10-K
1
tm2110286d1_10k.htm
FORM 10-K
UNITED STATES
SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
For the fiscal year ended December 31, 2020
or
For the transition period from ________ to
Commission file number: 001-39773
Hydrofarm Holdings
Group, Inc.
(Exact name of registrant as specified in its
charter)
Registrant’s telephone number, including area code (707) 765-9990
Securities registered pursuant to Section 12(b)
of the Exchange Act:
Title of each class Trading Symbol(s) Name of each exchange on which registered
Common Stock, $0.0001 par value per share HYFM The Nasdaq Stock Market LLC
Securities registered pursuant
to Section 12(g) of the Exchange Act: None
Indicate by check mark if
the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒
Indicate by check mark if
the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ☐ No ☒
Indicate by check mark whether
the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether
the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T
during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether
the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging
growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting
company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☐ Accelerated filer ☐
Non-accelerated filer ☒ Smaller reporting company ☐
Emerging growth company ☒
If an emerging growth company,
indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised
financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether
the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control
over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm
that prepared or issued its audit report. ☐
Indicate by check mark whether
the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
The aggregate market value
of the common stock held by non-affiliates of the registrant, based on the closing price of a share of common stock on December 31, 2020,
as reported by The Nasdaq Global Select Market on such date was approximately $1.4 billion. The registrant has elected to use December
31, 2020 as the calculation date, which was the last trading date of the registrant’s most recently completed fiscal year, because
on June 30, 2020 (the last business day of the registrant’s second fiscal quarter), the registrant was a privately-held company.
This calculation does not reflect a determination that certain persons are affiliates of the registrant for any other purpose.
As of March 16, 2021, the
registrant had 33,853,411 shares of common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions
of the registrant’s Proxy Statement for its 2021 Annual Meeting of Stockholders are incorporated by reference into Part III
of this Annual Report on Form 10-K to the extent stated herein. Such Proxy Statement will be filed with the Securities and Exchange Commission
within 120 days of the registrant’s fiscal year ended December 31, 2020.
TABLE OF CONTENTS
Page
PART I
Item 1. BUSINESS 3
Item 1A. RISK FACTORS 19
Item 1B. UNRESOLVED STAFF COMMENTS 44
Item 2. PROPERTIES 44
Item 3. LEGAL PROCEEDINGS 45
Item 4. MINE SAFETY DISCLOSURES 45
PART II
Item 6. SELECTED FINANCIAL DATA 47
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 60
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 61
Item 9A. CONTROLS AND PROCEDURES 62
Item 9B. OTHER INFORMATION 62
PART III
Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE 64
Item 11. EXECUTIVE COMPENSATION 64
Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES 64
PART IV
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES 65
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SPECIAL
NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form
10-K contains forward-looking statements about us and our industry that involve substantial risks and uncertainties. All statements other
than statements of historical facts contained in this Annual Report on Form 10-K including statements regarding our future results of
operations or financial condition, business strategy and plans and objectives of management for future operations, are forward-looking
statements. In some cases, you can identify forward-looking statements because they contain words such as “anticipate,” “believe,”
“contemplate,” “continue,” “could,” “estimate,” “expect,” “intend,”
“may,” “plan,” “potential,” “predict,” “project,” “should,” “target,”
“will” or “would” or the negative of these words or other similar terms or expressions. These forward-looking
statements include, but are not limited to, statements concerning the following:
• the costs of being a public company;
• our ability to keep pace with technological advances;
• the success of our marketing activities;
• a disruption of breach of our information technology systems;
• our current level of indebtedness;
• our dependence on third parties;
• the performance of third parties on which we depend;
• the fluctuation in the prices of the products we distribute;
• competitive industry pressures;
• the consolidation of our industry;
• compliance with environmental, health and safety laws;
• product shortages and relationships with key suppliers;
• our ability to attract key employees;
• the volatility of the price of our common stock;
• the marketability of our common stock; and
• other risks and uncertainties, including those listed in “Risk Factors.”
You should not rely on forward-looking
statements as predictions of future events. The outcome of the events described in these forward-looking statements is subject to risks,
uncertainties and other factors described under the header “Risk Factors” and elsewhere in this Annual Report on Form
10-K. New risks and uncertainties emerge from time to time, and it is not possible for us to predict all risks and uncertainties that
could have an impact on the forward-looking statements contained herein. The results, events and circumstances reflected in the forward-looking
statements may not be achieved or occur, and actual results, events or circumstances could differ materially from those described in the
forward-looking statements.
The forward-looking statements
made in this Annual Report on Form 10-K relate only to events as of the date on which the statements are made, and we undertake no obligation
to update them to reflect events or circumstances after the date of this Annual Report on Form 10-K or to reflect new information or
the occurrence of unanticipated events, except as required by law.
Unless the context otherwise
indicates, references in this Annual Report on Form 10-K to the terms “Hydrofarm”, “the Company,” “we,”
“our” and “us” refer to Hydrofarm Holdings Group, Inc. and its subsidiaries.
“Hydrofarm” and
other trade names and trademarks of ours appearing in this Annual Report on Form 10-K are our property. This Annual Report on Form 10-K
contains trade names and trademarks of other companies, which are the property of their respective owners. We do not intend our use or
display of other companies’ trade names or trademarks to imply an endorsement or sponsorship of us by such companies, or any relationship
with any of these companies.
We may announce material
business and financial information to our investors using our investor relations website (www.investors.hydrofarm.com/investor-relations).
We therefore encourage investors and others interested in Hydrofarm to review the information that we make available on our website,
in addition to following our filings with the Securities and Exchange Commission, or the SEC, webcasts, press releases and conference
calls.
2
PART
I
Item 1. BUSINESS
Overview
We are a leading independent
distributor and manufacturer of controlled environment agriculture (“CEA”, principally hydroponics) equipment and supplies,
including a broad portfolio of our own innovative portfolio of 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, who we connect with primarily through
our proprietary eCommerce marketplace. Over 80% of our net sales are into the 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 Canada
to a diversified range of retailers of commercial and home gardening equipment and supplies that include garden centers, hardware stores,
eCommerce retailers, commercial greenhouse builders, and commercial resellers.
How We Serve Our Customers
Our customer value proposition
is centered on two pillars. First, we strive to offer the best selection by being a branded provider of all CEA needs. Second, we seek
to be the gold standard in distribution and service, leveraging our infrastructure and reach to provide customers with just-in-time (“JIT”)
delivery capabilities and exceptional service across the U.S. and Canada.
Complete Range of Innovative CEA Products
We offer thousands of innovative,
branded CEA products that are supported by 24 patents and 60 registered trademarks. Our product offerings span lighting solutions, growing
media (i.e., premium soils and soil alternatives), nutrients, equipment and supplies and includes more than 6,000 stock-keeping-units
(“SKUs”) sold under leading proprietary, exclusive/preferred brands or non-exclusive/distributed brands. Some of our most
well-known brands include Phantom and Active Aqua as well as in-licensed brands such as FoxFarm and Grodan. We estimate that approximately
two-thirds of our net sales relate to recurring consumable products, including growing media, nutrients and supplies that require regular
replenishment. The remaining portion of our sales relate to durable products such as hydroponic lighting and equipment. The majority
of products we offer are produced by us or are supplied to us under exclusive/preferred brand relationships providing for attractive
margins and a significant competitive advantage as we offer retailers and resellers a breadth of products that cannot be purchased elsewhere.
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The following graphic
illustrates a representative set of our market-leading products across key CEA product categories:
Infrastructure and Reach for Fast Delivery,
High In-Stock Availability and Exceptional Service
Our infrastructure and reach
enable us to provide delivery and service capabilities to a highly diverse group of customers across the U.S. and Canada. We believe
that our six U.S.-based distribution centers can reach approximately 90% of the U.S. population within 24 to 48 hours and that our two
Canadian distribution centers can provide timely coverage to the full Canadian market.
In the U.S., we operate distribution
centers in Petaluma, California; Santa Fe Springs, California; Gresham, Oregon; Denver, Colorado; Fairless Hills, Pennsylvania; and New
Hudson, Michigan. In Canada, we have distribution centers in Langley, British Columbia and Cambridge, Ontario. Outside of North America,
we operate a distribution center in Zaragoza, Spain, and we have an office for product quality assurance and supply chain management
in Shenzhen, China. We partner with a network of third-party logistics companies that facilitate expeditious delivery to our customers
across the globe. The majority of customer orders are received through our business-to-business e-commerce platform. Through our differentiated
Distributor Managed Inventory (“DMI”) Program, we partner with our network of retailers and resellers to create customized,
JIT supply chain solutions for large commercial end users.
Over the past fifteen years,
we have grown our net sales at an approximate 17% CAGR. This historical growth is largely due to the growth in CEA growing across several
end-markets, including cannabis, and our ability to continuously develop, manufacture and distribute innovative branded products on timely
basis.
We believe our industry is
poised to grow significantly. Expanding populations, limited natural resources and a focus on the environment and the security of our
agricultural systems have illuminated the benefits of CEA compared to traditional outdoor agriculture. We believe the adoption of CEA
will continue to accelerate, particularly in the commercial agriculture industry, where CEA can be deployed to achieve grows that are
simultaneously more efficient for the planet and profitable for growers. Furthermore, certain of our end-markets are experiencing significant
growth, including cannabis. The global cannabis industry is a rapidly developing business opportunity for us, particularly as the legal
market in the U.S. continues to expand.
4
Our Industry Is Large And Rapidly Growing
The Expanding Controlled Environment Agriculture
Market
Our principal industry opportunity
is in the wholesale distribution of CEA equipment and supplies, which generally include grow light systems; advanced heating, ventilation,
and air conditioning (“HVAC”) systems; humidity and carbon dioxide monitors and controllers; water pumps, heaters, chillers,
and filters; nutrient and fertilizer delivery systems; and various growing media typically made from soil, rock wool or coconut fiber,
among others. Today, we believe that a majority of our products are sold for use in CEA applications.
CEA is an increasingly significant
and fast-growing component of the expansive global commercial agriculture and consumer gardening sectors. According to the USDA and National
Gardening Survey, the agriculture, food, and related industries sector produced more than $1 trillion worth of goods in the U.S. alone
in 2017, and U.S. households spent a record of approximately $48 billion at retail stores on gardening and growing supplies and equipment.
According to industry publications, the global CEA industry totaled approximately $65 billion in 2019, and is expected to grow at a CAGR
of 16% from 2019 to 2023. The rapid growth of CEA crop output will subsequently drive growth in the wholesale CEA equipment and supplies
industry. According to industry publications, the global wholesale CEA equipment and supplies industry totaled approximately $8 billion
in 2019 and is expected to grow at a CAGR of 12.8% from 2019 to 2025.
Significant Growth in the Cannabis Industry
Today, we believe that a
majority of the CEA equipment and supplies we sell to our customers is ultimately purchased by participants in the cannabis industry,
though we do not sell to participants in the cannabis industry directly. The North American cannabis industry is massive and growing
rapidly, driven largely by state-level legalization efforts in the U.S. and federal-level legalization in Canada. The current and expected
growth in the size of the cannabis market has and will continue to have a very significant, positive impact on our business.
Importantly, though Canada
and several U.S. states have taken significant steps towards cannabis legalization, we believe the North American legal cannabis market
is still in the nascent stages of realizing its growth potential. As of the date of this Annual Report on Form 10-K, only 15 U.S. states
and the District of Columbia had legalized cannabis for adult-use. The aggregate population of those states is only around one third
of the total U.S. population. Furthermore, in U.S. states that have passed cannabis laws, many such laws remain restrictive to consumer
access. As an example, we believe significant suppressed demand would be unlocked in Texas, should the state adopt a medical cannabis
law that more closely resembles that of their neighboring state, Oklahoma, where we have seen significant growth since cannabis was legalized
for medical use in 2018. In Canada, the governments of every province and territory have enacted laws allowing for the distribution and
sale of cannabis for adult-use purposes; however, the market remains in early stages of market development.
According to industry publications,
the U.S. cannabis market is projected to reach approximately $31.1 billion by 2024, up from approximately $12.2 billion in 2019, representing
a 21% CAGR. In Canada, the cannabis market is projected to reach approximately $6.2 billion by 2024, up from approximately $1.7 billion
in 2019, representing a 30% CAGR.
5
This significant growth in
the U.S. cannabis market is expected due to (i) state initiatives for new adult-use and/or medical-use programs in additional U.S. states,
(ii) expanded access for patients or consumers in existing state medical or adult-use cannabis programs, and (iii) increased consumption
driven by greater product diversity and choice, reduced stigma, and real and perceived health benefits in states with existing adult-use
or medical use programs.
Acceleration of CEA Adoption
Both the commercial agriculture
and cannabis industries are increasingly adopting more advanced agricultural technologies in order to enhance the productivity and efficiency
of operations. The benefits of CEA include:
• Greater product safety, quality and consistency;
CEA implementation continues
to increase globally, driven by the factors listed above as well as growth in fruit and vegetable farming, consumer gardening and the
continued adoption of vertical farming. Vertical farming, a subsector of CEA, has gained popularity mainly due to its unique advantage
of maximizing yield by growing crops in layers.
While a small portion of
cannabis cultivation may be grown in non-CEA settings, given the multitude of benefits of CEA cultivation, we believe CEA will continue
to be the primary method of growing cannabis, driving demand for our products. The movement towards the legalization of cannabis in the
U.S. and its legalization in Canada also comes with a corresponding increase in regulatory oversight and statutory requirements for growers
and their products. These regulations enhance product safety and transparency to consumers but usually necessitate the use of CEA in
cannabis cultivation in order to meet mandated THC content or impurity tolerances.
6
Increased Consumer Home Growing
We perceive consumer gardening
to be a significant driver of future CEA growth. We expect this growth in consumer gardening and growing spending to continue, driven
by both increased participation by millennials and strong continued participation by married households, adults over age 55, and adults
without children. We believe that these demographic dynamics will result in an increase in the number of consumer gardening category
participants, resulting in the purchase of more CEA products.
Strong Demand for Hemp for CBD Production
Hemp cultivation in North
America has grown significantly since the passage of the U.S. Farm Bill in December 2018. Consumers are increasingly using hemp-derived
products such as CBD for their therapeutic benefits. According to industry publications, the U.S. hemp-derived CBD market is expected
to grow from $1.2 billion in 2019 to $6.9 billion in 2025, representing a six-year CAGR of 33.8%. We have experienced strong demand for
our products from growers that solely harvest hemp and from cannabis growers who are adding hemp to their offerings. We are very well
positioned to continue to capitalize on the growth of industrial hemp cultivation in North America especially as cultivation is increasingly
done indoors. Both our current product portfolio and our pipeline of new products tailored to the needs of hemp cultivators will help
us serve this burgeoning market.
Increased Focus on Environmental, Social,
and Governance (“ESG”) Issues
We believe the growth and
change in our end-markets is in part driven by a variety of ESG trends aimed at preserving resources and enhancing the transparency and
safety of our food supply chains. Overall, CEA delivers superior performance characteristics versus traditional agriculture when compared
on select key ESG performance criteria:
7
COVID-19
The COVID-19 (“COVID-19”)
pandemic has caused significant shifts in consumer sentiment and behavior thereby altering the dynamics of the CEA industry. While the
rollout of vaccines has begun, the timing of vaccinations, herd immunity, and the lifting of shelter in place and similar restrictions
and movement restrictions is unknown. Its effect on the cannabis industry may also drive a greater volume of sales by our customers, increasing
demand for our CEA equipment and supplies. We believe that these changes, as outlined below, will benefit our industry in the long-term:
Our Competitive Strengths
We attribute our success
to the following competitive strengths.
Leading Market Positions in Attractive Growing
Markets
We are a leading independent
distributor and manufacturer of CEA equipment and supplies in the U.S. and Canada and one of the two major consolidators in the CEA industry.
The broader market is comprised of a fragmented group of smaller competitors. We serve several attractive end-markets, including hemp
and indirectly, the cannabis industry. Favorable trends in CEA, including increased adoption of vertical farming methods to increase
yields, are projected to drive a 24% CAGR for the vertical farming market through 2023 according to industry publications. Similarly,
growers’ increasing preference to reduce water and energy usage, limit pesticide use and risk of environmental runoff, and reduce
labor costs coupled with growing consumer demand for fruits and vegetables are expected to drive significant growth in CEA methods. Furthermore,
CEA allows farms to be located closer to their consumers, greatly reducing the costs and waste (namely CO2 and spoiled food) related
to transportation resulting in an overall smaller carbon footprint. However, we will likely see the most significant growth in cannabis.
Increased support for cannabis legalization at the federal level in the U.S., an increase in U.S. states’ implementation of adult-use
and medical cannabis programs, continued growth in the Canadian cannabis market following the implementation of the Cannabis Act in 2018,
and consumer and commercial awareness of the benefits associated with hemp-derived products will serve as significantly favorable tailwinds
that will drive continued growth.
New, Experienced Management Team with Proven
Track Record
Our management team possesses
significant public market experience, a history of driving long-term organic growth and a track record of successful business consolidations.
Bill Toler, Chairman and Chief Executive Officer, has over 35 years of executive leadership experience in supply chain and consumer packaged
goods, most recently serving as President and Chief Executive Officer of Hostess Brands from April 2014 to March 2018. Under his leadership,
Hostess Brands transitioned from a private to public company, regained a leading market position within the sweet baked goods category
and returned to profitability. Bill also previously served as Chief Executive Officer of Advance Pierre Foods and President of Pinnacle
Foods, in addition to holding executive roles at Campbell Soup Company, Nabisco and Procter & Gamble. Terence Fitch, President, possesses
significant relevant business experience including more than 20 years of management experience with the Coca-Cola Company and Coke Enterprises,
where he was responsible for manufacturing, supply chain, and sales and marketing for the multi-billion-dollar Refreshment Direct and
Independent Bottlers business units. For the past six years, Terence has been working on building, managing and designing large CEA operations
in Colorado and Arkansas. B. John Lindeman, Chief Financial Officer brings us more than 25 years of finance and leadership experience.
Most recently he served as Chief Financial Officer and Corporate Secretary at Calavo Growers, Inc. (Nasdaq-GS: CVGW), a fresh food company,
where he was responsible for the finance, accounting, IT and human resource functions. Prior to joining Calavo, he held various leadership
positions within the finance and investment banking industries at Janney Montgomery Scott, Stifel Nicolaus, Legg Mason and PricewaterhouseCoopers
LLP.
8
Broad Portfolio with Innovative Proprietary
Offerings and Recurring Consumables Sales
We have one of the largest
equipment and consumable product offerings in the industry. From lighting solutions to nutrients to grow mediums, we offer nearly everything
growers need to ensure their operations are maximizing efficiency, output and quality. We maintain an extensive portfolio of products
which includes 26 internally developed, proprietary brands across approximately 900 SKUs with 24 patents and 60 registered trademarks
as well as over 40 exclusive/preferred brands across approximately 900 SKUs. We maintain inventory across over 6,000 SKUs, and approximately
60% of our sales relate to proprietary and exclusive/ preferred brands. Our proprietary and exclusive/preferred brands include lighting,
equipment, grow media, nutrients and supplements. Our proprietary products command a significant gross margin premium relative to general
distributed brands. Our revenue mix continues to shift towards proprietary brands as we continue to innovate, improving overall margins.
Further, our revenue stream is highly consistent as, in our estimation, we believe that approximately two-thirds of our net sales are
generated from the sale of recurring consumable products including growing media, nutrients and supplies. Our top 20 customers buy over
3,000 SKUs in the aggregate.
Proprietary Sourcing and Supplier Relationships
Create Barriers to Entry
Our scale presents a significant
barrier to entry as we have developed exclusive distribution relationships, proprietary brands and a geographic footprint that enables
us to efficiently service customers across North America. We maintain approximately 900,000 square feet of distribution space across
six distribution centers in the U.S. and two distribution centers in Canada. Furthermore, we have cultivated over the last 40 years long-term
relationships with a network of approximately 400 suppliers, giving us access to a best-in-class products portfolio and allowing us to
provide a full range of CEA solutions to our customers. We source individual components from our diverse supplier base to assemble our
products, including utilizing a dedicated on-the-ground purchasing team in China to maintain and develop relationships with suppliers.
No single supplier makes up more than 10% of our total purchases in 2020.
Unique Ability to Serve Our Strong Customer
Base
We maintain long-standing
relationships with a diversified range of leading hydroponic retailers, retailers of commercial and home gardening equipment and supplies
that include garden centers, hardware stores, eCommerce retailers, commercial greenhouse builders, and commercial resellers. We serve
over 2,000 business-to-business customers across multiple channels in North America, providing customers with the capability to purchase
their entire product range from us. Our commercial sales and DMI programs further enhance our customer capabilities, offering consultation,
technical expertise, facilitated order fulfillment and JIT delivery of consumables. Our unique distribution capabilities allow us to
provide JIT delivery across North America, utilizing six strategically located distribution centers in the U.S. and our two distribution
centers in Canada. Our distribution footprint in the U.S. can reach approximately 90% of the population in 24 to 48 hours and our two
distribution centers in British Colombia and Ontario can provide timely coverage to the fully Canadian market. We maintain coverage of
industry trends and consumer preferences via thirteen sales managers complemented by teams made up of specialized product category experts.
Given our ability to provide a comprehensive product offering and excellent customer service, we maintain over seven-year relationships
with the majority of our largest customers.
Proven Mergers and Acquisitions (“M&A”)
Track Record
Our management team has extensive
experience with execution and integration of M&A opportunities. In November 2017, we acquired Eddi’s Wholesale Garden Supplies,
Ltd. (“Eddi’s”) and the distribution division of Greenstar Plant Products, Inc. (“GSD”), which we believe
were two of the leading CEA and lawn and garden distributors in Canada at the time of the acquisitions. Those acquisitions, combined
with our existing infrastructure and experience, have enabled us to become one of the leading CEA equipment distributors in Canada. Additionally,
we maintain relationships throughout our markets to identify specific product categories of interest for M&A activity. Our robust
understanding of commercial growers’ needs coupled with our experienced M&A team has prepared us to make additional acquisitions
in the hydroponics industry, which will help us to continue to grow our market share. We view M&A as a significant driver of potential
growth as the hydroponics industry is fragmented and primed for consolidation.
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Our Growth and Productivity Strategies
We are well positioned to
capitalize on the growth of our underlying markets through the following strategies.
Capitalizing on Rapidly Growing Markets
Our customers benefit from
macroeconomic factors driving the growth of CEA, including expanded adoption of CEA and vertical farming by commercial growers and consumers,
as well as the growth in cannabis, hemp and other end-markets. As the world population grows and urbanizes, vertical farming is increasingly
being used to meet the demand for food crops. Industry publications estimate that the global vertical farming market will expand at a
24% CAGR from 2019 to 2023. In addition, the U.S. and Canadian cannabis markets had an estimated value of approximately $14 billion in
2019, and are projected to grow to $37 billion by 2024. The hemp market has benefited from consumer adoption of hemp-derived CBD products.
According to industry publications, the U.S. hemp-derived CBD market is expected to grow from $1.2 billion in 2019 to $6.9 billion in
2025, representing a six-year CAGR of 33.8%. We expect to capitalize on favorable cannabis and hemp growth trends by continuing to expand
our operations globally.
Expanding our Proprietary Product Offering
We are expanding the breadth
of our product assortment through continued development of our own proprietary brands. Our proprietary brands command a meaningful gross
margin premium to our distributed products. Our core competency in new product innovation is in lighting, consumable and equipment categories,
and we are enhancing research and development in our other product categories to expand our brand portfolio’s value and further
enhance our margins. We have launched several new product lines over the past year, including PhotoBio LED lighting equipment and Phantom
Core HID lighting equipment. As evidenced by its strong sales velocity, the PhotoBio LED lighting line has what we believe is a higher
performance level at a lower cost than current leading LED products. We also maintain a pipeline of next generation proprietary products
and occasionally make investments in suppliers to create strategic relationships around the development of specific products and enhanced
distribution agreements.
Adding Strategic Distribution Relationships
and Exclusive/Preferred Brands
We can increase revenue with
significant cross-selling activity to our current installed customer base by offering a more comprehensive assortment of products required
by commercial growers to engage in cultivation. We have identified key suppliers with product solutions that are well established in
the grower community for exclusive/preferred brand relationships. Although select key suppliers experienced significant volume demands
for the year 2020, our exclusive/preferred brand relationships with leading brands continue to drive sales and margin improvement. We
believe we are a highly attractive distribution partner due to our scale and independence in growing media and nutrient categories. We
have established sixteen new exclusive/preferred distribution relationships over the past two years including with established equipment
and nutrient suppliers.
Enabling Wholesaler Network to Effectively
Serve Commercial Growers
Working with our wholesale
network, we are leveraging our sophisticated technical sales team to provide our wholesale network the ability to address the needs,
demanding requirements and higher volume of their larger-scale commercial customers. Establishing these relationships with our channel
provides us with insight and access to growers’ evolving demands, leading to both increased equipment sales and recurring sales
of consumables through our wholesale network. Our commercial grower outreach program, our analytically driven supply chain function and
DMI capabilities enable our wholesaler network to anticipate customer demand for products and ensure their availability. The goal of
these efforts is to maintain long-term relationships with our wholesalers by helping them be successful in providing cultivation square
footage savings and access to JIT inventory to their customer base. We believe this can result in profitability for our wholesalers’
customers on consumables and equipment. We also believe that increasing the value to our wholesale network will allow us to grow within
key accounts and expand sales of our products and services to new accounts.
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Expand our Operating Margins
We have developed and begun
to implement specific productivity initiatives across our business as a means of funding growth. Our initiatives include the following:
Acquiring Value-Enhancing Businesses
The hydroponics industry
is highly fragmented which we believe presents a significant opportunity for growth through M&A. Management is continually evaluating
M&A targets and we believe, in this fragmented market, there will be continued opportunities for M&A. M&A provides us an
opportunity to significantly increase distribution with independent brands and to add new products based on identified needs of commercial
growers. We utilize clear investment criteria to make disciplined M&A decisions that will accelerate sales and EBITDA growth, increase
competitive strength and market share and expand our proprietary brand portfolio.
We regularly pursue opportunities
to grow our business through acquisitions of strategically complementary businesses and typically have a pipeline of numerous acquisition
opportunities at differing stages of evaluation. We aim primarily to acquire companies that have a competitive market position
with the potential to increase market share, a strong brand, high recurring revenue and strong margin potential. In the ordinary
course of our business, we continually seek acquisition targets that can accelerate our growth and generate significant cash flows over
time. We are evaluating numerous opportunities for such acquisitions in the near term. Although the most advanced opportunities
in our pipeline would not individually or in the aggregate constitute “significant” acquisitions as defined by the SEC’s
Regulation S-X, any of these acquisitions could have a material effect on our results of operations and financial condition.
The status of opportunities
in our pipeline varies from early evaluation through preliminary discussions and varying levels of due diligence and negotiation of potential
transaction terms. We are not party to any definitive agreements in respect of such acquisition targets as of the date of
this Annual Report on Form 10-K and the timing and our desire to consummate any such acquisition depends, among other things, on the
results of our continuing due diligence, which may include, in each case, a quality of earnings report from a third party provider and,
in each case, audited financial statements, which we are requiring even though we do not expect the acquisitions to be “significant”
and to require us to include such audits in our public filings under the SEC’s Regulation S-X. Even if our due diligence
efforts lead us to desire to consummate acquisitions, there is no assurance that we will consummate the acquisition of any of the targets
in our pipeline. In addition to the continuing diligence efforts outlined above, we will still need to enter into definitive agreements
with the targets in a dynamic market which may impact corresponding valuation metrics and multiples and, even if an agreement is entered
into, both parties would need to satisfy any applicable closing conditions. There are a number of other factors that could impact our
ability to successfully complete these acquisitions, including competition for targets, sometimes from competitors with greater available
resources for acquisitions. However, negotiations and diligence relating to one or more of these potential acquisitions could advance
rapidly in the near future, and, accordingly, it is also possible that we could enter into and close under agreements to acquire one
or more businesses consistent with our acquisition strategy described above, shortly after the date of this Annual Report on Form 10-K.
Our more advanced negotiations
contemplate a purchase price consisting of both cash and our common stock or of cash only. We would be able to consummate the most
advanced of our potential acquisitions from available cash and our credit line. It should be noted that acquisitions involve
a number of risks and may not achieve our expectations; and therefore we could be adversely affected by any such acquisition. There are
a number of risks inherent in assessing the value, strengths, weaknesses, contingent or other liabilities, and potential profitability
of acquisition candidates, as well as the challenges of integrating acquired companies and achieving potential synergies once an acquisition
is consummated, that may cause an acquisition to fail. See “Risk Factors Relating to Our Business – Acquisitions, other
strategic alliances and investments could result in operating difficulties, dilution, and other harmful consequences that may adversely
impact our business and results of operations” for more information.
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Government Regulation
While there is no national
governmental regulation relating to the sale of hydroponics equipment, certain products included in our growing media and nutrients product
line are subject to certain registration requirements with some U.S. state regulators and federal regulations.
Media and Nutrients
Our leading product lines
are growing media and nutrients products. These product lines include organic soils and nutrients that contain ingredients that require
the companies that provide us with these products to register the product with certain regulators. The use and disposal of these products
in some jurisdictions are subject to regulation by various agencies. A decision by a regulatory agency to significantly restrict the
use of impact on those companies providing us with such regulated products, and as a result, limit our ability to sell these products.
International, federal, state,
provincial and local laws and regulations relating to environmental, health and safety matters affect us in several ways in light of the
ingredients that are used in products included in our growing media and nutrients product line. In the U.S., products containing pesticides
generally must be registered with the Environmental Protection Agency (the “EPA”), and similar state agencies before they
can be sold or applied. The failure by one of our partners to obtain, or the cancellation of any such registration, or the withdrawal
from the marketplace of such pesticides, could have an adverse effect on our businesses, the severity of which would depend on the products
involved, whether other products could be substituted and whether our competitors were similarly affected. The pesticides we use are either
granted a license by the EPA or exempt from such a license and may be evaluated by the EPA as part of its ongoing exposure risk assessment.
The EPA may decide that a pesticide we distribute will be limited or will not be re-registered for use in the U.S. We cannot predict the
outcome or the severity of the effect on our business of any future evaluations, if any, conducted by the EPA.
In addition, the use of certain
pesticide products are regulated by various international, federal, state, provincial and local environmental and public health agencies.
Although we strive to comply with such laws and regulations and have processes in place designed to achieve compliance, we may be unable
to prevent violations of these or other laws and regulations from occurring. Even if we are able to comply with all such laws and regulations
and obtain all necessary registrations and licenses, the pesticides or other products we apply or use, or the manner in which we apply
or use them, could be alleged to cause injury to the environment, to people or to animals, or such products could be banned in certain
circumstances.
Cannabis Industry
We sell our products through
third-party retailers and resellers which do not exclusively sell to the cannabis industry. Nonetheless, it is evident to us that the
legalization of cannabis in many U.S. states and Canada has ultimately had a significant, positive impact on our industry. Accordingly,
laws and regulations governing the cultivation and sale of cannabis and related products have an indirect effect on our business. Legislation
and regulations pertaining to the use and growth of cannabis are enacted on both the state and federal government level within the U.S.
The federal and state laws and regulations governing the growth and use of cannabis may be subject to change. New laws and regulations
pertaining to the use or cultivation of cannabis and enforcement actions by state and federal authorities concerning the cultivation or
use of cannabis could indirectly reduce demand for our products, and may impact our current and planned future operations.
Individual state laws regarding
the cultivation, possession, and of cannabis for adult and medical uses conflict with federal laws prohibiting the cultivation, possession
and use of cannabis for any purpose. A number of states have passed legislation legalizing or decriminalizing cannabis for adult-use,
other states have enacted legislation specifically permitting the cultivation and use of cannabis for medicinal purposes, and several
states have enacted legislation permitting cannabis cultivation and use for both adult and medicinal purposes.
Certain of our products may
be purchased for use in new and emerging industries and/or be subject to varying, inconsistent, and rapidly changing laws, regulations,
administrative practices, enforcement approaches, judicial interpretations, future scientific research and public perception.
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We sell products, including
hydroponic gardening products, through third-party retailers and resellers. End users may purchase these products for use in new and
emerging industries, including the growing of cannabis that may not grow or achieve market acceptance in a manner that we can predict.
The demand for these products is dependent on the growth of these industries, which is uncertain, as well as the laws governing the growth,
possession, and use of cannabis by adults for both adult and medical use.
Laws and regulations affecting
the U.S. cannabis industry are continually changing, which could detrimentally affect our growth, revenues, results of operations and
success generally. Local, state and federal cannabis laws and regulations are broad in scope and subject to evolving interpretations,
which could require the end users of certain of our products or us to incur substantial costs associated with compliance or to alter
our respective business plans. In addition, violations of these laws, or allegations of such violations, could disrupt our business and
result in a material adverse effect on our results of operation and financial condition.
The
public’s perception of cannabis may significantly impact the cannabis industry’s success. Both the medical and adult-use of
cannabis are controversial topics, and there is no guarantee that future scientific research, publicity, regulations, medical opinion,
and public opinion relating to cannabis will be favorable. The cannabis industry is an early-stage business that is constantly evolving
with no guarantee of viability. The market for medical and adult-use of cannabis is uncertain, and any adverse or negative publicity,
scientific research, limiting regulations, medical opinion and public opinion (whether or not accurate or with merit) relating to the
consumption of cannabis, whether in the U.S. or internationally, may have a material adverse effect on our operational results,
consumer base, and financial results. Among other things, such a shift in public opinion could cause state jurisdictions to abandon initiatives
or proposals to legalize medical or adult cannabis or adopt new laws or regulations restricting or prohibiting the medical or adult-use
of cannabis where it is now legal, thereby limiting the potential customers and end-users of our products who are engaged in the cannabis
industry (collectively “Cannabis Industry Participants”).
Demand for our products may
be negatively impacted depending on how laws, regulations, administrative practices, enforcement approaches, judicial interpretations,
and consumer perceptions develop. We cannot predict the nature of such developments or the effect, if any, that such developments could
have on our business.
We are subject to a number
of risks, directly and indirectly through our Cannabis Industry Participants, because cannabis is illegal under federal law.
Cannabis is illegal under
federal law. Federal law and enforcement may adversely affect the implementation of medical cannabis and/or adult-use cannabis laws,
and may negatively impact our revenues and profits.
Under the United States Controlled
Substances Act of 1970 (the “CSA”), the U.S. Government lists cannabis as a Schedule I controlled substance (i.e., deemed
to have no medical value), and accordingly the manufacturing (cultivation), sale, or possession of cannabis is federally illegal. It
is also federally illegal to advertise the sale of cannabis or to sell paraphernalia designed or intended primarily for use with cannabis,
unless the paraphernalia is authorized by federal, state, or local law. The United States Supreme Court has ruled in United States v.
Oakland Cannabis Buyers’ Coop. and Gonzales v. Raich, 532 U.S. 483 (2001), that the federal government has the right to regulate
and criminalize cannabis, even for medical purposes. The illegality of cannabis under federal law preempts state laws that legalize its
use. Therefore, strict enforcement of federal law regarding cannabis would likely adversely affect our revenues and results of operations.
Other laws that directly
impact the cannabis growers that are end users of certain of our products include:
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The former administration,
or any new administration or attorney general, could change federal enforcement policy or execution and decide to enforce the federal
cannabis laws more strongly. On January 4, 2018, former U.S. Attorney General Jeff Sessions issued a memorandum rescinding previous guidance
(directing U.S. Department of Justice and the U.S. Attorneys’ offices to focus their cannabis enforcement efforts under federal
law only in identified priority areas, such as sale to minors, criminal enterprises, and interstate sales). Under the Sessions memorandum,
local U.S. Attorneys’ offices retain discretion regarding the prosecution of cannabis activity authorized under state laws and
regulations. While former U.S. Attorney General William Barr expressed support for the National Organization to Reform Marijuana Laws
(NORML) during his Senate testimony on April 10, 2019, further change in the federal approach towards enforcement could negatively affect
the industry, potentially ending it entirely. Any such change in the federal government’s enforcement of current federal laws could
cause significant financial damage to us. The legal uncertainty and possible future changes in law could negatively affect our growth,
revenues, results of operations and success generally.
Federal authorities may decide
to change their current posture and begin to enforce current federal cannabis law and, if they decide to ignore the principles in the
Cole Memorandum and begin to aggressively enforce such laws, it is possible that they could allege that we violated federal laws by selling
products used in the cannabis industry. As a result, active enforcement of the current federal regulatory position on cannabis may thus
directly or indirectly adversely affect our revenues and profits.
Violations of any U.S. federal
laws and regulations could result in significant fines, penalties, administrative sanctions, convictions or settlements arising from
civil proceedings conducted by either the U.S. federal government or private citizens, or criminal charges, including, but not limited
to, disgorgement of profits, cessation of business activities or divestiture. This could have a material adverse effect on our business,
including our reputation and ability to conduct business, the listing of our securities on any stock exchanges, the settlement of trades
of our securities, our ability to obtain banking services, our financial position, operating results, profitability or liquidity or the
market price of our publicly traded shares. In addition, it is difficult for us to estimate the time or resources that would be needed
for the investigation of any such matters or their final resolution because, in part, the time and resources that may be needed are dependent
on the nature and extent of any information requested by the applicable authorities involved, and such time or resources could be substantial.
Businesses involved in the
cannabis industry, and investments in such businesses, are subject to a variety of laws and regulations related to money laundering,
financial recordkeeping and proceeds of crimes.
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We
sell our products through third-party retailers and resellers which do not exclusively sell to the cannabis industry. Investments in the
U.S. cannabis industry are subject to a variety of laws and regulations that involve money laundering, financial recordkeeping and proceeds
of crime, including the BSA, as amended by the Patriot Act, other anti-money laundering laws, and any related or similar rules, regulations
or guidelines, issued, administered or enforced by governmental authorities in the U.S.. In February 2014, the Financial Crimes
Enforcement Network (“FinCEN”) of the Treasury Department issued a memorandum (the “FinCEN Memo”) providing guidance
to banks seeking to provide services to cannabis businesses. The FinCEN Memo outlines circumstances under which banks may provide services
to cannabis businesses without risking prosecution for violation of U.S. federal money laundering laws. It refers to supplementary guidance
that Deputy Attorney General Cole issued to U.S. federal prosecutors relating to the prosecution of U.S. money laundering offenses predicated
on cannabis violations of the CSA and outlines extensive due diligence and reporting requirements, which most banks have viewed as onerous.
The FinCEN Memo currently remains in place, but it is unclear at this time whether the current administration will continue to follow
the guidelines of the FinCEN Memo. Such requirements could negatively affect the ability of certain of the end users of our products to
establish and maintain banking connections.
Cannabis Industry Participants
are subject to federal and state controlled substance laws and regulations. As a result, we are indirectly subject to a number of risks
related to controlled substances.
We sell our products through
third-party retailers and resellers which do not exclusively sell to the cannabis industry. Some of our products are sold to Cannabis
Industry Participants and used in connection with cannabis businesses that are subject to federal and state controlled substance laws