Purple Innovation, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion is intended to provide a more comprehensive review of the operating results and financial condition of Purple Innovation, Inc. than can be obtained from reading the Unaudited Condensed Consolidated Financial Statements alone. The discussion should be read in conjunction with the Unaudited Condensed Consolidated Financial Statements and the notes thereto included in “Part I. Item 1. Financial Statements.” FORWARD-LOOKING STATEMENTS This quarterly report on Form 10-Q (this “Quarterly Report”) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that represent our current expectations and beliefs. All statements other than statements of historical fact are “forward-looking statements” for purposes of federal and state securities laws. In some cases, you can identify these statements by forward-looking words such as “believe,” “expect,” “project,” “anticipate,” “estimate,” “intend,” “plan,” “targets,” “likely,” “will,” “would,” “could,” “may,” “might,” the negative of these words and other similar words. All forward-looking statements included in this Quarterly Report are made only as of the date thereof. It is routine for our internal projections and expectations to change throughout the year, and any forward-looking statements based upon these projections or expectations may change prior to the end of the next quarter or year. Investors are cautioned not to place undue reliance on any such forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law. We caution and advise readers that these statements are based on assumptions that may not be realized and involve risks and uncertainties that could cause actual results to differ materially from the expectations and beliefs contained herein. These risks include, among others, the evolving impact and duration of the COVID-19 pandemic, global supply chain issues, including increased shipping, material, and labor costs, and the impact of production and delivery issues on demand for our products. For a summary of these risks, see the risk factors included in the “Risk Factors” section in this Quarterly Report and in our Annual Report on Form 10-K/A filed with the Securities and Exchange Commission on May 10, 2021. Overview of Our Business Our mission is to help people feel and live better through innovative comfort solutions. We are a digitally-native vertical brand founded on comfort product innovation with premium offerings. We design and manufacture a variety of innovative, branded and premium comfort products, including mattresses, pillows, cushions, frames, sheets, and other products. Our products are the result of over 30 years of innovation and investment in proprietary and patented comfort technologies and the development of our own manufacturing processes. Our proprietary gel technology, Hyper-Elastic Polymer, underpins many of our comfort products and provides a range of benefits that differentiate our offerings from other competitors’ products. We market and sell our products through our DTC online channels, retail brick-and-mortar wholesale partners, Company showrooms and third-party online retailers. Organization Our business consists of Purple Inc. and its consolidated subsidiary, Purple LLC. Purple Inc. was incorporated in Delaware on May 19, 2015 as a special purpose acquisition company under the name of GPAC. On February 2, 2018, Purple Inc. consummated a transaction structured similar to a reverse recapitalization (the “Business Combination”) pursuant to which Purple Inc. acquired an equity interest in Purple LLC and became its sole managing member. As the sole managing member of Purple LLC, Purple Inc., through its officers and directors, is responsible for all operational and administrative decision making and control of the day-to-day business affairs of Purple LLC without the approval of any other member. In connection with the Business Combination, InnoHold retained an 82% economic interest in Purple LLC. InnoHold subsequently transferred a portion of its Class B Units to permitted transferees and exchanged its remaining shares for shares of Class A Stock that it sold. At September 30, 2021, Purple Inc. had a 99% economic interest in Purple LLC while other Class B Unit holders had the remaining 1%. 34 COVID-19 Pandemic Developments The COVID-19 pandemic has impacted many aspects of our operations, directly and indirectly, including disruption of our employees, consumer behavior, distribution and logistics, our suppliers, and the market overall. The scope and nature of these impacts continue to evolve. Because of the COVID-19 pandemic, we have taken precautionary measures recommended by the appropriate national and state health agencies to manage our resources and mitigate the adverse impact of the pandemic, which is intended to help minimize the risk to our Company, employees, customers, and the communities in which we operate. Although we have taken measures to protect our business, we cannot predict the specific duration for which precautionary measures relating to COVID-19 will stay in effect, and we may elect or be required to take additional measures as the information available to us continues to develop, including with respect to our employees, manufacturing facilities and distribution center, and relationships with our suppliers and customers. Also, we do not know the impact proposed government mandated vaccine policies for employers will have on our workforce. Subject to certain assumptions regarding the duration and severity of the COVID-19 pandemic, and government, consumer, and our responses thereto, based on our current projections we believe our cash on hand, ongoing cash generated from e-commerce, liquidity available under our line of credit, and continuing ramp up of store operations and our wholesale business, will be sufficient to cover our working capital requirements and anticipated capital expenditures for the next 12 months. While most state and local governments have eased restrictions on commercial retail activity, it is possible that a resurgence in cases of COVID-19 or one of its variants could prompt a return to tighter restrictions in certain areas of the country. Furthermore, while the bedding industry has fared much better during the pandemic than certain other sectors of the economy, continued economic weakness may eventually have an adverse impact upon the industry and our business. Therefore, significant uncertainty remains regarding the ongoing impact of the COVID-19 outbreak upon our financial condition and future results of operations, as well as upon the significant estimates and assumptions we utilize in reporting certain assets and liabilities. Recent Developments in our Business Production and Demand Developments During the second quarter of 2021, following an accident resulting in the death of an employee and subsequent safety improvements involving the Mattress Max machines, we encountered isolated production challenges caused by unanticipated mechanical and maintenance issues when bringing the machines back online. As a result, we experienced significantly reduced production levels causing shipment backlogs that unfavorably affected both second and third quarter net revenues. We exited the month of July with production from our existing machines back at planned levels and emerged from our backlog position at the end of August. We are confident that these mechanical and maintenance challenges are an isolated event and will have no impact on our ability to scale production beyond 2021. With our production back at planned levels, we were able to increase our finished goods inventory to adequate stock levels to enable timely shipments to our customers. However, even though we were able to return to planned production capacity in the third quarter, our results of operations have not yet returned to expected levels, which we believe is due primarily to slower than expected acceleration back to prior trending demand levels, as well as increases in the costs of shipping, materials and labor. We believe that the production challenges experienced in the second and third quarters adversely affected the confidence of consumers and our wholesale partners in our ability to timely deliver our products, which resulted in reduced orders and increased cancellations in both our DTC and wholesale channels. Further, in an effort to manage costs as we worked to resolve the production issues described above, we reduced our spending on marketing, which reduced demand for our products, particularly in our DTC channel. In addition to adversely impacting demand for our products, these issues also interrupted our momentum in growth. While our production has returned to normal and we have ramped up our marketing efforts, it is unclear how long it will take for demand, in both our DTC and wholesale channels, to return to expected levels. Given that we had not yet returned to normal levels by the end of the third quarter of 2021, we expect such issues to adversely impact our operating results for the fourth quarter of 2021. In addition to a slower recovery to expected demand levels following our return to full production capacity, our business has also been adversely impacted by increases in the cost of shipping, raw materials and labor. While we are still able to obtain necessary materials when needed, the costs of such materials have increased materially, consistent with general macroeconomic trends. In addition, as experienced in other industries, in order to remain competitive in hiring the labor necessary to maintain our production, we have had to increase wages and other compensation. These increases in materials and labor costs have resulted in higher cost of goods sold and lower margins. We believe that shipping, material and labor costs will continue to remain at elevated levels or increase further in the foreseeable future. In addition to the above issues, we are also closely monitoring the impacts of COVID-19 and general economic conditions on global supply chain, manufacturing, and logistics operations. As inflationary pressures increase, we anticipate that our production and operating costs will similarly increase. In addition, COVID-19 and other events, including port closures or labor shortages, have resulted in the continuation or worsening of manufacturing and shipping costs, delays and constraints. While most of our domestic suppliers have been able to continue operations and provide necessary materials when needed, we have experienced some constraints from certain suppliers, with respect to both the availability and cost of materials. We have also experienced some delays in shipments from our suppliers. Any significant delay or interruption in our supply chain could impair our ability to meet the demands of our customers and could harm our business. 35 Mattress Firm Relationship On November 8, 2021, Purple LLC and Mattress Firm agreed to terminate the Master Retailer Agreement (the “Agreement”) dated September 18, 2018 between Purple and Mattress Firm. The Agreement was replaced by a new Master Retailer Agreement with terms consistent with the Company’s standard retailer agreement. The replacement agreement eliminates all of the prior exclusivity arrangements. The new agreement provides opportunity for continued partnership and growth with Mattress Firm. With this new agreement in place, our ability to work with new wholesale customers will no longer be limited because of contractual exclusivity with specialty retailers and other constraints on entering markets in which Mattress Firm conducts business, which creates new opportunities. Operating Results for the Three Months Ended September 30, 2021 and 2020 The following table sets forth for the periods indicated, our results of operations and the percentage of total revenue represented in our condensed consolidated statements of operations: Three Months Ended September 30, 2021 % of Net Revenues 2020 % of Net Revenues Revenues, net $ 170,781 100.0 % $ 187,111 100.0 % Cost of revenues 109,701 64.2 98,857 52.8 Gross profit 61,080 35.8 88,254 47.2 Operating expenses: Marketing and sales 48,841 28.6 51,206 27.4 General and administrative 17,037 10.0 11,087 5.9 Research and development 1,784 1.0 1,687 0.9 Total operating expenses 67,662 39.6 63,980 34.2 Operating income (loss) (6,582 ) (3.9 ) 24,274 13.0 Other income (expense): Interest income (expense), net 10 — (1,232 ) (0.7 ) Other income, net 12 — 3 — Change in fair value – warrant liabilities 5,362 3.1 (103,962 ) (55.6 ) Loss on extinguishment of debt — — (5,782 ) (3.1 ) Tax receivable agreement income (expense) 846 0.5 (567 ) (0.3 ) Total other income (expense), net 6,230 3.6 (111,540 ) (59.6 ) Net loss before income taxes (352 ) (0.2 ) (87,266 ) (46.6 ) Income tax benefit 2,479 1.5 106 0.1 Net income (loss) 2,127 1.2 (87,160 ) (46.6 ) Net loss attributable to noncontrolling interest (44 ) — (147 ) (0.1 ) Net income (loss) attributable to Purple Innovation, Inc. $ 2,171 1.3 $ (87,013 ) (46.5 ) Revenue Net revenues decreased $16.3 million, or 8.7%, to $170.8 million for the three months ended September 30, 2021 compared to $187.1 million for the three months ended September 30, 2020. We believe that third quarter 2020 revenues were positively impacted during the COVID-19 pandemic, as individuals focused on home improvement activities, including purchasing mattresses and bedding products. The year-over-year decrease in net revenues consisted of DTC net revenues declining $21.4 million, or 15.9%, offset in part by net revenue growth of $5.1 million, or 9.6%, in our wholesale business. DTC net revenues were unfavorably impacted by the impact of production delays on our ability to manufacture and deliver products to our DTC customers in the third quarter, as well as reduced demand in our DTC channel in the same period. While our wholesale business was favorably impacted by wholesale partner expansion combined with a reopening of wholesale partner doors, we also experienced lower than expected demand from our wholesale customers. We believe that wholesale and DTC demand were adversely affected by the production issues we experienced in the second and third quarters of 2021, as our ability to manufacture and deliver our products to both DTC and wholesale customers was interrupted. In addition, in response to production delays we temporarily reduced our marketing spending, which reduced demand for our products, particularly with respect to our DTC channel. While we have returned to planned production and marketing activities, it is unclear when customer demand will return to expected levels. We currently anticipate that net revenues in the fourth quarter of 2021 will continue to be adversely impacted by slower than anticipated recovery to prior demand levels. Net revenues from a product perspective reflected a $20.5 million decrease in mattress sales, a $3.8 million increase in other bedding product sales and a $0.4 million increase in other product sales. 36 Cost of Revenues The cost of revenues increased $10.8 million, or 11.0%, to $109.7 million for the three months ended September 30, 2021 compared to $98.9 million for the three months ended September 30, 2020. This increase reflected an increase in direct material costs coupled with higher labor and overhead costs. Our gross profit percentage decreased to 35.8% of net revenues for the three months ended September 30, 2021 compared to 47.2% for the same period in 2020. The decrease in our gross profit percentage was primarily impacted by inefficiencies as we worked to resolve production issues, rising shipping, raw material and labor costs and a higher proportion of wholesale channel revenue, which carries a lower gross margin than revenue from the DTC channel. We anticipate that shipping, raw material and labor costs will remain at elevated levels or continue to increase in the foreseeable future. Marketing and Sales Marketing and sales expenses decreased $2.4 million, or 4.6%, to $48.8 million for the three months ended September 30, 2021 from $51.2 million for the three months ended September 30, 2020. The decrease reflected a $10.1 million decrease in advertising spend in response to production delays, offset in part by a $4.7 million increase in personnel costs related to planned growth of our workforce and a $3.0 million increase in other marketing and sales expenses. Marketing and sales expense as a percentage of net revenues was 28.6% for the three months ended September 30, 2021 compared to 27.4% for the comparative prior period. The higher percentage in the current quarter was due in part to net revenues being unfavorably impacted by production and demand issues, as described above. General and Administrative General and administrative expenses increased $6.0 million, or 53.7%, to $17.0 million for the three months ended September 30, 2021 compared to $11.1 million for the three months ended September 30, 2020. The increase was primarily due to a $2.5 million increase in legal and professional fees associated with increased expenses for consulting, professional staffing and executive placement costs, a $1.9 million increase in personnel costs related to planned growth of our workforce, and a $1.5 million increase in all other expenses. Research and Development Research and development costs increased $0.1 million, or 5.7%, to $1.8 million for the three months ended September 30, 2021 from $1.7 million for the three months ended September 30, 2020. The increase was primarily due to an increase in professional services costs related to product development activities. Operating Income (Loss) Operating income (loss) decreased $30.9 million to an operating loss of $6.6 million for the three months ended September 30, 2021 compared to operating income of $24.3 million for the three months ended September 30, 2020. This decrease was primarily due to net revenues being unfavorably impacted during the quarter by production and demand issues (as described above), increased costs and a higher proportion of wholesale channel revenue, which carries a lower gross margin than revenue from the DTC channel. Interest Expense During the three months ended September 30, 2021, interest expense totaling $0.8 million was offset by $0.8 million of capitalized interest, of which $0.6 million related to periods prior to the third quarter of 2021 and was recorded as an out-of-period correction in the third quarter of 2021. The Company incurred interest expense of $1.2 million for the three months ended September 30, 2020. The $0.4 million decrease in interest expense was primarily due to the $35.0 million Related Party Loan, which carried an interest rate of 12.00%, being refinanced in the third quarter of 2020 with a $45.0 million term loan at an initial interest rate of 3.50%. Interest expense in 2021 also includes amortization of deferred loan costs associated with the 2020 Credit Agreement and fees related to the revolving line of credit. 37 Change in Fair Value – Warrant Liabilities On February 26, 2019, the Incremental Lenders funded a $10.0 million increase in the Related Party Loan and received 2.6 million warrants to purchase 2.6 million shares of our Class A Stock at a price of $5.74 per share, subject to certain adjustments. We accounted for the Incremental Loan Warrants as liabilities and recorded them at fair value on the date of the transaction and subsequently re-measured to fair value at each reporting date with changes in the fair value included in earnings. We determined the fair value of the Incremental Loan Warrants to be $64.9 million at September 30, 2020. During the three months ended September 30, 2020, we recognized a loss of $18.0 million in our condensed consolidated statement of operations related to the change in fair value of these warrants. There was no gain or loss on the Incremental Loan Warrants for the three months ended September 30, 2021 as they were exercised in 2020. There were 15.5 million public warrants issued in connection with GPAC’s formation and IPO and 12.8 million sponsor warrants issued pursuant to a simultaneous private placement with the IPO. We have accounted for these warrants as liabilities and recorded them at fair value on the date of the transaction and subsequently re-measured to fair value at each reporting date with changes in fair value included in earnings. The 1.9 million sponsor warrants outstanding at September 30, 2021 had a fair value of $9.0 million. The fair value of the public and sponsor warrants outstanding at September 30, 2020 was $188.5 million. During the three months ended September 30, 2021, we recognized a gain of $5.4 million in our condensed consolidated statement of operations related to a decrease in the fair value of the sponsor warrants exercised during the quarter or that were outstanding at the end of the quarter. During the three months ended September 30, 2020, we recognized a loss of $86.0 million in our condensed consolidated statement of operations related to an increase in the fair value of the public and sponsor warrants exercised during the prior year quarter or that were outstanding at the end of the prior year quarter. Loss on Extinguishment of Debt On September 3, 2020, the Company paid $45.0 million to retire, in full, all indebtedness related to Purple LLC’s Related Party Loan. The payment included $25.0 million for the original loan under the agreement, $10.0 million for a subsequent incremental loan, $6.6 million for paid-in-kind interest, $2.5 million for a prepayment fee and $0.9 million for accrued interest. As a result of paying off the Related Party Loan, the Company recognized a $5.8 million loss on extinguishment of debt during the three months ended September 30, 2020. Tax Receivable Agreement Expense We are party to a 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 increases in its allocable share of the tax basis of the tangible and intangible assets of Purple LLC. Because of the Business Combination, subsequent exchanges of 43.5 million Class B Units for Class A Stock and changes in estimates relating to the expected tax benefits associated with the tax receivable agreement, the tax receivable agreement liability totaled $171.5 million and $172.0 million at September 30, 2021 and December 31, 2020, respectively. During the third quarter of 2021, we realized $0.8 million of tax receivable agreement income due to the impact of recording the 2020 provision to return adjustments. Of the $90.2 million liability recorded during the three months ended September 30, 2020, $89.7 million related to current period exchanges and was recorded as an adjustment to stockholders’ equity and $0.6 was recorded to expense as it related to reestablishing the tax receivable agreement liability related to prior year exchanges. Income Tax Benefit Our income tax benefit was $2.5 million for the three months ended September 30, 2021, compared to $0.1 million for the three months ended September 30, 2020. This increase primarily resulted from a change in the effective tax rate due to a portion of the valuation allowance being released in 2020 and the change in fair value of the warrant liability which is treated as a permanent item for tax purposes. 38 Noncontrolling Interest We attribute net income or loss to the Class B Units in Purple LLC as a noncontrolling interest at their aggregate ownership percentage. We calculate net income or loss attributable to noncontrolling interests on a quarterly basis using their weighted average ownership percentage. Net loss attributed to noncontrolling interests was negligible for the three months ended September 30, 2021 compared to a net loss of $0.1 million for the three months ended September 30, 2020. The decrease in the net income level attributed to noncontrolling interests primarily resulted from the noncontrolling ownership interest declining to approximately 1% for the three months ended September 30, 2021 from approximately 18% for the three months ended September 30, 2020. Operating Results for the Nine Months Ended September 30, 2021 and 2020 The following table sets forth for the periods indicated, our results of operations and the percentage of total revenue represented in our statements of operations: Nine Months Ended September 30, 2021 % of Net Revenues 2020 % of Net Revenues Revenues, net $ 539,796 100.0 % $ 474,582 100.0 % Cost of revenues 309,505 57.3 251,515 53.0 Gross profit 230,291 42.7 223,067 47.0 Operating expenses: Marketing and sales 163,053 30.2 127,313 26.8 General and administrative 54,024 10.0 27,312 5.8 Research and development 5,430 1.0 4,712 1.0 Total operating expenses 222,507 41.2 159,337 33.6 Operating income 7,784 1.4 63,730 13.4 Other income (expense): Interest expense (1,129 ) (0.2 ) (4,045 ) (0.9 ) Other income (expense), net (30 ) — 109 — Change in fair value – warrant liabilities 19,369 3.6 (212,593 ) (44.8 ) Loss on extinguishment of debt — — (5,782 ) (1.2 ) Tax receivable agreement income (expense) 639 0.1 (33,512 ) (7.1 ) Total other income (expense), net 18,849 3.5 (255,823 ) (53.9 ) Net income (loss) before income taxes 26,633 4.9 (192,093 ) (40.5 ) Income tax benefit (expense) (1,005 ) (0.2 ) 35,818 7.5 Net income (loss) 25,628 4.7 (156,275 ) (32.9 ) Net income attributable to noncontrolling interest 55 — 7,178 1.5 Net income (loss) attributable to Purple Innovation, Inc. $ 25,573 4.7 $ (163,453 ) (34.4 ) Revenue Net revenues increased $65.2 million, or 13.7%, to $539.8 million for the nine months ended September 30, 2021 compared to $474.6 million for the nine months ended September 30, 2020. This increase consisted of wholesale net revenues increasing $71.3 million, or 62.3%, offset in part by DTC net revenues decreasing $6.1 million, or 1.7%. Our wholesale business was favorably impacted by wholesale partner expansion combined with a reopening of wholesale partner doors. However, this favorable impact was offset by lower-than expected demand from our wholesale customers in the third quarter of 2021, primarily due to production delays experienced in the second and third quarter of 2021, as described above. DTC net revenues were also unfavorably impacted by the impact of production and demand issues on second and third quarter net revenues. The increase in net revenues from a product perspective reflected a $37.8 million increase in mattress sales, a $19.0 million increase in other bedding product sales and an $8.4 million increase in other product sales. This growth was primarily driven by an increase in wholesale customer demand. However, we believe that wholesale and DTC demand were adversely affected by the production issues we experienced in the second and third quarters of 2021, as our ability to manufacture and deliver our products to both DTC and wholesale customers was interrupted. In addition, in response to production delays, we temporarily reduced our marketing spending, which reduced demand for our products, particularly with respect to our DTC channel. While we have returned to planned production and marketing activities, it is unclear when customer demand will return to expected levels. We currently anticipate that net revenues in the fourth quarter of 2021 will continue to be adversely impacted by slower than anticipated recovery to prior demand levels. Cost of Revenues The cost of revenues increased $58.0 million, or 23.1%, to $309.5 million for the nine months ended September 30, 2021 compared to $251.5 million for the nine months ended September 30, 2020. The increase, which was primarily due to a $32.7 million increase in direct material costs, a $21.3 million increase in labor and overhead costs, and a $4.0 million increase in other costs, was primarily associated with increased product sales and higher production, shipping, material and labor costs. The gross profit percentage decreased to 42.7% of net revenues for the nine months ended September 30, 2021 from 47.0% for the comparative prior year period. The decrease in our gross profit percentage was primarily driven by a higher proportion of wholesale channel revenue, which carries a lower gross margin than revenue from the DTC channel, rising raw material and labor costs and the unfavorable impact of production issues. While we have returned to planned production capacity, we anticipate that shipping, raw material and labor costs will continue to remain at elevated levels or increase in the foreseeable future. 39 Marketing and Sales Marketing and sales expenses increased $35.7 million, or 28.1%, to $163.1 million for the nine months ended September 30, 2021 compared to $127.3 million for the nine months ended September 30, 2020. This increase reflected a $12.8 million increase in advertising costs due to higher advertising rates in 2021 and advertising costs in the prior year second quarter being uncharacteristically low due to the pandemic, a $12.3 million increase in personnel costs related to planned growth of our workforce and a $10.7 million increase in other marketing and sales expenses. Marketing and sales expense as a percentage of net revenues was 30.2% for the nine months ended September 30, 2021 compared to 26.8% for the nine months ended September 30, 2020. The higher percentage of net revenues in the first nine months of 2021 was due in part to product sales being unfavorably impacted by production and demand issues experienced in the second and third quarters of 2021, as described above, coupled with higher advertising rates in 2021 and advertising costs in the prior year second quarter being uncharacteristically low because of the pandemic. General and Administrative General and administrative expenses increased $26.7 million, or 97.8%, to $54.0 million for the nine months ended September 30, 2021 compared to $27.3 million for the nine months ended September 30, 2020. This increase was primarily due to a $16.8 million increase in legal and professional fees related to offering costs, including underwriting commissions related to shares sold by Coliseum Capital Partners, and increased expenses for consulting, professional staffing and executive placement costs, a $5.3 million increase related to planned increases in our workforce, and a $4.6 million increase in all other expenses. Research and Development Research and development costs increased $0.7 million, or 15.2%, to $5.4 million for the nine months ended September 30, 2021 from $4.7 million for the nine months ended September 30, 2020. This increase was primarily due to an increase in professional services costs related to product development activities. Operating Income Operating income decreased $55.9 million, or 87.8%, to $7.8 million for the nine months ended September 30, 2021, from operating income of $63.7 million for the nine months ended September 30, 2020. This decrease was primarily due to net revenues being unfavorably impacted by production and demand issues in the second and third quarters of 2021, increased costs and a higher proportion of wholesale channel revenue, which carries a lower gross margin than revenue from the DTC channel. Interest Expense Interest expense totaled $1.1 million for the nine months ended September 30, 2021 as compared to $4.0 million for the nine months ended September 30, 2020. Interest expense in 2021 was offset in part by $0.8 million of capitalized interest of which $0.6 million related to periods prior to the third quarter of 2021 and was recorded as an out-of-period correction in the third quarter of 2021. The $2.9 million decrease was also due to the $35.0 million Related Party Loan, which carried an interest rate of 12.00%, being refinanced in the third quarter of 2020 with a $45.0 million term loan at an initial interest rate of 3.50%. Interest expense in 2021 also includes amortization of deferred loan costs associated with the 2020 Credit Agreement and fees related to the revolving line of credit. Change in Fair Value – Warrant Liabilities On February 26, 2019, the Incremental Lenders funded a $10.0 million increase in the Related Party Loan and received 2.6 million warrants to purchase 2.6 million shares of our Class A Stock at a price of $5.74 per share, subject to certain adjustments. We accounted for the Incremental Loan Warrants as liabilities and recorded them at fair value on the date of the transaction and subsequently re-measured to fair value at each reporting date with changes in the fair value included in earnings. We determined the fair value of the Incremental Loan Warrants to be $64.9 million at September 30, 2020. During the nine months ended September 30, 2020, we recognized a loss of $43.3 million in our condensed consolidated statement of operations related to the change in fair value of these warrants. There was no gain or loss on the Incremental Loan Warrants for the nine months ended September 30, 2021 as they were all exercised in 2020. 40 There were 15.5 million public warrants issued in connection with GPAC’s formation and IPO and 12.8 million sponsor warrants issued pursuant to a simultaneous private placement with the IPO. We have accounted for these warrants as liabilities and recorded them at fair value on the date of the transaction and subsequently re-measured to fair value at each reporting date with changes in fair value included in earnings. The 1.9 million sponsor warrants outstanding at September 30, 2021 had a fair value of $9.0 million. The fair value of the public and sponsor warrants outstanding at September 30, 2020 was $188.5 million. During the nine months ended September 30, 2021, we recognized a gain of $19.4 million in our condensed consolidated statement of operations related to a decrease in the fair value of the sponsor warrants exercised during the nine-month period or that were outstanding at September 30, 2021. During the nine months ended September 30, 2020, we recognized a loss of $169.3 million in our condensed consolidated statement of operations related to an increase in the fair value of the public and sponsor warrants exercised during the prior year nine-month period or that were outstanding at the end of September 30, 2020. Loss on Extinguishment of Debt On September 3, 2020, the Company paid $45.0 million to retire, in full, all indebtedness related to Purple LLC’s Related Party Loan. The payment included $25.0 million for the original loan under the agreement, $10.0 million for a subsequent incremental loan, $6.6 million for paid-in-kind interest, $2.5 million for a prepayment fee and $0.9 million for accrued interest. As a result of paying off the Related Party Loan, the Company recognized a $5.8 million loss on extinguishment of debt during the nine months ended September 30, 2020. Tax Receivable Agreement Expense The tax receivable agreement liability totaled $171.5 million and $172.0 million at September 30, 2021 and December 31, 2020, respectively. During the first nine months of 2021, we realized $0.6 million of tax receivable agreement income due to the impact of recording the 2020 provision to return adjustments. Of the $168.3 million liability recorded during the nine months ended September 30, 2020, $134.9 million relates to current year exchanges and was recorded as an adjustment to stockholders’ equity and $33.5 million was recorded to expense as it related to reestablishing the tax receivable agreement liability related to prior year exchanges. Income Tax Benefit (Expense) Income tax expense was $1.0 million for the nine months ended September 30, 2021, compared to an income tax benefit of $35.8 million for the nine months ended September 30, 2020. Income tax expense for the nine months ended September 30, 2021 was primarily the result of no longer having a full valuation allowance, the decrease in noncontrolling interest, and the change in fair value of the warrant liability which is treated as a permanent item for tax purposes. The income tax benefit in the comparative prior nine-month period was primarily due to a portion of the valuation allowance associated with the Company’s federal and state deferred tax assets being released and recorded as an income tax benefit during the nine months ended September 30, 2020. Noncontrolling Interest Net income attributed to noncontrolling interests was $0.1 million for the nine months ended September 30, 2021, compared to $7.2 million for the nine months ended September 30, 2020. This decrease is the result of the noncontrolling interest ownership percentage being significantly lower in 2021 than 2020. Liquidity and Capital Resources Our primary cash needs have historically consisted of working capital, capital expenditures and debt service. Our working capital needs depend upon the timing of cash receipts from sales, payments to vendors and others, changes in inventories, and operating lease payment obligations. Our cash and working capital positions were $83.6 million and $74.9 million, respectively, as of September 30, 2021 compared to $123.0 million and $96.9 million, respectively, as of December 31, 2020. Inventories as of September 30, 2021 totaled $84.0 million compared with $65.7 million as of December 31, 2020 as production returned to planned levels and we were able to increase our finished goods inventory to adequate stock levels to enable timely shipments to our customers. Cash used for purchases of property and equipment increased from $14.2 million during the first nine months of 2020 to $40.1 million during the first nine months of 2021. This increase primarily resulted from continuing to invest in our business by building out our new manufacturing facility in Georgia that began operations in March 2021, enhancing our manufacturing capabilities in Utah, scaling our infrastructure to support the growth of our workforce, and opening 11 new Company showrooms during the first nine months of 2021. 41 In response to the COVID-19 pandemic, we took a number of precautionary measures to manage our resources and mitigate its adverse impact. Given the initial difficulty in predicting how long the pandemic would persist and its full impact, we managed our business and opportunities to preserve liquidity. In the second half of 2020, we ended most of the cash preservation programs and returned to full production to meet increased demand. During 2021, we have increased our inventory levels and invested in our manufacturing capacity and showroom expansion. Subject to certain assumptions regarding the duration and severity of the COVID-19 pandemic, and our responses thereto, based on our current projections we believe our cash on hand, ongoing cash generated from our DTC business, amounts available under our line of credit, increasing demand of our products in the wholesale channel and continuing ramp up of store operations, will be sufficient to cover our working capital requirements and anticipated capital expenditures for the next 12 months. On September 3, 2020, we paid $45.0 million to retire, in full, all indebtedness related to Purple LLC’s Related Party Loan. The payment included $25.0 million for the original loan under the agreement, $10.0 million for a subsequent incremental loan, $6.6 million for paid-in-kind interest, $2.5 million for a prepayment fee and $0.9 million for accrued interest. Also on September 3, 2020, Purple LLC entered into the 2020 Credit Agreement that provided for a $45.0 million term loan (the “Term Loan”) and a $55.0 million revolving line of credit. The agreement has a five-year term and borrowing rates for both the Term Loan and revolving line of credit are based on Purple LLC’s leverage ratio and can range from LIBOR plus a 3.00% to 3.75% margin with a LIBOR minimum of 0.50%. As of September 30, 2021, there was no balance outstanding on the revolving credit facility. Proceeds from the Term Loan were used to retire all indebtedness associated with the Related Party Loan. During the nine months ended September 30, 2021, 6.6 million sponsor warrants were exercised on a cash and cashless basis resulting in the issuance of 2.3 million shares of Class A Stock. The proceeds received for the cash exercise was $0.1 million. At September 30, 2021, there were 1.9 million sponsor warrants outstanding. In the event our cash flow from operations or other sources of financing are less than anticipated, we believe we will be able to fund operating expenses based on our ability to scale back operations, reduce marketing spend and postpone or discontinue our growth strategies. In such event, this could result in slower growth or no growth, and we may run the risk of losing key suppliers, we may not be able to timely satisfy customer orders, and we may not be able to retain all of our employees. In addition, we may be forced to restructure our obligations to current creditors or pursue work-out options. On November 8, 2021, we provided notice to KeyBank National Association requesting a $55.0 million draw on our revolving line of credit under the 2020 Credit Agreement, which represents the full amount available under the revolving line of credit. The initial borrowing rate will be 3.50%, based on the LIBOR floor of 0.5% plus 3.00%. As described above, we experienced production and demand issues in the second and third quarters of 2021 that adversely affected net revenues. We have also experienced increases in shipping, raw material and labor costs. While we have returned to planned production levels, we currently anticipate that the impact of lower-than-expected demand and higher shipping, material and labor costs will continue to adversely affect our business and results of operations through the fourth quarter of 2021. These issues may adversely affect our ability to comply with covenants under the 2020 Credit Agreement, which could result in our default under such covenants. If we are unable to comply with the covenants and other conditions under the 2020 Credit Agreement, we will need to seek a waiver or amendment to avoid a default. However, we may not be able to obtain such a waiver or amendment or may be required to incur additional expenses or accept unfavorable terms. If cash flow from operations or available financing under the 2020 Credit Agreement are not sufficient to fund our operating expenses or our growth strategies, we may need to raise additional capital. Our ability to obtain additional or alternative capital on acceptable terms or at all is subject to a variety of uncertainties, including instability in the credit and financial markets resulting from macroeconomic factors and approval from the lenders under the 2020 Credit Agreement. Adequate financing may not be available or, if offered, 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, as described above, may be combined with the issuance of warrants or other derivative securities, which each may have additional dilutive effects. Furthermore, we may incur substantial costs in pursuing future capital and financing, including investment banking fees, legal fees, accounting fees, printing and distribution expenses and other costs. We may also be required to recognize non-cash expenses in connection with certain securities we may issue, such as convertible notes and warrants, which will adversely impact our financial condition. If we cannot raise additional funds on favorable terms or at all, we may not be able to carry out all or parts of our long-term growth strategy, maintain our growth and competitiveness or continue in business. We are required to make certain payments to InnoHold under the tax receivable agreement, which may have a material adverse effect on our liquidity and capital resources. We are currently unable to determine the total future amount of these payments due to the unpredictable nature of several factors, including the timing of future exchanges, the market price of shares of Class A Stock at the time of the exchanges, the extent to which such exchanges are taxable and the amount and timing of future taxable income sufficient to utilize tax attributes that give rise to the payments under the tax receivable agreement. As of September 30, 2021, the tax receivable agreement liability reflected in our condensed consolidated balance sheet is $171.5 million of which $5.9 million is classified as other current liabilities in the condensed consolidated balance sheet. 42 Cash Flows for the Nine months Ended September 30, 2021 and 2020 The following summarizes our cash flows for the nine months ended September 30, 2021 and 2020 as reported in our condensed consolidated statements of cash flows (in thousands): Nine Months Ended September 30, 2021 2020 Net cash provided by operating activities $ 132 $ 87,400 Net cash used in investing activities (41,498 ) (25,084 ) Net cash provided by financing activities 2,027 2,161 Net (decrease) increase in cash (39,339 ) 64,477 Cash, beginning of the period 122,955 33,478 Cash, end of the period $ 83,616 $ 97,955 Nine months ended September 30, 2021 Compared to the Nine months ended September 30, 2020 Cash provided by operating activities was minimal during the nine months ended September 30, 2021 compared to $87.4 million for the nine months ended September 30, 2020. The decrease in cash provided by operations primarily resulted from a $49.9 million decrease in cash provided by operating income which was mainly driven by net revenues being unfavorably impacted by production and demand issues experienced in the second and third quarters of 2021, coupled with higher marketing and sales expenses, increased legal and professional fees and planned increases in our workforce. The decrease in cash provided by operations was further impacted by a $37.3 million decrease in operating cash flows related to net changes in operating assets and liabilities for the nine months ended September 30, 2021 compared to the corresponding nine-month period in the prior year. This decrease consisted of decreased cash from changes in period-over-period fluctuations in accounts receivable, inventories and liabilities, offset in part by an increase in cash related to a change in the year-over-year fluctuation in prepaid inventory and other assets. We currently anticipate that our operating results for the fourth quarter of 2021, including cash provided by operating activities, will continue to be adversely impacted by slower recovery to prior demand levels, and rising shipping, material and labor costs. Cash used in investing activities was $41.5 million for the nine months ended September 30, 2021 compared to $25.1 million for the nine months ended September 30, 2020. This increase primarily resulted from continuing to invest in our business by building out our new manufacturing facility in Georgia that began operations in March 2021, enhancing our manufacturing capabilities in Utah, scaling our infrastructure to support the growth of our workforce, and opening 11 new Company showrooms during the first nine months of 2021. Cash provided by financing activities during the nine months ended September 30, 2021 was $2.0 million compared to $2.2 million of cash provided by financing activities during the nine months ended September 30, 2020. Financing activities in the first nine months of 2021 included $4.1 million in proceeds from an InnoHold indemnification payment and $1.2 million of proceeds from warrant and stock option exercises, offset in part by $1.7 million in principal payments on the Term Loan, member tax distributions of $1.0 million and a $0.6 million payment for the tax receivable agreement. Critical Accounting Policies We discuss our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2020 Annual Report on Form 10-K/A filed May 10, 2021. There were no significant changes in our critical accounting policies since the end of fiscal 2020. 43 Off-Balance-Sheet Arrangements and Contractual Obligations As of September 30, 2021, we were not involved in any unconsolidated special purpose entity transactions and did not have any off-balance-sheet financing. Also, there was no balance outstanding on our $55.0 million revolving credit facility as of September 30, 2021. There have been no material changes to our contractual obligations during the three months ended September 30, 2021 from those previously disclosed in our Form 10-Q for the quarterly period ended March 31, 2021. Seasonality and Cyclicality We believe that sales of our products are typically subject to seasonality corresponding to different periods of the consumer spending cycle, holidays and other seasonal factors. Our sales may also vary with the performance of the broader economy consistent with the market. Available Information Our website address is www.purple.com. We make available free of charge on the Investor Relations portion of our website, investors.purple.com, our annual report on Form 10-K/A, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. We also use the Investor Relations portion of our website, investors.purple.com, as a channel of distribution of additional Company information that may be deemed material. Accordingly, investors should monitor this channel, in addition to following our press releases, SEC filings and public conference calls and webcasts. The contents of our website shall not be deemed to be incorporated herein by reference. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not Applicable. 44