Purple Innovation, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Amounts below are in U.S. dollars; financial statement figures are in millions unless noted.
Business context and reporting period
Purple designs and manufactures mattresses, pillows, and cushions using its Hyper-Elastic Polymer technology, selling through direct-to-consumer online channels, wholesale partners, and third-party retailers. On February 2, 2018, the company completed a transaction structured as a reverse recapitalization. Purple Innovation, Inc. became Purple LLC’s sole managing member, but held approximately 18% of its economic interest; InnoHold retained approximately 82%. The company consolidates Purple LLC, with InnoHold’s interest presented as noncontrolling interest. Historical operating results are those of Purple LLC.
Financial performance and liquidity
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Net revenue | $61.0 | $30.1 |
| Gross profit / margin | $26.4 / 43.3% | $14.3 / 47.5% |
| Operating expenses | $29.3 | $16.3 |
| Operating loss | $(2.9) | $(2.0) |
| Net loss | $(3.6) | $(2.0) |
| Net loss attributable to Purple Innovation, Inc. | $(1.4), or $(0.17) per share | $(2.0), or $(0.24) per share |
| Cash from operating activities | $(15.6) | $2.7 |
| Cash used in investing activities | $(2.7) | $(2.6) |
| Cash from financing activities | $41.5 | $(0.3) |
Revenue increased 102%, primarily from higher mattress sales, increased marketing, and the launch of higher-priced mattress models. Gross margin fell 4.2 percentage points, with manufacturing and quality-control inefficiencies, inventory adjustments, and higher freight costs cited as causes. Marketing and sales expense rose to $22.0 million, but declined as a share of revenue to 36.2% from 45.8%. General and administrative expense rose to $6.8 million, mainly reflecting transaction costs and public-company infrastructure.
At March 31, cash was $26.8 million, versus $3.6 million at year-end 2017. Current assets were $61.8 million and current liabilities $43.5 million, yielding reported positive working capital of $18.3 million; year-end working capital was negative $17.4 million. Inventory rose to $26.6 million from revised year-end $13.3 million. Operating cash use reflected inventory build, higher operating costs, and payments to vendors, including catch-up payments on overdue balances. Capital expenditures were $2.6 million in the quarter.
Debt included $25.0 million principal under the Coliseum credit agreement, carried at $19.1 million net of issuance costs and discounts, with a fixed 12% rate and February 2023 maturity. The company repaid and closed its Wells Fargo line of credit in February. The Coliseum agreement includes financial and operating restrictions, including limits on capital expenditures and additional borrowing, and restricts distributions subject to exceptions.
Material changes, outlook, risks, and unusual items
- Growth and execution: Management expected revenue to increase in absolute dollars through the rest of 2018, supported by marketing and wholesale expansion. Mattress Firm test locations had expanded from 51 to 117, with a further 73 locations expected in Q3; management cautioned the ramp might not deliver expected benefits. A fourth Mattress Max machine was completed, but production capacity depended on equipment reaching planned operating levels.
- Margins and spending: Management expected gross margin to improve as manufacturing efficiency, automation, and fixed-cost leverage improved. It expected advertising as a share of revenue to rise from Q2 and remain higher through the rest of 2018, and expected ongoing public-company and growth-related G&A costs to increase. Planned 2018 capital expenditures were $10–$15 million. This is management commentary, not quantified earnings guidance.
- Liquidity and obligations: Management believed existing cash flow and available liquidity would cover anticipated needs for the next 12 months under current conditions, while warning that financing may not be available on acceptable terms. A mineral-oil purchase agreement requires expected spending of approximately $14.4 million over two years; no liability was recorded because purchases were expected in the ordinary course. The company also entered a 15-year utility service arrangement for its Tooele facility, with early termination charges and certain terms not yet finalized.
- Transaction and tax arrangements: Transaction financing included approximately $25.9 million of proceeds, while the Coliseum loan supplied $25.0 million principal. Under the Tax Receivable Agreement, the company may owe InnoHold 80% of certain realized or deemed tax savings; no liability was recorded because realization was not considered probable. The company recorded a full valuation allowance against net deferred tax assets.
- Accounting correction and controls: The company revised December 31, 2017 inventory and equity downward by $2.454 million for an inventory-count and reconciliation error, which it deemed immaterial to 2017. It planned to revise the 2017 income statement when next filed. Management reported material weaknesses in internal control and concluded disclosure controls were ineffective at March 31, 2018; remediation was underway.
- Legal and listing matters: A former consultant claims $44 million and a 4% equity interest based on alleged oral agreements; Purple denies the allegations and intends to contest the case. In separate litigation over allegedly misleading product-safety claims, the company reported favorable court rulings but said the ultimate outcome remained uncertain. Nasdaq had questioned whether the warrants met the initial-listing 400 round-lot-holder requirement; a May 10 hearing had occurred, with the panel decision pending as of the filing. The Class A shares were not affected by that warrant-listing issue.
- Other risks: Management cited possible production and delivery constraints, customer cancellations and returns, rising digital-advertising costs, wholesale execution and profitability, seasonality, competition, financing needs, and the possibility that growth or forecasts may not be sustained. Management expected no cash dividends in the foreseeable future.
Important facts for investors to verify
- Whether the fourth Mattress Max machine and delivery network can meet demand while reducing production defects, delays, returns, and freight costs.
- Whether revenue growth and the Mattress Firm rollout translate into improved gross margins and operating performance, given expected higher marketing spending.
- Cash use, inventory levels, capital spending, and compliance with the 12% Coliseum debt agreement’s covenants and restrictions.
- Progress and effectiveness of remediation for material weaknesses, including controls over inventory counts and financial reporting.
- Updates on the consultant lawsuit, the warrant-listing appeal, and the potential timing and amount of any Tax Receivable Agreement payments.