GrowGeneration Corp. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with our consolidated financial statements and related notes that appear elsewhere in this report as well as our Annual Report on Form 10-K for the year ended December 31, 2021 filed with the SEC on March 10, 2022. We caution readers regarding certain forward-looking statements, within the meaning of the Securities Act of 1933, as amended, the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995 in the following discussion and elsewhere in this report. Forward looking statements are statements not based on historical information and which relate to future operations, strategies, financial results or other developments. Forward looking statements, particularly those identified with the words, “anticipates,” “believes,” “expects,” “plans,” “intends,” “objectives,” and similar expressions, are necessarily based upon estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control and many of which, with respect to future business decisions, are subject to change. These uncertainties and contingencies can affect actual results and could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on our behalf. We disclaim any obligation to update forward looking statements, except as required by law. OVERVIEW GrowGeneration Corp. (together with all of its direct and indirect wholly-owned subsidiaries, collectively “GrowGeneration” or the “Company”) was incorporated in Colorado in 2014. GrowGeneration is the largest chain of hydroponic garden centers in North America and is a leading marketer and distributor of nutrients, growing media, advanced indoor and greenhouse lighting, environmental control systems and accessories for hydroponic gardening. GrowGeneration also owns and operates an e-commerce platform, www.growgeneration.com, Mobile Media, a vertical racking and storage solutions business, Horticultural Rep Group, a horticultural products sales representative and distributor organization, and Drip Hydro, PowerSi, CharCoir, and several other proprietary private-label brands across multiple product categories from LED lighting to nutrients and additives and environmental control systems for indoor cultivation. Markets and Business Segments GrowGeneration sells thousands of products, including nutrients, growing media, advanced indoor and greenhouse lighting, environmental control systems, vertical benching and accessories for hydroponic gardening, as well as other indoor and outdoor growing products, that are designed and intended for growing a wide range of plants. In addition, vertical farms producing organic fruits and vegetables also utilize hydroponics due to a rising shortage of farmland as well as environmental vulnerabilities including drought, other severe weather conditions and insect pests. Our retail operations are driven by a wide selection of all hydroponic products, service and solutions driven staff and pick, pack and ship distribution and fulfillment capabilities. We employed approximately 494 employees as of September 30, 2022, a majority of them we have branded as “Grow Pros.” Currently, our operations span over 873,000 square feet of retail and warehouse space. The Company has three primary reportable segments, including retail operations, e-commerce and all other. The Company has segmented its operations to reflect the manner in which management reviews and evaluates the results of its operations. The structure reflects the manner in which the chief operating decision maker regularly assesses information for decision-making purposes, including the allocation of resources. We recognize specifically identifiable operating costs such as cost of sales, distribution expenses, selling and general administrative expenses within each segment. Certain general and administrative expenses, such as administrative and management expenses, salaries and benefits, share based compensation, director fees, legal expenses, accounting and consulting expenses and technology costs, are not allocated to the specific segments and are reflected in the enterprise results. 26 Competitive Advantages As the largest chain of hydroponic garden centers by revenue and number of stores in the United States based on management’s estimates, we believe that we have the following core competitive advantages over our competitors: • We offer a one-stop shopping experience to all types of growers by providing “selection, service, and solutions”; • We provide end-to-end solutions for our commercial customers from capex built-out to consumables to nourish their plants; • We have a knowledge-based sales team, all with horticultural experience; • We offer the options to transact online, in store, or buy online and pick up; • We consider ourselves to be a leader of the products we offer, from launching new technologies to the development of our private label products; and • We have a professional team for mergers and acquisitions, and to acquire and open new locations and successfully add them to our company portfolio. Growth Strategy Core to our growth strategy is to establish a presence with our retail garden centers in key markets throughout the United States. In addition to the 15 states in which we are currently operating, we have identified new market opportunities in certain other states where the market for our products is growing. The Company acquired 23 new locations in 2021 and expects to open additional stores in 2022 and 2023. An additional component of our growth strategy is the expansion of distribution and sales capabilities for products that the Company owns, distributes, or represents to independent retail garden centers for resale. R ESULTS OF OPERATIONS Comparison of the three months ended September 30, 2022 and 2021 Net revenue for the three months ended September 30, 2022 was approximately $70.9 million, compared to $116.0 million for the three months ended September 30, 2021, a decrease of approximately $45.2 million or 39%. The decrease was primarily attributed to a decrease of approximately $55.4 million related to same store sales, which represented a decrease of 58% year over year. Overall sales in our retail segment declined from $100.8 million to $47.9 million. Distributed sales were $19.8 million for the three months ended September 30, 2022, up 322% year-over-year due to the acquisitions of HRG and MMI. E-commerce sales decreased from $10.5 million for the three months ended September 30, 2021 to $3.1 million for the three months ended September 30, 2022. Cost of Sales Cost of sales for the three months ended September 30, 2022 was approximately $52.5 million, compared to approximately $81.9 million for the three months ended September 30, 2021, a decrease of approximately $29.4 million or 36%. The decrease in cost of sales was primarily due to the 39% decrease in sales comparing the three months ended September 30, 2022 to the three months ended September 30, 2021. Gross Profit Gross profit was approximately $18.3 million for the three months ended September 30, 2022, compared to approximately $34.1 million for the three months ended September 30, 2021, a decrease of approximately $15.7 million or 46%. The decrease in gross profit is primarily related to the 39% decrease in net sales comparing the three months ended September 30, 2022 to the three months ended September 30, 2021. Gross profit as a percentage of revenues was 25.9% for the three months ended September 30, 2022, compared to 29.4% for the three months ended September 30, 2021. Gross profit in our retail segment declined from $29.0 million for the three months ended September 30, 2021 to $10.4 million for the same period in 2022. Gross profit from distributed sales was $7.2 million for the three months ended September 30, 2022 up from $1.8 million for the same period in 2021. Gross profit from e-commerce revenue was $0.8 million for the three months ended September 30, 2022. 27 Operating Expenses Operating expenses are comprised of store operations, selling, general, and administrative, and depreciation and amortization. Operating costs were approximately $26.4 million for the three months ended September 30, 2022 and approximately $29.4 million for the three months ended September 30, 2021, a decrease of approximately $3.0 million or 10%. Store operating costs were approximately $13.6 million for the three months ended September 30, 2022, compared to $14.8 million for the three months ended September 30, 2021, a decrease of $1.3 million or 8%. Total corporate overhead, which is comprised of Selling, general, and administrative expense and Depreciation and amortization expense, was approximately $12.8 million for the three months ended September 30, 2022, compared to $14.5 million for the three months ended September 30, 2021, a decrease of $1.7 million or 12%. Selling, general, and administrative costs were approximately $8.8 million for the three months ended September 30, 2022, compared to approximately $10.5 million for the three months ended September 30, 2021. Salaries expense decreased to $4.0 million from $5.2 million primarily due to a decrease in corporate staff. General administrative expenses decreased to $3.6 million for the three months ended September 30, 2022 from $3.7 million for the same period in 2021. Other Income/Expense Total other income was approximately $0.2 million for the three months ended September 30, 2022, compared to expense of $0.4 million for the three months ended September 30, 2021. Segment Operating Income Operating income in our retail segment dropped from $4.0 million to an operating loss of $23.7 million as a result of lower sales volume, lower gross margins and higher expenses at existing stores combined with operating losses at two stores not in operation in the same period in 2021, including acquired and new retail locations. Operating income in our e-commerce segment decreased from a loss of $30.0 thousand to a loss of $2.8 million, as a result of the decrease in gross profit primarily from declining demand throughout the industry. Operating income in all other decreased to a loss of $18.4 million in the three months ended September 30, 2022 compared to income of $0.7 million in the three months ended September 30, 2021. Income Taxes Income tax benefit was $0.7 million for the three months ended September 30, 2022, compared to income tax expense of $1.1 million for the three months ended September 30, 2021. Effective tax rate is impacted by differences in timing of expenses for share-based compensation, depreciation, amortization and the impact of 162(m) on deductible wages. As such, the Company’s taxable income varies from reported income in a material way. The Company has evaluated positive and negative evidence and has concluded that its deferred tax assets are not expected to be realizable and has recorded a valuation allowance in the current period. Net Income Net loss for the three months ended September 30, 2022 was approximately $7.2 million, compared to net income of approximately $4.0 million for the three months ended September 30, 2021, a decrease of approximately $11.2 million. Comparison of the nine months ended September 30, 2022 and 2021 Net revenue for the nine months ended September 30, 2022 was approximately $223.7 million, compared to $331.9 million for the nine months ended September 30, 2021, a decrease of approximately $108.2 million or 33%. The decrease was primarily attributed to a decrease of approximately $141.0 million related to same store sales, which represented an approximate 51.6% decrease year over year. Overall sales in our retail segment declined from $290.9 million for the nine months ended September 30, 2021, to $167.6 million for the same period in 2022. Distributed sales increased to $44.1 million for the nine months ended September 30, 2022 compared to $12.5 million for the nine months ended September 30, 2021 due to the acquisitions of HRG and MMI. E-commerce sales decreased from $28.5 million for the nine months ended September 30, 2021, to $12.0 million for the same period in 2022. 28 Cost of Sales Cost of sales for the nine months ended September 30, 2022 was approximately $163.0 million, compared to approximately $236.8 million for the nine months ended September 30, 2021, a decrease of approximately $73.7 million or 31%. The decrease in cost of sales was primarily due to the 33% decrease in sales comparing the nine months ended September 30, 2022 to the nine months ended September 30, 2021. Gross Profit Gross profit was approximately $60.7 million for the nine months ended September 30, 2022, compared to approximately $95.2 million for the nine months ended September 30, 2021, a decrease of approximately $34.5 million or 36%. The decrease in gross profit is primarily related to the 33% decrease in net sales comparing the nine months ended September 30, 2022 to the nine months ended September 30, 2021. Gross profit as a percentage of net sales was 27.1% for the nine months ended September 30, 2022, compared to 28.7% for the nine months ended September 30, 2021. Gross profit in our retail segment declined from $81.5 million for the nine months ended September 30, 2021, to $41.4 million for the same period in 2022. Gross profit from distributed sales increased to $16.0 million for the nine months ended September 30, 2022 compared to $5.5 million for the nine months ended September 30, 2021. Gross profit from our e-commerce segment was $3.3 million for the nine months ended September 30, 2022 compared to $8.2 million for the nine months ended September 30, 2021. Operating Expenses Operating expenses are comprised of store operations, selling, general, and administrative, and depreciation and amortization. Operating costs were approximately $212.8 million for the nine months ended September 30, 2022 and approximately $73.1 million for the nine months ended September 30, 2021, an increase of approximately $139.7 million or 191%. The increase in operating expenses is primarily attributable to the impairment loss of $127.8 million recorded during the nine months ended September 30, 2022. Store operating costs were approximately $41.9 million for the nine months ended September 30, 2022, compared to $35.6 million for the nine months ended September 30, 2021, an increase of $6.2 million or 17%. The increase in store operating costs was directly attributable to the addition of 23 locations that were acquired during 2021, including two stores that were added subsequent to September 30, 2021. Total corporate overhead, which is comprised of Selling, general, and administrative expense and Depreciation and amortization expense, was approximately $43.1 million for the nine months ended September 30, 2022, compared to $37.5 million for the nine months ended September 30, 2021, an increase of $5.6 million or 15%. Selling, general, and administrative costs were approximately $28.2 million for the nine months ended September 30, 2022, compared to approximately $28.1 million for the nine months ended September 30, 2021. Salaries expense decreased to $14.7 million for the nine months ended September 30, 2022, from $14.9 million for the same period in 2021. General administrative expenses increased to $11.3 million for the nine months ended September 30, 2022, from $8.8 million for the same period in 2021, to support expanding operations. Impairment loss was approximately $127.8 million for the nine months ended September 30, 2022 following goodwill impairment testing performed in the second quarter as a result of the Company’s market capitalization falling below total net assets. In addition, financial performance continued to weaken during the quarter for which testing was performed. Refer to Critical Accounting Policies, Judgements, and Estimates and Note 8 - "Goodwill and Intangible Assets" of the notes to the condensed consolidated financial statements for additional information. Other Income/Expense Total other income was approximately $0.7 million for the nine months ended September 30, 2022, compared to expense of $0.4 million for the nine months ended September 30, 2021. This increase is primarily attributable to a gain recorded during the nine months ended September 30, 2022, related to an earnout revaluation adjustment related to The Harvest Company acquisition. 29 Segment Operating Income Operating income in our retail segment dropped from $18.9 million to an operating loss of $137.9 million. The operating loss for the current year includes an impairment of Operating income in our e-commerce segment declined from $0.4 million for the nine months ended September 30, 2021 to a loss of $11.9 million for the same period in 2022, as a result of lower revenue and higher operating expenses as well as integration costs of Agron.IO webstore that was consolidated with our core e-commerce webstore in the nine months ended September 30, 2022. Operating income in all other decreased to a loss of $2.3 million in the nine months ended September 30, 2022 compared to income of $2.7 million in the nine months ended September 30, 2021. Income Taxes Income tax benefit was $2.6 million for the nine months ended September 30, 2022, compared to income tax expense of $5.6 million for the nine months ended September 30, 2021. Effective tax rate is impacted by differences in timing of expenses for share-based compensation, depreciation, amortization and the impact of 162(m) on deductible wages. As such, the Company’s taxable income varies from reported income in a material way. The Company has evaluated positive and negative evidence and has concluded that its deferred tax assets are not expected to be realizable and has recorded a valuation allowance in the current period. Net Income Net loss for the nine months ended September 30, 2022 was approximately $148.8 million, compared to net income of approximately $16.9 million for the nine months ended September 30, 2021, a decrease of approximately $165.6 million. Operating Activities Net cash provided by operating activities for nine months ended September 30, 2022 was approximately $9.9 million compared to $1.9 million provided for the nine months ended September 30, 2021. The Company reduced prepaid inventory by $11.3 million in the current year as well as inventory by $20.7 million, which was partially offset by payments for accounts payable, accrued payroll, and a reduction in customer deposits.. Net cash provided by investing activities was approximately $21.4 million for the nine months ended September 30, 2022 compared to cash used of approximately $114.8 million for the nine months ended September 30, 2021. Investing activities in 2022 were primarily attributable to the maturity of marketable securities of $39.8 million partially offset by acquisitions of $6.8 million and vehicles and store equipment purchases of $11.6 million. Investing activities for the nine months ended September 30, 2021 were primarily related to store acquisitions of $71.8 million, purchase of marketable securities of $75.0 million, the purchase of vehicles and store equipment to support new store operations of $10.8 million, and intangible assets of $2.3 million. Net cash used in financing activities for the nine months ended September 30, 2022 was approximately $1.5 million and was primarily attributable to common stock withheld for employee payroll taxes. Net cash used by financing activities for nine months ended September 30, 2021 was $1.9 million and was primarily attributable to stock withheld to cover payroll taxes. Use of Non-GAAP Financial Information The Company believes that the presentation of results excluding certain items in “Adjusted EBITDA,” such as non-cash equity compensation charges, provides meaningful supplemental information to both management and investors, facilitating the evaluation of performance across reporting periods. The Company uses these non-GAAP measures for internal planning and reporting purposes. These non-GAAP measures are not in accordance with, or an alternative for, generally accepted accounting principles and may be different from non-GAAP measures used by other companies. The presentation of this additional information is not meant to be considered in isolation or as a substitute for net income or net income per share prepared in accordance with generally accepted accounting principles. 30 Set forth below is a reconciliation of Adjusted EBITDA to net income (loss): Three Months Ended September 30, 2022 2021 (000) (000) Net income (loss) $ (7,202) $ 4,027 Income taxes (718) 1,096 Interest expense 3 25 Depreciation and amortization 3,875 3,539 EBITDA $ (4,042) $ 8,687 Share based compensation (option compensation, warrant compensation, stock issued for services) 1,291 2,106 Fixed asset disposal 165 — Adjusted EBITDA $ (2,586) $ 10,793 Adjusted EBITDA per share, basic $ (0.04) $ 0.18 Adjusted EBITDA per share, diluted $ (0.04) $ 0.18 Nine Months Ended September 30, 2022 2021 (000) (000) Net income (loss) $ (148,758) $ 16,887 Income taxes (2,637) 5,569 Interest expense 16 31 Depreciation, and amortization 13,164 8,510 EBITDA $ (138,215) $ 30,997 Impairment loss 127,831 — Share based compensation (option compensation, warrant compensation, stock issued for services) 3,980 5,347 Fixed asset disposal 81 — Adjusted EBITDA $ (6,323) $ 36,344 Adjusted EBITDA per share, basic $ (0.10) $ 0.62 Adjusted EBITDA per share, diluted $ (0.10) $ 0.60 LIQUIDITY AND CAPITAL RESOURCES As of September 30, 2022, we had working capital of approximately $145.8 million, compared to working capital of approximately $169.8 million as of December 31, 2021, a decrease of approximately $24.0 million. The decrease in working capital from December 31, 2021 to September 30, 2022 was due primarily to a decrease in marketable securities, inventory and prepaid inventory partially offset by decreases in current liabilities. At September 30, 2022, we had cash and cash equivalents of approximately $71.1 million. Currently, we have no extraordinary demands, commitments or uncertainties that would reduce our current working capital. Our core strategy continues to focus on expanding our geographic reach across the United States and building our store and brand portfolio through organic growth and acquisitions. We believe that some of our store acquisitions and new store openings can come from cash flow from operations. We anticipate that we may need additional financing through equity offerings and/or debt financings in the future to continue to acquire and open new stores and related businesses. To date we have financed our operations through the issuance and sale of common stock, convertible notes and warrants. 31 Critical Accounting Policies, Judgements and Estimates Business Combinations Note 1 - Operations and Summary of Significant Accounting Policies to the consolidated financial statements included in Part II. Item 8 of our Form 10-K for the year ended December 31, 2021 describes the significant accounting policies used in preparation of these consolidated financial statements. We believe the following critical accounting policy and assumptions may have a material impact on reported financial condition and operating performance and involve significant levels of judgement to account for highly uncertain matters or are susceptible to significant change. In each of these areas, management makes estimates based on historical results, current trends and future projections. Therefore, these are considered to be our critical accounting policies and estimates. We account for transactions that represent business combinations under the acquisition method of accounting, which requires us to allocate the total consideration paid for each acquisition to the assets we acquire and liabilities we assume based on their fair values as of the date of acquisition, including identifiable intangible assets. The allocation of the purchase price utilizes significant estimates in determining the fair values of identifiable assets acquired and liabilities assumed, especially with respect to intangible assets. We may refine our estimates and make adjustments to the assets acquired and liabilities assumed over a measurement period, not to exceed one year. The Company has financial liabilities resulting from our business combinations, including contingent consideration arrangements. We estimate the fair value of these financial liabilities using Level 3 inputs that require the use of numerous assumptions, which may change based on the occurrence of future events and lead to increased or decreased operating income in future periods. Estimating the fair value at an acquisition date and in subsequent periods involves significant judgements, including projecting the future financial performance of the acquired businesses. The Company will update its assumptions each reporting period based on new developments and record such amounts at fair value based on the revised assumptions. Changes in the fair value of these financial liabilities are recorded in the Consolidated Statements of Operations within other income (expense). Impairment of Goodwill and Intangible Assets Goodwill reflects the cost of an acquisition in excess of the fair values assigned to identifiable net assets acquired. The Company reviews goodwill for impairment during the fourth fiscal quarter or more frequently if events or changes in circumstances indicate the asset might be impaired. The Company performs impairment reviews for its reporting units using a fair value method based on management's judgements and assumptions or third-party valuations. For goodwill impairment testing purposes, the Company determined four reporting units, three of which were subject to a quantitative assessment. The fair value of a reporting unit refers to the price that would be received to sell the unit as a whole in an orderly transaction between market participants at the measurement date. In estimating the fair value, the Company uses the income approach in which discounted cash flow analyses are used to derive estimates of fair value of each reporting unit. Multiples of earnings based on the average of historical, published multiples of earnings of comparable entities with similar operations and economic characteristics are also used in developing estimated fair values. The inputs utilized in the analyses are classified as Level 3 inputs within the fair value hierarchy as defined in ASC 820, "Fair Value Measurement." These calculations contain uncertainties as they require management to make assumptions about market comparables, future cash flows and appropriate discount rates (based on weighted average cost of capital ranging from 13% to 16% at June 30, 2022) to reflect the risk inherent in the future cash flows and to derive a reasonable enterprise value and related premium. The estimated future cash flows reflect management's latest assumptions of the financial projections based on current and anticipated competitive landscape, including estimates of revenue based on production volumes over the foreseeable future and long-term growth rates, and operating margins based on historical trends and future cost containment activities. A change in any of these estimates and assumptions could produce a different fair value, which could have a material impact on the results of the goodwill impairment test and on the Company's results of operations. The estimated fair value is then compared with the carrying amount of the reporting unit, including recorded goodwill. The Company is subject to financial statement risk to the extent that the carrying amount exceeds the estimated fair value. As a result of the tests, the Company recorded an impairment to goodwill during the second quarter of 2022. Refer to Note 8, "Goodwill and Intangible Assets," of the notes to the condensed consolidated financial statements for additional information. The Company reviews long-lived assets, including property, plant and equipment and other intangible assets with definite lives, for impairment whenever events or changes in circumstances indicate that the asset's carrying amount may not be recoverable. The Company conducts its long-lived asset impairment analyses in accordance with ASC 360-10-15, "Impairment or Disposal of Long-Lived Assets." ASC 360-10-15 requires the Company to group assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities and evaluate the asset group against the sum of the undiscounted future cash flows. If the undiscounted cash flows do not indicate the carrying amount of the 32 asset is recoverable, an impairment charge is measured as the amount by which the carrying amount of the asset group exceeds its fair value based on discounted cash flow analysis or appraisals. Intangible assets with definite lives continue to be amortized over their estimated useful lives and are subject to impairment testing as part of their asset group if events or changes in circumstances indicate that the asset might be impaired. A considerable amount of management judgement and assumptions are required in performing the impairment tests. During the second quarter of 2022, the Company concluded it had a triggering event. The Company’s market capitalization fell below total net assets. In addition, financial performance continued to weaken during the quarter, which is contrary to prior experience. Management reassessed business performance expectations, following persistent adverse developments in equity markets, deterioration in the environment in which the Company operates, inflation, lower than expected sales, and an increase in operating expenses. These indicators, in the aggregate, required impairment testing for finite-lived intangible assets at the asset group level and goodwill at the reporting unit level. These impairments were measured either under an income approach utilizing forecasted discounted cash flows to determine fair values of the impaired assets. These methods are consistent with the methods the Company employed in prior periods to value intangible assets. The inputs utilized in the analyses are classified as Level 3 inputs within the fair value hierarchy as defined in ASC 820, "Fair Value Measurement," and primarily consist of expected future operating margins and cash flows, weighted average cost of capital rates (13.3%), estimated salable values and third-party appraisal techniques such as market comparables. To the extent that profitability declines as compared to forecasted profitability or if adverse changes occur to key assumptions or other fair value measurement inputs, further impairment of long-lived assets could occur in the future. Refer to Note 8, "Goodwill and Intangible Assets," of the notes to the condensed consolidated financial statements for additional information. OFF-BALANCE SHEET ARRANGEMENTS We do not have any off-balance sheet arrangements (as that term is defined in Item 303 of Regulation S-K) that are reasonably likely to have a current or future material effect on our financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. For a summary of the Company’s quantitative and qualitative disclosures about market risk, please refer to Item 7A of our Form 10-K for the year ended December 31, 2021.