HYDROFARM HOLDINGS GROUP, INC. 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 consolidated financial statements and the notes contained elsewhere in this Annual Report on Form 10-K. 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 Annual Report on Form 10-K, 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 this Annual Report on Form 10-K. 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 theU.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 substantial 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 theU.S. andCanada 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.
Recent Developments
OnNovember 1, 2021 , we closed the acquisition of the IGE Entities. See Note 3 - Business Combinations underInnovative Growers Equipment, Inc. Acquisition, in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The IGE Entities are a manufacturer of horticulture benches, racking and LED lighting systems. The addition of the IGE Entities' commercial equipment product range complements our existing lineup of high performance, proprietary branded products.
Senior Secured Term Loan
OnOctober 25, 2021 , we entered into a senior secured term loan facility, in the aggregate principal amount of$125 million , withJPMorgan Chase Bank, N.A . as administrative agent for certain lenders (the "Term Loan"). The Term Loan bears interest at a rate of either LIBOR (with a 1.0% floor) plus 5.50%, or an alternate base rate (with a 2.0% floor) plus 4.50% and matures onOctober 25, 2028 . We used the net proceeds from the Term Loan to fund the cash portion of the IGE Entities' acquisition and for general corporate purposes, which may include, among other things, repaying any outstanding balance under our existing revolving facility and funding future M&A opportunities. Should additional capital needs arise, we can, per the terms of the Term Loan agreement, seek to upsize the facility. The Term Loan is more fully described in Note 10 - Debt under Term loans - Senior Secured Term Loan in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. 55
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Greenstar/Grotek Acquisition
OnAugust 3, 2021 , we closed the acquisition of Greenstar. See Note 3 - Business Combinations under Greenstar/Grotek Acquisition, in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Greenstar produces premium horticultural products and solutions for global, domestic and commercial use. Greenstar's owned brands include Grotek,Gaia Green , Supergreen, and EarthSafe. Grotek has been producing since 1998 and is sold internationally. Greenstar's brands are utilized by commercial operators including growers, landscapers, greenhouses, nurseries, organic farms, as well as independent retailers. Greenstar manufactures products for both the retail and commercial market. Investor Warrant Redemption OnJuly 19, 2021 , we completed the redemption (the "Warrant Redemption") of certain of our outstanding warrants (the "Investor Warrants") to purchase shares of our common stock that were issued in connection with a private placement of units. See Note 11 - Stockholders' Equity under Warrants - Redemption of investor warrants, in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Prior toJuly 19, 2021 , 3,367,647 Investor Warrants were exercised, generating approximately$56.8 million of gross proceeds to the Company. As a result, we redeemed 1,491 Investor Warrants for a redemption price of$0.00033712 per Investor Warrant. As ofDecember 31, 2021 , there were no Investor Warrants outstanding. We used the net proceeds from the redemption of the Investor Warrant for acquisitions, working capital and other general corporate purposes.
Aurora Acquisition
OnJuly 1, 2021 , we completed the acquisition of 100% of the issued and outstanding membership interests of Aurora. See Note 3 - Business Combinations under Aurora Acquisition, in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Founded in 2000, Aurora was a family-owned business with a strong vertically integrated manufacturing base with three locations acrossNorth America . The company is dedicated to ethical and sustainable practices and offers comprehensive plant fertility product lines free from harmful chemical residues and pesticides. Aurora adds to our growing proprietary brand nutrient and grow media line-ups, including its first organic nutrient and premium soil brands. We gained new domestic manufacturing and distribution capabilities on the east and west coasts along with a peat moss harvesting operation inCanada .
House and Garden Acquisition
OnJune 1, 2021 , we acquired 100% of the issued and outstanding shares of capital stock of the H&G Entities. See Note 3 - Business Combinations under House & Garden Acquisition, in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The H&G entities are located inArcata, California , and produce and distribute premium grade plant nutrients and fertilizers across the globe. The H&G entities offer a strong product line of plant nutrients that strengthens our position in the nutrient sector and complement our rapidly expanding portfolio of premium products for controlled environment agriculture.
Follow-on Public Offering
OnMay 3, 2021 , we closed our follow-on offering, in which we issued and sold 5,526,861 shares of our common stock, including the full exercise by the underwriters of their option to purchase 720,894 additional shares of our common stock, at a public offering price of$59.00 per share, which resulted in net proceeds of approximately$309.8 million after deducting underwriting discounts and commissions and offering expenses. We used the proceeds from the follow-on offering for acquisitions, working capital and other general corporate purposes.
Heavy 16 Acquisition
OnMay 3, 2021 , we acquired 100% of the issued and outstanding membership interests of Heavy 16. See Note 3 - Business Combinations under Heavy 16 Acquisition, in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Heavy 16 is a leading manufacturer and supplier of branded plant nutritional products, with nine core products that are currently sold acrossthe United States . The Heavy 16 products feature a full line of premium nutrients used in all stages of plant growth, helping to increase the yield and quality of crops. 56
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JPMorgan Credit Facility
OnMarch 29, 2021 , we and certain of our subsidiaries entered into a Senior Secured Revolving Credit Facility (the "JPMorgan Credit Facility") withJPMorgan Chase Bank, N.A ., as administrative agent, issuing bank and swingline lender, and the lenders from time to time party thereto. The JPMorgan Credit Facility replaced the Loan and Security Agreement withEncina Business Credit, LLC (the "Encina Credit Facility"). There was no outstanding indebtedness under the Encina Credit Facility when it was replaced. The JPMorgan Credit Facility, among other things, provides for an asset based senior revolving credit line (the "Senior Revolver") with JPMorgan as the initial lender. The three-year Senior Revolver had a borrowing limit of$50 million . We had the right to increase the amount of the Senior Revolver in an amount up to$25 million by obtaining commitments from JPMorgan or from other lenders. Our and our subsidiaries' obligations under the JPMorgan Credit Facility are secured by a first priority lien (subject to certain permitted liens) in substantially all of our and our subsidiaries' respective personal property assets pursuant to the terms of aU.S. and a Canadian Pledge and Security Agreement, datedMarch 29, 2021 , and the other security documents. OnAugust 31, 2021 , the JPMorgan Credit Facility was amended to increase the borrowing limit to$100 million and onOctober 25, 2021 was further amended to permit the Term Loan and to conform changes to provisions of the Term Loan. The JPMorgan Credit Facility is more fully described in Note 10 - Debt under Revolving asset-backed credit facilities - JPMorgan Revolving Credit Facility in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
New Distribution Centers
InApril 2021 , we entered into leases for two new distribution centers aggregating approximately 322,000 square feet. One is located inFairfield, California and is the distribution center that we relocated to from ourPetaluma, California distribution facility in the fourth quarter of 2021. The other distribution center is located inFontana, California which we relocated to from ourSanta Fe Springs, California distribution facility in the third quarter of 2021. See Note 7 - Leases, in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
In
InNovember 2021 , we executed a lease for approximately 109,000 square feet of warehouse space inCambridge, Ontario, Canada to be available upon expiration of the lease existing space, commencingJune 1, 2023 . See Note 7 - Leases, in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. InJanuary 2022 , we executed a lease for approximately 303,000 square feet of warehouse space inShoemakersville, Pennsylvania to be available upon expiration of the lease for existing space, commencingMarch 1, 2022 . See Note 7 - Leases, in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Effects of COVID-19 on Our Business
TheWorld Health Organization recognized COVID-19 as a public health emergency of international concern onJanuary 30, 2020 and as a global pandemic onMarch 11, 2020 . Vaccines for COVID-19 continue to be administered inthe United States and other countries around the world, but the extent and rate of vaccine adoption, the long-term efficacy of these vaccines and other factors remain uncertain. Authorities throughout the world have implemented measures to contain or mitigate the spread of the virus, including 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. The global pandemic and actions taken to contain COVID-19 have adversely affected the global economy and financial markets. In response to the COVID-19 pandemic, we implemented business continuity plans designed to address the impact of the COVID-19 pandemic on our business, such as restrictions on non-essential business travel, the institution of work-from-home practices and the implementation of strategies for workplace safety at our facilities. We have historically and may continue to source select products fromChina . It is difficult to predict the extent to which COVID-19, including the emergence and spread of more transmissible variants, may continue to spread. As of the date of this Annual Report on Form 10-K, manufacturers inChina and inNorth America are generally back in operation; however, new waves of the COVID-19 pandemic could result in the re-closure of factories inChina and/or inNorth America . Quarantine orders and travel restrictions withinthe United States and other countries may also adversely impact our supply chains, the manufacturing of our own products and our ability to obtain necessary materials. We are experiencing 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. Although we have not, to date, experienced any material interruptions in our ability to fill our customers' orders or manufacture our own products, we may in the future be unable to obtain adequate inventory to fill purchase orders or 57
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manufacture our own products, which could adversely affect our business, results of operations and financial condition. 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. 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.
Our customers reside in countries, primarily the
Our business has remained resilient during the COVID-19 pandemic. As ofDecember 31, 2021 , our manufacturing and distribution operations are viewed as essential services and continue to operate. Our key suppliers, retailers and resellers have been designated as essential services and remain open at this time; however, in certain places they are operating under reduced hours and capacity limitations. The majority ofU.S. and Canadian cannabis businesses have been designated as essential byU.S. State and Canadian government authorities. 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. Depending on the length and severity of COVID-19, we may experience an increase or decrease in customer orders driven by volatility in consumer shopping and consumption behavior. 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 (e.g. possible positive demand impact from shelter-in-place orders inthe United States , possible negative supply chain impact from workforce disruption at international and domestic suppliers and domestic ports and the possible negative impact on transportation costs) have had on the overall business. And so, while we do not believe that we are experiencing net material adverse impacts at this time, given the global economic slowdown, the overall disruption of global supply chains and distribution systems and the other risks and uncertainties associated with the COVID-19 pandemic, our business, financial condition, results of operations and growth prospects could be materially and adversely affected. While we believe that we are well positioned for the future as we navigate the crisis and prepare for an eventual return to a more normal operating environment, we continue to closely monitor the COVID-19 pandemic as we evolve our business continuity plans and response strategy.
Other Transactions
Initial Public Offering
OnDecember 14, 2020 , we completed our initial public offering ("IPO"), in which we issued and sold 9,966,667 shares of our common stock, including the full exercise by the underwriters of their option to purchase 1,300,000 additional shares of our common stock, at a public offering price of$20.00 per share, which resulted in net proceeds of$182.3 million after deducting underwriting discounts and commissions and offering expenses. The proceeds from the IPO were used to (i) repay amounts outstanding under the previous term loan withBrightwood Loan Services, LLC of$76.6 million (includes accrued interest and fees of$0.3 million ), (ii) to pay down certain amounts outstanding under the Encina Credit Facility of$33.4 million , (iii) to repay$3.3 million under the promissory note toJPMorgan Chase, N.A. through theU.S. Small Business Administration Paycheck Protection Program, and (iv) to pay$2.6 million to settle the Series A preferred stock dividend. Our common stock began trading on the Nasdaq Global Select Market onDecember 10, 2020 .
Reverse Stock Split
Our board of directors and stockholders approved an amendment to our amended and restated certificate of incorporation effecting a 1-for-3.3712 reverse stock split of our issued and outstanding shares of common stock. The reverse split was effected onNovember 24, 2020 without any change in the par value per share.
Components of Results of Operations
Net sales
We generate net sales from the distribution and manufacturing of hydroponic equipment and supplies to our customers. The hydroponic equipment and supplies that we sell include consumable products, such as growing media, nutrients and supplies that require regular replenishment and durable products, such as lighting and hydroponic equipment. Our scale allows us to provide delivery and service capabilities to a highly diverse group of customers across theU.S. andCanada . We 58
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generally do not sell directly to growers but rather our customer base consists of specialty hydroponic retailers, garden centers, eCommerce and greenhouse suppliers.
We periodically offer sales incentives to our customers, including early pay discounts, volume-based rebates, temporary price reductions, advertising credits and other trade activities. Net sales reflect our gross sales less sales incentives which are estimated and recorded at the time of sale plus amounts billed to customers for shipping and handling costs. We anticipate that sales incentives and/or the amount billed to customers for shipping and handling costs could impact our net sales and that changes in such promotional activities or freight recovery charges could impact period-over-period results.
Cost of goods sold
Cost of goods sold consists primarily of material costs, inbound and outbound freight costs, direct labor costs primarily for manufacturing and warehouse personnel, facility costs for manufacturing operations and depreciation, depletion and amortization of manufacturing and warehouse improvements and equipment. We expect our cost of goods sold to increase in absolute dollars in conjunction with our growth and as a result of higher freight and labor costs. However, we expect that, over time, cost of goods sold will decrease as a percentage of net revenue as a result of the scaling of our business including a higher proportion of the amount of proprietary and exclusive branded products that we sell.
Selling, general and administrative
Selling, general and administrative expenses consists primarily of marketing and advertising, facility costs for distribution operations, stock-based compensation, depreciation and amortization of all other assets and other selling, general and administrative costs, including but not limited to salaries, benefits, bonuses, stock-based compensation, professional fees and various costs related to becoming a publicly-traded company. We expect selling, general and administrative expenses to increase in absolute dollar terms as we scale our operations to meet increased demand for our products and operate as a public company with increased costs associated with insurance, finance, legal and accounting functions; however, we also expect that the significant increase in our scale will result in selling, general and administrative expenses as a percentage of net sales decreasing over time.
Results of Operations Data
The results of operations data in the following tables for the years ended
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Results of Operations - Comparison of Years Ended
The following table sets forth our consolidated statements of operations for the years endedDecember 31, 2021 , and 2020, including amounts and percentages of net sales for each year and the year-to-year change in dollars and percent (amounts in thousands): Years ended December 31, 2021 2020 Year to year change Net sales$ 479,420 100.0 %$ 342,205 100.0 %$ 137,215 40.1 % Cost of goods sold 377,934 78.8 % 278,572 81.4 % 99,362 35.7 % Gross profit 101,486 21.2 % 63,633 18.6 % 37,853 59.5 % Operating expenses: Selling, general and administrative 103,888 21.7 % 58,492 17.1 % 45,396 77.6
%
Impairment, restructuring and other 297 0.1 % 860 0.3 % (563) -65.5
%
(Loss) income from operations (2,699) -0.6 % 4,281 1.3 % (6,980) -163.0 % Interest expense (2,138) -0.4 % (10,141) -3.0 % 8,003 -78.9 % Loss on debt extinguishment (680) -0.1 % (907) -0.3 % 227 -25.0
%
Other (expense) income, net (204) 0.0 % 70 0.0 % (274) -391.4 % Loss before tax (5,721) -1.2 % (6,697) -2.0 % 976 -14.6 % Income tax benefit (expense) 19,137 4.0 % (576) -0.2 % 19,713 -3,422.4 % Net income (loss) 13,416 2.8 % (7,273) -2.1 % 20,689 -284.5 % Cumulative dividends allocated to Series A Convertible Preferred Stock - 0.0 % (2,597) -0.8 % 2,597 -100.0
%
Net income (loss) attributable to common stockholders$ 13,416 2.8 %$ (9,870) -2.9 %$ 23,286 -235.9 % Net sales Net sales for the year endedDecember 31, 2021 were$479.4 million , an increase of$137.2 million , or 40.1%, compared to the same period in 2020. The 40.1% increase was due to an approximate 35.0% increase in volume of products sold (a 13.1% increase in organic sales and a 21.9% increase from recently-acquired proprietary brands), a 3.6% increase in price and mix of products sold, and 1.5% growth from favorable foreign exchange rates. The increase in volume of products sold was primarily related to (i) expansion of our proprietary and preferred brands, (ii) large expansion of our plant nutrients products, (iii) first-half expansion in our business predominantly inCalifornia ,Oklahoma andMissouri , and (iv) growth from our acquisitions. The increase in price was primarily related to list price increases. The increase in foreign exchange related to recent weakness in theU.S. Dollar relative to the Canadian Dollar and to the Euro. Gross profit Gross profit for the year endedDecember 31, 2021 was$101.5 million , an increase of$37.9 million , or 59.5%, compared to the same period in 2020. The increase in gross profit was primarily related to (i) the aforementioned increase in net sales and (ii) a significant increase in our gross profit margin percentage (gross profit as a percentage of net sales). Our gross profit margin percentage increased to 21.2% for the year endedDecember 31, 2021 from 18.6% in the same period in 2020. The higher gross profit margin percentage is primarily due to a more favorable sales mix of proprietary and preferred brand products (due in part to the aforementioned proprietary brands that were recently acquired and the preferred brands products added in the year-to-date period), which typically carry a higher gross margin than our distributed branded products, partially offset by higher freight and labor costs which escalated significantly as a percentage of net sales in our third and fourth fiscal quarters.
Selling, general and administrative expenses
Selling, general and administrative expenses ("SG&A") for the year ended
December 31, 2021 were $103.9 million , an increase of $45.4 million , compared to
the same period in 2020. The increase is primarily related to acquisition and
integration expenses of $19.7 million , costs associated with the relocation of
certain of our distribution centers of $1.9 million , non-compensation general
and administrative costs associated with the new acquisitions (an increase of
$9.2 million ), compensation costs (an increase of $7.2 million ), insurance costs
(an increase of $2.6 million ), marketing (an increase of $2.3 million ), facility
costs (an increase of $2.3 million ), consulting fees (an increase of $1.7
million ), and $1.9 million of solicitation fees incurred in
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connection with the Warrant Redemption, offset by share-based compensation (a decrease of ($3.4) million) . These increases were largely the result of (i) our accelerated M&A strategy and (ii) the increased costs associated with running a public company and supporting our long-term growth strategy. The decrease in share-based compensation was due to the vesting of restricted stock units ("RSUs") last December with performance-based vesting requirements which was satisfied upon the consummation of our IPO. As a result, our IPO inDecember 2020 triggered a significant performance-based stock compensation charge of$6.1 million for previously unrecognized time-based vesting prior to the IPO.
Interest expense
Interest expense for the year endedDecember 31, 2021 was$2.1 million , a decrease of$8.0 million , or 78.9%, compared to the same period in the prior year. The decrease was primarily due to the payoff of the prior term loan withBrightwood Loan Services, LLC and pay down of the Encina Credit Facility in connection with theDecember 2020 IPO.
Loss on debt extinguishment
Loss on debt extinguishment for the year endedDecember 31, 2021 was$0.7 million , which resulted primarily from the write-off of unamortized deferred financing costs associated with the termination of the Encina Credit Facility. Loss on debt extinguishment for the year endedDecember 31, 2020 was$0.9 million , which resulted primarily from the write-off of unamortized deferred financings costs associated with the payoff of the prior term loan withBrightwood Loan Services, LLC .
Income tax benefit (expense)
Income tax benefit for the year endedDecember 31, 2021 was approximately$19.1 million . Our income tax benefit was primarily the result of a reduction in the valuation allowance recorded against our net deferred tax assets. In connection with the acquisition of the H&G Entities, we recorded a net deferred tax liability which provided an additional source of taxable income to support the realization of the pre-existing deferred tax assets. Our income tax benefit was partially offset by income taxes from certain foreign jurisdictions where we conduct business and state minimum income taxes inthe United States . We have a valuation allowance for deferred tax assets, including net operating loss carryforwards. The income tax expense for the year endedDecember 31, 2020 was primarily due to foreign and state income tax expense. 61
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Results of Operations - Comparison of Years Ended
The following table sets forth our consolidated statements of operations for the years endedDecember 31, 2020 and 2019, including amounts and percentages of net sales for each year and the year-to-year change in dollars and percent (amounts in thousands): Years ended December 31, 2020 2019 Year to year change Net sales$ 342,205 100.0 %$ 235,111 100.0 %$ 107,094 45.6 % Cost of goods sold 278,572 81.4 % 208,025 88.5 % 70,547 33.9 % Gross profit 63,633 18.6 % 27,086 11.5 % 36,547 134.9 % Operating expenses: Selling, general and administrative 58,492 17.1 % 43,784 18.6 % 14,708 33.6 % Impairment, restructuring and other 860 0.3 % 10,035 4.3 % (9,175) -91.4 % Income (loss) from operations 4,281 1.3 % (26,733) -11.4 % 31,014 -116.0 % Interest expense (10,141) -3.0 % (13,467) -5.7 % 3,326 -24.7 % Loss on debt extinguishment (907) -0.3 % (679) -0.3 % (228) 33.6 % Other income, net 70 0.0 % 105 0.0 % (35) -33.3 % Net loss before tax (6,697) -2.0 % (40,774) -17.4 % 34,077 -83.6 % Income tax (expense) benefit (576) -0.2 % 691 0.3 % (1,267) -183.4 % Net loss (7,273) -2.1 % (40,083) -17.1 % 32,810 -81.9 % Cumulative dividends allocated to Series A Convertible Preferred Stock (2,597) -0.8 % - 0.0 % (2,597) n/a % Net loss attributable to Hydrofarm Holdings Group, Inc.$ (9,870) -2.9 %$ (40,083) -17.1 %$ 30,213 -75.4 % Net sales Net sales for the year endedDecember 31, 2020 increased by$107.1 million or 45.6% compared to the year endedDecember 31, 2019 . The increase in net sales was primarily due to a 42.0% increase in volume of products sold and a 3.6% increase in price of products sold. The increase in volume of products sold was primarily related to (i) higher demand from the end-markets across numerousU.S. states, including but not limited toMichigan ,Oklahoma andCalifornia , andCanada and (ii) higher demand for our proprietary and preferred branded products which grew at a faster pace than our distributed brands during the period. The increase in price was primarily related to list price increases and more effective sales incentives. Although we cannot precisely quantify in absolute or relative terms, our accelerated rate of growth in net sales for the year endedDecember 31, 2020 correlates with shelter-in-place orders issued inMarch 2020 in response to the COVID-19 pandemic. A portion of our net sales during this period could have been related to pull-through demand for our products due to higher consumption of CEA products from individuals spending more time at home due to shelter-in-place measures. Although uncertainty created by the COVID-19 pandemic remains, and various state budgets remain under economic pressure, creating a greater chance of further cannabis legalization, we cannot assure you that such growth will continue. Gross profit Gross profit for the year endedDecember 31, 2020 increased by$36.5 million or 134.9% compared to the year endedDecember 31, 2019 . The increase in gross profit was primarily related to (i) the aforementioned increase in net sales and (ii) a significant increase in our gross profit margin percentage (gross profit as a percent of net sales). Our gross profit margin percentage increased to 18.6% for the year endedDecember 31, 2020 compared to 11.5% for the year endedDecember 31, 2019 . The higher gross profit margin percentage was primarily due to (i) a more favorable sales mix of proprietary and exclusive branded products, which typically carry a higher gross margin, (ii) lower freight cost, and (iii) inventory adjustments and write-downs that impacted the fourth quarter of 2019 primarily associated with our 2019 SKU rationalization. 62
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Selling, general and administrative expenses
Selling, general and administrative expenses for the year endedDecember 31, 2020 increased by$14.7 million or 33.6%, compared to the year endedDecember 31, 2019 due primarily to an increase of$8.7 million in stock-based compensation expense, of which$6.1 million was directly triggered by our IPO inDecember 2020 (more fully described below). SG&A expense excluding the portion of stock-based compensation expense triggered by the IPO decreased from 18.6% in 2019 to 15.3% in 2020 due to economies of scale as our net sales grew faster than our selling, general and administrative expenses. To support our long-term growth plan and our IPO, we undertook several initiatives in mid-to-late 2019 and early 2020 which resulted in the aforementioned$14.7 million increase in selling, general and administrative expenses, including increased stock-based compensation expenses, increased compensation costs (an increase of$3.9 million ), and increased professional service fees, including, but not limited to, the hiring of executives such as our new Chief Executive Officer, President and Chief Financial Officer and engaging new third parties such as an IT consulting firm, a new auditor, and several accounting and audit-related consultants (an increase of$4.4 million ). As more fully discussed in Note 12 - Stock-based compensation, in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K, we granted RSUs to certain officers, former directors and their affiliates which have vesting conditions including a performance-based vesting requirement which was satisfied upon the consummation of our IPO. As a result, our IPO inDecember 2020 triggered a significant performance-based stock compensation charge of$6.1 million for previously unrecognized time-based vesting prior to the IPO.
Impairment, restructuring and other
Impairment, restructuring and other expenses declined to$0.9 million for the year endedDecember 31, 2020 . For the year endedDecember 31, 2019 , we recognized a$5.4 million expense related to impairment of intangible assets for customer relationships;$2.0 million for restructuring costs, and$1.5 million for other expenses. We also incurred$1.1 million for a registration statement which was delayed, and accordingly, the third-party costs were expensed. See Note 15 - Impairment, restructuring and other, in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional information. Interest expense Interest expense decreased by$3.3 million or 24.7% for the year endedDecember 31, 2020 compared to the year endedDecember 31, 2019 . The average balance of our interest bearing debt for the year endedDecember 31, 2020 increased by$2.3 million compared to the year endedDecember 31, 2019 . This increase was offset by a decrease in the effective interest rate on the term loan withBrightwood Loan Services, LLC ("Brightwood Term Loan"), from approximately 13% for the year endedDecember 31, 2019 to an effective interest rate of approximately 10.2% for the year endedDecember 31, 2020 due to a reduction of the Brightwood Term Loan interest rate margin which became effective onJanuary 1, 2020 from LIBOR plus 10.0% to LIBOR plus 8.5% along with a reduction of average LIBOR from 2.5% to 1%. The decrease in interest costs was also slightly impacted by a decrease in the effective interest rate on our revolving credit facilities from approximately 9.9% for the year endedDecember 31, 2019 to approximately 9.3% for the year endedDecember 31, 2020 .
Loss on debt extinguishment
Loss on debt extinguishment for the year endedDecember 31, 2020 resulted from the write-off of unamortized deferred financing costs associated with the payoff of the Brightwood Term Loan in connection with the IPO. Similar costs in 2019 resulted from the write-off of unamortized deferred financing costs when the BofA Credit Facility was refinanced with the Encina Credit Facility.
Income tax expense
Income tax expense for the year ended
The net income tax benefit for the year endedDecember 31, 2019 is comprised of two amounts: (i) minimumU.S. state and Canadian provincial taxes which do not fluctuate with pre-tax income or loss; and, (ii) a deferred income tax benefit of$0.7 million primarily generated from the tax consequence of the impairment write-off which is not expected to recur.
Cumulative dividends allocated to Series A convertible preferred stock
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Our Series A Preferred Stock accrued a cumulative dividend during 2020 which is presented as a reduction of net loss which results in the net loss attributable to common stockholders. Dividends did not accrue prior to 2020. Upon the consummation of our IPO inDecember 2020 , the Series A Preferred Stock automatically converted into 2,291,469 shares of our common stock and we paid$2.6 million in cash to settle the Series A Preferred Stock dividend.
Non-GAAP Financial Measures
We report our financial results in accordance with accounting principles generally accepted inthe United States of America ("U.S. GAAP" or "GAAP"). However, management believes that certain non-GAAP financial measures provide investors of our financial information 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 income (loss) 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 audited 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 interest expense, or the amounts necessary to service interest or principal payments on our indebtedness;
• Adjusted EBITDA excludes depreciation 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.
We define Adjusted EBITDA as net income (loss) excluding interest expense,
income taxes, depreciation and amortization, stock-based compensation, employer
payroll taxes on stock-based compensation and other unusual and/or infrequent
costs, which we do not consider in our evaluation of ongoing operating
performance.
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The following table presents a reconciliation of net income (loss), the most
comparable GAAP financial measure, to Adjusted EBITDA for the years ended
Years ended December 31,
2021 2020 2019
Net income (loss) $ 13,416 $ (7,273) $ (40,083)
Interest expense 2,138 10,141 13,467
Income tax (benefit) expense (19,137) 576 (691)
Distribution center exit costs and other 2,641 - -
Depreciation, depletion and amortization 14,934 6,779
6,995
Impairment, restructuring and other 297 860
10,035
Acquisition and integration expenses* 24,210 - - Other expense (income), net 204 (70) (105) Stock-based compensation** 5,750 9,156 208 Loss on debt extinguishment 680 907 679 Investor warrant solicitation fees 1,949 -
-
Adjusted EBITDA$ 47,082 $ 21,076 $ (9,495) Adjusted EBITDA as a percent of net sales 9.8 % 6.2 %
(4.0) %
(*) Includes consulting, transaction services and legal fees incurred for the completed Heavy 16, House and Garden, Aurora, Greenstar/Grotek and IGE acquisitions and certain potential acquisitions.
(**) Includes employer payroll taxes on stock-based compensation
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Liquidity and Capital Resources
Cash Flow from Operating, Investing, and Financing Activities - Comparison of
Years Ended
The following table summarizes our cash flows for the years ended
Years
ended
2021 2020 2019
Net cash used in operating activities $ (45,067) $ (44,825) $ (13,302)
Net cash (used in) provided by investing activities (468,184) 546 (3,818)
Net cash provided by financing activities 464,707 88,145 19,900
Effect of exchange rate changes on cash, cash
equivalents and restricted cash (27) 232 2,154
Net (decrease) increase in cash, cash equivalents and restricted cash
(48,571) 44,098 4,934
Cash, cash equivalents and restricted cash at beginning of year
76,955 32,857 27,923
Cash, cash equivalents and restricted cash at end of
year $ 28,384 $ 76,955 $ 32,857
Operating Activities
Net cash used in operating activities was $45.1 million for the year ended
December 31, 2021 , primarily consisting of $13.4 million in net income, $4.4
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 and other non-cash
expenses, less a $62.9 million increase in working capital. This change in
working capital primarily reflects an aggregate increase of $47.8 million in
accounts receivable, inventories, prepaid expenses and other current assets, and
other assets for the period as well as an aggregate net decrease of $15.1
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.
Net cash used in operating activities was $44.8 million for the year ended
December 31, 2020 consisting of $20.2 million in non-cash expense addbacks which
were largely composed of stock-based compensation, depreciation and amortization
and non-cash operating lease expense, less net loss of $7.3 million , payment of
interest capitalized to principal of long-term debt of $13.9 million and a $43.8
million increase in working capital. The change in working capital primarily
reflects a $43.2 million increase in accounts receivable and inventory for the
period offset by a $10.7 million increase in accounts payable and accrued
expenses. The net change was due to the additional working capital needed to
support our growth in net sales.
Net cash used in operating activities was $13.3 million for the year ended
December 31, 2019 consisting of net loss of $40.1 million offset by $26.2
million in non-cash addbacks which were largely composed of depreciation and
amortization, impairment charges, interest expense added to principal and
non-cash operating lease expense, plus a $0.6 million increase in working
capital. The small change in working capital primarily reflects a $2.1 million
net decrease in accounts receivable and inventories as collections and net sales
during 2019 were slowed due to the industry downturn, plus a $1.2 million
increase in accounts payable and accrued expenses as we were able to align
payment of our obligations with our cash flow.
Investing Activities
Net cash used in investing activities for the year endedDecember 31, 2021 was$468.2 million , due primarily to five business acquisitions we completed during the period, which totaled$462.2 million in cash outflows and$6.0 million in purchases of property and equipment and other. We had minimal investing activities for the years endedDecember 31, 2020 and 2019. We made advances on notes receivable to third parties of$3.1 million the year endedDecember 31, 2019 and were repaid$2.0 million the year endedDecember 31, 2020 . Our business was not capital intensive during the years endedDecember 31, 2020 or 2019 and purchases of property and equipment were$1.4 million and$0.8 million , respectively.
Financing Activities
Net cash provided by financing activities was
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discount and issuance costs, and received an additional$56.8 million from the exercise of warrants, including the Warrant Redemption. We also paid$20.0 million related to employee's withholding tax in connection with the vesting of certain restricted stock units. Our IPO was completed inDecember 2020 generating$182.4 million in net proceeds. We used a portion of the proceeds to pay off the Brightwood Term Loan, to pay off our PPP loan and to paydown the outstanding balance under the Encina Credit Facility. Other activity was a net of$1.2 million from transactions with our Series A preferred stock investors and payments of$0.7 million on finance leases. Our net cash provided by these activities was$88.1 million for the period which we used for business growth and expansion. For the year endedDecember 31, 2019 , our borrowings under the working capital credit facilities marginally exceeded repayments which reflected stable working capital needs for the period. We also received$21.7 million from our Series A Preferred Stock offering including proceeds from the issuance of notes which converted into the Series A Preferred Stock. Net cash provided by these activities was$19.9 million for the period.
JPMorgan Revolving Credit Facility
OnMarch 29, 2021 , we entered into the JPMorgan Credit Facility, which provided for a borrowing limit of$50 million . The JPMorgan Credit Facility replaced the Encina Credit Facility. The JPMorgan Credit Facility is due onMarch 29, 2024 . OnAugust 31, 2021 , the JPMorgan Credit Facility was amended to increase the borrowing limit to$100 million and onOctober 25, 2021 was further amended to permit the Term Loan and to conform to provisions of the Term Loan. The JPMorgan Credit Facility has 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. Our obligations under the JPMorgan Credit Facility are secured by a first priority lien (subject to certain permitted liens) in substantially all of our and our subsidiaries' respective personal property assets pursuant to the terms of aU.S. and Canadian Pledge and Security Agreement datedMarch 29, 2021 and other security documents The JPMorgan Credit Facility maintains certain reporting requirements, affirmative covenants, negative covenants and financial covenants ("debt covenants"). The financial covenants include that we must maintain a minimum fixed charge coverage ratio of 1.1x on a rolling twelve-month basis. We were in compliance with all debt covenants as ofDecember 31, 2021 . As ofDecember 31, 2021 , approximately$83.6 million was available to borrow under the undrawn JPMorgan Credit Facility.
Senior Secured Term Loan
OnOctober 25, 2021 , we and certain of our direct and indirect subsidiaries entered into the Term Loan (as defined below) withJPMorgan 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 onOctober 25, 2028 . We received net proceeds of$119.9 million from the Term Loan after deducting discounts and deferred financing costs. The principal amounts of the Term Loan are scheduled to be repaid in consecutive quarterly installments in amounts equal to 0.25% of the$125 million principal amount of the Term Loan on the last day of each fiscal quarter commencingMarch 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. The Term Loan is secured by a first lien on our non-working capital assets and a second lien on our working capital assets. Contractual obligations See Note 7 - Leases, in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K, for discussions on future minimum lease payments under long-term non-cancelable operating and financing leases with remaining terms greater than one year.
See Note 10 - Debt, in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K, for discussions on future principal payments under long-term debt.
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From time to time in the normal course of business, we 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.
We had no material purchase commitments as of
Seasonality
Our net sales tend to be seasonally stronger in our fiscal second and third quarters due to robust sales in the warmer spring and summer months inNorth America (the United States andCanada are our primarily markets). This seasonal trend primarily relates to the garden center portion of our customer base and that certain of our customers may from time to time use some of our products (such as grow media and nutrients) in outdoor applications.
Availability and Use of Cash
We believe that our cash flows from operating activities and the JPMorgan Credit Facility and Term Loan will be sufficient to meet our capital expenditures, working capital needs and debt repayments for the foreseeable future. However, we cannot ensure that our business will generate sufficient cash flow from operating activities or that future borrowings will be available under our borrowing agreements in amounts sufficient to pay indebtedness or fund other working capital needs. Actual results of operations will depend on numerous factors, many of which are beyond our control as further discussed in Item 1A. Risk Factors included elsewhere in this Annual Report on Form 10-K.
Critical Accounting Policies and Estimates
Certain accounting policies require us to make estimates and judgments in determining the amounts reflected in the Consolidated Financial Statements. Such estimates and judgments necessarily involve varying, and possibly significant, degrees of uncertainty. Accordingly, certain amounts currently recorded in the financial statements will likely be adjusted in the future based on new available information and changes in other facts and circumstances. A discussion of our principal accounting policies that required the application of significant judgments as ofDecember 31, 2021 follows.
Business Combinations
Acquisitions of businesses are accounted for under 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 value of assets transferred, liabilities incurred to the former owners of the acquiree and the equity interest issued in exchange for control of the acquiree. Acquisition related costs are expensed as incurred. When the consideration transferred in a business combination includes a contingent consideration arrangement, which is where we may have the obligation to transfer additional assets or equity interest to the former owners if specified future events or conditions are met, the contingent consideration is measured at its acquisition date fair value and is included as part of the consideration transferred in a business combination. 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 our own equity instruments. Changes in fair value of 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 fair value of contingent consideration classified as a liability are included in net income in the period and changes in fair value of contingent consideration classified as equity are not recognized. For a given acquisition, we may identify certain pre-acquisition contingencies as of the acquisition date and we may extend our review and evaluation of these pre-acquisition contingencies throughout the measurement period in order to obtain sufficient information to assess these contingencies as part of acquisition accounting.Goodwill is measure 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 acquiree (if any) over the net acquisition-date fair value amounts of the identified assets acquired and liabilities assumed. If the initial accounting for a business combination is incomplete by the end of the reporting period in which the business combination occurs, we report 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 68
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information obtained about facts and circumstances that existed at the acquisition date that, if known, would have affected the amounts recognized at the time. Upon conclusion of the measurement period or final determination of the values of the assets acquired or liabilities assumed, whichever occurs first, any subsequent adjustments are recorded to net income (loss).
Our consolidated balance sheet atDecember 31, 2021 includes goodwill of acquired businesses and other indefinite-lived intangible assets. We evaluate these assets for impairment annually in the fourth quarter and on an interim basis if the facts and circumstances lead us to believe that more-likely-than-not there has been an impairment.Goodwill and indefinite-lived intangible asset impairment reviews include performing either an initial qualitative or quantitative evaluation for each of our reporting units and indefinite-lived intangible assets. As ofDecember 31, 2021 , we concluded it is more likely than not that goodwill and indefinite-live intangible assets recorded in our consolidated balance sheet were not impaired.
Long-lived tangible and finite-lived intangible assets
Long-lived tangible assets and finite-lived intangible assets are stated at cost. Depreciation and amortization expense is provided on the straight-line method and based on the estimated useful economic lives of the long-lived tangible assets. Intangible assets with finite lives are subject to amortization. These intangible assets are being amortized over their estimated useful economic lives typically ranging from 5 to 18 years. Long-lived tangible and finite-lived intangible assets are reviewed for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. As ofDecember 31, 2021 , we concluded that our long-lived tangible and finite-lived intangible assets recorded in our consolidated balance sheet were not impaired.
Recent accounting pronouncements
For information regarding recent accounting pronouncements, refer to Note 2 -
Basis of presentation and significant accounting policies - Recently issued
accounting pronouncements, to our consolidated financial statements included
elsewhere in this Annual Report on Form 10-K.
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