HYDROFARM HOLDINGS GROUP, INC. MANAGEMENT REPORT AND ANALYSIS OF FINANCIAL POSITION AND RESULTS OF OPERATIONS (Form 10-K)

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 consolidated financial statements and the notes contained elsewhere in
this Annual Report on Form 10-K. 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 Annual Report on Form
10-K, 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 this Annual Report on Form 10-K. See "Special Note Regarding
Forward-Looking Statements."

Company presentation

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, who we 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 Canada to 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.

RECENT DEVELOPMENTS

Equipment from Innovative Producers, Inc. Acquisition

On November 1, 2021, we closed the acquisition of the IGE Entities. See Note 3 -
Business Combinations under Innovative Growers Equipment, Inc. Acquisition, in
the notes to the consolidated financial statements included elsewhere in this
Annual Report on Form 10-K. The IGE Entities are a manufacturer of horticulture
benches, racking and LED lighting systems. The addition of the IGE Entities'
commercial equipment product range complements our existing lineup of high
performance, proprietary branded products.

Senior Secured Term Loan

On October 25, 2021, we entered into a senior secured term loan facility, in the
aggregate principal amount of $125 million, with JPMorgan Chase Bank, N.A. as
administrative agent for certain lenders (the "Term Loan"). The Term Loan bears
interest at a rate of either LIBOR (with a 1.0% floor) plus 5.50%, or an
alternate base rate (with a 2.0% floor) plus 4.50% and matures on October 25,
2028. We used the net proceeds from the Term Loan to fund the cash portion of
the IGE Entities' acquisition and for general corporate purposes, which may
include, among other things, repaying any outstanding balance under our existing
revolving facility and funding future M&A opportunities. Should additional
capital needs arise, we can, per the terms of the Term Loan agreement, seek to
upsize the facility. The Term Loan is more fully described in Note 10 - Debt
under Term loans - Senior Secured Term Loan in the notes to the consolidated
financial statements included elsewhere in this Annual Report on Form 10-K.

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Acquisition of Greenstar/Grotek

On August 3, 2021, we closed the acquisition of Greenstar. See Note 3 - Business
Combinations under Greenstar/Grotek Acquisition, in the notes to the
consolidated financial statements included elsewhere in this Annual Report on
Form 10-K. Greenstar produces premium horticultural products and solutions for
global, domestic and commercial use. Greenstar's owned brands include Grotek,
Gaia Green, Supergreen, and EarthSafe. Grotek has been producing since 1998 and
is sold internationally. Greenstar's brands are utilized by commercial operators
including growers, landscapers, greenhouses, nurseries, organic farms, as well
as independent retailers. Greenstar manufactures products for both the retail
and commercial market.

Investor Warrant Redemption

On July 19, 2021, we completed the redemption (the "Warrant Redemption") of
certain of our outstanding warrants (the "Investor Warrants") to purchase shares
of our common stock that were issued in connection with a private placement of
units. See Note 11 - Stockholders' Equity under Warrants - Redemption of
investor warrants, in the notes to the consolidated financial statements
included elsewhere in this Annual Report on Form 10-K. Prior to July 19, 2021,
3,367,647 Investor Warrants were exercised, generating approximately $56.8
million of gross proceeds to the Company. As a result, we redeemed 1,491
Investor Warrants for a redemption price of $0.00033712 per Investor Warrant. As
of December 31, 2021, there were no Investor Warrants outstanding. We used the
net proceeds from the redemption of the Investor Warrant for acquisitions,
working capital and other general corporate purposes.

Acquisition of Aurora

On July 1, 2021, we completed the acquisition of 100% of the issued and
outstanding membership interests of Aurora. See Note 3 - Business Combinations
under Aurora Acquisition, in the notes to the consolidated financial statements
included elsewhere in this Annual Report on Form 10-K. Founded in 2000, Aurora
was a family-owned business with a strong vertically integrated manufacturing
base with three locations across North America. The company is dedicated to
ethical and sustainable practices and offers comprehensive plant fertility
product lines free from harmful chemical residues and pesticides. Aurora adds to
our growing proprietary brand nutrient and grow media line-ups, including its
first organic nutrient and premium soil brands. We gained new domestic
manufacturing and distribution capabilities on the east and west coasts along
with a peat moss harvesting operation in Canada.

Acquisition of house and garden

On June 1, 2021, we acquired 100% of the issued and outstanding shares of
capital stock of the H&G Entities. See Note 3 - Business Combinations under
House & Garden Acquisition, in the notes to the consolidated financial
statements included elsewhere in this Annual Report on Form 10-K. The H&G
entities are located in Arcata, California, and produce and distribute premium
grade plant nutrients and fertilizers across the globe. The H&G entities offer a
strong product line of plant nutrients that strengthens our position in the
nutrient sector and complement our rapidly expanding portfolio of premium
products for controlled environment agriculture.

Follow-up public offer

On May 3, 2021, we closed our follow-on offering, in which we issued and sold
5,526,861 shares of our common stock, including the full exercise by the
underwriters of their option to purchase 720,894 additional shares of our common
stock, at a public offering price of $59.00 per share, which resulted in net
proceeds of approximately $309.8 million after deducting underwriting discounts
and commissions and offering expenses. We used the proceeds from the follow-on
offering for acquisitions, working capital and other general corporate purposes.

Heavy Acquisition 16

On May 3, 2021, we acquired 100% of the issued and outstanding membership
interests of Heavy 16. See Note 3 - Business Combinations under Heavy 16
Acquisition, in the notes to the consolidated financial statements included
elsewhere in this Annual Report on Form 10-K. Heavy 16 is a leading manufacturer
and supplier of branded plant nutritional products, with nine core products that
are currently sold across the United States. The Heavy 16 products feature a
full line of premium nutrients used in all stages of plant growth, helping to
increase the yield and quality of crops.

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JPMorgan credit facility

On March 29, 2021, we and certain of our subsidiaries entered into a Senior
Secured Revolving Credit Facility (the "JPMorgan Credit Facility") with JPMorgan
Chase Bank, N.A., as administrative agent, issuing bank and swingline lender,
and the lenders from time to time party thereto. The JPMorgan Credit Facility
replaced the Loan and Security Agreement with Encina Business Credit, LLC (the
"Encina Credit Facility"). There was no outstanding indebtedness under the
Encina Credit Facility when it was replaced. The JPMorgan Credit Facility, among
other things, provides for an asset based senior revolving credit line (the
"Senior Revolver") with JPMorgan as the initial lender. The three-year Senior
Revolver had a borrowing limit of $50 million. We had the right to increase the
amount of the Senior Revolver in an amount up to $25 million by obtaining
commitments from JPMorgan or from other lenders. Our and our subsidiaries'
obligations under the JPMorgan Credit Facility are secured by a first priority
lien (subject to certain permitted liens) in substantially all of our and our
subsidiaries' respective personal property assets pursuant to the terms of a
U.S. and a Canadian Pledge and Security Agreement, dated March 29, 2021, and the
other security documents. On August 31, 2021, the JPMorgan Credit Facility was
amended to increase the borrowing limit to $100 million and on October 25, 2021
was further amended to permit the Term Loan and to conform changes to provisions
of the Term Loan. The JPMorgan Credit Facility is more fully described in Note
10 - Debt under Revolving asset-backed credit facilities - JPMorgan Revolving
Credit Facility in the notes to the consolidated financial statements included
elsewhere in this Annual Report on Form 10-K.

New distribution centers

In April 2021, we entered into leases for two new distribution centers
aggregating approximately 322,000 square feet. One is located in Fairfield,
California and is the distribution center that we relocated to from our
Petaluma, California distribution facility in the fourth quarter of 2021. The
other distribution center is located in Fontana, California which we relocated
to from our Santa Fe Springs, California distribution facility in the third
quarter of 2021. See Note 7 - Leases, in the notes to the consolidated financial
statements included elsewhere in this Annual Report on Form 10-K.

In July 2021we signed a lease for approximately 246,000 square feet of warehouse space at Surrey, British ColumbiaCanada to be available at the expiration of the lease for the existing space, starting from January 1, 2023. See Note 7 – Leases, in the Notes to the Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.

In November 2021, we executed a lease for approximately 109,000 square feet of
warehouse space in Cambridge, Ontario, Canada to be available upon expiration of
the lease existing space, commencing June 1, 2023. See Note 7 - Leases, in the
notes to the consolidated financial statements included elsewhere in this Annual
Report on Form 10-K.

In January 2022, we executed a lease for approximately 303,000 square feet of
warehouse space in Shoemakersville, Pennsylvania to be available upon expiration
of the lease for existing space, commencing March 1, 2022. See Note 7 - Leases,
in the notes to the consolidated financial statements included elsewhere in this
Annual Report on Form 10-K.

Effects of COVID-19 on our business

The World Health Organization recognized 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 States
and 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.

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, such as
restrictions on non-essential business travel, the institution of work-from-home
practices and the implementation of strategies for workplace safety at our
facilities. 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. As
of the date of this Annual Report on Form 10-K, manufacturers in China and in
North America are generally back in operation; however, new waves of the
COVID-19 pandemic could result in the re-closure of factories in China and/or in
North America. Quarantine orders and travel restrictions within the United
States and 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

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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, mainly we and Canada, which are currently affected by the COVID-19 pandemic. Many of these customers have experienced shelter-in-place measures in an attempt to contain the spread of COVID-19, including general closures, closure of schools and non-essential businesses, bans on gatherings and restrictions on travel.

Our business has remained resilient during the COVID-19 pandemic. As of December
31, 2021, 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 net 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.

Other operations

Initial public offering

On December 14, 2020, we completed our initial public offering ("IPO"), in which
we issued and sold 9,966,667 shares of our common stock, including the full
exercise by the underwriters of their option to purchase 1,300,000 additional
shares of our common stock, at a public offering price of $20.00 per share,
which resulted in net proceeds of $182.3 million after deducting underwriting
discounts and commissions and offering expenses. The proceeds from the IPO were
used to (i) repay amounts outstanding under the previous term loan with
Brightwood Loan Services, LLC of $76.6 million (includes accrued interest and
fees of $0.3 million), (ii) to pay down certain amounts outstanding under the
Encina Credit Facility of $33.4 million, (iii) to repay $3.3 million under the
promissory note to JPMorgan Chase, N.A. through the U.S. Small Business
Administration Paycheck Protection Program, and (iv) to pay $2.6 million to
settle the Series A preferred stock dividend. Our common stock began trading on
the Nasdaq Global Select Market on December 10, 2020.

Reverse stock split

Our board of directors and stockholders approved an amendment to our amended and
restated certificate of incorporation effecting a 1-for-3.3712 reverse stock
split of our issued and outstanding shares of common stock. The reverse split
was effected on November 24, 2020 without any change in the par value per share.

Components of operating results

Net sales

We generate net sales from the distribution and manufacturing of hydroponic
equipment and supplies to our customers. The hydroponic equipment and supplies
that we sell include consumable products, such as growing media, nutrients and
supplies that require regular replenishment and durable products, such as
lighting and hydroponic equipment. Our scale allows us to provide delivery and
service capabilities to a highly diverse group of customers across the U.S. and
Canada. We

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do not generally sell direct to growers, but rather our customer base consists of specialty hydroponic retailers, garden centers, e-commerce and greenhouse suppliers.

We periodically offer sales incentives to our customers, including early pay
discounts, volume-based rebates, temporary price reductions, advertising credits
and other trade activities. Net sales reflect our gross sales less sales
incentives which are estimated and recorded at the time of sale plus amounts
billed to customers for shipping and handling costs. We anticipate that sales
incentives and/or the amount billed to customers for shipping and handling costs
could impact our net sales and that changes in such promotional activities or
freight recovery charges could impact period-over-period results.

Cost of Goods Sold

Cost of goods sold consists primarily of material costs, inbound and outbound
freight costs, direct labor costs primarily for manufacturing and warehouse
personnel, facility costs for manufacturing operations and depreciation,
depletion and amortization of manufacturing and warehouse improvements and
equipment. We expect our cost of goods sold to increase in absolute dollars in
conjunction with our growth and as a result of higher freight and labor costs.
However, we expect that, over time, cost of goods sold will decrease as a
percentage of net revenue as a result of the scaling of our business including a
higher proportion of the amount of proprietary and exclusive branded products
that we sell.

Selling, general and administrative expenses

Selling, general and administrative expenses consists primarily of marketing and
advertising, facility costs for distribution operations, stock-based
compensation, depreciation and amortization of all other assets and other
selling, general and administrative costs, including but not limited to
salaries, benefits, bonuses, stock-based compensation, professional fees and
various costs related to becoming a publicly-traded company. We expect selling,
general and administrative expenses to increase in absolute dollar terms as we
scale our operations to meet increased demand for our products and operate as a
public company with increased costs associated with insurance, finance, legal
and accounting functions; however, we also expect that the significant increase
in our scale will result in selling, general and administrative expenses as a
percentage of net sales decreasing over time.

Operating results data

The results of the operating data in the following tables for the years ended
December 31, 20212020 and 2019 are derived from the audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

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Results of Operations – Comparison of Years Ended December 31, 2021 and 2020

The following table sets forth our consolidated statements of operations for the
years ended December 31, 2021, and 2020, including amounts and percentages of
net sales for each year and the year-to-year change in dollars and percent
(amounts in thousands):

                                                              Years ended December 31,
                                                      2021                                     2020                           Year to year change
Net sales                             $     479,420                100.0    %      $ 342,205           100.0    %      $   137,215                40.1    %
Cost of goods sold                          377,934                 78.8    %        278,572            81.4    %           99,362                35.7    %
Gross profit                                101,486                 21.2    %         63,633            18.6    %           37,853                59.5    %
Operating expenses:
Selling, general and administrative         103,888                 21.7    %         58,492            17.1    %           45,396                77.6  

%

Impairment, restructuring and other             297                  0.1    %            860             0.3    %             (563)              -65.5  

%

(Loss) income from operations                (2,699)                -0.6    %          4,281             1.3    %           (6,980)             -163.0    %
Interest expense                             (2,138)                -0.4    %        (10,141)           -3.0    %            8,003               -78.9    %
Loss on debt extinguishment                    (680)                -0.1    %           (907)           -0.3    %              227               -25.0  

%

Other (expense) income, net                    (204)                 0.0    %             70             0.0    %             (274)             -391.4    %
Loss before tax                              (5,721)                -1.2    %         (6,697)           -2.0    %              976               -14.6    %
Income tax benefit (expense)                 19,137                  4.0    %           (576)           -0.2    %           19,713            -3,422.4    %
Net income (loss)                            13,416                  2.8    %         (7,273)           -2.1    %           20,689              -284.5    %
Cumulative dividends allocated to
Series A Convertible Preferred Stock              -                  0.0    %         (2,597)           -0.8    %            2,597              -100.0  

%

Net income (loss) attributable to
common stockholders                   $      13,416                  2.8    %      $  (9,870)           -2.9    %      $    23,286              -235.9    %


Net sales

Net sales for the year ended December 31, 2021 were $479.4 million, an increase
of $137.2 million, or 40.1%, compared to the same period in 2020. The 40.1%
increase was due to an approximate 35.0% increase in volume of products sold (a
13.1% increase in organic sales and a 21.9% increase from recently-acquired
proprietary brands), a 3.6% increase in price and mix of products sold, and 1.5%
growth from favorable foreign exchange rates. The increase in volume of products
sold was primarily related to (i) expansion of our proprietary and preferred
brands, (ii) large expansion of our plant nutrients products, (iii) first-half
expansion in our business predominantly in California, Oklahoma and Missouri,
and (iv) growth from our acquisitions. The increase in price was primarily
related to list price increases. The increase in foreign exchange related to
recent weakness in the U.S. Dollar relative to the Canadian Dollar and to the
Euro.

Gross profit

Gross profit for the year ended December 31, 2021 was $101.5 million, an
increase of $37.9 million, or 59.5%, compared to the same period in 2020. The
increase in gross profit was primarily related to (i) the aforementioned
increase in net sales and (ii) a significant increase in our gross profit margin
percentage (gross profit as a percentage of net sales). Our gross profit margin
percentage increased to 21.2% for the year ended December 31, 2021 from 18.6% in
the same period in 2020. The higher gross profit margin percentage is primarily
due to a more favorable sales mix of proprietary and preferred brand products
(due in part to the aforementioned proprietary brands that were recently
acquired and the preferred brands products added in the year-to-date period),
which typically carry a higher gross margin than our distributed branded
products, partially offset by higher freight and labor costs which escalated
significantly as a percentage of net sales in our third and fourth fiscal
quarters.

Selling, general and administrative expenses

Selling, general and administrative expenses ("SG&A") for the year ended
December 31, 2021 were $103.9 million, an increase of $45.4 million, compared to
the same period in 2020. The increase is primarily related to acquisition and
integration expenses of $19.7 million, costs associated with the relocation of
certain of our distribution centers of $1.9 million, non-compensation general
and administrative costs associated with the new acquisitions (an increase of
$9.2 million), compensation costs (an increase of $7.2 million), insurance costs
(an increase of $2.6 million), marketing (an increase of $2.3 million), facility
costs (an increase of $2.3 million), consulting fees (an increase of $1.7
million), and $1.9 million of solicitation fees incurred in

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connection with the Warrant Redemption, offset by share-based compensation (a
decrease of ($3.4) million). These increases were largely the result of (i) our
accelerated M&A strategy and (ii) the increased costs associated with running a
public company and supporting our long-term growth strategy. The decrease in
share-based compensation was due to the vesting of restricted stock units
("RSUs") last December with performance-based vesting requirements which was
satisfied upon the consummation of our IPO. As a result, our IPO in December
2020 triggered a significant performance-based stock compensation charge of $6.1
million for previously unrecognized time-based vesting prior to the IPO.

Interest expense

Interest expense for the year ended December 31, 2021 was $2.1 million, a
decrease of $8.0 million, or 78.9%, compared to the same period in the prior
year. The decrease was primarily due to the payoff of the prior term loan with
Brightwood Loan Services, LLC and pay down of the Encina Credit Facility in
connection with the December 2020 IPO.

Loss on extinguishment of debt

Loss on debt extinguishment for the year ended December 31, 2021 was $0.7
million, which resulted primarily from the write-off of unamortized deferred
financing costs associated with the termination of the Encina Credit Facility.
Loss on debt extinguishment for the year ended December 31, 2020 was $0.9
million, which resulted primarily from the write-off of unamortized deferred
financings costs associated with the payoff of the prior term loan with
Brightwood Loan Services, LLC.

Income tax benefit (expense)

Income tax benefit for the year ended December 31, 2021 was approximately $19.1
million. Our income tax benefit was primarily the result of a reduction in the
valuation allowance recorded against our net deferred tax assets. In connection
with the acquisition of the H&G Entities, we recorded a net deferred tax
liability which provided an additional source of taxable income to support the
realization of the pre-existing deferred tax assets. Our income tax benefit was
partially offset by income taxes from certain foreign jurisdictions where we
conduct business and state minimum income taxes in the United States. We have a
valuation allowance for deferred tax assets, including net operating loss
carryforwards. The income tax expense for the year ended December 31, 2020 was
primarily due to foreign and state income tax expense.

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Results of Operations – Comparison of Years Ended December 31, 2020 and 2019

The following table sets forth our consolidated statements of operations for the
years ended December 31, 2020 and 2019, including amounts and percentages of net
sales for each year and the year-to-year change in dollars and percent (amounts
in thousands):


                                                              Years ended December 31,
                                                      2020                                     2019                          Year to year change
Net sales                             $     342,205                100.0    %      $ 235,111              100.0 %      $   107,094              45.6    %
Cost of goods sold                          278,572                 81.4    %        208,025               88.5 %           70,547              33.9    %
Gross profit                                 63,633                 18.6    %         27,086               11.5 %           36,547             134.9    %
Operating expenses:
Selling, general and administrative          58,492                 17.1    %         43,784               18.6 %           14,708              33.6    %
Impairment, restructuring and other             860                  0.3    %         10,035                4.3 %           (9,175)            -91.4    %
Income (loss) from operations                 4,281                  1.3    %        (26,733)             -11.4 %           31,014            -116.0    %
Interest expense                            (10,141)                -3.0    %        (13,467)              -5.7 %            3,326             -24.7    %
Loss on debt extinguishment                    (907)                -0.3    %           (679)              -0.3 %             (228)             33.6    %
Other income, net                                70                  0.0    %            105                0.0 %              (35)            -33.3    %
Net loss before tax                          (6,697)                -2.0    %        (40,774)             -17.4 %           34,077             -83.6    %
Income tax (expense) benefit                   (576)                -0.2    %            691                0.3 %           (1,267)           -183.4    %
Net loss                                     (7,273)                -2.1    %        (40,083)             -17.1 %           32,810             -81.9    %
Cumulative dividends allocated to
Series A Convertible Preferred Stock         (2,597)                -0.8    %              -                0.0 %           (2,597)                 n/a %
Net loss attributable to Hydrofarm
Holdings Group, Inc.                  $      (9,870)                -2.9    %      $ (40,083)             -17.1 %      $    30,213             -75.4    %


Net sales

Net sales for the year ended December 31, 2020 increased by $107.1 million or
45.6% compared to the year ended December 31, 2019. The increase in net sales
was primarily due to a 42.0% increase in volume of products sold and a 3.6%
increase in price of products sold. The increase in volume of products sold was
primarily related to (i) higher demand from the end-markets across numerous U.S.
states, including but not limited to Michigan, Oklahoma and California, and
Canada and (ii) higher demand for our proprietary and preferred branded products
which grew at a faster pace than our distributed brands during the period. The
increase in price was primarily related to list price increases and more
effective sales incentives.

Although we cannot precisely quantify in absolute or relative terms, our
accelerated rate of growth in net sales for the year ended December 31, 2020
correlates with shelter-in-place orders issued in March 2020 in response to the
COVID-19 pandemic. A portion of our net sales during this period could have been
related to pull-through demand for our products due to higher consumption of CEA
products from individuals spending more time at home due to shelter-in-place
measures. Although uncertainty created by the COVID-19 pandemic remains, and
various state budgets remain under economic pressure, creating a greater chance
of further cannabis legalization, we cannot assure you that such growth will
continue.

Gross profit

Gross profit for the year ended December 31, 2020 increased by $36.5 million or
134.9% compared to the year ended December 31, 2019. The increase in gross
profit was primarily related to (i) the aforementioned increase in net sales and
(ii) a significant increase in our gross profit margin percentage (gross profit
as a percent of net sales). Our gross profit margin percentage increased to
18.6% for the year ended December 31, 2020 compared to 11.5% for the year ended
December 31, 2019. The higher gross profit margin percentage was primarily due
to (i) a more favorable sales mix of proprietary and exclusive branded products,
which typically carry a higher gross margin, (ii) lower freight cost, and (iii)
inventory adjustments and write-downs that impacted the fourth quarter of 2019
primarily associated with our 2019 SKU rationalization.


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Selling, general and administrative expenses

Selling, general and administrative expenses for the year ended December 31,
2020 increased by $14.7 million or 33.6%, compared to the year ended December
31, 2019 due primarily to an increase of $8.7 million in stock-based
compensation expense, of which $6.1 million was directly triggered by our IPO in
December 2020 (more fully described below). SG&A expense excluding the portion
of stock-based compensation expense triggered by the IPO decreased from 18.6% in
2019 to 15.3% in 2020 due to economies of scale as our net sales grew faster
than our selling, general and administrative expenses.

To support our long-term growth plan and our IPO, we undertook several
initiatives in mid-to-late 2019 and early 2020 which resulted in the
aforementioned $14.7 million increase in selling, general and administrative
expenses, including increased stock-based compensation expenses, increased
compensation costs (an increase of $3.9 million), and increased professional
service fees, including, but not limited to, the hiring of executives such as
our new Chief Executive Officer, President and Chief Financial Officer and
engaging new third parties such as an IT consulting firm, a new auditor, and
several accounting and audit-related consultants (an increase of $4.4 million).

As more fully discussed in Note 12 - Stock-based compensation, in the notes to
the consolidated financial statements included elsewhere in this Annual Report
on Form 10-K, we granted RSUs to certain officers, former directors and their
affiliates which have vesting conditions including a performance-based vesting
requirement which was satisfied upon the consummation of our IPO. As a result,
our IPO in December 2020 triggered a significant performance-based stock
compensation charge of $6.1 million for previously unrecognized time-based
vesting prior to the IPO.

Impairment, restructuring and others

Impairment, restructuring and other expenses declined to $0.9 million for the
year ended December 31, 2020. For the year ended December 31, 2019, we
recognized a $5.4 million expense related to impairment of intangible assets for
customer relationships; $2.0 million for restructuring costs, and $1.5 million
for other expenses. We also incurred $1.1 million for a registration statement
which was delayed, and accordingly, the third-party costs were expensed. See
Note 15 - Impairment, restructuring and other, in the notes to the consolidated
financial statements included elsewhere in this Annual Report on Form 10-K for
additional information.

Interest expense

Interest expense decreased by $3.3 million or 24.7% for the year ended December
31, 2020 compared to the year ended December 31, 2019. The average balance of
our interest bearing debt for the year ended December 31, 2020 increased by $2.3
million compared to the year ended December 31, 2019. This increase was offset
by a decrease in the effective interest rate on the term loan with Brightwood
Loan Services, LLC ("Brightwood Term Loan"), from approximately 13% for the year
ended December 31, 2019 to an effective interest rate of approximately 10.2% for
the year ended December 31, 2020 due to a reduction of the Brightwood Term Loan
interest rate margin which became effective on January 1, 2020 from LIBOR plus
10.0% to LIBOR plus 8.5% along with a reduction of average LIBOR from 2.5% to
1%. The decrease in interest costs was also slightly impacted by a decrease in
the effective interest rate on our revolving credit facilities from
approximately 9.9% for the year ended December 31, 2019 to approximately 9.3%
for the year ended December 31, 2020.

Loss on extinguishment of debt

Loss on debt extinguishment for the year ended December 31, 2020 resulted from
the write-off of unamortized deferred financing costs associated with the payoff
of the Brightwood Term Loan in connection with the IPO. Similar costs in 2019
resulted from the write-off of unamortized deferred financing costs when the
BofA Credit Facility was refinanced with the Encina Credit Facility.

income tax expense

Income tax expense for the year ended December 31, 2020 generally reflects a minimum we report income taxes that do not fluctuate with pre-tax profit or loss and Canadian taxes at any of our profitable Canadian subsidiaries.

The net income tax benefit for the year ended December 31, 2019 is comprised of
two amounts: (i) minimum U.S. state and Canadian provincial taxes which do not
fluctuate with pre-tax income or loss; and, (ii) a deferred income tax benefit
of $0.7 million primarily generated from the tax consequence of the impairment
write-off which is not expected to recur.

Cumulative dividends allocated to Series A Convertible Preferred Shares

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Our Series A Preferred Stock accrued a cumulative dividend during 2020 which is
presented as a reduction of net loss which results in the net loss attributable
to common stockholders. Dividends did not accrue prior to 2020. Upon the
consummation of our IPO in December 2020, the Series A Preferred Stock
automatically converted into 2,291,469 shares of our common stock and we paid
$2.6 million in cash to settle the Series A Preferred Stock dividend.

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 income (loss)
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 audited 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 interest expense or amounts required to service interest or principal repayments on our debt;

• 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 which adjusts the cash available to us;

• Adjusted EBITDA excludes the non-cash component of stock-based compensation;

• Adjusted EBITDA excludes the amount of employer social charges on stock-based compensation; and

• Adjusted EBITDA does not reflect the impact of earnings or expenses resulting from matters that we believe do not reflect, on a recurring basis, our ongoing operations.

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.


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The following table provides a reconciliation of net income (loss), the most comparable GAAP financial measure, to Adjusted EBITDA for the years ended
December 31, 20212020 and 2019 (in thousands):

                                                      Years ended December 31,
                                                2021           2020            2019
Net income (loss)                            $ 13,416       $ (7,273)      $ (40,083)
Interest expense                                2,138         10,141          13,467
Income tax (benefit) expense                  (19,137)           576            (691)
Distribution center exit costs and other        2,641              -        

Depreciation, depletion and amortization 14,934 6,779

6,995

Impairment, restructuring and other               297            860        

10,035

Acquisition and integration expenses*          24,210              -               -
Other expense (income), net                       204            (70)           (105)
Stock-based compensation**                      5,750          9,156             208
 Loss on debt extinguishment                      680            907             679
 Investor warrant solicitation fees             1,949              -        

Adjusted EBITDA                              $ 47,082       $ 21,076       $  (9,495)
Adjusted EBITDA as a percent of net sales         9.8  %         6.2  %     

(4.0)%

Includes advisory services, transaction services and legal fees incurred for the completed acquisitions of Heavy 16, House and Garden, Aurora, Greenstar/Grotek and IGE and certain potential acquisitions.

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(**) Includes employer social charges on share-based compensation

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Cash and capital resources Cash Flow from Operating, Investing and Financing Activities – Comparison of Years EndedDecember 31, 2021

2020 and 2019 The following table summarizes our cash flows for the years endedDecember 31, 2021

                                                                     Years 

2020 and 2019 (amounts in thousands): endedthe 31st of December

                                                            2021               2020               2019
Net cash used in operating activities                   $ (45,067)         $ (44,825)         $ (13,302)
Net cash (used in) provided by investing activities      (468,184)               546             (3,818)
Net cash provided by financing activities                 464,707             88,145             19,900
Effect of exchange rate changes on cash, cash
equivalents and restricted cash                               (27)               232              2,154

,

                                           (48,571)            44,098              4,934

Net increase (decrease) in cash, cash equivalents and restricted cash

                                                    76,955             32,857             27,923
Cash, cash equivalents and restricted cash at end of
year                                                    $  28,384          $  76,955          $  32,857


Operating Activities

Net cash used in operating activities was $45.1 million for the year ended
December 31, 2021, primarily consisting of $13.4 million in net income, $4.4
million in net non-cash expense reductions, which were largely comprised of
depreciation, depletion and amortization, stock-based compensation expense,
non-cash operating lease expense, deferred income tax benefit and other non-cash
expenses, less a $62.9 million increase in working capital. This change in
working capital primarily reflects an aggregate increase of $47.8 million in
accounts receivable, inventories, prepaid expenses and other current assets, and
other assets for the period as well as an aggregate net decrease of $15.1
million in accounts payable, accrued expenses and other current liabilities, and
a decrease in lease liabilities due to payments on lease obligations during the
period.

Net cash used in operating activities was $44.8 million for the year ended
December 31, 2020 consisting of $20.2 million in non-cash expense addbacks which
were largely composed of stock-based compensation, depreciation and amortization
and non-cash operating lease expense, less net loss of $7.3 million, payment of
interest capitalized to principal of long-term debt of $13.9 million and a $43.8
million increase in working capital. The change in working capital primarily
reflects a $43.2 million increase in accounts receivable and inventory for the
period offset by a $10.7 million increase in accounts payable and accrued
expenses. The net change was due to the additional working capital needed to
support our growth in net sales.

Net cash used in operating activities was $13.3 million for the year ended
December 31, 2019 consisting of net loss of $40.1 million offset by $26.2
million in non-cash addbacks which were largely composed of depreciation and
amortization, impairment charges, interest expense added to principal and
non-cash operating lease expense, plus a $0.6 million increase in working
capital. The small change in working capital primarily reflects a $2.1 million
net decrease in accounts receivable and inventories as collections and net sales
during 2019 were slowed due to the industry downturn, plus a $1.2 million
increase in accounts payable and accrued expenses as we were able to align
payment of our obligations with our cash flow.

Cash, cash equivalents and restricted cash at the beginning of the year

Net cash used in investing activities for the year ended December 31, 2021 was
$468.2 million, due primarily to five business acquisitions we completed during
the period, which totaled $462.2 million in cash outflows and $6.0 million in
purchases of property and equipment and other.

We had minimal investing activities for the years ended December 31, 2020 and
2019. We made advances on notes receivable to third parties of $3.1 million the
year ended December 31, 2019 and were repaid $2.0 million the year ended
December 31, 2020. Our business was not capital intensive during the years ended
December 31, 2020 or 2019 and purchases of property and equipment were $1.4
million and $0.8 million, respectively.

Investing activities

Fundraising activities Net cash provided by financing activities was $464.7 million
for the year endedDecember 31, 2021 . We received $309.8 million product of our follow-up offer, $119.9 million

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the proceeds of our senior secured term loan, net of

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discount and issuance costs, and received an additional $56.8 million from the
exercise of warrants, including the Warrant Redemption. We also paid $20.0
million related to employee's withholding tax in connection with the vesting of
certain restricted stock units.

Our IPO was completed in December 2020 generating $182.4 million in net
proceeds. We used a portion of the proceeds to pay off the Brightwood Term Loan,
to pay off our PPP loan and to paydown the outstanding balance under the Encina
Credit Facility. Other activity was a net of $1.2 million from transactions with
our Series A preferred stock investors and payments of $0.7 million on finance
leases. Our net cash provided by these activities was $88.1 million for the
period which we used for business growth and expansion.

For the year ended December 31, 2019, our borrowings under the working capital
credit facilities marginally exceeded repayments which reflected stable working
capital needs for the period. We also received $21.7 million from our Series A
Preferred Stock offering including proceeds from the issuance of notes which
converted into the Series A Preferred Stock. Net cash provided by these
activities was $19.9 million for the period.

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On March 29, 2021, we entered into the JPMorgan Credit Facility, which provided
for a borrowing limit of $50 million. The JPMorgan Credit Facility replaced the
Encina Credit Facility. The JPMorgan Credit Facility is due on March 29, 2024.

On August 31, 2021, the JPMorgan Credit Facility was amended to increase the
borrowing limit to $100 million and on October 25, 2021 was further amended to
permit the Term Loan and to conform to provisions of the Term Loan.

The JPMorgan Credit Facility has 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. Our obligations under the JPMorgan Credit Facility are secured by a
first priority lien (subject to certain permitted liens) in substantially all of
our and our subsidiaries' respective personal property assets pursuant to the
terms of a U.S. and Canadian Pledge and Security Agreement dated March 29, 2021
and other security documents

The JPMorgan Credit Facility maintains certain reporting requirements,
affirmative covenants, negative covenants and financial covenants ("debt
covenants"). The financial covenants include that we must maintain 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 December 31, 2021. As of December 31,
2021, approximately $83.6 million was available to borrow under the undrawn
JPMorgan Credit Facility.

JPMorgan Revolving Credit Facility

On October 25, 2021, we and certain of our direct and indirect subsidiaries
entered into the Term Loan (as defined below) with JPMorgan Chase Bank, N.A., as
administrative agent for certain lenders, pursuant to which we borrowed a
$125.0 million senior 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 million from the Term Loan after deducting discounts and deferred
financing costs.

The principal amounts of the Term Loan are scheduled to be repaid in consecutive
quarterly installments in amounts equal to 0.25% of the $125 million 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. The Term Loan is secured by a
first lien on our non-working capital assets and a second lien on our working
capital assets.

Contractual obligations

See Note 7 - Leases, in the notes to the consolidated financial statements
included elsewhere in this Annual Report on Form 10-K, for discussions on future
minimum lease payments under long-term non-cancelable operating and financing
leases with remaining terms greater than one year.

Senior Secured Term Loan

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See Note 10 – Debt, in the Notes to the Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K, for discussions of future principal payments on long-term debt.

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TABLE OF CONTENTS From time to time, in the normal course of business, we will enter into agreements with suppliers who offer favorable prices in exchange for a commitment to purchase minimum quantities of inventory over a defined period of time. We had no significant purchase commitments atDecember 31, 2021

.

Our net sales tend to be seasonally stronger in our fiscal second and third
quarters due to robust sales in the warmer spring and summer months in North
America (the United States and Canada are our primarily markets). This seasonal
trend primarily relates to the garden center portion of our customer base and
that certain of our customers may from time to time use some of our products
(such as grow media and nutrients) in outdoor applications.

Seasonality

We believe that our cash flows from operating activities and the JPMorgan Credit
Facility and Term Loan will be sufficient to meet our capital expenditures,
working capital needs and debt repayments for the foreseeable future. However,
we cannot ensure that our business will generate sufficient cash flow from
operating activities or that future borrowings will be available under our
borrowing agreements in amounts sufficient to pay indebtedness or fund other
working capital needs. Actual results of operations will depend on numerous
factors, many of which are beyond our control as further discussed in Item 1A.
Risk Factors included elsewhere in this Annual Report on Form 10-K.

Availability and use of cash

Certain accounting policies require us to make estimates and judgments in
determining the amounts reflected in the Consolidated Financial Statements. Such
estimates and judgments necessarily involve varying, and possibly significant,
degrees of uncertainty. Accordingly, certain amounts currently recorded in the
financial statements will likely be adjusted in the future based on new
available information and changes in other facts and circumstances. A discussion
of our principal accounting policies that required the application of
significant judgments as of December 31, 2021 follows.

Significant Accounting Policies and Estimates

Acquisitions of businesses are accounted for under the acquisition method. The
consideration transferred in a business combination is measured at fair value,
which is calculated as the sum of the acquisition date fair value of assets
transferred, liabilities incurred to the former owners of the acquiree and the
equity interest issued in exchange for control of the acquiree. Acquisition
related costs are expensed as incurred.

When the consideration transferred in a business combination includes a
contingent consideration arrangement, which is where we may have the obligation
to transfer additional assets or equity interest to the former owners if
specified future events or conditions are met, the contingent consideration is
measured at its acquisition date fair value and is included as part of the
consideration transferred in a business combination. Contingent consideration is
classified as a liability when the obligation requires settlement in cash or
other assets and is classified as equity when the obligation requires settlement
in our own equity instruments. Changes in fair value of contingent consideration
that qualify as measurement period adjustments are adjusted retrospectively with
a corresponding adjustment to goodwill. Measurement period adjustments are
adjustments that arise from additional information obtained during the
measurement period, which cannot exceed one year from the acquisition date,
about facts and circumstances that existed at the acquisition date. All other
subsequent changes in fair value of contingent consideration classified as a
liability are included in net income in the period and changes in fair value of
contingent consideration classified as equity are not recognized.

For a given acquisition, we may identify certain pre-acquisition contingencies
as of the acquisition date and we may extend our review and evaluation of these
pre-acquisition contingencies throughout the measurement period in order to
obtain sufficient information to assess these contingencies as part of
acquisition accounting.

Goodwill is measure as the excess of the sum of the consideration transferred,
the amount of any non-controlling interests in the acquiree, and the fair value
of the acquirer's previously held equity interest in the acquiree (if any) over
the net acquisition-date fair value amounts of the identified assets acquired
and liabilities assumed.

If the initial accounting for a business combination is incomplete by the end of
the reporting period in which the business combination occurs, we report
provisional amounts for the items for which the accounting is incomplete. Those
provisional amounts are adjusted during the measurement period, or additional
assets or liabilities are recognized to reflect new

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Business combinations

————————————————– ——————————

information obtained about facts and circumstances that existed at the
acquisition date that, if known, would have affected the amounts recognized at
the time. Upon conclusion of the measurement period or final determination of
the values of the assets acquired or liabilities assumed, whichever occurs
first, any subsequent adjustments are recorded to net income (loss).

TABLE OF CONTENTS Good will

Our consolidated balance sheet at December 31, 2021 includes goodwill of
acquired businesses and other indefinite-lived intangible assets. We evaluate
these assets for impairment annually in the fourth quarter and on an interim
basis if the facts and circumstances lead us to believe that
more-likely-than-not there has been an impairment. Goodwill and indefinite-lived
intangible asset impairment reviews include performing either an initial
qualitative or quantitative evaluation for each of our reporting units and
indefinite-lived intangible assets. As of December 31, 2021, we concluded it is
more likely than not that goodwill and indefinite-live intangible assets
recorded in our consolidated balance sheet were not impaired.

and intangible assets with an indefinite useful life

Long-lived tangible assets and finite-lived intangible assets are stated at
cost. Depreciation and amortization expense is provided on the straight-line
method and based on the estimated useful economic lives of the long-lived
tangible assets. Intangible assets with finite lives are subject to
amortization. These intangible assets are being amortized over their estimated
useful economic lives typically ranging from 5 to 18 years. Long-lived tangible
and finite-lived intangible assets are reviewed for impairment when events or
changes in circumstances indicate that the carrying amount may not be
recoverable. As of December 31, 2021, we concluded that our long-lived tangible
and finite-lived intangible assets recorded in our consolidated balance sheet
were not impaired.

Tangible long-lived assets and intangible assets with a finite life

For information regarding recent accounting pronouncements, refer to Note 2 -
Basis of presentation and significant accounting policies - Recently issued
accounting pronouncements, to our consolidated financial statements included
elsewhere in this Annual Report on Form 10-K.


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Recent accounting statements

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