HYDROFARM HOLDINGS GROUP, INC. 10-K

Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Index to Consolidated Financial Statements Report of Independent Registered Public Accounting Firm - Deloitte & Touche LLP F-1 Report of Independent Registered Public Accounting Firm – MNP LLP F-2 Consolidated Balance Sheets F-3 Consolidated Statements of Operations F-4 Consolidated Statements of Comprehensive Loss F-5 Consolidated Statements of Changes in Convertible Preferred Stock and Stockholders’ Equity F-6 Consolidated Statements of Cash Flows F-7 Notes to the Consolidated Financial Statements F-8 Schedule II – Valuation and Qualifying Accounts F-36 61 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the stockholders and the Board of Directors of Hydrofarm Holdings Group, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Hydrofarm Holdings Group, Inc. and subsidiaries (the "Company") as of December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive loss, changes in convertible preferred stock and stockholders’ equity, and cash flows, for each of the two years in the period ended December 31, 2020, and the related notes and Schedule II listed in the Index to Consolidated Financial Statements (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America. Change in Accounting Principle As discussed in Note 1 to the financial statements, effective January 1, 2019, the Company adopted Financial Accounting Standards Board ASC Topic 842, Leases , using the modified retrospective approach. Our opinion is not modified with respect to this matter. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ Deloitte & Touche LLP San Francisco, CA March 30, 2021 We have served as the Company's auditor since 2020. F- 1 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of Hydrofarm Holdings Group, Inc. Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated statements of operations, comprehensive loss, changes in convertible preferred stock and stockholders’ equity, and cash flows for the year ended December 31, 2018, and the related notes and schedule (collectively referred to as the consolidated financial statements) of Hydrofarm Holdings Group, Inc. (the “Company”). In our opinion, the consolidated financial statements present fairly, in all material respects, the results of the Company’s consolidated operations and its consolidated cash flows for the year ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America. Basis for Opinion These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. Our audit included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion. Chartered Professional Accountants Licensed Public Accountants We have served as the Company’s auditor since 2018. Toronto, Ontario May 10, 2019 (December 1, 2020 as to the effects of the reverse stock split discussed in Note 1) F- 2 Hydrofarm Holdings Group, Inc. CONSOLIDATED BALANCE SHEETS (In thousands, except for share and per share amounts) December 31, 2020 2019 Assets Current assets: Cash and cash equivalents $ 75,178 $ 22,866 Restricted cash 1,777 9,991 Accounts receivable, net 21,626 15,246 Inventories 88,618 50,228 Notes receivable 3,151 4,796 Prepaid expenses and other current assets 9,567 1,840 Total current assets 199,917 104,967 Property and equipment, net 3,988 3,550 Operating lease right-of-use assets 18,289 18,521 Intangible assets, net 52,421 57,406 Other assets 1,180 1,207 Total assets $ 275,795 $ 185,651 Liabilities, convertible preferred stock and stockholders’ equity Current liabilities: Accounts payable $ 22,638 $ 17,224 Accrued expenses and other current liabilities 21,615 9,188 Current portion of lease liabilities 3,701 3,181 Current portion of long-term debt 746 34,827 Total current liabilities 48,700 64,420 Long-term lease liabilities 15,320 15,786 Long-term debt 290 73,105 Other long-term liabilities 567 1,160 Total liabilities 64,877 154,471 Commitments and contingencies (Note 13) Convertible preferred stock ($0.0001 par value; 50,000,000 shares authorized; 0 and 7,007,429 shares issued and outstanding at December 31, 2020 and 2019, respectively) — 21,802 Stockholders’ equity Common stock ($0.0001 par value; 300,000,000 shares authorized at December 31, 2020 and 2019, respectively; 33,499,953 and 20,688,439 shares issued and outstanding at December 31, 2020 and 2019) 3 2 Additional paid-in capital 364,248 156,179 Accumulated other comprehensive income (loss) 599 (144 ) Accumulated deficit (153,932 ) (146,659 ) Total stockholders’ equity 210,918 9,378 Total liabilities, convertible preferred stock and stockholders’ equity $ 275,795 $ 185,651 The accompanying notes are an integral part of the consolidated financial statements. F- 3 Hydrofarm Holdings Group, Inc. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except share and per share amounts) Years ended December 31, 2020 2019 2018 Net sales $ 342,205 $ 235,111 $ 211,813 Cost of goods sold 278,572 208,025 187,743 Gross profit 63,633 27,086 24,070 Operating expenses: Selling, general and administrative 58,492 43,784 42,229 Impairment, restructuring and other 860 10,035 7,169 Income (loss) from operations 4,281 (26,733 ) (25,328 ) Interest expense (10,141 ) (13,467 ) (11,606 ) Loss on debt extinguishment (907 ) (679 ) — Other income, net 70 105 995 Loss before tax (6,697 ) (40,774 ) (35,939 ) Income tax (expense) benefit (576 ) 691 397 Net loss (7,273 ) (40,083 ) (35,542 ) Cumulative dividends allocated to Series A Convertible Preferred Stock (2,597 ) — — Net loss attributable to non-controlling interest — — (2,650 ) Net loss attributable to common stockholders $ (9,870 ) $ (40,083 ) $ (32,892 ) Net loss per share attributable to common stockholders (2018 assumes retroactive conversion of non-controlling interest into controlling interest): Basic $ (0.46 ) $ (1.94 ) $ (2.31 ) Diluted $ (0.46 ) $ (1.94 ) $ (2.31 ) Weighted-average shares used to compute net loss per share attributable to common stockholders: Basic 21,298,849 20,688,439 15,390,086 Diluted 21,298,849 20,688,439 15,390,086 The accompanying notes are an integral part of the consolidated financial statements. F- 4 Hydrofarm Holdings Group, Inc. CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (In thousands) Years ended December 31, 2020 2019 2018 Net loss $ (7,273 ) $ (40,083 ) $ (35,542 ) Other comprehensive income (loss): Foreign currency translation gain (loss) 743 1,709 (2,418 ) Total comprehensive loss (6,530 ) (38,374 ) (37,960 ) Comprehensive loss attributable to non-controlling interest — — (2,828 ) Comprehensive loss attributable to common stockholders $ (6,530 ) $ (38,374 ) $ (35,132 ) The accompanying notes are an integral part of the consolidated financial statements. F- 5 Hydrofarm Holdings Group, Inc. CONSOLIDATED STATEMENTS OF CHANGES IN CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY (In thousands, except for share amounts) Controlling Interest Convertible Preferred Stock Common Stock Shares Amount Shares Amount Additional Paid-In Capital Accumulated Other Comprehensive Income (Loss) Accumulated Deficit Total Stockholders' Equity Non- controlling Interest Total Stockholders' Equity Balance, January 1, 2018 — $ — 11,171,293 $ 1 $ 90,809 $ 484 $ (62,074 ) $ 29,220 $ 4,071 $ 33,291 Exchange of new shares for non-controlling interest in subsidiary — — 1,593,096 — 12,950 (97 ) (11,610 ) 1,243 (1,243 ) — Concurrent Offering of shares and warrants for cash — — 1,323,157 — 11,146 — — 11,146 — 11,146 Concurrent Offering of shares and warrants for conversion of loan from related party — — 484,681 — 4,088 — — 4,088 — 4,088 Reverse merger with Hydrofarm Holdings Group, Inc. as accounting acquiree — — 1,186,487 — 1 — — 1 — 1 Offering of shares and warrants for cash — — 4,929,725 1 41,498 — — 41,499 — 41,499 Offering and Concurrent Offering costs — — — — (4,521 ) — — (4,521 ) — (4,521 ) Net loss — — — — — — (32,892 ) (32,892 ) (2,650 ) (35,542 ) Foreign currency translation loss — — — — — (2,240 ) — (2,240 ) (178 ) (2,418 ) Balance, December 31, 2018 — — 20,688,439 2 155,971 (1,853 ) (106,576 ) 47,544 — 47,544 Proceeds from issuance of Series A Convertible Preferred Stock, net of issuance costs of $1,274 4,825,346 15,615 — — — — — — — — Issuance of Series A Convertible Preferred Stock upon conversion of debt 2,182,083 7,637 — — — — — — — — Receivable exchanged for issuance of Series A Convertible Preferred Stock — (1,450 ) — — — — — — — — Stock-based compensation expense — — — — 208 — — 208 — 208 Net loss — — — — — — (40,083 ) (40,083 ) — (40,083 ) Foreign currency translation gain — — — — — 1,709 — 1,709 — 1,709 Balance, December 31, 2019 7,007,429 21,802 20,688,439 2 156,179 (144 ) (146,659 ) 9,378 — 9,378 Proceeds from issuance of Series A Convertible Preferred Stock, net of issuance costs of $169 717,616 2,342 — — — — — — — — Collection of receivable for issuance of Series A Convertible Preferred Stock — 1,450 — — — — — — — — Stock-based compensation expense — — — — 8,895 — — 8,895 — 8,895 Series A Convertible Preferred Stock cumulative dividend — 2,597 — — (2,597 ) — — (2,597 ) — (2,597 ) Issuance of common stock in connection with initial public offering, net of offering costs of $17,063 — — 9,966,667 1 182,270 — — 182,271 — 182,271 Conversion of Series A Convertible Preferred Stock to common stock (7,725,045 ) (25,594 ) 2,291,469 — 25,594 — — 25,594 — 25,594 Payment of Series A Convertible Preferred Stock cumulative dividend — (2,597 ) — — — — — — — — Issuance of common stock for vesting of restricted stock units — — 793,080 — — — — — — — Shares withheld for payroll taxes related to vesting of restricted stock units — — (239,702 ) — (6,089 ) — — (6,089 ) — (6,089 ) Other — — — — (4 ) — — (4 ) — (4 ) Net loss — — — — — — (7,273 ) (7,273 ) — (7,273 ) Foreign currency translation gain — — — — — 743 — 743 — 743 Balance, December 31, 2020 — $ — 33,499,953 $ 3 $ 364,248 $ 599 $ (153,932 ) $ 210,918 $ — $ 210,918 The accompanying notes are an integral part of the consolidated financial statements. F- 6 Hydrofarm Holdings Group, Inc. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) Years ended December 31, 2020 2019 2018 Operating activities Net loss $ (7,273 ) $ (40,083 ) $ (35,542 ) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 6,779 6,995 8,260 Provision for doubtful accounts 83 933 534 (Benefit from) provision for inventory obsolescence (803 ) 707 (824 ) Stock-based compensation expense 8,895 208 — Amortization of inventory step-up of basis — — 798 Impairment charges — 5,390 2,716 Non-cash operating lease expense 3,469 3,650 — Amortization of deferred financing costs 928 967 643 Loss on debt extinguishment 907 679 — Interest expense capitalized to principal of long-term debt 20 9,644 6,883 Interest income capitalized to principal of notes receivable (101 ) — — Payment of interest capitalized to principal of long-term debt (13,901 ) (2,360 ) — Deferred income tax expense (benefit) 52 (718 ) (899 ) Other (59 ) 105 (22 ) Changes in assets and liabilities: Accounts receivable (6,329 ) (620 ) 6,821 Inventories (36,859 ) 2,725 22,043 Prepaid expenses and other current assets (7,733 ) (9 ) 509 Other assets 24 494 560 Accounts payable 4,795 (1,199 ) (5,652 ) Accrued expenses and other current liabilities 5,900 2,364 (3,079 ) Lease liabilities (3,126 ) (3,297 ) — Other long-term liabilities (493 ) 123 688 Net cash (used in) provided by operating activities (44,825 ) (13,302 ) 4,437 Investing activities Purchases of property and equipment (1,447 ) (768 ) (1,343 ) Purchases of intangible assets (61 ) — — Proceeds from sale of property and equipment 54 — — Issuance of notes receivable — (3,050 ) (2,000 ) Proceeds from notes receivable 2,000 — — Other — — 31 Net cash provided by (used in) investing activities 546 (3,818 ) (3,312 ) Financing activities Proceeds from issuance of common stock upon initial public offering, net of offering costs 182,419 — — Proceeds from issuance of Series A Convertible Preferred Stock, net of issuance costs 3,792 14,165 — Payments of Series A Preferred Stock cumulative dividend upon initial public offering (2,597 ) — — Proceeds from issuance of convertible debt — 7,532 — Borrowings from PPP Loan 3,274 — — Borrowings under revolving credit facilities 305,965 256,862 192,903 Payments of deferred financing costs (13 ) (1,697 ) — Repayments of PPP loan, long-term debt and revolving credit facilities (404,021 ) (256,785 ) (220,309 ) Payments made on financing leases (674 ) (177 ) — Proceeds from Offering and Concurrent Offering — — 52,645 Payments of offering costs on Offering and Concurrent Offering — — (4,521 ) Proceeds from loans from related party — — 6,000 Payments of loans from related party — — (2,000 ) Other — — 798 Net cash provided by financing activities 88,145 19,900 25,516 Effect of exchange rate changes on cash, cash equivalents and restricted cash 232 2,154 (924 ) Net increase in cash, cash equivalents and restricted cash 44,098 4,934 25,717 Cash, cash equivalents and restricted cash at beginning of year 32,857 27,923 2,206 Cash, cash equivalents and restricted cash at end of year $ 76,955 $ 32,857 $ 27,923 Non-cash investing and financing activities Conversion of Series A Convertible Preferred Stock to common stock $ 25,594 $ — $ — Shares withheld for payroll taxes related to vesting of restricted stock units 6,089 — — Right-of-use assets acquired under operating lease obligation 3,166 — — Property and equipment acquired under finance lease obligation 323 251 279 Purchases of property and equipment included in accounts payable and accrued liabilities 243 3 — Offering costs included in accounts payable and accrued liabilities 148 — — Assets transferred from other assets to property and equipment and intangible assets 129 — — Other assets deposit applied to finance lease upon payoff 66 — — Issuance of Series A Convertible Preferred Stock upon conversion of debt and accrued interest — 7,637 — Receivable related to issuance of Series A Convertible Preferred Stock — 1,450 — Deferred financing costs capitalized to principal of long-term debt — 615 — Conversion of loan from related party to common shares — — 4,088 Supplemental information Cash paid for interest 23,142 5,492 4,710 Cash paid for income taxes 94 63 613 The accompanying notes are an integral part of the consolidated financial statements. F- 7 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) 1. DESCRIPTION OF THE BUSINESS, BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES 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 distributor and manufacturer 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. Prior to the fall of 2018, the legal parent of Hydrofarm, LLC, the primary operating subsidiary, was Hydrofarm Investment Corp. As discussed further below under “ Recapitalization and reverse merger in 2018 ”, Hydrofarm Investment Corp. underwent a recapitalization and reverse merger in a series of transactions in which Hydrofarm Holdings Group, Inc., a shell company, became the legal parent. F- 8 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) Initial 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 9,966,667 shares of its common stock, including the full exercise by the underwriters of its option to purchase 1,300,000 additional shares of the common stock. The price was $20.00 per share. The Company received net proceeds of approximately $182.3 million from the IPO after deducting underwriting discounts and commissions and offering expenses. Reverse stock split In November 2020, the board of directors (the “Board”) of the Company approved a 1-for-3.3712 reverse stock split of the Company’s outstanding common stock, which was effected on November 24, 2020. All common stock and per share information has been retroactively adjusted to give effect to this reverse stock split for all periods presented. Shares of common stock underlying outstanding stock options and other equity instruments were proportionately decreased and the respective per share value and exercise prices, if applicable, were proportionately increased in accordance with the terms of the agreements governing such securities. There were no changes in the authorized shares or par values of the Company’s common stock and preferred stock as a result of the reverse stock split. Recapitalization and reverse merger in 2018 The Offering In the fall of 2018, Hydrofarm Holdings Group, Inc., previously a shell entity with nominal assets and liabilities and 1,186,487 shares of common stock outstanding, completed a private placement (the “Offering”) of units offered to third -party investors at a price of $8.43 each. Each unit consisted of one share of common stock and a warrant entitling the holder to purchase one-half (1/2) share of common stock at an exercise price of $16.86 per common share (the “Units”). The Offering raised $41,499 (excluding fees and expenses) for 4,929,725 (pre-split: 16,619,616) Units. The Concurrent Offering and reverse merger At approximately the same time as, and in relation to, the Offering, Hydrofarm Holdings Group, Inc. offered to investors in Hydrofarm Investment Corp. Units with the same terms as those in the Offering (the “Concurrent Offering”). Hydrofarm Holdings Group, Inc. raised $15,234 in the Concurrent Offering. Consideration consisted of $11,146 in cash for 1,323,157 (pre-split: 4,460,659) Units and the conversion to Units of a $4,000 loan outstanding plus accrued interest of $88 from a related party for 484,681 (pre-split: 1,633,958) Units (excluding fees and expenses). On August 28, 2018, in connection with the Offering and Concurrent Offering, in a series of concurrent transactions, the shareholders in Hydrofarm Investment Corp. and the holder of the non-controlling interest (“NCI”) in Hydrofarm Holdings LLC exchanged all of the holder’s interests for 12,764,389 shares of Hydrofarm Holdings Group, Inc.’s common stock which, along with 1,807,838 shares issued in the Concurrent Offering, totaled 14,572,227 shares and represented a 70.4% controlling interest. The exchange ratio for the 12,764,389 shares was 0.2966 Hydrofarm Holdings Group, Inc. common share for 0.4147 Hydrofarm Investment Corp. common share. As a result of the exchange, Hydrofarm Investment Corp. and its subsidiaries became wholly-owned subsidiaries of Hydrofarm Holdings Group, Inc. Hydrofarm, LLC continues as the principal operating subsidiary. Since this exchange was a common control transaction, the carrying value of the NCI was transferred to controlling interest allocated between paid in capital and the NCI’s share of accumulated losses at net book value. The transaction was treated as a tax-free exchange under Section 368(a) of the Internal Revenue Code of 1986, as amended. Under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 805, Business Combinations , since the members of Hydrofarm Investment Corp. prior to the exchange continued to hold a controlling interest in Hydrofarm Holdings Group, Inc. after the exchange (e.g., there was no change in control of Hydrofarm Investment Corp.), Hydrofarm Investment Corp. is deemed to be the “accounting acquirer” and Hydrofarm Holdings Group, Inc. is deemed to be the “accounting acquiree.” From an accounting perspective, the consolidated financial statements of the combined entity represent a continuation of the financial position and results of operations of the accounting acquirer/legal acquiree. Accordingly, the historical cost basis of assets, liabilities, capital and accumulated deficit of Hydrofarm Investment Corp. as the accounting acquirer/legal acquiree are carried over to the consolidated financial statements of the merged company. Hydrofarm Holdings Group, Inc. had no assets prior to the merger except $1 in cash, and no liabilities or operations; accordingly, it is considered a “shell company” which does not meet the definition of a “business” under ASC 805. For accounting purposes, mergers of operating companies into shell companies are considered to be capital transactions rather than business combinations. These transactions are equivalent to the issuance of stock by the private company for the net monetary assets, if any, of the shell corporation, accompanied by a recapitalization. The accounting for the transaction is identical to that resulting from a reverse acquisition, except that goodwill or other intangible assets would not be recognized. Since Hydrofarm Holdings Group, Inc. was a shell company, there is no accounting basis associated with the 1,186,487 shares of Hydrofarm Holdings Group, Inc. common stock deemed acquired in the merger other than the $1 in cash. Consolidated financial statements prepared following a reverse merger are issued under the name of the legal parent (accounting acquiree) and are a continuation of the financial statements of the legal subsidiary (accounting acquirer), with one adjustment. The adjustment retroactively states the accounting acquirer’s legal capital to reflect the legal capital of the accounting acquiree. Accordingly, the share and stated capital of Hydrofarm Investment Corp. have been retroactively adjusted in these consolidated financial statements and footnotes using the exchange ratio established in the merger agreements to reflect the number of shares of Hydrofarm Holdings Group, Inc. issued in the exchange. For convenience hence-forth here-in, the consolidated financial statements for periods prior to the exchange are referred to as those of the “Company” unless otherwise noted. Warrants issued to placement agents As part of the Offering and Concurrent Offering, placement agents were issued warrants to purchase 517,067 shares of common stock in the Company of which 172,351 shares subject to warrants are exercisable at a price of $16.86 per share and 344,716 shares subject to warrants are exercisable at a price of $8.43 per share. The following is a summary of the aggregate shares of common stock and shares subject to warrants issued as part of the Offering and Concurrent Offering: Common Stock Shares Subject to Warrants Offering 4,929,725 2,465,201 Concurrent Offering 1,323,157 661,583 Conversion of Loan 484,681 242,340 Subtotal 6,737,563 3,369,124 Placement agent warrants - 517,067 Total 6,737,563 3,886,191 Basis of consolidation and presentation The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and include the accounts of the Company and its wholly owned subsidiaries and any entities in which it maintains a controlling financial interest. All intercompany balances and transactions have been eliminated in consolidation. F- 9 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) Use of estimates The preparation of 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 liabilities as of the date of the 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, valuation of intangible assets and goodwill, valuation of stock and warrants issued in private placements, 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. Segment information and entity-wide disclosures Segment information The Company’s chief operating decision maker (“CODM”) 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 two operating segments, the U.S. and Canada, which meet the criteria for aggregation, and the Company has elected to present them as one 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. Since the Company operates as one reportable segment, all required segment financial information is found in the consolidated financial statements and footnotes with entity-wide disclosures presented below. Entity-wide disclosures Sales to external customers and property and equipment, net in the United States and Canada, determined by the location of the subsidiaries, were as follows: For the years ended December 31, 2020 2019 2018 United States $ 287,884 $ 194,618 $ 169,018 Canada 58,079 44,515 49,147 Intersegment eliminations (3,758 ) (4,022 ) (6,352 ) Total consolidated net sales $ 342,205 $ 235,111 $ 211,813 December 31, 2020 2019 United States $ 3,272 $ 2,660 Canada 716 890 Total property and equipment, net $ 3,988 $ 3,550 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. Concentrations of business and credit risk The Company maintains cash balances at certain financial institutions that can, at times, exceed amounts insured by the Federal Deposit Insurance Corporation (“FDIC”). The Company has not experienced any losses in these accounts and believes it is not exposed to any significant credit risk in this area. F- 10 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) Accounts receivable, which are unsecured except those that are backed by personal guarantees, expose the Company to credit risks such as collectability and business risks such as customer concentrations. Exposure to losses on receivables is principally dependent on each customer’s financial condition. Credit risk is mitigated by investigating the credit worthiness of most customers prior to establishing relationships with them and performing periodic review of the credit activities of those customers. Receivables arising from sales are not collateralized; however, credit risk is somewhat mitigated as a result of the large diverse customer base. No customer accounted for more than 10% of revenues in 2020, 2019, and 2018. One customer accounted for 11% of accounts receivable as of December 31, 2020, and 2019. No supplier accounted for more than 10% of purchases in 2020 and 2018, and one supplier accounted for 10% of purchases in 2019. Certain significant risks and uncertainties – COVID-19 Due to the ongoing COVID-19 pandemic, the Company has implemented business continuity plans designed to address and mitigate the impact of the COVID-19 pandemic on the Company’s business. The Company does not currently anticipate that the COVID-19 pandemic will have a material impact on the timelines for the Company’s product development and expansion efforts. However, the extent to which the COVID-19 pandemic impacts the Company’s business product development and expansion efforts, corporate development objectives and the value of and market for the Company’s common stock will depend on future developments that are highly uncertain and cannot be predicted with confidence at this time, such as the ultimate duration of the pandemic, travel restrictions, quarantines, social distancing and business closure requirements in the United States, and the effectiveness of actions taken globally to contain and treat the disease. The global economic slowdown, the overall disruption of global supply chains and distribution systems and the other risks and uncertainties associated with the pandemic could have a material adverse effect on the Company’s business, financial condition, results of operations and growth prospects. Fair value measurements Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company has applied the framework for measuring fair value which requires a fair value hierarchy to be applied to all fair value measurements. All financial instruments recognized at fair value are classified into one of three levels in the fair value hierarchy as follows: Level 1 — Valuation based on quoted prices (unadjusted) observed in active markets for identical assets or liabilities. Level 2 — Valuation techniques based on inputs that are quoted prices of similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not in active markets; inputs other than quoted prices used in a valuation model that are observable for that instrument; and inputs that are derived from or, corroborated by, observable market data by correlation or other means. Level 3 — Valuation techniques with significant unobservable market inputs. The Company measures certain non-financial assets and liabilities, including long-lived assets, intangible assets and goodwill, at fair value on a nonrecurring basis. Fair value measurements of non-financial assets and non-financial liabilities are used primarily in the impairment analyses of long-lived assets, intangible assets and goodwill. These inputs are classified as Level 3 in the fair value hierarchy. See discussion of impairment losses in Note 7, Intangible assets and goodwill . Foreign currency transactions The Company reports its financial results in United States dollars, which is the currency of the primary economic environment in which it operates. The functional currency for each of the Company’s foreign subsidiaries is generally its local currency. Assets and liabilities of these subsidiaries are translated at the exchange rates in effect at the end of each year. Income and expense items are translated at the average rates of exchange prevailing during the year. Translation gains and losses arising from the use of differing exchange rates from period to period are included in accumulated other comprehensive income (loss) within stockholders’ equity. Foreign currency transaction gains and losses are included in the determination of net loss and classified as other income, net in the consolidated statements of operations. F- 11 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) The effect of currency translation adjustments on cash, cash equivalents and restricted cash is presented separately in the consolidated statements of cash flows. Cash, cash equivalents and restricted cash Cash includes funds deposited in banks. Cash equivalents include highly liquid investments such as term deposits and money market instruments with original maturities of three months or less. As of December 31, 2020, and 2019, amounts included in restricted cash represent those funds required to be set aside as security for letters of credits, and other various contractual arrangements. The following table provides a reconciliation of cash, cash equivalents and restricted cash reported within the consolidated balance sheets to the consolidated statements of cash flows: December 31, 2020 2019 Cash and cash equivalents $ 75,178 $ 22,866 Restricted cash 1,777 9,991 Cash and cash equivalents, and restricted cash $ 76,955 $ 32,857 Accounts receivable, net Accounts receivable, net represents amounts due from customers less the allowance for doubtful accounts. Allowance for doubtful accounts reflects the Company’s estimate of amounts in its existing accounts receivable that may not be collected due to customer claims or customer inability or unwillingness to pay. The allowance is determined based on a combination of factors, including the age of the account, the credit worthiness of the customer, payment terms, the customer’s historical payment history and general economic conditions. Accounts receivable balances are charged off against the allowance account when the Company believes it is probable the receivable will not be recovered. Inventories Inventories are primarily comprised of finished goods and are stated at the lower of cost or net realizable value, principally determined by the first in, first out method of accounting. Inventory costs include the purchase price and other costs such as import duties, taxes, and transportation costs. Trade discounts are deducted from the purchase price. 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. If actual conditions are less favorable than those projected, it may be necessary to increase the allowance for excess and obsolete inventory. Any increase in the allowance will adversely impact results of operations. The establishment of an allowance for excess and obsolete inventory establishes a new cost basis in the inventory. Such allowance is not reduced until the product is sold. If inventory is sold, any related reserves would be reversed in the period of sale. Leases Leased assets are accounted for under FASB ASC 842, Leases (“ASC 842”). The Company early adopted ASC 842 using the modified retrospective approach effective January 1, 2019, and no cumulative effect adjustment was required to be recorded. The adoption of the new standard resulted in the recognition of operating lease right of use (“ROU”) assets and lease liabilities in the amount of approximately $24,872 and $25,135, respectively, in the Company’s consolidated balance sheets. The Company elected the “package of practical expedients” available at the time of implementation which permitted the Company to carry over from FASB ASC 840, Leases , its prior conclusions about lease identification, lease classification and initial direct costs. The short-term lease exemption for all leases with an initial term of 12 months or less was elected. F- 12 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) The Company determines if an arrangement contains a lease at inception. ROU assets represent the right to use an underlying asset for the lease term while lease liabilities represent the obligation to make lease payments for the lease term. Leases are then classified as either finance or operating, with classification affecting the pattern of expense recognition in the consolidated statements of operations. All leases greater than 12 months result in the recognition of a ROU asset and liability at the lease commencement date based on the present value of the lease payments over the lease term. The present value of the lease payments is calculated using the applicable weighted-average discount rate. The weighted-average discount rate is based on the discount rate implicit in the lease, or if the implicit rate is not readily determinable from the lease, the applicable incremental borrowing rate is estimated. The incremental borrowing rate is estimated using the currency denomination of the lease, the contractual lease term and the Company’s applicable borrowing rate. To determine the incremental borrowing rate, reference is made to interest rates that would be available to finance assets similar to the assets under lease in their related geographical location. The Company accounts for lease components separately from non-lease components, other than for office equipment. The Company has certain leases that include one or more options to renew with renewal terms that can extend the lease term from one to ten years. The exercise of the lease renewal options is at the Company’s discretion and are included in the determination of the ROU asset and lease liability when the option is reasonably certain of being exercised. Prior to adoption of ASC 842 Prior to January 1, 2019, o perating lease payments were recognized as expense on a straight-line basis over the lease term. In the event that lease incentives were received to enter into operating leases, such incentives were recognized as a liability and recognized as a reduction of rental expense on a straight-line basis. Property and equipment, net Property and equipment is recorded at cost less accumulated depreciation and provisions for impairment, if any. Expenditures for maintenance and repairs are expensed as incurred, while costs related to betterments and improvements that extend the useful lives of property and equipment are capitalized. When property and equipment are retired or otherwise disposed of, the cost of the asset and related accumulated depreciation are removed from the accounts with the resulting gain or loss being reflected in income (loss) from operations. Depreciation of property and equipment is provided on the straight-line method and is based on the estimated useful economic lives of the assets as follows: Machinery and equipment 5 years Leasehold improvements Lesser of useful life or term of the lease Computer equipment 3 – 4 years Furniture and fixtures 5 years Intangible assets and goodwill Definite-lived intangible assets are amortized using the straight-line method over their estimated useful lives. Certain trade names are considered to have indefinite useful lives. The cost of internal use computer software is expensed or capitalized depending on whether it is incurred in the preliminary project stage, application development stage or the post-implementation/operation stage. The following are the estimated useful lives for the major classes of definite life intangible assets: Computer software 5 years Customer relationships 18 years Intellectual property and licenses 5 – 15 years or the lesser of useful life and term of license Trade names 2 years Goodwill represents the excess of the cost 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. F- 13 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) Impairment The Company evaluates its long-lived assets, including amortizable intangible assets for indicators of possible impairment when events or changes in circumstances indicate the carrying amount of an asset or asset group (collectively, the “asset group”) may not be fully recoverable. The Company measures the recoverability of the asset group by comparing the carrying amount of such asset groups to the estimated future undiscounted cash flows it expects the asset group to generate. The asset group is defined as the lowest level for which identifiable cash flows are available and largely independent of the cash flows of other groups of assets. Impairment, if any, is measured as the amount by which the carrying value of the asset group exceeds its fair value and is recorded in impairment, restructuring and other in the consolidated statements of operations. The Company reviews its indefinite-lived intangible assets (primarily, trade names) annually in the fourth quarter or whenever events or changes in circumstances indicate the carrying amount may not be fully recoverable. When testing the trade names for impairment, the Company first performs an assessment of qualitative factors. If qualitative factors indicate that it is more likely than not that the fair value of the trade names are less than its carrying amount, the Company tests the trade names for impairment at the asset level using the relief-from-royalty method to determine fair value. The Company determines the fair value of the trade names and compares it to the carrying value. If the carrying value of the trade names exceeds the fair value, the Company recognizes an impairment loss in an amount equal to the excess. The Company reviews the carrying amount of goodwill for impairment annually in the fourth quarter of the fiscal year and whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Events that result in an impairment review include significant changes in the business climate, declines in operating results, or an expectation that the carrying amount may not be recoverable. When testing goodwill for impairment, the Company first performs a Step 0 Test. If qualitative factors indicate that it is more likely than not that the fair value of the relevant reporting unit is less than its carrying amount, the Company tests goodwill for impairment at the reporting unit level using a two-step approach. In step one, the Company determines if the fair value of the reporting unit exceeds the reporting unit’s carrying value. If step one indicates that the fair value of the reporting unit is less than its carrying value, the Company performs step two, determining the fair value of goodwill and, if the carrying value of goodwill exceeds its implied fair value, an impairment charge is recorded. The Company has determined that its reporting units for the purpose of goodwill impairment testing are the United States and Canada. Warrants issued in connection with financings The Company generally accounts for warrants issued in connection with debt and equity financings as a component of equity unless the warrants include a conditional obligation to issue a variable number of shares among other conditions or it is possible that the Company may need to settle the warrants in cash. Revenue recognition The Company early adopted FASB ASC 606, Revenue from Contracts with Customers (“ASC 606”), on January 1, 2018, with no material impact on its consolidated financial statements. ASC 606 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 CEA equipment and supplies. Inventory is maintained in regional distribution centers. Payment terms are primarily at the point of sale or due within thirty days. 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 have a single performance obligation and revenue is reported net of 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; these allowances and accruals are not material to the financial statements. The amount billed to customers for shipping and handling costs included in net sales was $4,314, $2,790, and $1,826 in 2020, 2019, and 2018, respectively. Shipping and handling costs that occur before the customer obtains control of the goods are deemed to be fulfillment activities and are accounted for as fulfillment costs included in cost of goods sold under the practical expedient provisions of ASC 606. Deferred revenues are not material. The Company does not receive noncash consideration for the sale of goods. 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 under the practical expedient provisions. Advertising and warranty costs Advertising costs paid to third-party vendors totaling $276, $666, and $771 in 2020, 2019, and 2018, respectively, were expensed as incurred. F- 14 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) An estimate of exposure for warranty claims is accrued based on both current and historical product sales data and warranty costs incurred. Product warranties, where applicable, range from one year to five years. The Company assesses the adequacy of its recorded warranty liability periodically and adjusts the amount as necessary. Warranty expense and the related accrual are not material to the financial statements. Deferred offering costs The Company capitalizes certain legal, accounting and other third-party fees that are directly related to an equity financing that is probable of successful completion until such financing is consummated. After consummation of an equity financing, these costs are recorded as a reduction of the proceeds received as a result of the financing. Should a planned equity financing be abandoned, terminated or significantly delayed, the deferred offering costs are immediately written off to operating expenses in the consolidated statements of operations in the period of determination. Upon the closing of the IPO in December 2020, all deferred offering costs were reclassified from prepaid expenses and other current assets and recorded as a reduction of the IPO proceeds in additional paid-in capital. Stock-based compensation The Company accounts for stock-based compensation expense in accordance with the fair value recognition and measurement provisions of U.S. GAAP, which requires compensation cost for the grant-date fair value of stock-based awards to be recognized over the requisite service period. The Company accounts for forfeiture when it occurs, and any compensation expense previously recognized on unvested shares will be reversed when forfeited. Service-based awards The Company records stock-based compensation expense for restricted stock units (“RSUs”) and service-based stock options on a straight-line basis over the requisite service period. The fair value of grants of restricted stock is based on the fair value of the common stock underlying the award. The fair value of the underlying common stock for grants prior to the Company’s IPO in December 2020 was determined by considering a number of objective, subjective and highly complex factors including independent third-party valuations of the Company’s common stock, operating and financial performance, the lack of liquidity of capital stock and general and industry specific economic outlook among other factors. The fair value of option-based awards is estimated using the Black-Scholes valuation model. The Black-Scholes model requires the use of highly subjective and complex assumptions, including the option’s expected term and the price volatility of the underlying stock. For inputs into the Black-Scholes model, the expected stock price volatility for the common stock is estimated by taking the average historic price volatility for industry peers based on daily price observations over a period equivalent to the expected term of the stock option grants. Industry peers consist of several public companies in the Company’s industry which are of similar size, complexity and stage of development. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury implied yield at the date of grant. The Company has elected to use the “simplified method” to determine the expected term which is the midpoint between the vesting date and the end of the contractual term because it has insufficient history upon which to base an assumption about the term; the Company believes the simplified method approximates a term if it were to be based on expected life. The expected dividend yield is 0.0% as the Company has not paid and does not anticipate paying dividends on its common stock. Performance-based awards The Company has granted RSU awards that vest upon the satisfaction of both service-based and performance-based conditions. The service-based condition for these awards generally is satisfied over four years. The performance-based conditions generally are satisfied upon achieving specified performance targets, such as the occurrence of a qualifying event, defined as the earlier of (i) the closing of certain specific liquidation or change in control transactions, or (ii) an IPO. The Company records stock-based compensation expense for performance-based equity awards on a straight-line basis over the requisite service period and only if performance-based conditions are considered probable to be satisfied. The cumulative portion of the service-based award that would have vested prior to the performance condition becoming probable is recognized once both conditions are satisfied. F- 15 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) Market-based awards The Company has granted RSUs that vest only upon the satisfaction of both performance-based and market-based conditions. The performance-based conditions are satisfied upon achieving specified performance targets, such as the occurrence of a qualifying event, as described above for performance-based awards. The market-based condition is satisfied upon the Company’s achievement of a qualifying traded share price within the specified time frame. The Company records stock-based compensation expense once the performance condition is satisfied regardless of whether the market condition is eventually met. For one award granted in 2020, the market condition was factored into its fair value. To estimate the fair value of the award granted in 2020 with the market-based condition, the “Monte Carlo Simulation Method” (the MCSM) was used which assesses the likelihood of vesting of the RSU grants based on the probability of both a triggering event and qualifying traded share price within the specified time frame. The resulting risk-adjusted probability was then applied to the underlying fair value of common stock incorporating scenarios under which various performance conditions and share price outcomes are modeled over the course of numerous iterations. Key assumptions in the MSCM included volatility, time horizon corresponding to the vesting measurement period of the award forecasted based on daily trading prices, risk free rate, and number of simulation trials. Income taxes The asset and liability method of accounting for income taxes is followed whereby deferred income tax assets are recognized for deductible temporary differences and operating loss carryforwards, and deferred income tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the amounts of assets and liabilities recorded for income tax and financial reporting purposes. Deferred income tax assets are recognized only to the extent that management determines that it is more likely than not that the deferred income tax assets will be realized. Deferred income tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. The income tax expense or benefit is the income tax payable or recoverable for the year plus or minus the change in deferred income tax assets and liabilities during the year. The Company will establish a liability for tax return positions when there is uncertainty as to whether the position will ultimately be sustained. Amounts for uncertain tax positions will be adjusted when new information becomes available or when positions are effectively settled. The Company will recognize interest expense and penalties related to these unrecognized tax benefits within income tax expense. U.S. GAAP provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits of the position. The amount recognized is measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the related tax authority. Comprehensive loss Comprehensive loss consists of two components: net loss and other comprehensive income. Other comprehensive income refers to gains that under U.S. GAAP are recorded directly as an element of stockholders’ equity, but are excluded from net loss, and comprised of currency translation adjustments relating to the Company’s foreign subsidiaries whose functional currency is not the U.S. dollar. Recently issued accounting pronouncements Adopted in 2020 In August 2018, the FASB issued Accounting Standards Update (“ASU”) No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework — Changes to the Disclosure Requirements for Fair Value Measurement , which eliminates certain disclosure requirements for fair value measurement for all entities, requires public entities to disclose certain new information and modifies some disclosure requirements. The Company adopted the standard effective January 1, 2020 with no impact on its disclosures about fair value measurements. In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting , which provides optional expedients and exceptions for applying U.S. GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments apply only to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. The Company adopted the standard effective March 12, 2020 with no impact on the consolidated financial statements and related disclosures. F- 16 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This ASU simplifies the accounting for income taxes by removing certain exceptions to the general principles in Topic 740 and improving consistent application of and simplifying U.S. GAAP for other areas of Topic 740 by clarifying and amending existing guidance. This ASU is effective for fiscal years beginning after December 15, 2021 and interim periods within fiscal years beginning after December 15, 2022. Early adoption is permitted (including in an interim period). The Company early adopted the standard effective October 1, 2020 with no impact on the consolidated financial statements and related disclosures. Accounting standards not yet effective In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments — Credit Losses: Measurement of Credit Losses on Financial Instruments (Topic 326) , with additional amendments issued subsequently. Topic 326 changes the impairment model for most financial assets. The new model uses a forward-looking expected loss method, which will generally result in earlier recognition of allowances for losses. Topic 326 is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact the adoption of Topic 326 will have on its consolidated financial statements. In October 2020, the FASB issued ASU No. 2020-10, Codification Improvements . The amendments improve the codification by having all disclosure-related guidance available in the disclosure sections of the codification. Prior to this ASU, various disclosure requirements or options to present information on the face of the financial statements or as a note to the financial statements were not included in the appropriate disclosure sections of the codification. The codification improvements also contain various other minor amendments to the codification that are not expected to have a significant effect on current accounting practice. The amendments are effective for annual periods beginning after December 15, 2020 and early adoption is permitted. The Company is currently evaluating the impact the adoption of this ASU will have on its consolidated financial statements. 2. NET LOSS PER COMMON SHARE (“EPS”) Basic EPS is computed using net loss attributable to common stockholders divided by the weighted-average number of common shares outstanding during each period, excluding unvested RSUs. Diluted EPS represents net loss attributable to common stockholders 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 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. Impact of recapitalization and reverse merger on 2018 EPS FASB ASC 260-10-55-12 states that nominal issuances of common stock are deemed to be in substance recapitalizations and should be reflected in EPS computations in a manner similar to a stock split or stock dividend for which retroactive treatment is required. In August 2018, the holders of a non-controlling interest in a subsidiary, which was previously presented as NCI, exchanged their interest for 1,593,096 shares of common stock in the Company (see Note 1, Description of the business, basis of presentation and significant accounting policies - Recapitalization and reverse merger in 2018 ). This exchange is deemed to be a nominal issuance of common stock; accordingly, the exchange is considered to have occurred as of inception (March 21, 2017) for the purposes of calculation of EPS for 2018. Furthermore, the net loss allocable to the NCI is assumed to have converted into a controlling interest as of inception for this purpose. In accordance with FASB ASC 805-40-45, the equity structure in the consolidated financial statements following a reverse merger reflects the equity structure of the legal acquirer (the accounting acquiree), including the equity interests issued by the legal acquirer to effect the merger. In calculating the weighted-average number of common stock outstanding (the denominator of the EPS calculation) during the period in which the reverse merger occurs: · The number of common stock outstanding from the beginning of that period to the acquisition date shall be computed on the basis of the weighted-average number of common stock of the legal acquiree (accounting acquirer) outstanding during the period multiplied by the exchange ratio established in the merger agreement. · The number of common stock outstanding from the acquisition date to the end of that period shall be the actual number of common stock of the legal acquirer (the accounting acquiree) outstanding during that period. F- 17 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) Basic EPS for each comparative period before the acquisition date presented in the consolidated financial statements following a reverse merger shall be calculated by dividing (a) the income of the legal acquiree attributable to common stockholders in each of those periods by (b) the legal acquiree’s historical weighted average number of common stock outstanding multiplied by the exchange ratio established in the acquisition agreement. Net loss per share attributable to common stockholders On December 14, 2020, the Company closed its IPO, in which it issued and sold 9,966,667 shares of its common stock at a price of $20.00 per share. On that date, all of the Company’s outstanding Series A Convertible Preferred Stock automatically converted into 2,291,469 shares of common stock. These shares were included in the Company’s issued and outstanding common stock starting on that date. The following table presents information necessary to calculate basic and diluted EPS for the years ended December 31, 2020, 2019, and 2018 For the years ended December 31, 2020 2019 2018 Net loss (2018 assumes retroactive conversion of NCI into controlling interest) $ (7,273 ) $ (40,083 ) $ (35,542 ) Cumulative dividends allocated to Series A Convertible Preferred Stock (2,597 ) - - Basic and diluted net loss attributable to common stockholders (9,870 ) (40,083 ) (35,542 ) Less: Effect on net loss of dilutive securities using the "if converted" method - - - Diluted net loss attributable to common stockholders after adjustment for assumed conversions $ (9,870 ) $ (40,083 ) $ (35,542 ) Weighted-average shares of common stock outstanding for basic and diluted EPS (2018 assumes retroactive conversion of NCI into controlling interest) 21,298,849 20,688,439 15,390,086 Basic and diluted net loss per share attributable to common stockholders $ (0.46 ) $ (1.94 ) $ (2.31 ) Since the Company was in a loss position for the years ended December 31, 2020, 2019, and 2018 basic EPS was the same as diluted EPS for the periods presented. Basic and diluted net loss per share attributable to common stockholders is computed using the two-class method as the convertible preferred stock is determined to be a participating security; however, the application of the if-converted method to participation in the net loss is anti-dilutive and therefore the impact is excluded. 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 on diluted EPS attributable to common stockholders: For the years ended December 31, 2020 2019 2018 Shares subject to warrants outstanding 3,886,191 3,886,191 3,886,191 Shares subject to stock options outstanding 922,796 819,879 - Shares subject to unvested restricted stock units 1,857,444 1,820,598 - Series A preferred stock convertible into common shares - 2,078,605 - F- 18 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) 3. ACCOUNTS RECEIVABLE, NET AND INVENTORIES Accounts receivable, net comprised the following: December 31, 2020 2019 Trade accounts receivable $ 20,252 $ 16,577 Allowance for doubtful accounts (918 ) (1,776 ) Other receivables 2,292 445 Total accounts receivable, net $ 21,626 $ 15,246 Inventories comprised the following: December 31, 2020 2019 Finished goods $ 91,050 $ 54,050 Allowance for inventory obsolescence (2,432 ) (3,822 ) Total inventories $ 88,618 $ 50,228 4. NOTES RECEIVABLE The Company advanced $2,000 in the form of a note receivable secured by equipment to a third-party in December 2018. As of December 31, 2019, the principal remained outstanding and total interest income at 8.0% per annum earned in 2019 was $160. Interest income recognized in 2020 was $24. The note was to mature on the earlier of a) 90 days after abandonment of a potential merger, b) acceleration due to default conditions, or c) December 2023. In January 2020, the Company formally abandoned the merger, and all outstanding principal and interest was repaid in February 2020. During 2019, the Company advanced a total of $2,931 in the form of a note receivable secured by equipment to another third-party, which earned interest at a rate of 8.0% for total interest earned in 2020 and 2019 of $101 and $119, respectively. The note was to mature on the earlier of a) four months or 12 months after abandonment of a potential merger by the third-party or the Company, respectively, b) acceleration due to default conditions or c) May 29, 2023. As of December 31, 2019, the third-party had defaulted on the interest payment due on September 20, 2019, triggering an increase to the default rate of 13%. In January 2020, the Company formally abandoned the merger and arranged for the principal balance to be paid in monthly installments of $254 through January 2021. Effective April 23, 2020, due to the third-party being in default on the note, the parties entered a forbearance agreement stipulating that payments commenced on May 8, 2020. As of December 31, 2020, the third-party had defaulted on the payments. Effective February 19, 2021, the Company amended and restated the note receivable secured by equipment to allow the third-party to receive equity financing that will be used to fund operations. The amended and restated terms modified a) the interest rate to a range from 6% to 8% over the term of the note, b) the maturity date to December 2024, and c) the installment payments to a range from 10% to 25% of the unpaid principal balance every six months beginning June 2022. The accrued interest of $220 as of December 31, 2020 was paid in January 2021. F- 19 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) 5. LEASES The Company leases its distribution centers and certain equipment under operating and finance leases. As of December 31, 2020 and 2019, no renewal option periods were included in any estimated minimum lease terms as the options were not deemed to be reasonably certain to be exercised. The depreciable life of ROU assets and leasehold improvements are limited by the expected lease term. None of the lease agreements include variable rental payments that are adjusted periodically for inflation based on the index rate; rather, most leases for the distributions centers provide for fixed periodic increases. The Company’s lease agreements do not contain any residual value guarantees or unusual restrictive covenants. Total ROU assets and lease liabilities were as follows: December 31, Balance Sheet Classification 2020 2019 Leased assets Operating ROU assets at cost Operating lease right-of-use assets $ 21,739 $ 21,906 Accumulated amortization Operating lease right-of-use assets (3,450 ) (3,385 ) Net book value $ 18,289 $ 18,521 Finance lease assets at cost Property and equipment, net $ 602 $ 1,060 Accumulated amortization Property and equipment, net (219 ) (375 ) Net book value $ 383 $ 685 Lease liabilities Current: Operating leases Current portion of lease liabilities $ 3,701 $ 3,181 Finance leases Current portion of long-term debt 159 431 Noncurrent: Operating leases Long-term lease liabilities 15,320 15,786 Finance leases Long-term debt 223 368 Total lease liabilities $ 19,403 $ 19,766 Total lease income and costs were as follows: For the years ended December 31, Classification 2020 2019 Operating lease costs Selling, general and administrative $ 4,260 $ 4,580 Finance lease costs: Amortization of lease assets Selling, general and administrative 257 239 Interest on lease liabilities Interest expense 58 46 Gain on lease termination Impairment, restructuring, and other — (160 ) Sublease income Selling, general and administrative (57 ) (369 ) In addition to the operating lease costs above, short-term and month-to-month lease expense was $1,406 and $1,276 for the years ended December 31, 2020 and 2019, respectively, and other costs associated with operating leases were $1,464 and $1,496, respectively, for non-lease components such as common area maintenance and other miscellaneous items. These costs are included within selling, general and administrative expenses in the consolidated statements of operations. F- 20 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) The aggregate future minimum lease payments under long-term noncancelable operating and finance leases with remaining terms greater than one year as of December 31, 2020 are as follows: Year ending December 31, Operating Finance 2021 $ 4,421 $ 176 2022 4,055 176 2023 2,490 56 2024 2,103 — 2025 2,156 — Thereafter 6,851 — Total rental payments 22,076 408 Less portion representing interest 3,055 26 Total principal 19,021 382 Less current portion 3,701 159 Long-term portion $ 15,320 $ 223 The following table summarizes the weighted-average remaining lease term as of December 31, 2020 and 2019 and the weighted-average discount rate on long-term leases for the years ended December 31, 2020 and 2019: 2020 2019 Weighted-average remaining lease term in years: Operating leases 6.8 7.5 Finance leases 2.2 2.4 Weighted-average discount rate: Operating leases (for leases expiring after 2020) 4.26 % 4.50 % Finance leases 5.61 % 7.17 % Cash paid for amounts included in lease liabilities in 2020 and 2019 were: Years ended December 31, Cash paid for amounts included in lease liabilities: 2020 2019 Operating cash flows from operating leases $ (3,917 ) $ (4,225 ) Operating cash flows from finance leases (58 ) (43 ) Financing cash flows from finance leases (674 ) (177 ) Disclosure for leases for 2018 under ASC 840 Rent expense related to certain warehouse, distribution and office facilities, vehicles and office equipment under leases with terms greater than one year was $6,509 in 2018. Other costs of $1,169 were associated with month-to-month leases. These costs are included in selling, general and administrative expenses in the consolidated statement of operations. F- 21 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) 6. PROPERTY AND EQUIPMENT, NET Property and equipment comprised the following: December 31, 2020 2019 Machinery and equipment $ 3,648 $ 3,200 Leasehold improvements 2,068 2,721 Other 3,647 2,197 Gross property and equipment 9,363 8,118 Less: accumulated depreciation (5,375 ) (4,568 ) Total property and equipment, net $ 3,988 $ 3,550 Depreciation and amortization expense related to property and equipment, was $1,625, $1,688, and $2,391 in 2020, 2019, and 2018, respectively. 7. INTANGIBLE ASSETS AND GOODWILL Intangible assets comprised the following: December 31, 2020 December 31, 2019 Gross Carrying Amount Accumulated Amortization Net Book Value Gross Carrying Amount Accumulated Amortization Net Book Value Finite-lived intangible assets: Computer software $ 7,775 $ (5,640 ) $ 2,135 $ 7,701 $ (4,136 ) $ 3,565 Customer relationship 59,375 (12,010 ) 47,365 59,375 (8,712 ) 50,663 Other 1,156 (1,156 ) - 1,133 (756 ) 377 Total finite-lived intangible assets, net 68,306 (18,806 ) 49,500 68,209 (13,604 ) 54,605 Indefinite-lived intangible asset: Trade names 2,801 - 2,801 2,801 - 2,801 Other 120 - 120 - - - Total Intangible assets, net $ 71,227 $ (18,806 ) $ 52,421 $ 71,010 $ (13,604 ) $ 57,406 Amortization expense was $5,154, $5,307, and $5,869 in 2020, 2019, and 2018, respectively. Estimated aggregate amortization expense for each of the five years ending December 31, 2021 through 2025 and thereafter is $4,829, $3,846, $3,338, $3,312, $3,303 and $30,872, respectively. For intangible assets subject to amortization, the weighted-average amortization period as of December 31, 2020 for computer software and customer relationships, was 5.0 years and 18.0 years, respectively. Intangible asset impairment The Company has one type of indefinite-lived intangible asset, trade names. If the fair value of the trade names is lower than the carrying amount, an impairment charge is recognized in an amount equal to the difference. In 2020 and 2019, the Company performed its annual Step 0 Test and the assessment of the qualitative factors indicated that it was more likely than not that the fair value of the trade name exceeded its carrying amount. In 2018, the Company estimated the fair value of the indefinite-lived trade names using the relief from-royalty method and determined that the fair value of trade names exceeded the carrying value. Accordingly, no impairment was recognized in 2020, 2019 or 2018. In 2020, for all amortizable intangible assets, the Company did not identify any events or changes in circumstances that would indicate that the carrying amount of the Company’s amortizable intangible assets would not be fully recoverable. During 2019 and 2018, for all amortizable intangible assets except for the customer relationships, the Company did not identify any events or changes in circumstances that would indicate that the carrying amount of the Company’s amortizable intangible assets would not be fully recoverable, therefore, there was no impairment of these intangible assets recognized in 2019 and 2018. For the customer relationships, the undiscounted cash flows over their useful lives were estimated primarily based on management’s assumptions and estimates related to revenue, compound annual growth rates and direct operating expenses. The Company used internal financial forecast models that included historical information and projected growth rates based on various assumption such as consumer health trends, potential medical benefits, regulatory challenges, and overall market developments. Revenue was adjusted annually for estimated customer attrition. For the US customer relationships in 2019 and 2018, and for the Canadian customer relationships in 2018, the sum of the future estimated undiscounted cash flows exceeded the carrying values, and accordingly, there was no impairment recognized. F- 22 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) For Canadian customer relationships in 2019, the sum of the estimated future undiscounted cash flows was insufficient to recover the asset carrying value. The Company then performed Step 2, a computation of fair value, which estimated revenues and direct expenses adjusted for organic growth, customer attrition and capital expenditures for the remaining life of customer relationships; a revisionary value was added to the cash flows. The projected future cash flows were then discounted to fair value which indicated little or no value associated with the intangible asset. Accordingly, the carrying value of the customer relationships totaling $5,390 was impaired and the charge was included in impairment, restructuring and other in the consolidated statements of operations. Goodwill Goodwill arose from the acquisition of certain businesses in Canada and other transactions during the year ended December 31, 2017. There were no additions to or disposals of goodwill in 2020, 2019 or 2018, and no impairment of goodwill in 2019. Goodwill was fully impaired as of December 31, 2018. Goodwill for the United States reporting unit had a gross value and corresponding accumulated impairment losses of $32,204 for a net book value of zero, and goodwill for the Canada reporting unit had a gross value and corresponding accumulated impairment losses totaling $3,244 for a net book value of zero as of both December 31, 2020, and 2019. In the fourth quarter of 2018, the Company performed Step 1 of the goodwill impairment test to determine if the fair value of the goodwill of the Canadian reporting unit was greater than the carrying amount. The fair value of invested capital for the Canadian reporting unit was determined using the income approach and included a comparison to the value using a market approach for reasonableness. Internal forecasts were used to estimate future cash flows, which included assumptions for forecasted revenue growth rates, margin estimates, various expenses, capital additions and working capital needs, which were consistent with internal projections and operating plans. A terminal value was included in the forecast based on capitalization multiple. The cash flows were discounted using a weighted average cost of capital (“WACC”) of 19.3%. The capitalization multiple and WACC were based in part on rates derived from an analysis of guideline companies, and generally considered commensurate with the risks and uncertainty inherent in the respective businesses and internally developed forecasts. As a result of the completion of Step 1, it was determined that the carrying amount exceeded the fair value of invested capital. Accordingly, the Company proceeded to Step 2 to measure impairment charges. In Step 2, the fair value of the reporting unit’s “implied goodwill,” was determined by allocating the reporting unit’s fair value derived in Step 1 to all of the reporting unit’s assets and liabilities other than goodwill and comparing the result to the carrying amount of goodwill. After determining the fair value of the Canadian reporting unit and considering the fair values of other assets contained therein, the Company concluded that there was no value remaining in the implied fair value of goodwill. Accordingly, goodwill allocated to the Canadian reporting unit was deemed to be fully impaired, and the Company recognized an impairment charge of $3,244 in 2018, which is included in impairment, restructuring and other in the consolidated statements of operations. Additionally, in 2018, the Company recorded a decrease in deferred tax liabilities and a decrease in the goodwill impairment related to the United States reporting unit of $528. The above resulted in a net impairment loss of $2,716 in 2018. 8. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES Accrued expenses and other current liabilities comprised the following: December 31, 2020 2019 Accrued compensation and benefits $ 9,902 $ 1,857 Goods in transit accrual 3,845 1,005 Freight, custom and duty accrual 2,603 977 Obligations due under a distribution agreement 590 1,154 Costs related to issuance of Series A Convertible Preferred Stock - 1,239 Other accrued liabilities 4,675 2,956 Total accrued expenses and other current liabilities $ 21,615 $ 9,188 The prior year amount for freight, custom and duty accrual was reclassified from other accrued liabilities to its own line item to conform to the current year presentation. F- 23 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) 9. DEBT Debt is comprised of the following: December 31, 2020 December 31, 2019 Unamortized Unamortized Outstanding Discount and Deferred Net Carrying Outstanding Discount and Deferred Net Carrying Principal Financing Costs Amount Principal Financing Costs Amount Term loan $ - $ - $ - $ 85,111 $ (1,513 ) $ 83,598 Line of credit - - - 23,864 (792 ) 23,072 Other 1,036 - 1,036 1,262 - 1,262 Total debt 1,036 - 1,036 110,237 (2,305 ) 107,932 Current portion 746 - 746 34,827 - 34,827 Long term 290 - 290 75,410 (2,305 ) 73,105 Total debt $ 1,036 $ - $ 1,036 $ 110,237 $ (2,305 ) $ 107,932 Term Loan with Brightwood In May 2017, a term loan in the aggregate principal amount of $75,000 (the “Term Loan”) was obtained by Hydrofarm Holdings LLC and certain of its direct and indirect subsidiaries (the “Term Loan Obligors”) from Brightwood Loan Services LLC, as administrative agent (“Brightwood”), and the lenders party thereto. Hydrofarm Holdings LLC is a shell entity and a subsidiary of Hydrofarm Holdings Group, Inc. Hydrofarm Holdings LLC’s subsidiary is Hydrofarm, LLC, the primary operating entity of the Company. The Term Loan was to mature on May 12, 2022. The Term Loan was secured by substantially all non-working capital assets and a second lien on working capital assets of the Term Loan Obligors. Interest was calculated at LIBOR plus a margin of 700 basis points on LIBOR based loans assuming the net leverage ratio as defined was met, otherwise at LIBOR plus a margin of 850 basis points. Principal payments at an annual basis of 2.5% of the original loan amount were due quarterly. Deferred financing costs were being amortized to interest expense over the term of the loan. The Term Loan has been subject to numerous amendments since its origination generally in connection with modifications to debt service, interest payments, interest rates, and debt covenants. Certain amendments required payments of fees. All amendments were accounted for as debt modifications. In order to comply with the financial covenant provisions as of November 30, 2018, the Term Loan Obligors (and BofA Obligors) issued a cure notice and made a debt service payment of $1,151 with proceeds from an equity contribution to Hydrofarm Holdings LLC from its ultimate parent, Hydrofarm Holdings Group, Inc., in January 2019 to the BofA Credit Facility (as defined below). The Brightwood fourth amendment on March 15, 2019 required that the Term Loan Obligors make a $3,000 principal prepayment on the Term Loan. F- 24 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) The Brightwood sixth amendment dated October 15, 2019, and a related side letter that was amended on January 16, 2020, provided that a portion of the proceeds raised in the December 2019 offering of Series A Convertible Preferred Stock would be used pay down the Term Loan; the amount was ultimately determined to be $8,370. As of December 31, 2019, cash of $8,370 is presented as a component of restricted cash on the accompanying consolidated balance sheet and an equal amount of the Term Loan is included in current portion of long-term debt. The payment was made in January 2020. For the year ended December 31, 2020, the effective interest rate was 10.18%, interest expense was $6,892, and amortization of deferred financing costs was $610. For the year ended December 31, 2019, the effective interest rate was 13.02%, interest expense was $10,151, of which $7,106 was added to the principal, and amortization of deferred financing costs was $483. For the year ended December 31, 2018, the effective interest rate was 12.13%, interest expense was $9,191, of which $6,795 was added to the principal, and amortization of deferred financing costs was $493. The balance of the term loan of $76,610 (including accrued interest) was repaid with proceeds from the IPO on December 14, 2020. A loss on debt extinguishment of $907 representing unamortized deferred financing costs was recognized at the time of repayment. Revolving asset-backed credit facilities In May 2017, a credit facility (“BofA Credit facility”) was obtained by Hydrofarm Holdings LLC and certain of its direct and indirect subsidiaries (the “BofA Obligors”) from Bank of America and the lenders’ party thereto. F- 25 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) The BofA Credit Facility has been subject to numerous amendments since its origination generally in connection with modifications to debt service, interest payments, interest rates, debt covenants, extension of due dates and the eventual payoff in July 2019. Certain amendments required payments of fees and each amendment was accounted for as a debt modification. As part of a forbearance agreement, a stockholder agreed to provide Hydrofarm Holdings LLC with an unsecured subordinated loan of $4,000 for a period and at terms specified in the forbearance agreement to provide for working capital needs of the BofA Obligors. On July 11, 2019, Hydrofarm Holdings LLC and certain of its direct and indirect subsidiaries (the “Encina Obligors”) replaced the BofA Credit Facility with 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 $45,000 (inclusive of a limit of up to $15,000 of borrowings for the Canadian borrowers and a swingline facility of up to $2,000), subject to applicable borrowing base availability, through Encina Business Credit, LLC (“Encina”). The amount of the facility is limited to the borrowing base (primarily calculated based on eligible accounts receivable and inventory) subject to certain reserves and limitations. The Encina Credit Facility is due on the earlier of July 11, 2022 or 90 days prior to the scheduled maturity date of the Term Loan. Interest, due monthly, is at LIBOR or a base rate, plus an applicable margin ranging between 3.75% to 5.50% per annum determined based on the fixed charge coverage ratio calculated over an applicable time period. A fee of 0.50% per annum is charged for available but unused borrowings as defined. An additional 200 basis points is added to the interest rate for any period during which the loan is in default. Deferred financing costs are being amortized over the term of the Encina Credit Facility. The Encina Credit Facility is secured by working capital assets and a second lien on non-working capital assets, and requires various restrictive and protective covenants and financial ratios. Additionally, the agreement requires the Encina Obligors to be in compliance with the financial and qualitative covenants of all other existing debt. The Encina Credit Facility provides for several financial covenants, as defined and limits on capital expenditures. Prior to April 2020, the Encina Credit Facility has been subject to numerous amendments since its origination generally in connection with modifications to available borrowings, financial covenants, permitted indebtedness and permitted capital expenditures. In April 2020 and May 2020, the Encina Credit Facility was amended by the third, fourth and fifth amendments, which (i) replaced the existing “fixed charge coverage ratio/minimum excess availability” financial covenant with an amended “availability block” and increased the “inventory sublimit,” each as more fully described in the amendment, (ii) provided for permitted indebtedness related to the PPP Loan, and (iii) increased permitted capital expenditures during any fiscal year to $750. In September 2020, the Encina Credit Facility was amended by the sixth amendment, which (i) further increased the “inventory sublimit” (as defined), and (ii) increased permitted capital expenditures during any fiscal year to $2,000. In December 2020, the Encina Credit Facility was amended by the seventh amendment, which (i) added to the Loan Agreement the definition of “IPO” and (ii) amended and restated the definition of “Change of Control”. All amendments were accounted for as debt modifications. For the year ended December 31, 2020, the effective interest rate was 9.27%, interest expense was $2,248 and amortization of deferred financing costs was $318. For the year ended December 31, 2019, the combined effective interest rate for the BofA Credit Facility and the Encina Credit Facility was 9.86%, interest expense was $2,161, all of which was added to the principal, and amortization of deferred financing costs was $228. Total combined fees for the BofA Credit Facility and the Encina Credit Facility of $377 were added to the principal in 2019. Additionally, the unamortized deferred financing costs related to the BofA Credit Facility totaling $391 were written off and recognized as a loss on debt extinguishment in the consolidated statements of operations in 2019. The effective interest rates on the BofA Credit Facility ranged from 5.00% to 5.06% in 2018 and the amortization of deferred financing costs was $150 in 2018. The balance of the Encina Credit Facility was $0 as of December 31, 2020, which reflects a pay-down of $33,353 with proceeds from the IPO. The Encina Obligors had approximately $34,521 available to borrow under the Encina Credit Facility as of December 31, 2020. The Encina Obligors were in compliance with all debt covenants as of December 31, 2020 and 2019. Note under Paycheck Protection Program In April 2020, the Company entered into a U.S. Small Business Administration (“SBA”) Paycheck Protection Program promissory note in the principal amount of $3,274 with JPMorgan Chase Bank’s SBA loan program under the March 2020 Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) (the “PPP Loan”). The PPP Loan bore interest at 1% per annum and payments were deferred for the first six months. On October 7, 2020, the Small Business Administration and Treasury Department confirmed a ten-month extension of the deferral period, granted by the PPP Flexibility Act of 2020, which automatically applied to all PPP Loans. Interest expense for the year ended December 31, 2020 was $22. The maturity date was April 7, 2022. The full balance of the PPP Loan, including accrued interest, of $3,296 was repaid on December 15, 2020 with proceeds from the IPO. F- 26 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) Debt convertible into preferred stock In September and October 2019, the Company issued debt to investors convertible into preferred stock for cash of $7,532, less issuance costs of $552, in the form of unsecured subordinated promissory notes with interest at 6.0% per annum due on March 30, 2020. The notes contained an automatic conversion feature triggered by a qualified financing as defined (e.g., private placement or initial public offering) of preferred stock of $5,000 or more. The number of shares into which the notes converted was to be based on a formula which divided outstanding principal and accrued interest by the per share price of the offering. The conditional share-settled conversion feature was deemed to be embedded derivative that did not meet the criteria to be bifurcated and carried at fair value; accordingly, all of the proceeds net of the issuance costs were allocated to the debt instrument. In December 2019, the Company completed an offering of Series A Convertible Preferred Stock which triggered conversion of $7,532 of principal plus $105 of accrued interest into 2,182,083 shares of Series A Convertible Preferred Stock (see Note 10, Convertible preferred stock and stockholders’ equity ). The unamortized deferred financing costs at the time of the conversion of $288 were written-off and are included in loss on debt extinguishment in the consolidated statements of operations in 2019. Aggregate future principal payments As of December 31, 2020, the aggregate future principal payments under long-term debt are not material to the financial statements and are due on various dates from 2021 to 2023. The aggregate future principal payments under finance lease obligations are included in Note 5, Leases . 10. CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY Capital stock As of December 31, 2020, the following summarizes shares authorized, issued and outstanding: Shares Shares authorized outstanding Convertible preferred stock at $0.0001 par value per share 50,000,000 - Common stock at $0.0001 par value per share 300,000,000 33,499,953 As of December 31, 2020, the following summarizes shares reserved for future issuance: Shares reserved Common stock reserved for issuance: for issuance Warrants 3,886,191 2020 Employee, Director, and Consultant Equity Incentive Plan 2,197,396 Restricted stock units 1,857,444 Stock options 922,796 Convertible preferred stock In December 2019, the Company issued 7,007,429 shares of Series A Convertible Preferred Stock with a par value of $24,526 in return for cash of $15,439, conversion of debt with a basis of $7,637, and $1,450 in receivables that were settled in January 2020. Offering costs totaled $1,274, of which $1,239 was included in accrued expense and other current liabilities in the consolidated balance sheet as of December 31, 2019. In January and February 2020, an additional 717,616 shares of preferred stock were issued primarily to existing investors for $2,511, less offering costs of $169, for net cash proceeds of $2,342. The Series A Convertible Preferred Stock was issued at $3.50 and ranked senior to all other classes of preferred and common stock. The preferred stock agreement provided for conversion to common stock at a ratio of 3.3712:1 at the option of the holder, a preference on liquidation, voting rights, and liquidity rights in the event an IPO did not occur within 18 months of the issuance date. Dividends were provided at a 10% dividend yield, cumulative, payable in cash or PIK (Series A Convertible Preferred Stock) at the issuer’s discretion; the rate was to increase to 11% after the 9-month anniversary and 12% after the 18-month anniversary. F- 27 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) The Series A Convertible Preferred Stock contained a redemption feature not solely within the control of the Company’s common shareholders and was, therefore, classified outside of permanent equity. None of the embedded features required bifurcation from the host instrument. The preferred stock agreement provided for mandatory conversion upon a qualified IPO based on a formula. Under this formula, all outstanding shares of Series A Preferred Stock converted into 2,291,469 shares of common stock concurrent with the IPO in December 2020. The cumulative dividend of $2,597 was settled in cash at the option of the Company rather than in shares of common stock. Common stock Each holder of common stock is entitled to one vote for each share of common stock. Common stockholders have no pre-emptive rights to acquire additional shares of common stock or other securities. The common stock is not subject to redemption rights and carries no subscription or conversion rights. In the event of liquidation, the stockholders are entitled to share in corporate assets on a pro rata basis after the Company satisfies all liabilities and after provision is made for any class of capital stock having preference over the common stock. Subject to corporate regulations and preferences to preferred stock, if any, dividends are at the discretion of the Board. Warrants As of December 31, 2020, and 2019, aggregate shares of common stock issuable under warrants totaled 3,886,191. Warrants issued to investors in the Offering and Concurrent Offering for the purchase of 3,369,124 shares (the “Investor Warrants”) are exercisable at $16.86 per share in whole or in part subject to typical adjustments for anti-dilution. The warrants expire three years from December 10, 2020 and are callable by the Company solely at its discretion if certain conditions are met. Placement agent warrants for the purchase of 172,351 shares of common stock are exercisable at a price of $16.86 per share and 344,716 are exercisable at a price of $8.43 per share. Placement agent warrants are exercisable in whole or in part subject to typical adjustments for anti-dilution and may be exercised on a “cashless” basis. Restriction on the ability to pay dividends Under the terms of the Encina Credit Facility, substantially all consolidated net assets of the Encina Obligors are subject to limitations regarding the restriction of payment of dividends to any direct or indirect parent. 11. STOCK-BASED COMPENSATION AND 401K PLAN Stock-based compensation plan overview The Company maintains three 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 and 2018 Plans and provides for the issuance of incentive stock options (“ISOs”), nonqualified stock options (“NSOs”), stock grants and stock-based awards to employees, directors, and consultants of the Company. No further awards will be issued under the 2018 and 2019 Plans. The Incentive Plans are administered by the Board. Notwithstanding the foregoing, the Board may delegate concurrent responsibility for administering each plan, including with respect to designated classes of persons eligible to receive an award under each plan, to a committee or committees (which term shall include subcommittees) consisting of one or more members of the Board (collectively, the “Plan Administrator”), subject to such limitations as the Board deems appropriate. In November 2020, the Board and stockholders approved the 2020 Plan and reserved an aggregate of 2,284,053 shares of common stock for issuance under the 2020 Plan. Subject to the provision of the 2020 Plan, the number of shares available for issuance under the 2020 Plan will be increased on January 1 of each year, beginning on January 1, 2021, and ending on January 2, 2030 in an amount equal to the lesser of (i) 4% of the outstanding shares of the Company’s common stock on such date or (ii) such number of shares determined by the Plan Administrator. The 2020 Plan provides for the grant of ISOs, NSOs, stock grants, and stock-based awards that are based in whole or in part by reference to the Company’s common stock. • The Plan Administrator may grant options designated as incentive stock options or nonqualified stock options. Options shall be granted with an exercise price per share not less than 100% of the fair market value of the common stock on the grant date, subject to certain limitations and exceptions as described in the plan agreements. Generally, the maximum term of an option shall be ten years from the grant date. The Plan Administrator shall establish and set forth in each instrument that evidences an option the time at which, or the installments in which, the option shall vest and become exercisable. F- 28 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) • The Plan Administrator may grant stock grants and stock-based awards, including securities convertible into shares, stock appreciation rights, phantom stock awards or stock units on such terms and conditions which may be based on continuous service with the Company or related company or the achievement of any performance goals, as the Plan Administrator shall determine in its sole discretion, which terms, conditions and restrictions shall be set forth in the instrument evidencing the award. As of December 2020, 2,197,396 shares of common stock are available for grant under the 2020 Plan. No awards were granted prior to 2019. Grants of restricted stock units RSUs granted to certain executives, employees and members of the Board expire 10 years after the grant date. The awards generally have a time-based vesting requirement (based on continuous employment) and certain awards also have a performance-based vesting requirement (defined as a liquidity event including an initial public offering); on the date the performance-based vesting requirement is satisfied, the employee will become vested in the number of RSUs that have satisfied the time-based vesting requirement, if any. In November 2020, five new independent directors were appointed to the Board replacing most of the members who previously served on the Board. In anticipation of reconstituting the Board, in October 2020, the compensation committee of the Board approved grants of 74,152 restricted stock units, in the aggregate, to certain Board members who were being replaced and their affiliates. These awards were fully vested at the time of grant. Upon vesting, the RSUs convert into shares of the Company’s common stock and unvested RSUs are not considered outstanding common shares. The following table summarizes the activity related to the Company’s RSUs for the year ended December 31, 2020. For purposes of this table, vested RSUs represent the shares for which the performance and service conditions had been fulfilled as of December 31, 2020: Number of RSUs Weighted average grant date fair value Balance, January 1, 2020 1,820,598 $ 5.10 Granted 829,926 $ 9.01 Vested (793,080 ) $ 5.80 Balance, December 31, 2020 1,857,444 $ 6.55 Through December 8, 2020, no stock-based compensation expense had been recognized for certain awards with a performance condition based on the occurrence of a qualifying event (i.e., IPO), as such qualifying event was not probable. Upon the IPO, the performance condition was met and the Company recognized $2,967 of stock-based compensation expense which was the cumulative portion of the service-based awards that vested. As of December 31, 2020, the performance-based vesting requirement on all outstanding awards had been met. As of December 31, 2020, the Company withheld 239,702 of the 718,928 shares of common stock issued upon vesting of certain RSUs to meet the employees’ payroll tax withholding requirements. The total tax withholding obligation of $6,089 as of December 31, 2020 is included in accrued expenses and other current liabilities in the consolidated balance sheets. After the IPO, the stock-based compensation expense related to remaining service-based awards is recorded over the remaining requisite service period. The following table summarizes the grant date fair value, expense for the year ended December 31, 2020 (no expense was recognized during the year ended December 31, 2019), and the balance of unamortized stock-based compensation related to RSUs as of December 31, 2020: Number of RSUs Grant date fair value Expense during the year Unamortized compensation RSUs subject only to the passage of time: Vested 793,080 $ 4,598 $ (4,598 ) $ - Total RSUs vested 793,080 $ 4,598 $ (4,598 ) $ — RSUs subject only to the passage of time: Unvested 1,560,814 $ 8,990 $ (911 ) $ 8,079 RSUs subject to market condition and passage of time: Unvested 296,630 3,180 (3,180 ) — Total RSUs outstanding 1,857,444 $ 12,170 $ (4,091 ) $ 8,079 The unamortized compensation costs of $8,079 are expected to be recognized over a weighted-average period of approximately 2.56 years. F- 29 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) The award granted to the member of the Board in July 2020 and modified in November 2020 contains a market-based vesting condition based on the traded value of shares of the Company’s common stock following the IPO over a specific time frame. For this award, the market condition was factored into its fair value; key assumptions used on the MCSM included volatility of 52.90%; time horizon of 2.64 years corresponding to the vesting measurement period of the award forecasted based on daily trading prices; risk-free rate of 0.23%; and 10,000 simulation trials. The fair value of the award at the modification date was $3,180, all of which was recorded as stock-based compensation expense when the performance condition was met upon the IPO. The total shares under the unvested RSU subject to a market-based vesting condition are 296,630 as of December 31, 2020. The tax benefit recognized in the consolidated statements of operations for stock-based compensation arrangements for the year ended December 31, 2020 was not material to the financial statements. There was no tax benefit in 2019. Stock options Options issued through December 31, 2020 vest under one of three schedules as follows: 20% vest as of the date of grant, then 1/45 th on the last day of the month for the following 36 months; 25% vest on the first anniversary of the date of grant, then 1/48 th on the last day of the month for the following 36 months; or, options vest upon grant. Vesting is subject to certain change in control provisions as provided in the incentive plan agreements and options may be exercised up to 10 years from the date of issuance. The following table summarizes the stock option activity for the year ended December 31, 2020: Number Weighted average exercise price Weighted average grant date fair value Weighted average remaining contractual term (years) Outstanding at January 1, 2020 819,879 $ 8.43 $ 0.71 9.27 Granted 150,119 $ 10.77 $ 7.10 Forfeited (47,202 ) $ 8.43 $ 0.70 Exercised - - Expired - - Outstanding at December 31, 2020 922,796 $ 8.81 $ 1.78 8.08 Exercisable as of December 31, 2020 476,910 $ 8.43 $ 0.71 7.39 Unvested at December 31, 2020 445,886 $ 9.22 $ 2.93 2.44 Vested and expected to vest as of December 31, 2020 922,796 $ 8.81 $ 1.78 8.08 Since options represent equity awards of the Company, such awards are fair valued as of the grant date for the purposes of measurement and recognition under U.S. GAAP. To measure the fair value of an option, the Black Scholes valuation model was utilized. The valuation model requires the input of highly subjective assumptions. Inputs to model were as follows for the periods indicated: Years ended December 31, 2020 2019 Fair Value of common stock underlying the options $6.07 to $17.85 $4.82 to $6.07 Volatility 45% to 55% 30% Risk-free rate 0.03% to 0.89% 1.37% to 2.49% Dividend yield Nil Nil Expected term in years 5.00 to 5.61 5.00 to 5.62 F- 30 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) The estimated fair value of the common stock range used in 2020 was from $6.07 per share to $17.85 per share. These amounts compare to the range used of $4.82 to $6.07 per share for all option grants in 2019. The change in the estimated fair value of common stock was due to a number of factors including a higher enterprise valuation in 2020 due to improvement in financial performance, namely (i) an increase in net sales; and (ii) a higher gross profit margin percentage. Another factor which impacted assumptions for the fair value of the common stock during 2020 was a higher probability of a successful IPO compared to assumptions in 2019. Also, the exercise prices for options granted after June 2020 were no longer in excess of the fair value of the underlying common share which further increased the option value compared to awards granted in 2019. The volatility for the year ended December 31, 2020 increased compared to the same period in 2019 as a result of increases in the volatilities of the public comparable companies used to determine the Company’s volatility. As result of these factors, the weighted average fair value per share of $0.71 for options outstanding as of January 1, 2020 was increased to a weighted-average fair value per share of $7.10 for options granted during the year ended December 31, 2020. Total compensation expense for stock options was approximately $206 and $208 in 2020 and 2019, respectively, and is included in selling, general and administrative expenses in the consolidated statements of operations. No tax benefit related to the stock option expense was recognized in 2020 and 2019. As of December 31, 2020, total compensation cost related to unvested option awards not yet recognized was $1,231 and the weighted-average period over which the compensation is expected to be recognized is 2.44 years. 401K Plan The Company maintains a qualified defined contribution plan under Section 401(k) of the Internal Revenue Code, which provides for voluntary contributions from the Company and its employees. Contributions from the Company were $191, $190, and nil in 2020, 2019, and 2018, respectively. 12. INCOME TAXES Loss from continuing operations before tax was as follows for the years ended: Years ended December 31, 2020 2019 2018 United States $ (9,908 ) $ (30,409 ) $ (31,493 ) Foreign 3,211 (10,365 ) (4,446 ) Loss from continuing operations before tax $ (6,697 ) $ (40,774 ) $ (35,939 ) F- 31 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) Significant components of income tax expense (benefit) from continuing operations consist of the following: Years ended December 31, 2020 2019 2018 Current: Federal $ - $ - $ 216 State 91 18 79 Foreign 433 9 207 Total current 524 27 502 Deferred: Federal - - 269 State - - - Foreign 52 (718 ) (1,168 ) Total deferred tax expense (benefit) 52 (718 ) (899 ) Total income tax expense (benefit) $ 576 $ (691 ) $ (397 ) The reconciliation of income tax computed at the U.S. federal statutory tax rates of 21% to income tax expense (benefit) from continuing operations consist of the following: Years ended December 31, 2020 2019 2018 Effective rate reconciliation U.S. federal tax benefit at statutory rate $ (1,406 ) $ (8,563 ) $ (7,547 ) State income taxes, net (171 ) (1,247 ) (1,009 ) Permanent items 19 89 1,692 Global intangible low-taxed income 866 - - Foreign rate differential 854 (891 ) (590 ) 162(m) Officers Compensation 3,514 - - Share-based compensation (2,834 ) - - Deferred adjustments (230 ) 563 - Tax Entity Classification Adjustment - - (1,927 ) Non-controlling interest - - 433 Transaction Costs 90 - - Valuation allowance (126 ) 9,358 6,370 Other, net - - 2,181 Total income tax expense (benefit) $ 576 $ (691 ) $ (397 ) F- 32 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) Deferred income tax assets and liabilities from continuing operations consists of the following as of: As of December 31, 2020 2019 Deferred tax assets Lease liabilities $ 4,838 $ 4,836 Accrued expenses 1,245 1,129 Share-based compensation 979 - Intangible assets 9,546 10,602 Net operating loss 17,152 17,589 Inventories 2,548 3,022 Interest expense 3,556 3,746 Deferred tax assets 39,864 40,924 Valuation allowance (34,434 ) (34,746 ) Total deferred tax assets 5,430 6,178 Deferred tax Liabilities Property and equipment (432 ) (1,054 ) Operating lease right-of-use assets (4,657 ) (4,729 ) Total deferred tax liabilities (5,089 ) (5,783 ) Net deferred tax assets $ 341 $ 395 The deferred income tax assets included in other long-term assets were $341 and $395 as of December 31, 2020 and 2019, respectively. As of December 31, 2020, the Company had federal and state net operating loss (“NOL”) carryforwards of approximately $62,500 and $52,300, respectively. The federal and state NOL carryforwards, if not utilized, will begin to expire in 2037 and 2027, respectively, and $49,000 of the federal losses are indefinite. In 2020, the Company had foreign NOL carryforwards of approximately $3,000. The foreign NOLs, if not utilized, will begin to expire in 2037. The Company determined the amount of its valuation allowance based on its estimates of taxable income by jurisdiction in which it operates over the periods in which the related deferred tax assets will be recoverable. As of December 31, 2020 and 2019, the Company believes it is more-likely-than-not that it will not be able to realize its US deferred tax assets and therefore has maintained a full valuation allowance against its US deferred tax assets. The Company has also provided a full valuation allowance against the majority of its Canadian and Spanish deferred tax assets. Carryforwards of NOLs are subject to possible limitation should a change in ownership occur, as defined by Internal Revenue Code Section 382. An ownership change is generally defined as a greater than 50% increase in equity ownership by 5% shareholders in any three-year period. As a result of the IPO, the aggregate ownership change exceeded the 50% threshold. The annual limitation resulting from this ownership change is not expected to result in the expiration of the NOL carry forwards before utilization. In 2020 and 2019, the Company did not record any liabilities related to uncertain tax positions. The Company does not have any tax positions for which it is reasonably possible that the total amount of gross unrecognized tax benefits will significantly change within 12 months of December 31, 2020. F- 33 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) The Company recognizes interest and penalties relating to unrecognized tax benefits as part of its income tax expense. The Company’s major filing jurisdictions are the United States and Canada. Due to the Company’s net operating loss carryforwards, the Company’s income tax returns remain subject to examination by federal, foreign and most state taxing authorities for all tax years. In response to the COVID-19 pandemic, the CARES Act was signed into law in March 2020. The CARES Act lifts certain deduction limitations originally imposed by the Tax Cuts and Jobs Act of 2017 (2017 Tax Act). Corporate taxpayers may carryback NOLs originating during 2018 through 2020 for up to five years, which was not previously allowed under the 2017 Tax Act. The CARES Act also eliminates the 80% of taxable income limitations by allowing corporate entities to fully utilize NOL carryforwards to offset taxable income in 2018, 2019 or 2020. Taxpayers may generally deduct interest up to the sum of 50% of adjusted taxable income plus business interest income (30% limit under the 2017 Tax Act) for tax years beginning January 1, 2019 and 2020. The CARES Act allows taxpayers with alternative minimum tax credits to claim a refund in 2020 for the entire amount of the credits instead of recovering the credits through refunds over a period of years, as originally enacted by the 2017 Tax Act. The CARES Act raises the corporate charitable deduction limit to 25% of taxable income and makes qualified improvement property generally eligible for 15-year cost-recovery and 100% bonus depreciation. In addition, the CARES Act allows companies to defer making certain payroll tax payments until future years. With the enactment of the CARES Act, the Company does not expect a financial statement impact on income taxes. The Company has not recorded any income tax expense or benefit related to the Act for the year ended December 31, 2020. 13. COMMITMENTS AND CONTINGENCIES, AND RELATED PARTY TRANSACTIONS Purchase commitments From 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. In June 2020, as part of negotiations with a supplier that began in late 2019, the Company amended its October 2017 agreement to distribute and sell certain garden products for a term ending in December 2024. Under the amended agreement, the Company committed to purchase inventory in periodic minimum volumes on a take-or-pay basis, as defined, over the term of the agreement in return for pricing that would provide the Company with a minimum gross margin along with the potential for rebates. Cost of goods sold in 2019 and 2018 include an additional $1,134 and $1,108 for amounts due associated with volumes purchased below minimum thresholds. Inventory purchased under this agreement totaled $9,146, $3,641, and $2,644 in 2020, 2019, and 2018, respectively. Minimum purchase requirements are $3,000, $3,500, $4,000 and $4,500 for 2021, 2022, 2023 and 2024, respectively. The Company expects that these minimum purchase commitment obligations will be met. Contingencies In 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 leases a distribution center in Petaluma, California from entities in which a related party is an investor. One lease is month to month and another lease terminated in June 2019. In 2020 and 2019, aggregate rent expense was $1,278 and $1,445, respectively. F- 34 Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) Related party transactions — Consulting Agreement In July 2020, the Company entered into a consulting agreement with a director to serve as an advisor to the Board and the chief executive officer. The agreement includes an award of 296,630 restricted stock units. In November 2020, the related consulting agreement was canceled and the award was modified (see Note 11, Stock-based compensation and 401K plan ). Subordinated loans from related party On May 22, 2018, in connection with forbearance and amendments to the BofA Credit Facility and Term Loan agreements discussed in Note 9, Debt , the Company obtained a subordinated note of $4,000 from a stockholder of the Company to fund operations. Interest was at a rate of 8.24% per annum with no payment of interest and principal made in cash prior to the maturity date. On June 29, 2018, in connection with and under the same terms as the May 22, 2018 subordinated note, an additional amount of $2,000 was secured from the stockholder. As discussed in Note 1, Description of the business, basis of presentation and significant accounting policies – Recapitalization and reverse merger in 2018 , the $4,000 note plus accrued interest of $88 was converted into equity in exchange for shares and warrants. The $2,000 subordinated loan was repaid in August 2018. 14. IMPAIRMENT, RESTRUCTURING AND OTHER In 2020, the Company incurred costs related to SEC filings and other transactions. In 2019 and 2018, certain expenses were incurred primarily related to recognition of impairment on intangible assets and goodwill as discussed in Note 7, Intangible assets and goodwill ; restructuring costs; fees for various statutory filings; severance costs for a reduction-in-force; and, costs to early terminate several leases. Restructuring costs were for professional fees related to consultation and assistance with re-engineering initiatives related to financial reporting, operational processes, and cost savings strategies. Impairment, restructuring and other comprised the following: For the years ended December 31, 2020 2019 2018 Costs related to SEC filings $ 529 $ 1,080 $ 776 Impairment of intangible assets and goodwill — 5,390 2,716 Restructuring costs — 1,973 3,431 Severance costs — 784 — Costs related to early termination of leases, net of gains — 337 — Other, net 331 471 246 $ 860 $ 10,035 $ 7,169 15. SUBSEQUENT EVENTS On March 29, 2021, the Company and certain of its subsidiaries entered into a Credit Facility agreement with JPMorgan Chase Bank, N.A. (“Chase”) (the “Chase Agreement”), whereby Chase agreed to provide a $50,000,000 revolving credit facility with an option to request an increase in the Revolving Commitment by up to $25 million, drawn in $5.0 million increments, for a total not to exceed $75 million, subject to customary conditions (“Revolver”). The Chase Agreement replaced the Encina Credit Facility. The maturity of the Revolver is three years from the date of the Chase Agreement. The Revolver maintains an interest rate of LIBOR plus 1.95% and has a 0.0% LIBOR floor. The Chase Agreement maintains certain reporting requirements, affirmative covenants, negative covenants and financial covenants. The financial covenants include that the Company must maintain a minimum fixed charge coverage ratio of 1.1x on a rolling twelve-month basis. The Chase Agreement is secured by the Company’s assets and the assets of certain of the Company’s subsidiaries obligated under the Chase Agreement. F- 35 Schedule II – Valuation and Qualifying Account Hydrofarm Holdings Group, Inc. For the years ended December 31, 2020, 2019, and 2018 (in thousands) Balance as of beginning of year Provisions /(Benefit) Deductions Balance as of end of year Year ended December 31, 2020 Allowance for doubtful accounts $ 1,776 $ 83 $ (941 ) $ 918 Allowance for inventory obsolescence 3,822 (803 ) (587 ) 2,432 Year ended December 31, 2019 Allowance for doubtful accounts 1,227 933 (384 ) 1,776 Allowance for inventory obsolescence 3,219 707 (104 ) 3,822 Year ended December 31, 2018 Allowance for doubtful accounts 2,955 534 (2,262 ) 1,227 Allowance for inventory obsolescence 4,618 (824 ) (575 ) 3,219 F- 36 Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.