Purple Innovation, Inc. (NASDAQ:PRPL) Q3 2023 Earnings Call Transcript

Purple Innovation, Inc. (NASDAQ:PRPL) Q3 2023 Earnings Call Transcript November 9, 2023

Operator: Good afternoon, ladies and gentlemen. Welcome to Purple Innovation Third Quarter 2023 Earnings Conference Call. [Operator Instructions] It is now my pleasure to introduce your host, Cody McAlester of ICR. Please go ahead.

Cody McAlester: Thank you for joining Purple Innovation’s third quarter 2023 earnings call. A copy of our earnings press release is available on the Investor Relations section of Purple’s website at www.purple.com. I would like to remind you that certain statements we will make in this presentation are forward-looking statements. These forward-looking statements reflect Purple Innovation’s judgment and analysis only as of today, and actual results may differ materially from current expectations based on a number of factors affecting the company’s business. Accordingly, you should not place undue reliance on these forward-looking statements. For a more thorough discussion of the risks and uncertainties associated with the forward-looking statements to be made in this conference call and webcast, we refer you to the disclaimer regarding forward-looking statements included in our third quarter 2023 earnings release, which was furnished to the SEC today on Form 8-K as well as our filings with the SEC referenced in that disclaimer.

We do not undertake any obligation to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise. Today’s presentation will include reference to non-GAAP financial measures such as EBITDA, adjusted EBITDA, adjusted gross margin, adjusted net income and adjusted earnings per share. A reconciliation of these non-GAAP financial measures to the most comparable GAAP financial measures is available within the earnings release, which can be found on our website. With that, I’ll turn the call over to Rob DeMartini, Purple Innovation’s Chief Executive Officer.

Rob DeMartini: Thank you, Cody, and thank you, and good afternoon, everyone. I want to start today’s call by welcoming Todd Vogensen, Purple’s newly appointed Chief Financial Officer, who joins me this afternoon. We are thrilled to have Todd on the Purple team and will look to draw on his successful track record of delivering positive results with several large public retail organizations. Todd’s leadership from the CFO seat will be incredibly valuable to the future of Purple as we continue to execute our new vision for the company. I also want to thank Ben Nussbaum for his significant contributions during his tenure as CFO. Bennett joined in the summer of 2021 on a 6-month interim contract and ended up agreeing to stay an extra 1.5 years through December of this year to stabilize our direction and fortify Purple’s financial systems and processes.

Turning now to our recent results. Our third quarter revenue of $140 million was up 18.8% to last quarter, marking our second consecutive quarter of sequential improvement and our largest quarter-over-quarter gain we’ve achieved in 12 quarters. Year-over-year, our revenue was down slightly to last year at a time when the bedding industry is estimated to be down in the high single or low double-digit range, confirming what our wholesale customers have been telling us that Purple is beginning to take market share. While our improving top line performance is yet to translate into improved profitability, this has been due largely to temporarily elevated costs related to the transition to our new product and branding strategy. Therefore, as we get further out from this launch phase, we’re confident that the combination of growth, gross margin expansion and expense leverage will drive sustained positive adjusted EBITDA and positive free cash flow.

Speaking in more detail about the performance of our path to premium sleep strategy, our new premium Sleep Better Live Purple marketing campaign, which communicates how our proprietary GelFlex grid delivers deep, uninterrupted sleep is fueling greater affinity for Purple and new consumer interest in the brand. The elevated branding with improved messaging that launched in mid-May drove a 22% increase in search volume for Purple in the third quarter compared to the second quarter. This heightened interest in the brand validates our position as a truly differentiated competitor in the premium space and is indication that our new messaging is resonating with consumers even as the industry dynamics remain challenging. Equally important, the response to our new product portfolio continues to be positive since launching in the second quarter.

Our new Luxe mattress line has continued to become a larger part of the volume in our showrooms, helping drive average selling price and four-wall margins higher, and this trend is now emerging in many of our wholesale doors with sales of the new higher-tier offerings steadily improving. At the same time, demand for our Essentials line, which consists of our reimagined excessively priced products has driven quarter-over-quarter revenue growth in our e-commerce business compared with the first half of the year. We are encouraged by the positive revenue trends and we’re focused on driving near-term bottom line improvement across the business. Starting with our marketing approach, we see further opportunity to elevate the Purple brand and make it synonymous with per premium sleep.

While we’ve made progress with the premiumization of the brand since May, we believe further refinement of both our message and our advertising tactics is necessary to deliver the premium message in a way that drives more profitable and rapid acceleration in brand interest and customer conversion. Additionally, there are opportunities to improve sell-through with each of our distribution channels, irrespective of a positive inflection in industry demand. This includes more advanced training of our retail partner sales associates, so they’re well versed in educating consumers on the sleep benefits of our differentiated technology, driving more traffic into our showrooms and improving conversion on our website, particularly for higher-end beds.

As we fine-tune our strategies, we’re confident that the actions that drove our sequential increase in top line performance this quarter will further accelerate results in the months and quarters ahead. Looking at our Q3 results in more detail, starting with showrooms. Revenues increased 26% compared to Q2 and 10% compared with the prior year period. As I mentioned, we’re seeing growing penetration of our highest-tiered products in our showrooms where our knowledgeable staff can highlight the benefit of our Luxe line and customers can feel the true luxury experience that our Rejuvenate mattresses provide. With price points ranging from $5,500 to $7,500, this performance, combined with reduced discounting and improved attachment rates with our new base program has helped drive our average selling prices in the channel higher by approximately 12% compared to the first 5 months of ‘23 prior to the mid-May launch.

At the same time, we’re seeing good response to our new adjustable basis, thanks to our ability to directly deliver our sleep messaging and sell consumers on the total purple ecosystem. Momentum in this channel continues to build with September being the best month year-to-date, highlighted by 60% of our stores comping positive, which is encouraging given the industry softness. Turning now to e-commerce. The channel experienced a significant sequential improvement, with revenue up 15% compared to the second quarter. I’m pleased that we were able to build on Q2’s stabilized revenue and delivered the largest quarter-on-quarter improvement in the e-commerce channel since the pandemic fuel second quarter of 2022 – excuse me, 2020 more than 3 years ago.

Our new product and marketing strategies are positively impacting this channel even as our price points move higher and industry transactions shift more back towards brick-and-mortar. Unique visits to purple.com were up 54% versus the same period last year, and though ASPs decreased 4% over the same time period, driven by a mix shift to the Essentials collection. While several metrics are moving in the right direction, led by traffic, conversion is still lagging. As I said earlier, we continue to test how to best optimize the site in order to capitalize on the increased traffic. There is still work to be done on this front, but I’m confident that the steps we’re taking will produce better results in the near and long term. In the wholesale channel, we continued the rollout of our new product collection, bringing the number of converted wholesale doors to about 2,000 or approximately 60% of total doors at the end of Q3.

The wholesale channel revenue was up 20% compared to last quarter and up 3% compared to last year. Importantly, our average daily sales has been steadily improving since the launch began, underscoring the strong performance of the new product collection. These improving trends also demonstrate that the work we’ve done educating our partners on tangible benefits of Purple’s proprietary grid technology is translating into stronger consumer demand. This is especially true for our premium and Luxe lines. The sales performance of our higher-priced, higher-margin mattresses has resulted in several of our customers recently increasing the number of slots for Purple. More recently, we launched the new products into Mattress Firm, and we’ll have that completed – that change will be completed 100% by the end of this month.

Overall, we are encouraged with the improvements we’ve instituted in the business and the momentum we’ve built so far in 2023 against a tough market backdrop. As we look to the final quarter of the year, we remain focused on strong execution of our path to premium sleep strategy. Recent results indicated we’re on the right track and that consumers are responding positively to our new product introductions. However, there are still a few areas of our strategy where improvement is necessary and several significant industry-wide headwinds remain in the near term. With considered purchases for both mattresses and higher ticket discretionary items in general, remaining under pressure, the near-term operating environment looks to be more challenging than we’d anticipated.

Based on weaker industry trends and our results year-to-date, we’re moderating our outlook for the remainder of 2023. Todd will walk you through on our guidance in more detail shortly, but we are still projecting to achieve both sequential and year-over-year revenue growth in Q4. We are continuing to invest in marketing to support the launch and drive broader awareness and demand for Purple products with a year-over-year increase in ad spend in Q4. While this decision along with higher-than-anticipated product cost is deepening our adjusted EBITDA loss for the year, we believe it best positions the company to build on its current top line run rate, gain further market share and achieve positive adjusted EBITDA in the back half of ‘24. In an effort to ensure we’re driving profitable growth next year, we have several initiatives in place to enhance margins on top of the fixed cost leverage we’ll realize on higher sales.

To discuss these numbers in more detail, I’ll now turn it over to Todd.

Todd Vogensen: Thank you, Rob. I’m excited to be speaking with everyone today, and I look forward to meeting many of you in the weeks and months ahead. With Rob covering our top line performance in detail, I’ll focus my comments primarily on gross margin and operating expenses, and then I’ll discuss how we’re approaching the remainder of the year. For full details regarding our financial results, please refer to our earnings press release, which is available on the Investor Relations section of our website. Before I begin my comments, we have one administrative item that I wanted to highlight. Today, we filed a Form 12b-25 disclosing that we’re delaying the filing of our third quarter Form 10-Q until November 14. We identified an error in our accounting for the warranty terms specified in contracts with our wholesale customers, and we’re evaluating the disclosure impact of such errors on our prior periods.

The results from our prior periods that are included in our earnings release have been revised to reflect the correction of this error. And today, we’ll be referencing prior period amounts that have been adjusted to give effect for the corrections. In addition, we will be recording these liabilities as a reduction to revenue in each future period, which will have a non-cash impact of reducing revenue by approximately 175 to 225 basis points going forward. These revenue reductions will flow directly through the P&L as a reduction to EBITDA. But again, they are a non-cash item in the period during which they’re reported and will only turn into cash adjustments as warranties are claimed over our 10-year warranty life. Now turning to our operating results.

As Rob said, we are pleased to have demonstrated continued sequential top line growth, especially given the headwinds that the industry continues to face. In terms of gross margin, our reported gross margin for the third quarter was 33.8% compared with 41.3% a year ago. Included in this year’s gross margin are several items associated with the transition to our new products. Excluding these items, adjusted gross margin for the third quarter of 2023 was 37.1%, approximately flat with adjusted gross margin in the second quarter of this year. The transition-related items represent costs directly connected to the new product transition, including airfreight for certain new product inputs, direct labor cost increases associated with new product production and lost revenue on the sell-in and replacement of floor model mattresses at our wholesale partners.

The combination of these items equated to approximately 330 basis points of margin pressure, which we expect to abate as we move into 2024. In addition to the product transition costs, we incurred approximately 420 basis points of headwinds that are more structural in nature, including 130 basis points from a channel mix shift in revenue to wholesale and marketplace, which carry a lower average selling price than our traditional DTC channel sales, 40 basis points from the lapping of Intellibed royalty benefits last year prior to the acquisition of Intellibed and the remaining gross margin headwinds primarily relate to the lapping of manufacturing efficiencies from last year when we had a higher amount of inventory production. Please note that while we expect to offset these structural headwinds in the future, we will do so through a combination of manufacturing and sourcing efficiencies, the shift towards more premium mattresses, price adjustments and more targeted discounting.

Now for operating expenses. Operating expenses were $79.9 million or 57.1% of net revenue in the third quarter of 2023 compared to $58.1 million or 40.7% of net revenue in the prior year period. The increase in operating expenses compared with the prior year was primarily driven by $12.6 million increase in advertising expense to support our new product launch, enhance Purple’s premium brand position and educate consumers on the unique health benefits of our proprietary gel grid technology. In addition, we incurred $2 million in expenses associated with the growth in our showroom footprint compared to the year ago period. And finally, please note that we incurred a $6.9 million non-cash impairment of goodwill this quarter, which is included in our operating expenses.

As a result, adjusted net loss for the third quarter of 2023 was $19.4 million compared to adjusted net income of $2.5 million last year. Adjusted EBITDA was negative $16.3 million versus $11.8 million a year ago. And third quarter adjusted loss per share was $0.18 compared to adjusted earnings per share of $0.03 in the prior year. Now moving to our balance sheet. As of September 30, 2023, the company had cash and cash equivalents of $26.6 million compared with $41.8 million at December 31, 2022. The decrease was driven by cash used in operations of $55.8 million year-to-date, capital expenditures of $9.4 million, primarily related to additional manufacturing investments and showroom expansion, partially offset by cash provided of $57 million received from the public stock offering completed in February of 2023.

At September 30, we had no amounts outstanding on our ABL facility. Inventories at September 30 were $72.1 million compared with $73.2 million at December 31, 2022. Now let me turn my comments to our outlook for the remainder of the year. Given the current state of the mattress industry, along with our performance year-to-date, we’re moderating our outlook for the balance of 2023. We now expect full year net revenue in the range of $510 million to $520 million and adjusted EBITDA loss between $55 million and $65 million. While we narrowed our full year revenue range to $10 million from $30 million, we are maintaining our $10 million range for adjusted EBITDA due to the variability in transition costs related to the product launches, which are impacting our gross margins this year.

This updated outlook implies fourth quarter revenue in the range of $145 million to $155 million and an adjusted EBITDA loss of between $20 million and $10 million. We’re encouraged with the sequential momentum we’re seeing in the top line. However, our adjusted EBITDA has underperformed our expectations. As Rob said, we’re working on several initiatives to improve margins as we drive toward profitable growth in the back half of 2024. In addition to benefiting from the diversification of our procurement partners, which was implemented earlier in 2023, there are other actions underway that will enhance gross margins in the coming quarters. These include select price increases on certain mattress models, along with some of our ancillary products, including seat cushions and sheets, steadily increasing the mix of our higher margin, higher ASP premium and Luxe mattresses, lowering the floor model sell-in and reducing discounting, reducing reliance on air freight and several initiatives to improve our manufacturing efficiency.

On expenses, we are currently deploying additional cost optimization efforts to rightsize operating budgets for G&A and channel management. Additionally, with our new products now in the market and garnering new consumer interest, we anticipate being able to be more efficient with our advertising spend in 2024. With respect to showrooms, they continue to provide a great environment for us to merchandise the full Purple sleep experience. However, given current industry trends, we plan to moderate showroom expansion and currently are planning to add only a handful of new locations in 2024. We are confident that along with the fixed cost leverage that we will continue to realize and higher sales volumes, these actions will result in a sequentially improving bottom line going forward.

Now I’ll turn the call back over to Rob.

Rob DeMartini: Thank you, Todd. I want to reiterate that I have confidence in the progress we’re making and the direction we’re going. The path to premium sleep strategy is driving improved revenue trends that are so far continuing into Q4, and we’re committed to continuing to execute in a way that brings us to profitability in 2024. Additionally, I’m confident that we have the team in place that will get us there. I want to say thank you to our employees who believe and are dedicated to our success, and thank you to our customers, who see the potential that Purple brings to them and are growing with us. Operator, we’re now ready for questions.

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Q&A Session

Operator: [Operator Instructions] And your first question comes from the line of Brad Thomas from KeyBanc Capital Markets. Your line is open.

Brad Thomas: Hi, good afternoon. Thanks for taking my question. Was hoping first, Rob, we could talk maybe a little bit about the performance of the Purple stores. I think that’s one of the best probably indicators of how the new assortment is performing. So I was wondering if you could talk a little bit about how they are doing versus the rest of the business.

Rob DeMartini: Yes. Thank you, Brad. I mean we clearly still have work to do in those stores. And it’s hard to put your finger on how much of it is us and how much of it is the category. But the mix has gotten significantly richer since the launch. So we’re selling both premium and Luxe mattresses better than we were before. September was the strongest month we’ve had in the last year, 1.5 years in those stores. I said 60 in the script, it’s actually 50% of the stores comped positively in the quarter, and September was the strongest month of those 3 months in the quarter. In total, the comps for the quarter were down 4%, again, not a good number, but relative to what we’re hearing about the category’s overall performance.

We’re encouraged with the direction the showrooms are going. As Todd said, we are going to slow down a bit new showrooms to make sure we can dial in the volume better to make sure that we’re not spending ahead of what we should be and get those stores to those pro forma volumes that we’ve put in front of you before.

Brad Thomas: That’s very helpful, Rob. And obviously, it seems to be a very challenging environment here for all. If some of these headwinds continue into 2024, can you talk about some of the cost opportunities or what you may focus on to improve from an expense standpoint, again, if the environment stays tough?

Rob DeMartini: Yes. I put them in two buckets, Brad, and Todd build on if I miss something. But we’ve already identified – I mean this year, the supply chain that Arikana runs has really been focused on getting those new products out. And obviously, by our execution, they have one done a good job doing it, but to had to spend some money that we otherwise wouldn’t have wanted to on air freight and things like that. 2024 is going to be really about improving our purchasing capabilities, working with our partners, trying to drive wasted cost out of the system. And we’ve identified gross margin savings that are significant to the business. On top of that, Todd talked about some pricing that we think we can take modestly. And then in the G&A area, we’ve already made changes both in overall staff as well as the showroom opening engine. So we are planning to be successful but being prepared for the market to stay tough.

Brad Thomas: Appreciate it. Thanks so much, and good luck.

Rob DeMartini: Alright. Thank you, Brad.

Operator: Your next question comes from the line of Seth Basham from Wedbush Securities. Your line is open.

Seth Basham: Thanks a lot and good afternoon. Just a follow-up on Brad’s last question. If you can help us thinking about the outlook for 2024 from a cash flow standpoint and from a liquidity standpoint, I mean do you expect to be able to generate positive cash flow in ‘24? And if not, what steps will you take to shore up liquidity?

Todd Vogensen: Yes, as we plan out looking into 2024, we’ve taken a pretty conservative look at it, and we are confident and comfortable with our liquidity position. As we do look into ‘24, we haven’t given guidance specifically, but I think it is fair to look at the P&L and say, for gross margin, we’ve had two quarters in a row where our adjusted margin rate has been right around 37%. And as Rob mentioned, we have a number of opportunities to build on that and kind of continue that march towards the 40% range as we go into next year. And then on expenses, there are a number of levers that we can and in many cases, will pull to make sure that we’re being cautious on our spending. And so all of that will lead to profitability that should improve sequentially as we go across the course of the year and put us in a strong position.

Seth Basham: Alright. Thank you. And thinking about your guidance for 2023, the changes you made, the decremental margin on the revenue reduction is absolutely huge. And I was hoping that you could give us a little bit more color on why that is. Where is the most pressure coming from? What cost did you incur that you didn’t anticipate a few months ago?

Rob DeMartini: Well, I think in the two sections that Todd broke out, there is about 7.5 margin points in there. And some of those are directly tied to launch costs. We talked last quarter about selling practices. And then they were complicated by – we launched nine mattresses – in hindsight, without enough lead time and ended up putting a lot of pressure on the supply chain, we’ve been air freighting components to make sure we could complete them. So we do expect to have all of that done by the end of this quarter and should get back to that starting gross margin – adjusted gross margin that Todd has talked about in the 37s and then from there, start building with legitimately identified savings programs either through sourcing methods or more efficient processes in the factories.

Seth Basham: Okay, that’s helpful. And my last follow-up question is just thinking about the ranges, adjusted EBITDA fourth quarter. You mentioned a wide range and it’s partly because of the variability and transition costs. Are you referring still to some of these things that air freight? Are you referring to the margins on selling and clearance of floor models. Can you give us a little bit more color there?

Rob DeMartini: Yes. Seth, it’s a little bit of both. We still have that last third in Q4. It’s mostly shipped. It will be completely done by the end of this month and installed. But because of the strength of demand in that channel, we are having to airfreight longer than we would have liked. We will be done with it by the time December is over. But based on the current volume expectation, we do expect to incur some of these gross margin compressing costs through the rest of the next 2 months of the quarter.

Seth Basham: Got it. Thank you.

Rob DeMartini: Thank you, Seth.

Operator: Your next question comes from the line of Jeremy Hamblin from Craig-Hallum Capital Group. Your line is open.

Jeremy Hamblin: Thanks. First, I wanted to start by asking about the implied gross margin that you’re expecting in that guidance for Q4 kind of both, like what do you expect those kind of transition start-up costs to be as a drag? And then what would be just the reported gross margin as well?

Todd Vogensen: Yes. So we gave top line and bottom line. I think it’s fair to say, as you look at the components and do the modeling, we would expect a reported number to be in the range of what we saw in Q3 with operating expenses coming down as we’re continuing to dial in some of the G&A costs and also being more efficient on our advertising spend. So it will – I think to think about gross margin as being roughly along the same lines as what you’ve seen across the course of Q2 and Q3 is a fair direction.

Jeremy Hamblin: Okay. And then to build on that, the point you noted about advertising, Rob, you indicated that I think search trends are up 22% since May, since you launched the new product, but it appears, obviously, that you are not really getting the conversion rates that you would have expected. Can you discuss why you think that might be happening? Is this a miss on the marketing message, or I mean, it’s not just the backdrop of a tough macro?