Purple Innovation, Inc. — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. Unaudited results; dollar amounts below are in millions except per-share data.
Business context
Purple designs and manufactures premium mattresses, pillows, cushions, bases, sheets, and related comfort products. It sells through direct-to-consumer (DTC) online channels, wholesale partners, third-party online retailers, and company showrooms. Results reflect a pronounced shift toward DTC sales during the COVID-19 pandemic.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Revenue | $165.1 | $103.0 | $287.5 | $186.7 |
| Gross profit | $81.6 | $42.8 | $134.8 | $76.9 |
| Gross margin | 49.4% | 41.5% | 46.9% | 41.2% |
| Operating income (loss) | $32.0 | $(2.4) | $39.5 | $2.4 |
| Net income (loss) | $(5.8) | $(7.3) | $14.2 | $(8.1) |
| Net income (loss) attributable to Purple Innovation, Inc. | $(2.0) | $(1.3) | $6.9 | $(1.5) |
| Reported basic EPS | $(0.07) | $(0.16) | $0.26 | $(0.17) |
- Q2 revenue rose 60.3%; DTC revenue increased 128% to $145.2 million, while wholesale revenue fell to $19.9 million from $39.3 million.
- For the six months, revenue increased 54.0%. Management attributed growth primarily to the channel shift toward higher-margin DTC sales.
- Q2 operating margin was 19.4%, versus an operating loss margin of 2.3% a year earlier. Marketing and sales expense was 23.9% of revenue, down from 34.9%; management cited advertising efficiencies and temporarily reduced spending.
- Despite positive operating income, Q2 reported a net loss, principally reflecting a $39.0 million non-cash warrant fair-value loss and $32.8 million of Tax Receivable Agreement (TRA) expense, partly offset by a $35.4 million income-tax benefit. The six-month period included $25.3 million of warrant remeasurement loss, $32.9 million of TRA expense, and a $35.7 million income-tax benefit.
Cash flow, balance sheet, debt, and liquidity
- Cash was $95.4 million at June 30, 2020, up from $33.5 million at December 31, 2019; working capital was $50.4 million, compared with $27.3 million at year-end.
- Six-month operating cash flow was $72.4 million, versus $2.1 million in 2019; investing cash flow was $(10.4) million, primarily reflecting $8.0 million of property and equipment purchases; financing cash flow was approximately $0.0 million. Cash increased by $61.9 million.
- Related-party debt had $41.6 million of principal outstanding, including capitalized interest; total debt including capital leases was reported as $42.1 million. The loan bears 12% interest. A March 2020 amendment permitted capitalization of all interest due for the first two 2020 quarters; the company reported compliance with covenants at June 30.
- Current assets were $161.6 million and current liabilities $111.2 million. The balance sheet reported $100.6 million of deferred income taxes, $47.0 million of warrant liabilities, and $78.1 million of TRA liability, including current and long-term portions.
- Management said cash, operating cash generation, and anticipated recovery in wholesale and showroom activity were expected to cover working capital and capital expenditure needs for the next 12 months, subject to assumptions about the pandemic and demand.
Material changes and unusual items
- In May 2020, a change-of-control-related warrant provision was triggered when the Pearces’ combined beneficial ownership fell below 50%. The exercise price on 2.6 million incremental loan warrants was reduced to zero. Their fair value rose to $47.0 million at quarter-end, creating substantial non-cash earnings volatility and potential shareholder dilution.
- The company released part of its deferred-tax valuation allowance after concluding deferred tax assets were more likely than not to be realized. It recorded a $35.7 million year-to-date tax benefit; the filing says an additional $2.7 million of remaining valuation allowance was expected to be released in subsequent quarters.
- Exchanges of Class B paired securities increased tax basis and contributed to TRA obligations. The company recorded $78.7 million of TRA liability by June 30 and estimated a potential $81.5 million obligation from transactions to date. A filing scenario estimated aggregate TRA liability of approximately $197.6 million if all 17.5 million then-outstanding paired securities were exchanged at an assumed share price of $26.16; this is an illustrative estimate, not a stated forecast.
- In July 2020, Purple signed a 128-month lease for approximately 520,000 square feet in Georgia for a planned manufacturing, distribution, and office facility expected to be operational in 2021. Initial rent is approximately $147,675 per month after the free-rent period, plus operating expenses.
Outlook, commentary, and risks
- Management said DTC demand remained strong and wholesale demand improved as stores reopened, but cautioned that the increase in DTC demand might not continue. The company ramped production and reported that its supply chain had not been significantly affected at the filing date.
- COVID-19 could again disrupt retail, wholesale demand, employees, manufacturing, logistics, suppliers, and liquidity. Showroom closures had resumed in some locations; one California showroom closed again in July.
- Other key risks include production capacity and execution of the Georgia facility, competition and margin pressure, reliance on specialized equipment and suppliers, substantial debt and restrictive covenants, possible need for additional capital, dilution from warrants and future financing, and uncertain TRA cash payments.
- The filing provides no specific revenue or earnings guidance. Its 12-month liquidity outlook is conditional on the duration and severity of COVID-19 and the continuation of cash generation and channel recovery.
- Disclosure controls and procedures were deemed ineffective at June 30 because of a material weakness in controls over the tax provision process, involving the valuation-allowance release and TRA accounting. Management reported that remediation steps had begun.
- Legal matters included an adverse claim resolved in Purple’s favor in June, with the appeal period expired; a Canadian intellectual-property action remained ongoing. A TCPA class action was voluntarily dismissed in July 2020.
Important facts for investors to verify
- Whether DTC growth and wholesale recovery persisted after Q2, and the resulting effects on gross margins, advertising costs, and returns.
- The warrant terms, zero-dollar exercise price, remeasurement assumptions, potential dilution, and related-party lender arrangements.
- The timing, assumptions, and cash-payment implications of the TRA, including subsequent exchanges and tax-asset realization.
- Progress, costs, and capacity impact of the Georgia facility, alongside the company’s ability to meet demand without supply or labor constraints.
- Remediation and testing of the tax-control material weakness, and any subsequent changes to disclosure-control effectiveness.
- Debt covenant compliance, interest capitalization, capital expenditure needs, and liquidity under renewed pandemic or demand stress.