma for last year, now we're calling 11% to 12%. The very clear bridge between those 2 is freight, labor, warehousing costs, those 3 things have hit us hard. We built the warehouses for the growth to continue. It's slowed, so we've got less efficiency there. The freight is coming on almost by day, okay? And then labor, if you can find people, they're more expensive they're not as good, and that's tough. And so everybody is seeing this, it's not unique to us or our industry. So we're all fighting through that, right? The way we mitigate that is we find and push through even more changes to our customer base to reflect the fairness of what we're having to pay in freight, what we're having to pay in labor or what we're having to do and these changes that we're talking about just went into effect in the 1st March on the new freight laws and raising the -- our minimums and raising our amount of soil we'll allow in a free freight order and putting on a fuel surcharge and putting on a small order surcharge, these things have just gone into effect, okay? In our planning and in our forecasting, we aren't sure, just for somebody ever done it. We aren't sure how much is going to stick, how much we have to get back, how much will stay for a long time, how much will stay for a short time. So those are hard numbers for us to model right now. And hopefully, we've been conservative, and we'll do a little better than we have. But getting back to the mid-teens is probably going to be a mid-23% to late '23 by the time we're at that full run rate. Seasonally, we're seeing our business look a little more like some of our competitors because stronger in the middle 2 quarters, weaker in the calendar first and fourth. And that's simply because you've got the SG&A base against smaller volumes in those 2 quarters. So you're not getting the same margin. So it's kind of like Q2 and Q3 is when most of the money is made for the year, Q1 and Q4 thinner. We hope to offset some of that this year and build for the next year, but that's kind of how the structure is looking right now.

Now those surcharges, those minimum order sizes. I mean are -- is that just unique to Hydrofarm? Are your competitors doing that? Or are do you -- are you unsure?

We led on that. So it varies. We're kind of -- we don't know what competitors are doing right now. We know we're doing it because it's fair and it's reasonable, and these are real costs that we are doing, and so we are getting so we have to pass them on. There's no way for us to absorb them and be a viable business. And so we'll see how that works going forward. But I think it's going to be most -- a lot of industries are doing it. We've been doing it in Canada for a while. We've been doing in our peat business for a while. So it's not new -- totally new to the company, but it's certainly new to our core retail business here in the U.S.

Okay. And then taking a step back, you kind of look at all the businesses you acquired throughout the year, right? And the implied EBITDA margins of them are well ahead of the mid-teens. So in your view, what that's really the long-term margin opportunity for this company? And if things go as planned, the category improves, if we were to look out 5 years, like what do you see as kind of the right EBITDA margin percentage?

Yes. With the growth -- normalized growth in the business and with the consumables and our own brands being a bigger part of the mix that we're driving towards, there's no reason we shouldn't be able to get to mid- to high teens in this industry. It feels a little aggressive sitting here right now, coming off of 9.8% and telling you this year is going to be 11% to 12%, but we can see the way this can model. And we are just getting started on rationalization of assets, fully integrating the plants getting a manufacturing strategy in place, getting GMP in place, all the things a good manufacturing companies are doing, we're just getting started with that. So that's going to have productivity benefit and lift and a lot of good stuff for us. But I think this business as it sits today should be mid- to high teens over the next 3 or 5 years.

Okay. And then just one last one for me. M&A has been a huge driver of the business this year. Can you maybe speak to the current pipeline? Where do you see opportunities, whether it be from a regional perspective or category perspective? And I guess you kind of alluded to this earlier in the presentation, but would you consider expanding out of North America?

Yes, yes and yes, right? So we're -- the M&A pipeline is still good. The agreement on valuation isn't as easy as it was a year ago. People haven't realized that their companies aren't worth as much as they were a year ago. So they are adjusting their expectations yet, so we're not buying. I would say that the most likely thing for us to do in the first half of this year will be a smaller tuck-in, strategic in nature, probably not transformational in size type of deal. Think of it as with all of the challenges of freight and the challenges of long hauls of product made in Western Canada having to come to Florida, I'm exaggerating, but some of that. Maybe buying a business that is more strategically positioned so you can get local supply, and so you can regionalize more of your production so that you're not pulling everything from your West Coast all the time. And all those type things might be a smarter way to go in the short term. And then when we get back to growing, be able to buy businesses with a little more momentum for both us and the seller.

Okay. Well, Bill, I'll just leave it there. Thank you so much for joining us today. We wish you the best of luck moving forward.

Thanks so much, Peter. Nice to be here.