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As confidentially submitted with the Securities and Exchange Commission on July 17, 2019.
This draft registration statement has not been publicly filed with the Securities and Exchange Commission and all information herein remains strictly confidential.
Registration No. 333-    ​
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
Hydrofarm Holdings Group, Inc.
(Exact name of registrant as specified in its charter)
Delaware
5191
81-4895761
(State or other jurisdiction of
incorporation or organization)
(Primary Standard Industrial
Classification Code Number)
(I.R.S. Employer
Identification Number)
2249 South McDowell Boulevard Ext.
Petaluma, California 94954
(707) 765-9990
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)
Cogency Global Inc.
850 New Burton Road, Suite 201
Dover, Delaware 19904
(800)483-1140
(Name, address, including zip code, and telephone number, including area code, of agent for service)
Copies to:
Kenneth R. Koch, Esq.
Mintz, Levin, Cohn, Ferris, Glovsky and Popeo P.C.
Chrysler Center, 666 Third Avenue
New York, NY 10017
Tel: (212) 935-3000
Approximate date of commencement of proposed sale to the public: From time to time after this registration statement becomes effective.
If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. ☐
If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ☐
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ☐
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration number of the earlier effective registration statement for the same offering. ☐
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 (Do not check if a smaller reporting company) ☐ 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 7(a)(2)(B) of the Securities Act. ☐
CALCULATION OF REGISTRATION FEE
Title of Each Class of Securities to be Registered
Amount to be
Registered(1)
Proposed Maximum
Offering Price
Per Share(2)
Proposed Maximum
Aggregate Offering
Price(2)
Amount of
Registration Fee
Common stock, par value $0.0001 per share
$      $      $     
Total
$ $
(1)
Includes shares of common stock issuable upon exercise of the underwriters’ option to purchase additional shares of common stock.
(2)
Estimated solely for purpose of calculating the registration fee according to Rule 457(o) under the Securities Act of 1933, as amended (the “Securities Act”).
The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

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The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.
SUBJECT TO COMPLETION, DATED            , 2019
Preliminary Prospectus
Hydrofarm Holdings Group, Inc.
[MISSING IMAGE: lg_hydrofarm.jpg]
           Shares of Common stock
This is an initial public offering of common stock of Hydrofarm Holdings Group, Inc.
Prior to this offering, there has been no public market for our common stock. It is currently estimated that the initial public offering price per share will be between $     and $    . We have applied to list our common stock on the Nasdaq Global Market under the symbol “      .”
We will be treated as an emerging growth company, as defined in the Jumpstart Our Business Startups Act of 2012, for certain purposes until we complete this offering. As such, in this prospectus we have taken advantage of certain reduced disclosure obligations that apply to emerging growth companies.
Investing in our common stock is highly speculative and involves a high degree of risk. See “Risk Factors” beginning on page 18 to read about factors you should consider before buying shares of our common stock.
Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of the disclosures in this prospectus. Any representation to the contrary is a criminal offense.
Per Share
Total
Initial public offering price
$      $     
Underwriting discounts and commissions(1)
$ $
Proceeds, before expenses, to Hydrofarm Holdings Group, Inc.
$ $
(1)
See the section titled “Underwriting” for a description of the compensation payable to the underwriters.
The underwriters expect to deliver the shares against payment in New York, New York, on or about            , 2019.
The date of this prospectus is            , 2019

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F-1
Through and including            , 2019 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to a dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscription.
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ABOUT THIS PROSPECTUS
This prospectus is part of a registration statement that we have filed with the Securities and Exchange Commission (the “SEC”). You should not assume that the information contained in this prospectus is accurate on any date subsequent to the date set forth on the front cover of this prospectus even though this prospectus is delivered or shares of common stock are sold or otherwise disposed of on a later date. It is important for you to read and consider all information contained in this prospectus in making your investment decision. You should also read and consider the information in the documents to which we have referred you under “Where You Can Find More Information” in this prospectus.
You should rely only on the information contained in this prospectus. We have not authorized anyone to give any information or to make any representation to you other than those contained in this prospectus. You must not rely upon any information or representation not contained in this prospectus. This prospectus does not constitute an offer to sell or the solicitation of an offer to buy any of our shares of common stock other than the shares of our common stock covered hereby, nor does this prospectus constitute an offer to sell or the solicitation of an offer to buy any securities in any jurisdiction to any person to whom it is unlawful to make such offer or solicitation in such jurisdiction. Persons who come into possession of this prospectus in jurisdictions outside the United States are required to inform themselves about, and to observe, any restrictions as to the offering and the distribution of this prospectus applicable to those jurisdictions.
Emerging Growth Company
We are an “emerging growth company”, as defined in the Jumpstart our Business Startups Act of 2012 (“JOBS Act”), and we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. We cannot predict if investors will find our common stock less attractive because we may rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.
Section 107 of the JOBS Act provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. In other words, an “emerging growth company” can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have elected not to opt out of the transition period pursuant to Section 107(b).
We could remain an “emerging growth company” for up to five years, or until the earliest of  (i) the last day of the first fiscal year in which our annual gross revenues exceed $1,070,000,000, (ii) the date that we become a “large accelerated filer” as defined in Rule 12b-2 under the Securities and Exchange Act of 1934, as amended, which would occur if the market value of our common stock that is held by non-affiliates exceeds $700 million as of the last business day of our most recently completed second fiscal quarter, or (iii) the date on which we have issued more than $1,070,000,000 in non-convertible debt during the preceding three-year period.
Smaller Reporting Company
We are also currently a “smaller reporting company,” meaning that we are not an investment company, an asset-backed issuer, or a majority-owned subsidiary of a parent company that is not a smaller reporting company and have a public float of less than $250 million or annual revenues of less than $100 million during the most recently completed fiscal year. In the event that we are still considered a “smaller reporting company,” at such time we cease being an “emerging growth company,” the disclosure we will be required to provide in our SEC filings will increase, but will still be less than it would be if we were not considered either an “emerging growth company” or a “smaller reporting company.” Specifically, similar to “emerging growth companies,” “smaller reporting companies” are able to provide simplified executive compensation
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disclosures in their filings; are exempt from the provisions of Section 404(b) of the Sarbanes-Oxley Act requiring that independent registered public accounting firms provide an attestation report on the effectiveness of internal control over financial reporting; and have certain other decreased disclosure obligations in their SEC filings, including, among other things, only being required to provide two years of audited financial statements in annual reports. Decreased disclosures in our SEC filings due to our status as an “emerging growth company” or “smaller reporting company” may make it harder for investors to analyze our results of operations and financial prospects.
Presentation of Financial Information
Pursuant to the applicable provisions of the Fixing America’s Surface Transportation Act, we are omitting our financial statements for periods prior to the year ended December 31, 2017, as well as the three months ended March 31, 2019 and 2018, respectively, because they relate to a historical period that we believe will not be required to be included in the prospectus at the time of the contemplated offering. We intend to amend the registration statement to include all financial information required by Regulation S-X at the date of such amendment.
On May 12, 2017, Hydrofarm Investment Corp., or the Successor, acquired, through its wholly-owned subsidiary Hydrofarm Holdings, LLC, all of the capital stock of Hydrofarm, Inc., or the Predecessor. Concurrently with the acquisition by Hydrofarm Investment Corp, Hydrofarm, Inc. converted from an S-Corp to a limited liability company and was renamed Hydrofarm, LLC. On August 28, 2018, Hydrofarm Investment Corp. merged with and into a wholly-owned subsidiary of Hydrofarm Holdings Group, Inc., as part of a recapitalization of the Company. As such, Successor refers to Hydrofarm Investment Corp, and its wholly owned subsidiaries for the period from May 12, 2017 through August 27, 2018 and Hydrofarm Holdings Group, Inc. and its wholly-owned subsidiaries from August 28, 2018 forward.
As a result of the acquisition of Hydrofarm, LLC by Hydrofarm Investment Corp. and the resulting change of control and changes due to the impact of purchase accounting, we are required to present separately the operating results for the Predecessor period ending on May 11, 2017 and the Successor periods beginning on May 12, 2017. Accordingly, unless otherwise indicated or the context otherwise requires, all references in this prospectus to “Hydrofarm,” the “Company,” “we,” “us,” “our” and other similar terms mean (1) the Predecessor for the period ending on May 11, 2017 and (2) the Successor for the period beginning on May 12, 2017, in each case together with its consolidated subsidiaries. References in this prospectus to “2017” represent the sum of the results of the Predecessor period ending on May 11, 2017 and the Successor period beginning on May 12, 2017 and for the period ending on December 31, 2017. The Successor is also presented as of and for the year ended December 31, 2018.
Industry and Market Data
This prospectus includes statistical and other industry and market data that we obtained from industry publications and research, surveys and studies conducted by third parties. Industry publications and third-party research, surveys and studies generally indicate that their information has been obtained from sources believed to be reliable, although they do not guarantee the accuracy or completeness of such information.
Trademarks
Our primary trademarks include “Hydrofarm”, “PHANTOM BALLAST”, “ACTIVEAQUA”, “ACTIVE AIR” and “PhotoBio” and all of which are registered in the United States with the U.S. Patent and Trademark Office.
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PROSPECTUS SUMMARY
This summary highlights selected information contained elsewhere in this prospectus and does not contain all of the information that you should consider in making your investment decision. Before investing in our common stock, you should carefully read this entire prospectus, including our financial statements and the related notes thereto and the information set forth under the “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections of this prospectus. In this prospectus, the term “cannabis” refers to all subspecies of the cannabis genius other than industrial hemp (as defined below), the term “CBD” refers to a non-intoxicating, naturally occurring cannabinoid found in cannabis and hemp with less than 0.3% tetrahydrocannabinol, and the term “industrial hemp” refers to any part of the Cannabis sativa L. plant, whether growing or not, with a delta-9 tetrahydrocannabinol concentration of not more than 0.3% on a dry weight basis, lawfully cultivated in the U.S. pursuant to, and in compliance with, a state agricultural program which sanctions such activity.
Company Overview
With more than 40 years of operating history, we are a leading independent wholesaler and manufacturer of hydroponics equipment and commercial horticultural products. Hydroponics is the farming of plants without the use of soil with various implementation systems that can be organized in multiple combinations to optimize the applicable environment. Hydroponics allows end users to control variables including temperature, humidity, CO2, lighting, nutrient concentration and PH, to create a controlled farming environment. As such, the benefits of hydroponics, an essential element of controlled environment agriculture (“CEA”), include, but are not limited to year-round production, reduced water consumption, rapid production, increased production density (plants can be placed closer together and vertically farmed) and insulation from pests. CEA, as broadly defined, is a technology-based farming method whereby growers produce crops within an enclosed growing structure, such as a greenhouse or building, to provide protection and maintain optimal growing conditions throughout the development of the crop. CEA provides farmers with the flexibility to produce whatever they desire, whenever and wherever. We service these farmers through a network of retailers and resellers that connect to us utilizing an automated eCommerce system, providing just in time delivery capabilities. Our mission is to provide professional on time service, delivery and value by offering the right gardening products, innovation, and expertise to make indoor, hydroponic, organic and/or greenhouse efforts easier and more productive.
We currently maintain more than 5,000 stock keeping units (“SKUs”) in our core U.S. business, including proprietary and exclusive brands and we serve as a one-stop source for some of the most desirable branded hydroponic merchandise. Our product assortment includes advanced indoor garden, lighting and ventilation systems, liquid plant food products, heat mats, and other related products and accessories for hydroponic gardening. Approximately 65% of our sales relate to recurring consumable products, including growing media, nutrients and supplies that require regular replenishment. The remaining 35% of 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 or 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 from our competitors. In addition, our diverse network of over 200 suppliers and proprietary sourcing capabilities presents a significant barrier to entry.
We utilize a vertically integrated operating model, shipping directly to retailers and resellers, providing what we believe to be nearly unmatched capabilities in the industry. We sell to a highly diverse group of over 2,000 customers across North America through four main channels: specialty hydroponic retailers (76% of sales), garden centers (14% of sales), eCommerce (8% of sales) and greenhouse suppliers (2% of sales). We believe that our six U.S.-based distribution centers can reach 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. Through our product offerings, customer service and sales and marketing efforts, we estimate that we enjoy an approximately 30% and 40% market share in the U.S. and Canadian hydroponic wholesale markets, respectively.
Over the past forty years, we have cultivated long-term relationships with key suppliers, retailers and resellers across the U.S. and Canada, developing strong expertise in the hydroponics market. We have capitalized on our scaled, efficient supply chain network and market expertise to consistently grow revenue
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at approximately 15% annually for the past 10 years through 2017, while maintaining a solid financial profile with steady, organic volume growth, healthy margins and modest capital expenditures. As a leading distributor of hydroponics equipment, we have indirectly benefitted from the growth of the U.S. cannabis market. However, we experienced a decline in sales and profitability in 2018 due to the broad hydroponics industry pull-back on equipment and ancillary purchases, driven by the disruption in the cannabis industry in California. California experienced a sales disruption principally due to administrative delays in the issuance of licenses to cannabis growers in California (the largest legal cannabis market in the world) upon the implementation of legalization of adult-use cannabis. License issuance complications in California had a negative effect on the hydroponics market overall and, as a result, our competitors, including Scotts Miracle-Gro, experienced similar sales challenges. With recent legislative relief, we are returning to normalized sales growth, consistent with historical trends. As a result, our sales in the second quarter of 2019 have increased over 10%, compared to the same period for the previous year.
Industry Overview
The hydroponics equipment and commercial horticultural products market currently benefits from the growth of several key markets including controlled environment and conventional agriculture, cannabis and industrial hemp.
Controlled Environment and Conventional Agriculture
CEA comprises activities relating to growing plants and crops entirely indoors, enabling farmers to control conditions of the environment to maximize yield year-round. CEA techniques require less water and pesticides compared to conventional farming, offering incremental benefits in the form of reduced energy consumption and lower labor requirements. While there are various types of CEA structures, growers prefer to use structures made of glass or poly material. According to industry publications, structures made of glass or poly material accounted for the largest share of CEA implementation globally in 2017, followed closely by converted warehouses in urban areas. CEA implementation continues to increase globally, driven by growth in fruit and vegetable farming and consumer gardening and continued adoption of vertical farming.
According to the Ontario Ministry of Agriculture, during 2017, fruits and vegetables fueled the growth of CEA based sales in Canada as fruit and vegetable sales grew at a 5.7% compound annual growth rate (“CAGR”) over the last five years. Vegetable farming in Canada alone is expected to grow at a 4.5% CAGR over a five-year period to $4.5 billion by 2023 and we anticipate that CEA grown vegetables (and ultimately CEA construction) will also experience growth. Currently, fruits and vegetables account for approximately 49% of total CEA sales.
Further, we perceive consumer gardening to be a significant driver of CEA growth. According to industry publications, 77% of U.S. households participate in lawn and garden activities, spending a record $47.8 billion on lawn and garden retail sales, a record average household spend of  $503. We expect this trend to increase, with participation highest amongst married households, people aged 55 and older, and those with no children. As the baby boom generation ages, this segment is expected to grow faster than the total population. We believe that this demographic will result in an increase in the number of lawn and garden product users and will ultimately drive the purchase of more CEA products.
Vertical farming, a subsector of CEA, has a number of advantages including reduced water usage and fewer pesticides. This practice has gained popularity mainly due to its unique advantage of maximizing yield by growing crops in layers. An industry publication projects the global market for controlled environment technologies to reach $40.3 billion in 2022, representing a 9.7% CAGR from $25.4 billion in 2017. This growth will include strong demand in the equipment segment, with the three largest components including climate control systems, lighting and irrigation. The equipment segment is expected to grow at a 9.9% CAGR over the same period.
Cannabis
We sell our products through third party retailers and resellers, however, 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. The cannabis industry is experiencing rapid growth driven by state-level legalization efforts in
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the U.S. and federal-level legalization in Canada. The emergence of the legal cannabis sector in the U.S., for medical and adult-use purposes, has been rapid as more U.S. states adopt regulations for its cultivation and sale. We believe the expansion of U.S. state adoption of legal cannabis will drive growth in the market for legalized cannabis along with demand for high quality indoor gardening products. According to industry publications, the U.S. cannabis market is projected to reach approximately $25 billion by 2025, up from approximately $8 billion in 2017. However, notwithstanding laws in various U.S. states permitting the use of some form of cannabis products, cannabis remains illegal in many U.S. states for medicinal or non-medicinal use, or both, and is illegal for any use under U.S. federal law, as cannabis is listed as a Schedule I drug under the U.S. Controlled Substances Act of 1970 (the “CSA”).
Thirty-three states, the District of Columbia, Puerto Rico, Guam, and the Commonwealth of the Northern Mariana Islands have legalized medical cannabis in some form, although not all of those jurisdictions have fully implemented their legalization programs. Eleven of these states, the District of Columbia and the Commonwealth of the Northern Mariana Islands have legalized cannabis for non-medical adult-use and two additional states (New Jersey and New York) are actively considering the legalization of cannabis for non-medical adult-use (including Illinois which will become effective January 1, 2020). Thirteen additional states have legalized high CBD cannabinoid found in cannabis and hemp, low tetrahydrocannabinol (“THC”) oils for a limited class of patients. Only three states (Idaho, South Dakota and Nebraska) currently prohibit cannabis entirely and completely ban both CBD and THC.
We believe support for cannabis legalization in the U.S. is gaining momentum. According to an October 2018 poll by Gallup, public support for the legalization of cannabis in the U.S. increased from approximately 12% in 1969 to approximately 66% in 2018. The U.S. cannabis industry has experienced significant growth over the past 12 months fueled in part by increasing consumer acceptance and the legalization of medical and recreational cannabis across the U.S. The following map illustrates U.S. states that have fully legalized cannabis (for medical and recreational purposes) and that have partially legalized cannabis (for medical purposes only) as of May 31, 2019:
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Legal access to dried cannabis for medical purposes was first allowed in Canada in 1999. The Cannabis Act (the “Cannabis Act”) currently governs the production, sale and distribution of medical cannabis and related oil extracts in Canada. As of September 2018, Health Canada reported over 342,103 client registrations for medical cannabis prescriptions. On April 13, 2017, the Government of Canada introduced Bill C-45, which proposed the enactment of the Cannabis Act to legalize and regulate access to cannabis. The Cannabis Act proposed a strict legal framework for controlling the production, distribution, sale and possession of medical and recreational adult-use cannabis in Canada. On June 21, 2018, the Government of
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Canada announced that Bill C-45, received Royal Assent. On July 11, 2018, the Government of Canada published the Cannabis Regulations under the Cannabis Act (the “Cannabis Regulations”). The Cannabis Regulations provide more detail on the medical and recreational regulatory regimes for cannabis, including licensing, security clearances and physical security requirements, product practices, outdoor growing, security, packaging and labelling, cannabis-containing drugs, document retention requirements, reporting and disclosure requirements, the new access to cannabis for medical purposes regime and industrial hemp. The majority of the Cannabis Act and the Cannabis Regulations came into force on October 17, 2018. While the Cannabis Act provides for the regulation by the federal government of, among other things, the commercial cultivation and processing of cannabis for recreational purposes, it provides the provinces and territories of Canada with the authority to regulate in respect of the other aspects of recreational cannabis, such as distribution, sale, minimum age requirements, places where cannabis can be consumed, and a range of other matters.
The governments of every Canadian province and territory have implemented regulatory regimes for the distribution and sale of cannabis for recreational purposes. Most provinces and territories have a minimum age of 19 years old, except for Québec and Alberta, where the minimum age is 18. Certain provinces, such as Ontario, have legislation in place that restricts the packaging of vapor products and the manner in which vapor products are displayed or promoted in stores. According to industry publications, the projected size of the Canadian adult-use market in 2019 ranged from C$1.8 billion to C$4.3 billion and a 2018 industry publication indicated that the sector is expected to grow to C$6.5 billion by 2020.
The outlook for the North American cannabis industry is positive. The industry is expected to continue benefiting from increasingly favorable attitudes toward both medical cannabis and recreational cannabis with expected significant consumer spending increases.
Industrial Hemp
We are well positioned to capitalize on the growth of the industrial hemp market through our current product portfolio and our pipeline of new products tailored to the needs of industrial hemp cultivators. Industrial hemp cultivation in the U.S. grew significantly over the last two years with total acreage of industrial hemp in the U.S. increasing from 9,767 acres in 2016 to 78,176 acres in 2018, a 183% CAGR, according to industry publications. We anticipate significant further growth in industrial hemp due to the passing of the Farm Bill in the U.S. in December 2018 (the “Farm Bill”) and as commercial and consumer awareness of the benefits associated with hemp-derived products continues to increase.
The Farm Bill specifically removed industrial hemp as a restricted commodity under the Controlled Substances Act. In addition, the Farm Bill designated industrial hemp as an agricultural commodity and permits the lawful cultivation of industrial hemp in all states and territories of the U.S. Commercial interest in industrial hemp has continued to grow as industrial hemp fiber and shivs, the inner core part of stalks harvested from industrial hemp, can be used as strong, sustainable and highly absorbent materials to make an array of industrial products including textiles, paper, bioplastics, building products and biofuel. Consumers are increasingly using hemp-derived products such as CBD for their therapeutic benefits. Accordingly, the Brightfield Group, a predictive analytics and market research firm for the legal CBD market, expects the U.S. CBD market (less than or equal to 0.3% THC) to reach $22 billion by 2022 and CBD retail sales are projected to grow at a 61.5% CAGR from $1.0 billion in 2019 to $6.8 billion in 2023.
Our Competitive Strengths
We attribute our success to the following competitive strengths.
Leading Market Positions in Attractive Growing Markets
We are a leading independent wholesaler and manufacturer of hydroponics equipment and commercial horticultural products in North America and one of the two major consolidators in the hydroponics products industry. We believe that we maintain an approximately 30% and 40% market share in the U.S. and Canadian hydroponic wholesale markets, respectively. The broader market is comprised of a fragmented group of smaller competitors. We serve several attractive end markets including controlled environment agriculture, cannabis and industrial hemp. Favorable trends in CEA, including increased adoption of
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vertical farming methods to increase yields, are projected to drive a 9.7% CAGR through 2022 according to industry publications. Similarly, growers’ increasing preference to reduce water and energy usage, limit pesticide use and reduce labor costs coupled with growing consumer demand for fruits and vegetables are expected to drive significant growth in CEA methods. However, we will likely see the most significant growth in cannabis and industrial hemp. Increased support for cannabis legalization at the federal level in the U.S., an increase in U.S. states’ implementation of adult-use and medicinal cannabis programs, continued growth in the Canadian cannabis market following the implementation of the Cannabis Act in 2018, the passing of the 2018 Farm Bill and consumer and commercial awareness of the benefits associated with hemp-derived products will serve as significantly favorable tailwinds that will drive continued growth.
Experienced Management Team with Proven Track Record
Our management team possess 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 guidance, 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 AdvancePierre 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. Jeff Peterson, Chief Financial Officer has over 25 years of experience across the indoor garden supply distribution, telecommunications/ethernet network and consumer software industries, holding senior management positions across firms such as Force10 Networks, Turin Networks, Advent Software and Learning Company. Mark Parker, Senior Vice President of Integration and Planning, has over 35 years of experience in the consumer packaged goods industry, holding senior management positions across major firms such as Reckitt Benckiser, Campbell Soup and Pinnacle Foods. In 2010, Mark started his own business consulting practice called iQ Solutions and strategically assisted organizations such as Del Monte, Sun Products and AdvancePierre Foods.
Broad Product Portfolio with Recurring Sales
We have one of the largest product offerings in the industry from lighting solutions to nutrients to grow mediums — everything growers need to ensure their operations are maximizing efficiency, output and quality. Accordingly, we maintain an extensive portfolio of products which includes 26 internally developed, proprietary brands across 1,400 SKUs with 24 patents, 62 registered trademarks, 11 domains and over 30 exclusive or preferred brands across 1,000 SKUs. We maintain approximately $54 million of inventory in over 5,000 SKUs and over 50% of our sales relate to proprietary and exclusive or preferred brands. 98% of our lighting, 59% of our equipment, 45% of our grow media, 29% of our nutrients and 36% of our supplements are proprietary or exclusive or preferred brands. Our proprietary products command an approximately 1,000bps gross margin premium relative to general distributed brands and our exclusive or preferred brands deliver approximately 270bps of incremental gross margin premium versus 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 65% of our revenue is generated from the sale of recurring consumable products including growing media, nutrients and supplies.
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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 over 800,000 square feet of distribution space across six distribution centers in the U.S. and two distribution centers in Canada. Furthermore, we have cultivated long-term relationships over the last 20 years with a network of over 200 suppliers, giving us access to a best-in-class products portfolio and allowing us to provide full hydroponic solutions to our customers. We source individual components from our diverse supplier base to assemble our best-in-class products. Our top 10 suppliers represent only an estimated 34% of total spend and approximately 9% of total spend is based with Chinese suppliers. We employ a multi-faceted tariff mitigation strategy in China which includes cost sharing with suppliers, passing through price increases and pursuing alternative production outside of China with existing and new suppliers.
Unique Ability to Serve Our Strong Customer Base
We maintain long-standing relationships with leading hydroponic retailers, eCommerce platforms, independent garden centers and greenhouse builders. We serve over 2,000 wholesale customers across multiple channels in North America, providing customers with the capability to purchase their entire product range from us. Our unique distribution capabilities allow us to provide just in time 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 very low customer concentration with our largest customer comprising approximately 6% of sales and our top 10 customers comprising approximately 20% of sales. 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 M&A Track Record
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 are two of the leading hydroponics and lawn and garden distributors in Canada, with combined annual revenues of  $45.3 million for the year ended December 31, 2018. Those acquisitions, combined with our existing infrastructure and experience, have enabled us to become one of the leading hydroponics equipment distributors in Canada. Additionally, we maintain relationships with commercial growers to identify specific product categories of interest for M&A activity. Our robust understanding of commercial growers’ needs coupled with our
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experience in Canada 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.
Our Growth Strategies
We expect long-term demand for our hydroponics products as we continue to develop and acquire proprietary products and as favorable tailwinds drive continued interest in our product portfolio including (i) continued expansion of hydroponic horticulture, including large scale vertical farming, hydroponic food production and consumer gardening (ii) continued legislation of medicinal and adult-use cannabis and (iii) steady demand for industrial hemp due to the recent approval of the Farm Bill in December 2018 and consumer adoption of CBD products. Hydroponic cultivators of all types require the equipment that we provide, including lights, benches, control systems, etc., along with “consumable” items such as nutrients (specialty fertilizer), growing media (specialty soils) and additives.
We expect to leverage these market trends through a strategy of providing a complete supply chain solution for hydroponic cultivators of all types. 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 conventional agriculture, vertical farming, cannabis and industrial hemp. 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 21.3% annually from 2018 to 2025. In addition, the global cannabis market, according to industry publications, is estimated to total $150 billion as of March 2019, and the cannabis market is projected to grow to $272 billion by 2028. Further, the industrial hemp market has benefited from consumer adoption of industrial hemp-derived CBD products. As such, according to industry publications, the global industrial hemp market is expected to grow to over $10 billion dollars by 2025, while the total market for CBD will jump from nearly $600 million in 2018 to $22 billion by 2022. Industrial hemp can grow rapidly under appropriate conditions and is capable of producing various by-products, making it an attractive cultivation product for some of our end customers. We expect to capitalize on favorable cannabis and hemp growth trends by continuing to expand our operations globally.
While we have benefited from the overall U.S. cannabis market growing by approximately 15% annually over the past decade, it did experience a reset in 2018. We believe the broad market has largely recovered in the first half of 2019 as our second quarter sales in 2019 are up across all six of our key regions including Northern California, Southern California, Mountain, Pacific Northwest, East and Midwest driven by new licensing of cannabis cultivators in California and renewed investments by all types of growers, including tobacco growers shifting to industrial hemp, across the U.S. Further regional expansion of cannabis legalization and increased industrial hemp cultivation driven by growing consumer demand for hemp-based CBD products following the passing of the 2018 Farm Bill should lead accelerated organic growth as we maintain an approximately 30% market share of U.S. hydroponics product sales and are well established in U.S. states transitioning to adult-use cannabis, medical cannabis and high CBD/low THC programs with large populations. In 2018, Vermont and Michigan approved adult-use cannabis programs, Oklahoma, Missouri and Utah approved medical-use cannabis programs and the 2018 Farm Bill designated hemp as an agricultural commodity and permitted the lawful cultivation of industrial hemp in all states and territories of the U.S. Illinois approved an adult-use cannabis program in 2019. States that are actively considering implementing adult-use cannabis programs include New Jersey, New York, Delaware, Rhode Island, Connecticut and Ohio while Kentucky, Tennessee and Georgia are contemplating implementing medical-use programs.
Expanding our Proprietary Product Offering
We are expanding the breadth of our product assortment through continued development of our own proprietary brands. Approximately 1,400 SKUs account for 30% of our sales and the product margin for these types of products is approximately 1,000 bps higher than our distributed products. Our core
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competency in new product innovation is in lighting, consumable and equipment categories. We have launched several new product lines over the past year, including PhotoBio (LED lighting equipment) and Phantom Core (HID lighting equipment). We also maintain a pipeline of next generation proprietary brand products.
Adding Strategic Distribution Relationships and Exclusive or Preferred Brands
We can increase revenue with significant cross-selling activity to our current installed customer base by including 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 or preferred brand relationships. Exclusive or preferred brand relationships with leading brands drive sales and margin improvement. We are a highly attractive distribution partner due to our scale and independence in growing media and nutrient categories. We have established eight new exclusive or preferred distribution relationships over the past year including with established equipment and nutrient suppliers. Exclusive or preferred brands sales doubled in May 2019 year-to-date versus the prior year period.
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 and our analytically driven supply chain function 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 just in time 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.
Continued Growth in eCommerce
We believe that eCommerce is an increasingly important sales channel for our business. We are well positioned to capture additional growth as a growing number of purchases made online. Currently, four of our top ten customers are eCommerce-based platforms or retailers that have eCommerce platforms. We launched an initiative in 2019 to expand our SKU offering and to optimize pricing with our eCommerce customer base and we are deploying an enhanced B2B eCommerce platform to drive incremental market share gains in our core retailer channel. eCommerce sales increased 27.5% May 2019 year-to-date compared to the same period in 2018.
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.
Risks Associated With Our Business
Our business is subject to a number of risks of which you should be aware before making an investment decision. These risks are discussed more fully in the “Risk Factors” section of this prospectus immediately following this prospectus summary. These risks include, but are not limited to, the following:
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competitive industry pressures;

our ability to keep pace with technological advances;

general economic and financial conditions, specifically in the United States and Canada;

the costs and risks associated with our international operations;

the costs of being a public company;

our ability to successfully identify appropriate acquisition targets, successfully acquire identified targets or successfully integrate the business of acquired companies;

the success of our marketing activities;

a disruption of breach of our information technology systems;

the costs of potential tariffs or a global trade war;

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;

product shortages and relationships with key suppliers;

federal and state legislation and regulations pertaining to the use and cultivation of cannabis in the United States, and such laws and regulations in Canada;

compliance with environmental, health and safety laws;

our ability to obtain and maintain protection for our intellectual property;

our ability to protect and defend against litigation, including intellectual property claims; and

our ability to attract key employees.
Recent Developments
Acquisitions
In November 2017, we acquired Eddi’s, and GSD, two of the leading hydroponics and lawn and garden distributors in Canada, with combined annual revenues of  $45.3 million for the year ended December 31, 2018 (the “Canadian Acquisitions”). The Canadian Acquisitions, combined with our existing infrastructure and experience, have enabled us to become, we believe, one of the leading lighting and hydroponics equipment distributors in Canada. We believe that this experience in Canada has prepared us to make additional acquisitions in the hydroponics industry, which will help us to continue to grow our market share.
Recent Transactions
Merger and Private Placement
In May 2017, Hydrofarm Investment Corp. (“HIC”), or the Successor, acquired, through its wholly-owned subsidiary, Hydrofarm Holdings, LLC, all of the capital stock of Hydrofarm, Inc., or the Predecessor, in a transaction referred to as the “Formation Transaction.” Concurrently with the acquisition by HIC, Hydrofarm, Inc. converted from an S-Corp to a limited liability company and was renamed Hydrofarm, LLC. We accounted for the Formation Transaction under Financial Accounting Standards Board’s, or FASB, Accounting Standards Codification Topic 805, “Business Combinations” as amended, as of the closing date, and as a result, the merger consideration was allocated to the respective fair values of
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the assets acquired and liabilities assumed from the Predecessor (commonly referred to as a “step-up in basis”). As a result of the application of acquisition method accounting, the Successor balances and amounts presented in the audited consolidated financial statements and footnotes are not comparable with those of the Predecessor.
On August 28, 2018, HIC merged with and into one of our wholly-owned subsidiaries, as part of a recapitalization of the Company in a transaction accounted for as a “reverse merger” where HIC is the “accounting acquirer/legal acquiree” and we are the “accounting acquiree/legal acquirer.” Consolidated financial statements prepared following a reverse merger are issued under the name of the legal parent (accounting acquiree) and are a continuation of the financial statements of the legal subsidiary (accounting acquirer), with one adjustment. The adjustment retroactively restates the accounting acquirer’s legal capital to reflect the legal capital of the accounting acquiree. Accordingly, the number of shares and stated capital of HIC have been retroactively adjusted using the exchange ratio established in the merger agreements to reflect the number of shares of we issued in the exchange.
In October 2018, we consummated a private placement offering of 16,619,616 units (each a “Unit,” and collectively, the “Units”) at a price per Unit or $2.50 for gross proceeds of approximately $41.5 million. Each Unit consisted of  (i) one (1) share of our common stock and (ii) a warrant (each a “Investor Warrant,” and collectively, the “Investor Warrants”), expiring three years after the earliest of  (x) the effectiveness of a resale registration statement, (y) the closing of an initial public offering of the Company’s common stock or (z) the closing of any other transaction or set of events that results in the Company being subject to the requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), entitling the holder to purchase one-half  (1/2) share of our common stock at an initial exercise price of $5.00 per full share (the “Private Placement”). As part of the Private Placement, we issued the placement agents for the Private Placement, A.G.P./Alliance Global Partners and SternAegis Ventures (the “Placement Agents”) warrants to purchase 1,742,955 shares of our common stock (the “Placement Agent Warrants”).
On August 28, 2018 as discussed above, one of our wholly-owned subsidiaries merged with and into HIC, with HIC becoming our wholly-owned subsidiary and continuing its and its subsidiaries’ existing business operations, including those of Hydrofarm, LLC, a subsidiary of HIC (the “Merger”). As such, Successor refers to HIC and its wholly owned subsidiaries for the period from May 12, 2017 through August 27, 2018 and us and our wholly-owned subsidiaries from August 28, 2018 forward.
In connection with the Private Placement, (i) HIC raised $15.2 million from its existing stockholders through the issuance of 6,094,617 units (the “Concurrent Offering”) and (ii) Hydrofarm Holdings, LLC (“Hydrofarm Holdings”), a subsidiary of HIC, and its affiliates entered into certain amendments to Hydrofarm Holdings’ credit facilities to amend certain covenants and other provisions under such credit facilities (the “Loan Transactions,” and together with the Private Placement, Merger and Concurrent Offering, the “2018 Financing Transactions”). The consideration in the Concurrent Offering consisted of $11.1 million in cash from existing stockholders of HIC and the conversion of  $4.1 million of an aggregate principal amount plus interest outstanding under an outstanding note. As part of the Merger, the securities of HIC issued in the Concurrent Offering were exchanged into shares of our common stock and warrants to purchase our common stock having the same terms and conditions as the securities included in the Units issued in this Private Placement.
Encina Refinancing
In July 2019, certain of our subsidiaries (the “Subsidiary Obligors”) entered into a Loan and Security Agreement with Encina Business Credit, LLC (the “Encina Credit Facility”). The Encina Credit Facility provides for revolving borrowings of up to $45 million, subject to applicable borrowing base availability, and a limit of up to $15 million of borrowings for the Canadian subsidiaries party thereto, matures in July 2022, and is secured by a first-priority lien on all cash, accounts receivable and inventory of the Subsidiary Obligors and a second-lien priority lien on all other personal property of the Subsidiary Obligors. The Encina Credit Facility also provides for a swingline facility of up to $2.0 million. A portion of the proceeds borrowed under the Encina Credit Facility were used to pay in full the Loan and Security Agreement dated November 8, 2017, as amended from time to time, among Bank of America, N.A. and the obligors party thereto.
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Corporate Structure
We have been in the business of indoor gardening since Hydrofarm, LLC, (originally, Applied Hydroponics, Inc.), one of our wholly-owned subsidiaries, was formed in the State of California on May 4, 1977. We conduct our business through our wholly-owned, direct and indirect subsidiaries. The chart below depicts our current organizational structure:
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Corporate Information
We were incorporated in Delaware in January 2017 under the name Innovation Acquisition One Corp. Our predecessor company, originally called Applied Hydroponics, Inc., was founded in 1977 in Northern California. We changed our name to Hydrofarm Holdings Group, Inc. on August 3, 2018 in connection with the Private Placement and Merger. Our principal executive offices are located at 2249 South McDowell Blvd Ext., Petaluma, California, 94954 (the “Petaluma HQ”) and our telephone number is (707) 765-9990. Our website address is www.hydrofarm.com. The information contained on, or that can be accessed through, our website is not, and shall not be deemed to be part of, this prospectus. We have included our website address in this prospectus solely as an inactive textual reference. Investors should not rely on any such information in deciding whether to purchase our common stock.
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THE OFFERING
Common stock offered by us
          shares of common stock.
Common stock to be outstanding after this offering
          shares of common stock.
Option to purchase additional shares
The underwriters have an option, exercisable within 30 days of the date of this prospectus, to purchase up to           additional shares of our common stock.
Use of Proceeds
We expect to use the proceeds from this offering to repay existing indebtedness, for acquisitions, for working capital and other general corporate purposes, which may include the hiring of additional personnel and capital expenditures. We estimate the net proceeds from this offering will be approximately $          million (or $          million if the underwriters exercise their option to purchase additional shares in full), assuming an initial public offering price of  $          per share, which is the midpoint of the price range set forth on the cover page of this prospectus, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. See “Use of Proceeds” beginning on page 46 of this prospectus.
Dividend Policy
We have never declared nor paid cash dividends on our common stock. We currently intend to retain any future earnings for use in the operation and expansion of our business. We do not expect to pay any dividends to holders of our common stock in the foreseeable future.
Risk Factors
Investing in our common stock involves a high degree of risk. See “Risk Factors” beginning on page 18 of this prospectus for a discussion of certain factors to consider carefully before deciding to invest in our common stock.
Proposed Nasdaq Global Market symbol
“      ”
The number of shares of our common stock outstanding after this offering is based on 69,745,562 shares of common stock outstanding as of December 31, 2018, and excludes:

13,100,069 shares of common stock issuable upon exercise of outstanding warrants to purchase our common stock at a weighted average exercise price of  $4.78 per share;

8,718,195 shares of common stock reserved for future issuance under our 2018 Equity Incentive Plan; and

no exercise by the underwriters of their option to purchase up to an additional           shares of our common stock from us.
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SUMMARY CONSOLIDATED FINANCIAL AND OTHER DATA
The following table presents our summary consolidated financial and other data for the periods and as of the dates indicated. The periods prior to and including May 11, 2017 includes Hydrofarm, Inc. and its subsidiaries and are referred to in the following table as “Predecessor,” and all periods after May 11, 2017 include Hydrofarm Investment Corp. and its subsidiaries, which recapitalized to Hydrofarm Holdings Group, Inc. in August 2018, and are referred to in the following table as “Successor.” The summary consolidated financial data as of December 31, 2016, for the period from January 1, 2017 through May 11, 2017, the period from commencement of operations (May 12, 2017) through December 31, 2017 and the year ended December 31, 2018, has been derived from the audited consolidated financial statements included elsewhere in this prospectus. The summary consolidated financial data for the year ended December 31, 2016 has been derived from the Predecessor’s audited consolidated financial statements, which are not included in this prospectus. The Predecessor and Successor financial data have been prepared on different accounting bases and therefore the sum of the data for the two reporting periods should not be used as an indicator of our full year performance. Our historical results are not necessarily indicative of the results that may be expected in the future, and our interim results are not necessarily indicative of the results to be expected for the full year or any other period.You should read the following financial information together with the information under “Capitalization,” “Selected Consolidated Financial and Other Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes included elsewhere in this prospectus.
The unaudited pro forma combined financial information for the year ended December 31, 2017 is derived from the “Unaudited Pro Forma Combined Financial Information” in this prospectus and is included for informational purposes only and does not purport to reflect the results of operations of Hydrofarm Holdings Group, Inc. that would have occurred had the Formation Transaction occurred on January 1, 2017. The unaudited pro forma combined financial information for the year ended December 31, 2017 (as more fully described in the “Unaudited Pro Forma Combined Financial Information”) contains a variety of adjustments, assumptions and estimates, is subject to numerous other uncertainties and the assumptions and adjustments as described in the notes accompanying the unaudited pro forma combined financial information included elsewhere in this prospectus and should not be relied upon as being indicative of our results of operations had the Formation Transaction occurred on the dates assumed.
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Successor
Predecessor
Pro Forma(1)
Predecessor
Year ended
December 31,
2018
Period from
May 12, 2017 to
December 31,
2017
Period from
January 1, 2017 to
May 11, 2017
Year ended
December 31,
2017
Year ended
December 31,
2016
(In Thousands, except share, per share and percentage information)
Operations Data
Net sales
$ 212,464 $ 151,525 $ 108,221 $ 259,746 $ 273,482
Cost of goods sold(2)
183,690 141,119 86,925 228,044 221,595
Gross profit
28,774 10,406 21,296 31,702 51,887
Operating expenses:
General and administrative expenses(3)
18,668 11,487 4,818 16,201 12,008
Salaries and benefits
16,463 8,679 4,630 13,309 11,588
Marketing expense(3)
2,584 2,274 695 2,969 3,149
Employee stock ownership plan charges(4)
30,327 6,480
Impairment charges(5)
3,244 45,425 45,425
Depreciation and amortization
7,170 3,769 428 5,836 1,237
Interest expense
11,606 5,643 547 7,929 1,134
Other expense (income)
4,238 4,305 (371) 4,696 (402)
Net (loss) income before tax
(35,199) (71,176) (19,778) (64,663) 16,693
Income tax (expense) benefit
(102) 266 (85) 182 (144)
Net (loss) income
$ (35,301) $ (70,910) $ (19,863) $ (64,481) $ 16,549
Basic and diluted net loss per common share
$ (0.68) $ (1.65) $ (1.50)
Weighted average shares outstanding(6)
51,883,059 43,031,327 43,031,327
Cash flow data
Net cash provided by (used in) operating activities
$ 4,303 $ (13,390) $ 10,069 $ 8,664
Net cash used in investing activities
(3,178) (207,877) (1,586) (6,070)
Net cash provided by (used in) financing activities
25,516 222,165 511 (2,049)
Balance sheet data
Cash and cash equivalents
$ 27,923 $ 2,206 $ 9,488 $ 689
Net working capital, excluding certain debt(7)
76,891 71,149 61,579 53,080
Total assets
175,532 189,510 119,457 100,253
Total liabilities
127,747 156,219 74,431 59,227
Total stockholders’ equity
47,785 33,291 45,026 41,026
Other financial data
Adjusted EBITDA(8)
$ (8,143) $ (503) $ 10,866 $ 10,363 $ 24,045
Adjusted EBITDA margin(9)
(3.8%) (0.3%) 10.0% 4.0% 8.8%
Capital expenditures(10)
1,715 2,403 1,586 3,989 959
(1)
The summary pro forma financial data was derived from our unaudited pro forma combined financial information for the year ended December 31, 2017 after giving pro forma effect to the Formation Transaction described above as if such transaction had occurred on January 1, 2017, and to several other transactions as if such transactions (excluding the Canadian Acquisitions) had occurred on
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January 1, 2017. The pro forma adjustments are based on available information and upon assumptions that our management believes are reasonable in order to reflect, on a pro forma basis, the impact of these transactions on the historical financial information of the Successor for 2017.
The unaudited pro forma combined financial information should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, “Risk Factors,” the historical audited consolidated financial statements and related notes, and the pro forma combined financial information and related notes, all included elsewhere in this prospectus. In addition, see “Unaudited Pro Forma Combined Financial Information” elsewhere in the prospectus for additional information on the pro forma adjustments made.
(2)
Costs of goods sold is exclusive of depreciation and amortization, which is presented separately. Also, costs of goods sold includes amortization of the step-up in basis recorded for inventory acquired in business acquisitions of  $798 for 2018 and $11,531 for 2017.
(3)
Marketing expense presented in this table reflects $695 reclassified from the amount reported in our Predecessor’s audited financial statement of operations for marketing, general and administrative expense of  $5,513 to conform to the presentation used by the Successor.
(4)
Our Predecessor utilized an Employee Stock Ownership Plan as part of its benefit to employees. In anticipation of the Formation Transaction, the ESOP Trustee caused the ESOP to fully repay the outstanding balance on the exempt loan to the ESOP, which caused the remaining 77,968 unallocated units to be released from suspense resulting in the units being earned and committed-to-be released (similar to vesting). The Predecessor then terminated the ESOP. The expense in 2017 reflects the fair value of the 77,968 units which is the measurement and recognition required by U.S. GAAP.
(5)
Impairment charges in 2018 resulted from impairment to goodwill that was initially stepped up to fair value in the Canadian Acquisitions, and impairment charges in the period from commencement of operations (May 12, 2017) to December 31, 2017 resulted from impairment to goodwill and trademarks that were initially stepped up to fair value in the Formation Transaction. See Footnote 11, Impairment of Indefinite-Lived Intangible Assets, Long-Lived Tangible and Definite-Lived Intangible Assets, and Goodwill in our 2018 audited financial statements for further discussion.
(6)
The weighted average shares outstanding increased in 2018 compared to 2017 due to the issuance of our shares from the exchange of the non-controlling interest of 5,370,648 shares of common stock, 16,619,616 shares issued in our Private Placement and 6,097,617 shares issued in the Concurrent Offering, and 4,000,000 shares of common stock issued in the reverse merger with us.
(7)
Net working capital, excluding certain debt is the sum of current assets less current liabilities, excluding interest-bearing debt included in current liabilities.
(8)
To supplement our audited consolidated financial statements, which are prepared and presented in accordance with U.S. GAAP, we use earnings before interest, taxes, depreciation and amortization (“EBITDA”) and Adjusted EBITDA, which are non-U.S. GAAP financial measures. We define EBITDA as net income (loss) before depreciation and amortization, impairment, interest, and taxes. We define Adjusted EBITDA as EBITDA further adjusted for the impact of certain non-cash and other items such as inventory fair value adjustments, as share-based compensation, restructure and transactions costs, and EBITDA from a deconsolidated entity, which we do not consider in our evaluation of ongoing operating performance.
We believe that EBITDA and Adjusted EBITDA, when used in conjunction with net income (loss) in accordance with U.S. GAAP, provide useful information about operating results, enhances the overall understanding of past financial performance and future prospects, and allows for greater transparency with respect to the key metric we use in our financial and operational decision making. EBITDA and Adjusted EBITDA are also frequently used by analysts, investors and other interested parties to evaluate companies in our industry. The presentation of this financial information is not intended to be considered in isolation or as a substitute for, or superior to, the financial information prepared and presented in accordance with U.S. GAAP, and it should not be construed as an inference that our
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future results will be unaffected by any items adjusted for in EBITDA and Adjusted EBITDA. In evaluating EBITDA and Adjusted EBITDA, you should be aware that in the future we may incur expenses that are the same as or similar to some of those adjusted in this presentation.
EBITDA and Adjusted EBITDA have limitations as analytical tools, and you should not consider them either in isolation or as a substitute for analyzing our results as reported under U.S. GAAP. Some of these limitations include the following:

They do not reflect every expenditure, future requirements for capital expenditures or contractual commitments;

They do not reflect changes in our working capital needs;

They do not reflect the significant interest expense, or the amounts necessary to service interest or principal payments on our indebtedness;

They do not reflect income tax expense (benefit), and because the payment of taxes is part of our operations, tax expense is a necessary element of our costs and ability to operate;

Although depreciation and amortization are eliminated in the calculation of EBITDA and Adjusted EBITDA, the assets being depreciated and amortized will often have to be replaced in the future, and EBITDA and Adjusted EBITDA do not reflect any costs of such replacements;

They do not reflect the non-cash component of share-based compensation;

EBITDA and Adjusted EBITDA do not reflect the impact of earnings or charges resulting from matters we consider not to be reflective, on a recurring basis, of our ongoing operations; and

Other companies in our industry may calculate EBITDA and Adjusted EBITDA, or similarly titled measures differently than we do, limiting its usefulness as a comparative measure.
We compensate for these limitations by relying primarily on our U.S. GAAP results and using EBITDA and Adjusted EBITDA only as supplemental information.
The following table reconciles our net income (loss) to Adjusted EBITDA:
Successor
Predecessor
Pro Forma
Predecessor
(In Thousands)
Year ended
December 31,
2018
Period from
May 12, 2017 to
December 31,
2017
Period from
January 1, 2017 to
May 11,
2017
Year ended
December 31,
2017
Year ended
December 31,
2016
Net (loss) income
$ (35,301) $ (70,910) $ (19,863) $ (64,481) $ 16,549
Interest expense
11,606 5,643 547 7,929 1,134
Depreciation and amortization
7,170 3,769 428 5,836 1,237
Impairment charges
3,244 45,425 45,425
Provision (benefit) for income taxes
102 (266) 85 (182) 144
EBITDA (13,179) (16,339) (18,803) (5,473) 19,064
Employee stock ownership plan charges
30,327 6,480
Inventory fair value adjustment(a)
798 11,531 11,531
Restructure and transaction costs(b)
4,238 4,305 4,305
EBITDA from deconsolidated entity(c)
(658) (1,499)
Adjusted EBITDA
$ (8,143) $ (503) $ 10,866 $ 10,363 $ 24,045
(a)
This adjustment reflects the one-time amortization charges related to the step-up in basis of inventory, in connection with the Formation Transaction.
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(b)
Restructure and transaction costs in 2018 are primarily related to assistance with corporate level business strategy, capital structure, and research for sources of various financial alternatives. Included in 2018 were $555 of management fees paid to affiliates of our 5% shareholders. In 2017, $3,185 of transaction costs were incurred in relation to the Formation Transaction and $542 of management fees were paid to affiliates of our 5% shareholders. The remaining balances were primarily related to other advisory, investment banking and professional services.
(c)
This adjustment eliminates the EBITDA of McDowell Group LLC (“McDowell”), a variable interest entity in which the Predecessor was the primary beneficiary until the Formation Transaction (when the debt guarantee giving rise to the assessment that the Predecessor was the primary beneficiary was settled).
(9)
Adjusted EBITDA margin is defined as Adjusted EBITDA divided by net sales.
(10)
Capital expenditures relate to purchases of property, plant, and equipment and computer software.
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RISK FACTORS
Investing in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below, together with all of the other information in this prospectus, including our financial statements and related notes, before deciding whether to invest in our common stock. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that affect us. If any of the following risks occur, our business, operating results and prospects could be materially harmed. In that event, the price of our common stock could decline, and you could lose part or all of your investment.
Risks Relating to Our Business
Our proprietary brand offerings expose us to various risks.
We expect to continue to grow our exclusive proprietary brand offerings. We have invested in development and procurement resources and marketing efforts relating to these proprietary brand offerings. Although we believe that our proprietary brand products offer value to our customers at each price point and provide us with higher gross margins than comparable third party branded products we sell, the expansion of our proprietary brand offerings also subjects us to certain specific risks in addition to those discussed elsewhere in this section, such as:

potential mandatory or voluntary product recalls;

our ability to successfully protect our proprietary rights (including defending against counterfeit, knock offs, grey-market, infringing or otherwise unauthorized goods); and

our ability to successfully navigate and avoid claims related to the proprietary rights of third parties.
An increase in sales of our proprietary brands may also adversely affect our sales of our vendors’ products, which may, in turn, adversely affect our relationship with our vendors. Our failure to adequately address some or all of these risks could have a material adverse effect on our business, results of operations and financial condition.
Our competitors and potential competitors may develop products and technologies that are more effective or commercially attractive than our products.
Our products compete against national and regional products and private label products produced by various suppliers, many of which are established companies that provide products that perform functions similar to our products. Our competitors may develop or market products that are more effective or commercially attractive than our current or future products. Some of our competitors have substantially greater financial, operational, marketing and technical resources than we do. Moreover, some of these competitors may offer a broader array of products and sell their products at prices lower than ours, and may have greater name recognition. In addition, if demand for our specialty indoor gardening supplies and products continues to grow, we may face competition from new entrants into our field. Due to this competition, there is no assurance that we will not encounter difficulties in generating or increasing revenues and capturing market share. In addition, increased competition may lead to reduced prices and/or margins for products we sell. We may not have the financial resources, relationships with key suppliers, technical expertise or marketing, distribution or support capabilities to compete successfully in the future.
We may not successfully develop new products or improve existing products or maintain our effectiveness in reaching consumers through rapidly evolving communication vehicles.
Our future success depends, in part, upon our ability to improve our existing products and to develop, manufacture and market new products to meet evolving consumer needs. We cannot be certain that we will be successful in developing, manufacturing and marketing new products or product innovations which satisfy consumer needs or achieve market acceptance, or that we will develop, manufacture and market new products or product innovations in a timely manner. If we fail to successfully develop, manufacture and market new products or product innovations, or if we fail to reach existing and potential consumers, our ability to maintain or grow our market share may be adversely affected, which in turn could materially
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adversely affect our business, financial condition and results of operations. In addition, the development and introduction of new and products and product innovations require substantial research, development and marketing expenditures, which we may be unable to recoup if such new products or innovations do not achieve market acceptance.
Many of the products we distribute and market, such as our fertilizers and nutrients, contain ingredients that are subject to regulatory approval or registration with certain U.S. state regulators. The need to obtain such approval or registration could delay the launch of new products or product innovations that contain ingredients or otherwise prevent us from developing and manufacturing certain products and product innovations.
Negative economic conditions, specifically in the United States and Canada, could adversely affect our business.
Uncertain global economic conditions could adversely affect our business. Negative global economic trends, particularly in the United States and Canada, such as decreased consumer and business spending, high unemployment levels, reduced rates of home ownership and housing starts, high foreclosure rates and declining consumer and business confidence, pose challenges to our business and could result in declining revenues, profitability and cash flow. Although we continue to devote significant resources to support our brands, unfavorable economic conditions may negatively affect consumer demand for our products. Our most price-sensitive customers may trade down to lower priced products during challenging economic times or if current economic conditions worsen, while other customers may reduce discretionary spending during periods of economic uncertainty, which could reduce sales volumes of our products in favor of our competitors’ products or result in a shift in our product mix from higher margin to lower margin products.
Our international operations make us susceptible to the costs and risks associated with operating internationally.
We operate some of our distribution centers in Canada and Spain and source products globally. We also operate a registered office in China. Accordingly, we are subject to risks associated with operating in foreign countries, including:

fluctuations in currency exchange rates;

limitations on the remittance of dividends and other payments by foreign subsidiaries;

additional costs of compliance with local regulations;

in certain countries, historically higher rates of inflation than in the United States;

changes in the economic conditions or consumer preferences or demand for our products in these markets;

restrictive actions by multi-national governing bodies, foreign governments or subdivisions thereof;

changes in foreign labor laws and regulations affecting our ability to hire and retain employees;

changes in U.S. and foreign laws regarding trade and investment;

less robust protection of our intellectual property under foreign laws; and

difficulty in obtaining distribution and support for our products.
In addition, our operations outside the United States are subject to the risk of new and different legal and regulatory requirements in local jurisdictions, potential difficulties in staffing and managing local operations and potentially adverse tax consequences. The costs associated with operating our continuing international business could adversely affect our results of operations, financial condition and cash flows in the future.
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We will incur increased costs as a result of being a public company.
As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. For example, we will incur increased legal and accounting costs as a result of being subject to the information and reporting requirements of the Exchange Act of 1934, as amended (the “Exchange Act”), and other federal securities laws. The costs of preparing and filing periodic and other reports, proxy statements and other information with the SEC and furnishing audited reports to stockholders, will cause significant increase in our expenses than if we remained privately-held. The cost of being a public company will divert resources that might otherwise have been used to develop our business, which could have a material adverse effect on our company.
As a privately held company, we have not been required to comply with certain corporate governance and financial reporting practices and policies required of a public reporting company. As a public reporting company, we will incur significant legal, accounting, insurance and other expenses that we have not incurred as a private company. If the registration statement of which this prospectus forms a part is declared effective, as a public company, we will be required to file with the SEC annual and quarterly information and other reports pursuant to the Exchange Act. We will also be required to ensure that we have the ability to prepare financial statements that are fully compliant with all SEC reporting requirements on a timely basis. In addition, we may become subject to other reporting and corporate governance requirements, including the requirements of any national securities exchange on which our common stock is listed, should we so qualify for listing, and certain provisions of the Sarbanes-Oxley Act of 2002, as amended (the “Sarbanes-Oxley Act”), and the regulations promulgated thereunder, which will impose significant compliance obligations upon us. As a public company, we will, among other things:

prepare and distribute periodic public reports and other stockholder communications in compliance;

comply with our obligations under the federal securities laws and applicable listing rules;

create or expand the roles and duties of our board of directors and committees of the board of directors;

institute more comprehensive financial reporting and disclosure compliance functions;

enhance our investor relations function;

establish new internal policies, including those relating to disclosure controls and procedures; and

involve and retain to a greater degree outside counsel and accountants in the activities listed above.
These changes will require a significant commitment of additional resources and many of our competitors already comply with these obligations. We may not be successful in complying with these obligations and the significant commitment of resources required for complying with them could have a material adverse effect on our business, financial condition and results of operations. These laws and regulations could also make it more difficult or costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. These laws and regulations could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our committees of our board of directors or as our executive officers.
In addition, if we fail to implement the requirements with respect to our internal accounting and audit functions, our ability to report our results of operations on a timely and accurate basis could be impaired and we could suffer adverse regulatory consequences or violate applicable listing standards. There could also be a negative reaction in the financial markets due to a loss of investor confidence in us and the reliability of our financial statements, which could have a material adverse effect on our business, financial condition and results of operations.
The changes necessitated by becoming a public company require a significant commitment of resources and management supervision that has increased and may continue to increase our costs and might place a strain on our systems and resources. As a result, our management’s attention might be
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diverted from other business concerns. If we fail to maintain an effective internal control environment or to comply with the numerous legal and regulatory requirements imposed on public companies, we could make material errors in, and be required to restate, our financial statements. Any such restatement could result in a loss of public confidence in the reliability of our financial statements and sanctions imposed on us by the SEC. We cannot predict or estimate the amount of additional costs we may incur or the timing of such costs. If we are unable to satisfy our obligations as a public company, we could be subject to delisting of our common stock, as applicable, fines, sanctions and other regulatory action and potentially civil litigation.
There may be limitations on the effectiveness of our internal controls, and a failure of our control systems to prevent error or fraud may materially harm our company.
Proper systems of internal control over financial accounting and disclosure are critical to the operation of a public company. We may be unable to effectively establish such systems, especially in light of the fact that we expect to operate as a publicly reporting company. This would leave us without the ability to reliably assimilate and compile financial information about our company and significantly impair our ability to prevent error and detect fraud, all of which would have a negative impact on us from many perspectives.
Moreover, we do not expect that disclosure controls or internal control over financial reporting, even if established, will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. Failure of our control systems to prevent error or fraud could materially adversely impact us.
In connection with our preparation of our consolidated financial statements, we identified material weaknesses in our internal control over financial reporting. Any failure to maintain effective internal control over financial reporting could harm us.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. GAAP. Under standards established by the Public Company Accounting Oversight Board (the “PCAOB”), a deficiency in internal control over financial reporting exists when the design or operation of a control does not allow management or personnel, in the normal course of performing their assigned functions, to prevent or detect misstatements on a timely basis. The PCAOB defines a material weakness as a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of annual or interim financial statements will not be prevented, or detected and corrected, on a timely basis. The PCAOB defines a significant deficiency as a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of a registrant’s financial reporting.
During the preparation of our consolidated financial statements for the year ended December 31, 2018, we identified certain material weaknesses in our internal control over financial reporting. The material weaknesses related to failure to properly detect and analyze issues in the accounting system related to inventory valuation, inventory cutoff, inventory held by third parties, fixed assets and consolidations. Since December 31, 2018, we believe we have remediated the issues in our accounting system related to inventory cutoff, inventory held by third parties and fixed assets and believe that our remediation efforts were successful. We also are in the process of remediating the previously identified material weakness relating to inventory valuation and consolidations but have not completed our plans to remediate the material weakness related to such controls. We continue to work on addressing remaining remediation activities within our Microsoft Dynamics AX environment and other information technology systems that support our financial reporting process enhanced with expert value-added resellers (“VARs”) and Microsoft support staff. The material weakness will not be considered remediated until our remediation plan has been fully implemented and we have concluded that our controls are operating effectively.
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In accordance with the provisions of the JOBS Act, we and our independent registered public accounting firm were not required to, and did not, perform an evaluation of our internal control over financial reporting as of December 31, 2018 pursuant to Section 404 of the Sarbanes-Oxley Act. Accordingly, we cannot assure you that we have identified all, or that we will not in the future have additional, material weaknesses. Further, material weaknesses may still exist when we report on the effectiveness of our internal control over financial reporting as required under Section 404 of the Sarbanes-Oxley Act in our Annual Report on Form 10-K for the fiscal year ending December 31, 2019.
Additional material weaknesses or significant deficiencies may be identified in the future. If we identify such issues or if we are unable to produce accurate and timely financial statements, our stock price may decline, and we may be unable to maintain compliance with the NASDAQ listing standards.
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.
Acquisitions are an important element of our overall corporate strategy, and these transactions could entail material investments by us and be material to our financial condition and results of operations. We expect to evaluate and enter into discussions regarding a wide array of potential strategic transactions. The process of integrating an acquired company, business, or product has created, and will continue to create, unforeseen operating difficulties and expenditures. The areas where we face risks may include, but are not limited to:

diversion of management’s time and focus from operating our business to acquisition integration challenges;

failure to successfully further develop the acquired business or products;

implementation or remediation of controls, procedures and policies at the acquired company;

integration of the acquired company’s accounting, human resources and other administrative systems, and coordination of product, engineering and sales and marketing functions;

transition of operations, users and customers onto our existing platforms;

reliance on the expertise of our strategic partners with respect to market development, sales, local regulatory compliance and other operational matters;

failure to obtain required approvals on a timely basis, if at all, from governmental authorities, or conditions placed upon approval, under competition and antitrust laws which could, among other things, delay or prevent us from completing a transaction, or otherwise restrict our ability to realize the expected financial or strategic goals of an acquisition;

in the case of foreign acquisitions, the need to integrate operations across different cultures and languages and to address the particular economic, currency, political and regulatory risks associated with specific countries;

cultural challenges associated with integrating employees from the acquired company into our organization, and retention of employees from the businesses we acquire;

liability for or reputational harm from activities of the acquired company before the acquisition or from our strategic partners, including patent and trademark infringement claims, violations of laws, commercial disputes, tax liabilities and other known and unknown liabilities; and

litigation or other claims in connection with the acquired company, including claims from terminated employees, customers, former shareholders or other third parties.
Our due diligence may fail to identify all liabilities associated with acquisitions and we may not assess the relative benefits and detriments of making an acquisition and may pay acquisition consideration exceeding the value of the acquired business. Our failure to address these risks or other problems encountered in connection with our past or future acquisitions and investments or strategic alliances could cause us to fail to realize the anticipated benefits of such acquisitions, investments or alliances, incur unanticipated liabilities, and harm our business generally.
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Our acquisitions could also result in dilutive issuances of our equity securities, the incurrence of debt, contingent liabilities or amortization expenses, or impairment of goodwill and purchased long-lived assets, and restructuring charges, any of which could harm our financial condition or results of operations and cash flows.
Although, acquisitions are an important element of our overall corporate strategy, there can be no assurance that we will be able to identify appropriate acquisition targets, successfully acquire identified targets or successfully integrate the business of acquired companies to realize the full, anticipated benefits of such acquisitions.
Damage to our reputation could have an adverse effect on our business.
Maintaining our strong reputation is a key component in our success. Product recalls, our inability to ship, sell or transport our products, governmental investigations and other matters may harm our reputation and acceptance of our products, which may materially and adversely affect our business operations, decrease sales and increase costs.
In addition, perceptions that the products we distribute and market are not safe could adversely affect us and contribute to the risk we will be subjected to legal action. We distribute and market a variety of products, such as nutrients, and growing media. On occasion, allegations or news reports may be made that some of these products have failed to perform up to expectations or have caused damage or injury to individuals or property. Public perception that the products we distribute or market are not safe could impair our reputation, involve us in litigation, damage our brand names and have a material adverse effect on our business.
Our marketing activities may not be successful.
We invest substantial resources in advertising, consumer promotions and other marketing activities to maintain, extend and expand our brand image. There can be no assurance that our marketing strategies will be effective or that the amount we invest in advertising activities will result in a corresponding increase in sales of our products. If our marketing initiatives are not successful, we will have incurred significant expenses without the benefit of higher revenues.
Our operations may be impaired if our information technology systems fail to perform adequately or if we are the subject of a data breach or cyber-attack.
We rely on information technology systems in order to conduct business, including communicating with employees and our distribution centers, ordering and managing materials from suppliers, selling and shipping products to retail customers and analyzing and reporting results of operations. While we have taken steps to ensure the security of our information technology systems, our systems may nevertheless be vulnerable to computer viruses, security breaches and other disruptions from unauthorized users. If our information technology systems are damaged or cease to function properly for an extended period of time, whether as a result of a significant cyber incident or otherwise, our ability to communicate internally as well as with our retail customers could be significantly impaired, which may adversely impact our business. Additionally, an operational failure or breach of security from increasingly sophisticated cyber threats could lead to the loss or disclosure of both our and our retail customers’ financial, product, and other confidential information, as well as personally identifiable information about our employees or customers, result in regulatory or other legal proceedings, and have a material adverse effect on our business and reputation.
We occupy many of our facilities under long-term non-cancellable leases, and we may be unable to renew our leases at the end of their terms.
Many of our facilities and distribution centers are located on leased premises subject to non-cancellable leases. Typically, our leases have initial terms ranging from three to ten years, with options to renew for specified periods of time. We believe that our future leases will likely also be long-term and non-cancellable and have similar renewal options. If we close or stop fully utilizing a facility, we will most likely remain obligated to perform under the applicable lease, which would include, among other things,
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making the base rent payments, and paying insurance, taxes and other expenses on the leased property for the remainder of the lease term. Our future minimum aggregate rental commitments for leases for our facilities and distribution centers, as of December 31, 2018, is approximately $27.4 million of which $26.4 million is not reflected as liabilities on our balance sheet. Our inability to terminate a lease when we stop fully utilizing a facility or exit a market can have a significant adverse impact on our financial condition, operating results and cash flows.
In addition, at the end of the lease term and any renewal period for a facility, we may be unable to renew the lease without substantial additional cost, if at all. If we are unable to renew our facility leases, we may close or relocate a facility, which could subject us to construction and other costs and risks, which in turn could have a material adverse effect on our business and operating results. Further, we may not be able to secure a replacement facility in a location that is as commercially viable, including access to rail service, as the lease we are unable to renew. Having to close a facility, even briefly to relocate, could reduce the sales that such facility would have contributed to our revenues.
The estimates and judgments we make, or the assumptions on which we rely, in preparing our consolidated financial statements could prove inaccurate.
Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of our assets, liabilities, revenues and expenses, the amounts of charges accrued by us and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. We cannot assure, however, that our estimates, or the assumptions underlying them, will not change over time or otherwise prove inaccurate. Any potential litigation related to the estimates and judgments we make, or the assumptions on which we rely, in preparing our consolidated financial statements could have a material adverse effect on our financial results, harm our business, and cause our share price to decline.
If we are unable to hire and retain key personnel, we may not be able to implement our business plan and our business may fail.
Our future success depends to a large extent on our ability to attract, hire, train and retain qualified managerial, operational and other personnel. We face significant competition for qualified and experienced employees in our industry and from other industries and, as a result, we may be unable to attract and retain the personnel needed to successfully conduct and grow our operations. Additionally, key personnel, including members of management, may leave and compete against us.
At present, we believe we have the necessary key personal to carry out our business plans but there can be no assurance that our beliefs will not prove unfounded. If we are unable to hire and retain key personnel, our business will be materially adversely affected.
Our independent registered public accounting firm’s report contains an explanatory paragraph that expresses substantial doubt about our ability to continue as a going concern.
The reports of our independent auditors on Hydrofarm, LLC’s financial statements for the period from January 1, 2017 to May 11, 2017, and on our financial statements for the period from commencement of operations (May 12, 2017) to December 31, 2017 and for the year ended December 31, 2018 included an explanatory paragraph indicating that our breach of financial covenants with our lenders and our need to identify and obtain additional capital sources raises substantial doubt about our ability to continue as a going concern. The inclusion of a going concern explanatory paragraph in future reports of our independent auditors may make it more difficult for us to secure additional financing or enter into strategic relationships on terms acceptable to us, if at all, and may materially and adversely affect the terms of any financing that we might obtain.
Potential tariffs or a global trade war could increase the cost of our products, which could adversely impact the competitiveness of our products and our financial results.
The United States recently imposed tariffs on certain imports from China, including on lighting and environmental control equipment manufactured in China. If the U.S. administration imposes additional
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tariffs, or if additional tariffs or trade restrictions are implemented by the United States or other countries in connection with a global trade war, our electronic ballasts produced in China could also be impacted. While it is too early to predict how the recently enacted tariffs and any future tariffs on items imported from China or elsewhere will impact our business, the cost of our products manufactured in China and imported into the United States or other countries could increase, which in turn could adversely affect the demand for these products and have a material adverse effect on our business and results of operations.
Our failure to fulfill all of our registration requirements may cause us to suffer liquidated damages, which may be very costly.
Pursuant to the terms of the Registration Rights Agreement that we entered into in connection with the Private Placement, we are required to use our commercially reasonable efforts to obtain effectiveness and maintain effectiveness of a registration statement with respect to the shares of our common stock underlying the securities issued in the Private Placement. The failure to do so could result in the payment of liquidated damages by us. The amount of liquidated damages potentially payable is equal to one-half of one percent (0.5%) of the purchase price per Unit paid by such purchaser for the registrable securities then held by such purchaser for each full period of thirty (30) days of our failure to obtain or maintain effectiveness of this registration statement, as applicable until such failure is cured. The payment amount shall be pro-rated for partial thirty (30) day periods. The maximum aggregate amount of payments to be made by us as the result of such failures, whether by reason of a failure to obtain effectiveness, a failure to maintain effectiveness or any combination thereof, shall be an amount equal to six percent (6%) of each purchaser’s aggregate investment amount of registrable securities then held by such purchaser. Notwithstanding the foregoing, no payments shall be owed with respect to any period during which all of the registrable securities registered securities shall have been sold or all of the registrable securities may be sold by such purchaser without restriction under Rule 144 of the Securities Act. There can be no assurance as to when this registration statement will be declared effective, if at all, or that we will be able to maintain the effectiveness of any registration statement, and therefore there can be no assurance that we will not incur liquidated damages with respect to the Registration Rights Agreement.
Risks Relating to Our Indebtedness
There are significant risks associated with the outstanding and future indebtedness of certain of our subsidiaries. Such subsidiaries ability to pay interest and repay the principal on their indebtedness is dependent upon our ability to manage our business operations, generate sufficient cash flows to service such debt and the other factors discussed in this section. There can be no assurance that we will be able to manage any of these risks successfully.
Certain of our subsidiaries are parties to material loan and lease agreements with different financial institutions. Such subsidiaries have used and/or will continue to use, the proceeds from these debt arrangements to fund working capital requirements and for the lease of certain equipment required to conduct our business. As of December 31, 2018, certain of our subsidiaries had an aggregate of  $102.2 million of outstanding indebtedness that will mature between calendar year 2019 and calendar year 2022, and we or our subsidiaries may incur additional indebtedness in the future.
Our subsidiaries’ current debt arrangements consist of the following. See “Description of Our Indebtedness” for additional information regarding the debt arrangements of certain of our subsidiaries.

Loan and Security Agreement among Hydrofarm Holdings, LLC, Hydrofarm, LLC, EHH Holdings, LLC (“EHH”), SunBlaster LLC (“SunBlaster”), Sunblaster Holdings ULC (“SunBlaster ULC”), Eddi’s Wholesale Garden Supplies, Ltd. (“EWGS” and, together with Sunblaster ULC, the “Canadian Borrowers”) and Hydrofarm Canada, LLC (“Hydrofarm Canada”) (collectively, the “Subsidiary Obligors”), and Encina Business Credit, LLC (“Encina”), as agent, and the other lenders party thereto, and (as amended and restated to date, the “Encina Credit Facility”). The Encina Credit Facility provides for revolving borrowings of up to $45 million asset-based revolving credit facility, subject to applicable borrowing base availability, and a limit of up to $15 million of borrowings for the Canadian Borrowers, which matures on the earlier of  (i) July 10, 2022, or (ii) 90 days prior to the scheduled maturity date of the Term Loan Agreement (as defined below), and is secured by a first-priority lien on all cash, accounts
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receivable and inventory of the Subsidiary Obligors and a second-lien priority lien on all other personal property of the Subsidiary Obligors. The Encina Credit Facility also provides for a swingline facility of up to $2.0 million. A portion of the proceeds borrowed under the Encina Credit Facility were used to pay in full the BofA Agreement (as defined below).

Term Loan Credit Agreement among Subsidiary Obligors and Brightwood Loan Services, LLC (“Brightwood”) and the other lenders party thereto (the “Term Loan Lenders”) (as amended to date, the “Term Loan Agreement”). The Term Loan Agreement provides for a term loan in an aggregate principal amount of  $75 million, which matures on May 12, 2022, and is secured by a second-priority lien on all cash, accounts receivable and inventory of the Subsidiary Obligors and a first-priority lien on all other assets and personal property of the Subsidiary Obligors, subject to certain exceptions. As of December 31, 2018 and 2017, we had borrowings outstanding under the Term Loan Agreement of approximately $80.4 million and $74.1 million, respectively.

Equipment lease agreement (the “First National Equipment Lease”) among Hydrofarm, LLC (with Hydrofarm Holdings, LLC acting as guarantor) and First National Capital, LLC (“First National”). Under the First National Equipment Lease, Hydrofarm, LLC leased equipment for day-to-day operations under a 48-month term. An aggregate of  $151,719 of the $797,744 initially borrowed under the First National Equipment Lease has been paid as of December 31, 2018.

Poliza Para Operaciones Bancarias, as amended, between Eltac XXI, S.L. (“Eltac”) and Banco de Sabadell, S.A. (the “Sabadell Agreement”). Under the Sabadell Agreement, Eltac received a €700,000 revolving credit facility, which matures on June 23, 2019 and is underwritten by an $800,000 USD standby letter of credit issued under the BofA Agreement by the Subsidiary Obligors for benefit of Banco de Sabadell for the purpose of financing €600,000 working capital and €100,000 for a bonded warehouse guarantee. The credit facility automatically renews annually provided the underlying guarantee is current. As of December 31, 2018, the loan balance under the Sabadell Agreement was €327,217.
In addition, we and any current and future subsidiaries of ours may incur substantial additional debt in the future, subject to the specified limitations in the existing agreements governing our subsidiaries’ indebtedness. If new debt is added to our or any of our subsidiaries’ debt levels, the risks described in “Risks Relating to Our Indebtedness” could intensify. See “Description of Our Indebtedness.
Our subsidiaries’ current and future indebtedness could have significant negative consequences for our business, results of operations and financial condition, including:

increasing our or our subsidiaries’ vulnerability to adverse economic and industry conditions;

limiting our subsidiaries’ ability to obtain additional financing;

requiring the dedication of a substantial portion of our subsidiaries’ cash flow from operations to service their respective indebtedness, thereby reducing the amount of cash flow available for other purposes;

limiting our flexibility in planning for, or reacting to, changes in our business; and

placing us at a possible competitive disadvantage with less leveraged competitors and competitors that may have better access to capital resources.
We cannot assure you that we will continue to maintain sufficient cash reserves or that our business will generate cash flow from operations at levels sufficient to permit us or our subsidiaries to pay principal, premium, if any, and interest on the indebtedness of our subsidiaries, or that our or our subsidiaries’ cash needs will not increase. If we or our subsidiaries are unable to generate sufficient cash flow or otherwise obtain funds necessary to make required payments, or if our subsidiaries fail to comply with the various requirements of their respective existing indebtedness or any other indebtedness which we or our subsidiaries may incur in the future, we or our subsidiaries would be in default, which could permit the holders of our or our subsidiaries’ indebtedness to accelerate the maturity of such indebtedness, requiring
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us or our subsidiaries to pay all obligations then outstanding, and/or to exercise other remedies provided to them under their respective agreements, and any applicable law. Any default under such indebtedness would have a material adverse effect on our business, results of operations and financial condition.
Each of the Term Loan Agreement and the Encina Credit Facility have restrictions on our ability to sell our products directly to the cannabis industry.
The Term Loan Agreement prohibits the Subsidiary Obligors from selling our products directly to cannabis growers or cultivators, or to sellers or retailers that sell only to the cannabis industry. The Encina Credit Facility prohibits the Subsidiary Obligors from selling our products to the cannabis industry. We maintain policies and procedures that are designed to promote and achieve compliance with these requirements.
This compliance requirement may require that we be more selective than our competitors when selecting to whom we sell our products, and in certain situations, may afford our competitors a competitive advantage compared to us if we are not able to sell our products to a certain customer, and may negatively impact our marketing efforts, sales and reputation in the market. Moreover, any breach of these compliance requirements, could result in the occurrence of an event of default under the Encina Credit Facility and the Term Loan Agreement, which would entitle Encina and the Term Loan Lenders to accelerate the payment of all obligations then outstanding, without any action by them or notice of any kind. The foregoing events would have a material adverse effect on our business, results of operations and financial condition.
Substantially all of the Subsidiary Obligors’ assets are pledged to secure obligations under the Subsidiary Obligors outstanding indebtedness.
The Subsidiary Obligors have granted a continuing security interest in substantially all of their assets to certain of our lenders under the agreements governing the Subsidiary Obligors’ indebtedness, as security for the Subsidiary Obligors’ obligations under such applicable loan agreements. If the Subsidiary Obligors default on any of their obligations under these agreements, Encina and the Term Loan Lenders will be entitled to exercise remedies available to them resulting from such default, including increasing the applicable interest rate on all amounts outstanding, declaring all amounts due thereunder immediately due and payable, assuming possession of the secured assets, and exercising rights and remedies of a secured party under the Uniform Commercial Code, as applicable then in the United States, or the Personal Property Security Act, as applicable then in Canada. Our ability to conduct our business may be materially harmed as a result of the exercise of any remedies, in the event that such remedies are exercisable, by any or all of Encina, the Term Loan Lenders, or First National.
The Subsidiary Obligors existing debt agreements contain, and our or our subsidiaries’ future debt agreements may contain, restrictions that may limit our flexibility in operating our business.
The Subsidiary Obligors’ existing debt agreements contain, and any documents governing our or our subsidiaries’ future indebtedness may contain, numerous financial and operating covenants that limit the discretion of management with respect to certain business matters. Such restrictive covenants include restrictions on, among others, our or our subsidiaries’ ability to: (1) incur additional indebtedness; (2) create or suffer to exist any liens upon any of our or our subsidiaries’ property; (3) pay dividends and other distributions or enter into agreements restricting our subsidiaries’ ability to pay dividends; (3) make any restricted investment; (4) make certain loans; make certain dispositions of assets; (5) merge, amalgamate, combine or consolidate; (6) engage in certain transactions with stockholders or affiliates; (7) amend or otherwise alter the terms of our or our subsidiaries’ indebtedness; or (8) alter the business that we conduct. The Subsidiary Obligors’ existing debt agreements also require, and any documents governing our or our subsidiaries’ future indebtedness may require, us to meet certain financial ratios and tests. Noncompliance with the applicable financial ratios and tests are specified defaults under each of the Encina Credit Facility and the Term Loan Agreement. The Subsidiary Obligors have previously failed to comply with such financial ratios and tests, which required us to engage Brightwood to request forbearance and negotiate amendments to the Term Loan Agreement.
The Subsidiary Obligors’ ability to comply with these and other provisions of their existing debt agreements is dependent on our future performance, which will be subject to many factors, some of which are beyond our control. The breach of any of these covenants or noncompliance with any of these financial
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ratios and tests could result in an event of default under the existing debt agreements, which, if not cured or waived, could result in acceleration of the related debt and the acceleration of debt under other instruments evidencing indebtedness that may also contain cross-acceleration or cross-default provisions. Variable rate indebtedness subjects the Subsidiary Obligors to the risk of higher interest rates, which could cause our future debt service obligations to increase significantly.
The substantial leverage of our subsidiaries could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry, expose us to interest rate risk to the extent of our subsidiaries’ variable rate debt and prevent our subsidiaries from meeting their obligations under their indebtedness.
Certain of our subsidiaries are highly leveraged. As of December 31, 2018, indebtedness of our subsidiaries was $102.2 million. Our subsidiaries’ high degree of leverage has serious consequences, including the following: (i) a substantial portion of our subsidiaries’ cash flow from operations is dedicated to the payment of principal and interest on indebtedness, thereby reducing the funds available for operations, future business opportunities and capital expenditures; (ii) our and our subsidiaries’ ability to obtain additional financing for working capital, capital expenditures, debt service requirements, acquisitions and general corporate purposes in the future may be limited; (iii) certain of the borrowings are at variable rates of interest, which will increase our subsidiaries’ vulnerability to increases in interest rates; (iv) we are at a competitive disadvantage to lesser leveraged competitors; (v) we may be unable to adjust rapidly to changing market conditions; (vi) the debt service requirements of our subsidiaries’ other indebtedness could make it more difficult for us or our subsidiaries to satisfy our other financial obligations; and (vii) we may be vulnerable in a downturn in general economic conditions or in our business and we may be unable to carry out activities that are important to our growth.
If our and our subsidiaries’ cash flows and capital resources are insufficient to fund our subsidiaries’ debt service obligations, we may be forced to reduce or delay investments and capital expenditures, or to sell assets, seek additional capital or restructure or refinance our subsidiaries’ indebtedness. Our ability to restructure or refinance our subsidiaries’ debt will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of our subsidiaries’ debt could be at higher interest rates and may require us or our subsidiaries to comply with more onerous covenants, which could further restrict our business operations. The terms of existing or future debt instruments may restrict us from adopting some of these alternatives. In addition, any failure to make payments of interest and principal on our subsidiaries’ outstanding indebtedness on a timely basis would likely result in a reduction of our subsidiaries’ credit rating, which could harm our or our subsidiaries’ ability to incur additional indebtedness. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our subsidiaries’ debt service and other obligations required under the respective agreements. The Encina Credit Facility and the Term Loan Agreement each restrict our subsidiaries’ ability to dispose of assets and use the proceeds from certain such dispositions. We may not be able to consummate those dispositions or to obtain the proceeds that we could realize from them and these proceeds may not be adequate to meet any payments or fees then due. These alternative measures may not be successful and may not permit our subsidiaries to meet their obligations.
If we are unable to generate sufficient cash flow to service our subsidiaries’ debt or to fund our other liquidity needs, we may need to restructure or refinance all or a portion of our subsidiaries’ debt, which could cause our subsidiaries to default on their obligations and impair our liquidity. We cannot assure you that we will be able to refinance our subsidiaries’ indebtedness. Any refinancing of our subsidiaries’ indebtedness could be at higher interest rates and may require us or our subsidiaries to comply with more onerous covenants that could further restrict our business operations. We from time to time may increase the amount of our subsidiaries indebtedness, modify the terms of our subsidiaries’ financing arrangements, make capital expenditures and take other actions that may substantially increase our subsidiaries’ leverage.
Risks Relating to Third Parties
Our reliance on a limited base of suppliers for certain products, such as light ballasts, may result in disruptions to our business and adversely affect our financial results.
Although we continue to implement risk-mitigation strategies for single-source suppliers, we rely on a limited number of suppliers for certain of our light ballasts, used in manufacturing our lighting systems. If
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we are unable to maintain supplier arrangements and relationships, if we are unable to contract with suppliers at the quantity and quality levels needed for our business, or if any of our key suppliers becomes insolvent or experience other financial distress, we could experience disruptions in production, which could have a material adverse effect on our financial condition, results of operations and cash flows.
A significant interruption in the operation of our or our suppliers’ facilities could impact our capacity to produce products and service our customers, which could adversely affect revenues and earnings.
Operations at our and our suppliers’ facilities are subject to disruption for a variety of reasons, including fire, flooding or other natural disasters, disease outbreaks or pandemics, acts of war, terrorism, government shut-downs and work stoppages. A significant interruption in the operation of our or our suppliers’ facilities, especially for those products manufactured at a limited number of facilities, such as fertilizer and liquid products, could significantly impact our capacity to sell products and service our customers in a timely manner, which could have a material adverse effect on our customer relationships, revenues, earnings and financial position.
If our suppliers are unable to source raw materials in sufficient quantities, on a timely basis, and at acceptable costs, our ability to sell our products may be harmed.
The manufacture of some of our products is complex and requires precise high quality manufacturing that is difficult to achieve. We have in the past, and may in the future, experience difficulties in manufacturing our products on a timely basis and in sufficient quantities. These difficulties have primarily related to difficulties associated with ramping up production of newly introduced products and may result in increased delivery lead-times and increased costs of manufacturing these products. Our failure to achieve and maintain the required high manufacturing standards could result in further delays or failures in product testing or delivery, cost overruns, product recalls or withdrawals, increased warranty costs or other problems that could harm our business and prospects.
In determining the required quantities of our products and the manufacturing schedule, we must make significant judgments and estimates based on historical experience, inventory levels, current market trends and other related factors. Because of the inherent nature of estimates, there could be significant differences between our estimates and the actual amounts of products we require, which could harm our business and results of operations.
Disruptions in availability or increases in the prices of raw materials sourced by suppliers could adversely affect our results of operations.
We source many of our product components from outside of the United States. The general availability and price of those components can be affected by numerous forces beyond our control, including political instability, trade restrictions and other government regulations, duties and tariffs, price controls, changes in currency exchange rates and weather.
A significant disruption in the availability of any of our key product components could negatively impact our business. In addition, increases in the prices of key commodities and other raw materials could adversely affect our ability to manage our cost structure. Market conditions may limit our ability to raise selling prices to offset increases in our raw material costs. Our proprietary technologies can limit our ability to locate or utilize alternative inputs for certain products. For certain inputs, new sources of supply may have to be qualified under regulatory standards, which can require additional investment and delay bringing a product to market.
If our suppliers that currently, or in the future, sell directly to the retail market in which we conduct our current or future business, enhance these efforts and cease or decrease their sales through us, our ability to sell certain products could be harmed.
Our distribution and sales and marketing capabilities provide significant value to our suppliers. Distributed brand suppliers sell through us in order to access thousands of retail and commercial customers across the United States and Canada with short order lead times, no minimum order quantity on individual items, free or minimal freight expense and trade credit terms. Based on our knowledge and communication
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with our suppliers, we believe some of our suppliers sell directly to the retail market. If these suppliers were to cease working with us, or proceed to enhance their direct-to-customer efforts, our product offerings, reputation, operation and business could be materially adversely effected.
Risks Relating to the Cannabis Industry
We sell our products through third party retailers and resellers. 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, the risks referred to below, to the extent they relate to our customers could impact us indirectly. In addition, if our business is deemed to transact with companies involved in the cannabis business, these risks could apply directly to us.
Our growth is highly dependent on the U.S. cannabis market and on such market in California particularly. New California regulations caused licensing shortages and future regulations may create other limitations that decrease the demand for our products. Regulations adopted in California and other states in the future may adversely impact our business.
The base of cannabis growers in the U.S. has grown over the past 20 years since the legalization of cannabis for medical uses in states such as California, Colorado and Washington, with a large number of those growers depending on products similar to those we distribute. The U.S. cannabis market is still in its infancy and early adopter states such as California, Colorado and Washington represent a large portion of historical industry revenues. The U.S. cannabis cultivation market is expected to be one of the fastest growing industries in the U.S. over the next five years. If the U.S. cannabis cultivation market does not grow as expected, our business, financial condition and results of operations could be adversely impacted. The California cannabis cultivation market is expected to be one of the fastest growing industries in California over the next five years. If the California cannabis cultivation market does not grow as expected, our business, financial condition and results of operations could be adversely impacted.
Cannabis remains illegal under U.S. federal law, with cannabis listed as a Schedule I substance under the United States Controlled Substances Act of 1970 (the “CSA”). Notwithstanding laws in various states permitting certain cannabis activities, all cannabis activities, including possession, distribution, processing and manufacturing of cannabis and investment in, and financial services or transactions involving proceeds of, or promoting such activities remain illegal under various U.S. federal criminal and civil laws and regulations, including the CSA, as well as laws and regulations of several states that have not legalized some or any cannabis activities to date. Compliance with applicable state laws regarding cannabis activities does not protect us from federal prosecution or other enforcement action, such as seizure or forfeiture remedies, nor does it provide any defense to such prosecution or action. Cannabis activities conducted in or related to conduct in multiple states may potentially face a higher level of scrutiny from federal authorities. Penalties for violating federal drug, conspiracy, aiding, abetting, bank fraud and/or money laundering laws may include prison, fines, and seizure/forfeiture of property used in connection with cannabis activities, including proceeds derived from such activities.
We sell our products through third party retailers and resellers, however, 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. We are not currently subject directly to any state laws or regulations controlling participants in the legal cannabis industry. However, regulation of the cannabis industry does impact those that we believe represent many end-users for our products and, accordingly, there can be no assurance that changes in regulation of the industry and more rigorous enforcement by federal authorities will not have a material adverse effect on us.
Legislation and regulations pertaining to the use and cultivation of cannabis are enacted on both the state and federal government level within the United States. As a result, the laws governing the cultivation and use of cannabis may be subject to change. Any new laws and regulations limiting the use or cultivation of cannabis and any enforcement actions by state and federal governments could indirectly reduce demand for our products, and may impact our current and planned future operations.
Individual state laws regarding the cultivation and possession 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
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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. Variations exist among those states’ cannabis laws. Evolving federal and state laws and regulations pertaining to the use or cultivation of cannabis, as well active enforcement by federal or state authorities of the laws and regulations governing the use and cultivation of cannabis may indirectly and adversely affect our business, our revenues and our profits.
The Term Loan Agreement prohibits the Subsidiary Obligors from selling our products directly to cannabis growers or cultivators, or to sellers or retailers that sell only to the cannabis industry. The Encina Credit Facility prohibits the Subsidiary Obligors from selling our products to the cannabis industry. See “— Risks Relating to Our Indebtedness.
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.
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.
Scientific research related to the benefits of cannabis remains in its early stages, is subject to a number of important assumptions, and may prove to be inaccurate. Future research studies and clinical trials may reach negative conclusions regarding the viability, safety, efficacy, dosing, social acceptance or other facts and perceptions related to medical cannabis, which could materially impact the demand for our products for use in the cannabis industry.
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 United States 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 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.
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Under 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:

Businesses trafficking in cannabis may not take tax deductions for costs beyond costs of goods sold under Code Section 280E. There is no way to predict how the federal government may treat cannabis business from a taxation standpoint in the future and no assurance can be given to what extent Code Section 280E, or other tax-related laws and regulations, may be applied to cannabis businesses in the future.

Because the manufacturing (cultivation), sale, possession and use of cannabis is illegal under federal law, cannabis businesses may have restricted intellectual property rights particularly with respect to obtaining trademarks and enforcing patents. In addition, cannabis businesses may face court action by third parties under the Racketeer Influenced and Corrupt Organizations Act (“RICO”). Intellectual property rights could be impaired as a result of cannabis business, and cannabis businesses could be named as a defendant in an action asserting a RICO violation.

Federal bankruptcy courts cannot provide relief for parties who engage in cannabis or cannabis businesses. Recent bankruptcy rulings have denied bankruptcies for cannabis dispensaries upon the justification that businesses cannot violate federal law and then claim the benefits of federal bankruptcy for the same activity and upon the justification that courts cannot ask a bankruptcy trustee to take possession of, and distribute cannabis assets as such action would violate the CSA. Therefore, cannabis businesses may not be able to seek the protection of the bankruptcy courts and this could materially affect their financial performance and/or their ability to obtain or maintain credit.

Since cannabis is illegal under federal law, there is a strong argument that banks cannot accept for deposit funds from businesses involved in the cannabis industry. Consequently, businesses involved in the cannabis industry often have difficulty finding a bank willing to accept their business. Any such inability to open or maintain bank accounts may make it difficult for cannabis businesses to operate. Under the Bank Secrecy Act (“BSA”), banks must report to the federal government any suspected illegal activity, which includes any transaction associated with a cannabis business. These reports must be filed even though the business is operating legitimately under state law.

Insurance that is otherwise readily available, such as general liability and directors and officer’s insurance, may be more difficult to find, and more expensive.
The current Trump 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, 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. 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.
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Federal authorities may enforce current federal cannabis law and, if they 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. Nonetheless, 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.
Our indirect involvement in the cannabis industry could affect the public’s perception of us and be detrimental to our reputation.
Damage to our reputation can be the result of the actual or perceived occurrence of any number of events, and could include any negative publicity, whether true or not. Cannabis has often been associated with various other narcotics, violence and criminal activities, the risk of which is that our retailers and resellers that transact with cannabis businesses might attract negative publicity. There is also risk that the action(s) of other participants, companies and service providers in the cannabis industry may negatively affect the reputation of the industry as a whole and thereby negatively impact our reputation. The increased use of social media and other web-based tools used to generate, publish and discuss user-generated content and to connect with other users has made it increasingly easier for individuals and groups to communicate and share opinions and views with regard to cannabis companies and their activities, whether true or not and the cannabis industry in general, whether true or not. We do not ultimately have direct control over how the cannabis industry is perceived by others. Reputation loss may result in decreased investor confidence, increased challenges in developing and maintaining community relations and an impediment to our overall ability to advance its business strategy and realize on its growth prospects, thereby having a material adverse impact on our business.
In addition, third parties with whom we may do business could perceive that they are exposed to reputational risk as a result of our retailers’ and resellers’ involvement with cannabis businesses. Failure to establish or maintain business relationships due to reputational risk arising in connection with the nature of our business could have a material adverse effect on our business, financial condition and results of operations.
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.
We sell our products through third party retailers and resellers. 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 United States. In February 2014, the Financial Crimes Enforcement Network 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.
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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. 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 and regulations. Companies that transact directly or indirectly with cannabis businesses are subject to a number of risks related to controlled substances, which risks could reduce demand for our products by Cannabis Industry Participants. Such risks include, but are not limited to, the following:

Cannabis is a Schedule I drug under the CSA and regulated by the Drug Enforcement Administration (the “DEA”) as an illegal substance. The Food and Drug Administration (“FDA”), in conjunction with the DEA, licenses cannabis research and drugs containing active ingredients derived from cannabis. If cannabis were to become legal under federal law, its sale and use could become regulated by the FDA or another federal agency.

If cannabis were to become regulated by the FDA or another federal agency, extensive regulations may be imposed on the sale or use of cannabis. Such regulations could result in a decrease in cannabis sales and have a material adverse impact on the demand for our products. If we or our Cannabis Industry Participants are unable to comply with any applicable regulations and/or registration prescribed by the FDA, we may be unable to continue to transact with retailers and resellers who sell products to cannabis businesses and/or our financial condition may be adversely impacted.

Controlled substance legislation differs between states and legislation in certain states may restrict or limit Cannabis Industry Participants from buying our products. Cannabis Industry Participants may be required to obtain separate state registrations, permits or licenses in order to be able to obtain, handle and/or distribute controlled substances in a state. Such state regulatory requirements may be costly and, the failure of such Cannabis Industry Participants to meet such regulatory requirements could lead to enforcement and sanctions by the states in addition to any from the DEA or otherwise arising under federal law. We could be implicated in such enforcement or sanctions because of the purchase of our products by such Cannabis Industry Participants.

The failure of our Cannabis Industry Participants to comply with applicable controlled substance laws and regulations, or the cost of compliance with these laws and regulations, may adversely affect the demand for our products and, as a result, the financial results of our business operations and our financial condition.
Furthermore, the Encina Credit Facility and the Term Loan Agreement each restrict our ability to sell our products directly to cannabis growers or cultivators, or to sellers or retailers that sell only to the cannabis industry. See “— Risks Relating to Our Indebtedness.
Risks Relating to Other Regulations
The Farm Bill recently passed, yet unanticipated changes in federal and state law related to industrial hemp may impact our business.
We sell products, including hydroponic gardening products, that end users may purchase for use in new and emerging industries, including industrial hemp cultivation. The demand for these products is dependent on the growth of these industries. The hemp market is expected to be one of the fastest growing industries in the U.S. over the next five years. If the U.S. hemp market does not grow as expected, our business, financial condition and results of operations could be adversely impacted.
In December 2018, the Farm Bill (the “Farm Bill”) was signed into law in the U.S. which specifically removed hemp as a restricted commodity under the Controlled Substances Act. The Farm Bill also delegates the authority to the states to regulate and limit the production of hemp and hemp-derived products within their territories. However, the 2018 Farm Bill also explicitly preserved the FDA’s authority to regulate products containing cannabis or cannabis-derived compounds under the Federal Food, Drug, and Cosmetic Act (“FD&C Act”) and section 351 of the Public Health Service Act. In doing so, Congress
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recognized FDA’s important public health role with respect to all the products it regulates. Therefore, because the 2018 Farm Bill did not change FDA’s authorities, cannabis and cannabis-derived products are subject to the same authorities and requirements as FDA-regulated products containing any other substance, regardless of whether the products fall within the definition of  “industrial hemp” under the 2018 Farm Bill. Although many states have adopted laws and regulations that allow for the production and sale of hemp and hemp-derived products under certain circumstances, no assurance can be given that such state laws may not be repealed or amended such that our intended products containing hemp-derived CBD would once again be deemed illegal under the laws of one or more states now permitting such products, which in turn would render such intended products illegal in those states under federal law even if the federal law is unchanged. Furthermore, CBD is not currently permitted by the FDA for use in food and beverages. Evolving federal and state laws and regulations pertaining to the use or cultivation of hemp, as well active enforcement by federal or state authorities of the laws and regulations governing the use and cultivation of hemp may indirectly and adversely affect potential growth of the hemp industry.
Certain state and other regulations pertaining to the use of certain ingredients in growing media and plant nutrients could adversely impact us by restricting our ability to sell such products.
One of our leading product lines is growing media and nutrients products. This product line includes certain products, such as 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 such products that have traditionally been used in the cultivation of our leading products could have an adverse impact on those companies providing us with such regulated products, and as a result, limit our ability to sell these products.
Compliance with, or violation of, environmental, health and safety laws and regulations, including laws pertaining to the use of pesticides, could result in significant costs that adversely impact our reputation, businesses, financial position, results of operations and cash flows.
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 United States, 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 United States. 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 is 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. The costs of compliance, noncompliance, investigation, remediation, combating reputational harm or defending civil or criminal proceedings, products liability, personal injury or other lawsuits could have a material adverse impact on our reputation, businesses, financial position, results of operations and cash flows.
Failure to comply with the United States Foreign Corrupt Practices Act could subject us to penalties and other adverse consequences.
As a Delaware corporation, we are subject to the United States Foreign Corrupt Practices Act, which generally prohibits United States companies from engaging in bribery or other prohibited payments to
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foreign officials for the purpose of obtaining or retaining business. Some foreign companies, including some that may compete with our Company, may not be subject to these prohibitions. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices may occur from time-to-time in countries in which we conduct our business. However, our employees or other agents may engage in conduct for which we might be held responsible. If our employees or other agents are found to have engaged in such practices, we could suffer severe penalties and other consequences that may have a material adverse effect on our business, financial condition and results of operations.
Risks Relating to Our Intellectual Property
Recent laws make it difficult to predict how patents will be issued or enforced in our industry.
Changes in either the patent laws or interpretation of the patent laws in the United States and other countries may have a significant impact on our ability to protect our technology and enforce our intellectual property rights. There have been numerous recent changes to the patent laws and to the rules of the United States Patent and Trademark Office (the “USPTO”), which may have a significant impact on our ability to protect our technology and enforce our intellectual property rights. For example, the Leahy-Smith America Invents Act, which was signed into law in 2011, includes a transition from a “first-to-invent” system to a “first-to-file” system, and changes the way issued patents can be challenged. Certain changes, such as the institution of inter partes review and post-grant and derivation proceedings, came into effect in 2012. Substantive changes to patent law associated with the Leahy-Smith America Invents Act may affect our ability to obtain patents, and, if obtained, to enforce or defend them in litigation or inter partes review, or post-grant or derivation proceedings, all of which could harm our business.
We may not be able to adequately protect our intellectual property and other proprietary rights that are material to our business.
Our ability to compete effectively depends in part on our rights to trademarks, patents and other intellectual property rights we own or license. We have not sought to register every one of our trademarks either in the United States or in every country in which such mark is used. Furthermore, because of the differences in foreign trademark, patent and other intellectual property or proprietary rights laws, we may not receive the same protection in other countries as we would in the United States with respect to the registered brand names and issued patents we hold. If we are unable to protect our intellectual property, proprietary information and/or brand names, we could suffer a material adverse effect on our business, financial condition and results of operations.
Litigation may be necessary to enforce our intellectual property rights and protect our proprietary information, or to defend against claims by third parties that our products or services infringe their intellectual property rights. Any litigation or claims brought by or against us could result in substantial costs and diversion of our resources. A successful claim of trademark, patent or other intellectual property infringement against us, or any other successful challenge to the use of our intellectual property, could subject us to damages or prevent us from providing certain products or services, or using certain of our recognized brand names, which could have a material adverse effect on our business, financial condition and results of operations.
Obtaining and maintaining our patent protection depends on compliance with various procedural, document submissions, fee payment and other requirements imposed by governmental patent agencies, and our patent protection could be reduced or eliminated for noncompliance with these requirements.
Periodic maintenance or annuity fees on any issued patents are due to be paid to the USPTO, and foreign patent agencies in several stages over the lifetime of the patent. The USPTO and various foreign governmental patent agencies require compliance with a number of procedural, documentary, fee payments and other similar provisions during the patent application process. While an inadvertent or unintentional lapse can in many cases be cured by payment of a late fee or by other means in accordance with the applicable rules, there are situations in which noncompliance can result in abandonment or lapse of the patent or patent application, resulting in partial or complete loss of patent rights in the relevant jurisdiction. Noncompliance events that could result in abandonment or lapse of a patent or patent application include, but are not limited to, failure to respond to official actions within prescribed time
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limits, nonpayment of fees and failure to properly legalize and submit formal documents. If we or our licensors fail to maintain the patents and patent applications covering our products, our competitors might be able to enter the market, which would have a material adverse effect on our business.
From time to time, we may need to rely on licenses to proprietary technologies, which may be difficult or expensive to obtain or we may lose certain licenses which may be difficult to replace, harming our competitive position.
We may need to obtain licenses to patents and other proprietary rights held by third parties to develop, manufacture and market our products, if, for example, we sought to develop our products, in conjunction with any patented technology. If we are unable to timely obtain these licenses on commercially reasonable terms and maintain these licenses, our ability to commercially market our products, may be inhibited or prevented, which could have a material adverse effect on our business, results of operations, financial condition and cash flows.
In spite of our best efforts, our licensors might conclude that we have materially breached our license agreements and might therefore terminate the license agreements, thereby removing our ability to develop and commercialize products and technology covered by these license agreements. If these in-licenses are terminated, or if the underlying patents fail to provide the intended exclusivity, competitors may have the freedom to market products identical to ours.
Third parties may initiate legal proceedings alleging that we are infringing their intellectual property rights, the outcome of which would be uncertain and could have a material adverse effect on the success of our business.
Our success depends upon our ability to develop, manufacture, market and sell our products, and to use our proprietary technologies without infringing the proprietary rights of third parties. We may become party to, or threatened with, future adversarial proceedings or litigation regarding intellectual property rights with respect to our products and technology, including interference or derivation proceedings and various other post-grant proceedings before the USPTO and/or non-United States opposition proceedings. Third parties may assert infringement claims against us based on existing patents or patents that may be granted in the future. As a result of any such infringement claims, or to avoid potential claims, we may choose or be compelled to seek intellectual property licenses from third parties. These licenses may not be available on acceptable terms, or at all. Even if we are able to obtain a license, the license would likely obligate us to pay license fees, royalties, minimum royalties and/or milestone payments and the rights granted to us could be nonexclusive, which would mean that our competitors may be able to obtain licenses to the same intellectual property. Ultimately, we could be prevented from commercializing a product and/or technology or be forced to cease some aspect of our business operations if, as a result of actual or threatened infringement claims, we are unable to enter into licenses of the relevant intellectual property on acceptable terms. Further, if we attempt to modify a product and/or technology or to develop alternative methods or products in response to infringement claims or to avoid potential claims, we could incur substantial costs, encounter delays in product introductions or interruptions in sales.
We may be subject to claims that our employees have wrongfully used or disclosed alleged trade secrets of their former employers.
Although we try to ensure that our employees do not use the proprietary information or know-how of others in their work for us, we may be subject to claims that we or these employees have used or disclosed intellectual property, including trade secrets or other proprietary information, of any such employee’s former employer. We are not aware of any threatened or pending claims related to these matters or concerning agreements with our employees, but in the future litigation may be necessary to defend against such claims. If we fail in defending any such claims, in addition to paying monetary damages, we may lose valuable intellectual property rights or personnel. Even if we are successful in defending against such claims, litigation could result in substantial costs and be a distraction to management.
Intellectual property disputes could cause us to spend substantial resources and distract our personnel from their normal responsibilities.
Even if resolved in our favor, litigation or other legal proceedings relating to intellectual property claims may cause us to incur significant expenses, and could distract our personnel from their normal
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responsibilities. In addition, there could be public announcements of the results of hearings, motions or other interim proceedings or developments, and if securities analysts or investors perceive these results to be negative, it could have a substantial adverse effect on the value of our common stock. Such litigation or proceedings could substantially increase our operating losses and reduce the resources available for development activities or any future sales, marketing or distribution activities. We may not have sufficient financial or other resources to adequately conduct such litigation or proceedings. Some of our competitors may be able to sustain the costs of such litigation or proceedings more effectively than we can because of their greater financial resources. Uncertainties resulting from the initiation and continuation of patent litigation or other proceedings could have a material adverse effect on our ability to compete in the marketplace.
Intellectual property rights do not necessarily address all potential threats to our competitive advantage.
The degree of future protection afforded by our intellectual property rights is uncertain because intellectual property rights have limitations, and may not adequately protect our business, or permit us to maintain our competitive advantage. The following examples are illustrative.

Others may be able to construct products that are similar to our products but that are not covered by the claims of the patents that we own or have exclusively licensed;

We or our licensors or strategic collaborators, if any, might not have been the first to make the inventions covered by the issued patent or pending patent application that we own or have exclusively licensed;

We or our licensors or strategic collaborators, if any, might not have been the first to file patent applications covering certain of our inventions;

Others may independently develop similar or alternative technologies or duplicate any of our technologies without infringing our intellectual property rights;

It is possible that our pending patent applications will not lead to issued patents;

Issued patents that we own or have exclusively licensed may not provide us with any competitive advantages, or may be held invalid or unenforceable, as a result of legal challenges by our competitors;

Our competitors might conduct research and development activities in countries where we do not have patent rights and then use the information learned from such activities to develop competitive products for sale in our major commercial markets;

We may not develop additional proprietary technologies that are patentable; and

The patents of others may have an adverse effect on our business.
Should any of these events occur, they could significantly harm our business, results of operations and prospects.
Risks Relating to Our Common Stock
We may issue capital stock that ranks senior or equally to our common stock as to liquidation preference and other rights and which may dilute our stockholders’ ownership interest.
Our amended and restated certificate of incorporation (the “Certificate of Incorporation”) does not prohibit us from issuing any series of preferred stock that would rank senior or equally to our common stock as to dividend payments and liquidation preference. Our Certificate of Incorporation allows for our board of directors to create new series of preferred stock without further approval by our stockholders, which could adversely affect the rights of the holders of our common stock. We have the authority to issue up to 50,000,000 shares of our preferred stock without further stockholder approval. The issuances of any series of preferred stock could have the effect of reducing the amounts available to our holders of common stock in the event of our liquidation. In addition, if we issue preferred stock with voting rights that dilute the voting power of our common stock, the market price of our common stock could decrease. Additional
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issuances and sales of preferred stock, or the perception that such issuances and sales could occur, may cause prevailing market prices for our common stock to decline and may adversely affect our ability to raise additional capital in the financial markets at times and prices favorable to us. In addition, any additional capital raised through the sale of equity or equity-backed securities may dilute our stockholders’ ownership percentages and could also result in a decrease in the market value of our common stock.
Provisions in our corporate charter documents and under Delaware law could make an acquisition of our company, which may be beneficial to our stockholders, more difficult and may prevent attempts by our stockholders to replace or remove our current management.
These provisions might discourage, delay or prevent a change in control of our company or a change in our management. The existence of these provisions could adversely affect the voting power of holders of common stock and limit the price that investors might be willing to pay in the future for shares of our common stock. Furthermore, we have the authority to issue up to 50,000,000 shares of our preferred stock without further stockholder approval, the rights of which will be determined at the discretion of the board of directors and that, if issued, could operate as a “poison pill” to dilute the stock ownership of a potential hostile acquirer to prevent an acquisition that our board of directors does not approve. In addition, Certificate of Incorporation and amended and restated bylaws (the “Bylaws”) contain provisions that may make the acquisition of our company more difficult, including the following:

Our authorized but unissued and unreserved common stock and preferred stock could make more difficult or discourage an attempt to obtain control of us by means of a proxy contest, tender offer, merger or otherwise;

our stockholders will only be able to take action at a meeting of stockholders and will not be able to take action by written consent for any matter, except in certain circumstances;

a special meeting of our stockholders may only be called by the chairperson of our board of directors or a majority of our board of directors;

advance notice procedures apply for stockholders to nominate candidates for election as directors or to bring matters before an annual meeting of stockholders; and

any amendments to our Certificate of Incorporation and Bylaws will require the approval of at least two-thirds of our then-outstanding voting power.
Delaware law contains anti-takeover provisions that could deter takeover attempts that could be beneficial to our stockholders.
Provisions of Delaware law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. Section 203 of the Delaware General Corporation Law may make the acquisition of our company and the removal of incumbent officers and directors more difficult by prohibiting stockholders holding 15% or more of our outstanding voting stock from acquiring us, without our the consent of our board of directors, for at least three years from the date they first hold 15% or more of the voting stock.
Various provisions of our lending agreements with Encina and Brightwood, in addition to our Certificate of Incorporation, amended and restated Bylaws and other corporate documents, could delay or prevent a change of control.
The Encina Credit Facility and the Term Loan Agreement each prohibit us from undergoing a change of control. Any takeover attempt could be delayed, or prevented, if an amendment or waiver is not provided by the respective lenders. See “— Risks Relating to Our Indebtedness” and “Description of Our Indebtedness.” Moreover, certain provisions of our Certificate of Incorporation and Bylaws and provisions of Delaware corporation law could delay or prevent a change of control or may impede the ability of the holders of our common stock to change our management. In particular, our Certificate of Incorporation and Bylaws, among other things will regulate how shareholders may present proposals or nominate directors for election at shareholders’ meetings and authorize our board of directors to issue preferred stock in one or more series, without shareholder approval. See “Description of Capital Stock — Anti-Takeover Provisions.
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We are a holding company and rely on dividends and other payments, advances and transfers of funds from our subsidiaries to meet our obligations and pay dividends, if any, and we may never pay any dividends to the holders of our common stock and capital appreciation, if any, of our common stock may be your sole source of gain on your investment.
We have no direct operations and no significant assets other than the ownership of capital stock and equity interests of our subsidiaries. Because we conduct our operations through our subsidiaries, we depend on those entities for dividends and other payments to generate the funds necessary to meet our financial obligations. Legal and contractual restrictions in our credit facility and other agreements which may govern future indebtedness of our subsidiaries, as well as the financial condition and operating requirements of our subsidiaries, may limit our ability to obtain cash from our subsidiaries. The earnings from, or other available assets of, our subsidiaries might not be sufficient to pay dividends or make distributions or loans to enable us to pay any dividends on our common stock or other obligations. Any of the foregoing could materially and adversely affect our business, financial condition, results of operations and cash flows. In addition, our ability to pay dividends is restricted by the terms of the Encina Credit Facility and the Term Loan Agreement and, in addition, future debt financing, if any, may contain terms prohibiting or limiting the amount of dividends that may be declared or paid on our securities.
We currently intend to retain any future earnings for use in the operation and expansion of our business. Accordingly, we do not expect to pay any dividends to holders of our common stock in the foreseeable future, but will review this policy as circumstances dictate. The declaration and payment of all future dividends to holders of our common stock, if any, will be at the sole discretion of our board of directors, which retains the right to change our dividend policy at any time. In addition, our ability to pay dividends is restricted by the terms of the Encina Credit Facility and the Term Loan Agreement and, in addition, future debt financing, if any, may contain terms prohibiting or limiting the amount of dividends that may be declared or paid on our securities. Consequently, capital appreciation, if any, of our common stock may be your sole source of gain on your investment for the foreseeable future.
Our majority stockholders will control our Company for the foreseeable future, including the outcome of matters requiring stockholder approval.
Our officers and directors and their affiliates collectively own approximately     % of our outstanding shares of common stock and will own            of our outstanding shares of common stock after the consummation of the offering contemplated hereby. Accordingly, if these shareholders were to choose to act together, they could have a significant influence over all matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions, such as a merger or other sale of our company or all or a significant percentage of our assets. This concentration of ownership could limit your ability to influence corporate matters and may have the effect of delaying or preventing a third party from acquiring control over us.
We cannot assure you that the interests of our management and affiliated persons will coincide with the interests of the investors. So long as our management and affiliated persons collectively controls a significant portion of our common stock, these individuals and/or entities controlled by them, will continue to collectively be able to strongly influence or effectively control our decisions. Further, the Sponsors (as defined herein) have the right to nominate seven members to our board of directors. Therefore, you should not invest in reliance on your ability to have any control over our company. See “Principal Stockholders,” “Certain Relationships and Related Party Transactions” and “Description of Capital Stock.
We have broad discretion in how we use our cash, cash equivalents and marketable securities and may not use these financial resources effectively, which could affect our results of operations and cause our stock price to decline.
Our management has considerable discretion in the application of our cash, cash equivalents and marketable securities. We intend to use the proceeds of this offering to repay existing indebtedness, for acquisitions, for working capital and other general corporate purposes, which may include the hiring of additional personnel and capital expenditures. As a result, investors will be relying upon management’s judgment with only limited information about our specific intentions for these proceeds. We may use the
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cash, cash equivalents and marketable securities for purposes that do not yield a significant return or any return at all for our stockholders. In addition, pending their use, we may invest the financial resources from our securities offerings in a manner that does not produce income or that loses value.
We have broad discretion in the use of the net proceeds from this offering and may not use them effectively.
We intend to allocate the net proceeds from this offering to our different areas of activity. Our management may not apply the net proceeds in ways that ultimately increase the value of your investment in our common stock. They will have broad discretion in the application of the use of proceeds from this offering, and you will be relying on the judgment of our management regarding the application of these proceeds. If we do not invest or apply the net proceeds from this offering in ways that enhance shareholder value, we may fail to achieve expected financial results, which could cause the price of our common stock to decline.
The trading price of our common stock may be volatile, and you could lose all or part of your investment.
Prior to this offering, there has been no public market for shares of our common stock. The initial public offering price of our common stock will be determined through negotiation among us and the underwriters. This price does not necessarily reflect the price at which investors in the market will be willing to buy and sell shares of our common stock following this offering. In addition, the trading price of our common stock following this offering is likely to be volatile and could be subject to fluctuations in response to various factors, some of which are beyond our control. These fluctuations could cause you to lose all or part of your investment in our common stock since you might be unable to sell your shares at or above the price you paid in this offering. Factors that could cause fluctuations in the trading price of our common stock include the following:

price and volume fluctuations in the overall stock market from time to time;

volatility in the trading prices and trading volumes of stocks in our industry;

changes in operating performance and stock market valuations of other companies generally, or those in our industry in particular;

sales of shares of our common stock by us or our stockholders;

failure of securities analysts to maintain coverage of us, changes in financial estimates by securities analysts who follow our company or our failure to meet these estimates or the expectations of investors;

the financial projections we may provide to the public, any changes in those projections or our failure to meet those projections;

announcements by us or our competitors of new offerings or platform features;

the public’s reaction to our press releases, other public announcements and filings with the SEC;

rumors and market speculation involving us or other companies in our industry;

actual or anticipated changes in our results of operations or fluctuations in our results of operations;

actual or anticipated developments in our business, our competitors’ businesses or the competitive landscape generally;

litigation involving us, our industry or both, or investigations by regulators into our operations or those of our competitors;

developments or disputes concerning our intellectual property or other proprietary rights;

announced or completed acquisitions of businesses, services or technologies by us or our competitors;

new laws or regulations or new interpretations of existing laws or regulations applicable to our business;
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changes in accounting standards, policies, guidelines, interpretations or principles;

any significant change in our management; and

general economic conditions and slow or negative growth of our markets.
In addition, in the past, following periods of volatility in the overall market and the market price of a particular company’s securities, securities class action litigation has often been instituted against these companies. This litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.
We are an emerging growth company, and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors.
As an emerging growth company, as defined in the JOBS Act, we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies including, but not limited to, not being required to obtain an assessment of the effectiveness of our internal controls over financial reporting from our independent registered public accounting firm pursuant to Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. To the extent we avail ourselves of these exemptions, our financial statements may not be comparable to companies that comply with such new or revised accounting standards. We cannot predict if investors will find our common stock less attractive because we will rely on these.
Our Certificate of Incorporation provides that the doctrine of  “corporate opportunity” will not apply with respect to any director or stockholder who is not employed by us or our affiliates.
The doctrine of corporate opportunity generally provides that a corporate fiduciary may not develop an opportunity using corporate resources, acquire an interest adverse to that of the corporation or acquire property that is reasonably incident to the present or prospective business of the corporation or in which the corporation has a present or expectancy interest, unless that opportunity is first presented to the corporation and the corporation chooses not to pursue that opportunity. The doctrine of corporate opportunity is intended to preclude officers or directors or other fiduciaries from personally benefiting from opportunities that belong to the corporation. Our Certificate of Incorporation provides that the doctrine of “corporate opportunity” does not apply with respect to any director or stockholder who is not employed by us or our affiliates. Any director or stockholder who is not employed by us or our affiliates will therefore have no duty to communicate or present corporate opportunities to us, and will have the right to either hold any corporate opportunity for their (and their affiliates’) own account and benefit or to recommend, assign or otherwise transfer such corporate opportunity to persons other than us, including to any director or stockholder who is not employed by us or our affiliates.
As a result, certain of our stockholders, directors and their respective affiliates will not be prohibited from operating or investing in competing businesses. We therefore may find ourselves in competition with certain of our stockholders, directors or their respective affiliates, and we may not have knowledge of, or be able to pursue, transactions that could potentially be beneficial to us. Accordingly, we may lose a corporate opportunity or suffer competitive harm, which could negatively impact our business or prospects.
Our security holders may be diluted by future issuances of securities by us.
In the future, we may issue our authorized but previously unissued equity securities, including additional shares of capital stock or securities convertible into or exchangeable for our capital stock. Such issuance of additional securities would dilute the ownership stake of the Company held by our existing stockholders and could adversely affect the value of our securities.
We may also issue additional shares of our common stock, warrants or other securities that are convertible into or exercisable for the purchase of shares of our common stock in connection with hiring and/or retaining employees or consultants, future acquisitions, future sales of our securities for capital
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raising purposes, or for other business purposes. The future issuance of any such additional shares of our common stock or other securities, for any reason including those stated above, may have a negative impact on the market price of our common stock. There can be no assurance that the issuance of any additional shares of common stock, warrants or other convertible securities may not be at a price (or exercise prices) below the price of the common stock offered hereby.
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements. You can generally identify forward-looking statements by our use of forward-looking terminology such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “potential,” “predict,” “seek,” “will” or “should,” or the negative thereof or other variations thereon or comparable terminology. In particular, statements about the markets in which we operate, including growth of our various markets, and statements about our expectations, beliefs, plans, strategies, objectives, prospects, assumptions or future events or performance contained in this prospectus under the headings “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Business” are forward-looking statements.
We have based these forward-looking statements on our current expectations, assumptions, estimates and projections. While we believe these expectations, assumptions, estimates and projections are reasonable, such forward-looking statements are only predictions and involve known and unknown risks and uncertainties, many of which are beyond our control. These and other important factors, including those discussed in this prospectus under the headings “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Business,” may cause our actual results, levels of activity, performance or events and circumstances to differ materially from any future results, levels of activity, performance or events and circumstances expressed or implied by these forward-looking statements. Some of the factors that could cause actual results to differ materially from those expressed or implied by the forward-looking statements include:

general economic and financial conditions, specifically in the United States and Canada;

federal and state legislation and regulations pertaining to the use and cultivation of cannabis in the United States, and such laws and regulations in Canada;

the costs of being a public company;

our ability to keep pace with technological advances;

our ability to successfully identify appropriate acquisition targets, successfully acquire identified targets or successfully integrate the business of acquired companies;

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;

our ability to obtain and maintain protection for our intellectual property;

our ability to protect and defend against litigation, including intellectual property claims;

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.”
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Moreover, we operate in a highly competitive and rapidly changing environment. New risks emerge from time to time and it is not possible for us to predict all risk factors, nor can we address the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause our actual results to differ materially from those contained in any forward-looking statements.
You should not rely upon forward-looking statements as predictions of future events. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee that the future results, levels of activity, performance or events and circumstances reflected in the forward-looking statements will be achieved or occur. We undertake no obligation to update publicly any forward-looking statements for any reason after the date of this prospectus to conform these statements to new information, actual results or to changes in our expectations, except as required by law.
You should read this prospectus and the documents that we reference in this prospectus and have filed with the SEC, as exhibits to the registration statement of which this prospectus is a part with the understanding that our actual future results, levels of activity, performance, and events and circumstances may be materially different from what we expect.
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USE OF PROCEEDS
We estimate that the net proceeds from the sale of shares of common stock in this offering will be approximately $     million, based on an assumed initial public offering price of  $     per share, which is the midpoint of the estimated price range set forth on the cover of this prospectus, and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us. If the underwriters exercise their over-allotment option in full, we estimate that our net proceeds will be $     million based on an assumed initial public offering price of  $     per share, which is the midpoint of the estimated price range set forth on the cover of this prospectus, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us.
The principal purposes of this offering are to repay existing indebtedness, for acquisitions, for working capital and other general corporate purposes, which may include the hiring of additional personnel and capital expenditures, to establish a public market for our common stock and to facilitate our future access to the public capital markets.
The expected use of the net proceeds from this offering represents our intentions based upon our current plans and business conditions, which could change in the future as our plans and business conditions evolve. As a result, our management will have broad discretion over the use of the net proceeds from this offering. The amounts and timing of our expenditures will depend upon numerous factors.
Each $1.00 increase (decrease) in the assumed initial public offering price of  $     per share, which is the midpoint of the estimated price range set forth on the cover of this prospectus, would increase (decrease) the net proceeds to us from this offering by approximately $     million, assuming the number of shares offered by us, as set forth on the cover of this prospectus, remains the same and after deducting underwriting discounts and commissions and estimated offering expenses payable by us. We may also increase or decrease the number of shares we are offering. An increase of 1.0 million shares in the number of shares offered by us, together with a concurrent $1.00 increase in the assumed initial public offering price of  $     per share, which is the midpoint of the estimated price range set forth on the cover of this prospectus, would increase the net proceeds to us from this offering by approximately $     million after deducting underwriting discounts and commissions and estimated offering expenses payable by us. Conversely, a decrease of 1.0 million shares in the number of shares offered by us together with a concurrent $1.00 decrease in the assumed initial public offering price of  $     per share, which is the midpoint of the estimated price range set forth on the cover of this prospectus, would decrease the net proceeds to us from this offering by approximately $     million after deducting underwriting discounts and commissions and estimated offering expenses payable by us. The as adjusted information discussed above is illustrative only and will adjust based on the actual initial public offering price and other terms of this offering determined at pricing.
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DIVIDEND POLICY
We have no direct operations and no significant assets other than ownership of capital stock and equity interests of our subsidiaries. Because we conduct its operations through our subsidiaries, we depend on our subsidiaries for dividends and other payments to generate the funds necessary to meet our financial obligations. Legal and contractual restrictions in our credit facility and other agreements which may govern future indebtedness of our subsidiaries, as well as the financial condition and operating requirements of our subsidiaries, may limit our ability to obtain cash from our subsidiaries. The earnings from, or other available assets of, our subsidiaries might not be sufficient to pay dividends or make distributions or loans to enable us to pay any dividends on our common stock or other obligations.
We have never declared nor paid any cash dividends to stockholders. Except as described herein, we currently intend to retain any future earnings for use in the operation and expansion of our business. Accordingly, we do not expect to pay any dividends to holders of our common stock in the foreseeable future, but will review this policy as circumstances dictate. The declaration and payment of all future dividends to holders of our common stock, if any, will be at the sole discretion of our board of directors, which retains the right to change our dividend policy at any time. In addition, our ability to pay dividends is currently restricted by the terms of the Encina Credit Facility and the Term Loan Agreement and, in addition, future debt or other financings, if any, may contain terms prohibiting or limiting the amount of dividends that may be declared or paid on our securities.
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CAPITALIZATION
The following table sets forth cash and cash equivalents, as well as our capitalization, as of December 31, 2018 as follows:

on an actual basis; and

on a pro forma as adjusted basis giving further effect to the sale by us of            shares of common stock in this offering at an assumed initial public offering price of  $     per share, which is the midpoint of the estimated price range set forth on the cover of this prospectus, and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.
The pro forma as adjusted information set forth in the table below is illustrative only and will be adjusted based on the actual initial public offering price and other terms of this offering determined at pricing. You should read this table together with our consolidated financial statements and related notes, and the sections titled “Selected Consolidated Financial and Other Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” that are included elsewhere in this prospectus.
As of December 31, 2018
Actual
Pro
forma
Pro
forma as
adjusted(1)
(in thousands, except for share and per share data)
Cash and cash equivalents
$ 27,923 $        $       
Total debt, net
100,520
Shareholders’ equity (deficit):
Preferred stock, par value $0.0001 per share: 50,000,000 shares
authorized, no shares issued and outstanding
Common stock, par value $0.0001 per share; 300,000,000
shares authorized, 69,745,562 shares issued and outstanding,
actual
7
Additional paid-in capital
155,966
Accumulated other comprehensive (loss) income
(1,853)
Accumulated deficit
(106,335)
Total shareholders’ equity (deficit)
47,785
Total capitalization
$ 148,305 $ $
(1)
Each $1.00 increase or decrease in the assumed initial public offering price of  $     per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus, would increase or decrease the amount of our pro forma as adjusted cash and cash equivalents, additional paid-in capital, total stockholders’ equity and total capitalization by $          , assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions payable by us. An increase or decrease of 1.0 million shares in the number of shares offered by us would increase or decrease, as applicable, the amount of our pro forma as adjusted cash and cash equivalents, additional paid-in capital, total stockholders’ equity and total capitalization by $          , assuming the assumed initial public offering price remains the same, and after deducting estimated underwriting discounts and commissions payable by us.
If the underwriters’ option to purchase additional shares of our common stock from us were exercised in full, pro forma as adjusted cash and cash equivalents, additional paid-in capital, total stockholders’ equity, total capitalization and shares outstanding as of December 31, 2018 would be $          , $          , $          , $           and           , respectively.
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The pro forma and pro forma as adjusted columns in the table above are based on 69,745,562 shares of our common stock outstanding as of December 31, 2018, (after giving effect to our 2018 Equity Incentive Plan), and excludes:

13,100,069 shares of common stock issuable upon exercise of outstanding warrants to purchase our common stock at weighted average exercise price of  $4.78 per share;

8,718,195 shares of common stock reserved for future issuance under our 2018 Equity Incentive Plan; and

no exercise by the underwriters of their option to purchase up to an additional            shares of our common stock from us.
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DILUTION
If you invest in our common stock in this offering, your ownership interest will be diluted immediately to the extent of the difference between the initial public offering price per share of our common stock in this offering and the pro forma as adjusted net tangible book value (deficit) per share of our common stock immediately after this offering.
As of December 31, 2018, our historical net tangible book deficit was $(20.6) million, or $(0.30) per share of common stock, based on 69,745,562 shares of our common stock outstanding. Our historical net tangible book deficit per share is equal to our total tangible assets, less total liabilities, divided by the number of outstanding shares of our common stock, assuming such conversion, as of December 31, 2018.
After giving further effect to the sale of             shares of common stock in this offering at the assumed initial public offering price of  $     per share, the midpoint of the price range set forth on the cover page of this prospectus, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value as of December 31, 2018, would have been approximately $     million, or approximately $     per share. This amount represents an immediate increase in pro forma net tangible book value of  $     per share to our existing stockholders and an immediate dilution in pro forma net tangible book value of approximately $     per share to new investors purchasing shares of common stock in this offering and the concurrent private placement.
Dilution per share to new investors is determined by subtracting pro forma as adjusted net tangible book value per share after this offering from the initial public offering price per share paid by new investors. The following table illustrates this dilution (without giving effect to any exercise by the underwriters of their option to purchase additional shares):
Assumed initial public offering price per share
$     
Historical net tangible book deficit per share as of December 31, 2018
$ (0.15)
Increase per share attributable to the pro forma adjustments described above
Pro forma net tangible book value per share as of December 31, 2018
Increase in pro forma net tangible book value per share attributable to new investors participating in this offering
Pro forma as adjusted net tangible book value per share after this offering
Dilution per share to new investors participating in this offering
$
The dilution information discussed above is illustrative only and will be adjusted based on the actual initial public offering price and other terms of this offering determined at pricing. Each $1.00 increase (decrease) in the assumed initial public offering price of  $     per share would increase (decrease) our pro forma as adjusted net tangible book value by $     per share and the dilution to new investors by $     per share, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. We may also increase or decrease the number of shares we are offering. An increase of 1.0 million shares in the number of shares offered by us would increase the pro forma as adjusted net tangible book value by $     per share and decrease the dilution to new investors by $     per share, assuming the assumed initial public offering price of  $     per share remains the same and after deducting the estimated underwriting discounts and commissions and estimated expenses payable by us. Similarly, each decrease of 1.0 million shares offered by us would decrease the pro forma as adjusted net tangible book value by $     per share and increase the dilution to new investors by $     per share, assuming the assumed initial public offering price of  $     per share remains the same and after deducting the estimated underwriting discounts and commissions and estimated expenses payable by us.
If the underwriters exercise their option to purchase      additional shares of our common stock in full in this offering, the pro forma as adjusted net tangible book value after the offering would be $     per share, the increase in pro forma net tangible book value per share to existing stockholders would be $     per share and the dilution per share to new investors would be $     per share, in each case assuming an initial public offering price of  $     per share.
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The following table summarizes as of December 31, 2018, on the pro forma as adjusted basis as described above, the differences between the number of shares of common stock purchased from us, the total consideration and the weighted-average price per share paid by existing stockholders (assuming an initial public offering price of  $     per share, which is the midpoint of the price range set forth on the cover page of this prospectus, and by investors participating in this offering, after deducting the estimated underwriting discounts and commissions and estimated offering expenses, at an assumed initial public offering price of  $     per share, the midpoint of the price range set forth on the cover page of this prospectus).
Shares Purchased
Total Consideration
Weighted-Average
Price Per
Share
Number
Percent
Amount
Percent
Existing stockholders
          ​
    % $                % $     
New public investors
Total
100% $ 100%
The table above assumes no exercise of the underwriters’ option to purchase            additional shares in this offering. If the underwriters exercise their option to purchase additional shares in full, the number of shares of our common stock held by existing stockholders would be reduced to     % of the total number of shares of our common stock outstanding after this offering and the concurrent private placement, and the number of shares of common stock held by new investors participating in the offering would be increased to     % of the total number of shares of our common stock outstanding after this offering and the concurrent private placement.
The foregoing tables and calculations (other than historical net tangible book value calculation) are based on 69,745,562 shares of common stock outstanding as of December 31, 2018, and exclude 13,100,069 shares of common stock issuable upon exercise of outstanding warrants to purchase our common stock at weighted average exercise price of  $4.78 per share.
To the extent that any options are exercised or other securities are issued under our equity incentive plans, or we issue additional shares of common stock in the future, there will be further dilution to investors participating in this offering.
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UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION
The unaudited pro forma combined financial information presented below has been derived from our historical consolidated financial statements appearing elsewhere in this prospectus, and gives effect to the following transactions (collectively, the “Pro Forma Transactions”):

Acquisition of the Predecessor on May 12, 2017;

Exchange of newly issued shares in the Company for the non-controlling interest which occurred in the fall of 2018;

Deconsolidation of McDowell Group LLC (“McDowell”), a variable interest entity in which the Predecessor was the primary beneficiary until the Formation Transaction when the Company was no longer deemed to be the primary beneficiary.
The unaudited pro forma combined financial information for the year ended December 31, 2017 gives effect to the Pro Forma Transactions as if they occurred on January 1, 2017.
The historical financial statements have been adjusted in the unaudited pro forma combined financial information to give effect to pro forma events that are (i) directly attributable to the Transactions; (ii) factually supportable; and (iii) with respect to the unaudited pro forma combined financial information, expected to have a continuing impact on the combined results. The unaudited pro forma combined financial information of the Successor and the Predecessor were obtained from audited information prepared in conformity with U.S. GAAP. The unaudited pro forma combined financial information is provided for informational and illustrative purposes only and does not purport to represent what the actual consolidated results of operations or the consolidated financial position of the Company would have been had the Transactions occurred on the dates assumed, nor is it necessarily indicative of future consolidated results of operations or consolidated financial position. The unaudited pro forma combined financial information is based on the assumptions, adjustments and eliminations described in the accompanying notes thereto. The unaudited pro forma combined financial information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited financial statements and related notes contained elsewhere in this prospectus.
The unaudited pro forma combined financial information is presented in accordance with the rules specified by Article 11 of Regulation S-X promulgated by the SEC using the acquisition method of accounting with the Successor as the acquirer of the Predecessor for accounting purposes using the assumptions described in the notes thereto.
For the purposes of computing depreciation and amortization, the consideration paid in the acquisition was allocated to assets acquired and liabilities assumed based upon their estimated fair values as of May 12, 2017. The amount of consideration in excess of the net assets acquired was recorded as goodwill which is not amortized.
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Successor
May 12, 2017 to
December 31, 2017
Predecessor
January 1, 2017 to
May 11, 2017
Pro Forma
Adjustments
Pro Forma
Year ended
December 31, 2017
(In Thousands, except for shares and per share data)
Net sales
$ 151,525 $ 108,221 $ $ 259,746
Cost of goods sold
141,119 86,925 228,044
Gross profit
10,406 21,296 31,702
Operating expenses:
Salaries and benefits
8,679 4,630 13,309
Marketing expense
2,274 695(1) 2,969
General and administrative expenses
11,487 5,513 (799)(1)(2) 16,201
ESOP
30,327 (30,327)(3)
Impairment charges
45,425 45,425
Depreciation and amortization
3,769 428 1,639(2)(4) 5,836
Interest expense
5,643 547 1,739(2)(5) 7,929
Other expense, net
4,305 (371) 762(2)(6) 4,696
Total expenses
81,582 41,074 (26,291) 96,365
Net (loss) income before tax
(71,176) (19,778) 26,291 (64,663)
Income tax benefit (expense)
266 (85) 1(2) 182
Net (loss) income
$ (70,910) $ (19,863) $ 26,292 $ (64,481)
Basic and diluted net loss per common share
$ (1.65) $ (1.50)
Shares used to compute net loss per common share
43,031,327
43,031,327
(1)
Reclassifies $695 of marketing expenses of the Predecessor from general and administrative expense to conform to the Company’s current presentation.
(2)
Deconsolidates the income and expenses of McDowell, a variable interest entity in which the Predecessor was the primary beneficiary until the Formation Transaction (when the debt guarantee giving rise to the assessment that the Predecessor was the primary beneficiary was settled) as if it were deconsolidated as of January 1, 2017.
(3)
Eliminates the expense associated with unallocated shares/units of the Predecessor held by the employee stock option plan which were redeemed as part of the Formation Transaction as if redemption by the Predecessor occurred as of January 1, 2017.
(4)
Provides estimates for depreciation and amortization on the new basis of property, plant and equipment ($13,220), software ($6,204) and customer relationships ($59,376) acquired by the Company in the Formation Transaction for the period from January 1, 2017 to May 11, 2017 as if the acquisition and step-up to fair value occurred as of January 1, 2017. For the purposes of computing depreciation and amortization, the consideration paid in the acquisition was allocated to assets acquired and liabilities assumed based upon their estimated fair values as of May 12, 2017. The amount of consideration in excess of the net assets acquired was recorded as goodwill which is not amortized.
(5)
Adjusts interest expense by $1,919 for the period January 1, 2017 to May 11, 2017 for a reduction in cost related to interest bearing debt of the Predecessor settled in the Formation Transaction and an estimated increase in costs related to the new term loan and credit facility as if the Formation Transaction occurred as of January 1, 2017. Interest on the term loan assumes that the quarterly interest payments were made during the period with interest on the monthly balance at the LIBOR one month average for 2017 plus the margin for a total rate of 8.68%; interest on the credit facility was based on the actual average balance of  $21,559 on the line of credit of Predecessor at January 1, 2017
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and May 11, 2017 with interest based on the effective rate for the period of 3.15%. For the purpose of this pro forma presentation, it has been assumed that the Company would have been in compliance with debt covenants during 2017 so no default rate has been added to interest. If default had been assumed, a 3.00% and 2.00% margin would have been added to the term loan and the credit facility, respectively; total pro forma interest expense would be $10,916 under that assumption.
(6)
Eliminates the mark-to-market adjustment of  $130 for the swap fair value for the period from January 1, 2017 to May 11, 2017 as if the swap, which was settled in the Formation Transaction, were settled as of January 1, 2017.
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SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
The following table presents our selected consolidated financial and other data for the periods and as of the dates indicated. The periods prior to and including May 11, 2017 includes Hydrofarm, Inc. and its subsidiaries and are referred to in the following table as “Predecessor,” and all periods after May 11, 2017 include Hydrofarm Investment Corp. and its subsidiaries, which recapitalized to Hydrofarm Holdings Group, Inc. in August 2018, and are referred to in the following table as “Successor.” The selected consolidated financial data as of December 31, 2016, for the period from January 1, 2017 through May 11, 2017, the period from commencement of operations (May 12, 2017) through December 31, 2017 and the year ended December 31, 2018, has been derived from the audited consolidated financial statements included elsewhere in this prospectus. The selected consolidated financial data for the year ended December 31, 2016 has been derived from the Predecessor’s audited consolidated financial statements, which are not included in this prospectus. The Predecessor and Successor financial data have been prepared on different accounting bases and therefore the sum of the data for the two reporting periods should not be used as an indicator of our full year performance. Our historical results are not necessarily indicative of the results that may be expected in the future, and our interim results are not necessarily indicative of the results to be expected for the full year or any other period.You should read the following financial information together with the information under “Capitalization,” “Selected Consolidated Financial and Other Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes included elsewhere in this prospectus.
The unaudited pro forma combined financial information for the year ended December 31, 2017 is derived from the “Unaudited Pro Forma Combined Financial Information” in this prospectus and is included for informational purposes only and does not purport to reflect the results of operations of Hydrofarm Holdings Group, Inc. that would have occurred had the Formation Transaction occurred on January 1, 2017. The unaudited pro forma combined financial information for the year ended December 31, 2017 (as more fully described in the “Unaudited Pro Forma Combined Financial Information”) contains a variety of adjustments, assumptions and estimates, is subject to numerous other uncertainties and the assumptions and adjustments as described in the notes accompanying the unaudited pro forma combined consolidated financial information included elsewhere in this prospectus and should not be relied upon as being indicative of our results of operations had the Formation Transaction occurred on the dates assumed.
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Successor
Predecessor
Pro Forma(1)
Predecessor
Year ended
December 31,
2018
Period from
May 12,
2017 to
December 31,
2017
Period from
January 1,
2017 to
May 11,
2017
Year ended
December 31,
2017
Year ended
December 31,
2016
(In Thousands, except share, per share and percentage information)
Operations Data
Net sales
$ 212,464 $ 151,525 $ 108,221 $ 259,746 $ 273,482
Cost of goods sold(2)
183,690 141,119 86,925 228,044 221,595
Gross profit
28,774 10,406 21,296 31,702 51,887
Operating expenses:
General and administrative expenses
18,668 11,487 4,818 16,201 12,008
Salaries and benefits(3)
16,463 8,679 4,630 13,309 11,588
Marketing expense(3)
2,584 2,274 695 2,969 3,149
Employee stock ownership plan charges(4)
30,327 6,480
Impairment charges(5)
3,244 45,425 45,425
Depreciation and amortization
7,170 3,769 428 5,836 1,237
Interest expense
11,606 5,643 547 7,929 1,134
Other expense (income)
4,238 4,305 (371) 4,696 (402)
Net (loss) income before tax
(35,199) (71,176) (19,778) (64,663) 16,693
Income tax (expense) benefit
(102) 266 (85) 182 (144)
Net (loss) income
$ (35,301) $ (70,910) $ (19,863) $ (64,481) $ 16,549
Basic and diluted net loss per common share
$ (0.68) $ (1.65) $ (1.50)
Weighted average shares outstanding(6)
51,883,059 43,031,327 43,031,327
Cash flow data
Net cash provided by (used in) operating activities
$ 4,303 $ (13,390) $ 10,069 $ 8,664
Net cash used in investing activities
(3,178) (207,877) (1,586) (6,070)
Net cash provided by (used in) financing activities
25,516 222,165 511 (2,049)
Balance sheet data
Cash and cash equivalents
$ 27,923 $ 2,206 $ 9,488 $ 689
Net working capital, excluding certain debt(7)
76,891 71,149 61,579 53,080
Total assets
175,532 189,510 119,457 100,253
Total liabilities
127,747 156,219 74,431 59,227
Total stockholders’ equity
47,785 33,291 45,026 41,026
Other financial data
Adjusted EBITDA(8)
$ (8,143) $ (503) $ 10,866 $ 10,363 $ 24,045
Adjusted EBITDA margin(9)
(3.8%) (0.3%) 10.0% 4.0% 8.8%
Capital expenditures(10)
1,715 2,403 1,586 3,989 959
(1)
The summary pro forma financial data was derived from our unaudited pro forma combined financial information for the year ended December 31, 2017 after giving pro forma effect to the Formation
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Transaction described above as if such transaction had occurred on January 1, 2017, and to several other transactions as if such transactions (excluding the Canadian Acquisitions) had occurred on January 1, 2017. The pro forma adjustments are based on available information and upon assumptions that our management believes are reasonable in order to reflect, on a pro forma basis, the impact of these transactions on the historical financial information of the Successor for 2017.
The unaudited pro forma combined financial information should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Risk Factors,” the historical audited consolidated financial statements and related notes, and the pro forma combined financial information and related notes, all included elsewhere in this prospectus. In addition, see “Unaudited Pro Forma Combined Financial Information” elsewhere in the prospectus for additional information on the pro forma adjustments made.
(2)
Costs of goods sold is exclusive of depreciation and amortization, which is presented separately. Also, costs of goods sold includes amortization of the step-up in basis recorded for inventory acquired in business acquisitions of  $798 for 2018 and $11,531 for 2017.
(3)
Marketing expense presented in this table reflects $695 reclassified from the amount reported in our Predecessor’s audited financial statement of operations for marketing, general and administrative expense of  $5,513 to conform to the presentation used by the Successor.
(4)
Our Predecessor utilized an Employee Stock Ownership Plan as part of its benefit to employees. In anticipation of the Formation Transaction, the ESOP Trustee caused the ESOP to fully repay the outstanding balance on the exempt loan to the ESOP which caused the remaining 77,968 unallocated units to be released from suspense resulting in the units being earned and committed-to-be released (similar to vesting). The Predecessor then terminated the ESOP. The expense in 2017 reflects the fair value of the 77,968 units which is the measurement and recognition required by U.S. GAAP.
(5)
Impairment charges in 2018 resulted from impairment to goodwill that was initially stepped up to fair value in the Canadian Acquisitions, and impairment charges in the period from commencement of operations (May 12, 2017) to December 31, 2017 resulted from impairment to goodwill and trademarks that were initially stepped up to fair value in the Formation Transaction. See Footnote 11, Impairment of Indefinite-Lived Intangible Assets, Long-Lived Tangible and Definite-Lived Intangible Assets, and Goodwill in our 2018 audited financial statements for further discussion.
(6)
The weighted average shares outstanding increased in 2018 compared to 2017 due to the issuance of our shares from the exchange of the non-controlling interest of 5,370,648 shares of common stock, 16,619,616 shares issued in our Private Placement and 6,097,617 shares issued in the Concurrent Offering, and 4,000,000 shares of common stock issued in the reverse merger with us.
(7)
Net working capital, excluding certain debt is the sum of current assets less current liabilities, excluding interest-bearing debt included in current liabilities.
(8)
To supplement our audited consolidated financial statements, which are prepared and presented in accordance with U.S. GAAP, we use earnings before interest, taxes, depreciation and amortization (“EBITDA”) and Adjusted EBITDA, which are non-U.S. GAAP financial measures. We define EBITDA as net income (loss) before depreciation and amortization, impairment, interest, and taxes. We define Adjusted EBITDA as EBITDA further adjusted for the impact of certain non-cash and other items such as inventory fair value adjustments, as share-based compensation, restructure and transactions costs, and EBITDA from a deconsolidated entity, which we do not consider in our evaluation of ongoing operating performance.
We believe that EBITDA and Adjusted EBITDA, when used in conjunction with net income (loss) in accordance with U.S. GAAP, provide useful information about operating results, enhances the overall understanding of past financial performance and future prospects, and allows for greater transparency with respect to the key metric we use in our financial and operational decision making. EBITDA and Adjusted EBITDA are also frequently used by analysts, investors and other interested parties to evaluate companies in our industry. The presentation of this financial information is not intended to be considered in isolation or as a substitute for, or superior to, the financial information prepared and
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presented in accordance with U.S. GAAP, and it should not be construed as an inference that our future results will be unaffected by any items adjusted for in EBITDA and Adjusted EBITDA. In evaluating EBITDA and Adjusted EBITDA, you should be aware that in the future we may incur expenses that are the same as or similar to some of those adjusted in this presentation.
EBITDA and Adjusted EBITDA have limitations as analytical tools, and you should not consider them either in isolation or as a substitute for analyzing our results as reported under U.S. GAAP. Some of these limitations include the following:

They do not reflect every expenditure, future requirements for capital expenditures or contractual commitments;

They do not reflect changes in our working capital needs;

They do not reflect the significant interest expense, or the amounts necessary to service interest or principal payments on our indebtedness;

They do not reflect income tax expense (benefit), and because the payment of taxes is part of our operations, tax expense is a necessary element of our costs and ability to operate;

Although depreciation and amortization are eliminated in the calculation of EBITDA and Adjusted EBITDA, the assets being depreciated and amortized will often have to be replaced in the future, and EBITDA and Adjusted EBITDA do not reflect any costs of such replacements;

They do not reflect the non-cash component of share-based compensation;

EBITDA and Adjusted EBITDA do not reflect the impact of earnings or charges resulting from matters we consider not to be reflective, on a recurring basis, of our ongoing operations; and

Other companies in our industry may calculate EBITDA and Adjusted EBITDA, or similarly titled measures differently than we do, limiting its usefulness as a comparative measure.
We compensate for these limitations by relying primarily on our U.S. GAAP results and using EBITDA and Adjusted EBITDA only as supplemental information.
The following table reconciles our net income (loss) to Adjusted EBITDA:
Successor
Predecessor
Pro Forma
Predecessor
Year ended
December 31,
2018
Period from
May 12,
2017 to
December 31,
2017
Period from
January 1,
2017 to
May 11,
2017
Year ended
December 31,
2017
Year ended
December 31,
2016
(In Thousands)
Net (loss) income
$ (35,301) $ (70,910) $ (19,863) $ (64,481) $ 16,549
Interest expense
11,606 5,643 547 7,929 1,134
Depreciation and amortization
7,170 3,769 428 5,836 1,237
Impairment charges
3,244 45,425 45,425
Provision (benefit) for income taxes
102 (266) 85 (182) 144
EBITDA (13,179) (16,339) (18,803) (5,473) 18,776
Employee stock ownership plan charges
30,327 6,480
Inventory fair value adjustment(a)
798 11,531 11,531
Restructure and transaction costs(b)
4,238 4,305 4,305
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Successor
Predecessor
Pro Forma
Predecessor
Year ended
December 31,
2018
Period from
May 12,
2017 to
December 31,
2017
Period from
January 1,
2017 to
May 11,
2017
Year ended
December 31,
2017
Year ended
December 31,
2016
(In Thousands)
EBITDA from deconsolidated
entity(c)
(658) (1,499)
Adjusted EBITDA
$ (8,143) $ (503) $ 10,866 $ 10,363 $ 24,045
(a)
This adjustment reflects the one-time amortization charges related to the step-up in basis of inventory, in connection with the Formation Transaction.
(b)
Restructure and transaction costs in 2018 are primarily related to assistance with corporate level business strategy, capital structure, and research for sources of various financial alternatives. Included in 2018 were $555 of management fees paid to affiliates of our 5% shareholders. In 2017, $3,185 of transaction costs were incurred in relation to the Formation Transaction and $542 of management fees were paid to affiliates of our 5% shareholders. The remaining balances were primarily related to other advisory, investment banking and professional services.
(c)
This adjustment eliminates the EBITDA of McDowell Group LLC (“McDowell”), a variable interest entity in which the Predecessor was the primary beneficiary until the Formation Transaction (when the debt guarantee giving rise to the assessment that the Predecessor was the primary beneficiary was settled).
(9)
Adjusted EBITDA margin is defined as Adjusted EBITDA divided by net sales.
(10)
Capital expenditures relate to purchases of property, plant, and equipment and computer software.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis provides information that we believe is relevant to an assessment and understanding of our results of operations and financial condition. You should read this analysis in conjunction with our audited and unaudited consolidated financial statements and related notes contained elsewhere in this prospectus. 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 prospectus, 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 prospectus. See “Special Note Regarding Forward-Looking Statements.” All amounts are in thousands of dollars.
Overview
With more than 40 years of operating history, we are a leading independent wholesaler and manufacturer of hydroponics equipment and commercial horticultural products. Hydroponics is the farming of plants without the use of soil with various implementation systems that can be organized in multiple combinations to optimize the applicable environment. Hydroponics allows end users to control variables including temperature, humidity, CO2, lighting, nutrient concentration and PH, to create a controlled farming environment. As such, the benefits of hydroponics, an essential element of controlled environment agriculture (“CEA”), include, but are not limited to year-round production, reduced water consumption, rapid production, increased production density (plants can be placed closer together and vertically farmed) and insulation from pests. CEA, as broadly defined, is a technology-based farming method whereby growers produce crops within an enclosed growing structure, such as a greenhouse or building, to provide protection and maintain optimal growing conditions throughout the development of the crop. CEA provides farmers with the flexibility to produce whatever they desire, whenever and wherever. We service these farmers through a network of retailers and resellers that connect to us utilizing an automated eCommerce system, providing just in time delivery capabilities. Our mission is to provide professional on time service, delivery and value by offering the right gardening products, innovation, and expertise to make indoor, hydroponic, organic and/or greenhouse efforts easier and more productive.
We currently maintain more than 5,000 stock keeping units (“SKUs”) in our core U.S. business, including proprietary and exclusive brands and we serve as a one-stop source for some of the most desirable branded hydroponic merchandise. Our product assortment includes advanced indoor garden, lighting and ventilation systems, liquid plant food products, heat mats, and other related products and accessories for hydroponic gardening. Approximately 65% of our sales relate to recurring consumable products, including growing media, nutrients and supplies that require regular replenishment. The remaining 35% of 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 or 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 from our competitors. In addition, our diverse network of over 200 suppliers and proprietary sourcing capabilities presents a significant barrier to entry.
We utilize a vertically integrated operating model, shipping directly to retailers and resellers, providing what we believe to be nearly unmatched capabilities in the industry. We sell to a highly diverse group of over 2,000 customers across North America through four main channels: specialty hydroponic retailers (76% of sales), garden centers (14% of sales), eCommerce (8% of sales) and greenhouse suppliers (2% of sales). We believe that our six U.S.-based distribution centers can reach 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. Through our product offerings, customer service and sales and marketing efforts, we estimate that we enjoy an approximately 30% and 40% market share in the U.S. and Canadian hydroponic wholesale markets, respectively.
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Recent Developments
Acquisitions
In November 2017, we acquired Eddi’s Wholesale Garden Supplies, Ltd. (“Eddi’s”), and the distribution division of Greenstar Plant Products, Inc. (“GSD”), two of the leading hydroponics and lawn and garden distributors in Canada, with combined annual revenues of  $45.3 million for the year ended December 31, 2018 (the “Canadian Acquisitions”). The Canadian Acquisitions, combined with our existing infrastructure and experience, have enabled us to become, we believe, one of the leading lighting and hydroponics equipment distributors in Canada. We believe that this experience in Canada has prepared us to make additional acquisitions in the hydroponics industry, which will help us to continue to grow our market share.
Recent Transactions
Merger and Private Placement
In May 2017, Hydrofarm Investment Corp. (“HIC”), or the Successor, acquired, through its wholly-owned subsidiary, Hydrofarm Holdings, LLC, all of the capital stock of Hydrofarm, Inc., or the Predecessor, in a transaction referred to as the “Formation Transaction.” Concurrently with the acquisition by HIC, Hydrofarm, Inc. converted from an S-Corp to a limited liability company and was renamed Hydrofarm, LLC. We accounted for the Formation Transaction under Financial Accounting Standards Board’s, or FASB, Accounting Standards Codification Topic 805, “Business Combinations” as amended, as of the closing date, and as a result, the merger consideration was allocated to the respective fair values of the assets acquired and liabilities assumed from the Predecessor (commonly referred to as a “step-up in basis”). As a result of the application of acquisition method accounting, the Successor balances and amounts presented in the audited consolidated financial statements and footnotes are not comparable with those of the Predecessor.
On August 28, 2018, HIC merged with and into one of our wholly-owned subsidiaries, as part of a recapitalization of the Company in a transaction accounted for as a “reverse merger” where HIC is the “accounting acquirer/legal acquiree” and we are the “accounting acquiree/legal acquirer.” Consolidated financial statements prepared following a reverse merger are issued under the name of the legal parent (accounting acquiree) and are a continuation of the financial statements of the legal subsidiary (accounting acquirer), with one adjustment. The adjustment retroactively restates the accounting acquirer’s legal capital to reflect the legal capital of the accounting acquiree. Accordingly, the number of shares and stated capital of HIC have been retroactively adjusted using the exchange ratio established in the merger agreements to reflect the number of shares of we issued in the exchange.
In October 2018, we consummated a private placement offering of 16,619,616 units (each a “Unit,” and collectively, the “Units”) at a price per Unit or $2.50 for gross proceeds of approximately $41.5 million. Each Unit consisted of  (i) one (1) share of our common stock and (ii) a warrant (each a “Investor Warrant,” and collectively, the “Investor Warrants”), expiring three years after the earliest of  (x) the effectiveness of a resale registration statement, (y) the closing of an initial public offering of the Company’s common stock or (z) the closing of any other transaction or set of events that results in the Company being subject to the requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), entitling the holder to purchase one-half  (1/2) share of our common stock at an initial exercise price of $5.00 per full share (the “Private Placement”). As part of the Private Placement, we issued the placement agents for the Private Placement, A.G.P./Alliance Global Partners and SternAegis Ventures (the “Placement Agents”) warrants to purchase 1,742,955 shares of our common stock (the “Placement Agent Warrants”).
On August 28, 2018 as discussed above, one of our wholly-owned subsidiaries merged with and into HIC, with HIC becoming our wholly-owned subsidiary and continuing its and its subsidiaries’ existing business operations, including those of Hydrofarm, LLC, a subsidiary of HIC (the “Merger”). As such, Successor refers to HIC and its wholly owned subsidiaries for the period from May 12, 2017 through August 27, 2018 and us and our wholly-owned subsidiaries from August 28, 2018 forward.
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In connection with the Private Placement, (i) HIC raised $15.2 million from its existing stockholders through the issuance of 6,094,617 units (the “Concurrent Offering”) and (ii) Hydrofarm Holdings, LLC (“Hydrofarm Holdings”), a subsidiary of HIC, and its affiliates entered into certain amendments to Hydrofarm Holdings’ credit facilities to amend certain covenants and other provisions under such credit facilities (the “Loan Transactions,” and together with the Private Placement, Merger and Concurrent Offering, the “2018 Financing Transactions”). The consideration in the Concurrent Offering consisted of $11.1 million in cash from existing stockholders of HIC and the conversion of  $4.1 million of an aggregate principal amount plus interest outstanding under an outstanding note. As part of the Merger, the securities of HIC issued in the Concurrent Offering were exchanged into shares of our common stock and warrants to purchase our common stock having the same terms and conditions as the securities included in the Units issued in this Private Placement.
Encina Refinancing
In July 2019, certain of our subsidiaries (the “Subsidiary Obligors”) entered into a Loan and Security Agreement with Encina Business Credit, LLC (the “Encina Credit Facility”). The Encina Credit Facility provides for revolving borrowings of up to $45 million, subject to applicable borrowing base availability, and a limit of up to $15 million of borrowings for the Canadian subsidiaries party thereto, matures in July 2022, and is secured by a first-priority lien on all cash, accounts receivable and inventory of the Subsidiary Obligors and a second-lien priority lien on all other personal property of the Subsidiary Obligors. The Encina Credit Facility also provides for a swingline facility of up to $2.0 million. A portion of the proceeds borrowed under the Encina Credit Facility were used to pay in full the Loan and Security Agreement dated November 8, 2017, as amended from time to time, among Bank of America, N.A. and the obligors party thereto.
Results of Operations
The following table sets forth our consolidated statements of operations and for the periods presented (in thousands, except for share and per share amounts):
Successor
Predecessor
Pro Forma
Year ended
December 31,
2018
Period from
May 12, 2017 to
December 31,
2017
Period from
January 1, 2017 to
May 11, 2017
Year ended
December 31,
2017
(In Thousands)
Net sales
$ 212,464 $ 151,525 $ 108,221 $ 259,746
Cost of goods sold(1)
183,690 141,119 86,925 228,044
Gross profit
28,774 10,406 21,296 31,702
Operating expenses:
General and administrative expenses
18,668 11,487 4,818 16,201
Salaries and benefits
16,463 8,679 4,630 13,309
Marketing expense
2,584 2,274 695 2,969
Employee stock ownership plan
30,327
Impairment charges
3,244 45,425 45,425
Depreciation and amortization
7,170 3,769 428 5,836
Interest expense
11,606 5,643 547 7,929
Other expense (income), net
4,238 4,305 (371) 4,696
Net loss before tax
(35,199) (71,176) (19,778) (64,663)
Income tax (expense) benefit
(102) 266 (85) 182
Net loss
$ (35,301) $ (70,910) $ (19,863) $ (64,481)
Other financial data
Adjusted EBITDA(2)
$ (8,143) $ (503) $ 10,866 $ 10,363
Capital expenditures(3)
1,715 2,403 1,586 3,989
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(1)
Cost of goods sold excludes depreciation and amortization shown separately.
(2)
Adjusted EBITDA is a non-GAAP financial performance measure. See “Summary Consolidated Financial and Other Data” for more information and a reconciliation of Adjusted EBITDA to Net Loss, the most directly comparable financial measure calculated and presented in accordance with GAAP.
(3)
Capital Expenditures relate to purchases of property, plant, and equipment and computer software.
The following table sets forth our consolidated statements of operations as a percentage of revenues for the periods presented:
Successor
Predecessor
Pro Forma
Year ended
December 31,
2018
Period from
May 12, 2017 to
December 31,
2017
Period from
January 1, 2017 to
May 11, 2017
Year ended
December 31,
2017
(In Thousands)
Net sales
100.0% 100.0% 100.0% 100.0%
Cost of goods sold(1)
86.5% 93.1% 80.3% 87.8%
Gross profit
13.5% 6.9% 19.7% 12.2%
Operating expenses:
General and administrative expenses
8.8% 7.6% 4.5% 6.2%
Salaries and benefits
7.7% 5.7% 4.3% 5.1%
Marketing expense
1.2% 1.5% 0.6% 1.1%
Employee stock ownership plan
0.0% 0.0% 28.0% 0.0%
Impairment charges
1.5% 30.0% 0.0% 17.5%
Depreciation and amortization
3.4% 2.5% 0.4% 2.2%
Interest expense
5.5% 3.7% 0.5% 3.1%
Other expense (income), net
2.0% 2.8% (0.3%) 1.8%
Net loss before tax
(16.6%) (46.9%) (18.3%) (24.8%)
Income tax (expense) benefit
(0.0%) 0.2% (0.1%) 0.1%
Net loss
(16.6%) (46.7%) (18.4%) (24.7%)
Comparison of 2018, Successor 2017 and Pro Forma 2017
References to “2018” refer to the full year ended December 31, 2018. References to “Successor 2017” refer to the period from commencement of operations (May 12, 2017) to December 31, 2017 and references to “Pro Forma 2017” refer to the year ended December 31, 2017 as if Hydrofarm Holding Group Inc., or the Successor, had acquired through its wholly-owned subsidiary, Hydrofarm Holdings, LLC, all of the capital stock of Hydrofarm, Inc., or the Predecessor, on January 1, 2017.
Net Sales
We distribute certain products that are used to improve the efficiency of the agricultural growing and the cultivation process. Our key products are growing media and nutrients, hydroponic systems, and lighting systems and bulbs.
Our diversified customer base is largely comprised of retailers of commercial and home gardening equipment and supplies, including: (i) garden centers and hardware stores, (ii) e-commerce webstores, such as Amazon.com (“Amazon”), (iii) specialty hydroponic retailers and (iv) commercial greenhouse builders. We anticipate that our product offerings will continue to attract a diversified customer base, especially as the hydroponics product retail market grows and the trend of U.S. state adoption of legalizing cannabis continues.
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We have a ten-year relationship with Amazon that covers indoor gardening products. Amazon purchases and warehouses more than 2,000 of our SKUs to be sold to customers within the U.S.
Our net sales for 2018 was $212,464 compared to $259,746 for Pro Forma 2017, a decrease of  $47,282 or 18.2%. This decrease was due to a decline in sales in the U.S. resulting from a pull-back on equipment purchases by customers in California, as well as the loss of a hydroponic product lines from a larger supplier. This pull-back was, we believe, due principally to administrative delays in the issuance of licenses to cannabis growers, pursuant to regulations governing the implementation of legalization of adult-use cannabis. Administrative delays were magnified by a lack of staffing at the California State licensing board, which was charged with reviewing and issuing licenses to cannabis growers. The slowdown began in late 2017 and continued until the fourth quarter of 2018 when California accelerated its issuance of licenses to cannabis growers. The loss of certain hydroponic product lines from a large supplier required a transition period in order to replace those product lines with similar products from other vendors.
Our net sales for 2018 was $212,464 compared to $151,525 for Successor 2017, an increase of  $60,939 or 40.2%. This increase reflects net sales for all of 2018 compared to net sales for a partial year for Successor 2017, which only includes sales for a partial year for Successor 2017 due to the Formation Transaction on May 12, 2017 and the Canadian Acquisitions in November 2017.
Gross Profit
Our products include both our branded proprietary products and distributed products. We work with a network of third-party common carrier trucking/freight companies that service our customers across the globe. The majority of customer orders are shipped and delivered within 24 to 48 hours of order receipt. Shipments are delivered to customers via less-than-truckload common carriers, dedicated lease trucks, small parcel or vendor dropship.
Our gross profit was $28,774 for 2018 compared to $31,702 for Pro forma 2017, a decrease of  $2,928 or 9.2%. The decrease was primarily related to lower sales volumes and product discounts after a slowdown in the industry resulted in overstock, particularly for lighting products. Our gross profit percent was 13.5% for 2018 compared to 12.2% for Pro forma 2017, a 130 basis point increase, as inventory levels stabilized in the latter part of 2018, which slightly improved profit margins.
Our gross profit for 2018 was $28,774 compared to $10,406 for Successor 2017, an increase of  $18,368, or 176.5%. This increase reflects a full year of sales for 2018 versus a partial year of sales for Successor 2017 due to the Formation Transaction on May 12, 2017 and the Canadian Acquisitions in November 2017.
Our gross profit percent was 13.5% for 2018 compared to 6.9% for Successor 2017, a 660 basis point increase. Our cost of goods sold for Successor 2017 includes $11,531 of amortization from the step-up in basis of inventory acquired as part of the Formation Transaction and our Canadian Acquisitions (it was only $798 for 2018; see Notes 1 and 5 to our audited consolidated financial statements for December 31, 2018 and 2017, Description of the business, Formation Transaction and Business acquisitions other than the Formation Transaction for further information). These amortization expenses are one-time charges. Adjusting the gross margin percent to exclude the amortization increases Successor 2017 gross margin percent to 14.5% from 6.9%. The difference between the 13.5% for 2018 and 14.5% for Successor 2017 as adjusted, reflects the impact of the slowdown and overstock of inventory on profit margins. Adjusting the gross margin percent to exclude the amortization increases the Pro forma 2017 gross margin percent from 12.2% to 16.6%. The 16.6% for Pro forma 2017 as adjusted, reflects the same downward trend as seen in Successor 2017 but it had less impact on gross margin for the full year for 2017 because the downturn did not begin until the fall of 2017.
Operating Expenses
General and Administrative Expense
General and administrative expenses include occupancy costs (such as rent, common area maintenance and utilities), supplies and equipment, warranty, bad debt, banking and merchant fees, insurance, technology, communication, and professional fees (such as legal, accounting and audit, and payroll administration).
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Our general and administrative expenses were $18,668 for 2018 compared to $16,201 for Pro Forma 2017, an increase of  $2,467 or 15.2%. This increase was primarily due the Canadian Acquisitions and an increase in facilities costs related to the opening of our Michigan distribution center, the expansion of one of our California distribution centers.
Our general and administrative expenses were $18,668 for 2018 compared to $11,487 for Successor 2017, an increase of  $7,181 or 62.5%. This increase was due to a full year of expenses for 2018 compared to a partial year of expenses for Successor 2017 due to the Formation Transaction on May 12, 2017 and the Canadian Acquisitions in November 2017. Additionally, our facilities costs increased due to the opening of our Michigan distribution center and the expansion of one of our California distribution centers.
Salaries and Benefits Expense
Most of our employees work in order processing, fulfilment and distribution, sales and marketing; finance and accounting; and technology support. Benefits include health insurance and a tax-qualified 401(k) retirement plan for U.S. employees. We recently added an employee stock option plan, but no options were issued as of December 31, 2018. We do not have any defined contribution or defined benefit plans.
Our salaries and benefit expenses were $16,463 for 2018 compared to $13,309 for Pro Forma 2017, an increase of  $3,154 or 23.7%. This increase was primarily due to the addition of employees from the Canadian Acquisitions and new hires of senior and executive staff in 2018 to accommodate expected growth.
Our salaries and benefit expenses were $16,463 for 2018 compared to $8,679 for Successor 2017, an increase of  $7,784 or 89.7%. This increase was due to a full year of expenses for 2018 compared to a partial year of expenses for Successor 2017 due to the Formation Transaction on May 12, 2017 and the Canadian Acquisitions in November 2017. Additionally, we hired senior and executive staff in 2018 to accommodate expected growth as well as the addition of employees from the Canadian Acquisitions.
Marketing Expense
Our marketing strategy consists of print media, online presence, and tradeshows (including private customer events). Marketing expenses include costs for conferences, conventions, trade shows, related travel costs, branding, catalog and advertising.
Our marketing expenses were $2,584 for 2018 compared to $2,969 for Pro Forma 2017, a decrease of $385 or 13.0%.
Our marketing expenses were $2,584 for 2018 compared to $2,274 for Successor 2017, an increase of $310 or 13.6%. This increase was due to a full year of expenses for 2018 compared to a partial year of expenses for Successor 2017 due to the Formation Transaction on May 12, 2017 and the Canadian Acquisitions in November 2017.
Impairment Charges
Impairment charges were $3,244, $45,425 and $45,425 for 2018, Successor 2017 and Pro Forma 2017, respectively.
In the fourth quarter of 2018, we identified indicators of impairment related to goodwill recorded in our Canadian reporting unit. As a result, we recognized an impairment charge of  $3,244 for the year ended December 31, 2018.
In the fourth quarter of 2017, we identified indicators of impairment for our U.S. reporting segment primarily due to the failure of the hydroponics industry in the U.S. to reach previously anticipated levels. Specifically, the expected growth impact of legalized adult-use cannabis requiring cultivators to invest in certain hydroponic and lighting equipment and nutrients supplied in the U.S. did not materialize because of delays due to licensing, regulation and tax procedures, primarily in California. As a result, we recognized impairment charges of  $32,732 to goodwill and $12,693 to trade names the Successor 2017 and Pro Forma 2017 periods.
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See Note 11, Impairment of indefinite-lived intangible assets, long-lived tangible and definite-lived intangible assets, and goodwill, in our audited consolidated financial statements for the year ended December 31, 2018 and 2017 for a more complete discussion of our impairment analysis.
Depreciation and Amortization
Our depreciation and amortization was $7,170 for 2018 compared to $5,836 for Pro Forma 2017, an increase by $1,344 or 22.9%. This increase was primarily due to the Canadian acquisitions in 2017 and an increase in depreciation expense due to computer software.
Our depreciation and amortization was $7,170 for 2018 compared to $3,769 for Successor 2017, an increase of  $3,401 or 90.2%. This increase was primarily due to acquisition of intangible assets as part of the Formation Transaction on May 12, 2017 and the Canadian Acquisitions in November 2017. Depreciation expense for computer software also increased.
Interest Expense
Our interest expense was $11,606 for 2018 compared to $7,929 for Pro Forma 2017, an increase of $3,677 or 46.4%. The increase was due to increases in the effective interest rate from the Brightwood Term Loan and BofA Credit Facility. Additionally, principal and interest payments were deferred in 2018 due to failure to meet covenants in 2018. During 2018, $6,795 of interest was capitalized into principal, which resulted in additional interest expense from the increase in the principal balance throughout the year.
Our interest expense was $11,606 for 2018 compared to $5,643 for Successor 2017, an increase of $5,963 or 105.7%. This increase was due to a full year of interest expense for 2018 compared to a partial year of expenses for Successor 2017 due to the Formation Transaction on May 12, 2017 and the Canadian Acquisitions in November 2017. This increase was also due to increases in the effective interest rate from the term loan (the “Brightwood Term Loan”) with Brightwood Loan Services, LLC and credit facility with Bank of America, N.A. (the “BofA Credit Facility”). Additionally, principal and interest payments were deferred in 2018 due to our failure to meet certain financial covenants in 2018. During 2018, $6,795 of interest was capitalized into principal, which resulted in additional interest expense from the increase in the principal balance throughout the year
The effective interest rate on the Brightwood Term Loan at December 31, 2017 was 8.18% which increased to 12.13% at December 31, 2018 due to the default interest of 300 basis points added to the margin as a result of our inability to comply with debt covenants during most of 2018.
Similarly, the effective interest rate on our BofA Credit Facility for 2017 ranged from 3.31% to 3.32% and increased to 5.00% to 5.06% for 2018 due to the default interest of 200 basis points added to the margin as a result of our inability to comply with certain financial covenants during most of 2018.
Other Expense, Net
Our other expenses, net were $4,238 for 2018 compared to $4,696 for Pro Forma 2017, a decrease of $458 or 9.8%. This decrease was primarily due to the deconsolidation of the income and expenses of McDowell Group LLC (“McDowell”), a variable interest entity in which the Predecessor was the primary beneficiary until the Formation Transaction (when the debt guarantee giving rise to the assessment that the Predecessor was the primary beneficiary was settled) as if it were deconsolidated as of January 1, 2017.
Our other expenses, net were $4,238 for 2018 compared to $4,305 for Successor 2017, a decrease of  $67 or 1.6%. This decrease was primarily due to a $769 gain in 2018 from the release of an earn-out accrual related to one of our Canadian Acquisitions and increases in costs related to assistance with corporate level business strategy, capital structure, and research for sources of various financial alternatives, partially offset by a decrease in transaction costs. Successor 2017 included $3,185 of transaction costs related to the Formation Transaction.
Income Tax Benefit (Expense)
We recognized a provision for income taxes of  ($102) for 2018 and a benefit from income taxes of  $266 for Successor 2017. Although we generated substantial net operating loss carryforwards (“NOLs”) in most of our taxable justifications which creates a deferred tax asset, we provided a valuation allowance against
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such amount because of uncertainty related to our ability to utilize the NOL’s in the future. The provision for income taxes for 2018 reflects minimum state taxes and taxes on certain of our non-U.S. subsidiaries. The tax benefit for Successor 2017 is associated with the non-U.S. subsidiaries. The reduction in the tax benefit in Pro Forma 2017 compared to Successor 2017 reflects the additional minimum state taxes included for the period from January 1, 2017 to May 11, 2017.
EBITDA and Adjusted EBITDA
The following table reconciles our net income or loss to Adjusted EBITDA for the periods presented (in thousands, except for share and per share amounts):
Successor
Predecessor
Pro Forma
Predecessor
Year ended
December 31,
2018
Period from
May 12, 2017 to
December 31,
2017
Period from
January 1,
2017 to
May 11,
2017
Year ended
December 31,
2017
Year ended
December 31,
2016
(In Thousands)
Net (loss) income
$ (35,301) $ (70,910) $ (19,863) $ (64,481) $ 16,549
Interest expense
11,606 5,643 547 7,929 1,134
Depreciation and amortization
7,170 3,769 428 5,836 1,237
Impairment charges
3,244 45,425 45,425
Provision (benefit) for income taxes
102 (266) 85 (182) 144
EBITDA (13,179) (16,339) (18,803) (5,473) 19,064
Employee stock ownership plan charges
30,327 6,480
Inventory fair value adjustment(1)
798 11,531 11,531
Restructure and transaction costs(2)
4,238 4,305 4,305
EBITDA from deconsolidated entity(3)
(658) (1,499)
Adjusted EBITDA
$ (8,143) $ (503) $ 10,866 $ 10,363 $ 24,045
(1)
This adjustment reflects the one-time amortization charges related to the step-up in basis of inventory, in connection with the Formation Transaction.
(2)
Restructure and transaction costs in 2018 are primarily related to assistance with corporate level business strategy, capital structure, and research for sources of various financial alternatives. Included in 2018 were $555 of management fees paid to affiliates of our 5% shareholders. In 2017, $3,185 of transaction costs were incurred in relation to the Formation Transaction and $542 of management fees were paid to affiliates of our 5% shareholders. The remaining balances were primarily related to other advisory, investment banking and professional services.
(3)
This adjustment eliminates the EBITDA of McDowell Group LLC (“McDowell”), a variable interest entity in which the Predecessor was the primary beneficiary until the Formation Transaction (when the debt guarantee giving rise to the assessment that the Predecessor was the primary beneficiary was settled.
EBITDA was a deficit of  $(13,179) for 2018, compared to a deficit of  $(16,339) for Successor 2017, an increase of  $3,160 or 19.3% due to the step-up in basis of inventory costs from the Formation Transaction in Successor 2017. Adjusted EBITDA for 2018 was $(8,143) for 2018 compared to $(503) for Successor 2017, a decrease of  $7,640, due primarily to lower gross margins and higher operating expenses.
EBITDA was a deficit of  $(13,179) for 2018, compared to ($5,474) for Pro Forma 2017, a decrease of $7,705. Adjusted EBITDA for 2018 was $(8,143) for 2018 compared to $10,363 for Pro Forma 2017, a decrease of  $18,506. The changes are due to the reasons noted above.
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Liquidity and Capital Resources
The following table summarizes our cash flows for the year ended December 31, 2018 and the period from commencement of operations (May 12, 2017) to December 31, 2017:
Successor
Year ended
December 31,
2018
Period from
May 12, 2017 to
December 31,
2017
(In Thousands)
Net cash provided by (used in) operating activities
$ 4,303 $ (13,390)
Net cash used in investing activities
(3,178