Purple Innovation, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018; filed November 14, 2018. Amounts below are in millions of dollars unless otherwise noted. Purple designs and sells mattresses, pillows, cushions and other comfort products through direct-to-consumer, wholesale and third-party online channels.
The February 2018 transaction was accounted for as a reverse recapitalization. Purple Inc. controls and consolidates Purple LLC, although it holds only about 18% of its economic interest; InnoHold holds about 82%, reflected as noncontrolling interest. Accordingly, consolidated results and losses attributable to Purple Inc. differ materially.
Key financial results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net revenue | $70.8 | $56.0 | $207.3 | $133.8 |
| Gross profit | $28.1 | $24.1 | $85.8 | $59.1 |
| Gross margin | 39.7% | 43.0% | 41.4% | 44.2% |
| Operating loss | $(3.4) | $(5.4) | $(11.7) | $(4.3) |
| Consolidated net loss | $(4.4) | $(5.4) | $(14.2) | $(4.3) |
| Net loss attributable to Purple Inc. | $(0.8) | $(5.4) | $(3.3) | $(4.3) |
| Loss per share attributable to Purple Inc. | $(0.09) | $(0.65) | $(0.40) | $(0.51) |
Q3 revenue rose 26%; nine-month revenue rose 55%. Management attributed growth mainly to mattress sales, new higher-priced models, more efficient marketing and wholesale expansion. Direct-to-consumer revenue increased 10% in Q3 and 41% year to date; wholesale revenue increased 528% and 634%, respectively, from the year-earlier periods.
Gross margin declined in both comparisons, reflecting higher product and freight costs, manufacturing inefficiencies during a warehouse-management-system transition, additional scrap identified by quality controls, and a greater wholesale sales mix. New mattress models partly offset the pressure. Q3 marketing expense fell 2% and declined as a share of revenue; nine-month marketing expense increased 44% in dollars but also fell as a share of revenue. General and administrative expense rose substantially, including costs of transaction completion, public-company operations, staffing and systems.
Cash, liquidity and debt
- Cash was $7.7 at September 30, 2018, versus $3.6 at December 31, 2017. Working capital was $4.3, compared with negative working capital of $18.3 at year-end 2017.
- Nine-month operating cash flow was a use of $27.4, versus a source of $8.8 in 2017. Investing cash use was $10.1, including $9.9 of property and equipment purchases. Financing provided $41.5, principally transaction proceeds and Coliseum borrowing.
- Inventory increased to $28.7 from $13.3 at year-end, including a substantial increase in finished goods. Management cited expanded products, demand, stocking for third-party delivery and production ramp-up against forecasts later reduced.
- Coliseum debt had $26.2 principal outstanding, a 12% fixed interest rate and February 2023 maturity; its balance-sheet carrying value, net of unamortized costs and discounts, was $20.7. Nine-month interest expense was $2.7, including $1.2 of interest paid in kind. The former Wells Fargo line was repaid and closed in February.
- Management expected 2018 capital expenditures of $10–$13. It said operating cash flow and other available liquidity should fund anticipated needs for the next 12 months, while noting that additional financing may be needed and is not assured.
Changes, outlook and significant matters
- Management expected retail-store penetration to increase in Q4 2018, and said G&A costs, excluding transaction costs and other one-time charges, would remain consistent with Q3 through year-end. It anticipated a slight quarterly increase in interest expense. The filing provides no specific revenue or earnings guidance.
- On November 12, 2018, the company completed a workforce reduction of more than 10% as a cost-reduction measure. Management said reduced operations or marketing and postponed growth initiatives could be options if cash generation fell short, but could slow or halt growth.
- The company corrected prior-period errors that management deemed immaterial to previously issued financial statements. Corrections included $1.7 of prepaid-inventory and cost-of-revenue errors over periods from 2017 through June 2018, a $1.3 inventory and cost-of-revenue correction for Q2 2018, and $0.2 of revenue and liability corrections for the first half of 2018. The 2017 year-end inventory balance was also reduced by $2.5. Management said the errors did not affect operating cash flow.
- Disclosure controls were deemed ineffective at September 30 because of material weaknesses involving supplier-deposit tracking, inventory valuation, account reconciliation and period cut-off. Remediation was underway; management cautioned it could take an extended period.
- Mattress Firm filed for Chapter 11 on October 5. Purple reported a $3.5 unsecured claim, which the debtors had paid by the filing date. The bankruptcy nevertheless creates uncertainty for the wholesale relationship and future distribution. Purple had entered a Master Retailer Agreement with Mattress Firm in September.
- Other risks include elevated product returns, delivery and manufacturing inefficiencies, intense competition, potential financing needs and a $14.4 minimum mineral-oil purchase commitment over two years. A former consultant’s lawsuit seeks $44 million and an alleged 4% equity interest; Purple denies the alleged agreements and intends to contest the case. The company also described ongoing litigation concerning allegedly misleading competitor-related claims.
- Purple’s warrants were delisted from Nasdaq effective September 28, 2018, and trade over the counter; its Class A shares remained Nasdaq-listed.
Most important facts for investors to verify
- Whether sales growth, particularly wholesale growth, can continue without further material erosion in gross margin or profitability.
- Inventory quality and sell-through, returns, delivery performance, and progress resolving manufacturing and warehouse-system inefficiencies.
- Cash use, working-capital requirements and access to additional financing, including the cost and restrictions of the 12% Coliseum facility.
- Whether internal-control remediation prevents further errors and whether future filings require additional revisions.
- Effects of Mattress Firm’s bankruptcy on the retailer relationship and wholesale strategy, notwithstanding payment of the reported claim.
- Potential outcomes and financial effects of the former consultant litigation, other contingencies and the Tax Receivable Agreement with InnoHold.