Item 7. Management’s Discussion and Analysis
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis provides information that we believe is relevant to an assessment and understanding of our results of operations and financial condition. You should read this analysis in conjunction with our audited consolidated financial statements and the notes contained elsewhere in this Annual Report on Form 10-K. This discussion and analysis contains statements of a forward-looking nature relating to future events or our future financial performance. Actual events or results may differ materially from forward-looking statements. In evaluating such statements, you should carefully consider the various factors identified in this Annual Report on Form 10-K, which could cause actual results to differ materially from those expressed in, or implied by, any forward-looking statements, including those set forth in "Risk Factors" in this Annual Report on Form 10-K. See "Special Note Regarding Forward-Looking Statements."
Company Overview
We are a leading independent manufacturer and distributor of branded hydroponics equipment and supplies for controlled environment agriculture ("CEA"), including grow lights, climate control solutions, growing media and nutrients, as well as a broad portfolio of innovative and proprietary branded products. We primarily serve the U.S. and Canadian markets, and believe we are one of the leading companies in these markets in an otherwise fragmented industry. For over 40 years, we have helped growers make growing easier and more productive. Our mission is to empower growers, farmers and cultivators with products that enable greater quality, efficiency, consistency, and speed in their grow projects.
Hydroponics is the farming of plants using soilless growing media and often artificial lighting in a controlled indoor or greenhouse environment. Hydroponics is the primary category of CEA and we use the terms CEA and hydroponics interchangeably. Our products are used to grow, farm and cultivate cannabis, flowers, fruits, plants, vegetables, grains and herbs in controlled environment settings that allow end users to control key farming variables including temperature, humidity, CO 2 , light intensity spectrum, nutrient concentration and pH. Through CEA, growers are able to be more efficient with physical space, water and resources, while enjoying year-round and more rapid grow cycles as well as more predictable and abundant grow yields, when compared to other traditional growing methods.
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 online ordering platform. 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 have experienced adverse financial results which we believe is primarily a result of an agricultural oversupply impacting our market. An agricultural oversupply has impacted our industry, driving cannabis wholesale prices down and resulting in a decrease in indoor and outdoor cultivation in the markets where we operate. The extent these market conditions will continue to negatively impact our business and results of operations is uncertain and difficult to predict at this time. We believe COVID-19 may have provided a positive demand impact for the Company 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 and 2023 due to agricultural oversupply initiated during the height of COVID-related shelter-in-place orders in 2020 and 2021.
In connection with our previously disclosed evaluation of our facility footprint and product and brand portfolio, we initiated a restructuring plan (the "Restructuring Plan") during the quarter ended December 31, 2022. In connection with the first phase of our Restructuring Plan, we have undertaken significant actions to streamline our operations, reduce costs and improve efficiencies during the industry recession. Our major initiatives included (i) narrowing our product and brand portfolio, including removing approximately one-third of all products and one-fifth of all brands relating to our primary product portfolio, which excluded our garden center business in Canada, and (ii) relocating and consolidating certain manufacturing and distribution centers including headcount reductions and reorganization to drive a solution based approach, 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 the 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. During the year ended December 31, 2023, we recorded a pre-tax restructuring charges of $2.1 million for the first phase of the Restructuring
46
TABLE OF CONTENTS
Plan, which were primarily costs related to the relocation and termination of certain facilities in Canada. The restructuring charges are primarily recorded within Cost of goods sold on the consolidated statements of operations. Total costs incurred relating to this first phase of the Restructuring Plan since it commenced in the fourth quarter of 2022, are (i) $6.4 million relating primarily to inventory markdowns, and (ii) $3.4 million relating primarily to the relocation and termination of certain facilities in Canada.
As a result of the continued adverse market conditions, in the third quarter of 2023 we announced and began implementing a second phase of the Restructuring Plan, including U.S. manufacturing facility consolidations, in particular with respect to our production of certain durable equipment products. We are reducing facility space and consolidating our manufacturing operations in the U.S. to improve efficiency and reduce costs. During the year ended December 31, 2023, we recorded estimated pre-tax charges of $9.2 million for the second phase of restructuring relating primarily to non-cash raw material inventory write-downs as we sell certain assets and reduce capacity and facility space, given low customer demand for these products. We also may evaluate other alternatives or opportunities to maximize our recovery of the inventory value. These restructuring charges are primarily recorded within Cost of goods sold on the consolidated statements of operations. Further, we estimate additional charges associated with this second phase of the Restructuring Plan may exceed $2.0 million and be incurred through the next several quarters as we consolidate and exit facilities. These estimated additional charges include an estimated cash impact that may exceed $1.0 million for facility consolidations and lease and other contract terminations. We anticipate the second phase of our restructuring plan and related actions may result in cost savings of approximately $1.5 million on an annualized basis. The amounts we will ultimately realize or disburse in connection with both phases of the Restructuring Plan could differ materially from our estimates, and we may not be able to realize the full extent of our anticipated cost savings.
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 goodwill 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 United States 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 during the remainder of 2022, or the year ended December 31, 2023.
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 sales declines we experienced, which we believe were primarily a result of an agricultural oversupply impacting our market, and a reduction to our profitability and loss from operations. These market conditions continued to negatively impact our business and results of operations during the remainder of 2022, and the year ended December 31, 2023.
We maintain an allowance for excess and obsolete inventory that is based upon assumptions about future demand and market conditions. 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 plan actions and incur future associated charges, and we may not be able to realize the full extent of our anticipated cost savings.
Filing Status
As of June 30, 2023, the market capitalization of outstanding shares of our common stock owned by non-affiliates decreased to below $60 million, which triggered the Company being classified as a non-accelerated filer with respect to SEC regulations and filing requirements effective December 31, 2023. As a result, our annual assessment of the effectiveness of our internal control over financial reporting does not require an audit by our external audit firm in compliance with the provisions of Section 404 of the Sarbanes-Oxley Act of 2002 for this Annual Report on Form 10-K for the year ended December 31, 2023. The Company continues to qualify as a smaller reporting company in accordance with Rule 12b-2 under the Exchange Act and continues to follow certain of the scaled back disclosure accommodations.
47
TABLE OF CONTENTS
Components of Results of Operations
Net sales
We generate net sales from the manufacturing and distribution 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 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 our customers primarily in the U.S. and Canada.
We periodically offer sales incentives to our customers, including early pay discounts, volume-based rebates, temporary price reductions, advertising credits and other trade activities. Net sales reflect our gross sales less sales incentives which are estimated and recorded at the time of sale plus amounts billed to customers for shipping and handling costs. We anticipate that sales incentives and/or the amount billed to customers for shipping and handling costs could impact our net sales and that changes in such promotional activities or freight recovery charges could impact period-over-period results.
Cost of goods sold
Cost of goods sold consists primarily of material costs, inbound and outbound freight costs, labor costs primarily for manufacturing and warehouse personnel, facility costs for manufacturing operations, depreciation, depletion and amortization of manufacturing and warehouse improvements and equipment, restructuring costs, inventory allowances, 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 when/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 successful in instituting our restructuring and related productivity and cost saving initiatives and/or if we are able to scale our business as we obtain a higher proportion of net sales associated with proprietary branded products.
Selling, general and administrative
Selling, general and administrative expenses ("SG&A") consists primarily of facility costs for distribution operations, depreciation and amortization of assets, certain acquisition and integration expenses, marketing and advertising, 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 - Comparison of Years Ended December 31, 2023, and 2022
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, 2023, and 2022, 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,
2023 2022 Year to year change
Net sales $ 226,581 100.0 % $ 344,501 100.0 % $ (117,920) -34.2 %
Cost of goods sold 188,969 83.4 % 315,165 91.5 % (126,196) -40.0 %
Gross profit 37,612 16.6 % 29,336 8.5 % 8,276 28.2 %
Operating expenses:
Selling, general and administrative 87,314 38.5 % 118,604 34.4 % (31,290) -26.4 %
Impairments — 0.0 % 192,328 55.8 % (192,328) -100.0 %
Loss from operations (49,702) -21.9 % (281,596) -81.7 % 231,894 82.3 %
Interest expense (15,442) -6.8 % (10,958) -3.2 % 4,484 40.9 %
Other income, net 118 0.1 % 696 0.2 % (578) -83.0 %
Loss before tax (65,026) -28.7 % (291,858) -84.7 % 226,832 77.7 %
Income tax benefit 213 0.1 % 6,443 1.9 % (6,230) -96.7 %
Net loss (64,813) -28.6 % (285,415) -82.8 % 220,602 77.3 %
48
TABLE OF CONTENTS
Net sales
Net sales for the year ended December 31, 2023, were $226.6 million, a decrease of $117.9 million, or 34.2%, compared to the same period in 2022. The 34.2% decrease was primarily due to a 32% decline in volume of products sold and a 2% decrease in price and mix of products sold. The decrease in volume of products sold was primarily related to the aforementioned oversupply in the cannabis industry. During the year ended December 31, 2023, we sold a higher mix of generally lower-priced consumables relative to higher-priced durable products, and reduced selling prices for certain brands and product segments, including previously reserved lighting products .
Gross profit
Gross profit for the year ended December 31, 2023, was $37.6 million, an increase of $8.3 million, or 28.2%, compared to the same period in 2022. The increase in gross profit was primarily due to (i) incurring lower inventory charges in the current year, as the prior year 2022 was impacted by $18.5 million of inventory reserves and related charges, (ii) a $4.8 million reduction in acquisition and integration expenses compared to the prior year, and (iii) benefits from selling a higher proportion of proprietary brand products, lower freight costs, and improved productivity. Our restructuring plan and related cost-saving initiatives contributed to realizing these net benefits. These improvements were partially offset by lower net sales in the current year and $3.2 million of higher restructuring charges in 2023 compared to the prior year period. The restructuring charges were primarily due to non-cash inventory markdowns. Our gross profit margin percentage increased to 16.6% for the year ended December 31, 2023, from 8.5% in the same period in 2022 .
Selling, general and administrative expenses
SG&A expenses for the year ended December 31, 2023, were $87.3 million, a decrease of $31.3 million, or 26.4%, compared to the same period in 2022. The decrease was partially due to a $9.7 million decline in amortization and depreciation expenses, as the prior year period included additional amortization expense due to adjustments to the useful lives of intangible assets, as described in Note 2 – Basis of Presentation and Significant Accounting Policies . Additionally, SG&A expenses decreased $21.6 million in the year ended December 31, 2023, due to lower expenses in several areas, including as a result of our cost saving and restructuring initiatives: (i) $5.5 million decrease in salaries and benefits, (ii) $4.1 million decrease in accounts receivable reserves and related charges, (iii) $3.4 million decrease in stock-based compensation, (iv) $2.9 million decrease in acquisition and integration expenses, and (v) $2.1 million decrease in professional and outside services, along with other expense reductions in multiple areas.
Impairments
The Company did not record any impairment charges for the year ended December 31, 2023. The Company 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 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 United States and Canada caused by macroeconomic and industry conditions. For the year ended December 31, 2022, the Company also recorded an impairment of a note receivable of $2.6 million. Refer to Note 2 – Basis of Presentation and Significant Accounting Policies and Note 14 – Fair Value Measurements for further description regarding the note receivable impairment.
Interest expense
Interest expense for the year ended December 31, 2023, was $15.4 million, an increase of $4.5 million, or 40.9%, compared to the same period in the prior year. The increase was primarily due to higher variable interest rates on our Term Loan.
Other income, net
Other income, net for the year ended December 31, 2023, was $0.1 million, a decrease of $0.6 million compared to the same period in the prior year. Other income, net for the year ended December 31, 2023, was primarily driven by foreign currency exchange rate gains and interest income, partially offset by legal fees associated with the amendment of the Term Loan. Other income, net for the year ended December 31, 2022 was primarily driven by foreign exchange rate gains, partially offset by the write-off of unamortized deferred financing costs associated with the modification of the Revolving Credit Facility entered into during the fourth quarter of 2022.
49
TABLE OF CONTENTS
Income tax benefit
We recorded an income tax benefit of $0.2 million for the year ended December 31, 2023, representing an effective tax rate of 0.3%. Our effective tax rate for the year ended December 31, 2023, differs from the federal statutory rate of 21% primarily due to maintaining a full valuation allowance against our net deferred tax assets in the United States and most foreign jurisdictions. The income tax benefit for the year ended December 31, 2023, was primarily due to minor foreign tax benefits in certain jurisdictions.
Income tax benefit for the year ended December 31, 2022, was $6.4 million. 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 3 - 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.
Liquidity and Capital Resources
Cash Flow from Operating, Investing, and Financing Activities
Comparison of Years Ended December 31, 2023, and 2022
The following table summarizes our cash flows for the years ended December 31, 2023, and 2022 (amounts in thousands):
Years ended December 31,
2023 2022
Net cash from operating activities $ 7,044 $ 21,989
Net cash used in investing activities (4,170) (8,487)
Net cash from (used in) financing activities 6,065 (20,200)
Effect of exchange rate changes on cash, cash equivalents and restricted cash 82 (395)
Net increase (decrease) in cash, cash equivalents and restricted cash
9,021 (7,093)
Cash, cash equivalents and restricted cash at beginning of year 21,291 28,384
Cash, cash equivalents and restricted cash at end of year $ 30,312 $ 21,291
Operating Activities
Net cash from operating activities was $7.0 million for the year ended December 31, 2023, was primarily due to a $12.4 million net cash inflow from a reduction of working capital, partially offset by a reported net loss of $64.8 million less non-cash items of $59.5 million. The net reduction in working capital was primarily driven by a $26.1 million decrease of inventories, partially offset by decreases of $9.2 million of lease liabilities and $3.5 million of accrued expenses and other current liabilities. During the year ended December 31, 2023, we paid $13.1 million in cash interest, compared to $9.6 million in the prior year. In addition, we obtained cash income tax refunds of $1.0 million in 2023 compared to $3.9 million of cash income tax payments in the prior year.
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.
Investing Activities
Net cash used in investing activities for the year ended December 31, 2023, was $4.2 million, due primarily to capital expenditures for property, plant and equipment. The 2023 cash usage primarily includes investments in our peat moss harvesting operation in Canada.
50
TABLE OF CONTENTS
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 investments in our manufacturing operations and the expansion and relocation of certain of our distribution centers. The 2022 cash usage primarily includes investments in the peat moss harvesting operation in Canada and IGE manufacturing operations in the U.S.
Financing Activities
Net cash from financing activities was $6.1 million for the year ended December 31, 2023, primarily driven by $8.6 million of proceeds from the Sale-Leaseback Transaction, partially offset by $1.3 million of quarterly principal payments of the Term Loan.
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.
Availability and Use of Cash
Our ability to make investments in our business, service our debt and maintain liquidity will depend upon our ability to generate excess operating cash flows through our operating subsidiaries. We believe that our cash flows from operating activities, combined with current cash levels and borrowing availability under the Revolving 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 guarantee 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. Actual results of operations will depend on numerous factors, many of which are beyond our control as further discussed in Part I, Item 1A, Risk Factors included 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 Eu gene, 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. Refer to further discussion below relatin g to Term Loan reinvestment provisions regarding the net cash proceeds of the Sale Leaseback Transaction.
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. Any potential such event may be subject to provisions referenced in our Term Loan and Revolving Credit Facility, such as subjecting the Company to making mandatory prepayments.
Term Loan
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"). The Term Loan was amended by Amendment No. 1 effective as of June 27, 2023, to replace the LIBOR referenced rates with SOFR referenced rates. Pursuant to Amendment No. 1, any Term Loan that constitutes a Eurodollar Rate Loan that was outstanding as of the Amendment No. 1 closing date continued until the end of the applicable interest period for such Eurodollar Rate Loan and the provisions of the Term Loan applicable thereto continued and remained in effect (notwithstanding the occurrence of the Amendment No. 1 closing date) until the end of the applicable interest period for such Eurodollar Rate Loan, after which such provisions had no further force or effect. Such Eurodollar Rate Loan shall subsequently either be an ABR Loan or a Term Benchmark Loan. The ABR Loans shall bear interest at the Alternate Base Rate (with a 2.0% floor) plus 4.50%, and Term Benchmark Loans shall bear interest at the Adjusted Term SOFR Rate (with a 1.0% floor) plus 5.50%. As of the date of filing this Annual Report on Form 10-K, the ABR Loan and Term Benchmark Loan credit spreads of 4.50% and 5.50%, respectively, within the Amendment No. 1 have not changed from the credit spreads in the original Term Loan. The Term Loan matures on October 25, 2028.
51
TABLE OF CONTENTS
The principal amounts of the Term Loan are scheduled to be repaid in consecutive quarterly installments in amounts equal to 0.25% of the original 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 of October 25, 2028. We are also required to make mandatory prepayments in the event of (i) achieving certain excess cash flow criteria, including the achievement and maintenance of a specific leverage ratio, (ii) selling assets that are collateral, or (iii) upon the issuance, offering, or placement of new debt obligations. As described in Note 6 – Leases , we received net cash proceeds in January 2023 from the Sale-Leaseback Transaction and are subject to a provision whereby such net cash proceeds can be reinvested into certain investments, such as capital expenditures. This provision of the Term Loan includes (i) cash investments made within a one-year period from the Sale Leaseback Transaction, and (ii) investments which are contractually committed within one-year of the Sale Leaseback Transaction, and paid within 180 days after entering into such contractual commitment. The amount of any net cash proceeds which are not reinvested would require us to make an offer to prepay the corresponding amount on the Term Loan in 2024. In accordance w ith this provision, we classified $1.7 million as current debt on our consolidated balance sheet as of December 31, 2023, and offer to prepay the Term Loan in this amount. In addition, we have $2.2 million of contractual commitments pursuant to this provision. Should any of the $2.2 million of contractual commitments not be paid within 180 days of their contractual commitment dates, we will be required to make an additional offer to prepay the corresponding amount in 2024. The foregoing description of the reinvestment provision does not purport to be complete and is qualified in its entirety by reference to the provisions of the Term Loan.
As of December 31, 2023, and 2022, the outstanding principal balance on the Term Loan was $122.5 million and $123.8 million, respectively.
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, 2023. The Term Loan is secured by a first lien on our non-working capital assets and a second lien on our working capital assets.
Revolving Credit Facility
On March 29, 2021, we and certain of our subsidiaries entered into a Senior Secured Revolving Credit Facility (the "Revolving Credit Facility") with JPMorgan Chase Bank, N.A., as administrative agent, issuing bank and swingline lender for a revolving line of credit up to $50 million. The Revolving Credit 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 Revolving Credit 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. The Revolving Credit 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 Revolving Credit Facility and granted liens on their assets. On December 22, 2022, the Company entered into the Fourth Amendment pursuant to which a sale-leaseback transaction was permitted, and certain other changes were made, including a reduction of the maximum commitment amount under the Revolving Credit Facility from $100 million to $75 million and transitioning the LIBOR based rates to SOFR based rates. On March 31, 2023, the Company and certain of its subsidiaries entered into the Fifth Amendment, pursuant to which the maturity date was extended to June 30, 2026, the maximum commitment amount under the Revolving Credit Facility was reduced to $55 million, and the interest rate on borrowings was revised to various spreads, based on the Company's fixed charge coverage ratio.
The Revolving Credit 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 0.40% per annum is charged for available but unused borrowings. Our obligations under the Revolving 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, as amended to include additional subsidiaries.
The Revolving Credit 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 Revolving Credit Facility is less than an amount equal to 10% of the Aggregate Revolving Commitment (currently $55 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.
52
TABLE OF CONTENTS
We were in compliance with all debt covenants as of December 31, 2023. As of December 31, 2023, approximately $22 million was available to borrow under the Revolving Credit Facility, before we would be required to comply with the minimum fixed charge coverage ratio of 1.1x.
As of December 31, 2023, and December 31, 2022, the Company had zero borrowed under the Revolving Credit Facility.
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.
Cash and cash equivalents
The cash and cash equivalents balances of $30.3 million and $21.3 million at December 31, 2023, and December 31, 2022, respectively, included $8.5 million and $7.3 million, respectively, held by foreign subsidiaries.
Material Cash Requirements
Our estimated 2024 material cash requirements include (i) principal repayments and anticipated interest payments based on current variable rates on our long-term debt of $3.0 million and $14.8 million, respectively, (ii) finance lease payments of $1.4 million, (iii) operating lease payments of $10.4 million, and (iv) $2.2 million subject to the Term Loan's reinvestment provision, as well as other purchase obligations to support our operations. We have estimated our material cash requirements assuming no borrowings under the Revolving Credit Facility and considering the current variable interest rates on our Term Loan that are based on Secured Overnight Financing Rate. However, these assumptions may change and variable rates on our Term Loan are subject to change as further described in Item 7A. The aforementioned estimated 2024 material cash requirements are substantially similar to our 2023 cash requirements. Refer to the above discussion relating to our cash flows from operating, investing and financing activities for the year ended December 31, 2023. Also refer to Item 8, Financial Statements , Note 9 - Debt , Note 6 - Leases , and Note 13 - Commitments and Contingencies 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.
Seasonality
Our net sales are typically seasonally stronger in our first three fiscal quarters due to robust sales in preparation of and during 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. Likely due to the industry recession, our net sales have declined in 2023 compared to 2022 and have led to seasonal patterns that may have less consistency. 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.
Critical Accounting Policies and Estimates
Certain accounting policies require us to make estimates and judgments in determining the amounts reflected in the Consolidated Financial Statements. Such estimates and judgments necessarily involve varying, and possibly significant, degrees of uncertainty. Accordingly, certain amounts currently recorded in the financial statements will likely be adjusted in the future based on new available information and changes in other facts and circumstances. A discussion of our principal accounting policies that required the application of significant judgments as of December 31, 2023 and 2022 follows.
Goodwill and indefinite-lived intangible assets
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 a full impairment of all goodwill due to market softness in
53
TABLE OF CONTENTS
demand in the U.S. and Canada. 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 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, 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. 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 long-lived tangibles and intangible assets for impairment in connection with the triggering event identified requiring a quantitative test for goodwill impairment. This impairment evaluation included 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 or the year ended December 31, 2023.
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 planned actions with respect to inventory.
Recent accounting pronouncements
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.
54
TABLE OF CONTENTS