Hydrofarm(HYFM) - 2022 Q4 - Annual Report

FORM 10-K Cover Page This section serves as the official cover page for the company's annual report on Form 10-K DOCUMENTS INCORPORATED BY REFERENCE Certain content from the 2023 annual shareholder meeting proxy statement is incorporated by reference into Part III of this 10-K report - Certain content from the company's 2023 annual shareholder meeting proxy statement has been incorporated by reference into Part III of this 10-K annual report, with the proxy statement to be filed within 120 days after the fiscal year ended December 31, 2022[8] TABLE OF CONTENTS This section provides an organized overview of the report's structure and content SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS This report contains forward-looking statements regarding business strategies, financial performance, and objectives, subject to various risks and uncertainties - This annual report contains forward-looking statements, as defined by the Private Securities Litigation Reform Act of 1995, concerning business strategies, future operating results, financial condition, objectives, and expectations, excluding historical facts[18] - Forward-looking statements are identified by words such as "believe," "may," "will," "potentially," "estimate," "continue," "anticipate," "intend," "could," "would," "project," "plan," "expect," but not all forward-looking statements contain these words[19] - Forward-looking statements are subject to risks, uncertainties, and assumptions described in the "Risk Factors" section and elsewhere in this annual report, where actual results may differ materially from projections, and the company undertakes no obligation to publicly update or revise any forward-looking statements unless required by law[21] PART I Item 1. BUSINESS Hydrofarm Holdings Group, Inc. is a leading North American manufacturer and distributor of controlled environment agriculture equipment and supplies Introduction Hydrofarm is a leading independent manufacturer and distributor of controlled environment agriculture equipment and supplies with over 40 years of history - Hydrofarm is a leading independent manufacturer and distributor of controlled environment agriculture (CEA) equipment and supplies, primarily serving the United States and Canadian markets[26] - The company's mission is to empower growers by providing products that enhance the quality, efficiency, consistency, and speed of cultivation projects[26] Key Financial Data | Metric | Fiscal Year 2022 | CAGR (2005-2022) | | :--- | :--- | :--- | | Net Sales | $345 million | Approx. 15% | How We Serve Our Customers The company serves customers by offering a comprehensive range of innovative CEA products and superior distribution and service capabilities - The company's customer value proposition is based on two pillars: offering the best selection of CEA products and being the gold standard in distribution and service[28] - The company offers thousands of innovative, branded CEA products, including lighting solutions, growing media, nutrients, equipment, and supplies[29] - Approximately two-thirds of net sales come from consumable products (growing media, nutrients, and supplies), with the remainder from durable products (lighting and equipment)[30] - Most of the company's products are either self-manufactured or supplied through exclusive/preferred brand relationships, which typically offer higher gross margins and competitive advantages[30] - The company operates six U.S. distribution centers and two Canadian distribution centers in North America, aiming to reach most customers within 48 hours, and also has a distribution center in Spain and a sourcing team in China[32][33] - The company has multiple manufacturing facilities in the U.S. and Canada, producing nutrients, soils, LED lights, and other products[34] The CEA Industry The Controlled Environment Agriculture industry is a significant global market segment with substantial growth projections, despite current cannabis market oversupply CEA Industry Market Size and Growth Forecast | Metric | 2022 Market Size | 2022-2027 CAGR | | :--- | :--- | :--- | | Global CEA Industry | Approx. $75 billion | 19% | | Global Hydroponics System Market | Approx. $12.1 billion | 16% | | North American Hydroponics System Market | Approx. $3.7 billion | 16% | - The company's historical growth (approx. 15% CAGR) has primarily been driven by the growth of the CEA market (including cannabis) and its innovative branded product and service capabilities[37] - Despite agricultural oversupply in the CEA cannabis market, the company believes the industry still has future growth prospects, especially as cannabis legalization progresses, with the U.S. cannabis market projected to reach approximately $52.6 billion by 2026, representing a 12.4% CAGR from 2022-2026[38][40] - Advantages of CEA include: higher product safety, quality, and consistency; more reliable, climate-independent year-round crop supply; lower pest and disease risk and reduced pesticide needs; less water and pesticide use; and reduced operating costs through efficient LED lighting, precise nutrient and water systems, and automation technologies[43] Increased Focus on Environmental, Social, and Governance ("ESG") Issues The company's CEA markets support ESG trends by promoting resource conservation, supply chain transparency, and superior agricultural performance - The company's CEA end markets support ESG trends by conserving resources, enhancing food supply chain transparency and safety, and offering superior performance compared to traditional agriculture[45] - The company published its inaugural ESG report on January 11, 2022, highlighting its environmental, health, and safety priorities and sustainable governance practices for fiscal year 2021[45] Our Competitive Strengths The company maintains a leading market position in the CEA industry through its extensive proprietary product portfolio, manufacturing capabilities, and customer-centric service - The company is a leading independent manufacturer and distributor of CEA equipment and supplies in the U.S. and Canada, and one of the two major consolidators in the industry[46] - The management team is highly experienced, including Chairman and CEO Bill Toler (former Hostess Brands CEO) and CFO B. John Lindeman (former Calavo Growers CFO)[47] - The company boasts over 35 internally developed or acquired proprietary brands and more than 60 preferred brands, with approximately 75% of sales derived from these brands, and proprietary brands typically yield higher gross margins[48] - The company operates seven internal manufacturing facilities in North America, covering nutrient blending, soil mixing, LED light manufacturing, and peat harvesting[49] - The company has established distribution relationships with approximately 400 suppliers and maintains a broad geographic footprint in North America, with six U.S. distribution centers covering most customers within 48 hours and two Canadian distribution centers serving the entire Canadian market[50][51] - The company serves large commercial end-users by restructuring its commercial sales team, adopting a solutions-oriented approach, and utilizing the DMI program to provide consulting, technical expertise, and timely delivery to wholesalers[52] Our Growth and Productivity Strategies The company pursues growth by leveraging the expanding CEA market, enhancing product offerings, empowering its wholesale network, and executing strategic acquisitions - The company benefits from the growth of the CEA market, including widespread adoption by commercial growers and consumers, as well as growth in cannabis and other end markets[53] - In 2021, the company significantly expanded its proprietary product portfolio and manufacturing capabilities through the acquisition of five companies: Heavy 16, House & Garden, Aurora Innovations, Greenstar Plant Products, and Innovative Growers Equipment[54][55] - The company invests in research and development to improve products and manufacturing processes, having launched new product lines such as PhotoBio LED lighting equipment[54] - The company is reorganizing its sales efforts to focus on the CEA food and floral markets, as well as the consumer gardening market[56] - The company empowers its wholesale network to serve large commercial growers by utilizing product experts and technical sales teams, offering cultivation space savings and timely inventory access[55] - The company views acquisitions as a critical component of its overall corporate strategy, aiming to accelerate sales and EBITDA growth by acquiring companies with competitive market positions, strong brands, high recurring revenue, and high-profit potential[57] Effects of COVID-19 on Our Business The COVID-19 pandemic continues to impact global supply chains and costs, potentially affecting demand and operational efficiency - The COVID-19 pandemic has had a significant and ongoing negative impact on global society, workplaces, economies, and healthcare systems[59] - The company has implemented business continuity plans and adheres to government safety protocols, with current operations unaffected by COVID-19-related facility closures, lockdowns, or travel restrictions[60] - The pandemic may lead to supply chain disruptions, hindered manufacturing of proprietary products, and difficulties in obtaining raw materials, which could adversely affect the business, operating results, and financial condition[60] - The company has experienced and may continue to experience extended supply chain lead times and increased shipping costs, with the COVID-19 pandemic being a primary cause[60] - Management believes COVID-19 may have positively impacted demand in 2020 and 2021 due to stay-at-home orders, but could negatively impact growth rates in 2022 due to agricultural oversupply[61] Government Regulation The company's products are subject to various state and federal regulations, with indirect impacts from the evolving legal landscape of the cannabis industry - The company's growing media and nutrient product lines in the U.S. are subject to state registration requirements, with organic products audited by the California Department of Food and Agriculture and the Organic Materials Review Institute, and pesticide products regulated by the Environmental Protection Agency (EPA)[62] - Canadian operations and product lines are regulated by the Canadian Food Inspection Agency, organic certified products by EcoCert, and peat harvesting operations by provincial and municipal agencies[62] - The company sells products through third-party retailers and distributors and does not directly sell to cannabis growers in countries where cannabis sales and use are prohibited, including the United States[66] - U.S. federal law still classifies cannabis as a Schedule I controlled substance, conflicting with state legalization laws, and changes in federal enforcement policy could have a material adverse effect on the cannabis industry and the company's business[75][78] - The company's credit agreement with JPMorgan restricts it from directly selling products to the cannabis industry[86] Intellectual Property The company protects its proprietary brands and technologies through a portfolio of patents and trademarks, which are crucial for competitive advantage - The company holds 15 U.S. design patents, 2 U.S. utility patents, 4 foreign patents and designs, 104 registered U.S. trademarks, and 114 registered foreign trademarks[87] - The company's 21 issued patents cover grow lighting and hydroponic systems and components, with expiration dates ranging from 2023 to 2035[87] - Intellectual property helps the company establish proprietary branded products, which typically generate higher sales margins than distributed products[87] - The company may need to enforce intellectual property and proprietary rights through litigation or defend against third-party infringement claims, which could result in significant costs and diversion of resources[88] - Due to the federal illegality of cannabis, companies involved in cannabis-related businesses may face restrictions in obtaining and enforcing patents and trademarks, which could impact the company's ability to protect its brands and proprietary technology[90] Human Capital The company's success relies on effective human resource management, including talent acquisition, development, and retention, amidst recent workforce reductions - As of December 31, 2022, the company had approximately 498 full-time employees globally, a reduction from 709 as of December 31, 2021[92] - In 2022, the company implemented layoffs and temporary employee furloughs to improve operational efficiency, with potential for further reductions in the future[92] - The company is committed to open and healthy communication, fostering an inclusive work environment to cultivate an innovative and team-oriented culture[91] - The company provides a comprehensive benefits platform, including an employee assistance program, and maintains a robust Environmental Health and Safety (EHS) management system, evaluating performance through an EHS scorecard[93][94][95] Corporate Structure Hydrofarm Holdings Group, Inc., incorporated in Delaware, operates through subsidiaries and functions as a "smaller reporting company" with simplified disclosure requirements - The company was incorporated in Delaware in January 2017 and conducts business through its wholly-owned direct and indirect subsidiaries, having supplied indoor gardening products since 1977[96][97] - The company qualifies as a "smaller reporting company" and has elected to comply with simplified disclosure requirements in this 10-K annual report[99] Item 1A. RISK FACTORS The company faces diverse risks related to business operations, debt, third-party dependencies, the cannabis industry, intellectual property, and capital stock Summary of Risk Factors The company's business is exposed to various risks and uncertainties across operational, financial, regulatory, and market domains - Risks facing the company's business include: proprietary brand risks, technological advancements, competitive pressures, asset impairment, inventory management, supply chain disruptions, international operations, environmental regulations, ESG practices, reputational damage, IT system disruptions, tariffs, taxes, capital needs, and product liability litigation[103] - Risks related to indebtedness include: substantial debt, ability to service debt, credit agreement restrictions (including prohibition on direct sales to the cannabis industry), and the impact of LIBOR to SOFR transition[103] - Risks related to third parties include: reliance on limited suppliers, difficulties or price increases in raw material procurement, and potential competition from suppliers directly entering the retail market[103][107] - Risks related to the cannabis industry include: conflicts between federal and state regulations, new California regulations, products affected by changing laws, federal illegality of cannabis, indirect involvement in the cannabis industry potentially harming reputation, and money laundering and financial record regulations[104][107] - Risks related to intellectual property include: unpredictability of patent issuance and enforcement, inadequate intellectual property protection, reliance on licenses, infringement claims, and costly intellectual property disputes[105][107] - Risks related to capital stock include: issuance of securities senior to common stock potentially causing dilution, anti-takeover provisions in corporate charter and Delaware law, risks as a holding company, Nasdaq listing standards, influence of large shareholders, and common stock price volatility[105][107] Risks Relating to Our Business The company's business operations are exposed to risks including product recalls, intense competition, asset impairment, supply chain disruptions, and regulatory compliance - Proprietary branded products may face product recalls, supply chain disruptions, and intellectual property protection challenges, potentially affecting relationships with suppliers[109] - Competitors may develop more effective or commercially attractive products, or sell at lower prices, making it difficult for the company to increase revenue and market share[110] - Failure to successfully develop new products or improve existing ones, or to meet consumer demand in a timely manner, could adversely affect market share[111] - As of December 31, 2022, the company's balance sheet included $300.4 million in net intangible assets, $111.4 million in inventory, $51.1 million in net property, plant, and equipment, and $65.3 million in operating lease right-of-use assets[114] - In 2022, the company recorded a $189.6 million goodwill impairment, reducing goodwill carrying value to zero, and recorded an $18.5 million inventory obsolescence reserve[114] - Poor inventory management could lead to obsolete inventory, decreased value, and significant write-downs, impacting operating results and financial condition[116] - Peat harvesting operations are susceptible to weather changes and climate change, potentially leading to lower-than-expected harvests[118][119] - Product defects or recalls could damage brand image, lead to decreased sales and profitability, and deplete financial resources[120] - Adverse economic and industry conditions (especially in the U.S. and Canada) could lead to reduced consumer and business spending, affecting the company's revenue, profitability, and cash flow[121] - Inflation and rising prices for raw materials, freight, labor, and energy could increase product manufacturing costs, negatively impacting profit margins and financial performance if not passed on to customers[122] - Acquisitions, strategic alliances, and investments may lead to operational difficulties, equity dilution, increased debt, contingent liabilities, and goodwill impairment, affecting financial condition and operating results[123][124][125][126] - Many of the company's facilities operate under long-term non-cancelable leases, and failure to renew or exit leases could result in additional costs or adversely affect the business[128][129] - Disruptions in freight carrier operations, increased shipping costs, or transportation delays could disrupt the supply chain, negatively impacting profit margins and financial performance[130] - International operations face risks including currency exchange rate fluctuations, restrictions on dividend remittances, compliance costs, increased fuel and import fees, inflation, changes in economic conditions, changes in trade and investment laws, and inadequate intellectual property protection[131] - Manufacturing risks from acquisitions include equipment failures, contamination, labor issues, raw material shortages, natural disasters, safety, and certification issues, potentially leading to product defects, recalls, and liability claims[132] - Failure to comply with environmental, health, and safety laws and regulations could result in significant costs, fines, or product recalls, damaging the company's reputation and financial condition[133][134][135][136] - Supply chain disruptions or failure to optimize the supply chain could adversely affect the business, financial condition, and operating results[137][138] - Increased scrutiny of ESG practices by customers, regulators, and investors may increase compliance costs or introduce new risks[139] - Climate change may affect facility availability, lead to increased costs for complying with climate change legislation and related regulations, and potentially impact financial performance[140][141] - Corporate and social responsibility and reputational risks could affect employee engagement, willingness of customers, suppliers, and partners to collaborate, and have a material adverse effect on the business[142] - As a public company, the company will continue to incur higher legal, accounting, Sarbanes-Oxley Act compliance, insurance, and other expenses, potentially diverting management's attention[143][144][145][146][147][148] - The company's election to use simplified disclosure as a "smaller reporting company" may lead investors to perceive its securities as less attractive, affecting the stock trading market and price volatility[149] - The company previously identified material weaknesses in internal control, which may recur in the future, and failure to maintain effective internal controls could affect the accuracy and timeliness of financial reporting, harming investor confidence[150][151][152][153][154] - The impact of the COVID-19 pandemic is unpredictable and could lead to reduced consumer spending, operational disruptions, supply chain constraints, and increased transportation costs, negatively affecting operating results and financial condition[155][156][157][158] - Reputational damage (e.g., product recalls, government investigations, allegations of unsafe products) could have a material adverse effect on business operations, sales, and costs[159][160] - Marketing activities may be unsuccessful, leading to significant resource investment without achieving sales growth[161] - IT system failures or cyberattacks could lead to operational disruptions, data breaches, negative publicity, and legal actions, materially adversely affecting the business and reputation[162][163][164][165][166] - Estimates and judgments in financial statement preparation may be inaccurate, leading to potential litigation and impaired financial performance[167] - Potential tariffs or global trade wars could increase product costs, affecting product competitiveness[168] - Changes in tax regulations, new tax laws, or additional tax burdens could affect profitability and cash flow[169][170] - The company's ability to utilize net operating loss (NOL) carryforwards may be limited, for example, due to ownership changes (Section 382) restricting annual utilization amounts[171][172] - If unable to obtain sufficient additional capital to fund operations, the company may be forced to limit the scope of its expansion[173] - Product liability lawsuits could result in significant liabilities, damage brand image, and deplete financial resources[174][175] Risks Relating to Our Indebtedness The company's substantial debt and restrictive credit agreements may limit operational flexibility, increase financial vulnerability, and impact market competitiveness - The company carries a substantial amount of debt and may incur additional debt in the future, which could limit cash flow for other business areas, affect debt servicing ability, and increase vulnerability to economic downturns and adverse industry conditions[177] - The JPMorgan credit agreement contains various financial and operational covenants that restrict the company's flexibility regarding debt, liens, dividend payments, investments, asset dispositions, mergers, and related-party transactions[177] - Violation of any covenant or failure to meet financial ratio tests could lead to debt default and accelerated repayment, materially adversely affecting the business, operating results, and financial condition[178] - The JPMorgan credit agreement prohibits the company from directly selling products to cannabis growers or retailers exclusively serving the cannabis industry, which may limit market options and affect competitiveness[179][180] - Most of the company's and its subsidiaries' assets are pledged under the JPMorgan credit agreement, and in case of default, JPMorgan has the right to exercise remedies, which could severely harm the company's business[181] - The transition from LIBOR to SOFR as an interest rate benchmark may result in higher borrowing costs and financial market disruptions, affecting the company's interest expense and earnings[182][183][184][185] Risks Relating to Third Parties The company faces risks from reliance on limited suppliers, global supply chain disruptions, and potential competition from its own suppliers - The company relies on a limited number of suppliers (e.g., for lighting ballasts), and disruptions in these relationships or their financial distress could lead to production interruptions, materially adversely affecting financial condition, operating results, and cash flow[187] - Global supply chain disruptions (e.g., COVID-19, labor disputes, natural disasters, trade sanctions, geopolitical tensions) could affect product supply, materially adversely impacting business operations, financial condition, and operating results[188][189] - Operational disruptions at company or supplier facilities (e.g., fire, flood, disease outbreaks, acts of war) could severely impact product production and customer service capabilities, harming customer relationships, revenue, and financial condition[190] - Suppliers' inability to procure raw materials in a timely manner, in sufficient quantities, or at acceptable costs, or increases in raw material prices, could harm the company's product sales ability and cost structure[191][192][193][194] - If suppliers directly enter the retail markets where the company operates and reduce sales through the company, it could materially adversely affect the company's product supply, reputation, and business[195] Risks Relating to the Cannabis Industry The company is indirectly affected by the cannabis industry's evolving legal status, facing risks from federal illegality, regulatory changes, and public perception - The company sells products through third-party retailers and distributors, indirectly benefiting from the trend of cannabis legalization in the U.S. and Canada[196] - Cannabis remains classified as a Schedule I controlled substance under U.S. federal law, and changes in federal enforcement policy could negatively impact the company's revenue and operating results[197][198][205][206] - Federal legal risks for cannabis industry participants include: inability to deduct expenses other than cost of goods sold under Section 280E of the Tax Code; limited intellectual property and proprietary rights; inability to access federal bankruptcy courts; restricted banking services; and difficulty obtaining insurance[199][201][202][203][204] - Cannabis industry regulations are constantly changing, which could lead to high compliance costs or changes in business plans for the company or its end-users[220] - Public perception of cannabis could affect industry success, and negative publicity, scientific research, or restrictive regulations could materially adversely impact the company's operating results, customer base, and financial results[222][224][225] - The JPMorgan credit agreement restricts the company from directly selling products to U.S. cannabis growers or retailers exclusively serving the U.S. cannabis industry[213][219] Risks Relating to Other Regulations The company's products and operations are subject to various state, federal, and international regulations, including those for data privacy and environmental protection - Certain ingredients in the growing media and nutrient product lines are subject to state and other regulatory restrictions, which may affect the company's ability to sell these products[228] - The company's peat harvesting operations in Canada face increasing federal, provincial, and regional regulatory and environmental scrutiny[229] - The company is subject to U.S. state and foreign data privacy and security laws and regulations, such as CCPA, CPRA, and GDPR, and failure to comply could lead to reputational damage, legal actions, and significant fines[230][231][232][233] - Compliance with or violations of environmental, health, and safety laws and regulations (including pesticide use) could result in significant costs and materially adversely affect the company's reputation, business, financial condition, and cash flow[235][236] Risks Relating to Our Intellectual Property The company faces challenges in protecting and enforcing its intellectual property, with risks of infringement, costly litigation, and reliance on third-party licenses - Changes in patent law or its interpretation could significantly impact the company's ability to protect technology and enforce intellectual property rights[237] - The company may be unable to adequately obtain, maintain, protect, or enforce its trademarks, patents, and other proprietary rights, leading to competitors copying technology or facing infringement claims[238][239][240][241] - Failure to comply with government patent agency requirements for procedures, filings, and fee payments could result in the abandonment or invalidation of patents or patent applications[242] - The company may need to rely on third-party licenses, and inability to obtain or maintain these licenses in a timely manner could hinder product commercialization and harm the business[243][244] - Third parties may initiate legal actions for intellectual property infringement, leading to the company incurring damages, being unable to offer certain products or services, or use certain brand names[245][246] - Intellectual property disputes could lead to the company investing significant resources, diverting management's attention, and potentially affecting stock value[248] - If the company's owned or licensed trademarks and trade names are not adequately protected, it may be unable to establish brand recognition in target markets, adversely affecting the business[249][250] - The protection of intellectual property and proprietary rights has limitations and may not fully safeguard the company's business or maintain its competitive advantage[251][252][254] Risks Relating to Our Capital Stock Risks related to capital stock include potential equity dilution, anti-takeover provisions, dividend policies, and stock price volatility - The company may issue debt or equity securities senior to common stock, leading to dilution of existing shareholders' ownership and potentially affecting the common stock market price[253][255] - Anti-takeover provisions in the company's charter and Delaware law may make it more difficult for the company to be acquired and could prevent shareholders from replacing management[256][257] - As a holding company, the company relies on subsidiary dividends to meet financial obligations, but may be subject to legal and contractual restrictions under the JPMorgan credit agreement and other agreements[258] - The company currently does not intend to pay dividends in the foreseeable future, and capital appreciation may be the sole source of future investment returns[259] - Failure to meet Nasdaq Global Select Market (Nasdaq) continued listing standards (e.g., minimum bid price) could result in common stock delisting, affecting market price and liquidity[260] - The company's largest shareholders will exert significant influence over company affairs for the foreseeable future, including matters requiring shareholder approval, potentially limiting the influence of other shareholders[261][262] - Future sales of a large number of common shares could negatively impact the market price[263] - The market price of the company's common stock is highly volatile and influenced by various factors, potentially leading to investors losing part or all of their investment[264][265] - The "corporate opportunity" doctrine in the company's charter does not apply to non-employee directors or shareholders, potentially leading to competition between the company and certain shareholders or directors, and loss of potentially advantageous transaction opportunities[266][267] General Risk Factors General risks include challenges in talent retention, potential litigation, dilution from equity awards, and compliance with anti-corruption laws - The company's future success depends on its ability to attract, recruit, train, and retain qualified management, operational, and other personnel, facing risks of talent competition and loss of key individuals[269] - In 2022, the company conducted layoffs and temporary employee furloughs, with potential for further reductions, which could lead to unexpected personnel attrition and decreased employee morale, affecting business plan execution[270] - Litigation could result in significant liabilities, diversion of resources, and negative publicity, materially adversely affecting the business, financial condition, and operating results[271] - The exercise of options could lead to significant dilution of existing shareholders' ownership and voting power, and increase the number of common shares available for resale in the public market, thereby negatively impacting the stock price[272][273] - Future issuances of additional securities (including common stock, warrants, or other convertible securities) could dilute existing shareholders' equity and negatively impact the common stock market price[274][275] - Failure to comply with the U.S. Foreign Corrupt Practices Act could result in severe penalties and other adverse consequences[276] - Anti-takeover provisions in Delaware law may make it more difficult for a third party to acquire the company, even if beneficial to shareholders[277] Item 1B. UNRESOLVED STAFF COMMENTS There are no unresolved staff comments in this report - No unresolved staff comments[278] Item 2. PROPERTIES The company operates numerous leased and owned distribution and manufacturing facilities across the United States and Canada - The company operates multiple distribution centers and manufacturing facilities in the United States and Canada[280][281] Key Facilities List | Location | Area (Square Feet) | Ownership Type | | :--- | :--- | :--- | | Distribution Centers: | | | | Fairfield, CA, U.S. | 175,000 | Leased | | Fontana, CA, U.S. | 147,000 | Leased | | Gresham, OR, U.S. | 98,000 | Leased | | Denver, CO, U.S. | 87,000 | Leased | | Shoemakersville, PA, U.S. | 303,000 | Leased | | New Hudson, MI, U.S. | 126,000 | Leased | | Langley, BC, Canada | 157,000 | Leased | | Cambridge, ON, Canada | 53,000 | Leased | | Manufacturing Facilities: | | | | Paramount, CA, U.S. | 25,000 | Leased | | Arcata, CA, U.S. | 115,000 | Leased | | Eugene, OR, U.S. | 242,000 | Owned (later sold and leased back) | | Goshen, NY, U.S. | 21,000 | Owned | | Sycamore, IL, U.S. | 316,000 | Leased | | Edmonton, AB, Canada | 26,000 | Leased | | Langley, BC, Canada | 79,000 | Leased | | Zaragoza, Spain | N/A | Distribution Center | - In January 2023, the company's property in Eugene, Oregon, was sold and leased back through a sale-leaseback transaction for a 15-year term, with annual rent starting at approximately $0.7 million[281] Item 3. LEGAL PROCEEDINGS The company is involved in various legal proceedings in the ordinary course of business, none of which are expected to have a material adverse effect - The company may be involved in various legal actions and proceedings in the ordinary course of business[282] - Currently, there are no legal actions or claims identified that are expected to have a material adverse effect on the business, financial condition, or operating results[282] Item 4. MINE SAFETY DISCLOSURES This item is not applicable to the company's operations - Not applicable[283] PART II Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The company's common stock trades on Nasdaq, with approximately 79 registered shareholders, and no dividends have been declared or paid - The company's common stock has traded on The Nasdaq Global Select Market under the symbol "HYFM" since December 10, 2020[284] - As of March 1, 2023, the company had approximately 79 registered holders of its common stock[285] - The company has never declared or paid any dividends on its common stock and plans to retain all available funds and future earnings for business operations and expansion, with no dividends expected in the foreseeable future[286] - The company has not sold any unregistered securities recently nor made any issuer purchases of equity securities[287][288] Item 6. RESERVED This item is reserved - This item is reserved[289] Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The company experienced adverse financial performance in 2022 due to market oversupply, leading to restructuring efforts and significant impairment charges Company Overview Hydrofarm Holdings Group, Inc. is a leading independent manufacturer and distributor of controlled environment agriculture equipment and supplies in North America - The company is a leading independent manufacturer and distributor of controlled environment agriculture (CEA) equipment and supplies, primarily serving the United States and Canadian markets[292] - The company's products are used for cultivating cannabis, flowers, fruits, plants, vegetables, grains, and herbs in controlled environments, allowing end-users to manage key growing variables[293] - The company serves commercial farmers and consumers through over 2,000 wholesale customer accounts, including specialty hydroponic retailers, commercial distributors, greenhouse builders, garden centers, hardware stores, and e-commerce retailers[293] Market Conditions Adverse market conditions in 2022, driven by agricultural oversupply, led to declining profitability, operating losses, and significant impairment charges - The company's financial performance in 2022 was poor, primarily due to agricultural oversupply leading to decreased market demand, resulting in reduced profitability and operating losses[294] - The company has initiated a restructuring plan to streamline operations, reduce costs, and improve efficiency, with key measures including optimizing the product and brand portfolio (removing approximately one-third of products and one-fifth of brands) and consolidating manufacturing and distribution centers[295][296] - In 2022, the company recorded a $189.6 million goodwill impairment, reducing the goodwill balance to zero, primarily due to deteriorating customer demand in the U.S. and Canada[297][298] - In 2022, the company recorded an $18.5 million inventory obsolescence reserve (primarily for lighting products) and a $2.9 million allowance for doubtful accounts and write-offs[299] - The company expects to incur approximately $1.7 million in additional restructuring charges in 2023 and anticipates that restructuring and related measures will result in approximately $7 million in annual cost savings[296] Five Acquisitions Completed in 2021 In 2021, the company completed five strategic acquisitions, significantly expanding its proprietary brand portfolio and manufacturing capabilities - In 2021, the company completed five acquisitions of CEA product brand manufacturers, significantly expanding its proprietary brand product portfolio and manufacturing capabilities[301] - Acquisitions included: Heavy 16 (plant nutrients, May 2021), House & Garden (plant nutrients and fertilizers, June 2021), Aurora (soils, growing media, plant nutrients, July 2021), Greenstar Plant Products (horticultural products and solutions, August 2021), and Innovative Growers Equipment (horticultural benches, racks, and grow lights, November 2021)[302] - These proprietary brands typically yield higher gross margins than distributed brands[301] Recent Financing Arrangements and Other Transactions The company executed several financing arrangements and transactions in 2021 and 2022, including a senior secured term loan and equity offerings - On October 25, 2021, the company entered into a $125 million senior secured term loan, with an interest rate of LIBOR (1.0% floor) plus 5.50% or an alternative base rate (2.0% floor) plus 4.50%, maturing on October 25, 2028[303] - On July 19, 2021, the company completed an investor warrant redemption, with 3,367,647 warrants exercised, generating approximately $56.8 million in gross proceeds[303] - On May 3, 2021, the company completed a follow-on public offering, issuing and selling 5,526,861 shares of common stock, generating approximately $309.8 million in net proceeds[303] - On March 29, 2021, the company entered into a JPMorgan revolving credit facility, initially with a $50 million borrowing limit, which was subsequently amended multiple times, reducing the maximum commitment to $75 million on December 22, 2022, and converting to a SOFR-based interest rate[303] Effects of COVID-19 on Our Business The COVID-19 pandemic continues to impact global supply chains and costs, potentially affecting demand and operational efficiency - The COVID-19 pandemic has had a significant and ongoing negative impact on global society, workplaces, economies, and healthcare systems[304] - The company has implemented business continuity plans and adheres to government safety protocols, with current operations unaffected by COVID-19-related facility closures, lockdowns, or travel restrictions[304] - The pandemic may lead to supply chain disruptions, hindered manufacturing of proprietary products, and difficulties in obtaining raw materials, which could adversely affect the business, operating results, and financial condition[304] - The company has experienced and may continue to experience extended supply chain lead times and increased shipping costs, with the COVID-19 pandemic being a primary cause[304] - Management believes COVID-19 may have positively impacted demand in 2020 and 2021 due to stay-at-home orders, but could negatively impact growth rates in 2022 due to agricultural oversupply[306] Components of Results of Operations The company's operating results are primarily driven by net sales, cost of goods sold, and selling, general, and administrative expenses - Net sales are derived from the distribution and manufacturing of hydroponic equipment and supplies, including consumables and durables, and are affected by sales incentives and freight recoveries[307][308] - Cost of goods sold primarily includes material costs, inbound and outbound freight, direct labor costs, manufacturing facility costs, depreciation, amortization, inventory reserves, restructuring charges, and certain acquisition and integration expenses[309] - Selling, general, and administrative (SG&A) expenses primarily include marketing and advertising, distribution facility costs, depreciation and amortization of other assets, certain acquisition and integration expenses, as well as salaries, benefits, stock-based compensation, and professional fees[310] Results of Operations - Comparison of Years Ended December 31, 2022, and 2021 In 2022, the company experienced a significant decline in net sales and gross profit, coupled with increased operating expenses and substantial impairment charges Operating Results Overview (2022 vs 2021) | Metric (in thousands) | 2022 | 2021 | Year-over-Year Change ($) | Year-over-Year Change (%) | | :--- | :--- | :--- | :--- | :--- | | Net Sales | 344,501 | 479,420 | (134,919) | -28.1% | | Cost of Goods Sold | 315,165 | 377,934 | (62,769) | -16.6% | | Gross Profit | 29,336 | 101,486 | (72,150) | -71.1% | | Selling, General & Administrative Expenses | 118,604 | 104,185 | 14,419 | 13.8% | | Impairment | 192,328 | — | 192,328 | N/A | | Operating Loss | (281,596) | (2,699) | 278,897 | 10,333.3% | | Interest Expense | (10,958) | (2,138) | 8,820 | 412.5% | | Loss Before Income Taxes | (291,858) | (5,721) | 286,137 | 5,001.5% | | Income Tax Benefit | 6,443 | 19,137 | (12,694) | -66.3% | | Net (Loss) Income | (285,415) | 13,416 | (298,831) | -2,227.4% | - Net sales decreased by 28.1%, primarily due to a 29.5% decline in product volume (organic sales down 46.5%, with 2021 acquired brands contributing 17.0% growth), partially offset by a 1.7% increase in price and product mix[314] - Gross profit decreased by 71.1%, with gross margin falling from 21.2% to 8.5%, mainly due to an $18.5 million increase in inventory obsolescence reserves, $7.5 million in restructuring costs, and higher freight and labor costs as a percentage of net sales[315] - Selling, general, and administrative (SG&A) expenses increased by 13.8%, primarily due to a $23.4 million increase in depreciation and amortization, a $2.9 million increase in allowance for doubtful accounts and write-offs, a $2.8 million increase in stock-based compensation, and a $2.1 million increase in compensation costs[316] - In 2022, a $189.6 million goodwill impairment was recorded, along with a $2.6 million impairment of notes receivable[317] - Interest expense increased by 412.5% to $11 million, primarily due to the term loan entered into in the fourth quarter of 2021 and rising interest rates throughout the year[318] - Income tax benefit decreased from $19.1 million in 2021 to $6.4 million in 2022, with the effective tax rate falling from 4.0% in 2021 to 2.2% in 2022, mainly due to non-deductible goodwill impairment, increased valuation allowance on U.S. deferred tax assets, and the establishment of a valuation allowance on Canadian deferred tax assets[321] Non-GAAP Financial Measures The company uses Adjusted EBITDA as a non-GAAP financial measure to supplement GAAP results and provide additional insights into its operating performance - The company uses "Adjusted EBITDA" as a non-GAAP financial measure to supplement GAAP financial statements, helping investors assess the company's performance[323] - Adjusted EBITDA is defined as net (loss) income, excluding interest expense, income taxes, depreciation, amortization, stock-based compensation expense (including employer payroll taxes), and other non-cash, non-recurring, or unusual costs (such as restructuring, impairment, severance, acquisition and integration expenses)[325] Reconciliation of Adjusted EBITDA to Net (Loss) Income (in thousands) | Metric | 2022 | 2021 | | :--- | :--- | :--- | | Net (Loss) Income (GAAP) | (285,415) | 13,416 | | Interest Expense | 10,958 | 2,138 | | Income Tax Benefit | (6,443) | (19,137) | | Distribution Center Exit Costs & Other | 1,412 | 2,641 | | Depreciation, Amortization | 41,527 | 14,934 | | Impairment | 192,328 | — | | Restructuring Charges | 7,687 | — | | Severance & Other | 1,224 | 297 | | Acquisition & Integration Expenses | 7,682 | 24,210 | | Other (Income) Expense, Net | (841) | 204 | | Stock-Based Compensation Expense | 8,543 | 5,750 | | Loss on Debt Extinguishment or Modification | 145 | 680 | | Investor Warrant Solicitation Fees | — | 1,949 | | Adjusted EBITDA (Non-GAAP) | (21,193) | 47,082 | | Percentage of Net Sales: | | | | Net (Loss) Income (GAAP) | (82.8)% | 2.8% | | Adjusted EBITDA (Non-GAAP) | (6.2)% | 9.8% | - Net (loss) income and Adjusted EBITDA in 2022 were negatively impacted by $21.4 million in inventory and accounts receivable reserves and related expenses[327] Liquidity and Capital Resources In 2022, the company generated positive cash flow from operations, supported by working capital reductions, and expects sufficient liquidity for future needs Cash Flow Overview (in thousands) | Cash Flow Type | 2022 | 2021 | | :--- | :--- | :--- | | Net Cash from Operating Activities | 21,989 | (45,067) | | Net Cash from Investing Activities | (8,487) | (468,184) | | Net Cash from Financing Activities | (20,200) | 464,707 | | Effect of Exchange Rate Changes | (395) | (27) | | Net Decrease in Cash, Cash Equivalents, and Restricted Cash | (7,093) | (48,571) | | Cash, Cash Equivalents, and Restricted Cash at Beginning of Period | 28,384 | 76,955 | | Cash, Cash Equivalents, and Restricted Cash at End of Period | 21,291 | 28,384 | - Operating activities generated $22 million in cash flow in 2022, primarily due to a $39.6 million decrease in working capital-related assets and liabilities, including a $57 million reduction in inventory and a $16.7 million reduction in accounts receivable[339] - Investing activities used $8.5 million in cash in 2022, primarily for capital expenditures in property, plant, and equipment, including growth investments in Canadian peat harvesting operations and U.S. IGE manufacturing operations[341] - Financing activities used $20.2 million in cash in 2022, primarily for $15.5 million in contingent consideration payments (mainly from the Aurora acquisition) and $1.3 million in term loan principal payments[343] - The maximum commitment amount for the JPMorgan revolving credit facility was reduced from $100 million to $75 million on December 22, 2022, and converted to a SOFR-based interest rate[347] - As of December 31, 2022, the company was in compliance with all debt covenants, with approximately $40 million available for borrowing under the JPMorgan revolving credit facility[351][352] - The company's net sales typically strengthen seasonally in the second and third fiscal quarters, and this pattern is expected to resume in 2023[358] - In January 2023, the company sold its Eugene, Oregon property through a sale-leaseback transaction, receiving $8.6 million in cash, which is planned for reinvestment in capital expenditures in 2023[360] Critical Accounting Policies and Estimates The company's financial statements rely on critical accounting policies and estimates, particularly for goodwill, long-lived assets, and inventory valuation - Goodwill is assessed for impairment annually in the fourth quarter, or on an interim basis if impairment indicators arise; on June 30, 2022, the company recorded a $189.6 million goodwill impairment due to a sustained decline in common stock market value and market conditions[364] - Long-lived tangible assets and finite-lived intangible assets are stated at cost and depreciated/amortized on a straight-line basis, with impairment reviews conducted when events or changes in circumstances indicate that the carrying amount may not be recoverable[365] - Inventory, including finished goods, work-in-process, and raw materials, is measured at the lower of cost or net realizable value, with reserves for excess and obsolete inventory based on assumptions about future demand, customer preferences, business strategies, and market conditions[367] - The company's strategic product consolidation involves removing approximately one-third of products and one-fifth of brands[367] Recent accounting pronouncements The company has reviewed recent accounting pronouncements and found no new standards relevant to its operations - The company has reviewed recently issued accounting pronouncements and found no new standards relevant to its operations[368] Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The company is primarily exposed to interest rate and foreign currency risks, with no significant hedging activities currently in place - The company is primarily exposed to interest rate risk, foreign currency risk, and inflation risk, with no significant exposure to commodity risk[369] - As of December 31, 2022, the company had $124 million in variable-rate debt, and a 100 basis point increase in interest rates would increase annual interest expense by approximately $1.2 million[370] - The company currently does not hedge against interest rate risk but may consider it in the future[370] - The company faces foreign currency risk, primarily from fluctuations in the Canadian Dollar (CAD) and Euro (EUR) exchange rates, affecting sales, purchase transactions, and labor costs[371] - The company currently does not have any foreign currency forward contracts and does not anticipate entering into such contracts for trading or speculative purposes[371] Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA This section presents the company's consolidated financial statements for 2022 and 2021, along with the independent auditor's reports and detailed notes Report of Independent Registered Public Accounting Firm Deloitte & Touche LLP issued an unqualified opinion on the company's consolidated financial statements, identifying inventory valuation as a key audit matter - Deloitte & Touche LLP has issued an unqualified opinion on the company's consolidated financial statements as of December 31, 2022, and 2021[377] - The auditors believe the financial statements are fairly presented in all material respects in accordance with U.S. Generally Accepted Accounting Principles[377] - Inventory valuation was identified as a key audit matter because, as of December 31, 2022, the excess and obsolete inventory reserve was $15.7 million, and management's estimates for future demand, customer preferences, and market conditions involve a high degree of judgment[382][383] Report of Independent Registered Public Accounting Firm (Internal Control) Deloitte & Touche LLP issued an unqualified opinion on the effectiveness of the company's internal control over financial reporting as of December 31, 2022 - Deloitte & Touche LLP has issued an unqualified opinion on the effectiveness of the company's internal control over financial reporting as of December 31, 2022[387] - The auditors believe the company maintained effective internal control over financial reporting in all material respects, based on the criteria established in Internal Control—Integrated Framework (2013) issued by COSO[387] Consolidated Balance Sheets As of December 31, 2022, the company's total assets and shareholder equity significantly decreased, primarily due to increased accumulated deficit and goodwill impairment Consolidated Balance Sheets Summary (in thousands) | Item | December 31, 2022 | December 31, 2021 | | :--- | :--- | :--- | | Assets: | | | | Cash and Cash Equivalents | 21,291 | 26,607 | | Restricted Cash | - | 1,777 | | Accounts Receivable, Net | 17,227 | 41,484 | | Inventories | 111,398 | 189,134 | | Prepaid Expenses and Other Current Assets | 5,032 | 9,760 | | Total Current Assets | 154,948 | 269,384 | | Property, Plant and Equipment, Net | 51,135 | 50,473 | | Operating Lease Right-of-Use Assets | 65,265 | 45,245 | | Goodwill | - | 204,868 | | Intangible Assets, Net | 300,366 | 314,819 | | Other Assets | 1,845 | 6,453 | | Total Assets | 573,559 | 891,242 | | Liabilities: | | | | Accounts Payable | 13,633 | 26,685 | | Accrued Expenses and Other Current Liabilities | 13,208 | 33,996 | | Deferred Revenue | 3,654 | 18,273 | | Current Lease Liabilities | 9,099 | 7,198 | | Current Portion of Long-Term Debt | 2,011 | 2,263 | | Total Current Liabilities | 41,605 | 88,415 | | Long-Term Lease Liabilities | 56,299 | 38,595 | | Long-Term Debt | 118,661 | 119,517 | | Deferred Tax Liabilities | 2,685 | 5,631 | | Other Long-Term Liabilities | 4,428 | 3,904 | | Total Liabilities | 223,678 | 256,062 | | Stockholders' Equity: | | | | Common Stock | 5 | 4 | | Additional Paid-in Capital | 783,042 | 777,074 | | Accumulated Other Comprehensive Loss | (7,235) | (1,382) | | Accumulated