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HYDROFARM HOLDINGS GROUP, INC. - Quarter Report: 2022 September (Form 10-Q)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2022
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For transition period from to
Commission File Number: 001-39773
Hydrofarm Holdings Group, Inc.
(Exact name of registrant as specified in its charter)
Delaware81-4895761
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
1510 Main Street
Shoemakersville, Pennsylvania 19555
(707) 765-9990
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

Securities registered pursuant to Section 12(b) of the Act:
Title of each classTrading SymbolName of each exchange on which registered
Common Stock, $0.0001 par value per shareHYFMNasdaq Global Select Market
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filerAccelerated filer
Non-accelerated filerSmaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes ☐ No ☒
As of October 31, 2022, the registrant had 45,170,429 shares of common stock, $0.0001 par value per share, outstanding.


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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements contained in this Quarterly Report on Form 10-Q other than statements of historical fact, including statements concerning our business strategy and plans, future operating results and financial position, as well as our objectives and expectations for our future operations, are forward-looking statements.
In some cases, you can identify forward-looking statements by such terminology as “believe,” “may,” “will,” “potentially,” “estimate,” “continue,” “anticipate,” “intend,” “could,” “would,” “project,” “plan,” “expect” and similar expressions that convey uncertainty of future events or outcomes, although not all forward-looking statements contain these words. Forward-looking statements include, but are not limited to, statements about:
industry conditions, including oversupply and decreasing prices of our customers' products which, in turn, has materially adversely impacted our sales and other results of operations and which may continue to do so in the future;
the potential for future charges associated with the impairment of our long-lived assets, inventory allowances and purchase commitment losses, and accounts receivable reserves;
our liquidity;
potential dilution that may result from equity financings while our stock prices are depressed;
general economic and financial conditions, specifically in the United States and Canada;
the conditions impacting our customers, including related crop prices and other factors impacting growers;
the adverse effects of public health epidemics, including the COVID-19 pandemic, on our business, results of operations and financial condition;
interruptions in our supply chain;
federal and state legislation and regulations pertaining to the use and cultivation of cannabis in the United States and Canada;
public perceptions and acceptance of cannabis use;
fluctuations in the price of various crops and other factors affecting growers;
the results of our recent acquisitions and strategic alliances;

our long-term non-cancellable leases under which many of our facilities operate, and our ability to renew or terminate our leases;

our reliance on, and relationships with, a limited base of key suppliers for certain products;
our ability to keep pace with technological advances;
our ability to execute our e-commerce business;
the costs of being a public company;
our ability to successfully identify appropriate acquisition targets, successfully acquire identified targets or successfully integrate the business of acquired companies;
the success of our marketing activities;
a disruption or breach of our information technology systems or cyber-attack;
our current level of indebtedness;
our dependence on third parties;
any change to our reputation or to the reputation of our products;
the performance of third parties on which we depend;
the fluctuation in the prices of the products we distribute;
competitive industry pressures;
the consolidation of our industry;


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compliance with environmental, health and safety laws;
our ability to protect and defend against litigation, including claims related to intellectual property and proprietary rights;
product shortages and relationships with key suppliers;
our ability to attract key employees;
the volatility of the price of our common stock;
the marketability of our common stock; and
other risks and uncertainties, including those listed in “Risk Factors.”
We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our business, financial condition, results of operations, prospects, and financial needs. These forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q and are subject to a number of risks, uncertainties and assumptions described in the section titled “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Because forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified, you should not rely on these forward-looking statements as predictions of future events. The events and circumstances reflected in our forward-looking statements may not be achieved or occur and actual results could differ materially from those projected in the forward-looking statements. We disclaim any intention or obligation to publicly update or revise any forward-looking statements for any reason or to conform such statements to actual results or revised expectations, except as required by law.
“Hydrofarm” and other trade names and trademarks of ours appearing in this Quarterly Report on Form 10-Q are our property. This Quarterly Report on Form 10-Q contains trade names and trademarks of other companies, which are the property of their respective owners. We do not intend our use or display of other companies’ trade names or trademarks to imply an endorsement or sponsorship of us by such companies, or any relationship with any of these companies.
Unless the context otherwise indicates, references in this Quarterly Report on Form 10-Q to the terms “Hydrofarm”, “the Company,” “we,” “our” and “us” refer to Hydrofarm Holdings Group, Inc. and its subsidiaries.



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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Hydrofarm Holdings Group, Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except share and per share amounts)
September 30,December 31,
20222021
Assets
Current assets:
Cash and cash equivalents$16,493 $26,607 
Restricted cash 1,777 
Accounts receivable, net23,800 41,484 
Inventories137,035 189,134 
Note receivable475 622 
Prepaid expenses and other current assets8,852 9,760 
Total current assets186,655 269,384 
Property, plant and equipment, net51,224 50,473 
Operating lease right-of-use assets49,251 45,245 
Goodwill 204,868 
Intangible assets, net306,168 314,819 
Other assets3,976 6,453 
Total assets$597,274 $891,242 
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable$19,044 $26,685 
Accrued expenses and other current liabilities12,505 33,996 
Deferred revenue7,066 18,273 
Current portion of lease liabilities8,009 7,198 
Current portion of long-term debt2,101 2,263 
Total current liabilities48,725 88,415 
Long-term lease liabilities42,710 38,595 
Long-term debt118,807 119,517 
Deferred tax liabilities 5,631 
Other long-term liabilities4,527 3,904 
Total liabilities214,769 256,062 
Commitments and contingencies (Note 13)
Stockholders’ equity
Common stock ($0.0001 par value; 300,000,000 shares authorized; 45,125,768 and 44,618,357 shares issued and outstanding at September 30, 2022, and December 31, 2021, respectively)
5 4 
Additional paid-in capital781,430 777,074 
Accumulated other comprehensive loss(8,267)(1,382)
Accumulated deficit(390,663)(140,516)
Total stockholders’ equity382,505 635,180 
Total liabilities and stockholders’ equity$597,274 $891,242 
The accompanying notes are an integral part of the condensed consolidated financial statements.
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Hydrofarm Holdings Group, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except share and per share amounts)
Three months ended September 30,Nine months ended September 30,
2022202120222021
Net sales$74,155 $123,822 $283,040 $369,011 
Cost of goods sold68,291 93,833 253,231 286,209 
Gross profit5,864 29,989 29,809 82,802 
Operating expenses:
Selling, general and administrative26,186 32,395 92,407 76,495 
Impairments  192,328  
(Loss) income from operations(20,322)(2,406)(254,926)6,307 
Interest expense(3,073)(132)(7,863)(276)
Loss on debt extinguishment   (680)
Other income (expense), net615 (41)971 86 
(Loss) income before tax(22,780)(2,579)(261,818)5,437 
Income tax (expense) benefit(759)19,844 11,671 19,025 
Net (loss) income$(23,539)$17,265 $(250,147)$24,462 
Net (loss) income per share:
Basic$(0.52)$0.39 $(5.57)$0.64 
Diluted$(0.52)$0.37 $(5.57)$0.58 
Weighted-average shares of common stock outstanding:
Basic45,089,286 43,760,975 44,907,355 38,497,925 
Diluted45,089,286 46,288,075 44,907,355 42,494,624 
The accompanying notes are an integral part of the condensed consolidated financial statements.
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Hydrofarm Holdings Group, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME (UNAUDITED)
(In thousands)
Three months ended September 30,Nine months ended September 30,
2022202120222021
Net (loss) income$(23,539)$17,265 $(250,147)$24,462 
 Other comprehensive loss:
    Foreign currency translation loss(4,714)(2,640)(6,885)(2,037)
      Total comprehensive (loss) income$(28,253)$14,625 $(257,032)$22,425 
The accompanying notes are an integral part of the condensed consolidated financial statements.
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Hydrofarm Holdings Group, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)
(In thousands, except for share amounts)
Common StockAdditional
Paid-In
Capital
Accumulated
Other
Comprehensive
 Income (Loss)
Accumulated
Deficit
Total
Stockholders’
Equity
SharesAmount
Balance, June 30, 202141,296,585 $4 $707,690 $1,202 $(146,735)$562,161 
Common stock issued upon exercise of options23,464  198   198 
Issuance of common stock for vesting of restricted stock units287,236      
Shares repurchased for withholding tax on restricted stock units(57,709) (2,984)  (2,984)
Issuance of common stock under cashless warrant exercise77,047      
Issuance of common stock under investor warrant exercise2,016,117  33,992   33,992 
Issuance of common stock in connection with business combination456,499  25,824   25,824 
Stock-based compensation expense  1,226   1,226 
Net income    17,265 17,265 
Foreign currency translation loss   (2,640) (2,640)
Balance, September 30, 2021
44,099,239 $4 $765,946 $(1,438)$(129,470)$635,042 
Balance, June 30, 202245,011,652 $4 $779,911 $(3,553)$(367,124)$409,238 
Issuance of common stock for vesting of restricted stock units159,526 1    1 
Shares repurchased for withholding tax on restricted stock units(45,410) (149)  (149)
Stock-based compensation expense  1,668   1,668 
Net loss    (23,539)(23,539)
Foreign currency translation loss   (4,714) (4,714)
Balance, September 30, 2022
45,125,768 $5 $781,430 $(8,267)$(390,663)$382,505 
The accompanying notes are an integral part of the condensed consolidated financial statements.







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Hydrofarm Holdings Group, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)
(In thousands, except for share amounts)
Common StockAdditional
Paid-In
Capital
Accumulated
Other
Comprehensive
Income (Loss)
Accumulated
Deficit
Total
Stockholders’
Equity
SharesAmount
Balance, January 1, 202133,499,953 $3 $364,248 $599 $(153,932)$210,918 
Common stock issued upon exercise of options125,411  1,057   1,057 
Issuance of common stock for vesting of restricted stock units652,983      
Shares repurchased for withholding tax on restricted stock units(204,369) (11,805)  (11,805)
Issuance of common stock under cashless warrant exercise418,309      
Issuance of common stock under investor warrant exercise3,367,647  56,779   56,779 
Issuance of common stock in connection with follow-on public offering, net of offering costs of $16,303
5,526,861 1 309,781   309,782 
Issuance of common stock in connection with business combination712,444  42,560   42,560 
Stock-based compensation expense  3,326   3,326 
Net income    24,462 24,462 
Foreign currency translation loss   (2,037) (2,037)
Balance, September 30, 2021
44,099,239 $4 $765,946 $(1,438)$(129,470)$635,042 
Balance, January 1, 202244,618,357 $4 $777,074 $(1,382)$(140,516)$635,180 
Common stock issued upon exercise of options8,283  75   75 
Issuance of common stock for vesting of restricted stock units699,704 1    1 
Shares repurchased for withholding tax on restricted stock units(200,675) (2,368)  (2,368)
Issuance of common stock under cashless warrant exercise99      
Stock-based compensation expense  6,649   6,649 
Net loss    (250,147)(250,147)
Foreign currency translation loss   (6,885) (6,885)
Balance, September 30, 2022
45,125,768 $5 $781,430 $(8,267)$(390,663)$382,505 
The accompanying notes are an integral part of the condensed consolidated financial statements.
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Hydrofarm Holdings Group, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
Nine months ended September 30,
20222021
Operating activities
Net (loss) income$(250,147)$24,462 
Adjustments to reconcile net (loss) income to net cash from (used in) operating activities:
Depreciation, depletion and amortization33,215 8,638 
Provision for inventory obsolescence16,348 1,052 
Stock-based compensation expense6,649 3,326 
Non-cash operating lease expense7,275 3,678 
Impairments192,328  
Change in fair value of contingent consideration(1,560)(126)
Deferred income tax benefit(12,387)(21,252)
Other1,064 434 
Changes in assets and liabilities:
Accounts receivable13,135 (1,740)
Inventories37,146 (51,071)
Prepaid expenses and other current assets(42)2,350 
Other assets(76)(2,567)
Accounts payable(6,542)(362)
Accrued expenses and other current liabilities(4,462)16,505 
Deferred revenue(10,971)2,190 
Lease liabilities(5,328)(3,118)
Other long-term liabilities(155)91 
Net cash from (used in) operating activities15,490 (17,510)
Investing activities
Business combinations, net of cash and cash equivalents 190 (415,918)
Purchases of property, plant and equipment(7,113)(3,069)
Other(463)(420)
Net cash used in investing activities(7,386)(419,407)
Financing activities
Proceeds from issuance of common stock upon follow-on public offering, net of offering costs 309,781 
Proceeds from exercises of investor warrants 56,779 
Payment of withholding tax related to restricted stock units(2,381)(17,894)
Borrowings under revolving credit facilities773 96,970 
Repayments of revolving credit facilities(891)(70,680)
Repayments of Term Loan(938) 
Payments to settle contingent consideration(15,574) 
Other(469)(509)
Net cash (used in) from financing activities(19,480)374,447 
Effect of exchange rate changes on cash, cash equivalents and restricted cash(515)(29)
Net decrease in cash, cash equivalents and restricted cash(11,891)(62,499)
Cash, cash equivalents and restricted cash at beginning of period28,384 76,955 
Cash, cash equivalents and restricted cash at end of period$16,493 $14,456 
The accompanying notes are an integral part of the condensed consolidated financial statements.
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Hydrofarm Holdings Group, Inc.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
1. DESCRIPTION OF THE BUSINESS
Description of the business
Hydrofarm Holdings Group, Inc. and its subsidiaries (collectively, the “Company”) was formed in May 2017 under the laws of the state of Delaware to acquire and continue the business of Hydrofarm, LLC established in 1977. The Company is a leading independent manufacturer and distributor of controlled environment agriculture (“CEA”, principally hydroponics) equipment and supplies, including a broad portfolio of proprietary branded products. Products offered include agricultural lighting devices, indoor climate control equipment, hydroponics and nutrients, and plant additives used to grow, farm and cultivate cannabis, flowers, fruits, plants, vegetables, grains and herbs in controlled environment settings that allow end users to control key farming variables including temperature, humidity, CO2, light intensity and color, nutrient concentration and pH.
Initial public offering and follow-on public offering
On December 14, 2020, the Company closed its initial public offering (“IPO”) under a registration statement effective December 9, 2020, in which it issued and sold 9,966,667 shares of its common stock, including the full exercise by the underwriters of their option to purchase 1,300,000 additional shares of common stock. The public offering price was $20.00 per share. The Company received net proceeds of $182,271 from the IPO after deducting underwriting discounts and commissions and offering expenses, of which $148 of offering expenses were paid in 2021.
On May 3, 2021, the Company closed its follow-on public offering ("follow-on offering") under a registration statement effective April 28, 2021, in which it issued and sold 5,526,861 shares of its common stock, including the full exercise by the underwriters of their option to purchase 720,894 additional shares of common stock. The public offering price was $59.00 per share. The Company received net proceeds of approximately $309,782 from the follow-on offering after deducting underwriting discounts and commissions and offering expenses.
2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries and have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and the requirements of the U.S. Securities and Exchange Commission (“SEC”) for interim financial reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by U.S. GAAP can be condensed or omitted. These condensed consolidated financial statements have been prepared on the same basis as the Company's annual consolidated financial statements and, in the opinion of management, reflect all normal and recurring adjustments which are necessary for the fair statement of the Company’s financial information. These interim results are not necessarily indicative of the results to be expected for the fiscal year ending December 31, 2022, or for any other interim period or for any other future year. All intercompany balances and transactions have been eliminated in consolidation. The Company reclassified the balance within "Impairment, restructuring and other" on the condensed consolidated statements of operations for the prior period into "Selling, general and administrative expenses" to conform to the current period presentation. The Company reclassified the balance of customer deposits, totaling $18,273 as of December 31, 2021, previously reported in "accounts payable" into "deferred revenue" in the condensed consolidated balance sheet as of December 31, 2021, to conform to the current period presentation. Consistent with the reclassifications on the condensed consolidated balance sheet, the Company made corresponding reclassifications to conform with the current period presentation in the condensed consolidated statement of cash flows.
The condensed consolidated balance sheet as of December 31, 2021, has been derived from the audited consolidated financial statements of the Company, which is included in the Company's Annual Report on Form 10-K for the year ended December 31, 2021 ("2021 Annual Report"). These condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and the notes thereto included in the 2021 Annual Report.
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Hydrofarm Holdings Group, Inc.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
Use of estimates
The preparation of condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Significant estimates include provisions for sales returns, rebates and claims from customers, realization of accounts receivable and inventories, fair value of assets acquired and liabilities assumed for business combinations, valuation of intangible assets and goodwill, estimated useful lives of long lived assets, incremental borrowing rate applied in lease accounting, valuation of stock-based compensation, recognition of deferred income taxes, recognition of liabilities related to commitments and contingencies and valuation allowances. Actual results may differ from these estimates. On an ongoing basis, the Company reviews its estimates to ensure that these estimates appropriately reflect changes in its business or new information available.
Business combinations
Acquisitions of businesses are accounted for using the acquisition method. The consideration transferred in a business combination is measured at fair value, which is calculated as the sum of the acquisition date fair values of the assets transferred, liabilities incurred to the former owners of the acquiree, and the equity interests issued in exchange for control of the acquiree. Acquisition related costs are recognized in net income (loss) as incurred.
When the consideration transferred in a business combination includes assets or liabilities resulting from a contingent consideration arrangement, the contingent consideration is measured at its acquisition date fair value and included as part of the consideration transferred in a business combination. Contingent consideration is established for business acquisitions where the Company has the obligation to transfer additional assets or equity interests to the former owners if specified future events occur or conditions are met. Contingent consideration is classified as a liability when the obligation requires settlement in cash or other assets and is classified as equity when the obligation requires settlement in the Company's own equity instruments. Changes in the fair value of the contingent consideration that qualify as measurement period adjustments are adjusted retrospectively, with a corresponding adjustment to goodwill. Measurement period adjustments are adjustments that arise from additional information obtained during the measurement period (which cannot exceed one year from the acquisition date) about facts and circumstances that existed at the acquisition date. All other subsequent changes in the fair value of contingent consideration classified as a liability are included in net income (loss) in the period. Changes in the fair value of contingent consideration classified as equity are not recognized.
For a given acquisition, the Company may identify certain pre-acquisition contingencies as of the acquisition date and may extend its review and evaluation of these pre-acquisition contingencies throughout the measurement period to obtain sufficient information to assess these contingencies as part of acquisition accounting, as applicable.
Goodwill is measured as the excess of the sum of the consideration transferred, the amount of any non‑controlling interests in the acquiree, and the fair value of the acquirer’s previously held equity interest in the acquire (if any) over the net of the acquisition‑date fair value amounts of the identifiable assets acquired, and the liabilities assumed.
If the initial accounting for a business combination is incomplete by the end of the reporting period in which the combination occurs, the Company reports provisional amounts for the items for which the accounting is incomplete. Those provisional amounts are adjusted during the measurement period, or additional assets or liabilities are recognized, to reflect new information obtained about facts and circumstances that existed at the acquisition date that, if known, would have affected the amounts recognized at that time. Upon conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to net income (loss).
Segment and entity-wide information
Segment information
The Company's chief operating decision maker is the chief executive officer ("CEO") who reviews financial information for the purposes of making operating decisions, assessing financial performance, and allocating resources.
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Hydrofarm Holdings Group, Inc.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
The business is organized as two operating segments, the U.S. and Canada, which meet the criteria for aggregation, and the Company has elected to present them as one reportable segment, which is the distribution and manufacture of CEA equipment and supplies. Aggregation is based on similarities which include the nature of its products, production or acquisition of inventory, customer base, fulfillment and distribution and economic characteristics.
Since the Company operates as one reportable segment, all required segment financial information is found in the condensed consolidated financial statements and footnotes with entity-wide disclosures presented below.
Entity-wide information
Sales to external customers and property, plant and equipment, and operating lease right-of-use assets, net in the United States and Canada, determined by the location of the subsidiaries, were as follows:
Three months ended September 30,Nine months ended September 30,
2022202120222021
United States$61,234 $104,623 $233,328 $306,651 
Canada13,605 21,268 54,444 67,364 
Intersegment eliminations(684)(2,069)(4,732)(5,004)
Total consolidated net sales$74,155 $123,822 $283,040 $369,011 
September 30,
2022
December 31,
2021
United States$82,419 $85,167 
Canada18,056 10,551 
Total property, plant and equipment, and operating lease right-of-use assets, net$100,475 $95,718 
All of the products sold by the Company are similar and classified as CEA equipment and supplies. The Company’s underlying accounting records currently do not support presentation of disaggregated net sales and any attempt to report them would be impracticable.
Note receivable
In 2019, the Company executed a note receivable secured by equipment to a third-party, the terms of which were amended and restated during the first quarter of 2021. The note receivable provided for interest and installment payments to the Company, and full maturity of the note in 2024. During the first quarter of 2022 the third-party defaulted on interest payments, and the Company measured an impairment on the note receivable based on the estimated fair value of the collateral. The Company recorded impairment losses of zero and $2,636 during the three and nine months ended September 30, 2022, respectively, in “Impairments” on the condensed consolidated statements of operations. There were no impairment losses recorded in the three and nine months ended September 30, 2021. As of September 30, 2022, the note receivable carrying value was $475.
Revenue recognition
The Company follows Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers (“ASC 606”) which requires that revenue recognized from contracts with customers be disaggregated into categories that depict how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors. The Company has determined that revenue is generated from one category, which is the distribution and manufacture of controlled environment agriculture equipment and supplies.
Revenue is recognized as control of promised goods is transferred to customers which generally occurs upon receipt at customers’ locations determined by the specific terms of the contract. Arrangements generally have a single performance obligation and revenue reported is comprised of fixed consideration and variable consideration which includes applicable
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Hydrofarm Holdings Group, Inc.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
volume rebates, cash discounts and sales returns and allowances. Variable consideration is estimated and recorded at the time of sale.
The amount billed to customers for shipping and handling costs included in net sales was $3,103 and $10,661 during the three and nine months ended September 30, 2022, respectively, and $2,242 and $5,170 during the three and nine months ended September 30, 2021, respectively. Shipping and handling costs that occur before the customer obtains control of the goods are deemed to be fulfillment activities and are accounted for as fulfillment costs included in cost of goods sold. The Company does not receive noncash consideration for the sale of goods. Contract consideration received from a customer prior to revenue recognition is recorded as a contract liability and is recognized as revenue when the Company satisfies the related performance obligation under the terms of the contract. The Company's contract liabilities, which consist primarily of customer deposits, are reported within deferred revenue in the condensed consolidated balance sheets, totaled $7,066 and $18,273 as of September 30, 2022, and December 31, 2021, respectively. There are no significant financing components. Excluded from revenue are any taxes assessed by governmental authorities, including value-added and other sales-related taxes that are imposed on and concurrent with revenue-generating activities.
Intangible assets and goodwill
Definite-lived intangible assets are amortized using the straight-line method over their estimated useful lives. The Company has one trade name that is considered to have an indefinite useful life. Intangible assets with finite lives are reviewed for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable.
Goodwill represents the excess of the acquisition price of an acquired business over the fair value of the identifiable assets acquired and liabilities assumed in a business combination less any subsequent write-downs for impairment. Goodwill is tested for impairment on an annual basis in the fourth quarter and more frequently if indicators of potential impairment exist. Impairment testing is conducted at the reporting unit level, which is generally defined as an operating segment or one level below an operating segment (also known as a component), for which discrete financial information is available and segment management regularly reviews the operating results. The Company has determined that its reporting units for the purpose of goodwill impairment testing are the U.S. and Canada.
Goodwill impairment reviews include performing either an initial qualitative or quantitative evaluation for each of the reporting units. Several methods may be used to estimate a reporting unit’s fair value, including market quotations, asset and liability fair values and other valuation techniques. If the carrying amount of a reporting unit, including goodwill, exceeds the estimated fair value, then the excess is charged to earnings as an impairment loss. Intangible assets with indefinite lives are also tested for impairment at least annually and when events or changes in circumstances indicate that, more-likely-than-not, the asset is impaired. Significant judgment is required in estimating fair values and performing goodwill and indefinite-lived intangible asset impairment tests.
Primarily due to a sustained decline in the Company's market value of common stock and market conditions, the Company identified a triggering event requiring a test for impairment as of June 30, 2022. As a result of the triggering event and subsequent testing for impairment, the Company fully impaired its Goodwill to zero as of June 30, 2022, but determined that no impairment was needed for intangible assets. During the three months ended September 30, 2022, the Company assessed whether a triggering event had occurred which would again require testing the intangible assets for impairment, however, no triggering event was identified. Refer to Note 4 - Goodwill and Intangible Assets, Net for additional details.
Income taxes—interim tax provision
The Company recorded income tax expense and an income tax benefit of $759 and $11,671 for the three and nine months ended September 30, 2022, respectively. The effective income tax rate for the three months ended September 30, 2022, was (3.3%). Given the Company's valuation allowances, there was no significant income tax benefit recorded from the pre-tax loss during the three months ended September 30, 2022, and the Company recorded tax expense in certain profitable jurisdictions. The Company's effective income tax rate was 4.5% for the nine months ended September 30, 2022, and differs from the federal statutory rate of 21% primarily due to the impairment of goodwill for certain 2021 acquisitions which was not deductible for U.S. tax purposes, increases in the Company's valuation allowance on U.S. deferred tax assets, and the establishment of a valuation allowance for Canadian deferred tax assets. As described in Note 4 - Goodwill and Intangible Assets, Net, during the three months ended June 30, 2022, the Company fully impaired the goodwill associated with all 2021 acquisitions. For the nine
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NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
months ended September 30, 2022, the Company recorded discrete income tax benefits of $12,058 relating primarily to measurement period adjustments associated with 2021 acquisitions, and certain tax benefits related to goodwill impairment.
The Company recorded an income tax benefit of $19,844 and $19,025 for the three and nine months ended September 30, 2021, respectively. The Company’s effective tax rate for the nine months ended September 30, 2021, differs from the federal statutory rate of 21% primarily as a result of reducing valuation allowances on the Company's net deferred tax assets due to certain acquisitions in the prior year.
Recent accounting pronouncements
The Company considers the applicability and impact of all Accounting Standards Updates ("ASUs") issued by the FASB. There were no ASUs that were assessed and determined to be applicable or expected to have a material impact on the Company's condensed consolidated financial statements.
3. BUSINESS COMBINATIONS
During 2021, the Company completed five acquisitions of branded manufacturers of CEA products, resulting in a significant expansion of its portfolio of proprietary branded products and specialized manufacturing capabilities. The Company finalized the determination of its allocation of the purchase price relating to these acquisitions as of June 30, 2022.
During the first quarter of 2022, the Company evaluated and adjusted the useful lives of certain intangible assets associated with entities that were acquired during 2021. In addition, the Company determined that the preliminary allocation of assets acquired related to indefinite lived trade names have a finite useful life because the expected usefulness of the trade names is limited. As a result of these adjustments to the provisional amounts, the Company recorded $5,894 of additional amortization expense during the first quarter of 2022, which related to amortization expense that would have been recorded in the previous reporting period from the acquisition date through December 31, 2021. The intangible assets were assigned estimated useful lives as follows: (i) customer relationships: 7 to 12 years, (ii) technology, formulations and recipes: 8 to 12 years, and (iii) trade names: 15 to 20 years.
Heavy 16 Acquisition
On May 3, 2021, the Company acquired 100% of the issued and outstanding membership interests of Field 16, LLC ("Heavy 16"), a manufacturer and supplier of branded plant nutritional products. As a result of the acquisition, the Company broadened its proprietary branded offering into the plant nutrients category complementing other product offerings. The acquisition fair value of the consideration transferred for Heavy 16 was $77,367, consisting of $60,287 in cash, $16,736 of the Company's common stock and $344 contingent consideration. The fair value of the common stock issued was determined based on the closing market price of the Company's common stock on the acquisition date.
Pursuant to the purchase agreement, the Company was required to pay up to an additional $2,500 of contingent consideration based on $200 for each $1,000 above a $21,000 threshold for net sales in calendar year 2021. As a result, the Company recorded a liability for contingent consideration at its estimated fair value of $344 as of the acquisition date in the condensed consolidated balance sheets. The contingent consideration was estimated using a Black-Scholes valuation model, which utilized Level 3 inputs as defined in ASC 820 - Fair Value Measurements. As of December 31, 2021, contingent consideration of $200 was calculated utilizing actual net sales for the full year ended December 31, 2021, and was paid in April 2022. The amount of goodwill is fully deductible for tax purposes. The financial results of Heavy 16 are included in the U.S. operating segment since the acquisition date.
House & Garden Acquisition
On June 1, 2021, the Company acquired 100% of the issued and outstanding shares of capital stock of House & Garden, Inc. (“HG”), Humboldt Wholesale, Inc. (“HW”), Allied Imports & Logistics, Inc. (“Allied”), South Coast Horticultural Supply, Inc. (“SC” and, together with HG, HW and Allied, the “H&G Entities”), a manufacturer and distributor of plant nutrients and fertilizers to domestic and various international markets. As a result of the acquisition, the Company further broadened its proprietary branded offering into the plant nutrients category complementing other product offerings. The acquisition date fair value of the consideration transferred for the H&G Entities was $133,483 in cash. The amount of goodwill is not deductible for
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NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
tax purposes. As part of the share acquisition of the H&G Entities, the Company allocated a significant value of the acquisition to identified intangible assets that are not deductible for U.S. tax purposes. Therefore, a deferred tax liability arose providing an additional source of taxable income to support the realization of pre-existing deferred tax assets. The financial results of the H&G Entities are included in the U.S. operating segment since the acquisition date.
Aurora Acquisition
On July 1, 2021, the Company acquired 100% of the issued and outstanding membership interests of Gotham Properties LLC (“Gotham Properties”), Aurora Innovations, LLC (“Aurora Innovations”), Aurora International, LLC (“Aurora International” and, together with Gotham Properties and Aurora Innovations, “Aurora”), a manufacturer of plant fertility product lines. As a result of the acquisition, the Company further broadened its proprietary branded offering into the plant nutrients and grow media category complementing other product offerings. The preliminary acquisition fair value of the consideration transferred for Aurora was $178,871, consisting of $133,962 in cash, $25,824 of the Company's common stock, $19,300 contingent consideration and $215 forgiveness of accounts payable. The fair value of the common stock issued was determined based on the closing market price of the Company's common stock on the acquisition date. The forgiveness of accounts payable represents an effective settlement of a preexisting relationship between the parties.
Pursuant to the purchase agreement, the Company was required to pay a maximum contingent consideration equal to $70,997. To the extent 2021 EBITDA of Aurora exceeded $15,556, the excess was multiplied by eleven to determine contingent consideration. As a result, the Company recorded a liability for contingent consideration at its estimated fair value of $19,300 as of the acquisition date in the condensed consolidated balance sheets. The contingent consideration was estimated using the discounted cash flow method, which estimated the incremental EBITDA based on the Company's forecasted 2021 EBITDA of Aurora as of the acquisition date, discounted to a present value as of the acquisition date using a discount rate of 15%. That measure was based on significant inputs that are not observable in the market, which utilized Level 3 inputs as defined in ASC 820 - Fair Value Measurements. The contingent consideration was remeasured to fair value at each reporting date until resolution with changes in fair value recognized within “Selling, general and administrative expenses” ("SG&A") in the condensed consolidated statements of operations. The contingent consideration of $15,274 was paid in July 2022 using available cash on hand. The amount of goodwill is fully deductible for tax purposes. The financial results of Aurora are included in the U.S. operating segment since the acquisition date.
Greenstar/Grotek Acquisition
On August 3, 2021, the Company acquired 100% of the issued and outstanding shares of Greenstar Plant Products Inc., (“Greenstar”), a manufacturer of horticultural products and solutions for global, domestic and commercial use. As a result of the acquisition, the Company further broadened its proprietary branded offering into the plant nutrients and grow media category complementing other product offerings. The preliminary acquisition fair value of the consideration transferred for Greenstar was $83,520, consisting of $85,121 in cash, less $1,601 forgiveness of accounts payable, net, and obligations due under a distribution agreement. The forgiveness of accounts payable, net, and obligations due under a distribution agreement represent an effective settlement of a preexisting relationship between the parties. The amount of goodwill is not deductible for U.S. tax purposes, but it is partially deductible for Canadian tax purposes. The financial results of Greenstar are included in the Canada operating segment since the acquisition date.
Innovative Growers Equipment, Inc. Acquisition
On November 1, 2021, the Company acquired 100% of the issued and outstanding shares of Innovative Growers Equipment, Inc., an Illinois corporation (“IGE”), Innovative AG Installation, Inc., an Illinois corporation (“IAG”), Innovative Racking Systems, Inc., an Illinois corporation (“IRS”), and Innovative Shipping Solutions, Inc., an Illinois corporation (“ISS” and, together with IGE, IAG, IRS, and their respective subsidiaries, the “IGE Entities”), a manufacturer of horticulture benches, racking and LED lighting systems which complement the Company’s existing lineup of high performance, proprietary branded products. The preliminary acquisition fair value of the consideration transferred for the IGE Entities was $60,902, consisting of $49,129 in cash, $11,051 of the Company's common stock, and $722 forgiveness of a contract asset. The fair value of the common stock issued was determined based on the closing market price of the Company's common stock on the acquisition date. The forgiveness of contract asset represents an effective settlement of a preexisting relationship between the parties. The amount of goodwill is not deductible for U.S. tax purposes. The financial results of the IGE Entities are included in the U.S. operating segment since the acquisition date.
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NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
The following table sets forth the components and allocation of the purchase price for the Company's acquisition of Heavy 16, the H&G Entities, Aurora, Greenstar and the IGE Entities:
Heavy 16H&G EntitiesAuroraGreenstarIGE Entities
Component of Purchase Price:
Cash$60,287 $133,483 $133,962 $85,121 $49,129 
Common stock16,736  25,824  11,051 
Contingent consideration344  19,300   
Forgiveness of assets and liabilities  (215)(1,601)722 
Total purchase price$77,367 $133,483 $178,871 $83,520 $60,902 
Acquisition-related costs$3,109 $5,063 $7,358 $3,688 $2,150 
Allocation of Purchase Price:
Identifiable assets (liabilities)
Accounts receivable$510 $3,308 $6,967 $982 $2,367 
Inventories1,451 6,559 11,031 8,728 30,592 
Prepaid expenses and other current assets34 493 1,086 447 470 
Property, plant and equipment1,078 358 37,991 1,717 4,274 
Operating lease right-of-use assets1,088 1,921  2,736 4,447 
Other assets25 213  176  
Accounts payable(1,055)(1,320)(4,360)(777)(21,686)
Accrued expenses and other current liabilities(226)(445)(768)(1,421)(859)
Current portion of lease liabilities(274)(447) (624)(815)
Current portion of long-term debt    (482)
Long-term deferred tax liabilities (25,589)  (6,769)
Long-term lease liabilities(868)(1,501) (1,836)(3,116)
Long-term debt    (1,434)
Other long-term liabilities  (3,840)  
Net identifiable assets1,763 (16,450)48,107 10,128 6,989 
Identifiable intangible assets
Other intangible assets200 200 824 383 2,430 
Customer relationships5,100 12,500 6,400 11,100 6,300 
Trademarks and trade names18,500 31,400 59,100 9,100 14,000 
Technology and formulations & recipes33,600 56,200 18,000 2,800 3,800 
Total identifiable intangible assets57,400 100,300 84,324 23,383 26,530 
Goodwill18,204 49,633 46,440 50,009 27,383 
Total purchase price allocation$77,367 $133,483 $178,871 $83,520 $60,902 
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NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
Supplemental Disclosure of Financial Results
The following represents estimated unaudited consolidated net sales and net income amounts for the three and nine months ended September 30, 2021, as if the five acquisitions had been included in the consolidated results of the Company for the entire period presented below. The estimated 2021 net income presented below also includes the impact of the aforementioned allocation adjustments to the useful lives of certain intangible assets, resulting in additional expense attributed to the 2021 periods presented. Management considers these estimates to represent an approximate measure of the performance of the combined Company:
Three Months Ended
September 30, 2021
Nine Months Ended
September 30, 2021
Estimated ($ in millions)
Net sales$136 $482 
Net income$24 $70 
4. GOODWILL AND INTANGIBLE ASSETS, NET
Goodwill
Primarily due to a sustained decline in the Company's market value of common stock and market conditions, the Company identified a triggering event requiring a test for impairment as of June 30, 2022. The Company completed its goodwill impairment testing and recorded an impairment charge of $189,572 as the test determined that the carrying value of the goodwill reporting units of U.S. and Canada was in excess of the fair value. The recognized impairment reduced the goodwill balance to zero as of June 30, 2022. The impairment was primarily due to a deterioration in customer demand in the U.S. and Canada caused by macroeconomic and industry conditions.
The Company determined the fair value of the U.S. and Canada reporting units based on an income approach, using the present value of future discounted cash flows, and based on a market approach. The fair values were reconciled to the market value of common stock of Hydrofarm to corroborate the estimates used in the interim test for impairment. Significant estimates used to determine fair value include the weighted average cost of capital, financial forecasts, and pricing multiples derived from publicly-traded companies that are comparable to the reporting units. Refer to Note 14 - Fair Value Measurements, for further discussion of valuation inputs. There was no goodwill impairment recognized during the year ended December 31, 2021. The changes in goodwill are as follows:
Goodwill
Balance at December 31, 2021$204,868 
Acquisition - IGE Entities - measurement period adjustments(21,304)
Acquisition - Greenstar - measurement period adjustments7,000 
Acquisition - all others - measurement period adjustments and foreign currency translation adjustments, net(992)
Impairments(189,572)
Balance at September 30, 2022
$ 
Intangible assets, net
Intangible assets with finite lives and indefinite lives are reviewed for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. For the quarter ended June 30, 2022, the Company performed an evaluation of intangible assets for impairment in connection with the triggering event identified requiring a quantitative test for goodwill impairment. Based on the Company's evaluation, there was no impairment of intangible assets for the quarter ended June 30, 2022. No such triggering event was identified during the three months ended September 30, 2022, however, there can be no guarantee that the Company will not record an impairment charge in the future. For a fuller discussion of the risk that such an impairment charge might be required in the future, please see “Item 1.A Risk Factors” and the risk factor
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NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
captioned “Long-lived assets and inventories represent a significant portion of our total assets and the Company may be required to record impairments or write-downs in future periods.” Intangible assets, net comprised the following:
September 30, 2022December 31, 2021
Gross Carrying AmountAccumulated AmortizationNet Book ValueGross Carrying AmountAccumulated AmortizationNet Book Value
Finite-lived intangible assets: 
Computer software$9,422 $(7,966)$1,456 $8,814 $(7,208)$1,606 
Customer relationship99,790 (22,679)77,111 101,222 (16,517)84,705 
Technology, formulations and recipes114,151 (12,894)101,257 110,561 (3,630)106,931 
Trade names131,292 (8,373)122,919    
Other4,762 (4,138)624 2,428 (1,744)684 
Total finite-lived intangible assets, net359,417 (56,050)303,367 223,025 (29,099)193,926 
Indefinite-lived intangible asset: 
Trade names2,801  2,801 120,773  120,773 
Other   120  120 
Total Intangible assets, net$362,218 $(56,050)$306,168 $343,918 $(29,099)$314,819 
Amortization expense related to intangible assets was $6,218 and $27,209 for the three and nine months ended September 30, 2022, respectively. Amortization expense related to intangible assets was $3,197 and $6,169 for the three and nine months ended September 30, 2021, respectively. Amortization expense includes the impact from intangible assets recorded in connection with five acquisitions completed during the year ended December 31, 2021. The following are the estimated useful lives and the weighted-average amortization period as of September 30, 2022, for the major classes of finite-lived intangible assets:
Useful lives
Weighted-average amortization period
Computer software5 years3 years
Customer relationships
7 to 18 years
11 years
Technology, formulations and recipes
8 to 12 years
10 years
Trade names
15 to 20 years
18 years
The estimated aggregate future amortization expense for intangible assets subject to amortization as of September 30, 2022, is summarized below:
Estimated Future Amortization Expense
For the period of October 1, 2022 to December 31, 2022$6,176 
Year ending December 31,
202324,488 
202424,396 
202524,247 
202623,940 
Thereafter200,120 
Total $303,367 
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Hydrofarm Holdings Group, Inc.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
5. EARNINGS (LOSS) PER COMMON SHARE (“EPS”)
Basic EPS is computed using net income (loss) divided by the weighted-average number of common shares outstanding during each period, excluding unvested restricted stock units (“RSUs”).
Diluted EPS represents net income (loss) divided by the weighted-average number of common shares outstanding during the period, including common stock equivalents. Common stock equivalents consist of shares subject to warrants and share-based awards with exercise prices less than the average market price of the Company’s common stock for the period, to the extent their inclusion would be dilutive. Regarding RSUs subject to a market condition, before the end of the contingency period, the number of contingently issuable shares (i.e., RSUs) to be included in diluted EPS would be based on the number of common shares issuable under the terms of the arrangement if the end of the reporting period was the end of the contingency period, assuming the result would be dilutive. Those contingently issuable shares would be included in the denominator of diluted EPS as of the beginning of the period, or as of the grant date of the share-based payment, if later.
The following table presents information necessary to calculate basic and diluted EPS for the three and nine months ended September 30, 2022 and 2021:
Three months ended
September 30,
Nine months ended
September 30,
2022202120222021
Net (loss) income$(23,539)$17,265 $(250,147)$24,462 
Weighted-average shares of common stock outstanding45,089,286 43,760,975 44,907,355 38,497,925 
Dilutive effect of warrants using the treasury stock method 710,760  1,860,523 
Dilutive effect of restricted stock units using the treasury stock method 1,175,279  1,424,184 
Dilutive effect of stock options using the treasury stock method 641,061  711,992 
Diluted weighted-average shares of common stock outstanding45,089,286 46,288,075 44,907,355 42,494,624 
Basic EPS$(0.52)$0.39 $(5.57)$0.64 
Diluted EPS$(0.52)$0.37 $(5.57)$0.58 
The computation of the weighted-average shares of common stock outstanding for diluted EPS includes the following potential common shares attributable to common stockholders using the treasury stock method for the weighted-average period during which the units were outstanding:
Three months ended
September 30,
Nine months ended
September 30,
2022202120222021
Shares subject to warrants outstanding 1,073,839  2,532,580 
Shares subject to unvested performance based and restricted stock units 1,294,652  1,536,886 
Shares subject to stock options outstanding 808,127  858,952 
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NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
The computation of the weighted-average shares of common stock outstanding for diluted EPS excludes the following potential common shares as their inclusion would have an anti-dilutive effect on diluted EPS attributable to common stockholders:
Three months ended
September 30,
Nine months ended
September 30,
2022202120222021
Shares subject to warrants outstanding17,669  17,669  
Shares subject to unvested performance based and restricted stock units1,220,733 66,451 1,220,733 29,816 
Shares subject to stock options outstanding682,361 44 682,361 11 
6. ACCOUNTS RECEIVABLE, NET, AND INVENTORIES
Accounts receivable, net comprised the following:
September 30,
2022
December 31,
2021
Trade accounts receivable$23,015 $35,511 
Allowance for doubtful accounts(2,238)(1,156)
Other receivables3,023 7,129 
Total accounts receivable, net$23,800 $41,484 
Inventories comprised the following:
September 30,
2022
December 31,
2021
Finished goods$104,535 $145,298 
Work-in-process6,888 5,967 
Raw materials45,308 41,399 
Allowance for inventory obsolescence(19,696)(3,530)
Total inventories$137,035 $189,134 
The allowance for inventory obsolescence increased during the nine months ended September 30, 2022, primarily a result of a reserve for certain lighting products. Inventories are stated at the lower of cost or net realizable value, and the Company maintains an allowance for excess and obsolete inventory that is based upon assumptions about future demand and market conditions.
7. OPERATING LEASES
The Company leases its distribution centers and manufacturing facilities from third parties under various non-cancelable lease agreements expiring at various dates through 2032. Certain leases contain escalation provisions and/or renewal options, giving the Company the right to extend the leases by up to 10 years. However, these options are generally not reflected in the calculation of the right-of-use assets and lease liabilities due to uncertainty surrounding the likelihood of renewal. The Company recognizes operating lease costs over the respective lease periods, including short-term and month-to-month leases. The Company incurred operating lease costs of $2,929 and $8,548, during the three and nine months ended September 30, 2022, respectively, and $2,429 and $5,601, during the three and nine months ended September 30, 2021, respectively. These costs are included primarily within SG&A in the condensed consolidated statements of operations.
The Company has operating subleases which have been accounted for by reference to the underlying asset subject to the lease, primarily as an offset to rent expense within SG&A. For the three and nine months ended September 30, 2022, the
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NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
Company recorded sublease income of $387 and $897, respectively. For the three and nine months ended September 30, 2021, the Company recorded sublease income of $28 and $85, respectively.
Supplemental balance sheet information related to the Company’s operating leases are as follows:
September 30,
2022
December 31,
2021
Assets
Operating lease right-of-use assets, net of accumulated amortization$49,251 $45,245 
Total leased assets$49,251 $45,245 
Liabilities
Current portion of lease liabilities$8,009 $7,198 
Long-term lease liabilities42,710 38,595 
Total lease liabilities$50,719 $45,793 
As of September 30, 2022, future minimum lease payments under non-cancelable operating leases are as follows:
Operating
For the period of October 1, 2022 to December 31, 2022$2,514 
Year ending December 31,
20239,212 
20248,956 
20258,329 
20266,827 
20276,365 
Thereafter14,223 
Total lease payments56,426 
Less portion representing interest(5,707)
Total principal50,719 
Less current portion(8,009)
Long-term portion$42,710 
In January 2022, the Company executed a lease for approximately 303,000 square feet of warehouse space in Shoemakersville, Pennsylvania, which commenced in March 2022, and recorded right-of-use assets for operating leases for $10,463.
The future minimum lease payments for executed non-cancelable operating leases not yet commenced are as follows:
Operating
For the period of October 1, 2022 to December 31, 2022$ 
Year ending December 31,
20232,628 
20242,978 
20253,285 
20263,609 
20273,710 
Thereafter20,599 
Total lease payments$36,809 
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NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
8. PROPERTY, PLANT AND EQUIPMENT, NET
Property, plant and equipment, net comprised the following:
September 30,
2022
December 31,
2021
Machinery and equipment$27,760 $25,177 
Peat bogs and related development10,333 8,686 
Building and improvements 9,713 9,510 
Land 6,087 6,120 
Furniture and fixtures4,051 2,867 
Computer equipment3,432 3,197 
Leasehold improvements3,091 3,207 
Gross property, plant and equipment
64,467 58,764 
Less: accumulated depreciation(13,243)(8,291)
Total property, plant and equipment, net$51,224 $50,473 
Depreciation, depletion and amortization expense related to property, plant and equipment, net was $2,221 and $6,006 for the three and nine months ended September 30, 2022, respectively. Depreciation, depletion and amortization expense related to property, plant and equipment, net was $1,662 and $2,469 for the three and nine months ended September 30, 2021, respectively.
9. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities comprised the following:
September 30,
2022
December 31,
2021
Accrued compensation and benefits$2,624 $3,713 
Freight, custom and duty accrual1,314 2,094 
Goods in transit accrual1,459 3,473 
Income tax accrual716 729 
Contingent consideration 17,034 
Other accrued liabilities6,392 6,953 
Total accrued expenses and other current liabilities$12,505 $33,996 
10. DEBT
Debt comprised the following:
September 30,
2022
December 31,
2021
Term loan - net of unamortized discount and deferred financing costs of $5,364 and $6,025 at September 30, 2022, and December 31, 2021, respectively
$118,698 $118,975 
Other2,210 2,805 
Total debt$120,908 $121,780 
Current portion of long-term debt$2,101 $2,263 
Long-term debt - net of unamortized discount and deferred financing costs of $5,364 and $6,025 at September 30, 2022, and December 31, 2021, respectively
118,807 119,517 
Total debt$120,908 $121,780 
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NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
Senior Secured Term Loan
On October 25, 2021, Hydrofarm Holdings Group, Inc. and certain of its direct and indirect subsidiaries (the "Obligors") entered into a Credit and Guaranty Agreement with JPMorgan Chase Bank, N.A., as administrative agent for certain lenders, pursuant to which the Company borrowed a $125,000 senior secured term loan (“Term Loan”). The Term Loan bears interest at LIBOR (with a 1.0% floor) plus 5.50%, or an alternative base rate (with a 2.0% floor), plus 4.50%, and is subject to a call premium of 2% in year one, 1% in year two, and 0% thereafter, and matures on October 25, 2028 ("Maturity Date"). Effective June 30, 2022, the Company entered into a six-month LIBOR interest rate of 2.88% plus 5.50%, for an all-in rate of 8.38% through December 30, 2022. Deferred financing costs and discount totaled $6,190 at inception of the Term Loan, and are being amortized to interest expense over the term of the loan. For the three months ended September 30, 2022, the effective interest rate was 9.21% and interest expense was $2,886, which includes amortization of deferred financing costs of $223. For the nine months ended September 30, 2022, the effective interest rate was 7.95% and interest expense was $7,416, which includes amortization of deferred financing costs of $661.
The principal amounts of the Term Loan are required to be repaid in consecutive quarterly installments in amounts equal to 0.25% of the principal amount of the Term Loan, on the last day of each fiscal quarter commencing March 31, 2022, with the balance of the Term Loan payable on the Maturity Date. The Company is also required to make mandatory prepayments upon the occurrence of certain events, including (i) achieving certain excess cash flow criteria, including the achievement and maintenance of a specific leverage ratio, (ii) selling assets that are collateral, or (iii) upon the issuance, offering, or placement of new debt obligations. There were no such mandatory prepayments made since inception of the Term Loan. As of September 30, 2022, and December 31, 2021, the outstanding principal balance on the Term Loan was $124,062 and $125,000, respectively.
The Term Loan requires the Company to maintain certain reporting requirements, affirmative covenants, and negative covenants, and the Company was in compliance with all requirements as of September 30, 2022. The Term Loan is secured by a first lien on the non-working capital assets of the Company and a second lien on the working capital assets of the Company. The Company may request additional term loan commitments subject to certain loan conditions.
JPMorgan Revolving Credit Facility
On March 29, 2021, the Obligors entered into a Senior Secured Revolving Credit Facility (the "Revolving Credit Facility") with JPMorgan Chase Bank, N.A., as administrative agent, issuing bank and swingline lender, and the lenders from time to time party thereto. The Revolving Credit Facility is due on the earlier of March 29, 2024, or any earlier date on which the revolving commitments are reduced to zero.
The three-year Revolving Credit Facility had a borrowing limit of $50,000 with an option to request an increase in the revolving commitment by up to $25,000, drawn in $5,000 increments, for a total not to exceed $75,000, subject to customary conditions. On August 31, 2021, the Obligors entered into an amendment (the "First Amendment") to increase their original borrowing limit to $100,000. In connection with the First Amendment, the Company's previously acquired subsidiaries became party to the Revolving Credit Facility as either borrowers or as guarantors. The Revolver maintains an interest rate of LIBOR plus 1.95% and has a 0.0% LIBOR floor. A fee of 0.25% per annum is charged for available but unused borrowings as defined. On October 25, 2021, the Company and its subsidiaries entered into a second amendment (the “Second Amendment”), with JPMorgan Chase Bank, N.A., pursuant to which the parties consented to the Term Loan described above and made certain conforming changes to comport with the Term Loan provisions.
The unamortized debt issuance costs were $680 as of September 30, 2022, and are included in Other assets in the condensed consolidated balance sheets. Debt issuance costs are being amortized to interest expense over the term of the Revolver.
The Revolving Credit Facility is an asset-based facility that is secured by a first lien on the working capital assets of the Company and a second lien on the non-working capital assets of the Company (including most of the Company’s subsidiaries). The borrowing base is based on a detailed monthly calculation of the sum of (a) a percentage of the Eligible Accounts at such time, plus (b) the lesser of (i) a percentage of the Eligible Inventory, at such time, valued at the lower of cost or market value, determined on a first-in-first-out basis, and (ii) the product of a percentage multiplied by the Net Orderly Liquidation Value percentage identified in the most recent inventory appraisal ordered by the Administrative Agent multiplied by the Eligible Inventory, valued at the lower of cost or market value, determined on a first-in-first-out basis, minus (c) Reserves (each of the
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Hydrofarm Holdings Group, Inc.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
defined terms above, as defined in the Revolving Credit Facility documents). As of September 30, 2022, the Company would be able to borrow approximately $62 million under the Revolving Credit Facility.
The Company is required to maintain certain reporting requirements, affirmative covenants and negative covenants, pursuant to terms outlined in the agreement. Additionally, if the Company’s Excess Availability (as defined in the Revolving Credit Facility documents) is less than $10,000, the Company will be required to maintain a minimum fixed charge coverage ratio of 1.1x on a rolling twelve-month basis until the Excess Availability is more than $10,000 for thirty consecutive days. The Company must also comply with a higher fixed charge coverage ratio of 1.15x in order to consummate permitted acquisitions and to make restricted payments, but no such acquisitions or payments are currently contemplated. As of September 30, 2022, the Company is in compliance with the covenants contained in the Revolving Credit Facility.
As of September 30, 2022, and December 31, 2021, the Company had zero borrowed under the facility.
Other Debt
Other debt as of September 30, 2022, was primarily comprised of $2,088 in finance lease obligations and $122 in a foreign subsidiary's other debt which constitutes an immaterial revolving line of credit.
Encina Credit Facility
On July 11, 2019, the Company and certain of its direct and indirect subsidiaries (the “Encina Obligors”) entered into the Encina Credit Facility through a certain Loan and Security Agreement whereby the Encina Obligors obtained a revolving asset-based loan commitment in the maximum amount of $45,000 (inclusive of a limit of up to $15,000 of borrowings for the Canadian borrowers and a swingline facility of up to $2,000), subject to applicable borrowing base availability, through Encina Business Credit, LLC. The Encina Credit Facility was due on the earlier of July 11, 2022, or 90 days prior to the scheduled maturity date of the Brightwood Loan Services LLC Term Loan. The Encina Credit Facility was secured by working capital assets and a second lien on non-working capital assets. The Encina Credit Facility was repaid in December 2020, and replaced in March 2021, by the Revolving Credit Facility (as defined above). The unamortized deferred financing costs and early termination fees totaling $680 were recognized as a loss on debt extinguishment in the condensed consolidated statements of operations for the nine months ended September 30, 2021.
11. STOCKHOLDERS’ EQUITY
Warrants
On July 19, 2021, the Company completed the redemption ("Redemption") of certain of its outstanding warrants (the "Investor Warrants") that were issued in connection with a private placement of units (the "private placement"), each unit consisting of a share of common stock and a warrant to purchase an additional one-half (1/2) shares of common stock.
The Company was entitled to redeem all of the outstanding Investor Warrants for a redemption price of $0.00033712 per Investor Warrant ("Redemption Price") if (i) there was an effective registration statement covering the resale of the shares of common stock underlying the Investor Warrants, and (ii) the volume-weighted average price of the Company's common stock for the twenty consecutive trading days prior to the date of the notice of redemption is at least $25.28, of which both requirements were met. Investor Warrants were exercisable at a price of $16.86 per share until July 19, 2021 (the "redemption date"). Any Investor Warrants that remained unexercised immediately after the redemption date were void and no longer exercisable, and the holders of those Investor Warrants were entitled to receive the Redemption Price.
Prior to the redemption date 3,367,647 Investor Warrants were exercised, generating total gross proceeds of $56,778. The Company redeemed 1,491 Investor Warrants at the Redemption Price.
In connection with the private placement, the Company agreed to engage the placement agent (the "Placement Agent") as the Company's warrant solicitation agent in the event the Investor Warrants were called for Redemption. The Company agreed to pay a warrant solicitation fee to the Placement Agent equal to five percent of the amount of net cash proceeds solicited by the Placement Agent upon the exercise of certain Investor Warrants following such call for Redemption.
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Hydrofarm Holdings Group, Inc.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
As of September 30, 2022, the following table summarizes the outstanding warrants:
Number of WarrantsExercise Price
Placement agent warrants11,662 $8.43 
Placement agent warrants6,007 $16.86 
Total17,669 $11.30 
As of December 31, 2021, the following table summarizes the outstanding warrants:
Number of WarrantsExercise Price
Placement agent warrants11,810 $8.43 
Placement agent warrants6,007 $16.86 
Total17,817 $11.27 
12. STOCK-BASED COMPENSATION
Stock-based compensation plan overview
The Company maintains three equity incentive plans: the 2018 Equity Incentive Plan (“2018 Plan”), the 2019 Employee, Director and Consultant Equity Incentive Plan (“2019 Plan”) and the 2020 Employee, Director, and Consultant Equity Incentive Plan (“2020 Plan” and collectively, “Incentive Plans”). The 2020 Plan serves as the successor to the 2019 Plan and 2018 Plan and provides for the issuance of incentive stock options, nonqualified stock options, stock grants and stock-based awards to employees, directors, and consultants of the Company. No further awards will be issued under the 2018 Plan and 2019 Plan. As of September 30, 2022, a total of 1,323,764 shares are available for grant under the 2020 Plan.
Restricted Stock Unit ("RSU") Activity
RSUs granted to certain executives, employees and members of the Board generally have a time-based vesting requirement (based on continuous employment). The stock-based compensation expense related to service-based awards is recorded over the requisite service period. During the nine months ended September 30, 2022, the Company granted RSU awards that are expected to vest either (i) ratably over a three-year period on each anniversary of the grant date, or (ii) with three vesting tranches, the first of which occurred on the grant date, and the following two tranches on each subsequent anniversary of the grant date. The following table summarizes the activity related to the Company's RSUs for the nine months ended September 30, 2022. For purposes of this table, vested RSUs represent the shares for which the service condition had been fulfilled during the nine months ended September 30, 2022:
Number of
RSUs
Weighted
average grant
date fair value
Balance, December 31, 20211,087,608 $9.71 
Granted785,486 $9.62 
Vested(706,061)$9.86 
Forfeited(47,629)$39.81 
Balance, September 30, 20221,119,404 $8.27 
As of September 30, 2022, total unamortized stock-based compensation cost related to unvested RSUs was $7,543 and the weighted-average period over which the compensation is expected to be recognized is 1.45 years. For the three and nine months ended September 30, 2022, the Company recognized $1,447 and $6,095, respectively, of total stock-based compensation
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Hydrofarm Holdings Group, Inc.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
expense for RSUs. As of September 30, 2022, there were 6,357 RSUs which had vested, but were not yet issued due to the recipients' elections to defer the awards.
Performance Stock Unit ("PSU") Activity
During the nine months ended September 30, 2022, the Company granted PSU awards that are subject to a one-year vesting requirement (based on continuous employment) and contain performance conditions based on certain performance metrics. The following table summarizes the activity related to the Company's PSUs for the nine months ended September 30, 2022:
Number of
PSUs
Weighted
average grant
date fair value
Balance, December 31, 2021 $ 
Granted116,113 $15.74 
Forfeited(14,784)$15.74 
Balance, September 30, 2022101,329 $15.74 
As of September 30, 2022, total unamortized stock-based compensation cost related to unvested PSUs was $231 and the weighted-average period over which the compensation is expected to be recognized is less than one year. For the three and nine months ended September 30, 2022, respectively, the Company recognized $96 and $256 of total stock-based compensation expense for PSUs.
Stock options
The following table summarizes the stock option activity for the nine months ended September 30, 2022:
NumberWeighted
average
exercise price
Weighted
average grant
date fair value
Weighted average
remaining contractual
term (years)
Outstanding as of December 31, 2021720,549 $9.57 $2.21 7.37
Granted4,250 $13.12 $12.95 
Exercised(8,283)$9.01 $2.12 
Cancelled(3,153)$9.41 $3.76 
Forfeited(31,002)$11.45 $7.07 
Outstanding as of September 30, 2022682,361 $9.50 $2.08 5.45
Options exercisable as of September 30, 2022578,554 $8.86 $1.30 5.10
Vested and expected to vest as of September 30, 2022682,361 $9.50 $2.08 5.45
The following table summarizes the unvested stock option activity for the nine months ended September 30, 2022:
NumberWeighted
average grant
date fair value
Unvested as of December 31, 2021202,515 $5.04 
Granted4,250 $12.95 
Vested(71,956)$2.33 
Forfeited(31,002)$7.07 
Unvested as of September 30, 2022103,807 $6.62 
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Hydrofarm Holdings Group, Inc.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
As of September 30, 2022, total compensation cost related to unvested awards not yet recognized was $494 and the weighted-average period over which the compensation is expected to be recognized is 1.54. For the three and nine months ended September 30, 2022, respectively, the Company recognized $125 and $298 of total stock-based compensation expense for stock options.
13. COMMITMENTS, CONTINGENCIES, AND RELATED PARTY TRANSACTIONS
Purchase commitments
From time to time in the normal course of business, the Company will enter into agreements with suppliers which provide favorable pricing in return for a commitment to purchase minimum amounts of inventory over a defined time period.
Contingencies
In the normal course of business, certain claims have been brought against the Company and, where applicable, its suppliers. While there is inherent difficulty in predicting the outcome of such matters, management has vigorously contested the validity of these claims. Based on available information, management believes the claims are without merit and does not expect that the outcome, individually or in the aggregate, would have a material adverse effect on the consolidated financial positions, results of operations, cash flows or future earnings.
Related party transactions — Hydrofarm Distribution Center
The Company leased a distribution center in Petaluma, California from entities in which a related party was a stockholder. For the three and nine months ended September 30, 2021, rent expense for the month-to-month lease totaled zero and $639, respectively.
14. FAIR VALUE MEASUREMENTS
Contingent consideration (as described in Note 3 - Business Combinations) is measured at estimated fair value on a recurring basis and based on Level 3 fair value measurements. The fair value of the contingent consideration for the Heavy 16 and Aurora acquisitions was $200 and $16,834, respectively, as of December 31, 2021. The fair value of the contingent consideration for the Heavy 16 and Aurora acquisitions were both zero as of September 30, 2022, as the liabilities were paid. The change in the fair value of contingent consideration during the three and nine months ended September 30, 2022, was zero and a benefit of $1,560, respectively. The change in the fair value of contingent consideration during the three and nine months ended September 30, 2021, was a benefit of $386 and $126, respectively. The change in the fair value of contingent consideration was recognized in SG&A on the condensed consolidated statements of operations for all periods presented. The valuation methodology and inputs used in the fair value measurement were disclosed in Note 3– Business Combinations.
Nonrecurring fair value measurements include the Company’s goodwill impairment recognized during the nine months ended September 30, 2022, as determined based on unobservable Level 3 inputs. Refer to Note 4 - Goodwill and Intangible Assets, Net, for further discussion. The note receivable (as described in Note 2 - Basis of Presentation and Significant Accounting Policies) was measured at fair value on a nonrecurring basis. During the nine months ended September 30, 2022, the Company measured an impairment on the note receivable based on the estimated fair value of the collateral, which was considered a Level 3 fair value measurement. The Company recorded an impairment loss of zero and $2,636 during the three and nine months ended September 30, 2022, recognized in Impairments on the condensed consolidated statements of operations. The carrying value of the note receivable was $475 and $3,111 as of September 30, 2022, and December 31, 2021, respectively.
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Hydrofarm Holdings Group, Inc.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
Other Fair Value Measurements
The following table summarizes the estimated fair value of the Company's assets and liabilities which are not measured at fair value but are provided for disclosure purposes:
September 30, 2022December 31, 2021
Fair Value Hierarchy LevelCarrying AmountEstimated Fair ValueCarrying AmountEstimated Fair Value
Term LoanLevel 2$124,062 $109,175 $125,000 $121,250 
The fair value of the Company's Term Loan was estimated based on Level 2 fair value measurements and was based on bank quotes. The carrying amount of the Term Loan reported above excludes unamortized deferred financing costs and discount. The carrying amount of Other Debt was $2,210 and $2,805 as of September 30, 2022, and December 31, 2021, respectively, and was primarily comprised of finance lease obligations. The estimated fair value of Other Debt approximated its carrying value given the applicable interest rates and the nature of the security interest in the Company’s assets, which were considered Level 3 fair value measurements. Refer to Note 10 - Debt, for further discussion of the Company's Term Loan and other debt.
Cash, cash equivalents, and restricted cash included funds deposited in banks, and the carrying values approximated fair values due to their short-term maturities. The carrying values of other current assets and liabilities including accounts receivable, accounts payable, accrued expenses and other current liabilities approximated their fair value due to their short-term maturities.
The Company did not have any transfers between Levels within the fair value hierarchy during the three and nine months ended September 30, 2022, and September 30, 2021.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis provides information that we believe is relevant to an assessment and understanding of our results of operations and financial condition. You should read this analysis in conjunction with our audited and unaudited consolidated financial statements and the notes contained elsewhere in this Quarterly Report on Form 10-Q and our 2021 Annual Report. This discussion and analysis contains statements of a forward-looking nature relating to future events or our future financial performance. These statements are only predictions, and actual events or results may differ materially. In evaluating such statements, you should carefully consider the various factors identified in this Quarterly Report on Form 10-Q, which could cause actual results to differ materially from those expressed in, or implied by, any forward-looking statements, including those set forth in “Risk Factors” in our 2021 Annual Report. See “Special Note Regarding Forward-Looking Statements.”
Company Overview
We are a leading independent manufacturer and distributor of CEA equipment and supplies, including a broad portfolio of our own innovative proprietary branded products. We primarily serve the U.S. and Canadian markets, and believe we are one of the leading competitors by market share in these markets in an otherwise highly fragmented industry. For over 40 years, we have helped growers make growing easier and more productive. Our mission is to empower growers, farmers and cultivators with products that enable greater quality, efficiency, consistency, and speed in their grow projects.
Hydroponics is the farming of plants using soilless growing media and often artificial lighting in a controlled indoor or greenhouse environment. Hydroponics is the primary category of CEA and we use the terms CEA and hydroponics interchangeably. Our products are used to grow, farm, and cultivate cannabis, flowers, fruits, plants, vegetables, grains and herbs in controlled environment settings that allow end users to control key farming variables including temperature, humidity, CO2, light intensity spectrum, nutrient concentration and pH. Through CEA, growers are able to be more efficient with physical space, water and resources, while enjoying year-round and more rapid grow cycles as well as more predictable and abundant grow yields, when compared to other traditional growing methods.
We reach commercial farmers and consumers through a broad and diversified network of over 2,000 wholesale customer accounts, who we connect with primarily through our proprietary e-commerce marketplace. A majority of our net sales are to specialty hydroponic retailers, through which growers are able to enjoy specialized merchandise assortments and knowledgeable staff. We also distribute our products across the U.S. and Canada to a diversified range of retailers of commercial and home gardening equipment and supplies that include garden centers, hardware stores, e-commerce retailers, commercial greenhouse builders, and commercial resellers.
During fiscal year 2021, we completed five acquisitions of branded manufacturers of CEA products, resulting in a significant expansion of our portfolio of proprietary branded products and our specialized manufacturing capabilities, including:
Heavy 16, a manufacturer of plant nutrients and additives, in May 2021;
House & Garden, a manufacturer of plant nutrients and additives, in June 2021;
Aurora Innovations, a manufacturer of soil, grow media, plant nutrients and additives, in July 2021;
Greenstar Plant Products, a manufacturer of plant nutrients and additives, in August 2021; and
Innovative Growers Equipment, a manufacturer of horticultural benches, racks and grow lights, in November 2021.
Market Conditions and Goodwill Impairment
As of June 30, 2022, primarily due to a sustained decline in the Company's market value of common stock and market conditions, we identified a triggering event requiring a test for goodwill impairment. We completed our goodwill impairment testing and recorded an impairment charge of $189.6 million as the test determined that the carrying value of the goodwill reporting units of U.S. and Canada was in excess of the fair value. The recognized impairment reduced the goodwill balance to zero as of June 30, 2022. The impairment was primarily due to a deterioration in customer demand in the U.S. and Canada caused by macroeconomic and industry conditions. We also review intangible assets with finite lives and indefinite lives for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. We did not identify a triggering event requiring a test for impairment during the three months ended September 30, 2022.
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In connection with the goodwill impairment analysis performed as of June 30, 2022, we determined the fair value of the U.S. and Canada reporting units based on an income approach, using the present value of future discounted cash flows, and based on a market approach. The fair values were reconciled to the market value of common stock of Hydrofarm to corroborate the estimates used in the interim test for impairment. The fair value determinations were a reflection of recent sales declines we have experienced, which we believe are primarily a result of an agricultural oversupply impacting our market, and a reduction to our current year profitability and loss from operations. These market conditions continued to negatively impact our business and results of operations during the quarter ended September 30, 2022. The extent to which these market conditions will continue to impact our business, results of operations, and cash flows are uncertain and difficult to predict at this time.
As a result of market conditions and our inventory balance, we have reduced manufacturing and production levels, and in certain cases, implemented headcount reductions or temporary employee furloughs which may continue in future periods. We are evaluating plans and potential actions to further streamline our operations, which may include among other things, the relocation of certain manufacturing and/or distribution facilities and the narrowing of our product and brand portfolio. While we may incur certain costs associated with these actions, we expect improved efficiencies which will support us through the industry recession.
We maintain an allowance for excess and obsolete inventory that is based upon assumptions about future demand and market conditions. During the three and nine months ended September 30, 2022, our condensed consolidated statements of operations included charges of $4.4 million and $17.8 million, respectively, primarily relating to increases to our allowance for inventory obsolescence relating to certain lighting products. It is possible we may incur an impairment charge related to intangible assets in the future, or additional increases and impairments to our allowance for inventory obsolescence in future periods depending on market and industry conditions. During the three months ended September 30, 2022, our condensed consolidated statements of operations included a $1.1 million increase in accounts receivable allowances, and it is possible that we may incur additional charges related to our accounts receivable allowances in the future.

Effects of COVID-19 on Our Business
The World Health Organization recognized COVID-19 as a global pandemic on March 11, 2020, and COVID-19 has had significant and ongoing negative impacts on global societies, workplaces, economies and health systems. Authorities throughout the world have implemented measures to contain or mitigate the spread of the virus, including at various times physical distancing, travel bans and restrictions, closure of non-essential businesses, quarantines, work-from-home directives, mask requirements, shelter-in-place orders, and vaccination programs, but despite these efforts, COVID-19 has persisted, has mutated into new variants, and is expected to become endemic. We have implemented business continuity plans and followed safety protocols as recommended by government guidelines, and we will continue to do so as the state of COVID-19 evolves. As of the filing of this Quarterly Report, our operations are not impacted by any COVID-19 related facility closures, lockdown measures, travel restrictions or similar limitations. However, new waves of COVID-19 or its variants could cause the reinstatement of such limitations, and such limitations may adversely impact our supply chains, the manufacturing of our own products and our ability to obtain necessary materials, all of which could adversely affect our business, results of operations and financial condition. We have historically and may continue to source select products from China. We have in the past, and may again in the future experience some extended lead times in our supply chain, as well as increased shipping costs and believe the COVID-19 pandemic is a contributing factor to those extended lead times and increased costs. Furthermore, potential suppliers or sources of materials may pass the increase in sourcing costs due to the COVID-19 pandemic to us through price increases, thereby impacting our potential future profit margins.
The extent to which the COVID-19 pandemic will ultimately impact our business, results of operations, financial condition and cash flows depends on future developments that are highly uncertain, rapidly evolving and difficult to predict at this time. It is difficult to assess or quantify with precision the impact COVID-19 has directly had on our business since we cannot precisely quantify the impacts, if any, that the various effects have had on the overall business. We believe COVID-19 may have provided a positive demand impact in 2020 and 2021 from shelter-in-place orders in the United States, a possible negative supply chain impact from workforce disruption at international and domestic suppliers, and a possible negative growth rate impact in 2022 due to agricultural oversupply initiated during the height of COVID-related shelter-in-place orders in 2020 and 2021. We continue to monitor the COVID-19 pandemic and will adjust our mitigation strategies as necessary to address changing health, operational or financial risks that may arise.
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Results of Operations—Comparison of three and nine months ended September 30, 2022 and 2021
The following table sets forth our unaudited interim condensed consolidated statements of operations for the three and nine months ended September 30, 2022 and 2021, including amounts and percentages of net sales for each period and the period-to-period change in dollars and percent (amounts in thousands):
Three months ended September 30,
20222021Period change
Net sales$74,155 100.0 %$123,822 100.0 %$(49,667)-40.1 %
Cost of goods sold68,291 92.1 %93,833 75.8 %(25,542)-27.2 %
Gross profit5,864 7.9 %29,989 24.2 %(24,125)-80.4 %
Operating expenses:
Selling, general and administrative26,186 35.3 %32,395 26.2 %(6,209)-19.2 %
Loss from operations(20,322)-27.4 %(2,406)-1.9 %(17,916)-744.6 %
Interest expense(3,073)-4.1 %(132)-0.1 %(2,941)-2,228.0 %
Other income (expense), net615 0.8 %(41)0.0 %656 1,600.0 %
Loss before tax(22,780)-30.7 %(2,579)-2.1 %(20,201)-783.3 %
Income tax (expense) benefit(759)-1.0 %19,844 16.0 %(20,603)-103.8 %
Net (loss) income$(23,539)-31.7 %$17,265 13.9 %$(40,804)-236.3 %
Nine months ended September 30,
20222021Period change
Net sales$283,040 100.0 %$369,011 100.0 %$(85,971)-23.3 %
Cost of goods sold253,231 89.5 %286,209 77.6 %(32,978)-11.5 %
Gross profit29,809 10.5 %82,802 22.4 %(52,993)-64.0 %
Operating expenses:
Selling, general and administrative92,407 32.6 %76,495 20.7 %15,912 20.8 %
Impairments192,328 68.0 % 0.0 %192,328 n/a
(Loss) income from operations(254,926)-90.1 %6,307 1.7 %(261,233)-4,142.0 %
Interest expense(7,863)-2.8 %(276)-0.1 %(7,587)-2,748.9 %
Loss on debt extinguishment 0.0 %(680)-0.2 %680 100.0 %
Other income, net971 0.3 %86 0.0 %885 1,029.1 %
(Loss) income before tax(261,818)-92.5 %5,437 1.5 %(267,255)-4,915.5 %
Income tax benefit11,671 4.1 %19,025 5.2 %(7,354)-38.7 %
Net (loss) income$(250,147)-88.4 %$24,462 6.6 %$(274,609)-1,122.6 %
Net sales
Net sales for the three months ended September 30, 2022, were $74.2 million, a decrease of $49.7 million, or 40.1% compared to the same period in 2021. Net sales for the nine months ended September 30, 2022, were $283.0 million, a decrease of $86.0 million, or 23.3%, compared to the same period in 2021.
The 40.1% decrease in net sales for the three months ended September 30, 2022, as compared to the same period in 2021, was due to a 42.6% decline in volume of products sold (a 52.1% decline in organic sales and a 9.5% increase from recently-acquired proprietary brands), a 2.7% increase in price and mix of products sold, and a 0.2% decline from unfavorable foreign exchange rates. The decrease in volume of products sold was primarily related to an agricultural oversupply, which put downward pressure on cannabis growing activity predominantly in California and Canada but also in many other U.S. states. The increase in price was primarily related to list price increases, as well as higher freight recovery. The decrease in foreign exchange related to recent strength in the U.S. Dollar relative to the Canadian Dollar and to the Euro.
The 23.3% decrease in net sales for the nine months ended September 30, 2022, as compared to the same period in 2021, was due to a 26.0% decline in volume of products sold (a 42.7% decline in organic sales and a 21.2% increase from recently-acquired proprietary brands), a 2.9% increase in price and mix of products sold, and a 0.2% decline from unfavorable foreign exchange rates. The decrease in volume of products sold was primarily related to the aforementioned oversupply in the cannabis
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industry. The increase in price was primarily related to list price increases, as well as higher freight recovery as we put multiple measures in place to combat rising freight costs. The decrease in foreign exchange related to recent strength in the U.S. Dollar relative to the Canadian Dollar and to the Euro.
Gross profit
Gross profit for the three months ended September 30, 2022, was $5.9 million, a decrease of $24.1 million, or 80.4%, compared to the same period in 2021. Gross profit for the nine months ended September 30, 2022, was $29.8 million, a decrease of $53.0 million, or 64.0%, compared to the same period in 2021.
The decrease in gross profit for the three months ended September 30, 2022, as compared to the same period in 2021, was primarily related to (i) the aforementioned decrease in net sales and (ii) a significant decrease in our gross profit margin percentage (gross profit as a percent of net sales). Our gross profit margin percentage decreased to 7.9% for the three months ended September 30, 2022, from 24.2% in the same period in 2021. The lower gross profit margin percentage is primarily due to an increase in the inventory obsolescence allowances and related charges of $4.4 million primarily related to certain lighting products. Also negatively impacting gross profit margin were freight and labor costs which were higher as percentage of net sales. These were partially offset by the aforementioned list price increases, as well as a higher proportion of higher-margin proprietary brand sales.
The decrease in gross profit for the nine months ended September 30, 2022, as compared to the same period in 2021, was primarily related to (i) the aforementioned decrease in net sales and (ii) a significant decrease in our gross profit margin percentage. Our gross profit margin percentage decreased to 10.5% for the nine months ended September 30, 2022, from 22.4% in the same period in 2021. The lower gross profit margin percentage is primarily due to an increase in the inventory obsolescence allowances and related charges of $17.8 million primarily related to certain lighting products. Also negatively impacting gross profit margin were freight and labor costs which were higher as percentage of net sales. These were partially offset by the aforementioned list price increases, as well as a higher proportion of higher-margin proprietary brand sales.
Selling, general and administrative expenses
Selling, general and administrative ("SG&A") expenses for the three months ended September 30, 2022, were $26.2 million, a decrease of $6.2 million compared to the same period in 2021. SG&A expenses for the nine months ended September 30, 2022, were $92.4 million, an increase of $15.9 million compared to the same period in 2021.
The $6.2 million decrease in SG&A expenses for the three months ended September 30, 2022, compared to prior year was primarily related to (i) an $8.2 million decrease in acquisition and integration expenses, (ii) $1.1 million of investor warrant solicitation fees incurred last year, (iii) a $0.5 million decrease in marketing expense, (iv) a $0.4 million decrease in compensation costs, and (v) a $0.3 million decrease in costs associated with the relocation of certain of our distribution centers. These decreases were partially offset by (i) a $3.1 million increase in depreciation, depletion and amortization expense, (ii) a $1.1 million increase in accounts receivable allowances and (iii) a $0.5 million increase in insurance costs.
The $15.9 million increase in SG&A expenses for the nine months ended September 30, 2022, compared to prior year was primarily related to (i) a $21.7 million increase in depreciation, depletion and amortization expense, of which $5.9 million represented amortization expense from adjustments to useful lives that were determined this year, (ii) a $3.3 million increase in compensation costs (primarily salaries and benefits for employees from companies acquired in 2021), of which $1.0 million was severance associated with a recent reduction-in-force, (iii) a $3.0 million increase in share-based compensation, (iv) a $1.5 million increase in accounts receivable allowances, (v) a $1.4 million increase in insurance costs, and (vi) a $1.1 million increase in costs associated with the relocation of certain of our distribution centers. These increases were partially offset by (i) a $16.2 million decrease in acquisition and integration expenses, (ii) $1.9 million of investor warrant solicitation fees incurred last year, and (iii) a $0.7 million increase in travel expense.
Impairments
The Company recorded goodwill impairment charges of zero and $189.6 million for the three and nine months ended September 30, 2022, respectively, as we determined that the carrying value of the goodwill reporting units of U.S. and Canada was in excess of the fair value. The recognized impairment reduced the goodwill balance to zero as of June 30, 2022. The impairment was primarily due to a deterioration in customer demand in the U.S. and Canada caused by macroeconomic and industry conditions. For the nine months ended September 30, 2022, the Company also recorded an impairment of a note receivable of $2.6 million.
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Interest expense
Interest expense for the three months ended September 30, 2022, was $3.1 million, an increase of $2.9 million compared to the same period in the prior year. Interest expense for the nine months ended September 30, 2022, was $7.9 million, an increase of $7.6 million compared to the same period in the prior year. The increase was due to the interest-bearing Term Loan entered into in the fourth quarter of 2021 and outstanding for the entire three and nine months ended September 30, 2022.
Loss on debt extinguishment
Loss on debt extinguishment for the nine months ended September 30, 2022, was zero, compared to $0.7 million in the prior year which resulted primarily from the write-off of unamortized deferred financing costs associated with the payoff of the Encina Credit Facility.
Other income (expense), net
Other income for the three and nine months ended September 30, 2022, was $0.6 million and $1.0 million, respectively. For the three and nine months ended September 30, 2021, other expense was $41 thousand and other income was $86 thousand, respectively. The increase in other income compared to the prior year periods relates primarily to foreign currency exchange rate gains in 2022.
Income tax (expense) benefit
Income tax expense for the three months ended September 30, 2022, was $0.8 million, compared to $19.8 million of income tax benefit in the prior year. Given the Company's valuation allowances, there was no significant income tax benefit recorded from the pre-tax loss during the three months ended September 30, 2022. Income tax benefit for the nine months ended September 30, 2022, was $11.7 million, compared to $19.0 million of income tax benefit in the prior year. Our effective income tax rate was 4.5% for the nine months ended September 30, 2022, and differs from the U.S. federal statutory rate of 21% primarily due to the impairment of goodwill for certain 2021 acquisitions which was not deductible for U.S. tax purposes, increases in our valuation allowance on U.S. deferred tax assets, and the establishment of a valuation allowance for Canadian deferred tax assets. As described in Note 4 - Goodwill and Intangible Assets, Net, during the three months ended June 30, 2022, we fully impaired the goodwill associated with all 2021 acquisitions. For the nine months ended September 30, 2022, we recorded discrete income tax benefits of $12.1 million relating primarily to measurement period adjustments associated with 2021 acquisitions, and certain tax benefits related to goodwill impairment.
For the nine months ended September 30, 2021, our income tax rate of (349.9)% differs from the federal statutory rate of 21% primarily as a result of reducing valuation allowances on the Company's net deferred tax assets due to certain acquisitions in the year.
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Non-GAAP Financial Measures
We report our financial results in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP” or “GAAP”). However, management believes that certain non-GAAP financial measures provide investors with additional useful information in evaluating our performance and that excluding certain items that may vary substantially in frequency and magnitude period-to-period from net (loss) income provides useful supplemental measures that assist in evaluating our ability to generate earnings and to more readily compare these metrics between past and future periods. These non-GAAP financial measures may be different than similarly titled measures used by other companies.
To supplement our condensed unaudited consolidated financial statements which are prepared in accordance with GAAP, we use “Adjusted EBITDA” and “Adjusted EBITDA as a percent of sales” which are non-GAAP financial measures (collectively referred to as “Adjusted EBITDA”). Our non-GAAP financial measures should not be considered in isolation from, or as substitutes for, financial information prepared in accordance with GAAP. There are several limitations related to the use of our non-GAAP financial measures as compared to the closest comparable GAAP measures. Some of these limitations include:
• Adjusted EBITDA does not reflect the significant interest expense, or the amounts necessary to service interest or principal payments on our indebtedness;
• Adjusted EBITDA excludes depreciation, depletion and amortization, and although these are non-cash expenses, the assets being depreciated and amortized may have to be replaced in the future;
• Adjusted EBITDA does not reflect our tax provision that adjusts cash available to us;
• Adjusted EBITDA excludes the non-cash component of stock-based compensation;
• Adjusted EBITDA excludes the amount of employer payroll taxes on stock-based compensation; and
• Adjusted EBITDA does not reflect the impact of earnings or charges resulting from matters we consider not to be reflective, on a recurring basis, of our ongoing operations. These items include impairments, severance and other expenses, acquisition-related expenses, distribution center exit costs, loss on debt extinguishment, investor warrant solicitation fees, and other income/ expense, net.
We define Adjusted EBITDA as net income (loss) excluding interest expense, income taxes, depreciation, depletion and amortization, stock-based compensation, employer payroll taxes on stock-based compensation and other unusual and/or infrequent costs (i.e. impairments, severance and other expenses, acquisition-related expenses, distribution center exit costs, loss on debt extinguishment, investor warrant solicitation fees, and other income/ expense, net), which we do not consider in our evaluation of ongoing operating performance.
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The following table presents a reconciliation of net (loss) income, the most comparable GAAP financial measure, to Adjusted EBITDA for the three and nine months ended September 30, 2022 and 2021 (in thousands):
Three months ended September 30,Nine months ended September 30,
2022202120222021
Net (loss) income (GAAP)$(23,539)$17,265 $(250,147)$24,462 
  Interest expense 3,073 132 7,863 276 
  Income tax expense (benefit)759 (19,844)(11,671)(19,025)
  Distribution center exit costs and other1
37 328 1,412 328 
  Depreciation, depletion and amortization8,439 4,860 33,215 8,638 
  Impairments2
— — 192,328 — 
  Severance and other3
253 246 1,224 262 
  Acquisition expenses4
867 10,589 7,102 20,814 
  Stock-based compensation5
1,678 1,347 6,834 3,863 
  Investor warrant solicitation fees6
— 1,105 — 1,949 
  Other (income) expense, net7
(615)41 (971)(86)
  Loss on debt extinguishment8
— — — 680 
Adjusted EBITDA (Non-GAAP)$(9,048)$16,069 $(12,811)$42,161 
As a percent of net sales:
Net (loss) income (GAAP)(31.7)%13.9 %(88.4)%6.6 %
Adjusted EBITDA (Non-GAAP)(12.2)%13.0 %(4.5)%11.4 %
Net Loss (GAAP) and Adjusted EBITDA (Non-GAAP) for the three and nine months ended September 30, 2022, were negatively impacted by $5.5 million and $18.9 million, respectively, of inventory related charges and accounts receivable allowances.
1. For the 2022 and 2021 periods presented, this relates to costs incurred to exit and relocate distribution centers in California and Pennsylvania including lease exit costs, transportation, and labor related costs.
2. The Company completed its goodwill impairment testing and recorded an impairment charge of $189.6 million during the nine months ended September 30, 2022, due to market softness in demand in the U.S. and Canada. Additionally, during the nine months ended September 30, 2022, the Company recorded an impairment primarily related to a $2.6 million charge associated with a note receivable that originated in 2019 associated with a third party independent processor serving the CBD market.
3. Severance and other primarily consists of severance costs incurred during the three and nine months ended September 30, 2022, related to workforce reductions to optimize our cost structure. Severance and other primarily consists of costs related to an aborted convertible loan transaction during the three and nine months ended September 30, 2021.
4. For the three months ended September 30, 2022, this includes non-cash purchase accounting inventory adjustments for Greenstar $0.1 million, and the elimination of acquisition and integration consulting, transaction services and legal fees incurred for the completed Heavy 16, House and Garden, Aurora, Greenstar, and Innovative Growers Equipment acquisitions and certain potential acquisitions of $0.8 million. For the nine months ended September 30, 2022, this includes non-cash purchase accounting inventory adjustments for House and Garden, Aurora, Greenstar and Innovative Growers Equipment of $4.5 million, and acquisition and integration consulting, transaction services and legal fees incurred for the completed Heavy 16, House and Garden, Aurora, Greenstar, and Innovative Growers Equipment acquisitions and certain potential acquisitions of $4.2 million, partially offset by the change in fair value of contingent consideration for Aurora of ($1.6 million). For the prior year period, acquisition and integration includes investment banking, consulting, transaction services and legal fees incurred for the completed Heavy 16, House & Garden, Aurora, Greenstar, and Innovative Growers Equipment acquisitions and certain potential acquisitions, including the inventory step up amounts of Heavy 16 and House and Garden of $2.0 million, for the nine months ended September 30, 2021.
5. Includes stock-based compensation and related employer payroll taxes on stock-based compensation for the periods presented.
6. Reflects the elimination of investor warrant solicitation fees.
7. Other (income) expense, net relates primarily to foreign currency exchange rate gains and losses and other non-operating income and expenses.
8. For the nine months ended September 30, 2021, loss on debt extinguishment resulted primarily from the write-off of unamortized deferred financing costs associated with the termination of the Encina Credit Facility.
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Liquidity and Capital Resources
The following table summarizes our cash flows for the nine months ended September 30, 2022 and 2021 (amounts in thousands):
Nine months ended September 30,
20222021
Net cash from (used in) operating activities$15,490 $(17,510)
Net cash used in investing activities(7,386)(419,407)
Net cash (used in) from financing activities(19,480)374,447 
Effect of exchange rate changes on cash, cash equivalents and restricted cash(515)(29)
Net decrease in cash, cash equivalents and restricted cash(11,891)(62,499)
Cash, cash equivalents and restricted cash at beginning of period28,384 76,955 
Cash, cash equivalents and restricted cash at end of period$16,493 $14,456 
Operating Activities
Net cash from operating activities was $15.5 million for the nine months ended September 30, 2022, primarily due to $22.7 million net cash inflow from a reduction of working capital. This included a decrease of $37.1 million in inventories and a decrease of $13.1 million in accounts receivable, net, partially offset by decreases of $11.0 million in deferred revenue and $11.0 million in accounts payable, accrued expenses and other current liabilities.
Net cash used in operating activities was $17.5 million for the nine months ended September 30, 2021, primarily consisting of $24.5 million in net income, $4.3 million in net non-cash expense reductions, which were largely comprised of depreciation, depletion and amortization, stock-based compensation expense, non-cash operating lease expense, deferred income tax benefit, provision for inventory obsolescence, change in the fair value of contingent consideration, and other non-cash expenses, less a $37.7 million increase in working capital. This change in working capital primarily reflects an aggregate increase of $53.0 million in accounts receivable, net, inventories, prepaid expenses and other current assets, and other assets for the period offset by an aggregate net increase of $15.3 million in accounts payable, accrued expenses and other current liabilities, and a decrease in lease liabilities due to payments on lease obligations during the period.
Investing Activities
Net cash used in investing activities was $7.4 million for the nine months ended September 30, 2022, and was due primarily to purchases of property, plant and equipment, which increased over the prior year due to our acquired companies' greater capital requirements and the relocation of certain of our distribution centers. The current year cash usage primarily includes our investment in the peat moss harvesting operation in Canada and IGE manufacturing operations in the U.S.
Net cash used in investing activities for the nine months ended September 30, 2021, was $419.4 million, due primarily to four business acquisitions we completed during the period, which totaled $415.9 million in cash outflows and $3.1 million of property, plant and equipment purchases.
Financing Activities
Net cash used in financing activities was $19.5 million for the nine months ended September 30, 2022, primarily consisting of $15.6 million in payments to settle contingent consideration. We paid $2.4 million related to employees' withholding tax in connection with the vesting of restricted stock units. In addition, we paid $0.9 million on the Term Loan.
Net cash provided by financing activities was $374.4 million for the nine months ended September 30, 2021. We received proceeds of $309.8 million from our follow-on offering, and received an additional $56.8 million from the exercises of investor warrants. We also paid $17.9 million related to employee's withholding tax in connection with the vesting of certain restricted stock units. In addition, we had $26.3 million in net borrowings on our Revolving Credit Facility during the period.
Liquidity
Our ability to make investments in our business, service our debt and maintain strong liquidity will depend upon our ability to generate excess operating cash flows through our operating subsidiaries. Based on current levels of operations, we believe that our cash flows from operations, combined with our current cash levels and borrowing availability, will be adequate
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to fund debt service requirements and provide cash, as required, to support our ongoing operations, capital expenditures, lease obligations and working capital needs through the next twelve months of operations.
If necessary, we believe that we could supplement our cash position through sale/leasebacks, asset sales and an equity financing. We believe it is prudent to be prepared if required and, accordingly, are engaged in the process of evaluating and preparing to implement one or more of the aforementioned activities.
Senior Secured Term Loan
On October 25, 2021, we and certain of our direct and indirect subsidiaries entered into the Term Loan with JPMorgan Chase Bank, N.A., as administrative agent for certain lenders, pursuant to which we borrowed a $125.0 million senior secured term loan. The Term Loan bears interest at LIBOR (with a 1.0% floor) plus 5.50%, or an alternative base rate (with a 2.0% floor), plus 4.50%, and is subject to a call premium of 2% in year one, 1% in year two, and 0% thereafter, and matures on October 25, 2028. We received net proceeds of $119.9 million in 2021 from the Term Loan after deducting discounts and deferred financing costs.
The principal amounts of the Term Loan are to be repaid in consecutive quarterly installments in amounts equal to 0.25% of the principal amount of the Term Loan, on the last day of each fiscal quarter commencing March 31, 2022, with the balance of the Term Loan payable on the Maturity Date.
The Term Loan requires us to maintain certain reporting requirements, affirmative covenants, and negative covenants, and we were in compliance with all requirements as of September 30, 2022. The Term Loan is secured by a first lien on the non-working capital assets of the Company and a second lien on the working capital assets. We may request additional term loan commitments subject to certain loan conditions.
JPMorgan Revolving Credit Facility
On March 29, 2021, we and certain of our direct and indirect subsidiaries entered into a Senior Secured Revolving Credit Facility with JPMorgan Chase Bank, N.A., as administrative agent, issuing bank and swingline lender, and the lenders from time-to-time party thereto. The Revolving Credit Facility replaced the Encina Credit Facility. The Revolving Credit Facility is due on the earlier of March 29, 2024, or any earlier date on which the revolving commitments are reduced to zero.
The Revolving Credit Facility has been amended since its origination in connection with modifications to increase the borrowing limit and to consent to the Term Loan.
The three-year Revolving Credit Facility has a borrowing limit of $100 million subject to customary conditions. The Revolver maintains an interest rate of LIBOR plus 1.95% and has a 0.0% LIBOR floor. A fee of 0.25% per annum is charged for available but unused borrowings as defined. The Revolving Credit Facility is an asset-based facility that is secured by a first lien on the working capital assets of the Company and a second lien on the non-working capital assets of the Company (including most of the Company’s subsidiaries). The borrowing base is based on a detailed monthly calculation of the sum of (a) a percentage of the Eligible Accounts at such time, plus (b) the lesser of (i) a percentage of the Eligible Inventory, at such time, valued at the lower of cost or market value, determined on a first-in-first-out basis, and (ii) the product of a percentage multiplied by the Net Orderly Liquidation Value percentage identified in the most recent inventory appraisal ordered by the Administrative Agent multiplied by the Eligible Inventory, valued at the lower of cost or market value, determined on a first-in-first-out basis, minus (c) Reserves (each of the defined terms above, as defined in the Revolving Credit Facility documents). As of September 30, 2022, the Company would be able to borrow approximately $62 million under the Revolving Credit Facility.
The Company is required to maintain certain reporting requirements, affirmative covenants and negative covenants, pursuant to terms outlined in the agreement. Additionally, if the Company’s Excess Availability (as defined in the Revolving Credit Facility documents) is less than $10,000, the Company will be required to maintain a minimum fixed charge coverage ratio of 1.1x on a rolling twelve-month basis until the Excess Availability is more than $10,000 for thirty consecutive days. The Company must also comply with a higher fixed charge coverage ratio of 1.15x in order to consummate permitted acquisitions and to make restricted payments, but no such acquisitions or payments are currently contemplated. As of September 30, 2022, the Company is in compliance with the covenants contained in the Revolving Credit Facility.
As of September 30, 2022, and December 31, 2021, the Company had zero borrowed under the facility.
Cash and cash equivalents
The cash and cash equivalents balances of $16.5 million and $26.6 million at September 30, 2022, and December 31, 2021, respectively, included $6.5 million and $4.1 million, respectively, held by foreign subsidiaries.
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Material Cash Requirements
Our material cash requirements include interest payments on our long-term debt, operating lease payments, and purchase obligations to support our operations. Refer to Part I, Item 1, Financial Statements, Note 10 - Debt, Note 7 - Operating Leases, and Note 13 - Commitments, Contingencies, and Related Party Transactions for details relating to our material cash requirements for debt, our leasing arrangements, including future maturities of our operating lease liabilities, and purchase obligations, respectively.
Critical Accounting Policies and Estimates
The preceding discussion and analysis of our consolidated results of operations and financial condition should be read in conjunction with our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. Our critical accounting policies and estimates are identified in Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of our most recently filed Form 10-K and include the discussion of estimates used in business combinations, goodwill, and long-lived assets. Such accounting policies and estimates require significant judgments and assumptions to be used in the preparation of the Condensed Consolidated Financial Statements included in this Form 10-Q, and actual results could differ materially from the amounts reported.
Goodwill is evaluated for impairment annually in the fourth quarter, or on an interim basis when an event or change in circumstances occurs, indicating that the carrying value may not be recoverable. Primarily due to a decline in the Company's market value of common stock and market conditions, the Company identified a triggering event requiring a test for impairment as of June 30, 2022. The Company completed its goodwill impairment testing and recorded an impairment charge due to market softness in demand in the U.S. and Canada. The Company determined the fair value of the U.S. and Canada reporting units based on an income approach, using the present value of future discounted cash flows, and based on a market approach. Significant estimates used to determine fair value include the weighted average cost of capital, financial forecasts, and pricing multiples derived from publicly-traded companies that are comparable to the reporting units. The fair values were reconciled to the market value of common stock of Hydrofarm to corroborate the estimates used in the interim test for impairment.
Intangible assets with finite lives and indefinite lives are reviewed for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. For the quarter ended June 30, 2022, the Company performed an evaluation of intangible assets for impairment in connection with the triggering event identified requiring a quantitative test for goodwill impairment. This impairment evaluation includes a comparison of the undiscounted cash flows expected to be generated by that long-lived asset or asset group to its carrying amount. If the carrying amount of the long-lived asset or asset group is not recoverable on an undiscounted cash flow basis, impairment is recognized to the extent that the carrying amount exceeds its fair value. Based on the Company's evaluation, there was no impairment of intangible assets or other long lived assets for the quarter ended June 30, 2022. No such triggering event was identified during the three months ended September 30, 2022.
The Company believes that the intangible asset impairment evaluations were based on reasonable assumptions that marketplace participants would use. However, such assumptions are inherently uncertain and actual results could differ from those estimates. Changes to or a failure to achieve our projected business assumptions, including growth and profitability, could result in a valuation that would trigger an impairment in future periods.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of economic losses due to adverse changes in financial market prices and rates. Our primary market risk has been interest rate, foreign currency and inflation risk. We do not have material exposure to commodity risk.
Interest Rate Risk
We are exposed to interest rate risk through our variable rate debt. As of September 30, 2022, we had $124.1 million of Term Loan debt that is subject to variable interest rates that are based on London interbank offered rate (“LIBOR”) or an alternate base rate, and is currently subject to a six-month LIBOR interest rate through December 30, 2022. Refer to Part I, Item 1, Financial Statements, Note 10 - Debt for details relating to the debt. If the rates were to increase by 100 basis points from the rates in effect as of September 30, 2022, our interest expense on the variable-rate debt would increase by an average of $1.1 million annually. There are inherent limitations in the sensitivity analysis presented, primarily due to the assumptions that interest rate changes would be instantaneous, while LIBOR changes regularly, and has changed since the date we entered into the six-month interest rate period. Additionally, we may elect 1, 3, or 6 month rates upon the expiration of the current interest rate period, which is December 30, 2022. We do not currently hedge our interest rate risk but may determine to do so in the future.
Foreign Currency Risk
The functional currencies of our foreign subsidiary operations are predominantly in the Canadian dollar (“CAD”) and the Euro. For the purposes of presenting these consolidated financial statements, the assets, and liabilities of subsidiaries with CAD or Euro functional currencies are translated into USD using exchange rates prevailing at the end of each reporting period. Income and expense items are translated at the average rate prevailing during the period with exchange differences impacting other comprehensive income (loss) in equity. Therefore, our results of operations and cash flows are subject to fluctuations due to changes in foreign currency exchange rates, principally the CAD.
However, we believe that the exposure to foreign currency fluctuation from product sales and operating expenses is not significant at this time as the related product sales and costs do not constitute a significant portion of our total net sales and expenses. In the future, our exposure to foreign currency risk could become more significant. To date, we have not entered into any foreign currency exchange contracts and currently do not expect to enter into foreign currency exchange contracts for trading or speculative purposes.
Impact of Inflation
Our results of operations and financial condition are presented based on historical costs. We cannot provide assurances that our results of operations and financial condition will not be materially impacted by inflation in the future.
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ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, with the participation and supervision of our Chief Executive Officer and our Chief Financial Officer, have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based upon that evaluation, the Company's management, including the Chief Executive Officer and the Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this Quarterly Report on Form 10-Q.
Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost benefit relationship of possible controls and procedures.
Changes in Internal Controls over Financial Reporting
There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, we may become involved in various lawsuits and legal proceedings, which arise, in the ordinary course of business. We are currently not aware of any legal proceedings or claims that we believe will have a material adverse effect on our business, financial condition or operating results.
ITEM 1A. RISK FACTORS
For a discussion of risk factors, please read Item 1A, "Risk Factors" in our 2021 Annual Report. Such risk factors continue to be relevant to an understanding of our business, financial condition and operating results. As of the date of this Quarterly Report on Form 10-Q, there have been the following material changes with respect to such risk factors.
Long-lived assets and inventories represent a significant portion of our total assets and we may be required to record impairments or write-downs in future periods.
Our condensed consolidated balance sheet as of September 30, 2022, includes $306.2 million of intangible assets, net, $137.0 million of inventories, $51.2 million of property, plant, and equipment, net, and $49.3 million of operating lease right-of-use assets. During the three months ended June 30, 2022, we recorded a $189.6 million goodwill impairment charge due to a decline in the estimated fair value of our reporting units. During the three and nine months ended September 30, 2022, we recorded allowances for inventory obsolescence of $4.4 million and $17.8 million, respectively, primarily due to certain durable lighting products.
Long-lived assets, such as intangible assets, property, plant and equipment and operating lease right-of-use assets are reviewed for impairment whenever events, changes or circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. If we were to conclude that a future write-down of our long-lived assets is necessary, we would have to record the appropriate charge, which could result in a material adverse effect on our results of operations. Inventories consist of manufactured goods, goods acquired for resale, and materials consumed in business operations. Inventories are stated at the lower of cost or net realizable value, and the Company maintains an allowance for excess and obsolete inventory. The estimate for excess and obsolete inventory is based upon assumptions about future demand and market conditions. The Company has experienced recent sales declines, which we believe are primarily a result of agricultural oversupply impacting our market. The extent to which these market conditions will continue to impact our business, results of operations, and cash flows are uncertain and difficult to predict at this time, and may result in lower margins, inventory write-downs, accounts receivable allowances, and impairments of our long-lived assets which could have a material adverse effect on our business, financial condition and results of operations.
If we fail to manage our inventory effectively, our results of operations, financial condition and liquidity may be materially and adversely affected.
Our business requires us to manage inventory effectively. We depend on our forecasts of demand for, and popularity of, various products to make purchase decisions and to manage our inventory of stock-keeping units. Demand for products, however, can change significantly between the time inventory or components are ordered and the date of sale. Demand may be affected by seasonality, new product launches, rapid changes in product cycles and pricing, product defects, promotions, changes in consumer spending patterns, changes in consumer tastes with respect to our products and other factors, and our consumers may not purchase products in the quantities that we expect. It may be difficult to accurately forecast demand and determine appropriate levels of product or components. From time to time in the normal course of business, we enter into agreements with our suppliers pursuant to which we are required to purchase minimum amounts of inventory over a defined time period. We receive favorable pricing terms in exchange for this arrangement, but such agreements could lead to an oversupply of inventory. If we fail to manage our inventory effectively or negotiate favorable credit terms with third-party suppliers, we may be subject to a heightened risk of inventory obsolescence, a decline in inventory values, and significant inventory write-downs or write-offs. In addition, if we are required to lower sale prices in order to reduce inventory level or to pay higher prices to our suppliers, our profit margins might be negatively affected. Any of the above may materially and adversely affect our business, financial condition and results of operations.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
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ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
None.
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ITEM 6. EXHIBITS
(a)Exhibits.
ExhibitDescription
10.1
31.1*
31.2*
32.1*#
32.2*#
101. INSInline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCHInline XBRL Taxonomy Schema Linkbase Document.
101.CALInline XBRL Taxonomy Calculation Linkbase Document.
101.DEFInline XBRL Taxonomy Definition Linkbase Document.
101.LABInline XBRL Taxonomy Labels Linkbase Document.
101.PREInline XBRL Taxonomy Presentation Linkbase Document.
104Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101).
*    Filed herewith.
#    The certifications attached as Exhibits 32.1 and 32.2 accompany this Quarterly Report on Form 10-Q pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, and shall not be deemed “filed” by the Company for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, nor shall they be deemed incorporated by reference into any filing of the registrant under the Securities Act of 1933, as amended, or the Exchange Act, whether made before or after the date hereof, regardless of any general incorporation language in such filing.
+    Certain schedules and exhibits have been omitted pursuant to Item 601(b)(2) of Regulation S-K. A copy of any omitted schedule and/or exhibit will be furnished to the Securities and Exchange Commission upon request.
†     Certain confidential portions (indicated by brackets and asterisks) have been omitted from this exhibit.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized.
Hydrofarm Holdings Group, Inc.
Date: November 9, 2022
/s/ William Toler
William Toler
Chief Executive Officer
(Principal Executive Officer)
Date: November 9, 2022
/s/ B. John Lindeman
B. John Lindeman
Chief Financial Officer
(Principal Financial Officer)
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