Purple Innovation, Inc. 10-Q

ITEM 1A. RISK FACTORS Except as described below, there have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K filed with the SEC on March 22, 2023. The disclosure of risks identified below does not imply that the risk has not already materialized. We may need additional capital to execute our business plan and fund operations and may not be able to obtain such capital on acceptable terms or at all. We expect to incur significant ongoing operating expenses in connection with the execution of our business strategies. We also expect to incur significant capital expenses as we seek to expand our business. Our efforts to obtain needed capital resources and sources of liquidity may not be sufficient to support our business operations and future growth strategies. If we are unable to satisfy our liquidity and capital resource requirements, we may have to scale back, postpone or discontinue our growth strategies, which could result in slower growth or no growth, and we may lose key suppliers, be unable to timely satisfy customer orders, and be unable to retain our employees. In addition, we may be forced to restructure our obligations to creditors, pursue work-out options or other protective measures. Our ability to access funds under the ABL Agreement (the “ABL Loans”) is subject to certain conditions, availability reserves, minimum availability requirements, borrowing base calculations and restrictive covenants, and there is no guarantee that we will be able to satisfy such conditions and restrictive covenants. In addition, because the amount available under the ABL Agreement is based on our borrowing base calculations and minimum availability requirements at the time of any draw, the amount available to us will change from time to time. In October 2023, the ABL Lenders implemented an availability reserve of $5.0 million, which reduces the amount available under our borrowing base. Certain events of default occurred under each of the 2023 Credit Agreements due to (i) the Company’s failure to (a) provide certain financial reporting and related materials on a timely basis and (b) complete certain post-closing deliverables as required under the ABL Agreement and (ii) the Company drawing on the loan under the ABL Agreement while the above events of default were in existence. In addition, the ABL Amendment and Term Loan Amendment increased our reporting obligations under the 2023 Credit Agreements and if we are not able to maintain compliance with such additional requirements we may experience future events of default, which could limit our ability to access the ABL Loans and adversely affect our financial position and operations. To the extent that waivers and amendments are necessary under either of the 2023 Credit Agreements, there can be no guarantee that we will be able to obtain waivers or amendments from the applicable Lenders if, in the future, we are unable to comply with the covenants and other terms of the 2023 Credit Agreements. Our failure to satisfy the required conditions under the 2023 Credit Agreements or maintain compliance with the financial and performance covenants under the 2023 Credit Agreements could result in future defaults, which would adversely affect our financial condition and results of operations, including, potentially, as a result of acceleration of our outstanding debt. We would also be restricted from drawing on the ABL Loans while an event of default is continuing. In addition, any default under the 2023 Credit Agreements would adversely affect our ability to obtain alternative financing, including additional indebtedness from subordinated lenders. Further, our ability to obtain additional capital on acceptable terms or at all is subject to a variety of uncertainties. Adequate alternative financing may not be available or, if available, may only be available on unfavorable terms or subject to covenants that we may not be able to satisfy. 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. 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. For example, on February 13, 2023, we completed an offering of our Class A Shares that increased the number of outstanding Class A Shares from 91,380,323 to 104,780,323. Newly issued securities may include preferences or superior voting rights or may be combined with the issuance of warrants or other derivative securities, which each may have additional dilutive effects. Furthermore, we may incur substantial costs in pursuing future capital and financing, including investment banking fees, legal fees, accounting fees, printing and distribution expenses and other costs. We may also be required to recognize non-cash expenses in connection with certain securities we may issue, such as convertible notes and warrants, which will adversely impact our financial condition. If we cannot raise additional funds on favorable terms or at all, we may not be able to carry out all or parts of our long-term growth strategy, maintain our growth and competitiveness or continue in business. 50 Our level of indebtedness and related covenants could limit our operational and financial flexibility and adversely affect our business if we breach such covenants and default on such indebtedness. Under the 2023 Credit Agreements, we are subject to a number of affirmative and negative covenants, including covenants regarding dispositions of property, investments, forming or acquiring subsidiaries, business combinations or acquisitions, incurrence of additional indebtedness, and transactions with affiliates, among other customary covenants, in each case, subject to certain exceptions. In particular, we are (i) restricted from incurring additional debt up to certain amounts, subject to limited exceptions, as set forth in each 2023 Credit Agreement, and (ii) required to maintain minimum revolving availability under the ABL Agreement, and, if revolving availability falls beneath a specified amount, a specified Consolidated Fixed Charge Coverage Ratio (as such term is defined in the ABL Agreement). The Loan Parties are also restricted from paying dividends or making other distributions or payments on their capital stock, subject to limited exceptions. These restrictions may prevent us from taking actions that we believe would be in the best interests of the business and may make it difficult for us to successfully execute our business strategy or effectively compete with companies that are not similarly restricted. If we determine that we need to take any action that is restricted under any 2023 Credit Agreement, we will need to first obtain a waiver from the applicable Agent and Lenders. Obtaining such waivers, if needed, may impose additional costs on us or we may be unable to obtain such waivers. Our ability to comply with these restrictive covenants in future periods will largely depend on our ability to successfully implement our overall business strategy. The breach of any of these covenants or restrictions could result in a default, which could potentially result in the acceleration of our outstanding debt. In the event of an acceleration of such debt, we could be forced to apply all available cash flows to repay such debt, which could also force us into bankruptcy or liquidation. Certain events of default occurred under each of the 2023 Credit Agreements due to (i) the Company’s failure to (a) provide certain financial reporting and related materials on a timely basis and (b) complete certain post-closing deliverables as required under the ABL Agreement and (ii) the Company drawing on the loan under the ABL Agreement while the above events of default were in existence. In addition, the ABL Amendment and Term Loan Amendment increased our reporting obligations under the 2023 Credit Agreements. If we are not able to maintain compliance with our covenants under the 2023 Credit Agreements, we may need to seek amendments or waivers to the Term Loan Agreement and ABL Agreement in the future, and may also need to obtain alternative sources of liquidity. Such alternative sources of liquidity, including subordinated date, may not be available on terms favorable to us or at all. To the extent that waivers and amendments under any 2023 Credit Agreement are necessary, there can be no guarantee that we will be able to obtain waivers or amendments from the applicable Lenders if, in the future, we are unable to comply with the covenants and other terms of any 2023 Credit Agreement. Our failure to satisfy the required conditions under the 2023 Credit Agreements, any amendments thereof, or maintain compliance with the financial and performance covenants under the 2023 Credit Agreements could result in future defaults, which would adversely affect our financial condition and results of operations, including, potentially, as a result of acceleration of our outstanding debt. In addition, any default under would adversely affect our ability to obtain alternative financing, and significantly limit our ability to execute our business strategies. We are required to make certain prepayments to our term and revolving loans and thereafter will not be able to benefit from that portion of the term loan and may not be able to draw upon our revolving line of credit. Under the Term Loan Agreement, as amended, we have mandatory prepayment obligations (i) upon the disposition of assets by any loan party or subsidiary resulting in net cash proceeds in excess of $1.0 million in any calendar year, and (ii) upon the receipt of cash in excess of $1.0 million by any loan party or subsidiary not in the ordinary course of business other than permitted under the Term Loan Agreement. Under the ABL Agreement, as amended, we have mandatory prepayment obligations (i) in the event of certain dispositions which result in the realization of net cash proceeds in excess of $1.0 million in any calendar year, (ii) upon the sale or issuance by any loan party or any of its subsidiaries of any of its equity interests other than those permitted under the ABL Agreement, (iii) upon the receipt of net cash proceeds by any loan party or subsidiary from the incurrence or issuance of debt other than permitted by the ABL Agreement, (iv) upon the receipt of cash in excess of $1.0 million by any loan party or subsidiary not in the ordinary course of business other than permitted under the ABL Agreement, and (v) and for over advances if at any time the total revolving credit outstanding exceeds the borrowing base as defined under the ABL Agreement. In addition, the ABL Agreement imposes limitations on other forms of indebtedness, liens, investments, and other operational actions. Moreover, under the ABL Agreement our borrowing is limited to a borrowing base that is periodically adjusted, and if for any reason the amount we have borrowed exceeds that borrowing base we may be required to prepay amounts equal to such excess. If for any reason we are required to prepay any amount owed under the Term Loan Agreement or ABL Agreement, we may not have sufficient liquidity available to make such prepayments and we would be in default under our obligations. In addition, any prepayment would require us to divert liquidity and capital resources away from the operating expenses of our business, which could adversely affect our relationships with suppliers and vendors and our ability to execute on our growth strategies, and prevent us from taking actions in our best interest or even continue in business. 51 We have identified a material weakness in our internal control over financial reporting and i f we fail to maintain an effective system of internal controls, we may not be able to report our financial results accurately, may make a material misstatement in our financial statements, may experience a financial loss, or may face litigation. Any inability to report and file our financial results accurately and timely could harm our business and adversely affect the value of our business. As a public company, we are required to establish and maintain internal controls over financial reporting and disclosure controls and procedures and to comply with other requirements of the Sarbanes-Oxley Act and the rules promulgated by the SEC. Even when such controls are implemented, management, including our Chief Executive Officer and Chief Financial Officer, cannot guarantee that our internal controls and disclosure controls and procedures will prevent all possible errors or loss. Because of the inherent limitations in all control systems, no system of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company or perpetrated against us will be prevented or have been detected. These inherent limitations include the possibility that judgments in decision-making can be faulty and subject to simple error or mistake. Furthermore, controls can be circumvented by individual acts of some persons, by collusion of two or more persons, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, measures of control may become inadequate because of changes in conditions, new fraudulent schemes, or the deterioration of compliance with policies or procedures. Because of inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and/or may not be detected. The accuracy of our financial reporting depends on the effectiveness of our internal control over financial reporting. Internal control over financial reporting can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements and may not prevent or detect misstatements. Failure to maintain effective internal control over financial reporting, or lapses in disclosure controls and procedures, could undermine the ability to provide accurate disclosure (including with respect to financial information) on a timely basis, which could cause investors to lose confidence in our disclosures (including with respect to financial information), require significant resources to remediate the lapse or deficiency, and expose us to legal or regulatory proceedings. In the course of preparing our financial statements as of September 30, 2023, we identified certain errors in our accounting for warranty reserves, relating specifically to our warranty reserves under wholesale contracts. As part of such process, we identified a material weakness in our internal controls over financial reporting. Our internal controls over financial reporting did not result in the proper accounting of warranty reserves relating to our long-term warranty obligations, which due to its cumulative impact on our consolidated financial statements as of September 30, 2023, we determined to be a material weakness. We continue to evaluate, design and work through the process of implementing controls and procedures under a remediation plan designed to address this material weakness, but there can be no assurance that we will be able to remediate this material weakness in a timely manner or at all. If our remediation measures are insufficient to address the material weaknesses, or if additional material weaknesses or significant deficiencies in our internal control are discovered or occur in the future, our financial statements may contain material misstatements and we could be required to restate our financial results, which could lead to substantial additional costs for accounting and legal fees and stockholder litigation. We cannot guarantee that we will not experience additional material weaknesses in our internal controls in the future. If additional material weaknesses or significant deficiencies in our internal control are discovered or occur in the future, our financial statements may contain material misstatements and we could be required to restate our financial results, which could lead to substantial additional costs for accounting and legal fees and stockholder litigation. Any failure to maintain such internal control could adversely impact our ability to report our financial position and results from operations on a timely and accurate basis. If our financial statements are not accurate, investors may not have a complete understanding of our operations. Likewise, if our financial statements are not filed on a timely basis, we could be subject to sanctions or investigations by the stock exchange on which our common stock is listed, the SEC or other regulatory authorities. In either case, this could result in a material adverse effect on our business. Failure to timely file will cause us to be ineligible to utilize short form registration statements on Form S-3, which may impair our ability to obtain capital in a timely fashion to execute our business strategies or issue shares to effect an acquisition. Ineffective internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our stock. As a result of our 2022 acquisition of Intellibed, we are in the process of integrating its systems and processes into ours, including bringing such systems and processes into our existing framework of internal controls. That process requires us to devote resources that might otherwise be used to grow the business. If we do not successfully integrate the Intellibed processes into our internal controls, there may be material misstatements that are not detected in a timely manner. 52 We may face litigation and other risks as a result of current and previous material weaknesses in our internal control over financial reporting. We have determined that a material weakness exists related to the accounting of our warranty reserves, which resulted in an understatement of our warranty reserves in prior periods. In addition, we have had previous material weaknesses that have been remediated, some of which resulted in restatements of our previously issued audited financial statements. As a result of such restatements, material weakness, and other matters that may in the future arise, we face potential for litigation or other disputes which may include, among others, claims invoking the federal and state securities laws, contractual claims or other claims arising from the restatement and material weaknesses in our internal control over financial reporting and the preparation of our financial statements. As of the date of this filing, we have no knowledge of any such litigation or dispute. However, we can provide no assurance that such litigation or dispute will not arise in the future. Any such litigation or dispute, whether successful or not, could have a material adverse effect on our business, results of operations and financial condition. Anti-takeover provisions in our Second Amended and Restated Certificate of Incorporation, our Third Amended and Restated Bylaws as well as provisions of Delaware law, contain anti-takeover provisions, any of which could delay or discourage a merger, tender offer, or assumption of control of the Company not approved by our Board of Directors that some stockholders may consider favorable. Provisions of Delaware law, our Second Amended and Restated Certificate of Incorporation, and our Third Amended and Restated Bylaws could hamper a third party’s acquisition of us or discourage a third party from attempting to acquire control of us. You may not have the opportunity to participate in these transactions. These provisions could also limit the price that investors might be willing to pay in the future for equity interests in the Company. These provisions include: ● the right of our Board to elect a director to fill a vacancy created by the expansion of our Board or the resignation, death or removal of a director in certain circumstances, which prevents stockholders from being able to fill vacancies on our Board; ● a prohibition on stockholder action by written consent, which forces stockholder action to be taken at an annual or special meeting of our stockholders; ● a prohibition on stockholders calling a special meeting and the requirement that a meeting of stockholders may only be called by members of our Board, which may delay the ability of our stockholders to force consideration of a proposal or to take action, including the removal of directors; ● the requirement that changes or amendments to certain provisions of our certificate of incorporation or bylaws must be approved by holders of at least two-thirds of our common stock; and ● advance notice procedures that stockholders must comply with in order to nominate candidates to our Board or to propose matters to be acted upon at a meeting of stockholders, which may discourage or deter a potential acquirer from conducting a solicitation of proxies to elect the acquirer’s own slate of directors or otherwise attempting to obtain control of us. In December 2022, we amended our bylaws to add requirements relating to stockholder nominations of directors, including a requirement that stockholder nominees complete a written questionnaire and that stockholder nominees make themselves available for interviews by our Board upon request. In addition, we are subject to the provisions of Section 203 of the Delaware General Corporation Law, which may prohibit certain transactions with stockholders owning 15% or more of our outstanding voting stock or require us to obtain stockholder approval prior to engaging in such transactions. Coliseum collectively holds approximately 44.7% of our outstanding voting stock. Any delay or prevention of a change in control transaction or changes in our Board could adversely affect our ability to execute transactions that are needed to carry out our operations and growth strategies and cause the market price of our common stock to decline. We may not be able to identify, complete or successfully integrate acquisitions, and any such acquisitions may not achieve the anticipated financial benefits, all of which could have a negative impact on our growth, financial condition, and results of operations. We may seek to acquire businesses in the future as we encounter acquisition prospects that would complement our current product offerings, increase the size and geographic scope of our operations, or otherwise offer strategic, growth and operating efficiency opportunities. We cannot assure investors that we will be able to identify and acquire acceptable acquisition candidates on terms favorable to us in the future, or that any acquisitions will achieve the anticipated strategic or financial benefits. Even if we do identify opportunities to acquire businesses, we may not be able to consummate such acquisitions due to a number of factors, including lacking access to sufficient capital to fund such acquisitions. 53 In addition, acquisitions involve numerous risks and uncertainties and may be of businesses in which we lack operational or market experience. The financing for any of these acquisitions could dilute the interests of our stockholders, result in an increase in our indebtedness or both. Future acquisitions could entail numerous risks, including: ● difficulties in integrating acquired technologies, operations or products; ● the difficulties of imposing financial and operating controls on the acquired companies and their management and the potential costs of doing so; ● the potential loss of key employees, customers, suppliers or distributors from acquired businesses and disruption to our direct selling channel; ● diversion of management’s attention from our core business; ● the failure to achieve the strategic objectives of these acquisitions; ● increased fixed costs; ● the failure of the acquired businesses to achieve the results we have projected in either the near or long term; ● the assumption of unexpected liabilities, including compliance and litigation risks; ● adverse effects on existing business relationships with our suppliers, sales force or consumers; ● Failure to gain consumer or wholesale market acceptance of acquired brands and products; and ● risks associated with entering markets or industries in which we have limited or no prior experience, including limited expertise in running the business, developing the technology, and selling and servicing the products. Our failure to successfully complete the integration of any acquired business, or a failure to effectively identify and pursue such acquisitions, could have a material adverse effect on our business, financial condition and operating results. Changes in accounting standards and subjective assumptions, estimates and judgments by management related to complex accounting matters, including matters relating to our Tax Receivable Agreement, could significantly affect our financial results. Generally accepted accounting principles and related accounting pronouncements, implementation guidelines and interpretations with regard to a wide range of matters that are relevant to our business are complex and involve many subjective assumptions, estimates and judgments by our management, including but not limited to estimates that affect our revenue recognition, accounts receivable and allowance for doubtful accounts, valuation of inventories, cost of revenues, sales returns, warranty liabilities, the recognition and measurement of loss contingencies, warrant liabilities, estimates of current and deferred income taxes, deferred income tax valuation allowances and amounts associated with our Tax Receivable Agreement with our founders dated February 22, 2018 (the “Tax Receivable Agreement”). Changes in these rules or their interpretation or changes in underlying assumptions, estimates or judgments by our management could significantly change our reported or expected financial performance, and could have a material adverse effect on our business and results of operations. For example, in the third quarter of 2023, management determined that certain assumptions made relating to the valuation of our fixed assets were no longer accurate. As a result, we were required to record an impairment charge relating to our fixed assets. Our business and our reputation could be adversely affected by the failure to protect sensitive employee, customer and consumer data, or to comply with evolving regulations relating to our obligation to protect such data. In the ordinary course of our business, we collect and store certain personal information from individuals, such as our customers and suppliers, and we process customer payment card and check information for purchases via our website. In addition, we may share with third-parties personal information we have collected. Cyber-attacks designed to gain access to sensitive information by breaching security systems of large organizations leading to unauthorized release of confidential information have occurred at a number of major U.S. companies despite widespread recognition of the cyber-attack threat and improved data protection methods. Computer hackers may attempt to penetrate our computer system or the systems of third-parties with which we have shared personal information and, if successful, misappropriate personal information, payment card or check information or confidential Company business information. In addition, a Company employee, contractor or other third party with whom we do business may attempt to circumvent our security measures in order to obtain such information and may purposefully or inadvertently cause a breach involving such information. For example, though it did not involve access to or release of personal information, we recently experienced an unauthorized intrusion into one of our vendor’s systems using a former contractor’s credentials that resulted in access to email addresses and an unauthorized email being sent under a valid Purple email address. Breaches involving any personal information could be more likely to the extent we have any material weakness in internal control over financial reporting related to information technology general controls in the areas of user access and segregation of duties related to certain IT systems that support the Company’s financial reporting processes. 54 We and third parties with which we have shared personal information have been subject to attempts to breach the security of networks, IT infrastructure, and controls through cyber-attack, malware, computer viruses, social engineering attacks, ransomware attacks, and other means of unauthorized access. For example, in 2022, we experienced a spear-phishing attack that resulted in the unauthorized change to a significant vendor’s bank account to which we made payments that were lost in part until the scheme was discovered. We expect that this attack will result in costs to us of up to $250,000. We anticipate that we may, in the future, continue to be subject to these and similar cyber threats. A breach of systems resulting in the unauthorized release of sensitive data could also adversely affect our reputation and lead to financial losses from remedial actions or potential liability, possibly including punitive damages, and could also materially increase the costs we already incur to protect against these risks. In addition, cyber-attacks, such as ransomware attacks, if successful, could interfere with our ability to access and use systems and records that are necessary to operate our business. Such attacks could materially adversely affect our reputation, relationships with customers, and operations and could require us to expend significant resources to resolve such issues. We continue to balance the additional risk with the cost to protect us against a breach. Additionally, while losses arising from a breach may be covered in part by insurance that we carry, such coverage may not be adequate for liabilities or losses actually incurred. We may be subject to data privacy and data breach laws in the states in which we do business, and as we expand into other countries, we may be subject to additional data privacy laws and regulations. In many states, state data privacy laws (such as the California Consumer Privacy Act), including application and interpretation, are rapidly evolving. The rapidly evolving nature of state and federal privacy laws, including potential inconsistencies between such laws and uncertainty as to their application, adds additional compliance costs and increases our risk of non-compliance. While we attempt to comply with such laws, we may not be in compliance at all times in all respects. Failure to comply with such laws may subject us to fines, administrative actions, and reputational harm. Nasdaq may delist our securities from its exchange, which could harm our business and limit our stockholders ’ liquidity. Our common stock is currently listed on the Nasdaq Global Select Market, which has qualitative and quantitative listing criteria. However, we cannot assure that our Class A common stock will continue to be listed on Nasdaq in the future. In order to continue listing our Class A common stock on Nasdaq, we must maintain certain financial, distribution and stock price levels. Generally, we must maintain a minimum amount in stockholders’ equity, a minimum number of holders of our Class A common stock, and a minimum bid price for our Class A common stock. If we are unable to comply with the continued listing requirements, our Class A common stock may be subject to delisting. If Nasdaq delists our Class A common stock from trading on its exchange and we are not able to list our securities on another national securities exchange, we expect our securities could be quoted on an over-the-counter market. If this were to occur, we could face significant material adverse consequences, including: ● a limited availability of market quotations for our securities; ● reduced liquidity for our securities; ● a determination that our Class A common stock is a “penny stock” which will require brokers trading in our Class A common stock to adhere to more stringent rules and possibly result in a reduced level of trading activity in the secondary trading market for our securities; ● a limited amount of news and analyst coverage; and ● a decreased ability to issue additional securities or obtain additional financing in the future. The National Securities Markets Improvement Act of 1996, which is a federal statute, prevents or preempts the states from regulating the sale of certain securities, which are referred to as “covered securities.” If our Class A common stock continues to be listed on Nasdaq, our Class A common stock will be a covered security. Although the states are preempted from regulating the sale of our securities, the federal statute does allow the states to investigate companies if there is a suspicion of fraud, and, if there is a finding of fraudulent activity, then the states can regulate or bar the sale of covered securities in a particular case.