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Section 1: 10-Q (QUARTERLY REPORT)

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

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

 

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2018

 

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)

 

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 þ No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted 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 and post 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   þ
Non-accelerated filer   ¨ 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 14, 2018, 9,730,636 shares of the registrant’s Class A common stock, $.0001 par value per share, and 44,071,318 shares of the registrant’s Class B common stock, $.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 Equity 3
    Condensed Consolidated Statements of Cash Flows 4
    Notes to Condensed Consolidated Financial Statements 5
  Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 22
  Item 3. Quantitative and Qualitative Disclosures about Market Risk 28
  Item 4. Controls and Procedures 28
       
Part II.  Other Information 29
  Item 1. Legal Proceedings 29
  Item 1A. Risk Factors 29
  Item 2. Unregistered Sales of Equity Securities and Use of Proceeds  
  Item 5. Other Information 34
  Item 6. Exhibits 35
       
  Signatures 36

 

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®, 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 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™. 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, 
   2018   2017 
       (Revised)(1) 
Assets        
Current assets:        
Cash and cash equivalents  $7,665   $3,593 
Accounts receivable, net   8,484    4,182 
Inventories, net   28,680    13,345 
Prepaid inventory   317    1,296 
Other current assets   2,246    492 
Total current assets   47,392    22,908 
Property and equipment, net   21,719    13,464 
Intangible assets, net   1,408    1,267 
Other long-term assets   5    22 
Total assets  $70,524   $37,661 
           
Liabilities and Equity          
Current liabilities:          
Accounts payable  $20,443   $21,131 
Accrued sales returns   5,507    4,825 
Accrued compensation   2,153    2,097 
Customer prepayments   7,291    3,213 
Accrued sales tax   5,655    8,466 
Other accrued liabilities   2,026    1,451 
Current portion of long-term obligations   31    29 
Total current liabilities   43,106    41,212 
Long-term debt   20,695    8,000 
Other long-term liabilities and obligations, net of current portion   3,493    2,368 
Total liabilities   67,294    51,580 
Commitments and contingencies (Note 9)          
Stockholders’ equity:          
Class A common stock; $0.0001 par value, 210,000 shares authorized; 9,731 issued and outstanding at September 30, 2018   1     
Class B common stock; $0.0001 par value, 90,000 shares authorized; 44,071 issued and outstanding at September 30, 2018   4     
Additional paid-in capital   3,646     
Accumulated deficit   (3,343)    
Total stockholders’ equity   308     
Noncontrolling interest   2,922     
Member deficit       (13,919)
Total equity   3,230    (13,919)
Total Liabilities and Equity  $70,524   $37,661 

 

(1) See Note 2, “—Correction of Immaterial Misstatements in Prior Period Financial Statements”.

 

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,
 
   2018   2017   2018   2017 
       (Revised)(1)       (Revised)(1) 
Revenues, net  $70,806   $56,011   $207,334   $133,820 
Cost of revenues   42,684    31,927    121,575    74,726 
Gross profit   28,122    24,084    85,759    59,094 
Operating expenses:                    
Marketing and sales   25,188    25,655    77,956    53,970 
General and administrative   5,804    3,520    17,870    8,473 
Research and development   578    356    1,644    904 
Total operating expenses   31,570    29,531    97,470    63,347 
Operating loss   (3,448)   (5,447)   (11,711)   (4,253)
Interest expense   999    4    2,672    4 
Other income, net   (83)   (2)   (184)   (2)
Net loss   (4,364)   (5,449)   (14,199)   (4,255)
Net loss attributable to noncontrolling interest   (3,575)       (10,856)    
Net loss attributable to Purple Innovation, Inc.  $(789)  $(5,449)  $(3,343)  $(4,255)
Net loss per common share—basic and diluted  $(0.09)  $(0.65)  $(0.40)  $(0.51)
Weighted average common shares outstanding—basic and diluted   8,437    8,389    8,412    8,389 

 

(1) See Note 2, “—Correction of Immaterial Misstatements in Prior Period Financial Statements”.

 

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

 

2

 

 

PURPLE INNOVATION, INC.

 

Condensed Consolidated Statements of Equity

(In thousands)

(Unaudited)

 

   Class A   Class B   Additional       Total
Common
             
   Common Stock   Common Stock   Paid-in   Accumulated   Stockholders’   Noncontrolling   Member   Total 
   Shares   Par Value   Shares   Par Value   Capital   Deficit   Equity   Interest   Deficit   Equity 
                                   (Revised)(1)     
Balance - December 31, 2017      $       $   $   $   $   $   $(13,919)  $(13,919)
Net loss                       (3,343)   (3,343)   (15,169)   4,313    (14,199)
Effect of the Transaction:                                                  
Proceeds and shares issued in the Transaction   9,683    1    44,071    4    (1,358)       (1,353)   18,091    9,606    26,344 
Assignment of founder shares and sponsor warrants                   4,691        4,691            4,691 
Stock-based compensation                   313        313            313 
Issuance of common stock   48                                     
Balance – September 30, 2018   9,731   $1    44,071   $4   $3,646   $(3,343)  $308   $2,922   $   $3,230 

 

(1)See Note 2, “—Correction of Immaterial Misstatements in Prior Period Financial Statements”.

 

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,
 
   2018   2017 
       (Revised)(1) 
Cash flows from operating activities:        
Net loss  $(14,199)   $(4,255) 
Adjustments to reconcile net loss to net cash from operating activities:          
Depreciation and amortization   1,534    465 
Non-cash interest   1,768     
Stock-based compensation   313     
Loss on disposal of property and equipment       10 
Changes in operating assets and liabilities:          
Increase in accounts receivable   (4,302)   (574)
Increase in inventories   (15,335)   (3,377)
Increase in prepaid inventory and other assets   (341)   (2,044)
Increase (decrease) in accounts payable   (567)   11,823 
Increase in accrued sales returns   682    2,172 
Increase (decrease) in accrued compensation   56    (196)
Increase (decrease) in customer prepayments   4,078    (1,985)
Increase (decrease) in other accrued liabilities   (1,087)   6,719 
Net cash (used in) provided by operating activities   (27,400)   8,758 
           
Cash flows from investing activities:          
Purchase of property and equipment   (9,878)   (5,317)
Investment in intangible assets   (173)   (167)
Net cash used in investing activities   (10,051)   (5,484)
           
Cash flows from financing activities:          
Proceeds from the Transaction   25,912     
Proceeds from credit agreement   24,000     
Payments on line of credit   (8,000)    
Payments for debt issuance costs   (367)    
Principal payments on capital lease obligations   (22)    
Member distributions       (3,790)
Payments on related party notes payable       (300)
Payments on long-term obligations       (42)
Net cash provided by (used in) financing activities   41,523    (4,132)
           
Net increase (decrease) in cash   4,072    (858)
Cash, beginning of the period   3,593    4,013 
Cash, end of the period  $7,665   $3,155 
           
Supplemental schedule of non-cash investing and financing activities:          
Property and equipment included in accounts payable  $428   $511 
Assignment of founder shares and sponsor warrants  $4,691   $ 

 

(1) See Note 2, “—Correction of Immaterial Misstatements in Prior Period Financial Statements”.

 

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

 

Purple Innovation, Inc., collectively with its subsidiary (the “Company” or “Purple”), is a comfort technology company which designs and manufactures products to improve how people sleep, sit and stand. The Company designs and manufactures a range of comfort technology products, including mattresses, pillows, cushions and other products, using its proprietary Hyper-Elastic Polymer® technology designed to improve comfort. The Company markets and sells its products through direct-to-consumer online channels, traditional wholesale partners and third-party online retailers.

 

The Company was incorporated in Delaware on May 19, 2015 as a special purpose acquisition company under the name of Global Partnership Acquisition Corp (“GPAC”) 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 “Transaction”) pursuant to which the Company acquired a portion of the equity of Purple Innovation, LLC (“Purple LLC”). At the closing of the Transaction (the “Closing”), the Company became the sole managing member of Purple LLC, and GPAC was renamed Purple Innovation, Inc. (“Purple 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 all 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 Transaction 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 Transaction 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 Transaction; (ii) the combined results of the Company following the Transaction; (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 regarding interim financial reporting. 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 Current Report on Form 8-K/A filed March 15, 2018. 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 three and nine months ended September 30, 2018 are not necessarily indicative of the results to be expected for the fiscal year ending December 31, 2018 or for any other interim period or other future year.

 

Variable Interest Entities

 

Purple LLC is a variable interest entity (“VIE”). The Company determined that it is the primary beneficiary of Purple LLC as Purple Inc 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, 2018, Purple Inc had approximately 18% 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, 2018, InnoHold had approximately 82% of the economic interest in Purple LLC; however, InnoHold has disproportionally fewer voting rights, and is shown as the noncontrolling interest (“NCI”) holder of Purple LLC. For further discussion see Note 10—Stockholders’ Equity and Member Deficit, “Noncontrolling Interest.”

 

5

 

 

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 liabilities, the recognition and measurement of loss contingencies and 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.

  

Correction of Immaterial Misstatements in Prior Period Financial Statements

 

In connection with the preparation of the unaudited condensed consolidated financial statements for the three and nine months ended September 30, 2018, the Company identified errors that caused an overstatement of previously reported prepaid inventory, net inventory, and minor changes in certain other liability accounts. The error in prepaid inventory related to the process deficiency in the tracking and reconciling of deposits made to overseas suppliers for inventory orders. The correction of this error reduces prepaid inventory and increases cost of revenues in an aggregate amount of $1.7 million for the periods from January 1, 2017 through June 30, 2018, wherein approximately $0.9 million relates to 2017 and interim periods within 2017 and the remaining approximately $0.8 million relates to 2018 periods. The error in net inventory related primarily to the valuation of certain subassembly inventory items. The correction of this error reduces net inventory and increases cost of revenues by $1.3 million for the three months ended June 30, 2018, and did not impact any other period. The minor changes in customer prepayments and accrued sales tax related to the process deficiency of reconciling the accounts and proper period cut-offs. The correction of these errors decreases current liabilities and increases revenue by $0.2 million for the six months ended June 30, 2018, and did not impact any other period. The Company previously reported an error in the overstatement of net inventory as of December 31, 2017 that arose in the fourth quarter of 2017 and did not impact the other quarters of 2017. The correction of this error reduces net inventory and increases cost of revenues by $2.5 million. The 2017 errors in aggregate continue to be immaterial, as are the aggregate errors in 2018.

 

In accordance with Staff Accounting Bulletin (“SAB”) No. 99, Materiality, and SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, the Company evaluated the errors and determined that the impact was not material to any of our previously issued financial statements. In regards to the interim 2018 errors and applicable interim 2017 periods, the Company corrected the statements of operations in the current period filing. The Company will correct the 2017 annual period errors prospectively and revise the financial statements when such period is included in future filings. Accordingly, as it relates to the 2017 annual period the Company corrected the balance sheet as of December 31, 2017 in the current period filing and the Company will correct the statement of operations for the entire 2017 annual period the next time those statements are filed. The errors had no impact on net cash provided by operating activities for any period presented.

 

6

 

 

The following tables present a summary of the impact by financial statement line item of the corrections for the three months ended March 31, 2017, three and six months ended June 30, 2017, three and nine months ended September 30, 2017, as of and for the year ended December 31, 2017 (with the cumulative effect of the previous 2017 adjustment), three months ended March 31, 2018, and for the three and six months ended June 30, 2018:

 

   Three Months Ended March 31, 2017 
(In thousands, except per share amounts)  As Previously Reported   Adjustment   As Revised 
Cost of revenues  $15,830   $96   $15,926 
Gross profit   14,294    (96)   14,198 
Operating loss   (1,986)   (96)   (2,082)
Net loss  $(1,980)  $(96)  $(2,076)
Net loss attributable to Purple Innovation, Inc.  $(1,980)  $(96)  $(2,076)
Net loss per common share - basic and diluted  $(0.24)  $(0.01)  $(0.25)

 

   Three Months Ended June 30, 2017   Six Months Ended June 30, 2017 
(In thousands, except per share amounts)  As Previously Reported   Adjustment   As Revised   As Previously Reported   Adjustment   As Revised 
Cost of revenues  $26,512   $361   $26,873   $42,342   $457   $42,799 
Gross profit   21,173    (361)   20,812    35,467    (457)   35,010 
Operating income   3,637    (361)   3,276    1,651    (457)   1,194 
Net income  $3,631   $(361)  $3,270   $1,651   $(457)  $1,194 
Net income attributable to Purple Innovation, Inc.  $3,631   $(361)  $3,270   $1,651   $(457)  $1,194 
Net income per common share - basic and diluted  $0.43   $(0.04)  $0.39   $0.20   $(0.05)  $0.15 

 

 

   Three Months Ended September 30, 2017   Nine Months Ended September 30, 2017 
(In thousands, except per share amounts)  As Previously Reported   Adjustment   As Revised   As Previously Reported   Adjustment   As Revised 
Cost of revenues  $31,562   $365   $31,927   $73,904   $822   $74,726 
Gross profit   24,449    (365)   24,084    59,916    (822)   59,094 
Operating loss   (5,082)   (365)   (5,447)   (3,431)   (822)   (4,253)
Net loss  $(5,084)  $(365)  $(5,449)  $(3,433)  $(822)  $(4,255)
Net loss attributable to Purple Innovation, Inc.  $(5,084)  $(365)  $(5,449)  $(3,433)  $(822)  $(4,255)
Net loss per common share - basic and diluted  $(0.61)  $(0.04)  $(0.65)  $(0.41)  $(0.10)  $(0.51)

 

 

   As of and for the Year Ended
December 31, 2017
 
(In thousands, except per share amounts)  As Previously Reported   Adjustment(1)   As Revised 
Inventory, net  $15,799   $(2,454)  $13,345 
Prepaid inventory   2,219    (923)   1,296 
Total assets   41,038    (3,377)   37,661 
Member deficit   (10,542)   (3,377)   (13,919)
Total liabilities and equity   41,038    (3,377)   37,661 
Cost of revenues   108,464    3,377    111,841 
Gross profit   88,395    (3,377)   85,018 
Operating loss   (5,370)   (3,377)   (8,747)
Net loss  $(5,442)  $(3,377)  $(8,819)
Net loss attributable to Purple Innovation, Inc.  $(5,442)  $(3,377)  $(8,819)
Net loss per common share - basic and diluted  $(0.65)  $(0.40)  $(1.05)

 

(1) Includes previous 2017 adjustment.

 

7

 

 

   Three Months Ended March 31, 2018 
(In thousands, except per share amounts)  As Previously Reported   Adjustment   As Revised 
Revenue  $60,980   $(212)  $60,768 
Cost of revenues   34,580    373    34,953 
Gross profit   26,400    (585)   25,815 
General and administrative   6,762    91    6,853 
Operating loss   (2,918)   (676)   (3,594)
Net loss  $(3,601)  $(676)  $(4,277)
Net loss attributable to noncontrolling interest  $(2,173)  $(554)  $(2,727)
Net loss attributable to Purple Innovation, Inc.  $(1,428)  $(122)  $(1,550)
Net loss per common share - basic and diluted  $(0.17)  $(0.01)  $(0.18)

 

   Three Months Ended June 30, 2018   Six Months Ended June 30, 2018 
(In thousands, except per share amounts)  As Previously Reported   Adjustment   As Revised   As Previously Reported   Adjustment   As Revised 
Revenue  $75,397   $363   $75,760   $136,377   $151   $136,528 
Cost of revenues   42,358    1,580    43,938    76,398    1,953    78,351 
Gross profit   33,039    (1,217)   31,822    59,439    (1,802)   57,637 
General and administrative   5,213        5,213    11,975    91    12,066 
Operating loss   (3,452)   (1,217)   (4,669)   (6,370)   (1,893)   (8,263)
Net loss  $(4,341)  $(1,217)  $(5,558)  $(7,942)  $(1,893)  $(9,835)
Net loss attributable to noncontrolling interest  $(3,556)  $(998)  $(4,554)  $(5,729)  $(1,552)  $(7,281)
Net loss attributable to Purple Innovation, Inc.  $(785)  $(219)  $(1,004)  $(2,213)  $(341)  $(2,554)
Net loss per common share - basic and diluted  $(0.09)  $(0.03)  $(0.12)  $(0.26)  $(0.04)  $(0.30)

 

Revenue Recognition

 

The Company generates revenues from the sale of its products. Revenue is recognized when the following revenue recognition criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or the service has been provided; (3) the selling price is fixed or determinable; and (4) collection of the resulting receivable is reasonably assured. Revenue is reported net of estimated sales returns and discounts and excludes sales taxes. As a part of the Company’s normal course of business, sales taxes are collected from customers. Such taxes collected are remitted, in a timely manner, to the appropriate governmental tax authority on behalf of the customer. The Company’s policy is to present revenue and costs, net of sales taxes.

 

With the exception of third-party “white glove” delivery and certain wholesale partners, revenue generated from product sales is recognized when the inventory is shipped to the customer, which is when title passes to the customer. Revenue generated from sales through third-party “white glove” delivery is recognized when the inventory is delivered to the customer and any required set up and removal services are complete. Revenue generated from certain wholesale partners is recognized when the inventory is delivered to the wholesale partner’s warehouse.

 

The Company does not normally charge additional amounts above list price to the customer for shipping and handling. Orders with an exceptionally high shipping cost may result in an additional charge to the customer with those amounts recorded as revenue under the same policy as product revenue. Shipping costs are recorded as a component of cost of revenues.

 

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

 

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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, 2018 or in prior periods. Basic net income (loss) per common share is calculated by dividing net income available (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 assuming exchanges of the Company’s outstanding Class B Stock and warrants for Class A Stock, and the vesting of unvested 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.

 

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 exercisable for shares of Class A Stock and the vesting of unvested Class A Stock.

 

Recent Accounting Pronouncements

 

New Revenue Guidance

 

In May 2014, in addition to several amendments issued during 2016, the FASB issued 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 guidance is based on the principle that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. These updates are effective for public companies for annual periods beginning after December 15, 2017, 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 and interim periods beginning January 1, 2019. The Company has the option of using either a full retrospective or a modified retrospective approach for the adoption of the new standard. The Company expects to adopt Topic 606 using the modified retrospective approach, under which the cumulative effect of initially applying Topic 606 is recognized as an adjustment to the opening balance of retained earnings in the first quarter of 2019.

 

The Company is concluding the assessment phase of implementing Topic 606 and has evaluated each of the five steps in Topic 606, which are as follows: (1) Identify the contract with the customer; (2) Identify the performance obligations in the contract; (3) Determine the transaction price; (4) Allocate the transaction price to the performance obligations; and (5) Recognize revenue when (or as) performance obligations are satisfied.

 

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The Company’s preliminary conclusion is that it does not expect reported revenue to be affected materially in any period due to the adoption of Topic 606 because: (1) the Company expects to identify similar performance obligations under Topic 606 as compared with deliverables and separate units of account previously identified; (2) the Company has determined the transaction price to be consistent; and (3) the Company records revenue at the same point in time, upon shipment or delivery under both Topic 605 and Topic 606, as applicable under the terms of the contract with the customer. Additionally, the Company does not expect the accounting for fulfillment costs or costs incurred to obtain a contract to be affected materially in any period due to the adoption of Topic 606.

 

There are certain considerations related to accounting policies, business processes, and internal control over financial reporting that are associated with implementing Topic 606. The Company is currently evaluating its policies, processes, and control framework for revenue recognition and identifying any changes that may need to be made in response to the new guidance. Disclosure requirements under the new guidance in Topic 606 have been significantly expanded in comparison to the disclosure requirements under the current guidance, including disclosures related to disaggregation of revenue into appropriate categories, performance obligations, the judgments made in revenue recognition determinations, adjustments to revenue which relate to activities from previous quarters or years, any significant reversals of revenue, and costs to obtain or fulfill contracts. Designing and implementing the appropriate controls over gathering and reporting the information required under Topic 606 is currently in process and the Company anticipates it will be completed prior to January 1, 2019.

 

New Lease Guidance

  

In February 2016, the FASB issued ASU No. 2016-02, “Leases,” 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. 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. The Company has not yet evaluated the impact this new standard may have on its financial statements and related disclosures.

 

Other Recent Accounting Pronouncements

 

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. These updates are effective for public companies for annual periods beginning after December 15, 2017, 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, 2019, and interim periods therein. The guidance in this standard is not expected to have a material impact on the financial statements.

 

In June 2016, the FASB issued ASU No, 2016-13, “Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments.” These amendments require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. These updates are effective for public companies for annual periods beginning after December 15, 2019, 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, 2021, and interim periods within annual periods beginning January 1, 2022, with early adoption permitted. The guidance in this standard is not expected to have a material impact on the financial statements.

 

In March 2016, the FASB issued ASU No. 2016-09, “Compensation-Stock Compensation: Improvements to Employee Share-Based Payment Accounting,” which updated the accounting guidance related to stock compensation. This update simplifies the accounting for employee share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. These updates are effective for public companies for annual periods beginning after December 15, 2016, 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, 2018, and interim periods within annual periods beginning January 1, 2019, with early adoption permitted. The guidance in this standard is not expected to have a material impact on the financial statements of the Company.

   

3. Merger Transaction

 

On February 2, 2018, upon consummation of the Transaction, 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, the following occurred:

 

-GPAC was renamed “Purple Innovation, Inc.” and the operating agreement of Purple LLC was amended so that, among other changes, the existing single class of common membership units was reclassified into two new classes of units, Class A membership units (the “Class A Units”) and Class B membership units (the “Class B Units”).

 

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  - 9.7 million Class A Units 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. 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.
  - 44.1 million Class B Units were issued and are solely held by 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. See Note 9—Commitments and Contingencies “—Indemnification Obligations” for discussion of terms related to Class B Stock and Class B Units held in an escrow account.
  - Purple Inc amended its articles of incorporation and renamed its existing common stock as Class A common stock (“Class A Stock”) and created a new class of stock named Class B common stock (“Class B Stock”) (refer to Note 10—Stockholders’ Equity and Member Deficit for a description of the Class A Stock and Class B Stock).
  - Purple Inc issued 44.1 million shares of Class B Stock to InnoHold.
  - Purple LLC initially obtained approximately $25.9 million in cash at the transaction date for working capital needs. Subsequent to the transaction date, a final closing reconciliation was performed resulting in an additional $0.4 million in cash to be received by Purple LLC from InnoHold, for a total of $26.3 million in cash received.

 

4. Inventories

 

Inventories consisted of the following (in thousands):

 

   September 30,   December 31, 
   2018   2017 
       (Revised) 
Raw materials  $11,089   $10,829 
Work-in-process   976    308 
Finished goods   17,263    2,450 
Inventory obsolescence reserve   (648)   (242)
Inventories, net  $28,680   $13,345 

 

5. Property and Equipment

 

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

 

   September 30,   December 31, 
   2018   2017 
Equipment  $14,904   $3,670 
Equipment in progress   4,104    8,609 
Leasehold improvements   3,295    1,265 
Office equipment   791    168 
Furniture and fixtures   844    469 
Equipment under capital lease   159    159 
Total property and equipment   24,097    14,340 
Accumulated depreciation   (2,378)   (876)
Property and equipment, net  $21,719   $13,464 

 

The Company recorded depreciation and amortization related to property and equipment of $0.5 million and $0.2 million during the three months ended September 30, 2018 and 2017. Depreciation and amortization of $1.5 million and $0.5 million were recorded during the nine months ended September 30, 2018 and 2017.

 

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6. Other Accrued Liabilities

 

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

 

   September 30,   December 31, 
   2018   2017 
Current portion of warranty accrual  $670   $640 
Website commissions   722    558 
Accrued property and franchise tax   258     
Accrued expenses   376    177 
Rent—related party       76 
Total other accrued liabilities  $2,026   $1,451 

 

7. Debt Obligations

 

Debt obligations consisted of the following at September 30, 2018 (in thousands):

 

   Principal
Borrowings
Outstanding
   Unamortized
Debt
Issuance
Costs
and
Discounts
   Net
Carrying
Value
   Interest
Rate
   Maturity
Date
Coliseum credit agreement  $26,170    (5,475)   20,695    12.0%  February 2023

 

Debt obligations consisted of the following at December 31, 2017 (in thousands):

 

   Principal
Borrowings
   Unused
Borrowing
   Interest   Maturity
   Outstanding   Capacity   Rate   Date
Wells Fargo line of credit(1)  $8,000   $2,000    4.6%  October 2019

 

(1) Revolving lines of credit are not presented net of unamortized debt issuance costs.

 

Coliseum 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 Debt Fund, L.P. (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 bears interest at a fixed rate of 12.0% per annum and matures on February 2, 2023. Interest accrues and is payable on the last business day of each fiscal quarter during the term of the Credit Agreement. 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. In addition, Purple LLC may elect for interest in excess of 5.0% per annum to be capitalized and added to the principal amounts of the Credit Agreement. The Credit Agreement provides for certain remedies to the Lenders in the event of customary events of default. The Credit Agreement also provides for standard indemnification of the Lenders and contains representations, warranties and certain covenants. While any amounts are outstanding under the Credit Agreement, Purple LLC is subject to a number of affirmative and negative covenants, including covenants regarding dispositions of property, investments, business combinations or acquisitions, incurrence of additional indebtedness and transactions with affiliates, among other customary covenants. In particular, Purple LLC is restricted from (i) making capital expenditures in excess of $20.0 million in any fiscal year, (ii) incurring capital lease obligations in excess of $10.0 million and (iii) incurring asset-based loans in excess of $20.0 million, subject to limited exceptions. Purple LLC is also restricted from making distributions or other payments on its membership interest, subject to limited exceptions.

 

The Company paid debt issuance costs, incurred an original issuance discount and discounts related to the Founder Shares (as defined in Note 10) 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 Transaction was $6.1 million.

 

Interest expense related to the Credit Agreement was $1.0 million and $2.6 million for the three and nine months ended September 30, 2018. No interest expense under this agreement was incurred in 2017. Of the interest expense incurred in 2018, $1.2 million was paid-in-kind through additions to the principal amount during the nine months ended September 30, 2018.

 

The Credit Agreement is carried at cost. At September 30, 2018, the fair value of the Credit Agreement is $27.9 million.

 

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Wells Fargo Line of Credit

 

In February 2018, the Company paid off and closed the line of credit with Wells Fargo by paying $8.1 million in cash including accrued interest and fees.

 

8. Related Party Transactions

 

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

 

Coliseum Capital Management, LLC

 

Immediately following the Closing, Adam Gray, managing partner of Coliseum Capital Management, LLC (“Coliseum”), was appointed to the Company’s board of directors. CCP, one of the lenders under the Credit Agreement is a related party of Coliseum. See Note 7—Debt Obligations.

 

Purple Founder Entities

 

TNT Holdings, LLC (“TNT”), EdiZONE, LLC (“EdiZONE”) and InnoHold (the “Purple Founder Entities”) were entities under common control with Purple LLC prior to the Transaction as TNT, EdiZONE and InnoHold are majority owned and controlled by Terry Pearce and Tony Pearce who also were the founders of Purple LLC and immediately following the Transaction were appointed to the Company’s board of directors (the “Purple Founders”).

 

On February 10, 2017, Purple LLC entered into a Shared Services Agreement with the Founder Entities, effective January 1, 2017, pursuant to which Purple LLC and the Founder Entities agreed to provide certain operational and administrative support services. Pursuant to the Shared Services Agreement, Casey McGarvey, Purple’s Chief Legal Officer, and other employees of Purple provided services to EdiZONE, LLC. Mr. McGarvey also provided similar services to InnoHold, the controlling member of Purple Inc, and to TNT. In the three and nine months ended September 30, 2018 and 2017, de minimis amounts of services were performed under this agreement.

 

TNT 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. The Company determined that TNT is not a VIE as it and Purple LLC do not hold any explicit or implicit variable interest in TNT and does not have a controlling financial interest in TNT. The Company incurred $0.3 million and $0.2 million in rent expense to TNT for the building lease of the Alpine facility in the three months ended September 30, 2018 and 2017. The Company incurred $0.9 million and $0.7 million in rent expense to TNT for the building lease of the Alpine facility in the nine months ended September 30, 2018 and 2017.

 

On November 1, 2017, Purple and EdiZONE executed the Confidential Assignment and License Back Agreement, pursuant to which EdiZONE assigned substantially all of its intellectual property to Purple and Purple licensed back to EdiZONE such intellectual property for use outside the consumer comfort and cushioning field of use reserved by Purple. EdiZONE also agreed to notify Purple of any breach of a third-party license agreement relating to consumer comfort intellectual property or consumer comfort products and Purple reserved the right to enforce EdiZONE’s rights with respect to such violations, provided that Purple agreed to pay the costs of such enforcement and to indemnify EdiZONE for any losses arising therefrom. EdiZONE further agreed not to extend such third-party licenses or waive any such violations, or to settle any claim with respect thereto, without Purple’s consent. In addition, EdiZONE also agreed to not sell or transfer any of its assets or assign any intellectual property or licenses relating to certain consumer comfort products and related intellectual property without Purple’s consent. EdiZONE has agreed not to use any intellectual property in the consumer comfort or cushioning field of use, subject only to its existing third-party licenses. EdiZONE previously granted third party licenses in the consumer comfort and cushioning field of use, and the Confidential Assignment and License Back Agreement allows EdiZONE to maintain these existing license agreements. On March 14, 2018, Purple and EdiZONE further amended and restated the Confidential Assignment and License Back Agreement to correct some inconsistencies in the agreement.

 

On February 2, 2018, in connection with the Closing, the Company entered into the Exchange Agreement with InnoHold, which provides for the exchange of Class B Units and of Class B Stock issued in connection with the Transaction into shares of Class A Stock. The initial exchange ratio will be (i) one Class B Unit plus (ii) one share of Class B Stock for one share of Class A Stock, in each case subject to certain adjustments.

 

On February 2, 2018, in connection with the Closing, the Company entered into the Tax Receivable Agreement with InnoHold. Pursuant to the Tax Receivable Agreement, the Company is required to pay InnoHold 80% of the amount of savings, if any, in U.S. federal, state and local income tax that the Company actually realizes (or is deemed to realize in the case of an early termination payment by the Company, or a change of control of the Company) as a result of the increases in tax basis and certain other tax benefits related to the payment of the cash consideration pursuant to the Merger Agreement and the exchange of the Class B Units (together with an equal number of shares of Class B Stock) for Class A Stock. The Company would retain the remaining 20% of cash savings, if any, realized. All payments of tax savings to InnoHold will be the Company’s obligation, and not that of Purple LLC.

 

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On February 2, 2018, in connection with the Closing, the Company entered into the Registration Rights Agreement with InnoHold and the Parent Representative. Under the Registration Rights Agreement, InnoHold holds registration rights that obligate the Company to register for resale under the Securities Act, all or any portion of the Equity Consideration (including Class A Stock issued in exchange for the Equity Consideration pursuant to the Exchange Agreement) (the “Registrable Securities”) so long as such shares are not then restricted under the Lock-Up Agreement. InnoHold is entitled to make a written demand for registration under the Securities Act of all or part of its Registrable Securities (up to a maximum of three demands in total), so long as such shares are not then restricted under the Lock-Up Agreement. Subject to certain exceptions, if any time after the Closing, the Company proposes to file a registration statement under the Securities Act with respect to its securities, under the Registration Rights Agreement, the Company shall give notice to InnoHold as to the proposed filing and offer InnoHold an opportunity to register the sale of such number of Registrable Securities as requested by InnoHold in writing. In addition, subject to certain exceptions, InnoHold is entitled under the Registration Rights Agreement to request in writing that the Company register the resale of any or all of its Registrable Securities on Form S-3 and any similar short-form registration that may be available at such time.

 

On February 2, 2018, in connection with the Closing, InnoHold and Terry Pearce and Tony Pearce, who together own a majority of InnoHold (collectively with InnoHold, the “Sellers”), entered into the Non-Competition Agreement with the Company, Purple LLC and their respective successors, affiliates and subsidiaries (referred to as the “Covered Parties”). Pursuant to the Non-Competition Agreement, for a period from the Closing until three years thereafter (or if later, until the one year anniversary of the date on which the Sellers, their affiliates or any of their respective officers, directors or employees are no longer directors, officers, managers or employees of the Company (the “Termination Date”)), each Seller and its affiliates will not, without the Company’s prior written consent, directly or indirectly engage in (or own, manage, finance or control, or become engaged or serve as an officer, director, employee, member, partner, agent, consultant, advisor or representative of), an entity that engages in the business of (i) designing and manufacturing comfort technology products worldwide to improve how people sleep, sit, and stand, including mattresses, pillows, platform bases and cushions, and (ii) marketing, licensing and selling its products worldwide through direct-to-consumer, traditional retail channels and partnerships (collectively, the “Business”) anywhere in the world, subject to certain specified exceptions for existing relationships. However, the Covered Parties and their affiliates are permitted under the Non-Competition Agreement to own passive portfolio company investments of no more than 2% in a competitor of the Covered Parties, so long as the Sellers, their affiliates and their respective shareholders, directors, officer, managers and employees who were involved with the business of the Covered Parties are not involved in the management or control of such competitor.

 

On February 2, 2018, in connection with the Closing, InnoHold entered into a lock-up agreement with the Company and the Parent Representative (“Lock-Up Agreement”) with respect to the equity securities of both the Company and Purple LLC received in the Transaction (the “Restricted Securities”). Pursuant to the Lock-Up Agreement, InnoHold agreed that it will not, from the Closing until the earliest of (x) the one year anniversary of the Closing, (y) the date on which the last sale price of the Class A Stock (or any successor publicly traded common equity security) equals or exceeds $12.00 per share (as equitably adjusted for stock splits, stock dividends, reorganizations, recapitalizations and the like) for any 20 trading days within any 30-trading day period commencing at least 150 days after the Closing or (z) the date on which the Company consummates a liquidation, merger, share exchange or other similar transaction with an unaffiliated third party that results in all of the Company’s stockholders having the right to exchange either equity holdings in the Company for cash, securities or other property: (i) lend, offer, pledge, hypothecate, encumber, donate, assign, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase, or otherwise transfer or dispose of, directly or indirectly, any of the Restricted Securities, (ii) enter into any swap or other arrangement that transfers to another, in whole or in part, any of the economic consequences of ownership of any of its Restricted Securities, or (iii) publicly announce any intention to effect any transaction specified in clause (i) or (ii). However, InnoHold is allowed to transfer any of its Restricted Securities under certain limited exceptions, including to affiliates, to family members or to its equity holders, provided in each such case that the transferee thereof agrees to be bound by the restrictions set forth in the Lock-Up Agreement. InnoHold is also permitted to transfer the Restricted Securities pursuant to an underwritten public offering to which all of the parties to the Lock-Up Agreement shall have consented.

 

9. Commitments and Contingencies

 

Required Member Distributions

 

Prior to the Transaction 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 Transaction. The Second Purple LLC Agreement does not include any mandatory distributions, other than tax distributions. During the three and nine months ended September 30, 2017, distributions of $1.4 million and $3.8 million were made by Purple LLC under the First Purple LLC Agreement. No distributions have been made under the Second Purple LLC Agreement in 2018.

  

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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 Tooele, 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 $1.3 million and is reduced annually on a straightline basis over the 10-year period. In the second quarter 2018, the utility improvements construction was completed and were made available to the Company. As of September 30, 2018, 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 two non-cancellable operating leases. Building space for its headquarters facility in Alpine, Utah is leased from TNT, an entity that prior to the Transaction was under common control with Purple LLC. The Company also leases a facility located in Tooele, Utah for use primarily as manufacturing and warehouse space. At September 30, 2018 and December 31, 2017, deferred rent of $2.4 million and $1.9 million, respectively is included in other long-term liabilities on the accompanying balance sheets. The Company recognizes rent expense on a straight-line basis over the non-cancellable lease term. During the three months ended September 30, 2018 and 2017, the Company recognized rent expense in the amount of $0.9 million and $0.7 million. During the nine months ended September 30, 2018 and 2017, the Company recognized rent expense in the amount of $2.6 million and $2.0 million.

 

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 exchange, the Company is offered a discount per gallon. The Company expects to pay approximately $14.4 million over the two-year period. As of September 30, 2018, the Company expects to fulfill its commitments under the agreement in the normal course of business, and as such, no liability has been recorded.

 

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.

 

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 Transaction 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 Common Stock. The registration statement was declared effective on April 3, 2018.

 

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 (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 delivers a notice of exchange multiplied by the number of Paired Securities being exchanged.

  

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Holders of Class B Units may elect to exchange all or any portion of their Class B Units (together with an equal number of shares of Class B Stock) as described above by delivering a notice to Purple LLC. However, the Class B Units (together with an equal number of shares of Class B Stock) may not be exchanged during a lock-up period ending on the earliest of (x) the one year anniversary of the Closing, (y) the date on which the last sale price of the Class A Stock (or any successor publicly traded common equity security) equals or exceeds $12.00 per share (as equitably adjusted for stock splits, stock dividends, reorganizations, recapitalizations and the like) for any 20 trading days within any 30-trading day period commencing at least 150 days after the Closing or (z) the date on which the Company consummates a liquidation, merger, share exchange or other similar transaction with an unaffiliated third party that results in all of the Company’s stockholders having the right to exchange either equity holdings in the Company for cash, securities or other property. The exchange will occur automatically upon the occurrence of a change of control or sale of substantially all of the assets of the Company or Purple LLC.

 

In certain cases, adjustments to the exchange ratio will occur in case of a split, reclassification, recapitalization, subdivision or similar transaction of or relating to the Class B Units or the shares of Class A 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 Class B Units 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 Class B Units shall bear its own expense regarding the exchange except that the Company shall be responsible for transfer taxes, stamp taxes and similar duties.

 

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 shareholder 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 having a voting interest in the Company that is identical to InnoHold’s economic interest in Purple LLC. 

 

Legal Proceedings 

 

On January 9, 2018, Chris Knudsen filed a complaint against Purple LLC in the Fourth Judicial District Court of the State of Utah. Mr. Knudsen is a former consultant to Purple LLC. His contract with the Company ended in March 2016. Mr. Knudsen alleges that Purple LLC orally agreed before the end of his consulting contract to appoint him as its chief executive officer beginning April 2016. Mr. Knudsen also contends that Purple LLC orally agreed to immediately issue him 4% of Purple LLC’s equity at the time of his appointment as chief executive officer. Mr. Knudsen alleges that Purple LLC breached these alleged oral agreements when it did not appoint him as chief executive officer on April 1, 2016 and did not provide any equity interests to him. Mr. Knudsen alleges that Purple LLC owes him a sum of $44 million for his purported equity stake in Purple LLC, plus interest, based on an initially announced $1.1 billion valuation. Mr. Knudsen also seeks declaratory relief that he owns the 4% equity position in Purple LLC. Purple LLC has responded to the complaint and denies that it reached an agreement with Mr. Knudsen for him to assume the role of chief executive officer, denies that it reached an agreement to provide equity to Mr. Knudsen, believes that this lawsuit is without merit and intends to vigorously contest 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.

 

Purple LLC filed a lawsuit against Honest Reviews, LLC (“HMR”), Ryan Monahan (“Mr. Monahan”) and GhostBed, Inc. (“GhostBed”) (collectively, the “Defendants”), alleging that the Defendants are working together on a competitive campaign to intentionally disseminate false and misleading statements regarding the safety of the Company’s mattresses, while at the same time failing to disclose to the public the fact that Mr. Monahan has, since 2015, provided significant digital marketing services to GhostBed, for which his company received substantial compensation. The Defendants have published a number of articles and related materials claiming, without substantiation, that the non-toxic anti-tack powder used in connection with the Company’s products can cause respiratory distress, exacerbate asthma or other respiratory conditions, and cause cancer or even death. Defendants have widely published these materials, including on the HMR website, honestmattressreviews.com, and all of associated HMR social media pages. On September 22, 2017, the United States District Court in Utah issued a preliminary injunction requiring full disclosure of the relationship between GhostBed and Monahan on the HMR website and social media, the removal of certain prior articles and other content regarding the Company, the anti-tack powder, and the lawsuit from the HMR website and social media, and requiring that any future posts by the Defendants regarding the Company or the lawsuit be accompanied by a full disclosure of the relationship between Monahan and GhostBed. On February 12, 2018, the Court sanctioned the Defendants for their untruthful and misleading statements to the Court by awarding $0.2 million in attorneys’ fees to Purple LLC and dismissing GhostBed’s counterclaims against Purple LLC. The preliminary injunction remains in effect as of this filing. The Defendants have not yet paid to Purple LLC the amount of the sanctions awarded by the Court, and Purple LLC has been forced to file motions against Defendants for contempt of the Court’s order, which motions remain pending at this time. Despite the Court’s favorable rulings to date, Purple LLC is unable to determine, at this stage, the possible outcome of the litigation.

  

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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. 

 

10. Stockholders’ Equity and Member Deficit

 

Prior to the Transaction, 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.

 

In connection with the Transaction, 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, 2018, 9.7 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 the earlier of (A) one year after the completion of the Transaction, or earlier if, subsequent to the Transaction, the last sale price of Class A Stock equals or exceeds $12.00 per share (subject to adjustments for stock splits, stock dividends, reorganizations, recapitalizations and the like) for any 20 trading days within any 30-trading day period commencing at least 150 days after the Transaction or (B) the date on which the Company completes a liquidation, merger, stock exchange or other similar transaction after the Transaction that results in all of its stockholders having the right to exchange their shares of common stock for cash, securities or other property.

 

In accordance with the terms of the Transaction, 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 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.

  

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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 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 Transaction until the earliest of (i) the one-year anniversary of the date of the Transaction, (ii) the date on which the last sale price of the Class A Stock equals or exceeds $12.00 per share for any 20 trading days within a 30-trading day period commencing at least 150 days after the date of the Transaction and (iii) the date on which the Company consummates a liquidation, merger share exchange or other similar transaction with an unaffiliated third party that results in all of the Company’s stockholders having the right to exchange equity holdings in the Company for cash, securities or other property. 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.

 

In connection with the Transaction, approximately 44.1 million shares of Series B Stock were issued to InnoHold as part of the equity consideration. At September 30, 2018, 44.1 million shares of Class B Stock were outstanding.

 

Warrants

 

There were 15.5 million public warrants (the “Public Warrants”) issued in connection with GPAC’s 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 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. Warrants must be exercised for a whole share.  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 Transaction, 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.

 

There were 12.8 million warrants, issued simultaneously with the IPO, pursuant to a private placement. The private placement warrants expire on the earlier to occur of: (i) 5 years after the date of the Transaction, or (ii) a redemption date if the stock trades over $24.00 for 20 trading days within a 30-day trading period while being exercisable and if there is an effective registration agreement. All other terms, rights and obligations remain the same as the warrants described above.

 

From the time of GPAC’s IPO up to the Transaction with Purple LLC, GPAC had 28.3 million warrants outstanding. At September 30, 2018, 28.3 million warrants were outstanding.

 

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, 2018, there were no shares of preferred stock outstanding.

  

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Noncontrolling Interest

 

NCI represents the membership interest held by holders other than the Company. On February 2, 2018, upon the close of the Transaction, and at September 30, 2018, InnoHold’s NCI percentage in Purple LLC was approximately 82%. The Company has consolidated the financial position and results of operations of Purple LLC and reflected the proportionate interest held by InnoHold as NCI.

 

11. 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 is expected to differ materially from the statutory rate.

 

As of September 30, 2018, the Company has a full valuation allowance on its net deferred tax assets. As of December 31, 2017, there were no deferred tax assets or valuation allowances at Purple LLC. In assessing the realizability of deferred tax assets, including the deferred tax assets to be recorded in connection with the Transaction 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 three and nine months ended September 30, 2018.

 

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 is recorded as a result of the Transaction since its legal form is 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 Company expects that the excess of its tax basis in its investment in Purple LLC over its book carrying value in this investment will result in a deferred tax asset that may reduce certain income tax payments in the future. This deferred tax asset will encompass the basis increase in the assets of Purple LLC as a result of the Transaction and Tax Receivable Agreement as well as the Company’s share of Purple LLC’s unrecognized temporary timing differences between book and tax. The Company is still collecting the necessary information to quantify this net deferred tax asset for the outside basis difference. As noted above due to the uncertainty around the generation of future taxable income the Company will record a valuation allowance against the net deferred tax asset for this outside basis difference in the investment in Purple LLC.

 

In connection with the Transaction the Company entered into the Tax Receivable Agreement with the NCI holder, InnoHold, which provides for the payment by the Company to InnoHold of 80% of the net cash savings, if any, in U.S. federal, state and local income tax that the Company actually realizes (or is deemed to realize in certain circumstances) in periods after the Closing as a result of (i) any tax basis increases in the assets of Purple LLC resulting from the distribution to InnoHold of the cash consideration, (ii) the tax basis increases in the assets of Purple LLC resulting from the redemption by Purple LLC or the exchange by the Company, as applicable, of Class B Paired Securities or cash, as applicable, and (iii) imputed interest deemed to be paid by the Company as a result of, and additional tax basis arising from, payments it makes under the Tax Receivable Agreement. As realization of the tax benefit related to the Transaction is not currently deemed probable, no liability under the Tax Receivable Agreement has been recognized in the accompanying condensed consolidated balance sheet.

 

In the future, if and when InnoHold exercises its 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 Class B Paired Securities by InnoHold and uncertainty about the ability of the Company to realize net cash savings, the Company does not believe it is appropriate to record a TRA Liability related to future exchanges until such time that InnoHold exercises its right to cause Class B Paired Securities to be exchanged or converted into the Company’s Class A Stock or cash and the Company believes that the associated tax benefits are more-likely-than-not to result in net cash savings.

  

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The Company is treated as acquiring historical net deferred tax assets of GPAC of approximately $0.3 million in the Transaction. These deferred tax assets, including those to be recorded in connection with the Transaction, the Tax Receivable Agreement and for net operating loss carryforwards generated in 2018, 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, 2018, no uncertain tax positions were recognized as liabilities in the condensed consolidated financial statements.

 

12. Net Loss Per Common Share

 

The Transaction was structured similar to a reverse recapitalization by which the Company issued stock for the net assets of Purple LLC accompanied by a recapitalization. Earnings per share has been recast for all historical periods to reflect the Company’s capital structure of all comparative periods.

 

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,
 
   2018   2017   2018   2017 
Numerator:                
Net loss attributable to Purple Innovation, Inc.  $(789)  $(5,449)  $(3,343)  $(4,255)
Denominator:                    
Weighted average shares—basic and diluted   8,437    8,389    8,412    8,389 
Net loss per common share:                    
Basic  $(0.09)  $(0.65)  $(0.40)  $(0.51)
Diluted  $(0.09)  $(0.65)  $(0.40)  $(0.51)

 

For the periods presented, the Company excluded 1.3 million shares of issued common stock subject to vesting and 14.2 million shares of common stock issuable upon conversion of the Company’s warrants as the effect was anti-dilutive.

 

 13. Equity Compensation Plans

 

InnoHold Incentive Units

 

The following table summarizes the total incentive unit activity granted by InnoHold and benefiting the Company for the nine months ended September 30, 2018 (in thousands):

 

   Incentive 
   Units 
Incentive units outstanding as of January 1, 2018   8,617 
Cancelled   (8,617)
Granted   10 
Exercised    
Forfeited   (3)
Incentive units outstanding as of September 30, 2018   7 
      
Incentive units vested at September 30, 2018   5 

 

In January 2017 pursuant to the 2016 Equity Incentive Plan that authorized the issuance of 12.0 million incentive units, the Company granted 11.3 million incentive units to Purple Team, LLC, an entity for the benefit of certain employees, which vest over four years (with 25% vesting after the first year and monthly vesting thereafter for the following 36 months) from the first of the month after their respective date of hire or January 1, 2016, whichever is later. These incentive units were non-voting and the unit holders only participate in potential liquidating distributions after a future majority sale of the Company. Incentive unit holders were only eligible to participate after the distribution threshold of approximately $135.0 million was met. The majority sale and $135.0 million threshold were considered performance conditions of the incentive units. As of December 31, 2017, the Company had not recorded any costs related to the incentive units, as the achievement of the performance conditions was not yet deemed probable.

  

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In conjunction with the Closing, the incentive units were cancelled and new incentive units were issued by InnoHold under its own limited liability company agreement (the “InnoHold Agreement”), which is considered a modification for accounting purposes. Under the revised terms of the incentive units granted under the InnoHold Agreement, the holders are only eligible to participate in InnoHold’s distributions, if any, after the distribution threshold of approximately $135.0 million is met, which is considered a performance condition. Under the terms of the new incentive units, holders may participate in tax and discretionary distributions once the remaining threshold is met. As of September 30, 2018, the remaining threshold is approximately $96.6 million. As of September 30, 2018, the Company has not recorded any expenses related to the incentive units, as the achievement of the performance condition was not yet deemed probable.

 

2017 Equity Incentive Plan

 

On April 10, 2018, the Company filed a Form S-8 to register 4.1 million shares of Class A Stock authorized for issuance under the Purple Innovation, Inc. 2017 Equity Incentive Plan (the “2017 Incentive Plan”). In May 2018, immediately vested stock awards of $0.3 million were issued under the 2017 Incentive Plan to members of the Company’s board of directors for services performed. As of September 30, 2018, approximately 4.1 million shares remained available under the 2017 Incentive Plan.

  

14. Subsequent Events

 

On October 1, 2018, Joseph B. Megibow began his employment to serve as Chief Executive Officer of the Company. In connection with his employment, Mr. Megibow received an equity inducement grant outside of the Company’s 2017 Equity Incentive Plan, of stock options to purchase 0.5 million shares of the Company’s Class A common stock. The options have an exercise price of $5.95 per share, vest over a four-year period and expire five years from the date of issuance.

 

On October 1, 2018, the Company granted to Mark A. Watkins, Chief Financial Officer, nonqualified stock options to purchase 0.3 million shares of the Company’s Class A common stock. The options have an exercise price of $5.95 per share, vest over a four-year period and expire five years from the date of issuance. On November 6, 2018 the Company granted Mr. Watkins additional options to purchase 0.07 million shares of the Company’s Class A common stock. The options have an exercise price of $6.08 per share, vest over a four-year period and expire five years from the date of issuance.

 

On October 2, 2018, the Company received an additional $0.4 million in cash from InnoHold pursuant to a final closing reconciliation of the Transaction.

 

On October 5, 2018 (the “Petition Date”), Mattress Firm, Inc. (“Mattress Firm”) and certain of its affiliates (collectively, the “Debtors”) filed voluntary petitions for bankruptcy pursuant to chapter 11 of title 11 of the United States Code with the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”).  As of the Petition Date, according to the Debtors’ chapter 11 petition, the Company held an unsecured claim against the Debtors in the amount of $3.5 million.  Also on October 5, 2018, the Debtors filed a Joint Prepackaged Chapter 11 Plan of Reorganization (the “Plan”).  The Plan proposes that holders of general unsecured claims will be paid in full, in cash either in the ordinary course of business or upon the date that Plan becomes effective.  Finally, the Debtors have filed a motion and obtained interim Bankruptcy Court authorization (and they are seeking final authorization) to pay undisputed prepetition claims for goods and services related to their operations in the ordinary course of business, subject to certain conditions (the “Pay All Motion”).  The Company is working with counsel to confirm its treatment under the Plan, confirm its eligibility under the Pay All Motion, and otherwise protect its rights throughout the Debtors’ bankruptcy process. As of the date of this filing, the debtors have paid the amount of the unsecured claim filed in the bankruptcy petition.

 

On November 9, 2018, Purple LLC and EdiZONE executed a Second Amended and Restated Confidential Assignment and License Back Agreement (the “Revised License Agreement”). On November 1, 2017, Purple LLC and EdiZONE executed the Confidential Assignment and License Back Agreement (the “Prior License Agreement”), pursuant to which EdiZONE assigned substantially all of its intellectual property to Purple LLC and Purple LLC licensed back to EdiZONE such intellectual property for use outside the consumer comfort and cushioning field of use reserved by Purple LLC. EdiZONE also agreed to notify Purple LLC of any breach of a third-party license agreement relating to consumer comfort intellectual property or consumer comfort products and Purple LLC reserved the right to enforce EdiZONE’s rights with respect to such violations, provided that Purple LLC agreed to pay the costs of such enforcement and to indemnify EdiZONE for any losses arising therefrom. EdiZONE further agreed not to extend such third-party licenses or waive any such violations, or to settle any claim with respect thereto, without Purple LLC’s consent. In addition, EdiZONE also agreed to not sell or transfer any of its assets or assign any intellectual property or licenses relating to certain consumer comfort products and related intellectual property without Purple LLC’s consent. EdiZONE previously granted third-party licenses in the consumer comfort and cushioning field of use, and the Prior License Agreement allowed EdiZONE to maintain these existing license agreements.  On March 14, 2018 Purple LLC and EdiZONE further amended and restated the Prior License Agreement to correct some inconsistencies in the Prior License Agreement.  On November 9, 2018, Purple LLC and EdiZONE executed the Revised License Agreement, pursuant to which EdiZONE continues to assign all of its comfort and cushioning intellectual property to Purple LLC and Purple LLC licensed back to EdiZONE certain intellectual property for use limited to certain license agreements EdiZONE had entered into with third parties. The Revised License Agreement clarifies the scope of the intellectual property assigned to Purple LLC and the subset of such intellectual property licensed back to EdiZONE by limiting EdiZONE’s license to only those uses that will enable EdiZONE to comply with its obligations under previously existing contracts, agreements and licenses. The Revised License Agreement also eliminates the license back to EdiZONE of intellectual property for uses unrelated to the existing contracts. The Revised License Agreement also modifies EdiZONE’s confidentiality obligations to be consistent with the above-described changes.

 

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

 

The following discussion is intended to provide a more comprehensive review of the operating results and financial condition of Purple Innovation, Inc. than can be obtained from reading the Unaudited Condensed Consolidated Financial Statements alone. The discussion should be read in conjunction with the Unaudited Condensed Consolidated Financial Statements and the notes thereto included in “Part I. Item 1. Financial Statements.” Unless the context otherwise requires, references to (i) “Purple,” “the Company,” “our company,” “we,” “our” and “us,” or like terms, refer to Purple Innovation, Inc. and its subsidiaries, currently Purple Innovation, LLC, (ii) “Purple Inc” refers to Purple Innovation, Inc. without its subsidiary and (iii) “Purple LLC” refers to Purple Innovation, LLC, an entity of which we act as the sole managing member and of whose common units we currently own approximately 18%. “Global Partner Acquisition Corp.” and “GPAC” refer to the Company prior to the Closing (defined below), and the “Purple Business” or “Purple before the Transaction” refers to the Purple business before it became a wholly owned subsidiary of the Company upon the Closing.

  

On February 2, 2018, we consummated a reverse recapitalization (the “Transaction”) pursuant to which we acquired a portion of the equity of Purple LLC. The Transaction 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 Transaction; (ii) the combined results of the Company following the Transaction; (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-Transaction) presented.

 

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 quarterly reports on Form 10-Q filed May 15, 2018 and August 9, 2018, and in our Current Report on Form 8-K filed with the Securities and Exchange Commission on February 8, 2018, as amended February 14, 2018, March 15, 2018 and April 17, 2018.

 

Introductory Note

 

On February 2, 2018 (the “Closing Date”), our predecessor, Global Partner Acquisition Corp. (“GPAC”) consummated the previously announced merger transaction (the “Transaction”) pursuant to that certain 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 the Company (“Merger Sub”), Purple Innovation, LLC, a Delaware limited liability company (“Purple LLC”), InnoHold, LLC, (“InnoHold”) a Delaware limited liability company and the sole equity holder of Purple LLC, and Global Partner Sponsor I LLC, solely in its capacity thereunder as the representative of GPAC after the consummation of the transactions contemplated by the Merger Agreement (the “Parent Representative” or 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 Transaction.

   

In connection with the closing of the Transaction (the “Closing”), the Company changed its name from “Global Partner Acquisition Corp.” to “Purple Innovation, Inc.”

  

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Overview of Our Business

 

Purple is a comfort technology company that designs and manufactures products to improve how people sleep, sit, and stand. We design and manufacture a range of comfort technology products, including mattresses, pillows, and cushions, using our patented Hyper-Elastic Polymer technology designed to improve comfort. We market and sell our products through our direct-to-consumer online channel, traditional wholesale partners and third-party online retailers.

 

Operating Results for the Three Months Ended September 30, 2018 and 2017

 

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

 

   Three Months Ended September 30, 
   2018   % of
Net Revenues
   2017   % of
Net Revenues
 
Revenues, net  $70,806    100.0%  $56,011    100.0%
Cost of revenues   42,684    60.3    31,927    57.0 
Gross profit   28,122    39.7    24,084    43.0 
Operating expenses:                    
Marketing and sales   25,188    35.6    25,655    45.8 
General and administrative   5,804    8.2    3,520    6.3 
Research and development   578    0.8    356    0.6 
Total operating expenses   31,570    44.6    29,531    52.7 
Operating loss   (3,448)   (4.9)   (5,447)   (9.7)
Interest expense   999    1.4    4     
Other income, net   (83)   (0.1)   (2)   (0.0)
Net loss   (4,364)   (6.2)   (5,449)   (9.7)
Net loss attributable to noncontrolling interest   (3,575)   (5.0)        
Net loss attributable to Purple Innovation, Inc.  $(789)   (1.1)  $(5,449)   (9.7)

 

Revenue

 

Total net revenue increased $14.8 million, or 26%, to $70.8 million for the three months ended September 30, 2018 from $56.0 million for the three months ended September 30, 2017 due mainly to a $16.9 million increase in mattress sales partially offset by a $4.7 million decrease in sales of bases and top of bed products. The increase in mattress sales was primarily attributable to a 10% increase in direct-to-consumer revenue driven by increased efficiencies in our marketing investments and the release of our new higher-priced mattress models and a 528% increase in wholesale revenue. With our retail partners we have expanded the number of stores carrying our products, and we expect store penetration to increase in the fourth quarter of 2018.

 

Cost of Revenues

 

The cost of revenues increased $10.8 million, or 34%, to $42.7 million for the three months ended September 30, 2018 from $31.9 million for the three months ended September 30, 2017. The increase is primarily due to a $4.7 million increase in direct materials related to the increased mattress sales and a $2.6 million increase in freight costs due to third party “white-glove” delivery. The gross profit percentage decreased to 39.7% of net revenues for third quarter 2018 from 43.0% for third quarter 2017. The decrease was partially driven by increased product costs, higher freight costs, inefficiencies in our manufacturing process as we migrated to a new warehouse management system, improved quality assurance processes that have identified additional scrap, and a shift in sales mix to more sales with wholesale pricing. These decreases to gross profit were partially offset by the higher product margins from the new mattress models.

 

Marketing and Sales

 

Marketing and sales expenses decreased $0.5 million, or 2%, to $25.2 million for the three months ended September 30, 2018 from $25.7 million for the three months ended September 30, 2017. The marketing and sales expense as a percentage of net revenue decreased to 35.6% for the three months ended September 30, 2018 from 45.8% for the three months ended September 30, 2017. This decrease is due to the Company’s efforts to improve the efficiency of marketing spend for the revenue generated.

 

General and Administrative

 

General and administrative expenses increased $2.3 million, or 65%, to $5.8 million for the three months ended September 30, 2018 from $3.5 million for the three months ended September 30, 2017. The increase was primarily due to the costs incurred to support top-line growth and maintain the infrastructure to operate as a public company. Salary and wage expense increased $1.6 million as we increased headcount commensurate with a public company operating level and an increase of $0.9 million in software subscriptions as we increased system infrastructure. These increases were partially offset by decreases in professional and legal fees, insurance and other expenses totaling $0.5 million in the aggregate.

  

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Research and Development

 

Research and development costs increased $0.2 million, or 62%, to $0.6 million for the three months ended September 30, 2018 from $0.4 million for the three months ended September 30, 2017. The increase is primarily due to increases in salaries and wages.

 

Operating loss

 

Operating loss was $3.4 million for the three months ended September 30, 2018, a change of $2.0 million from operating loss of $5.4 million for the three months ended September 30, 2017. The change was primarily due to higher revenues than the prior year and lower marketing spend as a percentage of net revenue in 2018, partially offset by a lower gross profit percentage.

 

Interest Expense

 

We incurred interest expense in 2018 primarily due to assumption of the Coliseum credit agreement that has an outstanding balance of $26.2 million at September 30, 2018 and accrues interest at a fixed rate of 12%. In addition, we incurred discounts and debt issuance costs related to the debt, which also amortize into interest expense as noncash interest.

 

Noncontrolling Interest

 

As a result of the Transaction in 2018, we attribute net income or loss to the Class B units in Purple LLC, owned by InnoHold, as a noncontrolling interest at its ownership percentage. At September 30, 2018, this ownership percentage was approximately 82%.

 

Operating Results for the Nine Months Ended September 30, 2018 and 2017

 

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

 

   Nine Months Ended September 30, 
   2018   % of
Net Revenues
   2017   % of
Net Revenues
 
Revenues, net  $207,334    100.0%  $133,820    100.0%
Cost of revenues   121,575    58.6    74,726    55.8 
Gross profit   85,759    41.4    59,094    44.2 
Operating expenses:                    
Marketing and sales   77,956    37.6    53,970    40.3 
General and administrative   17,870    8.6    8,473    6.3 
Research and development   1,644    0.8    904    0.7 
Total operating expenses   97,470    47.0    63,347    47.3 
Operating loss   (11,711)   (5.6)   (4,253)   (3.2)
Interest expense   2,672    1.3    4    0.0 
Other income, net   (184)   (0.1)   (2)   (0.0)
Net loss   (14,199)   (6.8)   (4,255)   (3.2)
Net loss attributable to noncontrolling interest   (10,856)   (5.2)        
Net loss attributable to Purple Innovation, Inc.  $(3,343)   (1.6)  $(4,255)   (3.2)

 

Revenue

 

Total net revenue increased $73.5 million, or 55%, to $207.3 million for the nine months ended September 30, 2018 from $133.8 million for the nine months ended September 30, 2017 due mainly to a $73.3 million increase in mattress sales and a $2.0 million increase in sales of top of bed products, partially offset by a $5.1 million decrease in sales of bases. The increase in mattress sales was primarily attributable to a 41% increase in direct-to-consumer revenue driven by increased efficiencies in our marketing investments and the release of our new higher-priced mattress models and a 634% increase in wholesale revenue. With our retail partners we have expanded the number of stores carrying our products, and we expect store penetration to increase in the fourth quarter of 2018.

  

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Cost of Revenues

 

The cost of revenues increased $46.8 million, or 63%, to $121.5 million for the nine months ended September 30, 2018 from $74.7 million for the nine months ended September 30, 2017. The increase is primarily due to a $21.9 million increase in direct materials related to the increased mattress sales and a $9.9 million increase in freight costs due to third party “white glove” delivery. The gross profit percentage decreased to 41.4% of net revenues through the third quarter of 2018 from 44.2% through the third quarter of 2017. The decrease was partially driven by increased product costs, higher freight costs, inefficiencies in our manufacturing process as we migrated to a new warehouse management system, improved quality assurance processes that have identified additional scrap, and a shift in sales mix to more sales with wholesale pricing. These decreases to gross profit were partially offset by the higher product margins from the new mattress models.

 

Marketing and Sales

 

Marketing and sales expenses increased $24.0 million, or 44%, to $78.0 million for the nine months ended September 30, 2018 from $54.0 million for the nine months ended September 30, 2017. The increase is primarily due to a $20.4 million increase in advertising costs, a $1.1 million increase in other marketing and sales expenses and a $2.4 million increase in marketing salaries related to an increase in the workforce. The marketing and sales expense as a percentage of net revenue decreased to 37.6% for the nine months ended September 30, 2018 from 40.3% for the nine months ended September 30, 2017. This decrease is due to the Company’s efforts to improve the efficiency of marketing spend for the revenue generated.

 

General and Administrative

 

General and administrative expenses increased $9.4 million, or 111%, to $17.9 million for the nine months ended September 30, 2018 from $8.5 million for the nine months ended September 30, 2017. The increase was primarily due to the costs incurred with completing the Transaction and costs incurred as we operate as a public company. Professional fees increased $3.7 million, primarily driven by Transaction costs. Salary and wage expense increased $3.0 million as we increased our workforce and incurred a $0.3 million charge for stock-based compensation, and $2.3 million in other expenses related primarily to software subscriptions as we increased systems infrastructure. We anticipate that our general and administrative costs, excluding Transaction costs and other one-time charges, will be consistent with the third quarter through the remainder of 2018.

 

Research and Development

 

Research and development costs increased $0.7 million, or 82%, to $1.6 million for the nine months ended September 30, 2018 from $0.9 million for the nine months ended September 30, 2017. The increase is primarily due to increases in salaries and wages.

 

Operating loss

 

Operating loss was $11.7 million for the nine months ended September 30, 2018, a change of $7.4 million from operating loss of $4.3 million for the nine months ended September 30, 2017. The change was primarily due to costs incurred to close the Transaction and inefficiencies in our manufacturing and logistics.

 

Interest Expense

 

We incurred interest expense in 2018 primarily due to assumption of the Coliseum credit agreement that has an outstanding balance of $26.2 million at September 30, 2018 and accrues interest at a fixed rate of 12%. In addition, we incurred discounts and debt issuance costs related to the debt, which also amortize into interest expense as noncash interest. We anticipate interest expense will increase slightly on a quarterly basis through the remainder of 2018.

 

Noncontrolling Interest

 

As a result of the Transaction in 2018, we attribute net income or loss to the Class B units in Purple LLC, owned by InnoHold, as a noncontrolling interest at its ownership percentage. At September 30, 2018, this ownership percentage was approximately 82%. We currently anticipate this percentage to remain consistent through the remainder of 2018.

 

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Liquidity and Capital Resources

 

Our primary cash needs have historically consisted of working capital, capital expenditures, member distributions 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 positive working capital of $4.3 million as of September 30, 2018, and we had negative working capital of $(18.3) million as of December 31, 2017. In 2018, we increased inventory balances due to an expanded product line, growing demand for our product and stocking of new models at third-party distribution centers for “white glove” delivery service. In addition, purchases of raw materials and production were ramped up related to initial revenue forecasts for the year that have since been reduced. Our capital expenditures primarily relate to acquiring and maintaining manufacturing equipment. Our cash used for capital expenditures was $9.9 million and $5.3 million for the nine months ended September 30, 2018 and 2017. We financed these capital expenditures through cash provided by operating activities and the cash received through the Transaction. We expect our capital expenditures for our facilities and equipment to be between $10.0 million and $13.0 million in 2018.  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.

 

Debt service consists of principal and interest payments on the outstanding balance of the Credit Agreement, certain equipment loans and capital leases. On February 2, 2018, we entered into the Credit Agreement and received approximately $24.0 million in proceeds after original issue discounts. 

 

In 2017, we entered into a $10.0 million debt facility with Wells Fargo Bank and as of December 31, 2017, approximately $8.0 million had been drawn against that facility. We were in breach of terms of the agreement by failing to facilitate collateral audits in accordance with the provisions of the agreement, but we received a waiver from Wells Fargo Bank of its default rights so long as we facilitated collateral audits by January 19, 2018. We delivered the collateral audit information to Wells Fargo by that deadline. Subsequent to the repayment of the loan, we determined that it would have breached the term to meet a certain EBITDA covenant as of December 31, 2017. On February 2, 2018, in connection with the Transaction, we paid off and closed the debt facility by paying $8.1 million in cash including accrued interest and fees. There were no events of default identified at that time.

 

On February 2, 2018, we also added approximately $25.9 million in cash to our balance sheet as part of the Closing and on October 2, 2018 we received another $0.4 million in cash pursuant to a final closing reconciliation.

 

During the nine months ended September 30, 2017, the $0.3 million principal plus accrued interest of the related-party notes payable to InnoHold was paid and the notes were extinguished.

 

We believe that our cash flow from operations, together with other available sources of liquidity, will be sufficient to fund anticipated operating expenses and our other anticipated liquidity needs for the next twelve months. In the event our cash flow from operations is 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. On November 12, 2018, we completed a reduction in force of more than 10% of our workforce as a cost reduction effort.

 

If cash flow is not sufficient to fund our operating expenses or our growth strategies, we may need to raise additional capital. We are actively pursuing bank financing to support working capital expansion and growth initiatives. Our ability to obtain additional capital on acceptable terms or at all is subject to a variety of uncertainties. Adequate financing may not be available or, if available, may only be available on unfavorable terms. 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 operations at current levels or growth strategies. In addition, future financings through equity investments are likely to be dilutive to our existing shareholders. Newly issued securities may include preferences or superior voting rights or 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. To meet the capital needs of our growing business, we may need to obtain additional financing from new investors and investors with whom we currently have arrangements. If any of the financial institutions that currently provide financing decide not to invest in the future due to general market conditions, concerns about our business or prospects or any other reason, or decide to invest at levels that are inadequate to support our anticipated needs or materially change the terms under which they are willing to provide future financing, we will need to identify new financial institutions and companies to provide financing and negotiate new financing terms. If we are unable to raise additional capital in a timely manner, our ability to meet our capital needs and fund future growth may be limited.

 

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. We are currently unable to anticipate the amount of these 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.

  

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Credit Agreement with Coliseum

        

For additional information regarding our credit agreement with Coliseum, refer to Note 7—Debt Obligations of the condensed consolidated financial statements.

  

Cash Flows for the Nine Months Ended September 30, 2018 and 2017

 

The following summarizes our cash flows for the nine months ended September 30, 2018 and 2017 as reported in our condensed consolidated statements of cash flows (in thousands):

 

   Nine Months Ended
September 30,
 
   2018   2017 
Net cash (used in) provided by operating activities  $(27,400)  $8,758 
Net cash used in investing activities   (10,051)   (5,484)
Net cash (used in) provided by financing activities   41,523    (4,132)
Net increase (decrease) in cash   4,072    (858)
Cash, beginning of the period   3,593    4,013 
Cash, end of the period  $7,665   $3,155 

 

Nine months ended September 30, 2018 compared to the nine months ended September 30, 2017

 

Cash used in operating activities was $27.4 million for the nine months ended September 30, 2018, an increase of $36.2 million from cash provided by operating activities of $8.8 million during the nine months ended September 30, 2017. This increase in cash used in operations was due to increased operating costs as evidenced by the increase in net loss of $9.9 million. In addition, cash used to purchase inventories increased $12.0 million, which purchases were made due to an expanded product line, the growing demand for our product and the stocking of new models at third-party distribution centers for “white glove” delivery service. The purchases of raw materials were ramped up related to initial revenue forecasts for the year that have since been reduced. We also paid down accounts payable balances resulting in a change of $12.4 million in 2018.

 

Cash used in investing activities was $10.1 million for the nine months ended September 30, 2018, an increase of $4.6 million from cash used in investing activities of $5.5 million during the nine months ended September 30, 2017. This increase in cash used in investing activities was primarily due to increased investment in property and equipment. 

 

Cash provided by financing activities was $41.5 million in the nine months ended September 30, 2018, a change of $45.6 million from cash used in financing of $4.1 million during the nine months ended September 30, 2017. The increase was primarily due to $25.9 million in proceeds from the Transaction and the draw of $24.0 million of debt under the Coliseum credit agreement. These cash inflows were partially offset by the repayment of $8.0 million in principal balance on the Wells Fargo line of credit.

 

Critical Accounting Policies

 

For changes to our critical accounting policies during the nine months ended September 30, 2018, refer to Note 2—Summary of Significant Accounting Policies of our condensed consolidated financial statements.

 

Contractual Obligations

 

Apart from a minimum purchase agreement entered into in February 2018, there were no significant changes to our contractual obligations as of September 30, 2018 from those disclosed in our Current Report on Form 8-K/A filed on March 15, 2018. Under the purchase agreement, we are required to purchase a minimum amount of mineral oil over two years. In exchange, we are offered a discount per gallon. We expect to pay approximately $14.4 million over the two-year period. As of September 30, 2018, we expect to fulfill our commitments under the agreement in the normal course of business, and as such, no liability has been recorded.

 

Seasonality and Cyclicality

 

Sales of our products fluctuate with periods of greater demand corresponding to different periods of the consumer spending cycle, holidays and seasonality. Our sales may also vary with the performance of the broader economy consistent with the market. However, the true extent of these fluctuations may have been masked by our historical growth rates and thus may not be readily apparent from our historical operating results and may be difficult to predict. As such, our historical operating results may not be indicative of future performance.

 

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.

 

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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.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

In connection with the Closing, the Wells Fargo facility was repaid in full and Purple LLC entered into a $25.0 million fixed interest rate credit agreement. As such, we do not have any variable rate debt. Otherwise, there have been no material changes in our market risk since December 31, 2017. For further information on our market risk, please see “Item 2.01. Completion of Acquisition or Disposition of Assets – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Quantitative and Qualitative Disclosures About Market Risk” in our Current Report on Form 8-K/A filed March 15, 2018.

 

We are exposed to various market risks, which include potential losses arising from adverse changes in market rates and prices, such as interest rates. We do not enter into derivatives or other financial instruments for trading or speculative purposes.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Prior to the completion of the Transaction, 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 Transaction, the internal control over financial reporting utilized by Purple LLC prior to the Transaction 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”). 

 

Based on that evaluation, our CEO and our CFO concluded that our disclosure controls and procedures were not effective as of September 30, 2018 as a result of material weaknesses in our internal control over financial reporting as previously disclosed in our Current Report on Form 8-K/A filed March 15, 2018 and in the first and second quarters of 2018.

 

Material Weakness

 

In connection with the preparation of our financial statements for the three and nine months ended September 30, 2018, we identified errors in the amount of $1.7 million that resulted in revisions to prepaid inventory and cost of revenues over periods from January 1, 2017 through September 30, 2018, errors in the amount of $1.3 million that resulted in revisions to the three months ended June 30, 2018 inventory and cost of revenues and errors in the amount of $0.2 million that resulted in revisions to the six months ended June 30, 2018 customer prepayments, accrued sales tax and revenues. These errors relate to the material weakness in our internal controls over financial reporting relating to tracking and reconciling deposits made to overseas suppliers, valuation of certain subassembly inventory items, reconciling accounts and proper period cut-offs.

 

In connection with the identification of material weaknesses in our internal control over financial reporting, we are evaluating, designing and implementing controls and procedures to address these 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 financial reporting, information technology and income taxes supplemented by external resources as necessary. To date, certain personnel have been added in each of these specific areas and additional training of existing resources is continuing to take place. We are enhancing risk assessment and monitoring controls to ensure that control activities are appropriately designed, implemented and operating effectively and have engaged an external accounting firm to assist with this process. 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.

 

Previously Reported Material Weakness

 

In connection with the preparation of our annual financial statements for the fiscal year ended December 31, 2016, we identified material weaknesses in our internal controls over financial reporting. Specifically, approximately $0.1 million and $4.3 million of post-closing net adjustments were made to our 2016 balance sheet and statement of operations, respectively, as a result of the material weaknesses. In addition, we revised our 2017 year-end inventory balance and cost of revenues in the amount of $2.5 million due to a material weakness identified during our first quarter of 2018 inventory accounting close procedures.

 

(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, 2018 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 other claims, legal proceedings and complaints arising in the ordinary course of business. Please refer to Note 9—Commitments and Contingencies to the condensed consolidated financial statements contained in this report and to Part II, Item 1 of our Quarterly Report on Form 10-Q filed on August 9, 2018 for certain information regarding our legal proceedings. In addition, the following legal proceedings have occurred following the date of our financial statements.

 

On October 5, 2018 (the “Petition Date”), Mattress Firm and certain of its affiliates (collectively, the “Debtors”) filed voluntary petitions for bankruptcy pursuant to chapter 11 of title 11 of the United States Code with the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”).  As of the Petition Date, according to the Debtors’ chapter 11 petition, Purple LLC held an unsecured claim against the Debtors in the amount of $3.5 million.  Also on October 5, 2018, the Debtors filed a Joint Prepackaged Chapter 11 Plan of Reorganization (the “Plan”).  The Plan proposes that holders of general unsecured claims will be paid in full, in cash either in the ordinary course of business or upon the date that Plan becomes effective.  Finally, the Debtors have filed a motion and obtained interim Bankruptcy Court authorization (and they are seeking final authorization) to pay undisputed prepetition claims for goods and services related to their operations in the ordinary course of business, subject to certain conditions (the “Pay All Motion”).  Purple LLC is working with counsel to confirm its treatment under the Plan, confirm its eligibility under the Pay All Motion, and otherwise protect its rights throughout the Debtors’ bankruptcy process. The Debtors’ chapter 11 petition, Plan, Pay All Motion, and other documents related to their bankruptcy case are accessible at no cost at https://dm.epiq11.com/#/case/MTF/info. As of the date of this filing, the debtors have paid the amount of the unsecured claim filed in the bankruptcy petition. 

 

ITEM 1A. RISK FACTORS

 

Except as described below, there have been no material changes from the risk factors previously disclosed in our Current Report on Form 8-K filed with the Securities and Exchange Commission on February 8, 2018, as amended February 14, 2018, March 15, 2018 and April 17, 2018, and our Quarterly Reports on Form 10-Q filed with the Securities and Exchange Commission on May 15, 2018 and August 9, 2018.

 

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

 

The vast 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 a relationship with Mattress Firm, but there can be no assurance that we will continue to experience success in existing Mattress Firm locations or that anticipated new locations will be successful. Moreover, on October 5, 2018 Mattress Firm filed a Voluntary Petition for Relief under Chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”). While Mattress Firm has assured us that our contract will not be impaired by the bankruptcy process, Mattress Firm’s Chapter 11 bankruptcy filing creates (i) uncertainty regarding the payments of amounts owed by Mattress Firm to us and (ii) the possibility that our contract with Mattress Firm could be voided by the bankruptcy court. Because Mattress Firm is important to our wholesale strategy, its bankruptcy filing may have a negative impact on our wholesale distribution.

 

In addition, we may not be successful in forming such relationships with any other retailers. Even if such arrangements are entered into, we may be unsuccessful in generating sales through wholesale channels. We may extend credit terms in connection with such retail relationships and such retail relationships may expose us to the risk of unpaid or late paid invoices. In addition, we may provide fixtures to retail partners that may be difficult to recover. 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, especially new mattress models, may be lower than from our current 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.

 

In addition, offerings of new products through our current direct-to-consumer platform and expansion of business into the wholesale distribution channel 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 into wholesale channels may require the development of additional, differentiated products to avoid price and distribution conflicts between wholesale 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.

 

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.

 

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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. 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.

 

On September 18, 2018 we entered into a Master Retailer Agreement with Mattress Firm, pursuant to which Mattress Firm is permitted to sell certain of our products in its retail stores. Even with the Master Retailer Agreement, the relationship may not be profitable to us or may impose additional costs that we would not otherwise incur under our current operations. Further, maintaining this relationship may require the commitment of significant amounts of time, financial resources and management attention, and it may result in prohibitions on certain sales channels through exclusivity requirements, which may adversely affect other aspects of our business. Moreover, on October 5, 2018 Mattress Firm filed a Voluntary Petition for Relief under the Bankruptcy Code. Mattress Firm’s Chapter 11 bankruptcy filing creates (i) uncertainty regarding the payments of amounts owed by Mattress Firm to us and (ii) the possibility that the Master Retailer Agreement with Mattress Firm could be voided by the bankruptcy court. Because Mattress Firm is important to our wholesale strategy, its bankruptcy filing may have a negative impact on our wholesale distribution.

 

We have identified material weaknesses in our internal control over financial reporting which could, if not remediated, result in material misstatements in our financial statements.

 

Our management has identified material weaknesses in our internal controls over financial reporting. A material weakness is defined as a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. Specifically, in connection with the preparation of our quarterly report for the quarter ended September 30, 2018 we discovered errors in the amount of $1.7 million that resulted in revisions to prepaid inventory and cost of revenues over periods from January 1, 2017 through June 30, 2018, errors in the amount of $1.3 million that resulted in revisions to the three months ended June 30, 2018 inventory balance and cost of revenues and errors in the amount of $0.2 million that resulted in revisions to the six months ended June 30, 2018 customer prepayments, accrued sales tax and revenues. In addition, in connection with the preparation of our annual audit for the year ended December 31, 2016, we made approximately $0.1 million and $4.3 million of post-closing net adjustments to our 2016 balance sheet and statement of operations, respectively, as a result of the material weaknesses, and in connection with our quarterly report for the quarter ended March 31, 2018, we revised our 2017 year-end inventory balance and cost of revenues in the amount of $2.5 million. We continue to evaluate, design and work through the process of implementing controls and procedures under a remediation plan designed to address these material weaknesses. 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 results, which could lead to substantial additional costs for accounting and legal fees and shareholder litigation.

 

NASDAQ may delist our securities from trading on its exchange, which could limit investors’ ability to make transactions in our securities and subject us to additional trading restrictions.

 

Our shares of Class A Stock are currently listed on NASDAQ. However, we cannot assure you that our Class A Stock will continue to be listed on NASDAQ in the future. In order to continue listing our Class A Stock on NASDAQ, we must maintain certain financial, distribution and stock price levels. Generally, we must maintain a minimum amount in stockholders’ equity and a minimum number of holders of our Class A Stock.

 

Our Warrants were previously listed on NASDAQ. On March 29, 2018, we received written notice from the NASDAQ staff stating that the staff has determined that we have not demonstrated that we meet the minimum 400 round lot holder requirement for initial listing of our Warrants set forth in NASDAQ Listing Rule 5515(a)(4) following the completion of the Transaction on February 2, 2018.

  

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The notice provided that unless we request an appeal of the staff’s determination to a NASDAQ Hearings Panel (the “Panel:”), the Warrants will be scheduled for delisting from NASDAQ and will be suspended at the opening of business on April 9, 2018, after which NASDAQ will remove the Warrants from listing and registration on NASDAQ.

 

We appealed the staff’s determination by submitting a timely request for a hearing, and on May 10, 2018 we presented at the hearing our request for an extension of time to come into compliance with the round lot holder requirement with respect to the Warrants. The request for a hearing stayed any suspension of trading in the Warrants on NASDAQ pending the issuance of the Panel’s decision following the hearing and the expiration of any extension granted by the panel. On May 17, 2018, the Company received a letter from the Panel informing the Company that the Panel granted the Company’s request to continue its listing of its warrants on the NASDAQ Stock Market, subject to certain conditions. First, on or before June 15, 2018, the Company was required to provide the Panel an update on the number of warrant holders. And if the Company did not at that time have 400 round lot holders, the Company must continue to provide updates to the Panel on the 15th of each month thereafter. The Company provided the required updates on or before each of June 15, July 15, August 15 and September 15, 2018 indicating that the Company did not yet have 400 round lot holders. Because the Company failed to demonstrate compliance by September 25, 2018, on September 26, 2018 the Panel issued a final delisting determination and the Company’s Warrants were delisted from NASDAQ effective September 28, 2018. The Warrants now trade over-the-counter.

 

The shares of our Class A Stock continue to trade on NASDAQ and are not impacted by the Panel’s final delisting determination relating to the Warrants.

 

If NASDAQ delists our Class A Stock from trading on its exchange and we are not able to list our securities on another national securities exchange, we expect our securities could be quoted on an over-the-counter market. If this were to occur, we could face significant material adverse consequences, including:

 

a limited availability of market quotations for our securities;

 

reduced liquidity for our securities;

 

a determination that our Common Stock is a “penny stock” which will require brokers trading in our Common Stock to adhere to more stringent rules and possibly result in a reduced level of trading activity in the secondary trading market for our securities;

 

a limited amount of news and analyst coverage; and

 

a decreased ability to issue additional securities or obtain additional financing in the future.

 

The National Securities Markets Improvement Act of 1996, which is a federal statute, prevents or preempts the states from regulating the sale of certain securities, which are referred to as “covered securities.” If our Class A Stock continues to be listed on NASDAQ, our Class A Stock will be a covered security. Although the states are preempted from regulating the sale of our securities, the federal statute does allow the states to investigate companies if there is a suspicion of fraud, and, if there is a finding of fraudulent activity, then the states can regulate or bar the sale of covered securities in a particular case.

 

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 beds.

 

We have two main manufacturing plants, which are located in Alpine, Utah and Grantsville, Utah. A significant percentage of our products are assembled to fulfill orders rather than stocking finished goods inventory in our plants. Although we could produce our products at both sites, we may consolidate production of certain products at one site over the other. Therefore, the disruption of operations of either of our two main manufacturing facilities for a significant period of time, or even permanently through the loss of the lease of our Grantsville facility, may increase our costs of doing business and lead to delays in shipping our beds 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.

 

Significant product returns could harm our business.

 

We allow our customers to return products, subject to our returns policies. If product returns are higher than we anticipate, our business, prospects, financial condition and results of operations could be harmed. Further, we modify our policies and procedures relating to returns from time to time, and policies and methods of collecting returned products intended to reduce the number of product returns may result in customer dissatisfaction. The occurrence of any of the foregoing could have a material adverse effect on our business.

 

We have experienced an increase in returns above previously anticipated levels. This increase has negatively impacted our business and profitability. If we are unable to identify correctly the causes of these increased returns or to counteract those causes, we may not be able to lower returns or prevent the rate of returns from increasing, which would continue to negatively impact our business and profitability.

 

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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. 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 and government 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.

 

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 has 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. If the antidumping investigation does 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.

 

Purple LLC has licensed certain intellectual property to EdiZONE, LLC, which is owned by Terry and Tony Pearce. Terry and Tony Pearce, and EdiZONE have licensed certain cushioning technology to competitors of Purple and have granted rights in the European Union to a competitor.

 

Purple LLC has licensed to EdiZONE, LLC, which is an entity owned by our founders, certain intellectual property rights for use by EdiZONE outside of the consumer comfort market. This license has been amended to narrow EdiZONE’s rights, but this license still could lead to conflicts of interest. If these conflicts of interest arise and are not properly addressed, we could have disputes with our founders and our business could be harmed.

 

EdiZONE previously entered into licenses for comfort-related intellectual property with three different unrelated third-parties. These licenses may prohibit us from selling our existing mattresses in certain geographic areas, including the European Union. There can be no assurance that our future sales in these geographic territories, if any, will not violate these licenses or that any modified mattresses created by us to avoid violation of these licenses will be successful. In addition, if these third parties violate their licenses or infringe on intellectual property owned by Purple LLC and Purple LLC is unable to take effective action against such violating or infringing parties, we may be unable to protect against this infringement or the effects of such violations and our business could be harmed.

 

Purple LLC has the right to enforce its intellectual property rights at Purple LLC’s option, contingent on Purple LLC’s agreement to indemnify EdiZONE and fund the expense of such enforcement. Purple LLC may not be able to enforce its rights and may not be successful in any such efforts to enforce its intellectual property rights and this may harm our business.

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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 the competitive pressures by enabling competitors to offer more efficient or lower-cost services.

 

We have experienced substantial difficulties with timely and accurate delivery of products which has taken more time than anticipated to correct. We believe this is a result of internal deficiencies as well as deficiencies of our third-party white glove delivery service provider, and our efforts to correct these deficiencies is ongoing. If we are unable to correct our internal deficiencies and obtain an increased level of service from our third-party delivery vendors, we may suffer lost sales, damage to our reputation and liabilities to customers that could have a material adverse impact on our business.

 

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, pillows and cushions. As a result, our products may be susceptible to failures that do not exist with traditional products. Failure to 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. These FDA registrations allow for FDA inspections and there is a risk that an FDA inspection could lead to product recall of the FDA registered cushions. The number of products is small; however, a recall can result, among other things, in lost sales, diverted resources and 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.

 

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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.

 

We have in some instances kept excessive amounts of raw material inventory and some finished goods inventory, which could be susceptible to shrinkage that may harm our ability to use or sell such inventory and may adversely impact our profitability.

 

Although we typically only keep two to four weeks of raw material inventory on hand, in some instances we have accumulated excessive amounts of raw materials inventory. We also have accumulated excessive amounts of some finished goods inventory. All such excessive inventory is subject to shrinkage from destruction, theft, obsolescence and factors that render such inventory unusable or unsellable, and we have lost inventory for such reasons. While we are taking efforts to right-size all raw materials and finished goods inventory, if our efforts are not successful, we could continue to experience excessive amounts of some items of raw materials and finished goods and related shrinkage that could adversely impact our cash flow, margins and profitability.

 

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 stockholder to be diluted.

 

In connection with the Closing of the Transaction, some of our employees were granted incentive units as members of InnoHold, which holds all of the outstanding shares of Class B Common Stock of the Company. Subject to compliance with the Exchange Agreement and Lock-up Agreement, InnoHold may distribute some of its Class B Common Stock to those employees in order to cancel their incentive units, thus enabling those employees to hold equity directly in the Company. If this distribution by InnoHold occurs, those employees receiving Class B Common Stock may need to exchange, subject to the Lock-up Agreement, the Exchange Agreement and certain other conditions and restrictions, all or some of their securities into shares of Class A Common Stock and then liquidate those shares of Class A Common Stock in order to pay taxes assessed as a result of the distribution from InnoHold. Sales of such shares of Class A Common Stock may occur during short windows of time when such employees are able to trade in the Company’s securities without violating the Company’s 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.

 

ITEM 5. OTHER INFORMATION

 

On November 1, 2017, Purple LLC and EdiZONE executed the Confidential Assignment and License Back Agreement (the “Prior License Agreement”), pursuant to which EdiZONE assigned substantially all of its intellectual property to Purple LLC and Purple LLC licensed back to EdiZONE such intellectual property for use outside the consumer comfort and cushioning field of use reserved by Purple LLC. EdiZONE also agreed to notify Purple LLC of any breach of a third-party license agreement relating to consumer comfort intellectual property or consumer comfort products and Purple LLC reserved the right to enforce EdiZONE’s rights with respect to such violations, provided that Purple LLC agreed to pay the costs of such enforcement and to indemnify EdiZONE for any losses arising therefrom. EdiZONE further agreed not to extend such third-party licenses or waive any such violations, or to settle any claim with respect thereto, without Purple LLC’s consent. In addition, EdiZONE also agreed to not sell or transfer any of its assets or assign any intellectual property or licenses relating to certain consumer comfort products and related intellectual property without Purple LLC’s consent. EdiZONE previously granted third-party licenses in the consumer comfort and cushioning field of use, and the Prior License Agreement allowed EdiZONE to maintain these existing license agreements.  On March 14, 2018Purple LLC and EdiZONE further amended and restated the Prior License Agreement to correct some inconsistencies in the Prior License Agreement.  

 

On November 9, 2018, Purple LLC and EdiZONE executed a Second Amended and Restated Confidential Assignment and License Back Agreement (the “Revised License Agreement”), pursuant to which EdiZONE continues to assign all of its comfort and cushioning intellectual property to Purple LLC and Purple LLC licensed back to EdiZONE certain intellectual property for use limited to certain license agreements EdiZONE had entered into with third parties. The Revised License Agreement clarifies the scope of the intellectual property assigned to Purple LLC and the subset of such intellectual property licensed back to EdiZONE by limiting EdiZONE’s license to only those uses that will enable EdiZONE to comply with its obligations under previously existing contracts, agreements and licenses. The Revised License Agreement also eliminates the license back to EdiZONE of intellectual property for uses unrelated to the existing contracts. The Revised License Agreement also modifies EdiZONE’s confidentiality obligations to be consistent with the above-described changes.

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ITEM 6. EXHIBITS

 

Number   Description
10.1   Employment agreement with the Company and Joseph B. Megibow. (1)
     
10.2   Second Amended and Restated Confidential Assignment and License Back Agreement between the Company and EdiZONE.*
     
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 Mark A. Watkins, 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 Mark A. Watkins, 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.
(1)

Included as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on September 25, 2018.

 

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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 14, 2018   By: /s/ Joseph B. Megibow
        Joseph B. Megibow
        Chief Executive Officer
        (Principal Executive Officer)
         
Date: November 14, 2018   By: /s/ Mark A. Watkins
        Mark A. Watkins
        Chief Financial Officer
        (Principal Financial and Accounting Officer)

 

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Section 2: EX-10.2 (SECOND AMENDED AND RESTATED CONFIDENTIAL ASSIGNMENT AND LICENSE BACK AGREEMENT BETWEEN THE COMPANY AND EDIZONE)

Exhibit 10.2

 

SECOND AMENDED AND RESTATED CONFIDENTIAL ASSIGNMENT AND LICENSE BACK

 

This Second Amended and Restated Confidential Assignment and License Back (hereinafter referred to as “Agreement”) is executed on November 9, 2018 and entered into to be effective as of December 27, 2016, between EdiZONE, LLC, a Delaware limited liability company having a place of business located at 123 E. 200 N., Alpine, UT 84004 (hereinafter referred to as “EdiZONE”) and Purple Innovation, LLC, a Delaware limited liability company (f/k/a WonderGel, LLC) also having a place of business located at 123 E. 200 N., Alpine, UT 84004 (hereinafter referred to as “Purple”). EdiZONE and Purple are affiliated companies having, as of December 27, 2016, common individuals as indirect members (hereinafter referred to as “Members”) also residing in Alpine, Utah. EdiZONE and Purple may hereafter be referred to herein as a Party or the Parties.

 

WHEREAS, on December 27, 2016, Members owned in equal shares the controlling interests in both EdiZONE and Purple, and accordingly EdiZONE and Purple were affiliated companies;

 

WHEREAS, prior to the Confidential Assignment and License Back Agreement between EdiZONE, as Assignor, and Purple, as Assignee, executed on January 16, 2017 and effective as of December 27, 2016, as amended and restated pursuant to the Amended and Restated Confidential Assignment and License Back between EdiZONE and Purple executed on November 1, 2017 and as modified March 14, 2018 (the “Original Agreement”), EdiZONE was the (i) owner of record of the patent applications and issued patents listed on Schedule A (all references to Schedules herein refer to those Schedules that are attached to the Original Agreement, as amended (other than as amended by this Agreement)) and any and all other U.S. and foreign patents and patent applications and inventions owned by EdiZONE and used, held for use, or otherwise necessary or desirable for the operation of the business of Purple as currently conducted or as proposed to be conducted (hereinafter referred to as the “Patent Properties”); (ii) owner of the trade secrets listed on Schedule B and any and all other trade secrets, know-how, data, and information owned by EdiZONE and used, held for use, or otherwise necessary or desirable for the operation of the business of Purple as currently conducted or as proposed to be conducted (hereinafter referred to as the “Trade Secret Properties”); (iii) owner, including in some cases the owner of record, of the trademarks and service marks listed in Schedule C and any and all other trademarks and service marks owned by EdiZONE and used, held for use, or otherwise necessary or desirable for the operation of the business of Purple as currently conducted or as proposed to be conducted (hereinafter referred to as the “Trademark Properties”); (iv) owner, including in one case the owner of record, of the copyrights listed on Schedule D and any and all other works of authorship and copyrights owned by EdiZONE and used, held for use, or otherwise necessary or desirable for the operation of the business of Purple as currently conducted or as proposed to be conducted (hereinafter referred to as the “Copyright Properties”); and (v) owner of the physical assets listed on Schedule E (hereinafter referred to as the “Tangible Properties”) (the Patent Properties, Trade Secret Properties, Trademark Properties, Copyright Properties, Tangible Properties are collectively referred to as the “Properties”) (for the avoidance of doubt, the Properties do not include anything listed on Schedule H);

 

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WHEREAS, prior to the Original Agreement, Purple had been duly authorized to use much of the Properties under a license agreement with EdiZONE, which agreement was terminated by the Parties in conjunction with the Original Agreement; and

 

WHEREAS, the Parties now desire to amend and restate the Original Agreement to provide for additional terms and conditions.

 

Accordingly, the Parties agree as follows:

 

1.  Original Agreement. This Agreement hereby amends and restates the Original Agreement, effective retroactively to December 27, 2016.

 

2.  Patent Properties Assignment to Purple. EdiZONE hereby conveys and assigns to Purple, and Purple accepts, EdiZONE’s entire right, title and interest in and to the Patent Properties and the inventions disclosed therein, including all continuation, continuation-in-part and divisional applications and all continuing prosecution applications based in whole or in part on the applications or on which the applications are based in whole or in part, and including all patents, as well as reexaminations and reissues thereof resulting from the applications. This conveyance includes EdiZONE’s entire right, title and interest in and to all counterparts to the applications that have been or may be filed outside the United States, whether pursued as a patent, an inventor’s certificate, a utility model or the like, including all rights of priority based on the applications, further including all continuation, continuation-in-part and divisional applications and all continuing prosecution applications based in whole or in part on the non-U.S. counterparts, and still further including all patents, inventor’s certificates, utility models and reissues based upon or resulting from any of the non-U.S. counterparts.

 

3.  Trade Secret Properties Assignment to Purple. EdiZONE hereby conveys and assigns to Purple, and Purple accepts, EdiZONE’s entire right, title and interest in and to the Trade Secret Properties.

 

4.  Trademark Properties Assignment to Purple. EdiZONE hereby conveys and assigns to Purple, and Purple accepts, EdiZONE’s entire right, title and interest in and to the Trademark Properties, and all good will associated therewith, including all phonetic equivalents, for use on or in association with any types of goods or services, and including all registrations in the United States and throughout the world. For the avoidance of doubt, this conveyance includes Purple’s right to monitor and direct all others who it may authorize to use a trademark.

 

5.  Copyright Properties Assignment to Purple. EdiZONE hereby conveys and assigns to Purple, and Purple accepts, EdiZONE’s entire right, title and interest in and to the Copyright Properties and all issuance, extensions, and renewals thereof, and any and all issuances, extensions, and renewals thereof.

 

6.  Tangible Properties Assignment to Purple. EdiZONE hereby conveys and assigns to Purple, and Purple accepts, EdiZONE’s entire right, title and interest in and to the Tangible Properties.

 

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7.  Purple’s Rights with Respect to the Properties. Subject to the rights of EdiZONE set forth specifically herein, Purple shall have all rights of ownership and control of the Properties, including, without limitation, the right to sell, assign or otherwise transfer and to license and sublicense the Properties without requiring the consent or approval of EdiZONE. Notwithstanding the foregoing, nothing herein shall be construed to authorize Purple to take any action not permitted to be taken by EdiZONE pursuant to the Existing Contracts (defined below).

 

8.  Existing Contracts and Non-Consumer Cushion Contracts.

 

a.Notwithstanding anything to the contrary herein, Purple consents and agrees that its rights to the Properties are subject to the rights of the licensees pursuant to the contracts, agreements and licenses entered into by EdiZONE and its predecessors in interest and listed on Schedule F and G (“Existing Contracts”) and Purple grants EdiZONE a limited license under the Properties solely for the purpose of enabling EdiZONE to comply with its obligations under the Existing Contracts.

 

b.EdiZONE shall not, and shall not authorize any other person or entity to, extend, renew, expand the scope of the intellectual property rights licensed, grant any waiver under, compromise, or consent to any assignment or transfer of, any of the Existing Contracts (whether or not such extension, renewal, expansion of the scope of intellectual property rights, or other action is permitted or provided for under the terms of any Existing Contracts, but not if the terms of any Existing Contract require such extension, renewal or other action under the circumstances). To the extent that any Existing Contract is automatically renewable unless terminated by EdiZONE, EdiZONE shall be obligated to terminate such Existing Contract at the earliest possible date following the date hereof. In addition, (i) in the event that the counterparty to any Existing Contract shall breach any of the terms thereof, under circumstances giving EdiZONE the right to terminate the Existing Contract, EdiZONE shall terminate such Existing Contract as promptly as practicable, in accordance with the terms of the Existing Contract, and (ii) EdiZONE shall not, at any time, enter into any new agreement, arrangement or commitment with any person or entity with respect to the Properties or products made using or embodying the same. The rights of EdiZONE set forth in this Section shall expire to the extent and at such time as each of the Existing Contracts expires or terminates. Notwithstanding anything herein to the contrary, nothing herein shall require EdiZONE to breach any Existing Contract.

 

c.In consideration for the assignment of the Properties and the other obligations of EdiZONE pursuant hereto, Purple agrees that it shall not engage in any business activity which would cause EdiZONE to be in breach of any Existing Contract by reason of Purple’s activity.

 

9.  EdiZONE Restrictive Covenant. In consideration for the license granted in Section 8 above, and the other obligations of Purple pursuant hereto, EdiZONE agrees that it shall not engage or otherwise cause any other person or entity to anywhere in the world, directly or indirectly, to engage in any business activity competitive with Purple, including, without limitation, developing or assisting in the development of any patents, trade secrets or other intellectual property competitive with the intellectual property used in consumer cushioning products.

 

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10. Enforcement of Intellectual Property Rights.

 

a.EdiZONE shall have an affirmative duty to monitor the compliance of its contractual assignees, licensees or sublicensees that may infringe upon or otherwise affect the Patent Properties, Trade Secret Properties or Purple’s other rights hereunder, in a commercially reasonable manner, in accordance with past vigilant practices.

 

b.If (a) either Party has knowledge of any threatened, suspected, alleged, or actual infringement or misappropriation of any of the Patent Properties or any of the Trade Secret Properties or (b) a third party alleges that any of the Patent Properties is invalid or unenforceable, or claims that a licensed product, or its use, development, manufacture, or sale infringes such third party’s intellectual property rights, then in either such case the Party possessing such knowledge or such awareness of such allegations shall promptly provide written notice as soon as practicable to the other Party and provide it with all details of such infringement, misappropriation or claim, as applicable, that are known to such Party.

 

c.The Parties recognize that it may be in the best interest of both Parties to cooperate in any settlement discussions relating to any threatened, suspected, alleged, or actual infringement or misappropriation of any of the Patent Properties or Trade Secret Properties, and the Parties agree to negotiate in good faith concerning such cooperation for thirty (30) days following notification of such infringement or threat (the “Notice” and the date of such Notice, the “Notice Date”). The negotiation shall include such items as the sharing of costs and the sharing of awards or settlement payments.

 

d.In the event that the Parties are unable to reach an agreement (to their mutual satisfaction) regarding cooperation pursuant to subsection c above within thirty (30) days after the Notice Date, or such other period as they may agree, Purple may, in its sole discretion and at its own expense, take any action that it deems appropriate (including no action) concerning such suspected infringement of or threat to any Patent Properties or Trade Secret Properties including, without limitation, the right to enforce the Patent Properties or Trade Secret Properties against third parties and any Patent Properties and Trade Secret Properties which are licensed to EdiZONE in this Agreement. To the extent practicable, Purple shall provide EdiZONE with reasonable notice with respect to any such proceedings or actions. If Purple receives any monetary recovery from such suspected infringer, Purple may use and dispose of such monetary recovery as it deems appropriate.

 

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e.If Purple has not taken any action with respect to a matter brought to Purple’s attention by Notice within one hundred and twenty (120) days after the Notice Date, EdiZONE may, subject to Purple’s approval, which may not be unreasonably withheld or delayed, and at EdiZONE’s own expense, to the extent necessary or desirable to comply with EdiZONE’s obligations under the Existing Contracts, take action against third parties referred to in the Notice concerning such suspected infringement of or threat to any Patent Properties or Trade Secret Properties which are licensed to EdiZONE in this Agreement. If EdiZONE receives any monetary recovery from such suspected infringer, EdiZONE may use and dispose of such monetary recovery as it deems appropriate.

 

f.To the extent it is necessary for EdiZONE or Purple to be joined in any enforcement proceeding or action commenced by the other Party, EdiZONE or Purple, as the case may be, agrees to voluntarily join or allow the other Party to sue in its name subject to the Party commencing such proceeding or action fully indemnifying and holding harmless the other Party from any and all costs, losses, liabilities, claims or other expenses (including, without limitation, reasonable attorneys’ fees) arising from such joinder in the enforcement proceeding or action; provided, however, that no such indemnification obligation shall arise from the breach of any license or agreement by the other Party, or the wrongful act or deed of the other Party or its officers, directors, members, equityholders, agents or representatives.

 

g.In any action or proceeding, the Parties agree to cooperate with each other in all matters that relate to or affect the prosecution, validity, enforceability and protection of the Patent Properties and Trade Secret Properties.

 

h.The Parties agree that Purple shall have the exclusive right to make all decisions regarding and arising out of the prosecution and related proceedings or actions involving the patentability, validity, enforceability and protection of the Patent Properties or Trade Secret Properties before any agency, court or other tribunal where such issues are raised. To the extent practicable, Purple shall provide EdiZONE with reasonable notice with respect to any such proceedings or actions. If Purple declines to take any of the foregoing protective actions with respect to any Patent Properties or Trade Secret Properties which are licensed to EdiZONE in this Agreement then EdiZONE shall have the right, but not the obligation, with Purple’s prior written consent, which shall not be unreasonably withheld or delayed, to take such protective actions, at EdiZONE’s own expense, to the extent such protective actions are necessary or desirable to comply with EdiZONE’s obligations under the Existing Contracts.

 

11. Confidentiality. EdiZONE agrees to take reasonable steps to keep confidential and not disclose to any person or entity any Confidential Information (as defined below) and shall not disclose the Confidential Information to any third party without the prior written consent of Purple, in its sole discretion, except that EdiZONE may disclose the Trade Secret Properties to the extent required by and solely in accordance with the terms and conditions of the Existing Contracts. EdiZONE shall use commercially reasonable efforts to enforce the confidentiality provisions in all Existing Contracts. As used in this Agreement, “Confidential Information” includes any and all information, in any form, relating to the Trade Secret Property, or to EdiZONE’s or Purple’s respective businesses (including but not limited to their respective budgets, business plans, marketing plans, personnel matters, business contacts, products, processes, know-how, designs, methods, improvements, discoveries, inventions, ideas, data, programs, and other works of authorship), but shall not include any information which (i) is, without any breach of any duty of confidentiality owed to EdiZONE or Purple, in the public domain, (ii) was already known to the receiving party, provided the receiving party can produce contemporaneous documentary evidence showing such prior knowledge, (iii) is received by the receiving party independently and in good faith from a third party, provided that, to the receiving party’s knowledge, such third party is not in breach of any duty of confidentiality relative to such information; and (iv) is developed by the receiving party independently of any Confidential Information received from EdiZONE or Purple, as evidenced by documentary or other tangible evidence.

 

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12.  Excluded Properties. The Parties agree, and for the avoidance of doubt and for purposes of clarity, that the properties listed on Schedule H are not part of the Properties and are not conveyed or assigned pursuant hereto.

 

13.  Registration; Prosecution and Defense Rights.

 

a.To the extent not already recorded, at Purple’s expense and as promptly as practicable after the date hereof, EdiZONE shall file with the United States Patent and Trademark Office (“USPTO”) assignments and other documentation to effectively assign to Purple the Patent Properties and the Trademark Properties, and shall file with the United States Copyright Office (“USCO”) assignments and other documentation to effectively assign to Purple the Copyright Properties. EdiZONE authorizes the Commissioner for Patents and the Commissioner for Trademarks in the USPTO and the Register of Copyrights in the USCO, and officials of any corresponding entities or agencies in any other jurisdictions, to record and register any such assignments of the Properties. Following the date hereof, EdiZONE shall take such steps and action, and provide such cooperation and assistance to Purple and its successors, assigns and legal representatives, as may be necessary to effect, evidence, or perfect the assignment of the Properties to Purple and its successors and assigns, including the execution and delivery of any affidavits, declarations, oaths, exhibits, assignments, powers of attorney, or other documents.

 

b.EdiZONE hereby grants to Purple, and Purple accepts, the right to prosecute (such term including filing of a patent application or trademark or copyright registration application) and defend the applications for patents, trademarks and copyright and all related patents, trademarks and copyrights assigned or licensed to Purple in this Agreement, including without limitation any opposition proceedings, reissue applications, reexaminations, and nullity or invalidity proceedings. EdiZONE authorizes all governmental bodies having the power to issue patents, reissues, inventor’s certificates or utility models to issue a patent, reissue, inventor’s certificate or utility model based on the patent applications or to register any trademark or copyright based on any trademark or copyright applications, or any related applications as described above, in the name of Purple.

 

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14.  Further Assurances. EdiZONE agrees upon request and without further consideration, except for the reimbursement of its reasonable costs: (a) to assist Purple in prosecuting any existing application in the Patent Properties, Trademark Properties or Copyright Properties and all related applications as described above, as well as opposition proceedings, reissue applications, reexaminations, and nullity or invalidity proceedings, (b) to provide Purple with information concerning any of the Properties to enable Purple to obtain, secure and protect the rights granted under this Agreement; (c) to sign papers, take oaths and testify in legal proceedings to enable Purple to obtain, secure and protect the rights granted under this Agreement; and (d) to perform all acts reasonably necessary to enable Purple to obtain, secure and protect the rights granted under this Agreement. EdiZONE expressly agrees, without limiting the foregoing, to execute at Purple’s expense separate assignment agreements as may be deemed necessary or appropriate by Purple for filing with the USPTO or any other governmental entity or authority.

 

15.  Warranties and Covenants.

 

a.Except as specifically set forth herein, EdiZONE makes no representation or warranty with respect to its title to the Properties.

 

b.EdiZONE represents and warrants to Purple that its assignment of the Properties to Purple pursuant hereto does not breach (i) the operating agreement or any other governing document of EdiZONE, or (ii) any law rule or regulation, or any governmental or administrative order, directive, decree applicable to EdiZONE or its properties or business; or (iii) contract, agreement, license or sublicense to which EdiZONE is a party or pursuant to which it or any of its assets or properties is subject or bound.

 

c.EdiZONE represents and warrants to Purple that the Properties are all of its patents, patent applications, inventions, trademarks, service marks, trade secrets, know-how, data, information, copyrights, and works of authorship that are used, held for use, or otherwise necessary or desirable for the operation of the business of Purple as currently conducted or as proposed to be conducted.

 

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d.EdiZONE further represents and warrants to Purple that no assignment, grant, mortgage, license or other agreement or encumbrance affecting the Properties has been made or entered into by EdiZONE, except as set forth on Schedules F and G and that, except as set forth in such Schedules, the full right to convey the Properties is possessed by the EdiZONE, except that some of the patents on Schedule A are the result of assignments from Stryker’s predecessor-in-interest, Gaymar Industries.

 

16.  Limitation to Warranties. The Properties conveyed hereunder are transferred and assigned “as is” and without any warranties not expressed herein, expressly excluding but not limited to warranties that the Properties are safe or will meet Purple’s needs and intended use or purposes or are fit for a particular purpose, merchantable, in good repair or without defects. In addition, no representation is made herein that any of the inventions is patentable, that the trademarks are registrable, that the trade secrets are unknown by others or not in the public domain, or that the intangible properties are valid or enforceable against third parties.

 

17.  Indemnification. Each of the Parties hereto agrees to indemnify and hold harmless the other Party from any and all costs, losses, liabilities, claims and other expenses (including, without limitation, reasonable attorneys’ fees) related to, or arising out of (i) the breach by such Party of any of the representations, warranties or covenants set forth herein, or (ii) the use at any time by such Party or its licensees of the Properties.

 

18.  Assignability; Binding Effect. EdiZONE may not assign the license back rights related to the Existing Agreements granted to it under this Agreement in whole or in part without the prior written consent of Purple, which shall not be unreasonably withheld or delayed. Purple may assign the Patent Properties, Copyright Properties, Trademark Properties, Trade Secret Properties, Tangible Properties, subject to the terms hereof and the Existing Contracts, without the express written consent of EdiZONE. This Agreement shall be binding upon the Parties and upon their respective successors and permitted assigns, including, without limitation, any transferee of any of the Properties as permitted by the terms hereof.

 

19.  Consideration. Each Party acknowledges that the other Party has provided, and it has received, valuable consideration sufficient and adequate for the rights granted to it under this Agreement, and for the benefit of the Parties’ respective Members.

 

20.  Controlling Law and Jurisdiction. This Agreement shall be construed in accordance with the law of the State of Utah applicable to agreements that are executed and fully performed therein. The Parties agree that the courts of the State of Utah and the United States District Courts therein shall have exclusive jurisdiction of any action or proceeding arising out of or related to this Agreement, without consideration of the applicable laws pertaining to conflict of laws.

 

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21.  Dispute Resolution. The Parties agree that should any dispute arise out of or relate to this Agreement or the breach thereof, which dispute the Parties cannot settle among themselves, the dispute shall be submitted to nonbinding mediation as a condition precedent to the commencement of any action at law or in equity. The mediation will be held in Salt Lake City, State of Utah, and shall be conducted in accordance with the mediation rules then applicable of the mediation service mutually agreed to by the Parties at that time (the “Service”). The aggrieved Party shall send written notice (“Notice”) to the other Party who within five (5) business days shall provide a list of acceptable mediation services and its response to the substance of the request. The Parties shall cooperate with the Service so that the matter can be expeditiously submitted for resolution proceedings. The Parties shall share the cost of the mediation equally. Unless otherwise agreed, and except as may be necessary to enforce payment of attorneys’ fees by a non-cooperating Party, all proceeds and submissions of the mediation shall be confidential and shall not be used for any purpose other than in the mediation proceedings. In the event that the Parties are unable to agree upon a Service within ten (10) business days after the aggrieved Party shall send the Notice to the other party, or in the event that the matter is not fully resolved within thirty (30) days from the date of the Notice, either Party shall be free to commence an action at law or in equity in any federal or state court having jurisdiction thereof, in accordance with the provisions of Section 20 hereof.

 

22.  Attorneys’ Fees and Costs. The prevailing party in any proceeding or action brought by one Party to this Agreement against the other Party, and which relates to this Agreement, shall be entitled to recover from the other Party its reasonable attorneys’ fees and costs. The payment of attorneys’ fees and costs shall be included in all indemnification obligations herein.

 

23.  Severability. If any provision of this Agreement is determined to be invalid or unenforceable, it shall be amended by the Parties consistent with the intent of this Agreement to the narrowest extent possible to render that provision valid and enforceable or, if necessary, removed from this Agreement, and shall not affect the validity and enforceability of the other provisions of this Agreement.

 

24.  Amendment and Integration. This Agreement constitutes the entire agreement among the Parties hereto and may not be amended or modified without the prior consent of the other Party, given in writing. This Agreement supersedes all prior agreements and understandings among the Parties with respect to the subject matter hereof; provided, however, that, for the avoidance of doubt, the March 3, 2017 Confirmatory Assignment (regarding patents) and Confirmatory Assignment (regarding trademarks), entered into for filing with the United State Patent and Trademark Office, the March 3, 2017 Exclusive License Agreement (regarding trademarks not yet assignable) and the April 11, 2017 Assignment, are agreed to continue to be in full force and effect notwithstanding this Agreement that is dated to be effective prior to those agreements.

 

(signatures on next page)

 

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[Signature Page to Second Amended and Restated Confidential Assignment and License Back]

 

EdiZONE, LLC

 

/s/ Terry Pearce   November 8, 2018
By:  Terry Pearce   Date
Title:  Manager    
     
Purple Innovation, LLC    
     
/s/ Joseph Megibow   November 9, 2018
By:  Joseph Megibow   Date
Title:  CEO    

 

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Section 3: EX-31.1 (CERTIFICATION)

EXHIBIT 31.1

 

CERTIFICATIONS

 

I, Joseph B. Megibow, certify that:

 

1. I have reviewed this quarterly report on Form 10-Q of Purple Innovation, Inc.;

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

  a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Dated: November 14, 2018 /s/ Joseph B. Megibow
  Joseph B. Megibow, Chief Executive Officer
  (Principal Executive Officer)

 

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Section 4: EX-31.2 (CERTIFICATION)

EXHIBIT 31.2

 

CERTIFICATIONS

 

I, Mark A. Watkins, certify that:

 

1. I have reviewed this quarterly report on Form 10-Q of Purple Innovation, Inc.;

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

  a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Dated: November 14, 2018 /s/ Mark A. Watkins
 

Mark A. Watkins, Chief Financial Officer

(Principal Financial and Accounting Officer)

 

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Section 5: EX-32.1 (CERTIFICATION)

EXHIBIT 32.1

 

CERTIFICATION

 

In connection with the Quarterly Report on Form 10-Q of Purple Innovation, Inc. (the “Corporation”) for the quarter ended September 30, 2018 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned, Joseph B. Megibow, Chief Executive Officer of the Corporation, hereby certifies, pursuant to Rule 13a-14(b) or Rule 15d-14(b) and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to his knowledge:

 

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and

 

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation.

 

Dated: November 14, 2018 /s/ Joseph B. Megibow
 

Joseph B. Megibow, Chief Executive Officer

(Principal Executive Officer)

 

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Section 6: EX-32.2 (CERTIFICATION)

EXHIBIT 32.2

 

CERTIFICATION

 

In connection with the Quarterly Report on Form 10-Q of Purple Innovation, Inc. (the “Corporation”) for the quarter ended September 30, 2018 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned, Mark A. Watkins, Chief Financial Officer of the Corporation, hereby certifies, pursuant to Rule 13a-14(b) or Rule 15d-14(b) and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to his knowledge:

 

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and

 

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation.

 

Dated: November 14, 2018 /s/ Mark A. Watkins
 

Mark A. Watkins, Chief Financial Officer

(Principal Financial and Accounting Officer)

  

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