Purple Innovation, Inc. (PRPL) Q4 2019 Earnings Report, Transcript and Summary

Greetings, ladies and gentlemen. Welcome to Purple Innovation Fourth Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] It is now my pleasure to introduce your host Brendon Frey of ICR. Please go ahead.

Thank you for joining Purple Innovation's Fourth Quarter 2019 Earnings Call. A copy of today's 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 expectation 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 fourth quarter 2019 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 references to non-GAAP financial measures, such as adjusted operating income EBITDA and adjusted EBITDA. 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 Joe Megibow.

Thank you, and good afternoon, everyone. We are joining you from our new headquarters in Lehi, Utah. With me on the call today is John Legg, our Chief Operating Officer; and Craig Phillips, our Chief Financial Officer. Following our prepared remarks, we'll be happy to take your questions. Fiscal year 2019 was a tremendous year for our company on many levels. We successfully executed our core strategies, fueling strong momentum in the Purple brand, robust top line growth and a significant improvement in profitability. We made important infrastructure investments that expanded production and drove increased efficiencies and we strengthened our organization with a number of key hires. A few of the many key highlights from the past year include: Increasing net revenue 50% to $428 million, more than doubling our wholesale doors, adding over 800 to our distribution network; launching our company-operated showroom strategy, expanding gross margin by 470 basis points, improving operating income by $33.1 million; and bringing our fifth Max machine -- manufacturing machine online and building out numbers six and seven ahead of launching them in early 2020; finally strengthening our balance sheet with a year-end cash balance of over $33 million. We ended a successful year with a strong fourth quarter providing us with great momentum into 2020. Looking at our recent performance in more detail, Q4 revenue increased 58% to $124 million, thanks to our increased wholesale presence combined with meaningful improvements to our DTC capabilities, as well as expanded awareness of our brand and differentiated product offering. By channel, starting with wholesale, in 2019, we added approximately 800 new doors to our wholesale footprint including over 100 in the fourth quarter. As we have stated in prior quarters, we believe that an omni-channel approach to retailing is essential to our success, and that includes providing a convenient way for customers to feel for themselves how different the Purple Grid is and our innovative comfort technology is from the rest of the market. With over 1,700 wholesale doors today and an average of more than three beds on the floor per door, we have established a strong physical presence across the U.S. through our relationships with leading national retailers such as Mattress Firm, Macy's, Bloomingdale's, and Bed Bath & Beyond as well as leading regional retailers such as Furniture Row, HOM, Steinhafels, Mathis Brothers, and Raymour & Flanigan that allow us to reach a significant percentage of our target market. On top of our expansion, we've continued to experience solid sell-through for our products in our existing doors. Now to direct-to-consumer, fourth quarter sales increased 29% year-over-year, a sharp acceleration from the 10% increase this business achieved in the third quarter. Throughout the year, we've implemented a number of initiatives to reignite growth in this channel. These included testing more heavily into targeted promotions to drive both traffic and conversion, which has proven to be both revenue and margin accretive as well as introducing bundles and improving our ability to cross-sell products on the website. Our recent results underscore the initial success of these actions. For example, over the holiday season, our DTC sales exceeded expectations with Black Friday and Cyber Monday being our highest and second highest days respectively in the company's history. An exciting development from the past year and an important component of our DTC plans was the launch of our company-owned showroom strategy. The aim of our company showrooms is to provide consumers, primarily in major metropolitan locations physical access to engage with our brand in a setting that showcases the premium and technical benefits of the full Purple assortment. We ended 2019 with five primarily West Coast locations in addition to our factory outlet in Salt Lake City. And there are currently -- we are currently evaluating additional sites including on the East Coast. While our showroom rollout is still in its early stages, sales trends have been accelerating each month and we look forward to growing contributions from this channel in 2020. Our strong overall performance this past year wouldn't have been possible without the substantial improvements to our manufacturing and fulfillment capabilities. To review our progress in more detail and provide insight into our plans for 2020, I'm going to turn the call over to John.

Thanks Joe, and it's a pleasure to be addressing everyone again. I'm very pleased with the progress our team made in 2019 in improving product quality, operational efficiency, and timely fulfillment helping to support the company's significant increase in revenue and gross margin compared with 2018. We achieved record production numbers in the fourth quarter and for the full year. Importantly, we dramatically increased output without significantly increasing labor, thanks to efficiencies in our production line through improved processes and increased automation. This has allowed us to better control and reduce cost per unit and further improve yields both on a year-over-year and sequential basis. Our record production was also driven by the addition of our fifth proprietary Mattress Max machine that went online in July. In preparation for another strong year of growth in 2020, we are in the final stages of building out our 6th and 7th Max machines and remain on schedule to bring these online in stages over the next couple of months. We are also close to finalizing the location for a new production facility in the eastern half of the United States that will eventually house Mattress Max eight and beyond as we work to stay ahead of the growing demand for our product portfolio. 2019 was also highlighted by meaningful cost savings realized through better sourcing tactics. These included dual sourcing, high-volume purchasing of our direct materials, and continuing to renegotiate master service agreements with key vendors. In 2020, we are focused on continuing with this strategic direction and expanding out to include Eastern U.S. operations and leveraging our increased volume opportunities. After working through fulfillment challenges in 2018, we made great strides on this critical front throughout 2019 driven by several internal initiatives as well as the benefits from our new 3PL partnership which has helped with accuracy, timeliness, and the cost of deliveries. Furthermore, we successfully launched a new warehouse management system in late September which contributed to the nearly 40% improvement in our delivery performance for the year. I'm incredibly proud of the work we've done over the past 12 months, evolving Purple into a world-class manufacturing organization. Our execution continues to provide significant benefit to the company and improve our overall supply chain position, and I'm confident that we are well positioned to support the company's near and long-term growth objectives. I look forward to updating you on our continued progress on future calls. And I'll turn it back over to Joe.

Thanks John. Looking ahead, we are committed to further strengthening our growth platforms and capabilities with continued focus on four key areas: Product innovation, omni-channel retailing, organizational effectiveness and brand development. Let me provide an update on each of these. Starting with product innovation, I'm thrilled to reiterate that J.D. Power named Purple as the highest ranking mattress in their new bed-in-a-box segment of the J.D. Power 2019 Mattress Satisfaction Report. Not to rest on our laurels, we continue to have many technologies and products in the pipeline that we are excited about starting with the new Harmony Pillow which launched in the fourth quarter that we believe is our best pillow yet in both comfort innovation and mass appeal. We tested more than 50 iterative prototypes over the past year and not only found the best pillow through this process, but have developed and applied for yet another completely new cushioning patent and found several manufacturing innovations that extend well beyond this product. Innovation is alive and well within Purple. And our customers agree, as sales have both far exceeded our expectations and better-yet are driving follow-on mattress sales. With mattresses, we implemented a re-assortment strategy during the third quarter that simplifies and better articulates the benefits of our current models, upgraded our original mattress with some of the benefits from the premium mattresses and are continuing to work on new mattress models coming over the next year ranging from improvements driven from our years of listening to customer feedback to new inventions that we are very excited about. Beyond mattresses, we are leaning hard over the next year into our existing non-mattress categories such as seat cushions, as well as some all new categories that we will launch this year in 2020. For omni-channel retailing, we will continue our efforts to service the customer whenever, wherever and however they want including continuing to aggressively expand our retail partner doors, significant improvements to our website and opening additional company-owned showrooms. With respect to wholesale on top of growing same door sales, our current focus is on both deepening our relationship with our national players, while building relationships with strong regional players that will allow us to expand our physical reach in areas of the country not serviced by our existing partners. We continue to find opportunities with strong regional retailers such as our recently launched partnership with Raymour & Flanigan and are currently in talks with several other retailers about new distribution opportunities beginning this year. We have found a great symbiotic relationship between DTC and wholesale with each channel supporting the other. As such, we will continue to invest in the development of our online and showroom capabilities. Our work on rebuilding purple.com is progressing and we anticipate launching the new website platform and design later this year. We have already made some significant improvements to the existing site, including improvements to our financing modules, cross-sell and upsell modules, the addition of bundles, gift guides and have launched gift cards. At the same time, we are selectively expanding our company-owned showrooms at a modest pace in 2020. With respect to organizational effectiveness, we filled several key roles in 2019 including our; COO, John Legg, whom you just heard from; our CFO, Craig Phillips; our Chief Retail Officer, Trace White; and quite a few critical VP level positions significantly strengthening our manufacturing, finance, brand, retail and e-commerce leadership. With new teams built out, the focus is adding additional resources and implementing best-in-class processes in order to continue improving execution across the board. And finally for both brand and DTC, we continue to collaborate with our several new agency relationships to better align our brand positioning and creative with the unique differentiated and premium benefits of our products, especially the Purple Grid. Our strong fourth quarter and full year performance underscores the progress we are making executing our strategic initiatives, which has provided the business with great momentum as 2020 gets underway. With a strong balance sheet, we are well positioned to invest in our brand, channels, and manufacturing, while also pursuing new growth opportunities. I'm confident that, we have the right people and strategies in place to build on our recent accomplishments and drive long-term profitable growth and sustained value creation for our shareholders. I also want to address, the current concerns regarding COVID-19. We are continuing to monitor all potential areas of impact and remain in close contact with our suppliers and partners. Fortunately, the vast majority of our sourcing remains domestic and we have found multiple domestic alternatives for the components we do import. We continue to invest in the safety of our employees and have strengthened our operations given the current concerns. As to sales impact, we have seen research indicating there may be benefits to stay-at-home DTC businesses. So all in, we have not yet seen any impact and are hopeful any future impact will be minimal. At this point Craig will now review the financials and our guidance in more detail.

Thanks, Joe. As Joe outlined, there's a lot to celebrate from our 2019 performance, including a strong finish to the year. For the three months ended December 31, 2019 net revenue was $124.3 million, up 58.3% compared to $78.5 million in the prior year period. The revenue increase was primarily due to strength in the wholesale channel with more doors and stronger sell-through than last year and strong growth in the DTC channel enabled by our website improvements and the company outlet and showrooms opened during the second half of 2019. Gross profit dollars were $59.2 million during the fourth quarter of 2019 compared to $26.8 million during the same period in 2018. Gross margin at 47.7% versus 34.2% in the fourth quarter of 2018. The significant year-over-year increase in gross margin was attributable to efficiencies in operations and logistics, along with benefits from product mix, partially offset by changes in channel mix. Wholesale channel revenue, which carries lower gross margins than our direct-to-consumer channel comprised approximately 36% of net revenue for the quarter compared with approximately 25% in the same quarter last year and 42% in the third quarter of 2019. Operating expenses were $56.5 million in the fourth quarter of 2019 versus $32.0 million in the prior year period. The increase in operating expenses was mainly driven by incremental marketing and advertising, including approximately $4 million of discretionary spend that shifted to the fourth quarter from the third quarter, as well as resources and infrastructure investments to drive sales growth. Marketing and selling expenses as a percentage of net revenue increased 560 basis points to 38.6% from 33% in the fourth quarter of 2018 as we invested in marketing programs to drive Q4 demand as well as promotions in late December to fuel sales early in the New Year. During the fourth quarter, we reported operating income of $2.8 million compared to an operating loss of $5.2 million in the fourth quarter of 2018. After adjusting for primarily legal fees, intangible asset adjustment, equity incentive compensation, interim CFO costs and severance and executive search cost, adjusted operating income was $3.9 million compared to an adjusted operating loss of $4.3 million in the fourth quarter of 2018. During the fourth quarter, we recorded expense of approximately $13.4 million from a change in the fair value of incremental loan warrants issued in conjunction with the amended and restated credit agreement we announced in February 2019. Inclusive of this non-cash expense, net loss for the quarter was $12.7 million compared to a net loss of $5.4 million in the year ago period. EBITDA for the quarter was negative $9.3 million, compared to negative EBITDA of $4.5 million in the fourth quarter of 2018. Adjusted EBITDA, which excludes the same non-recurring costs I just mentioned, plus warrant liability was positive $5.8 million versus negative adjusted EBITDA of $3.7 million in the same quarter last year. For the 12 months ended December 31, 2019, net revenue was $428.4 million, up 49.9% compared to $285.8 million in the prior year period. The revenue increase was primarily due to an increase in wholesale revenue driven by an increase of over 800 stores as compared to the same period last year, as well as an increase in DTC revenue of approximately $19 million and additional revenue from our retail outlet and showrooms opened in the second half of the year. Gross profit dollars in 2019 increased 67.8% to $189 million compared to $112.6 million in 2018. For the year, gross margin improved 470 basis points to 44.1% from 39.4%, driven by efficiencies in operations and logistics and higher margins due to product mix, partially offset by increased sales with wholesale pricing. Operating expenses were $172.8 million in 2019 versus $129.5 million in the prior year. As a percent of net revenue, operating expenses improved to 40.3% compared with 45.3% in 2018, driven by improved efficiencies and marketing initiatives, partially offset by an increase in non-cash stock-based compensation expense related to the conversion of Class B shares held by current employees. For 2019, marketing and sales expense as a percent of net revenue improved to 33.1% compared to 36.3% last year. For the year, we reported operating income of $16.2 million, an improvement of $33.1 million compared to an operating loss of $16.9 million in 2018. After adjusting for primarily legal fees, equity incentive compensation, interim CFO costs, and severance and executive search costs, adjusted operating income was $29.1 million compared to an adjusted operating loss of $12.9 million in 2018. 2019 included a $6.3 million non-cash expense associated with the loss on extinguishment of debt, a $16.8 million non-cash loss associated with the change in fair value of warrant liabilities, and a $10.1 million noncash stock compensation expense. Inclusive of these non-cash expenses, net loss for the year was $12.4 million compared to a net loss of $19.6 million in 2018. EBITDA for 2019 was negative $3 million compared to negative EBITDA of $14.7 million in 2018. Adjusted EBITDA which excludes non-recurring costs and the non-cash expenses I just mentioned was positive $33.4 million versus negative adjusted EBITDA of $10.7 million last year. Moving to our balance sheet, as of December 31, 2019, the company had cash and cash equivalents of $33.5 million, up from $12.2 million at December 31 2018. Our cash position at the end of 2019 compared with the end of 2018 was primarily driven by the positive EBITDA results and an increase in payables and accruals net of an increase in receivables and inventory. Net inventories totaled $47.6 million at December 31, 2019 compared with $22.9 million at December 31, 2018. The increase in inventory reflects the strong topline growth we experienced in 2019 particularly in our wholesale channel and the building of inventory ahead of our recent President's Day sale. Turning to our guidance, for 2020, we are currently forecasting full year revenue to be between $550 million and $575 million representing growth of 29% to 34% over 2019. This guidance considers DTC growth, additional company-owned showrooms, and an estimated 900 more partner doors resulting in faster wholesale growth in DTC in 2020. With respect to profitability we are forecasting adjusted EBITDA in the range of $44 million to $49 million compared to $33.4 million in 2019. This guidance reflects the pressure on gross margins from channel mix in the first half of the year as wholesale sales are estimated to increase as a percentage of overall sales until our investments in brand, DTC, call center, and additional showrooms enable our owned retail channel sales growth to accelerate. Our adjusted EBITDA guidance also includes approximately $3 million of incremental spending and costs associated with the new East Coast manufacturing facility we are investing in this year to support growth in 2021 and beyond. The gross margin headwinds from channel mix and the carrying cost of the new facility will be partially offset by the operational improvements and higher product margins from new offerings being introduced in 2020. Marketing and selling expenses as a percentage of revenue are expected to decrease in 2020 as a result of the increased proportion of wholesale sales in 2020 and improved marketing spend efficiencies. G&A costs as a percent of revenue are expected to remain relatively consistent with 2019 as we continue to tightly manage our administrative and headcount costs. I'll now turn it back over to Joe for his closing comments.

Thanks Craig. I want to reiterate what Craig stated regarding our 2020 outlook. We believe our intrinsic ongoing business is continuing to strengthen. We are choosing to invest $3 million of EBITDA into a facility that will allow us to double our capacity for 2021 and beyond and we expect to exit 2020 with meaningful gross margin improvements as our mix between owned retail and wholesale gets back to more of a 60/40 split. Now, from a position of strength, this is an investment year in core manufacturing and other infrastructure investments to support sustained growth and help drive the company towards our long-term adjusted EBITDA margin targets of 12% to 15%. This time a year ago, we had a lot of hard work ahead of us, but I was confident that with relentless focus on the fundamentals along with the resourcefulness and fortitude I've seen in our team we could achieve a remarkable amount. With our more than $40 million increase in EBITDA over 2018, I'm even more confident with what our team of talented and dedicated people are capable of heading into 2020. To that point, I'm very pleased with how Q1 is coming in, we have a lot to celebrate and I'd like to extend a heartfelt thanks to all of our employees for all of their hard work and success. With that, operator we are ready to take questions.

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question has come from the line of Brian Nagel of Oppenheimer. Please proceed with your questions.

Hi, good afternoon. Thanks for taking my questions. The first question, I wanted to dig a little further into just the marketing and sales growth and really the strategic thinking behind it. So clearly as you discussed in your prepared comments and we saw in the results, the growth in that line item accelerated here in the fourth quarter. As we look at that growth was that more -- how should we think about that as a driver of fourth quarter sales something more strategic in nature that really should help you drive -- continue to drive the top line into the future?

Sure. Hi, Brian, thanks for joining us here. You're talking about the expansion in marketing expense?

That's right.

Yes. So -- I mean we -- I mean, the most important thing is we continue to align our marketing expense with expected sales. We -- our plan is for efficiencies to continue to improve. So we're not buying top-line by any means. Really what's happening is as a number of our initiatives continue to expand throughout the year, the DTC improvements that you've already seen are revitalized. We didn't talk much about it. We're leaning heavily into our call center and driving accretive business through human beings that are in support of the website. We've got our showrooms we continue to expand. So I mean a variety of the opportunities we have in terms of growing our business, marketing comes alongside that. So I really think that's the bulk of it. It's just aligned with how we're seeing the year play out. I don't know Craig if you want to add anything in?

No, just for specifically our fourth quarter, I mean we anticipated that. We budgeted that would be higher than third quarter, and we had atypically deferred some into the fourth quarter.

Sorry, you were talking 2019 or into next year expansion? Yes, sorry for 2019, yes. It's -- yes that was just as planned. I mean really it's been aligned with the full year for 2019. We had some good guys in Q3 that we had mentioned that really deferred into Q4. But I think Q4, we felt was particularly strong. Again, some biggest dates we've had online back into very solid -- back in 29% growth in DTC. And what's been amazing is our ability to lean in, in not only acquiring traffic but with the promotional cadence we've had and leaning people into our more premium products. It's not only been top line accretive, but EBITDA accretive. So, overall it was as planned and we feel it really worked well.

And we made some decisions to invest in some marketing cost late in the fourth quarter that we saw get some benefit in early January.

Got it. That's really helpful. But the second follow-up question I had just the recent announcements with the partner -- of Raymour & Flanigan and clearly a leading player here in the Northeast. How do you think about that relationship as it relates to the relationship we have? Is this -- and I guess what I'm really asking is the incrementality of the sales will happen at Raymour & Flanigan versus potentially a shift from other retailers you're already dealing with.

So we -- I mean so far as best as we've been able to prove out there is still significantly more demand out there than our capacity to produce. That has been the narrative and the reality we've seen that we've been a capacity constrained business and that's why we are investing so much into nearly doubling our capacity this year. So, certainly I mean there's a very large population in the Northeast. A part of our strategy has been to find regional players strong regional players. And it's not just specific to the Northeast. Raymour just happens to be an example one in the Northeast. They've been good partners so far. We have strong partners primarily with Mattress Firm also in the Northeast. As of right now, we believe they're -- I mean we're -- overall we're -- if you look domestically, we're maybe call it 2.5% market share. We're still a relatively small player in the industry and we believe there's still significant opportunity for expansion and are nowhere near a point that we're cannibalizing from any one channel to each other or from any one retailer to another.

Thank you very much. Congrats on a good quarter. Good luck.

Thank you.

Thank you.

Our next questions come from the line of Brad Thomas of KeyBanc Capital Markets. Please proceed with your question.

Hi. Good afternoon. Congratulations on a great year.

Thank you.

Thank you.

Wanted to ask about the wholesale opportunity as well and maybe try and put it into context in a world where there's increasingly the potential that the consumer maybe takes a pause here. I think if I heard you guys correct, you said you thought that there was an opportunity to add 900 doors this year. Can you talk a little bit more about what that pipeline looks like and how much maybe you could expand that pipeline if for example sales per retail partner in the DTC side hit some choppiness here?

Yes. Again, obviously, these are all options for us to take. Right now we -- per the prior comments, we are still feeling more demand than we've been able to meet. We have many more partners. I mean, honestly, we're at a point right now that when we speak with other retail channel partners, it's not where it started years ago which is, hey, we'll throw it in 10 stores and see how it goes. If they want to work with us, they typically want to go fleet wide. So it's really just making sure we've got the capacity to support a major regional player as we look at that. Again, right now we have some existing retailers like Mattress Firm that there's still plenty of opportunity for expansion, and we're making sure that we are leveraging our existing players first, but we see lots of opportunity. If -- I mean, the beauty is if any one retailer, two retailers seen some softness, we do have opportunity to extend elsewhere. But mostly since -- again, since we're pretty vertically integrated, there are many levers we could pull here to manage our cost to the demand we see and including who knows, but there may be more demand for DTC in general depending on how things play out. And we're working on ways to -- and it's frankly, I'm glad we're doing all the investment we're doing on involving our DTC capabilities. We're working on making sure that we can meet those customers' needs in a variety of ways depending on how this plays out.

Very helpful. Thank you, Joe. And Craig, if I could follow-up on the some of the expenses and investments that you make here this year. I just wanted to make sure I heard this right, as we think about maybe the income statement, is there a way to think about what size investment you all are making this year to grow your manufacturing platform? And how should we think about that playing out by quarter from a timing perspective?

Yes. So, there's several pieces to that. As we mentioned Max 6 will come on here very soon with Max 7 right after it in the second quarter. We would likely open a facility on the East Coast sometime mid-year and start building Max 8 and 9. So it's going to be spread throughout the year. But from a CapEx standpoint an investment standpoint, we'll be opening our retail showrooms throughout the year. And then we are going to continue to make improvements in the existing facilities both in Grantsville and in Alpine. So it's going to be spread probably throughout the year with the big pieces coming -- actually when these large machines are put in place and opening that facility.

Yes. And Joe here. I mean Max 6; I was just told this morning that we will likely get our first test shot out of it within the next 24 hours. So there's a bit of time to tune and test it before it's into full scale production, but it is imminent and Max 7 will be right behind. But consider with the lead times on these Max machines, our new manufacturing facility on the East Coast. We'll be -- we're very far down the path looking at a number of locations, but we need to get into them relatively quickly in order to get the build-out. And even on that John Legg's on the phone, but we're probably -- on Max 8, 9 have spent close to 20% already on the longest lead time components, which we've already received. They're sitting here in Utah, but ready to be shipped out to our East Coast facility once it's available. So we're already well down the path and really it means, this is a continuous full year investment and we're well down that path.

And quite honestly, it's going to go both ways as well. So while we will have some of the margin pressure as we open the new facility before we're able to start producing beds, there's other investments like the retail showrooms and some of the equipment to the existing machines that we'll be adding in Grantsville that will be margin positive fairly quickly.

Great. Great. And then just one more clarification here around the coronavirus headwinds. As you all look at your supply chain and your sourcing, are there any components that could end up being bottlenecks at all? I don't think much, but anything that might hinder you from a component standpoint?

Yes. So the vast majority of our revenue is mattress. And we manufacture ourselves here domestically and most of the core raw materials, including the coil and foam is all sourced domestically. We do have some components like covers that right now are coming out of China. John Legg and his team has been in constant contact with those suppliers and we keep a pretty good inventory lead on those just given the lead times to get stuff across the ocean anyway. So we've got pretty good inventory supply as we sit today on those components. That said, they have been working on finding multiple onshore suppliers for nearly every single component we have as well as accessories we sell on top of that. So as of right now, we don't see any critical bottlenecks of any kind. There's some risk that some domestic suppliers may have a little bit of margin pressure but from a resiliency standpoint we think we're fine.

Very helpful. Thank you so much.

Our next question is coming from the line of Bobby Griffin of Raymond James. Please proceed with your question.

Good afternoon, everybody. I appreciate you taking my questions and congrats on a good quarter and a good year.

Thanks, Bobby.

Yes. I guess the first question I want to make sure I understood correctly. The 900 doors that are forecasted for 2020. Those are doors that have already been announced, right? Wholesale partnerships that have already been announced?

No. No, this is net new we're expecting?

Net new you're expecting. Okay. So -- and then I guess -- go ahead I'm sorry.

Partners. Sorry, it's not all new retail brands. Some of that is expansion within existing brands. But no we are expecting some significant growth in wholesale doors.

Okay yes. And then I guess the second part of that was just the product seems to continue to be doing very successful. Would you have the capacity if that number needs -- if you had demand to take that higher? Or would like door growth over 900 have to wait until Mattress Max machine seven, eight, nine were up and fully running?

Again six and seven will be up imminently. We said six would be up by the end of Q1 and seven early Q2. We're clearly on that path right now. With six and seven, which fully enables -- we're fully built out in our Utah location then. We have the capacity we need to meet our sales goals for the year. With eight and nine coming online later in the year that's really both -- that's upside potential and we will sell every mattress we make as we always have. That's upside potential late in the year but that's also building up the capacity we need into the expected growth into 2021.

Okay. Okay. That's very helpful. And I appreciate the details on the coronavirus and expected impact. I mean clearly a lot of focus on what potentially happens to U.S. consumers. I understand you probably don't want to get into habits of quarter-to-date but is there anything you could share with us about what you've heard from maybe some of your retail customers over the last three weeks, what you've seen in your DTC business to maybe give us a little flavor of how the consumer has been reacting over the last few weeks here?

Yes. As I mentioned in the prepared remarks. So far early signals for Q1 are momentum moving forward business as usual. So we have not seen any signs of softness as of today. Similarly, our best visibility is into our own showrooms to which we have not seen anything negative or heard anything from any of our neighbors. In fact, we've had some very, very strong weekends in the last couple weekends in our own showrooms. Our wholesale sales are -- continue to come in with the momentum view that we've had. So again, as of right now, again we're pleased that we haven't seen any direct impact. But obviously we are preparing for any outcomes and are continuing to watch this closely.

Okay. That's very helpful. And then I guess lastly Craig for me on cash flow and CapEx. Can you maybe tell us out of the $40 million, what portion of that is for the machines? And then secondly, should we expect cash flow from operations to take a corresponding step up to cover the increase in CapEx? Or there will be a little drawdown on cash on the balance sheet in 2020 to pay the CapEx?

Yes. So we'll clearly need to use some of the cash to build out the CapEx. But as it stands right now we -- our plan includes us being able to produce enough cash to do what we want to do without taking out any additional debt. And as far as the machines go, the price is really -- the cost for us to build those really hasn't changed. It's in the single-digits. The return is pretty quick on those. And we will not only be finishing six and seven and building eight and nine but also investing into machines 10 in the future so that those are up and ready to go early in 2021.

Perfect. Well, I appreciate all the details. Congrats again on a good end to the year and best of luck going forward.

Thanks so much.

[Operator Instructions] Our next question is coming from the line of Seth Basham of Wedbush Securities. Please proceed with your question.

Hey, Seth.

Seth we're not hearing you if you're there.

Seth, could you check if you’re phone is on mute please.

This is Seth.

Okay Seth you were up for Q&A?

I'm sorry about that. Yes. So my question is as follows. But first of all congratulations on a very strong quarter and a great year. As we look at your business and how it developed over the course of the past year, you guys grew your wholesale channel revenues quite substantially now at 62% of sales. I think you said that you plan to have a split of about 60% wholesale and 40% -- I'm sorry 60% DTC and 40% wholesale going forward. When is that goal likely to be achieved? And do you expect to go past that goal in 2020?

Good -- I'm sorry go past which goal? I want to make sure I heard that right.

DTC as a percentage of revenue, would you expect that to be below 60% in 2020?

Yes. So, for full year, we're -- we are going to see some shift from DTC into wholesale, primarily because we've just got wholesale demand in the first half of the year as we're -- again we in the back half of 2019 began our revitalization of DTC, which we're seeing terrific progress on and we expect continued forward momentum there. We've got immediate access for door expansion in wholesale. Consumers, who'd like to buy our product and retail distribution opportunities to get that product into their hands. So, we are taking that which absolutely is shifting the mix. Midyear could be even as close to 50-50. But again, as our DTC continues to accelerate as we're back into growth. And DTC is really fully owned retail. So, it's a mix of DTC. It's a mix of our own showrooms. It's a mix of what we're doing in our call centers. As that continues to grow, we expect it to head back to 60-40. For now, we're looking forward to be -- that we think that's a good ratio, long term we'll see. But we still believe we've got ample opportunity to lean more as a majority direct-to-consumer player with a very strong wholesale base underneath that.

Yes. And if you think about it, a lot of it's driven by -- we're going to have an immediate jump in capacity by adding 40% more capacity by adding two more machines. So, that will go to build the short-term wholesale doors as B2C continues to grow.

Yes.

Got it. That's very helpful. And when you think about the margin implications of this or likely to see more pressure on gross margins earlier in the year like given the revenue mix shift you're talking about while later in the year a little bit less pressure?

Yes, absolutely. And as our DTC business has gotten stronger, some of the benefits we had with wholesale which was -- we were mostly selling our least expensive mattresses online, while wholesale was leaning very heavily in our most expensive mattresses, we were getting a terrific margin benefit from that. Just as the brand has strengthened and as we've been able to better educate our customer into our premium mattresses, there has been a wider gap between the gross margin produced through wholesale, which is not surprising and what we get direct. So, yes absolutely, we expect some gross margin pressure in the beginning of the year, which will carry through to our full year numbers. But again, as I said in the prepared remarks, from an intrinsic business point of view, as we build out these capabilities and execute throughout the year, which I think we've proven a pretty decent track record on, we expect to exit the year with a much healthier gross margin position than we had in 2019.

Very helpful. And as we look at the 800 or so wholesale doors that you had opened a year ago, so during the fourth quarter of 2018, if you look at the average sales per store there in the fourth quarter of 2019, were they up, so we can get a sense of how those comparable stores are doing?

Yes. So, we've never really disclosed beds per door anything like that. What I will say is we actually just completed a pretty big deep dive on this with cohort views. And no matter how we cut it, we are continuing to see same-store sales increase, which is terrific and Q4 was no exception to that. So our strength in the marketplace continues to grow.

That's great. My last question is looking at your "return rate". If we take the delta between your gross and net revenues this year, they account to -- equate to about 7.4% of gross revenue compared to 10.5% last year. Significant improvement. Is this primarily driven by your revenue channel shift? Or is it by operational improvements? And how should we think about that number going forward?

Yes, it's -- Craig?

Yes. So, I think, it's probably both. We are expanding the wholesale side, which our return rate is clearly lower there, because they're dealing with a lot of those returns. So we are also continuing to improve on the quality of the product, as well as expanding our call center who handles all the returns for us. So they're also contributing to reducing that rate. And, going forward, always trying to continue to improve that rate and expect it to continue to.

But this is an area of very deliberate focus we've had. And coming in, this was a hot topic when I joined -- what -- that's now 5.5 quarters ago, I guess. We did a lot of root cause analysis on the reasons for returns and ability to call it save the sale and have found significant levers that have worked. And part of it is just working with the customer and in building out our call center capability, which has both helped us operationally from a cost point of view, but also, as I mentioned, is becoming a heck of a revenue center for us as well. We've just been able to find a lot of ways to make our customers happy with our product and have them keep the bed in ways that are a win-win for both of us and its working and continues to get better.

Clearly. Congratulations. Thanks again.

Thanks, Seth.

We have reached the end of the question-and-answer session. I will now turn the call back over to management for any closing remarks.

Great. So thank you, again, to everyone on the call and to the broader market. I could not be more pleased with how my first complete year with this company turned out. Joining in late 2018, I knew we had amazing differentiated product and I knew we had a great marketing platform. What was less certain was how well we can execute at scale. Now with the right team now in place, working incredibly well together, I'm so proud of what we were able to accomplish. 2020 is really the next step in our evolution, as we take this foundation we have built and now invest into capacity expansion, channel expansion, product expansion and category expansion. I remain incredibly confident in our strategy and our team's ability to execute. And, as always, I really want to thank the Purple team for the passion and incredibly hard work that they bring every single day. Thanks, again.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation and have a great evening.