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 2021 Annual Report. This discussion and analysis contains statements of a forward-looking nature relating to future events or our future financial performance. These statements are only predictions, and actual events or results may differ materially. 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 2021 Annual Report. See "Special Note Regarding Forward-Looking Statements."
We are a leading independent manufacturer and distributor of CEA equipment and supplies, including a broad portfolio of our own innovative proprietary branded products. We primarily serve the
U.S.and Canadian markets, and believe we are one of the leading competitors by market share in these markets in an otherwise highly fragmented industry. For over 40 years, we have helped growers make growing easier and more productive. Our mission is to empower growers, farmers and cultivators with products that enable greater quality, efficiency, consistency, and speed in their grow projects. Hydroponics is the farming of plants using soilless growing media and often artificial lighting in a controlled indoor or greenhouse environment. Hydroponics is the primary category of CEA and we use the terms CEA and hydroponics interchangeably. Our products are used to grow, farm, and cultivate cannabis, flowers, fruits, plants, vegetables, grains and herbs in controlled environment settings that allow end users to control key farming variables including temperature, humidity, CO2, 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, whowe connect with primarily through our proprietary e-commerce marketplace. A substantial majority of our net sales are to specialty hydroponic retailers, through which growers are able to enjoy specialized merchandise assortments and knowledgeable staff. We also distribute our products across the U.S.and Canadato a diversified range of retailers of commercial and home gardening equipment and supplies that include garden centers, hardware stores, e-commerce retailers, commercial greenhouse builders, and commercial resellers. During fiscal year 2021, we completed five acquisitions of branded manufacturers of CEA products, resulting in a significant expansion of our portfolio of proprietary branded products and our specialized manufacturing capabilities, including:
•Heavy 16, a manufacturer of plant nutrients and additives, in
•House & Garden, a manufacturer of plant nutrients and additives, in
•Aurora Innovations, a manufacturer of soil, grow media, plant nutrients and
•Greenstar Plant Products, a manufacturer of plant nutrients and additives, in
•Innovative Growers Equipment, a manufacturer of horticultural benches, racks
and grow lights, in
Effects of COVID-19 on Our Business
World Health Organizationrecognized COVID-19 as a public health emergency of international concern on January 30, 2020, and as a global pandemic on March 11, 2020. Vaccines for COVID-19 continue to be administered in the United Statesand other countries around the world, but the extent and rate of vaccine adoption, the long-term efficacy of these vaccines and other factors remain uncertain. Authorities throughout the world have implemented measures to contain or mitigate the spread of the virus, including physical distancing, travel bans and restrictions, closure of non-essential businesses, quarantines, work-from-home directives, mask requirements, shelter-in-place orders, and vaccination programs. The global pandemic and actions taken to contain COVID-19 have adversely affected the global economy and financial markets. 25
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In response to the COVID-19 pandemic, we implemented business continuity plans designed to address the impact of the COVID-19 pandemic on our business, and we continue to follow safety protocols and other appropriate measures recommended by the
Centers for Disease Control and Prevention, as well as various state and local executive orders, health orders and guidelines. We have historically and may continue to source select products from China. It is difficult to predict the extent to which COVID-19, including the emergence and spread of more transmissible variants, may continue to spread. Currently manufacturers in Chinaand in North Americaare generally back in operation; however, new waves of the COVID-19 pandemic could result in the re-closure of factories in Chinaand/or in North America. Quarantine orders and travel restrictions within the United Statesand other countries may also adversely impact our supply chains, the manufacturing of our own products and our ability to obtain necessary materials. We are experiencing some extended lead times in our supply chain, as well as increased shipping costs and believe the COVID-19 pandemic is a contributing factor to those extended lead times and increased costs. Although we have not, to date, experienced any material interruptions in our ability to fill our customers' orders or manufacture our own products, we may in the future be unable to obtain adequate inventory to fill purchase orders or manufacture our own products, which could adversely affect our business, results of operations and financial condition. Furthermore, potential suppliers or sources of materials may pass the increase in sourcing costs due to the COVID-19 pandemic to us through price increases, thereby impacting our potential future profit margins. We continue to monitor the COVID-19 pandemic and will adjust our mitigation strategies as necessary to address changing health, operational or financial risks that may arise.
Our customers reside in countries, primarily the
currently affected by the COVID-19 pandemic. Many of these customers have
experienced shelter-in-place measures in attempts to contain the spread of
COVID-19, including general lockdowns, closure of schools and non-essential
businesses, bans on gatherings and travel restrictions.
Our business has remained resilient during the COVID-19 pandemic. As of
March 31, 2022, our manufacturing and distribution operations are viewed as essential services and continue to operate. Our key suppliers, retailers and resellers have been designated as essential services and remain open at this time; however, in certain places they are operating under reduced hours and capacity limitations. The majority of U.S.and Canadian cannabis businesses have been designated as essential by U.S.State and Canadian government authorities. The extent to which the COVID-19 pandemic will ultimately impact our business, results of operations, financial condition and cash flows depends on future developments that are highly uncertain, rapidly evolving and difficult to predict at this time. Depending on the length and severity of COVID-19, we may experience an increase or decrease in customer orders driven by volatility in consumer shopping and consumption behavior. It is difficult to assess or quantify with precision the impact COVID-19 has directly had on our business since we cannot precisely quantify the impacts, if any, that the various effects (e.g. possible positive demand impact from shelter-in-place orders in the United States, possible negative supply chain impact from workforce disruption at international and domestic suppliers and domestic ports and the possible negative impact on transportation costs) have had on the overall business. And so, while we do not believe that we are experiencing material adverse impacts at this time, given the global economic slowdown, the overall disruption of global supply chains and distribution systems and the other risks and uncertainties associated with the COVID-19 pandemic, our business, financial condition, results of operations and growth prospects could be materially and adversely affected. While we believe that we are well positioned for the future as we navigate the crisis and prepare for an eventual return to a more normal operating environment, we continue to closely monitor the COVID-19 pandemic as we evolve our business continuity plans and response strategy.
Results of Operations-Comparison of three months ended
The following table sets forth our unaudited interim condensed consolidated
statements of operations for the three months ended
including amounts and percentages of net sales for each period and the
period-to-period change in dollars and percent (amounts in thousands):
TABLE OF CONTENTS Three months ended March 31, 2022 2021 Period change Net sales
$ 111,377100.0 % $ 111,389100.0 % $ (12)0.0 % Cost of goods sold 94,771 85.1 % 88,166 79.2 % 6,605 7.5 % Gross profit 16,606 14.9 % 23,223 20.8 % (6,617) -28.5 % Operating expenses: Selling, general and administrative 43,003 38.6 % 16,841 15.1 % 26,162 155.3 % (Loss) income from operations (26,397) -23.7 % 6,382 5.7 % (32,779) -513.6 % Interest expense (2,366) -2.1 % (90) -0.1 % (2,276) 2,528.9 % Loss on debt extinguishment - 0.0 % (680) -0.6 % 680 n/a % Other (expense) income, net (102) -0.1 % 84 0.1 % (186) -221.4 % (Loss) income before tax (28,865) -25.9 % 5,696 5.1 % (34,561) -606.8 % Income tax benefit (expense) 5,569 5.0 % (756) -0.7 % 6,325 -836.6 % Net (loss) income (23,296) -20.9 % 4,940 4.4 % (28,236) -571.6 % Net sales Net sales for the three months ended March 31, 2022, were $111.4 million, flat compared to the same period in 2021. The flat performance of net sales for the three months ended March 31, 2022, as compared to the same period in 2021 was due to a 2.1% decline in volume of products sold (a 36.7% decline in organic sales and a 34.6% increase from recently-acquired proprietary brands), a 2.2% increase in price and mix of products sold, and 0.1% decline from unfavorable foreign exchange rates. The decrease in volume of products sold was primarily related to what we believe is a short-term oversupply, which put downward pressure on cannabis growing activity predominantly in Californiaand Canadabut also in many other US states. The increase in price was primarily related to list price increases, as well as higher freight recovery as we put multiple measures in place to combat rising freight costs. The decrease in foreign exchange related to recent strength in the U.S.Dollar relative to the Canadian Dollar and to the Euro. Gross profit Gross profit for the three months ended March 31, 2022, was $16.6 million, a decrease of $6.6 million, or 28.5%, compared to the same period in 2021. The decrease in gross profit for the three months ended March 31, 2022, as compared to the same period in 2021 was related to higher freight and labor costs, certain non-cash purchase accounting inventory adjustments related predominately to the purchase of IGE completed in November 2021, and an increase in the inventory obsolescence allowance of $3.2 millionprimarily related to certain slow-moving lighting products. These were partially offset by the aforementioned list price increases, as well as a much higher proportion of higher-margin proprietary brand sales. Our gross profit margin percentage decreased to 14.9% for the three months ended March 31, 2022from 20.8% in the same period in 2021. The lower gross profit margin percentage is primarily due to the aforementioned adjustments.
Selling, general and administrative expenses
Selling, general and administrative expenses ("SG&A") for the three months ended
March 31, 2022, were $43.0 million, an increase of $26.2 millioncompared to the same period in 2021. The SG&A increase of $26.2 millionwas primarily related to (i) $13.5 millionincrease in amortization expense relating to intangible assets associated with our 2021 acquisitions, of which $5.9 millionrepresented amortization expense from adjustments to useful lives that were determined in the current period, (ii) compensation costs (an increase of $3.1 million, of which $0.6 millionwas severance associated with a recent reduction-in-force), (iii) an impairment of a note receivable ( $2.6 million; see Note 2 - Basis of Presentation and Significant Accounting Policies), (iv) share-based compensation expense (an increase of $1.8 million), (v) facility costs (an increase of $1.1 million), (vi) costs associated with the relocation of certain of our distribution centers of $1.1 million, (vii) acquisition and integration expenses of $1.0 million, and (viii) insurance costs (an increase of $0.5 million), travel (an increase of $0.3 million), and warranty costs (an increase of $0.3 million). These increases were largely the result of our accelerated M&A strategy and supporting our long-term growth strategy.
Interest expense for the three months ended
March 31, 2022, was $2.4 million, an increase of $2.3 millioncompared to the same period in the prior year. The increase was due to the interest-bearing Term Loan issued in the fourth quarter of 2021 and outstanding for the full period during the first quarter of 2022. 27
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Loss on debt extinguishment
Loss on debt extinguishment for the three months ended
March 31, 2022, was zero, compared to $0.7 millionin the prior year which resulted primarily from the write-off of unamortized deferred financing costs associated with the payoff of the Encina Credit Facility. Income tax (benefit) expense Income tax benefit for the three months ended March 31, 2022, was $5.6 million, compared to $0.8 millionof income tax expense in the prior year. The Company's effective income tax rate was 19.3% for the three months ended March 31, 2022. This rate differs from the U.S.federal statutory rate of 21% primarily as a result of a reduction in the valuation allowance recorded against the Company's net deferred tax assets due to the acquisition of the IGE Entities which had an income tax rate benefit of 23.4%. In addition, as described in Note 3 - Business Combinations, the Company determined that the preliminary allocation of assets acquired related to indefinite lived trade names have a finite useful life because the expected usefulness of the trade names is limited. As a result of adjusting this provisional amount, the Company recorded a reduction to the valuation allowance, which resulted in an income tax rate benefit of 6.1%.
For the three months ended
from the federal statutory rate of 21% primarily as a result of reducing
valuation allowances on the Company’s deferred tax assets related to net
operating loss carryforwards.
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Non-GAAP Financial Measures
We report our financial results in accordance with accounting principles generally accepted in
the United States of America(" U.S.GAAP" or "GAAP"). However, management believes that certain non-GAAP financial measures provide investors of our financial information with additional useful information in evaluating our performance and that excluding certain items that may vary substantially in frequency and magnitude period-to-period from net (loss) income provides useful supplemental measures that assist in evaluating our ability to generate earnings and to more readily compare these metrics between past and future periods. These non-GAAP financial measures may be different than similarly titled measures used by other companies. To supplement our condensed unaudited consolidated financial statements which are prepared in accordance with GAAP, we use "Adjusted EBITDA" and "Adjusted EBITDA as a percent of sales" which are non-GAAP financial measures (collectively referred to as "Adjusted EBITDA"). Our non-GAAP financial measures should not be considered in isolation from, or as substitutes for, financial information prepared in accordance with GAAP. There are several limitations related to the use of our non-GAAP financial measures as compared to the closest comparable GAAP measures. Some of these limitations include:
• Adjusted EBITDA does not reflect the significant interest expense, or the
amounts necessary to service interest or principal payments on our indebtedness;
• Adjusted EBITDA excludes depreciation and amortization, and although these are non-cash expenses, the assets being depreciated and amortized may have to be replaced in the future;
• Adjusted EBITDA does not reflect our tax provision that adjusts cash available
• Adjusted EBITDA excludes the non-cash component of stock-based compensation;
• Adjusted EBITDA excludes the amount of employer payroll taxes on stock-based
• Adjusted EBITDA does not reflect the impact of earnings or charges resulting
from matters we consider not to be reflective, on a recurring basis, of our
We define Adjusted EBITDA as net income (loss) excluding interest expense, income taxes, depreciation and amortization, stock-based compensation, employer payroll taxes on stock-based compensation and other unusual and/or infrequent costs, which we do not consider in our evaluation of ongoing operating performance. The following table presents a reconciliation of net (loss) income, the most comparable GAAP financial measure, to Adjusted EBITDA for the three months ended
March 31, 2022, and 2021 (in thousands): Three months ended March 31, 2022 2021 Net (loss) income $ (23,296) $ 4,940Interest expense 2,366 90 Income tax (benefit) expense (5,569) 756 Distribution center exit costs and other 1,086
Depreciation, depletion and amortization 16,941
Impairment, restructuring and other* 3,393
Acquisition expenses** 4,986
Other expense (income), net 102
Stock-based compensation*** 3,076
Loss on debt extinguishment -
Adjusted EBITDA $ 3,085
$ 9,905Adjusted EBITDA as a percent of net sales 2.8 % 8.9 % 29
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(*) Includes the elimination of impairment and other. During the quarter ended
(**) Includes non-cash purchase accounting inventory adjustments for House and Garden, Aurora, Greenstar and Innovative Growers Equipment of
$3.9 million, the elimination of acquisition and integration consulting, transaction services and legal fees incurred for the completed Heavy 16, House and Garden, Aurora, Greenstar, and Innovative Growers Equipment acquisitions and certain potential acquisitions of $2.6 million, partially offset by the change in fair value of contingent consideration for Aurora of ( $1.6 million) for the quarter ended March 31, 2022.
(***) Includes employer payroll taxes on stock-based compensation
Liquidity and Capital Resources
The following table summarizes our cash flows for the three months ended
2022 2021 Net cash used in operating activities
$ (10,155) $ (2,638)Net cash used in investing activities (2,385) (445) Net cash used in financing activities (1,953) (11,827)
Effect of exchange rate changes on cash, cash equivalents and
43 (4) Net decrease in cash, cash equivalents and restricted cash (14,450) (14,914)
Cash, cash equivalents and restricted cash at beginning of period 28,384
Cash, cash equivalents and restricted cash at end of period
Operating Activities Net cash used in operating activities was
$10.2 millionfor the three months ended March 31, 2022, primarily due to a net loss of $23.3 million, partially offset by net non-cash items. Additionally, we had a $9.1 millionnet cash usage for working capital during the first quarter of 2022. This was primarily due to an increase of $6.8 millionin accounts receivable and a decrease of $7.2 millionin deferred revenue, partially offset by a $10.5 millionincrease in accounts payable. Net cash used in operating activities was $2.6 millionfor the three months ended March 31, 2021, primarily consisting of $4.2 millionin non-cash expense addbacks including depreciation and amortization and stock-based compensation expense, to reconcile net income of $4.9 millionto net cash used in operating activities, less a $11.7 millionincrease in working capital. This change in working capital primarily reflects a $23.4 millionincrease in accounts receivable, inventories, prepaid expenses and other current assets, partially offset by a $14.4 millionincrease in accounts payable.
Net cash used in investing activities was
$2.4 millionand $0.4 millionfor the three months ended March 31, 2022and 2021, respectively, and was due primarily to purchases of property, plant and equipment.
Net cash used in financing activities was
$2.0 millionfor the three months ended March 31, 2022. We paid $1.6 millionrelated to employee withholding tax in connection with the vesting of restricted stock units. In addition, we paid $0.3 millionon the Term Loan. For the three months ended March 31, 2021, net cash used in financing activities was $11.8 millionand was primarily due to the payment of employee withholding tax in connection with the vesting of restricted stock units. 30
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JPMorgan Revolving Credit Facility
March 29, 2021, we and certain of our direct and indirect subsidiaries entered into a Senior Secured Revolving 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 JPMorgan Credit Facility has been amended since its origination in
connection with modifications to increase the borrowing limit and to consent to
the Term Loan.
The three-year JPMorgan Credit Facility has a borrowing limit of
$100 millionsubject to customary conditions. 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 Credit Facility maintains certain reporting requirements, affirmative covenants, negative covenants and financial covenants, including, in certain situations pursuant to terms outlined in the agreement, the maintenance of a minimum fixed charge coverage ratio of 1.1x on a rolling twelve-month basis. We were in compliance with all debt covenants as of March 31, 2022. As of March 31, 2022, the JPMorgan Obligors had approximately $99.7 millionavailable to borrow under the JPMorgan Credit Facility.
The JPMorgan Credit Facility is secured by our assets and the assets of certain
of our subsidiaries obligated under the JPMorgan Credit Facility.
Senior Secured Term Loan
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 certain lenders, pursuant to which we borrowed a $125.0 millionsenior secured term loan. The Term Loan bears interest at LIBOR (with a 1.0% floor) plus 5.50%, or an alternative base rate (with a 2.0% floor), plus 4.50%, and is subject to a call premium of 2% in year one, 1% in year two, and 0% thereafter, and matures on October 25, 2028. We received net proceeds of $119.9 millionfrom the Term Loan after deducting discounts and deferred financing costs. The principal amounts of the Term Loan are to be repaid in consecutive quarterly installments in amounts equal to 0.25% of the principal amount of the Term Loan, on the last day of each fiscal quarter commencing March 31, 2022, with the balance of the Term Loan payable on the Maturity Date. The Term Loan requires us to maintain certain reporting requirements, affirmative covenants, and negative covenants, and we were in compliance with all requirements as of March 31, 2022. The Term Loan is secured by a first lien on the non-working capital assets of the Company and a second lien on the working capital assets. We may request additional term loan commitments subject to certain loan conditions. Material Cash Requirements Our material cash requirements include interest payments on our long-term debt, operating lease payments, the payment of contingent consideration and purchase obligations to support our operations. Refer to Part I, Item 1, Financial Statements, Note 10 - Debt, Note 7 - Operating Leases, Note 3 - Business Combinations and Note 13 - Commitments, Contingencies, and Related PartyTransactions for details relating to our material cash requirements for debt, our leasing arrangements, including future maturities of our operating lease liabilities, contingent consideration, and purchase obligations, respectively. 31
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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 our most recently filed Form 10-K and include the discussion of estimates used in business combinations, goodwill, and long-lived assets. 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 Form 10-Q, and actual results could differ materially from the amounts reported.
Goodwillis evaluated for impairment annually in the fourth quarter, or on an interim basis when an event occurs, or circumstances change that indicates the carrying value may not be recoverable. Such events or circumstances that may require an interim test for goodwill impairment include, but are not limited to, industry and market considerations, as well as Company financial performance. The Company did not identify a triggering event requiring a quantitative test for impairment for the three months ended March 31, 2022.
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