10-Q 1 f10q0922_purpleinnova.htm QUARTERLY REPORT

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2022

 

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE TRANSITION PERIOD FROM _____________ TO _____________

 

Commission File Number: 001-37523

 

 

PURPLE INNOVATION, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   47-4078206
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)

 

4100 NORTH CHAPEL RIDGE ROAD SUITE 200

LEHI, UTAH

  84043
(Address of principal executive offices)   (Zip Code)

 

Registrant’s telephone number, including area code: (801) 756-2600

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class   Trading Symbol(s)   Name of each exchange on which registered
Class A Common Stock, par value $0.0001 per share   PRPL   The NASDAQ Stock Market LLC

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes    No  ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Date File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes    No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule12b-2 of the Exchange Act.

 

Large accelerated filer Accelerated filer
Non-accelerated filer Smaller reporting company
  Emerging growth company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐   No 

 

As of November 8, 2022, 91,380,166 shares of the registrant’s Class A common stock, $0.0001 par value per share, and 448,279 shares of the registrant’s Class B common stock, $0.0001 par value per share, were outstanding.

 

 

 

 

 

 

PURPLE INNOVATION, INC.

 

QUARTERLY REPORT ON FORM 10-Q

 

TABLE OF CONTENTS

 

      Page
Part I. Financial Information 1
  Item 1. Financial Statements (Unaudited): 1
    Condensed Consolidated Balance Sheets 1
    Condensed Consolidated Statements of Operations 2
    Condensed Consolidated Statements of Stockholders’ Equity 3
    Condensed Consolidated Statements of Cash Flows 4
    Notes to Condensed Consolidated Financial Statements 5
  Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 31
  Item 3. Quantitative and Qualitative Disclosures about Market Risk 42
  Item 4. Controls and Procedures 42
       
Part II.  Other Information 43
  Item 1. Legal Proceedings 43
  Item 1A. Risk Factors 43
  Item 6. Exhibits 56
  Signatures 57

 

In this Quarterly Report on Form 10-Q, references to “dollars” and “$” are to United States (“U.S.”) dollars.

 

We have several trademarks registered with the U.S. Patent and Trademark Office (USPTO), including EquaPressure®, WonderGel® and EquaGel® (for cushions), and Purple®, No Pressure®, Hyper-Elastic Polymer®, Somnigel®, Gel Matrix®, GelFlex®, Intellibed®, Gelee®, Intellipillow®, Matrix®, and Sleep Genius® (for plasticized elastomeric gel and certain types of products including mattresses, seat cushions, bed linen, mattress foundation and others). Additional registered trademarks include Purple Grid®, The Purple Mattress®, Purple Hybrid®, Purple Hybrid Premier®, Purple Plus®, Purple Plush®, Purple Duvet®, Purple Sheets®, Softstretch®, Purple Powerbase®, Purple Pillow®, Purple Foundation®, Reinventing Comfort®, Twincloud®, Ascent®, Furple®, and Purple Pay®. Applications are pending for registration of additional trademarks and some of these listed trademarks for additional classes of goods both in the U.S. and internationally. Our Purple, No Pressure and Hyper-Elastic Polymer trademarks are also registered and have applications pending for various classes of goods in numerous foreign jurisdictions, some of which include Australia, Canada, China, Europe, United Kingdom, Japan and Korea. Certain international trademark applications previously resided with EdiZONE, LLC, which is an entity owned by our founders, and were licensed to Purple LLC and we have taken the necessary steps to have those trademarks assigned to Purple LLC upon registration.

 

We also have a number of common law trademarks, including Harmony, Purple Harmony Pillow, Harmony Pillow, Purple +, Find Comfort, Dreams On Dreams, Reinventing Sleep™, Reinventing Comfort, Purple Ascent, Purple Powerbase Premier, Purple Powerbase Plus, Purple Glove, Eidertech, Mattress Max, WonderGel Original, WonderGel Extreme, DoubleGel, DoubleGel Plus, DoubleGel Ultra, Roll n’ Go, Fold N’ Go, Purple Bed, Purple Top, Portable Purple, Everywhere Purple, Simply Purple, Lite Purple, Royal Purple, Double Purple, Deep Purple, Ultimate Purple, Purple Back, EquaGel Straight Comfort, EquaGel General, EquaGel Protector, EquaGel Adjustable, +, Perfect Stay, SecureStretch, Purple Cloud, and Success Happens Overnight.

 

Many of the common law marks have registrations pending with the USPTO and other international jurisdictions. Solely for convenience, we refer to our trademarks in this Quarterly Report without the  or ® symbol, but such references are not intended to indicate that we will not assert, to the fullest extent under applicable law, our rights to our trademarks.

 

i

 

 

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

PURPLE INNOVATION, INC.

Condensed Consolidated Balance Sheets

(unaudited – in thousands, except for par value)

 

   September 30,
2022
   December 31,
2021
 
Assets        
Current assets:        
Cash, cash equivalents and restricted cash  $59,143   $91,616 
Accounts receivable, net   30,022    25,430 
Inventories, net   91,393    98,690 
Prepaid expenses   8,806    8,064 
Other current assets   5,349    5,702 
Total current assets   194,713    229,502 
Property and equipment, net   137,418    112,614 
Operating lease right-of-use assets   101,615    68,037 
Goodwill   6,441    
 
Intangible assets, net   24,069    13,204 
Deferred income taxes   220,771    217,791 
Other long-term assets   1,665    1,322 
Total assets  $686,692   $642,470 
           
Liabilities and Stockholders’ Equity          
Current liabilities:          
Accounts payable  $53,138   $79,752 
Accrued sales returns   5,300    7,116 
Accrued compensation   11,138    8,928 
Customer prepayments   3,786    10,854 
Accrued sales tax   2,298    4,672 
Accrued rebates and allowances   8,051    10,169 
Operating lease obligations – current portion   12,641    7,053 
Warrant liabilities   122    
 
Other current liabilities   12,072    13,470 
Total current liabilities   108,546    142,014 
Debt, net of current portion   36,451    94,113 
Operating lease obligations, net of current portion   114,436    81,159 
Warrant liabilities   
    4,343 
Tax receivable agreement liability, net of current portion   161,970    162,239 
Other long-term liabilities, net of current portion   16,986    12,061 
Total liabilities   438,389    495,929 
           
Commitments and contingencies (Note 14)   
 
    
 
 
           
Stockholders’ equity:          
Class A common stock; $0.0001 par value, 210,000 shares authorized; 91,378 issued and outstanding at September 30, 2022 and 66,493 issued and outstanding at December 31, 2021   9    7 
Class B common stock; $0.0001 par value, 90,000 shares authorized; 448 issued and outstanding at September 30, 2022 and at December 31, 2021   
    
 
Additional paid-in capital   528,972    407,591 
Accumulated deficit   (281,389)   (261,825)
Total stockholders’ equity attributable to Purple Innovation, Inc.   247,592    145,773 
Noncontrolling interest   711    768 
Total stockholders’ equity   248,303    146,541 
Total liabilities and stockholders’ equity  $686,692   $642,470 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

1

 

 

PURPLE INNOVATION, INC.

Condensed Consolidated Statements of Operations

(unaudited – in thousands, except per share amounts)

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2022   2021   2022   2021 
Revenues, net  $143,280   $170,781   $430,568   $539,796 
Cost of revenues   83,867    109,701    270,717    309,505 
Gross profit   59,413    61,080    159,851    230,291 
Operating expenses:                    
Marketing and sales   37,007    48,841    127,339    163,053 
General and administrative   19,166    17,037    55,833    54,024 
Research and development   1,927    1,784    5,818    5,430 
Total operating expenses   58,100    67,662    188,990    222,507 
Operating income (loss)   1,313    (6,582)   (29,139)   7,784 
Other income (expense):                    
Interest income (expense), net   (717)   10    (2,447)   (1,129)
Other income (expense), net   1,107    12    988    (30)
Change in fair value – warrant liabilities   (53)   5,362    4,221    19,369 
Tax receivable agreement income   
    846    
    639 
Total other income, net   337    6,230    2,762    18,849 
Net income (loss) before income taxes   1,650    (352)   (26,377)   26,633 
Income tax benefit (expense)   631    2,479    6,617    (1,005)
Net income (loss)   2,281    2,127    (19,760)   25,628 
Net income (loss) attributable to noncontrolling interest   3    (44)   (196)   55 
Net income (loss) attributable to Purple Innovation, Inc.  $2,278   $2,171   $(19,564)  $25,573 
                     
Net income (loss) per share:                    
Basic  $0.03   $0.03   $(0.25)  $0.39 
Diluted  $0.03   $(0.05)  $(0.25)  $0.09 
                     
Weighted average common shares outstanding:                    
Basic   85,666    66,335    78,544    65,741 
Diluted   86,115    67,287    78,992    68,319 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

2

 

 

PURPLE INNOVATION, INC.

Condensed Consolidated Statements of Stockholders’ Equity

(unaudited – in thousands)

 

   Class A   Class B   Additional   Accumulated   Total Stockholders’
Equity
Attributable
         
   Common Stock   Common Stock   Paid-in   Equity   to Purple   Noncontrolling   Total 
   Shares   Par Value   Shares   Par Value   Capital   (Deficit)   Innovation, Inc.   Interest   Equity 
                                     
Balance - December 31, 2021   66,493   $7    448   $
   $407,591   $(261,825)  $                145,773   $768   $146,541 
Net loss       
        
    
    (13,502)   (13,502)   (129)   (13,631)
Stock-based compensation       
        
    542    
    542    
    542 
Exercise of stock options   20    
        
    166    
    166    
    166 
Issuance of stock under equity compensation plans   25    
        
    
    
    
    
    
 
Issuance of stock upon underwritten public offering, net of costs   16,100    1        
    92,894    
    92,895    
    92,895 
Accrued distributions       
        
    (228)   
    (228)   
    (228)
Impact of transactions affecting NCI       
        
    (141)   
    (141)   141    
 
Balance – March 31, 2022   82,638   $8    448   $
   $500,824   $(275,327)  $225,505   $780   $226,285 
Net loss       
        
    
    (8,340)   (8,340)   (70)   (8,410)
Stock-based compensation       
        
    1,275    
    1,275    
    1,275 
Issuance of common stock under equity compensation plans   126    
        
    
    
    
    
    
 
Additional costs associated with underwritten public stock offering       
        
    (29)   
    (29)   
    (29)
Impact of transactions affecting NCI       
        
    (73)   
    (73)   73    
 
Balance – June 30, 2022   82,764   $8    448   $
   $501,997   $(283,667)  $218,338   $783   $219,121 
Net income       
        
    
    2,278    2,278    3    2,281 
Stock-based compensation       
        
    795    
    795    
    795 
Issuance of common stock under equity compensation plans   1    
        
    
    
    
    
    
 
Issuance of common stock for Intellibed acquisition   8,613    1        
    26,105    
    26,106    
    26,106 
Impact of transactions affecting NCI       
        
    75    
    75    (75)   
 
Balance – September 30, 2022   91,378   $9    448   $   $528,972   $(281,389)  $247,592   $711   $248,303 

 

   Class A   Class B   Additional   Accumulated   Total Stockholders’
Equity
Attributable
         
   Common Stock   Common Stock   Paid-in   Equity   to Purple   Noncontrolling   Total 
   Shares   Par Value   Shares   Par Value   Capital   (Deficit)  

Innovation, Inc.

   Interest   Equity 
                                     
Balance - December 31, 2020   63,914   $6    536   $
   $333,047   $(265,856)  $                     67,197   $344   $67,541 
Net income       
        
    
    20,824    20,824    115    20,939 
Stock-based compensation       
        
    479    
    479    
    479 
Exchange of stock   88    
    (88)   
    
    
    
    
    
 
Exercise of warrants   2,291    1    
    
    64,261    
    64,262    
    64,262 
Exercise of stock options   10    
    
    
    83    
    83    
    83 
Tax Receivable Agreement liability       
        
    (777)   
    (777)   
    (777)
Deferred income taxes       
        
    971    
    971    
    971 
Accrued distributions       
        
    (99)   
    (99)   
    (99)
InnoHold indemnification payment       
        
    4,142    
    4,142    
    4,142 
Impact of transactions affecting NCI       
        
    (265)   
    (265)   265    
 
Balance – March 31, 2021   66,303   $7    448   $
   $401,842   $(245,032)  $156,817   $724   $157,541 
Net income (loss)       
        
    
    2,578    2,578    (16)   2,562 
Stock-based compensation       
        
    1,113    
    1,113    
    1,113 
Exercise of warrants   1    
    
    
    26    
    26    
    26 
Exercise of stock options   45    
        
    369    
    369    
    369 
Tax Receivable Agreement liability       
        
    (3)   
    (3)   
    (3)
Deferred income taxes       
        
    3    
    3    
    3 
Accrued distributions       
        
    (87)   
    (87)   
    (87)
Issuance of common stock   22    
    
    
    
    
    
    
    
 
Impact of transactions affecting NCI       
        
    (192)   
    (192)   192    
 
Balance – June 30, 2021   66,371   $7    448   $
   $403,071   $(242,454)  $160,624   $900   $161,524 
Net income (loss)                       2,171    2,171    (44)   2,127 
Stock-based compensation                   765        765        765 
Exercise of warrants   6                149        149        149 
Exercise of stock options   72                590        590        590 
Tax Receivable Agreement liability                   4        4        4 
Deferred income taxes                   (5)       (5)       (5)
Accrued distributions                   (304)       (304)       (304)
Impact of transactions affecting NCI                   (56)       (56)   56     
Balance – September 30, 2021   66,449   $7    448   $   $404,214   $(240,283)  $163,938   $912   $164,850 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

3

 

 

PURPLE INNOVATION, INC.

Condensed Consolidated Statements of Cash Flows

(unaudited – in thousands)

 

   Nine Months Ended
September 30,
 
   2022   2021 
Cash flows from operating activities:        
Net income (loss)  $(19,760)  $25,628 
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:          
Depreciation and amortization   12,205    6,355 
Non-cash interest   883    388 
Change in fair value – warrant liabilities   (4,221)   (19,369)
Tax receivable agreement (income) expense   
    (639)
Stock-based compensation   2,612    2,357 
Gain from effective settlement of preexisting relationship   (1,421)   
 
Deferred income taxes   (6,850)   (1,737)
Changes in operating assets and liabilities:          
Accounts receivable   459    1,541 
Inventories   11,479    (18,319)
Prepaid expenses and other assets   (108)   2,169 
Operating leases, net   6,405    1,537 
Accounts payable   (26,615)   (2,199)
Accrued sales returns   (1,816)   (1,525)
Accrued compensation   1,590    (817)
Customer prepayments   (7,122)   3,030 
Accrued rebates and allowances   (2,118)   (2,820)
Other accrued liabilities   3,924    4,552 
Net cash provided by (used in) operating activities   (30,474)   132 
           
Cash flows from investing activities:          
Cash, cash equivalents and restricted cash acquired from acquisition, net of cash paid   3,648    
 
Purchase of property and equipment   (31,422)   (40,146)
Investment in intangible assets   (2,637)   (1,352)
Net cash used in investing activities   (30,411)   (41,498)
           
Cash flows from financing activities:          
Payments on term loan   (2,531)   (1,688)
Payments on revolving line of credit   (55,000)   
 
Payments for debt issuance costs   (1,242)   
 
Proceeds from stock offering   93,125    
 
Payments for public offering costs   (259)   
 
Proceeds from InnoHold indemnification payment   
    4,142 
Tax receivable agreement payments   (5,847)   (628)
Distributions to members   
    (957)
Proceeds from exercise of warrants   
    116 
Proceeds from exercise of stock options   166    1,042 
Net cash provided by financing activities   28,412    2,027 
           
Net decrease in cash   (32,473)   (39,339)
Cash, cash equivalents and restricted cash, beginning of the year   91,616    122,955 
Cash, cash equivalents and restricted cash, end of the period  $59,143   $83,616 
           
Supplemental disclosures of cash flow information:          
Cash paid during the period for interest, net of amounts capitalized  $1,832   $389 
Cash paid during the period for income taxes  $219   $4,495 
           
Supplemental schedule of non-cash investing and financing activities:          
Property and equipment included in accounts payable  $3,463   $5,707 
Issuance of common stock for Intellibed acquisition  $26,106   $
 
Non-cash leasehold improvements  $
   $3,238 
Accrued distributions  $228   $304 
Tax receivable agreement liability  $
   $776 
Deferred income taxes  $
   $969 
Exercise of liability warrants  $
   $64,321 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

4

 

 

PURPLE INNOVATION, INC.

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

1. Organization

 

The Company’s mission is to improve the lives of our consumers by delivering innovative better sleep solutions.

 

Purple Innovation, Inc. collectively with its subsidiary (the “Company” or “Purple Inc.”) is a digitally-native vertical brand founded on comfort product innovation with premium offerings. The Company designs and manufactures a variety of innovative, branded and premium comfort products, including mattresses, pillows, cushions, bases, sheets, and other products. The Company markets and sells its products through its e-commerce online channels, retail brick-and-mortar wholesale partners, Purple retail showrooms, and third-party online retailers.

 

The Company was incorporated in Delaware on May 19, 2015 as a special purpose acquisition company under the name of Global Partnership Acquisition Corp (“GPAC”).

 

On February 2, 2018, the Company consummated a transaction structured similar to a reverse recapitalization (the “Business Combination”) pursuant to which the Company acquired a portion of the equity of Purple Innovation, LLC (“Purple LLC”). At the closing of the Business Combination (the “Closing”), the Company became the sole managing member of Purple LLC, and GPAC was renamed Purple Innovation, Inc. As the sole managing member of Purple LLC, Purple Inc. through its officers and directors is responsible for all operational and administrative decision making and control of the day-to-day business affairs of Purple LLC without the approval of any other member.

 

On August 31, 2022, the Company acquired all of the issued and outstanding stock of Advanced Comfort Technologies, Inc., dba Intellibed (“Intellibed”) pursuant to an Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which Gelato Merger Sub, Inc., a wholly owned subsidiary of Purple Inc., merged with and into Intellibed, with Intellibed continuing as a wholly owned subsidiary of Purple Inc. For further discussion see Note 4 — Acquisition.

 

2. Summary of Significant Accounting Policies

 

Basis of Presentation and Principles of Consolidation

 

The condensed consolidated financial statements include the accounts of Purple Inc., its controlled subsidiary Purple LLC and its wholly owned subsidiary, Intellibed, from the date of acquisition. All intercompany balances and transactions have been eliminated in consolidation. As of September 30, 2022, Purple Inc. held 99.5% of the common units of Purple LLC and Purple LLC Class B Unit holders held 0.5% of the common units in Purple LLC.

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting and reflect the financial position, results of operations and cash flows of the Company. Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. As such, these unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2021. The unaudited condensed consolidated financial statements were prepared on the same basis as the audited consolidated financial statements and, in the opinion of management, reflect all adjustments (all of which were considered of normal recurring nature) considered necessary to present fairly the Company’s financial results. The results of the three and nine months ended September 30, 2022 are not necessarily indicative of the results to be expected for the fiscal year ending December 31, 2022 or for any other interim period or other future year.

 

Variable Interest Entities

 

Purple LLC is a variable interest entity. The Company determined that it is the primary beneficiary of Purple LLC as it is the sole managing member and has the power to direct the activities most significant to Purple LLC’s economic performance as well as the obligation to absorb losses and receive benefits that are potentially significant. At September 30, 2022, Purple Inc. had a 99.5% economic interest in Purple LLC and consolidated 100% of Purple LLC’s assets, liabilities and results of operations in the Company’s unaudited condensed consolidated financial statements contained herein. The holders of Purple LLC Class B Units (the “Class B Units”) held 0.5% of the economic interest in Purple LLC as of September 30, 2022. For further discussion see Note 16 — Stockholders’ Equity.

 

5

 

 

PURPLE INNOVATION, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

Use of Estimates

 

The preparation of the unaudited condensed consolidated financial statements in conformity with GAAP requires the Company to establish accounting policies and to make estimates and judgments that affect the reported amounts of assets and liabilities and disclose contingent assets and liabilities as of the date of the unaudited condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. The Company bases its estimates on historical experience and on various other assumptions believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. The Company regularly makes significant estimates and assumptions including, but not limited to, estimates that affect revenue recognition, accounts receivable and allowance for doubtful accounts, valuation of inventories, sales returns, warranty returns, warrant liabilities, stock based compensation, the recognition and measurement of loss contingencies, business combinations, estimates of current and deferred income taxes, deferred income tax valuation allowances and amounts associated with the Company’s tax receivable agreement with InnoHold, LLC (“InnoHold”). Predicting future events is inherently an imprecise activity and, as such, requires the use of judgment. Actual results could differ materially from those estimates.

 

Restructuring Charges

 

In February and April 2022, because of lower-than-expected demand and higher labor and overhead costs that adversely affected our results of operations in the fourth quarter of 2021, which continued into the first quarter of 2022, the Company completed a restructuring of its workforce to balance production, improve efficiencies and realign the Company’s cost structure to focus on quality of earnings in our current core business. As a result of the realignment and restructuring, the Company reduced employee headcount and incurred severance charges of $2.0 million during the nine months ended September 30, 2022.

 

In June 2022, the Company incurred a one-time separation fee of $3.1 million with a professional services provider for not continuing with their services. The fee was recorded as general and administrative expense in the condensed consolidated statement of operations for the nine months ended September 30, 2022.

 

The Company has also initiated other cost reduction and efficiency efforts to improve costs, increase margins and ensure compliance with debt covenants. If the Company’s cash flow from operations or other sources of financing are less than anticipated, the Company believes it will be able to fund operating expenses and comply with debt covenants based on its ability to scale back operations, reduce marketing spend, use the liquidity available under its revolving line of credit and postpone or discontinue growth strategies. In addition, in order to continue satisfying the conditions of the debt agreement the Company may be required to scale back operations, reduce marketing spend, prepay debt and postpone or discontinue our growth strategies.

 

Recent Accounting Pronouncements

 

Reference Rate Reform

 

In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting (“ASU 2020-04”), which provides guidance to alleviate the burden in accounting for reference rate reform by allowing certain expedients and exceptions in applying generally accepted accounting principles to contracts, hedging relationships, and other transactions impacted by reference rate reform. The provisions of ASU 2020-04 apply only to those transactions that reference LIBOR or another reference rate expected to be discontinued due to reference rate reform. This standard is currently effective and upon adoption may be applied prospectively to contract modifications made on or before December 31, 2022, when the reference rate replacement activity is expected to be completed. The Company does not currently have any receivables, hedging relationships, lease agreements, or debt agreements that reference LIBOR or another reference rate expected to be discontinued. In February 2022, the Company entered into an amendment to its 2020 financing arrangement that changed the interest reference rate on its term loan and revolving line of credit from LIBOR to the Secured Overnight Financing Rate (“SOFR”). The change to SOFR did not have any impact on the Company’s condensed consolidated financial statements – see Note 11—Debt for discussion of this amendment.

 

6

 

 

PURPLE INNOVATION, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

Measurement of Credit Losses

 

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”), which was further updated and clarified by the FASB through issuance of additional related ASUs. This guidance replaces the existing incurred loss impairment guidance and establishes a single allowance framework for financial assets carried at amortized cost based on expected credit losses. The estimate of expected credit losses requires the incorporation of historical information, current conditions, and reasonable and supportable forecasts. These updates are effective for public companies, excluding Smaller Reporting Companies (“SRC”), for annual periods beginning after December 15, 2019, including interim periods therein. The standard is effective for all other entities for annual periods beginning after December 15, 2022, including interim periods therein. The standard is effective for the Company’s interim and annual financial periods beginning January 1, 2023. This standard is to be applied utilizing a modified retrospective approach. The Company is currently evaluating the impact of this standard on its accounts receivable, cash, cash equivalents and restricted cash, and any other financial assets measured at amortized cost.

 

3. Underwritten Offering

 

In March 2022, the Company completed an underwritten offering of 16.1 million shares of Class A common stock, which included the underwriters exercising their over-allotment option in full to purchase an additional 2.1 million shares. The underwriter purchased the Class A common stock from the Company at a price of $5.65 per share, except that any shares sold by the underwriter to Coliseum Capital Partners, L.P. and Blackwell Partners LLC – Series A, up to an aggregate of 29.81% of the shares of Class A common stock pursuant to the offering, were purchased from the Company by the underwriter at a price of $6.10 per share. The aggregate gross proceeds received by the Company from the offering, including the exercise of the over-allotment, was $93.1 million. After deducting offering expenses of $0.2 million, aggregate net proceeds totaled $92.9 million.

 

4. Acquisition

 

On August 31, 2022, pursuant to the Merger Agreement, the Company acquired Intellibed, a premium sleep and health wellness company, offering gel-based mattresses scientifically designed for maximum back support, spinal alignment and pressure point relief. We believe that the addition of Intellibed will increase product offerings to customers, expand market opportunities, capitalize on synergies of the combined companies, and increase opportunities for innovation. In addition, the acquisition allowed the Company to consolidate ownership of its intellectual property and more fully capitalize on growing demand for products with gel technologies.

 

The acquisition date fair value of the consideration transferred for Intellibed was $28.3 million, which consisted of the following (in thousands):

 

Fair value of Class A common stock issued at closing  $23,069 
Fair value of Class A common stock held in escrow   1,467 
Fair value of contingent consideration   1,471 
Fair value of effective settlement of preexisting relationships   1,672 
Transaction expenses paid on behalf of Intellibed   546 
Due to seller   75 
Fair value of total purchase consideration  $28,300 

 

The fair value of common stock issued at closing consisted of 8.1 million shares of Class A common stock valued using the acquisition date closing price of $2.86. The fair value of common stock held in escrow consisted of 0.5 million shares of Class A common stock valued using the acquisition date closing price of $2.86. These shares are being held in escrow pending resolution of net working capital adjustments and certain indemnification matters, as described in the Merger Agreement.

 

Contingent consideration represents the fair value of 1.5 million shares of Class A common stock issuable to Intellibed security holders if the closing price of the Company’s stock does not equal or exceed $5.00 for at least ten trading days over any period of 30 consecutive trading days during the period beginning on the six-month anniversary of the closing date and ending on the 18-month anniversary of the closing date. The contingent shares were valued using a Monte-Carlo simulation model. Because the contingent consideration is payable with a fixed number of shares of the Company’s Class A common stock, it is classified as equity and will not require remeasurement in subsequent periods.

 

The fair value of effective settlement of preexisting relationships includes $1.4 million related to the fair value of a preexisting legal matter with Intellibed that was effectively settled on the acquisition date and $0.3 million related to the fair value of a preexisting royalty liability owed by Intellibed to the Company that was also effectively settled on the acquisition date. As a result of effectively settling the preexisting legal matter with Intellibed, the Company recorded a gain of $1.4 million as other income (expense), net in the condensed consolidated statement of operations for the three and nine months ended September 30, 2022. As a result of effectively settling the preexisting royalty liability, the Company and Intellibed recorded a corresponding receivable and payable, respectively, for the same $0.3 million amount that was eliminated in consolidation as of September 30, 2022.

 

7

 

 

PURPLE INNOVATION, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

The Company recorded the acquisition based on the fair value of the consideration transferred and then allocated the purchase price to the identifiable assets acquired and liabilities assumed based on their respective preliminary estimated fair values as of the acquisition date. Determining the fair value of assets acquired and liabilities assumed required management to use significant judgment and estimates including the selection of valuation methodologies, estimates of future revenues and cash flows, discount rates, and asset lives, among other items. While the Company used its best estimates and assumptions as a part of the purchase price allocation process to accurately value the assets acquired, including intangible assets, and the liabilities assumed at the acquisition date, the Company’s estimates are inherently uncertain and subject to refinement. Due to the close proximity of the acquisition date to the Company’s reporting date, the Company recorded the assets acquired and liabilities assumed at their preliminary estimated fair values. As of September 30, 2022, the Company had not finalized the determination of the working capital adjustments and the fair values allocated to various assets and liabilities, intangible assets and the residual amount allocated to goodwill. Consequently, during the measurement period, which could be up to one year from the acquisition date, the Company may record adjustments to the fair values of the assets acquired and the liabilities assumed, with a corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or the liabilities assumed, whichever comes first, any subsequent adjustments will be reflected in the Company’s condensed consolidated statement of operations.

 

Based upon the purchase price allocation, the following table summarizes the preliminary fair value of the assets acquired and liabilities assumed at the date of the acquisition (in thousands):

 

Net tangible assets (liabilities):

Cash, cash equivalents and restricted cash  $4,194 
Accounts receivable   5,051 
Inventory   4,182 
Other current assets   126 
Property and equipment   7,000 
Operating lease right-of-use assets   5,491 
Other long-term assets   68 
Accounts payable   (2,285)
Other current liabilities   (2,818)
Operating lease obligations   (4,373)
Deferred tax liabilities   (3,868)
Net tangible assets (liabilities)   12,768 
Goodwill   6,441 
Customer relationships   8,476 
Developed technology   615 
Net assets acquired and liabilities assumed  $28,300 

 

The Company believes the amount of goodwill resulting from the purchase price allocation is primarily attributable to expected synergies from the assembled workforce, an increase in development capabilities, increased offerings to customers, expanded market opportunities, and enhanced opportunities for growth and innovation. Goodwill will not be amortized but instead will be tested for impairment at least annually or more frequently if certain indicators of impairment are present. In the event that goodwill has become impaired, the Company will record an expense for the amount impaired during the quarter in which the determination is made. The goodwill recorded is not deductible for income tax purposes.

 

The two identified definite lived intangible assets, comprised of customer relationships and developed technology, will be amortized over their estimated useful lives of ten and three years, respectively. The customer relationships intangible asset represents the estimated fair value of the underlying relationships with Intellibed customers, valued utilizing the multi-period excess earnings method. The developed technology intangible represents the fair value of Intellibed industry-specific cloud and mobile software and related technologies, valued using the cost to recreate method.

 

The cash, cash equivalents and restricted cash balance acquired includes $1.7 million of cash deposited by Intellibed in a separate account pursuant to an escrow agreement with the Company. The purpose of the escrow cash amount is to cover Intellibed’s estimated state income tax liabilities, sales tax liabilities and related filing expenses that existed prior to the acquisition date. If the actual liabilities are less than estimated, any excess cash would be returned to the previous shareholders of Intellibed. If payments for these items exceed the escrow balance, the Company will be required to pay the excess. The Company recorded the $1.7 million of cash as an acquired restricted cash balance that is included in cash, cash equivalents and restricted cash in the condensed consolidated balance sheet as of September 30, 2022. The Company also recorded an assumed liability totaling $1.3 million for the sales and use tax and state and local income tax liabilities exposure that is reflected in other current liabilities in the condensed consolidated balance sheet as of September 30, 2022.

 

The Company has included the financial results of Intellibed in its condensed consolidated financial statements from the date of acquisition and recorded net revenues and pre-tax income of $2.7 million and $1.3 million, respectively, for the period from August 31, 2022 through September 30, 2022. The transaction costs associated with the acquisition of $2.8 million were recorded as general and administrative expense in the condensed consolidated statement of operations for the three and nine months ended September 30, 2022.

 

8

 

 

PURPLE INNOVATION, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

The following table provides unaudited pro forma financial information as if Intellibed had been acquired by the Company as of January 1, 2021. The unaudited pro forma information reflects adjustments for transaction and litigation expenses, immediate restructuring savings and additional depreciation and amortization resulting from the fair value adjustments to assets acquired. The pro forma results do not include any other anticipated cost synergies or effects of the combined companies. Accordingly, pro forma amounts are not necessarily indicative of the results to be expected had the acquisition been completed on the date indicated, nor is it indicative of the future operating results of the combined company (in thousands):

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2022     2021     2022     2021  
Net revenues   $ 150,517     $ 184,507     $ 461,106     $ 577,990  
Net income (loss)     6,993       5,499       (12,489 )     33,727  

 

The unaudited pro forma amounts above include the following adjustments:

 

A decrease of operating expenses by $4.4 million during the three and nine months ended September 30, 2022, to eliminate transaction costs directly related to the acquisition that do not have a continuing impact on operating results.

 

A decrease of operating expenses by $0.4 million and $1.3 million during the nine months ended September 30, 2022 and 2021, respectively, to eliminate litigation costs directly related to the lawsuit between the two Companies.

 

A decrease of operating expenses by $1.0 million and $0.2 million during the three months ended September 30, 2022 and 2021, respectively and $1.5 million and $0.4 million during the nine months ended September 30, 2022 and 2021, respectively, to eliminate costs directly related to immediate restructuring that do not have a continuing impact on operating results.

 

An increase of operating expenses by $0.5 million and $0.4 million during the three months ended September 30, 2022 and 2021, respectively and $1.5 million and $0.8 million during the nine months ended September 30, 2022 and 2021, respectively, to reflect the additional depreciation and amortization expense related to the increase in property and equipment assets and definite lived intangible assets.

 

The combined pro forma results were tax effected using the Company’s effective tax rate for the respective periods.

 

5. Fair Value Measurements

 

The Company uses the fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, essentially an exit price, based on the highest and best use of the asset or liability. The levels of the fair value hierarchy are:

 

Level 1—Quoted market prices in active markets for identical assets or liabilities;

 

Level 2—Significant other observable inputs (i.e., quoted prices for similar items in active markets, quoted prices for identical or similar items in markets that are not active, inputs other than quoted prices that are observable, such as interest rate and yield curves, and market-corroborated inputs); and

 

Level 3—Unobservable inputs in which there is little or no market data, which require the reporting unit to develop its own assumptions.

 

9

 

 

PURPLE INNOVATION, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

The classification of fair value measurements within the established three-level hierarchy is based upon the lowest level of input that is significant to the measurements. Financial instruments, although not recorded at fair value on a recurring basis include cash and cash equivalents, receivables, accounts payable and the Company’s debt obligations. The carrying amounts of cash and cash equivalents, receivables and accounts payable approximate fair value because of the short-term nature of these accounts. The fair value of the Company’s debt instruments is estimated to be face value based on the contractual terms of the debt arrangements and market-based expectations.

 

The sponsor warrant liabilities (see Note 12 — Warrant Liabilities for more information) are Level 3 instruments and use internal models to estimate fair value using certain significant unobservable inputs which requires determination of relevant inputs and assumptions. Accordingly, changes in these unobservable inputs may have a significant impact on fair value. Such inputs include risk free interest rate, expected average life, expected dividend yield, and expected volatility. These Level 3 liabilities generally decrease (increase) in value based upon an increase (decrease) in risk free interest rate and expected dividend yield. Conversely, the fair value of these Level 3 liabilities generally increase (decrease) in value if the expected average life or expected volatility were to increase (decrease).

 

The following table presents information about the Company’s liabilities that are measured at fair value on a recurring basis and indicates the fair value hierarchy of the valuation inputs the Company utilized to determine such fair value (dollars in thousands):

 

   Level   September 30,
2022
   December 31,
2021
 
Sponsor warrants   3   $122   $4,343 

 

The following table summarizes the Company’s total Level 3 liability activity for the nine months ended September 30, 2022 and 2021 (in thousands):

 

   Sponsor
Warrants
 
Fair value as of December 31, 2021  $4,343 
Fair value of warrants exercised   
 
Change in valuation inputs(1)   (4,221)
Fair value as of September 30, 2022  $122 
      
Fair value as of December 31, 2020  $92,708 
Fair value of warrants exercised   (64,321)
Change in valuation inputs(1)   (19,369)
Fair value as of September 30, 2021  $9,018 

 

(1) Changes in valuation inputs are recognized as the change in fair value – warrant liabilities in the condensed consolidated statement of operations.

 

6. Revenue from Contracts with Customers

 

The Company markets and sells its products through e-commerce online channels, retail brick-and-mortar wholesale partners, Purple retail showrooms, and third-party online retailers. Revenue is recognized when the Company satisfies its performance obligations. These performance obligations generally relate to delivering products to a customer, subject to the shipping terms of the contract.

 

10

 

 

PURPLE INNOVATION, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

Disaggregated Revenue

 

The Company classifies revenue into two sales categories: Direct-to-Consumer (“DTC”) and wholesale. The DTC category is comprised of the Company’s e-commerce channel that sells directly to consumers who purchase online and through our contact center, and the Purple retail showrooms channel that sells directly to consumers who purchase at a Company showroom location. The wholesale category includes all product sales to our retail brick and mortar wholesale partners where consumers make purchases at their retail locations or through their online channels. The Company classifies products into two major types: sleep products and other. Sleep products include mattresses, platforms, adjustable bases, mattress protectors, pillows and sheets. Other products include cushions and various other products.

 

The following tables present the Company’s net revenue disaggregated by sales category and product type (in thousands):

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
Channel  2022   2021   2022   2021 
DTC  $84,601   $112,863   $251,764   $353,985 
Wholesale   58,679    57,918    178,804    185,811 
Revenues, net  $143,280   $170,781   $430,568   $539,796 

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
Product  2022   2021   2022   2021 
Sleep products  $131,136   $156,077   $391,841   $494,628 
Other   12,144    14,704    38,727    45,168 
Revenues, net  $143,280   $170,781   $430,568   $539,796 

 

Contract Balances

 

Payment for sale of products through the e-commerce online channel, third-party online retailers, Purple retail showrooms and contact center is collected at point of sale in advance of shipping the products. Amounts received for unshipped products are recorded as customer prepayments. Customer prepayments totaled $3.8 million and $10.9 million at September 30, 2022 and December 31, 2021, respectively. During the three months ended September 30, 2022 and 2021, the Company recognized all revenue that was deferred in customer prepayments at June 30, 2022 and 2021, respectively.

 

7. Inventories, Net

 

Inventories, net consisted of the following (in thousands):

 

   September 30,   December 31, 
   2022   2021 
Raw materials  $33,593   $33,609 
Work-in-process   3,332    4,023 
Finished goods   55,511    63,419 
Inventory obsolescence reserve   (1,043)   (2,361)
Inventories, net  $91,393   $98,690 

 

11

 

 

PURPLE INNOVATION, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

8. Property and Equipment, Net

 

Property and equipment, net consisted of the following (in thousands):

 

   September 30,   December 31, 
   2022   2021 
Equipment  $65,688   $58,094 
Equipment in progress   20,490    19,840 
Leasehold improvements   53,478    38,098 
Furniture and fixtures   24,853    12,482 
Office equipment   4,393    4,843 
Total property and equipment   168,902    133,357 
Accumulated depreciation   (31,484)   (20,743)
Property and equipment, net  $137,418   $112,614 

 

Equipment in progress reflects equipment, primarily related to mattress manufacturing, which is being constructed and was not in service at September 30, 2022 or December 31, 2021. Interest capitalized on borrowings during the active construction period of major capital projects totaled $0.2 million and $0.6 million during the three and nine months ended September 30, 2022, respectively, and totaled $0.8 million and $0.8 million during the three and nine months ended September 30, 2021, respectively. Depreciation expense was $4.3 million and $11.4 million during the three and nine months ended September 30, 2022, respectively, and totaled $2.8 million and $6.2 million during the three and nine months ended September 30, 2021, respectively.

 

9. Leases

 

The Company leases its manufacturing and distribution facilities, corporate offices, Purple retail showrooms and certain equipment under non-cancelable operating leases with various expiration dates through 2036. The Company’s office and manufacturing leases provide for initial lease terms up to 16 years, while Purple retail showrooms have initial lease terms of up to ten years. Certain leases may contain options to extend the term of the original lease. The exercise of lease renewal options is at the Company’s discretion. Any lease renewal options are included in the lease term if exercise is reasonably certain at lease commencement. The Company also leases vehicles and other equipment under both operating and finance leases with initial lease terms of three to five years. The right-of-use asset for finance leases was $1.2 million and $0.7 million at September 30, 2022 and December 31, 2021, respectively.

 

The following table presents the Company’s lease costs (in thousands):

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2022   2021   2022   2021 
Operating lease costs  $4,213   $2,329   $11,051   $6,200 
Variable lease costs   386    819    1,509    1,396 
Short-term lease costs   
    67    11    191 
Total lease costs  $4,599   $3,215   $12,571   $7,787 

 

12

 

 

PURPLE INNOVATION, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

The table below reconciles the undiscounted cash flows for each of the first five years and total remaining years to the operating lease liabilities recorded on the condensed consolidated balance sheet at September 30, 2022 (in thousands):

 

2022 (excluding the nine months ended September 30, 2022)(1)  $1,661 
2023   20,184 
2024   19,085 
2025   18,827 
2026   18,920 
Thereafter   89,985 
Total operating lease payments   168,662 
Less – lease payments representing interest   (41,585)
Present value of operating lease payments  $127,077 

 

(1) Amount consists of $4.9 million of undiscounted cash flows offset by $3.2 million of tenant improvement allowances which are expected to be fully utilized in fiscal 2022.

 

As of September 30, 2022 and December 31, 2021, the weighted-average remaining term of operating leases was 9.2 years and 10.7 years, respectively, and the weighted-average discount rate of operating leases was 5.45% and 5.30%, respectively.

 

The following table provides supplemental information related to the Company’s condensed consolidated statement of cash flows for the nine months ended September 30, 2022 and 2021 (in thousands):

 

   Nine Months Ended
September 30,
 
   2022   2021 
Cash paid for amounts included in present value of operating lease liabilities  $5,866   $1,824 
Right-of-use assets obtained in exchange for operating lease liabilities   34,712    23,751 

 

10. Other Current Liabilities

 

Other current liabilities consisted of the following (in thousands):

 

   September 30,   December 31, 
   2022   2021 
Warranty accrual – current portion  $4,607   $3,914 
Insurance financing   2,254    1,043 
Long-term debt, net of unamortized issuance costs – current portion   2,137    2,297 
Accrued sales tax liability assumed in acquisition   937    
 
Accrued property taxes   643    
 
Accrued affiliate marketing   471    135 
Tax receivable agreement liability – current portion   269    5,847 
Other   754    234 
Total other current liabilities  $12,072   $13,470 

 

13

 

 

PURPLE INNOVATION, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

11. Debt

 

Debt consisted of the following (in thousands):

 

   September 30,   December 31, 
   2022   2021 
Term loan  $39,656   $42,188 
Revolving line of credit   
    55,000 
Less: unamortized issuance costs   (1,068)   (778)
Total debt   38,588    96,410 
Less: current portion of debt, net of unamortized issuance costs   (2,137)   (2,297)
Long-term debt, net  $36,451   $94,113 

 

Term Loan and Revolving Line of Credit

 

On September 3, 2020, Purple LLC entered into a financing arrangement with KeyBank National Association and a group of financial institutions (the “2020 Credit Agreement”). The 2020 Credit Agreement provides for a $45.0 million term loan and a $55.0 million revolving line of credit. The term loan will be repaid in accordance with a five-year amortization schedule and may be prepaid in whole or in part at any time without premium or penalty, subject to reimbursement of certain costs. The revolving credit facility has a term of five years and carries the same interest provisions as the term debt. A commitment fee is due quarterly based on the applicable margin applied to the unused total revolving commitment. The initial borrowing rate of 3.50% was based on LIBOR plus 3.00%.

 

Pursuant to a Pledge and Security Agreement between Purple LLC, KeyBank and the Company (the “Security Agreement”), the 2020 Credit Agreement is secured by a perfected first-priority security interest in the assets of Purple LLC and the Company, including a security interest in all intellectual property. Also, the Company agreed to an unconditional guaranty of the payment of all obligations and liabilities of Purple LLC under the 2020 Credit Agreement. The Security Agreement contains a pledge, as security for the Company’s guaranty, of all its ownership interest in Purple LLC. The 2020 Credit Agreement also provides for standard events of default, such as for non-payment and failure to perform or observe covenants, and contains standard indemnifications benefitting the lenders.

 

The 2020 Credit Agreement includes representations, warranties and certain covenants of Purple LLC and the Company. While any amounts are outstanding under the 2020 Credit Agreement, Purple LLC is subject to several affirmative and negative covenants, including covenants regarding dispositions of property, investments, forming or acquiring subsidiaries, business combinations or acquisitions, incurrence of additional indebtedness, and transactions with affiliates, among other customary covenants, subject to certain exceptions. In particular, Purple LLC is (i) subject to annual capital expenditure limits that can be adjusted based on the Company achieving certain net leverage ratio thresholds as provided in the 2020 Credit Agreement, (ii) restricted from incurring additional debt up to certain amounts, subject to limited exceptions, as set forth in the 2020 Credit Agreement, and (iii) maintain minimum consolidated net leverage and fixed charge coverage ratio thresholds at certain measurement dates (as defined in the 2020 Credit Agreement). Purple LLC is also restricted from paying dividends or making other distributions or payments on its capital stock, subject to limited exceptions. If the Company or Purple LLC fail to perform their obligations under these and other covenants, or should any event of default occur, the revolving loan commitments under the 2020 Credit Agreement may be terminated and any outstanding borrowings, together with accrued interest, could be declared immediately due and payable.

 

14

 

 

PURPLE INNOVATION, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

The Company’s operating and financial results for the year ended December 31, 2021 did not satisfy the financial and performance covenants required under the 2020 Credit Agreement. On February 28, 2022, prior to the covenant compliance certification date, the Company entered into the first amendment of the 2020 Credit Agreement to avoid a breach of these covenants and potential default. This amendment contained a covenant waiver period such that the net leverage ratio and fixed charge coverage ratio were not tested for the fiscal quarters ended December 31, 2021, March 31, 2022 and June 30, 2022. Other modifications in the amendment included revised leverage ratio and fixed charge coverage definitions and thresholds, the addition of minimum liquidity requirements with mandatory prepayments of the revolving loan if cash exceeded $25.0 million, new weekly and monthly reporting requirements, limits on the amount of capital expenditures, the addition of a lease incurrence test for opening additional showrooms, and additional negative covenants during a covenant amendment period that extends into 2023 until certain conditions are met. In addition, the interest rate on any outstanding borrowings under the 2020 Credit Agreement was changed from LIBOR with a floor of 0.5% plus an applicable margin (historically at 3.0%) to an initial rate of SOFR with a floor of 0.5% plus an applicable margin of 4.75%, for a total rate of 5.25% if the applicable liquidity threshold is met. If the Company does not meet this threshold, the interest rate would increase to SOFR with a floor of 0.5% plus 9.00%. Once the Company achieves a consolidated leverage ratio that is below 3.00 to 1.00, the interest rate will be based on SOFR with a floor of 0.5% plus a 3.00% to 3.75% margin depending on the consolidated leverage ratio. The interest rate on the term loan was 6.07% as of September 30, 2022. As of September 30, 2022, the Company was in compliance with all of the financial covenants related to the 2020 Credit Agreement, as amended.

 

Pursuant to the first amendment of the 2020 Credit Agreement, the Company incurred fees and expenses of $0.9 million that were recorded as debt issuance costs in the condensed consolidated balance sheet and made a $2.5 million payment on the term loan to cover the four quarterly principal payments due in 2022. The Company accounted for this amendment as a modification of existing debt in accordance with ASC 470 – Debt.

 

On March 23, 2022, the Company entered into a second amendment to the 2020 Credit Agreement. This amendment modified the 2020 Credit Agreement to allow Coliseum Capital Management, LLC (“CCM”) and its investment affiliates to acquire 35% or more of the combined voting power of all equity interests of the Company entitled to vote for the election of members of the Company’s board of directors without constituting an event of default. CCM is considered a related party of the Company in that Adam Gray, a member of our board of directors, serves as a managing partner of CCM. For further discussion see Note 15—Related Party TransactionsColiseum Capital Management, LLC. Pursuant to the second amendment of the 2020 Credit Agreement, the Company incurred fees and expenses of $0.4 million that were recorded as debt issuance costs in the condensed consolidated balance sheet. The Company accounted for this amendment as a modification of existing debt in accordance with ASC 470 – Debt.

 

On May 13, 2022 and September 9, 2022, the Company entered into a third and fourth amendment, respectively, to the 2020 Credit Agreement. These amendments modified the permitted leases schedule to reflect a change in showroom locations and a new lease for an innovation building. The amendments did not meet the criteria for a modification of existing debt and minimal expenses were recorded as general and administrative expense in the condensed consolidated statement of operations.

 

On July 14, 2022, the Company received consent under the 2020 Credit Agreement allowing the Company’s acquisition of Intellibed to constitute a permitted acquisition under the 2020 Credit Agreement. The Company incurred fees and expenses of $0.3 million that were recorded as general and administrative expense in the condensed consolidated statement of operations.

 

In November 2021, the Company executed a $55.0 million draw on its revolving line of credit. On March 31, 2022, the Company used a portion of the net proceeds received from its March 2022 stock offering to repay in full the $55.0 million of principal outstanding on the revolving line of credit. As of September 30, 2022, there was no balance outstanding on the revolving credit facility.

 

15

 

 

PURPLE INNOVATION, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

Interest expense under the 2020 Credit Agreement totaled $0.9 million and $2.9 million for the three and nine months ended September 30, 2022, respectively, and totaled $0.5 million and $1.6 million for the three and nine months ended September 30, 2021, respectively.

 

12. Warrant Liabilities

 

The Company issued 12.8 million sponsor warrants pursuant to a private placement conducted simultaneously with its initial public offering. Each of these warrants entitles the registered holder to purchase one-half of one share of the Company’s Class A common stock at a price of $5.75 per half share ($11.50 per full share), subject to adjustment pursuant to the terms of the warrant agreement. In accordance with the warrant agreement, a warrant holder may exercise its warrants only for a whole number of shares of the Class A common stock. In no event will the Company be required to net cash settle any warrant. The warrants have a five-year term which commenced on March 2, 2018, 30 days after the completion of the Business Combination, and will expire on February 2, 2023, or earlier upon redemption or liquidation. These sponsor warrants contain certain provisions that do not meet the criteria for equity classification and therefore must be recorded as liabilities. The liability for these warrants was recorded at fair value on the date of the Business Combination and are subsequently re-measured to fair value at each reporting date or exercise date with changes in the fair value included in earnings.

 

During the nine months ended September 30, 2021, 6.6 million sponsor warrants were exercised resulting in the issuance of 2.3 million shares of Class A common stock. There were no sponsor warrants exercised during the nine months ended September 30, 2022. The 1.9 million sponsor warrants outstanding at September 30, 2022 and December 31, 2021 had fair values of $0.1 million and $4.3 million, respectively.

 

The Company determined the fair value of the sponsor warrants using the Black Scholes model with the following assumptions:

 

   September 30,
2022
   December 31,
2021
 
Trading price of common stock on measurement date  $4.05   $13.27 
Exercise price  $5.75   $5.75 
Risk free interest rate   3.33%   0.39%
Warrant life in years   0.3    1.1 
Expected volatility   117.78%   73.78%
Expected dividend yield   
    
 

 

During the three months ended September 30, 2022, the Company recognized a loss of $0.1 million in its condensed consolidated statement of operations related to an increase in the fair value of the sponsor warrants outstanding at the end of the period. For the nine months ended September 30, 2022, the Company recognized a gain of $4.2 million and during the three and nine months ended September 30, 2021, the Company recognized gains of $5.4 million and $19.4 million, respectively, in its condensed consolidated statements of operations related to decreases in the fair value of the sponsor warrants exercised during the respective periods or that were outstanding at the end of the respective periods.

 

13. Other Long-Term Liabilities

 

Other long-term liabilities consist of the following (in thousands):

 

   September 30,   December 31, 
   2022   2021 
Warranty accrual  $19,505   $15,013 
Other   2,088    962 
Total   21,593    15,975 
Less – current portion of warranty accrual   (4,607)   (3,914)
Other long-term liabilities, net of current portion  $16,986   $12,061 

 

16

 

 

PURPLE INNOVATION, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

14. Commitments and Contingencies

 

Warranty Liabilities

 

The Company provides a limited warranty on most of the products it sells. The estimated warranty costs, which are expensed at the time of sale and included in cost of revenues, are based on the results of product testing, industry and historical trends and warranty claim rates incurred, and are adjusted for any current or expected trends as appropriate. Actual warranty claim costs could differ from these estimates. The Company regularly assesses and adjusts the estimate of accrued warranty claims by updating claims rates for actual trends and projected claim costs.  The Company classifies estimated warranty costs expected to be paid beyond a year as a long-term liability.

 

The Company had the following activity for warranty liabilities (in thousands):

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2022   2021   2022   2021 
Balance at beginning of period  $17,709   $11,278   $15,013   $8,397 
Additions charged to expense for current period sales   2,722    2,488    7,057    6,686 
Acquired warranty liability   140    
    140    
 
Deduction from reserves for current period claims   (1,066)   (631)   (2,705)   (1,948)
Balance at end of period  $19,505   $13,135   $19,505   $13,135 

  

Required Member Distributions

 

Prior to the Business Combination and pursuant to the then applicable First Amended and Restated Limited Liability Company Agreement (the “First Purple LLC Agreement”), Purple LLC was required to distribute to its members an amount equal to 45 percent of Purple LLC’s net taxable income following the end of each fiscal year. The First Purple LLC Agreement was amended and replaced by the Second Amended and Restated Limited Liability Company Agreement (the “Second Purple LLC Agreement”) on February 2, 2018 as part of the Business Combination. The Second Purple LLC Agreement was amended and replaced by the Third Amended and Restated Limited Liability Company Agreement (the “Third Purple LLC Agreement”) on September 3, 2020. The Second Purple LLC Agreement and the Third Purple LLC Agreement do not include any mandatory distributions, other than tax distributions. During the nine months ended September 30, 2021, the Company paid $1.0 million in tax distributions under the Third Purple LLC Agreement. There were no tax distributions paid during the nine months ended September 30, 2022. At September 30, 2022, the Company’s condensed consolidated balance sheet had $0.1 million of accrued tax distributions included in other current liabilities.

 

Subscription Agreement and Preemptive Rights

 

In February 2018, in connection with the Business Combination, the Company entered into a subscription agreement with Coliseum Capital Partners (“CCP”) and Blackwell Partners LLC – Series A (“Blackwell”), pursuant to which CCP and Blackwell agreed to purchase from the Company an aggregate of 4.0 million shares of Class A Stock at a purchase price of $10.00 per share (the “Coliseum Private Placement”). In connection with the Coliseum Private Placement, the Sponsor assigned (i) an aggregate of 1.3 million additional shares of Class A common stock to CCP and Blackwell and (ii) an aggregate of 3.3 million warrants to purchase 1.6 million shares of Class A common stock to CCP, Blackwell, and Coliseum Co-Invest Debt Fund, L.P. (“CDF”). The subscription agreement provides CCP and Blackwell with preemptive rights with respect to future sales of the Company’s securities. It also provides them with a right of first refusal with respect to certain debt and preferred equity financings by the Company. The Company also entered into a registration rights agreement with CCP, Blackwell, and CDF, providing for the registration of the shares of Class A common stock issued and assigned to CCP and Blackwell in the Coliseum Private Placement, as well as the shares of Class A common stock underlying the warrants received by CCP, Blackwell and CDF. The Company has filed a registration statement with respect to such securities.

 

Rights of Securities Holders

 

The holders of certain warrants exercisable into Class A common stock, including CCP, Blackwell and CDF, were entitled to registration rights pursuant to certain registration rights agreements of the Company as of the Business Combination date. In March 2018, the Company filed a registration statement registering these warrants (and any shares of Class A common stock issuable upon the exercise of the warrants), and certain unregistered shares of Class A common stock. The registration statement was declared effective on April 3, 2018. Under the Registration Rights Agreement dated February 2, 2018 between the Company and CCP, Blackwell, and CDF (the “Coliseum Investors”), the Coliseum Investors have the right to make written demands for up to three registrations of certain warrants and shares of Class A common stock held by them, including in underwritten offerings. In an underwritten offering of such warrants and shares of Class A common stock by the Coliseum Investors, the Company will pay underwriting discounts and commissions and certain expenses incurred by the Coliseum Investors.

 

On May 21, 2021, 7.3 million shares of Class A common stock were sold in a secondary offering by the Coliseum Investors at a price of $30.00 per share. The Company did not receive any of the proceeds from the secondary offering. The underwriting discount, commission and other related costs incurred by the Company for the secondary offering totaled $7.9 million and was recorded in May 2021 as general and administrative expense.

 

17

 

 

PURPLE INNOVATION, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

Stockholder Rights Agreement

  

On September 25, 2022, with the authorization of the Board, a special committee of independent and disinterested directors of the Company (the “Special Committee”) approved the adoption of a limited-duration stockholder rights agreement (the “Rights Agreement”) with an expiration date of September 25, 2023. The Special Committee adopted the Rights Agreement in response to CCM’s substantial increase in ownership of the Company’s shares over the last year and the Special Committee’s desire to have the time and flexibility necessary to evaluate an unsolicited and non-binding proposal from CCM to acquire the outstanding common stock of the Company not already beneficially owned by CCM (See Note 15—Related Party TransactionsColiseum Capital Management, LLC). The Rights Agreement is intended to enable the Company’s shareholders to realize the full value of their investment and to guard against any attempts to gain control of the Company without paying all shareholders an appropriate control premium. The Rights Agreement applies equally to all current and future shareholders and does not deter any offer or preclude the Special Committee from considering an offer that is fair and otherwise in the best interests of the Company’s shareholders.

 

Upon adopting the Rights Agreement, 300,000 shares of the Company’s authorized shares of preferred stock, par value $0.0001 per share, were designated as Series A Junior Participating Preferred Shares (the “Preferred Shares”). In accordance with the Rights Agreement, on September 25, 2022, the Special Committee authorized and declared a dividend of one preferred share purchase right (a “Right”) for each outstanding share of the Company’s Class A and Class B common stock to stockholders of record at the close of business on October 6, 2022. Upon the occurrence of certain triggering events, each Right entitles the holder to purchase from the Company one one-thousandth of a share of the newly designated Preferred Shares at an exercise price of $20.00 (the “Exercise Price”). The Rights will be exercisable only if a person or group acquires beneficial ownership (including certain synthetic equity positions created by derivative securities) of 20% or more of the Company’s outstanding shares of common stock. Any person or group that beneficially owned more than the triggering percentage when the Board adopted the Rights Agreement may continue to own its shares of common stock but may not acquire any additional shares without triggering the Rights Agreement. If Rights become exercisable, each holder of a Right (other than the acquiring person or group whose Rights will automatically become void) will have the right to receive, upon exercise, Class A common stock having a value equal to two times the exercise price of the Right. Each Preferred Share, if issued, will not be redeemable, will entitle the holder, when, as and if declared, to quarterly dividend payments equal to the greater of $1,000 per share or 1,000 times the amount of all cash dividends plus 1,000 times the amount of non-cash dividends or other distributions paid on one share of common stock, will entitle the holder to receive $1,000 plus accrued and unpaid dividends per share upon liquidation, will have the same voting power as 1,000 shares of Class A common stock and, if shares of common stock are exchanged via merger, consolidation or a similar transaction, will entitle the holder thereof to a per share payment equal to the payment made on 1,000 shares of common stock.

 

The initial issuance of the Rights as a dividend will have no financial accounting or reporting impact. The fair value of the Rights will be nominal since the Rights are not exercisable when issued and no value is attributable to them. Additionally, the Rights do not meet the definition of a liability under GAAP and will therefore not be accounted for as a long-term obligation.  Accordingly, unless the Rights become exercisable as discussed above, the Rights Agreement has no impact on the Company’s condensed consolidated financial statements.

 

Purple LLC Class B Unit Exchange Right

 

On February 2, 2018, in connection with the closing of the Business Combination, the Company entered into an exchange agreement with Purple LLC and InnoHold and Class B Unit holders who become a party thereto (the “Exchange Agreement”), which provides for the exchange of Purple LLC Class B Units (the “Class B Units”) and shares of Class B common stock (together with an equal number of Class B Units, the “Paired Securities”) for, at the Company’s option, either (A) shares of Class A common stock at an initial exchange ratio equal to one Paired Security for one share of Class A common stock or (B) a cash payment equal to the product of the average of the volume-weighted closing price of one share of Class A common stock for the ten trading days immediately prior to the date InnoHold or other Class B Unit holders deliver a notice of exchange multiplied by the number of Paired Securities being exchanged. In December 2018, InnoHold distributed Paired Securities to Terry Pearce and Tony Pearce who agreed to become parties to the Exchange Agreement. In June 2019, InnoHold distributed Paired Securities to certain current and former employees who also agreed to become parties to the exchange agreement. Holders of Class B Units may elect to exchange all or any portion of their Paired Securities as described above by delivering a notice to Purple LLC.

 

In certain cases, adjustments to the exchange ratio will occur in case of a split, reclassification, recapitalization, subdivision or similar transaction of or relating to the Class B Units or the shares of Class A common stock and Class B common stock or a transaction in which the Class A common stock is exchanged or converted into other securities or property. The exchange ratio will also adjust in certain circumstances when the Company acquires Class B Units other than through an exchange for its shares of Class A common stock.

 

The right of a holder of Paired Securities to exchange may be limited by the Company if it reasonably determines in good faith that such restrictions are required by applicable law (including securities laws), such exchange would not be permitted under other agreements of such holder with the Company or its subsidiaries, including the Third Purple LLC Agreement, or if such exchange would cause Purple LLC to be treated as a “publicly traded partnership” under applicable tax laws.

 

18

 

 

PURPLE INNOVATION, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

The Company and each holder of Paired Securities shall bear its own expense regarding the exchange except that the Company shall be responsible for transfer taxes, stamp taxes and similar duties.

 

There were no Paired Securities exchanged for Class A common stock during the nine months ended September 30, 2022. During the nine months ended September 30, 2021, 0.1 million of Paired Securities were exchanged for shares of Class A common stock.

 

Maintenance of One-to-One Ratios

 

The Third Purple LLC Agreement includes provisions intended to ensure that the Company at all times maintains a one-to-one ratio between (a) (i) the number of outstanding shares of Class A common stock and (ii) the number of Class A Units owned by the Company (subject to certain exceptions for certain rights to purchase equity securities of the Company under a “poison pill” or similar stockholder rights plan, if any, certain convertible or exchangeable securities issued under the Company’s equity compensation plan and certain equity securities issued pursuant to the Company’s equity compensation plan (other than a stock option plan) that are restricted or have not vested thereunder) and (b) (i) the number of other outstanding equity securities of the Company (including the warrants exercisable for shares of Class A common stock) and (ii) the number of corresponding outstanding equity securities of Purple LLC. These provisions are intended to result in non-controlling interest holders having a voting interest in the Company that is identical to their economic interest in Purple LLC.

 

Non-Income Related Taxes

 

The U.S. Supreme Court ruling in South Dakota v. Wayfair, Inc., No.17-494, reversed a longstanding precedent that remote sellers are not required to collect state and local sales taxes. The Company cannot predict the effect of these and other attempts to impose sales, income or other taxes on e-commerce. The Company currently collects and reports on sales tax in all states in which it does business. However, the application of existing, new or revised taxes on the Company’s business, in particular, sales taxes, VAT and similar taxes would likely increase the cost of doing business online and decrease the attractiveness of selling products over the internet. The application of these taxes on the Company’s business could also create significant increases in internal costs necessary to capture data and collect and remit taxes. There have been, and will continue to be, substantial ongoing costs associated with complying with the various indirect tax requirements in the numerous markets in which the Company conducts or will conduct business.

 

Legal Proceedings

 

On September 9, 2019, Purple LLC filed a Statement of Claim against PerfectSense Home Inc. and PerfectSense Trading Co. Ltd. (collectively, “PerfectSense”) in the Federal Court of Canada. PerfectSense is a manufacturer and supplier of mattresses and related products. PerfectSense owns the domain name www.purplesleep.ca, which used to, but no longer, redirects to its website at www.perfectsense.ca. In addition to this, Purple LLC has alleged that PerfectSense has designed their mattresses with the same look as the Purple mattresses (white mattress top, purple stripe, and grey bottom); used many of the marketing elements on Purple’s website (including a similar “exploded view” image of their mattress); and adopted the color purple as their dominant marketing color. Purple LLC is suing for a declaration that PerfectSense has infringed Purple LLC’s copyright and trademark rights and committed the tort of passing off. Purple LLC is asking for injunctive relief, damages, an accounting of profits, interest, costs, and delivery up or destruction of the infringing products (including delivery up of the www.purplesleep.ca domain). After filing the statement of claim, Purple LLC posted $15,000 CAD as security for PerfectSense’s costs. PerfectSense brought a motion to strike that was resolved on consent. Pleadings are now closed, and the action is proceeding under case management. Counsel for the defendant was removed from the record at their own request by Court Order. The Court further ordered the defendant to either appoint counsel or file a motion to permit an officer or director to represent the defendant in legal proceedings. On November 6, 2020, the defendant informally requested that the Court permit Mr. Henderson, the CEO and shareholder of the defendant, to represent the defendant in the action until such time as a lawyer could be appointed. Purple opposed this informal request, and it was denied by the Court. After granting PerfectSense a final extension of time to either appoint counsel or file a motion to permit Mr. Henderson to represent the defendant, PerfectSense appointed new counsel. The parties engaged in litigation discovery, exchanged affidavits of documents and scheduled examinations for discovery. Shortly thereafter, discovery adjourned and continues to be stayed while the parties negotiate formal terms of settlement. PerfectSense has not responded to Purple’s repeated attempts to finalize the settlement. Purple LLC filed a motion to enforce a settlement agreement.  On September 13, 2022, the Court granted Purple’s motion to enforce the settlement agreement and deemed the action to be discontinued on a without costs basis. As part of the settlement, PerfectSense is required to: (a) to change their mattress design so as not to resemble any of Purple’s mattress designs, (b) to change their website design to move away from Purple’s product designs, (c) to not register or use any domains that include the word “Purple”, and (d) to delete a number of domains that PerfectSense had previously registered which included the word “Purple”. PerfectSense was given 30 days from the date of the Court Order to comply with these terms. Purple is continuing to monitor PerfectSense to ensure compliance with the settlement agreement. Now that the action has been discontinued, Purple is taking steps to have the $15,000 CAD that was posted as security for PerfectSense’s costs paid out of court. 

 

On September 20, 2020, Purple LLC filed a complaint in the U.S. Court of International Trade seeking to recover approximately $7.0 million of Section 301 duties paid at the time of importation on certain Chinese-origin goods. More than 4,000 other complaints have been filed by other companies seeking similar refunds. On March 12, 2021 the United States filed a master answer that applies to all the Section 301 cases, including Purple LLC’s. On July 6, 2021, the court granted a preliminary injunction against liquidation of any unliquidated entries. On April 1, 2022, the court issued an opinion that remanded the case back to the U.S. Trade Representative (“USTR”) to address certain procedural flaws in USTR’s process for determining whether certain products were subject to the Section 301 duties. On August 1, 2022, USTR issued its remand results. On September 14, 2022, the plaintiffs submitted comments on the remand results. USTR filed their response to these comments on November 4, 2022. The plaintiffs have until December 5, 2022 to file a reply. If successful, this litigation could result in a refund of some or all of the Section 301 duties.

 

19

 

 

PURPLE INNOVATION, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

On October 13, 2020, Purple LLC filed a lawsuit against Responsive Surface Technology, LLC and its parent company, PatienTech, LLC (collectively referred to as “ReST”) in the United States District Court for the District of Utah. The lawsuit arises from ReST’s multiple breaches of its obligations to Purple LLC, including infringing upon Purple LLC’s trademarks, patents, and trade dress, among other claims. Purple seeks monetary damages, injunctive relief, and declaratory judgment based on certain conduct by ReST (“Case I”). On October 21, 2020, shortly after the complaint was filed in Case I, ReST filed a retaliatory lawsuit against Purple LLC, Gary DiCamillo, Adam Gray, Joseph Megibow, Terry Pearce, and Tony Pearce, also in the United States District Court for the District of Utah (“Case II”). Subsequently, the two cases were consolidated into one. Case II (now combined with Case I) involves many of the same facts and transactions as Case I. On January 19, 2021, ReST filed a motion to compel arbitration of the claims in Case I. Purple LLC opposed the motion to compel arbitration, arguing that ReST waived any rights they may have had to arbitration and that all the claims in both cases should stay in the courts. However, the Court granted ReST’s motion to compel arbitration, and stayed the proceedings in the United States District Court for the District of Utah. Additionally, the Court ruled that ReST’s claims against the Purple board members were not subject to arbitration, and the Court stayed ReST’s claims against those individuals.  Pursuant to the Court’s order, Purple filed a demand for arbitration with the American Arbitration Association (the “AAA”) on September 1, 2021.  ReST filed its counterclaim with the AAA on September 21, 2021.The parties have selected an arbitrator and they have agreed upon a scheduling order.  Currently, the parties are in the fact discovery phase of the arbitration. The parties have scheduled several depositions and exchange documents and discovery requests. The arbitration hearing is set to begin in July 2023. Purple LLC seeks over $4 million in damages from ReST, whereas ReST claims that Purple is liable to it for tens of millions of dollars. The outcome of this litigation cannot be predicted at this stage. However, Purple intends to vigorously pursue its claims and defend against the claims made by ReST.

 

On November 19, 2020, Purple LLC sued Intellibed in the U.S. District Court for the District of Utah for patent infringement, trademark infringement, trade secret misappropriation, and a number of related state law based claims. The principal allegations are that Intellibed has manufactured and sold unauthorized, infringing products under the Sleepy’s brand name owned by third-party Mattress Firm. Purple LLC also requested declaratory relief related to certain assignment terms of a license agreement in which Purple LLC is the licensor and Intellibed is the licensee. On December 14, 2020, Intellibed filed a motion to dismiss Counts I through XI of Purple LLC’s Complaint on the ground that these Counts fail to state a claim upon which relief can be granted. On December 15, 2020, Intellibed filed an Answer to Purple LLC’s complaint and also asserted against Purple LLC a total of eight counterclaims, including a number of declaratory judgment claims, breach of contract, and tortious interference claims. Intellibed’s main allegations are that its use of Purple LLC’s patents, trademark, and trade secrets in connection with Mattress Firm’s Sleepy’s products is authorized under the license agreement. On January 19, 2021, Purple LLC filed a motion to dismiss Intellibed’s fifth, sixth, seventh, and eighth counterclaims on the ground that these counterclaims fail to state a claim upon which relief can be granted. Briefing on Purple LLC’s partial motion to dismiss was completed on March 2, 2021. On January 19, 2021, Purple LLC also filed an Answer to Intellibed’s counterclaims, which were not subject to Purple LLC’s motion to dismiss. On January 27, 2021, Purple LLC filed a First Amended Complaint in response to Intellibed’s initial motion to dismiss. On February 10, 2021, Intellibed filed a motion to dismiss Counts I through XI of Purple LLC’s First Amended Complaint. Briefing on Intellibed’s partial motion to dismiss was completed on March 24, 2021. On September 28, 2021, the District Court dismissed Purple’s complaint without prejudice, and also dismissed ACTI’s counterclaim without prejudice, while the parties pursued dispute-resolution procedures set out in the license agreement.  On August 31, 2022, the Company acquired all of the issued and outstanding stock of Intellibed, as discussed above. In conjunction with the acquisition, the preexisting legal matter with Intellibed was effectively settled on the acquisition date. The fair value of the effective settlement of this legal matter was estimated to be a gain of $1.4 million, which was recorded by the Company as other income (expense), net in the condensed consolidated statement of operations for the three and nine months ended September 30, 2022. For additional information see Note 4—Acquisition.

 

20

 

 

PURPLE INNOVATION, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

On May 3, 2022, the Company filed a Complaint against Photon Interactive UK Limited (“Photon”) in the U.S. District Court for the District of Delaware regarding a Master Professional Services Agreement with Photon dated on or around November 1, 2019. Pursuant to the agreement, Photon was required to rebuild Purple’s website architecture and checkout process. The Company paid Photon $0.9 million under the Agreement. However, Photon failed to deliver any of the required deliverables as specified in the agreement. Purple withheld payment of the final $0.1 million due pursuant to Photon’s invoices pending a resolution with Photon. Since resolution discussions with Photon have failed, the Company filed the aforementioned complaint for breach of contract against Photon seeking, among other damages, reimbursement for all amounts paid to Photon under the agreement. Photon counter-sued, seeking payment for the $0.1 million withheld by Purple, and also advancing a vague claim for tortious interference. The litigation is presently in its discovery phase. The Company intends to vigorously litigate its claims to resolution. 

 

On August 5, 2022, Purple LLC filed a Complaint with the United States International Trade Commission (“ITC”) against numerous entities and individuals from the People’s Republic of China and South Korea (“Respondents”) that have been violating Purple’s intellectual property rights related to pillow and seat cushion products.  The Complaint alleges that the proposed Respondents are violating 19 U.S.C. § 1337 (“Section 337”) by importing into the United States, selling for importation into the United States, and/or selling in the United States after importation pillow and seat cushion products that infringe Purple’s trade dress rights or otherwise constitute unfair competition, infringe a certain Purple design patent, infringe Purple trademarks, and/or infringe Purple utility patents. The Complaint requests at least the following relief:  (i) a General Exclusion Order excluding from entry into the United States all pillow and seat cushion products that infringe any asserted Purple intellectual property right; (ii) Limited Exclusion Orders excluding from entry into the United States all pillow and cushion products of the proposed Respondents named in the Complaint that infringe any asserted Purple intellectual property right; and (iii) Cease and Desist Orders against the proposed Respondents named in the Complaint barring them from marketing, selling, advertising, or distributing infringing products in the United States, including via on-line retailers.  The ITC Administrative Law Judge has issued a Procedural Schedule for the Investigation that includes an April 12–14, 2023, Evidentiary Hearing and an October 12, 2023, Target Date for completion of the Investigation.  The Investigation is currently in its initial stages and fact discovery has just commenced.

 

On September 22, 2022, the Company filed an action in the U.S. District Court for the District of Utah styled Purple Innovation, LLC v. Bedmate-U Co., Ltd., against numerous entities and individuals from the People’s Republic of China and South Korea (“Respondents”).  The complaint alleges that the Respondents have (a) violated Lanham Act § 43(a), 15 U.S.C. § 1125(a) by committing acts of trade dress infringement; (b) infringed U.S. Trademark Registration No. 5,661,556; (c) infringed U.S. Trademark Registration No. 6,551,053; (d) violated Lanham Act § 43(a), 15 U.S.C. § 1125(a) by committing acts of trademark infringement; (e) infringed U.S. Patent No. D909,092; (f) infringed U.S. Patent No. 10,772,445; (g) infringed U.S. Patent No. 10,863,837; (h) violated Utah Unfair Competition Act, Utah Code § 13-5a-101 et seq.; and/or (i) committed common law unfair competition.  The complaint seeks injunctive relief, compensatory damages, disgorgement of profits, punitive and exemplary damages, and attorneys’ fees and costs.  This action is in its initial stages.

 

The Company is from time to time involved in various other claims, legal proceedings and complaints arising in the ordinary course of business. The Company does not believe that adverse decisions in any such pending or threatened proceedings, or any amount that the Company might be required to pay by reason thereof, would have a material adverse effect on the financial condition or future results of the Company.

 

15. Related Party Transactions

 

The Company had various transactions with entities or individuals which are considered related parties.

 

Coliseum Capital Management, LLC

 

Immediately following the Business Combination, Adam Gray was appointed to the Company’s Board of Directors (the “Board”). Mr. Gray is a manager of Coliseum Capital, LLC, which is the general partner of CCP and CDF, and he is also a managing partner of CCM, which is the investment manager of Blackwell. Mr. Gray has voting and dispositive control over securities held by CCP, CDF and Blackwell which were also Lenders under the Amended and Restated Credit Agreement. On September 17, 2022, the Company received an unsolicited and non-binding proposal from CCM to acquire the remaining outstanding common stock of the Company not already beneficially owned by CCM for $4.35 per share in cash. At the time of the offer, CCM beneficially owned approximately 45% of the outstanding equity of the Company. The CCM proposal is conditioned upon the transaction being (a) negotiated by, and subject to the approval of, a special committee of independent and disinterested members of the Board (the “Special Committee”) and (b) subject to a non-waivable condition requiring approval by the affirmative vote of a majority of the shares of common stock not owned by CCM or other interested parties. The Special Committee was formed by the Board to determine the necessary actions to evaluate the CCM proposal and determine the course of action that is in the best interests of all of the Company’s shareholders. The Board expressly granted the Special Committee the ability to decline the CCM proposal. In addition, the Special Committee adopted the Rights Agreement to have the time and flexibility necessary to evaluate the CCM offer. See Note 14—Commitments and ContingenciesSubscription Agreement and Preemptive Rights and Commitments and ContingenciesStockholder Rights Agreement for further discussion.

 

Purple Founder Entities

 

TNT Holdings, LLC (herein “TNT Holdings”), EdiZONE, LLC, (herein “EdiZONE”), an entity wholly owned by TNT Holdings, and InnoHold (collectively the “Purple Founder Entities”) were entities under common control with Purple LLC prior to the Business Combination. TNT Holdings and InnoHold are majority owned and controlled by Terry Pearce and Tony Pearce (the “Purple Founders”), who were appointed to the Company’s Board following the Business Combination. InnoHold was a majority shareholder of the Company until it sold a portion of its interests in a secondary public offering in May 2020 and the remainder of its interests in a secondary public offering in September 2020. The Purple Founders also resigned as employees of Purple LLC and retired from the Company’s Board in August 2020.

 

21

 

 

PURPLE INNOVATION, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

TNT Holdings owned the Alpine facility Purple LLC has been leasing since 2010, and the Purple Founders informed Purple LLC that TNT Holdings recently transferred ownership to 123E LLC, an entity controlled by the Purple Founders. Effective as of October 31, 2017, Purple LLC entered into an Amended and Restated Lease Agreement with TNT Holdings. The Company determined that neither TNT Holdings nor 123E LLC are a VIE as neither the Company nor Purple LLC hold any explicit or implicit variable interest in TNT Holdings or 123E LLC and do not have a controlling financial interest in TNT Holdings or 123E LLC. Purple LLC incurred $0.2 million and $0.7 million in rent expense to 123E LLC or TNT Holdings for the building lease of the Alpine facility for the three and nine months ended September 30, 2022, respectively, and $0.2 million and $0.7 million for the three and nine months ended September 30, 2021, respectively. Purple LLC continues to lease the Alpine facility that was formerly the Company headquarters, for use in production, research and development and video production. In accordance with the terms of that lease, on September 3, 2021, Purple LLC gave notice to 123E LLC that it intended to exercise its right to an early termination of the lease to occur on September 30, 2022. On July 20, 2022, the Company entered into an amendment to its Alpine facility lease agreement with 123E LLC. The amendment rescinded the Company’s previous notice of termination that was scheduled to be effective September 30, 2022 and extended the term such that the lease will remain in effect until September 30, 2023.

 

During the nine months ended September 30, 2021, certain current and former employees of Purple LLC who received distributions of Paired Securities from InnoHold exchanged 0.1 million of Paired Securities for Class A common stock. There were no such exchanges during the nine months ended September 30, 2022.

 

In connection with the Business Combination, to secure payment of a certain portion of specified post-closing indemnification rights of the Company under the Merger Agreement, 0.5 million shares of Class B common stock and 0.5 million Class B Units otherwise issuable to InnoHold as equity consideration were deposited in an escrow account for up to three years from the date of the Business Combination pursuant to a contingency escrow agreement. In September 2020, an amendment to the escrow agreement was signed whereby the 0.5 million shares of Class B Stock and 0.5 million Class B Units held in escrow were exchanged for $5.0 million. On February 3, 2021, the Company received $4.1 million from InnoHold as reimbursement for amounts that qualified for indemnification from the $5.0 million being held in escrow. The remaining $0.9 million in escrow was returned to InnoHold. The amount received from InnoHold was recorded as additional paid-in capital in the condensed consolidated balance sheet.

 

During the nine months ended September 30, 2021, Purple LLC paid InnoHold through withholding payments directly to various states, an aggregate of $0.4 million in required tax distributions pursuant to the Third Purple LLC Agreement. There were no such payments made by Purple LLC during the nine months ended September 30, 2022.

 

16. Stockholders’ Equity

 

Class A Common Stock

 

The Company has 210.0 million shares of Class A common stock authorized at a par value of $0.0001 per share. Holders of the Company’s Class A common stock are entitled to one vote for each share held on all matters to be voted on by the stockholders and participate in dividends, if declared by the Board, or receive any portion of any such assets in respect of their shares upon liquidation, dissolution, distribution of assets or winding-up of the Company in excess of the par value of such stock. Holders of Class A common stock and holders of Class B common stock voting together as a single class, have the exclusive right to vote for the election of directors and on all other matters properly submitted to a vote of the stockholders. Holders of Class A common stock and Class B common stock are entitled to one vote per share on matters to be voted on by stockholders. At September 30, 2022, 91.4 million shares of Class A common stock were outstanding.

 

22

 

 

PURPLE INNOVATION, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

Class B Common Stock

 

The Company has 90.0 million shares of Class B common stock authorized at a par value of $0.0001 per share. Holders of the Company’s Class B common stock will vote together as a single class with holders of the Company’s Class A common stock on all matters properly submitted to a vote of the stockholders. Shares of Class B common stock may be issued only to InnoHold, their respective successors and assigns, as well as any permitted transferees of InnoHold. A holder may transfer their shares of Class B common stock to any transferee (other than the Company) only if such holder also simultaneously transfers an equal number of such holder’s Purple LLC Class B Units to such transferee in compliance with the Third Purple LLC Agreement. The Class B common stock is not entitled to receive dividends, if declared by the Board, or to receive any portion of any such assets in respect of their shares upon liquidation, dissolution, distribution of assets or winding-up of the Company in excess of the par value of such stock.

 

In connection with the Business Combination, approximately 44.1 million shares of Class B common stock were issued to InnoHold as part of the equity consideration. InnoHold subsequently transferred a portion of its shares to permitted transfers and exchanged its remaining shares for Class A common stock that it sold. All of the 0.4 million shares of Class B common stock outstanding at September 30, 2022 were held by other parties.

 

Preferred Stock

 

The Company has 5.0 million shares of preferred stock authorized at a par value of $0.0001 per share. The preferred stock may be issued from time to time in one or more series. The directors are expressly authorized to provide for the issuance of shares of the preferred stock in one or more series and to establish from time to time the number of shares to be included in each such series and to fix the voting rights, designations and other special rights or restrictions. At September 30, 2022, there were no shares of preferred stock outstanding. See Note 14—Commitments and ContingenciesStockholder Rights Agreement for further discussion regarding preferred stock.

 

Sponsor Warrants

 

There were 12.8 million sponsor warrants issued pursuant to a private placement simultaneously with the Company’s IPO. The Company may call the warrants for redemption if the reported last sale price of the Class A common stock equals or exceeds $24.00 per share for any 20 trading days within a 30-trading day period ending on the third trading day prior to the date the Company sends the notice of redemption to the warrant holders; provided, however, that the sponsor warrants are not redeemable by the Company so long as they are held by the Sponsor or its permitted transferees. In addition, so long as such sponsor warrants are held by the Sponsor or its permitted transferee, the holder may elect to exercise the sponsor warrants on a cashless basis, by surrendering their sponsor warrants for that number of shares of Class A common stock equal to the quotient obtained by dividing (x) the product of the number of shares of Class A common stock underlying the sponsor warrants, multiplied by the difference between the exercise price of the sponsor warrants and the “fair market value” (defined below), by (y) the fair market value. The “fair market value” means the average reported last sale price of the Class A common stock for the 10 trading days ending on the third trading day prior to the date on which the notice of warrant exercise is sent to the warrant agent.

 

23

 

 

PURPLE INNOVATION, INC.

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

There were no sponsor warrants exercised during the nine months ended September 30, 2022. During the nine months ended September 30, 2021, 6.6 million sponsor warrants were exercised resulting in the issuance of 2.3 million shares of Class A common stock. There were 1.9 million sponsor warrants outstanding at September 30, 2022.

 

Noncontrolling Interest

 

Noncontrolling interest (“NCI”) is the membership interest in Purple LLC held by holders other than the Company. Upon the close of the Business Combination, and at December 31, 2018, InnoHold’s and other Class B Unit holders’ combined NCI percentage in Purple LLC was approximately 82%. At September 30, 2022, the combined NCI percentage in Purple LLC was 0.5%. The Company has consolidated the financial position and results of operations of Purple LLC and reflected the proportionate interest held by all such Purple LLC Class B Unit holders as NCI.

 

17. Income Taxes

 

At each interim period, the Company estimates its forecasted full-year effective tax rate. That forecasted rate is applied to year-to-date ordinary income or loss to compute the year-to-date income tax provision. In order to compute the annual effective tax rate, the Company estimates its full year ordinary income and total tax provision, including both current and deferred taxes.

 

For annual periods, the Company accounts for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. In assessing the realizability of deferred tax assets, management considers whether it is more-likely-than-not that the deferred tax assets will be realized. Deferred tax assets and liabilities are calculated by applying existing tax laws and the rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in the year of the enacted rate change. Our effective tax rate is primarily impacted by the allocation of income taxes to the noncontrolling interest and the non-taxable nature of the change in fair value of the warrant liability.

 

As of September 30, 2022, the Company had two material assets:1) Purple LLC, which is treated as a partnership for U.S. federal income tax purposes and for purposes of certain state and local income taxes and 2) Intellibed, which is taxed as a corporation for U.S. federal income tax purposes and for purposes of certain state and local income taxes. Purple LLC’s net taxable income and any related tax credits are passed through to its members and are included in the members’ tax returns, even though such net taxable income or tax credits may not have actually been distributed. While the Company consolidates Purple LLC for financial reporting purposes, the Company will be taxed on its share of earnings of Purple LLC not attributed to the noncontrolling interest holders, which will continue to bear their share of income tax on its allocable earnings of Purple LLC. The income tax burden on the earnings taxed to the noncontrolling interest holders is not reported by the Company in its consolidated financial statements under GAAP. As a result, the Company’s effective tax rate differs from the statutory rate. The primary factors impacting expected tax are the change in fair value of the warrant liabilities and adjustments for stock-based compensation.

 

Deferred tax assets at September 30, 2022 totaled $220.8 million, which is net of a $100.1 million valuation allowance that has been recorded against the residual outside partnership basis for the amount the Company believes is not more likely than not realizable. As a result, there was an overall increase of $30.2 million in the valuation allowance from December 31, 2021 to September 30, 2022, primarily as a result of an increase in the residual outside partnership basis.

 

24

 

 

PURPLE INNOVATION, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

The Company currently estimates its annual effective income tax rate to be 23.7%. The annualized effective tax rate for the Company differs from the federal rate of 21% primarily due to the non-taxable nature of the change in fair value of the warrant liabilities and state and local income taxes.

 

For the nine months ended September 30, 2022, the Company has recorded an income tax benefit of $6.6 million. The effective tax rate for the nine months ended September 30, 2022 was 25.1%. This rate differed from the federal statutory rate due primarily to a reduction of deferred tax assets associated with adjustments for stock-based compensation and the gain relating to the change in fair value of the warrant liability is excluded from taxable income for income tax purposes.

 

In connection with the Business Combination, the Company entered into a tax receivable agreement with InnoHold, which provides for the payment by the Company to InnoHold of 80% of the net cash savings, if any, in U.S. federal, state and local income tax that the Company actually realizes (or is deemed to realize in certain circumstances) in periods after the Closing as a result of (i) any tax basis increases in the assets of Purple LLC resulting from the distribution to InnoHold of the cash consideration, (ii) the tax basis increases in the assets of Purple LLC resulting from the redemption by Purple LLC or the exchange by the Company, as applicable, of Class B Paired Securities or cash, as applicable, and (iii) imputed interest deemed to be paid by the Company as a result of, and additional tax basis arising from, payments it makes under the agreement.

 

As noncontrolling interest holders exercise their right to exchange or cause Purple LLC to redeem all or a portion of their Class B Units, a tax receivable agreement liability may be recorded based on 80% of the estimated future cash tax savings that the Company may realize as a result of increases in the basis of the assets of Purple LLC attributed to the Company as a result of such exchange or redemption. The amount of the increase in asset basis, the related estimated cash tax savings and the attendant liability to be recorded will depend on the price of the Company’s Class A common stock at the time of the relevant redemption or exchange.

 

The estimation of liability under the tax receivable agreement is by its nature imprecise and subject to significant assumptions regarding the amount and timing of future taxable income. As a result of the initial merger transaction, the subsequent exchanges of Class B Units for Class A common stock and changes in estimates relating to the expected tax benefits associated with the liability under the agreement, the potential future tax receivable agreement liability was $162.2 million and $168.1 million as of September 30, 2022 and December 31, 2021, respectively. The reduction in the September 30, 2022 tax receivable agreement liability reflected a payment of $5.8 million made in January 2022.

 

As of December 31, 2021, the Company estimated $13.9 million of U.S. federal and $4.7 million of state net operating loss carryforwards available to reduce future taxable income. The federal net operating losses generally can be carried forward indefinitely for U.S. federal tax purposes with the exception of some NOLs acquired as part of the Intellibed acquisition which are subject to expiration beginning in 2037. Some state carryforwards are subject to expiration beginning in 2026. It is possible that we will not generate taxable income in time to use all or a portion of these net operating loss carryforwards before their expiration or at all. Additionally, the Company may be subject to the NOL utilization provisions of Section 382 of the Internal Revenue Code of 1986, as amended due to ownership changes that may have occurred previously or that could occur in the future. The effect of an ownership change may be the imposition of an annual limitation on the use of NOL carryforwards attributable to periods before the change. The amount of the annual limitation depends upon the value of the Company immediately before the change, changes to the Company’s capital during a specified period prior to the change, and the federal published interest rate. As of September 30, 2022, the Company has not completed its analyses in respect of Section 382 to determine whether a change in ownership has occurred, the annual limitation, if any, or whether any of the tax attributes are subject to a permanent limitation. Until an analysis is completed, there can be no assurance that the existing net operating loss carry-forwards or credits are not subject to significant limitation.

  

As of September 30, 2022, we had $220.8 million in net deferred tax assets.  These deferred tax assets include approximately $213.5 million related to the investment in the partnership.   We have considered both the positive and negative evidence in evaluating whether a valuation allowance is necessary. The Company is in a cumulative income position over the past 12 quarters, and we consider it more likely than not that we will have sufficient taxable income in the future that will allow us to realize these deferred tax assets. However, it is possible that certain economic conditions may decrease the likelihood that we will have sufficient taxable income in the future. Therefore, unless we are able to generate sufficient taxable income from our operations, a substantial valuation allowance to reduce our deferred tax assets may be required, which would materially increase our expenses in the period the allowance is recognized and materially adversely affect our results of operations and statement of financial condition.

 

25

 

 

PURPLE INNOVATION, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

The effects of uncertain tax positions are recognized in the consolidated financial statements if these positions meet a “more-likely-than-not” threshold. For those uncertain tax positions that are recognized in the consolidated financial statements, liabilities are established to reflect the portion of those positions it cannot conclude “more-likely-than-not” to be realized upon ultimate settlement. The Company’s policy is to recognize interest and penalties related to unrecognized tax benefits on the income tax expense line in the accompanying consolidated statement of income. Accrued interest and penalties would be included on the related tax liability line in the consolidated balance sheet. As of September 30, 2022, no material uncertain tax positions were recognized as liabilities in the condensed consolidated statements of operations.

 

18. Net Income (Loss) Per Common Share

 

Basic net income (loss) per common share is calculated by dividing net income (loss) attributable to common stockholders by the weighted average number of shares of Class A stock outstanding during each period. Diluted net income (loss) per share reflects the weighted-average number of common shares outstanding during the period used in the basic net income (loss) computation plus the effect of common stock equivalents that are dilutive.

 

The following table sets forth the calculation of basic and diluted weighted average shares outstanding and earnings (loss) per share for the periods presented (in thousands, except per share amounts):

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2022   2021   2022   2021 
Numerator:                
Net income (loss) attributable to Purple Innovation, Inc.-basic  $2,278   $2,171   $(19,564)  $25,573 
Less – dilutive effect of change in fair value – warrant liabilities   
    (5,362)   
    (19,369)
Net income (loss) attributed to noncontrolling interest   3    (44)   (196)   
 
Net income (loss) attributable to Purple Innovation, Inc.-diluted  $2,281   $(3,235)  $(19,760)  $6,204 
Denominator                    
Weighted average shares—basic   85,666    66,335    78,544    65,741 
Add – dilutive effect of equity awards   1    
    
    1,479 
Add – dilutive effect of warrants   
    504    
    1,099 
Add – dilutive effect of Class B shares   448    448    448    
 
Weighted average shares—diluted   86,115    67,287    78,992    68,319 
Net income (loss) per common share:                    
Basic  $0.03   $0.03   $(0.25)  $0.39 
Diluted  $0.03   $(0.05)  $(0.25)  $0.09 

  

26

 

 

PURPLE INNOVATION, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

For the three and nine months ended September 30, 2022, the Company excluded 3.2 million and 3.5 million, respectively, of Class A common shares issuable upon conversion of certain warrants, stock options, restricted stock and Class A shares subject to vesting as the effect was anti-dilutive. For the three months ended September 30, 2021, the Company excluded 1.3 million shares of Class A common stock issuable upon conversion of certain stock options, restricted stock and Class A shares subject to vesting as the effect was anti-dilutive. For the nine months ended September 30, 2021, the Company excluded 0.5 million of Paired Securities convertible into an equal number of Class A shares as the effect was anti-dilutive.

 

19. Equity Compensation Plans

 

2017 Equity Incentive Plan

 

The Purple Innovation, Inc. 2017 Equity Incentive Plan (the “2017 Incentive Plan”) provides for grants of stock options, stock appreciation rights, restricted stock units and other stock-based awards. Directors, officers and other employees and subsidiaries and affiliates, as well as others performing consulting or advisory services for the Company and its subsidiaries, will be eligible for grants under the 2017 Incentive Plan. As of September 30, 2022, an aggregate of 1.0 million shares are available for issuance or use under the 2017 Incentive Plan.

 

Class A Stock Awards

 

In May 2022, the Company granted stock awards under the 2017 Incentive Plan to independent directors on the Board. The stock awards vested immediately and the Company issued 0.1 million shares of Class A common stock and recognized $0.6 million in expense during the nine months ended September 30, 2022, which represented the fair value of the stock awards on the grant date.

 

Employee Stock Options

 

In March and June 2022, the Company granted 0.5 million and 0.1 million stock options, respectively, under the 2017 Incentive Plan to its chief executive officer at an exercise price of $6.82 per option. The stock options expire in five years and vest over a three-year period. In April 2022, with the chief executive officer’s consent, the Company rescinded and cancelled 0.4 million of the stock options granted in March 2022 because of annual limits set forth in the 2017 Incentive Plan. The Company determined the fair value of the net award of 0.2 million stock options to be $0.4 million which will be expensed on a straight-line basis over the vesting period.

 

The Company determined the fair value of the options granted during the nine months ended September 30, 2022 using the Black Scholes method with the following weighted average assumptions:

 

Fair market value  $2.02 
Exercise price  $6.82 
Risk free interest rate   2.67%
Expected term in years   3.45 
Expected volatility   54.22%
Expected dividend yield   
 

 

The following table summarizes the Company’s total stock option activity for the nine months ended September 30, 2022:

 

   Options
(in thousands)
   Weighted
Average
Exercise
Price
   Weighted
Average
Remaining
Contractual
Term in
Years
   Intrinsic
Value
(in thousands)
 
Options outstanding as of January 1, 2022   1,552   $8.65    1.9   $8,667 
Granted   594    6.82    
    
 
Exercised   (20)   8.32    
    
 
Forfeited/cancelled   (546)   8.14    
    
 
Options outstanding as of September 30, 2022   1,580   $8.14    1.4   $
 

 

27

 

 

PURPLE INNOVATION, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

Outstanding and exercisable stock options as of September 30, 2022 are as follows:

 

      Options Outstanding     Options Exercisable  
Exercise Prices     Number of
Options
Outstanding
(in thousands)
    Weighted
Average
Remaining Life
(Years)
    Number of
Options
Exercisable
(in thousands)
    Weighted
Average
Remaining Life
(Years)
    Intrinsic
Value
(in thousands)
 
$ 5.75       158       0.1       158       0.1     $      
  5.95       426       0.2       426       0.2        
  6.51       196       1.6       166       1.6        
  6.65       173       1.6       140       1.6        
  6.82       205       4.6                    
  7.99       19       2.2       15       2.2        
  8.32       108       1.8       77       1.8        
  8.55       97       0.2       97       0.2        
  13.12       110       2.1       77       1.9        
  21.70       52       0.2       52       0.2        
  32.28       35       3.5       15       3.5        

 

The following table summarizes the Company’s unvested stock option activity for the nine months ended September 30, 2022:

 

   Options
(in thousands)
   Weighted
Average
Grant Date
Fair Value
 
Nonvested options as of January 1, 2022   416   $3.60 
Granted   594    2.31 
Vested   (172)   3.17 
Forfeited   (482)   2.73 
Nonvested options as of September 30, 2022   356   $2.85 

 

The estimated fair value of Company stock options is amortized over the options vesting period on a straight-line basis. For the three and nine months ended September 30, 2022, the Company recognized stock option expense of $0.2 million and $0.5 million, respectively. The Company recorded stock option expense of $0.4 million and $1.3 million during the three and nine months ended September 30, 2021, respectively.

 

As of September 30, 2022, outstanding stock options had $0.9 million of unrecognized stock compensation cost with a remaining recognition period of 1.8 years.

 

28

 

 

PURPLE INNOVATION, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

Employee Restricted Stock Units

 

In March and June 2022, the Company granted 0.5 million and 0.1 million restricted stock units, respectively, under the 2017 Incentive Plan to the Company’s chief executive officer. These restricted stock awards had a grant date fair value of $6.32 and $4.81 per share, respectively. In April 2022, with the chief executive officer’s consent, the Company rescinded and cancelled 0.4 million of the restricted stock units granted in March 2022 because of annual limits set forth in the 2017 Incentive Plan. The estimated fair value of the net award of 0.2 million restricted stock units is being recognized on a straight-line basis over the three-year vesting period.

 

During the second quarter of 2022, the Company granted 1.1 million restricted stock units under the 2017 Incentive Plan to certain management of the Company. Approximately one-half of the restricted stock units granted included a market vesting condition. The restricted stock awards that did not have a market vesting condition had a weighted average grant date fair value of $5.53 per share. The estimated fair value of these awards is recognized on a straight-line basis over the vesting period. For those awards that include a market vesting condition, the estimated fair value of the restricted stock was measured on the grant date and incorporated the probability of vesting occurring. The estimated fair value is recognized over the derived service period (as determined by the valuation model), with such recognition occurring regardless of whether the market condition is met. The Company determined the weighted average grant date fair value of the awards with the market vesting condition to be $3.68 per share using a Monte Carlo Simulation of a Geometric Brownian Motion stock path model with the following weighted average assumptions:

 

Trading price of common stock on measurement date  $5.34 
Risk free interest rate   2.64%
Expected life in years   2.9 
Expected volatility   84.3%
Expected dividend yield   
 

 

The following table summarizes the Company’s restricted stock unit activity for the nine months ended September 30, 2022:

 

   Number
Outstanding
(in thousands)
   Weighted
Average
Grant Date
Fair Value
 
Nonvested restricted stock units as of January 1, 2022   165   $17.84 
Granted   1,181    4.77 
Vested   (33)   18.82 
Forfeited   (75)   11.50 
Nonvested restricted stock units as of September 30, 2022   1,238   $5.74 

 

The Company recorded restricted stock unit expense of $0.6 million and $1.5 million during the three and nine months ended September 30, 2022, respectively and $0.3 million and $0.3 million during the three and nine months ended September 30, 2021, respectively.

 

As of September 30, 2022, outstanding restricted stock units had $5.7 million of unrecognized stock compensation cost with a remaining recognition period of 2.4 years.

 

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PURPLE INNOVATION, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

 

Aggregate Non-Cash Stock-Based Compensation

 

The Company has accounted for all stock-based compensation under the provisions of ASC 718 Compensation—Stock Compensation. This standard requires the Company to record a non-cash expense associated with the fair value of stock-based compensation over the requisite service period.

 

The following table summarizes the aggregate non-cash stock-based compensation recognized in the statement of operations for stock awards, employee stock options and employee restricted stock units (in thousands):

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2022   2021   2022   2021 
Cost of revenues  $96   $119   $266   $208 
Marketing and sales   260    209    663    427 
General and administrative   386    414    1,570    1,689 
Research and development   53    23    113    33 
Total non-cash stock-based compensation  $795   $765   $2,612   $2,357 

 

20. Employee Retirement Plan

 

In July 2018 the Company established a 401(k) plan that qualifies as a deferred compensation arrangement under Section 401 of the IRS Code. All eligible employees over the age of 18 and with 4 months’ service are eligible to participate in the plan. The plan provides for Company matching of employee contributions up to 5% of eligible earnings. Company contributions immediately vest. The Company’s matching contribution expense was $0.8 million and $2.7 million for the three and nine months ended September 30, 2022, respectively, and $0.8 million and $2.3 million for the three and nine months ended September 30, 2021, respectively.

 

21. Subsequent Events

 

On October 3, 2022, the name of the wholly owned surviving entity from the Merger Agreement was changed to Intellibed, LLC. Purple Inc. contributed 100% of the membership interest in Intellibed, LLC to Purple LLC and Intellibed, LLC became a wholly owned subsidiary of Purple LLC.

 

On October 15, 2022, Keira Krausz signed an offer letter to become the Chief Marketing Officer of the Company, effective November 1, 2022. The Company will grant to Ms. Krausz, a one-time equity grant valued at $400,000 based on the market price of the Company’s Class A Common Stock on the day of the grant as an inducement grant outside the Company’s 2017 Equity Incentive Plan in accordance with the NASDAQ inducement grant exception found in NASDAQ Listing Rule 5635(c)(4). This grant has not yet been awarded.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion is intended to provide a more comprehensive review of the operating results and financial condition of Purple Innovation, Inc. than can be obtained from reading the Unaudited Condensed Consolidated Financial Statements alone. The discussion should be read in conjunction with the Unaudited Condensed Consolidated Financial Statements and the notes thereto included in “Part I. Item 1. Financial Statements.”

 

FORWARD-LOOKING STATEMENTS

 

This quarterly report on Form 10-Q (this “Quarterly Report”) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that represent our current expectations and beliefs. All statements other than statements of historical fact are “forward-looking statements” for purposes of federal and state securities laws. In some cases, you can identify these statements by forward-looking words such as “believe,” “expect,” “project,” “anticipate,” “estimate,” “intend,” “plan,” “targets,” “likely,” “will,” “would,” “could,” “may,” “might,” the negative of these words and other similar words.

 

All forward-looking statements included in this Quarterly Report are made only as of the date thereof. It is routine for our internal projections and expectations to change throughout the year, and any forward-looking statements based upon these projections or expectations may change prior to the end of the next quarter or year. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses (including the discussion under the heading “Outlook for Growth”), and other characterizations of future events or circumstances are forward-looking statements.

 

We caution and advise readers that these statements are only predictions and are subject to risks, uncertainties, and assumptions that are difficult to predict, including those included in the “Risk Factors” section of this Quarterly Report and in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 1, 2022. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements and investors are cautioned not to place undue reliance on any such statements. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law.

 

Overview of Our Business

 

Our mission is to improve the lives of our consumers by delivering innovative better sleep solutions.

 

We are a digitally-native vertical brand founded on comfort product innovation with premium offerings. We design and manufacture a variety of innovative, branded and premium comfort products, including mattresses, pillows, cushions, frames, sheets, and other products. Our products are the result of over 30 years of innovation and investment in proprietary and patented comfort technologies and the development of our own manufacturing processes. Our proprietary gel technology, Hyper-Elastic Polymer, underpins many of our comfort products and provides a range of benefits that differentiate our offerings from other competitors’ products. We market and sell our products directly to consumers through our e-commerce and Purple retail showroom channels and through our retail brick-and-mortar wholesale partner channel.

 

Organization

 

Our business consists of Purple Inc., its controlled subsidiary, Purple LLC, and its wholly owned subsidiary, Intellibed. Purple Inc. was incorporated in Delaware on May 19, 2015 as a special purpose acquisition company under the name of GPAC.

 

On February 2, 2018, Purple Inc. consummated a transaction structured similar to a reverse recapitalization pursuant to which Purple Inc. acquired an equity interest in Purple LLC and became its sole managing member. As the sole managing member of Purple LLC, Purple Inc., through its officers and directors, is responsible for all operational and administrative decision making and control of the day-to-day business affairs of Purple LLC without the approval of any other member. At September 30, 2022, Purple Inc. had a 99.5% economic interest in Purple LLC while other Class B Unit holders had the remaining 0.5%.

 

On August 31, 2022, the Company acquired all of the issued and outstanding stock of Intellibed with the surviving entity continuing as a wholly owned subsidiary of Purple Inc. For further discussion see Recent Developments in Our Business — Acquisition below.

 

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Executive Summary – Results of Operations

 

Net revenues decreased 16.1% to $143.3 million and 20.2% to $430.6 million for the three and nine months ended September 30, 2022, respectively, when compared to the corresponding periods in the prior year. These decreases were primarily due to softening demand for home related products and the negative effect of inflationary pressures on consumer discretionary spending.

 

Gross profit was $59.4 million for the three months ended September 30, 2022 compared to $61.1 million for the same period in the prior year. The gross profit percentage improved in the third quarter of 2022 to 41.5% as compared to 35.8% in the prior year third quarter. The increase in our gross profit percentage was primarily due to efficiency and cost reduction initiatives implemented in the first half of fiscal 2022 offset in part by a shift in revenue to our wholesale channel, which carries a lower average selling price than sales from our e-commerce and retail showroom channels. For the nine months ended September 30, 2022, gross profit decreased 30.6% to $159.9 million as compared to the prior year nine-month period due in part to the decrease in sales volume. The gross profit percentage for the first nine months of 2022 was 37.1% as compared to 42.7% for the prior year nine-month period. Our gross profit percentage was adversely impacted by elevated levels of materials, labor and freight costs, lower-than-expected demand levels and a shift in revenue to our wholesale channel. The benefits from our efficiency and cost reduction initiatives did not become fully impactful until the third quarter.

 

Operating expenses decreased 14.1% to $58.1 million and 15.1% to $189.0 million for the three and nine months ended September 30, 2022, respectively, when compared to the corresponding periods in the prior year. These decreases primarily reflected the impact of reduced advertising spend, two workforce reductions and the implementation of other cost saving measures.

 

Net income was $2.3 million for the three months ended September 30, 2022 as compared to net income of $2.2 million for the three months ended September 30, 2021. For the nine months ended September 30, 2022, the Company’s net loss was $19.6 million as compared to net income of $25.6 million for the nine months ended September 30, 2021.

 

Recent Developments in Our Business

 

Acquisition

 

On August 31, 2022, the Company acquired Intellibed, a premium sleep and health wellness company, offering gel-based mattresses scientifically designed for maximum back support, spinal alignment and pressure point relief. We believe that the addition of Intellibed will increase product offerings to customers, expand market opportunities, capitalize on synergies of the combined companies, and increase opportunities for innovation. In addition, the acquisition allowed the Company to consolidate ownership of its intellectual property and more fully capitalize on growing demand for products with gel technologies. The total purchase consideration for the acquisition was $28.3 million, which primarily consisted of 8.1 million shares of Class A common stock. Purchase consideration also included the fair value of 0.5 million shares of Class A common stock held in escrow pending resolution of net working capital adjustments and general representation and warranty provisions of the agreement, the fair value of contingent consideration of 1.5 million shares of Class A common stock issuable to Intellibed securityholders depending upon the price of the Class A common stock over the next 18 months, $1.4 million gain related to the fair value of a preexisting legal matter that was effectively settled on the acquisition date, and $0.9 million related to the fair value of other items.

 

Coliseum Capital Management, LLC Proposal

 

On September 17, 2022, the Company received an unsolicited and non-binding proposal from CCM to acquire the remaining outstanding common stock of the Company not already beneficially owned by CCM for $4.35 per share in cash. At the time of the offer, CCM beneficially owned approximately 45% of the outstanding equity of the Company. The CCM proposal is conditioned upon the transaction being (a) negotiated by, and subject to the approval of, a special committee of independent and disinterested members of the Board (the “Special Committee”) and (b) subject to a non-waivable condition requiring approval by the affirmative vote of a majority of the shares of common stock not owned by CCM or other interested parties. The Special Committee was formed by the Board to determine the necessary actions to evaluate the CCM proposal and determine the course of action that is in the best interests of all of the Company’s shareholders. The Board expressly granted the Special Committee the ability to decline the CCM proposal. In addition, the Special Committee adopted the Rights Plan to have the time and flexibility necessary to evaluate the CCM offer.

 

Stockholder Rights Agreement

 

On September 25, 2022, with the authorization of the Board, the Special Committee approved the adoption of a limited-duration stockholder rights agreement with an expiration date of September 25, 2023. The Special Committee adopted the Rights Agreement in response to CCM’s substantial increase in ownership of the Company’s shares over the last year and the Special Committee’s desire to have the time and flexibility necessary to evaluate CCM’s offer to acquire the outstanding common stock of the Company not already beneficially owned by CCM. The Rights Agreement is intended to enable the Company’s shareholders to realize the full value of their investment and to guard against any attempts to gain control of the Company without paying all shareholders an appropriate control premium. The Rights Agreement applies equally to all current and future shareholders and does not deter any offer or preclude the Special Committee from considering an offer that is fair and otherwise in the best interests of the Company’s shareholders.

 

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Upon adopting the Rights Agreement, 300,000 shares of the Company’s authorized shares of preferred stock, par value $0.0001 per share, were designated as Preferred Shares. In accordance with the Rights Agreement, on September 25, 2022, the Special Committee authorized and declared a dividend of one preferred share purchase right (a “Right”) for each outstanding share of the Company’s Class A and Class B common stock to stockholders of record at the close of business on October 6, 2022. Upon the occurrence of certain triggering events, each Right entitles the holder to purchase from the Company one one-thousandth of a share of the newly designated Preferred Shares at an exercise price of $20.00. The Rights will be exercisable only if a person or group acquires beneficial ownership (including certain synthetic equity positions created by derivative securities) of 20% or more of the Company’s outstanding shares of common stock. Any person or group that beneficially owned more than the triggering percentage when the Board adopted the Rights Agreement may continue to own its shares of common stock but may not acquire any additional shares without triggering the Rights Agreement. Unless the Rights become exercisable as discussed above, the Rights Agreement has no impact on the Company’s condensed consolidated financial statements.

 

Equity Financing

 

In March 2022, the Company completed an underwritten public offering of 16.1 million shares of Class A common stock, which included the additional 2.1 million shares of the over-allotment option that the underwriters exercised in full. The aggregate net proceeds received by the Company from the offering, after deducting offering expenses of $0.3 million, totaled $92.9 million.

 

Debt Financing

 

On September 3, 2020, Purple LLC entered into the 2020 Credit Agreement that provided for a $45.0 million term loan and a $55.0 million revolving line of credit. In November 2021, the Company executed a $55.0 million draw on its revolving line of credit, which represented the full amount available under the line. On March 31, 2022, the Company used a portion of the net proceeds from its underwritten public offering, described above, to repay in full the $55.0 million of principal outstanding on the revolving line of credit.

 

The Company’s operating and financial results for the year ended December 31, 2021 did not satisfy the financial and performance covenants required under the 2020 Credit Agreement. On February 28, 2022, prior to the covenant compliance certification date, the Company entered into the first amendment of the 2020 Credit Agreement to avoid a breach of these covenants and potential default. This amendment contained a covenant waiver period such that the net leverage ratio and fixed charge coverage ratio would not be tested for the fiscal quarters ended December 31, 2021, March 31, 2022 and June 30, 2022. Other modifications in the amendment included revised leverage ratio and fixed charge coverage definitions and thresholds, the addition of minimum liquidity requirements with mandatory prepayments of the revolving loan if cash exceeded $25.0 million, new weekly and monthly reporting requirements, limits on the amount of capital expenditures, the addition of a lease incurrence test for opening additional showrooms, additional negative covenants during a covenant amendment period that extends into 2023 until certain conditions are met, and the interest rate was changed from LIBOR plus 3.00% to SOFR plus 4.75%. Pursuant to this amendment, the Company made a $2.5 million payment on the term loan to cover the four quarterly principal payments due in 2022 and incurred fees and expenses of $0.8 million that were recorded as debt issuance costs in the condensed consolidated balance sheet.

 

On March 23, 2022, the Company entered into a second amendment to the 2020 Credit Agreement. This amendment modified the 2020 Credit Agreement to allow CCM and its investment affiliates to acquire 35% or more of the combined voting power of all equity interests of the Company entitled to vote for the election of members of the Company’s board of directors without constituting an event of default. CCM is considered a related party of the Company in that Adam Gray, a member of our board of directors, serves as a managing partner of CCM. Pursuant to this amendment, the Company incurred fees and expenses of $0.4 million that were recorded as debt issuance costs in the condensed consolidated balance sheet.

 

On May 13, 2022 and September 9, 2022, the Company entered into a third and fourth amendment, respectively, to the 2020 Credit Agreement. These amendments modified the permitted leases schedule to reflect a change in showroom locations and a new lease for an innovation building. The amendments did not meet the criteria for a modification of existing debt and the minimal expenses were recorded as a general and administrative expense in the condensed consolidated statement of operations.

 

On July 14, 2022, the Company received consent under the 2020 Credit Agreement allowing the Company’s acquisition of Intellibed to constitute a permitted acquisition under the 2020 Credit Agreement. The Company incurred fees and expenses of $0.3 million that were recorded as general and administrative expense in the condensed consolidated statement of operations.

 

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Operational Developments

 

The COVID-19 pandemic has impacted many aspects of our operations, directly and indirectly, including disruption of our employees, consumer behavior, distribution and logistics, our suppliers, and the market overall. The scope and nature of these impacts continue to evolve. Soon after the pandemic began, we experienced an increase in demand in our e-commerce channel, and in 2020 and 2021 the Company increased its production capacity to match actual and anticipated demand growth. In 2022, after two years of the pandemic, we began experiencing a pull-back in growth that left us with excess operational capacity in facilities, equipment, and personnel. Beginning in the first quarter of 2022 and continuing into the third quarter, the Company rebalanced production and fulfillment operations in its different facilities, reduced employee headcount and took other actions to lower costs.

 

We are closely monitoring the impacts of COVID-19 and general economic conditions on global supply chain, manufacturing, and logistics operations. As inflationary pressures increase, we anticipate that our production and operating costs will similarly increase. In addition, COVID-19 and other events, including port closures or labor shortages, have resulted in the continuation or worsening of manufacturing and shipping costs, delays and constraints. While most of our domestic suppliers have been able to continue operations and provide necessary materials when needed, we have experienced some constraints from certain suppliers, with respect to both the availability and cost of materials. In addition, as experienced in other industries, in order to remain competitive in hiring and retaining the labor necessary to maintain our production levels, we have increased wages and other compensation. These increases in materials, labor and freight costs have resulted in higher cost of goods sold and lower margins. We believe that materials, labor and freight costs will continue to remain at elevated levels or increase further in the foreseeable future.

 

In the fourth quarter of 2021 and continuing into 2022, our gross profits and results of operations have been, and we expect will continue to be adversely affected by elevated levels of materials, labor and freight costs and lower-than-expected demand levels. In early 2022, to offset the impact of higher costs on our gross profits, we increased prices and initiated several other projects to improve efficiencies and reduce costs, including balancing production between facilities to reduce freight costs and shorten delivery times. As the softening of demand for home related products continues, and consumer spending habits shift from e-commerce to brick and mortar, we are investing in showroom expansion where we are in the early stages of developing our capabilities. We also are growing our wholesale partner door count and focusing on improving wholesale door productivity. We ended the third quarter with 51 Purple showrooms after opening 11 new locations during the third quarter and we plan to add three more showrooms over the remainder of the year. In addition, at the end of the third quarter, our products are being sold through approximately 3,300 wholesale doors, having added approximately 800 net new doors during the first nine months of 2022. Improving the sales productivity of our wholesale doors remains a primary focus and a critical component of our strategy to respond to shifting demand patterns. After several years of hyper growth and increased investments to support current and future expansion, we are now building the framework for strong operational maturity and accountability after focusing on right-sizing our operations, improving our execution, and refining our strategies that will drive share gains in the premium mattress category and position the Company for accelerated growth when market conditions improve. We have also intentionally reduced our advertising spending in 2022 to improve marketing efficiency, stabilize profitability in a challenging macroeconomic environment and align spending with the current demand environment.

 

The acquisition of Intellibed is expected to be a strong strategic addition to the Company because of shared technology, geographic proximity of their primary facility, and target market extension. In addition, the acquisition allowed the Company to consolidate ownership of its intellectual property and more fully capitalize on growing demand for products with gel technologies. Intellibed’s higher price points compared to the Company’s existing product offerings will be a natural extension of our product line. The acquisition also benefits us by accelerating our product development schedule several years by being able to immediately enter the luxury segment of the sleep and wellness industry. In addition, we expect to capitalize on synergies of the combined companies and benefit from expanding the market presence of Intellibed’s product offerings.

 

Outlook for Growth

 

To support our plans for future growth and sustained profitability, we are focusing on the following opportunities:

 

  Develop and execute on strategies to meaningfully expand our wholesale business by prioritizing existing door profitability.
     
  Build premium brand position to grow market share of the premium mattress category.
     
  Refine and enhance marketing strategies to reach a broader audience, increase customer engagement and reduce dependency on price promotions as a means of driving sales.

 

  Strengthen research and development disciplines and go-to-market processes to further develop our current product categories and position our business to eventually expand to additional categories.
     
  Manage production labor and capacity utilization to promote efficient use of our manufacturing facilities as we grow into our production footprint.
     
  Manage input costs, operating efficiencies, and pricing to offset gross profit erosion.

 

 

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There is no guarantee that we will be able to effectively execute on these opportunities, which are subject to risks, uncertainties, and assumptions that are difficult to predict, including the risks described under “Risk Factors” and elsewhere herein. Therefore, actual results may differ materially and adversely from those described above. In addition, we may, in the future, adapt these focuses in response to changes in the market or our business.

 

Operating Results for the Three Months Ended September 30, 2022 and 2021

 

The following table sets forth for the periods indicated, our results of operations and the percentage of total revenue represented in our condensed consolidated statements of operations (dollars in thousands):

 

   Three Months Ended September 30, 
   2022   % of
Net
Revenues
   2021   % of
Net
 Revenues
 
Revenues, net  $143,280    100.0%  $170,781    100.0%
Cost of revenues   83,867    58.5    109,701    64.2 
Gross profit   59,413    41.5    61,080    35.8 
Operating expenses:                    
Marketing and sales   37,007    25.8    48,841    28.6 
General and administrative   19,166    13.4    17,037    10.0 
Research and development   1,927    1.3    1,784    1.0 
Total operating expenses   58,100    40.6    67,662    39.6 
Operating income (loss)   1,313    0.9    (6,582)   (3.9)
Other income (expense):                    
Interest income (expense), net   (717)   (0.5)   10     
Other income, net   1,107    0.8    12     
Change in fair value – warrant liabilities   (53)       5,362    3.1 
Tax receivable agreement income           846    0.5 
Total other income, net   337    0.2    6,230    3.6 
Net income (loss) before income taxes   1,650    1.2    (352)   (0.2)
Income tax benefit   631    0.4    2,479    1.5 
Net income   2,281    1.6    2,127    1.2 
Net income (loss) attributable to noncontrolling interest   3        (44)    
Net income attributable to Purple Innovation, Inc.  $2,278    1.6   $2,171    1.3 

 

Revenues, Net

 

Net revenues decreased $27.5 million, or 16.1%, to $143.3 million for the three months ended September 30, 2022 compared to $170.8 million for the three months ended September 30, 2021. The decline in net revenues reflected a $23.7 million decrease in mattress sales, a $1.2 million decrease in other sleep product sales and a $2.6 million decrease in other product sales. The decrease in net revenues was primarily due to softening demand for home related products and the negative effect of inflationary pressures on consumer discretionary spending. The decline in net revenues from a sales channel perspective consisted of DTC net revenues decreasing $28.3 million, or 25.0%, offset in part by wholesale net revenues increasing $0.8 million, or 1.3%. Within DTC, ecommerce net revenue declined $37.6 million, or 36.6%, due to the reasons stated above and showroom net revenue increased $9.9 million, or 110.4%, driven largely by the opening of 32 net new showrooms over the past 12 months. In addition to the softening demand discussed above, the decrease in DTC net revenues was impacted by a return to more normalized consumption patterns in fiscal 2022 with customers shifting away from e-commerce buying experienced during COVID and the economic stimulus. The increase in wholesale net revenues was primarily due to the Intellibed acquisition which added $2.6 million of wholesale net revenues from the date of acquisition through September 30, 2022, partially offset by reductions in revenue due to market conditions.

  

Cost of Revenues

 

Cost of revenues decreased $25.8 million, or 23.5%, to $83.9 million for the three months ended September 30, 2022 compared to $109.7 million for the three months ended September 30, 2021. This decrease was primarily due to the corresponding decrease in sales volume. Our gross profit percentage, which increased to 41.5% of net revenues in the third quarter of 2022 from 35.8% in the third quarter of 2021, benefited from efficiency and cost saving initiatives implemented in the first half of fiscal 2022 that included headcount reductions and the balancing of production and fulfillment operations between the facilities. Also, the gross profit percentage in the prior year third quarter was adversely impacted by inefficiencies related to the resolution of prior year production issues. The gross profit percentage in the third quarter of 2022 was negatively impacted by a shift in revenue to our wholesale channel, which carries a lower average selling price than sales from our e-commerce and retail sales channels.

 

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Marketing and Sales

 

Marketing and sales expense decreased $11.8 million, or 24.2%, to $37.0 million for the three months ended September 30, 2022 compared to $48.8 million for the three months ended September 30, 2021. This decrease was driven by a $16.7 million or 56.8% decline in advertising spending and a $3.8 million decrease in other marketing costs. The reduction in advertising spending was primarily due to management’s ongoing efforts to improve marketing efficiency, stabilize profitability in a challenging macroeconomic environment and align spending with current demand levels. The decrease in other marketing costs reflected the impact of management restructuring the marketing organization earlier in 2022. These decreases were offset in part by a $2.4 million increase in wholesale-related marketing and sales costs due primarily to growing the sales organization of our wholesale business and a $6.2 million increase in marketing and sales costs associated with continued expansion of our showroom business. Marketing and sales expense as a percentage of net revenues was 25.8% in the third quarter of 2022 compared to 28.6% in the third quarter of 2021. This decrease was primarily the result of reduced advertising spending.

 

General and Administrative

 

General and administrative expense increased $2.1 million, or 12.5%, to $19.2 million for the three months ended September 30, 2022 compared to $17.0 million for the three months ended September 30, 2021. This increase was primarily due to a $1.4 million increase in legal and professional fees, a $0.2 million increase in payroll and benefit expense and $0.5 million in general and administrative expense attributable to Intellibed. The increase in legal and professional fees was primarily due to $2.8 million of transaction costs associated with the Intellibed acquisition. Excluding the impact of Intellibed acquisition costs, legal and professional fees declined $1.4 million during the quarter due to lower consulting and legal fees. The increase in payroll and benefit costs was due mainly to job restructuring of certain employees in the first half of 2022.

 

Research and Development

 

Research and development costs increased $0.1 million, or 8.0%, to $1.9 million for the three months ended September 30, 2022 from $1.8 million for the three months ended September 30, 2021. This increase reflected higher payroll and benefit costs as our renewed focus on product innovation resulted in the growth of our research and development team, which included the addition of our chief innovation officer. The increase in payroll expenses was offset in part by a decrease in professional services costs as product development priorities were being refocused.

 

Operating Income (Loss)

 

Operating income was $1.3 million for the three months ended September 30, 2022 compared to an operating loss of $6.6 million for the three months ended September 30, 2021. The $7.9 million increase in operating income was primarily due to lower operating expenses.

 

Interest Expense

 

Interest expense totaled $0.7 million for the three months ended September 30, 2022 compared to a negligible amount of net interest income for the three months ended September 30, 2021. Interest expense was impacted by capitalized interest on borrowings that totaled $0.2 million and $0.8 million during the three months ended September 30, 2022 and 2021, respectively. The increase in interest expense was also impacted by the term loan interest rate increasing to 6.07% during the third quarter of 2022 compared to 3.50% in the third quarter of 2021. In February 2022, the Company entered into the first amendment to the 2020 Credit Agreement which, among other things, changed the reference interest rate from LIBOR to SOFR and increased the applicable margins.

 

Other Income (Expense), Net

 

Other income totaled $1.1 million in the three months ended September 30, 2022 compared to a negligible amount of other income for the three months ended September 30, 2021. This increase primarily resulted from the effective settlement of a preexisting legal matter between the Company and Intellibed upon the Company’s acquisition of Intellibed on August 31, 2022 at an estimated fair value gain of $1.4 million.

 

Change in Fair Value – Warrant Liabilities

 

The 1.9 million sponsor warrants outstanding at September 30, 2022 and 2021 had fair values of $0.1 million and $9.0 million, respectively. The decrease in fair value was primarily due to the Company’s Class A common stock price, one of the primary assumptions used to re-measure the warrant liability, declining from $21.02 at September 30, 2021, to $4.05 at September 30, 2022. During the three months ended September 30, 2022, the Company recorded a loss of $0.1 million related to an increase in the fair value of the warrants outstanding at the end of the period. For the three months ended September 30, 2021, the Company recognized a gain of $5.4 million related to a decrease in the fair value of the warrants outstanding at the end of the period.

 

Income Tax (Expense) Benefit

 

We had an income tax benefit of $0.6 million for the three months ended September 30, 2022 compared to an income tax benefit of $2.5 million for the three months ended September 30, 2021. The income tax benefit in the third quarter of 2022 was primarily the result of the Company having a net loss during the first nine months of 2022.

 

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Noncontrolling Interest

 

The Company calculates net income or loss attributable to noncontrolling interests on a quarterly basis using their weighted average ownership percentage. Net income attributed to noncontrolling interests and net loss attributed to noncontrolling interest were both negligible for the three months ended September 30, 2022 and 2021.

 

Operating Results for the Nine Months Ended September 30, 2022 and 2021

 

The following table sets forth for the periods indicated, our results of operations and the percentage of total revenue represented in our statements of operations (dollars in thousands):

  

   Nine Months Ended September 30, 
   2022   % of
Net
Revenues
   2021   % of
Net
 Revenues
 
Revenues, net  $430,568    100.0%  $539,796    100.0%
Cost of revenues   270,717    62.9    309,505    57.3 
Gross profit   159,851    37.1    230,291    42.7 
Operating expenses:                    
Marketing and sales   127,339    29.6    163,053    30.2 
General and administrative   55,833    13.0    54,024    10.0 
Research and development   5,818    1.4    5,430    1.0 
Total operating expenses   188,990    43.9    222,507    41.2 
Operating income (loss)   (29,139)   (6.8)   7,784    1.4 
Other income (expense):                    
Interest expense   (2,447)   (0.6)   (1,129)   (0.2)
Other income (expense), net   988    0.2    (30)    
Change in fair value – warrant liabilities   4,221    1.0    19,369    3.6 
Tax receivable agreement income           639    0.1 
Total other income, net   2,762    0.6    18,849    3.5 
Net income (loss) before income taxes   (26,377)   (6.1)   26,633    4.9 
Income tax benefit (expense)   6,617    1.5    (1,005)   (0.2)
Net income (loss)   (19,760)   (4.6)   25,628    4.7 
Net income (loss) attributable to noncontrolling interest   (196)       55     
Net income (loss) attributable to Purple Innovation, Inc.  $(19,564)   (4.5)  $25,573    4.7 

 

Revenues, Net

 

Net revenues decreased $109.2 million, or 20.2%, to $430.6 million for the nine months ended September 30, 2022 compared to $539.8 million for the nine months ended September 30, 2021. The decline in net revenues reflected a $93.5 million decrease in mattress sales, a $9.3 million decrease in other sleep product sales and a $6.4 million decrease in other product sales. The decrease in net revenues was primarily due to softening demand for home related products and the negative effect of inflationary pressures on consumer discretionary spending. Net revenues in the prior year nine-month period were positively impacted by the pull forward of demand in the first half of 2021 that was driven by the effects of COVID and economic stimulus. The decline in net revenues from a sales channel perspective consisted of DTC net revenues decreasing $102.2 million, or 28.9% and wholesale net revenues decreasing $7.0 million, or 3.8%. Within DTC, ecommerce net revenue declined $127.1 million, or 38.4%, due to the reasons stated above and showroom net revenue increased $25.6 million, or 129.1%, driven largely by the opening of 32 net new showrooms over the past 12 months. In addition to the softening demand discussed above, the decrease in DTC net revenues was impacted by a return to more normalized consumption patterns in fiscal 2022 with customers shifting away from e-commerce buying. The decrease in wholesale net revenues reflected reduced purchases by our existing wholesale partners during the first nine months of 2022 due to market conditions, offset in part by the effects of adding approximately 800 net new wholesale partner doors in fiscal 2022 coupled with wholesale net revenues contributed by Intellibed.

 

Cost of Revenues

 

Cost of revenues decreased $38.8 million, or 12.5%, to $270.7 million for the nine months ended September 30, 2022 compared to $309.5 million for the nine months ended September 30, 2021. This decrease was primarily due to the corresponding decrease in sales volume, offset in part by an increase in indirect labor and manufacturing overhead costs. Our gross profit percentage decreased to 37.1% of net revenues during the first nine months of 2022 from 42.7% for the first nine months of 2021. Our gross profit percentage was adversely impacted by elevated levels of material, labor and freight costs and lower-than-expected demand levels. In addition, we had a shift in revenue to our wholesale channel, which carries a lower average selling price than sales from our e-commerce and retail showroom channels. Our efficiency and cost saving initiatives, as well as the balancing of production and fulfillment operations between the facilities, were implemented during the first half of fiscal 2022 and did not become fully impactful until the third quarter.

 

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Marketing and Sales

 

Marketing and sales expense decreased $35.7 million, or 21.9%, to $127.3 million for the nine months ended September 30, 2022 compared to $163.1 million for the nine months ended September 30, 2021. This decrease was driven by a $56.4 million or 50.4% decline in advertising spending and a $5.8 million decrease in other marketing costs. The reduction in advertising spending was primarily due to management’s ongoing efforts to improve marketing efficiency, stabilize profitability in a challenging macroeconomic environment and align spending with current demand levels. The decrease in other marketing costs reflected the impact of management restructuring the marketing organization earlier in 2022. These decreases were offset in part by a $9.4 million increase in wholesale-related marketing and sales costs due in part to growing the sales organization of our wholesale business and a $17.1 million increase in marketing and sales costs associated with showroom expansion. Marketing and sales expense as a percentage of net revenues was 29.6% during the first nine months of 2022 compared to 30.2% for the first nine months of 2021.

 

General and Administrative

 

General and administrative expense increased $1.8 million, or 3.3%, to $55.8 million for the nine months ended September 30, 2022 compared to $54.0 million for the nine months ended September 30, 2021. This increase was primarily due to a $3.9 million increase in payroll and benefits expense and $0.5 million in added costs from the Intellibed consolidation, offset in part by a $3.2 million decrease in legal and professional fees. The increase in payroll and benefit costs was due mainly to job restructuring of certain employees in the first half of 2022. The decrease in legal and professional fees was primarily due to $7.9 million of underwriting commissions and other costs we paid in the prior year second quarter for shares sold by Coliseum Capital Partners. This decrease was partially offset by a one-time $3.1 million separation fee incurred by the Company during the second quarter of 2022 for not continuing with the services of a professional services provider coupled with $2.8 million of Intellibed transaction costs.

 

Research and Development

 

Research and development costs increased $0.4 million, or 7.1%, to $5.8 million for the nine months ended September 30, 2022 from $5.4 million for the nine months ended September 30, 2021. This increase reflected higher payroll and benefit costs as our renewed focus on product innovation resulted in the growth of our research and development team, which included the addition of our chief innovation officer. The increase in payroll expenses was offset in part by a decrease in professional services costs as product development priorities were being refocused.

 

Operating Income (Loss)

 

Operating income decreased $36.9 million to an operating loss of $29.1 million for the nine months ended September 30, 2022 compared to operating income of $7.8 million for the nine months ended September 30, 2021. This decrease primarily reflected a decrease in gross profit that was driven by lower net revenues and a decrease in gross profit margin.

 

Interest Expense

 

Interest expense totaled $2.4 million for the nine months ended September 30, 2022 compared to $1.1 million for the nine months ended September 30, 2021. The $1.3 million increase was due in part to interest expense of $0.6 million incurred on the $55.0 million revolving line of credit that was drawn down by the Company in November 2021 and repaid in full on March 31, 2022. The increase was also impacted by the term loan average interest rate increasing from 3.50% during the first nine months of 2021 to 5.42% during the first nine months of 2022. In February 2022, the Company entered into the first amendment to the 2020 Credit Agreement which, among other things, changed the reference interest rate from LIBOR to SOFR and increased the applicable margins. Interest capitalized on borrowings totaled $0.6 million and $0.8 million during the nine months ended September 30, 2022 and 2021, respectively.

 

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Other Income (Expense), Net

 

Other income totaled $1.0 million in the nine months ended September 30, 2022 compared to a negligible amount of other expense recorded during the nine months ended September 30, 2021. The increase in other income primarily resulted from the effective settlement of a preexisting legal matter between the Company and Intellibed upon the Company’s acquisition of Intellibed on August 31, 2022 at an estimated fair value gain of $1.4 million.

 

Change in Fair Value – Warrant Liabilities

 

The 1.9 million sponsor warrants outstanding at September 30, 2022 and 2021 had fair values of $0.1 million and $9.0 million, respectively. The decrease in fair value was primarily due to the Company’s Class A common stock price, one of the primary assumptions used to re-measure the warrant liability, declining from $21.02 at September 30, 2021, to $4.05 at September 30, 2022. During the nine months ended September 30, 2022 and 2021, we recognized gains of $4.2 million and $19.4 million, respectively, that resulted from decreases in the fair value of the warrants outstanding at the end of the respective periods.

 

Income Tax (Expense) Benefit

 

We had an income tax benefit of $6.6 million for the nine months ended September 30, 2022 compared to income tax expense of $1.0 million for the nine months ended September 30, 2021. The income tax benefit in the first nine months of 2022 was primarily the result of the Company having a net loss before income taxes of $26.4 million.

 

Noncontrolling Interest

 

The Company calculates net income or loss attributable to noncontrolling interests on a quarterly basis using their weighted average ownership percentage. Net loss attributed to noncontrolling interests was $0.2 million for the nine months ended September 30, 2022 compared to net income of $0.1 million for the nine months ended September 30, 2021.

 

Liquidity and Capital Resources

 

Our principal sources of funds are cash flows from operations and cash and cash equivalents on hand, supplemented with borrowings made pursuant to our credit facilities and proceeds received from offerings of our equity capital. Principal uses of funds consist of payments of principal and interest on our debt facilities, capital expenditures and working capital needs as well as other contractual obligations described below. Our working capital needs depend largely upon the timing of cash receipts from product sales, payments to vendors and others, changes in inventories, and operating lease payment obligations. Our unrestricted cash and working capital positions were $57.4 million and $86.2 million, respectively, as of September 30, 2022 compared to $91.6 million and $87.5 million, respectively, as of December 31, 2021. Cash used for capital expenditures decreased from $41.5 million in the first nine months of 2021 to $34.1 million during the first nine months of 2022. Our capital expenditures in the first nine months of 2022 primarily consisted of leasehold improvements and furniture and fixtures associated with the opening of new Purple retail showrooms.

 

In the event our cash flow from operations or other sources of financing are less than anticipated, we believe we will be able to fund operating expenses and comply with debt covenants based on our ability to scale back operations, reduce marketing spend, use the liquidity we have available under our revolving line of credit and postpone or discontinue our growth strategies. Our 2020 Credit Agreement, as amended, includes various covenants and obligations that may make it difficult to obtain additional capital on terms that are favorable to us and to execute on our growth strategies. In addition, in order to continue satisfying the conditions of the debt agreement we may be required to scale back operations, reduce marketing spend, prepay debt and postpone or discontinue our growth strategies. We may also be forced to restructure our obligations to current creditors, pursue work-out options or seek additional funding sources including new debt or equity capital.

 

Based on our current projections, we believe our cash on hand, amounts available under our revolving line of credit, and expected cash to be generated from our e-commerce, wholesale, and Purple retail store channels will be sufficient to meet our working capital requirements, comply with debt covenants and cover anticipated capital expenditures for the next 12 months and beyond.

 

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Underwritten Offering

 

In March 2022, the Company completed an underwritten public offering of 16.1 million shares of Class A common stock, which included the additional 2.1 million shares of the over-allotment option that the underwriters exercised in full. The aggregate net proceeds received by the Company from the offering, after deducting offering expenses of $0.3 million, totaled $92.9 million.

 

Debt

 

On September 3, 2020, Purple LLC entered into the 2020 Credit Agreement that provided for a $45.0 million term loan and a $55.0 million revolving line of credit. The term loan is being repaid in accordance with a five-year amortization schedule and may be prepaid in whole or in part at any time without premium or penalty, subject to reimbursement of certain costs. The revolving credit facility has a term of five years and carries the same interest provisions as the term debt. A commitment fee is due quarterly based on the applicable margin applied to the unused total revolving commitment. In November 2021, the Company executed a $55.0 million draw on its revolving line of credit, which represented the full amount available under the line. On March 31, 2022, the Company used a portion of the net proceeds from the offering to repay in full the $55.0 million of principal outstanding on the revolving line of credit.

 

The Company’s operating and financial results for the year ended December 31, 2021 did not satisfy the financial and performance covenants required under the 2020 Credit Agreement. On February 28, 2022, prior to the covenant compliance certification date, the Company entered into the first amendment of the 2020 Credit Agreement to avoid a breach of these covenants and potential default. This amendment contained a covenant waiver period such that the net leverage ratio and fixed charge coverage ratio would not be tested for the fiscal quarters ended December 31, 2021, March 31, 2022 and June 30, 2022. Other modifications in the amendment included revised leverage ratio and fixed charge coverage definitions and thresholds, the addition of minimum liquidity requirements with mandatory prepayments of the revolving loan if cash exceeded $25.0 million, new weekly and monthly reporting requirements, limits on the amount of capital expenditures, the addition of a lease incurrence test for opening additional showrooms, and additional negative covenants during a covenant amendment period that extends into 2023 until certain conditions are met. In addition, the interest rate on any outstanding borrowings under the 2020 Credit Agreement was changed from LIBOR with a floor of 0.5% plus an applicable margin (historically at 3.0%) to an initial rate of SOFR with a floor of 0.5% plus 4.75%, for a total rate of 5.25% if the applicable liquidity threshold is met. If the Company does not meet this threshold, the interest rate would increase to SOFR with a floor of 0.5% plus 9.00%. Once the Company achieves a consolidated leverage ratio that is below 3.00 to 1.00, the interest rate will be based on SOFR with a floor of 0.5% plus a 3.00% to 3.75% margin depending on the consolidated leverage ratio. The interest rate on the term loan was 6.07% as of September 30, 2022. As of September 30, 2022, the Company was in compliance with all of the financial covenants related to the 2020 Credit Agreement, as amended.

 

Pursuant to the first amendment of the 2020 Credit Agreement, the Company incurred fees and expenses of $0.9 million that were recorded as debt issuance costs in the condensed consolidated balance sheet and made a $2.5 million payment on the term loan to cover the four quarterly principal payments due in 2022. The Company accounted for this amendment as a modification of existing debt in accordance with ASC 470 – Debt.

 

On March 23, 2022, the Company entered into a second amendment to the 2020 Credit Agreement. This amendment modified the 2020 Credit Agreement to allow CCM and its investment affiliates to acquire 35% or more of the combined voting power of all equity interests of the Company entitled to vote for the election of members of the Company’s board of directors without constituting an event of default. CCM is considered a related party of the Company in that Adam Gray, a member of our board of directors, serves as a managing partner of CCM.

 

On May 13, 2022 and September 9, 2022, the Company entered into a third and fourth amendment, respectively, to the 2020 Credit Agreement. These amendments modified the permitted leases schedule to reflect a change in showroom locations and a new lease for an innovation building. The amendments did not meet the criteria for a modification of existing debt and the minimal expenses were recorded as a general and administrative expense in the condensed consolidated statement of operations.

 

Pursuant to the second amendment of the 2020 Credit Agreement, the Company incurred fees and expenses of $0.4 million that were recorded as debt issuance costs in the condensed consolidated balance sheet. The Company accounted for this amendment as a modification of existing debt in accordance with ASC 470 – Debt.

 

Tax Receivable Agreement

 

We are required to make certain payments to InnoHold under a tax receivable agreement, which may have a material adverse effect on our liquidity and capital resources. We are currently unable to determine the total future amount of these payments due to the unpredictable nature of several factors, including the timing of future exchanges, the market price of shares of Class A common stock at the time of the exchanges, the extent to which such exchanges are taxable and the amount and timing of future taxable income sufficient to utilize tax attributes that give rise to the payments under the agreement. As of September 30, 2022 and December 31, 2021, the tax receivable agreement liability reflected in the Company’s consolidated balance sheet was $162.2 million and $168.1 million, respectively. This decrease was due to a $5.8 million payment that was made during the first quarter of 2022.

 

Other Contractual Obligations

 

In addition to the material contractual obligations discussed above, other material contractual obligations primarily include operating lease payments obligations. See Note 9 of the condensed consolidated financial statements for additional information.

 

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Cash Flows for the Nine Months Ended September 30, 2022 Compared to the Nine Months Ended September 30, 2021

 

The following summarizes our cash flows for the nine months ended September 30, 2022 and 2021 as reported in our condensed consolidated statements of cash flows (in thousands):

 

   Nine Months Ended
September 30,
 
   2022   2021 
Net cash provided by (used in) operating activities  $(30,474)  $132 
Net cash used in investing activities   (30,411)   (41,498)
Net cash provided by financing activities   28,412    2,027 
Net decrease in cash   (32,473)   (39,339)
Cash, cash equivalents and restricted cash, beginning of the period   91,616    122,955 
Cash, cash equivalents and restricted cash, end of the period  $59,143   $83,616 

 

Cash used in operating activities of $30.5 million for the nine months ended September 30, 2022 primarily resulted from a $19.8 million net loss combined with a $13.9 million decrease in operating cash flow related to net changes in operating assets and liabilities. These decreases related mostly to a $26.6 million decrease in accounts payable, offset in part by an $11.5 million decrease in inventories. The decline in accounts payable was mainly due to the balance at prior year-end being higher than normal because of payment timing coupled with the impact of larger advertising spend in the fourth quarter of 2021. The decrease in inventory was primarily due to management’s efforts to rebalance production and fulfillment operations during the first half of 2022.

 

Cash used in investing activities reflected capital expenditures of $34.1 million during the nine months ended September 30, 2022 compared to $41.5 million for the nine months ended September 30, 2021. Capital expenditures during the first nine months of 2022 primarily consisted of investments in leasehold improvements and furniture and fixtures related to the opening of new Purple retail showrooms. Cash flows from investing activities also included cash acquired in the acquisition of Intellibed that consisted of $1.9 million of cash and cash equivalents and $1.7 million of restricted cash.

 

Cash provided by financing activities was $28.4 million during the nine months ended September 30, 2022 compared to $2.0 million during the nine months ended September 30, 2021. Financing activities during the first nine months of 2022 included $92.9 million of net proceeds received from the underwritten stock offering, offset in part by a $55.0 million revolving line of credit payment, a $5.8 million payment on the tax receivable agreement, and $3.8 million in other debt related payments.

 

Critical Accounting Policies

 

We discuss our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2021 Annual Report on Form 10-K filed March 1, 2022. There were no significant changes in our critical accounting policies since the end of fiscal 2021.

 

Available Information

 

Our website address is www.purple.com. We make available free of charge on the Investor Relations portion of our website, investors.purple.com, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

 

We also use the Investor Relations portion of our website, investors.purple.com, as a channel of distribution of additional Company information that may be deemed material. Accordingly, investors should monitor this channel, in addition to following our press releases, SEC filings and public conference calls and webcasts. The contents of our website shall not be deemed to be incorporated herein by reference.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Interest Rate Risk

 

Our operating results are subject to risk from interest rate fluctuations on the outstanding borrowings under our 2020 Credit Agreement. Our term loan and revolving line of credit both bear interest at variable rates, which exposes us to market risks relating to changes in interest rates. Interest rate risk is highly sensitive due to many factors, including U.S. monetary and tax policies, U.S. and international economic factors and other factors beyond our control. As of September 30, 2022, we had $39.7 million of variable rate debt outstanding under our term loan and no borrowings outstanding under our revolving line of credit. An increase of 100 basis points in the effective interest rate on our outstanding debt at September 30, 2022 would result in an increase in interest expense of approximately $0.4 million over the next 12 months. We do not use derivative financial instruments for speculative or trading purposes, but this does not preclude our adoption of specific hedging strategies in the future.

 

ITEM 4. CONTROLS AND PROCEDURES

 

(a) Evaluation of Disclosure Controls and Procedures

 

As of the end of the period covered by this report, under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Interim Chief Financial Officer (“CFO” and together with the CEO, the “Certifying Officers”), we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Disclosure controls and procedures are controls and other procedures designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is accumulated and communicated to management, including our Certifying Officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure.

 

Based upon this evaluation, and the above criteria, our CEO and CFO concluded that due to the previously reported material weakness described below, the Company’s disclosure controls and procedures were not effective as of September 30, 2022.

 

Previously Reported Material Weakness in Internal Control

 

A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim consolidated financial statements will not be prevented or detected on a timely basis.

 

As previously reported, we determined a material weakness existed relating to ineffective information technology general controls (“ITGCs”) in the areas of user access and segregation of duties related to certain information technology (“IT”) systems that support the Company’s financial reporting processes. We believe that these control deficiencies were a result of turnover of critical IT leadership; insufficient training of IT personnel; and inadequate risk-assessment processes to identify and assess user access in certain IT systems that could impact internal controls over financial reporting. As a result, we determined that we did not have effective controls to prevent or detect a material financial statement misstatement on a timely basis.

 

In response to this material weakness, management, with oversight of the Audit Committee of the Board of Directors, has identified and is in the process of implementing steps to remediate the material weakness. The Company has allocated resources to remediate user access related control and segregation of duties deficiencies. Our remediation efforts also include providing training to personnel associated with reviewing IT user access. In addition, we continue to engage consultants to advise us on making further improvements to our ITGCs. Although we intend to complete the remediation process as promptly as possible, we cannot at this time estimate how long it will take to remediate this material weakness. Until this material weakness is remediated, we plan to continue to perform additional analyses and other procedures to ensure that our consolidated financial statements are prepared in accordance with GAAP.

 

The material weakness did not result in any identified misstatements in our condensed consolidated financial statements, and there were no changes to previously issued financial results. However, because the material weakness creates a reasonable possibility that a material misstatement to our condensed consolidated financial statements would not be prevented or detected on a timely basis, the Company’s management concluded that at September 30, 2022, the Company’s internal control over financial reporting was ineffective.

 

(b) Changes in Internal Controls Over Financial Reporting.

 

Other than the remediation efforts related to the design and implementation of sufficient controls and processes around ITGCs, there were no changes in our internal control over financial reporting during the quarter ended September 30, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

The Company is from time to time involved in various claims, legal proceedings and complaints arising in the ordinary course of business. Please refer to Note 14 — Commitments and Contingencies and Note 21 – Subsequent Events to the condensed consolidated financial statements contained in this report for certain information regarding our legal proceedings.

 

ITEM 1A. RISK FACTORS

 

Except as described below, there have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K filed with the SEC on March 1, 2022.The disclosure of risks identified below does not imply that the risk has not already materialized.

 

Changes in economic conditions, including inflationary trends in the price of our input costs, such as raw materials and labor, and impacts on our consumers, could adversely affect our business and financial results.

 

The bedding industry is subject to volatility in the price of petroleum-based and steel products, which affects the cost of certain raw materials. The price and availability of these raw materials are subject to market conditions affecting supply and demand. Given the significance of the cost of these materials to our products, volatility in the prices of the underlying commodities can significantly affect profitability.

 

We have experienced and may continue to experience, volatility and increases in the price of certain of these raw materials as a result of a global market and supply chain disruptions, continuing impacts of the COVID-19 pandemic, and the broader inflationary environment.

 

In addition, persistent inflation has and may continue to erode consumer discretionary spending. Reductions in consumer discretionary spending have and we anticipate will continue to adversely affect demand for our products.

 

The previous growth of our business placed significant strain on our resources and if we are unable to manage future growth, we may not have profitable operations or sufficient capital resources.

 

Historically, we have expanded our operations, including expanding our workforce, increasing our product offerings and scaling our infrastructure to support expansion of our manufacturing capacity, our wholesale channel expansion and the opening of Purple retail showrooms. Our planned growth includes increasing our manufacturing efficiencies, developing and introducing new products and developing new and broader distribution channels, including wholesale and Purple retail showrooms, and extending our global reach to other countries. This expansion increases the complexity of our business and places significant strain on our management, personnel, operations, systems, technical performance, financial resources, and internal financial control and reporting functions.

 

Our continued success depends, in part, upon our ability to manage and expand our operations and facilities and production capacity. The growth in our operations has placed, and may continue to place, significant demands on our management and operational and financial infrastructure. If we do not manage growth effectively, the quality of our products and fulfillment capabilities may suffer which could adversely affect our operating results. Our revenue growth may not be sustainable, and our percentage growth rates may decrease. If we are unable to satisfy our liquidity and capital resource requirements, we may have to scale back, postpone or discontinue our growth strategies, which could result in slower growth, no growth, or shrinking, and we may run the risk of losing key suppliers, we may not be able to timely satisfy customer orders, and we may not be able to retain our employees. In addition, we may be forced to restructure our obligations to creditors or pursue work-out options.

 

Our growth depends in part on our ability to manage the opening and operating of new production facilities and Purple retail showrooms, which will require our entering into leases and other obligations. To be successful, we will need to continue developing retail expertise and we will need to hire new employees in states that may have employment laws that could increase our expenses. In general, operating new facilities and opening Purple retail showrooms in new locations exposes us to laws in other states, including California, that may not be as employer-friendly as those in which we currently operate, and may expose us to new liabilities. If we are not able to successfully manage the process of expanding operations geographically, opening Purple retail showrooms and maintaining operations in an expanding number of facilities and Purple retail showrooms, we may have to close Purple retail showrooms or operations facilities and incur sunk costs and continuing obligations that could put a strain upon our resources, damage our brand and reputation and limit our growth.

 

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To manage growth effectively, we would need to continue to implement operational, financial and management controls and reporting systems and procedures and improve the systems and procedures that are currently in place. There is no assurance that we will be able to fulfill our staffing requirements for our business, successfully train and assimilate new employees, or expand our management base and enhance our operating and financial systems. Failure to achieve any of these goals will prevent us from managing our growth in an effective manner and could have a material adverse effect on our business, financial condition or results of operations. In addition, a softening of demand, whether caused by changes in customer preferences or a weakening of the U.S. or global economies, may result and has resulted in decreased revenue or growth. For example, we are experiencing weaker demand in part as a result of current inflationary trends. Due to uncertainty in the weaking U.S. and global economies caused by inflation and other factors, we may not be able to accurately forecast our growth rate. We base our expense levels and investment plans on sales estimates. A significant portion of our expenses and investments is fixed, and we may not be able to adjust our spending quickly enough if our sales are less than expected.

 

We have identified the need for improved processes and procedures to avoid delays in the timely delivery of our mattress products and to improve the customer’s experience. Also, we have experienced rapid growth in our employee base, and the need to implement processes and procedures for improving employee training and retention. Competition for employees where our production facilities are located also has increased the costs for employee retention. We have implemented improved processes and procedures in an environment of continuous change, but our use of resources may not be as effective as intended or we may need to apply more resources than expected to continue to make changes to improve our employee retention and effectiveness and the quality of our products and services over time. If we are unable to make continuous improvement, achieve greater efficiencies in our operating expenses and improve our products and services, our business could be adversely affected.

 

Disruption of operations in our manufacturing facilities, including as a result of, among other things, workplace injuries, pandemics or natural disasters, has and could increase our costs of doing business or lead to delays in shipping our products and could materially adversely affect our operating results and our ability to grow our business.

 

We have four manufacturing plants, which are located in Salt Lake City, Utah, Alpine, Utah, Grantsville, Utah, and McDonough, Georgia. In the future we may also enter into leases for additional manufacturing plants.

 

The disruption of operations of our manufacturing facilities for a significant period of time, or even permanently, such as due to a closure related to the COVID-19 pandemic, natural disasters, the loss or expiration of a lease or mechanical failures in our manufacturing equipment, may increase our costs of doing business and lead to delays in manufacturing and shipping our products to customers and could materially and adversely affect our operating results and our ability to grow our business. In addition, the occurrence of workplace injuries or other industrial accidents at one or more of our manufacturing plants has required, and may require in the future, that we suspend production or modify our operations, which could lead to delays in manufacturing and shipping our products to customers. Likewise, acts of workplace violence may require us to temporarily suspend production or modify our operations. Such delays could adversely affect our sales, customer satisfaction, profitability, cash flows, liquidity and financial condition. Because three of our currently operating manufacturing plants are located within the same geographic region, regional economic downturns, natural disasters, closures due to COVID-19, the unavailability of utilities as a result of climate events or otherwise, or other issues could potentially disrupt a significant portion of our manufacturing and other operating activities, which could adversely affect our business. Our Utah facilities are near earthquake fault lines and our Georgia facility is located in an area that may be subject to hurricanes; such natural disasters in these areas could disrupt manufacturing and other operating activities, which could adversely affect our business.

 

Any disruption of our operations, and related impacts on our operating results, could also adversely affect the market price of our Class A Stock, which could result in securities litigation. Such litigation could result in substantial costs, divert resources and the attention of management from our core business, and adversely affect our business.

 

 

We may need additional capital to execute our business plan and fund operations and may not be able to obtain such capital on acceptable terms or at all.

 

In connection with the development and expansion of our business, we expect to incur significant capital and operational expenses. We believe that we can increase our sales and net income by implementing a growth strategy that focuses on (i) increasing our manufacturing efficiency; (ii) increasing our e-commerce sales; (iii) expanding our wholesale distribution channel; (iv) opening additional Purple retail showrooms; (v) expanding our global sales; (vi) engaging global partners to improve distribution efficiencies and cost savings; and (vii) product assortment and category expansion.

 

Our ability to obtain other capital resources and sources of liquidity may not be sufficient to support future growth strategies. If we are unable to satisfy our liquidity and capital resource requirements, we may have to scale back, postpone or discontinue our growth strategies, which could result in slower growth or no growth, and we may run the risk of losing key suppliers, we may not be able to timely satisfy customer orders, and we may not be able to retain our employees. In addition, we may be forced to restructure our obligations to creditors, pursue work-out options or other protective measures.

 

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While we have had access to a $55 million revolving credit facility under our financing arrangement with KeyBank National Association and a group of financial institutions (as amended, the “2020 Credit Agreement”), our ability to access such funds is subject to certain conditions. Further, our ability to obtain additional or alternative capital on acceptable terms or at all is subject to a variety of uncertainties, including approval from KeyBank National Association and a group of financial institutions (the “Institutional Lenders”) under the 2020 Credit Agreement. Adequate financing may not be available or, if available, may only be available on unfavorable terms. The restrictive covenants in the 2020 Credit Agreement may make it difficult to obtain additional capital on terms that are favorable to us, and we may not be able to satisfy the conditions necessary to obtain additional funds pursuant to the revolving credit facility under the 2020 Credit Agreement. There is no assurance we will obtain the capital we require. As a result, there can be no assurance that we will be able to fund our future operations or growth strategies.

 

Our operating and financial results for the year ended December 31, 2021 did not satisfy our financial and performance covenants required pursuant to the 2020 Credit Agreement. In order to avoid a breach of such covenants and related default, on February 28, 2022, prior to the covenant compliance certification date under the 2020 Credit Agreement, we entered into the first amendment of the 2020 Credit Agreement. The amendment contains a covenant waiver period such that the net leverage ratio and fixed charge coverage ratio will not be tested for the fiscal quarter ended December 31, 2021 through the fiscal quarter ended June 30, 2022. Other changes in the amendment include modification of leverage ratio and fixed charge coverage definitions and thresholds, the addition of minimum liquidity requirements with mandatory prepayments of the revolving loan if cash exceeds $25.0 million, new weekly and monthly reporting requirements, limits on the amount of capital expenditures, including expenditures for acquisition of other businesses or technologies, the addition of a lease incurrence test for opening additional showrooms, and additional negative covenants during a covenant amendment period that will extend into 2023 until certain conditions are met. In addition, the interest rate on outstanding borrowings under the 2020 Credit Agreement changed from LIBOR to secured overnight financing rate (“SOFR”).

 

To the extent that future or additional waivers and amendments are necessary, there can be no guarantee that we will be able to obtain waivers or further amendments from the lenders under the 2020 Credit Agreement if, in the future, we are unable to comply with the covenants and other terms of the 2020 Credit Agreement. Our failure to satisfy the required conditions under the amendment or maintain compliance with the financial and performance covenants under the 2020 Credit Agreement could result in a default, which would adversely affect our financial condition and results of operations, including as a result of acceleration of our outstanding debt. In addition, any default under the 2020 Credit Agreement would adversely affect our ability to obtain alternative financing.

 

Future equity or debt financings may require us to also issue warrants or other equity securities that are likely to be dilutive to our existing stockholders. Newly issued securities may include preferences or superior voting rights or may be combined with the issuance of warrants or other derivative securities, which each may have additional dilutive effects. Furthermore, we may incur substantial costs in pursuing future capital and financing, including investment banking fees, legal fees, accounting fees, printing and distribution expenses and other costs. We may also be required to recognize non-cash expenses in connection with certain securities we may issue, such as convertible notes and warrants, which will adversely impact our financial condition. If we cannot raise additional funds on favorable terms or at all, we may not be able to carry out all or parts of our long-term growth strategy, maintain our growth and competitiveness or continue in business.

 

We may not be able to identify, complete or successfully integrate acquisitions and acquisitions that we do make, if any, may not achieve the anticipated financial benefits, all of which could have a negative impact on our growth, financial condition, and results of operations.

 

We may seek to acquire businesses in the future as we encounter acquisition prospects that would complement our current product offerings, increase the size and geographic scope of our operations, or otherwise offer strategic, growth and operating efficiency opportunities. We cannot assure investors that we will be able to identify and acquire acceptable acquisition candidates on terms favorable to us in the future, or that any acquisitions will achieve the anticipated strategic or financial benefits. Even if we do identify opportunities to acquire businesses, we may not be able to consummate such acquisitions due to a number of factors, including lacking access to sufficient capital to fund such acquisitions and restrictions contained in our Credit Agreement on our ability to make acquisitions.

 

In addition, acquisitions involve numerous risks and uncertainties and may be of businesses in which we lack operational or market experience. The financing for any of these acquisitions could dilute the interests of our stockholders, result in an increase in our indebtedness or both. Future acquisitions could entail numerous risks, including:

 

  difficulties in integrating acquired technologies, operations or products;

 

  the difficulties of imposing financial and operating controls on the acquired companies and their management and the potential costs of doing so;

 

  the potential loss of key employees, customers, suppliers or distributors from acquired businesses and disruption to our direct selling channel;

 

  diversion of management’s attention from our core business;

 

  the failure to achieve the strategic objectives of these acquisitions;

 

  increased fixed costs;

 

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  the failure of the acquired businesses to achieve the results we have projected in either the near or long term;

 

  the assumption of unexpected liabilities, including compliance and litigation risks;

 

 

adverse effects on existing business relationships with our suppliers, sales force or consumers;

     
 

Failure to gain consumer or wholesale market acceptance of acquired brands and products; and 

 

  risks associated with entering markets or industries in which we have limited or no prior experience, including limited expertise in running the business, developing the technology, and selling and servicing the products.

 

Our failure to successfully complete the integration of any acquired business, or a failure to effectively identify and pursue such acquisitions, could have a material adverse effect on our business, financial condition and operating results. For example, we recently acquired Intellibed , which has operated in a higher priced market in which we may not be able to successfully operate. Moreover, Intellibed has used different systems and different manufacturing processes using different personnel. If we are not able to effectively integrate Intellibed’s systems or products into our operations, our business will be adversely affected. In addition, integrating Intellibed into our business will require us to expend significant resources and significant effort from our management team, which could divert such resources and management’s attention from developing our core business and adversely affect our results of operations.

 

Our future growth and profitability depend upon the strength of our Purple brand and the effectiveness and efficiency of our marketing programs and our ability to attract and retain customers.

 

We are highly dependent on the effectiveness of our marketing messages and the efficiency of our advertising expenditures in generating consumer awareness and sales of our products. We continue to evolve our marketing strategies, adjusting our messages, the amount we spend on advertising and where we spend it. We may not always be successful in developing effective messages and new marketing channels, as consumer preferences and competition change, and in achieving efficiency in our advertising expenditures.

 

We depend heavily on internet-based advertising to market our products through internet-based media and e-commerce platforms. If we are unable to continue utilizing such platforms, if those media and platforms diminish in efficacy, importance or size, if consumer usage of the platform decreases, or if we are unable to direct our advertising to our target consumer groups, our advertising efforts may be ineffective, and our business could be adversely affected. The costs of advertising through these platforms have increased significantly, which has resulted in decreased efficiency in the use of our advertising expenditures, and we expect these costs may continue to increase in the future.

 

We have relationships with traditional and digital media partners, online services, search engines, affiliate marketing websites, directories and other website and e-commerce businesses to provide content, advertising and other links that direct customers to our website. We rely on these relationships as significant sources of traffic to our website and to generate new customers. If we are unable to develop or maintain these relationships or develop and maintain new relationships for newly developed and necessary marketing services on acceptable terms, our ability to attract new customers and our financial condition would suffer. In addition, current or future relationships or agreements may fail to produce the sales that we anticipate. The cost of advertising for web-based platforms, such as Facebook, are increasing. Increasing advertising costs erode the efficiency of our advertising efforts. If we are unable to effectively manage our advertising costs or if our advertising efforts fail to produce the sales that we anticipate, our business could be adversely affected.

 

On October 20, 2020, the United States Department of Justice brought an antitrust lawsuit against Google claiming that Google improperly uses its monopoly over Internet search to impede competition and harm consumers. Our cost of advertising on Google may remain high if Google’s monopoly over internet searches is not prevented and competitive search engines are not allowed to compete. Alternatively, if Google is required because of this lawsuit to split up the company or sell assets, there is no assurance this will decrease advertising costs and it may lead to increased costs due to an increased number of service providers who obtain oligopoly power to control advertising costs or inefficiencies from a reduction in scale. Although this lawsuit may lower our advertising costs, there is risk that it may not and would lead to increased costs which would reduce our profitability and harm our business.

 

Consumers are increasingly using digital tools as a part of their shopping experience. As a result, our future growth and profitability will depend in part on (i) the effectiveness and efficiency of our online experience for disparate worldwide audiences, including advertising and search optimization programs in generating consumer awareness and sales of our products, (ii) our ability to prevent confusion among consumers that can result from search engines that allow competitors to use or bid on our trademarks to direct consumers to competitors’ websites, (iii) our ability to prevent internet publication or television broadcast of false or misleading information regarding our products or our competitors’ products, (iv) the nature and tone of consumer sentiment published on various social media sites, and (v) the stability of our website. In recent years, a number of direct to consumer, internet-based retailers, like us, have emerged and have driven up the cost of basic search terms, which has and may continue to increase the cost of our internet-based marketing programs. More recently, the large traditional mattress manufacturers have been increasing their efforts to increase their direct to consumer sales which also is increasing the cost of our internet-based marketing programs and cost of customer conversion.

 

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In the past, we have been the target of publications by purported consumer reviewers who claim to have identified health and safety concerns with our products. While we believe such claims to be baseless, refuting such claims requires us to expend significant resources to educate current and potential customers on the safety of our products. Even if we are able to broadly disseminate factual information to refute such claims and reinforce the safety of our products, such claims and attendant adverse publicity could persist and damage our reputation and brand value and result in lower sales.

 

The number of third-party review websites is increasing and customers have many platforms on which they can review our products, and such reviews are becoming increasingly influential with consumers. Negative reviews from such sources may receive widespread attention from consumers, which could damage our reputation and brand value and result in lower sales. If we are unable to effectively manage relationships with such reviewers to promote accurate reviews of our products, reviewers may decline to review our products or may post reviews with misleading information, which could damage our reputation and make it more difficult for us to improve our brand value.

 

If our marketing messages are ineffective or our advertising expenditures, geographic price-points, and other marketing programs, including digital programs, are inefficient in creating awareness and consideration of our products and brand name and in driving consumer traffic to our website, our sales, profitability, cash flows and financial condition may be adversely impacted. In addition, if we are not effective in preventing the publication of confusing, false or misleading information regarding our brand or our products, or if there arises significant negative consumer sentiment on social media regarding our brand or our products, our sales, profitability, cash flows and financial condition may be adversely impacted.

 

Our expansion into new products, market segments and geographic regions subjects us to additional business, legal, financial, and competitive risks.

 

The majority of our sales are made directly to consumers through our DTC channels. We have been expanding our business into the wholesale distribution channel through relationships with our wholesale partners but there can be no assurance that we will continue to experience success with our wholesale partners or that anticipated new locations will be successful.

 

We may be unsuccessful in generating additional sales through wholesale channels. We may extend credit terms in connection with such relationships and such relationships may expose us to the risk of unpaid or late paid invoices. In addition, we may provide fixtures to such partners that may be difficult to recover or re-use. Our wholesale customers may not purchase our products in the volume we expect.

 

Profitability, if any, from sales to wholesale customers and new product offerings may be lower than from our DTC model and current products, and we may not be successful enough in these newer activities to recoup our investments in them. If any of these issues were to arise, they could damage our reputation, limit our growth, and negatively affect our operating results.

 

We may be unsuccessful in opening any Purple retail showrooms beyond those already opened in cities across the U.S. Operating Purple retail showrooms includes additional risks. For example, we will incur expenses and accept obligations related to additional leases, insurance, distribution and delivery challenges, increased employee management, and new marketing challenges. If we are not successful in our efforts to profitably operate these new stores, our reputation and brand could be damaged, growth could be limited, and our business may be harmed.

  

In addition, offerings of new products through our e-commerce, wholesale distribution channel and Purple retail showrooms may present new and difficult challenges, and we may be subject to claims if customers of these offerings experience service disruptions or failures or other quality issues. Expansion of sales channels may require the development of additional, differentiated products to avoid price and distribution conflicts between and within sales channels. Wholesale expansion increases our risk as our wholesale partners will require delaying payments to us on net terms ranging from a few days to 60 or more days, or they may delay paying us beyond the agreed-upon net terms or fail to pay. Our Company showroom expansion increases our risk for inventory shrinkage from destruction, theft, obsolescence and other factors that render such inventory unusable or unsellable.

 

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New products may come with unknown warranty and return risks. New product offerings or expansion into new market channels or geographic regions may subject us to new or additional regulation, which would impose potentially significant compliance and distribution costs.

 

Our future growth and profitability depend, in part, upon our ability to achieve and maintain sufficient production capacity to meet customer demands.

 

We manufacture our mattresses using our proprietary and patented Mattress Max and other machinery to make our Hyper-Elastic Polymer cushioning material. Because these machines are proprietary and we do not yet have a long history of their maintenance needs, we may not be able to sufficiently maintain them for operation at full capacity or at all when needed. We have experienced unexpected maintenance issues following a shutdown of these machines that took longer to bring them up to full operating capacity then what we expected. Also, because of the unique features of our machines, and due to continuing improvements to these machines, new machines are not readily available and must be constructed which takes time. If we are unable to construct new machines and implement them into our production process in a timely manner, if our existing machines are unable to function at the desired capacity, or if we are unable to develop replacements for the existing machines if such replacements should become necessary, our production capacity may be constrained and our ability to respond to customer demand may be adversely impacted. We manufacture mattresses and other products using components provided by third-party suppliers. If those third-party suppliers are unable to provide us with such components or if our assembly capacity is insufficient, our ability to respond to customer demand may be adversely impacted. This would negatively impact our ability to grow our business and achieve profitability.

 

We have engaged in significant related-party transactions with affiliates and owners that may give rise to conflicts of interest, result in losses to the Company or otherwise adversely affect our operations and the value of our business.

 

We have engaged in numerous related-party transactions involving significant shareholders and directors of the Company, as well as with other entities affiliated with such persons.

 

For example, prior to the Business Combination, InnoHold, previously a significant stockholder of the Company and an entity owned by the founders, Terry and Tony Pearce, granted equity incentive awards in Purple LLC to certain key employees at that time. As a result of the structure of those awards being granted through a separate entity, the equity incentives were required, because of the structure of the Business Combination, to be exchanged for ownership units in InnoHold, to avoid those equity interests becoming of no value to the participants. Those participants’ ownership interests had certain restrictions, including vesting requirements. These equity incentives granted to key employees prior to the Business Combination are forfeited to the extent the grant to an employee is not fully vested at the time that such employee’s employment is terminated. Before and for a period of time since the Business Combination, all forfeitures occurring from departing employees have inured to the benefit of only the owners of InnoHold, and not all of our stockholders. This means that the forfeited equity did not increase our currently approved equity incentive pool. Because the forfeited equity resulting from these departures prior to this distribution was held at InnoHold, that forfeited equity did not replenish our equity incentive pool and could not be used for equity grants to those who have replaced and will replace these employees or for other purposes essential to the business. During 2019, to avoid future forfeitures from inuring only to the benefit of InnoHold’s owners, InnoHold distributed to the incentive participants their pro rata share of InnoHold’s ownership of shares of Class B common stock, par value $0.0001 (“Class B Stock”) in Purple Inc. and Class B Common Units (“Class B Units”) in Purple LLC, after which any forfeitures would inure to the benefit of all shareholders. InnoHold distributed additional paired shares of Class B Stock in Purple Inc. and Class B Units in Purple LLC which also will be subject to the same vesting requirements and result in forfeitures inuring to the benefit of all shareholders. Our current equity incentive pool, as approved by the stockholders prior to the Business Combination in the Purple Innovation, Inc. 2017 Equity Incentive Plan (“2017 Equity Incentive Plan”), did not account for the departure, before this distribution by InnoHold, of such key employees who had existing equity grants through InnoHold, and there is a risk that we will have to seek approval from the Board and stockholders to refresh the equity incentive pool earlier than anticipated at the time of the Business Combination because of the unanticipated need to use shares from the existing pool to hire and retain other key employees needed to achieve the Company’s growth objectives. If the equity pool is not refreshed, there is a risk that we may not be able to hire and retain such key employees. If the equity pool is refreshed with authorized shares of the Company that are issued in accordance with our 2017 Equity Incentive Plan, our stockholders will be diluted. This distribution by InnoHold to the equity incentive participants has caused us to incur administrative expenses related to the distributions, the management of the differing vesting schedules and compliance with their rights under the distribution agreements. In addition, the calculations of the distributive share and related income tax withholdings with respect to holders of InnoHold’s Class B Units, as well as the processes by which such distributions and withholdings are made, are highly complex. As a result, there is a risk that the recipients of such distributions or other third parties may claim that we have miscalculated the distribution or income tax withholding amounts or failed to timely pay the taxes. The cost of responding to such claims, including but not limited to the diversion of management’s attention from our operations and defense or settlement costs, could negatively impact our operations and financial results.

 

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In connection with the Business Combination, Purple LLC also entered into that certain Credit Agreement dated February 2, 2018, with the Coliseum Capital Partners, L.P. (“CCP”), Blackwell Partners LLC – Series A (“Blackwell”) and Coliseum Co-invest Debt Fund, L.P. (“CDF” and together with CCP and Blackwell, the “Former Lenders”), which was guaranteed by Purple Inc. The Former Lenders also were stockholders and warrant holders of the Company and appointed one director to serve on our Board, Adam Gray, who continues to serve on our Board and is affiliated with the Lenders. Further, on February 26, 2019, the Amended and Restated Credit Agreement between Purple LLC and certain of the Former Lenders (the “Incremental Lenders”), and each of the related documents, including the issuance of additional warrants to the Incremental Lenders, was closed and an incremental loan was funded. In connection with the funding of the incremental loan, we issued to the Incremental Lenders warrants to purchase shares of our Class A Stock. On March 27, 2020, the Amended and Restated Credit Agreement was amended to allow Purple LLC at its election a 5% paid-in-kind interest deferral for the first two quarters of 2020. On May 15, 2020, the Amended and Restated Credit Agreement was further amended to remove a negative covenant so that there would not be an event of default if the Former Lenders acquired 25% or more ownership of the Company. On August 20, 2020, the Company and Purple LLC entered into a Waiver and Consent to Amended and Restated Credit Agreement with the Former Lenders, that, among other things, waives an event of default as a result of InnoHold ceasing to own 25% or more of the aggregate equity interests in the Company, subject to certain conditions as more fully provided in such waiver. On September 3, 2020, we paid off the full amount owed and a prepayment premium to the Former Lenders in the aggregate amount of $45.0 million and terminated the Amended and Restated Credit Agreement, subject to those provisions that survive termination. The Former Lenders further have continuing rights of first refusal related to indebtedness of the Company as set forth in the Subscription Agreement entered into by them and the Company at the time of the Business Combination. Adam Gray continues to serve on our Board and the Former Lenders, together, hold a significant portion of our outstanding shares of Class A Stock and voting power. The Former Lenders currently own, in the aggregate, approximately 45.0% of the Company’s outstanding shares and voting power. Future transactions with the Lenders, if any, may give rise to conflicts of interest or otherwise adversely affect our business.

 

On September 17, 2022, Coliseum Capital Management, LLC (“CCM”), our largest shareholder and an affiliate of the Former Lenders, delivered to us an unsolicited bid to acquire the remaining outstanding shares of our Class A and Class B Stock not already beneficially owned by CCM for $4.35 per share in cash. There can be no assurance that CCM’s proposed transaction will occur. Responding to unsolicited bids, including the bid received from CCM, may require management to devote additional resources and attention that would otherwise be directed to our operations.

 

See Note 15, Related-Party Transactions of the Notes to the Condensed Consolidated Financial Statements, included in PART I, ITEM 1 of this Report, “Financial Statements,” and is incorporated herein by reference.

 

We may not be able to successfully anticipate consumer trends and demand and our failure to do so may lead to loss of consumer acceptance of the products we sell, resulting in reduced net sales.

 

Our success depends in part on our ability to anticipate and respond to changing trends and consumer demands in a timely manner. Changes in consumers’ tastes and trends and the resulting change in our product mix, as well as failure to offer our consumers multiple avenues for purchasing our products, could adversely affect our business and operating results. For example, as retail stores began to reopen following the elimination or easing of restrictions in connection with the COVID-19 pandemic, consumers began to shift away from online retail purchases towards brick-and-mortar shopping. Our gross profit margins for sales through wholesale customers are lower than those in our DTC channel and, as a result, this shift in customer preference has and we anticipate will continue to adversely impact our gross profit margins.

 

Further, general macroeconomic conditions, including persistent inflation, has and may continue to adversely affect consumer demand for our products, which are generally priced at a premium. Any reductions in consumer demand for our products has and may continue to adversely affect our sales and financial position.

 

If we fail to identify and respond to emerging trends, consumer acceptance of the products we manufacture and sell and our image with current or potential customers may be harmed, which could reduce our net sales. If we misjudge market trends, we may significantly overstock inventory and be forced to take significant inventory markdowns, which would have a negative impact on our gross profit and cash flow. Conversely, shortages of inventory or time to fulfillment of our products that prove popular could also reduce our sales.

 

Our business could suffer if we are unsuccessful in making, integrating, and maintaining commercial agreements, strategic alliances, and other business relationships.

 

To successfully operate our business, we rely on commercial agreements and strategic relationships with suppliers, service providers and certain wholesale partners and customers. As we grow, we may acquire other businesses to incorporate into our operations. These arrangements can be complex and require substantial infrastructure capacity, personnel, and other resource commitments. Further, our business partners may have disruptions in their businesses or choose to no longer do business with us and the impact of such disruption or choices could be magnified to the extent such business partners represent a significant part of our business. We may not be able to implement, maintain, or develop the components of these commercial relationships. Moreover, we may not be able to enter into additional commercial relationships and strategic alliances on favorable terms or at all.

 

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Our wholesale relationships may from time to time be terminated by us or our partners, or the terms of such relationships may be amended or modified. As a result of such terminations, we would lose sales previously generated through such relationships, which could have a material adverse impact on our net sales, profitability and financial position. Disputes with wholesale partners also may arise related to such relationships, or any terminations of related agreements, which could cause us to incur expenses, delay our receipt of amounts owed to us, interfere with our relationship with other retailers, subject us to liabilities and distract us from our strategic objectives. As our agreements terminate or relationships unwind, we may be unable to renew or replace these agreements on comparable terms, or at all, and the loss of sales from such relationships could harm our business. We may in the future enter into amendments on less favorable terms or encounter parties that have difficulty meeting their contractual obligations to us, which could adversely affect our operating results.

 

Our present and future services agreements, other commercial agreements, and strategic relationships and acquisitions create additional risks such as:

 

  failure to effectively integrate acquisitions;

 

  disruption of our ongoing business, including loss of management focus on existing businesses;

 

  ●  impairment of other relationships;

 

  ●  variability in revenue and income from entering into, amending, or terminating such agreements or relationships.

 

The final assembly of some of our mattresses is executed by third-party partners and suppliers. If we are unable to maintain those relationships or if such third parties are disrupted in their ability to perform such final assembly and we are unable to make alternative arrangements, our ability to produce certain mattresses may be adversely impacted, which could adversely affect our operating results and financial position.

 

We have entered into arrangements with wholesale partners through which we sell certain of our products in their retail stores. We anticipate increasing the number of these partnerships. Our relationships with our wholesale partners may not be profitable to us or may impose additional costs that we would not otherwise incur under our DTC operations. Our wholesale partners may choose not to continue doing business with us or may choose to reduce the amount of our products they order, which would result in a corresponding loss of revenue. Our wholesale partners may experience their own business disruptions, including for example bankruptcy, that could affect their ability to continue to do business with us. Our wholesale partners may engage in conduct that could breach the contractual rights we owe other wholesale partners or interfere with their other legal rights. Our wholesale partners may compete against us in DTC or other channels that are important to us and may erode our business in such channels. Further, maintaining these relationships may require the commitment of significant amounts of time, financial resources and management attention, and may result in prohibitions on certain sales channels through exclusivity requirements, which may adversely affect other aspects of our business.

 

We have opened and plan to continue to open a growing number of Purple retail showrooms in cities across the U.S. Our business is expanding into additional Purple retail showrooms which, like our online e-commerce retail store, may compete more directly with our wholesale partners for customers. In our effort to make our products available to consumers in multiple retail channels, there is the risk that sales may diminish in other channels, costs may be incurred without an increase in overall sales and our wholesale partners may no longer carry our products. Managing an omni-channel distribution strategy, including the relationships with business partners in each channel, may require significant amounts of time, resources and attention which may adversely affect other aspects of our business.

 

We operate in a highly competitive Comfort Industry, and if we are unable to compete successfully, we may lose customers and our sales may decline.

 

The Comfort Industry market is highly competitive and fragmented. We face competition from many manufacturers (including competitors that primarily manufacture and import from China and other low-cost countries), traditional brick-and-mortar retailers and online retailers, including direct-to-consumer competitors. Participants in the Comfort Industry compete primarily on price, quality, brand name recognition, product availability and product performance and compete across a range of distribution channels. The highly competitive nature of the Comfort Industry means we are continually subject to the risk of loss of market share, loss of significant customers, reductions in margins, and the inability to acquire new customers.

 

A number of our significant competitors offer products that compete directly with our products. Any such competition by established manufacturers and retailers or new entrants into the market could have a material adverse effect on our business, financial condition and operating results. Comfort Industry manufacturers and retailers are seeking to increase their channels of distribution and are looking for new ways to reach the consumer. Many newer competitors in the mattress industry have begun to offer products directly to consumers through the Internet and other distribution channels. Some of our established competitors and partners have begun to offer products similar to ours as well. Many of our competitors source their products from countries such as China and Vietnam, where the costs may be lower than our costs. Companies providing for the distribution of mattresses online or through retail stores, such as Mattress Firm, Amazon and Walmart, also have begun to offer competing products in their respective channels. In addition, retailers outside the U.S. have integrated vertically in the furniture and sleep product industries, and it is possible that retailers may acquire other retailers or may seek to vertically integrate in the U.S. by acquiring a mattress manufacturer.

 

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Many of our current and potential competitors may have substantially greater financial support, technical and marketing resources, larger customer bases, longer operating histories, greater name recognition, mature distribution methods, and more established relationships in the industry than we do and sell products through broader and more established distribution channels. These competitors, or new entrants into the market, may compete aggressively and gain market share with existing or new products, and may pursue or expand their presence in the Comfort Industry. We cannot be sure we will have the resources or expertise to compete successfully in the future. We have limited ability to anticipate the timing and scale of new product introductions, advertising campaigns or new pricing strategies by our competitors, which could inhibit our ability to retain or increase market share, or to maintain our product margins. Our current and potential competitors may secure better terms from vendors, adopt more aggressive pricing, and devote more resources to technology, infrastructure, fulfillment, and marketing. Also, due to the large number of competitors and their wide range of product offerings, we may not be able to continue to differentiate our products through value, styling or functionality from those of our competitors. Our products are also typically heavier than others and some markets we wish to expand into will not support delivery of our heavy products through parcel services or other affordable home delivery services, limiting our ability to serve the market.

 

In addition, the barriers to entry into the retail sleep product industry are relatively low. New or existing sleep product retailers could enter our markets and increase the competition we face. Competition in existing and new markets may also prevent or delay our ability to gain relative market share. Any of the developments described above could have a material adverse effect on our planned growth and future results of operations.

 

We will face different market dynamics and competition as we develop new products to expand our presence in our target markets. In some markets, our future competitors may have greater brand recognition and broader distribution than we currently enjoy. We may not be as successful as our competitors in generating revenues in those markets due to the lack of recognition of our brands, lack of customer acceptance, lack of product quality history and other factors. As a result, any new expansion efforts could be costlier and less profitable than our efforts in our existing markets. If we are not as successful as our competitors are in our target markets, our sales could decline, our margins could be impacted negatively and we could lose market share, any of which could materially harm our business.

 

If we are unable to effectively compete with other manufacturers and retailers of mattresses, pillows, cushions, and our other products our sales, profitability, cash flows and financial condition may be adversely impacted.

 

If we fail to maintain an effective system of internal controls, we may not be able to report our financial results accurately, may make a material misstatement in our financial statements, or may experience a financial loss. Any inability to report and file our financial results accurately and timely could harm our business and adversely affect the value of our business.

 

As a public company, we are required to establish and maintain internal controls over financial reporting and disclosure controls and procedures and to comply with other requirements of the Sarbanes-Oxley Act and the rules promulgated by the SEC. Even when such controls are implemented, management, including our Chief Executive Officer and Chief Financial Officer, cannot guarantee that our internal controls and disclosure controls and procedures will prevent all possible errors or loss. Because of the inherent limitations in all control systems, no system of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company or perpetrated against us will be prevented or have been detected. These inherent limitations include the possibility that judgments in decision-making can be faulty and subject to simple error or mistake. Furthermore, controls can be circumvented by individual acts of some persons, by collusion of two or more persons, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, measures of control may become inadequate because of changes in conditions, new fraudulent schemes, or the deterioration of compliance with policies or procedures. Because of inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and/or may not be detected.

 

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The accuracy of our financial reporting depends on the effectiveness of our internal control over financial reporting. Internal control over financial reporting can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements and may not prevent or detect misstatements. Failure to maintain effective internal control over financial reporting, or lapses in disclosure controls and procedures, could undermine the ability to provide accurate disclosure (including with respect to financial information) on a timely basis, which could cause investors to lose confidence in our disclosures (including with respect to financial information), require significant resources to remediate the lapse or deficiency, and expose us to legal or regulatory proceedings. We have in the past identified material weaknesses in our internal controls over financial reporting, some of which resulted in restatements of our financial statements. During 2021, we identified a material weakness in internal control over financial reporting related to ineffective information technology general controls in the areas of user access and segregation of duties related to certain information technology systems that support the Company’s financial reporting processes. We believe that these control deficiencies were a result of turnover of critical IT leadership; insufficient training of IT resources; and inadequate risk-assessment processes to identify and assess access in certain IT environments that could impact internal controls over financial reporting. Because the material weakness creates a reasonable possibility that a material misstatement to our consolidated financial statements would not be prevented or detected on a timely basis, the Company’s management concluded that at December 31, 2021 and September 30, 2022, the Company’s internal control over financial reporting was ineffective.

 

We continue to evaluate, design and work through the process of implementing controls and procedures under a remediation plan designed to address this material weakness, but there can be no assurance that we will be able to remediate this material weakness in a timely manner or at all. If our remediation measures are insufficient to address the material weaknesses, or if additional material weaknesses or significant deficiencies in our internal control are discovered or occur in the future, our financial statements may contain material misstatements and we could be required to restate our financial results, which could lead to substantial additional costs for accounting and legal fees and stockholder litigation.

 

Any failure to maintain such internal control could adversely impact our ability to report our financial position and results from operations on a timely and accurate basis. If our financial statements are not accurate, investors may not have a complete understanding of our operations. Likewise, if our financial statements are not filed on a timely basis, we could be subject to sanctions or investigations by the stock exchange on which our common stock is listed, the SEC or other regulatory authorities. In either case, this could result in a material adverse effect on our business. Failure to timely file will cause us to be ineligible to utilize short form registration statements on Form S-3, which may impair our ability to obtain capital in a timely fashion to execute our business strategies or issue shares to effect an acquisition. Ineffective internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our stock. In addition, we may face potential for litigation or other disputes which may include, among others, claims invoking the federal and state securities laws, contractual claims or other claims arising from the restatement and material weaknesses in our internal control over financial reporting and the preparation of our financial statements. Any such litigation or dispute, whether successful or not, could have a material adverse effect on our business, results of operations and financial condition.

 

As a result of our 2022 acquisition of Intellibed, we are in the process of integrating its systems and processes into ours, including bringing such systems and processes into our existing framework of internal controls. That process requires us to devote resources that might otherwise be used to grow the business. If we do not successfully integrate the Intellibed processes into our internal controls, there may be material misstatements that are not detected in a timely manner.

 

We are required to make certain prepayments to any revolving loans and thereafter may not be able to draw upon our revolving line of credit.

 

Under the 2020 Credit Agreement, as amended, if the aggregate amount of cash and cash equivalents we hold exceeds $25.0 million, we are required to prepay an amount equal to the lesser of (i) the outstanding revolving loans and (ii) the amount of cash and cash equivalents in excess of $25.0 million. In addition, we are prohibited from making additional borrowings under the revolver if after giving effect to any borrowing, and any transactions to be consummated therewith, the aggregate amount of cash and cash equivalents exceeds $25.0 million. As a result of these two restrictions, our ability to accumulate cash in excess of $25.0 million is limited. If for any reason we are unable to borrow on our revolving credit facility, we would be limited in available cash to pay expenses and meet our obligations, which lack of liquidity could impair our relationships with suppliers and vendors, delay our growth plans or prevent us from taking actions in our best interest or even continue in business.

 

We could be subject to additional sales tax or other indirect tax liabilities.

 

The application of indirect taxes (such as sales and use tax, value-added tax (“VAT”), goods and services tax, business tax and gross receipt tax) to e-commerce businesses and to our users is a complex and evolving issue and we may be unable to timely or accurately determine our obligations with respect to such indirect taxes, if any, in various jurisdictions. Many of the fundamental statutes and regulations that impose these taxes were established before the adoption and growth of the Internet and e-commerce. 

 

An increasing number of states and foreign jurisdictions have considered or adopted laws or administrative practices, with or without notice, that impose additional obligations on remote sellers and online marketplaces to collect transaction taxes such as sales, consumption, value added, or similar taxes. Failure to comply with such laws or administrative practices or a successful assertion by such states or foreign jurisdictions requiring us to collect taxes where we did not, could result in substantial tax liabilities for past sales, as well as penalties and interest.

 

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We are subject to sales tax or other indirect tax obligations as imposed by the various states in the United States. If the tax authorities in these jurisdictions were to challenge our filings or request an audit, our tax liability may increase. We are currently undergoing routine audits in a few states. Moreover, as a result of our Intellibed acquisition, we are now subject to Intellibed’s sales tax or other indirect tax obligations and taxing authority challenges. Failure to properly identify and pay Intellibed’s tax obligations could result in a significant negative impact.

 

We may be subject to laws, regulations, and administrative practices that require us to collect information from our customers, vendors, merchants, and other third parties for tax reporting purposes and report such information to various government agencies. The scope of such requirements continues to expand, requiring us to develop and implement new compliance systems. Failure to comply with such laws and regulations could result in significant penalties.

 

The U.S. Supreme Court ruling in South Dakota v. Wayfair, Inc., No.17-494, reversed a longstanding precedent that remote sellers are not required to collect state and local sales taxes. We cannot predict the effect of these and other attempts to impose sales, income or other taxes on e-commerce. The Company currently collects and reports on sales tax in all states in which it does business. However, the application of existing, new or revised taxes on our business, in particular, sales taxes, VAT and similar taxes would likely increase the cost of doing business online and decrease the attractiveness of selling products over the internet. The application of these taxes on our business could also create significant increases in internal costs necessary to capture data and collect and remit taxes. There have been, and will continue to be, substantial ongoing costs associated with complying with the various indirect tax requirements in the numerous markets in which we conduct or will conduct business.

 

We may not be able to protect our product designs, brand, and other proprietary rights adequately, which could adversely affect our competitive position and reduce the value of our products and brands, and litigation to protect our intellectual property rights may be costly.

 

We attempt to strengthen and differentiate our product portfolio by developing new and innovative brands, product designs and functionality and materials for use in our products. We regard our trademarks, service marks, copyrights, patents, trade dress, trade secrets, proprietary technology, and similar intellectual property as critical to our success, and we rely on trademark, copyright, and patent law, trade secret protection, and confidentiality agreements and license agreements with our vendors, contractors, employees, customers, and others to protect our proprietary rights.

 

We own various U.S. and foreign patents and patent applications related to certain elements of the design and function of our products including mattresses, pillows, cushions and related products, as well as related to proprietary formulas and related technology for certain materials used in the manufacturing of our products. We own numerous registered and unregistered trademarks and trademark applications, as well as other intellectual property rights, including trade secrets, trade dress and copyrights, which we believe have significant value and are important to the marketing of our products. Our success will depend in part on our ability to protect our products, methods, processes and other technologies, to preserve our trade secrets, and to operate without infringing on the proprietary rights of third parties.

 

As we continue to increase our innovations and create new products and technologies, and as we enter new product spaces, we may be limited by the intellectual property rights of others. We respect the intellectual property rights of others; however, our ability to innovate and increase our product footprint may be limited by the intellectual property rights of those other parties.

 

Despite our efforts, we may not be able to adequately protect or enforce our intellectual property and other proprietary rights. We have seen an increase in the number of counterfeit goods and products that infringe on our patents, trademarks and trade dress. We have increased our proactive policing of these counterfeit goods which has led to an increased cost of intellectual property enforcement. Effective protection or enforcement of intellectual property rights may be unavailable or limited in the jurisdictions in which we do business. We also may be unable to acquire or maintain appropriate trademarks and domain names in all jurisdictions in which we do business. Furthermore, regulations governing domain names may not protect our trademarks and similar proprietary rights. We may be unable to prevent third parties from acquiring domain names that are similar to, infringe upon, or diminish the value of our trademarks and other proprietary rights.

 

The protection of our intellectual property, such as preventing counterfeit goods from entering the market or defending our patents, may require the expenditure of significant financial and managerial resources. For example, we recently filed an action with the International Trade Commission to combat a number of counterfeit goods; such action could take up to sixteen (16) months to be completed and may not result in judgments that are favorable to us. Even if we obtain a favorable judgment from the International Trade Commission, the prevalence of counterfeit goods could continue harm our ability to enforce some of our intellectual property, our brand, our trade dress, and a number of our patents. We may not be able to discover or determine the extent of all unauthorized use of our proprietary rights. Policing the unauthorized use of our proprietary technology, trademarks and copyrights can be difficult and expensive. Litigation has been and may continue to be necessary to protect our intellectual property rights, which may be costly and may divert our management’s attention away from our core business. Furthermore, there is no guarantee that litigation would result in an outcome favorable to us. Third parties that license our proprietary rights also may take actions that diminish the value of our proprietary rights or reputation. We also cannot be certain that others will not independently develop or otherwise acquire equivalent or superior technology or other intellectual property rights. If we are unable to protect our proprietary rights adequately, it would have a negative impact on our operations.

 

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Purple LLC has licensed certain intellectual property to EdiZONE, LLC, which is owned by Tony and Terry Pearce, former members of our Board, via TNT Holdings, LLC (“TNT Holdings”), for the purpose of enabling EdiZONE to meet its contractual obligations to licensees of EdiZONE under contracts entered into years before the Business Combination, and some of those licensees are competitors of Purple LLC and have exclusivity rights that Purple LLC is required to observe.

 

Prior to the Business Combination, we also entered into an Amended and Restated Confidential Assignment and License Back Agreement with EdiZONE, an entity beneficially owned and controlled by the founders, Tony Pearce and Terry Pearce (former employees, directors and beneficial majority shareholders), through their ownership of TNT Holdings, pursuant to which EdiZONE transferred tangible and intellectual property to us and we licensed back to EdiZONE certain intellectual property previously licensed by EdiZONE to third parties prior to the Business Combination in order to enable EdiZONE to continue to meet certain pre-existing license obligations to those third parties. EdiZONE and the Pearces have agreed to not modify or extend these third-party licenses and to not enter new third-party licenses. As these third-party license obligations end, all rights under the license revert to the Company.

 

Among EdiZONE’s previously entered into licenses of comfort-related intellectual property, as described above, one license includes exclusivity rights that may prohibit us from selling our existing mattresses or potentially new products in the European Union. That risk may be addressed by redesign of the configuration of the Hyper-Elastic Polymer material in that geographic region by either using existing technologies already assigned by EdiZONE to Purple LLC or developing new technologies. Alternatively, that risk may not exist at all to the extent Purple LLC’s current mattress products are the subject of expired patent rights licensed by that licensee or because Purple LLC is not the licensor. However, there can be no assurance that our future sales in the European Union, if any, will not be challenged by EdiZONE’s licensee as a violation of the license agreement, or that any redesigned mattresses created by us will be successful in that market when we may enter it. If Purple LLC’s activities are challenged by a licensee, Purple LLC has an indemnification obligation to EdiZONE and the Pearces, which may be an expense to the Company.

 

If any of these third parties violate their licenses with EdiZONE or infringe on intellectual property owned by Purple LLC and Purple LLC is unable to take effective action against such violating or infringing parties, we may be unable to protect against this infringement or the effects of such violations and our business could be harmed.

 

Purple LLC has obtained, with the cooperation of EdiZONE and the Pearces, the right to enforce its intellectual property rights at Purple LLC’s option, provided that Purple LLC will indemnify EdiZONE and fund the expense of such enforcement. In the event such enforcement is deemed necessary by Purple LLC, Purple LLC may not be successful in any such efforts to enforce its intellectual property and other rights and this may harm our business.

 

While the current license back to EdiZONE, as amended following the Business Combination, is much narrower than the license that existed at the time of the Business Combination, EdiZONE’s third-party licenses may lead to conflicts between us and EdiZONE. If conflicts do arise and are not properly addressed, disputes may occur which may be detrimental to the Company.

 

Anti-takeover provisions in our Second Amended and Restated Certificate of Incorporation, as well as provisions of Delaware law and our stockholder rights plan, contain anti-takeover provisions, any of which could delay or discourage a merger, tender offer, or assumption of control of the Company not approved by our Board of Directors that some stockholders may consider favorable.

 

Provisions of Delaware law and our Second Amended and Restated Certificate of Incorporation could hamper a third party’s acquisition of us, or discourage a third party from attempting to acquire control of us. You may not have the opportunity to participate in these transactions. These provisions could also limit the price that investors might be willing to pay in the future for equity interests in the Company. These provisions include:

 

  no cumulative voting in the election of directors, which limits the ability of minority stockholders to elect director candidates;

 

  the right of our Board to elect a director to fill a vacancy created by the expansion of our Board or the resignation, death or removal of a director in certain circumstances, which prevents stockholders from being able to fill vacancies on our Board;

 

  a prohibition on stockholder action by written consent, which forces stockholder action to be taken at an annual or special meeting of our stockholders;

 

  a prohibition on stockholders calling a special meeting and the requirement that a meeting of stockholders may only be called by members of our Board, which may delay the ability of our stockholders to force consideration of a proposal or to take action, including the removal of directors;

 

  the requirement that changes or amendments to certain provisions of our certificate of incorporation or bylaws must be approved by holders of at least two-thirds of our common stock; and

 

 

  advance notice procedures that stockholders must comply with in order to nominate candidates to our Board or to propose matters to be acted upon at a meeting of stockholders, which may discourage or deter a potential acquirer from conducting a solicitation of proxies to elect the acquirer’s own slate of directors or otherwise attempting to obtain control of us.

 

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In addition, we are subject to the provisions of Section 203 of the Delaware General Corporation Law, which may prohibit certain transactions with stockholders owning 15% or more of our outstanding voting stock or require us to obtain stockholder approval prior to engaging in such transactions. CCP and certain of its affiliates collectively hold approximately 45.0% of our outstanding voting stock. Any delay or prevention of a change in control transaction or changes in our board of directors could adversely affect our ability to execute transactions that are needed to carry out our operations and growth strategies and cause the market price of our common stock to decline.

 

Additionally, on September 25, 2022, we adopted a restated stockholder rights plan that would cause substantial dilution to, and substantially increase the costs paid by, a stockholder who attempts to acquire us on terms not approved by our board. The intent of the stockholder rights plan is to protect our stockholders’ interests by encouraging anyone seeking control of our Company to negotiate with our board. However, our stockholder rights plan could make it more difficult for a third party to acquire us without the consent of our board, even if doing so may be beneficial to our stockholders. This plan may discourage, delay or prevent a tender offer or takeover attempt, including offers or attempts that could result in a premium over the market price of our common stock. This plan could reduce the price that stockholders might be willing to pay for shares of our common stock in the future. Furthermore, the anti-takeover provisions of our stockholder rights plan may entrench management and make it more difficult to replace management even if the stockholders consider it beneficial to do so.

 

We may issue debt and equity securities or securities convertible into equity securities, any of which may be senior to our Class A Stock as to distributions and in liquidation, which could negatively affect the value of our Class A Stock.

 

In the future, we may attempt to increase our capital resources by entering into additional debt or debt-like financing that is unsecured or secured by up to all of our assets, or by issuing additional debt or equity securities, which could include issuances of secured or unsecured notes, preferred stock, hybrid securities or securities convertible into or exchangeable for equity securities. For example, in March 2022 we completed a public offering of shares of Class A Stock. In the event of our liquidation, our lenders and holders of our debt would receive distributions of our available assets before distributions to holders of our Class A Stock, and holders of securities senior to the Class A Stock would receive distributions of our available assets before distributions to the holders of our Class A Stock. Because our decision to incur debt and issue securities in future offerings may be influenced by market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings or debt financings. Further, market conditions could require us to accept less favorable terms for the issuance of our securities in the future.

 

In certain cases, payments under the Tax Receivable Agreement may be accelerated or significantly exceed the actual benefits we realize in respect of the tax attributes subject to the Tax Receivable Agreement.

 

The Tax Receivable Agreement provides that, in the event that we exercise our right to early termination of the Tax Receivable Agreement, or in the event of a change of control of the Company or we are more than 90 days late in making of a payment due under the Tax Receivable Agreement, the Tax Receivable Agreement will terminate, and we will be required to make a lump-sum payment to InnoHold equal to the present value of all forecasted future payments that would have otherwise been made under the Tax Receivable Agreement, which lump-sum payment would be based on certain assumptions, including those relating to our future taxable income. We estimate the potential lump-sum payment to be approximately $118.7 million. The change of control payment to InnoHold and the other owners could be substantial and could exceed the actual tax benefits that we receive as a result of acquiring units from other owners of Purple LLC because the amounts of such payments would be calculated assuming that we would have been able to use the potential tax benefits each year for the remainder of the amortization periods applicable to the basis increases, and that tax rates applicable to us would be the same as they were in the year of the termination. In these situations, our obligations under the Tax Receivable Agreement could have a substantial negative impact on our liquidity and could have the effect of delaying, deferring or preventing certain mergers, asset sales, other forms of business combinations or other changes of control due to the additional transaction cost a potential acquirer may attribute to satisfying such obligations. There can be no assurance that we will be able to finance our obligations under the Tax Receivable Agreement.

 

Decisions made in the course of running our business, such as with respect to mergers, asset sales, other forms of business combinations or other changes in control, may influence the timing and amount of payments that are received by InnoHold under the Tax Receivable Agreement. For example, the earlier disposition of assets following an exchange or acquisition transaction will generally accelerate payments under the Tax Receivable Agreement and increase the present value of such payments, and the disposition of assets before an exchange or acquisition transaction will increase an existing owner’s tax liability without giving rise to any rights of InnoHold to receive payments under the Tax Receivable Agreement.

 

Even in the absence of an early termination of the Tax Receivable Agreement, change of control of the Company or a payment that is more than 90 days late under the Tax Receivable Agreement, there may be a material negative effect on our liquidity if the payments under the Tax Receivable Agreement exceed the actual income or franchise tax savings that we realize in respect of the tax attributes subject to the Tax Receivable Agreement or if distributions to us by Purple LLC are not sufficient to permit us to make payments under the Tax Receivable Agreement after we have paid taxes and other expenses. Furthermore, our obligations to make payments under the Tax Receivable Agreement could make us a less attractive target for an acquisition, particularly in the case of an acquirer that cannot use some or all of the tax benefits that are deemed realized under the Tax Receivable Agreement. We may need to incur additional indebtedness to finance payments under the Tax Receivable Agreement to the extent our cash resources are insufficient to meet our obligations under the Tax Receivable Agreement as a result of timing discrepancies or otherwise which may have a material adverse effect on our financial condition. There can be no assurance that we will be able to finance our obligations under the Tax Receivable Agreement.

 

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Our ability to utilize our net operating loss carryforwards and certain other tax attributes may be limited.

 

Under Section 382 and related provisions of the Internal Revenue Code of 1986, as amended (the “Code”), if a corporation undergoes an “ownership change” generally defined as a greater than 50 percentage point change (by value) in its equity ownership by certain stockholders over a three-year period), the corporation’s ability to use its pre-change net operating loss carryforwards (“NOLs”) and other pre-change tax attributes to offset its post-change income may be limited. If finalized, Treasury Regulations currently proposed under Section 382 of the Code may further limit our ability to utilize our pre-change NOLs or other tax attributes if we undergo a future ownership change. We may have experienced ownership changes in the past, and we may experience ownership changes in the future and/or subsequent shifts in our stock ownership (some of which may be outside our control). Thus, our ability to utilize carryforwards of our net operating losses, including net operating losses acquired from the Intellibed acquisition, and other tax attributes to reduce future tax liabilities may be substantially restricted. At this time, we have not completed a study to assess the impact, if any, of ownership changes on our NOLs under Section 382 of the Code.