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(Exact name of registrant as specified in its charter)
iDelaware
i81-4895761
(State
or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification Number)
i1510 Main Street
iShoemakersville,
iPennsylvaniai19526
(i707)
i765-9990
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)
Securities registered pursuant to Section 12(b) of the Act:
Title
of each class
Trading Symbol
Name of each exchange on which registered
iCommon Stock, $0.0001 par value per share
iHYFM
iNasdaq
Global Select Market
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. iYes ☒ No ☐
Indicate
by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files). iYes ☒ No ☐
Indicate by check mark whether the registrant
is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,”“accelerated filer,”“smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
iLarge
accelerated filer
☒
Accelerated filer
☐
Non-accelerated filer
☐
Smaller reporting company
i☐
Emerging growth
company
i☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act. ☐
Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes ☐ No i☒
As of July 31, 2022, the registrant had i45,094,226
shares of common stock, $0.0001 par value per share, outstanding.
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements contained in this Quarterly Report on Form 10-Q other than statements of historical fact, including statements concerning our business strategy and plans, future operating results and financial position, as well as our objectives and expectations for our future operations, are forward-looking statements.
In some cases, you can identify forward-looking statements by such terminology as “believe,”“may,”“will,”“potentially,”“estimate,”“continue,”“anticipate,”“intend,”“could,”“would,”“project,”“plan,”“expect”
and similar expressions that convey uncertainty of future events or outcomes, although not all forward-looking statements contain these words. Forward-looking statements include, but are not limited to, statements about:
•industry conditions, including oversupply and decreasing prices of our customers' products which, in turn, has materially adversely impacted our sales and other results of operations and which may continue to do so in the future;
•the potential for future non-cash charges for the impairment of our long-lived assets and/or inventory and accounts receivable reserves;
•our liquidity;
•potential dilution that may result from equity financings while our stock prices are depressed;
•general
economic and financial conditions, specifically in the United States and Canada;
•the adverse effects of public health epidemics, including the COVID-19 pandemic, on our business, results of operations and financial condition;
•interruptions in our supply chain;
•federal and state legislation and regulations pertaining to the use and cultivation of cannabis in the United States and Canada;
•public perceptions and acceptance of cannabis use;
•fluctuations in the price of various crops and other factors affecting growers;
•the results of our recent acquisitions and
strategic alliances;
•our ability to execute our e-commerce business;
•the costs of being a public company;
•our ability to keep pace with technological advances;
•our ability to successfully identify appropriate acquisition targets, successfully acquire identified targets or successfully integrate the business of acquired companies;
•the success of our marketing activities;
•a disruption or breach of our information technology systems or cyber-attack;
•our current level of indebtedness;
•our
dependence on third parties;
•any change to our reputation or to the reputation of our products;
•the performance of third parties on which we depend;
•the fluctuation in the prices of the products we distribute;
•competitive industry pressures;
•the consolidation of our industry;
•compliance with environmental, health and safety laws;
•our ability to protect and defend against litigation, including claims related to intellectual property and proprietary rights;
•product
shortages and relationships with key suppliers;
•the conditions impacting our customers, including related crop prices and other factors impacting growers;
•our ability to attract key employees;
•the volatility of the price of our common stock;
•the marketability of our common stock; and
•other risks and uncertainties, including those listed in “Risk Factors.”
We
have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our business, financial condition, results of operations, prospects, and financial needs. These forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q and are subject to a number of risks, uncertainties and assumptions described in the section titled “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Because forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified, you should not rely on these forward-looking statements as predictions of future events. The events and circumstances reflected in our forward-looking statements may not be achieved or occur and actual results could differ materially from those projected in the forward-looking statements. We disclaim any intention or obligation
to publicly update or revise any forward-looking statements for any reason or to conform such statements to actual results or revised expectations, except as required by law.
“Hydrofarm” and other trade names and trademarks of ours appearing in this Quarterly Report on Form 10-Q are our property. This Quarterly Report on Form 10-Q contains trade names and trademarks of other companies, which are the property of their respective owners. We do not intend our use or display of other companies’ trade names or trademarks to imply an endorsement or sponsorship of us by such companies, or any relationship with any of these companies.
Unless the context otherwise indicates, references in this Quarterly Report on Form 10-Q to the terms “Hydrofarm”, “the Company,”“we,”“our”
and “us” refer to Hydrofarm Holdings Group, Inc. and its subsidiaries.
Common
stock ($ii0.0001/ par value; ii300,000,000/
shares authorized; ii45,011,652/ and ii44,618,357/
shares issued and outstanding at June 30, 2022 and December 31, 2021, respectively)
i4
i4
Additional
paid-in capital
i779,911
i777,074
Accumulated
other comprehensive loss
(i3,553)
(i1,382)
Accumulated
deficit
(i367,124)
(i140,516)
Total
stockholders’ equity
i409,238
i635,180
Total
liabilities and stockholders’ equity
$
i649,249
$
i891,242
The
accompanying notes are an integral part of the condensed consolidated financial statements.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
1.
iDESCRIPTION OF THE BUSINESS
Description of the business
Hydrofarm Holdings Group, Inc. and its subsidiaries (collectively, the “Company”) was formed in May 2017 under the laws of the state of Delaware to acquire and continue the business of Hydrofarm, LLC established in 1977. The
Company is a leading independent manufacturer and distributor of controlled environment agriculture (“CEA”, principally hydroponics) equipment and supplies, including a broad portfolio of proprietary branded products. Products offered include agricultural lighting devices, indoor climate control equipment, hydroponics and nutrients, and plant additives used to grow, farm and cultivate cannabis, flowers, fruits, plants, vegetables, grains and herbs in controlled environment settings that allow end users to control key farming variables including temperature, humidity, CO2, light intensity and color, nutrient concentration and pH.
Initial public offering and follow-on public offering
On December 14, 2020, the
Company closed its initial public offering (“IPO”) under a registration statement effective December 9, 2020, in which it issued and sold i9,966,667 shares of its common stock, including the full exercise by the underwriters of their option to purchase i1,300,000
additional shares of common stock. The public offering price was $i20.00 per share. The Company received net proceeds of $i182,271
from the IPO after deducting underwriting discounts and commissions and offering expenses, of which $i148 of offering expenses were paid in 2021.
On May 3, 2021, the Company closed its follow-on public offering ("follow-on offering") under a registration statement effective April 28, 2021, in which it issued and sold i5,526,861
shares of its common stock, including the full exercise by the underwriters of their option to purchase i720,894 additional shares of common stock. The public offering price was $i59.00
per share. The Company received net proceeds of approximately $i309,782 from the follow-on offering after deducting underwriting discounts and commissions and offering expenses.
2. iBASIS
OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
i
The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries and have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and the requirements of the U.S.
Securities and Exchange Commission (“SEC”) for interim financial reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by U.S. GAAP can be condensed or omitted. These condensed consolidated financial statements have been prepared on the same basis as the Company's annual consolidated financial statements and, in the opinion of management, reflect all normal and recurring adjustments which are necessary for the fair statement of the Company’s financial information. These interim results are not necessarily indicative of the results to be expected for the fiscal year ending December 31, 2022, or for any other interim period or for any other future year. All intercompany balances
and transactions have been eliminated in consolidation. The Company reclassified the balance within "Impairment, restructuring and other" on the condensed consolidated statements of operations for the prior period into "Selling, general and administrative expenses" to conform to the current period presentation. The Company reclassified the balance of customer deposits previously reported in "accounts payable" into "deferred revenue" in the condensed consolidated balance sheet as of December 31, 2021, to conform to the current period presentation. The amount totaled $i18,273
as of December 31, 2021.
The condensed consolidated balance sheet as of December 31, 2021, has been derived from the audited consolidated financial statements of the Company, which is included in the Company's Annual Report on Form 10-K for the year ended December 31, 2021 ("2021 Annual Report"). These condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and the notes thereto included in the 2021 Annual Report.
/
Use
of estimates
iThe preparation of condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
liabilities as of the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Significant estimates include provisions for sales returns, rebates and claims from customers, realization of accounts receivable and inventories, fair value of assets acquired and liabilities assumed for business combinations, valuation of intangible assets and goodwill, estimated useful lives of long lived assets, incremental borrowing rate applied in
lease accounting, valuation of stock-based compensation, recognition of deferred income taxes, recognition of liabilities related to commitments and contingencies and valuation allowances. Actual results may differ from these estimates. On an ongoing basis, the Company reviews its estimates to ensure that these estimates appropriately reflect changes in its business or new information available.
Business combinations
i
Acquisitions of businesses are accounted for using the acquisition
method. The consideration transferred in a business combination is measured at fair value, which is calculated as the sum of the acquisition date fair values of the assets transferred, liabilities incurred to the former owners of the acquiree, and the equity interests issued in exchange for control of the acquiree. Acquisition related costs are recognized in net income (loss) as incurred.
When the consideration transferred in a business combination includes assets or liabilities resulting from a contingent consideration arrangement, the contingent consideration is measured at its acquisition date fair value and included as part of the consideration transferred in a business combination. Contingent consideration is established for business acquisitions where the Company has the obligation to transfer additional assets or equity interests to
the former owners if specified future events occur or conditions are met. Contingent consideration is classified as a liability when the obligation requires settlement in cash or other assets and is classified as equity when the obligation requires settlement in the Company's own equity instruments. Changes in the fair value of the contingent consideration that qualify as measurement period adjustments are adjusted retrospectively, with a corresponding adjustment to goodwill. Measurement period adjustments are adjustments that arise from additional information obtained during the measurement period (which cannot exceed one year from the acquisition date) about facts and circumstances that existed at the acquisition date. All other subsequent changes in the fair value of contingent consideration classified as a liability are included in net income (loss) in the period. Changes in the
fair value of contingent consideration classified as equity are not recognized.
For a given acquisition, the Company may identify certain pre-acquisition contingencies as of the acquisition date and may extend its review and evaluation of these pre-acquisition contingencies throughout the measurement period to obtain sufficient information to assess these contingencies as part of acquisition accounting, as applicable.
Goodwill is measured as the excess of the sum of the consideration transferred, the amount of any non‑controlling interests in the acquiree, and the fair value of the acquirer’s previously held equity interest in the acquire (if any) over the net of the acquisition‑date fair value amounts of the identifiable assets acquired, and the liabilities assumed.
If
the initial accounting for a business combination is incomplete by the end of the reporting period in which the combination occurs, the Company reports provisional amounts for the items for which the accounting is incomplete. Those provisional amounts are adjusted during the measurement period, or additional assets or liabilities are recognized, to reflect new information obtained about facts and circumstances that existed at the acquisition date that, if known, would have affected the amounts recognized at that time. Upon conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to net income (loss).
Segment and entity-wide information
Segment information
The
Company's chief operating decision maker is the chief executive officer ("CEO") who reviews financial information for the purposes of making operating decisions, assessing financial performance, and allocating resources.
The business is organized as itwo operating segments, the U.S. and Canada, which meet the criteria for aggregation, and the Company has elected to present them as ione
reportable segment, which is the distribution and manufacture of CEA equipment and supplies. Aggregation is based on similarities which include the nature of its products, production or acquisition of inventory, customer base, fulfillment and distribution and economic characteristics.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
Since the
Company operates as ione reportable segment, all required segment financial information is found in the condensed consolidated financial statements and footnotes with entity-wide disclosures presented below.
Entity-wide information
ii
Sales
to external customers and property, plant and equipment, net in the United States and Canada, determined by the location of the subsidiaries, were as follows:
Total
property, plant and equipment, and operating lease right-of-use assets, net
$
i104,545
$
i95,718
//
All
of the products sold by the Company are similar and classified as CEA equipment and supplies. The Company’s underlying accounting records currently do not support presentation of disaggregated net sales and any attempt to report them would be impracticable.
Note receivable
In 2019, the Company executed a note receivable secured by equipment to a third-party, the terms of which were amended and restated during the first quarter of 2021. The note receivable provided for interest and installment payments to the Company, and full maturity of
the note in 2024. During the first quarter of 2022, the third-party defaulted on interest payments, and the Company measured an impairment on the note receivable based on the estimated fair value of the collateral. The Company recorded impairment losses of izero and $i2,636
during the three and six months ended June 30, 2022, respectively, in “Impairments” on the condensed consolidated statements of operations. As of June 30, 2022, the note receivable carrying value was $i475.
Revenue recognition
i
The
Company follows Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers (“ASC 606”) which requires that revenue recognized from contracts with customers be disaggregated into categories that depict how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors. The Company has determined that revenue is generated from one category, which is the distribution and manufacture of controlled environment agriculture equipment and supplies.
Revenue is recognized as control of
promised goods is transferred to customers which generally occurs upon receipt at customers’ locations determined by the specific terms of the contract. Arrangements generally have a single performance obligation and revenue reported is comprised of fixed consideration and variable consideration which includes applicable volume rebates, cash discounts and sales returns and allowances. Variable consideration is estimated and recorded at the time of sale.
The amount billed to customers for shipping and handling costs included in net sales was $i3,679
and $i7,558 during the three and six months ended June 30, 2022, respectively, and $i1,683
and $i2,928 during the three and six months ended June 30, 2021, respectively. Shipping and handling costs that occur before the customer obtains control of the goods are deemed to be
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
fulfillment activities and are accounted for as fulfillment costs included in cost of goods sold. The Company does not receive noncash consideration for the sale of goods. Contract consideration received from a customer prior to revenue recognition is recorded as a contract liability and is recognized as revenue
when the Company satisfies the related performance obligation under the terms of the contract. The Company's contract liabilities, which consist primarily of customer deposits, are reported within deferred revenue in the condensed consolidated balance sheets, totaled $i11,333
and $i18,273 as of June 30, 2022, and December 31, 2021, respectively. There are no significant financing components. Excluded from revenue are any taxes assessed by governmental authorities, including value-added and other sales-related taxes that are imposed on and concurrent with revenue-generating activities.
Intangible assets and goodwill
i
Definite-lived
intangible assets are amortized using the straight-line method over their estimated useful lives. The Company has one trade name that is considered to have an indefinite useful life. Intangible assets with finite lives are reviewed for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable.
Goodwill represents the excess of the acquisition price of an acquired business over the fair value of the identifiable assets acquired and liabilities assumed in a business combination less any subsequent write-downs for impairment. Goodwill is tested for impairment on an annual basis in the fourth quarter and more frequently if indicators of potential impairment exist. Impairment testing is conducted at the reporting unit level, which is generally defined as an operating segment or one level below
an operating segment (also known as a component), for which discrete financial information is available and segment management regularly reviews the operating results. The Company has determined that its reporting units for the purpose of goodwill impairment testing are the United States ("U.S.") and Canada.
Goodwill impairment reviews include performing either an initial qualitative or quantitative evaluation for each of the reporting units. Several methods may be used to estimate a reporting unit’s fair value, including market quotations, asset and liability fair values and other valuation techniques. If the carrying amount of a reporting unit, including goodwill, exceeds the estimated fair value, then the excess is charged to earnings as an impairment loss. Intangible assets with indefinite lives are also tested for impairment at
least annually and when events or changes in circumstances indicate that, more-likely-than-not, the asset is impaired. Significant judgment is required in estimating fair values and performing goodwill and indefinite-lived intangible asset impairment tests.
Primarily due to a sustained decline in the Company's market value of common stock and market conditions, the Company identified a triggering event requiring a test for impairment as of June 30, 2022. Refer to Note 4 - Goodwill and Intangible Assets, Net for additional details.
Income taxes—interim tax provision
iThe
Company recorded an income tax benefit of $i6,861 and $i12,430 for the three and six months ended June 30,
2022, respectively. The Company's effective income tax rate was i5.2% for the six months ended June 30, 2022, and differs from the federal statutory rate of 21% primarily due to the impairment of goodwill for certain 2021 acquisitions which was not deductible for U.S. tax purposes, increases in the Company's valuation allowance on U.S. deferred
tax assets, and the establishment of a valuation allowance for Canadian deferred tax assets. As described in Note 4 - Goodwill and Intangible Assets, Net, during the three months ended June 30, 2022, the Company fully impaired the goodwill associated with all 2021 acquisitions. For the six months ended June 30, 2022, the Company recorded discrete income tax benefits of $i12,058
relating primarily to measurement period adjustments associated with 2021 acquisitions, and certain tax benefits related to goodwill impairment. /
The Company recorded income tax expense of $i63 and $i819
for the three and six months ended June 30, 2021, respectively. The Company’s effective tax rate for the six months ended June 30, 2021, differs from the federal statutory rate of 21% primarily as a result of reducing valuation allowances on the Company's deferred tax assets related to net operating loss carryforwards.
NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
Recent accounting pronouncements
iThe Company considers the applicability and impact of all Accounting Standards Updates ("ASUs") issued by the FASB. There were no ASUs that were assessed and determined to be applicable
or expected to have a material impact on the Company's condensed consolidated financial statements.
3. iBUSINESS COMBINATIONS
During 2021, the Companycompleted
ifive acquisitions of branded manufacturers of CEA products, resulting in a significant expansion of its portfolio of proprietary branded products and specialized manufacturing capabilities. The Company finalized the determination of its allocation of the purchase price relating to these acquisitions as of June 30, 2022.
During the first quarter of 2022, the
Company evaluated and adjusted the useful lives of certain intangible assets associated with entities that were acquired during 2021. In addition, the Company determined that the preliminary allocation of assets acquired related to indefinite lived trade names have a finite useful life because the expected usefulness of the trade names is limited. As a result of these adjustments to the provisional amounts, the Company recorded $i5,894
of additional amortization expense during the first quarter of 2022, which related to amortization expense that would have been recorded in the previous reporting period from the acquisition date through December 31, 2021. The intangible assets were assigned estimated useful lives as follows: (i) customer relationships: i7 to i12
years, (ii) technology, formulations and recipes: i8 to i12 years, and (iii) trade names: i15
to i20 years.
Heavy 16 Acquisition
On May 3, 2021, the Company acquired i100%
of the issued and outstanding membership interests of Field 16, LLC ("Heavy 16"), a manufacturer and supplier of branded plant nutritional products. As a result of the acquisition, the Company broadened its proprietary branded offering into the plant nutrients category complementing other product offerings. The acquisition fair value of the consideration transferred for Heavy 16 was $i77,367, consisting of $i60,287
in cash, $i16,736 of the Company's common stock and $i344
contingent consideration. The fair value of the common stock issued was determined based on the closing market price of the Company's common stock on the acquisition date.
Pursuant to the purchase agreement, the Company was required to pay up to an additional $i2,500
of contingent consideration based on $i200 for each $i1,000
above a $i21,000 threshold for net sales in calendar year 2021. As a result, the Company recorded a liability for contingent consideration at its estimated fair value of $i344
as of the acquisition date in the condensed consolidated balance sheets. The contingent consideration was estimated using a Black-Scholes valuation model, which utilized Level 3 inputs as defined in ASC 820 - Fair Value Measurements. As of December 31, 2021, contingent consideration of $ii200/
was calculated utilizing actual net sales for the full year ended December 31, 2021, and was paid in April 2022. The amount of goodwill is fully deductible for tax purposes. The financial results of Heavy 16 are included in the U.S. operating segment since the acquisition date.
House & Garden Acquisition
On June 1, 2021, the Company acquired i100%
of the issued and outstanding shares of capital stock of House & Garden, Inc. (“HG”), Humboldt Wholesale, Inc. (“HW”), Allied Imports & Logistics, Inc. (“Allied”), South Coast Horticultural Supply, Inc. (“SC” and, together with HG, HW and Allied, the “H&G Entities”), a manufacturer and distributor of plant nutrients and fertilizers to domestic and various international markets. As a result of the acquisition, the Company further broadened its proprietary branded offering into the plant nutrients category complementing other product offerings. The acquisition date fair value of the consideration transferred for the H&G Entities was $i133,483
in cash. The amount of goodwill is not deductible for tax purposes. As part of the share acquisition of the H&G Entities, the Company allocated a significant value of the acquisition to identified intangible assets that are not deductible for U.S. tax purposes. Therefore, a deferred tax liability arose providing an additional source of taxable income to support the realization of pre-existing deferred tax assets. The financial results of the H&G Entities are included in the U.S. operating segment since the acquisition date.
NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
Aurora Acquisition
On July 1, 2021, the Company acquired i100% of the issued and outstanding membership interests
of Gotham Properties LLC (“Gotham Properties”), Aurora Innovations LLC (“Aurora Innovations”), Aurora International LLC (“Aurora International” and, together with Gotham Properties and Aurora Innovations, “Aurora”), a manufacturer of plant fertility product lines. As a result of the acquisition, the Company further broadened its proprietary branded offering into the plant nutrients and grow media category complementing other product offerings. The preliminary acquisition fair value of the consideration transferred for Aurora was $i178,871,
consisting of $i133,962 in cash, $i25,824 of
the Company's common stock, $i19,300 contingent consideration and $i215
forgiveness of accounts payable. The fair value of the common stock issued was determined based on the closing market price of the Company's common stock on the acquisition date. The forgiveness of accounts payable represents an effective settlement of a preexisting relationship between the parties.
Pursuant to the purchase agreement, the Company was required to pay a maximum contingent consideration equal to $i70,997.
To the extent 2021 EBITDA of Aurora exceeded $i15,556, the excess was multiplied by ieleven
to determine contingent consideration. As a result, the Company recorded a liability for contingent consideration at its estimated fair value of $i19,300 as of the acquisition date in the condensed consolidated balance sheets. The contingent consideration was estimated using the discounted cash flow method, which estimated the incremental EBITDA based on the
Company's forecasted 2021 EBITDA of Aurora as of the acquisition date, discounted to a present value as of the acquisition date using a discount rate of i15%. That measure was based on significant inputs that are not observable in the market, which utilized Level 3 inputs as defined in ASC 820 - Fair Value Measurements. The contingent consideration was remeasured to fair value at each reporting date until resolution with changes in fair value recognized within SG&A in
the condensed consolidated statements of operations. As of June 30, 2022, the related contingent consideration was $i15,274, and was subsequently paid in July 2022 using available cash on hand. The amount of goodwill is fully deductible for tax purposes. The financial results of Aurora are included in the U.S. operating segment since the acquisition date.
Greenstar/Grotek Acquisition
On
August 3, 2021, the Company acquired i100% of the issued and outstanding shares of Greenstar Plant Products Inc., (“Greenstar”), a manufacturer of horticultural products and solutions for global, domestic and commercial use. As a result of the acquisition, the Company further broadened its proprietary branded offering into
the plant nutrients and grow media category complementing other product offerings. The preliminary acquisition fair value of the consideration transferred for Greenstar was $i83,520, consisting of $i85,121
in cash, less $i1,601 forgiveness of accounts payable, net, and obligations due under a distribution agreement. The forgiveness of accounts payable, net, and obligations due under a distribution agreement represent an effective settlement of a preexisting relationship between the parties. The amount of goodwill is not deductible for U.S. tax purposes, but it is partially deductible for Canadian tax purposes. The financial results of Greenstar are included in the Canada operating
segment since the acquisition date.
Innovative Growers Equipment, Inc. Acquisition
On November 1, 2021, the Company acquired i100% of the issued and outstanding shares of Innovative Growers Equipment, Inc., an Illinois corporation (“IGE”), Innovative AG Installation, Inc., an Illinois corporation (“IAG”), Innovative
Racking Systems, Inc., an Illinois corporation (“IRS”), and Innovative Shipping Solutions, Inc., an Illinois corporation (“ISS” and, together with IGE, IAG, IRS, and their respective subsidiaries, the “IGE Entities”), a manufacturer of horticulture benches, racking and LED lighting systems which complement the Company’s existing lineup of high performance, proprietary branded products. The preliminary acquisition fair value of the consideration transferred for the IGE Entities was $i60,902,
consisting of $i49,129 in cash, $i11,051 of the
Company's common stock, and $i722 forgiveness of a contract asset. The fair value of the common stock issued was determined based on the closing market price of the Company's common stock on the acquisition date. The forgiveness of contract asset represents
an effective settlement of a preexisting relationship between the parties. The amount of goodwill is not deductible for U.S. tax purposes. The financial results of the IGE Entities are included in the U.S. operating segment since the acquisition date.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
i
The
following table sets forth the components and allocation of the purchase price for the Company's acquisition of Heavy 16, the H&G Entities, Aurora, Greenstar and the IGE Entities:
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
Supplemental Disclosure of Financial Results
i
The following represents certain estimated unaudited consolidated net sales and net income amounts for the three and six months
ended June 30, 2021, as if the ifive acquisitions had been included in the consolidated results of the Company for the entire period presented below. Management considers these estimates to represent an approximate measure of the performance of the combined Company:
Primarily due to a sustained decline in the Company's market value of common stock and market conditions, the Company identified a triggering event requiring a test for impairment as of June 30, 2022.
The Company completed its goodwill impairment testing and recorded an impairment charge of $i189,572 as the test determined that the carrying value of the goodwill reporting units of U.S. and Canada was in excess of the fair value. The recognized impairment reduced the goodwill balance to izero
as of June 30, 2022. The impairment was primarily due to a deterioration in customer demand in the U.S. and Canada caused by macroeconomic and industry conditions.
The Company determined the fair value of the U.S. and Canada reporting units based on an income approach, using the present value of future discounted cash flows, and based on a market approach. The fair values were reconciled to the market value of common stock of Hydrofarm to corroborate the estimates used in the interim test for impairment. Significant estimates used to determine fair value include the weighted average cost of capital, financial forecasts, and pricing multiples derived from publicly-traded companies that are comparable to the reporting units. Refer to Note 14 - Fair Value Measurements,
for further discussion of valuation inputs. There was ino goodwill impairment recognized during the year ended December 31, 2021. iThe changes in goodwill are
as follows:
Intangible assets with finite lives and indefinite lives are reviewed for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. For the quarter ended June 30, 2022, the
Company performed an evaluation of intangible assets for impairment in connection with the triggering event identified requiring a quantitative test for goodwill impairment. Based on the Company's evaluation, there was no impairment of intangible assets for the quarter ended June 30, 2022. However, there can be no guarantee that the Company will not record an impairment charge in the future. For a fuller discussion of the risk that such an impairment charge might be required in the future, please see “Item 1.A Risk Factors” and the risk factor captioned “Long-lived assets and inventories represent a significant portion of our total
Amortization
expense related to intangibles was $i6,245 and $i20,991 for the three and six months ended June 30, 2022,
respectively. Amortization expense related to intangibles was $i1,766 and $i2,972 for the three and six months ended June
30, 2021, respectively. Amortization expense in 2022 includes the impact from intangible assets recorded in connection with ifive acquisitions completed during the year ended December 31, 2021. The following are the estimated useful lives and the weighted-average amortization period as of June 30, 2022, for the major classes of finite-lived intangible assets:
Useful
lives
Weighted-average amortization period
Computer software
i5 years
i4
years
Customer relationships
i7 to i18 years
i11
years
Technology, formulations and recipes
i8 to i12 years
i11
years
Trade names
i15 to i20 years
i19
years
i
The estimated aggregate future amortization expense for intangible assets subject to amortization as of June 30, 2022, is summarized below:
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
5. iEARNINGS (LOSS) PER COMMON SHARE (“EPS”)
Basic EPS is computed using net income (loss) divided by the weighted-average number of common shares
outstanding during each period, excluding unvested restricted stock units (“RSUs”).
Diluted EPS represents net income (loss) divided by the weighted-average number of common shares outstanding during the period, including common stock equivalents. Common stock equivalents consist of shares subject to warrants and share-based awards with exercise prices less than the average market price of the Company’s common stock for the period, to the extent their inclusion would be dilutive. Regarding RSUs subject to a market condition, before the end of the contingency period, the number of contingently issuable shares (i.e., RSUs) to be included in diluted EPS would be based on the number of common shares issuable under the terms of the arrangement if the end of the reporting period was the end of the contingency period, assuming the result
would be dilutive. Those contingently issuable shares would be included in the denominator of diluted EPS as of the beginning of the period, or as of the grant date of the share-based payment, if later.
i
The following table presents information necessary to calculate basic and diluted EPS for the three and six months ended June 30, 2022, and 2021:
Weighted-average
shares of common stock outstanding
i44,910,193
i37,862,417
i44,814,881
i35,792,374
Dilutive
effect of warrants using the treasury stock method
i—
i2,030,346
i—
i2,435,405
Dilutive
effect of restricted stock units using the treasury stock method
i—
i1,441,790
i—
i1,550,076
Dilutive
effect of stock options using the treasury stock method
i—
i710,376
i—
i745,831
Diluted
weighted-average shares of common stock outstanding
i44,910,193
i42,044,929
i44,814,881
i40,523,686
Basic
EPS
$
(i4.53)
$
i0.06
$
(i5.06)
$
i0.20
Diluted
EPS
$
(i4.53)
$
i0.05
$
(i5.06)
$
i0.18
/i
The
computation of the weighted-average shares of common stock outstanding for diluted EPS excludes the following potential common shares as their inclusion would have an anti-dilutive effect:
The
allowance for inventory obsolescence increased during the six months ended June 30, 2022, primarily a result of a reserve for certain lighting products. Inventories are stated at the lower of cost or net realizable value, and the Company maintains an allowance for excess and obsolete inventory that is based upon assumptions about future demand and market conditions.
7. iOPERATING
LEASES
The Company leases its distribution centers and manufacturing facilities from third parties under various non-cancelable lease agreements expiring at various dates through 2032. Certain leases contain escalation provisions and/or renewal options, giving the Company the right to extend the leases by up to i10 years. However, these options are generally not reflected in the calculation of the right-of-use assets
and lease liabilities due to uncertainty surrounding the likelihood of renewal. The Company recognizes operating lease costs over the respective lease periods, including short-term and month-to-month leases. The Company incurred operating lease costs of $i3,022 and $i5,619,
during the three and six months ended June 30, 2022. respectively, and $i1,678 and $i3,172, during the three and six months ended June 30,
2021, respectively. These costs are included primarily within selling, general and administrative expense in the condensed consolidated statements of operations.
i
Supplemental balance sheet information related to the Company’s operating leases are as follows:
During the three months ended March 31, 2022, the Company
executed a lease for approximately i303,000 square feet of warehouse space in Shoemakersville, Pennsylvania, and recorded right-of-use assets for operating leases for $i10,463.
i
The future minimum lease payments for executed non-cancelable operating leases not yet commenced are as follows:
Depreciation,
depletion and amortization expense related to property, plant and equipment, net was $i1,590 and $i3,785 for the three and six months ended June 30, 2022, respectively. Depreciation,
depletion and amortization expense related to property, plant and equipment, net was $i421 and $i806 for the three and six months ended June 30, 2021, respectively.
9.
iACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
i
Accrued
expenses and other current liabilities comprised the following:
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
Senior Secured Term Loan
On October 25, 2021, Hydrofarm Holdings Group, Inc. and certain of its direct and indirect subsidiaries (the "Obligors") entered into a Credit and Guaranty Agreement with JPMorgan Chase Bank, N.A., as administrative agent for certain lenders, pursuant to which the Company
borrowed a $i125,000 senior secured term loan (“Term Loan”). The Term Loan bears interest at LIBOR (with a i1.0% floor) plus i5.50%,
or an alternative base rate (with a i2.0% floor), plus i4.50%, and is subject to a call premium of i2%
in year one, i1% in year two, and i0% thereafter, and matures on October 25, 2028 ("Maturity Date"). Effective June
30, 2022, the Company entered into a six-month rate lock at LIBOR of i2.88% plus i5.50%, for an
all-in rate of i8.38% through December 30, 2022. Deferred financing costs and discount totaled $i6,190
at inception of the Term Loan, and are being amortized to interest expense over the term of the loan. For the three months ended June 30, 2022, the effective interest rate was i7.34% and interest expense was $i2,281,
which includes amortization of deferred financing costs of $i220. For the six months ended June 30, 2022, the effective interest rate was i7.32% and interest
expense was $i4,530, which includes amortization of deferred financing costs of $i438.
The principal amounts of the Term Loan are required to be repaid in consecutive quarterly
installments in amounts equal to i0.25% of the principal amount of the Term Loan, on the last day of each fiscal quarter commencing March 31, 2022, with the balance of the Term Loan payable on the Maturity Date. The Company is also required to make mandatory prepayments upon the occurrence of certain events, including (i) achieving certain excess cash flow criteria, including the achievement and maintenance
of a specific leverage ratio, (ii) selling assets that are collateral, or (iii) upon the issuance, offering, or placement of new debt obligations. There were no such mandatory prepayments made since inception of the Term Loan. As of June 30, 2022, and December 31, 2021, the outstanding principal balance on the Term Loan was $i124,375 and $i125,000,
respectively.
The Term Loan requires the Company to maintain certain reporting requirements, affirmative covenants, and negative covenants, and the Company was in compliance with all requirements as of June 30, 2022. The Term Loan is secured by a first lien on the non-working capital assets of the Company and a second lien on the working capital assets of the Company. The Company may request additional term loan commitments subject to certain loan
conditions.
JPMorgan Revolving Credit Facility
On March 29, 2021, the Obligors entered into a Senior Secured Revolving Credit Facility (the "Revolving Credit Facility") with JPMorgan Chase Bank, N.A., as administrative agent, issuing bank and swingline lender, and the lenders from time to time party thereto. The Revolving Credit Facility is due on the earlier of March 29, 2024, or any earlier date on which the revolving commitments are reduced to zero.
The ithree-year
Revolving Credit Facility had a borrowing limit of $i50,000 with an option to request an increase in the revolving commitment by up to $i25,000,
drawn in $i5,000 increments, for a total not to exceed $i75,000,
subject to customary conditions. On August 31, 2021, the Obligors entered into an amendment (the "First Amendment") to increase their original borrowing limit to $i100,000. In connection with the First Amendment, the Company's previously acquired subsidiaries became party to the Revolving Credit Facility
as either borrowers or as guarantors. The Revolver maintains an interest rate of LIBOR plus i1.95% and has a i0.0% LIBOR floor. A fee of i0.25%
per annum is charged for available but unused borrowings as defined. On October 25, 2021, the Company and its subsidiaries entered into a second amendment (the “Second Amendment”), with JPMorgan Chase Bank, N.A., pursuant to which the parties consented to the Term Loan described above and made certain conforming changes to comport with the Term Loan provisions.
The unamortized debt issuance costs were $i794
as of June 30, 2022, and are included in Other assets in the condensed consolidated balance sheets. Debt issuance costs are being amortized to interest expense over the term of the Revolver.
The Revolving Credit Facility is an asset-based facility that is secured by a first lien on the working capital assets of the Company and a second lien on the non-working capital assets of the Company (including most of the Company’s subsidiaries). The borrowing base is based on a detailed monthly calculation of the sum of (a) a percentage
of the Eligible Accounts at such time, plus (b) the lesser of (i) a percentage of the Eligible Inventory, at such time, valued at the lower of cost or market value, determined on a first-in-first-out basis, and (ii) the product of a percentage multiplied by the Net Orderly Liquidation Value percentage identified in the most recent inventory appraisal ordered by the Administrative Agent multiplied by the Eligible Inventory, valued at the lower of cost or market value, determined on a first-in-first-out basis, minus (c) Reserves (each of the
NOTES TO THE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
defined terms above, as defined in the Revolving Credit Facility documents). As of June 30, 2022, the Company would be able to borrow approximately $i70 million under
the Revolving Credit Facility.
The Company is required to maintain certain reporting requirements, affirmative covenants and negative covenants, pursuant to terms outlined in the agreement. Additionally, if the Company’s Excess Availability (as defined in the Revolving Credit Facility documents) is less than $i10,000, the
Company will be required to maintain a minimum fixed charge coverage ratio of i1.1x on a rolling itwelve-month basis until the Excess
Availability is more than $i10,000 for thirty consecutive days. The Company must also comply with a higher fixed charge coverage ratio of i1.15x
in order to consummate permitted acquisitions and to make restricted payments, but no such acquisitions or payments are currently contemplated. As of June 30, 2022, the Company is in compliance with the covenants contained in the Revolving Credit Facility.
Other debt is primarily comprised of approximately $i2,250 in finance lease obligations and $i106 in a foreign subsidiary's
other debt.
Encina Credit Facility
On July 11, 2019, the Company and certain of its direct and indirect subsidiaries (the “Encina Obligors”) entered into the Encina Credit Facility through a certain Loan and Security Agreement whereby the Encina Obligors obtained a revolving asset-based loan commitment in the maximum amount of $i45,000
(inclusive of a limit of up to $i15,000 of borrowings for the Canadian borrowers and a swingline facility of up to $i2,000),
subject to applicable borrowing base availability, through Encina Business Credit, LLC. The Encina Credit Facility was due on the earlier of July 11, 2022, or i90 days prior to the scheduled maturity date of the Brightwood Loan Services LLC Term Loan. The Encina Credit Facility was secured by working capital assets and a second lien on non-working capital assets. The Encina Credit Facility was repaid in December 2020 and replaced in March 2021 by the Revolving Credit Facility (as defined above). The unamortized deferred financing
costs and early termination fees totaling $i680 were recognized as a loss on debt extinguishment in the condensed consolidated statements of operations for the six months ended June 30, 2021.
11. iSTOCKHOLDERS’
EQUITY
Warrants
On July 19, 2021, the Company completed the redemption ("Redemption") of certain of its outstanding warrants (the "Investor Warrants") that were issued in connection with a private placement of units (the "private placement"), each unit consisting of a share of common stock and a warrant to purchase an additional one-half (1/2) shares of common stock.
The Company was entitled to redeem all of the outstanding Investor Warrants for a redemption price of $i0.00033712
per Investor Warrant ("Redemption Price") if (i) there was an effective registration statement covering the resale of the shares of common stock underlying the Investor Warrants, and (ii) the volume-weighted average price of the Company's common stock for the twenty consecutive trading days prior to the date of the notice of redemption is at least $i25.28, of which both requirements were met. Investor Warrants were exercisable at a price of $i16.86
per share until July 19, 2021 (the "redemption date"). Any Investor Warrants that remained unexercised immediately after the redemption date were void and no longer exercisable, and the holders of those Investor Warrants were entitled to receive the Redemption Price.
Prior to the redemption date i3,367,647 Investor
Warrants were exercised, generating total gross proceeds of $i56,778. The Company redeemed i1,491
Investor Warrants at the Redemption Price.
In connection with the private placement, the Company agreed to engage the placement agent (the "Placement Agent") as the Company's warrant solicitation agent in the event the Investor Warrants were called for Redemption. The Company agreed to pay a warrant solicitation fee to the Placement Agent equal to ifive
percent of the amount of net cash proceeds solicited by the Placement Agent upon the exercise of certain Investor Warrants following such call for Redemption.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
i
As
of June 30, 2022, the following table summarizes the outstanding warrants:
Number of Warrants
Exercise Price
Placement agent warrants
i11,662
$
i8.43
Placement
agent warrants
i6,007
$
i16.86
Total
i17,669
$
i11.30
/
12.
iSTOCK-BASED COMPENSATION
Stock-based compensation plan overview
The Company maintains ithree
equity incentive plans: the 2018 Equity Incentive Plan (“2018 Plan”), the 2019 Employee, Director and Consultant Equity Incentive Plan (“2019 Plan”) and the 2020 Employee, Director, and Consultant Equity Incentive Plan (“2020 Plan” and collectively, “Incentive Plans”). The 2020 Plan serves as the successor to the 2019 Plan and 2018 Plan and provides for the issuance of incentive stock options, nonqualified stock options, stock grants and stock-based awards to employees, directors, and consultants of the Company. No further awards will be issued under the 2018 Plan and 2019 Plan. As of June 30, 2022, a total of i1,628,154
shares are available for grant under the 2020 Plan.
Restricted Stock Unit ("RSU") Activity
RSUs granted to certain executives, employees and members of the Board generally have a time-based vesting requirement (based on continuous employment). The stock-based compensation expense related to service-based awards is recorded over the requisite service period. During the six months ended June 30, 2022, the Company granted RSU awards that are expected to vest either (i) ratably over a ithree-year
period on each anniversary of the grant date, or (ii) with three vesting tranches, the first of which occurred on the grant date, and the following two tranches on each subsequent anniversary of the grant date. The following table summarizes the activity related to the Company's RSUs for the six months ended June 30, 2022. iFor purposes of this table, vested RSUs represent the shares for
which the service condition had been fulfilled during the six months ended June 30, 2022:
As
of June 30, 2022, total unamortized stock-based compensation cost related to unvested RSUs was $i7,617 and the weighted-average period over which the compensation is expected to be recognized is i1.37
years. For the three and six months ended June 30, 2022, the Company recognized $i1,849 and $i4,648,
respectively, of total stock-based compensation expense for RSUs. As of June 30, 2022, there were i6,357 RSUs which had vested, but were not yet issued due to the recipients' elections to defer the awards.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
Performance Stock Unit ("PSU") Activity
During the six months ended June 30, 2022, the Company granted PSU awards that are subject to a ione-year
vesting requirement (based on continuous employment) and contain performance conditions based on certain performance metrics. The following table summarizes the activity related to the Company's PSUs for the six months ended June 30, 2022:
As
of June 30, 2022, total unamortized stock-based compensation cost related to unvested PSUs was $i425 and the weighted-average period over which the compensation is expected to be recognized is less than ione
year. For the three and six months ended June 30, 2022, respectively, the Company recognized $i115 and $i160
of total stock-based compensation expense for PSUs.
Stock options
i
The following table summarizes the stock option activity for the six months ended June 30, 2022:
Number
Weighted average exercise
price
Weighted average grant date fair value
Weighted average remaining contractual term (years)
As
of June 30, 2022, total compensation cost related to unvested awards not yet recognized was $i680 and the weighted-average period over which the compensation is expected to be recognized is i1.80
years. For the three and six months ended June 30, 2022, respectively, the Company recognized $i109 and $i173
of total stock-based compensation expense for stock options.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except share and per share amounts)
13. iCOMMITMENTS,
CONTINGENCIES, AND RELATED PARTY TRANSACTIONS
Purchase commitments
iFrom time to time in the normal course of business, the Company will enter into agreements with suppliers which provide favorable pricing in return for a commitment to purchase minimum amounts of inventory over a defined time period.
Contingencies
iIn
the normal course of business, certain claims have been brought against the Company and, where applicable, its suppliers. While there is inherent difficulty in predicting the outcome of such matters, management has vigorously contested the validity of these claims. Based on available information, management believes the claims are without merit and does not expect that the outcome, individually or in the aggregate, would have a material adverse effect on the consolidated financial positions, results of operations, cash flows or future earnings.
Related party transactions — Hydrofarm Distribution Center
The Company leased a distribution center in Petaluma, California from entities in which a related party
was a stockholder. For the three and six months ended June 30, 2021, rent expense for the month-to-month lease totaled $i319 and $i639, respectively.
14.
iFAIR VALUE MEASUREMENTS
i
The following table summarizes the estimated fair value of the
Company's assets and liabilities for which disclosure of fair value is required:
The
carrying values of cash and cash equivalents, restricted cash, accounts receivable, accounts payable, accrued and other current liabilities approximate their fair value due to their short-term maturities. The carrying value of the note receivable (as described in Note 2 - Basis of Presentation and Significant Accounting Policies) and the carrying value of contingent consideration (as described in Note 3 - Business Combinations) are based on level 3 fair value measurements and are reported at estimated fair value. The fair value of the Company's Term Loan was based on bank quotes and the carrying amount reported above excludes unamortized deferred financing costs and discount.
Nonrecurring fair value measurements include the
Company’s goodwill impairment recognized during the three and six months ended June 30, 2022, as determined based on unobservable Level 3 inputs. Refer to Note 4 - Goodwill and Intangible Assets, Net, for further discussion.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis provides information that we
believe is relevant to an assessment and understanding of our results of operations and financial condition. You should read this analysis in conjunction with our audited and unaudited consolidated financial statements and the notes contained elsewhere in this Quarterly Report on Form 10-Q and our 2021 Annual Report. This discussion and analysis contains statements of a forward-looking nature relating to future events or our future financial performance. These statements are only predictions, and actual events or results may differ materially. In evaluating such statements, you should carefully consider the various factors identified in this Quarterly Report on Form 10-Q, which could cause actual results to differ materially from those expressed in, or implied by, any forward-looking statements, including those set forth in “Risk Factors” in our 2021 Annual Report. See “Special Note Regarding Forward-Looking Statements.”
Company
Overview
We are a leading independent manufacturer and distributor of CEA equipment and supplies, including a broad portfolio of our own innovative proprietary branded products. We primarily serve the U.S. and Canadian markets, and believe we are one of the leading competitors by market share in these markets in an otherwise highly fragmented industry. For over 40 years, we have helped growers make growing easier and more productive. Our mission is to empower growers, farmers and cultivators with products that enable greater quality, efficiency, consistency, and speed in their grow projects.
Hydroponics is the farming of plants using soilless growing media and often artificial lighting in a controlled indoor or greenhouse environment. Hydroponics is the primary category of CEA and we use the terms CEA and hydroponics interchangeably. Our products are used to grow, farm, and cultivate
cannabis, flowers, fruits, plants, vegetables, grains and herbs in controlled environment settings that allow end users to control key farming variables including temperature, humidity, CO2, light intensity spectrum, nutrient concentration and pH. Through CEA, growers are able to be more efficient with physical space, water and resources, while enjoying year-round and more rapid grow cycles as well as more predictable and abundant grow yields, when compared to other traditional growing methods.
We reach commercial farmers and consumers through a broad and diversified network of over 2,000 wholesale customer accounts, who we connect with primarily through our proprietary e-commerce marketplace. A 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 the U.S. and Canada to a diversified range of retailers of commercial and home gardening equipment and supplies that include garden centers, hardware stores, e-commerce retailers, commercial greenhouse builders, and commercial resellers.
During fiscal year 2021, we completed five acquisitions of branded manufacturers of CEA products, resulting in a significant expansion of our portfolio of proprietary branded products and our specialized manufacturing capabilities, including:
•Heavy 16, a manufacturer of plant nutrients and additives, in May 2021;
•House & Garden, a manufacturer of plant nutrients and additives, in June 2021;
•Aurora Innovations, a manufacturer of soil, grow media, plant
nutrients and additives, in July 2021;
•Greenstar Plant Products, a manufacturer of plant nutrients and additives, in August 2021; and
•Innovative Growers Equipment, a manufacturer of horticultural benches, racks and grow lights, in November 2021.
Primarily due to a sustained decline in the Company's market value of common stock and market
conditions, we identified a triggering event requiring a test for goodwill impairment as of June 30, 2022. We completed our goodwill impairment testing and recorded an impairment charge of $189.6 million as the test determined that the carrying value of the goodwill reporting units of U.S. and Canada was in excess of the fair value. The recognized impairment reduced the goodwill balance to zero as of June 30, 2022. The impairment was primarily due to a deterioration in customer demand in the U.S. and Canada caused by macroeconomic and industry conditions.
We determined the fair value of the U.S. and Canada reporting units based on an income approach, using the present value of future discounted cash flows, and based on a market approach. The fair values were reconciled to the market value of common stock of Hydrofarm to corroborate
the estimates used in the interim test for impairment. The fair value determinations were a reflection of recent sales declines we have experienced, which we believe are primarily a result of an agricultural oversupply impacting our market, and a reduction to our current year profitability and loss from operations. The extent to which these market conditions will continue to impact our business, results of operations, and cash flows are uncertain and difficult to predict at this time. As a result of market conditions and our inventory balance, we have reduced manufacturing and production levels, and in certain cases, implemented temporary employee furloughs all of which may continue in future periods.
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.
Further, we maintain an allowance for excess and obsolete inventory that is based upon assumptions about future demand and market conditions. During the three and six months ended June 30, 2022, our condensed consolidated statements of operations were negatively impacted by $10.2 million and $13.4 million, respectively, of increases to our allowance for inventory obsolescence primarily due to certain lighting products. It is possible we may incur an impairment charge related to intangible assets in the future, or additional increases to our allowance for inventory obsolescence in future periods depending on market and industry conditions.
Effects of COVID-19 on Our Business
The World Health Organization recognized COVID-19 as a global pandemic on March 11, 2020, and COVID-19 has had
significant and ongoing negative impacts on global societies, workplaces, economies and health systems. Authorities throughout the world have implemented measures to contain or mitigate the spread of the virus, including at various times physical distancing, travel bans and restrictions, closure of non-essential businesses, quarantines, work-from-home directives, mask requirements, shelter-in-place orders, and vaccination programs, but despite these efforts, COVID-19 has persisted, has mutated into new variants, and is expected to become endemic. We have implemented business continuity plans and followed safety protocols as recommended by government guidelines, and we will continue to do so as the state of COVID-19 evolves. As of the filing of this Quarterly Report, our operations are not impacted by any COVID-19 related facility closures, lockdown measures, travel restrictions or similar limitations. However, new waves of COVID-19 or its variants could cause the reinstatement
of such limitations, and such limitations may adversely impact our supply chains, the manufacturing of our own products and our ability to obtain necessary materials, all of which could adversely affect our business, results of operations and financial condition. We have historically and may continue to source select products from China. We 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. Furthermore, potential suppliers or sources of materials may pass the increase in sourcing costs due to the COVID-19 pandemic to us through price increases, thereby impacting our potential future profit margins.
The extent to which the COVID-19 pandemic will ultimately impact our business, results of operations, financial condition and cash flows depends on future developments that are
highly uncertain, rapidly evolving and difficult to predict at this time. It is difficult to assess or quantify with precision the impact COVID-19 has directly had on our business since we cannot precisely quantify the impacts, if any, that the various effects have had on the overall business. We believe COVID-19 may have provided a positive demand impact in 2020 and 2021 from shelter-in-place orders in the United States, a possible negative supply chain impact from workforce disruption at international and domestic suppliers, and a possible negative growth rate impact in 2022 due to agricultural oversupply initiated during the height of COVID-related shelter-in-place orders in 2020 and 2021. We continue to monitor the COVID-19 pandemic and will adjust our mitigation strategies as necessary to address changing health, operational or financial risks that may arise.
Results of Operations—Comparison of three and six months ended June 30, 2022 and 2021
The following table sets forth our unaudited interim condensed consolidated statements of operations for the three and six months ended June 30, 2022, and 2021, including amounts and percentages of net sales for each period and the period-to-period change in dollars and percent (amounts in thousands):
Net sales for the three months ended June 30, 2022, were $97.5 million, a decrease of $36.3 million, or 27.1% compared to the same period in 2021. Net sales for the six months ended June 30, 2022, were $208.9 million, a decrease of $36.3 million, or 14.8%, compared to the same period in 2021.
The 27.1% decrease in net sales for the three months ended June 30, 2022, as compared to the same period in 2021, was due to a 29.9% decline in volume of products sold (a 43.4% decline in organic sales and a 13.5% increase from recently-acquired proprietary brands), a 3.1% increase in price and mix of products sold, and 0.3% decline from unfavorable foreign exchange rates.
The decrease in volume of products sold was primarily related to an agricultural oversupply, which put downward pressure on cannabis growing activity predominantly in California and Canada but also in many other U.S. states. The increase in price was primarily related to list price increases, as well as higher freight recovery. The decrease in foreign exchange related to recent strength in the U.S. Dollar relative to the Canadian Dollar and to the Euro.
The 14.8% decrease in net sales for the six months ended June 30, 2022, as compared to the same period in 2021, was due to a 17.4% decline in volume of products sold (a 40.5% decline in organic sales and a 23.1% increase from recently-acquired proprietary brands), a 2.8% increase in price and mix of products sold, and a 0.2% decline from unfavorable foreign exchange rates. The decrease in volume of products sold was primarily
related to the aforementioned oversupply in the cannabis industry. The increase in price was primarily related to list price increases, as well as higher freight recovery as we put multiple measures in place to combat rising freight costs. The decrease in foreign exchange related to recent strength in the U.S. Dollar relative to the Canadian Dollar and to the Euro.
Gross profit
Gross profit for the three months ended June 30, 2022, was $7.3 million, a decrease of $22.3 million, or 75.2%, compared to the same period in 2021. Gross profit for the six months ended June 30, 2022, was $23.9 million, a decrease of $28.9 million, or 54.7%, compared to the same period in 2021.
The decrease in gross profit for the three months ended June
30, 2022, as compared to the same period in 2021, was primarily related to (i) the aforementioned decrease in net sales and (ii) a significant decrease in our gross profit margin percentage (gross profit as a percent of net sales). Our gross profit margin percentage decreased to 7.5% for the three months ended June 30, 2022, from 22.1% in the same period in 2021. The lower gross profit margin percentage is primarily due to an increase in the inventory obsolescence allowance of $10.2 million primarily related to certain lighting products. Also negatively impacting gross profit margin were freight and labor costs which were higher as percentage of net sales. These were partially offset by the aforementioned list price increases, as well as a higher proportion of higher-margin proprietary brand sales.
The decrease in gross profit for the six months ended June
30, 2022, as compared to the same period in 2021, was primarily related to (i) the aforementioned decrease in net sales and (ii) a significant decrease in our gross profit margin percentage (gross profit as a percent of net sales). Our gross profit margin percentage decreased to 11.5% for the three months ended June 30, 2022, from 21.5% in the same period in 2021. The lower gross profit margin percentage is primarily due to an increase in the inventory obsolescence allowance of $13.4 million primarily related to certain lighting products. Also negatively impacting gross profit margin were freight and labor costs which were higher as percentage of net sales. These were partially offset by the aforementioned list price increases, as well as a proportion of higher-margin proprietary brand sales.
Selling, general and administrative expenses
Selling,
general and administrative ("SG&A") expenses for the three months ended June 30, 2022, were $26.0 million, a decrease of $1.3 million compared to the same period in 2021. SG&A expenses for the six months ended June 30, 2022, was $66.2 million, an increase of $22.1 million compared to the same period in 2021.
The $1.3 million decrease in SG&A for the three months ended June 30, 2022, compared to prior year was primarily related to (i) an $8.4 million decrease in acquisition and integration expenses, and (ii) a $0.4 million decrease in consulting and professional fees. These decreases were partially offset by (i) a $4.7 million increase in depreciation, depletion and amortization expense, (ii) an $1.0 million increase in facility costs, (iii) a $0.8 million increase
in share-based compensation expense, (iv) a $0.6 million increase in compensation expense (primarily salaries and benefits for employees from companies acquired in 2021), of which $0.2 million was severance associated with a recent reduction-in-force, (v) a $0.4 million increase in insurance costs.
The $22.1 million increase in SG&A for the six months ended June 30, 2022, compared to prior year was primarily related to (i) an $18.6 million increase in depreciation, depletion and amortization expense, of which $5.9 million represented
amortization
expense from adjustments to useful lives that were determined this year, (ii) a $3.7 million increase in compensation costs (primarily salaries and benefits for employees from companies acquired in 2021), of which $0.8 million was severance associated with a recent reduction-in-force, (iii) a $2.7 million increase in share-based compensation, (iv) a $2.0 million increase in facility costs, (v) an $1.4 million of costs associated with the relocation of certain of our distribution centers, (vi) a $0.9 million increase in insurance costs, and (vii) a $0.7 million increase in travel costs. These increases were partially offset by (i) an $8.0 million decrease in acquisition and integration expenses, and (ii) a $0.9 million decrease in consulting and professional fees.
Impairments
The Company recorded
a goodwill impairment charge of $189.6 million for the three and six months ended June 30, 2022, as we determined that the carrying value of the goodwill reporting units of U.S. and Canada was in excess of the fair value. The recognized impairment reduced the goodwill balance to zero as of June 30, 2022. The impairment was primarily due to a deterioration in customer demand in the U.S. and Canada caused by macroeconomic and industry conditions. For the six months ended June 30, 2022, the Company also recorded, in the fiscal first quarter, an impairment of a note receivable of $2.6 million.
Interest expense
Interest expense for the three months ended
June 30, 2022, was $2.4 million, an increase of $2.4 million compared to the same period in the prior year. Interest expense for the six months ended June 30, 2022, was $4.8 million, an increase of $4.6 million compared to the same period in the prior year. The increase was due to the interest-bearing Term Loan entered into in the fourth quarter of 2021 and outstanding for the full period during the first half of 2022.
Loss on debt extinguishment
Loss on debt extinguishment for the six months ended June 30, 2022, was zero, compared to $0.7 million in the prior year which resulted primarily from the write-off of unamortized deferred financing costs associated with the payoff of the Encina Credit Facility.
Income
tax (benefit) expense
Income tax benefit for the three months ended June 30, 2022, was $6.9 million, compared to $0.1 million of income tax expense in the prior year. Income tax benefit for the six months ended June 30, 2022, was $12.4 million, compared to $0.8 million of income tax expense in the prior year. Our effective income tax rate was 5.2% for the six months ended June 30, 2022, and differs from the U.S. federal statutory rate of 21% primarily due to the impairment of goodwill for certain 2021 acquisitions which was not deductible for U.S. tax purposes, increases in our valuation allowance on U.S. deferred
tax assets, and the establishment of a valuation allowance for Canadian deferred tax assets. As described in Note 4 - Goodwill and Intangible Assets, Net, during the three months ended June 30, 2022, we fully impaired the goodwill associated with all 2021 acquisitions. For the six months ended June 30, 2022, we recorded discrete income tax benefits of $12.1 million relating primarily to measurement period adjustments associated with 2021 acquisitions, and certain tax benefits related to goodwill impairment.
For the six months ended June 30, 2021, our income tax rate of 10.2% differs from the federal statutory rate of 21% primarily as a result of reducing valuation allowances on the our deferred tax assets related to net operating
loss carryforwards.
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 (loss) income provides useful supplemental measures that assist in evaluating our ability to generate
earnings and to more readily compare these metrics between past and future periods. These non-GAAP financial measures may be different than similarly titled measures used by other companies.
To supplement our condensed unaudited consolidated financial statements which are prepared in accordance with GAAP, we use “Adjusted EBITDA” and “Adjusted EBITDA as a percent of sales” which are non-GAAP financial measures (collectively referred to as “Adjusted EBITDA”). Our non-GAAP financial measures should not be considered in isolation from, or as substitutes for, financial information prepared in accordance with GAAP. There are several limitations related to the use of our non-GAAP financial measures as compared to the closest comparable GAAP measures. Some of these limitations include:
• Adjusted EBITDA does not reflect the significant interest expense, or the amounts
necessary to service interest or principal payments on our indebtedness;
• Adjusted EBITDA excludes depreciation, depletion and amortization, and although these are non-cash expenses, the assets being depreciated and amortized may have to be replaced in the future;
• Adjusted EBITDA does not reflect our tax provision that adjusts cash available to us;
• Adjusted EBITDA excludes the non-cash component of stock-based compensation;
• Adjusted EBITDA excludes the amount of employer payroll taxes on stock-based compensation; and
• Adjusted EBITDA does not reflect the impact of earnings or charges resulting from matters we consider not to be reflective, on a recurring basis, of our ongoing operations.
We define Adjusted
EBITDA as net income (loss) excluding interest expense, income taxes, depreciation, depletion and amortization, stock-based compensation, employer payroll taxes on stock-based compensation and other unusual and/or infrequent costs, which we do not consider in our evaluation of ongoing operating performance. The following table presents a reconciliation of net (loss) income, the most comparable GAAP financial measure, to Adjusted EBITDA for the three and six months ended June 30, 2022, and 2021 (in thousands):
1. Relates to costs incurred to exit and relocate distribution centers in California and Pennsylvania including lease exit costs, transportation, and labor related costs.
2. The Company completed its goodwill impairment testing and recorded an impairment charge of $189.6 million in the three months ended June 30, 2022, due to market softness in demand in the U.S. and Canada. During the quarter ended March 31, 2022, impairment primarily related to a $2.6 million charge associated with a note receivable that originated in 2019 associated with a third party independent processor serving the CBD market.
3. Severance costs incurred during
the three and six months ended June 30, 2022, related to workforce reductions to optimize our cost structure.
4. For the three months ended June 30, 2022, this includes non-cash purchase accounting inventory adjustments for House & Garden and Greenstar $0.4 million, and the elimination of acquisition and integration consulting, transaction services and legal fees incurred for the completed Heavy 16, House & Garden, Aurora, Greenstar, and the Innovative Growers Equipment acquisitions and certain potential acquisitions of $0.8 million. For the six months ended June 30, 2022, this includes non-cash purchase accounting inventory adjustments for House & Garden, Aurora, Greenstar and the Innovative Growers Equipment of $4.4 million, the elimination of acquisition and integration
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 of $3.4 million, partially offset by the change in fair value of contingent consideration for Aurora of ($1.6 million).
5. Includes stock-based compensation and related employer payroll taxes on stock-based compensation for the periods presented.
6. Reflects the elimination of one-time investor warrant solicitation fees.
Liquidity and Capital Resources
The following table summarizes our cash flows for the six months ended June 30, 2022, and 2021 (amounts in thousands):
Effect of exchange rate changes on cash, cash equivalents and restricted cash
(115)
73
Net (decrease) increase in cash, cash equivalents and restricted cash
(939)
118,412
Cash, cash equivalents and restricted cash
at beginning of period
28,384
76,955
Cash, cash equivalents and restricted cash at end of period
$
27,445
$
195,367
Operating Activities
Net cash from operating activities was $7.3 million for the six months ended June 30, 2022, primarily due to $7.2 million net cash inflow from a reduction of working capital. This included a decrease of $21.3
million in inventories and a decrease of $6.2 million in accounts receivable, partially offset by decreases of $6.7 million in deferred revenue and $6.4 million in accrued expenses and other current liabilities.
Net cash used in operating activities was $0.5 million for the six months ended June 30, 2021, primarily consisting of $9.2 million in non-cash expense addbacks, which were largely composed of depreciation, depletion and amortization, stock-based compensation expense, non-cash operating lease and other non-cash expense, to reconcile net income of $7.2 million to net cash used in operating activities, less a $16.9 million increase in working capital. This change in working capital primarily reflects an aggregate increase of $33.7 million in accounts receivable, inventories, prepaid expenses and other current assets, and other assets for the period offset by an aggregate
net increase of $16.8 million in accounts payable, accrued expenses and other current liabilities, and a decrease in lease liabilities due to payments on lease obligations during the period.
Investing Activities
Net cash used in investing activities was $4.7 million for the six months ended June 30, 2022, and was due primarily to purchases of property, plant and equipment, which increased over prior year due to our acquired companies' greater capital requirements.
Net cash used in investing activities for
the six months ended June 30, 2021, was $196.6 million, due mostly to the Heavy 16 and the House & Garden acquisitions we completed during the period. The outflows associated with the Heavy 16 acquisition and the House & Garden acquisitions totaled $195.8 million.
Financing Activities
Net cash used in financing activities was $3.3 million for the six months ended June 30, 2022. We paid $2.1 million related to employees' withholding tax in connection with the vesting of restricted stock units. In addition, we paid $0.6 million on the Term Loan.
Net cash from financing activities for the six months ended June 30, 2021, was $315.4 million. We received proceeds of $309.8 million from
our follow-on offering, and received an additional $20.3 million from the redemption ("Redemption") of investor warrants. We received the remaining balance of the $56.8 million of gross proceeds from the Redemption in July 2021. We also paid $14.9 million related to employees' withholding tax in connection with the vesting of restricted stock units.
Liquidity
Our ability to make investments in our business, service our debt and maintaining strong liquidity will depend upon our ability to generate excess operating cash flows through our operating subsidiaries. Based on current levels of operations, we believe that our cash flows from operations, combined with our current cash levels and borrowing availability, will be adequate to fund debt service requirements and provide cash, as required,
to support our ongoing operations, capital expenditures, lease obligations and working capital needs through the next twelve months of operations.
If necessary, we believe that we could supplement our cash position through sales/leasebacks, asset sales and an equity financing. We are hopeful that none of these actions will be necessary in the down market we are currently experiencing. However, we also believe it is prudent to be prepared if required and, accordingly, are engaged in the preliminary process of evaluating and preparing to implement such steps should it prove necessary.
Senior Secured Term Loan
On October 25, 2021, we and certain of our direct and indirect subsidiaries
entered into the Term Loan with JPMorgan Chase Bank, N.A., as administrative agent for certain lenders, pursuant to which we borrowed a $125.0 million senior secured term loan. The Term Loan bears interest at LIBOR (with a 1.0% floor) plus 5.50%, or an alternative base rate (with a 2.0% floor), plus 4.50%, and is subject to a call premium of 2% in year one, 1% in year two, and 0% thereafter, and matures on October 25, 2028. We received net proceeds of $119.9 million in 2021 from the Term Loan after deducting discounts and deferred financing costs.
The principal amounts of the Term Loan are to be repaid in consecutive quarterly installments in amounts equal to 0.25% of the principal amount of the Term Loan, on the last day of each fiscal quarter commencing March 31, 2022, with the balance of the Term Loan
payable on the Maturity Date.
The Term Loan requires us to maintain certain reporting requirements, affirmative covenants, and negative covenants, and we were in compliance with all requirements as of June 30, 2022. The Term Loan is secured by a first lien on the non-working capital assets of the Company and a second lien on the working capital assets. We may request additional term loan commitments subject to certain loan conditions.
JPMorgan Revolving Credit Facility
On March 29, 2021, we and certain of our direct and indirect subsidiaries
entered into a Senior Secured Revolving Credit Facility with JPMorgan Chase Bank, N.A., as administrative agent, issuing bank and swingline lender, and the lenders from time-to-time party thereto. The Revolving Credit Facility replaced the Encina Credit Facility. The Revolving Credit Facility is due on the earlier of March 29, 2024, or any earlier date on which the revolving commitments are reduced to zero.
The Revolving Credit Facility has been amended since its origination in connection with modifications to increase the borrowing limit and to consent to the Term Loan.
The three-year Revolving Credit Facility has a borrowing limit of $100 million subject to customary conditions. The Revolver maintains an interest rate of LIBOR plus 1.95% and has a 0.0% LIBOR floor. A fee of 0.25% per annum is charged for available but unused borrowings
as defined. The Revolving Credit Facility is an asset-based facility that is secured by a first lien on the working capital assets of the Company and a second lien on the non-working capital assets of the Company (including most of the Company’s subsidiaries). The borrowing base is based on a detailed monthly calculation of the sum of
(a)
a percentage of the Eligible Accounts at such time, plus (b) the lesser of (i) a percentage of the Eligible Inventory, at such time, valued at the lower of cost or market value, determined on a first-in-first-out basis, and (ii) the product of a percentage multiplied by the Net Orderly Liquidation Value percentage identified in the most recent inventory appraisal ordered by the Administrative Agent multiplied by the Eligible Inventory, valued at the lower of cost or market value, determined on a first-in-first-out basis, minus (c) Reserves (each of the defined terms above, as defined in the Revolving Credit Facility documents). As of June 30, 2022, the Company would be able to borrow approximately $70 million under the Revolving Credit Facility.
The
Company is required to maintain certain reporting requirements, affirmative covenants and negative covenants, pursuant to terms outlined in the agreement. Additionally, if the Company’s Excess Availability (as defined in the Revolving Credit Facility documents) is less than $10,000, the Company will be required to maintain a minimum fixed charge coverage ratio of 1.1x on a rolling twelve-month basis until the Excess Availability is more than $10,000 for P30D consecutive days. The Company must also comply with a higher fixed charge coverage ratio of 1.15x in order to consummate permitted acquisitions and to make restricted payments, but no such acquisitions or payments are currently contemplated. As of June 30,
2022, the Company is in compliance with the covenants contained in the Revolving Credit Facility.
Our material cash requirements include interest payments on our long-term debt, operating lease payments, the payment of contingent consideration, which was subsequently paid out in cash in July 2022, and purchase obligations to support our operations. Refer to Part I, Item 1, Financial Statements, Note 10 - Debt,
Note 7 - Operating Leases, Note 3 - Business Combinations and Note 13 - Commitments, Contingencies, and Related Party Transactions for details relating to our material cash requirements for debt, our leasing arrangements, including future maturities of our operating lease liabilities, contingent consideration, and purchase obligations, respectively.
Critical Accounting Policies and Estimates
The preceding discussion and analysis of our consolidated results of operations and financial condition should be read in conjunction with our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. Our critical accounting policies and estimates are identified in Management's Discussion and Analysis of Financial
Condition and Results of Operations in Part II, Item 7 of our most recently filed Form 10-K and include the discussion of estimates used in business combinations, goodwill, and long-lived assets. Such accounting policies and estimates require significant judgments and assumptions to be used in the preparation of the Condensed Consolidated Financial Statements included in this Form 10-Q, and actual results could differ materially from the amounts reported.
Goodwill is evaluated for impairment annually in the fourth quarter, or on an interim basis when an event or change in circumstances occurs, indicating that the carrying value may not be recoverable. Primarily due to a decline in the Company's market value of common stock and market conditions, the Company
identified a triggering event requiring a test for impairment as of June 30, 2022. The Company completed its goodwill impairment testing and recorded an impairment charge due to market softness in demand in the U.S. and Canada. The Company determined the fair value of the U.S. and Canada reporting units based on an income approach, using the present value of future discounted cash flows, and based on a market approach. Significant estimates used to determine fair value include the weighted average cost of capital, financial forecasts, and pricing multiples derived from publicly-traded companies that are comparable to the reporting units. The fair values were reconciled to the market value of common stock of Hydrofarm to corroborate the estimates used
in the interim test for impairment.
Intangible assets with finite lives and indefinite lives are reviewed for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. For the quarter ended June 30, 2022, the Company performed an evaluation of intangible assets for impairment in connection with the triggering event identified requiring a quantitative test for goodwill impairment. This impairment evaluation includes a comparison of the undiscounted cash flows expected to be generated by that long-lived asset or asset group to its carrying amount. If the carrying amount of the long-lived asset or asset group is not recoverable on an undiscounted cash flow basis, impairment is recognized to the extent that the carrying amount exceeds its fair
value. Based on the Company's evaluation, there was no impairment of intangible assets or other long lived assets for the quarter ended June 30, 2022.
The Company believes that the intangible asset impairment evaluations were based on reasonable assumptions that marketplace participants would use. However, such assumptions are inherently uncertain and actual results could differ from those estimates. Changes to or a failure to achieve our projected business assumptions, including growth and profitability, could result in a valuation that would trigger an impairment in future periods.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of economic losses due to adverse changes in financial market prices and rates. Our primary market risk has been interest rate, foreign currency and inflation risk. We do not have material exposure to commodity risk.
Interest Rate Risk
We are exposed to interest rate risk through our variable rate debt. As of June 30, 2022, we had $124.4 million of debt subject to variable interest rates that are based on London interbank offered rate (“LIBOR”) or an alternate base rate. If these rates were to increase by 100 basis from the rates in effect as of June 30, 2022, our interest expense
on the variable-rate debt would increase by an average of $1.2 million annually. We do not currently hedge our interest rate risks but may determine to do so in the future.
Foreign Currency Risk
The functional currencies of our foreign subsidiary operations are predominantly in the Canadian dollar (“CAD”) and the Euro. For the purposes of presenting these consolidated financial statements, the assets, and liabilities of subsidiaries with CAD or Euro functional currencies are translated into USD using exchange rates prevailing at the end of each reporting period. Income and expense items are translated at the average rate prevailing during the period with exchange differences impacting other comprehensive income (loss) in equity. Therefore, our results of operations and cash flows are
subject to fluctuations due to changes in foreign currency exchange rates, principally the CAD.
However, we believe that the exposure to foreign currency fluctuation from product sales and operating expenses is not significant at this time as the related product sales and costs do not constitute a significant portion of our total net sales and expenses. As we grow and expand the geographic reach of our operations, our exposure to foreign currency risk could become more significant. To date, we have not entered into any foreign currency exchange contracts and currently do not expect to enter into foreign currency exchange contracts for trading or speculative purposes.
Impact of Inflation
Our
results of operations and financial condition are presented based on historical costs. We cannot provide assurances that our results of operations and financial condition will not be materially impacted by inflation in the future.
Our management, with the participation and supervision of our Chief Executive Officer and our Chief Financial Officer, have evaluated
the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based upon that evaluation, the Company's management, including the Chief Executive Officer and the Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this Quarterly Report on Form 10-Q.
Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized,
and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost benefit relationship of possible controls and procedures.
Changes in Internal Controls over Financial Reporting
There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act)
that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
From time to time, we may become involved in various lawsuits and legal
proceedings, which arise, in the ordinary course of business. We are currently not aware of any legal proceedings or claims that we believe will have a material adverse effect on our business, financial condition or operating results.
ITEM 1A. RISK FACTORS
For a discussion of risk factors, please read Item 1A, "Risk Factors" in our 2021 Annual Report. Such risk factors continue to be relevant to an understanding of our business, financial condition and operating results. As of the date of this Quarterly Report on Form 10-Q, there have been the following material changes with respect to such risk factors.
Long-lived assets and inventories represent a significant portion of our total assets and we may be required
to record impairments or write-downs in future periods.
Our condensed consolidated balance sheet as of June 30, 2022, includes $313.5 million of intangible assets, net, $157.3 million of inventories, $52.6 million of property, plant, and equipment, net, and $51.9 million of operating lease right-of-use assets. During the three months ended June 30, 2022, we recorded a $189.6 million goodwill impairment charge due to a decline in the estimated fair value of our reporting units. During the three months ended June 30, 2022, we recorded additional allowances for inventory obsolescence of $10.2 million primarily due to certain durable lighting products.
Long-lived assets, such as intangible assets, property, plant and equipment and operating
lease right-of-use assets are reviewed for impairment whenever events, changes or circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. If we were to conclude that a future write-down of our long-lived assets is necessary, we would have to record the appropriate charge, which could result in a material adverse effect on our results of operations. Inventories consist of manufactured goods, goods acquired for resale, and materials consumed in business operations. Inventories are stated at the lower of cost or net realizable value, and the Company maintains an allowance for excess and obsolete inventory. The estimate for excess and obsolete inventory is based upon assumptions about future demand and market conditions. The Company has experienced recent sales
declines, which we believe are primarily a result of agricultural oversupply impacting our market. The extent to which these market conditions will continue to impact our business, results of operations, and cash flows are uncertain and difficult to predict at this time, and may result in lower margins, inventory write-downs, and impairments of our long-lived assets which could have a material adverse effect on our business, financial condition and results of operations.
If we fail to manage our inventory effectively, our results of operations, financial condition and liquidity may be materially and adversely affected.
Our business requires us to manage inventory effectively. We depend on our forecasts of demand for, and popularity of, various products to make purchase decisions and to manage our inventory of stock-keeping units. Demand for products, however, can change significantly
between the time inventory or components are ordered and the date of sale. Demand may be affected by seasonality, new product launches, rapid changes in product cycles and pricing, product defects, promotions, changes in consumer spending patterns, changes in consumer tastes with respect to our products and other factors, and our consumers may not purchase products in the quantities that we expect. It may be difficult to accurately forecast demand and determine appropriate levels of product or components. From time to time in the normal course of business, we enter into agreements with our suppliers pursuant to which we are required to purchase minimum amounts of inventory over a defined time period. We receive favorable pricing terms in exchange for this arrangement, but such agreements could lead to an oversupply of inventory. If we fail to manage our inventory effectively or negotiate favorable credit terms with third-party suppliers, we may be subject to a heightened
risk of inventory obsolescence, a decline in inventory values, and significant inventory write-downs or write-offs. In addition, if we are required to lower sale prices in order to reduce inventory level or to pay higher prices to our suppliers, our profit margins might be negatively affected. Any of the above may materially and adversely affect our business, financial condition and results of operations.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
# The certifications attached as Exhibits 32.1 and 32.2 accompany this Quarterly Report on Form 10-Q pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, and shall not be deemed “filed” by the Company for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, nor shall they be deemed incorporated by reference into any filing of the registrant under the Securities Act of 1933, as amended, or the Exchange Act, whether made before or after the date hereof, regardless of any general incorporation language in such filing.
+ Certain schedules
and exhibits have been omitted pursuant to Item 601(b)(2) of Regulation S-K. A copy of any omitted schedule and/or exhibit will be furnished to the Securities and Exchange Commission upon request.
† Certain confidential portions (indicated by brackets and asterisks) have been omitted from this exhibit.
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized.