HYDROFARM HOLDINGS GROUP, INC. 10-K

Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Index to Consolidated Financial Statements Page Report of Independent Registered Public Accounting Firm (PCAOB ID No. 34 ) 72 Consolidated Balance Sheets 75 Consolidated Statements of Operations 76 Consolidated Statements of Comprehensive Income (Loss) 77 Consolidated Statements of Changes in Convertible Preferred Stock and Stockholders’ Equity 78 Consolidated Statements of Cash Flows 79 Notes to the Consolidated Financial Statements 81 Schedule II – Valuation and Qualifying Accounts 120 71 TABLE OF CONTENTS 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, 2021 and 2020, the related consolidated statements of operations, comprehensive income (loss), changes in convertible preferred stock and stockholders' equity, and cash flows, for each of the three years in the period ended December 31, 2021, 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, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 1, 2022, expressed an unqualified opinion on the Company's internal control over financial reporting. 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 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. 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. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. 72 TABLE OF CONTENTS Acquisitions - Refer to Note 3 to the financial statements Critical Audit Matter Description The Company completed various acquisitions during the year ended December 31, 2021 for an aggregate purchase price of approximately $533.3 million. The Company accounted for the acquisitions under the acquisition method of accounting for business combinations. Accordingly, the purchase price was allocated to the assets acquired and liabilities assumed based on their respective fair values, including customer relationship intangible assets of $42.1 million, trademark and tradename intangible assets of $118.1 million, technology and formulations & recipes of $110.6 million, and other intangible assets of $1.6 million, for total intangible assets recognized of $272.4 million. Management estimated the fair value of the intangible assets using the income approach specifically, the multi-period excess earnings and relief from royalty methods. The fair value determination of the intangible assets required management to make significant estimates and assumptions related to future cash flows and selection of the discount rates. We identified the fair value determination of the intangible assets as a critical audit matter because of the significant estimates and assumptions management makes to determine the fair value of these assets. This required a high degree of auditor judgment and an increased extent of effort, including the need to involve our fair value specialists, when performing audit procedures to evaluate the reasonableness of management’s forecasts of future cash flows and the selection of the discount rates used in the determination of the initial fair value of the intangible assets. How the Critical Audit Matter Was Addressed in the Audit Our audit procedures related to the forecasts of future cash flows and the selection of the discount rate for the acquired intangible assets included the following, among others: • We tested the effectiveness of controls over the valuation of the intangible assets, including management’s controls over forecasts of future cash flows and selection of the discount rate. • We assessed the reasonableness of management’s forecasts of future cash flows by comparing the projections to historical results and certain peer companies’ historical results. • With the assistance of our fair value specialists, we evaluated the reasonableness of the (1) valuation methodology and (2) discount rate by: – Testing the source information underlying the determination of the discount rate and testing the mathematical accuracy of the calculation. – Developing a range of independent estimates and comparing those to the discount rate selected by management. • We evaluated whether the estimated future cash flows were consistent with evidence obtained in other areas of the audit. /s/ Deloitte & Touche LLP Minneapolis, Minnesota March 1, 2022 We have served as the Company's auditor since 2020. 73 TABLE OF CONTENTS REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the stockholders and the Board of Directors of Hydrofarm Holdings Group, Inc. Opinion on Internal Control over Financial Reporting We have audited the internal control over financial reporting of Hydrofarm Holdings Group, Inc. and subsidiaries (the “Company”) as of December 31, 2021, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2021, of the Company and our report dated March 1, 2022, expressed an unqualified opinion on those consolidated financial statements. As described in Management’s Annual Report on Internal Control over Financial Reporting, management excluded from its assessment the internal control over financial reporting at Heavy 16, House and Garden, Aurora, Greenstar and Innovative Growers Equipment, Inc., which were acquired on May 3, June 1, July 1, August 3 and November 1, 2021 respectively, and whose financial statements constitute 85% and 68% of net and total assets, respectively, 13% of revenues, and 37% of net income of the consolidated financial statement amounts as of and for the year ended December 31, 2021. Accordingly, our audit did not include the internal control over financial reporting at Heavy 16, House and Garden, Aurora, Greenstar and Innovative Growers Equipment, Inc. Basis for Opinion The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control over Financial Reporting A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Deloitte & Touche LLP Minneapolis, Minnesota March 1, 2022 74 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share amounts) December 31, 2021 2020 Assets Current assets: Cash and cash equivalents $ 26,607 $ 75,178 Restricted cash 1,777 1,777 Accounts receivable, net 41,484 21,626 Inventories 189,134 88,618 Notes receivable 622 3,151 Prepaid expenses and other current assets 9,760 9,567 Total current assets 269,384 199,917 Property, plant and equipment, net 50,473 3,988 Operating lease right-of-use assets 45,245 18,289 Goodwill 204,868 — Intangible assets, net 314,819 52,421 Other assets 6,453 1,180 Total assets $ 891,242 $ 275,795 Liabilities and stockholders’ equity Current liabilities: Accounts payable $ 44,958 $ 22,638 Accrued expenses and other current liabilities 33,996 21,615 Current portion of lease liabilities 7,198 3,701 Current portion of long-term debt 2,263 746 Total current liabilities 88,415 48,700 Long-term lease liabilities 38,595 15,320 Long-term debt 119,517 290 Long-term deferred tax liabilities 5,631 — Other long-term liabilities 3,904 567 Total liabilities 256,062 64,877 Commitments and contingencies (Note 14) Stockholders’ equity Common stock ($ 0.0001 par value; 300,000,000 shares authorized; 44,618,357 and 33,499,953 shares issued and outstanding at December 31, 2021 and December 31, 2020, respectively) 4 3 Additional paid-in capital 777,074 364,248 Accumulated other comprehensive (loss) income ( 1,382 ) 599 Accumulated deficit ( 140,516 ) ( 153,932 ) Total stockholders’ equity 635,180 210,918 Total liabilities and stockholders’ equity $ 891,242 $ 275,795 The accompanying notes are an integral part of the consolidated financial statements. 75 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except share and per share amounts) Years ended December 31, 2021 2020 2019 Net sales $ 479,420 $ 342,205 $ 235,111 Cost of goods sold 377,934 278,572 208,025 Gross profit 101,486 63,633 27,086 Operating expenses: Selling, general and administrative 103,888 58,492 43,784 Impairment, restructuring and other 297 860 10,035 (Loss) income from operations ( 2,699 ) 4,281 ( 26,733 ) Interest expense ( 2,138 ) ( 10,141 ) ( 13,467 ) Loss on debt extinguishment ( 680 ) ( 907 ) ( 679 ) Other (expense) income, net ( 204 ) 70 105 Loss before tax ( 5,721 ) ( 6,697 ) ( 40,774 ) Income tax benefit (expense) 19,137 ( 576 ) 691 Net income (loss) 13,416 ( 7,273 ) ( 40,083 ) Cumulative dividends allocated to Series A Convertible Preferred Stock — ( 2,597 ) — Net income (loss) attributable to common stockholders $ 13,416 $ ( 9,870 ) $ ( 40,083 ) Net income (loss) per share attributable to common stockholders: Basic $ 0.34 $ ( 0.46 ) $ ( 1.94 ) Diluted $ 0.31 $ ( 0.46 ) $ ( 1.94 ) Weighted-average shares used to compute net income (loss) per share attributable to common stockholders: Basic 39,991,809 21,298,849 20,688,439 Diluted 42,989,195 21,298,849 20,688,439 The accompanying notes are an integral part of the consolidated financial statements. 76 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (In thousands) Years ended December 31, 2021 2020 2019 Net income (loss) $ 13,416 $ ( 7,273 ) $ ( 40,083 ) Other comprehensive (loss) income: Foreign currency translation (loss) gain ( 1,981 ) 743 1,709 Total comprehensive income (loss) $ 11,435 $ ( 6,530 ) $ ( 38,374 ) The accompanying notes are an integral part of the consolidated financial statements. 77 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. CONSOLIDATED STATEMENTS OF CHANGES IN CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY (In thousands, except for share amounts) Convertible Preferred Stock Common Stock Additional Paid-In Capital Accumulated Other Comprehensive (Loss) Income Accumulated Deficit Total Stockholders’ Equity Shares Amount Shares Amount Balance, January 1, 2019 — $ — 20,688,439 $ 2 $ 155,971 $ ( 1,853 ) $ ( 106,576 ) $ 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 Net loss — — — — — — ( 40,083 ) ( 40,083 ) Foreign currency translation gain — — — — — 1,709 — 1,709 Balance, December 31, 2019 7,007,429 21,802 20,688,439 2 156,179 ( 144 ) ( 146,659 ) 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 Series A Convertible Preferred Stock cumulative dividend — 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 Conversion of Series A Convertible Preferred Stock to common stock ( 7,725,045 ) ( 25,594 ) 2,291,469 — 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 repurchased for withholding tax on restricted stock units — — ( 239,702 ) — ( 6,089 ) — — ( 6,089 ) Other — — — — ( 4 ) — — ( 4 ) Net loss — — — — — — ( 7,273 ) ( 7,273 ) Foreign currency translation gain — — — — — 743 — 743 Balance, December 31, 2020 — — 33,499,953 3 364,248 599 ( 153,932 ) 210,918 Common stock issued upon exercise of options — — 186,633 — 1,595 — — 1,595 Issuance of common stock for vesting of restricted stock units — — 851,741 — — — — — Shares repurchased for withholding tax on restricted stock units — — ( 268,867 ) — ( 13,945 ) — — ( 13,945 ) Issuance of common stock under cashless warrant exercise — — 418,633 — — — — — Issuance of common stock under investor warrant exercise — — 3,367,647 — 56,778 — — 56,778 Issuance of common stock in connection with follow-on public offering, net of offering costs of $ 16,303 — — 5,526,861 1 309,781 — — 309,782 Issuance of common stock in connection with business combinations — — 1,035,756 — 53,611 — — 53,611 Stock-based compensation expense — — — — 5,006 — — 5,006 Net income — — — — — — 13,416 13,416 Foreign currency translation loss — — — — — ( 1,981 ) — ( 1,981 ) Balance, December 31, 2021 — $ — 44,618,357 $ 4 $ 777,074 $ ( 1,382 ) $ ( 140,516 ) $ 635,180 The accompanying notes are an integral part of the consolidated financial statements. 78 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) Years ended December 31, 2021 2020 2019 Operating activities Net income (loss) $ 13,416 $ ( 7,273 ) $ ( 40,083 ) Adjustments to reconcile net income (loss) to net cash used in operating activities: Depreciation, depletion and amortization 14,934 6,779 6,995 Stock-based compensation expense 5,006 8,895 208 Non-cash operating lease expense 5,660 3,469 3,650 Impairment charges — — 5,390 Interest expense capitalized to principal of long-term debt — 20 9,644 Change in fair value of contingent consideration ( 2,610 ) — — Payment of interest capitalized to principal of long-term debt — ( 13,901 ) ( 2,360 ) Deferred income tax (benefit) expense ( 20,996 ) 52 ( 718 ) Other 2,455 955 3,391 Changes in assets and liabilities: Accounts receivable ( 1,926 ) ( 6,329 ) ( 620 ) Inventories ( 46,849 ) ( 36,859 ) 2,725 Prepaid expenses and other current assets 2,761 ( 7,733 ) ( 9 ) Other assets ( 1,781 ) 24 494 Accounts payable ( 7,223 ) 4,795 ( 1,199 ) Accrued expenses and other current liabilities ( 3,238 ) 5,900 2,364 Lease liabilities ( 4,676 ) ( 3,126 ) ( 3,297 ) Other long-term liabilities — ( 493 ) 123 Net cash used in operating activities ( 45,067 ) ( 44,825 ) ( 13,302 ) Investing activities Business combinations, net of cash and cash equivalents ( 462,172 ) — — Purchases of property and equipment ( 5,402 ) ( 1,447 ) ( 768 ) Issuance of notes receivable — — ( 3,050 ) Proceeds from notes receivable — 2,000 — Other ( 610 ) ( 7 ) — Net cash (used in) provided by investing activities ( 468,184 ) 546 ( 3,818 ) Continued 79 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) Years ended December 31, 2021 2020 2019 Financing activities Proceeds from issuance of common stock upon follow-on public offering, net of offering costs 309,782 — — Proceeds from issuance of term loan, net of discount and issuance costs 119,879 — — Borrowings under revolving credit facilities 142,628 305,965 256,862 Repayments of PPP loan, long-term debt and revolving credit facilities ( 143,003 ) ( 404,021 ) ( 256,785 ) Proceeds from exercises of investor warrants 56,778 — — Payment of withholding tax related to restricted stock units ( 20,025 ) — — 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 ) — Borrowings from PPP Loan — 3,274 — Other ( 1,332 ) ( 687 ) 5,658 Net cash provided by financing activities 464,707 88,145 19,900 Effect of exchange rate changes on cash, cash equivalents and restricted cash ( 27 ) 232 2,154 Net (decrease) increase in cash, cash equivalents and restricted cash ( 48,571 ) 44,098 4,934 Cash, cash equivalents and restricted cash at beginning of year 76,955 32,857 27,923 Cash, cash equivalents and restricted cash at end of year $ 28,384 76,955 32,857 Non-cash investing and financing activities Issuance of common stock as consideration in connection with business combinations $ 53,611 $ — $ — Increase in accrued expenses and other current liabilities for contingent consideration 19,644 — — Right-of-use assets acquired under operating lease obligation 22,873 3,166 — Conversion of Series A Convertible Preferred Stock to common stock — 25,594 — Shares repurchased for withholding tax on restricted stock units 9 6,089 — 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 Supplemental information Cash paid for interest 1,621 23,142 5,492 Cash paid for income taxes 1,963 94 63 Concluded The accompanying notes are an integral part of the consolidated financial statements. 80 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) 1. DESCRIPTION OF THE BUSINESS Description of the business Hydrofarm Holdings Group, Inc. and its subsidiaries (collectively, the “Company”) was formed in May 2017 under the laws of the state of Delaware to acquire and continue the business of Hydrofarm, LLC established in 1977. The Company is a leading independent manufacturer and distributor of CEA 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, CO 2 , light intensity and color, nutrient concentration and pH. 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. 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 their option to purchase 1,300,000 additional shares of common stock. The public offering price was $ 20.00 per share. The Company received net proceeds of $ 182,271 from the IPO after deducting underwriting discounts and commissions and offering expenses, of which $ 148 of offering expenses were paid in 2021. Follow-on public offering On May 3, 2021, the Company closed its follow-on public offering ("follow-on offering") under a registration statement effective April 28, 2021, in which it issued and sold 5,526,861 shares of its common stock, including the full exercise by the underwriters of their option to purchase 720,894 additional shares of common stock. The public offering price was $ 59.00 per share. The Company received net proceeds of $ 309,782 from the follow-on offering after deducting underwriting discounts and commissions and offering expenses. 2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES 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. 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 reasonable under the 81 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) circumstances. Actual results may differ from these estimates. On an ongoing basis, management reviews its estimates to ensure that these estimates appropriately reflect changes in its business or new information available. Business combinations Acquisitions of businesses are accounted for using the acquisition method. The consideration transferred in a business combination is measured at fair value, which is calculated as the sum of the acquisition date fair values of the assets transferred, liabilities incurred to the former owners of the acquiree and the equity interests issued in exchange for control of the acquiree. Acquisition-related costs are recognized as selling, general and administrative expenses in the periods in which the costs are incurred and services are received. When the consideration transferred in a business combination includes assets or liabilities resulting from a contingent consideration arrangement, the contingent consideration is measured at its acquisition date fair value and included as part of the consideration transferred in a business combination. Contingent consideration is established for business acquisitions where the Company has the obligation to transfer additional assets or equity interests to the former owners if specified future events occur or conditions are met. Contingent consideration is classified as a liability when the obligation requires settlement in cash or other assets and is classified as equity when the obligation requires settlement in the Company's own equity instruments. Changes in the fair value of the contingent consideration that qualify as measurement period adjustments are adjusted retrospectively, with a corresponding adjustment to goodwill. Measurement period adjustments are adjustments that arise from additional information obtained during the measurement period (which cannot exceed one year from the acquisition date) about facts and circumstances that existed at the acquisition date. All other subsequent changes in the fair value of contingent consideration classified as an asset or liability are included in selling, general and administrative expenses in the period. Changes in the fair value of contingent consideration classified as equity are not recognized. For a given acquisition, the Company may identify certain pre-acquisition contingencies as of the acquisition date and may extend its review and evaluation of these pre-acquisition contingencies throughout the measurement period in order to obtain sufficient information to assess these contingencies as part of acquisition accounting, as applicable. Goodwill is measured as the excess of the sum of the consideration transferred, the amount of any non‑controlling interests in the acquiree, and the fair value of the acquirer’s previously held equity interest in the acquiree (if any) over the net of the acquisition‑date fair value amounts of the identifiable assets acquired and the liabilities assumed. If the initial accounting for a business combination is incomplete by the end of the reporting period in which the combination occurs, the Company reports provisional amounts for the items for which the accounting is incomplete. Those provisional amounts are adjusted during the measurement period, or additional assets or liabilities are recognized, to reflect new information obtained about facts and circumstances that existed at the acquisition date that, if known, would have affected the amounts recognized at that time. Upon conclusion of the measurement period or final determination of the net assets acquired, whichever comes first, any subsequent adjustments are recorded to net income (loss). Segment and entity-wide information Segment information The Company's chief operating decision maker is the chief executive officer ("CEO") who reviews financial information for the purposes of making operating decisions, assessing financial performance and allocating resources. The business is organized as 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. 82 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) 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 information Sales to external customers and property, plant and equipment, net and operating lease right-of-use assets in the United States and Canada, determined by the location of the subsidiaries, were as follows: Years ended December 31, 2021 2020 2019 United States $ 399,749 $ 287,884 $ 194,618 Canada 87,281 58,079 44,515 Intersegment eliminations ( 7,610 ) ( 3,758 ) ( 4,022 ) Total consolidated net sales $ 479,420 $ 342,205 $ 235,111 December 31, 2021 2020 United States $ 85,167 $ 19,025 Canada 10,551 3,252 Total property, plant and equipment, net and operating lease right-of-use assets $ 95,718 $ 22,277 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. 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 2021, 2020, and 2019. No customer accounted for more than 10% of accounts receivable in 2021. One customer accounted for 11 % of accounts receivable as of December 31, 2020 and another customer accounted for 11 % of accounts receivable as of December 31, 2019. One supplier accounted for 10 % of purchases in 2021 and another supplier accounted for 10 % of purchases in 2019. No supplier accounted for more than 10% of purchases in 2020. 83 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) 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. The fair value of contingent consideration is classified within level 3 of the fair value hierarchy (See discussion of contingent consideration in Note 3 - Business Combinations ). Foreign currency matters 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. Monetary assets and liabilities, and transactions denominated in currencies other than the functional currency are remeasured to the functional currency at the exchange rate in effect at the end of each period. Foreign currency transaction gains and losses are included in the determination of net income (loss) and classified as other (expense) income, net in the consolidated statements of operations. Assets and liabilities of foreign subsidiaries are translated at the exchange rates in effect at the end of each period. Revenues, expenses, gains and losses are translated at the average rates of exchange prevailing during the period. Accumulated deficit and other equity accounts are translated at historical rates. Translation gains and losses are included in accumulated other comprehensive (loss) income within stockholders’ equity. 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, 2021, and 2020, 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, 2021 2020 Cash and cash equivalents $ 26,607 $ 75,178 Restricted cash 1,777 1,777 Cash and cash equivalents, and restricted cash $ 28,384 $ 76,955 As of December 31, 2019, cash and cash equivalents and restricted cash were $ 22,866 and $ 9,991 , respectively, for total cash, cash equivalents, and restricted cash as of $ 32,857 . 84 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) 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, but not limited to the age of the account, the credit worthiness of the customer, payment terms, the customer’s historical payment history and general economic conditions. Management reviews these factors quarterly to determine if any adjustments are needed to the allowance for doubtful accounts . Inventories Inventories consist of manufactured goods, goods acquired for resale, and materials consumed in business operations. Inventories are stated at the lower of cost or net realizable value, principally determined by the first in, first out method of accounting. 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. Management reviews these assumptions periodically to determine if any adjustments are needed to the allowance for excess and obsolete inventory. 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 Leases are accounted for under Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 842, Leases . At inception of a contract, the Company determines whether that contract is or contains a lease. A contract is or contains a lease if the contract conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration. Leases are then classified as either finance or operating, with classification affecting the pattern of expense recognition in the consolidated statements of operations. Right-of-use assets ("ROU") represent the right to use an underlying asset for the lease term while lease liabilities represent the obligation to make lease payments arising from a lease, measured on a discount basis. All leases greater than 12 months result in the recognition of a ROU and a lease 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. The exercise of the lease renewal options is at the Company’s discretion. A lease renewal option is included in the determination of the ROU asset and lease liability when the option is reasonably certain of being exercised. 85 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) Property, plant and equipment Property, plant and equipment ("PP&E") is recorded at cost less accumulated depreciation, depletion and amortization. PP&E assets are reviewed for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. Property, plant and equipment excluding leasehold improvements and peat bogs and related development are depreciated using the straight-line method. Leasehold improvements are amortized using the straight-line method. The following table summarizes the estimated useful lives as follows: Buildings and improvements 10 - 40 years Machinery and equipment 5 - 15 years Leasehold improvements Lesser of useful life or term of the lease Computer equipment 3 - 4 years Furniture and fixtures 5 years Peat bogs and related development costs are depleted using the units of production method over the total expected volume of the peat bogs. Intangible assets and goodwill Definite-lived intangible assets are amortized using the straight-line method over their estimated useful lives. Certain trademarks and trade names are considered to have indefinite useful lives. Intangible assets with finite lives are reviewed for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. The following are the estimated useful lives for the major classes of definite-lived intangible assets: Computer software 5 years Customer relationships 10 to 20 years Technology and formulations & recipes 10 to 18 years Goodwill represents the excess of the acquisition price of an acquired business over the fair value of the identifiable assets acquired and liabilities assumed in a business combination less any subsequent write-downs for impairment. Goodwill is tested for impairment on an annual basis in the fourth quarter and more frequently if indicators of potential impairment exist. Impairment testing is conducted at the reporting unit level, which is generally defined as an operating segment or one level below an operating segment (also known as a component), for which discrete financial information is available and segment management regularly reviews the operating results. The Company has determined that its reporting units for the purpose of goodwill impairment testing are the United States and Canada. Goodwill impairment reviews include performing either an initial qualitative or quantitative evaluation for each of the reporting units. Several methods may be used to estimate a reporting unit’s fair value, including market quotations, asset and liability fair values and other valuation techniques. If the carrying amount of a reporting unit, including goodwill, exceeds the estimated fair value, then the excess is charged to earnings as an impairment loss. Intangible assets with indefinite lives are also tested for impairment at least annually and when events or changes in circumstances indicate that, more-likely-than-not, the asset is impaired. Significant judgment is required in estimating fair values and performing goodwill and indefinite-lived intangible asset impairment tests. 86 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) 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 ASC 606, Revenue from Contracts with Customers, requires that revenue recognized from contracts with customers be disaggregated into categories that depict how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors. The Company has determined that revenue is generated from one category, which is the distribution and manufacture of controlled environment agriculture equipment and supplies. Revenue is recognized as control of promised goods is transferred to customers which generally occurs upon receipt at customers’ locations determined by the specific terms of the contract. Arrangements generally have a single performance obligation and revenue 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 $ 8,050 , $ 4,314 , and $ 2,790 in 2021, 2020, and 2019, 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. The Company does not receive noncash consideration for the sale of goods. Contract consideration received from a customer prior to revenue recognition is recorded as a contract liability and is recognized as revenue when the Company satisfies the related performance obligation under the terms of the contract. The Company's contract liabilities, which consist primarily of customer deposits are reported within accounts payable in the consolidated balance sheets, totaled $ 18,273 and $ 1,079 as of December 31, 2021 and 2020, respectively. There are no significant financing components. Excluded from revenue are any taxes assessed by governmental authorities, including value-added and other sales-related taxes that are imposed on and concurrent with revenue-generating activities. 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. 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 they occur 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 RSUs 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. For 2021, the fair value of the underlying common stock for RSUs is the closing date price of the Company's common stock at the grant-date. 87 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) 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. 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 of the Company's common stock or industry peers equivalent. 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 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. 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” ("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 were 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 88 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) 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. Recently issued accounting pronouncements Adopted in 2021 In October 2020, the FASB issued Accounting Standards Update ("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 adopted the standard effective January 1, 2021 with no impact on the consolidated financial statements. In August 2020, the FASB issued ASU No. 2020-06, Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging-Contracts in Entity's Own Equity . This ASU simplifies the accounting for certain financial instruments with characteristics of liabilities and equity, including convertible instruments and contracts on an entity’s own equity. This ASU is part of the FASB’s simplification initiative, which aims to reduce unnecessary complexity in U.S. GAAP. The amendments are effective for fiscal years beginning after December 15, 2021, and early adoption is permitted. The Company early adopted the standard effective January 1, 2021 with no impact on the consolidated financial statements. In August 2018, the FASB issued ASU No. 2018-15, Intangibles-Goodwill and Other-Internal-Use Software (Topic 350) : Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract, ” which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The Company early adopted the standard effective October 1, 2021 with no impact on the consolidated financial statements. In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326) . The ASU introduces a new credit loss methodology, Current Expected Credit Losses (CECL), which requires earlier recognition of credit losses, while also providing additional transparency about credit risk. Since its original issuance in 2016, the FASB has issued several updates to the original ASU. The Company recognizes an allowance for credit losses for financial assets carried at amortized cost to present the net amount expected to be collected as of the balance sheet date. Such allowance is based on the credit losses expected to arise over the life of the asset (contractual term) which includes consideration of prepayments and based on our expectation as of the balance sheet date. The Company adopted the standard effective October 1, 2021 with no impact on the consolidated financial statements. 89 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) 3. BUSINESS COMBINATIONS Heavy 16 Acquisition On May 3, 2021, the Company acquired 100 % of the issued and outstanding membership interests of Field 16, LLC ("Heavy 16"), a manufacturer and supplier of branded plant nutritional products. As a result of the acquisition, the Company is broadening its proprietary branded offering into the plant nutrients category complementing other product offerings. The preliminary acquisition fair value of the consideration transferred for Heavy 16 was $ 77,367 , consisting of $ 60,287 in cash, $ 16,736 of the Company's common stock and $ 344 contingent consideration. The fair value of the common stock issued was determined based on the closing market price of the Company's common stock on the acquisition date. The financial results of Heavy 16 are included in the U.S. operating segment since the acquisition date. Pursuant to the purchase agreement, the Company may pay up to an additional $ 2,500 of contingent consideration based on $ 200 for each $ 1,000 above a $ 21,000 threshold for net sales in calendar year 2021. As a result, the Company recorded a liability for contingent consideration at its estimated fair value of $ 344 as of the acquisition date in the consolidated balance sheets. The contingent consideration was estimated using a Black-Scholes valuation model, which utilized Level 3 inputs as defined in ASC 820 - Fair Value Measurements, including estimated financial forecasts . The key assumptions in applying the valuation model were as follows: a 10 % required revenue metric risk premium and 0.33 % discount periods . The contingent consideration was divided into thirteen standalone option calculations and utilized the same expected value of revenue which was calculated by discounting forecasted sales, by the revenue return metric, and adding year-to-date net sales. The contingent consideration is remeasured to fair value at each reporting date until the contingency is resolved with changes in fair value being recognized within selling, general and administrative expense in the consolidated statements of operations. As of December 31, 2021, contingent consideration of $ 200 was calculated utilizing actual net sales for the full year ended December 31, 2021 and was included in accrued expenses and other current liabilities in the consolidated balance sheets. The contingent consideration is expected to be paid in April 2022. 90 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) The following table sets forth the components and preliminary allocation of the purchase price for the Company's acquisition of Heavy 16: Components of Purchase Price: Amount Cash $ 60,287 Common stock 16,736 Contingent consideration 344 Total purchase price $ 77,367 Acquisition-related costs $ 2,885 Allocation of Purchase Price: Identifiable assets (liabilities) Accounts receivable $ 510 Inventories 1,451 Prepaid expenses and other current assets 34 Property and equipment 1,078 Operating lease right-of-use assets 1,088 Other assets 25 Accounts payable ( 1,055 ) Accrued expenses and other current liabilities ( 226 ) Current portion of lease liabilities ( 274 ) Long-term lease liabilities ( 868 ) Net tangible assets 1,763 Identifiable intangible assets Other intangible assets 200 Customer relationships 5,100 Trademarks and trade names 18,500 Technology and formulations & recipes 33,600 Total identifiable intangible assets 57,400 Goodwill 18,204 Total purchase price allocation $ 77,367 The Company has obtained a preliminary third-party valuation report of certain tangible and identifiable intangible assets and is in the process of reviewing and evaluating the information. The primary area that remains preliminary relates to the fair value of all identifiable intangible assets acquired Goodwill arose on the acquisition of Heavy 16 because the consideration paid for the combination effectively included amounts in relation to the benefit of expected synergies, revenue growth, future market development and the assembled workforce. These benefits are not recognized separately from goodwill and they do not meet the recognition criteria for identifiable intangible assets. The amount of goodwill is fully deductible for U.S. tax purposes. The customer relationships and technology and formulations & recipes were assigned estimated useful lives of 18 years. The trademarks and trade names are considered to have indefinite useful lives. 91 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) House & Garden Acquisition On June 1, 2021, the Company acquired 100 % of the issued and outstanding shares of capital stock of House & Garden, Inc. (“HG”), Humboldt Wholesale, Inc. (“HW”), Allied Imports & Logistics, Inc. (“Allied”), South Coast Horticultural Supply, Inc. (“SC” and, together with HG, HW and Allied, the “H&G Entities”), a manufacturer and distributor of plant nutrients and fertilizers to domestic and various international markets. As a result of the acquisition, the Company is further broadening its proprietary branded offering into the plant nutrients category complementing other product offerings. The preliminary acquisition date fair value of the consideration transferred for the H&G Entities was $ 133,483 in cash. The financial results of the H&G Entities are included in the U.S. operating segment since the acquisition date. The following table sets forth the components and the preliminary allocation of the purchase price for the Company's acquisition of the H&G Entities: 92 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) Component of Purchase Price: Amount Cash $ 133,483 Total purchase price $ 133,483 Acquisition-related costs $ 4,908 Allocation of Purchase Price: Identifiable assets (liabilities) Accounts receivable $ 3,308 Inventories 6,559 Prepaid expenses and other current assets 493 Property and equipment 358 Operating lease right-of-use assets 1,921 Other assets 213 Accounts payable ( 1,320 ) Accrued expenses and other current liabilities ( 519 ) Current portion of lease liabilities ( 447 ) Long-term deferred tax liabilities ( 25,589 ) Long-term lease liabilities ( 1,501 ) Net tangible assets ( 16,524 ) Identifiable intangible assets Other intangible assets 200 Customer relationships 12,500 Trademarks and trade names 31,400 Technology and formulations & recipes 56,200 Total identifiable intangible assets 100,300 Goodwill 49,707 Total purchase price allocation $ 133,483 The Company has obtained a preliminary third-party valuation report of certain tangible and identifiable intangible assets and is in the process of reviewing and evaluating the information. The primary area that remains preliminary relates to the fair value of all identifiable intangible assets acquired Goodwill arose on the acquisition of the H&G Entities because the consideration paid for the combination effectively included amounts in relation to the benefit of expected synergies, revenue growth, future market development and the assembled workforce. These benefits are not recognized separately from goodwill and they do not meet the recognition criteria for identifiable intangible assets. The amount of goodwill is not deductible for U.S. tax purposes. The customer relationships and technology and formulations & recipes were assigned estimated useful lives of 18 years. The trademarks and trade names are considered to have indefinite useful lives. As part of the share acquisition of the H&G Entities, the Company allocated a significant value of the acquisition to identified intangible assets that are not deductible for U.S. tax purposes. Therefore, a deferred tax liability arose providing an additional source of taxable income to support the realization of pre-existing deferred tax assets. 93 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) Aurora Acquisition On July 1, 2021, the Company acquired 100 % of the issued and outstanding membership interests of Gotham Properties LLC (“Gotham Properties”), Aurora Innovations LLC (“Aurora Innovations”), Aurora International LLC (“Aurora International” and, together with Gotham Properties and Aurora Innovations, “Aurora”), a manufacturer of plant fertility product lines. As a result of the acquisition, the Company is further broadening its proprietary branded offering into the plant nutrients and grow media category complementing other product offerings. The preliminary acquisition fair value of the consideration transferred for Aurora was $ 178,871 , consisting of $ 134,961 in cash, $ 25,824 of the Company's common stock, $ 19,300 contingent consideration, less $ 999 escrow receivable, $ 215 forgiveness of accounts payable. The fair value of the common stock issued was determined based on the closing market price of the Company's common stock on the acquisition date. The forgiveness of accounts payable represents an effective settlement of a preexisting relationship between the parties. The financial results of Aurora are included in the U.S. operating segment since the acquisition date. Pursuant to the purchase agreement, the Company may pay a maximum contingent consideration equal to $ 70,997 . To the extent 2021 EBITDA of Aurora exceeded $ 15,556 , the excess was multiplied by eleven to determine contingent consideration. As a result, the Company recorded a liability for contingent consideration at its estimated fair value of $ 19,300 as of the acquisition date in the consolidated balance sheets. The contingent consideration was estimated using the discounted cash flow method, which estimated the incremental EBITDA based on the Company's forecasted 2021 EBITDA of Aurora as of the acquisition date, discounted to a present value as of the acquisition date using a discount rate of 15 %. That measure was based on significant inputs that were not observable in the market, which ASC 820 - Fair Value Measurements refers to as a Level 3 input . The contingent consideration is remeasured to fair value at each reporting date until the contingency is resolved with changes in fair value being recognized within selling, general and administrative expense in the consolidated statements of operations. As of December 31, 2021, contingent consideration of $ 16,834 was calculated utilizing actual 2021 EBITDA for the full year ended December 31, 2021 and was included in accrued expenses and other current liabilities in the consolidated balance sheets. The contingent consideration and is expected to be paid in April 2022. 94 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) The following table sets forth the components and the preliminary allocation of the purchase price for the Company's acquisition of Aurora: Components of Purchase Price: Amount Cash $ 134,961 Common stock 25,824 Contingent consideration 19,300 Forgiveness of accounts payable ( 215 ) Escrow receivable ( 999 ) Total purchase price $ 178,871 Acquisition-related costs $ 6,698 Allocation of Purchase Price: Identifiable assets (liabilities) Accounts receivable $ 6,967 Inventories 11,086 Prepaid expenses and other current assets 1,086 Property, plant and equipment 37,991 Accounts payable ( 4,360 ) Accrued expenses and other current liabilities ( 804 ) Other long-term liabilities ( 3,852 ) Net tangible assets $ 48,114 Identifiable intangible assets Other intangible assets 824 Customer relationships 6,400 Trademarks and trade names 59,100 Technology and formulations & recipes 18,000 Total identifiable intangible assets 84,324 Goodwill 46,433 Total purchase price allocation $ 178,871 The Company has obtained a preliminary third-party valuation report of tangible and identifiable intangible assets and is in the process of reviewing and evaluating the information. Accordingly, the preliminary purchase price allocation is subject to change. The Company expects to finalize the valuation as soon as practicable, but not later than one year from the acquisition date. The amount of goodwill is fully deductible for U.S. tax purposes. Goodwill arose on the acquisition of Aurora because the consideration paid for the combination effectively included amounts in relation to the benefit of expected synergies, revenue growth, future market development and the assembled workforce. These benefits are not recognized separately from goodwill and they do not meet the recognition criteria for identifiable intangible assets. The customer relationships and technology and formulations & recipes were assigned estimated useful lives of 16 and 18 years, respectively. The trademarks and trade names are considered to have indefinite useful lives. 95 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) Greenstar/Grotek Acquisition On August 3, 2021, the Company acquired 100 % of the issued and outstanding shares of Greenstar Plant Products Inc., (“Greenstar”), a manufacturer of horticultural products and solutions for global, domestic and commercial use. As a result of the acquisition, the Company is further broadening its proprietary branded offering into the plant nutrients and grow media category complementing other product offerings. The preliminary acquisition fair value of the consideration transferred for Greenstar was $ 83,520 , consisting of $ 85,121 in cash, less $ 1,601 forgiveness of accounts payable, net, and obligations due under a distribution agreement. The forgiveness of accounts payable, net, and obligations due under a distribution agreement represent an effective settlement of a preexisting relationship between the parties. The financial results of Greenstar are included in the Canada operating segment since the acquisition date. The following table sets forth the components and the preliminary allocation of the purchase price for the Company's acquisition of Greenstar: Components of Purchase Price: Amount Cash $ 85,121 Forgiveness of accounts payable, net, and obligations due under a distribution agreement ( 1,601 ) Total purchase price $ 83,520 Acquisition-related costs $ 3,451 Allocation of Purchase Price: Identifiable assets (liabilities) Accounts receivable $ 982 Inventories 8,728 Prepaid expenses and other current assets 447 Property and equipment 1,717 Operating lease right-of-use assets 2,736 Other assets 176 Accounts payable ( 777 ) Accrued expenses and other current liabilities ( 1,421 ) Current portion of lease liabilities ( 624 ) Long-term lease liabilities ( 1,836 ) Net tangible assets 10,128 Identifiable intangible assets Other intangible assets 383 Customer relationships 18,100 Trademarks and trade names 9,100 Technology and formulations & recipes 2,800 Total identifiable intangible assets 30,383 Goodwill 43,009 Total purchase price allocation $ 83,520 96 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) The Company has obtained a preliminary third-party valuation report of certain tangible and identifiable intangible assets and is in the process of reviewing and evaluating the information. The primary area that remains preliminary relates to the fair value of all identifiable intangible assets acquired. Accordingly, the preliminary purchase price allocation is subject to change. The Company expects to finalize the valuation as soon as practicable, but not later than one year from the acquisition date. The amount of goodwill is not deductible for U.S. tax purposes, but it is partially deductible for Canadian tax purposes. The customer relationships and technology and formulations & recipes were assigned estimated useful lives of 18 years. The trademarks and trade names are considered to have indefinite useful lives. Innovative Growers Equipment, Inc. Acquisition On November 1, 2021, the Company acquired 100 % of the issued and outstanding shares of Innovative Growers Equipment, Inc., an Illinois corporation (“IGE”), Innovative AG Installation, Inc., an Illinois corporation (“IAG”), Innovative Racking Systems, Inc., an Illinois corporation (“IRS”), and Innovative Shipping Solutions, Inc., an Illinois corporation (“ISS” and, together with IGE, IAG, IRS, and their respective subsidiaries, the “IGE Entities”), a manufacturer of horticulture benches, racking and LED lighting systems which complement the Company’s existing lineup of high performance, proprietary branded products. The preliminary acquisition fair value of the consideration transferred for the IGE Entities was $ 60,093 , consisting of $ 48,320 in cash, $ 11,051 of the Company's common stock, and $ 722 forgiveness of a contract asset. The fair value of the common stock issued was determined based on the closing market price of the Company's common stock on the acquisition date. The forgiveness of contract asset represents an effective settlement of a preexisting relationship between the parties. The financial results of the IGE Entities are included in the U.S. operating segment since the acquisition date. The following table sets forth the components and the preliminary allocation of the purchase price for the Company's acquisition of the IGE Entities: 97 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) Component of Purchase Price: Amount Cash $ 48,320 Common stock 11,051 Forgiveness of contract asset 722 Total purchase price $ 60,093 Acquisition-related costs $ 1,417 Allocation of Purchase Price: Identifiable assets (liabilities) Accounts receivable $ 4,424 Inventories 27,017 Prepaid expenses and other current assets 466 Property and equipment 3,907 Operating lease right-of-use assets 3,998 Accounts payable ( 21,912 ) Accrued expenses and other current liabilities ( 559 ) Current portion of lease liabilities ( 813 ) Current portion of long-term debt ( 478 ) Long-term lease liabilities ( 3,185 ) Long-term debt ( 1,459 ) Net tangible assets 11,406 Goodwill 48,687 Total purchase price allocation $ 60,093 The Company is in the process of obtaining third-party valuations of certain tangible and intangible assets; thus, the provisional measurement of goodwill is subject to change. The amount of goodwill is not deductible for U.S. tax purposes. Supplemental Disclosure of Financial Results The following represents the unaudited consolidated statements of operations as if the acquisitions had been included in the consolidated results of the Company for the entire periods presented below. Management considers these estimates to represent an approximate measure of the performance of the combined Company (in millions): Years ended December 31, 2021 2020 Net sales $ 596 $ 492 Net income (loss) $ 79 $ ( 11 ) These amounts have been calculated after applying the Company's accounting policies and adjusting the results of the acquisitions to reflect the additional amortization of intangibles and the purchase price adjustments as if they had been applied on January 1, 2020. The supplemental net income for the year ended December 31, 2021 were adjusted to exclude the acquisition-related and integration costs incurred in connection with the acquisitions. Accordingly, the 2020 supplemental net income was adjusted to include these charges. For the tax effects of the net income adjustments, the Company factored in its net operating loss carryforwards. 98 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) Since the acquisition date, the estimated net sales and net income of these acquisitions are as follows (in millions): Year ended December 31, 2021 Net sales $ 76 Net income $ 14 The Company is in the process of integrating the operations of these acquisitions into Hydrofarm, LLC and its subsidiaries and their existing functions (e.g., sales, supply chain, marketing, etc.). Accordingly, the net sales and net income of these acquisitions represent an approximation. 4. GOODWILL AND INTANGIBLE ASSETS, NET As of December 31, 2021, the Company completed the acquisitions of Heavy 16, the H&G Entities, Aurora, Greenstar and the IGE Entities (see Note 3 - Business Combinations ). Goodwill The changes in goodwill are as follows: December 31, 2021 Balance at beginning of year $ — Acquisition - Heavy 16 18,204 Acquisition - H&G Entities 49,707 Acquisition - Aurora 46,433 Acquisition - Greenstar 43,009 Acquisition - IGE Entities 48,687 Foreign currency translation adjustments, net ( 1,172 ) Balance at end of year $ 204,868 99 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) Intangible Assets, net Intangible assets, net comprised the following: December 31, 2021 December 31, 2020 Gross Carrying Amount Accumulated Amortization Net Book Value Gross Carrying Amount Accumulated Amortization Net Book Value Finite-lived intangible assets: Computer software $ 8,814 $ ( 7,208 ) $ 1,606 $ 7,775 $ ( 5,640 ) $ 2,135 Customer relationship (1) 101,222 ( 16,517 ) 84,705 59,375 ( 12,010 ) 47,365 Technology and formulations & recipes (1) 110,561 ( 3,630 ) 106,931 — — — Other (1) 2,428 ( 1,744 ) 684 1,156 ( 1,156 ) — Total finite-lived intangible assets, net 223,025 ( 29,099 ) 193,926 68,306 ( 18,806 ) 49,500 Indefinite-lived intangible asset: Trade names (1) 120,773 — 120,773 2,801 — 2,801 Other 120 — 120 120 — 120 Total Intangible assets, net $ 343,918 $ ( 29,099 ) $ 314,819 $ 71,227 $ ( 18,806 ) $ 52,421 ( 1 ) Includes the intangible assets acquired from Heavy 16, the H&G Entities and Greenstar. See Note 3 - Business Combinations. Amortization expense was $ 10,354 , $ 5,154 and $ 5,307 for the years ended December 31, 2021, 2020 and 2019, respectively. For intangible assets subject to amortization, the weighted-average amortization period as of December 31, 2021 for computer software, customer relationships, and technology and formulations & recipes was 5.0 years, 18.0 years, and 18.0 years, respectively. The estimated aggregate future amortization expense for intangible assets subject to amortization as December 31, 2021 is summarized below: Estimated Future Amortization Expense Year ending December 31, 2022 $ 12,871 2023 12,246 2024 12,181 2025 12,069 Thereafter 144,559 Total $ 193,926 100 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) 5. NET INCOME (LOSS) PER COMMON SHARE (“EPS”) Basic EPS is computed using net income (loss) attributable to common stockholders divided by the weighted-average number of common shares outstanding during each period, excluding unvested restricted stock units (“RSUs”). Diluted EPS represents net income (loss) 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 (i.e., RSUs) to be included in diluted EPS would be based on the number of common shares issuable under the terms of the arrangement if the end of the reporting period was the end of the contingency period, assuming the result would be dilutive. Those contingently issuable shares would be included in the denominator of diluted EPS as of the beginning of the period, or as of the grant date of the share-based payment, if later. Basic and diluted net income (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 and the application of the if-converted method is not more dilutive. Net income (loss) per share attributable to common stockholders The following table presents information necessary to calculate basic and diluted EPS for the years ended December 31, 2021, 2020 and 2019: Years ended December 31, 2021 2020 2019 Net income (loss) $ 13,416 $ ( 7,273 ) $ ( 40,083 ) Cumulative dividends allocated to Series A Convertible Preferred Stock — ( 2,597 ) — Net income (loss) available for distribution 13,416 ( 9,870 ) ( 40,083 ) Less: Undistributed earnings allocable to participating securities — — — Basic and diluted net income (loss) attributable to common stockholders $ 13,416 $ ( 9,870 ) $ ( 40,083 ) Less: Effect on net income (loss) of dilutive securities using the “if converted” method — — — Diluted net income (loss) attributable to common stockholders after adjustment for assumed conversions $ 13,416 $ ( 9,870 ) $ ( 40,083 ) Weighted-average shares of common stock outstanding for basic net income (loss) per share attributable to common stockholders 39,991,809 21,298,849 20,688,439 Dilutive effect of warrants using the treasury stock method 1,395,393 — — Dilutive effect of restricted stock units using the treasury stock method 1,068,984 — — Dilutive effect of stock options using the treasury stock method 533,009 — — Weighted-average shares of common stock outstanding for diluted net income per share attributable to common stockholders 42,989,195 21,298,849 20,688,439 Basic net income (loss) per share attributable to common stockholders $ 0.34 $ ( 0.46 ) $ ( 1.94 ) Diluted net income (loss) per share attributable to common stockholders $ 0.31 $ ( 0.46 ) $ ( 1.94 ) 101 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) 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: Years ended December 31, 2021 2020 2019 Shares subject to warrants outstanding 17,817 3,886,191 3,886,191 Shares subject to unvested restricted stock units with performance and/or time-based vesting conditions — 1,857,444 1,820,598 Shares subject to unvested restricted stock units with time-based vesting conditions 71,871 — — Shares subject to stock options outstanding 10,641 922,796 819,879 Shares of common stock subject to conversion of 7,725,045 shares Series A Convertible Preferred Stock — — 2,078,605 6. ACCOUNTS RECEIVABLE, NET AND INVENTORIES Accounts receivable, net comprised the following: December 31, 2021 2020 Trade accounts receivable $ 35,511 $ 20,252 Allowance for doubtful accounts ( 1,156 ) ( 918 ) Other receivables 7,129 2,292 Total accounts receivable, net $ 41,484 $ 21,626 Inventories comprised the following: December 31, 2021 2020 Finished goods $ 145,298 $ 83,213 Work-in-process 5,967 — Raw materials 41,399 7,837 Allowance for inventory obsolescence ( 3,530 ) ( 2,432 ) Total inventories $ 189,134 $ 88,618 The December 31, 2020 amounts for raw materials were reclassified from finished goods to separate line items to conform to the current year presentation. 102 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) 7. LEASES The Company leases its distribution centers and certain manufacturing facilities from third parties under various non-cancelable operating lease agreements. Also, the Company leases some equipment under finance leases. As of December 31, 2021 and 2020, no renewal option periods were included in any estimated minimum lease terms as the options were not deemed reasonably certain to be exercised. Total ROU assets and lease liabilities were as follows: December 31, Balance Sheet Classification 2021 2020 Leased assets Operating ROU assets Operating lease right-of-use assets $ 45,245 $ 18,289 Finance lease assets Property and equipment, net $ 2,365 $ 383 Lease liabilities Current: Operating leases Current portion of lease liabilities $ 7,198 $ 3,701 Finance leases Current portion of long-term debt 739 159 Noncurrent: Operating leases Long-term lease liabilities 38,595 15,320 Finance leases Long-term debt 1,628 223 Total lease liabilities $ 48,160 $ 19,403 Total lease income and costs were as follows: For the years ended December 31, Classification 2021 2020 2019 Operating lease costs Selling, general and administrative $ 6,664 $ 4,260 $ 4,580 Finance lease costs: Amortization of lease assets Selling, general and administrative 291 257 239 Interest on lease liabilities Interest expense 33 58 46 Gain on lease termination Impairment, restructuring, and other — — ( 160 ) Sublease income Selling, general and administrative ( 277 ) ( 57 ) ( 369 ) In addition to the operating lease costs above, short-term and month-to-month lease expense was $ 2,268 , $ 1,406 and $ 1,276 for the years ended December 31, 2021, 2020, and 2019, respectively, and other costs associated with operating leases were $ 1,957 , $ 1,464 and $ 1,496 , respectively, for non-lease components such as common area maintenance and other 103 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) miscellaneous items. These costs were included within selling, general and administrative expenses in the consolidated statements of operations. The aggregate future minimum lease payments under long-term non-cancelable operating and finance leases with remaining terms greater than one year as of December 31, 2021 are as follows: Year ending December 31, Operating Finance 2022 $ 8,569 $ 830 2023 7,924 707 2024 7,182 582 2025 6,442 441 2026 5,031 — Thereafter 16,300 — Total rental payments 51,448 2,560 Less portion representing interest 5,655 193 Total principal 45,793 2,367 Less current portion 7,198 739 Long-term portion $ 38,595 $ 1,628 The following table summarizes the weighted-average remaining lease term as of December 31, 2021, 2020 and 2019 as well as the weighted-average discount rate on long-term leases for the years ended December 31, 2021, 2020 and 2019: 2021 2020 2019 Weighted-average remaining lease term in years: Operating leases 6.8 6.8 7.5 Finance leases 3.5 2.2 2.4 Weighted-average discount rate: Operating leases 3.32 % 4.26 % 4.50 % Finance leases 4.62 % 5.61 % 7.17 % Cash paid for amounts included in lease liabilities in 2021, 2020 and 2019 were: Cash paid for amounts included in lease liabilities: 2021 2020 2019 Operating cash flows from operating leases $ ( 5,675 ) $ ( 3,917 ) ( 4,225 ) Operating cash flows from finance leases ( 33 ) ( 58 ) ( 43 ) Financing cash flows from finance leases ( 302 ) ( 674 ) ( 177 ) In July 2021, the Company executed a lease for approximately 246,000 square feet of warehouse space in Surrey, British Columbia, Canada to be available upon expiration of the lease for existing space. The new lease commencing January 1, 2023 has a term of 120 months with two options to renew for an additional five years each at the greater of an amount equal to the annual rent payable for the last twelve months of the initial term or the then fair market value. There is no rent abatement. Monthly rent fee starts at approximate $ 230 , and increases periodically to the final year when the monthly rent is $ 293 . 104 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) In November 2021, the Company executed a lease for approximately 109,000 square feet of warehouse in Cambridge, Ontario, Canada. The new lease commencing June 1, 2023 has a term of 120 months with two options to renew for an additional five years each at the then prevailing fair market rental value. Rent is abated for the first month. Thereafter, monthly rent starts at approximately $ 71 , and increases periodically to the final year where the monthly rent is $ 92 . In January 2022, the Company executed a lease for approximately 303,000 square feet of warehouse in Shoemakersville, Pennsylvania to be available upon expiration of the lease for existing space. The new lease commencing March 1, 2022 has a term of 84 months with an option to renew for one additional period of five years at the prevailing market rate. Rent is abated for the first two months . Thereafter, monthly rent is approximately $ 68 , and increases periodically to the final year where the monthly rent is $ 162 . The future minimum lease payments for executed non-cancelable operating leases not yet commenced are as follows: Operating Year ending December 31, 2022 $ 542 2023 4,624 2024 4,938 2025 5,322 2026 5,723 Thereafter 30,425 Total rental payments $ 51,574 8. PROPERTY, PLANT AND EQUIPMENT, NET Property, plant and equipment, net comprised the following: December 31, 2021 2020 Machinery and equipment $ 25,177 $ 3,648 Building and improvements 9,510 190 Land 6,120 224 Leasehold improvements 3,207 2,068 Peat bogs and related development 8,686 — Computer equipment 3,197 2,079 Furniture and fixtures 2,867 1,154 Gross property, plant, and equipment 58,764 9,363 Less: accumulated depreciation, depletion and amortization ( 8,291 ) ( 5,375 ) Total property, plant and equipment, net $ 50,473 $ 3,988 The table above includes the property, plant, and equipment assets acquired from Heavy 16, the H&G Entities, Aurora, Greenstar, and the IGE Entities (see Note 3 - Business Combinations). The December 31, 2020, amounts for building and improvements, land, and computer equipment were reclassified from other to separate line items to conform to the current year presentation. Depreciation, depletion and amortization expense related to property, plant, and equipment, net was $ 4,580 for the year ended December 31, 2021. Depreciation and amortization was $ 1,625 and $ 1,688 for the years ended December 31, 2020 and 2019, respectively. 105 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) 9. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES Accrued expenses and other current liabilities comprised the following: December 31, 2021 2020 Accrued compensation and benefits $ 3,713 $ 9,902 Freight, custom and duty accrual 2,094 2,603 Goods in transit accrual 3,473 3,845 Corporate tax accrual 729 585 Contingent consideration 17,034 — Other accrued liabilities 6,953 4,680 Total accrued expenses and other current liabilities $ 33,996 $ 21,615 The December 31, 2020, amounts for corporate tax accrual was reclassified from other accrued liabilities to a separate line item and the obligations due under a distribution agreement were reclassified to other accrued liabilities to conform to the current year presentation. 10. DEBT Debt is comprised of the following: December 31, 2021 2020 Term loan - net of unamortized discount & deferred financing costs of $ 6,025 $ 118,975 $ — Other 2,805 1,036 Total debt $ 121,780 $ 1,036 Current portion of long-term debt $ 2,263 $ 746 Long-term debt - net of discount and deferred financing costs of $ 6,025 119,517 290 Total debt $ 121,780 $ 1,036 Term loans Term Loan with Brightwood In May 2017, a term loan in the aggregate principal amount of $ 75,000 (the “Brightwood Term Loan”) was obtained by Hydrofarm Holdings LLC and certain of its direct and indirect subsidiaries (the “Brightwood Term Loan Obligors”) from Brightwood Loan Services LLC. The Brightwood Term Loan was scheduled to mature on May 12, 2022, and was secured by substantially all non-working capital assets and a second lien on working capital assets of the Brightwood 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 Brightwood Term Loan was 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. 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, 106 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) 2020, the effective interest rate was 10.18 %, interest expense was $ 6,892 , and amortization of deferred financing costs was $ 610 . The balance of the Brightwood 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. Senior Secured Term Loan On October 25, 2021, the Company and its subsidiaries entered into a Credit and Guaranty Agreement with JPMorgan Chase Bank, N.A., as administrative agent for certain lenders, pursuant to which the Company borrowed a $ 125,000 senior secured term loan (“Term Loan”). The Term Loan bears interest at LIBOR (with a 1.0 % floor) plus 5.50 %, or an alternative base rate (with a 2.0 % floor), plus 4.50 %, and is subject to a call premium of 2 % in year one, 1 % in year two, and 0 % thereafter, and matures on October 25, 2028 ("Maturity Date"). D eferred financing costs totaled $ 6,190 and are being amortized to interest expense over the term of the loan. The principal amounts of the Term Loan are scheduled to be repaid in consecutive quarterly installments in amounts equal to 0.25 % of the $ 125,000 principal amount of the Term Loan on the last day of each fiscal quarter commencing March 31, 2022, with the balance of the Term Loan payable on the Maturity Date. The Company is required to make mandatory prepayments in the event of (i) achieving certain excess cash flow criteria, including the achievement and maintenance of a specific leverage ratio, (ii) selling assets that are collateral, or (iii) upon the issuance, offering, or placement of new debt obligations. The Term Loan requires the Company to maintain certain reporting requirements, affirmative covenants, and negative covenants. The Term Loan is secured by a first lien on the non-working capital assets of the Company and a second lien on the working capital assets of the Company. The Company may request additional term loan commitments subject to certain loan conditions. The Company was in compliance with all reporting requirements, affirmative covenants, and negative covenants as of December 31, 2021. For the year ended December 31, 2021, the effective interest rate was 1.36 %, interest expense was $ 1,535 , and amortization of deferred financing costs was $ 165 . Revolving asset-backed credit facilities Bank of America and Encina Credit Facility 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. The BofA Credit Facility was 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. On July 11, 2019, the Company and certain of its direct and indirect subsidiaries (the “Encina Obligors”) entered into the Encina Credit Facility through a certain Loan and Security Agreement whereby the Encina Obligors obtained a revolving asset-based loan commitment in the maximum amount of $ 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. The Encina Credit Facility was due on the earlier of July 11, 2022 or 90 days prior to the scheduled maturity date of the Brightwood Term Loan. The Encina Credit Facility was secured by working capital assets and a second lien on non-working capital assets. 107 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) Interest was calculated 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 was charged for available, but unused borrowings as defined. An additional 200 basis points was added to the interest rate for any period during which the loan was in default. Deferred financing costs were amortized over the term of the Encina Credit Facility. The Encina Credit Facility was subject to numerous amendments since its origination generally in connection with modifications to available borrowings, financial covenants, permitted indebtedness and permitted capital expenditures. Certain amendments required payments of fees. All amendments were accounted for as debt modifications. 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 . 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. 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 . The balance of the Encina Credit Facility was $ 0 as of December 31, 2020, which reflected 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. The Encina Credit Facility was replaced in March 2021 by the JPMorgan Revolving Credit Facility. For the year ended December 31, 2021, the Company recognized interest expense of $ 82 . The unamortized deferred financing costs and early termination fees totaling $ 680 were recognized as a loss on debt extinguishment in the consolidated statements of operations for the year ended December 31, 2021. JPMorgan Revolving Credit Facility On March 29, 2021, Hydrofarm Holdings Group, Inc. and certain of its direct and indirect subsidiaries (the "JPMorgan Obligors") entered into a Senior Secured Revolving Credit Facility (the "JPMorgan Credit Facility") with JPMorgan Chase Bank, N.A., as administrative agent, issuing bank and swingline lender, and the lenders from time to time party thereto. The JPMorgan Credit Facility is due on March 29, 2024. D eferred financing costs totaled $ 1,226 and are being amortized to interest expense over the term of the loan. The deferred financing costs for the JPMorgan Credit Facility are included in other assets in the consolidated balance sheets as of December 31, 2021. The three-year JPMorgan Credit Facility had a borrowing limit of $ 50,000 with an option to request an increase in the revolving commitment by up to $ 25,000 , drawn in $ 5,000 increments, for a total not to exceed $ 75,000 , subject to customary condition ("Revolver"). On August 31, 2021, the JPMorgan Obligors entered into an amendment (the "First Amendment") to increase their original borrowing limit to $ 100,000 . In connection with the First Amendment, the Company's acquired subsidiaries became party to the JPMorgan Credit Facility as either borrowers or as guarantors. The Revolver maintains an interest rate of LIBOR plus 1.95 % and has a 0.0 % LIBOR floor. A fee of 0.25 % per annum is charged for available, but unused borrowings as defined. 108 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) On October 25, 2021, the Company and its subsidiaries entered into a second amendment (the “Second Amendment”), with JPMorgan Chase Bank, N.A., pursuant to which the parties consented to the Term Loan and the lien priorities described above, and made certain conforming changes to the provisions of the Term Loan. All amendments in 2021 were accounted for as debt modifications. The JPMorgan Credit Facility is secured by the Company’s assets and the assets of certain of the Company’s subsidiaries. The Company is required to maintain certain reporting requirements, affirmative covenants, negative covenants and financial covenants. The financial covenants include the maintenance of a minimum fixed charge coverage ratio of 1.1 x on a rolling twelve-month basis. For the year ended December 31, 2021, the effective interest rate was 4.36 %, interest expense was $ 117 , and amortization of deferred financing costs was $ 206 . The balance of the JPMorgan Credit Facility was $ 0 as of December 31, 2021. The Company had approximately $ 83,619 available to borrow under the Revolver as of December 31, 2021. The JPMorgan Obligors were in compliance with all debt covenants as of December 31, 2021. 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. 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 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 11, S tockholders’ Equity ). The total unamortized deferred financing costs was $ 288 and was recognized as a loss on debt extinguishment in the consolidated statements of operations in 2019. 109 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) Aggregate future principal payments As of December 31, 2021, the aggregate future principal payments under long-term debt, excluding payments due under finance lease obligations presented in Note 7, Leases , are as follows: Debt Year ending December 31, 2022 $ 1,524 2023 1,307 2024 1,268 2025 1,270 2026 1,270 Thereafter 118,799 Total principal payments under long-term debt $ 125,438 The following is a reconciliation of payment due: Finance lease obligations Debt Total Current portion of long-term debt $ 739 $ 1,524 $ 2,263 Long-term debt 1,628 123,914 125,542 Total payments due $ 2,367 $ 125,438 $ 127,805 11. STOCKHOLDERS’ EQUITY Capital stock As of December 31, 2021, the following summarizes shares authorized, issued and outstanding: Capital stock authorized and outstanding: Shares authorized Shares outstanding Convertible preferred stock 50,000,000 — Common stock 300,000,000 44,618,357 As of December 31, 2021, the following summarizes shares of common stock reserved for issuance: Common stock reserved for issuance: Shares reserved for issuance Warrants 17,817 2020 Employee, Director, and Consultant Equity Incentive Plan 2,118,067 Restricted stock units 1,087,608 Stock options 720,549 110 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) Convertible preferred stock In December 2019, the Company issued 7,007,429 shares of Series A Convertible Preferred Stock (the "Series A 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, less offering costs totaled $ 1,274 . In January and February 2020, an additional 717,616 shares of Series A 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 preferred stock purchase 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 and 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 Redemption of investor warrants On July 19, 2021, the Company completed the redemption ("Redemption") of certain of its outstanding warrants (the "Investor Warrants") that were issued in connection with a private placement of units (the "private placement"), each consisting of a share of common stock and a warrant to purchase an additional one-half (1/2) shares of common stock, which concluded in the fall of 2018. The Company was entitled to redeem all of the outstanding Investor Warrants for a redemption price of $ 0.00033712 per Investor Warrant ("redemption price") if (i) there was an effective registration statement covering the resale of the shares of common stock underlying the Investor Warrants, and (ii) the volume-weighted average price of the Company's common stock for the twenty consecutive trading days prior to the date of the notice of redemption was at least $ 25.28 , of which both requirements were met. Investor Warrants were exercisable at a price of $ 16.86 per share until July 19, 2021 (the "redemption date"). Any Investor Warrants that remained unexercised immediately after the redemption date were void and no longer exercisable, and the holders of those Investor Warrants were entitled to receive the redemption price. Prior to the redemption date, 3,367,647 Investor Warrants were exercised, generating total gross proceeds of $ 56,778 . The Company redeemed 1,491 Investor Warrants at the redemption price. In connection with the private placement, the Company agreed to engage the placement agent (the "Placement Agent") as the Company's warrant solicitation agent in the event the Investor Warrants were called for Redemption. The Company agreed to pay a warrant solicitation fee to the Placement Agent equal to five percent of the amount of net cash proceeds solicited by the Placement Agent upon the exercise of certain Investor Warrants following such call for Redemption. For the year ended December 31, 2021, warrant solicitation fee expense totaled $ 1,949 and was included in selling, general and administrative expenses in the consolidated statements of operations. 111 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) Redemption of placement agents warrants In connection with the private placement, 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. 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. For the year ended December 31, 2021, 166,343 placement agent warrants were exercised on a cashless basis at a price of $ 16.86 per share for 129,265 shares of common stock and 332,907 placement agent warrants were exercised on as cashless basis at a price of $ 8.43 per share for 289,368 shares of common stock. As of December 31, 2021, the following table summarizes the outstanding warrants: Number of Warrants Exercise Price Placement agent warrants 11,809 $ 8.43 Placement agent warrants 6,008 $ 16.86 Total 17,817 $ 11.27 12. STOCK-BASED COMPENSATION 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 Plan and 2018 Plan 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 Plan and 2019 Plan. Of the total shares available for grant under the 2020 Plan, 2,118,067 shares remain available as of December 31, 2021. 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. 112 TABLE OF CONTENTS 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. 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 condition (based on continuous employment) and certain awards also have a performance-based vesting condition (defined as a qualifying liquidity event including an initial public offering); on the date the performance-based vesting condition is satisfied, the employee becomes vested in the number of RSUs that have satisfied the time-based vesting condition, if any. Upon vesting, the RSUs convert into shares of the Company’s common stock. Through December 8, 2020, no stock-based compensation expense had been recognized for certain awards with a performance-based condition based on the occurrence of a qualifying liquidity event, as such qualifying event was not probable. Upon the IPO, the performance-based vesting condition was satisfied and the Company recognized $ 2,967 of stock-based compensation expense for RSUs which was the cumulative portion of the service-based awards that vested. For the year ended December 31, 2020, the Company recognized $ 8,689 of stock-based compensation expense for RSUs. No stock-based compensation expense was recognized for RSUs for the year ended December 31, 2019. For the year ended December 31, 2020, the Company withheld 239,702 of the 718,928 shares of common stock issued upon vesting of RSUs to meet employees' payroll tax withholding requirements. The total tax withholding obligation of $ 6,089 as of December 31, 2020 was included in accrued expenses and other current liabilities in the consolidated balance sheets. The payment was made in January 2021. After the IPO, the stock-based compensation expense related to remaining service-based awards is recorded over the remaining requisite service period. The award granted to a former member of the Board (the "former Board member") 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. The fair value of the award, at the modification date, was $ 3,180 , all of which was recorded as stock-based compensation expense upon the IPO. In July 2021, the market-based vesting condition for this award was satisfied and 148,315 RSUs of the former Board member vested. The total shares under the unvested RSUs subject to time-based vesting conditions were 111,236 as of December 31, 2021. For the year ended December 31, 2021, there were no performance awards with market-based conditions granted. For the year ended December 31, 2021, the Company recognized $ 4,566 of total stock-based compensation expense for restricted stock units. For the year ended December 31, 2021, the Company withheld 268,867 of the 851,741 of common stock issued upon vesting of RSUs to meet employees' payroll tax withholding requirements. The tax withholding payments of $ 13,936 were made in 2021 in addition to the tax withholding obligation from 2020 paid in 2021 (as described above). The total tax withholding obligation of $ 9 as of December 31, 2021 was included in accrued expenses and other current liabilities in the consolidated balance sheets. The following table summarizes the activity related to the Company's RSUs for the year ended December 31, 2021. For purposes of this table, vested RSUs represent the shares for which the service requirements had been fulfilled as of December 31, 2021: Number of RSUs Weighted average grant date fair value Balance, January 1, 2021 1,857,444 $ 6.55 Granted 81,905 $ 54.72 Vested ( 851,741 ) $ 7.15 Balance, December 31, 2021 1,087,608 $ 9.71 113 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) The total fair value of RSUs vested for the years ended December 31, 2021, 2020 and 2019 was $ 6,090 , $ 4,598 , and $ 0 , respectively. As of December 31, 2021, total unamortized stock-based compensation cost related to unvested RSUs was $ 7,997 and the weighted-average period over which the compensation is expected to be recognized is 1.65 years. The tax benefits recognized in the consolidated statements of operations for stock-based compensation arrangements for the years ended December 31, 2021 and 2020 were not material to the financial statements. There was no tax benefit recognized in 2019. Stock options The vesting of stock options 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, 2021: Number Weighted average exercise price Weighted average grant date fair value Weighted average remaining contractual term (years) Outstanding as of January 1, 2021 922,796 $ 8.81 $ 1.78 8.08 Granted 10,641 $ 59.03 $ 25.58 Exercised ( 186,633 ) $ 8.54 $ 0.96 Cancelled ( 510 ) $ 8.43 $ 0.70 Forfeited ( 25,745 ) $ 10.26 $ 5.67 Outstanding as of December 31, 2021 720,549 $ 9.57 $ 2.21 7.37 Exercisable as of December 31, 2021 518,034 $ 8.57 $ 1.10 7.25 Unvested as of December 31, 2021 202,515 $ 12.13 $ 5.04 1.96 Vested and expected to vest as of December 31, 2021 720,549 $ 9.57 $ 2.21 7.37 Since stock 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 the model were as follows for the periods indicated: Years ended December 31, 2021 2020 2019 Fair value of common stock underlying the options $ 59.03 $ 6.07 to $ 17.85 $ 4.82 to $ 6.07 Volatility 45 % 45 % to 55 % 30 % Risk-free rate 0.85 % 0.03 % to 0.89 % 1.37 % to 2.49 % Dividend yield Nil Nil Nil Expected term in years 6.0 5.00 to 5.61 5.00 to 5.62 As of December 31, 2021, total compensation cost related to unvested awards not yet recognized was $ 919 and the weighted-average period over which the compensation is expected to be recognized is 1.96 years. Total compensation expense for stock options was $ 440 , $ 206 , and $ 208 in 2021, 2020, and 2019, respectively. 114 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) 13. INCOME TAXES Loss from continuing operations before tax was as follows: Years ended December 31, 2021 2020 2019 United States $ ( 9,262 ) $ ( 9,908 ) $ ( 30,409 ) Foreign 3,541 3,211 ( 10,365 ) Loss from continuing operations before tax $ ( 5,721 ) $ ( 6,697 ) $ ( 40,774 ) Significant components of income tax (benefit) expense from continuing operations consist of the following: Years ended December 31, 2021 2020 2019 Current: Federal $ — $ — $ — State 72 91 18 Foreign 1,787 433 9 Total current 1,859 524 27 Deferred: Federal ( 18,275 ) — — State ( 1,962 ) — — Foreign ( 759 ) 52 ( 718 ) Total deferred ( 20,996 ) 52 ( 718 ) Total income tax (benefit) expense $ ( 19,137 ) $ 576 $ ( 691 ) 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, 2021 2020 2019 Effective rate reconciliation U.S. federal tax benefit at statutory rate $ ( 1,201 ) $ ( 1,406 ) $ ( 8,563 ) State income taxes, net 68 ( 171 ) ( 1,247 ) Permanent items 542 19 89 Global intangible low-taxed income 972 866 — Foreign rate differential 1,032 854 ( 891 ) 162(m) officers compensation 6,969 3,514 — Share-based compensation ( 8,118 ) ( 2,834 ) — Deferred adjustments 67 ( 230 ) 563 Transaction costs 2,290 90 — Other, net ( 973 ) — — Valuation allowance ( 20,785 ) ( 126 ) 9,358 Total income tax (benefit) expense $ ( 19,137 ) $ 576 $ ( 691 ) 115 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) Deferred income tax assets and liabilities consist of the following: December 31, 2021 2020 Deferred tax assets Lease liabilities $ 11,714 $ 4,838 Accrued expenses 1,215 1,245 Share-based compensation 460 979 Intangible assets — 9,546 Net operating loss 19,543 17,152 Inventories 4,948 2,548 Interest expense 2,154 3,556 Other 1,243 — Deferred tax assets 41,277 39,864 Valuation allowance ( 14,892 ) ( 34,434 ) Total deferred tax assets 26,385 5,430 Deferred tax liabilities Intangible assets ( 17,526 ) — Property, plant and equipment ( 2,518 ) ( 432 ) Operating lease right-of-use assets ( 11,579 ) ( 4,657 ) Total deferred tax liabilities ( 31,623 ) ( 5,089 ) Net deferred tax (liability) asset $ ( 5,238 ) $ 341 Other long-term assets - deferred tax assets $ 393 $ 341 Long-term deferred tax liabilities ( 5,631 ) — Net deferred tax (liability) asset $ ( 5,238 ) $ 341 As of December 31, 2021, the Company had federal and state net operating loss (“NOL”) carryforwards of approximately $ 74,900 and $ 56,900 , respectively. The federal and state NOL carryforwards, if not utilized, will begin to expire in 2037 and 2027, respectively, and $ 62,000 of the federal losses are indefinite. Foreign NOL carryforwards were approximately $ 1,000 and $ 3,000 at December 31, 2021 and 2020, respectively. 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, 2021 and 2020, the Company believes it is more-likely-than-not that it will not be able to realize its U.S. deferred tax assets and therefore has maintained a full valuation allowance against its U.S. deferred tax assets. The Company has also provided a full valuation allowance against the majority of its Spanish deferred tax assets. In connection with the acquisition of shares of H&G, the Company recorded a net deferred tax liability which provides an additional source of taxable income to support the realization of pre-existing deferred tax assets. As a result, a portion of the Company's valuation allowance was released and the Company recorded a $ 20,785 tax benefit. The amount of valuation allowance has decreased $ 19,542 for the year ended December 31, 2021. The decrease is mainly due to deferred tax liabilities recorded as a result of purchase price accounting, slightly offset by other changes in deferred tax assets and liabilities during the year. 116 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) 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 2021 and 2020, 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, 2021. 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 carry-back 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 CARES Act for the year ended December 31, 2021. 14. 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. 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 117 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) 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 and Certain Facilities The Company leased a distribution center in Petaluma, California from entities in which a related party was a stockholder. For the years ended December 31, 2021, 2020 and 2019, rent expense for the month to month lease totaled $ 639 , $ 1,278 , and $ 1,445 , respectively. The Company leases certain facilities from a member of management who is also a member in a LLC that is the lessor. For the year ended December 31, 2021, rent expense for the two leases totaled $ 149 . 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 12, Stock-based Compensation ). 15. IMPAIRMENT, RESTRUCTURING AND OTHER In 2021, the Company incurred $ 297 of costs primarily related to an aborted convertible loan transaction. In 2020, the Company incurred $ 860 of costs related to SEC filings and other transactions. In 2019, the Company recognized $ 10,035 of impairment of intangible assets, several restructuring and recapitalization events, and fees for various statutory filings. The impairment of intangible assets of $ 5,390 in 2019 was related to the Canadian customer relationships. 16. FAIR VALUE MEASUREMENTS The following table summarizes the fair value of the Company’s assets and liabilities for which disclosure of fair value is required: 2021 2020 Fair Value Hierarchy Level Carrying Amount Estimated Fair Value Carrying Amount Estimated Fair Value Assets Cash and cash equivalents Level 1 26,607 26,607 75,178 75,178 Restricted cash Level 1 1,777 1,777 1,777 1,777 Note receivable Level 3 3,111 3,111 3,151 3,151 Liabilities Contingent consideration: Heavy 16 Acquisition Level 3 200 200 N/A N/A Aurora Acquisition Level 3 16,834 16,834 N/A N/A Term Loan Level 2 125,000 121,250 N/A N/A Revolving asset-backed credit facilities: Encina Credit Facility Level 3 N/A N/A — — JPMorgan Credit Facility Level 3 — — N/A N/A Other debt Level 3 2,805 2,805 1,036 1,036 118 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share amounts) 17. SUBSEQUENT EVENTS The Company executed a new operating lease after December 31, 2021, which is described in Note 7 - Leases . 119 TABLE OF CONTENTS Schedule II – Valuation and Qualifying Accounts Hydrofarm Holdings Group, Inc. For the years ended December 31, 2021, 2020, and 2019 (in thousands) Balance as of (Benefits) / Other / Balance as of beginning of year Provisions Deductions end of year Year ended December 31, 2021 Allowance for doubtful accounts $ 918 $ ( 110 ) $ 348 $ 1,156 Allowance for inventory obsolescence 2,432 1,201 ( 103 ) 3,530 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 ) 3,822 120 TABLE OF CONTENTS Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.