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 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 online ordering platform. Our products are distributed acrossthe United States andCanada through a diversified range of retailers of commercial and home gardening equipment and supplies. Our customers include specialty hydroponic retailers, commercial resellers and greenhouse builders, garden centers, hardware stores, and e-commerce retailers. Specialty hydroponic retailers can provide growers with specialized merchandise assortments and knowledgeable staff.
Market Conditions
We experienced adverse financial results during 2022 which we believe is primarily a result of an agricultural oversupply impacting our market. This has led to a reduction in our 2022 profitability, as compared to the prior year, and a loss from operations. These market conditions continued to negatively impact our business and results of operations, and the extent to which this will continue is uncertain and difficult to predict at this time. In connection with our previously disclosed evaluation of our facility footprint and product and brand portfolio, we began a restructuring plan during the quarter endedDecember 31, 2022 . We are undertaking significant actions to streamline our operations, reduce costs and improve efficiencies during the industry recession. Our major initiatives include (i) narrowing our product and brand portfolio and (ii) relocating and consolidating certain manufacturing and distribution centers including headcount reductions and reorganization to drive a solution based approach. We are focusing commercial sales on competencies and product assortment gained from our recent acquisitions. During the year endedDecember 31, 2022 , we recorded pre-tax charges of$6.8 million relating to inventory markdowns of products and brands being removed from our portfolio, which is primarily non-cash, and$0.9 million relating primarily to the relocation and termination of certain facilities inCanada , which are primarily cash charges. Restructuring charges are primarily recorded within Cost of goods sold on the consolidated statement of operations for the year endedDecember 31, 2022 . We plan to incur approximately$1.7 million of additional charges in 2023, which are primarily cash, associated with the execution of our restructuring plan, which we expect to complete in the first half of 2023. We may also execute a second phase of our restructuring plan in 2023 and incur additional costs. Our strategic product consolidation entails removing approximately one-third of all products and one-fifth of all brands relating to our primary product portfolio, which excludes our garden center business inCanada . We expect the restructuring and related actions to result in cost savings of approximately$7.0 million on an annualized basis. 50
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As ofJune 30, 2022 , primarily due to a sustained decline in the market value of our common stock and the market conditions described above, 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 reporting units ofU.S. andCanada was in excess of the fair value. The recognized impairment reduced the goodwill balance to zero as ofJune 30, 2022 . The impairment was primarily due to a deterioration in customer demand in theU.S. andCanada 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 of intangible assets during the remainder of 2022. In connection with the goodwill impairment analysis performed as ofJune 30, 2022 , we determined the fair value of theU.S. andCanada 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 our common stock 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 2022 profitability and loss from operations. We maintain an allowance for excess and obsolete inventory that is based upon assumptions about future demand and market conditions. During the year endedDecember 31, 2022 , our consolidated statements of operations included charges of$18.5 million , primarily relating to increases to our allowance for inventory obsolescence relating to certain lighting products, which are incremental to the restructuring costs described above. In addition, during the year endedDecember 31, 2022 , our consolidated statements of operations included$2.9 million of accounts receivable allowances and write downs. While we believe our estimates of charges relating to our restructuring plan, long-lived assets, inventory obsolescence, and accounts receivable allowances are reasonable, it is possible that we may incur additional charges in the future and actual results may differ significantly from these estimates and assumptions. Depending on the length and severity of the industry and market conditions impacting our business, it is possible we may execute additional restructuring plans and incur future associated charges, and we may not be able to realize the full extent of our anticipated cost savings.
Five Acquisitions Completed in 2021
During the year ended
•Heavy 16, a manufacturer of plant nutrients and additives, inMay 2021 . Heavy 16 was a leading manufacturer and supplier of branded plant nutritional products, with nine core products featuring a full line of premium nutrients used in all stages of plant growth, helping to increase the yield and quality of crops. •House & Garden, a manufacturer of plant nutrients and additives, inJune 2021 . House & Garden is located inArcata, California , and produces and distributes premium grade plant nutrients and fertilizers, offering a strong product line to strengthen our position in the nutrient sector. •Aurora, a manufacturer of soil, grow media, plant nutrients and additives, inJuly 2021 . Aurora provides comprehensive plant fertility products and grow media and includes organic nutrient and premium soil brands. With the Aurora acquisition, we gained new domestic manufacturing and distribution capabilities on the east and west coasts along with a peat moss harvesting operation inCanada . •Greenstar Plant Products, a manufacturer of plant nutrients and additives, inAugust 2021 . Greenstar produces premium horticultural products and solutions with brands including Grotek,Gaia Green , Supergreen, and EarthSafe. •Innovative Growers Equipment, a manufacturer of horticultural benches, racks and grow lights, inNovember 2021 . The acquisition ofInnovative Growers Equipment added to our existing lineup of high performance, proprietary branded products.
See Note 3 - Business Combinations in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
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Recent Financing Arrangements and Other Transactions
During the years ended
•Term Loan: OnOctober 25, 2021 , we entered into a senior secured term loan facility, in the aggregate principal amount of$125.0 million , withJPMorgan Chase Bank, N.A . as administrative agent for the 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 . •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. Prior to the redemption date, 3,367,647 Investor Warrants were exercised, generating total gross proceeds of approximately$56.8 million . As ofDecember 31, 2022 , and 2021, respectively, there were no Investor Warrants outstanding. •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. •JPMorgan Revolving Loan Facility: OnMarch 29, 2021 , we and certain of our subsidiaries entered into a Senior Secured Revolving Credit Facility (the "JPMorgan Revolving Loan Facility") withJPMorgan Chase Bank, N.A ., as administrative agent, issuing bank and swingline lender for a three-year revolving line of credit up to$50 million . Our and our subsidiaries' obligations under the JPMorgan Revolving Loan Facility are secured by first priority liens (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. The JPMorgan Revolving Loan Facility was amended by the First Amendment datedAugust 31, 2021 , which increased the revolving line of credit by an additional$50 million for an aggregate borrowing limit of$100 million . The JPMorgan Revolving Loan Facility was further amended by the Second Amendment datedOctober 25, 2021 , which, among other things, permitted the incurrence of the Term Loan and made certain other changes. The JPMorgan Revolving Loan Facility was further amended by the Third Amendment and Joinder datedAugust 23, 2022 , pursuant to which several previously acquired subsidiaries became parties to the JPMorgan Revolving Loan Facility and granted liens on their assets. OnDecember 22, 2022 , we entered into a Fourth Amendment pursuant to which the maximum commitment amount under the JPMorgan Revolving Loan Facility was reduced from$100 million to$75 million , and certain other changes were made, including transitioning the LIBOR based rates to SOFR based rates.
The aforementioned financing arrangements and other transactions are more fully described 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 global pandemic onMarch 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 Annual Report on Form 10-K, 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 fromChina . 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. 52
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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 and 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 inthe 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.
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 are subject to regular replenishment and durable products, such as lighting and hydroponic equipment. Our scale allows us to provide delivery and service capabilities to customers across theU.S. andCanada . 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, depreciation, depletion and amortization of manufacturing and warehouse improvements and equipment, inventory allowances, restructuring costs, and certain acquisition and integration expenses. We expect that our cost of goods sold would increase in absolute dollars in conjunction with net sales growth if that occurs in the future. However, we expect that, over time, cost of goods sold may decrease as a percentage of net sales if we are able to scale our business as we obtain a higher proportion of net sales associated with proprietary and exclusive branded products.
Selling, general and administrative
Selling, general and administrative expenses ("SG&A") consists primarily of marketing and advertising, facility costs for distribution operations, depreciation and amortization of all other assets, certain acquisition and integration expenses 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 being a publicly-traded company.
Results of Operations Data
The results of operations data in the following table for the years ended
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Results of Operations - Comparison of Years Ended
The results of operations data in the following table, including amounts and percentages of net sales for each year and the year-to-year change in dollars and percent, for the years endedDecember 31, 2022 , and 2021, have been derived from the audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K (amounts in thousands): Years ended December 31, 2022 2021 Year to year change Net sales$ 344,501 100.0 %$ 479,420 100.0 %$ (134,919) -28.1 % Cost of goods sold 315,165 91.5 % 377,934 78.8 % (62,769) -16.6 % Gross profit 29,336 8.5 % 101,486 21.2 % (72,150) -71.1 % Operating expenses: Selling, general and administrative 118,604 34.4 % 104,185 21.7 % 14,419 13.8 % Impairments 192,328 55.8 % - 0.0 % 192,328 N/A Loss from operations (281,596) -81.7 % (2,699) -0.6 % 278,897 10,333.3 % Interest expense (10,958) -3.2 % (2,138) -0.4 % 8,820 412.5 % Loss on debt extinguishment or modification (145) 0.0 % (680) -0.1 % (535) -78.7 % Other income (expense), net 841 0.2 % (204) 0.0 % 1,045 512.3 % Loss before tax (291,858) -84.7 % (5,721) -1.2 % 286,137 5,001.5 % Income tax benefit 6,443 1.9 % 19,137 4.0 % (12,694) -66.3 % Net (loss) income (285,415) -82.8 % 13,416 2.8 % (298,831) -2,227.4 % Net sales Net sales for the year endedDecember 31, 2022 , were$344.5 million , a decrease of$134.9 million , or 28.1%, compared to the same period in 2021. The 28.1% decrease was due to a 29.5% decline in volume of products sold (a 46.5% decline in organic sales and a 17.0% increase from 2021 acquired proprietary brands), a 1.7% increase in price and mix of products sold, and a 0.3% decline from unfavorable foreign exchange rates. The decrease in volume of products sold was primarily related to the aforementioned oversupply in the cannabis 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 theU.S. Dollar relative to the Canadian Dollar and to the Euro.
Gross profit
Gross profit for the year endedDecember 31, 2022 , was$29.3 million , a decrease of$72.2 million , or 71.1%, compared to the same period in 2021. The decrease in gross profit was primarily related to the aforementioned decrease in net sales and a significant decrease in our gross profit margin percentage. Our gross profit margin percentage decreased to 8.5% for the year endedDecember 31, 2022 , from 21.2% 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$18.5 million primarily related to certain lighting products, and restructuring costs of$7.5 million associated with inventory markdowns of products and brands being removed from our portfolio and the relocation and termination of certain facilities inCanada . Also negatively impacting gross profit margin were freight and labor costs which were higher as a 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
SG&A expenses for the year endedDecember 31, 2022 , were$118.6 million , an increase of$14.4 million , or 13.8% compared to the same period in 2021. The increase is primarily related to (i) a$23.4 million increase in depreciation, depletion and amortization expense primarily due to the acquisitions completed in 2021 which includes$5.9 million of additional amortization expense from adjustments to useful lives that were determined this year, (ii) a$2.9 million increase in accounts receivable allowances and write-offs, (iii) a$2.8 million increase in share-based compensation, (iv) a$2.1 million increase in compensation costs (primarily salaries and benefits for employees from companies acquired in 2021), of which$0.7 million was an increase in severance associated with a recent reduction-in-force, and (v) a$2.0 million increase in insurance costs. The SG&A increases compared to the prior year were partially offset by (i) a$16.8 million decrease in acquisition and integration expenses, and (ii) a$1.9 million decrease from investor warrant solicitation fees incurred last year. 54
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Impairments
We recorded goodwill impairment charges of$189.6 million for the year endedDecember 31, 2022 , as we determined that the carrying value of the reporting units ofU.S. andCanada were in excess of the fair value. The recognized impairment reduced the goodwill balance to zero as ofDecember 31, 2022 . The impairment was primarily due to a deterioration in customer demand in theU.S. andCanada caused by macroeconomic and industry conditions. For the year endedDecember 31, 2022 , we also recorded an impairment of a note receivable of$2.6 million . Interest expense Interest expense for the year endedDecember 31, 2022 , was$11.0 million , an increase of$8.8 million , or 412.5%, compared to the same period in the prior year. The increase was primarily due to the interest-bearing Term Loan entered into in the fourth quarter of 2021 and outstanding for the entirety of 2022, as well as interest rate increases through the year.
Loss on debt extinguishment or modification
Loss on debt extinguishment or modification for the year endedDecember 31, 2022 , was$0.1 million , a decrease of$0.5 million , or 78.7%, compared to the same period in 2021. The Loss on debt extinguishment or modification for the year endedDecember 31, 2022 , resulted primarily from the write-off of unamortized deferred financing costs associated with the modification of the JPMorgan Revolving Loan Facility entered into during the fourth quarter of 2022, which reduced our borrowing capacity from$100 million to$75 million , permitted a sale and leaseback transaction, and made certain other changes, including transitioning the LIBOR based rates to SOFR based rates. Loss on debt extinguishment or modification for the year endedDecember 31, 2021 , resulted primarily from the write-off of unamortized deferred financing costs associated with the termination of the Encina Credit Facility.
Other income (expense), net
Other income for the year endedDecember 31, 2022 , was$0.8 million compared to Other expense of$0.2 million for the year endedDecember 31, 2021 . The increase in other income compared to the prior year periods relates primarily to foreign currency exchange rate gains in 2022.
Income tax benefit
Income tax benefit for the year endedDecember 31, 2022 , was$6.4 million , compared to$19.1 million in the prior year. Our effective income tax rate was 2.2% for the year endedDecember 31, 2022 , and differs from theU.S. federal statutory rate of 21% primarily due to the impairment of goodwill for certain 2021 acquisitions which was not deductible forU.S. tax purposes, increases in our valuation allowance onU.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 year endedDecember 31, 2022 , we fully impaired the goodwill associated with all 2021 acquisitions. In connection with the measurement period adjustments associated with 2021 acquisitions, the Company 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. The Company's income tax benefit was partially offset by income taxes from certain foreign subsidiaries. For the year endedDecember 31, 2021 , 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 in 2021 which provided an additional source of taxable income to support the realization of the pre-existing deferred tax assets. 55
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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 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 audited consolidated financial statements which are prepared in accordance with GAAP, and to supplement "net (loss) income" and "net (loss) income as a percent of sales", we use "Adjusted EBITDA" and "Adjusted EBITDA as a percent of sales" which are non-GAAP financial measures. 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 restructuring, impairments, severance
and other expenses, acquisition and integration expenses, distribution center
exit costs, loss on debt extinguishment or modification, investor warrant
solicitation fees, and other (expense) income, net.
We define Adjusted EBITDA as net (loss) income excluding interest expense,
income taxes, depreciation, depletion and amortization, stock-based compensation
including employer payroll taxes on stock-based compensation and other non-cash,
unusual and/or infrequent costs (i.e., restructuring, impairments, severance and
other expenses, acquisition and integration expenses, distribution center exit
costs, loss on debt extinguishment or modification, 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 years ended
Years ended December 31,
2022 2021
Net (loss) income (GAAP) $ (285,415) $ 13,416
Interest expense 10,958 2,138
Income tax benefit (6,443) (19,137)
Distribution center exit costs and other1 1,412 2,641
Depreciation, depletion and amortization 41,527 14,934 Impairments2 192,328 - Restructuring expenses3 7,687 - Severance and other4 1,224 297 Acquisition and integration expenses5 7,682 24,210 Other (income) expense, net6 (841) 204 Stock-based compensation7 8,543 5,750 Loss on debt extinguishment or modification8 145
680
Investor warrant solicitation fees9 - 1,949 Adjusted EBITDA (Non-GAAP)$ (21,193) $ 47,082 As a percent of net sales: Net (loss) income (GAAP) (82.8) % 2.8 % Adjusted EBITDA (Non-GAAP) (6.2) % 9.8 %
Net (loss) income (GAAP) and Adjusted EBITDA (Non-GAAP) for the year ended
1. For the 2022 and 2021 periods presented, this relates to costs incurred to exit and relocate distribution centers inCalifornia andPennsylvania 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 year endedDecember 31, 2022 , due to market softness in demand in theU.S. andCanada . Additionally, during the year endedDecember 31, 2022 , the Company recorded an impairment primarily related to a$2.6 million charge associated with a note receivable that originated in 2019 in connection with a third party independent processor serving the CBD market. 3. During the year endedDecember 31, 2022 , the Company recorded pre-tax charges of$6.8 million relating to the inventory markdowns of products and brands being removed from our portfolio and$0.9 million relating primarily to the relocation and termination of certain facilities inCanada . 4. Severance and other primarily consists of severance costs incurred during the year endedDecember 31, 2022 , related to workforce reductions to optimize our cost structure. Severance and other primarily consists of costs related to an aborted financing during the year endedDecember 31, 2021 . 5. For the year endedDecember 31, 2022 , acquisition and integration expenses include non-cash purchase accounting inventory adjustments for House and Garden, Aurora, Greenstar and Innovative Growers Equipment of$4.8 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$4.5 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 expenses primarily include 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 non-cash purchase accounting inventory adjustments of$4.5 million , partially offset by the change in fair value of contingent consideration for Aurora of ($2.5 million ) for the year endedDecember 31, 2021 .
6. Other (income) expense, net relates primarily to foreign currency exchange rate gains and losses and other non-operating income and expenses.
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7. Includes stock-based compensation and related employer payroll taxes on stock-based compensation for the periods presented.
8. For the year endedDecember 31, 2022 , loss on debt extinguishment or modification resulted primarily from the write-off of unamortized deferred financing costs associated with the modification of the JPMorgan Revolving Loan Facility. For the year endedDecember 31, 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.
9. Reflects the elimination of investor warrant solicitation fees.
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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
2022 2021
Net cash from (used in) operating activities $ 21,989 $ (45,067)
Net cash used in investing activities (8,487) (468,184)
Net cash (used in) from financing activities (20,200) 464,707
Effect of exchange rate changes on cash, cash equivalents and restricted cash
(395) (27)
Net decrease in cash, cash equivalents and restricted cash (7,093) (48,571)
Cash, cash equivalents and restricted cash at beginning of year 28,384
76,955
Cash, cash equivalents and restricted cash at end of year
Operating Activities Net cash from operating activities was$22.0 million for the year endedDecember 31, 2022 , primarily due to a$39.6 million net cash inflow from a reduction of working capital related assets and liabilities. This included a decrease of$57.0 million in inventories and a decrease of$16.7 million in accounts receivable, net, partially offset by decreases of$13.3 million in deferred revenue and$16.5 million in accounts payable, accrued expenses and other current liabilities. The net cash inflow from a reduction of working capital is partially offset by consolidated net loss on the statement of operations. During the year endedDecember 31, 2022 , we paid$9.6 million in cash interest, compared to$1.6 million in the prior year. Net cash used in operating activities was$45.1 million for the year endedDecember 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, deferred revenue, and a decrease in lease liabilities due to payments on lease obligations during the period.
Investing Activities
Net cash used in investing activities for the year endedDecember 31, 2022 , was$8.5 million , due primarily to capital expenditures for property, plant and equipment, which increased over the prior year primarily due to growth investments in our manufacturing operations and the expansion and relocation of certain of our distribution centers. The 2022 cash usage primarily includes our growth-oriented investments in the peat moss harvesting operation inCanada and IGE manufacturing operations in theU.S. 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 capital expenditures for property, plant and equipment and other.
Financing Activities
Net cash used in financing activities was$20.2 million for the year endedDecember 31, 2022 , primarily consisting of$15.5 million in payments to settle contingent consideration, primarily on our Aurora acquisition. We paid$2.5 million related to employees' withholding tax in connection with the vesting of restricted stock units. In addition, we paid$1.3 million in principal payments on the Term Loan.
Net cash provided by financing activities was
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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 employees' withholding tax in connection with the vesting of certain restricted stock units.
JPMorgan Revolving Loan Facility
On
The JPMorgan Revolving Loan Facility was amended by the First Amendment datedAugust 31, 2021 , which increased the revolving line of credit by an additional$50 million for an aggregate borrowing limit of$100 million . The JPMorgan Revolving Loan Facility was further amended by the Second Amendment datedOctober 25, 2021 which, among other things, permitted the incurrence of the Term Loan and made certain other changes including subordinating its liens on non-working capital assets to the obligations under the Term Loan. The JPMorgan Revolving Loan Facility was further amended by the Third Amendment and Joinder datedAugust 23, 2022 , pursuant to which several previously acquired subsidiaries became parties to the JPMorgan Revolving Loan Facility and granted liens on their assets. OnDecember 22, 2022 , the Company entered into the Fourth Amendment pursuant to which the maximum commitment amount under the JPMorgan Revolving Loan Facility was reduced from$100 million to$75 million , a sale and leaseback transaction was permitted and certain other changes were made, including transitioning the LIBOR based rates to SOFR based rates. The JPMorgan Revolving Loan Facility provides for various interest rate options including the Adjusted Term SOFR Rate, the Adjusted REVSOFR30 Rate, the CB Floating Rate, the Adjusted Daily Simple SOFR, the CBFR, the Canadian Prime Rate, or the CDOR Rate. The rates that use SOFR as the reference rate (Adjusted Term SOFR Rate, the Adjusted REVSOFR30 Rate, the Adjusted Daily Simple SOFR and the CBFR rate) use the Term SOFR Rate plus 1.95%. Each rate has a 0.0% 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, as amended to include additional subsidiaries. The JPMorgan Revolving Loan Facility maintains certain reporting requirements, affirmative covenants, negative covenants and financial covenants. A certain financial covenant becomes applicable in the event that our excess availability under the JPMorgan Revolving Loan Facility is less than an amount equal to 10% of the Aggregate Revolving Commitment (currently$75 million ) and would require us to maintain a minimum fixed charge coverage ratio of 1.1x on a rolling twelve-month basis.
In order to consummate permitted acquisitions or to make restricted payments, the Company would be required to comply with a higher fixed charge coverage ratio of 1.15x, but no such acquisitions or payments are currently contemplated.
We were in compliance with all debt covenants as ofDecember 31, 2022 . As ofDecember 31, 2022 , approximately$40 million was available to borrow under the undrawn JPMorgan Revolving Loan Facility, before we would be required to comply with the minimum fixed charge coverage ratio of 1.1x.
Term Loan
OnOctober 25, 2021 , we and certain of our direct and indirect subsidiaries entered into the Term Loan withJPMorgan Chase Bank, N.A ., as administrative agent for the 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 ofOctober 25, 2028 . The Term Loan requires us to maintain certain reporting requirements, affirmative covenants, and negative covenants. We were in compliance with all debt covenants as ofDecember 31, 2022 . The Term Loan is secured by a first lien on our non-working capital assets and a second lien on our working capital assets. 60
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Cash and cash equivalents
The cash and cash equivalents balances of$21.3 million and$26.6 million atDecember 31, 2022 , andDecember 31, 2021 , respectively, included$7.3 million and$4.1 million , respectively, held by foreign subsidiaries.
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 II, Item 8, Financial Statements, Note 10 - Debt, Note 7 - Leases, and Note 14 - Commitments and 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.
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.
Seasonality
Our net sales are typically 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 is primarily due to the garden center portion of our customer base, and because certain of our customers may use some of our products (such as grow media and nutrients) in outdoor applications. While this seasonal pattern did not hold true during fiscal 2022, likely due to the industry recession, we expect this typical seasonal pattern to return in fiscal 2023. Also, we typically expect to utilize cash from operating activities in the first quarter to fund our working capital requirements related to the seasonal sales pattern described above. Availability and Use of Cash 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. We believe that the Company will generate positive cash flows from operating activities over the next twelve months. We believe that our cash flows from operating activities, combined with current cash levels and borrowing availability under the JPMorgan Credit Facility, will be adequate to support our ongoing operations, to fund debt service requirements, capital expenditures, lease obligations and working capital needs through the next twelve months of operations. 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. InJanuary 2023 ,Gotham Properties LLC , anOregon limited liability company and our subsidiary ("Seller"), consummated a Purchase and Sale Agreement withJ & D Property, LLC , aNevada limited liability company ("Purchaser") pursuant to which certain real property located in theCity of Eugene , County of Lane,State of Oregon (the "Eugene Property") was sold to Purchaser for$8.6 million and then leased back by Seller (the "Sale-Leaseback Transaction"). The new lease has a term of 15 years with annual rent starting at approximately$0.7 million and increases to the final year when annual rent is approximately$1.0 million . The Eugene Property serves as the manufacturing and processing site for certain of our grow media and nutrient brands. We intend to reinvest the net cash proceeds into certain permitted investments in 2023, such as capital expenditures. If necessary, we believe that we could supplement our cash position through additional sale/leasebacks, asset sales and equity financing. We believe it is prudent to be prepared if required and, accordingly, continue to be engaged in the process of evaluating and preparing to implement one or more of the aforementioned activities.
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, 2022 follows. 61
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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 acquiree (if any) over the net acquisition-date fair value amounts of the identified assets acquired and liabilities assumed in a business combination.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 market value of our common stock and market conditions, we identified a triggering event requiring a test for impairment as ofJune 30, 2022 . We completed our goodwill impairment testing and recorded an impairment charge due to market softness in demand in theU.S. andCanada . We determined the fair value of theU.S. andCanada 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 our common stock of to corroborate the estimates used in the interim test for impairment.
Long-lived tangible and finite-lived intangible assets
Long-lived tangible assets and finite-lived intangible assets are stated at cost. Depreciation, depletion and amortization expense is primarily 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. 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 endedJune 30, 2022 , we 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 our evaluation, there was no impairment of intangible assets or other long-lived assets for the quarter endedJune 30, 2022 . No such triggering event was identified during the remainder of 2022. We believe 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.
Inventory valuation
Inventories consist of finished goods, work-in-process, and raw materials used in manufacturing products. Inventories are stated at the lower of cost or net realizable value, principally determined by the first in, first out method of accounting. We maintain an allowance for excess and obsolete inventory. The estimate for excess and obsolete inventory is based upon assumptions about current and anticipated demand, customer preferences, business strategies, and market conditions. Management reviews these assumptions periodically to determine if any adjustments are needed to the allowance for excess and obsolete inventory. The establishment of an allowance for excess and obsolete inventory establishes a new cost basis in the inventory. Such allowance is not reduced until the product is sold. If inventory is sold, any related reserves would be reversed in the period of sale. The Company estimates inventory markdowns relating to restructuring charges based upon current and anticipated demand, customer preferences, business strategies, and market conditions including management's actions with respect to inventory products and brands being removed from our portfolio.Hydrofarm's strategic product consolidation entails removing approximately one-third of all products and one-fifth of all brands relating to our primary product portfolio.
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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