What changed in this filing

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Item 5. Market for Registrant’s Common Equity

2022-03-01 compared with 2021-03-30 · 7 added, 797 removed, 6 unchanged (99% of the section changed)

MARKET FOR REGISTRANT’S

COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

Our common stock began trading

on The Nasdaq Global Select Market under the symbol “HYFM”

on December 10, 2020.

Prior to that date, there was no public

trading market for our common stock.

Our common stock began trading on The Nasdaq Global Select Market under the symbol “HYFM” on December 10, 2020.

Prior to that date, there was no public trading market for our common stock.

Holders of our Common Stock

As of March 17, 2021, there

were approximately 12,198 stockholders of record of our common stock.

As of February 17, 2022, there were approximately 18,746 stockholders of record of our common stock.

Dividend Policy

We have never declared or

paid any dividends on our common stock.

We currently intend to retain all available funds and any future earnings for the operation and

expansion of our business.

We have never declared or paid any dividends on our common stock.

We currently intend to retain all available funds and any future earnings for the operation and expansion of our business.

Accordingly, we do not anticipate declaring or paying dividends in the foreseeable future.

The payment of

any future dividends will be at the discretion of our Board of Directors and will depend on our results of operations, capital requirements,

financial condition, prospects, contractual arrangements, any limitations on payment of dividends present in any debt agreements, and

other factors that our Board of Directors may deem relevant .

Stock Performance Graph

This performance graph is not “soliciting material,”

not deemed filed with the SEC and is not to be incorporated by reference in any filing by us under the Securities Act of 1933 or the Securities

Exchange Act of 1934, as amended, whether made before or after the date hereof and irrespective of any general incorporation language

in any such filing.

The stock price performance shown on the graph is not necessarily indicative of future price performance.

Comparison of Cumulative Total Return

Among Hydrofarm Holdings Group, Inc., S&P 500 Consumer Discretionary

Sector and the Nasdaq Composite Index

The above graph measures the change in a $100 investment in our common stock from December 10,

2020 (the date our common stock commenced trading on The Nasdaq Global Select Market) through December 31, 2020.

Our relative performance is then compared with the S&P 500 Consumer Discretionary Sector and the Nasdaq Composite Index.

graph uses the closing market price on December 10, 2020 of $51.99 per share as the initial value of our common stock.

the $20 per share price paid in our December 2020 initial public offering, the

total return through December 31, 2020 would greatly exceed the amount shown in the graph above.

The payment of any future dividends will be at the discretion of our Board of Directors and will depend on our results of operations, capital requirements, financial condition, prospects, contractual arrangements, any limitations on payment of dividends present in any debt agreements, and other factors that our Board of Directors may deem relevant.

Recent Sales of Unregistered Securities

On December 31, 2019,

we entered into a securities purchase agreement with certain investors named therein, pursuant to which we issued and sold, in a private

placement offering between December 2019 and February 2020, 7,725,045 shares of our Series A Convertible Preferred Stock,

par value $0.0001 per share, at an offering price of $3.50.

We received gross proceeds of approximately $27 million (which includes

proceeds of approximately $8 million raised from the issuances of convertible unsecured subordinated promissory notes in September

and October 2019, which converted into shares of our Series A Preferred Stock) in connection with our initial public offering,

before deducting fees and related offering expenses.

The securities above were offered and sold pursuant to an exemption from the registration requirements under Section 4(a)(2) of the Securities

Act since, among other things, the transactions did not involve a public offering.

Issuer Purchases of Equity Securities

Not applicable.

SELECTED FINANCIAL DATA

MANAGEMENT’S DISCUSSION

AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion

and analysis provides information that we believe is relevant to an assessment and understanding of our results of operations and financial

You should read this analysis in conjunction with our audited consolidated financial statements and the related notes contained

elsewhere in this Annual Report on Form 10-K.

This discussion and analysis contains statements of a forward-looking nature relating to

future events or our future financial performance.

These statements are only predictions, and actual events or results may differ materially.

In evaluating such statements, you should carefully consider the various factors identified in this Annual Report on Form 10-K, which

could cause actual results to differ materially from those expressed in, or implied by, any forward-looking statements, including those

set forth in “Risk Factors”

in this Annual Report on Form 10-K.

See “Special Note Regarding Forward-Looking Statements.”

Company Overview

are a leading independent distributor and manufacturer of controlled environment agriculture (“CEA”, principally hydroponics)

equipment and supplies, including a broad portfolio of our own innovative portfolio of proprietary branded products.

We primarily serve

and Canadian markets, and believe we are one of the leading competitors by market share in these markets in an otherwise

highly fragmented industry.

For over 40 years, we have helped growers make growing easier and more productive.

Our mission is to empower

growers, farmers and cultivators with products that enable greater quality, efficiency, consistency and speed in their grow projects.

Hydroponics is the farming

of plants using soilless growing media and often artificial lighting in a controlled indoor or greenhouse environment.

Hydroponics is

the primary category of CEA and we use the terms CEA and hydroponics interchangeably.

Our products are used to grow, farm and cultivate

cannabis, flowers, fruits, plants, vegetables, grains and herbs in controlled environment settings that allow end users to control key

farming variables including temperature, humidity, CO2, light intensity spectrum, nutrient concentration and pH.

Through CEA, growers

are able to be more efficient with physical space, water and resources, while enjoying year-round and more rapid grow cycles as well

as more predictable and abundant grow yields, when compared to other traditional growing methods.

reach commercial farmers and consumers through a broad and diversified network of over 2,000 wholesale customer accounts, who we connect

with primarily through our proprietary eCommerce marketplace.

Over 80% of our net sales are into the specialty hydroponic retailers, through

which growers are able to enjoy specialized merchandise assortments and knowledgeable staff.

We also distribute our products across the

and Canada to a diversified range of retailers of commercial and home gardening equipment and supplies that include garden

centers, hardware stores, eCommerce retailers, commercial greenhouse builders, and commercial resellers.

Recent Developments

Initial Public Offering

On December 14, 2020, we completed

our IPO, in which we issued and sold 9,966,667 shares of our common stock, including the full exercise by the underwriters of their option

to purchase 1,300,000 additional shares of our common stock, at a public offering price of $20.00 per share, which resulted in net proceeds

of $182.3 million after deducting underwriting discounts and commissions and offering expenses.

The proceeds from the IPO were used (i)

to repay the amounts outstanding under the Term Loan Credit Agreement among our subsidiary obligors, Brightwood Loan Services, LLC and

the other lenders party thereto (as amended to date, the “Term Loan Agreement”) of $76.6 million (includes accrued interest

and fees of $0.3 million), (ii) to paydown certain amounts outstanding under the Encina Credit Facility of $33.4 million, (iii) to repay $3.3 million under the promissory note to JPMorgan Chase, N.A.

through the U.S.

Business Administrative Paycheck Protection Program (the “PPP Loan”), and (iv) to pay $2.6 million to settle the Series A

Preferred Stock dividend.

Our common stock began trading on the Nasdaq Global Select Market on December 10, 2020.

Effects of Coronavirus on Our Business

The World Health Organization

recognized COVID-19 as a public health emergency of international concern on January 30, 2020 and as a global pandemic on March 11, 2020.

Public health responses have included national pandemic preparedness and response plans, travel restrictions, quarantines, curfews, event

postponements and cancellations and closures of facilities including local schools and businesses.

While the rollout of vaccines has begun,

the timing of vaccinations, herd immunity, and the lifting of shelter in place and similar restrictions and movement restrictions is unknown.

The global pandemic and actions taken to contain COVID-19 have adversely affected the global economy and financial markets.

In response to the COVID-19

pandemic, we implemented business continuity plans designed to address the impact of the COVID-19 pandemic on our business, such as restrictions

on non-essential business travel, the institution of work-from-home practices and the implementation of strategies for workplace safety

at our facilities.

In March 2020, the majority of the employees at our headquarters transitioned to working remotely.

For several weeks

following the initial outbreak of COVID-19, we experienced a material impact to our supply chain that inhibited growth and results of

And from time-to-time during the COVID-19 pandemic, we experienced delays in the receipt of goods from international and

domestic suppliers as well as a general slowdown in freight processing times resulting in shipping delays and higher periodic freight

It is difficult to predict the extent to which COVID-19 may continue to spread.

As of the date of this Annual Report on Form 10-K,

manufacturers in China and in North America are generally back in operation;

however, new waves of the COVID-19 pandemic could result

in the re-closure of factories in China and/or in North America.

Quarantine orders and travel restrictions within the U.S.

countries may also adversely impact our supply chains, the manufacturing of our own products and our ability to obtain necessary materials.

Consequently, we may be unable to obtain adequate inventory to fill purchase orders or manufacture our own products, which could adversely

affect our business, results of operations and financial condition.

Furthermore, potential suppliers or sources of materials may pass

the increase in sourcing costs due to the COVID-19 pandemic to us through price increases, thereby impacting our potential future profit

Our customers reside in countries,

primarily the U.S.

and Canada that are currently affected by the COVID-19 pandemic.

Many of these customers have experienced shelter-in-place

measures in attempts to contain the spread of COVID-19, including general lockdowns, closure of schools and non-essential businesses,

bans on gatherings and travel restrictions.

Although we cannot precisely quantify in absolute or relative terms, our accelerated rate

of growth in net sales for the twelve months ended December 31, 2020 correlates with shelter-in-place orders issued in many locations

in March 2020 in response to the COVID-19 pandemic.

Our sales growth for the twelve months ended December 31, 2020 was approximately

46% higher than the same period in 2019.

A portion of our net sales during this period could be due to pull-through demand for our products

due to higher consumption of CEA products from individuals spending more time at home due to shelter-in-place measures.

Although uncertainty

created by the COVID-19 pandemic remains, and various state budgets remain under economic pressure creating a greater chance of further

cannabis legalization, we cannot assure you that such a rate of growth will continue.

Our business has remained

resilient during the COVID-19 pandemic.

As of December 31, 2020, our manufacturing and distribution operations were viewed as essential

services and continued to operate.

Our key suppliers, retailers and resellers have been designated as essential services and remain open

at this time;

however, in certain places they are operating under reduced hours and capacity limitations.

The majority of U.S.

cannabis businesses have been designated as essential by U.S.

state and Canadian government authorities.

The extent to which the COVID-19

pandemic will ultimately impact our business, results of operations, financial condition and cash flows depends on future developments

that are highly uncertain, rapidly evolving and difficult to predict at this time.

Depending on the length and severity of COVID-19, we

may experience an increase or decrease in customer orders driven by volatility in consumer shopping and consumption behavior.

It is difficult

to assess or quantify with precision the impact COVID-19 has directly had on our business since we cannot precisely quantify the impacts,

if any, that the various effects (e.g.

possible positive demand impact from shelter-in-place orders in the U.S., possible negative supply

chain impact from workforce disruption at international and domestic suppliers and domestic ports and the possible negative impact on

transportation costs) have had on the overall business.

And so, while we do not believe that we are experiencing net material adverse

impacts at this time, given the global economic slowdown, the overall disruption of global supply chains and distribution systems and

the other risks and uncertainties associated with the COVID-19 pandemic, our business, financial condition, results of operations and

growth prospects could be materially and adversely affected.

While we believe that we are well positioned for the future as we navigate

the crisis and prepare for an eventual return to a more normal operating environment, we continue to closely monitor the COVID-19 pandemic

as we evolve our business continuity plans and response strategy.

of Results of Operations

We generate net sales from

the distribution and manufacturing of hydroponic equipment and supplies to our customers.

The hydroponic equipment and supplies that

we sell include consumable products, such as growing media, nutrients and supplies that require regular replenishment and durable products,

such as lighting and hydroponic equipment.

Our scale allows us to provide delivery and service capabilities to a highly diverse group

of customers across the U.S.

We do not sell directly to farmers but rather our customer base consists of specialty hydroponic

retailers, garden centers, eCommerce and greenhouse suppliers.

We periodically offer sales

incentives to our customers, including early pay discounts, volume-based rebates, temporary price reductions, advertising credits and

other trade activities.

Net sales reflect our gross sales less sales incentives which are estimated and recorded at the time of sale

plus amounts billed to customers for shipping and handling costs.

We anticipate that sales incentives could impact our net sales and

that changes in such promotional activities could impact period-over-period results.

Cost of goods sold

Cost of goods sold consists

primarily of material costs, inbound and outbound freight, direct labor costs primarily for production and warehouse personnel and depreciation

and amortization of warehouse improvements and equipment.

We expect our cost of goods sold to increase in absolute dollars in conjunction

with our growth.

However, we expect that, over time, cost of goods sold will decrease as a percentage of net revenue as a result of the

scaling of our business including a higher proportion of the amount of proprietary and exclusive branded products that we sell.

Selling, general and administrative

expenses consists primarily of marketing and advertising, stock-based compensation, depreciation and amortization of all other assets

and other selling, general and administrative costs, including but not limited to salaries, benefits, bonuses, professional fees and

various costs related to becoming a publicly-traded company.

We expect selling, general and administrative expenses to increase in absolute

dollar terms as we scale our operations to meet increased demand for our products and operate as a public company with increased costs

associated with insurance, finance, legal and accounting functions;

however, we also expect that the significant increase in our scale

will result in selling, general and administrative expenses as a percentage of net sales decreasing over time.

Results of Operations Data

The results of operations

data in the following tables for the years ended December 31, 2020, 2019 and 2018 have been derived from the audited consolidated financial

statements included elsewhere in this Annual Report on Form 10-K.

of Operations –

Comparison of Years Ended December 31, 2020 and 2019

The following table sets

forth our consolidated statements of operations for the years ended December 31, 2020 and 2019, including amounts and percentages of

net sales for each year and the year-to-year change in dollars and percent (amounts in thousands):

Cost of goods sold

Operating expenses:

Selling, general and administrative

Impairment, restructuring and other

Income (loss) from operations

Interest expense

Loss on debt extinguishment

Other income, net

Net loss before tax

Income tax (expense) benefit

Cumulative dividends allocated to Series A

convertible preferred stock

Net loss attributable to Hydrofarm Holdings Group, Inc.

Net sales for the year ended

December 31, 2020 increased by $107.1 million or 45.6% compared to the year ended December 31, 2019.

The increase in net sales was primarily

due to a 42.0% increase in volume of products sold and a 3.6% increase in price of products sold.

The increase in volume of products

sold was primarily related to (i) higher demand from the end-markets across numerous U.S.

states, including but not limited to Michigan,

Oklahoma and California, and Canada and (ii) higher demand for our proprietary and preferred branded products which grew at a faster

pace than our distributed brands during the period.

The increase in price was primarily related to list price increases and more effective

sales incentives.

Although we cannot precisely

quantify in absolute or relative terms, our accelerated rate of growth in net sales for the year ended December 31, 2020 correlates with

shelter-in-place orders issued in March 2020 in response to the COVID-19 pandemic.

A portion of our net sales during this period could

be related to pull-through demand for our products due to higher consumption of CEA products from individuals spending more time at home

due to shelter-in-place measures.

Although uncertainty created by the COVID-19 pandemic remains, and various state budgets remain under

economic pressure, creating a greater chance of further cannabis legalization, we cannot assure you that such growth will continue.

Gross profit for the

year ended December 31, 2020 increased by $36.5 million or 134.9% compared to the year ended December 31, 2019.

The increase in

gross profit was primarily related to (i) the aforementioned increase in net sales and (ii) a significant increase in our gross

profit margin percentage (gross profit as a percent of net sales).

Our gross profit margin percentage increased to 18.6% for the

year ended December 31, 2020 compared to 11.5% for the year ended December 31, 2019.

The higher gross profit margin percentage is

primarily due to (i) a more favorable sales mix of proprietary and exclusive branded products, which typically carry a higher gross

margin, (ii) lower freight cost, and (iii) inventory adjustments and write-downs that impacted the

fourth quarter of 2019 primarily associated with our 2019 SKU rationalization.

Selling, general and

administrative expenses

Selling, general and administrative

(“SG&A”) expenses for the year ended December 31, 2020 increased by $14.7 million or 33.6%, compared to the year ended

December 31, 2019 due primarily to an increase of $8.7 million in stock-based compensation expense, of which $6.1 million was directly

triggered by our IPO in December 2020 (more fully described below).

SG&A expense excluding the portion of stock-based compensation

expense triggered by the IPO decreased from 18.6% in 2019 to 15.3% in 2020 due to economies of scale as our net sales grew faster than

our selling, general and administrative expenses.

To support our long-term

growth plan and our IPO, we undertook several initiatives in mid-to-late 2019 and early 2020 which resulted in the aforementioned $14.7

million increase in selling, general and administrative expenses, including increased stock-based compensation expenses, increased compensation

costs (an increase of $3.9 million), and increased professional service fees, including, but not limited to, the hiring of executives

such as our new Chief Executive Officer, President and Chief Financial Officer and engaging new third parties such as an IT consulting

firm, a new auditor, and several accounting and audit-related consultants (an increase of $4.4 million).

As more fully discussed in

Note 11, Stock-based compensation and 401K plan , in our consolidated financial statements included elsewhere in this Annual Report

on Form 10-K, we granted restricted stock units (“RSUs”) to certain officers, former directors and their affiliates which

have vesting conditions including a performance-based vesting requirement which was satisfied upon the consummation of our IPO.

result, our IPO in December 2020 triggered a significant performance-based stock compensation charge of $6.1 million for previously unrecognized

time-based vesting prior to the IPO.

restructuring and other

Impairment, restructuring

and other expenses declined to $0.9 million for the year ended December 31, 2020 from $5.4 million in 2019.

For the year ended December

31, 2019, we recognized expenses related to the impairment of intangible asset for customer relationships;

$2.0 million for restructuring

and, other similar activities related to our capitalization.

We also incurred $1.1 million for a registration statement which

was delayed, and accordingly, the third-party costs were expensed.

See Note 14, Impairment, restructuring and other, in our consolidated

financial statements included elsewhere in this Annual Report on Form 10-K for additional information.

Interest expense

Interest expense decreased

by $3.3 million or 24.7% for the year ended December 31, 2020 compared to the year ended December 31, 2019.

The average balance

of our interest bearing debt for the year ended December 31, 2020 increased by $2.3 million compared to the year ended December 31, 2019.

This increase was offset by a decrease in the effective interest rate on the Term Loan Agreement, from approximately 13% for the year

ended December 31, 2019 to an effective interest rate of approximately 10.2% for the year ended December 31, 2020 due to a reduction

of the Term Loan Agreement interest rate margin which became effective on January 1, 2020 from LIBOR plus 10.0% to LIBOR plus 8.5% along

with a reduction of average LIBOR from 2.5% to 1%.

The decrease in interest costs was also slightly impacted by a decrease in the

effective interest rate on our revolving credit facilities from approximately 9.9% for the year ended December 31, 2019 to approximately

9.3% for the year ended December 31, 2020.

debt extinguishment

Loss on debt extinguishment

for the year ended December 31, 2020 resulted from the write-off of unamortized deferred financing costs associated with the payoff of

the Term Loan Agreement in connection with the IPO.

Similar costs in 2019 resulted from the write-off of unamortized deferred financing

costs when the BofA Credit Facility was refinanced with the Encina Credit Facility.

Income tax expense

Income tax expense for the

year ended December 31, 2020 generally reflects minimum U.S.

state income taxes which do not fluctuate with pre-tax income or loss and

Canadian taxes in one of our profitable Canadian subsidiaries.

The net income tax benefit

for the year ended December 31, 2019 is comprised of two amounts:

(i) minimum U.S.

state and Canadian provincial taxes which do not fluctuate

with pre-tax income or loss;

and, (ii) a deferred income tax benefit of $0.7 million primarily generated from the tax consequence

of the impairment write-off which is not expected to recur.

Cumulative dividends allocated

to Series A convertible preferred stock

Our Series A Preferred Stock

accrued a cumulative dividend during 2020 which is presented as a reduction of net loss which results in the net loss attributable to

common stockholders.

Dividends did not accrue prior to 2020.

Upon the consummation of our IPO in December 2020, the Series A Preferred

Stock automatically converted into 2,291,469 shares of our common stock and we paid $2.6 million in cash to settle the Series A Preferred

Stock dividend.

of Operations –

Comparison of Years Ended December 31, 2019 and 2018

The following table sets forth

our consolidated statements of operations for the years ended December 31, 2019 and 2018, including amounts and percentages of net sales

for each year and the year-to-year change in dollars and percent (amounts in thousands):

Year to year change

Cost of goods sold

Operating expenses:

Selling, general and administrative

Impairment, restructuring and other

Loss from operations

Interest expense

Loss on debt extinguishment

Other income, net

Loss before tax

Income tax benefit

Net loss attributable to non-controlling

Net loss attributable to Hydrofarm Holdings

Net sales for the year ended

December 31, 2019 increased $23.3 million or 11.0% compared to the year ended December 31, 2018.

The increase was primarily due to an

increase in the volume sold during the period.

For the year ended December 31, 2019, we realized an approximate 11.6% increase in volume

offset by a 0.6% decrease in price.

Our sales in certain non-U.S.

markets were impacted by IT system challenges experienced during the

integration of our Canadian businesses, an issue we do not expect to continue in 2020.

The increase in U.S.

volume sold was primarily

related to (i) higher demand from the end-markets across numerous U.S.

states, including but not limited to Oklahoma, Michigan and California

and (ii) higher demand for our proprietary and preferred branded products which grew at a faster pace than our distributed brands for

the year ended December 31, 2019.

Gross profit for the year

ended December 31, 2019 increased $3.0 million or 12.5% compared to the year ended December 31, 2018.

The increase in gross profit was

primarily related to (i) the 11.0% increase in net sales and (ii) a small increase in gross profit margin percentage (gross profit as

a percent of net sales) associated with a more favorable mix of proprietary and exclusive branded products as compared to the prior year.

This increase was partially offset by the year-over-year decrease in net sales (as noted above) and associated gross profit in non-U.S.

Selling, general and

administrative expenses

Selling, general and administrative

expenses for the year ended December 31, 2019 increased $1.6 million or 3.7% compared to the year ended December 31, 2018.

was primarily due to (i) higher outside accounting and IT consultant expense of $2.0 million related to increased preparation for the

IPO and (ii) higher bad debt expenses of $0.4 million primarily attributable to the challenges in the Canadian market in 2019 offset by

lower facility expenses of $0.7 million due to adjusting our warehouse footprint.

Impairment, restructuring

Certain expenses of $10.0

million for 2019 and $7.2 million for 2018 primarily related to recognition of impairment on intangible assets, several restructuring

and recapitalization events, and fees for various statutory filings.

The impairment in 2019 related to the impairment of our intangible

asset for customer relationships;

in 2018, the impairment was for goodwill.

Restructuring and recapitalization events refer to our debt

refinancing in 2019 and 2018;

our Preferred Stock Offering in 2019;

the recapitalization and reverse merger in 2018;

and, other similar

activities related to our capitalization.

In 2019, we filed a registration statement which was delayed, and the third-party costs were

See Note 14, Impairment, restructuring and other, in our consolidated financial statements included elsewhere in this

Annual Report on Form 10-K for additional information.

Interest expense

Interest expense was $13.5

million for the year ended December 31, 2019 compared to $11.6 million for the year ended December 31, 2018, reflecting an increase of

$1.9 million or 16.0%.

The increase in interest expense

was due in part to an increase in the effective interest rate on the Term Loan Agreement to 13.0% for the year ended December 31, 2019

from 12.1% for the year ended December 31, 2018.

Additionally, interest payments for the years ended December 31, 2019 and 2018 of $7.1

million and $6.8 million, respectively, were deferred and added to principal which resulted in additional interest on the increase in

the principal balance.

Similarly, the effective interest

rate on the revolving credit facilities increased to 9.8% for the year ended December 31, 2019 compared to 5.0% to 5.1% for the year ended

December 31, 2018 as we transitioned from the BofA Credit Facility in July 2019 to the Encina Credit Facility.

Income tax benefit

Income tax benefit was $0.7

million or 1.7% of loss before tax for the year ended December 31, 2019 compared to $0.4 million or 1.1% for the year ended December 31,

The net income tax benefit is comprised of two amounts:

a current tax expense of $27 thousand and $0.5 million for 2019 and 2018,

respectively;

and, a deferred income tax benefit of $0.7 million and $0.9 million for 2019 and 2018, respectively.

The current portion

of the provision (tax expense) generally reflects minimum U.S.

state and Canadian provincial taxes which do not fluctuate with pre-tax

income or loss.

The deferred income tax benefit in each year was primarily generated from the tax consequence of the impairment write-offs;

these income tax benefits are not expected to recur.

Net loss attributable

to non-controlling interest

In May 2017, Hydrofarm Investment

(“HIC”), acquired, through its wholly-owned subsidiary, Hydrofarm Holdings, LLC, all of the capital stock of Hydrofarm,

Inc., in a transaction referred to as the “Formation Transaction.”

Concurrently with the acquisition by HIC, Hydrofarm, Inc.

converted from an S-Corp to a limited liability company and was renamed Hydrofarm, LLC.

At the time of the Formation Transaction in May

2017, an investor in Hydrofarm, LLC retained a 12.5% interest in Hydrofarm Holdings, LLC which was presented as a non-controlling interest

and allocated a portion of our losses until it was exchanged for shares in our parent and reclassified to controlling interest.

1, Description of the business, basis of presentation and significant accounting policies –

Recapitalization and reverse

merger in 2018, in our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional information.

Non-GAAP Financial Measures

report our financial results in accordance with generally accepted accounting principles in the U.S.

(“GAAP”).

management believes that certain non-GAAP financial measures provide investors of our financial information with additional useful information

in evaluating our performance and that excluding certain items that may vary substantially in frequency and magnitude period-to-period

from net income (loss) provides useful supplemental measures that assist in evaluating our ability to generate earnings and to more readily

compare these metrics between past and future periods.

These non-GAAP financial measures may be different than similarly titled measures

used by other companies.

To supplement our audited

consolidated financial statements which are prepared in accordance with GAAP, we use “Adjusted EBITDA”

and “Adjusted

EBITDA as a percent of sales”

which are non-GAAP financial measures (collectively referred to as “Adjusted EBITDA”).

Our non-GAAP financial measures should not be considered in isolation from, or as substitutes for, financial information prepared in

accordance with GAAP.

There are several limitations related to the use of our non-GAAP financial measures as compared to the closest

comparable GAAP measures.

Some of these limitations include:

Adjusted EBITDA does not reflect the

significant interest expense, or the amounts necessary to service interest or principal payments

on our indebtedness;

Adjusted EBITDA excludes depreciation

and amortization, and although these are non-cash expenses, the assets being depreciated

and amortized may have to be replaced in the future;

Adjusted EBITDA does not reflect our

tax provision that adjusts cash available to us;

Adjusted EBITDA excludes the non-cash

component of stock-based compensation;

Adjusted EBITDA excludes the amount

of employer payroll taxes on stock-based compensation;

Adjusted EBITDA does not reflect the

impact of earnings or charges resulting from matters we consider not to be reflective, on

a recurring basis, of our ongoing operations.

We define Adjusted EBITDA

as net income (loss) excluding interest expense, income taxes, depreciation and amortization, stock-based compensation, employer payroll

taxes on stock-based compensation and other unusual and/or infrequent costs, which we do not consider in our evaluation of ongoing operating

The following table presents a reconciliation of net income (loss), the most comparable GAAP financial measure, to Adjusted

EBITDA for each of the years ended December 31, 2020, 2019 and 2018:

ended December 31,

(In thousands)

Interest expense

Income tax expense

Depreciation and

Impairment, restructuring

Other income, net

Stock-based compensation(1)

on debt extinguishment

Adjusted EBITDA as a

percent of net sales

the amount of employer payroll taxes on share-based compensation

CASH FLOWS FROM OPERATING, INVESTING, AND

FINANCING ACTIVITIES

Cash Flows from Operating, Investing,

and Financing Activities —

Comparison of Years Ended December 31, 2020 and 2019

The following table summarizes

our cash flows for the years ended 2020 and 2019 (amounts in thousands):

Net cash used in operating activities

Net cash provided by (used in) investing activities

Net cash provided by financing activities

Effect of exchange rate changes on cash, cash equivalents and restricted cash

Net increase in cash, cash equivalents and restricted cash

Cash, cash equivalents and restricted cash at beginning of year

Cash, cash equivalents and restricted cash at end of year

Operating Activities

Net cash used in operating

activities was $44.8 million for the year ended December 31, 2020 consisting of $20.2 million in non-cash expense addbacks which were

largely composed of stock-based compensation, depreciation and amortization and non-cash operating lease expense, less net loss of $7.3

million, payment of interest capitalized to principal of long-term debt of $13.9 million and a $43.8 million increase in working capital.

The change in working capital primarily reflects a $43.2 million increase in accounts receivable and inventory for the period offset by

a $10.7 million increase in accounts payable and accrued expenses.

The net change was due to the additional working capital needed to

support our growth in net sales.

Net cash used in operating

activities was $13.3 million for the year ended December 31, 2019 consisting of net loss of $40.1 million offset by $26.2 million in

non-cash addbacks which were largely composed of depreciation and amortization, impairment charges, interest expense added to principal

and non-cash operating lease expense, plus a $0.6 million increase in working capital.

The small change in working capital primarily

reflects a $2.1 million net decrease in accounts receivable and inventories as collections and net sales during 2019 were slowed due

to the industry downturn, plus a $1.2 million increase in accounts payable and accrued expenses as we were able to align payment of our

obligations with our cash flow.

Investing Activities

We had minimal investing

activities for the years ended December 31, 2020 and 2019.

We made advances on notes receivable to third parties of $3.1 million the

year ended December 31, 2019 and were repaid $2.0 million the year ended December 31, 2020.

Our business was not capital intensive during

the years ended December 31, 2020 or 2019 and purchases of property and equipment were $1.4 million and $0.8 million, respectively.

We have no material commitments

for capital expenditures.

Financing Activities

Our IPO was completed in

December 2020 generating $182.3 million in net proceeds.

We used a portion of the proceeds to pay off our Term Loan Agreement, to payoff

our PPP loan and to paydown the outstanding balance under the Encina Credit Facili t y.

Other activity was a net of $1.2 million

from transactions with our Series A preferred stock investors and payments of $1.0 million on finance leases.

Our net cash provided by

these activities was $88.1 million for the period which we will use for our planned business growth and expansion.

For the year ended December

31, 2019, our borrowings under the working capital credit facilities marginally exceeded repayments which reflected stable working capital

needs for the period.

We also received $21.7 million from our Series A Preferred Stock offering including proceeds from the issuance

of notes which converted into the Series A Preferred Stock.

Net cash provided by these activities was $19.9 million for the period.

Cash Flows from Operating, Investing,

and Financing Activities —

Comparison of Years Ended December 31, 2019 and 2018

The following table summarizes

our cash flows for the years ended 2019 and 2018 (amounts in thousands):

Net cash (used in) provided by operating activities

Net cash used in investing activities

Net cash provided by financing activities

Effect of exchange rate changes on cash, cash equivalents and restricted cash

Net increase in cash, cash equivalents and restricted cash

Cash, cash equivalents and restricted cash at beginning of year

Cash, cash equivalents and restricted cash at end of year

Operating Activities

Net cash used in operating

activities was $13.3 million for the year ended December 31, 2019.

This consisted of net loss of $40.1 million offset by $26.2 million

in non-cash addbacks, which were largely composed of depreciation and amortization, impairment charges, interest expense added to principal

and non-cash operating lease expense, plus a $0.6 million increase in working capital.

The small change in working capital primarily

reflects a $2.1 million net decrease in accounts receivable and inventories as collections and net sales during 2019 were slowed due

to the industry downturn, plus a $1.2 million increase in accounts payable and accrued expenses as we were able to align payment of our

obligations with our cash flow.

Net cash provided by operating

activities was $4.4 million for the year ended December 31, 2018.

The increase in cash used in operating activities for the year ended

December 31, 2019 compared to the prior year was mostly due to the $22.0 million net drawdown of 2017 inventory (inventory purchased

and carried in ending inventory at December 31, 2017 and sold in 2018) by the year ended December 31, 2018 as inventory overstock issues

from the industry down-turn in late 2017 which continued into 2018 were addressed and rebalanced.

Investing Activities

Net cash used in investing

activities was $3.8 million for the year ended December 31, 2019 and $3.3 million for the year ended December 31, 2018.

cash was primarily for a $3.1 million advance on an interest bearing note receivable to a third party secured by equipment;

cash was used for a similar advance of $2 million to another third party.

Financing Activities

Net cash provided by financing

activities was $19.9 million for the year ended December 31, 2019 consisting primarily of proceeds from the Preferred Stock Offering,

net of offering costs, of $21.7 million which includes proceeds from debt eventually converted into the preferred stock.

improved our capital and liquidity.

The other significant activity was replacement of the BofA Credit Facility with the Encina Credit

Net cash provided by financing

activities was $25.5 million for the year ended December 31, 2018 primarily consisting of $52.6 million less offering costs of $4.5 million

from our offering and concurrent offering of common stock to investors, and a net of $4 million from a related party.

The offering improved

our capital and liquidity.

Our sources of cash provided by financing activities were offset by a $27.4 million net payment on our revolving

credit facility.

Our net sales tend to be

seasonally stronger in our fiscal second and third quarters which corresponds with the more robust in the warmer spring and summer months

in North America (US and Canada are our primarily markets).

This seasonal trend primarily relates to consumers of our grow media and

nutrient products utilizing natural sunlight in their CEA or outdoor grow application.

LIQUIDITY AND CAPITAL RESOURCES

Our liquidity and capital

resources were significantly improved by our IPO in December 2020 which resulted in net proceeds of $182.3 million after deducting underwriting

discounts and commissions and offering expenses.

The proceeds from the IPO were used to repay $76.6 million (including accrued interest

and fees of $0.3 million) outstanding under the Term Loan Agreement, $33.4 million outstanding under the Encina Credit Facility and $3.3

million under the PPP Loan, and to pay $2.6 million to settle the Series A Preferred Stock dividend.

As of December 31, 2020,

we had a cash balance of $75.2 million and restricted cash of $1.8 million;

$1.0 million of interest-bearing liabilities;

$15.0 million of inventory purchase commitment obligations, of which $3.0 million is due in 2021;

and $22.1 million of lease obligations associated with our right-of-use assets of which

$4.4 million is due in 2021.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

In preparing our consolidated

financial statements in conformity with GAAP, we must make decisions that impact the reported amounts of assets, liabilities, revenues

and expenses, and related disclosures.

Such decisions include the selection of the appropriate accounting principles to be applied and

the assumptions on which to base accounting estimates.

In reaching such decisions, we apply judgments based on our understanding and

analysis of the relevant circumstances, historical experience, and business valuations.

Actual amounts could differ from those estimated

at the time the Consolidated Financial Statements are prepared.

Our significant accounting

policies are described in Note 1, Description of the business, basis of presentation and significant accounting policies, to our

consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Some of those significant accounting policies

require us to make difficult, subjective, or complex judgments or estimates.

An accounting estimate is considered to be critical if it

meets both of the following criteria:

(i) the estimate requires assumptions about matters that are highly uncertain at the time the accounting

estimate is made, and (ii) different estimates reasonably could have been used, or changes in the estimate that are reasonably likely

to occur from period to period may have a material impact on the presentation of our financial condition, changes in financial condition,

or results of operations.

Our critical accounting estimates include the following:

Revenue recognition,

volume rebates and provision for doubtful accounts

All of our revenue is derived

from the sale of inventory and we recognize revenue as control of promised goods or services is transferred to customers.

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.

The recognition

of variable consideration requires the use of estimates.

While we believe these estimates to be reasonable based on the then current

facts and circumstances, there can be no assurance that actual amounts realized will not differ materially from estimated amounts recorded.

Provisions for uncollectible

receivables due from customers are established based on management’s judgment as to the ultimate collectability of these balances

and are recorded net of the receivable.

The allowance is 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.

Inventories are primarily

comprised of finished goods and are recorded at the lower of cost or net realizable value determined by the first-in, first-out method

of accounting.

Net realizable value represents the estimated selling price for inventories in the ordinary course of business, less all

estimated costs of completion and costs necessary to make the sale.

The determination of net realizable value requires significant judgment,

including consideration of factors such as shrinkage, the aging of and future demand for inventory, expected future selling price we

expect to realize by selling the inventory and our contractual arrangements with customers.

Reserves for excess and obsolete inventory

are based upon quantities on hand, projected volumes from demand forecasts and net realizable value.

The estimates are subjective in

nature and are made at a point in time, using available information, expected business plans, and expected market conditions.

the actual amount received on sale could differ from the estimated value of inventory.

Periodic reviews are performed on the inventory

The impact of changes in inventory reserves is reflected in cost of goods sold.

The adequacy of our adjustments could be materially

affected by changes in the supply and demand for our products.

Long-lived tangible

and finite-lived intangible assets including right-of-use assets

Long-lived tangible assets,

primarily property and equipment, are stated at cost;

right-of-use assets are recorded under Financial Accounting Standards Board (FASB)

Accounting Standards Codification (ASC) 842, Leases .

Depreciation is provided on the straight-line method and based on the estimated

useful economic lives of the assets.

Intangible assets with finite lives, and therefore subject to amortization, include customer relationships,

enterprise resource software and certain tradenames.

These intangible assets are being amortized over their estimated useful economic

lives typically ranging from 5 to 18 years.

We qualitatively assess potential

indicators of impairment, referred to informally as Step 0, of our long-lived tangible and finite-lived intangible assets whenever events

or changes in circumstances indicate that the asset or asset group’s carrying value may not be recoverable.

An asset group is defined

as the lowest level for which identifiable cash flows can be associated with groups of assets and related liabilities.

If indicators

are present, we follow a quantitative two-step process when testing for impairment.

In Step 1, we perform a recoverability test by analyzing

whether the carrying amount of the asset or asset group exceeds the sum of the undiscounted cash flows expected to result from their

use over their expected life and eventual disposition.

If the sum of the future undiscounted cash flows is greater than the carrying

amount, the test is passed and no further work is performed.

If the carrying amount is greater than the sum of the future undiscounted

cash flows, the recovery test is deemed to have failed, and Step 2 is performed.

In Step 2, the fair values of the long-lived tangible

and definite-lived intangible assets are determined, and an impairment charge is recognized based on the excess of the carrying amount

of the long-lived asset over its respective fair value.

We use assumptions for revenue

and expenses such as forecasted growth rates, margin estimates, historical cost ratios, capital additions and working capital needs,

which are consistent with internal projections and operating plans.

The forecast period is estimated using the remaining useful lives

of primary assets in the group which involves judgement about assets to be included in the group subject to the test and to economic

and technological obsolesce impacting the term.

These and other assumptions are impacted by economic conditions and expectations of management

and materially different assumptions in the future regarding the performance of the businesses could impact the useful lives of assets

or estimate of future undiscounted cash flows.

Share-based compensation

Stock-based compensation

cost is measured as of the grant date based on the fair value of the award and is expensed ratably over the service period of the award,

which is typically the vesting period for time-based awards.

Performance-based awards are expensed over the requisite service period

based on achievement of performance criteria.

We have elected to account for forfeitures when they occur, and any compensation expense

previously recognized on unvested shares will be reversed.

The fair value of restricted

stock awards is estimated based on the fair value of the common stock underlying the restricted stock awards.

We estimated the fair value

of option-based awards subject to only a service condition on the date of grant 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.

The highly subjective and complex assumptions in the Black-Scholes model also include the estimated fair value

of our common stock underlying the options.

To measure the value of the

underlying common stock, the initial grant-date fair value of shares of common stock underlying the award is determined.

Such valuation

is the responsibility of, and determined by, the board of directors, with input from management.

Until our IPO in December 2020, there

was no public market for our common stock.

Therefore, the board of directors determined the fair value of common stock at the grant date

by considering a number of objective, subjective and highly complex factors including independent third-party valuations of our common

stock, operating and financial performance, the lack of liquidity of capital stock and general and industry specific economic outlook,

among other factors.

For purposes of

determining the fair market value of our common stock during the periods prior to our IPO, we used a third-party valuation service

provider to provide support for our analysis.

For most of 2019, we primarily relied on valuation methods which included using the

discounted cash flow and guideline public company methods.

From latter part of 2019 until our IPO, a “probability weighted

expected return method”

(the “PWERM method”) analysis was used which placed greater emphasis on the Preferred

Stock Offering completed in December 2019 to establish the value of our common stock;

the PWERM method requires us to develop

assumptions and estimates for both the probability of an IPO liquidity event and remaining private outcomes, as well as the values

we expect those outcomes could yield.

These methods consider operating and financial performance including estimating future cash

flows and discounting those cash flows at an appropriate rate, the lack of liquidity of capital stock and general and industry

specific economic outlook, among other factors.

These estimates will not be necessary to determine the fair value of underlying

shares of common stock for new awards once the underlying shares begin trading.

Estimates of fair market value for awards grants

near our IPO incorporated the offering price in the calculation.

In 2020, we granted a restricted

stock award that vest only upon the satisfaction of both performance-based and market-based conditions.

In determining the fair value

of the award, the “Monte Carlo Simulation Method”

(the MCSM) was used to assess the likelihood of vesting of the restricted

stock units based on the probability of both a triggering event and qualifying traded share price within the specified time frame.

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.

Importantly, 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.

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 our 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.

We have 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 no history upon which to base an assumption about the term;

we believe the simplified method approximates a term if it were to

be based on expected life.

We will continue

to use the Black-Scholes model for option pricing.

Application of these approaches

involves the use of estimates, judgments and assumptions that are highly complex and subjective, such as those regarding our expected

future revenue, expenses, cash flows, discount rates, market multiples, the selection of comparable companies and the probability of

possible future events.

Changes in any or all of these estimates and assumptions or the relationships between those assumptions impact

our valuations as of each valuation date and may have a material impact on the valuation of our common stock.

Emerging Growth Company

We are an emerging growth

company as defined in the JOBS Act.

Under the JOBS Act, companies have extended transition periods available for complying with new or

revised accounting standards.

We have elected this exemption to delay adopting new or revised accounting standards until such time as

those standards apply to private companies.

Where allowable, we have early adopted certain standards as described in Note 1, Description

of the business, basis of presentation and significant accounting policies, in our consolidated financial statements included elsewhere

in this Annual Report on Form 10-K.

In addition, we intend to

rely on the other exemptions and reduced reporting requirements provided by the JOBS Act.

Subject to certain conditions set forth in

the JOBS Act, we are entitled to rely on certain exemptions as an emerging growth company, we are not required to, among other things,

(i) provide an auditor’s attestation report on our system of internal controls over financial reporting pursuant to Section 404(b),

(ii) provide all of the compensation disclosure that may be required of non-emerging growth public companies under the Dodd-Frank Wall

Street Reform and Consumer Protection Act, (iii) comply with any requirement that may be adopted by the Public Company Accounting

Oversight Board regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information

about the audit and the financial statements (auditor discussion and analysis), and (iv) disclose certain executive compensation-related

These exemptions will apply for a period of five years following the completion of our initial public offering or until we no

longer meet the requirements of being an emerging growth company, whichever is earlier.

Recent accounting pronouncements

For information regarding

recent accounting pronouncements, refer to Note 1, Description of the business, basis of presentation and significant accounting policies

Recently issued accounting pronouncements , to our consolidated financial statements included elsewhere in this Annual Report

on Form 10-K.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 5. Market for Registrant’s Common Equity