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. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses (including the discussion under the heading “Outlook for Growth”), and other characterizations of future events or circumstances are forward-looking statements. We caution and advise readers that these statements are only predictions and are subject to risks, uncertainties, and assumptions that are difficult to predict, including those included in the “Risk Factors” section of this Quarterly Report and in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 1, 2022. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements and investors are cautioned not to place undue reliance on any such statements. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law. Overview of Our Business Our mission is to improve the lives of our consumers by delivering innovative better sleep solutions. We are a digitally-native vertical brand founded on comfort product innovation with premium offerings. We design and manufacture a variety of innovative, branded and premium comfort products, including mattresses, pillows, cushions, frames, sheets, and other products. Our products are the result of over 30 years of innovation and investment in proprietary and patented comfort technologies and the development of our own manufacturing processes. Our proprietary gel technology, Hyper-Elastic Polymer, underpins many of our comfort products and provides a range of benefits that differentiate our offerings from other competitors’ products. We market and sell our products directly to consumers through our e-commerce and Purple retail showroom channels and through our retail brick-and-mortar wholesale partner channel. Organization Our business consists of Purple Inc., its controlled subsidiary, Purple LLC, and its wholly owned subsidiary, Intellibed. Purple Inc. was incorporated in Delaware on May 19, 2015 as a special purpose acquisition company under the name of GPAC. On February 2, 2018, Purple Inc. consummated a transaction structured similar to a reverse recapitalization pursuant to which Purple Inc. acquired an equity interest in Purple LLC and became its sole managing member. As the sole managing member of Purple LLC, Purple Inc., through its officers and directors, is responsible for all operational and administrative decision making and control of the day-to-day business affairs of Purple LLC without the approval of any other member. At September 30, 2022, Purple Inc. had a 99.5% economic interest in Purple LLC while other Class B Unit holders had the remaining 0.5%. On August 31, 2022, the Company acquired all of the issued and outstanding stock of Intellibed with the surviving entity continuing as a wholly owned subsidiary of Purple Inc. For further discussion see Recent Developments in Our Business — Acquisition below. 31 Executive Summary – Results of Operations Net revenues decreased 16.1% to $143.3 million and 20.2% to $430.6 million for the three and nine months ended September 30, 2022, respectively, when compared to the corresponding periods in the prior year. These decreases were primarily due to softening demand for home related products and the negative effect of inflationary pressures on consumer discretionary spending. Gross profit was $59.4 million for the three months ended September 30, 2022 compared to $61.1 million for the same period in the prior year. The gross profit percentage improved in the third quarter of 2022 to 41.5% as compared to 35.8% in the prior year third quarter. The increase in our gross profit percentage was primarily due to efficiency and cost reduction initiatives implemented in the first half of fiscal 2022 offset in part by a shift in revenue to our wholesale channel, which carries a lower average selling price than sales from our e-commerce and retail showroom channels. For the nine months ended September 30, 2022, gross profit decreased 30.6% to $159.9 million as compared to the prior year nine-month period due in part to the decrease in sales volume. The gross profit percentage for the first nine months of 2022 was 37.1% as compared to 42.7% for the prior year nine-month period. Our gross profit percentage was adversely impacted by elevated levels of materials, labor and freight costs, lower-than-expected demand levels and a shift in revenue to our wholesale channel. The benefits from our efficiency and cost reduction initiatives did not become fully impactful until the third quarter. Operating expenses decreased 14.1% to $58.1 million and 15.1% to $189.0 million for the three and nine months ended September 30, 2022, respectively, when compared to the corresponding periods in the prior year. These decreases primarily reflected the impact of reduced advertising spend, two workforce reductions and the implementation of other cost saving measures. Net income was $2.3 million for the three months ended September 30, 2022 as compared to net income of $2.2 million for the three months ended September 30, 2021. For the nine months ended September 30, 2022, the Company’s net loss was $19.6 million as compared to net income of $25.6 million for the nine months ended September 30, 2021. Recent Developments in Our Business Acquisition On August 31, 2022, the Company acquired Intellibed, a premium sleep and health wellness company, offering gel-based mattresses scientifically designed for maximum back support, spinal alignment and pressure point relief. We believe that the addition of Intellibed will increase product offerings to customers, expand market opportunities, capitalize on synergies of the combined companies, and increase opportunities for innovation. In addition, the acquisition allowed the Company to consolidate ownership of its intellectual property and more fully capitalize on growing demand for products with gel technologies. The total purchase consideration for the acquisition was $28.3 million, which primarily consisted of 8.1 million shares of Class A common stock. Purchase consideration also included the fair value of 0.5 million shares of Class A common stock held in escrow pending resolution of net working capital adjustments and general representation and warranty provisions of the agreement, the fair value of contingent consideration of 1.5 million shares of Class A common stock issuable to Intellibed securityholders depending upon the price of the Class A common stock over the next 18 months, $1.4 million gain related to the fair value of a preexisting legal matter that was effectively settled on the acquisition date, and $0.9 million related to the fair value of other items. Coliseum Capital Management, LLC Proposal On September 17, 2022, the Company received an unsolicited and non-binding proposal from CCM to acquire the remaining outstanding common stock of the Company not already beneficially owned by CCM for $4.35 per share in cash. At the time of the offer, CCM beneficially owned approximately 45% of the outstanding equity of the Company. The CCM proposal is conditioned upon the transaction being (a) negotiated by, and subject to the approval of, a special committee of independent and disinterested members of the Board (the “Special Committee”) and (b) subject to a non-waivable condition requiring approval by the affirmative vote of a majority of the shares of common stock not owned by CCM or other interested parties. The Special Committee was formed by the Board to determine the necessary actions to evaluate the CCM proposal and determine the course of action that is in the best interests of all of the Company’s shareholders. The Board expressly granted the Special Committee the ability to decline the CCM proposal. In addition, the Special Committee adopted the Rights Plan to have the time and flexibility necessary to evaluate the CCM offer. Stockholder Rights Agreement On September 25, 2022, with the authorization of the Board, the Special Committee approved the adoption of a limited-duration stockholder rights agreement with an expiration date of September 25, 2023. The Special Committee adopted the Rights Agreement in response to CCM’s substantial increase in ownership of the Company’s shares over the last year and the Special Committee’s desire to have the time and flexibility necessary to evaluate CCM’s offer to acquire the outstanding common stock of the Company not already beneficially owned by CCM. The Rights Agreement is intended to enable the Company’s shareholders to realize the full value of their investment and to guard against any attempts to gain control of the Company without paying all shareholders an appropriate control premium. The Rights Agreement applies equally to all current and future shareholders and does not deter any offer or preclude the Special Committee from considering an offer that is fair and otherwise in the best interests of the Company’s shareholders. 32 Upon adopting the Rights Agreement, 300,000 shares of the Company’s authorized shares of preferred stock, par value $0.0001 per share, were designated as Preferred Shares. In accordance with the Rights Agreement, on September 25, 2022, the Special Committee authorized and declared a dividend of one preferred share purchase right (a “Right”) for each outstanding share of the Company’s Class A and Class B common stock to stockholders of record at the close of business on October 6, 2022. Upon the occurrence of certain triggering events, each Right entitles the holder to purchase from the Company one one-thousandth of a share of the newly designated Preferred Shares at an exercise price of $20.00 . The Rights will be exercisable only if a person or group acquires beneficial ownership (including certain synthetic equity positions created by derivative securities) of 20% or more of the Company’s outstanding shares of common stock. Any person or group that beneficially owned more than the triggering percentage when the Board adopted the Rights Agreement may continue to own its shares of common stock but may not acquire any additional shares without triggering the Rights Agreement. Unless the Rights become exercisable as discussed above, the Rights Agreement has no impact on the Company’s condensed consolidated financial statements . Equity Financing In March 2022, the Company completed an underwritten public offering of 16.1 million shares of Class A common stock, which included the additional 2.1 million shares of the over-allotment option that the underwriters exercised in full. The aggregate net proceeds received by the Company from the offering, after deducting offering expenses of $0.3 million, totaled $92.9 million. Debt Financing On September 3, 2020, Purple LLC entered into the 2020 Credit Agreement that provided for a $45.0 million term loan and a $55.0 million revolving line of credit. In November 2021, the Company executed a $55.0 million draw on its revolving line of credit, which represented the full amount available under the line. On March 31, 2022, the Company used a portion of the net proceeds from its underwritten public offering, described above, to repay in full the $55.0 million of principal outstanding on the revolving line of credit. The Company’s operating and financial results for the year ended December 31, 2021 did not satisfy the financial and performance covenants required under the 2020 Credit Agreement. On February 28, 2022, prior to the covenant compliance certification date, the Company entered into the first amendment of the 2020 Credit Agreement to avoid a breach of these covenants and potential default. This amendment contained a covenant waiver period such that the net leverage ratio and fixed charge coverage ratio would not be tested for the fiscal quarters ended December 31, 2021, March 31, 2022 and June 30, 2022. Other modifications in the amendment included revised leverage ratio and fixed charge coverage definitions and thresholds, the addition of minimum liquidity requirements with mandatory prepayments of the revolving loan if cash exceeded $25.0 million, new weekly and monthly reporting requirements, limits on the amount of capital expenditures, the addition of a lease incurrence test for opening additional showrooms, additional negative covenants during a covenant amendment period that extends into 2023 until certain conditions are met, and the interest rate was changed from LIBOR plus 3.00% to SOFR plus 4.75%. Pursuant to this amendment, the Company made a $2.5 million payment on the term loan to cover the four quarterly principal payments due in 2022 and incurred fees and expenses of $0.8 million that were recorded as debt issuance costs in the condensed consolidated balance sheet. On March 23, 2022, the Company entered into a second amendment to the 2020 Credit Agreement. This amendment modified the 2020 Credit Agreement to allow CCM and its investment affiliates to acquire 35% or more of the combined voting power of all equity interests of the Company entitled to vote for the election of members of the Company’s board of directors without constituting an event of default. CCM is considered a related party of the Company in that Adam Gray, a member of our board of directors, serves as a managing partner of CCM. Pursuant to this amendment, the Company incurred fees and expenses of $0.4 million that were recorded as debt issuance costs in the condensed consolidated balance sheet. On May 13, 2022 and September 9, 2022, the Company entered into a third and fourth amendment, respectively, to the 2020 Credit Agreement. These amendments modified the permitted leases schedule to reflect a change in showroom locations and a new lease for an innovation building. The amendments did not meet the criteria for a modification of existing debt and the minimal expenses were recorded as a general and administrative expense in the condensed consolidated statement of operations. On July 14, 2022, the Company received consent under the 2020 Credit Agreement allowing the Company’s acquisition of Intellibed to constitute a permitted acquisition under the 2020 Credit Agreement. The Company incurred fees and expenses of $0.3 million that were recorded as general and administrative expense in the condensed consolidated statement of operations. 33 Operational Developments The COVID-19 pandemic has impacted many aspects of our operations, directly and indirectly, including disruption of our employees, consumer behavior, distribution and logistics, our suppliers, and the market overall. The scope and nature of these impacts continue to evolve. Soon after the pandemic began, we experienced an increase in demand in our e-commerce channel, and in 2020 and 2021 the Company increased its production capacity to match actual and anticipated demand growth. In 2022, after two years of the pandemic, we began experiencing a pull-back in growth that left us with excess operational capacity in facilities, equipment, and personnel. Beginning in the first quarter of 2022 and continuing into the third quarter, the Company rebalanced production and fulfillment operations in its different facilities, reduced employee headcount and took other actions to lower costs. We are closely monitoring the impacts of COVID-19 and general economic conditions on global supply chain, manufacturing, and logistics operations. As inflationary pressures increase, we anticipate that our production and operating costs will similarly increase. In addition, COVID-19 and other events, including port closures or labor shortages, have resulted in the continuation or worsening of manufacturing and shipping costs, delays and constraints. While most of our domestic suppliers have been able to continue operations and provide necessary materials when needed, we have experienced some constraints from certain suppliers, with respect to both the availability and cost of materials. In addition, as experienced in other industries, in order to remain competitive in hiring and retaining the labor necessary to maintain our production levels, we have increased wages and other compensation. These increases in materials, labor and freight costs have resulted in higher cost of goods sold and lower margins. We believe that materials, labor and freight costs will continue to remain at elevated levels or increase further in the foreseeable future. In the fourth quarter of 2021 and continuing into 2022, our gross profits and results of operations have been, and we expect will continue to be adversely affected by elevated levels of materials, labor and freight costs and lower-than-expected demand levels. In early 2022, to offset the impact of higher costs on our gross profits, we increased prices and initiated several other projects to improve efficiencies and reduce costs, including balancing production between facilities to reduce freight costs and shorten delivery times. As the softening of demand for home related products continues, and consumer spending habits shift from e-commerce to brick and mortar, we are investing in showroom expansion where we are in the early stages of developing our capabilities. We also are growing our wholesale partner door count and focusing on improving wholesale door productivity. We ended the third quarter with 51 Purple showrooms after opening 11 new locations during the third quarter and we plan to add three more showrooms over the remainder of the year. In addition, at the end of the third quarter, our products are being sold through approximately 3,300 wholesale doors, having added approximately 800 net new doors during the first nine months of 2022. Improving the sales productivity of our wholesale doors remains a primary focus and a critical component of our strategy to respond to shifting demand patterns. After several years of hyper growth and increased investments to support current and future expansion, we are now building the framework for strong operational maturity and accountability after focusing on right-sizing our operations, improving our execution, and refining our strategies that will drive share gains in the premium mattress category and position the Company for accelerated growth when market conditions improve. We have also intentionally reduced our advertising spending in 2022 to improve marketing efficiency, stabilize profitability in a challenging macroeconomic environment and align spending with the current demand environment. The acquisition of Intellibed is expected to be a strong strategic addition to the Company because of shared technology, geographic proximity of their primary facility, and target market extension. In addition, the acquisition allowed the Company to consolidate ownership of its intellectual property and more fully capitalize on growing demand for products with gel technologies. Intellibed’s higher price points compared to the Company’s existing product offerings will be a natural extension of our product line. The acquisition also benefits us by accelerating our product development schedule several years by being able to immediately enter the luxury segment of the sleep and wellness industry. In addition, we expect to capitalize on synergies of the combined companies and benefit from expanding the market presence of Intellibed’s product offerings. Outlook for Growth To support our plans for future growth and sustained profitability, we are focusing on the following opportunities: ● Develop and execute on strategies to meaningfully expand our wholesale business by prioritizing existing door profitability. ● Build premium brand position to grow market share of the premium mattress category. ● Refine and enhance marketing strategies to reach a broader audience, increase customer engagement and reduce dependency on price promotions as a means of driving sales. ● Strengthen research and development disciplines and go-to-market processes to further develop our current product categories and position our business to eventually expand to additional categories. ● Manage production labor and capacity utilization to promote efficient use of our manufacturing facilities as we grow into our production footprint. ● Manage input costs, operating efficiencies, and pricing to offset gross profit erosion. 34 There is no guarantee that we will be able to effectively execute on these opportunities, which are subject to risks, uncertainties, and assumptions that are difficult to predict, including the risks described under “Risk Factors” and elsewhere herein. Therefore, actual results may differ materially and adversely from those described above. In addition, we may, in the future, adapt these focuses in response to changes in the market or our business. Operating Results for the Three Months Ended September 30, 2022 and 2021 The following table sets forth for the periods indicated, our results of operations and the percentage of total revenue represented in our condensed consolidated statements of operations (dollars in thousands): Three Months Ended September 30, 2022 % of Net Revenues 2021 % of Net Revenues Revenues, net $ 143,280 100.0 % $ 170,781 100.0 % Cost of revenues 83,867 58.5 109,701 64.2 Gross profit 59,413 41.5 61,080 35.8 Operating expenses: Marketing and sales 37,007 25.8 48,841 28.6 General and administrative 19,166 13.4 17,037 10.0 Research and development 1,927 1.3 1,784 1.0 Total operating expenses 58,100 40.6 67,662 39.6 Operating income (loss) 1,313 0.9 (6,582 ) (3.9 ) Other income (expense): Interest income (expense), net (717 ) (0.5 ) 10 — Other income, net 1,107 0.8 12 — Change in fair value – warrant liabilities (53 ) — 5,362 3.1 Tax receivable agreement income — — 846 0.5 Total other income, net 337 0.2 6,230 3.6 Net income (loss) before income taxes 1,650 1.2 (352 ) (0.2 ) Income tax benefit 631 0.4 2,479 1.5 Net income 2,281 1.6 2,127 1.2 Net income (loss) attributable to noncontrolling interest 3 — (44 ) — Net income attributable to Purple Innovation, Inc. $ 2,278 1.6 $ 2,171 1.3 Revenues, Net Net revenues decreased $27.5 million, or 16.1%, to $143.3 million for the three months ended September 30, 2022 compared to $170.8 million for the three months ended September 30, 2021. The decline in net revenues reflected a $23.7 million decrease in mattress sales, a $1.2 million decrease in other sleep product sales and a $2.6 million decrease in other product sales. The decrease in net revenues was primarily due to softening demand for home related products and the negative effect of inflationary pressures on consumer discretionary spending. The decline in net revenues from a sales channel perspective consisted of DTC net revenues decreasing $28.3 million, or 25.0%, offset in part by wholesale net revenues increasing $0.8 million, or 1.3%. Within DTC, ecommerce net revenue declined $37.6 million, or 36.6%, due to the reasons stated above and showroom net revenue increased $9.9 million, or 110.4%, driven largely by the opening of 32 net new showrooms over the past 12 months. In addition to the softening demand discussed above, the decrease in DTC net revenues was impacted by a return to more normalized consumption patterns in fiscal 2022 with customers shifting away from e-commerce buying experienced during COVID and the economic stimulus. The increase in wholesale net revenues was primarily due to the Intellibed acquisition which added $2.6 million of wholesale net revenues from the date of acquisition through September 30, 2022, partially offset by reductions in revenue due to market conditions. Cost of Revenues Cost of revenues decreased $25.8 million, or 23.5%, to $83.9 million for the three months ended September 30, 2022 compared to $109.7 million for the three months ended September 30, 2021. This decrease was primarily due to the corresponding decrease in sales volume. Our gross profit percentage, which increased to 41.5% of net revenues in the third quarter of 2022 from 35.8% in the third quarter of 2021, benefited from efficiency and cost saving initiatives implemented in the first half of fiscal 2022 that included headcount reductions and the balancing of production and fulfillment operations between the facilities. Also, the gross profit percentage in the prior year third quarter was adversely impacted by inefficiencies related to the resolution of prior year production issues. The gross profit percentage in the third quarter of 2022 was negatively impacted by a shift in revenue to our wholesale channel, which carries a lower average selling price than sales from our e-commerce and retail sales channels. 35 Marketing and Sales Marketing and sales expense decreased $11.8 million, or 24.2%, to $37.0 million for the three months ended September 30, 2022 compared to $48.8 million for the three months ended September 30, 2021. This decrease was driven by a $16.7 million or 56.8% decline in advertising spending and a $3.8 million decrease in other marketing costs. The reduction in advertising spending was primarily due to management’s ongoing efforts to improve marketing efficiency, stabilize profitability in a challenging macroeconomic environment and align spending with current demand levels. The decrease in other marketing costs reflected the impact of management restructuring the marketing organization earlier in 2022. These decreases were offset in part by a $2.4 million increase in wholesale-related marketing and sales costs due primarily to growing the sales organization of our wholesale business and a $6.2 million increase in marketing and sales costs associated with continued expansion of our showroom business. Marketing and sales expense as a percentage of net revenues was 25.8% in the third quarter of 2022 compared to 28.6% in the third quarter of 2021. This decrease was primarily the result of reduced advertising spending. General and Administrative General and administrative expense increased $2.1 million, or 12.5%, to $19.2 million for the three months ended September 30, 2022 compared to $17.0 million for the three months ended September 30, 2021. This increase was primarily due to a $1.4 million increase in legal and professional fees, a $0.2 million increase in payroll and benefit expense and $0.5 million in general and administrative expense attributable to Intellibed. The increase in legal and professional fees was primarily due to $2.8 million of transaction costs associated with the Intellibed acquisition. Excluding the impact of Intellibed acquisition costs, legal and professional fees declined $1.4 million during the quarter due to lower consulting and legal fees. The increase in payroll and benefit costs was due mainly to job restructuring of certain employees in the first half of 2022. Research and Development Research and development costs increased $0.1 million, or 8.0%, to $1.9 million for the three months ended September 30, 2022 from $1.8 million for the three months ended September 30, 2021. This increase reflected higher payroll and benefit costs as our renewed focus on product innovation resulted in the growth of our research and development team, which included the addition of our chief innovation officer. The increase in payroll expenses was offset in part by a decrease in professional services costs as product development priorities were being refocused. Operating Income (Loss) Operating income was $1.3 million for the three months ended September 30, 2022 compared to an operating loss of $6.6 million for the three months ended September 30, 2021. The $7.9 million increase in operating income was primarily due to lower operating expenses. Interest Expense Interest expense totaled $0.7 million for the three months ended September 30, 2022 compared to a negligible amount of net interest income for the three months ended September 30, 2021. Interest expense was impacted by capitalized interest on borrowings that totaled $0.2 million and $0.8 million during the three months ended September 30, 2022 and 2021, respectively. The increase in interest expense was also impacted by the term loan interest rate increasing to 6.07% during the third quarter of 2022 compared to 3.50% in the third quarter of 2021. In February 2022, the Company entered into the first amendment to the 2020 Credit Agreement which, among other things, changed the reference interest rate from LIBOR to SOFR and increased the applicable margins. Other Income (Expense), Net Other income totaled $1.1 million in the three months ended September 30, 2022 compared to a negligible amount of other income for the three months ended September 30, 2021. This increase primarily resulted from the effective settlement of a preexisting legal matter between the Company and Intellibed upon the Company’s acquisition of Intellibed on August 31, 2022 at an estimated fair value gain of $1.4 million. Change in Fair Value – Warrant Liabilities The 1.9 million sponsor warrants outstanding at September 30, 2022 and 2021 had fair values of $0.1 million and $9.0 million, respectively. The decrease in fair value was primarily due to the Company’s Class A common stock price, one of the primary assumptions used to re-measure the warrant liability, declining from $21.02 at September 30, 2021, to $4.05 at September 30, 2022. During the three months ended September 30, 2022, the Company recorded a loss of $0.1 million related to an increase in the fair value of the warrants outstanding at the end of the period. For the three months ended September 30, 2021, the Company recognized a gain of $5.4 million related to a decrease in the fair value of the warrants outstanding at the end of the period. Income Tax (Expense) Benefit We had an income tax benefit of $0.6 million for the three months ended September 30, 2022 compared to an income tax benefit of $2.5 million for the three months ended September 30, 2021. The income tax benefit in the third quarter of 2022 was primarily the result of the Company having a net loss during the first nine months of 2022. 36 Noncontrolling Interest The Company calculates net income or loss attributable to noncontrolling interests on a quarterly basis using their weighted average ownership percentage. Net income attributed to noncontrolling interests and net loss attributed to noncontrolling interest were both negligible for the three months ended September 30, 2022 and 2021. Operating Results for the Nine Months Ended September 30, 2022 and 2021 The following table sets forth for the periods indicated, our results of operations and the percentage of total revenue represented in our statements of operations (dollars in thousands): Nine Months Ended September 30, 2022 % of Net Revenues 2021 % of Net Revenues Revenues, net $ 430,568 100.0 % $ 539,796 100.0 % Cost of revenues 270,717 62.9 309,505 57.3 Gross profit 159,851 37.1 230,291 42.7 Operating expenses: Marketing and sales 127,339 29.6 163,053 30.2 General and administrative 55,833 13.0 54,024 10.0 Research and development 5,818 1.4 5,430 1.0 Total operating expenses 188,990 43.9 222,507 41.2 Operating income (loss) (29,139 ) (6.8 ) 7,784 1.4 Other income (expense): Interest expense (2,447 ) (0.6 ) (1,129 ) (0.2 ) Other income (expense), net 988 0.2 (30 ) — Change in fair value – warrant liabilities 4,221 1.0 19,369 3.6 Tax receivable agreement income — — 639 0.1 Total other income, net 2,762 0.6 18,849 3.5 Net income (loss) before income taxes (26,377 ) (6.1 ) 26,633 4.9 Income tax benefit (expense) 6,617 1.5 (1,005 ) (0.2 ) Net income (loss) (19,760 ) (4.6 ) 25,628 4.7 Net income (loss) attributable to noncontrolling interest (196 ) — 55 — Net income (loss) attributable to Purple Innovation, Inc. $ (19,564 ) (4.5 ) $ 25,573 4.7 Revenues, Net Net revenues decreased $109.2 million, or 20.2%, to $430.6 million for the nine months ended September 30, 2022 compared to $539.8 million for the nine months ended September 30, 2021. The decline in net revenues reflected a $93.5 million decrease in mattress sales, a $9.3 million decrease in other sleep product sales and a $6.4 million decrease in other product sales. The decrease in net revenues was primarily due to softening demand for home related products and the negative effect of inflationary pressures on consumer discretionary spending. Net revenues in the prior year nine-month period were positively impacted by the pull forward of demand in the first half of 2021 that was driven by the effects of COVID and economic stimulus. The decline in net revenues from a sales channel perspective consisted of DTC net revenues decreasing $102.2 million, or 28.9% and wholesale net revenues decreasing $7.0 million, or 3.8%. Within DTC, ecommerce net revenue declined $127.1 million, or 38.4%, due to the reasons stated above and showroom net revenue increased $25.6 million, or 129.1%, driven largely by the opening of 32 net new showrooms over the past 12 months. In addition to the softening demand discussed above, the decrease in DTC net revenues was impacted by a return to more normalized consumption patterns in fiscal 2022 with customers shifting away from e-commerce buying. The decrease in wholesale net revenues reflected reduced purchases by our existing wholesale partners during the first nine months of 2022 due to market conditions, offset in part by the effects of adding approximately 800 net new wholesale partner doors in fiscal 2022 coupled with wholesale net revenues contributed by Intellibed. Cost of Revenues Cost of revenues decreased $38.8 million, or 12.5%, to $270.7 million for the nine months ended September 30, 2022 compared to $309.5 million for the nine months ended September 30, 2021. This decrease was primarily due to the corresponding decrease in sales volume, offset in part by an increase in indirect labor and manufacturing overhead costs. Our gross profit percentage decreased to 37.1% of net revenues during the first nine months of 2022 from 42.7% for the first nine months of 2021. Our gross profit percentage was adversely impacted by elevated levels of material, labor and freight costs and lower-than-expected demand levels. In addition, we had a shift in revenue to our wholesale channel, which carries a lower average selling price than sales from our e-commerce and retail showroom channels. Our efficiency and cost saving initiatives, as well as the balancing of production and fulfillment operations between the facilities, were implemented during the first half of fiscal 2022 and did not become fully impactful until the third quarter. 37 Marketing and Sales Marketing and sales expense decreased $35.7 million, or 21.9%, to $127.3 million for the nine months ended September 30, 2022 compared to $163.1 million for the nine months ended September 30, 2021. This decrease was driven by a $56.4 million or 50.4% decline in advertising spending and a $5.8 million decrease in other marketing costs. The reduction in advertising spending was primarily due to management’s ongoing efforts to improve marketing efficiency, stabilize profitability in a challenging macroeconomic environment and align spending with current demand levels. The decrease in other marketing costs reflected the impact of management restructuring the marketing organization earlier in 2022. These decreases were offset in part by a $9.4 million increase in wholesale-related marketing and sales costs due in part to growing the sales organization of our wholesale business and a $17.1 million increase in marketing and sales costs associated with showroom expansion. Marketing and sales expense as a percentage of net revenues was 29.6% during the first nine months of 2022 compared to 30.2% for the first nine months of 2021. General and Administrative General and administrative expense increased $1.8 million, or 3.3%, to $55.8 million for the nine months ended September 30, 2022 compared to $54.0 million for the nine months ended September 30, 2021. This increase was primarily due to a $3.9 million increase in payroll and benefits expense and $0.5 million in added costs from the Intellibed consolidation, offset in part by a $3.2 million decrease in legal and professional fees. The increase in payroll and benefit costs was due mainly to job restructuring of certain employees in the first half of 2022. The decrease in legal and professional fees was primarily due to $7.9 million of underwriting commissions and other costs we paid in the prior year second quarter for shares sold by Coliseum Capital Partners. This decrease was partially offset by a one-time $3.1 million separation fee incurred by the Company during the second quarter of 2022 for not continuing with the services of a professional services provider coupled with $2.8 million of Intellibed transaction costs. Research and Development Research and development costs increased $0.4 million, or 7.1%, to $5.8 million for the nine months ended September 30, 2022 from $5.4 million for the nine months ended September 30, 2021. This increase reflected higher payroll and benefit costs as our renewed focus on product innovation resulted in the growth of our research and development team, which included the addition of our chief innovation officer. The increase in payroll expenses was offset in part by a decrease in professional services costs as product development priorities were being refocused. Operating Income (Loss) Operating income decreased $36.9 million to an operating loss of $29.1 million for the nine months ended September 30, 2022 compared to operating income of $7.8 million for the nine months ended September 30, 2021. This decrease primarily reflected a decrease in gross profit that was driven by lower net revenues and a decrease in gross profit margin. Interest Expense Interest expense totaled $2.4 million for the nine months ended September 30, 2022 compared to $1.1 million for the nine months ended September 30, 2021. The $1.3 million increase was due in part to interest expense of $0.6 million incurred on the $55.0 million revolving line of credit that was drawn down by the Company in November 2021 and repaid in full on March 31, 2022. The increase was also impacted by the term loan average interest rate increasing from 3.50% during the first nine months of 2021 to 5.42% during the first nine months of 2022. In February 2022, the Company entered into the first amendment to the 2020 Credit Agreement which, among other things, changed the reference interest rate from LIBOR to SOFR and increased the applicable margins. Interest capitalized on borrowings totaled $0.6 million and $0.8 million during the nine months ended September 30, 2022 and 2021, respectively. 38 Other Income (Expense), Net Other income totaled $1.0 million in the nine months ended September 30, 2022 compared to a negligible amount of other expense recorded during the nine months ended September 30, 2021. The increase in other income primarily resulted from the effective settlement of a preexisting legal matter between the Company and Intellibed upon the Company’s acquisition of Intellibed on August 31, 2022 at an estimated fair value gain of $1.4 million. Change in Fair Value – Warrant Liabilities The 1.9 million sponsor warrants outstanding at September 30, 2022 and 2021 had fair values of $0.1 million and $9.0 million, respectively. The decrease in fair value was primarily due to the Company’s Class A common stock price, one of the primary assumptions used to re-measure the warrant liability, declining from $21.02 at September 30, 2021, to $4.05 at September 30, 2022. During the nine months ended September 30, 2022 and 2021, we recognized gains of $4.2 million and $19.4 million, respectively, that resulted from decreases in the fair value of the warrants outstanding at the end of the respective periods. Income Tax (Expense) Benefit We had an income tax benefit of $6.6 million for the nine months ended September 30, 2022 compared to income tax expense of $1.0 million for the nine months ended September 30, 2021. The income tax benefit in the first nine months of 2022 was primarily the result of the Company having a net loss before income taxes of $26.4 million. Noncontrolling Interest The Company calculates net income or loss attributable to noncontrolling interests on a quarterly basis using their weighted average ownership percentage. Net loss attributed to noncontrolling interests was $0.2 million for the nine months ended September 30, 2022 compared to net income of $0.1 million for the nine months ended September 30, 2021. Liquidity and Capital Resources Our principal sources of funds are cash flows from operations and cash and cash equivalents on hand, supplemented with borrowings made pursuant to our credit facilities and proceeds received from offerings of our equity capital. Principal uses of funds consist of payments of principal and interest on our debt facilities, capital expenditures and working capital needs as well as other contractual obligations described below. Our working capital needs depend largely upon the timing of cash receipts from product sales, payments to vendors and others, changes in inventories, and operating lease payment obligations. Our unrestricted cash and working capital positions were $57.4 million and $86.2 million, respectively, as of September 30, 2022 compared to $91.6 million and $87.5 million, respectively, as of December 31, 2021. Cash used for capital expenditures decreased from $41.5 million in the first nine months of 2021 to $34.1 million during the first nine months of 2022. Our capital expenditures in the first nine months of 2022 primarily consisted of leasehold improvements and furniture and fixtures associated with the opening of new Purple retail showrooms. In the event our cash flow from operations or other sources of financing are less than anticipated, we believe we will be able to fund operating expenses and comply with debt covenants based on our ability to scale back operations, reduce marketing spend, use the liquidity we have available under our revolving line of credit and postpone or discontinue our growth strategies. Our 2020 Credit Agreement, as amended, includes various covenants and obligations that may make it difficult to obtain additional capital on terms that are favorable to us and to execute on our growth strategies. In addition, in order to continue satisfying the conditions of the debt agreement we may be required to scale back operations, reduce marketing spend, prepay debt and postpone or discontinue our growth strategies. We may also be forced to restructure our obligations to current creditors, pursue work-out options or seek additional funding sources including new debt or equity capital. Based on our current projections, we believe our cash on hand, amounts available under our revolving line of credit, and expected cash to be generated from our e-commerce, wholesale, and Purple retail store channels will be sufficient to meet our working capital requirements, comply with debt covenants and cover anticipated capital expenditures for the next 12 months and beyond. 39 Underwritten Offering In March 2022, the Company completed an underwritten public offering of 16.1 million shares of Class A common stock, which included the additional 2.1 million shares of the over-allotment option that the underwriters exercised in full. The aggregate net proceeds received by the Company from the offering, after deducting offering expenses of $0.3 million, totaled $92.9 million. Debt On September 3, 2020, Purple LLC entered into the 2020 Credit Agreement that provided for a $45.0 million term loan and a $55.0 million revolving line of credit. The term loan is being repaid in accordance with a five-year amortization schedule and may be prepaid in whole or in part at any time without premium or penalty, subject to reimbursement of certain costs. The revolving credit facility has a term of five years and carries the same interest provisions as the term debt. A commitment fee is due quarterly based on the applicable margin applied to the unused total revolving commitment. In November 2021, the Company executed a $55.0 million draw on its revolving line of credit, which represented the full amount available under the line. On March 31, 2022, the Company used a portion of the net proceeds from the offering to repay in full the $55.0 million of principal outstanding on the revolving line of credit. The Company’s operating and financial results for the year ended December 31, 2021 did not satisfy the financial and performance covenants required under the 2020 Credit Agreement. On February 28, 2022, prior to the covenant compliance certification date, the Company entered into the first amendment of the 2020 Credit Agreement to avoid a breach of these covenants and potential default. This amendment contained a covenant waiver period such that the net leverage ratio and fixed charge coverage ratio would not be tested for the fiscal quarters ended December 31, 2021, March 31, 2022 and June 30, 2022. Other modifications in the amendment included revised leverage ratio and fixed charge coverage definitions and thresholds, the addition of minimum liquidity requirements with mandatory prepayments of the revolving loan if cash exceeded $25.0 million, new weekly and monthly reporting requirements, limits on the amount of capital expenditures, the addition of a lease incurrence test for opening additional showrooms, and additional negative covenants during a covenant amendment period that extends into 2023 until certain conditions are met. In addition, the interest rate on any outstanding borrowings under the 2020 Credit Agreement was changed from LIBOR with a floor of 0.5% plus an applicable margin (historically at 3.0%) to an initial rate of SOFR with a floor of 0.5% plus 4.75%, for a total rate of 5.25% if the applicable liquidity threshold is met. If the Company does not meet this threshold, the interest rate would increase to SOFR with a floor of 0.5% plus 9.00%. Once the Company achieves a consolidated leverage ratio that is below 3.00 to 1.00, the interest rate will be based on SOFR with a floor of 0.5% plus a 3.00% to 3.75% margin depending on the consolidated leverage ratio. The interest rate on the term loan was 6.07% as of September 30, 2022. As of September 30, 2022, the Company was in compliance with all of the financial covenants related to the 2020 Credit Agreement, as amended. Pursuant to the first amendment of the 2020 Credit Agreement, the Company incurred fees and expenses of $0.9 million that were recorded as debt issuance costs in the condensed consolidated balance sheet and made a $2.5 million payment on the term loan to cover the four quarterly principal payments due in 2022. The Company accounted for this amendment as a modification of existing debt in accordance with ASC 470 – Debt . On March 23, 2022, the Company entered into a second amendment to the 2020 Credit Agreement. This amendment modified the 2020 Credit Agreement to allow CCM and its investment affiliates to acquire 35% or more of the combined voting power of all equity interests of the Company entitled to vote for the election of members of the Company’s board of directors without constituting an event of default. CCM is considered a related party of the Company in that Adam Gray, a member of our board of directors, serves as a managing partner of CCM. On May 13, 2022 and September 9, 2022, the Company entered into a third and fourth amendment, respectively, to the 2020 Credit Agreement. These amendments modified the permitted leases schedule to reflect a change in showroom locations and a new lease for an innovation building. The amendments did not meet the criteria for a modification of existing debt and the minimal expenses were recorded as a general and administrative expense in the condensed consolidated statement of operations. Pursuant to the second amendment of the 2020 Credit Agreement, the Company incurred fees and expenses of $0.4 million that were recorded as debt issuance costs in the condensed consolidated balance sheet. The Company accounted for this amendment as a modification of existing debt in accordance with ASC 470 – Debt . Tax Receivable Agreement We are required to make certain payments to InnoHold under a tax receivable agreement, which may have a material adverse effect on our liquidity and capital resources. We are currently unable to determine the total future amount of these payments due to the unpredictable nature of several factors, including the timing of future exchanges, the market price of shares of Class A common stock at the time of the exchanges, the extent to which such exchanges are taxable and the amount and timing of future taxable income sufficient to utilize tax attributes that give rise to the payments under the agreement. As of September 30, 2022 and December 31, 2021, the tax receivable agreement liability reflected in the Company’s consolidated balance sheet was $162.2 million and $168.1 million, respectively. This decrease was due to a $5.8 million payment that was made during the first quarter of 2022. Other Contractual Obligations In addition to the material contractual obligations discussed above, other material contractual obligations primarily include operating lease payments obligations. See Note 9 of the condensed consolidated financial statements for additional information. 40 Cash Flows for the Nine Months Ended September 30, 2022 Compared to the Nine Months Ended September 30, 2021 The following summarizes our cash flows for the nine months ended September 30, 2022 and 2021 as reported in our condensed consolidated statements of cash flows (in thousands): Nine Months Ended September 30, 2022 2021 Net cash provided by (used in) operating activities $ (30,474 ) $ 132 Net cash used in investing activities (30,411 ) (41,498 ) Net cash provided by financing activities 28,412 2,027 Net decrease in cash (32,473 ) (39,339 ) Cash, cash equivalents and restricted cash, beginning of the period 91,616 122,955 Cash, cash equivalents and restricted cash, end of the period $ 59,143 $ 83,616 Cash used in operating activities of $30.5 million for the nine months ended September 30, 2022 primarily resulted from a $19.8 million net loss combined with a $13.9 million decrease in operating cash flow related to net changes in operating assets and liabilities. These decreases related mostly to a $26.6 million decrease in accounts payable, offset in part by an $11.5 million decrease in inventories. The decline in accounts payable was mainly due to the balance at prior year-end being higher than normal because of payment timing coupled with the impact of larger advertising spend in the fourth quarter of 2021. The decrease in inventory was primarily due to management’s efforts to rebalance production and fulfillment operations during the first half of 2022. Cash used in investing activities reflected capital expenditures of $34.1 million during the nine months ended September 30, 2022 compared to $41.5 million for the nine months ended September 30, 2021. Capital expenditures during the first nine months of 2022 primarily consisted of investments in leasehold improvements and furniture and fixtures related to the opening of new Purple retail showrooms. Cash flows from investing activities also included cash acquired in the acquisition of Intellibed that consisted of $1.9 million of cash and cash equivalents and $1.7 million of restricted cash. Cash provided by financing activities was $28.4 million during the nine months ended September 30, 2022 compared to $2.0 million during the nine months ended September 30, 2021. Financing activities during the first nine months of 2022 included $92.9 million of net proceeds received from the underwritten stock offering, offset in part by a $55.0 million revolving line of credit payment, a $5.8 million payment on the tax receivable agreement, and $3.8 million in other debt related payments. Critical Accounting Policies We discuss our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2021 Annual Report on Form 10-K filed March 1, 2022. There were no significant changes in our critical accounting policies since the end of fiscal 2021. Available Information Our website address is www.purple.com. We make available free of charge on the Investor Relations portion of our website, investors.purple.com, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. We also use the Investor Relations portion of our website, investors.purple.com, as a channel of distribution of additional Company information that may be deemed material. Accordingly, investors should monitor this channel, in addition to following our press releases, SEC filings and public conference calls and webcasts. The contents of our website shall not be deemed to be incorporated herein by reference. 41