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Item 7. Management’s Discussion and Analysis

2023-03-09 compared with 2022-03-01 · 246 added, 302 removed, 100 unchanged (85% of the section changed)

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We primarily serve the U.S.

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

and Canadian markets, and believe we are one of the leading competitors in these markets in an otherwise highly fragmented industry.

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

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Through CEA, growers are able to be more efficient with physical space, water and resources, while enjoying year-round and more rapid grow cycles as well as more predictable and abundant grow yields, when compared to other traditional growing methods.

We reach commercial farmers and consumers through a broad and diversified network of over 2,000 wholesale customer accounts, who we connect with primarily through our proprietary e-commerce marketplace.

A substantial majority of our net sales are to specialty hydroponic retailers, through which growers are able to enjoy specialized merchandise assortments and knowledgeable staff.

We also distribute our products across the U.S.

and Canada to a diversified range of retailers of commercial and home gardening equipment and supplies that include garden centers, hardware stores, e-commerce retailers, commercial greenhouse builders, and commercial resellers.

Recent Developments

Innovative Growers Equipment, Inc.

On November 1, 2021, we closed the acquisition of the IGE Entities.

See Note 3 - Business Combinations under Innovative Growers Equipment, Inc.

Acquisition, in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

The IGE Entities are a manufacturer of horticulture benches, racking and LED lighting systems.

The addition of the IGE Entities' commercial equipment product range complements our existing lineup of high performance, proprietary branded products.

Senior Secured Term Loan

Our products are distributed across the United States and Canada through a diversified range of retailers of commercial and home gardening equipment and supplies.

Our customers include specialty hydroponic retailers, commercial resellers and greenhouse builders, garden centers, hardware stores, and e-commerce retailers.

Specialty hydroponic retailers can provide growers with specialized merchandise assortments and knowledgeable staff.

Market Conditions

We experienced adverse financial results during 2022 which we believe is primarily a result of an agricultural oversupply impacting our market.

This has led to a reduction in our 2022 profitability, as compared to the prior year, and a loss from operations.

These market conditions continued to negatively impact our business and results of operations, and the extent to which this will continue is uncertain and difficult to predict at this time.

In connection with our previously disclosed evaluation of our facility footprint and product and brand portfolio, we began a restructuring plan during the quarter ended December 31, 2022.

We are undertaking significant actions to streamline our operations, reduce costs and improve efficiencies during the industry recession.

Our major initiatives include (i) narrowing our product and brand portfolio and (ii) relocating and consolidating certain manufacturing and distribution centers including headcount reductions and reorganization to drive a solution based approach.

We are focusing commercial sales on competencies and product assortment gained from our recent acquisitions.

During the year ended December 31, 2022, we recorded pre-tax charges of $6.8 million relating to inventory markdowns of products and brands being removed from our portfolio, which is primarily non-cash, and $0.9 million relating primarily to the relocation and termination of certain facilities in Canada, which are primarily cash charges.

Restructuring charges are primarily recorded within Cost of goods sold on the consolidated statement of operations for the year ended December 31, 2022.

We plan to incur approximately $1.7 million of additional charges in 2023, which are primarily cash, associated with the execution of our restructuring plan, which we expect to complete in the first half of 2023.

We may also execute a second phase of our restructuring plan in 2023 and incur additional costs.

Our strategic product consolidation entails removing approximately one-third of all products and one-fifth of all brands relating to our primary product portfolio, which excludes our garden center business in Canada.

We expect the restructuring and related actions to result in cost savings of approximately $7.0 million on an annualized basis.

As of June 30, 2022, primarily due to a sustained decline in the market value of our common stock and the market conditions described above, we identified a triggering event requiring a test for goodwill impairment.

We completed our goodwill impairment testing and recorded an impairment charge of $189.6 million as the test determined that the carrying value of the reporting units of U.S.

and Canada was in excess of the fair value.

The recognized impairment reduced the goodwill balance to zero as of June 30, 2022.

The impairment was primarily due to a deterioration in customer demand in the U.S.

and Canada caused by macroeconomic and industry conditions.

We also review intangible assets with finite lives and indefinite lives for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable.

We did not identify a triggering event requiring a test for impairment of intangible assets during the remainder of 2022.

In connection with the goodwill impairment analysis performed as of June 30, 2022, we determined the fair value of the U.S.

and Canada reporting units based on an income approach, using the present value of future discounted cash flows, and based on a market approach.

The fair values were reconciled to the market value of our common stock to corroborate the estimates used in the interim test for impairment.

The fair value determinations were a reflection of recent sales declines we have experienced, which we believe are primarily a result of an agricultural oversupply impacting our market, and a reduction to our 2022 profitability and loss from operations.

We maintain an allowance for excess and obsolete inventory that is based upon assumptions about future demand and market conditions.

During the year ended December 31, 2022, our consolidated statements of operations included charges of $18.5 million, primarily relating to increases to our allowance for inventory obsolescence relating to certain lighting products, which are incremental to the restructuring costs described above.

In addition, during the year ended December 31, 2022, our consolidated statements of operations included $2.9 million of accounts receivable allowances and write downs.

While we believe our estimates of charges relating to our restructuring plan, long-lived assets, inventory obsolescence, and accounts receivable allowances are reasonable, it is possible that we may incur additional charges in the future and actual results may differ significantly from these estimates and assumptions.

Depending on the length and severity of the industry and market conditions impacting our business, it is possible we may execute additional restructuring plans and incur future associated charges, and we may not be able to realize the full extent of our anticipated cost savings.

Five Acquisitions Completed in 2021

During the year ended December 31, 2021, we completed the following five acquisitions of branded manufacturers of CEA products, resulting in a significant expansion of our portfolio of proprietary branded products and manufacturing capabilities.

Our proprietary brands generally provide for higher gross profit margins compared to distributed brands.

• Heavy 16, a manufacturer of plant nutrients and additives, in May 2021.

Heavy 16 was a leading manufacturer and supplier of branded plant nutritional products, with nine core products featuring a full line of premium nutrients used in all stages of plant growth, helping to increase the yield and quality of crops.

• House & Garden, a manufacturer of plant nutrients and additives, in June 2021.

House & Garden is located in Arcata, California, and produces and distributes premium grade plant nutrients and fertilizers, offering a strong product line to strengthen our position in the nutrient sector.

• Aurora, a manufacturer of soil, grow media, plant nutrients and additives, in July 2021.

Aurora provides comprehensive plant fertility products and grow media and includes organic nutrient and premium soil brands.

With the Aurora acquisition, we gained new domestic manufacturing and distribution capabilities on the east and west coasts along with a peat moss harvesting operation in Canada.

• Greenstar Plant Products, a manufacturer of plant nutrients and additives, in August 2021.

Greenstar produces premium horticultural products and solutions with brands including Grotek, Gaia Green, Supergreen, and EarthSafe.

• Innovative Growers Equipment, a manufacturer of horticultural benches, racks and grow lights, in November 2021.

The acquisition of Innovative Growers Equipment added to our existing lineup of high performance, proprietary branded products.

S ee Note 3 - Business Combinations in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Recent Financing Arrangements and Other Transactions

During the years ended December 31, 2022, and 2021, we entered into new financing arrangements and other significant transactions including:

On October 25, 2021, we entered into a senior secured term loan facility, in the aggregate principal amount of $125.0 million, with JPMorgan Chase Bank, N.A.

as administrative agent for certain lenders (the "Term Loan").

as administrative agent for the lenders (the "Term Loan").

The Term Loan bears interest at a rate of either LIBOR (with a 1.0% floor) plus 5.50%, or an alternate base rate (with a 2.0% floor) plus 4.50% and matures on October 25, 2028.

We used the net proceeds from the Term Loan to fund the cash portion of the IGE Entities' acquisition and for general corporate purposes, which may include, among other things, repaying any outstanding balance under our existing revolving facility and funding future M&A opportunities.

Should additional capital needs arise, we can, per the terms of the Term Loan agreement, seek to upsize the facility.

The Term Loan is more fully described in Note 10 - Debt under Term loans - Senior Secured Term Loan in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Greenstar/Grotek Acquisition

On August 3, 2021, we closed the acquisition of Greenstar.

See Note 3 - Business Combinations under Greenstar/Grotek Acquisition , in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K .

Greenstar produces premium horticultural products and solutions for global, domestic and commercial use.

Greenstar’s owned brands include Grotek, Gaia Green, Supergreen, and EarthSafe.

Grotek has been producing since 1998 and is sold internationally.

Greenstar’s brands are utilized by commercial operators including growers, landscapers, greenhouses, nurseries, organic farms, as well as independent retailers.

Greenstar manufactures products for both the retail and commercial market.

◦ Investor Warrant Redemption:

On July 19, 2021, we completed the redemption (the “Warrant Redemption”) of certain of our outstanding warrants (the "Investor Warrants") to purchase shares of our common stock that were issued in connection with a private placement of units.

See Note 11 - Stockholders' Equity under Warrants - Redemption of investor warrants , in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Prior to July 19, 2021, 3,367,647 Investor Warrants were exercised, generating approximately $56.8 million of gross proceeds to the Company.

As a result, we redeemed 1,491 Investor Warrants for a redemption price of $0.00033712 per Investor Warrant.

As of December 31, 2021, there were no Investor Warrants outstanding.

We used the net proceeds from the redemption of the Investor Warrant for acquisitions, working capital and other general corporate purposes.

Aurora Acquisition

On July 1, 2021, we completed the acquisition of 100% of the issued and outstanding membership interests of Aurora.

S ee Note 3 - Business Combinations under Aurora Acquisition , in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K .

Founded in 2000, Aurora was a family-owned business with a strong vertically integrated manufacturing base with three locations across North America.

The company is dedicated to ethical and sustainable practices and offers comprehensive plant fertility product lines free from harmful chemical residues and pesticides.

Aurora adds to our growing proprietary brand nutrient and grow media line-ups, including its first organic nutrient and premium soil brands.

We gained new domestic manufacturing and distribution capabilities on the east and west coasts along with a peat moss harvesting operation in Canada.

House and Garden Acquisition

On June 1, 2021, we acquired 100% of the issued and outstanding shares of capital stock of the H&G Entities.

S ee Note 3 - Business Combinations under House & Garden Acquisition , in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K .

The H&G entities are located in Arcata, California, and produce and distribute premium grade plant nutrients and fertilizers across the globe.

The H&G entities offer a strong product line of plant nutrients that strengthens our position in the nutrient sector and complement our rapidly expanding portfolio of premium products for controlled environment agriculture.

Prior to the redemption date, 3,367,647 Investor Warrants were exercised, generating total gross proceeds of approximately $56.8 million.

As of December 31, 2022, and 2021, respectively, there were no Investor Warrants outstanding.

◦ Follow-on Public Offering:

On May 3, 2021, we closed our follow-on offering, in which we issued and sold 5,526,861 shares of our common stock, including the full exercise by the underwriters of their option to purchase 720,894 additional shares of our common stock, at a public offering price of $59.00 per share, which resulted in net proceeds of approximately $309.8 million after deducting underwriting discounts and commissions and offering expenses.

We used the proceeds from the follow-on offering for acquisitions, working capital and other general corporate purposes.

Heavy 16 Acquisition

On May 3, 2021, we acquired 100% of the issued and outstanding membership interests of Heavy 16.

S ee Note 3 - Business Combinations under Heavy 16 Acquisition , in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K .

Heavy 16 is a leading manufacturer and supplier of branded plant nutritional products, with nine core products that are currently sold across the United States.

The Heavy 16 products feature a full line of premium nutrients used in all stages of plant growth, helping to increase the yield and quality of crops.

JPMorgan Credit Facility

On March 29, 2021, we and certain of our subsidiaries 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 replaced the Loan and Security Agreement with Encina Business Credit, LLC (the “Encina Credit Facility”).

There was no outstanding indebtedness under the Encina Credit Facility when it was replaced.

The JPMorgan Credit Facility, among other things, provides for an asset based senior revolving credit line (the “Senior Revolver”) with JPMorgan as the initial lender.

The three-year Senior Revolver had a borrowing limit of $50 million.

We had the right to increase the amount of the Senior Revolver in an amount up to $25 million by obtaining commitments from JPMorgan or from other lenders.

Our and our subsidiaries’ obligations under the JPMorgan Credit Facility are secured by a first priority lien (subject to certain permitted liens) in substantially all of our and our subsidiaries’ respective personal property assets pursuant to the terms of a U.S.

◦ JPMorgan Revolving Loan Facility:

On March 29, 2021, we and certain of our subsidiaries entered into a Senior Secured Revolving Credit Facility (the “JPMorgan Revolving Loan Facility”) with JPMorgan Chase Bank, N.A., as administrative agent, issuing bank and swingline lender for a three-year revolving line of credit up to $50 million.

Our and our subsidiaries’ obligations under the JPMorgan Revolving Loan Facility are secured by first priority liens (subject to certain permitted liens) in substantially all of our and our subsidiaries’ respective personal property assets pursuant to the terms of a U.S.

and a Canadian Pledge and Security Agreement, dated March 29, 2021, and the other security documents.

On August 31, 2021, the JPMorgan Credit Facility was amended to increase the borrowing limit to $100 million and on October 25, 2021 was further amended to permit the Term Loan and to conform changes to provisions of the Term Loan.

The JPMorgan Credit Facility is more fully described in Note 10 - Debt under Revolving asset-backed credit facilities - JPMorgan Revolving Credit Facility in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

New Distribution Centers

In April 2021, we entered into leases for two new distribution centers aggregating approximately 322,000 square feet.

One is located in Fairfield, California and is the distribution center that we relocated to from our Petaluma, California distribution facility in the fourth quarter of 2021.

The other distribution center is located in Fontana, California which we relocated to from our Santa Fe Springs, California distribution facility in the third quarter of 2021.

See Note 7 - Leases , in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K .

In July 2021, we 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, commencing January 1, 2023.

See Note 7 - Leases , in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K .

In November 2021, we executed a lease for approximately 109,000 square feet of warehouse space in Cambridge, Ontario, Canada to be available upon expiration of the lease existing space, commencing June 1, 2023.

See Note 7 - Leases , in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

In January 2022, we executed a lease for approximately 303,000 square feet of warehouse space in Shoemakersville, Pennsylvania to be available upon expiration of the lease for existing space, commencing March 1, 2022.

See Note 7 - Leases , in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K .

The JPMorgan Revolving Loan Facility was amended by the First Amendment dated August 31, 2021, which increased the revolving line of credit by an additional $50 million for an aggregate borrowing limit of $100 million.

The JPMorgan Revolving Loan Facility was further amended by the Second Amendment dated October 25, 2021, which, among other things, permitted the incurrence of the Term Loan and made certain other changes.

The JPMorgan Revolving Loan Facility was further amended by the Third Amendment and Joinder dated August 23, 2022, pursuant to which several previously acquired subsidiaries became parties to the JPMorgan Revolving Loan Facility and granted liens on their assets.

On December 22, 2022, we entered into a Fourth Amendment pursuant to which the maximum commitment amount under the JPMorgan Revolving Loan Facility was reduced from $100 million to $75 million, and certain other changes were made, including transitioning the LIBOR based rates to SOFR based rates.

The aforementioned financing arrangements and other transactions are more fully described in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Effects of COVID-19 on Our Business

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

Vaccines for COVID-19 continue to be administered in the United States and other countries around the world, but the extent and rate of vaccine adoption, the long-term efficacy of these vaccines and other factors remain uncertain.

Authorities throughout the world have implemented measures to contain or mitigate the spread of the virus, including physical distancing, travel bans and restrictions, closure of non-essential businesses, quarantines, work-from-home directives, mask requirements, shelter-in-place orders and vaccination programs.

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

In response to the COVID-19 pandemic, we implemented business continuity plans designed to address the impact of the COVID-19 pandemic on our business, such as restrictions on non-essential business travel, the institution of work-from-home practices and the implementation of strategies for workplace safety at our facilities.

The World Health Organization recognized COVID-19 as a global pandemic on March 11, 2020, and COVID-19 has had significant and ongoing negative impacts on global societies, workplaces, economies and health systems.

Authorities throughout the world have implemented measures to contain or mitigate the spread of the virus, including at various times physical distancing, travel bans and restrictions, closure of non-essential businesses, quarantines, work-from-home directives, mask requirements, shelter-in-place orders, and vaccination programs, but despite these efforts, COVID-19 has persisted, has mutated into new variants, and is expected to become endemic.

We have implemented business continuity plans and followed safety protocols as recommended by government guidelines, and we will continue to do so as the state of COVID-19 evolves.

As of the filing of this Annual Report on Form 10-K, our operations are not impacted by any COVID-19 related facility closures, lockdown measures, travel restrictions or similar limitations.

However, new waves of COVID-19 or its variants could cause the reinstatement of such limitations, and such limitations may adversely impact our supply chains, the manufacturing of our own products and our ability to obtain necessary materials, all of which could adversely affect our business, results of operations and financial condition.

We have historically and may continue to source select products from China.

It is difficult to predict the extent to which COVID-19, including the emergence and spread of more transmissible variants, may continue to spread.

As of the date of this Annual Report on Form 10-K, manufacturers in China and in North America are generally back in operation;

however, new waves of the COVID-19 pandemic could result in the re-closure of factories in China and/or in North America.

Quarantine orders and travel restrictions within the United States and other countries may also adversely impact our supply chains, the manufacturing of our own products and our ability to obtain necessary materials.

We are experiencing some extended lead times in our supply chain, as well as increased shipping costs and believe the COVID-19 pandemic is a contributing factor to those extended lead times and increased costs.

Although we have not, to date, experienced any material interruptions in our ability to fill our customers' orders or manufacture our own products, we may in the future be unable to obtain adequate inventory to fill purchase orders or

manufacture our own products, which could adversely affect our business, results of operations and financial condition.

We have in the past, and may again in the future experience some extended lead times in our supply chain, as well as increased shipping costs and believe the COVID-19 pandemic is a contributing factor to those extended lead times and increased costs.

Furthermore, potential suppliers or sources of materials may pass the increase in sourcing costs due to the COVID-19 pandemic to us through price increases, thereby impacting our potential future profit margins.

The extent to which the COVID-19 pandemic will ultimately impact our business, results of operations, financial condition and cash flows depends on future developments that are highly and rapidly evolving and difficult to predict at this time.

It is difficult to assess or quantify with precision the impact COVID-19 has directly had on our business since we cannot precisely quantify the impacts, if any, that the various effects have had on the overall business.

We believe COVID-19 may have provided a positive demand impact in 2020 and 2021 from shelter-in-place orders in the United States, a possible negative supply chain impact from workforce disruption at international and domestic suppliers, and a possible negative growth rate impact in 2022 due to agricultural oversupply initiated during the height of COVID-related shelter-in-place orders in 2020 and 2021.

We continue to monitor the COVID-19 pandemic and will adjust our mitigation strategies as necessary to address changing health, operational or financial risks that may arise.

Our customers reside in countries, primarily the U.S.

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

Many of these customers have experienced shelter-in-place measures in attempts to contain the spread of COVID-19, including general lockdowns, closure of schools and non-essential businesses, bans on gatherings and travel restrictions.

Our business has remained resilient during the COVID-19 pandemic.

As of December 31, 2021, our manufacturing and distribution operations are viewed as essential services and continue to operate.

Our key suppliers, retailers and resellers have been designated as essential services and remain open at this time;

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

The majority of U.S.

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

State and Canadian government authorities.

The extent to which the COVID-19 pandemic will ultimately impact our business, results of operations, financial condition and cash flows depends on future developments that are highly uncertain, rapidly evolving and difficult to predict at this time.

Depending on the length and severity of COVID-19, we may experience an increase or decrease in customer orders driven by volatility in consumer shopping and consumption behavior.

It is difficult to assess or quantify with precision the impact COVID-19 has directly had on our business since we cannot precisely quantify the impacts, if any, that the various effects (e.g.

possible positive demand impact from shelter-in-place orders in the United States, possible negative supply chain impact from workforce disruption at international and domestic suppliers and domestic ports and the possible negative impact on transportation costs) have had on the overall business.

And so, while we do not believe that we are experiencing net material adverse impacts at this time, given the global economic slowdown, the overall disruption of global supply chains and distribution systems and the other risks and uncertainties associated with the COVID-19 pandemic, our business, financial condition, results of operations and growth prospects could be materially and adversely affected.

While we believe that we are well positioned for the future as we navigate the crisis and prepare for an eventual return to a more normal operating environment, we continue to closely monitor the COVID-19 pandemic as we evolve our business continuity plans and response strategy.

Other Transactions

Initial Public Offering

On December 14, 2020, we completed our initial public offering (“IPO”), in which we issued and sold 9,966,667 shares of our common stock, including the full exercise by the underwriters of their option to purchase 1,300,000 additional shares of our common stock, at a public offering price of $20.00 per share, which resulted in net proceeds of $182.3 million after deducting underwriting discounts and commissions and offering expenses.

The proceeds from the IPO were used to (i) repay amounts outstanding under the previous term loan with Brightwood Loan Services, LLC of $76.6 million (includes accrued interest and fees of $0.3 million), (ii) to pay down certain amounts outstanding under the Encina Credit Facility of $33.4 million, (iii) to repay $3.3 million under the promissory note to JPMorgan Chase, N.A.

through the U.S.

Small Business Administration Paycheck Protection Program, and (iv) to pay $2.6 million to settle the Series A preferred stock dividend.

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

Reverse Stock Split

Our board of directors and stockholders approved an amendment to our amended and restated certificate of incorporation effecting a 1-for-3.3712 reverse stock split of our issued and outstanding shares of common stock.

The reverse split was effected on November 24, 2020 without any change in the par value per share.

Components of Results of Operations

We generate net sales from the distribution and manufacturing of hydroponic equipment and supplies to our customers.

The hydroponic equipment and supplies that we sell include consumable products, such as growing media, nutrients and supplies that require regular replenishment and durable products, such as lighting and hydroponic equipment.

Our scale allows us to provide delivery and service capabilities to a highly diverse group of customers across the U.S.

generally do not sell directly to growers but rather our customer base consists of specialty hydroponic retailers, garden centers, eCommerce and greenhouse suppliers.

The hydroponic equipment and supplies that we sell include consumable products, such as growing media, nutrients and supplies that are subject to regular replenishment and durable products, such as lighting and hydroponic equipment.

Our scale allows us to provide delivery and service capabilities to customers across the U.S.

We periodically offer sales incentives to our customers, including early pay discounts, volume-based rebates, temporary price reductions, advertising credits and other trade activities.

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Cost of goods sold

Cost of goods sold consists primarily of material costs, inbound and outbound freight costs, direct labor costs primarily for manufacturing and warehouse personnel, facility costs for manufacturing operations and depreciation, depletion and amortization of manufacturing and warehouse improvements and equipment.

We expect our cost of goods sold to increase in absolute dollars in conjunction with our growth and as a result of higher freight and labor costs.

However, we expect that, over time, cost of goods sold will decrease as a percentage of net revenue as a result of the scaling of our business including a higher proportion of the amount of proprietary and exclusive branded products that we sell.

Cost of goods sold consists primarily of material costs, inbound and outbound freight costs, direct labor costs primarily for manufacturing and warehouse personnel, facility costs for manufacturing operations, depreciation, depletion and amortization of manufacturing and warehouse improvements and equipment, inventory allowances, restructuring costs, and certain acquisition and integration expenses.

We expect that our cost of goods sold would increase in absolute dollars in conjunction with net sales growth if that occurs in the future.

However, we expect that, over time, cost of goods sold may decrease as a percentage of net sales if we are able to scale our business as we obtain a higher proportion of net sales associated with proprietary and exclusive branded products.

Selling, general and administrative

Selling, general and administrative expenses consists primarily of marketing and advertising, facility costs for distribution operations, stock-based compensation, depreciation and amortization of all other assets and other selling, general and administrative costs, including but not limited to salaries, benefits, bonuses, stock-based compensation, professional fees and various costs related to becoming a publicly-traded company.

We expect selling, general and administrative expenses to increase in absolute dollar terms as we scale our operations to meet increased demand for our products and operate as a public company with increased costs associated with insurance, finance, legal and accounting functions;

however, we also expect that the significant increase in our scale will result in selling, general and administrative expenses as a percentage of net sales decreasing over time.

Selling, general and administrative expenses ("SG&A") consists primarily of marketing and advertising, facility costs for distribution operations, depreciation and amortization of all other assets, certain acquisition and integration expenses and other selling, general and administrative costs, including but not limited to salaries, benefits, bonuses, stock-based compensation, professional fees, and various costs related to being a publicly-traded company.

Results of Operations Data

The results of operations data in the following tables for the years ended December 31, 2021, 2020, and 2019 have been derived from the audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

The results of operations data in the following table for the years ended December 31, 2022, and 2021 have been derived from the audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Results of Operations - Comparison of Years Ended December 31, 2022, and 2021

The following table sets forth our consolidated statements of operations for the years ended December 31, 2021, and 2020, including amounts and percentages of net sales for each year and the year-to-year change in dollars and percent (amounts in thousands):

The results of operations data in the following table, including amounts and percentages of net sales for each year and the year-to-year change in dollars and percent, for the years ended December 31, 2022, and 2021, have been derived from the audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K (amounts in thousands):

Years ended December 31,

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Selling, general and administrative 118,604 34.4 % 104,185 21.7 % 14,419 13.8 %

Impairment, restructuring and other 297 0.1 % 860 0.3 % (563) -65.5 %

(Loss) income from operations (2,699) -0.6 % 4,281 1.3 % (6,980) -163.0 %

Impairments 192,328 55.8 % — 0.0 % 192,328 N/A

Loss from operations (281,596) -81.7 % (2,699) -0.6 % 278,897 10,333.3 %

Interest expense (10,958) -3.2 % (2,138) -0.4 % 8,820 412.5 %

Loss on debt extinguishment (680) -0.1 % (907) -0.3 % 227 -25.0 %

Other (expense) income, net (204) 0.0 % 70 0.0 % (274) -391.4 %

Loss on debt extinguishment or modification (145) 0.0 % (680) -0.1 % (535) -78.7 %

Other income (expense), net 841 0.2 % (204) 0.0 % 1,045 512.3 %

Loss before tax (291,858) -84.7 % (5,721) -1.2 % 286,137 5,001.5 %

Income tax benefit (expense) 19,137 4.0 % (576) -0.2 % 19,713 -3,422.4 %

Net income (loss) 13,416 2.8 % (7,273) -2.1 % 20,689 -284.5 %

Cumulative dividends allocated to Series A Convertible Preferred Stock — 0.0 % (2,597) -0.8 % 2,597 -100.0 %

Net income (loss) attributable to common stockholders $ 13,416 2.8 % $ (9,870) -2.9 % $ 23,286 -235.9 %

Net sales for the year ended December 31, 2021 were $479.4 million, an increase of $137.2 million, or 40.1%, compared to the same period in 2020.

The 40.1% increase was due to an approximate 35.0% increase in volume of products sold (a 13.1% increase in organic sales and a 21.9% increase from recently-acquired proprietary brands), a 3.6% increase in price and mix of products sold, and 1.5% growth from favorable foreign exchange rates.

The increase in volume of products sold was primarily related to (i) expansion of our proprietary and preferred brands, (ii) large expansion of our plant nutrients products, (iii) first-half expansion in our business predominantly in California, Oklahoma and Missouri, and (iv) growth from our acquisitions.

The increase in price was primarily related to list price increases.

The increase in foreign exchange related to recent weakness in the U.S.

Income tax benefit 6,443 1.9 % 19,137 4.0 % (12,694) -66.3 %

Net (loss) income (285,415) -82.8 % 13,416 2.8 % (298,831) -2,227.4 %

Net sales for the year ended December 31, 2022, were $344.5 million, a decrease of $134.9 million, or 28.1%, compared to the same period in 2021.

The 28.1% decrease was due to a 29.5% decline in volume of products sold (a 46.5% decline in organic sales and a 17.0% increase from 2021 acquired proprietary brands), a 1.7% increase in price and mix of products sold, and a 0.3% decline from unfavorable foreign exchange rates.

The decrease in volume of products sold was primarily related to the aforementioned oversupply in the cannabis industry.

The increase in price was primarily related to list price increases, as well as higher freight recovery as we put multiple measures in place to combat rising freight costs.

The decrease in foreign exchange related to recent strength in the U.S.

Dollar relative to the Canadian Dollar and to the Euro.

Gross profit for the year ended December 31, 2021 was $101.5 million, an increase of $37.9 million, or 59.5%, compared to the same period in 2020.

The increase in gross profit was primarily related to (i) the aforementioned increase in net sales and (ii) a significant increase in our gross profit margin percentage (gross profit as a percentage of net sales).

Our gross profit margin percentage increased to 21.2% for the year ended December 31, 2021 from 18.6% in the same period in 2020.

The higher gross profit margin percentage is primarily due to a more favorable sales mix of proprietary and preferred brand products (due in part to the aforementioned proprietary brands that were recently acquired and the preferred brands products added in the year-to-date period), which typically carry a higher gross margin than our distributed branded products, partially offset by higher freight and labor costs which escalated significantly as a percentage of net sales in our third and fourth fiscal quarters.

Selling, general and administrative expenses

Selling, general and administrative expenses ("SG&A") for the year ended December 31, 2021 were $103.9 million, an increase of $45.4 million, compared to the same period in 2020.

The increase is primarily related to acquisition and integration expenses of $19.7 million, costs associated with the relocation of certain of our distribution centers of $1.9 million, non-compensation general and administrative costs associated with the new acquisitions (an increase of $9.2 million), compensation costs (an increase of $7.2 million), insurance costs (an increase of $2.6 million), marketing (an increase of $2.3 million), facility costs (an increase of $2.3 million), consulting fees (an increase of $1.7 million), and $1.9 million of solicitation fees incurred in

connection with the Warrant Redemption, offset by share-based compensation (a decrease of ($3.4) million).

These increases were largely the result of (i) our accelerated M&A strategy and (ii) the increased costs associated with running a public company and supporting our long-term growth strategy.

The decrease in share-based compensation was due to the vesting of restricted stock units ("RSUs") last December with performance-based vesting requirements which was satisfied upon the consummation of our IPO.

As a result, our IPO in December 2020 triggered a significant performance-based stock compensation charge of $6.1 million for previously unrecognized time-based vesting prior to the IPO.

Interest expense

Interest expense for the year ended December 31, 2021 was $2.1 million, a decrease of $8.0 million, or 78.9%, compared to the same period in the prior year.

The decrease was primarily due to the payoff of the prior term loan with Brightwood Loan Services, LLC and pay down of the Encina Credit Facility in connection with the December 2020 IPO.

Loss on debt extinguishment

Loss on debt extinguishment for the year ended December 31, 2021 was $0.7 million, which resulted primarily from the write-off of unamortized deferred financing costs associated with the termination of the Encina Credit Facility.

Loss on debt extinguishment for the year ended December 31, 2020 was $0.9 million, which resulted primarily from the write-off of unamortized deferred financings costs associated with the payoff of the prior term loan with Brightwood Loan Services, LLC.

Income tax benefit (expense)

Income tax benefit for the year ended December 31, 2021 was approximately $19.1 million.

Our income tax benefit was primarily the result of a reduction in the valuation allowance recorded against our net deferred tax assets.

In connection with the acquisition of the H&G Entities, we recorded a net deferred tax liability which provided an additional source of taxable income to support the realization of the pre-existing deferred tax assets.

Our income tax benefit was partially offset by income taxes from certain foreign jurisdictions where we conduct business and state minimum income taxes in the United States.

We have a valuation allowance for deferred tax assets, including net operating loss carryforwards.

The income tax expense for the year ended December 31, 2020 was primarily due to foreign and state income tax expense.

Results of Operations – Comparison of Years Ended December 31, 2020 and 2019

The following table sets forth our consolidated statements of operations for the years ended December 31, 2020 and 2019, including amounts and percentages of net sales for each year and the year-to-year change in dollars and percent (amounts in thousands):

Years ended December 31,

2020 2019 Year to year change

Net sales $ 342,205 100.0 % $ 235,111 100.0 % $ 107,094 45.6 %

Cost of goods sold 278,572 81.4 % 208,025 88.5 % 70,547 33.9 %

Gross profit 63,633 18.6 % 27,086 11.5 % 36,547 134.9 %

Operating expenses:

Selling, general and administrative 58,492 17.1 % 43,784 18.6 % 14,708 33.6 %

Impairment, restructuring and other 860 0.3 % 10,035 4.3 % (9,175) -91.4 %

Income (loss) from operations 4,281 1.3 % (26,733) -11.4 % 31,014 -116.0 %

Interest expense (10,141) -3.0 % (13,467) -5.7 % 3,326 -24.7 %

Loss on debt extinguishment (907) -0.3 % (679) -0.3 % (228) 33.6 %

Other income, net 70 0.0 % 105 0.0 % (35) -33.3 %

Net loss before tax (6,697) -2.0 % (40,774) -17.4 % 34,077 -83.6 %

Income tax (expense) benefit (576) -0.2 % 691 0.3 % (1,267) -183.4 %

Net loss (7,273) -2.1 % (40,083) -17.1 % 32,810 -81.9 %

Cumulative dividends allocated to Series A Convertible Preferred Stock (2,597) -0.8 % — 0.0 % (2,597) n/a %

Net loss attributable to Hydrofarm Holdings Group, Inc.

$ (9,870) -2.9 % $ (40,083) -17.1 % $ 30,213 -75.4 %

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

The increase in net sales was primarily due to a 42.0% increase in volume of products sold and a 3.6% increase in price of products sold.

The increase in volume of products sold was primarily related to (i) higher demand from the end-markets across numerous U.S.

states, including but not limited to Michigan, Oklahoma and California, and Canada and (ii) higher demand for our proprietary and preferred branded products which grew at a faster pace than our distributed brands during the period.

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

Although we cannot precisely quantify in absolute or relative terms, our accelerated rate of growth in net sales for the year ended December 31, 2020 correlates with shelter-in-place orders issued in March 2020 in response to the COVID-19 pandemic.

A portion of our net sales during this period could have been related to pull-through demand for our products due to higher consumption of CEA products from individuals spending more time at home due to shelter-in-place measures.

Although uncertainty created by the COVID-19 pandemic remains, and various state budgets remain under economic pressure, creating a greater chance of further cannabis legalization, we cannot assure you that such growth will continue.

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

Our gross profit margin percentage increased to 18.6% for the year ended December 31, 2020 compared to 11.5% for the year ended December 31, 2019.

The higher gross profit margin percentage was primarily due to (i) a more favorable sales mix of proprietary and exclusive branded products, which typically carry a higher gross margin, (ii) lower freight cost, and (iii) inventory adjustments and write-downs that impacted the fourth quarter of 2019 primarily associated with our 2019 SKU rationalization.

Gross profit for the year ended December 31, 2022, was $29.3 million, a decrease of $72.2 million, or 71.1%, compared to the same period in 2021.

The decrease in gross profit was primarily related to the aforementioned decrease in net sales and a significant decrease in our gross profit margin percentage.

Our gross profit margin percentage decreased to 8.5% for the year ended December 31, 2022, from 21.2% in the same period in 2021.

The lower gross profit margin percentage is primarily due to an increase in the inventory obsolescence allowances and related charges of $18.5 million primarily related to certain lighting products, and restructuring costs of $7.5 million associated with inventory markdowns of products and brands being removed from our portfolio and the relocation and termination of certain facilities in Canada.

Also negatively impacting gross profit margin were freight and labor costs which were higher as a percentage of net sales.

These were partially offset by the aforementioned list price increases, as well as a higher proportion of higher-margin proprietary brand sales.

Selling, general and administrative expenses

Selling, general and administrative expenses for the year ended December 31, 2020 increased by $14.7 million or 33.6%, compared to the year ended December 31, 2019 due primarily to an increase of $8.7 million in stock-based compensation expense, of which $6.1 million was directly triggered by our IPO in December 2020 (more fully described below).

SG&A expense excluding the portion of stock-based compensation expense triggered by the IPO decreased from 18.6% in 2019 to 15.3% in 2020 due to economies of scale as our net sales grew faster than our selling, general and administrative expenses.

To support our long-term growth plan and our IPO, we undertook several initiatives in mid-to-late 2019 and early 2020 which resulted in the aforementioned $14.7 million increase in selling, general and administrative expenses, including increased stock-based compensation expenses, increased compensation costs (an increase of $3.9 million), and increased professional service fees, including, but not limited to, the hiring of executives such as our new Chief Executive Officer, President and Chief Financial Officer and engaging new third parties such as an IT consulting firm, a new auditor, and several accounting and audit-related consultants (an increase of $4.4 million).

As more fully discussed in Note 12 - Stock-based compensation , in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K, we granted RSUs to certain officers, former directors and their affiliates which have vesting conditions including a performance-based vesting requirement which was satisfied upon the consummation of our IPO.

As a result, our IPO in December 2020 triggered a significant performance-based stock compensation charge of $6.1 million for previously unrecognized time-based vesting prior to the IPO.

Impairment, restructuring and other

Impairment, restructuring and other expenses declined to $0.9 million for the year ended December 31, 2020.

For the year ended December 31, 2019, we recognized a $5.4 million expense related to impairment of intangible assets for customer relationships;

$2.0 million for restructuring costs, and $1.5 million for other expenses.

We also incurred $1.1 million for a registration statement which was delayed, and accordingly, the third-party costs were expensed.

See Note 15 - Impairment, restructuring and other , in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional information.

SG&A expenses for the year ended December 31, 2022, were $118.6 million, an increase of $14.4 million, or 13.8% compared to the same period in 2021.

The increase is primarily related to (i) a $23.4 million increase in depreciation, depletion and amortization expense primarily due to the acquisitions completed in 2021 which includes $5.9 million of additional amortization expense from adjustments to useful lives that were determined this year, (ii) a $2.9 million increase in accounts receivable allowances and write-offs, (iii) a $2.8 million increase in share-based compensation, (iv) a $2.1 million increase in compensation costs (primarily salaries and benefits for employees from companies acquired in 2021), of which $0.7 million was an increase in severance associated with a recent reduction-in-force, and (v) a $2.0 million increase in insurance costs.

The SG&A increases compared to the prior year were partially offset by (i) a $16.8 million decrease in acquisition and integration expenses, and (ii) a $1.9 million decrease from investor warrant solicitation fees incurred last year.

We recorded goodwill impairment charges of $189.6 million for the year ended December 31, 2022, as we determined that the carrying value of the reporting units of U.S.

and Canada were in excess of the fair value.

The recognized impairment reduced the goodwill balance to zero as of December 31, 2022.

The impairment was primarily due to a deterioration in customer demand in the U.S.

and Canada caused by macroeconomic and industry conditions.

For the year ended December 31, 2022, we also recorded an impairment of a note receivable of $2.6 million.

Interest expense

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

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

This increase was offset by a decrease in the effective interest rate on the term loan with Brightwood Loan Services, LLC ("Brightwood Term Loan"), from approximately 13% for the year ended December 31, 2019 to an effective interest rate of approximately 10.2% for the year ended December 31, 2020 due to a reduction of the Brightwood Term Loan interest rate margin which became effective on January 1, 2020 from LIBOR plus 10.0% to LIBOR plus 8.5% along with a reduction of average LIBOR from 2.5% to 1%.

The decrease in interest costs was also slightly impacted by a decrease in the effective interest rate on our revolving credit facilities from approximately 9.9% for the year ended December 31, 2019 to approximately 9.3% for the year ended December 31, 2020.

Loss on debt extinguishment

Loss on debt extinguishment for the year ended December 31, 2020 resulted from the write-off of unamortized deferred financing costs associated with the payoff of the Brightwood Term Loan in connection with the IPO.

Similar costs in 2019 resulted from the write-off of unamortized deferred financing costs when the BofA Credit Facility was refinanced with the Encina Credit Facility.

Income tax expense

Income tax expense for the year ended December 31, 2020 generally reflects minimum U.S.

state income taxes which do not fluctuate with pre-tax income or loss and Canadian taxes in one of our profitable Canadian subsidiaries.

The net income tax benefit for the year ended December 31, 2019 is comprised of two amounts:

(i) minimum U.S.

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

and, (ii) a deferred income tax benefit of $0.7 million primarily generated from the tax consequence of the impairment write-off which is not expected to recur.

Cumulative dividends allocated to Series A convertible preferred stock

Our Series A Preferred Stock accrued a cumulative dividend during 2020 which is presented as a reduction of net loss which results in the net loss attributable to common stockholders.

Dividends did not accrue prior to 2020.

Upon the consummation of our IPO in December 2020, the Series A Preferred Stock automatically converted into 2,291,469 shares of our common stock and we paid $2.6 million in cash to settle the Series A Preferred Stock dividend.

Interest expense for the year ended December 31, 2022, was $11.0 million, an increase of $8.8 million, or 412.5%, compared to the same period in the prior year.

The increase was primarily due to the interest-bearing Term Loan entered into in the fourth quarter of 2021 and outstanding for the entirety of 2022, as well as interest rate increases through the year.

Loss on debt extinguishment or modification

Loss on debt extinguishment or modification for the year ended December 31, 2022, was $0.1 million, a decrease of $0.5 million, or 78.7%, compared to the same period in 2021.

The Loss on debt extinguishment or modification for the year ended December 31, 2022, resulted primarily from the write-off of unamortized deferred financing costs associated with the modification of the JPMorgan Revolving Loan Facility entered into during the fourth quarter of 2022, which reduced our borrowing capacity from $100 million to $75 million, permitted a sale and leaseback transaction, and made certain other changes, including transitioning the LIBOR based rates to SOFR based rates.

Loss on debt extinguishment or modification for the year ended December 31, 2021, resulted primarily from the write-off of unamortized deferred financing costs associated with the termination of the Encina Credit Facility.

Other income (expense), net

Other income for the year ended December 31, 2022, was $0.8 million compared to Other expense of $0.2 million for the year ended December 31, 2021.

The increase in other income compared to the prior year periods relates primarily to foreign currency exchange rate gains in 2022.

Income tax benefit

Income tax benefit for the year ended December 31, 2022, was $6.4 million, compared to $19.1 million in the prior year.

Our effective income tax rate was 2.2% for the year ended December 31, 2022, and differs from the U.S.

federal statutory rate of 21% primarily due to the impairment of goodwill for certain 2021 acquisitions which was not deductible for U.S.

tax purposes, increases in our valuation allowance on U.S.

deferred tax assets, and the establishment of a valuation allowance for Canadian deferred tax assets.

As described in Note 4 - Goodwill and Intangible Assets, Net , during the year ended December 31, 2022, we fully impaired the goodwill associated with all 2021 acquisitions.

In connection with the measurement period adjustments associated with 2021 acquisitions, the Company recorded a net deferred tax liability which provided an additional source of taxable income to support the realization of the pre-existing deferred tax assets.

The Company's income tax benefit was partially offset by income taxes from certain foreign subsidiaries.

For the year ended December 31, 2021, income tax benefit was primarily the result of a reduction in the valuation allowance recorded against our net deferred tax assets.

In connection with the acquisition of the H&G Entities, we recorded a net deferred tax liability in 2021 which provided an additional source of taxable income to support the realization of the pre-existing deferred tax assets.

Non-GAAP Financial Measures

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GAAP” or “GAAP”).

However, management believes that certain non-GAAP financial measures provide investors of our financial information with additional useful information in evaluating our performance and that excluding certain items that may vary substantially in frequency and magnitude period-to-period from net income (loss) provides useful supplemental measures that assist in evaluating our ability to generate earnings and to more readily compare these metrics between past and future periods.

However, management believes that certain non-GAAP financial measures provide investors with additional useful information in evaluating our performance and that excluding certain items that may vary substantially in frequency and magnitude period-to-period from net (loss) income provides useful supplemental measures that assist in evaluating our ability to generate earnings and to more readily compare these metrics between past and future periods.

These non-GAAP financial measures may be different than similarly titled measures used by other companies.

To supplement our audited consolidated financial statements which are prepared in accordance with GAAP, we use “Adjusted EBITDA” and “Adjusted EBITDA as a percent of sales” which are non-GAAP financial measures (collectively referred to as “Adjusted EBITDA”).

To supplement our audited consolidated financial statements which are prepared in accordance with GAAP, and to supplement "net (loss) income" and "net (loss) income as a percent of sales", we use “Adjusted EBITDA” and “Adjusted EBITDA as a percent of sales” which are non-GAAP financial measures.

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

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Some of these limitations include:

• Adjusted EBITDA does not reflect interest expense, or the amounts necessary to service interest or principal payments on our indebtedness;

• Adjusted EBITDA excludes depreciation and amortization, and although these are non-cash expenses, the assets being depreciated and amortized may have to be replaced in the future;

• Adjusted EBITDA does not reflect the significant interest expense, or the amounts necessary to service interest or principal payments on our indebtedness;

• Adjusted EBITDA excludes depreciation, depletion and amortization, and although these are non-cash expenses, the assets being depreciated and amortized may have to be replaced in the future;

• Adjusted EBITDA does not reflect our tax provision that adjusts cash available to us;

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• Adjusted EBITDA does not reflect the impact of earnings or charges resulting from matters we consider not to be reflective, on a recurring basis, of our ongoing operations.

We define Adjusted EBITDA as net income (loss) excluding interest expense, income taxes, depreciation and amortization, stock-based compensation, employer payroll taxes on stock-based compensation and other unusual and/or infrequent costs, which we do not consider in our evaluation of ongoing operating performance.

The following table presents a reconciliation of net income (loss), the most comparable GAAP financial measure, to Adjusted EBITDA for the years ended December 31, 2021, 2020 and 2019 (in thousands):

These items include restructuring, impairments, severance and other expenses, acquisition and integration expenses, distribution center exit costs, loss on debt extinguishment or modification, investor warrant solicitation fees, and other (expense) income, net.

We define Adjusted EBITDA as net (loss) income excluding interest expense, income taxes, depreciation, depletion and amortization, stock-based compensation including employer payroll taxes on stock-based compensation and other non-cash, unusual and/or infrequent costs (i.e., restructuring, impairments, severance and other expenses, acquisition and integration expenses, distribution center exit costs, loss on debt extinguishment or modification, investor warrant solicitation fees, and other income/expense, net), which we do not consider in our evaluation of ongoing operating performance.

The following table presents a reconciliation of net (loss) income, the most comparable GAAP financial measure, to Adjusted EBITDA for the years ended December 31, 2022, and 2021 (in thousands):

Years ended December 31,

2021 2020 2019

Net income (loss) $ 13,416 $ (7,273) $ (40,083)

Net (loss) income (GAAP) $ (285,415) $ 13,416

Interest expense 10,958 2,138

Income tax (benefit) expense (19,137) 576 (691)

Income tax benefit (6,443) (19,137)

Distribution center exit costs and other 1

Depreciation, depletion and amortization 41,527 14,934

Impairment, restructuring and other 297 860 10,035

Impairments 2

Restructuring expenses 3

Severance and other 4

Acquisition and integration expenses 5

Other expense (income), net 204 (70) (105)

Other (income) expense, net 6

Stock-based compensation 7

Loss on debt extinguishment 680 907 679

Loss on debt extinguishment or modification 8

Investor warrant solicitation fees 9

Adjusted EBITDA $ 47,082 $ 21,076 $ (9,495)

Adjusted EBITDA as a percent of net sales 9.8 % 6.2 % (4.0) %

(*) Includes consulting, transaction services and legal fees incurred for the completed Heavy 16, House and Garden, Aurora, Greenstar/Grotek and IGE acquisitions and certain potential acquisitions.

(**) Includes employer payroll taxes on stock-based compensation

Adjusted EBITDA (Non-GAAP) $ (21,193) $ 47,082

As a percent of net sales:

Net (loss) income (GAAP) (82.8) % 2.8 %

Adjusted EBITDA (Non-GAAP) (6.2) % 9.8 %

Net (loss) income (GAAP) and Adjusted EBITDA (Non-GAAP) for the year ended December 31, 2022, were negatively impacted by $21.4 million of inventory and accounts receivable reserves and related charges.

For the 2022 and 2021 periods presented, this relates to costs incurred to exit and relocate distribution centers in California and Pennsylvania including lease exit costs, transportation, and labor related costs.

The Company completed its goodwill impairment testing and recorded an impairment charge of $189.6 million during year ended December 31, 2022, due to market softness in demand in the U.S.

Additionally, during the year ended December 31, 2022, the Company recorded an impairment primarily related to a $2.6 million charge associated with a note receivable that originated in 2019 in connection with a third party independent processor serving the CBD market.

During the year ended December 31, 2022, the Company recorded pre-tax charges of $6.8 million relating to the inventory markdowns of products and brands being removed from our portfolio and $0.9 million relating primarily to the relocation and termination of certain facilities in Canada.

Severance and other primarily consists of severance costs incurred during the year ended December 31, 2022, related to workforce reductions to optimize our cost structure.

Severance and other primarily consists of costs related to an aborted financing during the year ended December 31, 2021.

For the year ended December 31, 2022, acquisition and integration expenses include non-cash purchase accounting inventory adjustments for House and Garden, Aurora, Greenstar and Innovative Growers Equipment of $4.8 million, and acquisition and integration consulting, transaction services and legal fees incurred for the completed Heavy 16, House and Garden, Aurora, Greenstar, and Innovative Growers Equipment acquisitions and certain potential acquisitions of $4.5 million, partially offset by the change in fair value of contingent consideration for Aurora of ($1.6 million).

For the prior year period, acquisition and integration expenses primarily include investment banking, consulting, transaction services and legal fees incurred for the completed Heavy 16, House & Garden, Aurora, Greenstar, and Innovative Growers Equipment acquisitions and certain potential acquisitions, including non-cash purchase accounting inventory adjustment s of $4.5 million, partially offset by the change in fair value of contingent consideration for Aurora of ($2.5 million) for the year ended December 31, 2021 .

Other (income) expense, net relates primarily to foreign currency exchange rate gains and losses and other non-operating income and expenses.

Includes stock-based compensation and related employer payroll taxes on stock-based compensation for the periods presented.

For the year ended December 31, 2022, loss on debt extinguishment or modification resulted primarily from the write-off of unamortized deferred financing costs associated with the modification of the JPMorgan Revolving Loan Facility.

For the year ended December 31, 2021, loss on debt extinguishment resulted primarily from the write-off of unam ortized deferred financing costs associated with the termination of the Encina Credit Facility.

Reflects the elimination of investor warrant solicitation fees.

Liquidity and Capital Resources

Cash Flow from Operating, Investing, and Financing Activities - Comparison of Years Ended December 31, 2021, 2020, and 2019

Cash Flow from Operating, Investing, and Financing Activities

Comparison of Years Ended December 31, 2022, and 2021

The following table summarizes our cash flows for the years ended December 31, 2022, and 2021 (amounts in thousands):

Years ended December 31,

2021 2020 2019

Net cash used in operating activities $ (45,067) $ (44,825) $ (13,302)

Net cash (used in) provided by investing activities (468,184) 546 (3,818)

Net cash provided by financing activities 464,707 88,145 19,900

Net cash from (used in) operating activities $ 21,989 $ (45,067)

Net cash used in investing activities (8,487) (468,184)

Net cash (used in) from financing activities (20,200) 464,707

Effect of exchange rate changes on cash, cash equivalents and restricted cash (395) (27)

Net (decrease) increase in cash, cash equivalents and restricted cash

Net decrease in cash, cash equivalents and restricted cash

(7,093) (48,571)

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Operating Activities

Net cash from operating activities was $22.0 million for the year ended December 31, 2022, primarily due to a $39.6 million net cash inflow from a reduction of working capital related assets and liabilities.

This included a decrease of $57.0 million in inventories and a decrease of $16.7 million in accounts receivable, net, partially offset by decreases of $13.3 million in deferred revenue and $16.5 million in accounts payable, accrued expenses and other current liabilities.

The net cash inflow from a reduction of working capital is partially offset by consolidated net loss on the statement of operations.

During the year ended December 31, 2022, we paid $9.6 million in cash interest, compared to $1.6 million in the prior year.

Net cash used in operating activities was $45.1 million for the year ended December 31, 2021, primarily consisting of $13.4 million in net income, $4.4 million in net non-cash expense reductions, which were largely comprised of depreciation, depletion and amortization, stock-based compensation expense, non-cash operating lease expense, deferred income tax benefit and other non-cash expenses, less a $62.9 million increase in working capital.

This change in working capital primarily reflects an aggregate increase of $47.8 million in accounts receivable, inventories, prepaid expenses and other current assets, and other assets for the period as well as an aggregate net decrease of $15.1 million in accounts payable, accrued expenses and other current liabilities, and a decrease in lease liabilities due to payments on lease obligations during the period.

Net cash used in operating activities was $44.8 million for the year ended December 31, 2020 consisting of $20.2 million in non-cash expense addbacks which were largely composed of stock-based compensation, depreciation and amortization and non-cash operating lease expense, less net loss of $7.3 million, payment of interest capitalized to principal of long-term debt of $13.9 million and a $43.8 million increase in working capital.

The change in working capital primarily reflects a $43.2 million increase in accounts receivable and inventory for the period offset by a $10.7 million increase in accounts payable and accrued expenses.

The net change was due to the additional working capital needed to support our growth in net sales.

Net cash used in operating activities was $13.3 million for the year ended December 31, 2019 consisting of net loss of $40.1 million offset by $26.2 million in non-cash addbacks which were largely composed of depreciation and amortization, impairment charges, interest expense added to principal and non-cash operating lease expense, plus a $0.6 million increase in working capital.

The small change in working capital primarily reflects a $2.1 million net decrease in accounts receivable and inventories as collections and net sales during 2019 were slowed due to the industry downturn, plus a $1.2 million increase in accounts payable and accrued expenses as we were able to align payment of our obligations with our cash flow.

This change in working capital primarily reflects an aggregate increase of $47.8 million in accounts receivable, inventories, prepaid expenses and other current assets, and other assets for the period as well as an aggregate net decrease of $15.1 million in accounts payable, accrued expenses and other current liabilities, deferred revenue, and a decrease in lease liabilities due to payments on lease obligations during the period.

Investing Activities

Net cash used in investing activities for the year ended December 31, 2021 was $468.2 million, due primarily to five business acquisitions we completed during the period, which totaled $462.2 million in cash outflows and $6.0 million in purchases of property and equipment and other.

We had minimal investing activities for the years ended December 31, 2020 and 2019.

We made advances on notes receivable to third parties of $3.1 million the year ended December 31, 2019 and were repaid $2.0 million the year ended December 31, 2020.

Our business was not capital intensive during the years ended December 31, 2020 or 2019 and purchases of property and equipment were $1.4 million and $0.8 million, respectively.

Net cash used in investing activities for the year ended December 31, 2022, was $8.5 million, due primarily to capital expenditures for property, plant and equipment, which increased over the prior year primarily due to growth investments in our manufacturing operations and the expansion and relocation of certain of our distribution centers.

The 2022 cash usage primarily includes our growth-oriented investments in the peat moss harvesting operation in Canada and IGE manufacturing operations in the U.S.

Net cash used in investing activities for the year ended December 31, 2021, was $468.2 million, due primarily to five business acquisitions we completed during the period, which totaled $462.2 million in cash outflows and $6.0 million in capital expenditures for property, plant and equipment and other.

Financing Activities

Net cash used in financing activities was $20.2 million for the year ended December 31, 2022, primarily consisting of $15.5 million in payments to settle contingent consideration, primarily on our Aurora acquisition.

We paid $2.5 million related to employees' withholding tax in connection with the vesting of restricted stock units.

In addition, we paid $1.3 million in principal payments on the Term Loan.

Net cash provided by financing activities was $464.7 million for the year ended December 31, 2021.

We received $309.8 million proceeds from our follow-on offering, $119.9 million proceeds from our senior secured Term Loan, net of

discount and issuance costs, and received an additional $56.8 million from the exercise of warrants, including the Warrant Redemption.

We also paid $20.0 million related to employee's withholding tax in connection with the vesting of certain restricted stock units.

Our IPO was completed in December 2020 generating $182.4 million in net proceeds.

We used a portion of the proceeds to pay off the Brightwood Term Loan, to pay off our PPP loan and to paydown the outstanding balance under the Encina Credit Facility.

Other activity was a net of $1.2 million from transactions with our Series A preferred stock investors and payments of $0.7 million on finance leases.

Our net cash provided by these activities was $88.1 million for the period which we used for business growth and expansion.

For the year ended December 31, 2019, our borrowings under the working capital credit facilities marginally exceeded repayments which reflected stable working capital needs for the period.

We also received $21.7 million from our Series A Preferred Stock offering including proceeds from the issuance of notes which converted into the Series A Preferred Stock.

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

JPMorgan Revolving Credit Facility

On March 29, 2021, we entered into the JPMorgan Credit Facility, which provided for a borrowing limit of $50 million.

The JPMorgan Credit Facility replaced the Encina Credit Facility.

The JPMorgan Credit Facility is due on March 29, 2024.

The JPMorgan Credit Facility has an interest rate of LIBOR plus 1.95% and has a 0.0% LIBOR floor.

We received $309.8 million proceeds from our follow-on offering, $119.9 million proceeds from the Term Loan, net of discount and

issuance costs, and received an additional $56.8 million from the exercise of warrants, including the Warrant Redemption.

We also paid $20.0 million related to employees' withholding tax in connection with the vesting of certain restricted stock units.

JPMorgan Revolving Loan Facility

On March 29, 2021, we entered into the JPMorgan Revolving Loan Facility, which provided for a borrowing limit of $50 million.

The JPMorgan Revolving Loan Facility replaced the Encina Credit Facility.

The JPMorgan Revolving Loan Facility matures on March 29, 2024.

The JPMorgan Revolving Loan Facility was further amended by the Second Amendment dated October 25, 2021 which, among other things, permitted the incurrence of the Term Loan and made certain other changes including subordinating its liens on non-working capital assets to the obligations under the Term Loan.

On December 22, 2022, the Company entered into the Fourth Amendment pursuant to which the maximum commitment amount under the JPMorgan Revolving Loan Facility was reduced from $100 million to $75 million, a sale and leaseback transaction was permitted and certain other changes were made, including transitioning the LIBOR based rates to SOFR based rates.

The JPMorgan Revolving Loan Facility provides for various interest rate options including the Adjusted Term SOFR Rate, the Adjusted REVSOFR30 Rate, the CB Floating Rate, the Adjusted Daily Simple SOFR, the CBFR, the Canadian Prime Rate, or the CDOR Rate.

The rates that use SOFR as the reference rate (Adjusted Term SOFR Rate, the Adjusted REVSOFR30 Rate, the Adjusted Daily Simple SOFR and the CBFR rate) use the Term SOFR Rate plus 1.95%.

Each rate has a 0.0% floor.

A fee of 0.25% per annum is charged for available but unused borrowings.

Our obligations under the JPMorgan Credit Facility are secured by a first priority lien (subject to certain permitted liens) in substantially all of our and our subsidiaries' respective personal property assets pursuant to the terms of a U.S.

and Canadian Pledge and Security Agreement dated March 29, 2021 and other security documents

The JPMorgan Credit Facility maintains certain reporting requirements, affirmative covenants, negative covenants and financial covenants ("debt covenants").

The financial covenants include that we must maintain a minimum fixed charge coverage ratio of 1.1x on a rolling twelve-month basis.

and Canadian Pledge and Security Agreement dated March 29, 2021 and other security documents, as amended to include additional subsidiaries.

The JPMorgan Revolving Loan Facility maintains certain reporting requirements, affirmative covenants, negative covenants and financial covenants.

A certain financial covenant becomes applicable in the event that our excess availability under the JPMorgan Revolving Loan Facility is less than an amount equal to 10% of the Aggregate Revolving Commitment (currently $75 million) and would require us to maintain a minimum fixed charge coverage ratio of 1.1x on a rolling twelve-month basis.

In order to consummate permitted acquisitions or to make restricted payments, the Company would be required to comply with a higher fixed charge coverage ratio of 1.15x, but no such acquisitions or payments are currently contemplated.

We were in compliance with all debt covenants as of December 31, 2022.

As of December 31, 2021, approximately $83.6 million was available to borrow under the undrawn JPMorgan Credit Facility.

Senior Secured Term Loan

On October 25, 2021, we and certain of our direct and indirect subsidiaries entered into the Term Loan (as defined below) with JPMorgan Chase Bank, N.A., as administrative agent for certain lenders, pursuant to which we borrowed a $125.0 million senior secured term loan.

As of December 31, 2022, approximately $40 million was available to borrow under the undrawn JPMorgan Revolving Loan Facility, before we would be required to comply with the minimum fixed charge coverage ratio of 1.1x.

On October 25, 2021, we and certain of our direct and indirect subsidiaries entered into the Term Loan with JPMorgan Chase Bank, N.A., as administrative agent for the lenders, pursuant to which we borrowed a $125.0 million senior secured 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.

We received net proceeds of $119.9 million from the Term Loan after deducting discounts and deferred financing costs.

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 million 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 Term Loan requires us to maintain certain reporting requirements, affirmative covenants, and negative covenants.

We were in compliance with all debt covenants as of December 31, 2022.

The Term Loan is secured by a first lien on our non-working capital assets and a second lien on our working capital assets.

Contractual obligations

See Note 7 - Leases, in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K, for discussions on future minimum lease payments under long-term non-cancelable operating and financing leases with remaining terms greater than one year.

See Note 10 - Debt, in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K, for discussions on future principal payments under long-term debt.

Cash and cash equivalents

The cash and cash equivalents balances of $21.3 million and $26.6 million at December 31, 2022, and December 31, 2021, respectively, included $7.3 million and $4.1 million, respectively, held by foreign subsidiaries.

Material Cash Requirements

Our material cash requirements include interest payments on our long-term debt, operating lease payments, and purchase obligations to support our operations.

Refer to Part II, Item 8, Financial Statements, Note 10 - Debt , Note 7 - Leases , and Note 14 - Commitments and Contingencies, and Related Party Transactions for details relating to our material cash requirements for debt, our leasing arrangements, including future maturities of our operating lease liabilities, and purchase obligations, respectively.

From time to time in the normal course of business, we 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.

We had no material purchase commitments as of December 31, 2021.

Our net sales tend to be seasonally stronger in our fiscal second and third quarters due to robust sales in the warmer spring and summer months in North America (the United States and Canada are our primarily markets).

This seasonal trend primarily relates to the garden center portion of our customer base and that certain of our customers may from time to time use some of our products (such as grow media and nutrients) in outdoor applications.

Our net sales are typically seasonally stronger in our fiscal second and third quarters due to robust sales in the warmer spring and summer months in North America (the United States and Canada are our primarily markets).

This seasonal trend is primarily due to the garden center portion of our customer base, and because certain of our customers may use some of our products (such as grow media and nutrients) in outdoor applications.

While this seasonal pattern did not hold true during fiscal 2022, likely due to the industry recession, we expect this typical seasonal pattern to return in fiscal 2023.

Also, we typically expect to utilize cash from operating activities in the first quarter to fund our working capital requirements related to the seasonal sales pattern described above.

Availability and Use of Cash

We believe that our cash flows from operating activities and the JPMorgan Credit Facility and Term Loan will be sufficient to meet our capital expenditures, working capital needs and debt repayments for the foreseeable future.

Our ability to make investments in our business, service our debt and maintain strong liquidity will depend upon our ability to generate excess operating cash flows through our operating subsidiaries.

We believe that the Company will generate positive cash flows from operating activities over the next twelve months.

We believe that our cash flows from operating activities, combined with current cash levels and borrowing availability under the JPMorgan Credit Facility, will be adequate to support our ongoing operations, to fund debt service requirements, capital expenditures, lease obligations and working capital needs through the next twelve months of operations.

However, we cannot ensure that our business will generate sufficient cash flow from operating activities or that future borrowings will be available under our borrowing agreements in amounts sufficient to pay indebtedness or fund other working capital needs.

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

In January 2023, Gotham Properties LLC, an Oregon limited liability company and our subsidiary (“Seller”), consummated a Purchase and Sale Agreement with J & D Property, LLC, a Nevada limited liability company (“Purchaser”) pursuant to which certain real property located in the City of Eugene, County of Lane, State of Oregon (the “Eugene Property”) was sold to Purchaser for $8.6 million and then leased back by Seller (the “Sale-Leaseback Transaction”).

The new lease has a term of 15 years with annual rent starting at approximately $0.7 million and increases to the final year when annual rent is approximately $1.0 million.

The Eugene Property serves as the manufacturing and processing site for certain of our grow media and nutrient brands.

We intend to reinvest the net cash proceeds into certain permitted investments in 2023, such as capital expenditures.

If necessary, we believe that we could supplement our cash position through additional sale/leasebacks, asset sales and equity financing.

We believe it is prudent to be prepared if required and, accordingly, continue to be engaged in the process of evaluating and preparing to implement one or more of the aforementioned activities.

Critical Accounting Policies and Estimates

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A discussion of our principal accounting policies that required the application of significant judgments as of December 31, 2022 follows.

Business Combinations

Acquisitions of businesses are accounted for under 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 value of assets transferred, liabilities incurred to the former owners of the acquiree and the equity interest issued in exchange for control of the acquiree.

Acquisition related costs are expensed as incurred.

When the consideration transferred in a business combination includes a contingent consideration arrangement, which is where we may have the obligation to transfer additional assets or equity interest to the former owners if specified future events or conditions are met, the contingent consideration is measured at its acquisition date fair value and is included as part of the consideration transferred in a business combination.

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 our own equity instruments.

Changes in fair value of 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 fair value of contingent consideration classified as a liability are included in net income in the period and changes in fair value of contingent consideration classified as equity are not recognized.

For a given acquisition, we may identify certain pre-acquisition contingencies as of the acquisition date and we may extend our 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.

Goodwill is measure 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 acquisition-date fair value amounts of the identified assets acquired and liabilities assumed.

If the initial accounting for a business combination is incomplete by the end of the reporting period in which the business combination occurs, we report 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 the time.

Upon conclusion of the measurement period or final determination of the values of the assets acquired or liabilities assumed, whichever occurs first, any subsequent adjustments are recorded to net income (loss).

Goodwill and indefinite-lived intangible assets

Our consolidated balance sheet at December 31, 2021 includes goodwill of acquired businesses and other indefinite-lived intangible assets.

We evaluate these assets for impairment annually in the fourth quarter and on an interim basis if the facts and circumstances lead us to believe that more-likely-than-not there has been an impairment.

Goodwill and indefinite-lived intangible asset impairment reviews include performing either an initial qualitative or quantitative evaluation for each of our reporting units and indefinite-lived intangible assets.

As of December 31, 2021, we concluded it is more likely than not that goodwill and indefinite-live intangible assets recorded in our consolidated balance sheet were not impaired.

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 acquisition-date fair value amounts of the identified assets acquired and liabilities assumed in a business combination.

Goodwill is evaluated for impairment annually in the fourth quarter, or on an interim basis when an event or change in circumstances occurs, indicating that the carrying value may not be recoverable.

Primarily due to a decline in the market value of our common stock and market conditions, we identified a triggering event requiring a test for impairment as of June 30, 2022.

We completed our goodwill impairment testing and recorded an impairment charge due to market softness in demand in the U.S.

We determined the fair value of the U.S.

and Canada reporting units based on an income approach, using the present value of future discounted cash flows, and based on a market approach.

Significant estimates used to determine fair value include the weighted average cost of capital, financial forecasts, and pricing multiples derived from publicly-traded companies that are comparable to the reporting units.

The fair values were reconciled to the market value of our common stock of to corroborate the estimates used in the interim test for impairment.

Long-lived tangible and finite-lived intangible assets

Long-lived tangible assets and finite-lived intangible assets are stated at cost.

Depreciation and amortization expense is provided on the straight-line method and based on the estimated useful economic lives of the long-lived tangible assets.

Depreciation, depletion and amortization expense is primarily provided on the straight-line method and based on the estimated useful economic lives of the long-lived tangible assets.

Intangible assets with finite lives are subject to amortization.

These intangible assets are being amortized over their estimated useful economic lives typically ranging from 5 to 18 years.

Long-lived tangible and finite-lived intangible assets are reviewed for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable.

As of December 31, 2021, we concluded that our long-lived tangible and finite-lived intangible assets recorded in our consolidated balance sheet were not impaired.

Intangible assets with finite lives and indefinite lives are reviewed for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable.

For the quarter ended June 30, 2022, we performed an evaluation of intangible assets for impairment in connection with the triggering event identified requiring a quantitative test for goodwill impairment.

This impairment evaluation includes a comparison of the undiscounted cash flows expected to be generated by that long-lived asset or asset group to its carrying amount.

If the carrying amount of the long-lived asset or asset group is not recoverable on an undiscounted cash flow basis, impairment is recognized to the extent that the carrying amount exceeds its fair value.

Based on our evaluation, there was no impairment of intangible assets or other long-lived assets for the quarter ended June 30, 2022.

No such triggering event was identified during the remainder of 2022.

We believe that the intangible asset impairment evaluations were based on reasonable assumptions that marketplace participants would use.

However, such assumptions are inherently uncertain and actual results could differ from those estimates.

Changes to or a failure to achieve our projected business assumptions, including growth and profitability, could result in a valuation that would trigger an impairment in future periods.

Inventory valuation

Inventories consist of finished goods, work-in-process, and raw materials used in manufacturing products.

Inventories are stated at the lower of cost or net realizable value, principally determined by the first in, first out method of accounting.

We maintain an allowance for excess and obsolete inventory.

The estimate for excess and obsolete inventory is based upon assumptions about current and anticipated demand, customer preferences, business strategies, 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.

The Company estimates inventory markdowns relating to restructuring charges based upon current and anticipated demand, customer preferences, business strategies, and market conditions including management's actions with respect to inventory products and brands being removed from our portfolio.

Hydrofarm's strategic product consolidation entails removing approximately one-third of all products and one-fifth of all brands relating to our primary product portfolio.

Recent accounting pronouncements

For information regarding recent accounting pronouncements, refer to Note 2 - B asis of presentation and significant accounting policies — Recently issued accounting pronouncements , to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

For information regarding recent accounting pronouncements, refer to Note 2 - Basis of presentation and significant accounting policies — Recently issued accounting pronouncements , to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

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

What changed 10-K

Item 7. Management’s Discussion and Analysis