HYDROFARM HOLDINGS GROUP, INC. 10-Q

ITEM 2. 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 and unaudited consolidated financial statements and the notes contained elsewhere in this Quarterly Report on Form 10-Q and our 2024 Annual Report. 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 Quarterly Report on Form 10-Q, 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 our 2024 Annual Report. 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, grow media and nutrients, as well as a broad portfolio of innovative, 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 grow 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 are primarily a result of an agricultural oversupply impacting our market and resulting in a decrease in indoor and outdoor cultivation. 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 the periods since due to agricultural oversupply initiated during the height of COVID-19 related shelter-in-place orders in 2020 and 2021. In addition, we believe demand for our products has been negatively impacted by the extended period to enact reform of U.S. federal regulations, including cannabis rescheduling, which have been slow to develop and possibly leading cannabis operators to reduce investments in our products, particularly durable goods. In addition, we believe our financial results have been negatively impacted by hydroponic retail store closings and, in some cases, associated accounts receivable allowances. We are closely monitoring the recent tariff and trade policy actions changes taken by the United States and foreign governments. The situation remains fluid due to the rapidly changing global trade environment, and we are evaluating the potential implications of these actions on our business including net sales and profitability. High tariffs on imported products from China, or new tariffs from other countries, could impact the cost of certain products and may negatively impact the Company's 2025 financial performance. For additional information, see the risk factors in our 2024 Annual Report, including the risk entitled “Potential tariffs or a global trade war could increase the cost of our products, which could adversely impact the competitiveness of our products and our financial results.” 23 TABLE OF CONTENTS We began a Restructuring Plan in 2022, and undertook significant actions to streamline operations, reduce costs and improve efficiencies. The major initiatives of the first phase of the Restructuring Plan included (i) narrowing our product and brand portfolio and (ii) the relocation and consolidation of certain manufacturing and distribution centers, including headcount reductions and reorganization to drive a solution based approach. We completed the first phase of the Restructuring Plan during the year ended December 31, 2023. As a result of the continued adverse market conditions, we implemented a second phase of the Restructuring Plan in 2023. The second phase is complete as of March 31, 2025 and it included U.S. manufacturing facility consolidations, in particular with respect to production of certain durable equipment products. Restructuring activities included termination and disposal costs associated with inventory, facilities, and headcount reductions, and non-cash charges consisting of fixed asset and inventory write-downs. Total costs incurred relating to this second phase of the Restructuring Plan, from its commencement in 2023 through March 31, 2025, were (i) $9.7 million of non-cash charges relating primarily to inventory markdowns, and (ii) $2.0 million of cash charges relating primarily to the consolidation of U.S. manufacturing facilities. In 2024, we entered into the Purchase Agreement with the Buyer to sell the inventories, and property, plant and equipment associated with our IGE branded products for approximately $8.7 million, while retaining our proprietary brand and customer relationships. In connection with the Asset Sale, we entered into an exclusive supply agreement with the Buyer, pursuant to which the Buyer provides contract manufacturing and we continue to sell our proprietary branded durable products, which include horticulture benches, racking and LED lighting systems. After completion of the Asset Sale and the aforementioned restructuring actions, we have now consolidated our manufacturing operations into two U.S. locations and our peat moss harvesting and processing operation in Canada. We continue to evaluate our product portfolio and supply chain, in order to improve efficiency, lower our costs and reduce footprint. We are also evaluating other opportunities to sell excess owned land to supplement our cash position and potential contract manufacturing or other outsourcing arrangements. Depending on the length and severity of the industry and market conditions, including the fluid and complex international tariff situation, impacting our business, it is possible we may execute additional restructuring plan actions. Additionally, the amount we will ultimately realize as benefits associated with our Restructuring Plan could differ materially from our estimates, and we may incur additional non-cash charges in future periods depending on our ability to execute asset sales or pursue other alternatives. We may not be able to realize the full extent of anticipated cost savings if industry conditions persist and net sales volumes worsen. Results of Operations—Comparison of three months ended March 31, 2025 and 2024 The following table sets forth our unaudited interim condensed consolidated statements of operations for the three months ended March 31, 2025, and 2024, including amounts and percentages of net sales for each period and the period-to-period change in dollars and percent (amounts in thousands): Three months ended March 31, 2025 2024 Period change Net sales $ 40,534 100.0 % $ 54,172 100.0 % $ (13,638) -25.2 % Cost of goods sold 33,657 83.0 % 43,247 79.8 % (9,590) -22.2 % Gross profit 6,877 17.0 % 10,925 20.2 % (4,048) -37.1 % Operating expenses: Selling, general and administrative 17,863 44.1 % 19,621 36.2 % (1,758) -9.0 % Loss from operations (10,986) -27.1 % (8,696) -16.1 % (2,290) -26.3 % Interest expense (3,377) -8.3 % (3,931) -7.3 % (554) -14.1 % Other income, net 60 0.1 % 215 0.4 % (155) -72.1 % Loss before tax (14,303) -35.3 % (12,412) -22.9 % (1,891) -15.2 % Income tax expense (82) -0.2 % (196) -0.4 % (114) -58.2 % Net loss $ (14,385) -35.5 % $ (12,608) -23.3 % $ (1,777) -14.1 % 24 TABLE OF CONTENTS Net sales Net sales for the three months ended March 31, 2025, were $40.5 million, a decrease of $13.6 million, or 25.2% compared to the same period in 2024. The 25.2% decrease in net sales for the three months ended March 31, 2025, as compared to the same period in 2024, was primarily due to a 22.6% reduction in volume and mix of products sold and a 1.8% decrease in price. This decline was largely driven by the previously mentioned oversupply in the cannabis industry. Gross profit Gross profit for the three months ended March 31, 2025, was $6.9 million, a decrease of $4.0 million, or 37.1%, compared to the same period in 2024. Our gross profit margin percentage decreased to 17.0% for the three months ended March 31, 2025, from 20.2% in the same period in 2024. Gross profit and gross profit margin for the three months ended March 31, 2025, decreased as a result of lower net sales and due to selling a lower proportion of proprietary brand products. Selling, general and administrative expenses SG&A expenses for the three months ended March 31, 2025, were $17.9 million, a decrease of $1.8 million, or 9.0% compared to the same period in 2024. The decrease was due to lower expenses, primarily a result of our cost saving and restructuring initiatives, as follows: (i) a $1.3 million decrease in employee compensation costs, including stock-based compensation and salaries and benefits, and (ii) a $0.5 million decrease in facility costs. Interest expense Interest expense for the three months ended March 31, 2025, was $3.4 million, a decrease from $3.9 million of interest expense recorded in the same period in the prior year. The decrease for the three months ended March 31, 2025 was primarily due to lower debt outstanding due to principal repayments and lower variable interest rates on our Term Loan. Other income, net Other income, net for the three months ended March 31, 2025, was $0.1 million, a decrease compared to $0.2 million during the same period in the prior year. Other income, net for the three months ended March 31, 2025, was primarily driven by interest income. Income taxes We recorded income tax expense of $0.1 million for the three months ended March 31, 2025, representing an effective tax rate of (0.6)%. Our effective tax rate for the three months ended March 31, 2025, differs from the federal statutory rate of 21% primarily due to U.S. and foreign jurisdictions in full valuation allowance. The income tax expense for the three months ended March 31, 2025, was primarily due to foreign taxes in certain jurisdictions and U.S. state taxes. We recorded income tax expense of $0.2 million for the three months ended March 31, 2024, representing an effective tax rate of (1.6)%. Our effective tax rate for the three months ended March 31, 2024, 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 expense for the three months ended March 31, 2024, was primarily due to U.S. state taxes and foreign taxes in certain jurisdictions. 25 TABLE OF CONTENTS Liquidity and Capital Resources Cash Flow from Operating, Investing, and Financing Activities Comparison of the three months ended March 31, 2025, and March 31, 2024 The following table summarizes our cash flows for the three months ended March 31, 2025, and 2024 (amounts in thousands): Three months ended March 31, 2025 2024 Net cash used in operating activities $ (11,763) $ (2,297) Net cash used in investing activities (248) (1,408) Net cash used in financing activities (413) (2,358) Effect of exchange rate changes on cash and cash equivalents 41 (97) Net decrease in cash and cash equivalents (12,383) (6,160) Cash and cash equivalents at beginning of period 26,111 30,312 Cash and cash equivalents at end of period $ 13,728 $ 24,152 Operating Activities Net cash used in operating activities was $11.8 million for the three months ended March 31, 2025. The net cash usage was primarily due to a $14.4 million net loss and an $8.3 million net cash outflow from an increase in working capital, partially offset by net non-cash items of $10.9 million. The $8.3 million net increase in working capital was primarily comprised of a $6.8 million increase in accounts receivable, a $3.2 million decrease in accrued expenses and other current liabilities, and a $1.8 million decrease of lease liabilities, partially offset by a $3.8 million decrease in accounts payable. During the three months ended March 31, 2025, we paid $5.2 million in cash interest. Net cash used in operating activities was $2.3 million for the three months ended March 31, 2024. Consistent with historical seasonal trends, we utilized cash from operating activities in the first quarter to fund our working capital. The $1.3 million net reduction in working capital was primarily driven by a $5.7 million increase of accounts receivable and a $2.0 million decrease of lease liabilities, partially offset by a $4.2 million increase of accounts payable and accrued expenses and other current liabilities and a $2.2 million decrease of inventory. During the three months ended March 31, 2024, we paid $4.7 million in cash interest. Investing Activities Net cash used in investing activities was $0.2 million for the three months ended March 31, 2025, compared to $1.4 million for the three months ended March 31, 2024. The net cash used in investing activities for both periods was primarily due to capital expenditures of property, plant and equipment. Financing Activities Net cash used in financing activities was $0.4 million for the three months ended March 31, 2025, primarily driven by (i) $0.3 million of Term Loan repayments relating to required quarterly payments of principal, and (ii) finance lease principal payments of $0.1 million. Net cash used in financing activities was $2.4 million for the three months ended March 31, 2024, primarily driven by $2.0 million of Term Loan repayments relating to required quarterly payments of principal and prepayments made under the Term Loan's reinvestment provision from a sale-leaseback transaction that closed in January 2023. Availability and Use of Cash Our ability to make investments in our business, service our debt and maintain liquidity will primarily 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 26 TABLE OF CONTENTS depend on numerous factors, many of which are beyond our control as further discussed in Item 1A. Risk Factors included in this Quarterly Report on Form 10-Q and in our 2024 Annual Report. As further described in Note 3 – Restructuring and Asset Sales and Note 10 – Debt, we closed on the Asset Sale, whereby, in accordance with our Term Loan, the net proceeds, approximately $6.3 million, are required to be reinvested into certain permitted investments, such as capital expenditures or permitted acquisitions/ investments, or offered to prepay Term Loan principal. As of March 31, 2025, in accordance with this provision, we have estimated the total reinvestments and believe it is probable that an offer to prepay may be made in an estimated amount of $4.6 million. The amount we may offer to prepay is uncertain and based on future activity. The estimated amount has been classified as current debt on our condensed consolidated balance sheet. Refer to further discussion below, relatin g to Term Loan reinvestment provisions regarding the net cash proceeds of the Asset Sale . If necessary, we believe that we could supplement our cash position through additional asset sales or divestiture of one or more of our brands or lines of business. During 2024, we sold a portion of the excess owned land at our Goshen, New York location, and are evaluating other opportunities to sell excess owned land to supplement our cash position. 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 refer enced in our Term Loan and Revolving Credit Facility, such as subjecting us to make 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 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 is outstanding as of the Amendment No. 1 closing date shall continue until the end of the applicable interest period for such Eurodollar Rate Loan and the provisions of the Term Loan applicable thereto shall continue and remain 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 shall have 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 Quarterly Report on Form 10-Q, 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. 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. 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) certain asset sales that are collateral, or (iii) upon the issuance, offering, or placement of new debt obligations. As described in Note 3 – Restructuring and Asset Sales and Note 10 – Debt , we received net cash proceeds of approximately $6.3 million in May 2024 from the Asset Sale 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 Asset Sale, and (ii) investments which are contractually committed within one-year of the Asset Sale, 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 2025. As of March 31, 2025, in accordance with this provision, we have estimated the total reinvestments and believe it is probable that an offer to prepay may be made in an estimated amount of $4.6 million. The amount we may offer to prepay is uncertain and based on future activity. The estimated amount has been classified as current debt on our condensed consolidated balance sheet. 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 March 31, 2025, and December 31, 2024, the outstanding principal balance on the Term Loan was $119.0 million and $119.3 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 March 31, 2025. The Term Loan is secured by a first lien on our non-working capital assets and a second lien on our working capital assets. 27 TABLE OF CONTENTS Revolving Credit Facility On March 29, 2021, we and certain of our subsidiaries entered into the 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, we entered into the Fourth Amendment to the Revolving Credit Facility 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, we and certain of our subsidiaries entered into the Fifth Amendment to the Revolving Credit Facility, 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 our fixed charge coverage ratio. On November 1, 2024, we and certain of our subsidiaries entered into the Sixth Amendment to the Revolving Credit Facility pursuant to which the maximum commitment amount was reduced to $35 million. 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, or the CBFR. 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 ($35 million as of March 31, 2025) 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, we 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 received a consent from JPMorgan Chase Bank, N.A., as administrative agent, to permit the cash settlement of fractional shares in connection with the reverse stock split, which is described further in Note 2 – Basis of Presentation and Significant Accounting Policies . We were in compliance with all debt covenants as of March 31, 2025. As of March 31, 2025, approximately $17 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 March 31, 2025, and December 31, 2024, we had zero borrowed under the Revolving Credit Facility. The aforementioned financing arrangements and other transactions are more fully described in the notes to the condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. Subsequent event - Revolving Credit Facility Seventh Amendment On May 9, 2025, we entered into the Seventh Amendment to the Revolving Credit Facility, pursuant to which the maturity date of the Revolving Credit Facility was extended from June 30, 2026 to June 30, 2027, the maximum commitment amount under the Revolving Credit Facility was reduced from $35,000 to $22,000, and certain other changes were made, including the addition of a $2,000 availability block, an increase of the cash dominion trigger from less than 10% of availability to less than 50% of availability and an increase of the fixed charge ratio trigger from less than 10% excess availability to less than 20% of excess availability. 28 TABLE OF CONTENTS Cash and Cash Equivalents The cash and cash equivalents balances of $13.7 million and $26.1 million at March 31, 2025, and December 31, 2024, respectively, included $8.3 million and $11.9 million, respectively, held by foreign subsidiaries. Material Cash Requirements Our estimated material cash requirements include (i) principal repayments and anticipated interest payments on our long-term debt, (ii) finance lease payments, (iii) operating lease payments, and (iv) balances subject to the Term Loan reinvestment provision, as well as other purchase obligations to support our operations. Variable rates on our Term Loan are subject to change as further described in Item 3. Quantitative and Qualitative Disclosures About Market Risk . Refer to Item 1. Financial Statements , Note 10 – Debt , Note 7 – Leases , and Note 14 – 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. Critical Accounting Policies and Estimates The preceding discussion and analysis of our consolidated results of operations and financial condition should be read in conjunction with our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. Our critical accounting policies and estimates are identified in Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of the 2024 Annual Report and include the discussion of estimates used in indefinite lived intangible assets, long-lived tangible and finite-lived intangible assets, and inventory valuation. Such accounting policies and estimates require significant judgments and assumptions to be used in the preparation of the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q, and actual results could differ materially from the amounts reported. Recent Accounting Pronouncements For information regarding recent accounting pronouncements, refer to Note 2 – Basis of Presentation and Significant Accounting Policies — Recent accounting pronouncements , to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. 29 TABLE OF CONTENTS