Purple Innovation, Inc. (PRPL) Q2 2020 Earnings Report, Transcript and Summary

Greetings, ladies and gentlemen. Welcome to Purple Innovation's Second Quarter 2020 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, Mr. Brendon Frey of ICR. Please go ahead, sir.

Thank you for joining Purple Innovation's second quarter 2020 earnings call. A copy of today's press release is available on the Investor Relations section of Purple's Web site at www.purple.com. I would like to remind you that certain statements we will make in this presentation our 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 second quarter 2020 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 our otherwise. Today’s presentation will include references to non-GAAP financial measures, such as 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 Web site. With that, I'll turn the call over to Joe Megibow.

Thank you, and good afternoon everyone. 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. Throughout the past few months, the COVID-19 pandemic has driven dramatic changes in the retail industry and the economy as a whole. Along with this, we have seen consumer demand and behavior changes as well, most notably a sharp acceleration of e-commerce adoption, including home goods. As a digitally native company with deep vertical integration and with differentiated products in multiple categories for the home, this created an opportunity for Purple. I'm extremely proud of how our organization was able to navigate a complex, rapidly changing environment and very successfully execute. Our performance during these unprecedented times underscores how far we've come in maturing our operations, and further highlights the growing awareness and desirability of our premium product offerings. As a quick recap, following a nearly complete disruption to our wholesale business and a brief slowdown in DTC demand in late-March, DTC sales quickly reaccelerated in early April. One of the key advantages of our operating model is our ability to quickly pivot in response to marketplace shifts after significantly scaling back our manufacturing operations early in the pandemic as a proactive measure to preserve our cash. We quickly ramped up our production and fulfillment capabilities, and refocused our efforts on our direct to consumer core competencies to capture the significant acceleration in digital channel demand. In addition to an overall increase in online retail, shelter at home directives also fueled higher demand for many home related categories, including the bedroom and home office categories. So in addition to experiencing a surge in demand for our mattresses, several of our other categories also grew triple digits, led by our seat cushions, pillows and sheets. Overall, it was a record quarter despite the ongoing challenges from COVID-19 with net revenue growing 60% to $165 million and adjusted EBITDA increasing by $29 million to $35 million from $6 million a year ago. These results fueled a dramatic improvement in our cash position, which stood at $95 million as of June 30th, up 185% from the end of 2019 and up 262% compared with March 31, 2020. Looking at our performance in more detail, DTC revenue increased 128% to $145 million with strong increases over the prior year period in each month of the quarter. As we reported on our Q1 call in May, April's DTC orders were up 178%. This was followed by 125% increase in May and an 83% increase in June. When considering orders as compared to net revenue, it is important to note that there's a lag between when an order is received and when it is fulfilled and booked as revenue. This delta can vary due to several factors, including current inventory availability and how the product is delivered, FedEx, or our in home delivery partners. Because we had adjusted production schedules to match current demand, at the start of the pandemic, we were capacity constrained for much of the second quarter as demand outpaced our expectations. As a result, a material amount of orders wasn't shipped or delivered until the following month, which for June means the revenue associated with those orders wasn't recognized until July or third quarter. With our seven fax machine coming online in early June, we were able to work through our order backlog and today, DTC orders are typically shipping out within a week. Another important variance as compared to net revenue is that orders are before any cancellations or returns. In terms of product performance, across our DTC channel, we experienced fantastic growth. For mattresses, demand was strongest for our hybrid premier product line, which contributed to 15% increase in our average selling price. As our most premium models tended to have higher mix when sold in wholesale channels, this further reinforces the shift in consumer demand we've seen move to online. Meanwhile, our non mattress categories grew at an even faster pace as consumers sought our premium products to enhance their home life. We lean heavily into this trend, notably for seat cushions as people working from home found themselves desiring comfortable home offices. We quickly upgraded the merchandising of our seat cushions on purple.com, including new content, new bundles, new marketing creative and new promotions, making it much easier for consumers to find and browse online and determine the product that best meets their needs. In total, we have seen the share of our business from non mattress products nearly double since Q2 last year. With the consumer demand shifting significantly online, alongside declining channel marketing costs, we shifted our marketing strategy to better reach the consumer. We pulled back on more expensive channels, such as retargeting and focused on casting a much wider net with traditional tactics. With this larger addressable market, we were able to substantially increase traffic to our site, while maintaining healthy conversion rates. This drove significant growth with the added benefit of marketing leverage. Alongside the margin benefit with DTC orders, this dynamic led to significant operating expense leverage contributing to our record adjusted EBITDA performance. Our exceptional DTC performance more than offset the decline in wholesale revenue, particularly early in the quarter as many of our partner doors were closed or operating at reduced hours. For the quarter, wholesale revenue was down 49% compared to the same period last year. However, after difficult start, trends improved as the quarter progressed and more doors reopened and store traffic improved. For April, we previously reported wholesale orders were down 43%, improving to down less than 2% in May and in June, orders were back in the positive double digits as compared to the same periods last year. The improvement was driven in part by restocking of inventory levels, particularly ahead of the Memorial Day on July 4th promotional periods, both of which were very successful with sell through well above last year's levels. Even more than occurs with DTC orders, there can be a revenue recognition lag between when wholesale orders are placed and when they're scheduled for delivery. The strong increase in June orders has translated into a good July for wholesale net revenue growth, and we expect this momentum to continue. As we catch up on production, we are doing everything we can to support our wholesale partners. With recent industry wide shortages on pocket coils, we have seen even more demand as our pocket coils are wrapped with quality fabrics chosen specifically for our mattresses that are not experiencing shortages. In addition to supporting our existing partners, we added several new wholesale partners, including City Furniture, Big Sandy Superstore, as well as a 38-door test with rooms to go. All in we are in over 1,800 doors as of the end of June and we are pleased to report that all of them are now open to customers in some capacity. Until our new production facilities are operating, we expect only a modest growth in wholesale door count. Although, should we observe demand shifting back into brick and mortar, we have the opportunity to easily pivot in support of our customer. Our strong year-to-date performance has put us in a great position to further invest in growth. This includes Purple South, our new manufacturing facility we were thrilled to finally announced last month. At this point, I want to turn the call over to John to discuss this major initiative in more detail.

Thanks, Joe. We are very excited to be moving forward with this important investment. Located approximately 30 miles southeast of Atlanta, the 520,000 square foot location will feature manufacturing, assembly, warehousing, inventory management and order fulfillment once fully operational. Our plan is to phase in operations in the coming months starting with warehouse and fulfillment, followed by assembly and manufacturing. Purple South will be home to our next Max machine and our first machines outside of Utah. We currently expect Max 8 to be online by the end of 2020 with Max 9 operational early next year. The addition of Max 8 and 9 will increase our production capacity by roughly 25% to 30%, and our current thinking is to add another four machines in 2021 to support future DTC and wholesale channel growth. On top of expanding mattress production, we will be installing six injection molding machines at purple south to increase our seat cushion and pillow production capabilities. These machines will double our current capacity, allowing us to better meet the growing demand for these two categories. With a facility based in the southeast, we will be able to get product to consumers located in the eastern half of the U.S. faster and more efficiently, providing a better overall user experience and generating cost savings over time. There are also supply chain benefits associated with this location, such as the large labor pool, which will allow us to better balance labor, with production planning across all of our facilities. Also, several of our large suppliers are in close proximity to new plant. We are very proud to be a U.S. manufacturer. And during these challenging times, it is especially rewarding to be able to invest in expanding our domestic footprint, creating many new jobs in the process. With that, I'll turn it back to Joe.

Thanks, John, and terrific work. In addition to expanding capacity, we are also moving ahead with investments in our four key initiatives, product innovation, omni channel retailing, organizational effectiveness and brand development. Starting with product innovation, we have seen significant growth in our newly launched products from the end of last year, including our premium harmony pillow, our innovative new foundation that almost magically expands with no tools required, our upgraded platform base and our upgraded protector. In early Q2, we updated our original Purple pillow with boosters that finally make this unique pillow height adjustable for any sleeping position, which has measurably improved customer satisfaction. We also launched our new premium SoftStretch sheets, our softest, most durable, breathable sheets yet and also expanded our colorways to six trend right options. Strategically, we continue to find a premium assortment expansions, create both an upsell opportunity and see very high attach rates with our premium hybrid mattresses, both of which are proving true with SoftStretch sheets. With people spending more time at home, we have also seen significant increase in demand for our innovative seat cushions. We created very successful bundles, especially a very well received combination of our lumbar supporting back cushions with our most popular office seat cushions. We continue to believe that our seat cushions have enormous potential and the recent shift in behaviors have accelerated customer demand and our focus on the category. As John said, we are doubling our capacity and have many new offerings in the works. Which brings us to omnichannel retailing. We continue to lean into enhancements, and improvements on our existing online platform, including new financing options with the introduction of split it, improved bundle upsell flows and more relevant cross sell modules. The growing strength of the team was evidenced by how quickly they were able to tease out the demand signals for non mattress products, especially seat cushions and pivot our site content, page structure and merchandising incredibly quickly, including building new bundles and offers. It is a great example of how much more agile and mature we are becoming. The larger initiative of redesigning and fully replatforming the site continues to be in progress, and is still planned for launch well before holiday period this year. For our owned retail showrooms, it was a tough quarter with mandatory shutdowns for three of our five current locations. Fortunately, as I mentioned last quarter, we were able to pivot the furloughed associates into sales roles on our newly launched sales chat capability in our contact center, and those associates each drove more revenue than they were driving in their showrooms, which is just amazing. As of today, we have four of our showrooms open and sales performance is getting close to pre-COVID-19 levels. We remain very optimistic on the channel and are currently exploring additional locations across the country. We will continue to conservatively pace ourselves and we hope to get back to our previously stated rate of about five new showrooms per quarter. As for organizational effectiveness, this continues to be an important focus, given our incredible growth. We ended Q2 with nearly 1,200 employees and as of now, have already crossed 1,300 employees as we continue to lean into production. Hiring was challenging in Q1, as we found ourselves competing with attractive unemployment benefits. Fortunately, our recruiting teams continue to reinvent our approach, and we are close to 90% of where we would like to be. Despite the rapid growth, we continue to be laser focused on costs, maintaining G&A as a percentage of revenue in the mid single digit range. We continue to improve processes and efficiencies as we mature. Most importantly, we have been able to continue to maintain productivity, alongside doing everything we can to provide safe, clean, working environments for those employees who continue to work in our manufacturing and warehousing facilities. These new health and safety processes and standards are becoming normal for us, especially given our number of new hires that have no other point of reference. I continue to be impressed with the dedication and fortitude of the team. They really are the heart of Purple. Finally, with brand development, we continue to mature and build out our capabilities and our brand narrative. Our focus remains on the evolution of our brand in support of the premium nature of our products, as well as our unique innovations with the Purple Grid and our hyperelastic polymer and the very real benefits they provide. Our recent spots are indicative of this direction and have been very well received. I'll now turn it over to Craig, who will review the financials in more detail.

Thanks, Joe. As Joe outlined, we had a very strong second quarter even with the continued challenges created by COVID-19. As you'll hear later, we also had several significant non-cash adjustments during the quarter related to the fair value of outstanding warrants driven by the increase in our stock price, the removal of our reserve on our deferred tax assets and a corresponding tax receivable agreement liability. For the three months ended June 30, 2020, net revenue was $165.1 million, up 60.3% compared to $103 million in the prior year period. The revenue increase was driven primarily by strong growth in mattresses at our DTC channel, along with higher demand for pillows, sheets and seat cushions. This was partially offset by lower wholesale revenue due to the disruption in partner store operations, including temporary closures in response to COVID-19. For the quarter, DTC channel net revenue increased to 127.9% year-over-year, while wholesale channel net revenue declined 49.3%. Earlier in the quarter, we announced order totals for April and May. Customer orders for both DTC and wholesale do not take into account customer returns, cancellations, or timing of revenue recognition that is dependent on shipping and delivery dates. Given our capacity limitations, many orders placed during the quarter will not be recognized as revenue until the following quarter as we continue to expand capacity and reduce our backlog of orders. Gross profit dollars were $81.6 million during the second quarter of 2020 compared to $42.8 million during the same period in 2019, with gross margin at 49.4% versus 41.5% in the second quarter of 2019. The 790 basis point increase in gross margin year-over-year was primarily attributable to the higher proportion of DTC channel revenue, which carries higher gross margins than our wholesale channel. DTC revenues comprised approximately 88% of net revenue for the quarter compared with approximately 62% in the same quarter last year and 66% in the first quarter of 2020. With partner doors continuing to reopen and resuming more normalized store operations, we expect wholesale revenue to increase as a percentage of overall revenue during the second half of 2020 compared with the second quarter. This expected channel shift back towards wholesale, combined with investments in building capacity and our new manufacturing facility, will likely result in gross margin rates closer to the first quarter of this year than what we saw in the second quarter. Operating expenses were $49.7 million in the second quarter of 2020 versus $45.1 million in the prior year period. Marketing and sales expenses, as a percentage of net revenue, decreased to 23.9% compared with 34.9% last year due to efficiencies in our advertising spend created from enhanced marketing strategies and increased online shopping due to COVID, lower rates in certain marketing channels in which we advertise and an intentional reduction in ad spend in April as part of our previously announced cash preservation efforts. We're expecting marketing and sales expense as a percentage of that revenue to return to our historical range below 30% during the second half of 2020. For the second quarter, we reported operating income of $32 million compared to operating loss of $2.4 million in the second quarter of 2019, an improvement of over $34 million. During the second quarter, we recorded a non-cash expense of approximately $39 million from a change in the fair value of warrant liabilities compared with $3.7 million for the same fair value adjustment in the year ago period. In the second quarter of 2020, we also recorded a $32.8 million noncash expense associated with our tax receivable agreement liability, as well as approximately $8 million in income taxes on our current period income, which was more than offset by $44 million income tax benefit. Income tax benefit was primarily related to the release of a reserve for deferred tax assets created when paired B shareholders exchange their shares for Class A shares, creating an amortizable tax basis difference. Income generated in the second quarter created a net three year cumulative pretax adjusted book income. The effect of this, combined with our forecasts for profitable growth, has given the company the opportunity to release the valuation allowance on our roughly $100 million of deferred tax assets, resulting in the $44 million income tax benefit I just mentioned and an additional $56 million recorded through additional paid in capital. These deferred tax assets were generated primarily from a step up in tax basis when the Class B paired securities are exchanged for Class A shares. These deferred tax assets will continue to increase as Class D paired securities are exchanged for Class A shares in the future, and are amortized for tax over 15 years after each exchange. And currently, as required in the tax receivable agreement we have previously discussed, we are required to record a liability to InnoHold for 80% of the tax benefit received from the amortization of the deferred tax assets created from its exchanges. The TRA liability is only paid when the company receives an actual cash tax benefit from the filing of its corporate income tax return. The current period expense in the income statement relates primarily to the changes made in previous years. The impact of exchanges in 2020, primarily due to the secondary offering in May, were charged to additional paid in capital. Inclusive of these noncash expenses and tax benefits, net loss for the quarter was $5.8 million compared to a net loss of $7.3 million in the year ago period. EBITDA for the quarter was negative $37.8 million compared to negative EBITDA of $5.2 million in the second quarter of 2019. Adjusted EBITDA, which excludes noncash expenses associated with the change in fair value of warrant liabilities, noncash expense associated with the loss on extinguishment of debt. Tax receivable agreement expense, noncash stock based compensation, legal fees, Interim CFO and consulting costs in a year ago period, severance and COVID-19 related expenses this year, was $35.2 million versus adjusted EBITDA of $6.2 million in the same quarter last year. Moving to our balance sheet. Net inventories totaled $39.8 million at June 30, 2020 compared with $47.6 million at December 31, 2019 and $42.1 million at March 31, 2020. As of June 30, 2020, the company had cash and cash equivalents of $95.4 million compared with $33.5 million at December 31, 2019, an increase of 184.8%. Compared with March 31, 2020, cash and cash equivalents increased by 261.7%. The significant increase in our cash position was driven primarily by the acceleration in DTC sales, cash preservation efforts early in the quarter and substantially all of our wholesale partners remain current throughout the quarter in spite of the significant decline in wholesale orders. With over $95 million in cash at the end of June and continued demand for our products, we feel we're well positioned to continue investing in our business, which includes our new manufacturing facility, company operated showrooms and innovation initiatives. Due to the continued uncertainty in the overall economy, we are continuing to refrain from providing guidance at this time. While we are very pleased with our overall second quarter performance, particularly our 21.3% adjusted EBITDA margin. I do want to point out that some of the dynamics our business benefited from in the second quarter are not likely to repeat to the same extent in the second half of the year, namely, the 88% penetration in our higher margin DTC channel as wholesale orders continue to grow, as well as the significant leverage in advertising spend we saw in Q2 as we invest more dollars to support holiday promotions. Additionally, as we opened the new facility in Atlanta, it is expected that it will, for at least the first year, be operating at an efficiency rate well below the existing facilities in Utah and will put pressure on our current margin rates. Further, we furloughed a significant number of employees, both manufacturing and corporate, during the months of April and May, established a hiring freeze and eliminated all non-essential spending, including travel, as part of our cash preservation efforts. Now with available cash, we have again started spending into infrastructure to support our planned growth. However, these additional costs will also put pressure on growth and adjusted EBITDA margins. I'll now turn it back to Joe for his closing comments.

Thanks, Craig. This has been an unusual quarter by every measure, with some of our deepest lows as we furloughed a third of the company effectively shutting down production, and then to some of our highest highs as we rally, pivoted and grew to a stronger, larger and more productive organization than ever in our history. I'll reiterate what I said last quarter. I believe that building a world class team, having a solid strategy, terrific execution and capturing some good market tailwinds is a formula for success. Looking forward, we’ll caution that there is market uncertainty in the back half of the year and we expect a more balanced channel mix eventually. Regardless, in Q2, our team’s solid execution and our continued success winning share in the marketplace produced substantial results, which have strengthened our balance sheet and are now supporting both investment into capacity expansion, while also providing a cushion to weather possible future market downturns. That, we believe is the most important takeaway, that our relentless focus on the fundamentals enables us to adapt to uncertainty and find a way to keep growing and keep taking share. We are in early innings in this regard and we believe we are demonstrating that we are set up for long-term success. To that end, I want to send a heartfelt thanks to all of our employees and partners for their hard work, dedication and resiliency as we continue to navigate through this together. At this time, we will be open for questions.

Thank you. At this time, we will be conducting a question and answer session. [Operator Instructions] Your first question comes from line of Brad Thomas with KeyBanc Capital Markets. Please proceed with your question.

I want to first ask about the demand trends that you're seeing in the business, and I was hoping you could give us a little bit more color on what you've been seeing in the two different channels in July and thus far in August?

Yes, demand, I mean, continues to be remarkably strong. The story we've had on just demand outpacing our ability to manufacturer continues to be more true than ever. We said coming out of COVID here that basically all of the unit demand that we have had through brick and mortar and our wholesale partners shifted online, which remains largely true. On top of that, we really haven't seen any decline in demand online. But on top of that with wholesale coming back, it's just strengthens the total market for our product. We are seeing healthy growth in wholesale. We mentioned in the prepared remarks all of our retail partner doors are open in some capacity, which is terrific. And we're seeing strength and the ordering coming in. The reality is we're throttling our business. I mean, we've done everything we can to make sure we're working with extra demand. We've had fewer days of promotions. We've had less de-promotions. We actually raise prices over this period. And we've been working very carefully with our wholesale partners to ensure they're not meaning and to a level that we can’t provide mattresses for the customer demand. So overall, very healthy demand, really at this point, continue to just be limited by our own capacity, which clearly is where we're putting a lot of investment now and getting that built out.

And as we think about that delay between the timing of orders and your ability to make deliveries. How should we think about the backlog, if you will, or the order base that we're working with as you move into 3Q and potentially the amount of tailwind or pickup that you may have going forward?

The good news is with Max 6 and Max 7 coming on, we've added a significant amount of capacity. And John and his team have just done a terrific job on squeezing even more out of what we have and continual operation and yield improvements. The biggest limiter we've had and we mentioned this lightly in the prepared remarks has been labor. We're still only staffed at about 90% of what we are able to sustain, which is really just the labor pool has been depressed as there's been healthy stimulus out there that has kept a decent amount of hourly labor out of the workforce. We've gotten very aggressive and trying to talk about labor and has done a terrific job of pulling them in, but we continue to grow that. I mean as we've gotten the labor pool up and production up, we are, for all intents and purposes, are out of backlog now and basically manufacturing what's being ordered day by day. I mean basically everything we make is going right out the door. What we're trying to do now is we continue to build up production, is make sure we've got capacity we need into Labor Day and the back half of the year if we continue to get more -- we continue get production levels up. I think right now we're at a very healthy balance. Again, we've got very strong demand and growing. We’re alongside that increasing our capacity. And the real win is as we get Max 8 online later this year and outside Atlanta and then the five more Max machines quickly behind that is where we really open this up.

Your next question comes from line of Brian Nagel with Oppenheimer. Please proceed with your question.

So I want to ask you what has mentioned a lot in the prepared comments, just the impacts so to say that delay from the orders to shipping. So as we look at the sales of $165 million. What would that have been, had you not have that impacted delays?

It's not so much what would it have been, I think what we're trying to map is we had reported in April and May orders, which we haven't ever really talked about before. And there's a pretty big delta with orders, which are a great indicator of demand and velocity and why we were excited to share that with net revenue, which has both timing considerations on revenue recognition as we don't recognize until receipt, which with a customer if it's, for instance, white glove or [technical difficulty] delivery can be a week or two after they order depending on the network and deliveries in general across everything from FedEx and UPS to freight has been running slower than normal. And with -- as we've had significant orders coming in and in recent with wholesale, they may order weeks and weeks ahead. So we may get a purchase order for 1,000 beds, some of which they're asking for receipt three weeks from now, four weeks from now. So until those beds are received, we don't recognize that revenue. That's just normal business for us. That's not any change from any prior period. It's just a matching up to the orders that we quoted earlier. Craig, I don't know if you want to add anymore color to that.

Yeah, it was all about transparency. COVID hit and we wanted people to understand that we were not being impacted in a way that some might have been or that others were. The another piece that is not included that we didn't talk about was the fact that the orders do not include returns or cancellations. So again, it was more to give velocity. And so if you can understand, we were still receiving active orders in wholesale and through DTC, just be transparent of where we were on business.

And then the second question also on sales, but I guess more forward-looking and more nuanced. But you talked about in your prepared comments in response to Brad's question here just the strength here and strength into July, putting aside some of these timing differences, the strength into July. But as you look at your business now recognizing that you're still in situation where you're sort of say, catching up too strong demand with manufacturing capacity. So how do you think about just the sustainability of what we've seen lately against this backdrop of COVID, which has clearly changed consumer behaviour? Are there key other key metrics you're looking for to help you understand sustainability, or just how you think about the sustainability now as you think basically through the back half of the year?

If I can, I split sustainability into two aspects. One is just general demand. Are we going to continue to have significant growth in consumer demand and continue to have an opportunity to gain share in the marketplace? And in that regard, we are continuing to see acceleration. We are further building our brand presence. We're being further rewarded for the quality and customer satisfaction that our product dries that we continue despite our ever growing marketing expense, word of mouth continues to be, the number one consumer reported reason on why -- how consumers learn and hear about Purple, which speaks volumes to the satisfaction and quality of our products. So in that regard, we see terrific opportunity, not slowing at all in the back half of the year. The question, the other half of the question, is really on channel mix. Given clearly in a predominantly DTC led business, we have very favorable economics. We're both top line, we're driving more net revenue per unit and in a capacity constrained business that obviously flows right in, as well as clearly we've got significant margin benefit, which is flowing right through into adjusted EBITDA and clearly into cash. So in that regard, we see the ship heading more back to our wholesale as you would expect. This is a category that has historically been 85% brick and mortar and 15% or so online. So you would expect that as stores open and consumers reenter stores, you're going to see some pullback and we were basically 90% online, 10% wholesale in the middle of all this. That said, it's not shifting that quickly. It's I think [technical difficulty] rarely do. We're continuing to see very strong online demand and growing demand in general. And I think the consumer behavior has changed likely permanently, where I think there is going to be a larger addressable online audiences there's ever been and we clearly, are set up to capture that. So I think back half will look less online as we saw in Q2, I think there were some extended circumstances there. But I think in terms of trends prior to COVID-19, this still looks very favorable for Purple.

Your next question comes from the line of Seth Basham with Wedbush Securities.

My first question, not to beat a dead horse here, but thinking about this revenue shift. It sounds like this is a much bigger shift than you normally would have experienced in recent quarters. And I'm wondering whether or not part of it is simply not just because of the capacity constraints, but also because of cancellation and returns rate. Were those much higher than normal? I know that's simply a function of taking longer to delay delivery or some other factor?

So cancellation returns actually continue to get better. It was frankly a significant challenge, a headwind for us when I joined nearly two years ago now, and we continue to improve that. And the industry averages are in the high single digit percentage, and we tend to be in that range, which is a delta looking at orders versus net revenue that. If we did get towards the end of the quarter and significant wholesale orders, the vast majority of which are going to be realized in Q3. So again, very strong demand and the orders came in but that revenue recognition won't happen. And consider normally in a quarter, it's not even so much what's happened moving out. But normally, we would have been receiving -- getting the benefit of revenue in this quarter that came in, in prior months and we just wholesale went dark. So we weren't getting the recognition that from prior orders, but we're now getting new orders that will show up in Q3. So, I actually don't think there's anything out of the ordinary in terms of revenue recognitions. Just about we have this crazy quarter where there was basically no wholesale. And now that wholesale is coming back, we're just not seeing that flow through appropriately as it goes on. I mean, Craig, can you provide any more color?

The only thing I was going to point out that was we actually in addition to the DTC shift -- channel shift, we also seen a shift in our allocation between mattress and non-mattress to some of the products that have a 30 day return cycle, not a 100 day. So overall, our return rate is slightly improved due to that product mix shift. But now we've been watching the mattress return rates very closely every week almost daily since COVID hit. And we're ready if something did happen but we did not see any material change because of COVID.

And second, it sounds like you guys are you guys are racing as fast as you can to increase capacity and utilize that capacity. As you look forward to Labor Day here, which is the biggest holiday of the year for mattress sales. Would you expect to revert to capacity constraints for that period of time?

Yeah, we're right now managing very tightly. I'd say one of -- I've mentioned the maturing of the organization quite a few times. And the way the team has been able to come together a huge part of that is our predictability on manufacturing and a solid S&OP process where we really have incredible visibility into what we're making every day and what we expect to sell every day. We're getting very, very good at that. So we feel very good about our ability to have capacity we need for Labor Day. We are manufacturing into that right now. And some of it is how deep are we going to have to go promotionally and we go less deep now. We don't have to. We sell the mattresses either way. That's great financially for the company. So there's obviously been unplanned market conditions this year nearly around every corner and many of those have been fortunate for us. So I mean it's -- we never really can predict exactly what's going to happen on this holiday. But we feel very good that we've got capacity we need. We're continuing to staff up. We expect to be fully staffed by then, which increases our output. We're continuing to get more yield out of machines. And John's team is just doing a terrific job there. So I think we are set up for a very strong Labor Day.

Your next question comes from Curtis Nagle with Bank of America. Please proceed with your question.

Good afternoon. thanks very much. John, I just wanted to follow up on point you made earlier just about the price increases you guys took, I think anywhere from, I don’t know $50 to maybe $200. Just curious on the rationale. I mean it doesn’t sound like it had anything to do with say, raw materials and more to do with the fact that I guess you guys have strong pricing power, and obviously limited capacity. I guess anything else driving that decision?

Some of it is getting appropriately priced in the marketplace as we've looked at the competitive sets and competitive pricing and consumer demand. And so the value equation we see with consumers, we felt that we have some opportunity to rightsize the pricing. We took a closer look down to the product level on individual margins and saw that we had some areas where we maybe have some nice symmetry in the pricing, but not necessarily thinking through the true margin impact and there was some opportunity to clean up there. As we looked at our wholesale support and making sure that we've got the margin room to get what we need out of wholesale partners, we've been continue to looking for ways to get healthier margin structure. So I mean, no matter how we cut it, it seemed like a good thing to do. And we've got the demand right now. We treat this every time as a task and we see did we get it right and how the consumers react and does this make sense? And remarkably, it appears we did have some opportunity to raise prices. We saw almost zero change in demand and are getting ourselves priced where we can get the margins that are appropriate, and give us more opportunity to better work with our wholesale partners.

And then just a follow up for Craig, just to I guess think about year end cash position, capital spending that kind of thing and you guys have obviously quite a bit more stressed right now. And it's great that you can use that to reinvest in the business. But just curious how we should think through that for the rest of the year.

So the way I would think about it is that we've announced Atlanta, so we are going to have a build out there to a certain extent. We are going to, as Joe mentioned in his prepared remarks, start getting back into opening some of our company own stores. But also the shift, interestingly shift to DTC and our wholesale partners staying current that was part of what drove our additional cash balance. So as wholesale starts to come back and we're selling product on terms, again, as we were before with wholesale, that's going to use some of that cash. So I don't necessarily expect it to stay at the 90, 95 level. But with what we have planned for wholesale -- for building out Atlanta, building out the stores, selling back in for wholesale, we have as much as we need to be able to do what our plans are. But I don’t expect to just stay where it is right now. No.

Your next question comes from line of Bobby Griffin with Raymond James, please proceed with your question.

I guess my first question is the follow up I guess on the build out of the machines. I just want to share I, A, understood the numbers correctly. So we'll try to get to mattress A or Mattress Max 8 by the end of 2020 and then add an incremental of four in 2021. So by the end of 2021, one to be around 12. Is that correct?

Yeah, we’re close. We actually have room for six more Max machines in the facility outside Atlanta. So we'll get one of those. It'll be Max 8 by the end of this year and another one fast following in early 2021. We then will have four more, which will flesh out the full six machines out there by the end of 2021. So one more this year, five more next year. And I mean to the prior -- Craig's comments on the capital allocation. By the everybody of 2021, our new facility we're just opening is already at capacity and we're already looking for our third large facility as we with the lead times on Max machines and getting these facilities negotiated and open. I mean, we're going to be well underway by the end of 2021 into a whole additional facility.

And I guess maybe to help connect the dots in our longer term views of it. I know it's tough to predict the mix between DTC and wholesale but assuming a certain mix, whether it’s 75-25. What is the average yield of one Mattress Max machine now for us to think about? Is it $80 million per machine it revenue we can do, or is it $90 million, or help us frame that up a little bit, please?

I mean we've had commentary out there in the past, which we said is in the ballpark with the fully loaded attach revenue to a Max machine of between $80 million and $100 million but that was in pre COVID framing of things. So clearly, there's more net revenue potential when we're selling a higher percentage online are non-bedding business continues to grow, seat cushions is on fire, pillows and sheets continue to grow very rapidly. So the revenue potential, either on an attach basis or we're actually just building some very healthy businesses independent of our mattresses continues to grow. So there's very high dependency on what that mix is and these other business categories. So I'd say the 80 to 100 is still, you know, a good framing but if things continue as they have been, it could be more than that.

So we could think of it once that other facility is built out, you’ll have capacity in excess of over $1 billion in revenue?

We're getting into that range. I mean, keep in mind the other thing is we need excess capacity. These machines get older we need to -- I mean, they're like diesel engines. They can run forever if you take care of them but we've got to put -- we've got to maintain them and properly service them. When you're having to make every mattress every minute of every day and get it out the door, it really creates pressure on the network. So some of this is how do we build out to the point that we genuinely have surplus, we have the opportunity and flexibility to lean in at times of peak and how's the business resiliency to allow a machine to be taken offline without impacting anything. So that's part of the goal as well. Just we cannot continue to run it the way we have. But it's building that capacity as we absolutely will over the next couple of years be getting into that $1 billion run rate and having the capacity we need to truly run a surplus.

Your next question comes from line of Susan Anderson with B. Riley FBR. Please proceed with your question.

This is Alec Legg on for Susan. Thanks for taking our question. My first question is just related to pricing. I believe you mentioned 15% growth in ASP. How much of that was through the product mix shift this quarter into that higher dollar products? I believe you moved towards focusing on producing higher dollar mattresses this quarter? And should we anticipate that to be lower or stabilizing going forward.

Well, first of all -- and so that the 15% I mentioned was strictly mattress ASP. So that the other product mix is outside of that specific piece of data. And the other important thing is we have seen our mattress ASP just continue to grow substantially quarter over quarter, year-over-year quarter-over-quarter, year-over-year year over here …as we have developed a demand for a more premium product and are selling more of our premium mattresses online. Wholesale has always indexed to our more premium mattresses. So during the time that wholesale was much more shutdown, we saw significant increase into our hybrid premieres, which drove absolutely as you're suggesting that ASP increase. As wholesale starts to open back up, we are seeing a little bit of mix back toward normal. But that that normal is still a significantly better ASP than we saw this time last year. So yeah, I think it is going to stabilize a little more toward where we were pre-COVID. But again, it doesn't change the broader trend we continue to see ASP go up.

And then just a follow-up on, just a modeling question. How should we look at marketing expense for the remainder of the year? And then also on customer acquisition costs. Have you seen that trending more beneficial as some of these online markets, such as like Facebook losing a lot of advertising spend. If you could provide some color on marketing and customer acquisition costs, that would be helpful?

This was a terrific quarter from the marketing point of view. We saw our customer acquisition costs decline double digit percentage and just our return on ad spend rise in general, with some of the strongest we've ever seen. And that’s considering the growth we had in direct to consumer, it's fairly remarkable to be able to go after significantly larger addressable market online, substantially grow traffic to the site, while holding conversion constant and growing ASP and AOB in general. It's a combination that rarely all works together. So we actually got marketing leverage this quarter while substantially growing our business. And the good news is we continue to see depressed marketing costs. So, there's still arbitrage opportunity right now from both a CAC and ROAS point of view. These are shifts, at some point in marketing costs I suspect and more demand will come into the marketplace, and it will get back toward normal but this is part of the maturity of the team. And I'm just thrilled with their ability to just day by day tease out where these opportunities are, pivot our spend into the most opportune areas, cast a wider net and capture this customer and do it with better and better efficiencies. So still a lot of opportunity in front of us.

Your final question comes from line of Jeremy Hamblin with Craig-Hallum. Please proceed with your question.

I wanted to first start with a couple of clarifying questions on gross margin and CapEx. So you saw about 800 basis points of improvement. Obviously, a lot of that is due to the channel mix. But I wanted to get a sense, if you could quantify that a little bit more? If you saw your more traditional, let's say, 60-40 or 65-35 mix. How would those gross margins have played out? Would they be in the 46% range? Or can you give us a sense of what that might have been?

So I would say what we've said is that the substantial change in gross margin has come from the channel mix shift. It's likely those margins would have stayed fairly close to where they were the first quarter. If you drop it down to an EBITDA margin, there was also some substantial pick up there in the savings, in the marketing and advertising costs. We were in the low 20s versus what we typically are in the low 30s. So the biggest difference in the gross margin was channel mix shift.

And just, I do want to say, while they would have been similar to Q1. We continue to improve this business quarter on quarter as we've been doing for the last couple of years. So both, as we mentioned in the prior question as ASP continues to go up, we get better margin. We've continued to get lower product returns, we've continued to lower operating costs in general. So there is -- we had already reported that we are working on ample opportunity to improve our margins, just this kind of substantial shift is clearly driven in large part by the channel mix.

And then in terms of Purple South. The CapEx spend that you would expect for that in 2020 would be what and then some big plans for 2021 on that? Can you just quantify, specific to just Purple South for 2021 as well on the CapEx for that project facility?

Yes, a lot of it depends on timing and what we can get done before the end of the year. If you look at our earnings -- our press release. When we announced Atlanta, it's expected to be around $20 million over the term -- between this year and next year once we get it up to full operating efficiency. So how that splits out between the end of this year and next year is really based on timing.

And then last question, I actually just wanted to ask you, you've had a lot of success with this brand and it's clearly captured consumer attention and I'm sure your retail partners as well. Are there any plans at this point in time for potential brand extension into other areas outside of your traditional bedding or seat cushion?

Yeah, it’s -- plans at this time is a little open ended. Strategically, we have absolutely said that as part of our overall company strategy. At our core, we have remarkably innovated gels, we’re very good at injection molding and extrusion and all of this. We've gotten novel applications and an entire battery of underutilized patents in cushioning and comfort in general. So right now, we're focused on being the best mattress company there is out there. And we are very early days. We were a relatively small player today in market share at around 3% to 4%. And we're looking to gain meaningful share. But as we do that, as we're leaning into seat cushions right now, for example, we see multiple category opportunities, both direct to own product as well as some OEM possibilities. That's been our stated strategy for some time and we absolutely will continue to be leaning into that as we get more cash on the balance sheet and more strength as a brand.

Ladies and gentlemen, we have reached the end of the question and answer session. And I would like to turn the call back to Mr. Joseph Megibow for closing remarks.

Thank you so much. I continue to be amazed with the growth and maturing in the Purple team, which is clearly demonstrated with our continued positive momentum. While COVID-19 has created very real challenges worldwide, our team has been able to find opportunities to lean in and meet ever growing demand. Our unique product is resonating with customers more than ever and we continue to win share in a very competitive marketplace. Our ongoing commitment to innovating real comfort solutions that meaningfully help everybody feel and live better has never seem more relevant than in our current environment. And our vertical integration has given us proven adaptability to constant market shifts. We're especially excited about our new facility outside Atlanta, which grows manufacturing and warehousing to over 1.2 million square feet in total, and continues our commitment to domestic manufacturing and creating more jobs. To all of our customers and partners, as well as our employees, stay healthy, be safe and sleep well.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.