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 and unaudited consolidated financial statements and the notes contained
elsewhere in this Quarterly Report on Form 10-Q and our 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 2020 Annual
Report. See "Special Note Regarding Forward-Looking Statements."
Company Overview
We are a leading independent distributor and manufacturer of controlled
environment agriculture ("CEA", principally hydroponics) equipment and supplies,
including a broad portfolio of our own innovative portfolio of 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 eCommerce marketplace. Over 80% of our net sales are
into the 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, eCommerce retailers, commercial greenhouse builders,
and commercial resellers.
Recent Developments
Follow-on Public Offering
On May 3, 2021 , we closed our follow-on public 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 estimated offering expenses. We expect to use the proceeds
from the FPO for acquisitions, working capital and other general corporate
purposes.
HEAVY 16 Acquisition
On May 3, 2021 , we closed an acquisition of 100% of the issued and outstanding
membership interests of Field 16, LLC, a Delaware limited liability company
("HEAVY 16"), pursuant to the terms of a unit purchase and contribution
agreement, dated April 26, 2021 (the "Purchase Agreement"), by and among us,
HEAVY 16, F16 Holding LLC , a California limited liability company (the
''Seller''), and the members of the Seller, for a purchase price of up to $78.1
million , consisting of $63.1 million in cash and 255,945 shares of our common
stock valued at approximately $15 million based on the market at the time the
Purchase Agreement was executed (the "Acquisition"). The purchase price includes
a potential earn out payment of up to $2.5 million based on achievement of
certain performance metrics. In connection with the Acquisition, we intend to
enter into employment agreements with certain key employees of HEAVY 16.
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HEAVY 16 is a leading manufacturer and supplier of branded plant nutritional
products, with nine core products that are currently sold to approximately 300
retail stores across the U.S. The HEAVY 16 products feature a full line of
premium nutrients with nine core products used in all stages of plant growth,
helping to increase the yield and quality of crops.
New Distribution Centers
In April 2021 , we entered into leases for two new distribution centers
aggregating approximately 322,000 square feet. One is located in Fairfield,
California and is the distribution center that we will relocate to from our
Petaluma, California distribution facility in connection with the pending sale
of that building. The other distribution center is located in Fontana,
California which we will relocate to from our Santa Fe Springs, California
distribution facility.
Effects of Coronavirus on Our Business
The World Health Organization recognized COVID-19 as a public health emergency
of international concern on January 30, 2020 and as a global pandemic on
March 11, 2020 . Public health responses have included national pandemic
preparedness and response plans, travel restrictions, quarantines, curfews,
event postponements and cancellations and closures of facilities including local
schools and businesses. While the rollout of vaccines has begun, the timing of
vaccinations, herd immunity, and the lifting of shelter in place and similar
restrictions and movement restrictions is unknown. 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. In March 2020 , the majority of the employees at our headquarters
transitioned to working remotely. For several weeks following the initial
outbreak of COVID-19, we experienced a material impact to our supply chain that
inhibited growth and results of operations. While we are not currently
experiencing material adverse impacts to our supply chain, we intend to continue
to source many products from China . It is difficult to predict the extent to
which COVID-19 may continue to spread. As of the date of this Quarterly Report
on Form 10-Q manufacturers in China and in North America are generally back in
operation; however, new waves of the COVID-19 pandemic could result in the
re-closure of factories in China and/or in North America . Quarantine orders and
travel restrictions within the U.S. and other countries may also adversely
impact our supply chains, the manufacturing of our own products and our ability
to obtain necessary materials. Consequently, we may be unable to obtain adequate
inventory to fill purchase orders or 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.
Our customers reside in countries, primarily the U.S. and Canada , that are
currently affected by the COVID-19 pandemic. Many of these customers have
experienced shelter-in-place measures in attempts to contain the spread of
COVID-19, including general lockdowns, closure of schools and non-essential
businesses, bans on gatherings and travel restrictions. Our sales growth for the
three months ended March 31, 2021 was approximately $44.5 million or 66.5%
higher than the same period in 2020. A portion of our net sales during this
period could be due 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.
Our business has remained resilient during the COVID-19 pandemic. As of March
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 of U.S. and Canadian cannabis businesses have been
designated as essential by U.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.
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Recent Transactions
JPMorgan Credit Facility
On March 29, 2021 , we and certain of our subsidiaries entered into a Senior
Secured Revolving Credit Facility (the "JPMorgan Credit Facility") with JPMorgan
Chase Bank, N.A ., as administrative agent, issuing bank and swingline lender
("JPMorgan"), and the lenders from time to time party thereto. The JPMorgan
Credit Facility replaces the Loan and Security Agreement with Encina Business
Credit, LLC (as amended to date, 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 has a borrowing limit of $50
million . We have 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 a U.S. and a Canadian Pledge and
Security Agreement, dated March 29, 2021 and the other security documents. The
JPMorgan Credit Facility is more fully described in Note 7, Debt under Revolving
asset-back credit facilities in the notes to our unaudited interim condensed
consolidated financial statements.
Initial Public Offering
On December 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 Term Loan by and among Term Loan
Obligors, Brightwood Loan Services, LLC and the other lenders party thereto 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 to JPMorgan
Chase, N.A. through the U.S. Small Business Administrative 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 on
December 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 on November 24, 2020 without any change in the par value per share.
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Results of Operations-Comparison of three months ended March 31, 2021 and 2020
The following table sets forth our unaudited interim condensed consolidated
statements of operations for the three months ended March 31, 2021 and 2020,
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 March 31,
2021 2020 Period change
Net sales $ 111,389 100.0 % $ 66,897 100.0 % $ 44,492 66.5 %
Cost of goods sold 88,166 79.2 % 55,333 82.7 % 32,833 59.3 %
Gross profit 23,223 20.8 % 11,564 17.3 % 11,659 100.8 %
Operating expenses:
Selling, general and administrative 16,826 15.1 % 11,722 17.5 % 5,104 43.5 %
Impairment, restructuring and other 15 0.0 % 9 0.0 % 6 66.7 %
Income (loss) from operations 6,382 5.7 % (167) -0.2 % 6,549 -3,921.6 %
Interest expense (90) -0.1 % (2,803) -4.2 % 2,713 -96.8 %
Loss on debt extinguishment (680) -0.6 % - 0.0 % (680) n/a %
Other income, net 84 0.1 % 21 0.0 % 63 300.0 %
Income (loss) before tax 5,696 5.1 % (2,949) -4.4 % 8,645 -293.2 %
Income tax expense (756) -0.7 % (144) -0.2 % (612) 425.0 %
Net income (loss) 4,940 4.4 % (3,093) -4.6 % 8,033 -259.7 %
Cumulative dividends allocated to
Series A Convertible Preferred Stock - 0.0 % (634) -0.9 % 634 -100.0 %
Net income (loss) attributable to
common stockholders $ 4,940 4.4 % $ (3,727) -5.6 % 8,667 -232.5 %
Net sales
Net sales for the three months ended March 31, 2021 increased $44.5 million , or
66.5%, compared to the same period in 2020. The increase in net sales was
primarily due to a 59.6% increase in volume of products sold and a 6.9% 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 numerous U.S. states,
including, but not limited to California , Oklahoma , Michigan and Canada , and
(ii) higher demand for our proprietary branded products which grew at a faster
pace than our preferred and distributed brands during the period. The increase
in price was primarily related to list price increases and more effective sales
incentives.
Gross profit
Gross profit for the three months ended March 31, 2021 increased $11.7 million ,
or 100.8%, 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
percent of net sales). Our gross profit margin percentage increased to 20.8% for
the three months ended March 31, 2021 from 17.3% in the same period in 2020. The
higher gross profit margin percentage is primarily due to a more favorable sales
mix of proprietary brand products, which typically carries a higher gross margin
than our preferred and distributed branded products, improved labor efficiency,
and lower freight cost as a percentage of net sales.
Selling, general and administrative expenses
Selling, general and administrative expenses for the three months ended March
31, 2021 increased by $5.1 million , or 43.5%, compared to the same period in
2020, but decreased as a percentage of sales to 15.1% from 17.5% due to
economies of scale as our net sales grew faster than our selling, general and
administrative expenses. The $5.1 million increase in selling, general and
administrative expenses is primarily related to higher compensation costs (an
increase of $1.5 million ), consulting fees (an increase of $1.8 million , which
includes $0.7 million of acquisition-related costs), insurance costs (an
increase of $0.6 million ), and share-based compensation (an increase of $1.2
million , which includes $0.2 million of employer payroll taxes). These increases
were largely the result of the increased costs associated with running a public
company and support of our long-term growth strategy.
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Interest expense
Interest expense decreased by $2.7 million , or 96.8%, for the three months ended
March 31, 2021 compared to the same period in the prior year, due to the payoff
of the Term Loan and pay down of the Encina Credit Facility in connection with
the IPO.
Loss on debt extinguishment
Loss on debt extinguishment for the three months ended March 31, 2021 was $0.7
million , which resulted primarily from the write-off of unamortized deferred
financing costs associated with the payoff of the Encina Credit Facility.
Income tax expense
Income tax expense increased by $0.6 million for the three months ended
March 31, 2021 compared to the same period in the prior year, due to an increase
in income before taxes.
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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 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 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 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. The following table presents a reconciliation of net income (loss),
the most comparable GAAP financial measure, to Adjusted EBITDA for the three
months ended March 31, 2021 and 2020 (In thousands):
Three months ended March 31,
2021 2020
Net Income (Loss) $ 4,940 $ (3,093)
Interest expense 90 2,803
Income taxes 756 144
Depreciation and amortization 1,591 1,715
Impairment, restructuring and other 15 9 Acquisition expenses * 659 - Other income, net (84) (21) Stock-based compensation** 1,258
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Loss on debt extinguishment 680
-
Adjusted EBITDA$ 9,905 $ 1,591 Adjusted EBITDA as a percent of net sales 8.9 %
2.4 %
(*) Includes consulting, transaction services and legal fees incurred for the completed HEAVY16 acquisition and certain potential acquisitions. (**) Includes the amount of employer payroll taxes on stock-based compensation.
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Liquidity and Capital Resources
The following table summarizes our cash flows for the three months ended
March 31, 2021 and 2020 (amounts in thousands):
Three months ended
2021 2020
Net cash used in operating activities $ (2,638) $ (1,747)
Net cash (used in) provided by investing activities (445) 1,932
Net cash used in financing activities (11,827) (1,234)
Effect of exchange rate changes on cash, cash equivalents and restricted cash
(4) (146)
Net decrease in cash, cash equivalents and restricted cash (14,914) (1,195)
Cash, cash equivalents and restricted cash at beginning of period 76,955
32,857
Cash, cash equivalents and restricted cash at end of period
Operating Activities Net cash used in operating activities was$2.6 million for the three months endedMarch 31, 2021 , primarily consisting of$4.2 million in non-cash expense addbacks, which were largely composed of depreciation and amortization, stock-based compensation expense, non-cash operating lease and other non-cash expense, to reconcile net income of$4.9 million to net cash used in operating activities, less a$11.7 million increase in working capital. This change in working capital primarily reflects a$23.4 million increase in accounts receivable, inventories, prepaid expenses and other current assets, and other assets for the period offset by a$14.3 million increase in accounts payable, as well as a decrease in accrued expenses and other current liabilities of$1.8 million , and a decrease in lease liabilities of$0.8 million due to payments on lease obligations during the period. Net cash used in operating activities was$1.7 million for the three months endedMarch 31, 2020 , primarily consisting of$3.2 million in non-cash addbacks, which were largely composed of depreciation and amortization, non-cash operating lease and other non-cash expense, to reconcile net loss of$3.1 million to net cash used in operating activities, less a$1.8 million increase in working capital. This change in working capital primarily reflects a$5.7 million net increase in accounts receivable and inventories for the period offset by a$4.8 million increase in accounts payable and accrued expenses and other current liabilities as well as a decrease in lease liabilities of$0.9 million due to payments on lease obligations during the period. Investing Activities We had minimal investing activities for the three months endedMarch 31, 2021 . For the three months endedMarch 31, 2020 , we received proceeds from a$2.0 million note receivable from a third party. Financing Activities For the three months endedMarch 31, 2021 , we paid$11.6 million related to employee's withholding tax in connection with the vesting of certain restricted stock units. For the three months endedMarch 31, 2020 , draws under the Encina Credit Facility were less than repayments by$4.9 million . We also received proceeds of$3.8 million from the issuance of Series A preferred stock. Credit Facilities OnMarch 29, 2021 , we and certain of our direct and indirect subsidiaries (the "JPMorgan Obligors") 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 Encina Credit Facility. The JPMorgan Credit Facility is due on the earlier ofMarch 29, 2024 or any earlier date on which the revolving commitments are reduced to zero. The three-year JPMorgan Credit Facility has a borrowing limit of$50.0 million with an option to request an increase in the revolving commitment by up to$25.0 million , drawn in$5.0 million increments, for a total not to exceed$75.0 million , subject to customary condition ("Revolver"). 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 JPMorgan Obligors had approximately$50.0 million available to borrow under the JPMorgan Credit Facility as ofMarch 31, 2021 . 26
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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. The
JPMorgan Obligors were in compliance with all debt covenants as of March 31,
2021 .
The JPMorgan Credit Facility is secured by our assets and the assets of certain
of our subsidiaries obligated under the JPMorgan Credit Facility.
Emerging Growth Company Status
We are an emerging growth company as defined in the Jumpstart Our Business
Startups Act of 2012 (the "JOBS Act"). Under the JOBS Act, companies have
extended transition periods available for complying with new or revised
accounting standards. We have elected this exemption to delay adopting new or
revised accounting standards until such time as those standards apply to private
companies.
In addition, we intend to rely on the other exemptions and reduced reporting
requirements provided by the JOBS Act. Subject to certain conditions set forth
in the JOBS Act, we are entitled to rely on certain exemptions as an emerging
growth company, we are not required to, among other things, (i) provide an
auditor's attestation report on our system of internal controls over financial
reporting pursuant to Section 404(b), (ii) provide all of the compensation
disclosure that may be required of non-emerging growth public companies under
the Dodd-Frank Wall Street Reform and Consumer Protection Act, (iii) comply with
any requirement that may be adopted by the Public Company Accounting Oversight
Board regarding mandatory audit firm rotation or a supplement to the auditor's
report providing additional information about the audit and the financial
statements (auditor discussion and analysis), and (iv) disclose certain
executive compensation-related items. These exemptions will apply for a period
of five years following the completion of our IPO or until we no longer meet the
requirements of being an emerging growth company, whichever is earlier. We
expect that we will no longer be an emerging growth company on December 31,
2021 .
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. The 2020 Annual Report includes additional information about us, our
operations, our financial condition, our critical accounting policies and
accounting estimates, and should be read in conjunction with this Quarterly
Report on Form 10-Q.
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