10-Q 1 f10q0919_purpleinnovation.htm QUARTERLY REPORT
Purple Innovation, Inc.
10-Q on 11/06/2019   Download
SEC Document
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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, 2019

 

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)
  (IRS Employer
Identification No.)

 

123 EAST 200 NORTH

ALPINE, UTAH 84004

(Address of principal executive offices, including zip code)

 

(801) 756-2600

(Registrant’s telephone number, including area code)

 

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
Warrants to purchase one-half of one share of Class A Common Stock   PRPLW   OTC PINK

 

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes þ 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 þ Smaller reporting company þ
  Emerging growth company þ

 

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 þ

 

As of November 5, 2019, 10,521,612 shares of the registrant’s Class A common stock, $0.0001 par value per share, and 43,365,879 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 (Deficit)/Member Deficit 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 26
  Item 3. Quantitative and Qualitative Disclosures about Market Risk 34
  Item 4. Controls and Procedures 34
       
Part II. Other Information 35
  Item 1. Legal Proceedings 35
  Item 1A. Risk Factors 35
  Item 6. Exhibits 55
  Signatures 56

 

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

 

We have a number of trademarks registered with the U.S. Patent and Trademark Office, including EquaPressure®, WonderGel® and EquaGel® (for cushions), and Purple® (the logo and standard character mark) (for mattresses and pillows as well as plasticized elastomeric gel), No Pressure® and Hyper-Elastic Polymer® (for plasticized elastomeric gel and certain types of products, including mattresses); and the color “purple” (for mattresses). We also have a number of common law trademarks, including Purple Powerbase™, Purple Powerbase Premier™, Purple Powerbase Plus™, Purple Glove™, Eidertech™, Purple Grid™, Mattress Max™, WonderGel Original™, WonderGel Extreme™, DoubleGel™, DoubleGel Plus™, DoubleGel Ultra™, Roll n’ Go™, Fold N’ Go™, Purple Bed™, Purple Top™, Purple Pillow™, 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™ and EquaGel Adjustable™. 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

(In thousands, except par value)

(Unaudited)

 

   September 30,   December 31, 
   2019   2018 
         
Assets        
Current assets:        
Cash and cash equivalents  $31,293   $12,232 
Accounts receivable, net   26,687    10,241 
Inventories, net   34,818    22,940 
Prepaid inventory   1,350    790 
Other current assets   3,590    1,494 
Total current assets   97,738    47,697 
Property and equipment, net   25,816    22,514 
Intangible assets, net   1,679    1,493 
Other long-term assets   284    5 
Total assets  $125,517   $71,709 
           
Liabilities and Stockholders’ Equity (Deficit)          
Current liabilities:          
Accounts payable  $35,622   $24,828 
Accrued sales returns   5,294    5,457 
Accrued compensation   5,521    2,691 
Customer prepayments   7,692    7,522 
Accrued sales tax   4,075    5,538 
Other current liabilities   9,442    2,541 
Total current liabilities   67,646    48,577 
Long-term debt, related-party   34,525    21,411 
Warrant liabilities   8,236     
Other long-term liabilities, net of current portion   7,127    3,732 
Total liabilities   117,534    73,720 
Commitments and contingencies (Note 12)          
Stockholders’ equity (deficit):          
Class A common stock; $0.0001 par value, 210,000 shares authorized; 10,501 issued and outstanding at September 30, 2019 and 9,731 issued and outstanding at December 31, 2018   1    1 
Class B common stock; $0.0001 par value, 90,000 shares authorized; 43,387 issued and outstanding at September 30, 2019 and 44,071 issued and outstanding at December 31, 2018   4    4 
Additional paid-in capital   5,748    3,655 
Accumulated deficit   (4,196)   (4,322)
Total stockholders’ equity (deficit)   1,557    (662)
Noncontrolling interest   6,426    (1,349)
Total equity (deficit)   7,983    (2,011)
Total liabilities and stockholders’ equity (deficit)  $125,517   $71,709 

 

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

 

1

 

 

PURPLE INNOVATION, INC.

 

Condensed Consolidated Statements of Operations

(In thousands, except per share amounts)

(Unaudited)

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2019   2018   2019   2018 
                 
Revenues, net  $117,406   $70,806   $304,058   $207,334 
Cost of revenues   64,523    42,684    174,323    121,575 
Gross profit   52,883    28,122    129,735    85,759 
Operating expenses:                    
Marketing and sales   34,055    25,188    94,039    77,956 
General and administrative   6,745    5,804    19,243    17,870 
Research and development   1,070    578    3,004    1,644 
Total operating expenses   41,870    31,570    116,286    97,470 
Operating income (loss)   11,013    (3,448)   13,449    (11,711)
Interest expense   1,356    999    3,801    2,672 
Other income, net   (138)   (83)   (373)   (184)
Loss on extinguishment of debt           6,299     
Change in fair value – warrant liabilities   1,384        3,372     
Net income (loss)   8,411    (4,364)   350    (14,199)
Net income (loss) attributable to noncontrolling interest   6,817    (3,575)   224    (10,856)
Net income (loss) attributable to Purple Innovation, Inc.  $1,594   $(789)  $126   $(3,343)
Net income (loss) per share:                    
    Basic  $0.18   $(0.09)  $0.01   $(0.40)
    Diluted  $0.16   $(0.09)  $0.01   $(0.40)
Weighted average common shares outstanding:                    
    Basic   8,828    8,437    8,576    8,412 
    Diluted   52,793    8,437    52,454    8,412 

 

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

 

2

 

 

PURPLE INNOVATION, INC.

 

Condensed Consolidated Statements of Stockholders’ Equity (Deficit)/Member Deficit

(In thousands)

(Unaudited)

 

   Class A   Class B   Additional   Accumulated  

Total

Stockholders’

       Total 
   Common Stock   Common Stock   Paid-in  

Equity

  

Equity

   Noncontrolling  

Equity

 
   Shares   Par Value   Shares   Par Value   Capital   (Deficit)   (Deficit)   Interest   (Deficit) 
                                     
Balance - December 31, 2018   9,731   $1    44,071   $4   $3,655   $(4,322)  $(662)  $(1,349)  $(2,011)
Net loss                       (130)   (130)   (590)   (720)
Stock-based compensation                   73        73        73 
Balance – March 31, 2019   9,731   $1    44,071   $4   $3,728   $(4,452)  $(719)  $(1,939)  $(2,658)
Net loss                       (1,338)   (1,338)   (6,003)   (7,341)
Stock-based compensation                   6,733        6,733        6,733 
Repurchase of stock options                   (97)       (97)       (97)
Issuance of common stock   96                                 
Balance – June 30, 2019   9,827   $1    44,071   $4   $10,364   $(5,790)  $4,579   $(7,942)  $(3,363)
Net income                       1,594    1,594    6,817    8,411 
Stock-based compensation                   2,935        2,935        2,935 
Exchanges of common stock   677        (677)                        
Forfeiture of unvested common stock   (3)       (7)                        
Impact of transactions affecting noncontrolling interest                   (7,551)       (7,551)   7,551     
Balance – September 30, 2019   10,501   $1    43,387   $4   $5,748   $(4,196)  $1,557   $6,426   $7,983 

  

   Class A   Class B   Additional       Total             
   Common Stock   Common Stock   Paid-in   Accumulated   Stockholders’   Noncontrolling   Member   Total 
   Shares   Par Value   Shares   Par Value   Capital   Deficit   Equity   Interest   Deficit   Equity 
                                         
Balance - December 31, 2017      $       $   $   $   $   $   $(13,919)  $(13,919)
Net loss                       (1,550)   (1,550)   (7,051)   4,324    (4,277)
Effect of the Business Combination:                                                  
Proceeds and shares issued in the Business Combination   9,683    1    44,071    4    (1,600)       (1,595)   17,912    9,595    25,912 
Assignment of founder shares and sponsor warrants                   4,691        4,691            4,691 
Balance – March 31, 2018   9,683    1    44,071    4    3,091    (1,550)   1,546    10,861        12,407 
Net loss                       (1,004)   (1,004)   (4,554)       (5,558)
Stock-based compensation                   313        313            313 
Balance – June 30, 2018   9,683   $1    44,071   $4   $3,404   $(2,554)  $855   $6,307   $   $7,162 
Net loss                       (789)   (789)   (3,575)       (4,364)
Proceeds and shares issued in the Business Combination                   77        77    355        432 
Issuance of common stock   48                                     
Balance – September 30, 2018   9,731   $1    44,071   $4   $3,481   $(3,343)  $143   $3,087   $   $3,230 

 

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

 

3

 

 

PURPLE INNOVATION, INC.

 

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

   Nine Months Ended
September 30,
 
   2019   2018 
         
Cash flows from operating activities:        
Net income (loss)  $350   $(14,199)
Adjustments to reconcile net income (loss) to net cash from operating activities:          
Depreciation and amortization   2,492    1,534 
Non-cash interest   2,439    1,768 
Loss on extinguishment of debt   6,299     
Loss on change in fair value - warrant liabilities   3,372     
Stock-based compensation   9,740    313 
Changes in operating assets and liabilities:          
Increase in accounts receivable   (16,446)   (4,302)
Increase in inventories   (11,878)   (15,335)
Increase in prepaid inventory and other assets   (2,935)   (341)
Increase (decrease) in accounts payable   11,102    (567)
Increase (decrease) in accrued sales returns   (163)   682 
Increase in accrued compensation   2,830    56 
Increase in customer prepayments   170    4,078 
Increase (decrease) in other accrued liabilities   8,472    (1,087)
Net cash provided by (used in) operating activities   15,844    (27,400)
           
Cash flows from investing activities:          
Purchase of property and equipment   (5,657)   (9,878)
Investment in intangible assets   (246)   (173)
Net cash used in investing activities   (5,903)   (10,051)
           
Cash flows from financing activities:          
Proceeds from the Business Combination       25,912 
Proceeds from related-party debt   10,000    24,000 
Repurchase of stock options   (97)    
Payments on line of credit       (8,000)
Payments for debt issuance costs   (758)   (367)
Principal payments on capital lease obligations   (25)   (22)
Net cash provided by financing activities   9,120    41,523 
           
Net increase in cash   19,061    4,072 
Cash, beginning of the period   12,232    3,593 
Cash, end of the period  $31,293   $7,665 
           
Supplemental schedule of non-cash investing and financing activities:          
Property and equipment included in accounts payable  $155   $428 
Equipment acquired through capital lease  $386   $ 
Assignment of founder shares and sponsor warrants  $   $4,691 
Equipment acquired under build-to-suit service agreement  $   $1,288 
Sale-leaseback of equipment under build-to-suit service agreement  $   $(1,288)

 

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

 

Our mission is to help people feel and live better through innovative comfort 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, bases, 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 through our direct-to-consumer (“DTC”) online channels, retail brick-and-mortar wholesale partners, third-party online retailers and our Company showrooms.

 

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”) for the purpose of effecting a merger, capital stock exchange, asset acquisition, stock purchase, reorganization or similar business combination involving the Company and one or more businesses. 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, unless specified in the amended operating agreement.

 

2. Summary of Significant Accounting Policies

 

Basis of Presentation and Principles of Consolidation

 

The Company consists of Purple Inc. and its consolidated subsidiary Purple LLC. Pursuant to the Business Combination described in Note 3 — Merger Transaction, Purple Inc. acquired approximately 18% of the common units of Purple LLC, while InnoHold, LLC (“InnoHold”) retained approximately 82% of the common units in Purple LLC.

 

The Business Combination was structured similar to a reverse recapitalization. The historical operations of Purple LLC are deemed to be those of the Company. Thus, the financial statements included in this report reflect (i) the historical operating results of Purple LLC prior to the Business Combination; (ii) the combined results of the Company following the Business Combination; (iii) the assets and liabilities of Purple LLC at their historical cost; and (iv) the Company’s equity and earnings per share for all periods presented.

 

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 the 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 financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K filed March 14, 2019. The unaudited condensed consolidated financial statements were prepared on the same basis as the audited 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 nine months ended September 30, 2019 are not necessarily indicative of the results to be expected for the fiscal year ending December 31, 2019 or for any other interim period or other future year.

 

5

 

 

Variable Interest Entities

 

Purple LLC is a variable interest entity (“VIE”). 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, 2019, Purple Inc. had approximately a 19% 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. At September 30, 2019, InnoHold and other parties owned approximately 81% of the economic interest in Purple LLC; however, InnoHold and other parties have disproportionally fewer voting rights, and are shown as the noncontrolling interest (“NCI”) holder of Purple LLC. For further discussion see Note 13 — Stockholders’ Equity.

 

Reclassification

 

Certain amounts in the prior period financial statements have been reclassified to conform to the presentation of the current period financial statements. These reclassifications had no effect on the previously reported net loss.

 

Use of Estimates

 

The preparation of the unaudited condensed consolidated financial statements requires management to make estimates and assumptions that affect the amounts reported in the unaudited condensed consolidated financial statements and accompanying notes. The Company regularly makes significant estimates and assumptions including, but not limited to, estimates that affect the Company’s revenue recognition, accounts receivable and allowance for doubtful accounts, valuation of inventories, cost of revenues, sales returns, warranty returns, the recognition and measurement of loss contingencies, warrant liabilities, estimates of current and deferred income taxes, deferred income tax valuation allowances and amounts associated with the Company’s Tax Receivable Agreement with InnoHold (the “Tax Receivable Agreement”). Predicting future events is inherently an imprecise activity and, as such, requires the use of judgment. 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. Actual results could differ materially from those estimates.

 

Revenue Recognition

 

The Company markets and sells its products through direct-to-consumer online channels, traditional wholesale partners, third-party online retailers, the Company factory outlet store and Company showrooms. Revenue is recognized when the Company satisfies its performance obligations under the contract which is transferring the promised products to the customer. This principle is achieved in the following steps:

 

Identify the contract with the customer. A contract with a customer exists when (i) the Company enters into an enforceable contract with a customer that defines each party’s rights regarding the goods to be transferred and identifies the payment terms related to these goods, (ii) the contract has commercial substance and, (iii) the Company determines that collection of substantially all consideration for the goods that are transferred is probable based on the customer’s intent and ability to pay the promised consideration. The Company does not have significant costs to obtain contracts with customers.

 

Identify the performance obligations in the contract. The Company’s contracts with customers do not include multiple performance obligations to be completed over a period of time. The performance obligations generally relate to delivering products to a customer, subject to the shipping terms of the contract. The Company has made an accounting policy election to account for shipping and handling activities performed after a customer obtains control of the goods, including “white glove” delivery services, as activities to fulfill the promise to transfer the good. The Company does not offer extended warranty or service plans. The Company does not provide an option to its customers to purchase future products at a discount and therefore there are no material option rights.

 

6

 

 

Determine the transaction price. Payment for sale of products through the direct-to-consumer online channels and third-party online retailers is collected at point of sale in advance of shipping the products. Amounts received for unshipped products are recorded as customer prepayments. Payment by traditional wholesale customers is due under customary fixed payment terms. None of the Company’s contracts contain a significant financing component. Revenue is recorded at the net sales price, which includes estimates of variable consideration such as product returns, volume rebates, and other adjustments. The estimates of variable consideration are based on historical return experience, historical and projected sales data, and current contract terms. Variable consideration is included in revenue only to the extent that it is probable that a significant reversal of the revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved. Taxes collected from customers relating to product sales and remitted to governmental authorities are excluded from revenues.

 

Allocate the transaction price to performance obligations in the contract. The Company’s contracts with customers do not include multiple performance obligations. Therefore, the Company recognizes revenue upon transfer of the product to the customer’s control at contractually stated pricing.

 

Recognize revenue when or as we satisfy a performance obligation. The Company satisfies performance obligations at a point in time upon either shipment or delivery of goods, in accordance with the terms of each contract with the customer. With the exception of third-party “white glove” delivery and certain wholesale partners, revenue generated from product sales is recognized at shipping point, the point in time the customer obtains control of the products. Revenue generated from sales through third-party “white glove” delivery is recognized at the point in time when the product is delivered to the customer. Revenue generated from certain wholesale partners is recognized at a point in time when the product is delivered to the wholesale partner’s warehouse. The Company does not have service revenue.

 

Customer prepayments include cash amounts transacted with customers prior to product delivery.

 

Debt Issuance Costs and Discounts

 

Debt issuance costs and discounts are presented in the balance sheet as a direct deduction from the carrying amount of the related debt liability and are amortized into interest expense using an effective interest rate over the duration of the debt. Refer to Note 8 – Long-Term Debt, Related-Party.

 

Fair Value Liability Warrants

 

The Company accounts for fair value liability warrants under the provisions of ASC 480 - Distinguishing Liabilities from Equity. ASC 480 requires the recording of certain liabilities at their fair value. Changes in the fair value of these liabilities are recognized in earnings. As a result of certain terms, conditions and features included in the incremental warrants issued by the Company, they are required to be accounted for as a liability at estimated fair value, with changes in fair value recognized in earnings. Refer to Note 9 – Warrant Liabilities.

 

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 (e.g. 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.

 

7

 

 

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, accrued expenses and the Company’s debt obligations. The carrying amounts of cash and cash equivalents, receivables, accounts payable and accrued expenses approximate fair value because of the short-term nature of these accounts. The fair value of the Company’s debt instrument is estimated to be its face value based on the contractual terms of the debt instrument and market-based expectations. The warrant liability is a Level 3 instrument and uses an internal model 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 would 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 would generally increase (decrease) in value if the expected average life or expected volatility were to increase (decrease).

 

Income Taxes

 

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.

 

The Company accounts for uncertainty in income taxes using a recognition and measurement threshold for tax positions taken or expected to be taken in a tax return, which are subject to examination by federal and state taxing authorities. The tax benefit from an uncertain tax position is recognized when it is more likely than not that the position will be sustained upon examination by taxing authorities based on technical merits of the position. The amount of the tax benefit recognized is the largest amount of the benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. The effective tax rate and the tax basis of assets and liabilities reflect management’s estimates of the ultimate outcome of various tax uncertainties. The Company recognizes penalties and interest related to uncertain tax positions within the provision (benefit) for income taxes line in the accompanying condensed consolidated statements of operations.

 

Purple LLC, the Company’s accounting predecessor, is a limited liability company treated as a partnership for U.S. federal income tax purposes that is not subject to U.S. federal income tax.

 

Net Income (Loss) Per Share

 

The two-class method of computing net income (loss) per share is required for entities that have participating securities. The two-class method is an earnings allocation formula that determines net income (loss) per share for participating securities according to dividends declared (or accumulated) and participation rights in undistributed earnings. The Company’s Class B Stock has no economic interest in the earnings of the Company, resulting in the two-class method not being applicable as of September 30, 2019 or in prior periods. Basic net income (loss) per common share is calculated by dividing net loss attributable to common shareholders by the weighted average number of shares of Class A Stock outstanding each period. Diluted net income (loss) per share adds to those shares the incremental shares that would have been outstanding and potentially dilutive assuming exchanges of the Company’s outstanding warrants, stock options and Class B Stock for Class A Stock, and the vesting of unvested and restricted Class A Stock. An anti-dilutive impact is an increase in net income per share or a reduction in net loss per share resulting from the conversion, exercise or contingent issuance of certain securities.

 

8

 

 

The Company uses the “if-converted” method to determine the potential dilutive effect of conversions of its outstanding Class B Stock, and the treasury stock method to determine the potential dilutive effect of its outstanding warrants and stock options exercisable for shares of Class A Stock and the vesting of unvested and restricted Class A Stock.

 

Recent Accounting Pronouncements

 

New Revenue Guidance

 

In May 2014, in addition to several amendments issued during 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606). Topic 606 outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The Company adopted this ASU effective January 1, 2019 on a modified retrospective basis. Adoption of this standard did not result in significant changes to the Company’s accounting policies, business processes, systems or controls, or have a material impact on the Company’s financial position, results of operations, or cash flows. As such, prior period amounts are not adjusted and continue to be reported under accounting standards then in effect, and the Company did not record a cumulative adjustment to the opening equity balance of accumulated deficit as of January 1, 2019. However, additional disclosures have been added in accordance with the requirements of Topic 606 and are reflected in Note 4 – Revenue from Contracts with Customers.

 

New Business Combination Guidance

 

In January 2017, the FASB issued ASU 2017-01, “Business Combinations: Clarifying the Definition of a Business.” The purpose of this ASU is to clarify the definition of a business to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendments affect all companies and other reporting organizations that must determine whether they have acquired or sold a business. The Company adopted this ASU effective January 1, 2019. The guidance in this standard did not have a material impact on the financial statements.

 

New Lease Guidance

 

In February 2016, the FASB issued ASU No. 2016-02, “Leases,” and in March 2019, the FASB issued ASU No. 2019-01, “Leases: Codification Improvements”, which updated the accounting guidance related to leases to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. They also clarify implementation issues. These updates are effective for public companies for annual periods beginning after December 15, 2018, including interim periods therein. The Company is allowed to use the private company adoption timelines, and therefore the standard is effective for the Company for its annual period beginning January 1, 2020, and interim periods within annual periods beginning January 1, 2021. The standard is to be applied utilizing a modified retrospective approach, with early adoption permitted. We are in the process of implementing a new lease accounting system in connection with the adoption. While we expect a material impact to our consolidated balance sheet as a result of the adoption of this new guidance, we continue to evaluate the effect of the new standard on our consolidated financial statements and related disclosures. We also expect that adoption of the new guidance will require changes to our internal controls over financial reporting.

 

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3. Merger Transaction

 

On February 2, 2018, upon consummation of the Business Combination, Purple LLC merged with and into a wholly owned subsidiary of GPAC (PRPL Acquisition, LLC), with Purple LLC being the survivor in that merger pursuant to an Agreement and Plan of Merger (the “Merger Agreement”), by and among GPAC, PRPL Acquisition, LLC, a Delaware limited liability company and a wholly owned subsidiary of GPAC (“Merger Sub”), Purple LLC and InnoHold. In connection with the Closing, GPAC was renamed “Purple Innovation, Inc.” and its articles of incorporation were amended to rename its common stock to Class A common stock (“Class A Stock”) and created a new class of stock named Class B common stock (“Class B Stock”) of which 44.1 million shares of Class B Stock were issued to InnoHold (refer to Note 13 — Stockholders’ Equity for a description of the Class A Stock and Class B Stock).

 

Additionally, at the Closing, 9.7 million Class A Units of Purple LLC were issued and are solely held by Purple Inc. They are voting common units entitled to share in the profits and losses of Purple LLC and receive distributions as declared by Purple LLC’s manager. 44.1 million Class B Units of Purple LLC were issued to InnoHold who has limited voting rights in Purple LLC and is entitled to share in the profits and losses of Purple LLC and to receive distributions as declared by Purple LLC’s manager. The amended operating agreement appoints Purple Inc. as the sole managing member of Purple LLC. As the sole managing member, Purple Inc. operates and controls all of the business and affairs of Purple LLC. Accordingly, although Purple Inc. has a minority economic interest in Purple LLC, Purple Inc. has the sole voting interest in and control of the management and operations of Purple LLC.

 

4. Revenue from Contracts with Customers

 

The Company markets and sells its products through direct-to-consumer online channels, traditional wholesale partners, and third-party online retailers. Revenue is recognized when the Company satisfies its performance obligations under the contract which is transferring the promised products to the customer as described in Note 2 – Summary of Significant Accounting Policies.

 

Contract Balances

 

Payment for sale of products through the direct-to-consumer online channels and third-party online retailers is collected at point of sale in advance of shipping the products. Amounts received for unshipped products are recorded as customer prepayments. Customer prepayments were $7.7 million at September 30, 2019 and $7.5 million at December 31, 2018. During the nine months ended September 30, 2019, the Company recognized $7.5 million of revenue that was deferred in customer prepayments at December 31, 2018.

 

Disaggregated Revenue

 

The following table presents the Company’s revenue disaggregated by sales channel and product (in thousands):

 

   Three
Months
Ended
September 30,
   Nine
Months
Ended
September 30,
 
Channel  2019   2019 
         
Direct-to-consumer  $67,950   $185,109 
Wholesale partner   49,456    118,949 
Revenues, net  $117,406   $304,058 

 

   Three
Months
Ended
September 30,
   Nine
Months
Ended
September 30,
 
Product  2019   2019 
         
Bedding  $110,332   $283,844 
Other   7,074    20,214 
Revenues, net  $117,406   $304,058 

 

The Company sells products through two channels: Direct-to-Consumer and Wholesale. The Direct-to-Consumer channel includes product sales through various direct-to-consumer channels. The Wholesale channel includes all product sales to traditional third-party retailers and their online channels. The Company classifies products into two major categories: Bedding and Other. Bedding products include mattresses, platforms, adjustable bases, mattress protectors, pillows and sheets. Other products include cushions and various other products.

 

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5. Inventories

 

Inventories consist of the following (in thousands):

 

   September 30,   December 31, 
   2019   2018 
         
Raw materials  $12,107   $10,763 
Work-in-process   2,637    521 
Finished goods   21,054    12,364 
Inventory obsolescence reserve   (980)   (708)
Inventories, net  $34,818   $22,940 

 

6. Property and Equipment

 

Property and equipment consist of the following (in thousands):

 

   September 30,   December 31, 
   2019   2018 
Equipment  $18,712   $15,465 
Equipment in progress   2,514    2,895 
Leasehold improvements   4,481    3,359 
Furniture and fixtures   3,538    2,817 
Office equipment   1,281    799 
Equipment under capital lease   662    159 
Total property and equipment   31,188    25,494 
Accumulated depreciation and amortization   (5,372)   (2,980)
Property and equipment, net  $25,816   $22,514 

 

The Company recorded depreciation and amortization related to property and equipment of $0.9 million and $0.5 million during the three months ended September 30, 2019 and 2018, respectively, and $2.4 million and $1.5 million during the nine months ended September 30, 2019 and 2018, respectively.

 

7. Other Current Liabilities

 

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

 

   September 30,   December 31, 
   2019   2018 
Co-op advertising, rebates, promotions  $6,122   $430 
Warranty accrual – current portion   1,364    893 
Website commissions   815    823 
Insurance financing   703     
Accrued expenses   368    363 
Capital leases – current portion   70    32 
Total other current liabilities  $9,442   $2,541 

 

8. Long-Term Debt, Related-Party

 

Long-term debt, related-party consists of the following (in thousands):

 

   September 30,   December 31, 
   2019   2018 
Long-term debt, related-party  $38,513   $26,647 
Less: unamortized debt issuance costs and discounts   (3,988)   (5,236)
Total long-term debt, related-party  $34,525   $21,411 

 

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Credit Agreement

 

On February 2, 2018, Purple LLC entered into a Credit Agreement (the “Credit Agreement”) with 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 “Lenders”), pursuant to which the Lenders agreed to make a loan in an aggregate principal amount of $25.0 million. The Credit Agreement was closed and funded in connection with the Closing on February 2, 2018. As part of the Credit Agreement, Global Partner Sponsor I LLC (the “Sponsor”) agreed to assign to the Lenders an aggregate of 2.5 million warrants to purchase 1.3 million shares of its Class A Stock. The Credit Agreement was amended and restated on January 28, 2019 as discussed below.

 

The Company paid debt issuance costs, incurred an original issuance discount and discounts related to the Founder Shares (as defined in Note 13 – Stockholders’ Equity) and Sponsor Warrants that were assigned in conjunction with the Credit Agreement. The amount of these reductions collectively allocated to debt at the time of the Business Combination was $6.1 million.

 

Amended and Restated Credit Agreement

 

On January 28, 2019, Purple LLC entered into a First Amendment to the Credit Agreement (the “First Amendment”) with the Lenders which amends the Credit Agreement. In the First Amendment, Purple LLC agreed to enter into the Amended and Restated Credit Agreement, under which two of the Lenders (“Incremental Lenders”) agreed to provide an incremental loan of $10.0 million such that the total amount of principal indebtedness provided to Purple LLC is increased to $35.0 million. A stockholder meeting was held on February 25, 2019 at which time a majority of non-interested stockholders voted in favor of this transaction. The Amended and Restated Credit Agreement, and each of the related documents, was accordingly closed and the incremental $10.0 million loan was funded on February 26, 2019 and the Company issued to the Incremental Lenders 2.6 million warrants to purchase 2.6 million shares of the Company’s Class A Stock at a price of $5.74 per share, subject to certain adjustments. Among other things, the terms of the Amended and Restated Credit Agreement extends the maturity date for all loans under the Credit Agreement to five years from closing of the incremental loan, lowers the amount allowed for an asset-based loan to $10.0 million, revises certain restrictive covenants to make them more applicable to the Company’s current business, provides the ability for the Company to request additional loans from the Lenders not to exceed $10 million and other closing conditions, representations, warranties and covenants customary for a transaction of this type. All indebtedness under the Amended and Restated Credit Agreement bears interest at 12.0% per annum and is payable on the last business day of each fiscal quarter, provided that Purple LLC will be required to pay up to an additional 4.0% of interest per annum if it fails to meet certain EBITDA thresholds and an additional 2.0% of interest per annum if the Company is not in material compliance with the Sarbanes-Oxley Act of 2002. In addition, Purple LLC may elect for interest in excess of 5.0% per annum to be capitalized and added to the principal amount. Any principal pre-payments in the first year are subject to a make-whole payment, while principal pre-payments in years two through four are subject to certain pre-payment penalties. The Amended and Restated Credit Agreement provided for certain remedies to the Lenders in the event of customary events of default and provides for standard indemnification of the Lenders. Purple LLC continues to be restricted from making annual capital expenditures in excess of $20.0 million and incurring capital lease obligations in excess of $10.0 million at any time outstanding, subject to limited exceptions.

 

The Company paid fees in the amount of $0.5 million and debt issuance costs in the amount of $0.3 million in conjunction with the incremental loan under the Amended and Restated Credit Agreement. Interest expense related to the Credit Agreement and the Amended and Restated Credit Agreement was $1.4 million and $1.0 million for the three months ended September 30, 2019 and 2018, respectively, and $3.8 million and $2.6 million for the nine months ended September 30, 2019 and 2018, respectively.

 

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Loss on Extinguishment of Debt

 

The Company accounted for the debt restructuring under the Amended and Restated Credit Agreement in accordance with ASC 470 - Debt. The Company determined that there are separate lenders for purposes of determining if there was an extinguishment or modification. The amended debt terms with CDF were not determined to be substantial and therefore the existing debt attributable to CDF was accounted for as a modification of debt. The amended debt terms with the Incremental Lenders were determined to be substantially different terms from their existing debt and therefore required to be accounted for as an extinguishment of their existing debt. Accordingly, the Company recognized a loss on the extinguishment of their existing debt of approximately $6.3 million for the nine months ended September 30, 2019. This is a non-cash expense primarily associated with the recognition of related unamortized debt discount and debt issuance costs and the fair value of the incremental warrants issued.

 

9. Warrant Liabilities

 

The Incremental Loan Warrants issued in conjunction with the Amended and Restated Credit Agreement contain a warrant repurchase provision which, upon an occurrence of a fundamental transaction as defined in the warrant agreement, could give rise to an obligation of the Company to pay cash to the warrant holders. The Company has determined that this provision requires the warrants to be accounted for as a liability at fair value on the date of the transaction under guidance prescribed in ASC 480 - Distinguishing Liabilities from Equity. The liability for the warrants is subsequently re-measured to fair value at each reporting date with changes in the fair value included in earnings. The Company recorded a $1.4 million and a $3.4 million loss on the increase in fair value of the Incremental Loan Warrants for the three and nine months ended September 30, 2019, respectively.

 

The Company determined the fair value of the Incremental Loan Warrants to be $4.9 million on the date of the transaction on February 26, 2019 using a Monte Carlo Simulation of a Geometric Brownian Motion stock path model with the following assumptions: 

 

Trading price of common stock on measurement date  $5.59 
Exercise price  $5.74 
Risk free interest rate   2.45%
Warrant lives in years   5.0 
Expected volatility   34.37%
Expected dividend yield    

 

The Company determined the fair value of the Incremental Loan Warrants to be $8.2 million on September 30, 2019 using a Monte Carlo Simulation of a Geometric Brownian Motion stock path model with the following assumptions:

 

Trading price of common stock on measurement date  $7.53 
Exercise price  $5.74 
Risk free interest rate   1.55%
Warrant life in years   4.4 
Expected volatility   36.29%
Expected dividend yield    

 

10. Other Long-Term Liabilities

 

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

 

   September 30,   December 31, 
   2019   2018 
Deferred rent expense  $2,594   $2,531 
Warranty accrual   5,477    2,009 
Capital leases   490    117 
Total other long-term liabilities   8,561    4,657 
Less: current portion of long-term liabilities   (1,434)   (925)
Other long-term liabilities, net of current portion  $7,127   $3,732 

 

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11. 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 (“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 Coliseum Capital Management, LLC (“CCM”), which is the investment manager of Blackwell. Mr. Gray has voting and dispositive control over securities held by CCP, CDF and Blackwell which are the “Lenders” under the Credit Agreement. On February 26, 2019, the Amended and Restated Credit Agreement between Purple LLC and the Lenders thereto, and each of the related documents, including the issuance of additional warrants to the Incremental Lenders, was closed and an incremental loan of $10.0 million was funded (see Note 8 – Long Term Debt, Related Party). The Lenders in aggregate had $38.5 million in principal borrowings outstanding as of September 30, 2019, comprised of $25.0 million in original loan amount, $10.0 million in incremental loan amount and $3.5 million in capitalized interest. The Company made interest payments to the Lenders in the amount of $0.5 million and $0.3 million during the three months ended September 30, 2019 and 2018, respectively, and $1.3 million and $0.8 million during the nine months ended September 30, 2019 and 2018, respectively.

 

Purple Founder Entities

 

TNT Holdings, LLC (herein “TNT Holdings”), EdiZONE, LLC (herein “EdiZONE”) and InnoHold, LLC (herein “InnoHold”) (the “Purple Founder Entities”) were entities under common control with Purple LLC prior to the Business Combination as TNT Holdings and InnoHold are majority owned and controlled by Terry Pearce and Tony Pearce (with EdiZONE being wholly owned by TNT Holdings) who also were the founders of Purple LLC and immediately following the Business Combination were appointed to the Company’s Board (the “Purple Founders”). InnoHold is a majority shareholder of the Company.

 

TNT Holdings owns the Alpine facility Purple LLC leases. Effective as of October 31, 2017, Purple LLC entered into an Amended and Restated Lease Agreement with TNT Holdings. The Company determined that TNT Holdings is not a VIE as neither the Company nor Purple LLC hold any explicit or implicit variable interest in TNT Holdings and do not have a controlling financial interest in TNT Holdings. The Company incurred $0.2 million and $0.3 million in rent expense to TNT Holdings for the building lease of the Alpine facility for the three months ended September 30, 2019 and 2018, respectively and $0.8 million and $0.9 million for the nine months ended September 30, 2019 and 2018, respectively. The Company has been leasing its headquarters facility in Alpine, Utah from TNT Holdings since 2010. The Company has leased a new facility in Lehi, Utah and will be moving its headquarters into that building before the end of the first quarter 2020. The Company intends currently to continue to lease from TNT Holdings the building in Alpine, Utah and use it as its facility for production, research and development and video productions.

 

On February 2, 2019, the lock-up agreement expired that was entered into in connection with the Closing. The lock-up agreement was entered into by InnoHold between the Company and the Parent Representative with respect to the equity securities that both the Company and Purple LLC received in the Business Combination (the “Previously Restricted Securities”). As of September 30, 2019, following the expiration of the lock-up agreement, 0.7 million Previously Restricted Securities have been exchanged for Class A Stock by certain current and former employees of the Company who received distributions of such Previously Restricted Securities from InnoHold. See Note 16 — Equity Compensation Plans.

 

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12. Commitments and Contingencies

 

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 InnoHold 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 does not include any mandatory distributions, other than tax distributions. No distributions have been made under the Second Purple LLC Agreement in 2019 or 2018. 

 

Service Agreement

 

In October 2017, the Company entered into an electric service agreement with the local power company. The agreement provided for the construction and installation of certain utility improvements to provide increased power capacity to the manufacturing and warehouse facility in Grantsville, Utah. The Company prepaid $0.5 million related to the improvements and agreed to a minimum contract billing amount over a 15-year period based on regulated rate schedules and changes in actual demand during the billing period. The agreement includes an early termination clause that requires the Company to pay a pro-rata termination charge if the Company terminates within the first 10 years of the service start date. The early termination charge is $1.0 million as of September 30, 2019 and is reduced annually on a straight-line basis over the 10-year period. During 2018, the utility improvements construction was completed and were made available to the Company. As of September 30, 2019, the Company expects to fulfill its commitments under the agreement in the normal course of business, and as such, no liability has been recorded.

 

Operating Leases

 

The Company leases various office and warehouse facilities under non-cancellable operating leases. Office and manufacturing space for its headquarters facility in Alpine, Utah is leased from TNT Holdings an entity that prior to the Business Combination was under common control with InnoHold, which was the majority and controlling owner of Purple LLC. The lease was originally entered into in 2010, but in October 2017 was amended with a lease term of 10 years that expires in September 2027 with an early-out clause without penalties after 5 years and includes an option for a 5-year extension. The Company leases a facility located in Grantsville, Utah for use primarily as manufacturing and warehouse space. The lease was entered into in August 2016 with a lease term of 66 months and expires in January 2022 with two 5-year extension options. The Company also leases another facility in Grantsville, Utah for use as temporary warehouse space. The lease was entered into in May 2019 with a lease term of 4 months which expired in August 2019 with a holdover option on a month to month basis. The Company has entered into leases for Company showrooms in Seattle, Washington, San Diego, California and San Jose, California. The leases commence in October and November 2019 with lease terms of three to 16 months without any renewal options. The Company entered into a lease for the Company factory outlet store in Salt Lake City, Utah. The lease was entered into in June 2019 with a lease term of 36 months with one 5-year extension option. The Company has also entered into a lease for Corporate office space in Lehi, Utah. The lease was entered into in June 2019 with a lease term of 10 years with an option to early terminate after the eighty-fourth calendar month and an option for two 5-year extensions. The Company will be moving its headquarters into the building before the end of the first quarter 2020. The Company recognizes rent expense on lease payments, including those with rent escalations and rent free periods, on a straight-line basis over the expected lease term. The Company recognized rent expense in the amount of $0.8 million and $0.9 million during the three months ended September 30, 2019 and 2018, respectively, and $2.6 million and $2.9 million during the nine months ended September 30, 2019 and 2018, respectively.

 

Purchase Agreement

 

In February 2018, the Company entered into a purchase contract with a supplier of mineral oil that includes a minimum purchase commitment over a two-year period. In April 2019, the contract was amended to provide for a minimum purchase commitment over a four-year period ending in April 2023. In exchange, the Company is offered a further discount per gallon. As of September 30, 2019, approximately $17.9 million remains on the purchase contract. Based on current usage rates, the Company expects to fulfill its commitments under the agreement in the normal course of business, and as such, no liability has been recorded.

 

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Indemnification Obligations

 

From time to time, the Company enters into contracts that contingently require it to indemnify parties against claims. These contracts primarily relate to provisions in the Company’s services agreements with related parties that may require the Company to indemnify the related parties against services rendered; and certain agreements with the Company’s officers and directors under which the Company may be required to indemnify such persons for liabilities. In connection with the Closing, to secure the 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 Stock and 0.5 million Class B Units otherwise issuable to InnoHold as equity consideration have been deposited in an escrow account for up to three years from the Closing pursuant to a contingency escrow agreement. As of September 30, 2019, 0.5 million shares of Class B Stock and 0.5 million Class B Units otherwise issuable to InnoHold as equity consideration remain deposited in an escrow account and no indemnification claims have been made.

 

Rights of Securities Holders

 

The holders of certain Warrants exercisable into Class A Stock and certain other unregistered Class A Stock 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 the Warrants (and any shares of Class A Stock issuable upon the exercise of the Warrants), and certain unregistered shares of Class A Stock. The registration statement was declared effective on April 3, 2018.

 

The holders of the Incremental Warrants exercisable into Class A Stock were entitled to registration rights pursuant to the registration rights agreement of the Company in connection with the Amended and Restated Credit Agreement. In March 2019, the Company filed a registration statement registering the Warrants (and any shares of Class A Stock issuable upon the exercise of the Warrants). The registration statement was declared effective on May 17, 2019.

 

Purple LLC Class B Unit Exchange Right. 

 

On February 2, 2018, in connection with the Closing, 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 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 Stock at an initial exchange ratio equal to one Paired Security for one share of Class A 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 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 also 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. See Note 16 — Equity Compensation Plans.

 

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. However, the Paired Securities were not able to be exchanged during a lock-up period that ended on the one-year anniversary of the Closing, on February 2, 2019.

 

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 Stock and Class B Stock or a transaction in which the Class A 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 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 Operating Agreement, or if such exchange would cause Purple LLC to be treated as a “publicly traded partnership” under applicable tax laws.

 

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.

 

During the nine months ended September 30, 2019, following the expiration of the lock-up period, 0.7 million Paired Securities were exchanged for shares of Class A Stock.

 

16

 

 

Maintenance of One-to-One Ratios.

 

The Second 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 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 Stock) and (ii) the number of corresponding outstanding equity securities of Purple LLC. These provisions are intended to result in InnoHold and other 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. 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.

 

Legal Proceedings 

 

On January 9, 2018, Chris Knudsen, a former consultant to the Company, filed a complaint against Purple LLC in the Fourth Judicial District Court of the State of Utah. Mr. Knudsen alleges that before his consulting contract ended in March 2016, he and Purple LLC reached an oral agreement under which Mr. Knudsen would become the company’s chief executive officer on April 1, 2016, and under which Mr. Knudsen would immediately receive a 4% equity interest in Purple LLC. Mr. Knudsen alleges that Purple LLC’s failure to make him the company’s chief executive officer on April 1, 2016, constitutes a breach of that oral agreement, and Mr. Knudsen claims damages of $12 to $25 million, based on his calculation of the value of a 4% interest in Purple LLC. In the alternative, Mr. Knudsen seeks declaratory relief that he owns the 4% equity position in Purple LLC. Purple LLC denies that it reached an agreement with Mr. Knudsen for him to assume the role of chief executive officer and denies that it reached an agreement to provide equity to Mr. Knudsen. Purple LLC believes that Mr. Knudsen’s lawsuit is without merit and is vigorously contesting it. The Company maintains insurance to defend against claims of this nature, which management believes is adequate to cover the cost of its defense of Mr. Knudsen’s claims. Fact discovery in this matter has been completed and expert discovery is scheduled to be completed in November 2019.

 

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. The Company alleges that PerfectSense has infringed on 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. PerfectSense has not yet answered the complaint.

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. 

 

13. Stockholders’ Equity

 

Prior to the Business Combination, GPAC was a shell company with no operations, formed as a vehicle to effect a business combination with one or more operating businesses. After the Closing, the Company became a holding company whose sole material asset consists of its interest in Purple LLC.

 

Class A Common Stock

 

The Company has 210.0 million shares of Class A Stock authorized at a par value of $0.0001 per share. Holders of the Company’s Class A 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 the Class A Stock and holders of the Class B 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 Stock and Class B Stock are entitled to one vote per share on matters to be voted on by stockholders.

 

17

 

 

In connection with the Business Combination, all of GPAC’s issued and outstanding shares of common stock were renamed to Class A Stock. The Company distributed approximately $90.6 million of the cash proceeds from the Company’s initial public offering to redeem approximately 9.0 million shares of Class A Stock, which shares were then cancelled by GPAC. In addition, the Sponsor agreed to forfeit an aggregate of 1.3 million of the 3.9 million shares of common stock it received at GPAC’s formation (the “Founder Shares”), which forfeited shares were then cancelled by the Company. GPAC issued an additional 4.0 million shares of Class A Stock to investors as part of a private investment in public equity (PIPE financing). At September 30, 2019, 10.5 million shares of Class A Stock were outstanding.

 

The Founder Shares are identical to the shares of Class A Stock sold in GPAC’s initial public offering, and holders of these shares have the same stockholder rights as public stockholders, except that the Founder Shares are subject to certain transfer and vesting restrictions described below.

 

The Sponsor agreed not to transfer, assign or sell, except to certain permitted transferees, including to its members or in connection with a business combination, any of its Founder Shares until either one year passed after the completion of the Business Combination or certain other events occurred. Upon its own terms this restriction expired on February 2, 2019.

 

In accordance with the terms of the Business Combination, the Sponsor agreed to subject 0.6 million shares of Class A Stock owned by it to vesting and forfeiture. The shares of Class A Stock subject to vesting will be forfeited eight years from the Closing, unless any of the following events (each a “Triggering Event”) occurs prior to that time:(i) the closing price of the Class A Stock on the principal exchange on which it is listed is at or above $12.50 for 20 trading days over a thirty trading day period (subject to certain adjustments), (ii) a change of control of the Company, (iii) a “going private” transaction by the Company pursuant to Rule 13e-3 under the Exchange Act or such other time as the Company ceases to be subject to the reporting obligations under Section 13 or 15(d) of the Exchange Act, or (iv) the time that the Company’s Class A Stock ceases to be listed on a national securities exchange. Such shares of Class A Stock will no longer be subject to forfeiture upon the occurrence of a Triggering event. In addition, in connection with the Coliseum Private Placement, the Sponsor assigned 1.3 million shares of Class A Stock of which 0.6 million shares are subject to the same vesting and forfeiture conditions described above. Further, the Sponsor had distributed the remaining Founder Shares to its members during the first quarter of 2018. Such distributed Founder Shares remain subject to the vesting and forfeiture conditions described above.

 

Class B Common Stock

 

The Company has 90.0 million shares of Class B Stock authorized at a par value of $0.0001 per share. Holders of the Company’s Class B Stock will vote together as a single class with holders of the Company’s Class A Stock on all matters properly submitted to a vote of the stockholders. Shares of Class B Stock may be issued only to InnoHold, their respective successors and assigns, as well as any permitted transferees of InnoHold. A holder of Class B Stock may transfer shares of Class B 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 Second Purple LLC Agreement. Additionally, InnoHold agreed to restrictions on certain transfers of the Company’s securities which include, subject to certain exceptions, restrictions on the transfer of their common stock from the date of the Business Combination until the earliest of the one-year anniversary of the date of the Business Combination or the occurrence of certain other events. Upon its own terms this transfer restriction expired on February 2, 2019. The Class B 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.

 

18

 

 

In connection with the Business Combination, approximately 44.1 million shares of Series B Stock were issued to InnoHold as part of the equity consideration. At September 30, 2019, 43.4 million shares of Class B Stock were outstanding.

 

Public and Sponsor Warrants

 

There were 15.5 million public warrants (the “Public Warrants”) issued in connection with GPAC’s formation and IPO and 12.8 million warrants (the “Sponsor Warrants”), issued pursuant to a private placement simultaneously with the IPO. Each of the Company’s warrants entitles the registered holder to purchase one-half of one share of the Company’s Class A 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. Pursuant to the warrant agreement, a warrant holder may exercise its warrants only for a whole number of shares of the Class A Stock. For example, if a warrant holder holds one warrant to purchase one-half of one share of Class A Stock, such warrant will not be exercisable. If a warrant holder holds two warrants, such warrants will be exercisable for one share of the Class A 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.

 

The Company may call the warrants for redemption if the reported last sale price of the Class A 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, with respect to the Sponsor Warrants, 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 Stock equal to the quotient obtained by dividing (x) the product of the number of shares of Class A 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 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. All other terms, rights and obligations of the Sponsor Warrants remain the same as the Public Warrants. Both the Public and Sponsor Warrants are classified as equity instruments in the accompanying condensed consolidated balance sheet.

 

From the time of GPAC’s IPO up to the Business Combination with Purple LLC, GPAC had 28.3 million warrants outstanding. At September 30, 2019, all 28.3 million warrants remain outstanding.

 

Incremental Loan Warrants

 

In connection with the Amended and Restated Credit Agreement, the Company issued to CCP and Blackwell, as the Incremental Lenders funding the Incremental Loan, 2.6 million Incremental Loan Warrants to purchase 2.6 million shares of the Company’s Class A Stock. Each Incremental Loan Warrant entitles the registered holder to purchase one share of the Company’s Class A Stock at a price of $5.74 per share, subject to adjustment pursuant to the terms of the warrant agreement. The Incremental Loan Warrants have a five-year term and will expire on February 26, 2024, or earlier upon redemption or liquidation.

 

19

 

 

The Company may call the warrants for redemption at a price of $0.01 per Share of Class A Stock if the reported last sale price of the Class A 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. If the Company calls the Incremental Loan Warrants for redemption, it will have the option to require the holder to exercise the Incremental Loan Warrants on a cashless basis, by surrendering their Incremental Loan Warrants for that number of shares of Class A Stock equal to the quotient obtained by dividing (x) the product of the number of shares of Class A Stock underlying the Incremental Loan 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 Stock for the 10 trading days ending on the third trading day prior to the date on which the notice of redemption is sent to the holders of Incremental Loan Warrants.

 

In the event of a “fundamental transaction” as defined in the warrant agreement, the holder will have the right to purchase and receive the same kind and amount of consideration receivable by the stockholders of the Company upon the occurrence of such fundamental transaction. The warrant agreement requires the Company to cause the surviving company in a fundamental transaction, to assume the obligations of the Company under the Incremental Loan Warrants. In addition, a clause in the Incremental Loan Warrant Agreement states, upon the occurrence of a fundamental transaction, that the holders of the Incremental Loan Warrants may elect to either (i) have the exercise price of the warrant reduced by the Black-Scholes value of the Incremental Loan Warrants (as set forth in the Incremental Loan Warrants Agreement) or (ii) cause the Company or its successor to repurchase all or a portion of the Incremental Loan Warrants at the Black-Scholes value (as set forth in the Incremental Loan Warrants). As a result of this clause, the Incremental Loan Warrants embody an obligation to repurchase the Company’s equity shares, or is indexed to such an obligation, and may require the Company to settle the obligation by transferring assets. As such, the Incremental Loan Warrants are classified as liabilities under ASC 480 - Distinguishing Liabilities from Equity. See Note 13 — Stockholders’ Equity.

 

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, 2019, there were no shares of preferred stock outstanding.

 

Noncontrolling Interest

 

NCI represents the membership interest held in Purple LLC by holders other than the Company, through ownership of Class B Units. As of September 30, 2019 Class B Unit holders’ had a combined NCI percentage in Purple LLC of approximately 80.5%. 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.

 

14. Income Taxes

 

The Company’s sole material asset is 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. 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 future earnings of Purple LLC not attributed to the NCI holder, InnoHold, which will continue to bear its share of income tax on its allocable future earnings of Purple LLC. The income tax burden on the earnings taxed to the NCI is not reported by the Company in its condensed consolidated financial statements under GAAP. As a result, the Company’s effective tax rate differs materially from the statutory rate.

 

As of September 30, 2019, the Company has a full valuation allowance on its net deferred tax assets. In assessing the realizability of deferred tax assets, including the deferred tax assets recorded in connection with the Business Combination and generated under the Tax Receivable Agreement described below, management determined that it was more likely than not that its net deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible and consideration of tax-planning strategies. Considering these factors, a valuation allowance was recorded in the year ended December 31, 2018, and the Company continues to be in a full valuation allowance position for the period ended September 30, 2019.

 

20

 

 

The Company currently estimates its annual effective income tax rate to be 0%. The effective tax rate for Purple Inc. differs from the federal rate of 21% primarily due to (1) a full valuation allowance, (2) NCI in Purple LLC that is allocated to InnoHold and (3) various other items such as limitations on meals and entertainment, certain stock compensation and other costs.

 

No current income tax liability was recorded as a result of the Business Combination since its legal form was treated as a purchase of interests or assets in a non-taxable pass through partnership for U.S. federal income tax purposes such that the Company did not assume an existing tax obligation on the purchased assets. The excess of the Company’s tax basis in its investment in Purple LLC over its book carrying value in this investment resulted in a deferred tax asset that may reduce certain income tax payments in the future. This deferred tax asset encompasses the basis increase in the assets of Purple LLC as a result of the Business Combination and Tax Receivable Agreement as well as the Company’s share of Purple LLC’s unrecognized temporary timing differences between book and tax. For the year ended December 31, 2018, the Company recorded a deferred tax asset related to this initial outside basis difference, with an offsetting effect recorded in additional paid in capital. As noted above, due to uncertainties relating to the realization of the outside basis difference deferred tax asset, the Company recorded a full valuation allowance in 2018, with an offsetting effect recorded in additional paid in capital, such that the net effect to additional paid in capital was zero.

 

In connection with the Business Combination the Company entered into the Tax Receivable Agreement with the NCI holders, which provides for the payment by the Company to the NCI holders 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 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 Tax Receivable Agreement. As realization of the tax benefit related to the Business Combination is not currently deemed probable, no liability under the Tax Receivable Agreement has been recognized in the accompanying condensed consolidated balance sheet.

 

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 of September 30, 2019, the Company’s preliminary estimate of the TRA liability resulting from the distribution of the cash consideration to InnoHold in connection with the Business Combination and tax basis increases as a result of the exchange of 0.7 million Paired Securities, was approximately $11.4 million. However, the Company has not been able to determine that payments under the TRA are likely to occur and therefore has concluded that no recognizable TRA liability has been incurred. To the extent the Company realizes tax benefits in future years, or in the event of a change in future tax rates, this liability may change.

 

As InnoHold and its assignees of Paired Securities exercise their right to exchange or cause Purple LLC to redeem all or a portion of its Class B Units, a liability under the Tax Receivable Agreement (a “TRA 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 TRA Liability to be recorded will depend on the price of the Company’s Class A Stock at the time of the relevant redemption or exchange. Due to the uncertainty surrounding the amount and timing of future redemptions of Paired Securities and uncertainty about the ability of the Company to realize net cash savings, and other factors, the Company currently does not believe it is likely that tax benefits from an exchange of Paired Securities is likely to result in net cash savings and further does not believe it is appropriate to record a TRA Liability related to past and future exchanges until such time that the Company believes that the associated tax benefits are more-likely-than-not to result in net cash savings. 

 

The Company is treated as acquiring historical net deferred tax assets of GPAC of approximately $0.3 million in the Business Combination. These deferred tax assets, including those to be recorded in connection with the Business Combination, the Tax Receivable Agreement and for net operating loss carryforwards generated in 2019, are offset by a valuation allowance such that no net deferred tax assets are presently recorded on the financial statements, as the Company does not presently believe that the deferred tax assets are more likely than not realizable.

 

The effects of uncertain tax positions are recognized in the condensed consolidated financial statements if these positions meet a “more-likely-than-not” threshold. For those uncertain tax positions that are recognized in the condensed 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. As of September 30, 2019, no uncertain tax positions were recognized as liabilities in the condensed consolidated financial statements.

 

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15. Net Income (Loss) Per Common Share

 

The Business Combination was structured similar to a reverse recapitalization by which the Company issued stock for the net assets of Purple LLC accompanied by a recapitalization. The following table sets forth the calculation of basic and diluted weighted average shares outstanding and earnings per share for the periods presented (in thousands, except per share amounts):

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2019   2018   2019   2018 
Net income (loss) (numerator):                
Net income (loss) attributable to Purple Innovation, Inc.-basic  $1,594   $(789)  $126   $(3,343)
Add: Net income attributed to the noncontrolling interest   6,817        224     
Net income (loss) attributable to Purple Innovation, Inc.-diluted  $8,411   $(789)  $350   $(3,343)
Weighted average shares (denominator):                    
Weighted average shares—basic   8,828    8,437    8,576    8,412 
Add: Dilutive effects of equity awards   262        91     
Add: Dilutive effects of Class B Common Stock   43,703        43,787     
Weighted average shares—diluted   52,793    8,437    52,454    8,412 
Net income (loss) per common share:                    
Basic  $0.18   $(0.09)  $0.01   $(0.40)
Diluted  $0.16   $(0.09)  $0.01   $(0.40)

  

For the three and nine months ended September 30, 2019, the Company excluded 1.3 million shares of issued Class A Stock subject to vesting and 17.0 million and 17.4 million shares, respectively of Class A Stock issuable upon conversion of certain Company warrants and stock options as the effect was anti-dilutive. For the three and nine months ended September 30, 2018, the Company excluded 1.3 million shares of issued Class A Stock subject to vesting, 14.2 million shares of Class A Stock issuable upon conversion of the Company’s warrants and 44.1 million Paired Securities convertible into shares of Class A Stock as the effect was anti-dilutive.

 

16. 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 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. The aggregate number of shares of Common Stock which may be issued or used for reference purposes under the 2017 Incentive Plan or with respect to which awards may be granted may not exceed 4.1 million shares. As of September 30, 2019, approximately 2.9 million shares remain available under the 2017 Incentive Plan.

  

Class A Common Stock Awards

 

In May 2019, the Company granted stock awards under the Company’s 2017 Equity Incentive Plan to the independent directors on the Board. The stock awards vested immediately, and for the nine months ended September 30, 2019, the Company recognized $0.3 million in expense which represents the fair value of the stock award on the grant date.

 

In May 2019, the Company granted a restricted stock award to Joseph B. Megibow, the Company’s Chief Executive Officer (the “CEO”) pursuant to the terms of his employment agreement.  The restricted stock award is for 0.1 million shares and has certain vesting conditions, including vesting on the earlier of a change in control or the satisfaction of all three specific service and market conditions. Such conditions require: (i) the CEO to stay employed as CEO through September 30, 2021, unless terminated without cause; (ii) the CEO to retain certain shares of common stock owned at the time of the grant through September 30, 2021; and (iii) the common stock of the Company to trade above $10 a share for any twenty of thirty consecutive trading days during the twelve months ended March 31, 2022. Accordingly, the earliest the three vesting conditions could all be met is at some point during the year ended March 31, 2022. As this award includes a market vesting condition, the estimated fair value of the restricted stock is measured on the grant date and incorporates the probability of vesting occurring. The Company determined the fair value of the restricted stock on the grant date to be $0.2 million and the derived service period to be 2.58 years using a Monte Carlo Simulation of a Geometric Brownian Motion stock path model with the following assumptions: 

 

Trading price of common stock on measurement date  $6.56 
Risk free interest rate   1.9%
Expected life in years   3.0 
Expected volatility   36.5%
Expected dividend yield    

 

The estimated fair value is recognized over the derived service period (as determined by the valuation model) on a straight-line basis, with such recognition occurring whether the instrument ultimately vests or not.

  

22

 

 

In May 2018, the Company granted stock awards under the Company’s 2017 Equity Incentive Plan to the independent directors on the Board. The stock awards vested immediately, and for the nine months ended September 30, 2018, the Company recognized $0.3 million in expense which represents the fair value of the stock award on the grant date.

 

Employee Stock Options

 

During the nine months ended September 30, 2019, the Company granted 1.1 million stock options under the Company’s 2017 Equity Incentive Plan to certain management of the Company. The stock options have exercise prices that range from $5.75 to $8.32 per option. The stock options expire in five years and vest over a four-year period. The estimated fair value of the stock options, less expected forfeitures, is amortized over the options vesting period on a straight-line basis. The Company determined the fair value of the 1.1 million options granted during the nine months ended September 30, 2019 to be $2.1 million which will be expensed over the vesting period of four years.

 

During the nine months ended September 30, 2019, 0.3 million unvested stock options were forfeited by Mark Watkins, the former Chief Financial Officer of the Company, upon his resignation and departure from the Company. As the Chief Financial Officer, Mr. Watkins was not permitted to exercise and sell all of his 0.1 million vested options during the limited 90-day exercise time period under the terms of his option grant. The Company entered into an agreement whereby the Company paid Mr. Watkins a settlement amount equal to the difference between the closing price of the stock on the date of the settlement and the exercise strike price of $5.95. The Company paid Mr. Watkins $0.1 million and cancelled his vested stock options.

 

The following are the assumptions used in calculating the fair value of the total stock options granted during the nine months ended September 30, 2019 using the Black-Scholes method:

 

Fair market value     $5.75 - $8.14  
Exercise price     $5.75 - $8.32  
Risk free interest rate     1.44% - 2.50%  
Expected term in years     3.44 - 3.58  
Expected volatility     36.3% - 37.3%  
Expected dividend yield      

 

The following table summarizes the Company’s total stock option activity for the nine months ended September 30, 2019:

 

  

Options

(in thousands)

  

Weighted

Average

Exercise

Price

  

Weighted

Average

Remaining

Contractual

Term in

Years

  

Intrinsic

Value $

 
As of September 30, 2019:                
Options outstanding as of January 1, 2019   933   $5.96    4.8   $ 
Granted   1,066    6.79         
Exercised                
Forfeited/cancelled   (395)   5.97         
Options outstanding as of September 30, 2019   1,604   $6.51    4.4   $1,837 

 

Outstanding and exercisable stock options as of September 30, 2019 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  
$ 5.75       250       4.39           $            $  
  5.95       538         4.00                          
  6.51       359       4.64                    
  6.65       200       4.61                    
  8.07       8       4.91                    
  8.32       250       4.75                    

 

The estimated fair value of the Company stock options, less expected forfeitures, is amortized over the options vesting period on the straight-line basis. The Company recognized $0.2 million and $0.4 million in stock-based compensation expenses related to stock options during the three and nine months ended September 30, 2019, respectively. There were no stock options awarded or outstanding as of September 30, 2018.

 

As of September 30, 2019, there was $2.4 million of total unrecognized stock compensation cost with a remaining recognition period of 3.4 years.

 

23

 

 

InnoHold Incentive Units

 

In January 2017, pursuant to the 2016 Equity Incentive Plan approved by InnoHold and Purple LLC that authorized the issuance of 12.0 million incentive units, Purple LLC granted 11.3 million incentive units to Purple Team LLC, an entity for the benefit of certain employees who were participants in that plan.

 

In conjunction with the Business Combination, Purple Team LLC was merged into InnoHold with InnoHold being the surviving entity and the Purple Team LLC incentive units were cancelled and new incentive units were issued by InnoHold under its own limited liability company agreement (the “InnoHold Agreement”), which was considered a modification for accounting purposes. Under the revised terms of the incentive units granted under the InnoHold Agreement, the incentive unit holders were only eligible to participate in InnoHold’s distributions, if any, after the distribution threshold of approximately $135.0 million is met and in accordance with the same vesting schedule that had existed at the time of the initial grant.

 

On February 8, 2019, InnoHold initiated a tender offer to each of these incentive unit holders, some of which are current employees of Purple LLC, to distribute to each a pro rata number of 2.5 million Paired Securities held by InnoHold in exchange for the cancellation of their ownership interests in InnoHold. All InnoHold incentive unit holders accepted the offer, and the terms and distribution of each transaction were finalized and closed on June 25, 2019.

 

The following table summarizes the total incentive unit activity granted first by Purple Team LLC and then continued through InnoHold for the benefit of the Company:

 

(in thousands)  Incentive
Units
 
As of September 30, 2019     
Incentive units outstanding as of January 1, 2019   7 
Granted    
Exercised    
Forfeited/Cancelled   (7)
Incentive units outstanding as of September 30, 2019    
      
Incentive units vested as of September 30, 2019    

 

At the closing of the tender offer, those incentive unit holders received, based on their pro rata holdings of InnoHold Class B Units, a portion of 2.5 million Paired Securities held by InnoHold, of which a total of 1.7 million Paired Securities were distributed at the closing of the tender offer and the remaining 0.8 million were distributed in July and August 2019. The distribution of certain Paired Securities was a taxable event for the recipients of those Paired Securities, and such recipients, or us on their behalf, exchanged, subject to the Exchange Agreement and certain other conditions and restrictions, all or some of their securities into shares of Class A Common Stock and then liquidated some of those shares of Class A Common Stock in order to pay taxes assessed. The remaining distributed Paired Securities were subject to a lock-up period whereby they were not able to sell exchanged Paired Securities until October 25, 2019 except for a small number of Paired Securities that remain subject to vesting contingent upon such current employees’ continued employment with the Company. The distribution by InnoHold to the incentive unit holders that are current employees of the Company resulted in the recognition of non-cash stock compensation expense for the Company in the amount of $8.9 million, which represents the fair value of the Paired Securities as of the respective distribution dates. These transactions are not dilutive to any stockholder holding or having rights to purchase the Company’s Class A Stock. As of September 30, 2019, 0.7 million of the Paired Securities have been exchanged for Class A Stock by the incentive unit holders.

 

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Aggregate Non-Cash Stock 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 table below summarizes the aggregate non-cash stock compensation recognized in the statement of operations for stock awards, employee stock options and the distribution by InnoHold of Paired Securities.

 

(in thousands)  Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
Non-Cash Stock Compensation  2019   2018   2019   2018 
                 
Cost of revenues  $164   $   $629   $ 
Marketing and sales   1,332        4,215     
General and administrative   1,199        4,140    313 
Research and development   240        756     
Total non-cash stock compensation  $2,935   $   $9,740   $313 

 

17. 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 matching contribution expense was $0.4 million and $1.0 million for the three and nine months ended September 30, 2019, respectively.

 

18. Subsequent Events

 

On October 1, 2019, pursuant to his employment agreement, the Company granted Joseph B. Megibow, Chief Executive Officer, nonqualified stock options to purchase 0.2 million shares of the Company’s Class A Stock. The options have an exercise price of $8.55 per share, vest over a four-year period and expire five years from the date of issuance. In addition, on October 11, 2019, the Company extended for an additional twelve months, the travel and housing reimbursements to Mr. Megibow as provided in his employment agreement.

 

On October 1, 2019, Craig Phillips began his employment to serve as Chief Financial Officer of the Company. Mr. Phillips has been serving as the Interim Chief Financial Officer since March 2019. In connection with his employment, Mr. Phillips was granted nonqualified stock options to purchase 0.3 million shares of the Company’s Class A Stock. The options have an exercise price of $8.17 per share, vest over a 3.5 year period and expire five years from the date of issuance.

 

On October 11, 2019, the Company filed a registration statement on Form S-3 with the Securities and Exchange Commission registering the possible resale by certain selling stockholders of up to 20 million shares of Class A Stock issuable upon an exchange of an equal number of Paired Securities. The registration statement is not yet effective.

 

25

 

 

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. Investors are cautioned not to place undue reliance on any such forward-looking 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.

 

We caution and advise readers that these statements are based on assumptions that may not be realized and involve risks and uncertainties that could cause actual results to differ materially from the expectations and beliefs contained herein. For a summary of these risks, see the risk factors included in the “Risk Factors” section in this Quarterly Report, in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 14, 2019 and in our Quarterly Reports on Form 10-Q filed with the Securities and Exchange Commission on May 7, 2019 and August 13, 2019.

 

Introductory Note

 

On February 2, 2018, our predecessor, GPAC, consummated the Business Combination pursuant to the Merger Agreement, by and among GPAC, Merger Sub, Purple LLC, InnoHold and the Sponsor, which provided for the Company’s acquisition of Purple LLC’s business through the merger of Merger Sub with and into Purple LLC, with Purple LLC being the survivor in the Business Combination.

 

In connection with the Closing, the Company changed its name from “Global Partner Acquisition Corp.” to “Purple Innovation, Inc.” The Business Combination was accounted for as a reverse recapitalization because the former owners of Purple LLC have control over the combined company through their 82% ownership of the common stock of the Company. Although the Company was the legal acquirer, the historical operations of Purple LLC are deemed to be those of the Company. Thus, the financial statements included in this Quarterly Report on Form 10-Q reflect (i) the historical operating results of Purple LLC prior to the Business Combination; (ii) the combined results of the Company following the Business Combination; (iii) the assets and liabilities of Purple LLC at their historical cost; and (iv) the Company’s equity and earnings per share for all periods (both pre- and post-Business Combination) presented.

 

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Overview of Our Business

 

Our mission is to help people feel and live better through innovative comfort 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 through our direct-to-consumer (“DTC”) online channels, retail brick-and-mortar wholesale partners, third-party online retailers and our Company showrooms.

 

Operating Results for the Three Months Ended September 30, 2019 and 2018

 

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

 

   Three Months Ended September 30, 
   2019   % of
Net 
Revenues
   2018   % of
Net
 Revenues
 
Revenues, net  $117,406    100.0%  $70,806    100.0%
Cost of revenues   64,523    55.0    42,684    60.3 
Gross profit   52,883    45.0    28,122    39.7 
Operating expenses:                    
Marketing and sales   34,055    29.0    25,188    35.6 
General and administrative   6,745    5.7    5,804    8.2 
Research and development   1,070    0.9    578    0.8 
Total operating expenses   41,870    35.7    31,570    44.6 
Operating income (loss)   11,013    9.4    (3,448)   (4.9)
Interest expense   1,356    1.2    999    1.4 
Other income, net   (138)   (0.1)   (83)   (0.1)
Change in fair value – warrant liabilities   1,384    1.2         
Net income (loss)   8,411    7.2    (4,364)   (6.2)
Net income (loss) attributable to noncontrolling interest   6,817    5.8    (3,575)   (5.0)
Net income (loss) attributable to Purple Innovation, Inc.  $1,594    1.4   $(789)   (1.1)

  

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Revenue

 

Total net revenue increased $46.6 million, or 65.8%, to $117.4 million for the three months ended September 30, 2019 from $70.8 million for the three months ended September 30, 2018 due mainly to a $46.7 million increase in bedding sales. The increase in bedding sales was primarily attributable to an increase in wholesale revenue driven by an increase of over 1,200 stores and an increase in DTC revenue as compared to the same period last year. 

 

Cost of Revenues

 

The cost of revenues increased $21.8 million, or 51.2%, to $64.5 million for the three months ended September 30, 2019 from $42.7 million for the three months ended September 30, 2018. The increase is primarily due to a proportionate increase in direct materials, labor and overhead related to the increased mattress sales partially offset by a decrease in costs due to efficiencies in operations and logistics. The gross profit percentage increased 5.3% of net revenues to 45.0% for the three months ended September 30, 2019 from 39.7% for the three months ended September 30, 2018. The increase was primarily driven by efficiencies in operations and logistics and higher margins due to product mix, partially offset by increased sales with wholesale pricing.

 

Marketing and Sales

 

Marketing and sales expenses increased $8.9 million, or 35.2%, to $34.1 million for the three months ended September 30, 2019 from $25.2 million for the three months ended September 30, 2018. The increase is primarily due to increased advertising spending, resources and infrastructure to drive increased sales as well as non-cash stock compensation of $1.3 million. The overall marketing and sales expense as a percentage of net revenue decreased to 29.0% for the three months ended September 30, 2019 from 35.6% for the three months ended September 30, 2018 due to the increase in wholesale revenue, a reduction of marketing spend and the improved efficiency of marketing spend for the revenue generated in the DTC channel.

 

General and Administrative

 

General and administrative expenses increased $0.9 million, or 16.2%, to $6.7 million for the three months ended September 30, 2019 from $5.8 million for the three months ended September 30, 2018. The increase was primarily due to non-cash stock compensation of $1.2 million partially offset by a decrease in other expenses of $0.3 million.

 

Research and Development

 

Research and development costs increased $0.5 million, or 85.1%, to $1.1 million for the three months ended September 30, 2019 from $0.6 million for the three months ended September 30, 2018. The increase is primarily due to increases in salaries and wages as we added resources for product innovation along with non-cash stock compensation of $0.2 million.

 

Operating income (loss)

 

Operating income was $11.0 million for the three months ended September 30, 2019, an increase of $14.5 million from an operating loss of $3.4 million for the three months ended September 30, 2018. The increase was primarily due to higher revenues than the prior year at a higher margin rate and lower marketing spend as a percentage of net revenue in 2019 partially offset by $2.9 million in non-cash stock compensation.

 

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Interest Expense

 

Interest expense increased $0.4 million, or 35.7%, to $1.4 million for the three months ended September 30, 2019 from $1.0 million for the three months ended September 30, 2018. The increase is due primarily to the additional $10.0 million funds borrowed in February 2019 pursuant to the Amended and Restated Credit Agreement as well as interest added to the outstanding loan balance as allowed by the Agreement. The outstanding loan balance was $38.5 million as of September 30, 2019 and $26.6 million as of December 31, 2018.

 

Change in Fair Value – Warrant Liabilities

 

The Incremental Loan Warrants issued in conjunction with the Amended and Restated Credit Agreement are classified as liabilities and recorded at fair value on the date of the transaction and subsequently re-measured to fair value at each reporting date with changes in the fair value included in earnings. The change in fair value from the previous quarter resulted in a non-cash loss in the amount of $1.4 million recorded in earnings for the three months ended September 30, 2019 due mainly to the increase in stock price over the previous quarter.

 

Noncontrolling Interest

 

As a result of the Business Combination in 2018, we attribute net income or loss to the Class B Units in Purple LLC, owned by InnoHold and other Class B Unit holders, as a noncontrolling interest at their ownership percentage. At September 30, 2019, this noncontrolling ownership percentage was approximately 81%.

 

Operating Results for the Nine Months Ended September 30, 2019 and 2018

 

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

 

   Nine Months Ended September 30, 
   2019  

% of
Net
Revenues

   2018  

% of
Net
Revenues

 
Revenues, net  $304,058    100.0%  $207,334    100.0%
Cost of revenues   174,323    57.3    121,575    58.6 
Gross profit   129,735    42.7    85,759    41.4 
Operating expenses:                    
Marketing and sales   94,039    30.9    77,956    37.6 
General and administrative   19,243    6.3    17,870    8.6 
Research and development   3,004    1.0    1,644    0.8 
Total operating expenses   116,286    38.2    97,470    47.0 
Operating income (loss)   13,449    4.4    (11,711)   (5.6)
Interest expense   3,801    1.3    2,672    1.3 
Other income, net   (373)   (0.1)   (184)   (0.1)
Loss on extinguishment of debt   6,299    2.1         
Change in fair value – warrant liabilities   3,372    1.1         
Net income (loss)   350    0.1    (14,199)   (6.8)
Net income (loss) attributable to noncontrolling interest   224    0.1    (10,856)   (5.2)
Net income (loss) attributable to Purple Innovation, Inc.  $126    0.0   $(3,343)   (1.6)

  

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Revenue

 

Total net revenue increased $96.7 million, or 46.7%, to $304.1 million for the nine months ended September 30, 2019 from $207.3 million for the nine months ended September 30, 2018 due mainly to a $94.2 million increase in bedding sales and a $2.5 million increase in other products. The increase in bedding sales was primarily attributable to an increase in wholesale revenue driven by an increase of over 1,200 stores as compared to the same period last year.

 

Cost of Revenues

 

The cost of revenues increased $52.7 million, or 43.4%, to $174.3 million for the nine months ended September 30, 2019 from $121.6 million for the nine months ended September 30, 2018. The increase is primarily due to a proportionate increase in direct materials, labor and overhead related to the increased mattress sales partially offset by a decrease in costs due to efficiencies in operations and logistics. The gross profit percentage increased by 1.3% of net revenues to 42.7% for the nine months ended September 30, 2019 from 41.4% for the nine months ended September 30, 2018. The increase was primarily driven by efficiencies in operations and logistics and higher margins due to product mix, partially offset by increased sales with wholesale pricing.

 

Marketing and Sales

 

Marketing and sales expenses increased $16.1 million, or 20.6%, to $94.0 million for the nine months ended September 30, 2019 from $78.0 million for the nine months ended September 30, 2018. The increase is primarily due to added advertising spending, resources and infrastructure to drive increased sales as well as $4.2 million in non-cash stock compensation. The overall marketing and sales expense as a percentage of net revenue decreased to 30.9% for the nine months ended September 30, 2019 from 37.6% for the nine months ended September 30, 2018 due to the increase in wholesale revenue and the improved efficiency of marketing spend for the revenue generated in the DTC channel.

 

General and Administrative

 

General and administrative expenses increased $1.4 million, or 7.7%, to $19.2 million for the nine months ended September 30, 2019 from $17.9 million for the nine months ended September 30, 2018. The increase was primarily due to non-cash stock compensation expense of $4.1 million partially offset by lower costs in 2019 as compared to the high costs incurred in 2018 related to the Business Combination in February 2018.

 

Research and Development

 

Research and development costs increased $1.4 million, or 82.7%, to $3.0 million for the nine months ended September 30, 2019 from $1.6 million for the nine months ended September 30, 2018. The increase is primarily due to increases in salaries and wages as we added resources for new product innovation and $0.8 million in non-cash stock compensation.

 

Operating income (loss)

 

Operating income was $13.4 million for the nine months ended September 30, 2019, an increase of $25.1 million from an operating loss of $11.7 million for the nine months ended September 30, 2018. The change was primarily due to higher revenues than the prior year at a slightly higher margin rate and lower marketing spend and administrative costs as a percentage of net revenue in 2019 partially offset by a $9.4 million increase in non-cash stock compensation.

 

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Interest Expense

 

Interest expense increased $1.1 million, or 42.3%, to $3.8 million for the nine months ended September 30, 2019 from $2.7 million for the nine months ended September 30, 2018. The increase is due primarily to the additional $10.0 million funds borrowed pursuant to the Amended and Restated Credit Agreement as well as $1.9 million in interest added to the outstanding loan balance as allowed in the Amended and Restated Credit Agreement. The outstanding loan balance was $38.5 million as of September 30, 2019 and $26.6 million as of December 31, 2018.

 

Loss on Extinguishment of Debt

 

In conjunction with the Incremental Loan under the Amended and Restated Credit Agreement the Company determined that the amended debt terms resulted in substantially different terms for a portion of the existing debt and therefore is required to be accounted for as an extinguishment of a portion of the existing debt. Accordingly, a non-cash loss was recognized on the extinguishment of a portion of the existing debt of approximately $6.3 million. This is a non-cash expense primarily associated with the recognition of related unamortized debt discount and debt issuance costs and the fair value of the Incremental Loan Warrants issued.

 

Change in Fair Value – Warrant Liabilities

 

The Incremental Loan Warrants issued in conjunction with the Amended and Restated Credit Agreement are classified as liabilities and recorded at fair value on the date of the transaction and subsequently re-measured to fair value at each reporting date with changes in the fair value included in earnings. The change in fair value from the date of the transaction resulted in a non-cash loss in the amount of $3.4 million recorded in earnings for the nine months ended September 30, 2019.

 

Noncontrolling Interest

 

As a result of the Business Combination in 2018, we attribute net income or loss to the Class B Units in Purple LLC, owned by InnoHold and other Class B Unit holders, as a noncontrolling interest at their ownership percentage. At September 30, 2019, this noncontrolling ownership percentage was approximately 81%.

 

Liquidity and Capital Resources

 

Our primary cash needs have historically consisted of working capital, capital expenditures, member distributions prior to the Business Combination and debt service. Our working capital needs depend upon the timing of cash receipts from sales, payments to vendors and others, changes in inventories, and capital and operating lease payment obligations. We had working capital of $30.1 million as of September 30, 2019, and we had negative working capital of $(0.9) million as of December 31, 2018. During the nine months ended September 30, 2019, our accounts receivable increased by $16.4 million mainly due to an increase in our wholesale revenue and timing of promotions. Our capital expenditures primarily relate to acquiring and maintaining manufacturing equipment and expanding capacity. Our cash used for capital expenditures was $5.7 million for the nine months ended September 30, 2019. We financed these capital expenditures through cash provided by operating activities and proceeds from the Amended and Restated Credit Agreement. We expect our capital expenditures for our facilities and equipment to be approximately $10 - $12 million in total during 2019. We believe that our cash flow from operations, together with other available sources of liquidity, including the additional cash we received and have access to under the Amended and Restated Credit Agreement, will be sufficient to fund anticipated operating expenses, growth initiatives and our other anticipated liquidity needs for the next twelve months, based on our current operating conditions. Actual amounts for capital expenditures or capital needed to fund operations could differ significantly from current expectations because of operating needs, growth needs, regulatory changes, other expenses, or other factors.

 

On January 28, 2019, Purple LLC entered into the First Amendment, which amended the Credit Agreement. In the First Amendment, Purple LLC agreed to enter into the Amended and Restated Credit Agreement  under which the Lenders agreed to provide an incremental loan of $10.0 million such that the total amount of principal indebtedness provided to Purple LLC was increased to $35.0 million. A stockholder meeting was held on February 25, 2019 at which time a majority of non-interested stockholders voted in favor of this transaction. Accordingly, the Amended and Restated Credit Agreement, and each related document, was closed and an incremental loan of $10.0 million was funded. In addition, we issued to the Lenders warrants to purchase 2.6 million shares of the Company’s Class A Stock at a price of $5.74 per share, subject to certain adjustments. On February 26, 2019, we received approximately $9.2 million in proceeds after debt issuance costs and fees. For additional information regarding our credit agreement with Coliseum, refer to Note 8 — Long-Term Debt, Related Party of our condensed consolidated financial statements.

 

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Debt service for the nine months ended September 30, 2019 totaled $3.8 million and consisted of interest paid in-kind and with cash on the Amended and Restated Credit Agreement as well as principal and interest payments on certain capital leases.

 

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 based on our ability to scale back operations, reduce marketing spend and postpone or discontinue our growth strategies. In such event, this 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 all of our employees. In addition, we may be forced to restructure our obligations to current creditors or pursue work-out options.

 

If cash flow from operations or available financing under the Amended and Restated Credit Agreement are not sufficient to fund our operating expenses or our growth strategies, we may need to raise additional capital. Our ability to obtain additional capital on acceptable terms or at all is subject to a variety of uncertainties, including approval from the Lenders. Adequate financing may not be available or, if available, may only be available on unfavorable terms. The restrictive covenants in the Amended and Restated Credit Agreement may make it difficult to obtain additional capital on terms that are favorable to us, and the Lenders may not agree to lend us additional funds. 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. In addition, future equity or debt financings, including under the Amended and Restated Credit Agreement, 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, as described above, 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 are required to make certain payments to InnoHold under the Tax Receivable Agreement, which payments may have a material adverse effect on our liquidity and capital resources. As of September 30, 2019, the Company’s preliminary estimate of the TRA liability resulting from the distribution of the cash consideration to InnoHold in connection with the Business Combination and tax basis increases as a result of the exchange of 0.7 million Paired Securities, was approximately $11.4 million. However, the Company has not been able to determine that payments under the TRA are likely to occur and therefore has concluded that no recognizable TRA liability has been incurred. We are currently unable to determine the timing of the payment of this amount or anticipate future amounts of payments due to the unpredictable nature of several factors, including when we will have taxable income, the timing of exchanges, the market price of shares of Class A Stock at the time of the exchange, the extent to which such exchanges are taxable and the amount and timing of income.

 

Cash Flows for the Nine Months Ended September 30, 2019 and 2018

 

The following summarizes our cash flows for the nine months ended September 30, 2019 and 2018 as reported in our condensed consolidated statements of cash flows (in thousands):

 

   Nine Months Ended
September 30,
 
   2019   2018 
Net cash provided by (used in) operating activities  $15,844   $(27,400)
Net cash used in investing activities   (5,903)   (10,051)
Net cash provided by financing activities   9,120    41,523 
Net increase in cash   19,061    4,072 
Cash, beginning of the period   12,232    3,593 
Cash, end of the period  $31,293   $7,665 

 

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Nine months ended September 30, 2019 compared to the nine months ended September 30, 2018

 

Cash provided by operating activities was $15.8 million for the nine months ended September 30, 2019, as compared to cash used in operating activities of $27.4 million during the nine months ended September 30, 2018. This $43.2 million increase in cash provided by operations was primarily due to decreased operating costs, as evidenced by an increase of $35.6 million in cash operating income, and a decrease of $3.5 million of cash used to purchase inventories. In 2018 we were increasing inventory due to an expanded product line, growing demand for our product and the stocking of new models at third-party distribution centers for “white glove” delivery service. During the nine months ended September 30, 2019, we achieved greater efficiencies with respect to our inventory planning and finished goods levels, compared to the same period in 2018.

 

Cash used in investing activities was $5.9 million for the nine months ended September 30, 2019, a decrease of $4.1 million from cash used in investing activities of $10.1 million during the nine months ended September 30, 2018 primarily due to large expenditures incurred in 2018 for a power upgrade and warehouse infrastructure. No such expenditures were made in 2019, in addition we had an increased efficiency and utilization of existing equipment as well as the timing of investment in new equipment during the nine months ended September 30, 2019. 

 

Cash provided by financing activities was $9.1 million in the nine months ended September 30, 2019, a decrease of $32.4 million from cash provided by financing of $41.5 million during the nine months ended September 30, 2018. The decrease was primarily due to $49.9 million in funds provided to the Company as a result of the Business Combination in February 2018 partially offset by the $10.0 million in funds received in February 2019 pursuant to the Amended and Restated Credit Agreement and $8.0 million payment in 2018 to pay off and terminate our Wells Fargo line of credit.

 

Critical Accounting Policies

 

For a description of our critical accounting policies, refer to Note 2 — Summary of Significant Accounting Policies of our condensed consolidated financial statements.

 

Contractual Obligations

 

On June 10, 2019, the Company signed a Lease (the “Lease”) with North Slope One, LLC for approximately 42,837 rentable square feet located at 4100 North Chapel Ridge Road in Lehi, Utah (the “Building”). The Company anticipates moving its corporate headquarters into the Building before the end of the first quarter 2020. The term of the Lease is from approximately December 2019 through November 2029, with the Company having an option to early terminate after the eighty-fourth calendar month. Under the Lease, the Company will pay a reduced basic monthly rent of $24,988 for the first seven months, followed by basic monthly rent of $96,383 for the next five months. Thereafter the basic monthly rent increases 2.5% per year to a maximum basic monthly rent of $120,372 for the final twelve months of the Lease in 2028-2029. The Lease provides for a tenant improvement allowance of $52 per usable square foot. The Lease also provides the Company with crown signage rights, a right of first refusal on other space, and an option to extend for two additional five-year periods.

 

Seasonality and Cyclicality

 

We believe that sales of our products are typically subject to seasonality corresponding to different periods of the consumer spending cycle, holidays and other seasonal factors. Our sales may also vary with the performance of the broader economy consistent with the market.

 

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 reports 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 Securities and Exchange Commission.

 

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, Securities and Exchange Commission 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

 

Not Applicable.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Prior to the completion of the Business Combination, Purple LLC was a private company with accounting personnel and other supervisory resources sufficient for its reporting requirements as a private company. Upon the Closing, the sole business conducted by the Company is the business conducted by Purple LLC. As a result of the Business Combination, the internal control over financial reporting utilized by Purple LLC prior to the Business Combination became the internal control over financial reporting of the Company. As an emerging growth company, we are exempt from the auditor attestation requirements with respect to internal control over financial reporting under Section 404(b) of the Sarbanes Oxley Act of 2002.

 

(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 Chief Financial Officer (“CFO”), 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 on that evaluation, our CEO and our CFO concluded that our disclosure controls and procedures were not effective as of September 30, 2019 as a result of material weaknesses in our internal control over financial reporting disclosed below and as previously disclosed in our Current Report on Form 10-K filed March 14, 2019, Form 10-Q filed May 7, 2019 and Form 10-Q filed August 13, 2019.

 

Previously Reported Material Weakness

 

In connection with the preparation of our annual financial statements for prior fiscal years, and continuing into the September 30, 2019 quarterly period, we identified material weaknesses in our internal control over financial reporting.  While accounting for complex transactions, including the Incremental Loan transaction during a previous quarterly period, material weaknesses have been identified resulting in accounting adjustments.  Other material weaknesses identified in prior fiscal periods have also resulted in adjustments in those periods to prepaid inventory and net inventory on the balance sheet, and cost of revenues within the statement of operations.  The material weaknesses were primarily caused by the deficient design and operation of internal control processes, including appropriate management review of complex transactions.

 

As of December 31, 2018, we had not designed and implemented sufficient controls and processes around our accounting related analyses and reconciliations. As a result, we determined that we did not have adequate procedures and controls, to ensure that accurate financial statements could be prepared timely.

 

We have begun taking numerous steps and plans to remediate the underlying causes of the material weaknesses. The measures include the hiring and contracting of additional personnel and other supervisory resources to strengthen internal control over financial reporting, specifically in the areas of technical accounting and our month-end close processes. To date, certain personnel have been added in each of these specific areas and additional training of existing resources has taken place. In addition, we have also engaged third-party consultants to assist the company in enhancing risk assessment and monitoring controls to ensure that control activities are appropriately designed, implemented and operating effectively. We believe that the combination of these remediation activities will enable us to broaden the scope and quality of our controls relating to the oversight and review of our financial statements. However, these remediation efforts are still in process and have not yet been completed. A material weakness in internal control over financial reporting is a matter that may require an extended period to correct. We will continue to evaluate, design and implement policies and procedures to address these material weaknesses, including the enhancement of accounting personnel to adequately execute our accounting processes and address our internal control over financial reporting as a public company.

 

If our remedial 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 result which could lead to substantial additional costs for accounting and legal fees.

 

(b) Changes in Internal Controls Over Financial Reporting.

 

Other than the changes described above, there have been no changes in our internal control over financial reporting that occurred during the nine months ended September 30, 2019 that have materially affected, or are reasonably likely to materially affect, our internal controls 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 12 — Commitments and Contingencies to the condensed consolidated financial statements contained in this report and to Part I, Item 3 of our Annual Report on Form 10-K filed on March 14, 2019 for certain information regarding our legal proceedings. No additional legal proceedings have occurred following the date of our financial statements.

 

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 Securities and Exchange Commission on March 14, 2019.

 

We may experience significant fluctuations in our operating results and growth rate, which could adversely affect our performance and financial results.

 

Our revenue growth may not be sustainable, and our percentage growth rates may decrease. Our revenue and operating profit growth depend on the continued growth of demand for our products, and our business is affected by general economic and business conditions worldwide. A softening of demand, whether caused by changes in customer confidence or preferences or a weakening of the U.S. or global economies, may result in decreased revenue or growth.

 

In addition, we rely on estimates and forecasts of our expenses and revenues to inform our business strategies, and some of our past estimates and forecasts have not been accurate. The rapidly evolving nature of the direct-to-consumer mattress industry and our business make forecasting operating results difficult. If we fail to accurately forecast our expenses and revenues, our business, prospects, financial condition and results of operations may suffer, and the value of our business may decline. If our estimates and forecasts prove incorrect, we may not be able to adjust our operations quickly enough to respond to lower than expected sales or higher than expected expenses.

 

Our sales and operating results will also fluctuate for many other reasons, including due to risks described elsewhere in this section and the following:

 

  our ability to attract new customers and the cost of acquiring new customers;
     
  our ability and the time required to develop new Mattress Max machines, develop new production lines, scale production capacity and appropriately train staff;
     
  the success of our wholesale and our Company showroom expansion efforts;
     
  our ability to have enough production capacity to meet customer demand;
     
  our ability to effectively manage increasing sales and marketing expenses;
     
  our access to sufficient capital resources and liquidity to fund the growth of our business;
     
  competition from the sublicensees of intellectual property licensed back to EdiZONE;

 

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  our ability to offer products on favorable terms, manage inventory, fulfill orders and manage product returns;
     
  the introduction of competitive products, services, price decreases, discounts ,or improvements;
     
  timing, effectiveness, and costs of expansion and upgrades of our systems and infrastructure;
     
  the success of our geographic and product line expansions, including but not limited to power requirements, labor needs, and ease of product distribution;
     
  the success of hiring, expeditiously training, and retaining engaged labor locally and worldwide;
     
  our ability to secure and retain superior global partners for specialized delivery services;
     
  the extent to which we use debt or equity financing, and the terms of any such financing for, our current operations and future growth;
     
  the outcomes of legal proceedings, claims, or governmental investigations or rulings, which may include significant monetary damages or injunctive relief and could have a material adverse impact on our operating results;
     
  the enforceability and validity of our intellectual property rights;
     
  our ability to accommodate variations in the mix of products we sell;
     
  variations in our level of product returns, as well as our methods of collecting product returns or exchanges;
     
  the extent to which we offer free shipping;
     
  the extent to which we invest in technology and content, manufacturing, fulfillment, and other expense categories;
     
  increases in the prices of materials used in the manufacturing of our products or the costs to produce our products, including but not limited to new or unanticipated tariffs;
     
  our ability to anticipate and prepare for disruptions to manufacturing;
     
  the extent to which operators of the networks between our customers and our websites successfully charge fees to grant our customers unimpaired and unconstrained access to our online services;
     
  our ability to collect amounts owed to us when they become due;
     
  the extent to which our internal network or website is affected by denial of service attacks, malicious unauthorized access, outages, and similar events;
     
  the extent to which our internal network is affected by spyware, viruses, phishing and other spam emails, intrusions, data theft, downtime, and similar events;
     
  our ability to manage the expenses associated with multiple facilities;
     
  our ability to secure attractive real estate locations for expansion with sustainable cost structures; and
     
  our ability to protect inventory assets from internal and external theft or damage.

 

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

 

We are rapidly and significantly expanding our operations, including increasing our product offerings and scaling our infrastructure to support expansion of our manufacturing capacity, our wholesale channel expansion and the opening of our Company showrooms. Our planned growth includes moving our administrative offices, increasing our manufacturing capacity, developing and introducing new products and developing new and broader distribution channels, including wholesale and Company 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 in the face of continued growth. 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 our growth effectively, the quality of our products and fulfillment capabilities 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 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 all of 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 of our Company showrooms which will require our entering leases and other obligations while the success of our Company showrooms remains unproven. To be successful, we will need to obtain or develop retailing expertise and we will need to hire new employees in states that may have employment laws that could increase our expenses. In general, opening our Company showrooms in new locations exposes us to laws in other states 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 opening our Company showrooms and maintaining operations in an expanding number of stores, we may have to close stores and incur sunk costs and continuing obligations that could put a strain upon our resources, damage our brand and reputation and limit our growth.

 

To manage our growth effectively, we will 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, our revenue and operating profit growth depends on the continued growth of demand for the products offered by us, and our business is affected by general economic and business conditions worldwide. A softening of demand, whether caused by changes in customer preferences or a weakening of the U.S. or global economies, may result in decreased revenue or growth. Further, 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.

 

When rolling out our new mattress lines through our direct-to-consumer sales channel, we identified a need for internal controls to avoid delays in the timely delivery of our new mattress products and to improve the customer’s experience. Also, we have experienced rapid growth in our employee base, and the need to implement controls and procedures for improving employee training and retention has increased. Competition for employees where our production facilities are located also has increased the costs for employee retention. We have implemented improved controls and procedures in an environment of continuous change and 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.

 

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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 capacity, (ii) increasing our direct-to-consumer sales; (iii) expanding our wholesale distribution channel, particularly for our mattress products; (iv) opening our Company showrooms; (v) expanding our global sales; (vi) engaging global partners to improve distribution efficiencies and cost savings; and (vii) product assortment and category expansion.

 

We believe that our cash flow from operations, together with other available sources of liquidity, including the additional cash we received on February 26, 2019 and additional cash we may have access to under the Amended and Restated Credit Agreement, will be sufficient to fund anticipated operating expenses, growth initiatives and our other anticipated liquidity needs for the next twelve months, based on our current operating conditions. 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 all of our employees. In addition, we may be forced to restructure our obligations to creditors, pursue work-out options or other protective measures.

 

Our ability to obtain additional capital on acceptable terms or at all is subject to a variety of uncertainties, including approval from the lenders under that certain Amended and Restated Credit Agreement dated February 26, 2019 by and among Purple LLC and the lender parties thereto. Adequate financing may not be available or, if available, may only be available on unfavorable terms. The restrictive covenants in the Amended and Restated Credit Agreement may make it difficult to obtain additional capital on terms that are favorable to us, and the lenders may not agree to lend us additional funds. 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. In addition, future equity or debt financings, including under the Amended and Restated Credit Agreement, 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, as described above, 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.

 

 Our future growth and profitability may depend in part on our ability to continue to improve and expand our product line and to successfully execute new product introductions.

 

As described in greater detail below, the mattress, pillow and cushion industries are highly competitive, and our ability to compete effectively and to profitably grow our market share depends in part on our ability to continue to improve and expand our product line and related accessory products.

 

We incur significant research and development and other expenditures in the pursuit of improvements and additions to our product line. If these efforts do not result in meaningful product improvements or new product introductions, or if we are not able to gain widespread consumer acceptance of product improvements or new product introductions, our sales, profitability, cash flows and financial condition may be adversely affected. In addition, if any significant product improvements or new product introductions are not successful, our reputation and brand image may be adversely affected, and our business may be harmed.

 

A significant portion of our gross profit comes from our mattress products. If we are unable to develop new models of our mattress products or successfully market and sell new mattress models, our profitability may be adversely affected, and our business may be harmed

 

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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 website or certain other e-commerce platforms. 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 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. We have limited experience in the wholesale channel, and 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 direct-to-consumer 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 of our Company showrooms beyond the store we currently have at our headquarters in Alpine, Utah, the Company factory outlet store in Salt Lake City, Utah and the newly opened Company showrooms in San Diego, California and Seattle, Washington. We have limited experience in opening and operating our Company showrooms. Operating our Company 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 direct-to-consumer platform, wholesale distribution channel and our Company 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. Our Company showroom expansion increases our risk for inventory shrinkage from destruction, theft, obsolescence and factors that render such inventory unusable or unsellable.

 

New products may come with the same warranty and return risks as mentioned above. 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™ machinery to make our Hyper-Elastic Polymer® cushioning material. Because of the unique features of our Mattress Max machines, new machines are not readily available and must be constructed. We also have experienced inefficiencies in sourcing of materials and production of finished products. We have taken steps to improve our processes and capabilities, but if we are unable to maintain our improvements and continue our improvement initiatives to increase efficiencies, we may not be able to keep up with demand which would harm our business. If we are unable to construct new Mattress Max machines and implement them into our production process in a timely manner, if our existing Mattress Max machines are unable to function at the desired capacity, or if we are unable to develop replacements for the existing Mattress Max machines, our production capacity may be constrained and our ability to respond to customer demand may be adversely impacted. This would negatively impact our ability to grow our business and achieve profitability.

 

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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 controlling persons and officers of the Company, as well as with other entities affiliated with controlling persons. Several of these transactions were entered into prior to the Business Combination. For example, since 2010, we have leased our facilities in Alpine, Utah from TNT Holdings, which is owned by Tony Pearce and Terry Pearce. As we grow, and our needs change, we may need to negotiate a termination or modification of this lease. We have leased a new facility in Lehi, Utah and will be moving our headquarters into that building before the end of the first quarter 2020. We currently intend to continue to lease from TNT Holdings the building in Alpine, Utah and use it as a facility for production, research and development and video productions. We also may at some time purchase this Alpine facility from TNT Holdings. Tony and Terry Pearce, either personally or through one or more of their other entities, also have tangible property located in this Alpine facility that has not been clearly identified and separated from our property, although we expect this tangible property to be either removed or identified and separated in 2019. Tony and Terry Pearce pay no rent or other compensation to us to store such property in our leased facility. While there is currently no dispute over the lease, and we do not anticipate a dispute, there could arise in the future a dispute between us and Tony and Terry Pearce over this lease for reasons not currently foreseeable.

 

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 Tony Pearce and Terry Pearce 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. These third parties include direct competitors to us that at the time of the Business Combination were not selling products through retail channels in which we were selling our products. One of these third parties is now a domestic competitor of ours, as it now sells mattresses through some of the same retailers through which we also sell our products. This competitor’s sales revenues are increasing, resulting in increasing royalties paid to EdiZONE from this licensee. Another third-party licensee may make it difficult for us to expand into certain geographic regions, such as the European Union. Casey McGarvey, our Chief Legal Officer, is also entitled to receive a small percent of such royalties from EdiZONE related to these third-party licenses, in accordance with a small investment made in EdiZONE years before the Business Combination. While the current license back to EdiZONE, as recently amended following the Business Combination, is much narrower than the license that existed at the time of the Business Combination, these third-party licenses, including licenses by EdiZONE to our competitors, may lead to conflicts of interest between us and our insiders receiving royalties. At the time this agreement with EdiZONE was first entered into, Purple LLC had only Tony and Terry Pearce as directors. Subsequent to the Business Combination, the license to EdiZONE was amended to broaden our rights and narrow EdiZONE’s rights with the approval of our independent directors.

 

Prior to the Business Combination, we also entered into a Shared Services Agreement with other entities controlled by Tony Pearce and Terry Pearce, including EdiZONE, which covered the provision of services to these entities by our employees. The Shared Services Agreement was terminated by us effective July 24, 2019. No legal or accounting services were provided by Purple LLC during 2019 prior to this termination.

 

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Prior to the Business Combination, InnoHold, an entity owned by Terry and Tony Pearce and our controlling stockholder, also 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 participant’s 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 yet fully vested at the time that employee’s employment is terminated. Before and 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. This pertains to but is not limited to the forfeitures resulting from the departures occurring after the Business Combination in 2018, including that of the former Chief Executive Officer, Chief Marketing Officer and Chief Brand Officer. 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 current and future equity grants to those who have replaced and will replace these employees or for other purposes essential to the business. 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 Class B Common Stock in Purple Inc. and Class B Units in Purple LLC, after which any forfeitures would inure to the benefit of all of our stockholders. InnoHold distributed additional paired shares of Class B Common 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 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 replacements for the prior Chief Executive Officer, Chief Marketing Officer and others. If the equity pool is not refreshed, there is a risk that we may not be able to hire and retain 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. Also, this distribution by InnoHold to the equity incentive participants has caused us to incur administration expenses related to the distributions, 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.

 

In connection with the Business Combination, Purple LLC also entered into a Credit Agreement with the lenders which was guaranteed by Purple Inc. The lenders also are stockholders and warrant holders of the Company and appointed one director to serve on our Board, Adam Gray. Further, on February 26, 2019, the Amended and Restated Credit Agreement between Purple LLC and the lenders thereto, and each of the related documents, including the issuance of additional warrants to the lenders, was closed and an incremental loan was funded. The exercise of rights under this Amended and Restated Credit Agreement by the lenders may create conflicts of interest between us and Mr. Gray.

 

See “Item 13. Certain Relationships and Related Transactions, and Director Independence” in our Annual Report on Form 10-K for the year ended December 31, 2018 for a further discussion of all related-party transactions between the Company and insiders.  

 

Disruption of operations in either of our two main manufacturing facilities, including as a result of natural disasters, could increase our costs of doing business or lead to delays in shipping our products.

 

We have two main manufacturing plants, which are located in Alpine, Utah and Grantsville, Utah. Although we could produce some of our products at both sites, we have consolidated production of certain products at each site. Therefore, the disruption of operations of our manufacturing facilities, particularly where manufacturing has been consolidated, for a significant period of time, or even permanently, such as through the loss of the lease, may increase our costs of doing business and lead to delays in shipping our products to customers. Such delays could adversely affect our sales, customer satisfaction, profitability, cash flows and financial condition. Because both of our manufacturing plants are located within the same geographic region, regional economic downturns, natural disasters or other issues could potentially disrupt all of our manufacturing and other operating activities, which could adversely affect our business.

 

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Failure to achieve and maintain a high level of product quality could negatively impact our sales, profitability, cash flows and financial condition.

 

Our products are highly differentiated from traditional mattresses, sheets, protectors, pillows and cushions. As a result, our products may be susceptible to failures that do not exist with traditional products. We also source some products from third parties whose products may have design or manufacturing defects of which we are not aware. Some of our suppliers of finished goods are in China and it may not be possible to obtain recourse for defects in products from those suppliers. We strive to ensure the quality of all finished goods we purchase, and we have discovered instances where quality of supplied products did not meet our high standards. Failure to discover defects or achieve and maintain acceptable quality standards could impact consumer acceptance of our products or could result in negative media and Internet reports or owner dissatisfaction that could negatively impact our brand image and sales levels.

 

In addition, a decline in product quality could result in an increase in return rates and a corresponding decrease in sales, or an increase in product warranty claims in excess of our warranty reserves. An unexpected increase in return rates or warranty claims could harm our sales, profitability, cash flows and financial condition.

 

We currently maintain FDA registrations on a select group of our cushions that are sold through third parties. We are subject to FDA registrations with respect to such products and there is a risk that an FDA inspection could lead to product recall of the FDA registered cushions. While the number of such products is small, a recall could result, among other things, in lost sales, diverted resources, potential harm to our reputation and increased customer service costs, which may have a material adverse effect on our financial condition.

 

As a consumer innovation company with differentiated products, we face an inherent risk of exposure to product liability claims if the use of our products is alleged to have resulted in personal injury or property damage. If any of our products proves to be defective, we may be required to recall or redesign such products. Such recalls of products can result in, among other things, lost sales, diverted resources, potential harm to our reputation and increased customer service costs, which could have a material adverse effect on our financial condition.

 

We maintain insurance against some forms of product liability claims, but such coverage may not be adequate for liabilities actually incurred. A successful claim brought against us in excess of available insurance coverage, or any claim that results in significant adverse publicity against us, may have a material adverse effect on our sales, profitability, cash flows and financial condition.

 

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We are subject to warranty claims for our products, which could result in unexpected expense.

 

Our products carry warranties for defects in quality and workmanship. Historically, the amount for return of products, discounts provided to affected customers and cost for returns or warrant claims has been immaterial. However, we may experience significant expense as the result of future product quality issues, product recalls or product liability claims which may have a material adverse effect on our business. The actual costs of servicing future warranty claims may exceed our expectations and have a material adverse effect on our results of operations, financial condition and cash flows. Further, we may modify our warranties from time to time, and limitations to warranties intended to reduce the number of claims may result in customer dissatisfaction. The occurrence of any of the foregoing could have a material adverse effect on our business.

 

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. 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.

 

As our agreements terminate or relationships unwind, we may be unable to renew or replace these agreements on comparable terms, or at all. 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 create additional risks such as:

 

  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; and
     
  difficulty integrating under the commercial agreements.

 

We have entered into arrangements with several wholesale partners through which we sell certain of our products in their retail stores. We anticipate increasing the number of these partnerships. Also, we have agreed to exclusivity of certain products with some of our wholesale partners. 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 prior DTC-only operations. 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 exclusivity rights of other wholesale partners. 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 a Company factory outlet store and two Company showrooms. Our business is expanding into additional Company showrooms which, like our online e-commerce retail store, will compete with our wholesale partners for customers. Our relationships with our wholesale partners may be adversely affected by this competition. 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.

 

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We operate in the highly competitive mattress, pillow and cushion industries, and if we are unable to compete successfully, we may lose customers and our sales may decline.

 

The mattress, pillow and cushion markets are highly competitive and fragmented. We face competition from many manufacturers (including competitors that primarily manufacture and import from China), traditional brick-and-mortar retailers and online retailers, including direct-to-consumer competitors. Participants in the mattress, pillow and cushion industries 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 mattress, pillow and cushion industries 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. Mattress, pillow and cushion manufacturers and retailers are seeking to increase their channels of distribution and are looking for new ways to reach the consumer. Like us, many newer competitors in the mattress industry have begun to offer “bed-in-a-box” or similar products directly to consumers through the Internet and other distribution channels. Some of our established competitors have begun to offer “bed-in-a-box” products as well. Companies providing for the distribution of mattresses online or through retail stores, such as 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 bedding 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.

 

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 mattress, pillow and cushion industries. 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.

 

One competitor, which has been a licensee of EdiZONE for over fifteen years, uses substantially similar technology to our Hyper-Elastic Polymer material and Purple Grid cushion in its own mattress, topper and pillow products sold through branded retail stores domestically and in Canada. This competitor recently has been seen to be growing its sales and now distributes its products through wholesale partners with retail locations where our mattresses are sold. This competitor may continue to increase its sales and expand into additional distribution channels which could erode our sales in those retail locations and channels. The continuing growth of this single competitor could adversely affect our business.

 

A consolidation of the domestic market for foam may increase the prices for foam in the geographical market in which we purchase foam which could adversely affect our business.

 

In addition, the barriers to entry into the retail bedding industry are relatively low. New or existing bedding 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.

 

Moreover, the U.S. Department of Commerce (the “Department”) opened an antidumping investigation into whether mattresses imported from China are being sold into the United States at below fair market value. The investigation results from a petition filed by U.S. mattress manufacturers claiming that in recent years Chinese exporters have unfairly made large gains in market share by undercutting prices. On May 29, 2019 the Department made a preliminary determination to impose import duties on Chinese exporters. On October 18, 2019 the Department made its final determination imposing import duties on exporters of Chinese mattresses. Upon publication of the final determination, the Department will instruct U.S. Customs and Border Protection to continue to collect cash deposits equal to the applicable final weighted-average dumping rate. The U.S. International Trade Commission (ITC) is currently scheduled to make its final injury determination on about December 2, 2019. If the ITC reaches an affirmative final injury determination, the Department will issue an antidumping order. If the ITC reaches a negative final determination of injury, the antidumping investigation will be terminated and no order will be issued. If there is not a final determination of injury or if the antidumping duties do not result in the prevention of dumping of underpriced Chinese mattresses into the U.S. market, we could continue to experience a negative impact on our planned growth and the 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 and cushions, our sales, profitability, cash flows and financial condition may be adversely impacted.

 

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Substantial and increasingly intense competition worldwide in e-commerce may harm our business.

 

Consumers who might purchase our products from us online have a wide variety of alternatives for purchasing competing mattresses, pillows and cushions, including traditional brick and mortar retailers (as well as the online and mobile operations of these traditional retailers), other online direct-to-consumer retailers and their related mobile offerings, online and offline classified services, online retailer platforms, such as Amazon.com, and other shopping channels, such as offline and online home shopping networks.

 

The Internet and mobile networks provide new, rapidly evolving and intensely competitive channels for the sale of all types of goods and services, including products that compete directly with our products. Consumers who purchase mattresses, pillows and cushions through us have more and more alternatives, and merchants have more online channels to reach consumers. We expect competition to continue to intensify. Online and offline businesses increasingly are competing with each other and our competitors include a number of online and offline retailers with significant resources, large user communities and well-established brands. Moreover, the barriers to entry into these channels can be low, and businesses easily can launch online sites or mobile platforms and applications at nominal cost by using commercially available software or partnering with any of a number of successful e-commerce companies. As we respond to changes in the competitive environment, we may, from time to time, make pricing, service or marketing decisions or acquisitions that may be controversial with and lead to dissatisfaction among our customers, which could reduce activity on our platform and harm our profitability.

 

In addition, sellers in our industry are increasingly utilizing multiple sales channels, including the acquisition of new customers by paying for search-related advertisements on horizontal search engine sites, such as Google, Yahoo!, Naver and Baidu. We use product search engines and paid search advertising to help users find our sites, but these services also have the potential to divert users to other online shopping destinations. Consumers may choose to search for products with a horizontal search engine or shopping comparison website, and such sites may also send users to other shopping destinations. Consumers may not be familiar with or confused by our current web address: purple.com.

 

We also face increased competitive pressure as the competitive norm for, and the expected level of service from, e-commerce has significantly increased, due to, among other factors, improved user experience, greater ease of buying goods, lower (or no) shipping costs, faster delivery times and more favorable return policies. Also, certain platform businesses, many of whom are larger than us or have greater capitalization, have a dominant and secure position in other industries or certain significant markets, and offer a broader variety of mattress, pillow and cushion products to consumers and retailers that we do not offer. If we are unable to change our product offerings in ways that reflect the changing demands of e-commerce and mobile commerce marketplaces, particularly the higher growth of sales of fixed-price items and higher expected service levels, or compete effectively with and adapt to changes in larger platform businesses, our business will suffer.

 

Some of our e-commerce competitors offer a significantly broader range of products and services than we do. Competitors with other revenue sources may be able to devote more resources to marketing and promotional campaigns, adopt more aggressive pricing policies and devote more resources to website, mobile platforms and applications and systems development than we can. Other direct-to-consumer retailers and e-commerce competitors may offer or continue to offer faster shipping, free shipping, delivery on Sunday, same-day delivery, favorable return policies or other transaction-related services which improve the user experience on their sites and which could be impractical or inefficient for us to match. Competitors may be able to innovate faster and more efficiently, and new technologies may increase competitive pressure by enabling competitors to offer more efficient or lower-cost services.

  

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We attempt to maintain only the necessary amounts of raw material inventory, which could leave us vulnerable to shortages in supply of components that may harm our ability to satisfy consumer demand and may adversely impact our sales and profitability.

 

We attempt to maintain only the necessary amounts of raw material inventory on hand, which could leave us vulnerable to shortages in supply of components that may harm our ability to satisfy consumer demand and may adversely impact our sales and profitability. Lead times for ordered components may vary significantly, especially as we source some of our materials from China. Moreover, we may experience increased costs in sourcing Chinese materials as a result of the current status of the U.S.-China trade relationship or may experience related disruption if we seek to replace Chinese suppliers with suppliers in other countries. In addition, some components used to manufacture our products are provided on a sole source basis. Any unexpected shortage of materials caused by any disruption of supply or an unexpected increase in the demand for our products, could lead to delays in shipping our beds to customers. Any such delays could adversely affect our sales, customer satisfaction, profitability, cash flows and financial condition.

 

We rely upon several key suppliers that are, in some instances, the only source of supply currently used by us for particular materials, components or services. A disruption in the supply or substantial increase in cost of any of these products or services could harm our sales, profitability, cash flows and financial condition.

 

We currently obtain all of the raw materials and components used to produce our mattresses, pillows and cushions from outside sources. In some cases, we have chosen to obtain these materials and components from suppliers who serve as the only source of supply, or who supply the vast majority of our needs of the particular material or component. While we believe that these materials and components, or suitable replacements, could be obtained from other sources, in the event of a disruption or loss of supply of relevant materials or components for any reason, we may not be able to find alternative sources of supply, or if found, may not be found on comparable terms. In addition, a change in the financial condition of some of our suppliers could impede their ability to provide products to us in a timely manner. Further, we maintain relatively small supplies of our raw materials and outsourced goods at our manufacturing facilities, and any disruption in the on-going shipment of supplies to us could interrupt production of our products, which could result in a decrease of our sales or could cause an increase in our cost of sales, either of which could decrease our liquidity and profitability.

 

 If our relationship with the primary supplier of our mineral oil is terminated, we could have short-term difficulty in replacing these sources since there are relatively few other suppliers presently capable of supplying the local volume that we would need in a short period of time.

 

Our success is highly dependent on our ability to provide timely delivery to our customers, and any disruption in our delivery capabilities or our related planning and control processes may adversely affect our operating results.

 

An important part of our success is due to our ability to deliver our products to our customers in a timely manner. This in turn is due to our successful planning and distribution infrastructure, including ordering, transportation and receipt processing, the ability of our suppliers to meet our distribution requirements and the ability of our contractors to meet our delivery requirements. Our ability to maintain this success depends on the continued identification and implementation of improvements to our planning processes, distribution infrastructure and supply chain. We also need to ensure that our distribution infrastructure and supply chain keep pace with our anticipated growth and increased product output. The cost of these enhanced processes could be significant and any failure to maintain, grow or improve them could adversely affect our operating results.

 

We rely on FedEx and other carriers to deliver our products to customers on a timely, convenient, and cost-effective basis. We also rely on the systems of such carriers to provide us with accurate information about the status and delivery of our products. Any significant delay in deliveries to our customers could lead to increased cancellations and returns and cause us to lose sales. Any increase in freight charges could increase our costs of doing business and harm our sales, profitability, cash flows and financial condition. Lack of accurate information from such carriers could damage our brand and our relationship with our customers.

 

Our business could also be adversely affected if there are delays in product shipments to us due to freight difficulties, delays in product shipments clearing U.S. Customs for reasons of non-compliance or otherwise, challenges with our suppliers or contractors involving strikes or other difficulties at their principal transport providers or otherwise. Such delays could adversely affect our profitability and reputation.

  

We have experienced delays in the timely delivery of our mattress products. These delays have caused customer dissatisfaction with their experience with the Company and, in some cases, customers have cancelled their orders or returned their mattresses. We are working to rectify these delays with both internal operating and customer service controls and assistance offered to our third-party delivery providers. We have contracted with new delivery providers and are also seeking to qualify other delivery providers who can meet our standards. If we are unable to correct these deficiencies, we may suffer lost sales, damage to our reputation and liabilities to customers that could have a material adverse impact on our business.

  

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Our business and our reputation could be adversely affected by the failure to protect sensitive employee, customer and consumer data, or to comply with evolving regulations relating to our obligation to protect such data.

 

In the ordinary course of our business, we collect and store certain personal information from individuals, such as our customers and suppliers, and we process customer payment card and check information for purchases via our website. In addition, we may share with third-parties personal information we have collected. Cyber-attacks designed to gain access to sensitive information by breaching security systems of large organizations leading to unauthorized release of confidential information have occurred recently at a number of major U.S. companies despite widespread recognition of the cyber-attack threat and improved data protection methods. Computer hackers may attempt to penetrate our computer system or the systems of third-parties with which we have shared personal information and, if successful, misappropriate personal information, payment card or check information or confidential Company business information. In addition, a Company employee, contractor or other third party with whom we do business may attempt to circumvent our security measures in order to obtain such information and may purposefully or inadvertently cause a breach involving such information.

 

We and third-parties with which we have shared personal information have been subject to attempts to breach the security of networks, IT infrastructure, and controls through cyber-attack, malware, computer viruses, social engineering attacks, and other means of unauthorized access. To the best of our knowledge, attempts to breach our networks and IT infrastructure have not been successful to date, but we have been a victim of a spear-phishing attack. A breach of systems that resulted in the unauthorized release of sensitive data could adversely affect our reputation and lead to financial losses from remedial actions or potential liability, possibly including punitive damages. An electronic security breach resulting in the unauthorized release of sensitive data from information systems could also materially increase the costs we already incur to protect against these risks. We continue to balance the additional risk with the cost to protect us against a breach. Additionally, while losses arising from a breach may be covered in part by insurance that we carry, such coverage may not be adequate for liabilities or losses actually incurred.

 

We may be subject to data privacy and data breach laws in the states in which we do business, and as we expand into other countries, we may be subject to additional data privacy laws and regulations. State data privacy laws (such as the California Consumer Privacy Act), including application and interpretation, are rapidly evolving. While we attempt to comply with such laws, we may not be in compliance at all times in all respects. Failure to comply with such laws may subject us to fines, administrative actions, and reputational harm.

 

We are subject to payments-related risks.

 

We accept payments using a variety of methods, including credit card, debit card, credit accounts (including promotional financing), gift cards, direct debit from a customer’s bank account, electronic payments (e.g., PayPal and Venmo), consumer invoicing and physical bank check. For existing and future payment options we offer to our customers, we may become subject to additional regulations and compliance requirements (including obligations to implement enhanced authentication processes that could result in significant costs and reduce the ease of use of our payment methods). For certain payment methods, including credit and debit cards, we pay interchange and other fees, which may increase over time and raise our operating costs and negatively impact our profitability. We rely on third parties to provide certain payment methods and payment processing services, including the processing of credit cards, debit cards, electronic checks, electronic fund transfers, and promotional financing. In each case, it could disrupt our business if these companies become unwilling or unable to provide these services to us.

 

Our customers primarily use credit cards to buy from us. We are subject to the policies, procedures and rules of credit card issuers and payment card processors. We are completely dependent upon our payment card processors to process the sales transactions and remit the proceeds to us. The payment card processors have the right to withhold funds otherwise payable to us to establish or increase reserves based on their assessment of the inherent risks of payment card processing and their assessment of the risks of processing our customers’ payment cards at any time, and have done so from time to time in the past. We are also subject to payment card association operating rules, including data security rules, certification requirements, and rules governing electronic funds transfers, which could change or be reinterpreted in ways that make it difficult or impossible for us to comply. If we fail to comply with any of these policies, procedures, rules or requirements, or if our data security systems are breached or compromised, we may be liable for card issuing banks’ costs, subject to fines and higher transaction fees, and lose our ability to accept credit and debit card payments from our customers, process electronic funds transfers, or facilitate other types of online payments, and our business and operating results could be adversely affected. In addition, events affecting our payment card processors, including cyber-attacks, Internet or other infrastructure or communications impairment or other events that could interrupt the normal operation of the payment card processors, could have a material adverse effect on our business. 

 

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Credit card fraud and our response to it could adversely affect our business.

 

We have received and anticipate we will continue to receive orders placed with fraudulent credit card data. If we fail to adequately control fraudulent credit card transactions it could reduce our net revenues and our gross profit or cause credit card or payment system companies to increase their fees to us or disallow their cards’ use for customer payments on our website. We may suffer losses as a result of orders placed with fraudulent credit card data even if the associated financial institution approved payment of the orders. Under current credit card practices, we may be liable for fraudulent credit card transactions because we do not obtain a cardholder’s signature. If we are unable to detect or control credit card fraud, claims against us for these transactions could harm our business, prospects, financial condition and results of operation.

 

Further, to the extent that our efforts to prevent fraudulent orders result in our inadvertent refusal to fill legitimate orders, we would lose the benefit of legitimate potential sales and risk the alienation of legitimate customers. The occurrence of any of the foregoing could have a material adverse effect on our business.

 

We depend on a few key employees, and if we lose the services of certain of our principal executive officers, we may not be able to run our business effectively.

 

Our future success depends in part on our ability to attract and retain key executive, merchandising, marketing, sales, finance, operations and engineering personnel. If any of our executive officers cease to be employed by us, we would have to hire additional qualified personnel. Our ability to successfully attract and hire other experienced and qualified executive officers cannot be assured and may be difficult because we face competition for these professionals from our competitors, our suppliers and other companies operating in our industry. Since the Business Combination, we have hired a new Chief Executive Officer, Chief Operating Officer, Chief Financial Officer, and a Chief Retail Officer. We have also experienced the departure of the prior Chief Marketing Officer and the prior Chief Branding Officer. These departures and any delay in replacing these executives could significantly disrupt our ability to grow and pursue its strategic plans. We are currently in the process of searching for a qualified replacement for our Chief Marketing Officer. While we believe our new executive officers have benefitted and will continue to benefit us, finding qualified replacements is time-consuming, takes Company resources, and can disrupt our growth and achievement of strategic plans.

 

Further, the involvement of Tony and Terry Pearce has been crucial to the success of our company because of their extensive experience with and technical knowledge of our products. Pursuant to the employment agreements that have been entered into with them in connection with the consummation of the Business Combination, they are not required to work a particular number of hours for us or to be based at any particular location. While still providing services to us under their employment agreements, both Tony and Terry Pearce have reduced their time spent in the office. If we are unsuccessful in our efforts to build out our research and development capabilities around the many technologies conceived by Tony and Terry Pearce, our ability to develop new technologies and innovative products may be adversely affected.

 

Our business exposes us to personal injury, property damage and product liability claims, which could result in adverse publicity and harm to our brands and our results of operations.

 

We may be subject to personal injury, property damage and product liability claims for the products that we sell or related to the Company showrooms we will operate. Any personal injury, property damage or product liability claim made against us, whether or not it has merit, could be time consuming and costly to defend, resulting in adverse publicity, or damage to our reputation, and have an adverse effect on our results of operations. In addition, any negative publicity involving our vendors, employees, labor contractors, delivery contractors and other parties who are not within our control could negatively impact us.

 

Further, the products we sell are subject to regulation by the U.S. Consumer Product Safety Commission (“CPSC”) and similar state and international regulatory authorities. Such products could be subject to recalls and other actions by these authorities. Product safety concerns may require us to voluntarily remove selected products from our stores. Such recalls and voluntary removal of products can result in, among other things, lost sales, diverted resources, potential harm to our reputation and increased customer service costs, which could have a material adverse effect on our financial condition.

 

We have complied with CPSC regulations to voluntarily report our discovery of a potential defect in an accessory product supplied to us and some of our competitors by third parties which has resulted in some failures of the product to perform as intended and which could be determined to be a substantial product hazard for our customers. A handful of minor injuries have been reported, although no serious injuries have been substantiated as a result of such failures. We are working with the CPSC to investigate and make sure appropriate action is taken. We have stopped selling this product while we investigate and work with the CPSC. We are also working on developing improvements to ensure that this product functions properly for the intended useful life. However, there can be no assurance that we will be successful in developing such improvements or that any proposed improvements will remove all defects from this product or be approved by the CPSC. If it is determined this product is not safe and cannot be made safe, we may choose or be required to undertake a different corrective action, such as replacing the product or providing a refund to all of our customers who have purchased it. The CPSC could make a finding that the product is defective and dangerous and/or exert pressure on us to issue a joint voluntary recall, involving a replacement of the product, which could harm our brand and reputation and inhibit our ability to attract customers for any of our products. At this stage we are unable to determine the likely cost to us to resolve this issue. However, if we are required to recall all of the affected products, the cost of doing so could materially adversely impact our operations and financial results, as well as our use of cash to achieve our growth plans. In addition, we may be unable to obtain recourse from the supplier for any liability incurred with respect to such product failures and related remediation actions. If we determine that improvement of the products is possible, and if approved by the CPSC, we will incur the expense of such improvement. If a customer is harmed by a product failure there also could be litigation and expenses related to a claim of personal injury, which could harm our brand and reputation and negatively affect our operating results.

 

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We have received notice from the CPSC of several other purported consumer complaints regarding some of our products. While we believe such complaints to be baseless, in terms of the alleged harms and, in some cases, the individual’s actual use of our product, we are required to devote significant amounts of time, attention and other resources, including financial resources, to investigating and responding to such complaints. Further, because the complaints are available to the public, such complaints could result in adverse publicity or damage to our reputation and brand value and result in lower sales.

 

We maintain insurance against some forms of personal injury, property damage and product liability claims, but such coverage may not be adequate for liabilities actually incurred. A successful claim brought against us in excess of available insurance coverage, or any claim or product recall that results in significant adverse publicity against us, may have a material adverse effect on our sales, profitability, cash flows and financial condition.

 

Regulatory requirements, including, but not limited to, trade, customs, environmental, health and safety requirements, may require costly expenditures and expose us to liability.

 

Our products and our marketing and advertising programs are subject to regulation in the U.S. by various federal, state and local regulatory authorities, including the Federal Trade Commission and U.S. Customs and Border Protection. In addition, our operations are subject to federal, state and local consumer protection regulations and other laws relating specifically to the bedding industry. These rules and regulations may change from time to time or may conflict. There may be continuing costs of regulatory compliance including continuous testing, additional quality control processes and appropriate auditing of design and process compliance. For example, the CPSC and other jurisdictions have adopted rules relating to fire retardancy standards for the mattress industry. Some states and the U.S. Congress continue to consider fire retardancy regulations that may be different from or more stringent than the current standard. Additionally, California, Rhode Island and Connecticut have all enacted laws requiring the recycling of mattresses discarded in their states. State and local bedding industry regulations vary among the states in which we operate but generally impose requirements as to the proper labeling of bedding merchandise, restrictions regarding the identification of merchandise as “new” or otherwise, controls as to hygiene and other aspects of product handling, disposal, sales, resales and penalties for violations. We or our suppliers may be required to incur significant expense to the extent that these regulations change and require new and different compliance measures. For example, new legislation aimed at improving the fire retardancy of mattresses, regulating the handling of mattresses in connection with preventing or controlling the spread of bed bugs could be passed, or requiring the recycling of discarded mattresses, could result in product recalls or in a significant increase in the cost of operating our business. In addition, failure to comply with these various regulations may result in penalties, the inability to conduct business as previously conducted or at all, or adverse publicity, among other things. Adoption of multi-layered regulatory regimes, particularly if they conflict with each other, could increase our costs, alter our manufacturing processes and impair the performance of our products which may have an adverse effect on our business. We are also subject to various health and environmental provisions, such as California Proposition 65 (the Safe Drinking Water and Toxic Enforcement Act of 1986) and 16 CFR Part 1633 (Standard for the Flammability (Open Flame) of Mattress Sets).

 

Our marketing and advertising practices could also become the subject of proceedings before regulatory authorities or the subject of civil claims by competitors and other parties, which could result in civil litigation or regulatory penalties and require us to alter or end these practices or adopt new practices that are not as effective or are more expensive. Despite our efforts to comply with all marketing laws and regulations, we may not be in complete compliance at all times. Some competitors engage in the practice of regularly sending notices of non-compliance with certain of these regulations, and demand proof of compliance, and while we may believe we comply this practice consumes our resources, could lead to litigation and may have a negative impact on our financial condition.

 

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In addition, we are subject to federal, state and local laws and regulations relating to pollution, environmental protection and occupational health and safety. We may not be in complete compliance with all such requirements at all times, and we have been required in the past to make changes to our facilities in order to comply with these requirements. We have made and will continue to make capital and other expenditures to comply with environmental and health and safety requirements. If a release of harmful or hazardous substances occurs on or from our properties or any associated offsite disposal location, or if contamination from prior activities is discovered at any of our properties, we may be held liable and the amount of such liability could be material. As a manufacturer of mattresses, pillows, cushions and related products, we use and dispose of a number of substances, such as glue, oil, solvents and other petroleum products, as well as certain foam ingredients, that may subject us to regulation under numerous foreign, federal and state laws and regulations governing the environment. Among other laws and regulations, we are subject in the U.S. to the Federal Water Pollution Control Act, the Comprehensive Environmental Response, Compensation and Liability Act, the Resource Conservation and Recovery Act, the Clean Air Act and related state and local statutes and regulations.

 

We are also subject to federal laws and regulations relating to international shipments, customs, and import controls. We may not be in complete compliance with all such requirements at all times, and if we are not in compliance with such requirements, we may be subject to penalties or fines, which could have an adverse impact on our financial condition and results of operations.

 

Our operations could also be impacted by a number of pending legislative and regulatory proposals to address greenhouse gas emissions in the U.S. and other countries. Certain countries have adopted the Kyoto Protocol. New greenhouse gas reduction targets have been established under the Kyoto Protocol, as amended. This and other initiatives under consideration could affect our operations. These actions could increase costs associated with our manufacturing operations, including costs for raw materials, pollution control equipment and transportation. Because it is uncertain what laws will be enacted, we cannot predict the potential impact of such laws on our future consolidated financial condition, results of operations, or cash flows.

 

We are also subject to regulations and laws specifically governing the Internet, e-commerce, electronic devices, and other services. These regulations and laws may cover taxation, privacy, data protection, pricing, content, copyrights, distribution, mobile communications, electronic device certification, electronic waste, energy consumption, electronic contracts and other communications, competition, consumer protection, trade and protectionist measures, web services, the provision of online payment services, information reporting requirements, unencumbered Internet access to our services or access to our facilities, the design and operation of websites and the characteristics and quality of products and services. It is not clear how existing laws governing issues such as property ownership, libel, and personal privacy apply to the Internet, e-commerce, digital content, and web services. Unfavorable regulations and laws could diminish the demand for, or availability of, our products and services and increase our cost of doing business.

 

Claims have been made against us for alleged violations of the Americans with Disability Act (“ADA”) related to accessibility to our website by the blind. The law is unsettled as to whether the ADA covers websites and what standards are applicable, but courts in certain jurisdictions have recognized these types of ADA claims. While we comply with industry standards for making our website accessible to the blind, and regularly test our site for this purpose, we may be subject to such claims and, as a result, we may be required to expend resources in defense of these claims that could increase our cost of doing business.

 

We could be subject to additional income tax liabilities.

 

We are subject to federal and state income taxes in the U.S. tax laws, regulations, and administrative practices in the U.S. and in various state and local jurisdictions are subject to significant change, and significant judgment is required in evaluating and estimating our provision and accruals for taxes. In addition, some states and cities require additional taxes or fees for the right to sell mattresses in their jurisdiction. While we have established reserves based on assumptions and estimates that we believe are reasonable to cover such taxes and fees, these reserves may prove to be insufficient.

 

Our determination of our tax liability is always subject to audit and review by applicable tax authorities. Any adverse outcome of any such audit or review could harm our business, and the ultimate tax outcome may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made. Regardless of the outcome, responding to any such audit or review could cause us to incur significant costs and could divert resources away from our operations.

 

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There are many transactions that occur during the ordinary course of business for which the ultimate tax liability is uncertain. Our effective tax rates could be affected by earnings being lower than anticipated in jurisdictions where we have lower statutory rates and higher than anticipated in jurisdictions where we have higher statutory rates, losses incurred in jurisdictions for which we are not able to realize the related tax benefit, changes in foreign currency exchange rates, entry into new businesses and geographies and changes to our existing businesses, acquisitions (including integrations) and investments, changes in the price of our securities, changes in our deferred tax assets and liabilities and their valuation, and changes in the relevant tax, accounting, and other laws, regulations, administrative practices, principles, and interpretations.

 

A number of U.S. states have attempted to increase corporate tax revenues by taking an expansive view of corporate presence to attempt to impose corporate income taxes and other direct business taxes on companies that have no physical presence in their state, and taxing authorities in other jurisdictions may take similar actions. Many U.S. states are also altering their apportionment formulas to increase the amount of taxable income or loss attributable to their state from certain out-of-state businesses. Further, we may be required in the future to pay sales and other taxes and fees to states where our products were warehoused before shipping. If more taxing authorities are successful in applying direct taxes to Internet companies that do not have a physical presence in their respective jurisdictions, this could increase our effective tax rate.

 

Provisions in our Second Amended and Restated Certificate of Incorporation may limit our stockholders’ ability to obtain a favorable judicial forum.

 

Our Second Amended and Restated Certificate of Incorporation provides that the Court of Chancery of the State of Delaware shall be the sole and exclusive forum for substantially all disputes between us and our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers, employees or agents. It also provides that, unless we consent to the selection of an alternative forum, the Court of Chancery of the State of Delaware shall be the sole and exclusive forum for any derivative action or proceeding brought on our behalf; any action asserting a claim for or based on a breach of duty or obligation owed by any current or former director, officer or employee of ours to us or to our stockholders, including any claim alleging the aiding and abetting of such a breach; any action asserting a claim against us or any current or former director, officer or employee of ours arising pursuant to any provision of the Delaware General Corporation Law or our certificate of incorporation or bylaws; or any action asserting a claim related to or involving us that is governed by the internal affairs doctrine. This exclusive forum provision would not apply to suits brought to enforce any liability or duty created by the Securities Act or the Exchange Act or any other claim for which the federal courts have exclusive jurisdiction. To the extent that any such claims may be based upon federal law claims, Section 27 of the Exchange Act creates exclusive federal jurisdiction over all suits brought to enforce any duty or liability created by the Exchange Act or the rules and regulations thereunder. Furthermore, Section 22 of the Securities Act creates concurrent jurisdiction for federal and state courts over all suits brought to enforce any duty or liability created by the Securities Act or the rules and regulations thereunder. This choice of forum provision may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers or employees, which may discourage such lawsuits against us and our directors, officers or employees. Alternatively, if a court were to find the choice of forum provision contained in our certificate of incorporation to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving such action in other jurisdictions, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

We incur significant costs as a result of our operating as a public company and our management is required to devote substantial time to compliance with the regulatory requirements placed on a public company.

 

As a public company with substantial operations, we incur significant legal, accounting and other expenses. The costs of preparing and filing annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission and furnishing audited reports to stockholders are time-consuming and costly.

 

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It is also time-consuming, difficult and costly for us to develop and implement the internal controls and reporting procedures required by the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act. Certain members of our management have limited or no experience operating a company whose securities are listed on a national securities exchange or with the rules and reporting practices required by the federal securities laws as applied to a publicly traded company. We may need to recruit, hire, train and retain additional financial reporting, internal control and other personnel in order to develop and implement appropriate internal controls and reporting procedures. If we are unable to comply with the internal controls requirements of the Sarbanes-Oxley Act, we may not be able to obtain the independent accountant certifications required by the Sarbanes-Oxley Act.

 

If we fail to establish and maintain an effective system of internal controls, we may not be able to report our financial results accurately 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.

 

We have been the victim of a spear-phishing attack that resulted in the diversion of a payroll payment to a bank account that did not belong to the employee, resulting in the loss of those funds. Though we have implemented additional controls to address spear-phishing and phishing attacks, such controls may not be effective to protect us against such attacks in the future and we may incur financial losses that alone or together could adversely impact the business.

 

Future sales of our Class A Common Stock by our existing stockholders may cause our stock price to fall.

 

The market price of our Class A Common Stock could decline as a result of sales by our existing stockholders in the market, or the perception that these sales could occur. These sales might also make it more difficult for us to sell equity securities at a time and price that we deem appropriate. In addition, subsequent public issuances of our stock would cause the interest of each current Purple Inc. stockholder to be diluted. In connection with the Closing of the Business Combination, the founders, Tony and Terry Pearce, through InnoHold, LLC control the majority of the shares of Class B Common Stock of the Company which constitutes over 80% of all ownership interests in the Company. The lock-up period following the Business Combination has expired, and the founders are now able to exchange their Class B shares for Class A shares and sell them; and at the demand of InnoHold, Tony Pearce and Terry Pearce under the Registration Rights Agreement, the Company has filed a registration statement on Form S-3 for the resale by InnoHold, Terry Pearce and Tony Pearce of up to an aggregate of 20 million shares of Class A Stock issuable upon the exchange, under the Exchange Agreement, of 20 million shares of Class B Stock and an equal number of Class B Units in Purple LLC. Such registration statement has not yet been declared effective by the SEC. Also, at this time, CCP, Blackwell and CDF own a majority of the shares of Class A Common Stock of the Company. Any of these shareholders may choose to sell shares of Common Stock, and the founders particularly may decide to liquidate a substantial portion of their interest in view of their age and for other personal reasons. The amount of shares they are able to sell, if sold in large blocks or relatively close to each other in time, could result in downward pressure on the price of our Class A Stock.

 

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In connection with the Closing of the Business Combination, some of our current and former employees were granted incentive units as members of InnoHold, which together with Tony and Terry Pearce hold all of the outstanding shares of Class B Common Stock of the Company. On February 8, 2019, InnoHold initiated a tender offer to each of these incentive unit holders to distribute to each a pro rata number of the Paired Securities held by InnoHold in exchange for the cancellation of their ownership interests in InnoHold. All InnoHold incentive unit holders accepted the offer, and the terms and distribution of each transaction were finalized and closed on June 25, 2019. As of the closing, those incentive unit holders received, based on their pro rata holdings of InnoHold Class B Units, a portion of 2.5 million Paired Securities held by InnoHold, of which a total of 1.7 million Paired Securities were distributed at the closing and the remaining 0.8 million were distributed in July and August 2019. The distribution of certain Paired Securities was a taxable event for the recipients of those Paired Securities, and such recipients, or us on their behalf, exchanged, subject to the Exchange Agreement and certain other conditions and restrictions, all or some of their securities into shares of Class A Common Stock and then liquidated some of those shares of Class A Common Stock in order to pay taxes assessed. Some of the participants receiving these equity incentives, including those who no longer work for us, may want to liquidate some or all of the equity distributed to them by InnoHold. Sales of such shares of Class A Common Stock may occur relatively close to each other in time, including during short windows of time when such current employees are able to trade in our securities without violating our insider trading policy, and such consolidated trading in such short windows of time could result in downward pressure on the price of our Class A Common Stock.

 

This risk of downward pressure on the price of our Class A Common Stock is particularly acute at this time inasmuch as the average trading volume of our Class A Common Stock remains relatively low on average, making it more difficult to sell a substantial number of shares at any point in time. This risk related to the lack of an active trading market also may make it more difficult for any shareholder to sell their shares, and until an active trading market develops and becomes sustainable, it is likely to make our stock less desirable to investors. InnoHold, CCP, Blackwell and CDF, who hold most of our Common Stock, may not sell shares, or sell enough shares, to increase the float to a point where a sustainable market develops. InnoHold and the Pearces have exercised their rights under the Registration Rights Agreement for the registration of the resale of up to an aggregate of 20 million shares of Class A Stock issuable upon the exchange of Paired Securities. We have filed a registration statement on Form S-3 with respect to the resale of such shares. While such registration statement has not yet been declared effective by the SEC, once effective, they may sell such shares in amounts that cause a decrease in our stock price.

 

A market for our securities may not develop, which would adversely affect the liquidity and price of our securities.

 

The price of our securities may vary significantly due to our operating performance and general market or economic conditions. Furthermore, an active trading market for our securities may never develop or, if developed, it may not be sustained for many reasons, including that InnoHold, CCP, Blackwell and CDF, who hold most of our Common Stock, may not sell shares, or sell enough shares, to increase the float to a point where a sustainable market develops. You may be unable to sell your securities unless a market can be established and sustained.

 

Purple LLC’s level of indebtedness could adversely affect Purple LLC’s and our ability to meet its obligations under its indebtedness, react to changes in the economy or its industry and to raise additional capital to fund operations.

 

As of September 30, 2019, Purple LLC had total debt of $39.0 million outstanding, comprised of $38.5 million outstanding under the Amended and Restated Credit Agreement and $0.5 million in capital lease obligations. Our level of indebtedness could have important consequences to stockholders. For example, it could:

 

make it more difficult to satisfy our obligations with respect to our indebtedness, resulting in possible defaults on, and acceleration of, such indebtedness;

 

increase our vulnerability to general adverse economic and industry conditions;

 

require us to dedicate a substantial portion of our cash flows from operations to payments on indebtedness, thereby reducing the availability of such cash flows to fund working capital, capital expenditures and other general corporate requirements or to carry out other aspects of its business;

  

limit our ability to obtain additional financing to fund future working capital, capital expenditures and other general corporate requirements or to carry out other aspects of its business;

 

limit our ability to make material acquisitions or take advantage of business opportunities that may arise; and

 

place us at a potential competitive disadvantage compared to its competitors that have less debt.

  

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We may also incur future debt obligations that might subject us to additional restrictive covenants that could affect our financial and operational flexibility.

 

We could issue additional preferred stock without stockholder approval with the effect of diluting then current stockholder interests, impairing their voting rights and potentially discouraging a takeover that stockholders may consider favorable.

 

Pursuant to our Amended and Restated Certificate of Incorporation, the Board has the ability to authorize the issuance of up to five million shares of preferred stock at any time and from time to time, with such terms and preferences as the Board determines and without any stockholder approval other than as may be required by NASDAQ rules. The issuance of such shares of preferred stock could dilute the interest of, or impair the voting power of, our common stockholders. The issuance of such preferred stock could also be used as a method of discouraging, delaying or preventing a change of control. 

 

Although we may be entitled to tax benefits relating to additional tax depreciation or amortization deductions as a result of the tax basis step-up we receive in connection with the exchanges of Class B Units into our Class A Common Stock and related transactions, we will be required to pay InnoHold 80% of these tax benefits under the Tax Receivable Agreement.

 

Some owners may, subject to certain conditions and transfer restrictions, exchange their Class B Units and shares of Class B Common Stock for shares of Class A Common Stock pursuant to the Exchange Agreement. The deemed exchanges in the Business Combination and any exchanges pursuant to the Exchange Agreement, are expected to result in increases in our allocable share of the tax basis of the tangible and intangible assets of Purple LLC. These increases in tax basis may increase (for tax purposes) depreciation and amortization deductions and therefore reduce the amount of income or franchise tax that we would otherwise be required to pay in the future, although the Internal Revenue Service (“IRS”) or any applicable foreign, state or local tax authority may challenge all or part of that tax basis increase, and a court could sustain such a challenge. As of November 6, 2019, there have been 0.7 million exchanges of Class B Units and shares of Class B Common Stock for shares of Class A Common Stock by some of those incentive recipients who received these Paired Securities in the distribution from InnoHold.

 

In connection with the Business Combination, we entered into the Tax Receivable Agreement, which generally provides for the payment by us to exchanging holders of Class B Units and shares of Class B Common Stock of 80% of certain tax benefits, if any, that we realize as a result of these increases in tax basis and of certain other tax benefits related to entering into the Tax Receivable Agreement, including income or franchise tax benefits attributable to payments under the Tax Receivable Agreement. These payment obligations pursuant to the Tax Receivable Agreement are the obligation of the Company and not of Purple LLC. The actual increase in our allocable share of the Company’s tax basis in its assets, as well as the amount and timing of any payments under the Tax Receivable Agreement, will vary depending upon a number of factors, including the timing of exchanges, the market price of shares of our Common Stock at the time of the exchange, the extent to which such exchanges are taxable and the amount and timing of our income. As of September 30, 2019, the Company’s preliminary estimate of the TRA liability resulting from the distribution of the cash consideration to InnoHold in connection with the Business Combination and tax basis increases as a result of the exchange of 0.7 million Paired Securities, was approximately $11.4 million. However, the Company has not been able to determine that payments under the TRA are likely to occur and therefore has concluded that no recognizable TRA liability has been incurred. To the extent the Company realizes tax benefits in future years, or in the event of a change in future tax rates, this liability may change.

 

Because not all of the foregoing factors are known at this time as to the exchanges that have occurred, and none are known for future exchanges this year or in subsequent years, we cannot yet determine the amounts (if any) that would be payable under the Tax Receivable Agreement. However, we expect that as a result of the possible size and frequency of the exchanges and the resulting increases in the tax basis of the tangible and intangible assets of Purple LLC, the payments that we expect to make under the Tax Receivable Agreement will be substantial and could have a material adverse effect on our financial condition. The payments under the Tax Receivable Agreement are not conditioned upon continued ownership of the Company by the holders of units.

 

InnoHold and other owners of the securities will not be required to reimburse us for any excess payments that may previously have been made under the Tax Receivable Agreement, for example, due to adjustments resulting from examinations by taxing authorities. Rather, excess payments made to such holders will be netted against payments otherwise to be made, if any, after the determination of such excess. As a result, in certain circumstances we could make payments under the Tax Receivable Agreement in excess of our actual income or franchise tax savings, which could materially impair our financial condition.

  

ITEM 5. OTHER INFORMATION

 

We have determined that, due to an administrative error, the version of our Amended and Restated Certificate of Incorporation included as an exhibit to our Current Report on Form 8-K filed with the SEC on February 8, 2018 included some minor technical differences from the correct version filed with the Secretary of State of the State of Delaware. Descriptions provided in our other filings with the SEC regarding our Amended and Restated Certificate of Incorporation and the rights of our stockholders accurately reflected the terms of our Amended and Restated Certificate of Incorporation. The correct version of our Amended and Restated Certificate of Incorporation is included as Exhibit 3.1 to this Quarterly Report on Form 10-Q.

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ITEM 6. EXHIBITS

 

Number   Description
3.1*   Amended and Restated Certificate of Incorporation
10.1+   Employment Agreement between the Company and Craig L. Phillips (incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K (File No. 001-37523) filed with the SEC on October 4, 2019).
10.2+   Option Grant Agreement between the Company and Craig L. Phillips (incorporated by reference to Exhibit 10.2 to the Current Report on Form 8-K (File No. 001-37523) filed with the SEC on October 4, 2019).
31.1*   Certification by Joseph B. Megibow, Chief Executive Officer, pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*   Certification by Craig L. Phillips, Chief Financial Officer, pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*   Certification by Joseph B. Megibow, Chief Executive Officer, pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*   Certification by Craig L. Phillips, Chief Financial Officer, pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS   XBRL Instance Document
101.SCH   XBRL Taxonomy Extension Schema Document
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document
101.LAB   XBRL Taxonomy Extension Label Linkbase Document
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document

 

* Filed herewith.
+ Indicates management contract or compensatory plan.

 

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SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    PURPLE INNOVATION, INC.
       
Date: November 6, 2019 By: /s/ Joseph B. Megibow
      Joseph B. Megibow
      Chief Executive Officer
      (Principal Executive Officer)
       
Date: November 6, 2019 By: /s/ Craig L. Phillips
      Craig L. Phillips
      Chief Financial Officer
      (Principal Financial and Accounting Officer)

 

 

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