HYDROFARM HOLDINGS GROUP INC

Previous wording

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.

Current wording

We have experienced adverse financial results which we believe is 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 2022 and 2023 due to agricultural oversupply initiated during the height of COVID-related shelter-in-place orders in 2020 and 2021.

Previous wording

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 2022. In connection with the first phase of our Restructuring Plan, 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. Total costs incurred relating to this first phase of the Restructuring Plan from its commencement in 2022 to its completion in 2023, were (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.

Current wording

In connection with our previously disclosed restructuring plan (the "Restructuring Plan") in 2022, we undertook the following major initiatives: (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. Total costs incurred relating to this first phase of the Restructuring Plan from its commencement in 2022 to its completion in 2023, were (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.

Previous wording

As a result of the continued adverse market conditions, in the third quarter of 2023 we began 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. These restructuring charges are primarily recorded within Cost of goods sold on the consolidated statements of operations. During the three months ended March 31, 2024, we recorded pre-tax restructuring charges of $0.1 million, relating primarily to cash charges associated with the consolidation of U.S. manufacturing facilities. 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.

Current wording

During the three and six months ended June 30, 2024, we also executed the consolidation of other U.S. manufacturing facilities as previously planned, and recorded restructuring charges of $0.9 million and $1.1 million, respectively. 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 operation in Canada. We are evaluating other opportunities to sell excess owned land to supplement our cash position, and potential contract manufacturing or outsourcing arrangements to reduce costs and further consolidate our facility footprint, including certain distribution center locations. We estimate additional charges associated with the second phase of our Restructuring Plan or other alternative actions in the second half of 2024 may exceed $2.0 million and include estimated cash and non-cash impacts for these facility consolidations. We anticipate the second phase of our Restructuring Plan and related actions may result in annual cost savings of over $2.0 million. The amounts we will ultimately realize or disburse in connection with the Restructuring Plan could differ materially from our estimates, depending on our ability to execute various alternatives, and we may not be able to realize the full extent of our anticipated cost savings.

Previous wording

Results of Operations—Comparison of three months ended March 31, 2024 and 2023

Current wording

Results of Operations—Comparison of three and six months ended June 30, 2024 and 2023

Previous wording

The following table sets forth our unaudited interim condensed consolidated statements of operations for the three months ended March 31, 2024, and 2023, including amounts and percentages of net sales for each period and the period-to-period change in dollars and percent (amounts in thousands):

Current wording

The following table sets forth our unaudited interim condensed consolidated statements of operations for the three and six months ended June 30, 2024, and 2023, including amounts and percentages of net sales for each period and the period-to-period change in dollars and percent (amounts in thousands):

Previous wording

The 12.9% decrease in net sales for the three months ended March 31, 2024, as compared to the same period in 2023, was dueto a 12.6% decline in volume/mix of products sold and a 0.3% decrease in price. The decrease in volume/mix of products sold was primarily related to the aforementioned oversupply in the cannabis industry.

Current wording

The 13.1% decrease in net sales for the three months ended June 30, 2024, as compared to the same period in 2023, was primarily due to a 10.3% decline in volume/mix of products sold and a 2.6% decrease in price. The decrease in volume/mix of products sold was primarily related to the aforementioned oversupply in the cannabis industry. The 13.0% decrease in net sales for the six months ended June 30, 2024, as compared to the same period in 2023, was due to a 11.1% decline in volume/mix of products sold and a 1.9% decrease in price. The decrease in volume/mix of products sold was primarily related to the aforementioned oversupply in the cannabis industry.

Previous wording

Gross profit for the three months ended March 31, 2024, was $10.9 million, a decrease of $0.5 million, or 4.0%, compared to the same period in 2023. The decrease was due to lower net sales. Our gross profit margin percentage increased to

Current wording

Gross profit for the three months ended June 30, 2024, was $10.9 million, a decrease of $3.6 million, or 25.0%, compared to the same period in 2023. Gross profit for the six months ended June 30, 2024, was $21.8 million, a decrease of $4.1 million, or 15.8%, compared to the same period in 2023.

Previous wording

SG&A expenses for the three months ended March 31, 2024, were $19.6 million, a decrease of $4.8 million, or 19.7% compared to the same period in 2023. The decrease was due to lower expenses in several areas, including as a result of our cost saving and restructuring initiatives: (i) $1.4 million decrease in facility costs, (ii) $1.0 million decrease in professional and outside services, (iii) $0.8 million decrease in insurance costs, and (iv) $0.8 million decrease in salaries and benefits, along with other expense reductions in multiple areas.

Current wording

SG&A expenses decreased $4.8 million for the three months ended June 30, 2024, as compared to the same period in 2023. The decrease was due to lower expenses in several areas, including as a result of our cost saving and restructuring initiatives: (i) $1.4 million decrease in salaries and benefits, (ii) $1.3 million decrease in facility costs, and (iii) $1.0 million decrease in stock-based compensation, along with other expense reductions in multiple areas including professional fees and outside services and insurance costs.

Previous wording

Interest expense for the three months ended March 31, 2024, was $3.9 million, an increase of $0.2 million compared to the same period in the prior year. The increase was primarily due to higher variable interest rates on our Term Loan.

Current wording

Interest expense for the three months ended June 30, 2024, was $3.8 million, which is consistent with the same period in the prior year. Interest expense for the six months ended June 30, 2024, was $7.7 million, an increase of $0.3 million compared to the same period in the prior year. The increase was primarily due to higher variable interest rates on our Term Loan, partially offset by lower debt outstanding due to principal repayments.

Previous wording

Other income, net for the three months ended March 31, 2024, was $0.2 million, an increase of $0.2 million compared to the same period in the prior year. Other income, net for the three months ended March 31, 2024, was primarily driven by interest income and foreign currency exchange rate gains.

Current wording

Other income, net for the three months ended June 30, 2024, was $0.1 million, an increase of $0.5 million compared to Other expense, net of $0.4 million during the same period in the prior year. Other income, net for the six months ended June 30, 2024, was $0.3 million, an increase of $0.7 million compared to Other expense, net of $0.4 million during the same period in the prior year. Other income, net for the three and six months ended June 30, 2024, was primarily driven by interest income and foreign currency exchange gains.

Previous wording

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.

Current wording

We recorded income tax expense of $0.4 million and $0.6 million for the three and six months ended June 30, 2024, respectively, representing an effective tax rate of (1.7)% in both periods. Our effective tax rate for the six months ended June 30, 2024, differs from the federal statutory rate of 21% primarily due to US and foreign jurisdictions in full valuation allowance. The income tax expense for the three and six months ended June 30, 2024, was primarily due to foreign taxes in certain jurisdictions and U.S. state taxes.

Previous wording

We recorded an income tax expense of $0.1 million for the three months ended March 31, 2023, representing an effective income tax rate of (0.9)%. Our effective tax rate for the three months ended March 31, 2023, differs from the federal statutory rate of 21% primarily due to the Company maintaining a full valuation allowance against its net deferred tax assets in the U.S. and most foreign jurisdictions. The income tax expense for the three months ended March 31, 2023, was primarily due to foreign taxes in certain jurisdictions.

Current wording

We recorded an income tax benefit of $0.3 million and $0.2 million for the three and six months ended June 30, 2023, representing an effective income tax rate of 2.4% and 0.6%, respectively. Our effective tax rate for the six months ended June 30, 2023, differs from the federal statutory rate of 21% primarily due to the Company maintaining a full valuation allowance against its net deferred tax assets in the U.S. and most foreign jurisdictions. The tax benefit for the three and six months ended June 30, 2023, was primarily due to a net foreign tax benefit in certain jurisdictions.

Previous wording

Comparison of the three months ended March 31, 2024, and March 31, 2023

Current wording

Comparison of the six months ended June 30, 2024, and June 30, 2023

Previous wording

The following table summarizes our cash flows for the three months ended March 31, 2024, and 2023 (amounts in thousands):

Current wording

The following table summarizes our cash flows for the six months ended June 30, 2024, and 2023 (amounts in thousands):

Previous wording

Net cash used in operating activities was $9.0 million for the three months ended March 31, 2023, primarily due to a net loss of $16.8 million, partially offset by net non-cash items. Additionally, we had a $5.5 million net cash usage for working capital. This was primarily due to an increase of $5.1 million in accounts receivable, net, and decreases of $3.1 million of accrued expenses and other current liabilities, $2.2 million of lease liabilities, and $1.1 million in deferred revenue, partially offset by a decrease of $7.3 million in inventories.

Current wording

Net cash from operating activities was $1.0 million for the six months ended June 30, 2023, driven by positive cash from operating activities in the second quarter. The net cash from operating activities was primarily due to a $3.6 million net cash inflow from a reduction in working capital, partially offset by a net loss of $29.7 million less net non-cash items of $27.1 million. The net reduction in working capital was primarily driven by a decrease of $15.4 million in inventories, partially offset by decreases of $4.5 million of lease liabilities, $3.3 million of accrued expenses and other current liabilities, $1.3 million in deferred revenue, and $1.2 million of accounts payable.

Previous wording

Net cash used in investing activities was $1.4 million and $1.6 million for the three months ended March 31, 2024, and March 31, 2023, respectively, primarily due to capital expenditures of property, plant and equipment.

Current wording

Net cash from investing activities was $2.3 million for the six months ended June 30, 2024, and net cash used in investing activities was $3.3 million for the six months ended June 30, 2023. We received cash proceeds from the Asset Sale associated with the sale of property, plant and equipment of $3.7 million during the six months ended June 30, 2024, along with other cash from investing activities of $0.4 million. These cash proceeds were partially offset by $1.8 million of capital expenditures of property, plant and equipment. The net cash used in investing activities for the six months ended June 30, 2023 was primarily due to capital expenditures of property, plant and equipment.

Previous wording

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 in conjunction with the Sale-Leaseback Transaction.

Current wording

Net cash from financing activities was $7.4 million for the six months ended June 30, 2023, primarily driven by $8.6 million of proceeds from the Sale-Leaseback Transaction. In addition, we paid $0.6 million on the Term Loan relating to required quarterly payments of principal.

Previous wording

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.

Current wording

If necessary, we believe that we could supplement our cash position through additional sale-leasebacks, asset sales and equity financing. During the three months ended June 30, 2024, we entered into an agreement to sell 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 the Company to make mandatory prepayments.

Previous wording

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 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 with this provision, we classified $1.7 million as current debt on our consolidated balance sheet as of December 31, 2023, and prepaid the Term Loan in this amount during the three months ended March 31, 2024. In addition, we had $2.2 million of contractual commitments pursuant to this provision as of December 31, 2023. 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.

Current wording

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 7 –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 with this provision, we classified $1.7 million as current debt on our consolidated balance sheet as of December 31, 2023, and prepaid the Term Loan in this amount during the three months ended March 31, 2024. As of June 30, 2024, the Company determined that $0.3 million of contractual commitments pursuant to this provision were not paid, and made an additional offer to prepay this amount. In accordance with this provision, the Company classified$0.3 millionas current debt as of June 30, 2024, which was paid in the third quarter of 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.

Previous wording

As of March 31, 2024, and December 31, 2023, the outstanding principal balance on the Term Loan was $120.5 million and $122.5 million, respectively.

Current wording

As of June 30, 2024, and December 31, 2023, the outstanding principal balance on the Term Loan was $120.2 million and $122.5 million, respectively.

Previous wording

We were in compliance with all debt covenants as of March 31, 2024. As of March 31, 2024, approximately $25 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.

Current wording

We were in compliance with all debt covenants as of June 30, 2024. As of June 30, 2024, approximately $20 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. The reduction in borrowing availability during the second quarter of 2024 was primarily due to the sale of inventory as part of the Asset Sale.

Previous wording

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

Current wording

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.

Previous wording

The cash and cash equivalents balances of $24.2 million and $30.3 million at March 31, 2024, and December 31, 2023, respectively, included $7.1 million and $8.5 million, respectively, held by foreign subsidiaries.

Current wording

The cash and cash equivalents balances of $30.3 million and $30.3 million at June 30, 2024, and December 31, 2023, respectively, included $11.0 million and $8.5 million, respectively, held by foreign subsidiaries.