Item 1A. Risk Factors
Item 1A. Risk Factors
The risk factors
summarized and detailed below could materially harm our business, operating results and/or financial condition, impair our future
prospects and/or cause the price of our common stock to decline. Any defined terms used in the Risk Factor Summary are defined
in the full Risk Factors. These are not all of the risks we face and other factors not presently known to us or that we currently
believe are immaterial may also affect our business if they occur. Material risks that may affect our business, operating results
and financial condition include, but are not necessarily limited to, those relating to:
Risk Factor Summary
Risks Related to Our Operations
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Significant fluctuations in our operating results and growth rate;
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Our short operating history in an evolving industry;
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Lack of availability and quality of raw materials;
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Significant strain of managing the growth of our business;
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Our ability to obtain additional capital on acceptable terms or at all;
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Changes in accounting standards and assumptions, estimates and judgments by management related to complex accounting matters;
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Our ability to continue to improve and expand our product line;
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Our expansion into new products, market segments and geographic regions;
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The ongoing COVID-19 pandemic including its effect on our supply chain, workforce, and operations;
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The COVID-19 pandemic effect on customer demand;
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The strength of our Purple brand, the effectiveness of our marketing, and our ability to attract and retain customers;
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Our ability to achieve and maintain production capacity to meet customer demands;
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Our significant related-party transactions that may give rise to conflicts of interest;
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Disruption of operations in manufacturing facilities, including pandemics or natural disasters;
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Unsuccessful anticipation of consumer trends and demand;
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Excess inventory susceptible to shrinkage;
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Ability to make, integrate, and maintain commercial agreements, strategic alliances, and other business relationships;
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Competition in a highly competitive comfort industry;
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Substantial and increasingly intense competition worldwide in e-commerce;
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Any reduction in the availability of credit to consumers;
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Maintaining only the necessary amounts of raw material and product inventory;
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Ability to provide timely delivery to our customers;
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Dependence on a few key employees;
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Failure to maintain internal controls and the potential impact of making material misstatements on financial results and reporting;
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The identified material
weakness in our internal controls over financial reporting and the need to implement additional finance and accounting systems, procedures
and controls as we grow; and
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Failure of or disruptions to our information technology systems.
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Regulatory and Litigation Risks
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Ability to participate in government COVID-19 relief programs;
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Regulatory requirements
requiring costly expenditures and exposure to liability, some of which are specific to the manufacture and disposal of mattresses;
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Income tax, sales tax or
other tax liabilities; and
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The risk of litigation resulting from the impact of the material weakness
in our internal controls over financial reporting.
Risks Relating to our Intellectual Property and Use of
Technology
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Ability to protect our product designs and other proprietary rights both domestically and internationally;
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Claims that we or our licensors have infringed the proprietary rights of others;
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Purple LLC’s license of intellectual property to EdiZONE, LLC;
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Ability to keep pace with rapid technological developments; and
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Failure to protect sensitive employee, customer and consumer data.
Risks Relating to Our Organizational Structure
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Anti-takeover provisions in Delaware law and our Second Amended and Restated Certificate of Incorporation;
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Provisions in our Second Amended and Restated Certificate of Incorporation making it difficult for investors to bring legal action against us or our directors or officers;
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Provisions in our Second Amendment and Restated Certificate of Incorporation limiting a stockholders’ ability to obtain a favorable judicial forum;
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Future sales of our Class A Common Stock (“Class A Stock”) by our existing shareholders that may cause stock prices to fall;
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Dilution as a result of the issuance of additional shares;
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Ownership of Purple LLC as our only significant asset and its effect on our ability to pay dividends or make distributions or loans or satisfy other financial obligations;
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Not anticipating paying any cash dividends in the foreseeable future;
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Level of indebtedness could limit our operational and financial flexibility;
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Warrants exercise that could result in dilution; and
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Issuance of additional preferred stock, debt, or securities without stockholder approval.
Tax Risks Relating to Our Structure
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Requirement to pay InnoHold, LLC (“InnoHold”) 80% of the tax benefits under the Tax Receivable Agreement;
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Possible acceleration or changes in payments under the Tax Receivable Agreement;
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Ability to realize all or a portion of the tax benefits that are expected to result from the acquisition of Units from holders of Purple LLC Class B Units;
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Unanticipated changes in effective tax rates or adverse outcomes resulting from examination of our income or other tax returns; and
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Ability to utilize our net operating loss carryforwards and certain other tax attributes.
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Risks Related
to Our Operations
We may experience significant fluctuations
in our operating results and growth rate, which could adversely affect our performance and financial results.
Our revenue growth may
not be sustainable, and our percentage growth rates may decrease. Our revenue and operating profit growth depend on the continued
growth of demand for our products, and our business is affected by general political, economic and business conditions worldwide.
Our business, our employees and our partners may also be negatively affected by political or social unrest including potential
reputational damage, disruption of our physical facilities or those of our wholesale partners, and boycotts by employees or boycotts
against us, our suppliers, our wholesale partners and our advertising partners. A softening of demand, whether caused by changes
in customer confidence or preferences or a weakening of the U.S. or global economies, may result in decreased revenue or growth.
In addition, we rely
on estimates and forecasts of our expenses and revenues to provide guidance and inform our business strategies, and some of our
past estimates and forecasts have not been accurate. The rapidly evolving nature of our business makes forecasting operating results
difficult. If we fail to accurately forecast our expenses and revenues, our business, prospects, financial condition and results
of operations may suffer, and the value of our business may decline. If our estimates and forecasts prove incorrect, we may not
be able to adjust our operations quickly enough to respond to lower-than-expected sales or higher-than-expected expenses.
You should consider
our business in light of the risks and difficulties we may encounter, as described above and elsewhere in this “Risk Factors”
section. If we fail to address the risks and difficulties that we face, our business and operating results will be adversely affected.
We have a limited operating history
in an evolving industry and, as a result, our past results may not be indicative of future operating performance.
We are a rapidly growing
business with a limited operating history. Our relatively limited operating history makes it difficult to assess our future performance.
We have encountered and will continue to encounter risks and difficulties frequently experienced by growing companies in rapidly
developing and changing industries, including inconsistent financial results, challenges in forecasting accuracy, determining appropriate
investments of our limited resources, market acceptance of our products and services and future products and services, competition
from new and established companies, including those with greater financial and technical resources, enhancing our products and
services and developing new products and services.
For the year ended December 31,
2020, we incurred a net loss of ($229.8) million and in 2019 we incurred a net loss of ($30.9) million. In 2020, we generated $81.3
million of operating cash flow and ended the year with working capital of $96.9 million and an accumulated deficit of $265.9 million.
In 2019, we generated $22.9 million of operating cash flow and ended the year with working capital of $27.3 million and an
accumulated deficit of $29.0 million. We need continued positive cash flow from operations and additional capital to execute our
business plan and growth initiatives. If we are unable to satisfy our liquidity and capital resource requirements our business could
become adversely affected.
Lack of availability and quality
of raw materials could cause and has caused delays that could result in our inability to provide goods to our customers or could
increase our costs, either of which could decrease our earnings.
In manufacturing products,
we use various commodity components, such as polyurethane foam, oil, our spring units, ingredients for our Hyper-Elastic Polymer material,
our water-based adhesive and other raw materials. Because we are dependent on outside suppliers for our raw materials, lack of
availability, and quality could have a negative effect on our cost of sales and our ability to meet our customers’ demands.
Competitive and marketing pressures may prevent us from passing along price increases to our customers, and the inability to meet
our customers’ demands could cause us to lose sales.
Some components, such
as foam and spring units, are widely used in our industry. Shortages in such components, due to any reason including increase in
demand, weather events, supply chain difficulties within the supplier or otherwise, could adversely affect our production capacity
and financial results. If we were unable to obtain raw materials and components from suppliers, we would have to find replacement
suppliers. Any new arrangements for raw materials and components might not be on favorable terms, if we are able to enter into
new arrangements at all. If a supplier for a component failed to supply such component in required amounts this could significantly
interrupt production and increase costs.
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The growth of our business places
significant strain on our resources and if we are unable to manage our growth, we may not have profitable operations or sufficient
capital resources.
We are rapidly and significantly
expanding our operations, including expanding our workforce, increasing our product offerings and scaling our infrastructure to
support expansion of our manufacturing capacity, our wholesale channel expansion and the opening of our Company showrooms. Our
planned growth includes increasing our manufacturing capacity, developing and introducing new products and developing new and broader
distribution channels, including wholesale and Company showrooms, and extending our global reach to other countries. This expansion
increases the complexity of our business and places significant strain on our management, personnel, operations, systems, technical
performance, financial resources, and internal financial control and reporting functions.
Our continued success
depends, in part, upon our ability to manage and expand our operations and facilities and production capacity in the face of continued
growth. The growth in our operations has placed, and may continue to place, significant demands on our management and operational
and financial infrastructure. If we do not manage our growth effectively, the quality of our products and fulfillment capabilities
may suffer which could adversely affect our operating results. Our revenue growth may not be sustainable, and our percentage growth
rates may decrease. If we are unable to satisfy our liquidity and capital resource requirements, we may have to scale back, postpone
or discontinue our growth strategies, which could result in slower growth or no growth, and we may run the risk of losing key suppliers,
we may not be able to timely satisfy customer orders, and we may not be able to retain our employees. In addition, we may be forced
to restructure our obligations to creditors or pursue work-out options.
Our growth depends in
part on our ability to manage the opening and operating of new production facilities and our Company showrooms which will require
our entering into leases and other obligations while the success of expanding operations geographically. To be successful, we will
need to obtain or develop retail expertise and we will need to hire new employees in states that may have employment laws that
could increase our expenses. In general, operating new production facilities and opening our Company showrooms in new locations
exposes us to laws in other states, including California, that may not be as employer-friendly as those in which we currently operate,
and may expose us to new liabilities. If we are not able to successfully manage the process of expanding operations geographically,
opening our Company showrooms and maintaining operations in an expanding number of facilities and Company showrooms, we may have
to close Company showrooms and incur sunk costs and continuing obligations that could put a strain upon our resources, damage our
brand and reputation and limit our growth.
To manage our growth
effectively, we will need to continue to implement operational, financial and management controls and reporting systems and procedures
and improve the systems and procedures that are currently in place. There is no assurance that we will be able to fulfill our staffing
requirements for our business, successfully train and assimilate new employees, or expand our management base and enhance our operating
and financial systems. Failure to achieve any of these goals will prevent us from managing our growth in an effective manner and
could have a material adverse effect on our business, financial condition or results of operations. In addition, a softening of
demand, whether caused by changes in customer preferences or a weakening of the U.S. or global economies, may result in decreased
revenue or growth. Further, we may not be able to accurately forecast our growth rate. We base our expense levels and investment
plans on sales estimates. A significant portion of our expenses and investments is fixed, and we may not be able to adjust our
spending quickly enough if our sales are less than expected.
We have identified a
need for improved processes and procedures to avoid delays in the timely delivery of our mattress products and to improve the customer’s
experience. Also, we have experienced rapid growth in our employee base, and the need to implement processes and procedures for
improving employee training and retention. Competition for employees where our production facilities are located also has increased
the costs for employee retention. We have implemented improved processes and procedures in an environment of continuous change,
but our use of resources may not be as effective as intended or we may need to apply more resources than expected to continue to
make changes to improve our employee retention and effectiveness and the quality of our products and services over time. If we
are unable to make continuous improvement, achieve greater efficiencies in our operating expenses and improve our products and
services, our business could be adversely affected.
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We may need additional capital to
execute our business plan and fund operations and may not be able to obtain such capital on acceptable terms or at all.
In connection with the
development and expansion of our business, we expect to incur significant capital and operational expenses. We believe that we
can increase our sales and net income by implementing a growth strategy that focuses on (i) increasing our manufacturing capacity,
including by establishing additional manufacturing locations; (ii) increasing our DTC sales; (iii) expanding
our wholesale distribution channel; (iv) opening additional Company showrooms; (v) expanding our global sales; (vi) engaging
global partners to improve distribution efficiencies and cost savings; and (vii) product assortment and category expansion.
Our ability to obtain
other capital resources and sources of liquidity may not be sufficient to support future growth strategies. If we are unable to
satisfy our liquidity and capital resource requirements, we may have to scale back, postpone or discontinue our growth strategies,
which could result in slower growth or no growth, and we may run the risk of losing key suppliers, we may not be able to timely
satisfy customer orders, and we may not be able to retain our employees. In addition, we may be forced to restructure our obligations
to creditors, pursue work-out options or other protective measures.
While we have access
to a $55 million revolving credit facility under the 2020 Credit Agreement, our ability to access such funds is subject to certain
conditions, which we may not be able to satisfy at such time that we seek to draw on the revolving credit facility. Further, our
ability to obtain additional or alternative capital on acceptable terms or at all is subject to a variety of uncertainties, including
approval from KeyBank National Association and a group of financial institutions (the “Institutional Lenders”) under
the 2020 Credit Agreement. Adequate financing may not be available or, if available, may only be available on unfavorable terms.
The restrictive covenants in the 2020 Credit Agreement may make it difficult to obtain additional capital on terms that are favorable
to us, and we may not be able to satisfy the conditions necessary to obtain additional funds pursuant to the revolving credit facility
under the 2020 Credit Agreement. There is no assurance we will obtain the capital we require. As a result, there can be no assurance
that we will be able to fund our future operations or growth strategies. In addition, future equity or debt financings may require
us to also issue warrants or other equity securities that are likely to be dilutive to our existing stockholders. Newly issued
securities may include preferences or superior voting rights or may be combined with the issuance of warrants or other derivative
securities, which each may have additional dilutive effects. Furthermore, we may incur substantial costs in pursuing future capital
and financing, including investment banking fees, legal fees, accounting fees, printing and distribution expenses and other costs.
We may also be required to recognize non-cash expenses in connection with certain securities we may issue, such as convertible
notes and warrants, which will adversely impact our financial condition. If we cannot raise additional funds on favorable terms
or at all, we may not be able to carry out all or parts of our long-term growth strategy, maintain our growth and competitiveness
or continue in business.
Changes in accounting standards and
subjective assumptions, estimates and judgments by management related to complex accounting matters, including matters relating
to our Tax Receivable Agreement, could significantly affect our financial results.
Generally accepted accounting
principles and related accounting pronouncements, implementation guidelines and interpretations with regard to a wide range of
matters that are relevant to our business are complex and involve many subjective assumptions, estimates and judgments by our management,
including but not limited to estimates that affect our 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,
warrant liabilities, estimates of current and deferred income taxes, deferred income tax valuation allowances and amounts associated
with our Tax Receivable Agreement with InnoHold dated February 22, 2018 (the “Tax Receivable Agreement”). Changes in
these rules or their interpretation or changes in underlying assumptions, estimates or judgments by our management could significantly
change our reported or expected financial performance, and could have a material adverse effect on our business.
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Our future
growth and profitability may depend in part on our ability to continue to improve and expand our product line and to successfully
execute new product introductions.
As
described in greater detail below, the mattress, pillow, bedding, bed base, cushion and related industries (“Comfort Industry”)
are highly competitive, and our ability to compete effectively and to profitably grow our market share depends in part on our ability
to continue to improve and expand our product line and related accessory products.
We
incur significant research and development and other expenditures in the pursuit of improvements and additions to our product line.
If these efforts do not result in meaningful product improvements or new product introductions, or if we are not able to gain widespread
consumer acceptance of product improvements or new product introductions, our sales, profitability, cash flows and financial condition
may be adversely affected. In addition, if any significant product improvements or new product introductions are not successful,
our reputation and brand image may be adversely affected, and our business may be harmed.
A
significant portion of our gross profit comes from our mattress products. If we are unable to develop new models of our mattress
products or successfully market and sell new mattress models, our profitability may be adversely affected, and our business may
be harmed.
Our expansion into new products,
market segments and geographic regions subjects us to additional business, legal, financial, and competitive risks.
The majority of our
sales are made directly to consumers through our website or certain other e-commerce platforms. We have been expanding
our business into the wholesale distribution channel through relationships with our wholesale partners but there can be no assurance
that we will continue to experience success with our wholesale partners or that anticipated new locations will be successful.
We may be unsuccessful
in generating additional sales through wholesale channels. We may extend credit terms in connection with such relationships and
such relationships may expose us to the risk of unpaid or late paid invoices. In addition, we may provide fixtures to such partners
that may be difficult to recover or re-use. Our wholesale customers may not purchase our products in the volume we expect.
Profitability, if any,
from sales to wholesale customers and new product offerings may be lower than from our DTC model and current products,
and we may not be successful enough in these newer activities to recoup our investments in them. If any of these issues were to
arise, they could damage our reputation, limit our growth, and negatively affect our operating results.
We may be unsuccessful
in opening any of our Company showrooms beyond those already opened in cities across the U.S.. We have limited experience in opening
and operating our Company showrooms. Operating our Company showrooms includes additional risks. For example, we will incur expenses
and accept obligations related to additional leases, insurance, distribution and delivery challenges, increased employee management,
and new marketing challenges. If we are not successful in our efforts to profitably operate these new stores, our reputation and
brand could be damaged, growth could be limited, and our business may be harmed.
In addition, offerings
of new products through our DTC, wholesale distribution channel and our Company showrooms may present new and difficult challenges,
and we may be subject to claims if customers of these offerings experience service disruptions or failures or other quality issues.
Expansion of sales channels may require the development of additional, differentiated products to avoid price and distribution
conflicts between and within sales channels. Wholesale expansion increases our risk as our wholesale partners will require delaying
payments to us on net terms ranging from a few days to 60 or more days, or they may delay paying us beyond the agreed-upon net
terms or fail to pay. Our Company showroom expansion increases our risk for inventory shrinkage from destruction, theft, obsolescence
and other factors that render such inventory unusable or unsellable.
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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The ongoing COVID-19 pandemic and
responses thereto have adversely affected and may continue to adversely affect aspects of our business, including, among other
things, our supply chain, workforce, and operations.
The COVID-19 pandemic
has resulted in far-reaching economic and financial disruptions that have adversely affected, and are likely to continue to adversely
affect, the Company’s business, financial condition, capital, liquidity and results of operations. The U.S. federal government,
U.S. states and many local jurisdictions have issued at various times, and others in the future may issue, “shelter-in-place”
orders, quarantines, executive orders and similar government orders, restrictions, and recommendations for their residents to control
the spread of COVID-19. Such orders, restrictions and recommendations, and the perception that additional orders, restrictions
or recommendations could occur, have resulted in widespread closures of businesses not deemed “essential,” work stoppages,
slowdowns and delays, work-from-home policies, travel restrictions and cancellation of events, as well as increased volatility
in stock prices, among other effects. While certain jurisdictions may ease restrictions, we cannot be certain that other jurisdictions
will do so or that eased restrictions are permanent. Furthermore, many jurisdictions have experienced a resurgence in COVID-19
cases, which has prompted governments to reinstate previously scaled back restrictions. If other jurisdictions experience a resurgence
in COVID-19 cases, they may also prolong restrictions or adopt additional restrictions that could negatively affect our business,
including, but not limited to, requiring us to close our manufacturing facilities. In addition, policies in the United States regarding
the government response to the COVID-19 pandemic may further change.
We continue to monitor
our operations and government mandates and may elect or be required to temporarily close our offices, manufacturing plants or Company
showrooms to protect our employees, and limit our access to customers and limit customer use of our products as they are required
to prioritize resources to address the public healthcare needs arising from the COVID-19 pandemic. The disruptions to our activities
and operations may negatively impact our business, operating results and financial condition. There is a risk that government actions,
or lack thereof, will not be effective at containing COVID-19, and that government actions or inactions, including the orders and
restrictions described above and premature lessening of those restrictions, that are intended to contain the spread of COVID-19
while also minimizing harm to the economy, will have a devastating negative impact on the world economy at large, in which case
the risks to our sales, operating results and financial condition described herein would be elevated significantly.
The duration of the
COVID-19 pandemic’s impact on our business may be difficult to assess or predict. The widespread pandemic has resulted, and
may continue to result for an extended period, in significant disruption of global financial markets, and may restrict our ability
to access capital, which would negatively affect our liquidity. While we have been able to reverse some previous actions undertaken,
such as, among others, temporarily deferring capital expenditures, furloughing certain employees, and temporarily deferring compensation
for our senior executives, we may be required to take such actions again, or take additional actions, if there is a resurgence
of COVID-19 cases or reinstatement of government restrictions. As a result of such actions or restrictions, we may be unable to
complete capital expenditure projects or investments in the future, which would limit our ability to grow our business, and our
results of operations and financial condition will be adversely affected.
Further, quarantines
or government reaction or shutdowns for COVID-19 could disrupt our supply chain. Travel and import restrictions may also disrupt
our ability to manufacture or distribute our products. Any import or export or other cargo restrictions related to our products
or the raw materials used to manufacture our products would restrict our ability to manufacture and ship products and harm our
business, financial condition and results of operations. Our key personnel and other employees could also be affected by COVID-19,
potentially reducing their availability. In addition, the government responses to COVID-19 or the procedures we take to mitigate
its effect on our workforce could reduce the efficiency of our operations or prove insufficient to mitigate the adverse impact
of COVID-19 on our business. We may delay or reduce certain capital spending and related projects until the travel and logistical
impacts of COVID-19 are lifted, which could delay the completion of such projects.
Even after initial quarantines
and other government restrictions are scaled back, there is risk that we will be unable to continue normal production and operations,
due to, among other things, disruptions and delays in our supply chain, government relief programs that enable production workers
to remain out of the workforce, and difficulties in ramping up our own operations. We may also experience disputes with our suppliers
and/or customers as a result of such difficulties. Further, there may be subsequent outbreaks of COVID-19 that could disrupt our
operations. In addition, as employees return to work, we may face claims by such employees or regulatory authorities that we have
not provided adequate protection to our employees with respect to the spread of COVID-19 at our facilities.
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The global outbreak
of COVID-19 continues to rapidly evolve. The ultimate impact of the COVID-19 outbreak is highly uncertain and subject to change.
We do not yet know the full extent of potential delays or impacts on our business or the global economy as a whole. We do not yet
know the impact that vaccines may have in mitigating or ending the outbreak of COVID-19, or how the availability of such vaccines
may affect our work force. However, these effects could have a continuing material impact on our operations, sales and ability
to continue as a going concern. To the extent the COVID-19 pandemic adversely affects our business and financial results, it may
also have the effect of heightening many of the other risks described in this “Risk Factors” section, such as those
relating to our level of indebtedness, our need to generate sufficient cash flows to service our indebtedness and our ability to
comply with the covenants contained in the agreements that govern our indebtedness.
Customer demand for and our ability
to sell and market our products, particularly within our wholesale and Company showroom businesses, has been and may in the future
be adversely affected by the COVID-19 pandemic and responses thereto.
The COVID-19 pandemic
has created significant uncertainty in our business, slowed our anticipated wholesale partner and showroom plans and resulted in
a temporary contraction of our wholesale and Company showroom businesses due to temporary shutdowns of non-essential businesses,
reduced demand for physical retail locations, and shelter-at-home and social distancing directives where our products are displayed
in physical stores. The future impact to our wholesale partners and consumer demand from the COVID-19 pandemic or a future health
epidemic or other outbreak occurring in other locations, particularly in North America, is unknown. If we fail to anticipate changes
in demand or consumer behavior resulting from the COVID-19 pandemic or other outbreaks it could adversely affect our business or
operating results.
If sales in our channels
decline, including as a result of stay-at-home orders, social distancing mandates, temporary closures of or decreased shopping
in our wholesale partners’ stores or our Company showrooms, or deteriorating general economic conditions, our business may
be adversely affected. Moreover, we may be impacted by difficulties experienced by our wholesale partners as a result of the COVID-19
pandemic, including disruptions in their supply chains, their liquidity challenges and their ability to keep open or reopen retail
locations. In addition, while for the year ended December 31, 2020 we experienced an increase in demand for our products through
our DTC channel, there can be no guarantee that sales through our DTC channel will continue to increase or will not decline.
Our future growth and profitability
depend upon the strength of our Purple brand and the effectiveness and efficiency of our marketing programs and our ability to
attract and retain customers.
We are highly dependent
on the effectiveness of our marketing messages and the efficiency of our advertising expenditures in generating consumer awareness
and sales of our products. We continue to evolve our marketing strategies, adjusting our messages, the amount we spend on advertising
and where we spend it. We may not always be successful in developing effective messages and new marketing channels, as consumer
preferences and competition change, and in achieving efficiency in our advertising expenditures.
We depend heavily on
internet-based advertising to market our products through internet-based media and e-commerce platforms. If we are unable to continue
utilizing such platforms, if those media and platforms diminish in importance or size, or if we are unable to direct our advertising
to our target consumer groups, our advertising efforts may be ineffective, and our business could be adversely affected. The costs
of advertising through these platforms have increased significantly, which has resulted in decreased efficiency in the use of our
advertising expenditures, and we expect these costs may continue to increase in the future.
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We have relationships
with online services, search engines, affiliate marketing websites, directories and other website and e-commerce businesses
to provide content, advertising and other links that direct customers to our website. We rely on these relationships as significant
sources of traffic to our website and to generate new customers. If we are unable to develop or maintain these relationships or
develop and maintain new relationships for newly developed and necessary marketing services on acceptable terms, our ability to
attract new customers and our financial condition would suffer. In addition, current or future relationships or agreements may
fail to produce the sales that we anticipate. The cost of advertising for web-based platforms, such as Facebook, are
increasing. Increasing advertising costs erode the efficiency of our advertising efforts. If we are unable to effectively manage
our advertising costs or if our advertising efforts fail to produce the sales that we anticipate, our business could be adversely
affected.
On October 20, 2020,
the United States Department of Justice brought an antitrust lawsuit against Google claiming that Google improperly uses its monopoly
over Internet search to impede competition and harm consumers. Our cost of advertising on Google may remain high if Google’s
monopoly over Internet searches is not prevented and competitive search engines are not allowed to compete. Alternatively, if Google
is required because of this lawsuit to split up the company or sell assets, there is no assurance this will decrease advertising
costs and it may lead to increased costs due to an increased number of service providers who obtain oligopoly power to control
advertising costs or inefficiencies from a reduction in scale. Although this lawsuit may lower our advertising costs, there is
risk that it may not and would lead to increased costs which would reduce our profitability and harm our business.
Consumers are increasingly
using digital tools as a part of their shopping experience. As a result, our future growth and profitability will depend in part
on (i) the effectiveness and efficiency of our online experience for disparate worldwide audiences, including advertising
and search optimization programs in generating consumer awareness and sales of our products, (ii) our ability to prevent confusion
among consumers that can result from search engines that allow competitors to use or bid on our trademarks to direct consumers
to competitors’ websites, (iii) our ability to prevent Internet publication or television broadcast of false or misleading
information regarding our products or our competitors’ products, (iv) the nature and tone of consumer sentiment published
on various social media sites, and (v) the stability of our website. In recent years, a number of DTC, Internet-based
retailers, like us, have emerged and have driven up the cost of basic search terms, which has and may continue to increase the
cost of our Internet-based marketing programs. More recently, the large traditional mattress manufacturers have been increasing
their efforts to increase their DTC sales which also is increasing the cost of our Internet-based marketing programs and cost of
customer conversion.
In the past, we have
been the target of publications by purported consumer reviewers who claim to have identified health and safety concerns with our
products. While we believe such claims to be baseless, refuting such claims requires us to expend significant resources to educate
current and potential customers on the safety of our products. Even if we are able to broadly disseminate factual information to
refute such claims and reinforce the safety of our products, such claims and attendant adverse publicity could persist and damage
our reputation and brand value and result in lower sales.
The number of third-party
review websites is increasing, and such reviews are becoming increasingly influential with consumers. Negative reviews from such
sources may receive widespread attention from consumers, which could damage our reputation and brand value and result in lower
sales. If we are unable to effectively manage relationships with such reviewers to promote accurate reviews of our products, reviewers
may decline to review our products or may post reviews with misleading information, which could damage our reputation and make
it more difficult for us to improve our brand value.
If our marketing messages
are ineffective or our advertising expenditures, geographic price-points, and other marketing programs, including digital programs,
are inefficient in creating awareness and consideration of our products and brand name and in driving consumer traffic to our website,
our sales, profitability, cash flows and financial condition may be adversely impacted. In addition, if we are not effective in
preventing the publication of confusing, false or misleading information regarding our brand or our products, or if there arises
significant negative consumer sentiment on social media regarding our brand or our products, our sales, profitability, cash flows
and financial condition may be adversely impacted.
19
Our future growth and profitability
depend, in part, upon our ability to achieve and maintain sufficient production capacity to meet customer demands.
We manufacture our mattresses
using our proprietary and patented Mattress Max machinery to make our Hyper-Elastic Polymer cushioning material. Because
of the unique features of our Mattress Max machines, new machines are not readily available and must be constructed. We also have
experienced inefficiencies in sourcing of materials and production of finished products. We have taken steps to improve our processes
and capabilities, but if we are unable to maintain our improvements and continue our improvement initiatives to increase efficiencies
or if we are unable to promptly and efficiently open our new Georgia manufacturing facility, we may not be able to keep up with
demand which would harm our business. If we are unable to construct new Mattress Max machines and implement them into our production
process in a timely manner, if our existing Mattress Max machines are unable to function at the desired capacity, or if we are
unable to develop replacements for the existing Mattress Max machines if such replacements should become necessary, our production
capacity may be constrained and our ability to respond to customer demand may be adversely impacted. We manufacture mattresses
and other products using components provided by third-party suppliers. If those third-party suppliers are unable to provide us
with such components or if our assembly capacity is insufficient, our ability to respond to customer demand may be adversely impacted.
This would negatively impact our ability to grow our business and achieve profitability.
We have engaged in significant related-party
transactions with affiliates and owners that may give rise to conflicts of interest, result in losses to the Company or otherwise
adversely affect our operations and the value of our business.
We have engaged in numerous
related-party transactions involving significant shareholders and directors of the Company, as well as with other entities affiliated
with such persons.
For example, prior to
the Business Combination, InnoHold, previously a significant stockholder of the Company and an entity owned by the founders, Terry
and Tony Pearce, granted equity incentive awards in Purple LLC to certain key employees at that time. As a result of the structure
of those awards being granted through a separate entity, the equity incentives were required, because of the structure of the Business
Combination, to be exchanged for ownership units in InnoHold, to avoid those equity interests becoming of no value to the participants.
Those participants’ ownership interests had certain restrictions, including vesting requirements. These equity incentives
granted to key employees prior to the Business Combination are forfeited to the extent the grant to an employee is not fully vested
at the time that such employee’s employment is terminated. Before and for a period of time since the Business Combination,
all forfeitures occurring from departing employees have inured to the benefit of only the owners of InnoHold, and not all of our
stockholders. This means that the forfeited equity did not increase our currently approved equity incentive pool. Because the forfeited
equity resulting from these departures prior to this distribution was held at InnoHold, that forfeited equity did not replenish
our equity incentive pool and could not be used for equity grants to those who have replaced and will replace these employees or
for other purposes essential to the business. During 2019, to avoid future forfeitures from inuring only to the benefit of InnoHold’s
owners, InnoHold distributed to the incentive participants their pro rata share of InnoHold’s ownership of shares of Class B
common stock, par value $0.0001 (“Class B Stock”) in Purple Inc. and Class B Common Units (“Class B Units”)
in Purple LLC, after which any forfeitures would inure to the benefit of all of our stockholders. InnoHold distributed additional
paired shares of Class B Stock in Purple Inc. and Class B Units in Purple LLC which also will be subject to the same
vesting requirements and result in forfeitures inuring to the benefit of all shareholders. Our current equity incentive pool, as
approved by the stockholders prior to the Business Combination in the Purple Innovation, Inc. 2017 Equity Incentive Plan (“2017
Equity Incentive Plan”), did not account for the departure, before this distribution by InnoHold, of such key employees who
had existing equity grants through InnoHold, and there is a risk that we will have to seek approval from the Board and stockholders
to refresh the equity incentive pool earlier than anticipated at the time of the Business Combination because of the unanticipated
need to use shares from the existing pool to hire and retain other key employees needed to achieve the Company’s growth objectives.
If the equity pool is not refreshed, there is a risk that we may not be able to hire and retain such key employees. If the equity
pool is refreshed with authorized shares of the Company that are issued in accordance with our 2017 Equity Incentive Plan, our
stockholders will be diluted. Also, this distribution by InnoHold to the equity incentive participants has caused us to incur administrative
expenses related to the distributions, the management of the differing vesting schedules and compliance with their rights under
the distribution agreements. In addition, the calculations of the distributive share and related income tax withholdings with respect
to holders of InnoHold’s Class B Units, as well as the processes by which such distributions and withholdings are made,
are highly complex. As a result, there is a risk that the recipients of such distributions or other third parties may claim that
we have miscalculated the distribution or income tax withholding amounts or failed to timely pay the taxes. The cost of responding
to such claims, including but not limited to the diversion of management’s attention from our operations and defense or settlement
costs, could negatively impact our operations and financial results.
20
In connection with the
Business Combination, Purple LLC also entered into that certain Credit Agreement dated February 2, 2018, with the Coliseum Capital
Partners, L.P. (“CCP”), Blackwell Partners LLC – Series A (“Blackwell”) and Coliseum Co-invest Debt
Fund, L.P. (“CDF” and together with CCP and Blackwell, the “Lenders”), which was guaranteed by Purple Inc.
The Lenders also were stockholders and warrant holders of the Company and appointed one director to serve on our Board, Adam Gray,
who continues to serve on our Board and is affiliated with the Lenders. Further, on February 26, 2019, the Amended and Restated
Credit Agreement between Purple LLC and certain of the Lenders (the “Incremental Lenders”), and each of the related
documents, including the issuance of additional warrants to the Incremental Lenders, was closed and an incremental loan was funded.
In connection with the funding of the incremental loan, we issued to the Incremental Lenders warrants to purchase shares of our
Class A Stock. On March 27, 2020, the Amended and Restated Credit Agreement was amended to allow Purple LLC at its election
a 5% paid-in-kind interest deferral for the first two quarters of 2020. On May 15, 2020, the Amended and Restated Credit Agreement
was further amended to remove a negative covenant so that there would not be an event of default if the Lenders acquired 25% or
more ownership of the Company. On August 20, 2020, the Company and Purple LLC entered into a Waiver and Consent to Amended
and Restated Credit Agreement with the Lenders, that, among other things, waives an event of default as a result of InnoHold ceasing
to own 25% or more of the aggregate equity interests in the Company, subject to certain conditions as more fully provided in such
waiver. On September 3, 2020, we paid off the full amount owed and a prepayment premium to the Lenders in the aggregate amount
of $45.0 million and terminated the Amended and Restated Credit Agreement, subject to those provisions that survive termination.
The Lenders further have continuing rights of first refusal related to indebtedness of the Company as set forth in the Subscription
Agreement entered into by them and the Company at the time of the Business Combination. Adam Gray continues to serve on our Board
and the Lenders, together, hold a significant portion of our outstanding shares of Class A Stock and voting power. Future transactions
with the Lenders, if any, may give rise to conflicts of interest or otherwise adversely affect our business.
See
Note 15, “Related-Party Transactions,” of the Notes to the Consolidated Financial Statements, included in Part II, ITEM 8
of this Report, “Financial Statements and Supplementary Data,” and is incorporated herein by reference.
Disruption of operations in our manufacturing
facilities, including as a result of pandemics or natural disasters, could increase our costs of doing business or lead to delays
in shipping our products.
We have two manufacturing
plants, which are located in Alpine, Utah and Grantsville, Utah. We began operations on March 3, 2021 at a third manufacturing
plant in McDonough, Georgia that manufactures and distributes products. In the future we may also enter into leases for additional
manufacturing plants.
Although we can produce
some of our products at both Utah sites, we have consolidated production of certain products at each site. Therefore, the disruption
of operations of our manufacturing facilities, particularly where manufacturing has been consolidated, for a significant period
of time, or even permanently, or disruptions to the scheduled build-out of the Georgia facility such as through a closure related
to the COVID-19 pandemic or the loss of the lease, may increase our costs of doing business and lead to delays in shipping our
products to customers. Such delays could adversely affect our sales, customer satisfaction, profitability, cash flows, liquidity
and financial condition. Because both of our currently operating manufacturing plants are located within the same geographic region,
regional economic downturns, natural disasters, closures due to COVID-19 or other issues could potentially disrupt all of our manufacturing
and other operating activities, which could adversely affect our business. On March 18, 2020, Magna, Utah was the epicenter
of a 5.7 magnitude earthquake that was felt approximately 20 miles away at our Grantsville, Utah manufacturing plant but not felt
at our Alpine, Utah manufacturing plant. Since that date, there have been approximately one-thousand aftershocks. Though no damage
occurred at either manufacturing plant from the 5.7 earthquake or its aftershocks, continued or increased earthquake activity in
the area could disrupt manufacturing and other operating activities, which could adversely affect our business.
21
We may not
be able to successfully anticipate consumer trends and demand and our failure to do so may lead to loss of consumer acceptance
of the products we sell, resulting in reduced net sales.
Our
success depends in part on our ability to anticipate and respond to changing trends and consumer demands in a timely manner. Changes
in consumers’ tastes and trends and the resulting change in our product mix, as well as failure to offer our consumers multiple
avenues for purchasing our products, could adversely affect our business and operating results. If we fail to identify and respond
to emerging trends, consumer acceptance of the products we manufacture and sell and our image with current or potential customers
may be harmed, which could reduce our net sales. If we misjudge market trends, we may significantly overstock inventory and be
forced to take significant inventory markdowns, which would have a negative impact on our gross profit and cash flow. Conversely,
shortages of inventory or time to fulfillment of our products that prove popular could also reduce our sales.
We have
in some instances kept excess 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 attempt to maintain only the necessary amounts of raw material inventory on hand, in some instances we have accumulated excess
amounts of raw materials inventory. We also have accumulated in the past excess amounts of some finished goods inventory, and we
may again have excess amounts of some of our inventory. All such excess 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 take efforts to right-size all raw materials and finished goods inventory, if our efforts are not successful, we could
continue to experience excess amounts of some items of raw materials and finished goods and related shrinkage that could adversely
impact our cash flow, margins and profitability.
Our business could suffer if we are
unsuccessful in making, integrating, and maintaining commercial agreements, strategic alliances, and other business relationships.
To successfully operate
our business, we rely on commercial agreements and strategic relationships with suppliers, service providers and certain wholesale
partners and customers. As we grow, we may acquire other businesses to incorporate into our operations. These arrangements can
be complex and require substantial infrastructure capacity, personnel, and other resource commitments. Further, our business partners
may have disruptions in their businesses or choose to no longer do business with us and the impact of such disruption or choices
could be magnified to the extent such business partners represent a significant part of our business. We may not be able to implement,
maintain, or develop the components of these commercial relationships. Moreover, we may not be able to enter into additional commercial
relationships and strategic alliances on favorable terms or at all.
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 and acquisitions create additional risks such as:
●
failure to effectively integrate acquisitions;
●
disruption of our ongoing business, including loss of management focus on existing businesses;
●
impairment of other relationships;
●
variability in revenue and income from entering into, amending, or terminating such agreements or relationships; and
●
difficulty integrating under the commercial agreements.
22
We have entered into
arrangements with several wholesale partners through which we sell certain of our products in their retail stores. We anticipate
increasing the number of these partnerships. Also, we have agreed to exclusivity of certain products with some of our wholesale
partners. Our relationships with our wholesale partners may not be profitable to us or may impose additional costs that we would
not otherwise incur under our DTC operations. Our wholesale partners may choose not to continue doing business with us, which
would result in a corresponding loss of revenue. Our wholesale partners may experience their own business disruptions, including
for example bankruptcy, that could affect their ability to continue to do business with us. Our wholesale partners may engage in
conduct that could breach the exclusivity rights of other wholesale partners. Our wholesale partners may compete against us in
DTC or other channels that are important to us, and may erode our business in such channels. Further, maintaining these relationships
may require the commitment of significant amounts of time, financial resources and management attention, and may result in prohibitions
on certain sales channels through exclusivity requirements, which may adversely affect other aspects of our business.
We have opened nine
Company showrooms in cities across the U.S.. Our business is expanding into additional Company showrooms which, like our online e-commerce retail
store, may compete more directly with our wholesale partners for customers. In our effort to make our products available to consumers
in multiple retail channels, there is the risk that sales may diminish in other channels, costs may be incurred without an increase
in overall sales and our wholesale partners may no longer carry our products. Managing an omni-channel distribution strategy, including
the relationships with business partners in each channel, may require significant amounts of time, resources and attention which
may adversely affect other aspects of our business.
We operate in a highly competitive
Comfort Industry, and if we are unable to compete successfully, we may lose customers and our sales may decline.
The Comfort Industry
market is highly competitive and fragmented. We face competition from many manufacturers (including competitors that primarily
manufacture and import from China and other low-cost countries), traditional brick-and-mortar retailers and online retailers,
including direct-to-consumer competitors. One domestic competitor has a license to use some of the intellectual property
we own but do not use at this time. Participants in the Comfort Industry compete primarily on price, quality, brand name recognition,
product availability and product performance and compete across a range of distribution channels. The highly competitive nature
of the Comfort Industry means we are continually subject to the risk of loss of market share, loss of significant customers, reductions
in margins, and the inability to acquire new customers.
A number of our significant
competitors offer products that compete directly with our products. Any such competition by established manufacturers and retailers
or new entrants into the market could have a material adverse effect on our business, financial condition and operating results.
Comfort Industry manufacturers and retailers are seeking to increase their channels of distribution and are looking for new ways
to reach the consumer. 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. Many of our competitors source their products from countries
such as China and Vietnam, where the costs may be lower than our costs. Companies providing for the distribution of mattresses
online or through retail stores, such as Amazon and Walmart, also have begun to offer competing products in their respective channels.
In addition, retailers outside the U.S. have integrated vertically in the furniture and bedding industries, and it is possible
that retailers may acquire other retailers or may seek to vertically integrate in the U.S. by acquiring a mattress manufacturer.
Many of our current
and potential competitors may have substantially greater financial support, technical and marketing resources, larger customer
bases, longer operating histories, greater name recognition, mature distribution methods, and more established relationships in
the industry than we do and sell products through broader and more established distribution channels. These competitors, or new
entrants into the market, may compete aggressively and gain market share with existing or new products, and may pursue or expand
their presence in the Comfort Industry. We cannot be sure we will have the resources or expertise to compete successfully in the
future. We have limited ability to anticipate the timing and scale of new product introductions, advertising campaigns or new pricing
strategies by our competitors, which could inhibit our ability to retain or increase market share, or to maintain our product margins.
Our current and potential competitors may secure better terms from vendors, adopt more aggressive pricing, and devote more resources
to technology, infrastructure, fulfillment, and marketing. Also, due to the large number of competitors and their wide range of
product offerings, we may not be able to continue to differentiate our products through value, styling or functionality from those
of our competitors. Our products are also typically heavier than others and some markets we wish to expand into will not support
delivery of our heavy products through parcel services or other affordable home delivery services, limiting our ability to serve
the market.
23
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.
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.
A consolidation of the
domestic market for foam may increase the prices for foam in the geographical market in which we purchase foam, which could adversely
affect our business. We source a specialized type of foam from a supplier who has been in bankruptcy, and the ability of that supplier
to remain in business in the short- or long-term may affect our ability to continue to obtain that specialized foam and require
us to modify our product offerings, lose sales or incur increased expenses that could adversely affect our cash flows, margins
and profitability.
If we are unable to
effectively compete with other manufacturers and retailers of mattresses, pillows, cushions, and our other products our sales,
profitability, cash flows and financial condition may be adversely impacted.
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 DTC 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.
24
E-commerce
customers have come to expect improved user experience, greater ease of buying goods, lower (or no) shipping costs, faster delivery
times and more favorable return policies from e-commerce sellers. 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 Comfort Industry 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 DTC retailers
and e-commerce competitors may offer or continue to offer faster shipping, free shipping, delivery on Sunday, same-day delivery,
favorable return policies or other transaction-related services which improve the user experience on their sites and which could
be impractical or inefficient for us to match. Competitors may be able to innovate faster and more efficiently, and new technologies
may increase competitive pressure by enabling competitors to offer more efficient or lower-cost services.
A reduction
in the availability of credit to consumers generally or under our existing consumer credit programs or the availability of more
favorable credit terms with competitors could harm our sales, profitability, cash flows and financial condition.
We
offer financing to consumers through third-party consumer finance companies. During the year ended December 31, 2020, a significant
percentage of our sales were financed through third-party consumer finance companies. The amount of credit available to consumers
may be adversely impacted by macroeconomic factors that affect the financial position of consumers as suppliers of credit adjust
their lending criteria. In addition, changes in federal regulations effective in 2010 placed additional restrictions on all consumer
credit programs, including limiting the types of promotional credit offerings that may be offered to consumers.
These
third-party consumer finance companies offer consumer financing options to our customers through agreements that may be terminated
by us or the companies upon thirty days’ prior written notice. These consumer finance companies have discretion to control
the content of financing offers to our customers and to set minimum credit standards under which credit is extended to customers.
These consumer finance companies may make more favorable terms available to our competitors, or they may offer more favorable terms
in channels other than the channels in which we focus our efforts.
Reduction
of credit availability due to changing economic conditions, changes in regulatory requirements, or the termination of our agreements
with third-party consumer finance companies could harm our sales, profitability, cash flows and financial condition. The availability
of more favorable credit terms offered by competitors could harm our sales, profitability, cash flows and financial condition.
We attempt
to maintain only the necessary amounts of raw material inventory and products, which could leave us vulnerable to shortages in
supply of components and products that may harm our ability to satisfy consumer demand and may adversely impact our sales and profitability.
We
attempt to maintain only the necessary amounts of products and raw material inventory on hand, which could leave us vulnerable
to shortages in supply of products or components that may harm our ability to satisfy consumer demand and may adversely impact
our sales and profitability. Lead times for ordered components and products may vary significantly, especially as we source some
of our materials and products from China or other countries. Our business may be harmed by legal, regulatory, economic, political,
health concerns and unforeseen risks associated with international trade in those countries. Moreover, we may experience increased
costs in sourcing Chinese materials as a result of the uncertain status of the U.S.-China trade relationship or may experience
related disruption if we seek to replace Chinese suppliers with suppliers in other countries. In addition, some components used
to manufacture our products are provided on a sole source basis. Any unexpected shortage of products or materials caused by any
disruption of supply or an unexpected increase in the demand for our products, could lead to delays in shipping our products to
customers. Any such delays could adversely affect our sales, customer satisfaction, profitability, cash flows and financial condition.
25
We
rely upon several key suppliers that are, in some instances, the only source of supply currently used by us for particular products,
materials, components or services. A disruption in the supply or substantial increase in cost of any of these products or services
could harm our sales, profitability, cash flows and financial condition.
We
currently obtain all of the raw materials and components used to produce our mattresses, pillows and cushions from outside sources.
In some cases, we have chosen to obtain these materials and components from suppliers who serve as the only source of supply, or
who supply the vast majority of our needs of the particular material or component. While we believe that these materials and components,
or suitable replacements, could be obtained from other sources, in the event of a disruption or loss of supply of relevant materials
or components for any reason, we may not be able to find alternative sources of supply, or if found, may not be found on comparable
terms. In addition, a change in the financial condition of some of our suppliers could impede their ability to provide products
to us in a timely manner.
If
our relationship with the primary supplier of our mineral oil is terminated, we could have short-term difficulty in replacing this
source since there are relatively few other suppliers presently capable of supplying the local volume that we would need in a short
period of time.
Our success
is highly dependent on our ability to provide timely delivery to our customers, and any disruption in our delivery capabilities
or our related planning and control processes may adversely affect our operating results.
An
important part of our success is due to our ability to deliver our products to our customers in a timely manner. This in turn is
due to our successful planning and distribution infrastructure, including ordering, transportation and receipt processing, the
ability of our suppliers to meet our distribution requirements and the ability of our contractors to meet our delivery requirements.
Our ability to maintain this success depends on the continued identification and implementation of improvements to our planning
processes, distribution infrastructure and supply chain. We also need to ensure that our distribution infrastructure and supply
chain keep pace with our anticipated growth and increased product output. The cost of these enhanced processes could be significant
and any failure to maintain, grow or improve them could adversely affect our operating results.
Except
in the Salt Lake City, Utah area, we rely on common carriers and freight forwarders to deliver our products to customers on a timely,
convenient, and cost-effective basis. We also rely on the systems of such carriers to provide us with accurate information about
the status and delivery of our products. Any disruption to the business of delivery carriers could cause our business to be adversely
affected. Any significant delay in deliveries to our customers could lead to increased cancellations and returns and cause us to
lose sales. Any increase in freight charges could increase our costs of doing business and harm our sales, profitability, cash
flows and financial condition. Lack of accurate information from such carriers could damage our brand and our relationship with
our customers. In the Salt Lake City, Utah area, we are using Company-owned delivery services that have been successful and efficient,
and we intend to continue growing such services as demand and volume dictate. If our Company-owned delivery services do not continue
to deliver products in a timely or cost-effective manner, we may need to revert to third party carriers and our reputation and
business may be adversely affected.
Our
business could also be adversely affected if there are delays in product shipments to us due to freight difficulties, delays in
product shipments clearing U.S. Customs and Border Protection (“CBP”) for reasons of non-compliance or otherwise,
challenges with our suppliers or contractors involving strikes or other difficulties at their principal transport providers or
otherwise. The adverse effect on our business could include increase in freight costs if we choose to use more air freight. Our
business could also be adversely affected if the business of our suppliers is disrupted because of infectious diseases or fear
thereof such that quarantines, factory closures, labor disturbances, and transportation delays result. Such delays and events could
adversely affect our profitability and reputation.
We depend on a few key employees,
and if we lose the services of certain of our principal executive officers, we may not be able to run our business effectively.
Our future success depends
in part on our ability to attract and retain key executive, merchandising, marketing, sales, finance, operations and engineering
personnel. If any of our executive officers cease to be employed by us, we would have to hire additional qualified personnel. Our
ability to successfully attract and hire other experienced and qualified executive officers cannot be assured and may be difficult
because we face competition for these professionals from our competitors, our suppliers and other companies operating in our industry
and in our geographic locations. Since the Business Combination, we have hired a new Chief Executive Officer, Chief Operating Officer,
Chief Financial Officer, and a Chief Retail Officer. We have also experienced the departure of the prior Chief Marketing Officer
and the prior Chief Branding Officer. These departures and any delay in replacing these executives could significantly disrupt
our ability to grow and pursue our strategic plans. We have been in the process of searching for a qualified replacement for our
Chief Marketing Officer for approximately two years. While we believe our current executive officers have benefitted and will continue
to benefit us, finding qualified replacements is time-consuming, takes Company resources, and can disrupt our growth and achievement
of strategic plans. We do not maintain key-person insurance for members of our executive management team.
26
If we fail
to maintain an effective system of internal controls, we may not be able to report our financial results accurately, may make a
material misstatement in our financial statements, or may experience a financial loss. Any inability to report and file our financial
results accurately and timely could harm our business and adversely affect the value of our business.
As
a public company, we are required to establish and maintain internal controls over financial reporting and disclosure controls
and procedures and to comply with other requirements of the Sarbanes-Oxley Act and the rules promulgated by the SEC. Even when
such controls are implemented, management, including our Chief Executive Officer and Chief Financial Officer, cannot guarantee
that our internal controls and disclosure controls and procedures will prevent all possible errors or loss. Because of the inherent
limitations in all control systems, no system of controls can provide absolute assurance that all control issues and instances
of fraud, if any, within the Company or perpetrated against us will be prevented or have been detected. These inherent limitations
include the possibility that judgments in decision-making can be faulty and subject to simple error or mistake. Furthermore, controls
can be circumvented by individual acts of some persons, by collusion of two or more persons, or by management override of the controls.
The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there
can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time,
measures of control may become inadequate because of changes in conditions, new fraudulent schemes, or the deterioration of compliance
with policies or procedures. Because of inherent limitations in a cost-effective control system, misstatements due to error or
fraud may occur and/or may not be detected.
The
accuracy of our financial reporting depends on the effectiveness of our internal control over financial reporting. Internal control over
financial reporting can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements
and may not prevent or detect misstatements. Failure to maintain effective internal control over financial reporting, or lapses in disclosure
controls and procedures, could undermine the ability to provide accurate disclosure (including with respect to financial information)
on a timely basis, which could cause investors to lose confidence in our disclosures (including with respect to financial information),
require significant resources to remediate the lapse or deficiency, and expose us to legal or regulatory proceedings. We have identified
a material weakness in our internal controls over financial reporting in connection with the restatement of our financial statements
as of and for the years ended December 31, 2020 and 2019. If the identified material weakness is not remediated or if additional material
weaknesses or significant deficiencies in our internal control are discovered or occur in the future, our financial statements may in
the future contain material misstatements and we could be required to restate our financial results, which could lead to substantial
additional costs for accounting and legal fees and stockholder litigation.
We have identified a material weakness
in our internal control over financial reporting and if we are unable to develop and maintain an effective system of internal control
over financial reporting, we may not be able to accurately report our financial results in a timely manner, which may adversely affect
investor confidence in us and materially and adversely affect our business and operating results.
Following this issuance
of the SEC Statement, on April 28, 2021, our management and our audit committee concluded that, in light of the SEC Statement, it was
appropriate to restate our previously issued audited financial statements as of and for the years ended December 31, 2020 and 2019. See
Note 3, “Restatement of Previously Issued Consolidated Financial Statements,” of the Notes to the consolidated financial
statements for additional details regarding the restatement. As part of such process, we identified a material weakness in our internal
controls over financial reporting. Our internal control over financial reporting did not result in the proper classification of the public
and sponsor warrants we issued in connection with our IPO and a simultaneous private placement, respectively, which due to its impact
on our consolidated financial statements, we determined to be a material weakness.
We continue to evaluate,
design and work through the process of implementing controls and procedures under a remediation plan designed to address this material
weakness, but there can be no assurance that we will be able to remediate this material weakness in a timely manner or at all. If our
remediation measures are insufficient to address the material weaknesses, or if additional material weaknesses or significant deficiencies
in our internal control are discovered or occur in the future, our financial statements may contain material misstatements and we could
be required to restate our financial results, which could lead to substantial additional costs for accounting and legal fees and stockholder
litigation.
Any failure to maintain
such internal control could adversely impact our ability to report our financial position and results from operations on a timely and
accurate basis. If our financial statements are not accurate, investors may not have a complete understanding of our operations. Likewise,
if our financial statements are not filed on a timely basis, we could be subject to sanctions or investigations by the stock exchange
on which our common stock is listed, the SEC or other regulatory authorities. In either case, this could result in a material adverse
effect on our business. Failure to timely file will cause us to be ineligible to utilize short form registration statements on Form S-3,
which may impair our ability to obtain capital in a timely fashion to execute our business strategies or issue shares to effect an acquisition.
Ineffective internal controls could also cause investors to lose confidence in our reported financial information, which could have a
negative effect on the trading price of our stock.
We may need
to implement additional finance and accounting systems, procedures and controls as we grow our business and organization and to
satisfy new reporting requirements.
We
have a limited operating history, and our systems, procedures and controls are still developing to match the complexity of our
business. We are required to comply with a variety of reporting, accounting and other rules and regulations. Compliance with existing
requirements is expensive. As a public company, we are required to comply with additional regulations and other requirements. These
and future requirements may increase our costs and require additional management time and resources. We may need to implement additional
finance and accounting systems, procedures and controls to satisfy our reporting requirements. If our internal control over financial
reporting is determined to be ineffective, such failure could cause investors to lose confidence in our reported financial information,
negatively affect the value of our business, subject us to regulatory investigations and penalties, and could have a material adverse
effect on our business.
27
Our business
operations could be disrupted if our information technology systems fail to perform adequately or are disrupted by natural disasters
or other catastrophes or if we are unable to protect the integrity and security of our information systems.
We
depend largely upon our information technology systems in the conduct of all aspects of our operations. If our information technology
systems fail to perform as anticipated, we could experience difficulties in virtually any area of our operations, including but
not limited to receiving orders from customers, replenishing inventories or delivering our products. We may be required to incur
significant capital expenditures in the pursuit of improvements or upgrades to our management information systems. These efforts
may take longer and may require greater financial and other resources than anticipated, may cause distraction of key personnel,
and may cause short-term disruptions to our existing systems and our business. If we experience difficulties in implementing new
or upgraded information systems or experience significant system failures, or if we are unable to successfully modify our information
systems to respond to changes in our business needs, our ability to run our business could be adversely affected. It is also possible
that our competitors could develop better e-commerce platforms than ours, which could negatively impact our sales.
In
addition, our systems may experience service interruptions or degradation due to hardware and software defects or malfunctions,
computer denial-of-service and other cyberattacks, human error, earthquakes, hurricanes, floods, fires, natural disasters,
power losses, disruptions in telecommunications services, fraud, military or political conflicts, terrorist attacks, computer viruses,
or other events. Some of our systems are not fully redundant and our disaster recovery planning is not sufficient for all eventualities.
Our systems are also subject to break-ins, sabotage, information hijacking or ransom, and intentional acts of vandalism.
Any of these or other systems related problems could, in turn, adversely affect our sales and profitability.
Regulatory and Litigation Risks
We may not be eligible to participate
in some of the relief programs provided under the recently adopted Coronavirus Aid Relief, and Economic Security (CARES) Act, the
Consolidated Appropriations Act, 2021, or other government programs and even if we are eligible we may not realize any material
benefits from participating in such programs.
In response to the economic
impact of the COVID-19 pandemic, the United States has enacted legislation, including the Coronavirus Aid Relief, and Economic
Security (CARES) Act and the Consolidated Appropriations Act, 2021, intended to provide relief to individuals and businesses, including,
but not limited to, through stimulus payments to individuals, tax relief and benefits, and other programs. We continue to evaluate
the applicability of the CARES Act and the Consolidated Appropriations Act, 2021, to the Company, and the potential impacts on
our business and are actively seeking to take advantage of applicable programs.
While we may determine
to apply for programs available under the such legislation, there is no guarantee that we will meet any eligibility requirements
to participate in such programs or, even if we are able to participate, that such programs will provide meaningful benefit to our
business. In addition to relief programs provided in connection with the COVID-19 pandemic, the U.S. government and state/local
governments may offer additional programs intended to assist employers. We may fail to qualify for or take advantage of such COVID-19
relief programs, which may have a negative impact on our business. In the event we are able to participate in such programs, our
participation may impose additional restrictions on our business that could adversely affect our business and our ability to respond
to the changing economic environment. In addition, previously adopted government programs designed to provide assistance to businesses
and consumers may not be sufficient and further assistance may not be provided and the U.S. government and state and local governments
may not act to provide additional assistance, which could adversely affect consumer spending and our business.
Regulatory requirements, including,
but not limited to, trade, customs, environmental, health and safety requirements, may require costly expenditures and expose us
to liability.
Our products and our
marketing and advertising programs are subject to regulation in the U.S. by various federal, state and local regulatory authorities,
including the Federal Trade Commission and the CBP. In addition, our operations are subject to federal, state and local consumer
protection regulations and other laws relating specifically to the bedding industry. These rules and regulations may conflict and
may change from time to time, as a result of changes in the political environment or otherwise. There may be continuing costs of
regulatory compliance including continuous testing, additional quality control processes and appropriate auditing of design and
process compliance.
28
In addition, we are
subject to federal, state and local laws and regulations relating to pollution, environmental protection and occupational health
and safety. We may not be in complete compliance with all such requirements at all times, and we have been required in the past
to make changes to our facilities in order to comply with these requirements. We have made and will continue to make capital and
other expenditures to comply with environmental and health and safety requirements. If a release of harmful or hazardous substances
occurs on or from our properties or any associated offsite disposal location, or if contamination from prior activities is discovered
at any of our properties, we may be held liable and the amount of such liability could be material. As a manufacturer of mattresses,
pillows, cushions and related products, we use and dispose of a number of substances, such as glue, oil, solvents and other petroleum
products, as well as certain foam ingredients, that may subject us to regulation under numerous foreign, federal and state laws
and regulations governing the environment. Among other laws and regulations, we are subject in the U.S. to the Federal Water Pollution
Control Act, the Comprehensive Environmental Response, Compensation and Liability Act, the Resource Conservation and Recovery Act,
the Clean Air Act and related state and local statutes and regulations.
We are also subject
to federal laws and regulations relating to international shipments, customs, and import controls. We may not be in complete compliance
with all such requirements at all times, and if we are not in compliance with such requirements, we may be subject to penalties
or fines, which could have an adverse impact on our financial condition and results of operations.
Our operations could
also be impacted by a number of pending legislative and regulatory proposals to address greenhouse gas emissions in the U.S. and
other countries. The U.S. and certain other countries have adopted the Kyoto Protocol. New greenhouse gas reduction targets have
been established under the Kyoto Protocol, as amended. This and other initiatives under consideration could affect our operations.
These actions could increase costs associated with our manufacturing operations, including costs for raw materials, pollution control
equipment and transportation. Because it is uncertain what laws will be enacted, we cannot predict the potential impact of such
laws on our future consolidated financial condition, results of operations, or cash flows.
We are also subject
to regulations and laws specifically governing the Internet, e-commerce, electronic devices, and other services. These
regulations and laws may cover taxation, privacy, data protection, pricing, content, copyrights, distribution, mobile communications,
electronic device certification, electronic waste, energy consumption, electronic contracts and other communications, competition,
consumer protection, trade and protectionist measures, web services, the provision of online payment services, information reporting
requirements, unencumbered Internet access to our services or access to our facilities, the design and operation of websites and
the characteristics and quality of products and services. It is not clear how existing laws governing issues such as property ownership,
libel, and personal privacy apply to the Internet, e-commerce, digital content, and web services. Unfavorable regulations
and laws could diminish the demand for, or availability of, our products and services and increase our cost of doing business.
Claims have been made
against us for alleged violations of the Americans with Disabilities Act (“ADA”) related to accessibility to our website
by the blind. The law is unsettled as to which types of websites the ADA covers and what standards are applicable, but courts
in certain jurisdictions have recognized these types of ADA claims. While we comply with industry standards and are continuing
to significantly enhance our compliance efforts for making our website accessible to the blind, and regularly test our site for
this purpose, we may be subject to such claims and, as a result, we may be required to expend resources in defense of these claims
that could increase our cost of doing business.
We are also subject
to various health and environmental provisions such as California Proposition 65 (the Safe Drinking Water and Toxic Enforcement
Act of 1986). We have received a claim that one of our products does not have the proper warning label required by California Proposition
65, which requires businesses to provide warnings to Californians about significant exposures to chemicals that are known to the
State of California to cause cancer, birth defects or other reproductive harm. While we are investigating this claim and generally
make efforts to comply with Proposition 65, we may be subject to such claims and, as a result, we may be required to expend resources
in defense of these claims that could increase our cost of doing business. In addition, to the extent we may have violated Proposition
65 we may incur expense associated with complying including but not limited to providing warnings or product recalls.
Regulatory
requirements relating to the manufacture and disposal of mattresses may increase our product costs and increase the risk of disruption
to our business.
The U.S. Consumer Product
Safety Commission (“CPSC”) and other jurisdictions have adopted rules relating to fire retardancy standards for the
mattress industry. Some states and the U.S. Congress continue to consider fire retardancy regulations that may be different from
or more stringent than the current standard. In addition, these regulations require manufacturers to implement quality assurance
programs and encourage manufacturers to conduct random testing of products. These regulations also require maintenance and retention
of compliance documentation. These quality assurance and documentation requirements are costly to implement and maintain. If any
product testing, other evidence, or regulatory inspections yield results indicating that any of our products may not meet the flammability
standards, we may be required to temporarily cease production and distribution or to recall products from the field, and we may
be subject to fines or penalties, any of which outcomes could harm our business, reputation, sales, profitability, cash flows and
financial condition.
29
The
CPSC adopted new flammability standards and related regulations which became effective nationwide in July 2007 for mattresses and
mattress and foundation sets. Compliance with these requirements has resulted in higher materials and manufacturing costs for our
products and has required modifications to our information systems and business operations, further increasing our costs and negatively
impacting our capacity. Some states and the U.S. Congress continue to consider fire retardancy regulations that may be different
from or more stringent than the CPSC standard. Adoption of multi-layered regulatory regimes, particularly if they conflict with
each other, could increase our costs, alter our manufacturing processes and impair the performance of our products which may have
an adverse effect on our business.
Also, California recently
enacted laws effective in 2021 requiring mattress retailers delivering mattresses via common carrier in California to offer to
pick up their customers’ old mattresses. Additionally, California, Rhode Island and Connecticut have all enacted laws requiring
the recycling of mattresses discarded in their states. State and local bedding industry regulations vary among the states in which
we operate but generally impose requirements as to the proper labeling of bedding merchandise, restrictions regarding the identification
of merchandise as “new” or otherwise, controls as to hygiene and other aspects of product handling, disposal, sales,
resales and penalties for violations. We or our suppliers may be required to incur significant expense to the extent that these
regulations change and require new and different compliance measures.
New legislation aimed
at improving the fire retardancy of mattresses, regulating the handling of mattresses in connection with preventing or controlling
the spread of bed bugs could be passed, or requiring the collection or recycling of discarded mattresses, could result in product
recalls or in a significant increase in the cost of operating our business. In addition, failure to comply with these various regulations
may result in penalties, the inability to conduct business as previously conducted or at all, or adverse publicity, among other
things. Adoption of multi-layered regulatory regimes, particularly if they conflict with each other, could increase our costs,
alter our manufacturing processes and impair the performance of our products which may have an adverse effect on our business.
We are also subject to various health and environmental provisions such as 16 CFR Part 1633 (Standard for the Flammability (Open
Flame) of Mattress Sets).
We could be subject to additional
sales tax or other indirect tax liabilities.
The application of indirect
taxes (such as sales and use tax, value-added tax (“VAT”), goods and services tax, business tax and gross receipt tax)
to e-commerce businesses and to our users is a complex and evolving issue and we may be unable to timely or accurately
determine our obligations with respect to such indirect taxes, if any, in various jurisdictions. Many of the fundamental statutes
and regulations that impose these taxes were established before the adoption and growth of the Internet and e-commerce. In
many cases, it is not clear how existing statutes apply to the Internet or e-commerce.
An increasing number
of states and foreign jurisdictions have considered or adopted laws or administrative practices, with or without notice, that impose
additional obligations on remote sellers and online marketplaces to collect transaction taxes such as sales, consumption, value
added, or similar taxes. Failure to comply with such laws or administrative practices or a successful assertion by such states
or foreign jurisdictions requiring us to collect taxes where we did not, could result in substantial tax liabilities for past sales,
as well as penalties and interest.
We are subject to sales
tax or other indirect tax obligations as imposed by the various states in the United States. If the tax authorities in these jurisdictions
were to challenge our filings or request an audit, our tax liability may increase.
We may be subject to
laws, regulations, and administrative practices that require us to collect information from our customers, vendors, merchants,
and other third parties for tax reporting purposes and report such information to various government agencies. The scope of such
requirements continues to expand, requiring us to develop and implement new compliance systems. Failure to comply with such laws
and regulations could result in significant penalties.
30
The U.S. Supreme Court
ruling in South Dakota v. Wayfair, Inc. , No.17-494, reversed a longstanding precedent that remote sellers are not required
to collect state and local sales taxes. We cannot predict the effect of these and other attempts to impose sales, income or other
taxes on e-commerce. The Company currently collects and reports on sales tax in all states in which it does business. However,
the application of existing, new or revised taxes on our business, in particular, sales taxes, VAT and similar taxes would likely
increase the cost of doing business online and decrease the attractiveness of selling products over the internet. The application
of these taxes on our business could also create significant increases in internal costs necessary to capture data and collect
and remit taxes. There have been, and will continue to be, substantial ongoing costs associated with complying with the various
indirect tax requirements in the numerous markets in which we conduct or will conduct business.
We could
be subject to additional income tax liabilities.
We
are subject to federal and state income taxes in the U.S. tax laws, regulations, and administrative practices in the U.S. and in
various state and local jurisdictions are subject to significant change or increase, and significant judgment is required in evaluating
and estimating our provision and accruals for taxes. In addition, some states and cities require additional taxes or fees for the
right to sell mattresses in their jurisdiction. While we have established reserves based on assumptions and estimates that we believe
are reasonable to cover such taxes and fees, these reserves may prove to be insufficient.
Our
determination of our tax liability is always subject to audit and review by applicable tax authorities. Any adverse outcome of
any such audit or review could harm our business, and the ultimate tax outcome may differ from the amounts recorded in our financial
statements and may materially affect our financial results in the period or periods for which such determination is made. Regardless
of the outcome, responding to any such audit or review could cause us to incur significant costs and could divert resources away
from our operations.
There
are many transactions that occur during the ordinary course of business for which the ultimate tax liability is uncertain. Our
effective tax rates could be affected by earnings being lower than anticipated in jurisdictions where we have lower statutory rates
and higher than anticipated in jurisdictions where we have higher statutory rates, losses incurred in jurisdictions for which we
are not able to realize the related tax benefit, changes in foreign currency exchange rates, entry into new businesses and geographies
and changes to our existing businesses, acquisitions (including integrations) and investments, changes in the price of our securities,
changes in our deferred tax assets and liabilities and their valuation, and changes in the relevant tax, accounting, and other
laws, regulations, administrative practices, principles, and interpretations.
A
number of U.S. states have attempted to increase corporate tax revenues by taking an expansive view of corporate presence to attempt
to impose corporate income taxes and other direct business taxes on companies that have no physical presence in their state, and
taxing authorities in other jurisdictions may take similar actions. Many U.S. states are also altering their apportionment formulas
to increase the amount of taxable income or loss attributable to their state from certain out-of-state businesses. Further,
we may be required in the future to pay sales and other taxes and fees to states where our products were warehoused before shipping.
If more taxing authorities are successful in applying direct taxes to Internet companies that do not have a physical presence in
their respective jurisdictions, this could increase our effective tax rate.
We may face
litigation and other risks as a result of the material weakness in our internal control over financial reporting.
Following the issuance
of the SEC Statement, our management and our audit committee concluded that it was appropriate to restate our previously issued audited
financial statements as of and for the years ended December 31, 2020 and 2019. As part of the restatement, we identified a material weakness
in our internal controls over financial reporting.
As a result of such restatement,
material weakness, and other matters raised or that may in the future be raised by the SEC, we face potential for litigation or other
disputes which may include, among others, claims invoking the federal and state securities laws, contractual claims or other claims arising
from the restatement and material weaknesses in our internal control over financial reporting and the preparation of our financial statements.
As of the date of this Annual Report, we have no knowledge of any such litigation or dispute. However, we can provide no assurance that
such litigation or dispute will not arise in the future. Any such litigation or dispute, whether successful or not, could have a material
adverse effect on our business, results of operations and financial condition.
31
Risks Relating to our Intellectual Property and Use of
Technology
We may not
be able to protect our product designs and other proprietary rights adequately, which could adversely affect our competitive position
and reduce the value of our products and brands, and litigation to protect our intellectual property rights may be costly.
We
attempt to strengthen and differentiate our product portfolio by developing new and innovative brands, product designs and functionality
and materials for use in our products. We regard our trademarks, service marks, copyrights, patents, trade dress, trade secrets,
proprietary technology, and similar intellectual property as critical to our success, and we rely on trademark, copyright, and
patent law, trade secret protection, and confidentiality agreements and license agreements with our vendors, contractors, employees,
customers, and others to protect our proprietary rights.
We
own various U.S. and foreign patents and patent applications related to certain elements of the design and function of our products
including mattresses, pillows, cushions and related products, as well as related to proprietary formulas and related technology
for certain materials used in the manufacturing of our products. We own numerous registered and unregistered trademarks and trademark
applications, as well as other intellectual property rights, including trade secrets, trade dress and copyrights, which we believe
have significant value and are important to the marketing of our products. Our success will depend in part on our ability to protect
our products, methods, processes and other technologies, to preserve our trade secrets, and to operate without infringing on the
proprietary rights of third parties.
As
we continue to increase our innovations and create new products and technologies, and as we enter new product spaces, we may be
limited by the intellectual property rights of others. We respect the intellectual property rights of others; however, our ability
to innovate and increase our product footprint may be limited by the intellectual property rights of those other parties.
Despite
our efforts, we may not be able to adequately protect or enforce our intellectual property and other proprietary rights. We have
seen an increase in the number of counterfeit goods and products that infringe on our patents. Effective protection or enforcement
of intellectual property rights may be unavailable or limited in the jurisdictions in which we do business. We also may be unable
to acquire or maintain appropriate trademarks and domain names in all jurisdictions in which we do business. Furthermore, regulations
governing domain names may not protect our trademarks and similar proprietary rights. We may be unable to prevent third parties
from acquiring domain names that are similar to, infringe upon, or diminish the value of our trademarks and other proprietary rights.
The
protection of our intellectual property, such as preventing counterfeit goods from entering the market or defending our patents,
may require the expenditure of significant financial and managerial resources. We may not be able to discover or determine the
extent of all unauthorized use of our proprietary rights. Policing the unauthorized use of our proprietary technology, trademarks
and copyrights can be difficult and expensive. Litigation might be necessary to protect our intellectual property rights, which
may be costly and may divert our management’s attention away from our core business. Furthermore, there is no guarantee that
litigation would result in an outcome favorable to us. Third parties that license our proprietary rights also may take actions
that diminish the value of our proprietary rights or reputation. We also cannot be certain that others will not independently develop
or otherwise acquire equivalent or superior technology or other intellectual property rights. If we are unable to protect our proprietary
rights adequately, it would have a negative impact on our operations.
32
We, or the
owners of any intellectual property rights licensed to us, may be subject to claims that we or such licensors have infringed the
proprietary rights of others, which could require us and our licensors to obtain a license or change designs.
We
have been subject to, and expect to continue to be subject to, claims and legal proceedings regarding alleged infringement by us
of the intellectual property rights of third parties. Although we do not believe any of our products infringe upon the proprietary
rights of others, there is no assurance that infringement or invalidity claims (or claims for indemnification resulting from infringement
claims) will not be asserted or prosecuted against us or those from whom we have licenses or that any such assertions or prosecutions
will not have a material adverse effect on our business. Regardless of whether any such claims are valid or can be asserted successfully,
defending against such claims could cause us to incur costs and could divert resources away from our other activities. In addition,
assertion of infringement claims could result in injunctions that prevent us from distributing our products. If any claims or actions
are asserted against us or those from whom we have licenses, we may seek to obtain a license to the intellectual property rights
that are in dispute. Such a license may not be available on reasonable terms, or at all, which could force us to change our designs.
Purple LLC has licensed certain intellectual
property to EdiZONE, LLC, which is owned by Tony and Terry Pearce, former members of our Board, via TNT Holdings, LLC (“TNT
Holdings”), for the purpose of enabling EdiZONE to meet its contractual obligations to licensees of EdiZONE under contracts
entered into years before the Business Combination, and some of those licensees are competitors of Purple LLC and have exclusivity
rights that Purple LLC is required to observe.
Prior to the Business
Combination, we also entered into an Amended and Restated Confidential Assignment and License Back Agreement with EdiZONE, an entity
beneficially owned and controlled by the founders, Tony Pearce and Terry Pearce (former employees, directors and beneficial majority
shareholders), through their ownership of TNT Holdings, pursuant to which EdiZONE transferred tangible and intellectual property
to us and we licensed back to EdiZONE certain intellectual property previously licensed by EdiZONE to third parties prior to the
Business Combination in order to enable EdiZONE to continue to meet certain pre-existing license obligations to those
third parties. EdiZONE and the Pearces have agreed to not modify or extend these third-party licenses and to not enter new third-party
licenses. As these third-party license obligations end, all rights under the license revert to the Company. These third parties
include direct competitors to us that at the time of the Business Combination were not selling products through retail channels
and in geographical areas in which we were selling our products. One of these third parties is Advanced Comfort Technologies, Inc.
dba Intellibed (“Intellibed”) who has been a licensee of EdiZONE for over fifteen years. Intellibed sells mattresses
in the U.S. and Canada including now through some of the same retailers through which we also sell our products.
On August 14, 2020,
with the approval of our independent directors, Purple LLC entered into a License Transfer and IP Assignment Agreement with EdiZONE
(the “EdiZONE Agreement”), pursuant to which EdiZONE assigned to Purple LLC all its interest in and obligations under
its license to Intellibed (the “Intellibed License Agreement”) which covers patents, trade secrets as well as the trademarks,
including the GEL MATRIX and INTELLIPILLOW trademarks transferred under the EdiZONE Agreement, now owned by Purple LLC. In connection
with such assignment, we agreed to indemnify EdiZONE against claims by Intellibed against EdiZONE relating to EdiZONE’s breach
under the Intellibed License Agreement, if any, future claims arising out of the execution of the EdiZONE Agreement, or Purple
LLC’s ownership, enforcement or breach of the Intellibed License Agreement. As a result of the EdiZONE Agreement, Intellibed
pays royalties under the Intellibed License Agreement, and now owes its contractual obligations thereunder to Purple LLC. Should
the Intellibed License Agreement end or be terminated, all of Intellibed’s rights thereunder revert to Purple LLC, including
the right to continue to sell mattress, topper and pillow products using the same trademarks required by the license to be used
with such products and to benefit from all equity in those brands.
33
Under the Intellibed
License Agreement, Intellibed is licensed the right to use technology we do not use in our products or to make our products. That
licensed technology allows Intellibed to make a certain type of hollow buckling cushioning structure from elastomeric material,
which Intellibed uses in its own mattress, topper and pillow products, but using only a specific type of elastomeric material and
manufacturing process that were developed by EdiZONE years earlier that has long been replaced by the Company with more advanced
gel materials and more efficient manufacturing processes that Intellibed has no right to use. Whereas Intellibed’s rights
are limited to specific products and has exclusivity to this technology only for mattresses, the Company can use the licensed technologies,
should it want to, for any purpose except mattresses, and Intellibed cannot use any of the many other technologies owned by Purple
LLC including any of the advanced technologies being used for Purple products. Nevertheless, because of the appearance of Intellibed’s
cushioning element, its products may be wrongfully perceived by consumers as being comparable to the Company’s mattress and
pillow products. Likewise, because of the novelty of the Company’s technologies, consumers and investors also may conclude
incorrectly that Intellibed’s licensed elastomeric material and manufacturing process can produce a cushioning element with
the same qualities and at the same scale as the Company’s Hyper-Elastic Polymer material in the Purple Grid cushion used
in Purple products. This confusion could lead consumers to purchase Intellibed’s products instead of the Company’s
products. The lack of a clear understanding of these differences could result in lower sales that would harm the Company.
Intellibed has been growing
its sales over the past years and now distributes a portion of its products through wholesale partners with retail locations where our
mattresses are sold. This competitor may continue to increase its sales and expand into additional distribution channels which could
erode our sales in those retail locations and channels. This competitor may decide to sell its business to other competitors, which may
have implications on the assignment and continuity of the Intellibed License Agreement, including the continuing receipt by Purple LLC
of royalties under the Intellibed License Agreement, or it may go out of business. Even with the Company’s receipt of royalties
from Intellibed and entitlement to the value of the brand being built by Intellibed, pursuant to the Intellibed License Agreement, the
continuing growth of this single competitor could adversely affect our business during the time that the license is effective, to the
extent lost sales are not offset by royalties, and alternatively the cessation of the Intellibed License Agreement may require the Company
to incur the costs of making and selling GEL MATRIX branded products to preserve and monetize the value of the equity in that brand.
Although the Company believes there is value in controlling this license covering limited intellectual property owned, but not being
used, by Purple LLC, that value may be offset by expenses related to Intellibed’s conduct and events outside our control. Purple
LLC currently is involved in litigation with Intellibed involving rights of the parties to the Intellibed License Agreement and what
we believe to be unlawful conduct by Intellibed outside its licensed rights, as explained more fully in the section on litigation. See
Note 14, “Commitments and Contingencies,” of the Notes to the Consolidated Financial
Statements, included in Part II, ITEM 8 of this Report, “Financial Statements and Supplementary Data,” which is incorporated
herein by reference.
Among EdiZONE’s
previously entered into licenses of comfort-related intellectual property, as described above, another license includes exclusivity
rights that may prohibit us from selling our existing mattresses or potentially new products in the European Union. That risk may
be addressed by redesign of the configuration of the Hyper-Elastic Polymer material in that geographic region by either using existing
technologies already assigned by EdiZONE to Purple LLC or developing new technologies. Alternatively, that risk may not exist at
all to the extent Purple LLC’s current mattress products are the subject of expired patent rights licensed by that licensee
or because Purple LLC is not the licensor. However, there can be no assurance that our future sales in the European Union, if any,
will not be challenged by EdiZONE’s licensee as a violation of the license agreement, or that any redesigned mattresses created
by us will be successful in that market should when we may enter it. If Purple LLC’s activities are challenged by a licensee,
Purple LLC has an indemnification obligation to EdiZONE and the Pearces, which may be an expense to the Company.
If any of these third
parties violate their licenses with EdiZONE or infringe on intellectual property owned by Purple LLC and Purple LLC is unable to
take effective action against such violating or infringing parties, we may be unable to protect against this infringement or the
effects of such violations and our business could be harmed.
Purple LLC has obtained,
with the cooperation of EdiZONE and the Pearces, the right to enforce its intellectual property rights at Purple LLC’s option,
provided that Purple LLC will indemnify EdiZONE and fund the expense of such enforcement. In addition, as the licensor under the
Intellibed License Agreement, the Company now has the ability to enforce its intellectual property rights directly against Intellibed.
In the event such enforcement is deemed necessary by Purple LLC, and in the case currently pending against Intellibed, Purple LLC
may not be successful in any such efforts to enforce its intellectual property and other rights under the Intellibed License Agreement
and this may harm our business.
34
While the current license
back to EdiZONE, as amended following the Business Combination, is much narrower than the license that existed at the time of the
Business Combination, EdiZONE’s third-party licenses may lead to conflicts between us and EdiZONE. The EdiZONE Agreement
pertaining to the Intellibed License Agreement also may lead to conflicts with EdiZONE and the Pearces. Although only the current
conflict with Intellibed exists at this time and other conflicts are not foreseen, if additional conflicts do arise and are not
properly addressed, disputes may occur which may be detrimental to the Company.
If we cannot
keep pace with rapid technological developments to provide new and innovative programs, products and services, the use of our products
and our revenues could decline.
Rapid,
significant technological changes continue to confront the industries in which we operate. We cannot predict the effect of technological
changes on our business. We expect that new services and technologies applicable to the industries in which we operate will continue
to emerge. These new services and technologies may be superior to, or render obsolete, the technologies we currently use in our
products and services. Incorporating new technologies into our products and services may require substantial expenditures and take
considerable time, and ultimately may not be successful. In addition, our ability to adopt new services and develop new technologies
may be inhibited by industry-wide standards, new laws and regulations, resistance to change from clients or merchants, or third
parties’ intellectual property rights. Our success will depend on our ability to develop new technologies and adapt to technological
changes and evolving industry standards.
Our business
and our reputation could be adversely affected by the failure to protect sensitive employee, customer and consumer data, or to
comply with evolving regulations relating to our obligation to protect such data.
In
the ordinary course of our business, we collect and store certain personal information from individuals, such as our customers
and suppliers, and we process customer payment card and check information for purchases via our website. In addition, we may share
with third-parties personal information we have collected. Cyber-attacks designed to gain access to sensitive information by breaching
security systems of large organizations leading to unauthorized release of confidential information have occurred recently at a
number of major U.S. companies despite widespread recognition of the cyber-attack threat and improved data protection methods.
Computer hackers may attempt to penetrate our computer system or the systems of third-parties with which we have shared personal
information and, if successful, misappropriate personal information, payment card or check information or confidential Company
business information. In addition, a Company employee, contractor or other third party with whom we do business may attempt to
circumvent our security measures in order to obtain such information and may purposefully or inadvertently cause a breach involving
such information.
We
and third-parties with which we have shared personal information have been subject to attempts to breach the security of networks,
IT infrastructure, and controls through cyber-attack, malware, computer viruses, social engineering attacks, and other means of
unauthorized access. To the best of our knowledge, attempts to breach our networks and IT infrastructure have not been successful
to date, but we have been a victim of a spear-phishing attack. A breach of systems that resulted in the unauthorized release of
sensitive data could adversely affect our reputation and lead to financial losses from remedial actions or potential liability,
possibly including punitive damages. An electronic security breach resulting in the unauthorized release of sensitive data from
information systems could also materially increase the costs we already incur to protect against these risks. We continue to balance
the additional risk with the cost to protect us against a breach. Additionally, while losses arising from a breach may be covered
in part by insurance that we carry, such coverage may not be adequate for liabilities or losses actually incurred.
We
may be subject to data privacy and data breach laws in the states in which we do business, and as we expand into other countries,
we may be subject to additional data privacy laws and regulations. State data privacy laws (such as the California Consumer Privacy
Act), including application and interpretation, are rapidly evolving. While we attempt to comply with such laws, we may not be
in compliance at all times in all respects. Failure to comply with such laws may subject us to fines, administrative actions, and
reputational harm.
35
Risks Relating to our Organizational
Structure
Delaware
law and our Second Amended and Restated Certificate of Incorporation contain anti-takeover provisions, any of which could delay
or discourage a merger, tender offer, or assumption of control of the Company not approved by our Board of Directors that some
stockholders may consider favorable.
Provisions
of Delaware law and our Second Amended and Restated Certificate of Incorporation could hamper a third party’s acquisition
of us, or discourage a third party from attempting to acquire control of us. You may not have the opportunity to participate in
these transactions. These provisions could also limit the price that investors might be willing to pay in the future for equity
interests in the Company. These provisions include:
●
no cumulative voting in the election of directors, which limits the ability of minority stockholders to elect director candidates;
●
the right of our Board to elect a director to fill a vacancy created by the expansion of our Board or the resignation, death or removal of a director in certain circumstances, which prevents stockholders from being able to fill vacancies on our Board;
●
a prohibition on stockholder action by written consent, which forces stockholder action to be taken at an annual or special meeting of our stockholders;
●
a prohibition on stockholders calling a special meeting and the requirement that a meeting of stockholders may only be called by members of our Board, which may delay the ability of our stockholders to force consideration of a proposal or to take action, including the removal of directors;
●
the requirement that changes or amendments to certain provisions of our certificate of incorporation or bylaws must be approved by holders of at least two-thirds of our common stock; and
●
advance notice procedures that stockholders must comply with in order to nominate candidates to our Board or to propose matters to be acted upon at a meeting of stockholders, which may discourage or deter a potential acquirer from conducting a solicitation of proxies to elect the acquirer’s own slate of directors or otherwise attempting to obtain control of us.
Provisions
in our Second Amended and Restated Certificate of Incorporation could make it very difficult for an investor to bring any legal
actions against us and our directors or officers and could require us to pay any amounts incurred by our directors or officers
in any such actions.
Our
Second Amended and Restated Certificate of Incorporation provides that, to the fullest extent permitted by law, our directors shall
not be personally liable for monetary damages for breach of fiduciary duties. Our Second Amended and Restated Certificate of Incorporation
also allows us to indemnify our directors and officers from and against any and all costs, charges and expenses resulting from
their acting in such capacities with us. This means that if you were able to enforce an action against our directors or officers,
in all likelihood, we would be required to pay any expenses they incurred in defending the lawsuit and any judgment or settlement
they otherwise would be required to pay. Accordingly, our indemnification obligations could divert needed financial resources and
may adversely affect our business, financial condition, results of operations and cash flows, and adversely affect the value of
our business.
Provisions
in our Second Amended and Restated Certificate of Incorporation may limit our stockholders’ ability to obtain a favorable
judicial forum.
Our
Second Amended and Restated Certificate of Incorporation provides that the Court of Chancery of the State of Delaware shall be
the sole and exclusive forum for substantially all disputes between us and our stockholders, which could limit our stockholders’
ability to obtain a favorable judicial forum for disputes with us or our directors, officers, employees or agents. It also provides
that, unless we consent to the selection of an alternative forum, the Court of Chancery of the State of Delaware shall be the sole
and exclusive forum for any derivative action or proceeding brought on our behalf; any action asserting a claim for or based on
a breach of duty or obligation owed by any current or former director, officer or employee of ours to us or to our stockholders,
including any claim alleging the aiding and abetting of such a breach; any action asserting a claim against us or any current or
former director, officer or employee of ours arising pursuant to any provision of the Delaware General Corporation Law or our certificate
of incorporation or bylaws; or any action asserting a claim related to or involving us that is governed by the internal affairs
doctrine. This exclusive forum provision would not apply to suits brought to enforce any liability or duty created by the
Securities Act or the Exchange Act or any other claim for which the federal courts have exclusive jurisdiction. To the extent that
any such claims may be based upon federal law claims, Section 27 of the Exchange Act creates exclusive federal jurisdiction
over all suits brought to enforce any duty or liability created by the Exchange Act or the rules and regulations thereunder. Furthermore,
Section 22 of the Securities Act creates concurrent jurisdiction for federal and state courts over all suits brought to enforce
any duty or liability created by the Securities Act or the rules and regulations thereunder. This choice of forum provision
may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our
directors, officers or employees, which may discourage such lawsuits against us and our directors, officers or employees. Alternatively,
if a court were to find the choice of forum provision contained in our certificate of incorporation to be inapplicable or unenforceable
in an action, we may incur additional costs associated with resolving such action in other jurisdictions, which could have a material
adverse effect on our business, financial condition, results of operations and prospects.
36
Future sales of our Class A
Stock by our existing stockholders may cause our stock price to fall.
The market price of
our Class A Stock could decline as a result of sales by a few large stockholders, including CCP and Blackwell, 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.
Our stockholders
may experience substantial dilution in the value of their investment if we issue additional shares of our capital stock.
Our
charter allows us to issue up to 300 million shares of our Common Stock, including 210 million shares of Class A Stock and 90 million
shares of Class B Stock, and up to five million shares of undesignated preferred stock, par value $0.0001 per share. To raise additional
capital, we may in the future sell additional shares of our Class A Stock or other securities convertible into or exchangeable
for our Class A Stock at prices that are lower than the prices paid by existing stockholders, and investors purchasing shares or
other securities in the future could have rights superior to existing stockholders, which could result in substantial dilution
to the interests of existing stockholders.
Our only significant asset is our
ownership of Purple LLC and such ownership may not be sufficient to pay dividends or make distributions or loans to enable us to
pay any dividends on our Class A Stock or satisfy our other financial obligations, including our obligations under the Tax
Receivable Agreement.
We are a holding company
and do not directly own any operating assets other than our ownership of interests in Purple LLC. We depend on Purple LLC for distributions,
loans and other payments to generate the funds necessary to meet our financial obligations, including our expenses as a publicly
traded company, to pay any dividends, and to satisfy our obligations under the Tax Receivable Agreement. The earnings from, or
other available assets of, Purple LLC may not be sufficient to make distributions or pay dividends, pay expenses or satisfy our
other financial obligations, including our obligations under the Tax Receivable Agreement. Moreover, our debt covenants may not
allow us to pay dividends.
We do not anticipate paying any cash
dividends in the foreseeable future.
We intend to retain
future earnings, if any, for use in the business or for other corporate purposes and do not anticipate that cash dividends with
respect to our Class A Stock will be paid in the foreseeable future. Any decision as to the future payment of dividends will
depend on our results of operations, financial position and such other factors as our Board, in its discretion, deems relevant.
As a result, capital appreciation, if any, of our Class A Stock will be a stockholder’s sole source of gain for the
foreseeable future. Moreover, our debt covenants may not allow us to pay dividends.
Our level
of indebtedness and related covenants could limit our operational and financial flexibility and significant adversely affect our
business if we breach such covenants and default on such indebtedness.
As
of December 31, 2020, Purple LLC had total debt of $44.4 million outstanding under the 2020 Credit Agreement. While any amounts
are outstanding under the 2020 Credit Agreement, we are subject to a number of affirmative and negative covenants, including covenants
regarding dispositions of property, investments, forming or acquiring subsidiaries, business combinations or acquisitions, incurrence
of additional indebtedness, and transactions with affiliates, among other customary covenants, subject to certain exceptions. In
particular, we are (i) subject to annual capital expenditure limits that can be adjusted based on the Company achieving certain
Net Leverage Ratio thresholds as provided in the 2020 Credit Agreement, (ii) restricted from incurring additional debt up to certain
amounts, subject to limited exceptions, as set forth in the Credit Agreement, and (iii) maintain minimum Consolidated Net Leverage
Ratio and Fixed Charge Coverage Ratio (as those terms are defined in the Credit Agreement) thresholds at certain measurement dates.
Purple LLC is also restricted from paying dividends or making other distributions or payments on its capital stock, subject to
limited exceptions.
37
These
restrictions may prevent us from taking actions that we believe would be in the best interests of the business and may make it
difficult for us to successfully execute our business strategy or effectively compete with companies that are not similarly restricted.
If we determine that we need to take any action that is restricted under the 2020 Credit Agreement, we will need to first obtain
a waiver from the Institutional Lenders. Obtaining such waivers, if needed, may impose additional costs on the Company or we may
be unable to obtain such waivers. Our ability to comply with these restrictive covenants in future periods will largely depend
on our ability to successfully implement our overall business strategy. The breach of any of these covenants or restrictions could
result in a default, which could result in the acceleration of our outstanding debt. In the event of an acceleration of such debt,
we could be forced to apply all available cash flows to repay such debt, which could also force us into bankruptcy or liquidation.
Our warrants are accounted for as liabilities
and the changes in value of our warrants could have a material effect on our financial results.
The SEC Statement identified
certain settlement terms and provisions related to certain tender offers following a business combination, which terms are similar to
those contained in the warrant agreement governing our warrants. As a result of the SEC Statement, we reevaluated the accounting treatment
of our public warrants and sponsor warrants, and determined to classify the warrants as derivative liabilities measured at fair value,
with changes in fair value each period reported in earnings.
As a result, included
on our consolidated balance sheets as of December 31, 2020 and 2019 contained elsewhere in this Annual Report are derivative liabilities
related to embedded features contained within our warrants. ASC
815, provides for the remeasurement of the fair value of such derivatives at each balance sheet date, with a resulting non-cash
gain or loss related to the change in the fair value being recognized in earnings in the statement of operations. As a result of the
recurring fair value measurement, our consolidated financial statements and results of operations may fluctuate quarterly, based on factors,
which are outside of our control. Due to the recurring fair value measurement, we expect that we will recognize non-cash gains or losses
on our warrants each reporting period and that the amount of such gains or losses could be material.
Certain outstanding warrants could
be exercised and result in dilution of all shareholders without any concurrent payment or other benefit to the Company.
Certain outstanding
warrants held by former members of Global Partner Sponsor, LLC (the sponsor for GPAC) and its permitted transferees are not redeemable
and may be exercised on a cashless basis. As of March 8, 2021, approximately 1.9 million sponsor warrants remain outstanding, which
are exercisable for an aggregate of less than one million shares of Class A Stock. If the holders of the sponsor warrants choose
to exercise their warrants on a cashless basis, we would be required to issue shares of Class A Stock without any further consideration
paid to us, resulting in dilution to our existing stockholders.
We could
issue additional preferred stock without stockholder approval with the effect of diluting then current stockholder interests, impairing
their voting rights and potentially discouraging a takeover that stockholders may consider favorable.
Pursuant
to our Second Amended and Restated Certificate of Incorporation, the Board has the ability to authorize the issuance of up to five
million shares of preferred stock at any time and from time to time, with such terms and preferences as the Board determines and
without any stockholder approval other than as may be required by NASDAQ Global Market rules. The issuance of such shares of preferred
stock could dilute the interest of, or impair the voting power of, our common stockholders. The issuance of such preferred stock
could also be used as a method of discouraging, delaying or preventing a change of control.
We may issue debt and equity securities
or securities convertible into equity securities, any of which may be senior to our Class A Stock as to distributions and
in liquidation, which could negatively affect the value of our Class A Stock.
In the future, we may
attempt to increase our capital resources by entering into additional debt or debt-like financing that is unsecured or secured
by up to all of our assets, or by issuing additional debt or equity securities, which could include issuances of secured or unsecured
notes, preferred stock, hybrid securities or securities convertible into or exchangeable for equity securities. In the event of
our liquidation, our lenders and holders of our debt would receive distributions of our available assets before distributions to
holders of our Class A Stock, and holders of preferred securities would receive distributions of our available assets before
distributions to the holders of our Class A Stock. Because our decision to incur debt and issue securities in future offerings
may be influenced by market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or
nature of our future offerings or debt financings. Further, market conditions could require us to accept less favorable terms for
the issuance of our securities in the future.
38
Tax Risks Relating
to our Structure
Although we may be entitled to tax
benefits relating to additional tax depreciation or amortization deductions as a result of the tax basis step-up we receive
in connection with the exchanges of Class B Units and shares of Class B Stock into our Class A Stock and related
transactions, we will be required to pay InnoHold 80% of these tax benefits under the Tax Receivable Agreement.
Owners of Class B
Units and shares of Class B Stock may, subject to certain conditions and transfer restrictions, exchange their Class B
Units and shares of Class B Stock (together with an equal number of Class B Units, the “Paired Securities”) for
shares of Class A Stock pursuant to an exchange agreement, dated February 2, 2018, with Purple LLC, InnoHold and the Class
B Unit holders who became a party thereto (the “Exchange Agreement”). The deemed exchanges in the Business Combination
and any exchanges pursuant to the Exchange Agreement are expected to result in increases in our allocable share of the tax basis
of the tangible and intangible assets of Purple LLC. These increases in tax basis may increase (for tax purposes) depreciation
and amortization deductions and therefore reduce the amount of income or franchise tax that we would otherwise be required to pay
in the future, although the Internal Revenue Service or any applicable foreign, state or local tax authority may challenge all
or part of that tax basis increase, and a court could sustain such a challenge. As of December 31, 2020, there have been 43.5 million
exchanges of Class B Units and shares of Class B Stock for shares of Class A Stock, in addition to the deemed exchanges
that occurred in connection with the Business Combination.
In connection with the
Business Combination, we entered into the Tax Receivable Agreement, which generally provides for the payment by us to InnoHold
of 80% of certain tax benefits, if any, that we realize as a result of these increases in tax basis and of certain other tax benefits
related to entering into the Tax Receivable Agreement, including income or franchise tax benefits attributable to payments under
the Tax Receivable Agreement. These payment obligations pursuant to the Tax Receivable Agreement are the obligation of the Company
and not of Purple LLC. The actual increase in our allocable share of the Company’s tax basis in its assets, as well as the
amount and timing of any payments under the Tax Receivable Agreement, will vary depending upon a number of factors, including the
timing of exchanges, the market price of shares of our common stock at the time of the exchange, the extent to which such exchanges
are taxable and the amount and timing of our income. As of December 31, 2020, the Company’s preliminary estimate of the liability
under the Tax Receivable Agreement resulting from the deemed exchanges that occurred in connection with the Business Combination
and subsequent exchanges of 43.5 million Paired Securities as of December 31, 2020 was approximately $172.0 million. ($0.5 million
in 2019 and an incremental $171.5 million through December 31, 2020). To the extent the Company realizes tax benefits in future
years, or in the event of a change in future tax rates, or if payments under the Tax Receivable Agreement are required to be accelerated,
this liability may exceed the estimated liability.
Because not all of the
relevant factors described above are known at this time with respect to the exchanges that have occurred, and none of the relevant
factors are known with respect to 0.5 million future exchanges (whether this year or in subsequent years), except as estimated
above, we cannot yet with certainty determine the final amounts that will be payable under the Tax Receivable Agreement. However,
as a result of the size and frequency of the exchanges and the resulting increases in the tax basis of the tangible and intangible
assets of Purple LLC, the payments under the Tax Receivable Agreement will be substantial and could have a material adverse effect
on our financial condition. The payments under the Tax Receivable Agreement are not conditioned upon continued ownership of the
Company by the holders of Class B Units.
InnoHold will not be
required to reimburse us for any excess payments that may previously have been made under the Tax Receivable Agreement, for example,
due to adjustments resulting from examinations by taxing authorities. Rather, excess payments made to such holders will be netted
against payments otherwise to be made, if any, after the determination of such excess. As a result, in certain circumstances we
could make payments under the Tax Receivable Agreement in excess of our actual income or franchise tax savings, if any, and we
may not be able to recoup such excess, which could materially impair our financial condition and adversely affect our liquidity.
39
If all of the 0.5 million
Paired Securities outstanding as of December 31, 2020 were exchanged for shares of Class A Stock pursuant to the Exchange Agreement,
and the fair market value of the Class A Stock at the time of such exchange were equal to $29.79 per share (the closing price of
a share of our Class A Stock on March 8, 2021), our aggregate liability under the Tax Receivable Agreement would be, including the
estimated $172.0 million liability described above, approximately $175.7 million in total, with the majority payable in estimated
annual amounts ranging from $2.0 million to $14.6 million over a 16-year period. The foregoing estimate of our aggregate liability
is based on certain assumptions, including that there are no changes in relevant tax law, that we are able to fully depreciate or amortize
our assets, and that we recognize taxable income sufficient to realize the full benefit of the increased depreciation and amortization
of our assets in each of the tax years. These assumptions may not be accurate with respect to all or any exchanges of Paired Securities
for Class A Stock. As a result, the amount and timing of our actual aggregate liability under the Tax Receivable Agreement may differ
materially from our estimates depending on a number of factors, including those described above and elsewhere in this Annual Report on
Form 10-K/A.
In certain
cases, payments under the Tax Receivable Agreement may be accelerated or significantly exceed the actual benefits we realize in
respect of the tax attributes subject to the Tax Receivable Agreement.
The
Tax Receivable Agreement provides that, in the event that we exercise our right to early termination of the Tax Receivable Agreement,
or in the event of a change of control of the Company or we are more than 90 days late in making of a payment due under the Tax
Receivable Agreement, the Tax Receivable Agreement will terminate, and we will be required to make a lump-sum payment
to InnoHold equal to the present value of all forecasted future payments that would have otherwise been made under the Tax Receivable
Agreement, which lump-sum payment would be based on certain assumptions, including those relating to our future taxable
income. The change of control payment to InnoHold and the other owners could be substantial and could exceed the actual tax benefits
that we receive as a result of acquiring units from other owners of Purple LLC because the amounts of such payments would be calculated
assuming that we would have been able to use the potential tax benefits each year for the remainder of the amortization periods
applicable to the basis increases, and that tax rates applicable to us would be the same as they were in the year of the termination.
In these situations, our obligations under the Tax Receivable Agreement could have a substantial negative impact on our liquidity
and could have the effect of delaying, deferring or preventing certain mergers, asset sales, other forms of business combinations
or other changes of control due to the additional transaction cost a potential acquirer may attribute to satisfying such obligations.
There can be no assurance that we will be able to finance our obligations under the Tax Receivable Agreement.
Decisions
made in the course of running our business, such as with respect to mergers, asset sales, other forms of business combinations
or other changes in control, may influence the timing and amount of payments that are received by InnoHold under the Tax Receivable
Agreement. For example, the earlier disposition of assets following an exchange or acquisition transaction will generally accelerate
payments under the Tax Receivable Agreement and increase the present value of such payments, and the disposition of assets before
an exchange or acquisition transaction will increase an existing owner’s tax liability without giving rise to any rights
of InnoHold to receive payments under the Tax Receivable Agreement.
Even
in the absence of an early termination of the Tax Receivable Agreement, change of control of the Company or a payment that is more
than 90 days late under the Tax Receivable Agreement, there may be a material negative effect on our liquidity if the payments
under the Tax Receivable Agreement exceed the actual income or franchise tax savings that we realize in respect of the tax attributes
subject to the Tax Receivable Agreement or if distributions to us by Purple LLC are not sufficient to permit us to make payments
under the Tax Receivable Agreement after we have paid taxes and other expenses. Furthermore, our obligations to make payments under
the Tax Receivable Agreement could make us a less attractive target for an acquisition, particularly in the case of an acquirer
that cannot use some or all of the tax benefits that are deemed realized under the Tax Receivable Agreement. We may need to incur
additional indebtedness to finance payments under the Tax Receivable Agreement to the extent our cash resources are insufficient
to meet our obligations under the Tax Receivable Agreement as a result of timing discrepancies or otherwise which may have a material
adverse effect on our financial condition. There can be no assurance that we will be able to finance our obligations under the
Tax Receivable Agreement.
40
We may not be able to realize all
or a portion of the tax benefits that are expected to result from the acquisition of Units from Purple LLC Class B Unitholders.
Pursuant to the Tax
Receivable Agreement, the Company will share tax savings resulting from (A) the amortization of the anticipated step-up in
tax basis in Purple LLC’s assets as a result of (i) the Business Combination and (ii) the exchange of (a) the
Class B Units and (b) the Class B Stock, in each case that were received in connection with the Business Combination,
for shares of Class A Stock pursuant to the Exchange Agreement and (B) certain other related transactions with InnoHold
in connection with the Business Combination. The amount of any such tax savings attributable to the payment of cash to InnoHold
in connection with the Business Combination and the exchanges contemplated by the Exchange Agreement will be paid 80% to InnoHold
and other owners of such securities and retained 20% by the Company. Our ability to realize, and benefit from, these tax savings
depends on a number of assumptions, including that we will earn sufficient taxable income each year during the period over which
the deductions arising from any such basis increases and payments are available and that there are no adverse changes in applicable
law or regulations. If our actual taxable income were insufficient to fully utilize such tax benefits or there were adverse changes
in applicable law or regulations, we may be unable to realize all or a portion of these expected benefits and our cash flows and
stockholders’ equity could be negatively affected.
Unanticipated
changes in effective tax rates, including as a result of new tax jurisdictions, or adverse outcomes resulting from examination
of our income or other tax returns could adversely affect our financial condition and results of operations.
Our
future effective tax rates could be subject to volatility or adversely affected by a number of factors, including:
●
changes in the valuation of our deferred tax assets and liabilities;
●
expected timing and amount of the release of any tax valuation allowances;
●
tax effects of stock-based compensation;
●
costs related to intercompany restructurings; and
●
the addition of new tax jurisdictions or changes in tax laws, regulations or interpretations thereof.
In addition, we may
be subject to audits of our income, sales and other transaction taxes by U.S. federal and state authorities. Outcomes from these
audits could have an adverse effect on our financial condition and results of operations.
Our ability to utilize our net operating
loss carryforwards and certain other tax attributes may be limited.
Under Section 382 and related provisions of the Internal
Revenue Code of 1986, as amended (the “Code”), if a corporation undergoes an “ownership change” generally
defined as a greater than 50 percentage point change (by value) in its equity ownership by certain stockholders over a three-year
period), the corporation’s ability to use its pre-change net operating loss carryforwards (“NOLs”) and other
pre-change tax attributes to offset its post-change income may be limited. If finalized, Treasury Regulations currently proposed
under Section 382 of the Code may further limit our ability to utilize our pre-change NOLs or other tax attributes if we undergo
a future ownership change. We may have experienced ownership changes in the past, and we may experience ownership changes in the
future and/or subsequent shifts in our stock ownership (some of which may be outside our control). Thus, our ability to utilize
carryforwards of our net operating losses and other tax attributes to reduce future tax liabilities may be substantially restricted.
At this time, we have not completed a study to assess the impact, if any, of ownership changes on our NOLs under Section 382
of the Code.
41
Item 1B. Unresolved Staff Comments
None.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.