HYDROFARM HOLDINGS GROUP, INC. 10-Q

ITEM 1. FINANCIAL STATEMENTS Hydrofarm Holdings Group, Inc. CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) (In thousands, except share and per share amounts) March 31, December 31, 2021 2020 Assets Current assets: Cash and cash equivalents $ 60,264 $ 75,178 Restricted cash 1,777 1,777 Accounts receivable, net 33,520 21,626 Inventories 96,277 88,618 Notes receivable — 3,151 Prepaid expenses and other current assets 13,825 9,567 Total current assets 205,663 199,917 Property and equipment, net 3,771 3,988 Operating lease right-of-use assets 17,360 18,289 Intangible assets, net 51,267 52,421 Other assets 4,616 1,180 Total assets $ 282,677 $ 275,795 Liabilities, convertible preferred stock and stockholders’ equity Current liabilities: Accounts payable $ 36,807 $ 22,638 Accrued expenses and other current liabilities 14,177 21,615 Current portion of lease liabilities 3,836 3,701 Current portion of long-term debt 822 746 Total current liabilities 55,642 48,700 Long-term lease liabilities 14,385 15,320 Long-term debt 238 290 Other long-term liabilities 564 567 Total liabilities 70,829 64,877 Commitments and contingencies (Note 10) Convertible preferred stock ( $ 0.0001 par value; 50,000,000 shares authorized; 0 shares issued and outstanding at March 31, 2021 and December 31, 2020) — — Stockholders’ equity Common stock ($ 0.0001 par value; 300,000,000 shares authorized; 33,970,364 and 33,499,953 shares issued and outstanding at March 31, 2021 and December 31, 2020, respectively) 3 3 Additional paid-in capital 360,015 364,248 Accumulated other comprehensive income 822 599 Accumulated deficit ( 148,992 ) ( 153,932 ) Total stockholders’ equity 211,848 210,918 Total liabilities, convertible preferred stock and stockholders’ equity $ 282,677 $ 275,795 The accompanying notes are an integral part of the condensed consolidated financial statements. 1 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (In thousands, except share and per share amounts) Three months ended March 31, 2021 2020 Net sales $ 111,389 $ 66,897 Cost of goods sold 88,166 55,333 Gross profit 23,223 11,564 Operating expenses: Selling, general and administrative 16,826 11,722 Impairment, restructuring and other 15 9 Income (loss) from operations 6,382 ( 167 ) Interest expense ( 90 ) ( 2,803 ) Loss on debt extinguishment ( 680 ) — Other income, net 84 21 Income (loss) before tax 5,696 ( 2,949 ) Income tax expense ( 756 ) ( 144 ) Net income (loss) 4,940 ( 3,093 ) Cumulative dividends allocated to Series A Convertible Preferred Stock — ( 634 ) Net income (loss) attributable to common stockholders $ 4,940 $ ( 3,727 ) Net income (loss) per share attributable to common stockholders: Basic $ 0.15 $ ( 0.18 ) Diluted $ 0.13 $ ( 0.18 ) Weighted-average shares of common stock outstanding: Basic 33,717,103 20,688,439 Diluted 38,997,031 20,688,439 The accompanying notes are an integral part of the condensed consolidated financial statements. 2 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED) (In thousands) Three months ended March 31, 2021 2020 Net income (loss) $ 4,940 $ ( 3,093 ) Other comprehensive income (loss): Foreign currency translation gain (loss) 223 ( 1,283 ) Total comprehensive income (loss) $ 5,163 $ ( 4,376 ) The accompanying notes are an integral part of the condensed consolidated financial statements. 3 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY (UNAUDITED) (In thousands, except for share amounts) Convertible Preferred Stock Common Stock Additional Paid-In Capital Accumulated Other Comprehensive (Loss) Income Accumulated Deficit Total Stockholders’ Equity Shares Amount Shares Amount Balance, January 1, 2020 7,007,429 $ 21,802 20,688,439 $ 2 $ 156,179 $ ( 144 ) $ ( 146,659 ) $ 9,378 Proceeds from issuance of Series A Convertible Preferred Stock, net of issuance costs of $ 169 717,616 2,342 — — — — — — Collection of receivable for issuance of Series A Convertible Preferred Stock — 1,450 — — — — — — Stock-based compensation expense — — — — 34 — — 34 Series A Convertible Preferred Stock cumulative dividend — 634 — — ( 634 ) — — ( 634 ) Net loss — — — — — — ( 3,093 ) ( 3,093 ) Foreign currency translation loss — — — — — ( 1,283 ) — ( 1,283 ) Balance, March 31, 2020 7,725,045 $ 26,228 20,688,439 $ 2 $ 155,579 $ ( 1,427 ) $ ( 149,752 ) $ 4,402 Balance, January 1, 2021 — $ — 33,499,953 $ 3 $ 364,248 $ 599 $ ( 153,932 ) $ 210,918 Common stock issued upon exercise of options — — 32,272 — 272 — — 272 Issuance of common stock for vesting of restricted stock units — — 214,324 — — — — — Shares repurchased for withholding tax on restricted stock units — — ( 88,360 ) — ( 5,506 ) — — ( 5,506 ) Issuance of common stock under cashless warrant exercise — — 312,175 — — — — — Stock-based compensation expense — — — — 1,001 — — 1,001 Net income — — — — — — 4,940 4,940 Foreign currency translation gain — — — — — 223 — 223 Balance, March 31, 2021 — $ — 33,970,364 $ 3 $ 360,015 $ 822 $ ( 148,992 ) $ 211,848 The accompanying notes are an integral part of the condensed consolidated financial statements. 4 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (In thousands) Three months ended March 31, 2021 2020 Operating activities Net income (loss) $ 4,940 $ ( 3,093 ) Adjustments to reconcile net income (loss) to net cash used in operating activities: Depreciation and amortization 1,591 1,715 Stock-based compensation expense 1,001 34 Non-cash operating lease expense 958 876 Other 640 589 Changes in assets and liabilities: Accounts receivable ( 11,554 ) ( 10,056 ) Inventories ( 7,496 ) 4,316 Prepaid expenses and other current assets ( 3,970 ) 16 Other assets ( 414 ) 36 Accounts payable 14,332 1,882 Accrued expenses and other current liabilities ( 1,840 ) 2,816 Lease liabilities ( 826 ) ( 879 ) Other long-term liabilities — 1 Net cash used in operating activities ( 2,638 ) ( 1,747 ) Investing activities Purchases of property and equipment ( 428 ) ( 82 ) Proceeds from notes receivable — 2,000 Other ( 17 ) 14 Net cash (used in) provided by investing activities ( 445 ) 1,932 Financing activities Payment of withholding tax related to restricted stock units ( 11,595 ) — Borrowings under revolving credit facilities 52,344 51,570 Repayments of revolving credit facilities ( 52,250 ) ( 56,436 ) Proceeds from issuance of Series A Convertible Preferred Stock, net of issuance costs — 3,792 Other ( 326 ) ( 160 ) Net cash used in financing activities ( 11,827 ) ( 1,234 ) Effect of exchange rate changes on cash, cash equivalents and restricted cash ( 4 ) ( 146 ) Net decrease in cash, cash equivalents and restricted cash ( 14,914 ) ( 1,195 ) Cash, cash equivalents and restricted cash at beginning of period 76,955 32,857 Cash, cash equivalents and restricted cash at end of period $ 62,041 $ 31,662 The accompanying notes are an integral part of the condensed consolidated financial statements. 5 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (dollars in thousands, except share and per share amounts) 1. DESCRIPTION OF THE BUSINESS Description of the business Hydrofarm Holdings Group, Inc. and its subsidiaries (collectively, the “Company”) was formed in May 2017 under the laws of the state of Delaware to acquire and continue the business of Hydrofarm, LLC established in 1977. The Company is a leading distributor and manufacturer of controlled environment agriculture (“CEA”, principally hydroponics) equipment and supplies, including a broad portfolio of proprietary branded products. Products offered include agricultural lighting devices, indoor climate control equipment, hydroponics and nutrients, and plant additives used to grow, farm and cultivate cannabis, flowers, fruits, plants, vegetables, grains and herbs in controlled environment settings that allow end users to control key farming variables including temperature, humidity, CO 2 , light intensity and color, nutrient concentration and pH. Initial public offering On December 14, 2020, the Company closed its initial public offering (“IPO”) under a registration statement effective December 9, 2020, in which it issued and sold 9,966,667 shares of its common stock, including the full exercise by the underwriters of its option to purchase 1,300,000 additional shares of the common stock. The price was $ 20.00 per share. The Company received net proceeds of approximately $ 182.3 million from the IPO after deducting underwriting discounts and commissions and offering expenses. 2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES Basis of presentation The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries and have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and the requirements of the U.S. Securities and Exchange Commission (“SEC”) for interim financial reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by U.S. GAAP can be condensed or omitted. These condensed consolidated financial statements have been prepared on the same basis as the Company's annual consolidated financial statements and, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments, which are necessary for the fair statement of the Company’s financial information. These interim results are not necessarily indicative of the results to be expected for the fiscal year ending December 31, 2021, or for any other interim period or for any other future year. All intercompany balances and transactions have been eliminated in consolidation. The condensed consolidated balance sheet as of December 31, 2020 has been derived from the audited consolidated financial statements of the Company, which is included in the Company's Annual Report on Form 10-K ("2020 Annual Report"). These condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and the notes thereto included in the 2020 Annual Report. Use of estimates The preparation of condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Significant estimates include provisions for sales returns, rebates and claims from customers, realization of accounts receivable and inventories, valuation of intangible assets, valuation of stock and warrants issued in private placements, valuation of stock-based compensation, recognition of deferred income taxes, recognition of liabilities related to commitments and contingencies and valuation allowances. Actual results may differ from these estimates. On an ongoing basis, the Company reviews its estimates to ensure that these estimates appropriately reflect changes in its business or new information available. 6 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (dollars in thousands, except share and per share amounts) Segment and entity-wide information Segment information The Company's chief operating decision maker ("CODM") is the chief executive officer ("CEO") who reviews financial information for the purposes of making operating decisions, assessing financial performance and allocating resources. The business is organized as two operating segments, the U.S. and Canada, which meet the criteria for aggregation, and the Company has elected to present them as one reportable segment, which is the distribution and manufacture of CEA equipment and supplies. Aggregation is based on similarities which include the nature of its products, production or acquisition of inventory, customer base, fulfillment and distribution and economic characteristics. Since the Company operates as one reportable segment, all required segment financial information is found in the condensed consolidated financial statements and footnotes with entity-wide disclosures presented below. Entity-wide information Sales to external customers and property and equipment, net in the United States and Canada, determined by the location of the subsidiaries, were as follows: For the three months ended March 31, 2021 2020 United States $ 90,672 $ 53,504 Canada 22,264 14,102 Intersegment eliminations ( 1,547 ) ( 709 ) Total consolidated net sales $ 111,389 $ 66,897 March 31, 2021 December 31, 2020 United States $ 3,118 $ 3,272 Canada 653 716 Total property and equipment, net $ 3,771 $ 3,988 All of the products sold by the Company are similar and classified as CEA equipment and supplies. The Company’s underlying accounting records currently do not support presentation of disaggregated net sales and any attempt to report them would be impracticable. Cash, cash equivalents and restricted cash The following table provides a reconciliation of cash, cash equivalents and restricted cash reported within the condensed consolidated balance sheets to the consolidated statements of cash flows. March 31, 2021 December 31, 2020 Cash and cash equivalents $ 60,264 $ 75,178 Restricted cash 1,777 1,777 Cash and cash equivalents, and restricted cash $ 62,041 $ 76,955 Cash and cash equivalents and restricted cash as of March 31, 2020 were $ 30,037 and $ 1,625 , respectively, for total cash, cash equivalents and restricted cash as of March 31, 2020 of $ 31,662 . 7 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (dollars in thousands, except share and per share amounts) Revenue recognition The Company follows Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers (“ASC 606”) which requires that revenue recognized from contracts with customers be disaggregated into categories that depict how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors. The Company has determined that revenue is generated from one category, which is the distribution and manufacture of controlled environment agriculture equipment and supplies. Inventory is maintained in regional distribution centers. Payment terms are primarily at the point of sale or due within thirty days. The amount billed to customers for shipping and handling costs included in net sales was $ 1,245 and $ 756 for the three months ended March 31, 2021 and 2020, respectively. Shipping and handling costs that occur before the customer obtains control of the goods are deemed to be fulfillment activities and are accounted for as fulfillment costs included in cost of goods sold under the practical expedient provisions of ASC 606. Deferred revenues are not material. The Company does not receive noncash consideration for the sale of goods. There are no significant financing components. Excluded from revenue are any taxes assessed by governmental authorities, including value-added and other sales-related taxes that are imposed on and concurrent with revenue-generating activities under the practical expedient provisions. Income taxes—interim tax provision The income tax provision is calculated for an interim period by distinguishing between elements recognized in the income tax provision through applying an estimated annual effective tax rate (the “ETR”) to a measure of year-to-date operating results referred to as “ordinary income (or loss),” and discretely recognizing specific events referred to as “discrete items” as they occur. The income tax provision or benefit for each interim period is the difference between the year-to-date amount for the current period and the year-to-date amount for the prior period. Under FASB ASC 740-270-30-36, entities subject to income taxes in multiple jurisdictions should apply one overall ETR instead of separate ETRs for each jurisdiction when calculating the interim-period income tax or benefit related to consolidated ordinary income (or loss) for the year-to-date interim period, except in certain circumstances. The Company’s effective tax rates for the three months ended March 31, 2021 and 2020 differ from the federal statutory rate of 21% principally as a result of reducing valuation allowances on the Company's deferred tax assets related to net operating loss carryforward. Fair value No financial assets or liabilities are measured at fair value on a recurring basis for the periods presented. The carrying values of cash and cash equivalents, restricted cash, accounts receivable, accounts payable, accrued and other current liabilities and revolving asset-backed credit facility approximate their fair value due to their short-term maturities using level 2 inputs. Recently issued accounting pronouncements Adopted in 2021 In October 2020, the FASB issued Accounting Standards Update ("ASU") No. 2020-10, Codification Improvements . The amendments improve the codification by having all disclosure-related guidance available in the disclosure sections of the codification. Prior to this ASU, various disclosure requirements or options to present information on the face of the financial statements or as a note to the financial statements were not included in the appropriate disclosure sections of the codification. The codification improvements also contain various other minor amendments to the codification that are not expected to have a significant effect on current accounting practice. The amendments are effective for annual periods beginning after December 15, 2020 and early adoption is permitted. The Company early adopted the standard effective January 1, 2021 with no impact on the condensed consolidated financial statements. 8 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (dollars in thousands, except share and per share amounts) Accounting standards not yet effective In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses: Measurement of Credit Losses on Financial Instruments (Topic 326) , with additional amendments issued subsequently. Topic 326 changes the impairment model for most financial assets. The new model uses a forward-looking expected loss method, which will generally result in earlier recognition of allowances for losses. Topic 326 is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact the adoption of Topic 326 will have on its condensed consolidated financial statements. 3. NET INCOME (LOSS) PER COMMON SHARE (“EPS”) Basic EPS is computed using net income (loss) attributable to common stockholders divided by the weighted-average number of common shares outstanding during each period, excluding unvested restricted stock units (“RSUs”). Diluted EPS represents net income (loss) attributable to common stockholders divided by the weighted-average number of common shares outstanding during the period, including common stock equivalents. Common stock equivalents consist of shares subject to warrants and share-based awards with exercise prices less than the average market price of the Company’s common stock for the period, to the extent their inclusion would be dilutive. Regarding RSUs subject to a market condition, before the end of the contingency period, the number of contingently issuable shares (i.e., RSUs) to be included in diluted EPS would be based on the number of common shares issuable under the terms of the arrangement if the end of the reporting period was the end of the contingency period, assuming the result would be dilutive. Those contingently issuable shares would be included in the denominator of diluted EPS as of the beginning of the period, or as of the grant date of the share-based payment, if later. Net income (loss) per share attributable to common stockholders The following table presents information necessary to calculate basic and diluted EPS for the three months ended March 31, 2021 and 2020: Three months ended March 31, 2021 2020 Net income (loss) $ 4,940 $ ( 3,093 ) Cumulative dividends allocated to Series A Convertible Preferred Stock — ( 634 ) Net income (loss) available for distribution 4,940 ( 3,727 ) Less: Undistributed earnings allocable to participating securities — — Basic and diluted net income (loss) attributable to common stockholders $ 4,940 $ ( 3,727 ) Less: Effect on net income (loss) of dilutive securities using the “if converted” method — — Diluted net income (loss) attributable to common stockholders after adjustment for assumed conversions $ 4,940 $ ( 3,727 ) Weighted-average shares of common stock outstanding for basic net income (loss) per share attributable to common stockholders 33,717,103 20,688,439 Dilutive effect of warrants using the treasury stock method 2,840,464 — Dilutive effect of restricted stock units using the treasury stock method 1,658,866 — Dilutive effect of stock options using the treasury stock method 780,598 — Weighted-average shares of common stock outstanding for diluted net income (loss) per share attributable to common stockholders 38,997,031 20,688,439 Basic net income (loss) per share attributable to common stockholders $ 0.15 $ ( 0.18 ) Diluted net income (loss) per share attributable to common stockholders $ 0.13 $ ( 0.18 ) 9 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (dollars in thousands, except share and per share amounts) Basic and diluted net income (loss) per share attributable to common stockholders is computed using the two-class method as the convertible preferred stock is determined to be a participating security and the application of the if-converted method is not more dilutive. The computation of the weighted-average shares of common stock outstanding for diluted EPS includes the following potential common shares attributable to common stockholders using the treasury stock method for the weighted-average period during which the units were outstanding: Three months ended March 31, 2021 2020 Shares subject to warrants outstanding 3,701,139 — Shares subject to unvested restricted stock units 1,766,324 — Shares subject to stock options outstanding 912,449 — The computation of the weighted-average shares of common stock outstanding for diluted EPS excludes the following potential common shares as their inclusion would have an anti-dilutive effect on diluted EPS attributable to common stockholders: Three months ended March 31, 2021 2020 Shares subject to warrants outstanding — 3,886,191 Shares subject to unvested restricted stock units with performance conditions — 1,820,598 Shares subject to stock options outstanding — 796,131 Shares of common stock subject to conversion of 7,725,045 shares Series A Convertible Preferred Stock — 2,291,469 Shares of common stock subject to share settlement of $ 634 cumulative dividend on Series A Convertible Preferred Stock — 53,729 4. ACCOUNTS RECEIVABLE, NET AND INVENTORIES Accounts receivable, net comprised the following: March 31, 2021 December 31, 2020 Trade accounts receivable $ 33,207 $ 20,252 Allowance for doubtful accounts ( 681 ) ( 918 ) Other receivables 994 2,292 Total accounts receivable, net $ 33,520 $ 21,626 Inventories comprised the following: March 31, 2021 December 31, 2020 Finished goods $ 98,705 $ 91,050 Allowance for inventory obsolescence ( 2,428 ) ( 2,432 ) Total inventories $ 96,277 $ 88,618 10 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (dollars in thousands, except share and per share amounts) 5. OPERATING LEASES The Company leases its distribution centers from third parties under various non-cancelable lease agreements expiring at various dates through 2030. Certain lease agreements contain renewal options. The Company recognizes operating lease costs over the respective lease periods, including short-term and month-to-month leases. During the three months ended March 31, 2021 and 2020, the Company incurred operating lease costs of $ 1,494 and $ 1,418 , respectively, included within selling, general and administrative expense in the condensed consolidated statements of operations. Supplemental balance sheet information related to the Company’s operating leases are as follows: March 31, 2021 December 31, 2020 Assets Operating lease right-of-use assets $ 17,360 $ 18,289 Total leased assets $ 17,360 $ 18,289 Liabilities Current portion of lease liabilities $ 3,836 $ 3,701 Long-term lease liabilities 14,385 15,320 Total lease liabilities $ 18,221 $ 19,021 As of March 31, 2021, future minimum lease payments under non-cancelable operating leases are as follows: Operating For the period of April 1, 2021 to December 31, 2021 $ 3,413 Year ending December 31, 2022 4,069 2023 2,490 2024 2,103 2025 2,156 2026 1,584 Thereafter 5,266 Total rental payments 21,081 Less portion representing interest ( 2,860 ) Total principal 18,221 Less current portion ( 3,836 ) Long-term portion $ 14,385 In April 2021, the Company executed a lease for approximately 175,000 square feet of warehouse space in Fairfield, CA for a distribution center that the Company will relocate to from its Petaluma, California distribution facility. The new lease commencing August 15, 2021 has a term of 126 months with an option to renew at the then fair market value for another ten years . Rent is abated for the first six months . Thereafter, monthly rent is approximately $ 77 , and increases periodically to the final year where the monthly rent is $ 134 . In April 2021, the Company executed a lease for approximately 147,000 square feet of warehouse space in Fontana, CA to be available upon expiration of the lease for existing space. The new lease commencing July 1, 2021 has a term of 86.5 months with an option to renew for another five years at the greater of 103 % of the rent payable during the last month of the initial term or the then fair market value. Rent is abated for the first two and a half months. Thereafter, monthly rent is approximately $ 115 , and increases periodically to the final year where the monthly rent is $ 141 . 11 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (dollars in thousands, except share and per share amounts) The future minimum lease payments for executed non-cancelable operating leases not yet commenced are as follows: Operating For the period of April 1, 2021 to December 31, 2021 $ 501 Year ending December 31, 2022 2,272 2023 2,688 2024 2,769 2025 2,853 2026 2,938 Thereafter 10,403 Total rental payments $ 24,424 6. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES Accrued expenses and other current liabilities comprised the following: March 31, 2021 December 31, 2020 Accrued compensation and benefits $ 2,741 $ 9,902 Freight, custom and duty accrual 2,650 2,603 Goods in transit accrual 1,894 3,845 Audit, tax and legal accrual 1,848 237 Corporate tax accrual 1,331 585 Obligations due under a distribution agreement 500 590 Other accrued liabilities 3,213 3,853 Total accrued expenses and other current liabilities $ 14,177 $ 21,615 The December 31, 2020 amounts for audit, tax and legal accrual and corporate tax accrual were reclassified from other accrued liabilities to separate line items to conform to the current year presentation. 12 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (dollars in thousands, except share and per share amounts) 7. DEBT Term Loan with Brightwood In May 2017, a term loan in the aggregate principal amount of $ 75,000 (the “Term Loan”) was obtained by Hydrofarm Holdings LLC and certain of its direct and indirect subsidiaries (the “Term Loan Obligors”) from Brightwood Loan Services LLC. The Term Loan was to mature on May 12, 2022 and was secured by substantially all non-working capital assets and a second lien on working capital assets of the Term Loan Obligors. For the three months ended March 31, 2020, the effective interest rate was 12.10 % and interest expense was $ 2,208 . The Term Loan was repaid in December 2020. Revolving asset-backed credit facilities On July 11, 2019, Hydrofarm Holdings LLC and certain of its direct and indirect subsidiaries (the “Encina Obligors”) entered into the Encina Credit Facility through a certain Loan and Security Agreement whereby the Encina Obligors obtained a revolving asset-based loan commitment in the maximum amount of $ 45,000 (inclusive of a limit of up to $ 15,000 of borrowings for the Canadian borrowers and a swingline facility of up to $ 2,000 ), subject to applicable borrowing base availability, through Encina Business Credit, LLC. The Encina Credit Facility was due on the earlier of July 11, 2022 or 90 days prior to the scheduled maturity date of the Term Loan. The Encina Credit Facility was secured by working capital assets and a second lien on non-working capital assets. For the three months ended March 31, 2020, the effective interest rate was 9.10 % and interest expense was $ 523 . The Encina Credit Facility was repaid in December 2020 and replaced in March 2021. The unamortized deferred financing costs and early termination fees totaling $ 680 were recognized as a loss on debt extinguishment in the condensed consolidated statements of operations for the three months ended March 31, 2021. On March 29, 2021, Hydrofarm Holdings Group, Inc. and certain of its direct and indirect subsidiaries (the "JPMorgan Obligors") entered into a Senior Secured Revolving Credit Facility (the "JPMorgan Credit Facility") with JPMorgan Chase Bank, N.A., as administrative agent, issuing bank and swingline lender, and the lenders from time to time party thereto. The JPMorgan Credit Facility replaced the Encina Credit Facility. The JPMorgan Credit Facility is due on the earlier of March 29, 2024 or any earlier date on which the revolving commitments are reduced to zero. The three-year JPMorgan Credit Facility has a borrowing limit of $ 50,000 with an option to request an increase in the revolving commitment by up to $ 25,000 , drawn in $ 5,000 increments, for a total not to exceed $ 75,000 , subject to customary condition ("Revolver"). The Revolver maintains an interest rate of LIBOR plus 1.95 % and has a 0.0 % LIBOR floor. A fee of 0.25 % per annum is charged for available but unused borrowings as defined. The JPMorgan Obligors had approximately $ 50,000 available to borrow under the JPMorgan Credit Facility as of March 31, 2021. The JPMorgan Credit Facility maintains certain reporting requirements, affirmative covenants, negative covenants and financial covenants ("debt covenants"). The financial covenants include that the Company must maintain a minimum fixed charge coverage ratio of 1.1 x on a rolling twelve-month basis. The JPMorgan Obligors were in compliance with all debt covenants as of March 31, 2021. The JPMorgan Credit Facility is secured by the Company’s assets and the assets of certain of the Company’s subsidiaries obligated under the JPMorgan Credit Facility. 13 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (dollars in thousands, except share and per share amounts) 8. CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY Capital stock As of March 31, 2021, the following summarizes shares authorized, issued and outstanding: Capital stock authorized and outstanding: Shares authorized Shares outstanding Convertible preferred stock 50,000,000 — Common stock 300,000,000 33,970,364 As of March 31, 2021, the following summarizes shares of common stock reserved for issuance: Common stock reserved for issuance: Shares reserved for issuance Warrants 3,516,086 2020 Employee, Director, and Consultant Equity Incentive Plan 2,197,988 Restricted stock units 1,643,120 Stock options 889,932 Convertible preferred stock classified outside of permanent equity In December 2019, the Company issued 7,007,429 shares of Series A Convertible Preferred Stock (the "Series A preferred stock") with a par value of $ 24,526 in return for cash of $ 15,439 , conversion of debt with a basis of $ 7,637 , and $ 1,450 in receivables that were settled in January 2020, less offering costs totaled $ 1,274 . In January and February 2020, an additional 717,616 shares of Series A preferred stock were issued primarily to existing investors for $ 2,511 , less offering costs of $ 169 , for net cash proceeds of $ 2,342 . The Series A preferred stock purchase agreement provided for mandatory conversion upon a qualified IPO based on a formula. Under this formula, all outstanding shares of Series A preferred stock converted into 2,291,469 shares of common stock concurrent with the IPO in December 2020 and the cumulative dividend of $ 2,597 was settled in cash at the option of the Company rather than in shares of common stock. Common stock Each holder of common stock is entitled to one vote for each share of common stock. Common stockholders have no pre-emptive rights to acquire additional share of common stock or other securities. The common stock is not subject to redemption rights and carries no subscription or conversion rights. In the event of liquidation, the stockholders are entitled to share in corporate assets on a pro rata basis after the Company satisfies all liabilities and after provision is made for any class of capital stock having preference over the common stock. Subject to corporate regulations and preferences to preferred stock, if any, dividends are at the discretion of the Company’s board of directors (the ‘‘Board’’). 14 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (dollars in thousands, except share and per share amounts) Warrants As of March 31, 2021, the following table summarizes the outstanding warrants: Number of Warrants Exercise Price Investor warrants 3,369,124 $ 16.86 Placement agent warrants 129,981 $ 8.43 Placement agent warrants 16,981 $ 16.86 Total 3,516,086 $ 16.55 For the three months ended March 31, 2021, 155,370 placement agent warrants were exercised on a cashless basis at a price of $ 16.86 per share for 121,401 shares of common stock and 214,735 placement agent warrants were exercised on as cashless basis at a price of $ 8.43 per share for 190,774 shares of common stock. 15 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (dollars in thousands, except share and per share amounts) 9. STOCK-BASED COMPENSATION Stock-based compensation plan overview The Company maintains three equity incentive plans: the 2018 Equity Incentive Plan (“2018 Plan”), the 2019 Employee, Director and Consultant Equity Incentive Plan (“2019 Plan”) and the 2020 Employee, Director, and Consultant Equity Incentive Plan (“2020 Plan” and collectively, “Incentive Plans”). The 2020 Plan serves as the successor to the 2019 Plan and 2018 Plan and provides for the issuance of incentive stock options, nonqualified stock options, stock grants and stock-based awards to employees, directors, and consultants of the Company. No further awards will be issued under the 2018 Plan and 2019 Plan. Of the total shares available for grant under the 2020 Plan, 2,197,988 remain available as of March 31, 2021. RSU Activity RSUs granted to certain executives, employees and members of the Board expire 10 years after the grant date. The awards generally have a time-based vesting requirement (based on continuous employment) and certain awards also have a performance-based vesting requirement (defined as a liquidity event including an initial public offering). Upon the IPO, the performance-based vesting requirement was satisfied and the employees became vested in the number of RSUs that had satisfied the time-based vesting requirement. The stock-based compensation expense related to remaining service-based awards is recorded over the remaining requisite service period. The following table summarizes the activity related to the Company's RSUs for the three months ended March 31, 2021. For purposes of this table, vested RSUs represent the shares for which the service condition had been fulfilled as of March 31, 2021: Number of RSUs Weighted average grant date fair value Balance, January 1, 2021 1,857,444 $ 6.55 Granted — $ — Vested ( 214,324 ) $ 5.56 Balance, March 31, 2021 1,643,120 $ 6.68 As of March 31, 2021, total unamortized stock-based compensation cost related to unvested RSUs was $ 7,179 and the weighted-average period over which the compensation is expected to be recognized is 2.30 years.The award granted to the member of the Board in July 2020 and modified in November 2020 contains a market-based vesting condition based on the traded value of shares of the Company’s common stock following the IPO over a specific time frame. For this award, the market condition was factored into its fair value. All of the stock-based compensation expense related to this award was recognized upon the IPO in December 2020. The total shares under the unvested RSUs subject to a market-based vesting condition are 296,630 as of March 31, 2021. 16 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (dollars in thousands, except share and per share amounts) Stock options The following table summarizes the stock option activity for the three months ended March 31, 2021: Number Weighted average exercise price Weighted average grant date fair value Weighted average remaining contractual term (years) Outstanding as of January 1, 2021 922,796 $ 8.81 $ 1.78 8.08 Granted — $ — $ — Forfeited ( 592 ) $ 11.06 $ 9.89 Exercised ( 32,272 ) 8.43 0.77 Outstanding as of March 31, 2021 889,932 $ 8.82 $ 1.81 7.94 Exercisable as of March 31, 2021 494,980 $ 8.43 $ 0.74 7.39 Unvested as of March 31, 2021 394,952 $ 9.31 $ 3.19 2.29 Vested and expected to vest as of March 31, 2021 889,932 $ 8.82 $ 1.81 7.94 As of March 31, 2021, total compensation cost related to unvested awards not yet recognized was $ 1,125 and the weighted-average period over which the compensation is expected to be recognized is 2.29 years. 17 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (dollars in thousands, except share and per share amounts) 10. COMMITMENTS AND CONTINGENCIES, AND RELATED PARTY TRANSACTIONS Purchase commitments From time to time in the normal course of business, the Company will enter into agreements with suppliers which provide favorable pricing in return for a commitment to purchase minimum amounts of inventory over a defined time period. In June 2020, as part of negotiations with the supplier that began in late 2019, the Company amended its October 2017 agreement to distribute and sell certain garden products for a term ending in December 2024. Under the amended agreement, the Company committed to purchase inventory in periodic minimum volumes on a take-or-pay basis, as defined, over the term of the agreement. In 2021, the Company expects to meet the minimum purchase commitment obligations. Contingencies In the normal course of business, certain claims have been brought against the Company and, where applicable, its suppliers. While there is inherent difficulty in predicting the outcome of such matters, management has vigorously contested the validity of these claims. Based on available information, management believes the claims are without merit and does not expect that the outcome, individually or in the aggregate, would have a material adverse effect on the consolidated financial positions, results of operations, cash flows or future earnings. Related party transactions—Hydrofarm Distribution Center The Company leases a distribution center in Petaluma, California from entities in which a related party is an investor. For the three months ended March 31, 2021 and 2020, rent expense for the month to month lease totaled $ 320 and $ 319 , respectively. 18 TABLE OF CONTENTS Hydrofarm Holdings Group, Inc. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (dollars in thousands, except share and per share amounts) 11. SUBSEQUENT EVENTS On May 3, 2021, the Company acquired 100 % of the issued and outstanding membership interests of Field 16, LLC, a Delaware limited liability company ("HEAVY 16"), pursuant to the terms of a unit purchase and contribution agreement, dated April 26, 2021, by and between the Company, HEAVY 16, F16 Holding LLC, a California limited liability company (the “Seller”), and the members of the Seller, for a purchase price of up to $ 78.1 million, consisting of $ 63.1 million in cash and $ 15 million of the Company's common stock, subject to customary adjustments at closing for cash, working capital, transaction expenses and indebtedness of HEAVY 16 (the "Acquisition"). The purchase price includes a potential earn out payment of up to $ 2.5 million based on achievement of certain performance metrics. In connection with the Acquisition, the Company intends to enter into employment agreements with certain key employees of HEAVY 16. On May 3, 2021, the Company completed its follow-on public offering ("FPO") under a registration statement effective April 28, 2021, in which it issued and sold 5,526,861 shares of its common stock, including the full exercise by the underwriters of its option to purchase 720,894 additional shares of the Company's common stock. The public offering price was $ 59.00 per share. The Company received net proceeds of approximately $ 309.8 million from the FPO after deducting underwriting discounts and commissions and estimated offering expenses. 19 TABLE OF CONTENTS