Greetings, ladies and gentlemen, and welcome to Purple Innovation First Quarter 2018 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, Shannon Devine. Please go ahead.

Thank you for joining us today to discuss Purple Innovation's first quarter 2018 earnings results. On today's call are Terry Pearce, Co-Founder, Chairman and CEO; and Mark Watkins, Chief Financial Officer. 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 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 that is included in our first quarter 2018 earnings release, which was furnished to the SEC today on Form 8-K, as well as our filings with the SEC reference 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 can be found within the earnings release and our quarterly report on Form 10-Q, each of which can be found on our website. With that, I'll turn the call over to Terry Pearce. Terry?

Thank you. Thank you all for joining us. I'll start by touching on our first quarter results including key drivers of our top-line performance. Mark will then walk through the numbers in greater detail and outline our updated outlook. After my closing comments, we will be happy to take questions. As you will hear in our comments today, the company is healthy. Although we have pared back our near-term expectations for revenue, we believe the company will be EBITDA breakeven this year. We are making this adjustment to drive toward our long-term objectives. We will come back to this a bit later, but the key understanding is that the Purple team continues to believe that our differentiated products and marketing are driving longer-term market share. We delivered a strong start to the year as revenues increased over 100% from Q1 2017 to $61 million in Q1 2018, meeting our top-line projections. During the first quarter, we continued to experience strong demand for our original mattress in our direct-to-consumer channel. Growth was driven by marketing investments made over the past year that significantly increased brand awareness and focused customer interest on our differentiated technology. Our recent performance was in part, also driven by the introduction of new higher priced mattress models, which debuted at retail in November 2017 and on our website in early February 2018. The new models offer a choice of two-inch, three-inch, or four-inch deep Purple Hyper-Elastic Polymer for incrementally personalized comfort along with a completely different mattress core design. Reaction to the new models has been very positive and is allowing us to reach a broader consumer audience. Site-visitor conversion rate has been lower since introduction of the new models as anticipated for higher price considered purchase. We are monitoring, analyzing, and optimizing on a daily basis.…

Thank you, Terry. I'll begin by discussing our quarterly results, and we'll then review our updated guidance for the year. For the three months ended March 31, 2018, net revenue was $61.0 million, up 102% compared to $30.1 million in the prior year period. The revenue increase was primarily due to higher demand for our mattresses and other products in our direct consumer channel. Supporting the growth were increased marketing investments promoting our new mattress offerings, our improved manufacturing capacity, and to a lesser extend increased contributions from our wholesale channel that comprised 6% of our net revenue for the quarter. Gross profit dollars were up 84.7% to $26.4 million during the first quarter of 2018, compared to $14.3 million during the same period in 2017 with gross margin of 43.3% compared to 47.5% in the first quarter of 2017. The first quarter of 2017 gross margin included adjustments that were not reflective of the full-year operations with the full year 2017, reported gross margin at 43.7% of net revenue as a better comparison. That said the first quarter 2018 gross margin was less than expected for two primary reasons. First, we incurred inventory adjustments related to inefficiencies we experienced in quality control and manufacturing process as we scaled the production of the new mattresses to meet higher than expected demand. Second, we experienced higher freight costs during the first quarter associated with the online launch of the new mattress models as we initially flat-packed the new models as opposed to rolling them to achieve our February launch date. In late April, we resolved this issue, and began rolling the new mattress models and therefore expect to continued headwind to gross margin from increased freight costs in part of Q2. But expect lower freight costs in the second half of…

Thanks, Mark. We continue to be very optimistic about Purple's future prospects. There is a long runway for sustainable growth ahead of us, both in the online, DTC and wholesale channels. We have future growth opportunities from new product expansion and, as Mark mentioned, international expansion. We remain committed to capitalizing on the many opportunities that our unique comfort technologies give the company. While vertical integration can be challenging, it is one of the reasons we are optimistic about our long-term potential as a company, because of additional margin contribution and especially the IP protection it provides. We are committed to striking a balance between expanding market share and increasing our bottom-line in order to drive long-term value for shareholders. Operator, we are now ready to take questions.

Thank you. [Operator Instructions] Our first question comes from the line of Seth Basham with Wedbush Securities. Please proceed with your question.

Thanks a lot and good afternoon. My first question is around marketing efficiency. If you guys could elaborate on the key issues you're facing right now, break down the impact from advertising rate inflation versus more limited conversion that you are expecting in your decision to reduce your ad spend?

Yeah, you bet. As we look at just pure CPMs, we have seen those continue to increase over the prior year quite dramatically. We had expected going back to the beginning of the year that CPMs would moderate in terms of the year-over-year increases, and that has not happened. In fact, we've seen some acceleration. And that's really due to a few factors. One is just general economic conditions. The economy is good. There’s trends of people moving over into more and more digital marketing. And the marketing in the digital space is largely auction-based, and so it's driving those prices up. In addition, just our bed-in-a-box competitors, there is a very aggressive digital advertising going on right now, again, more so than we had originally anticipated for this year. There’s more entrants into the space and the existing competitors are stepping up their game as well to the tune of many, many millions of dollars above what we would have expected to be incurred on our side because of those increases to the auctions, and targeting the same type of consumers. And so, we are seeing upwards of high-double-digit, even triple-digit year-over-year increases in CPMs with our primary digital advertising partners. In general, our cost of our customer has gone up. As we're trying to expand our target audience, it's more expensive, and we need to do that to expand our growth rate. But it's something that we are looking to moderate to some degree and that's part of the reason for the change in guidance. Because what it allows us to do is it allows us to better optimize our ad spend as we target a broader audience. In other words, we're able to try new marketing tactics for our given audience, adapt, test, and then scale. And so, it's a combination of competition, just general economic conditions, and the bed-in-a-box players being so aggressive in digital advertising.

Got it. As it relates to conversion specifically on your traditional digital ad channels, are you seeing any significant changes in conversion for your core products putting aside your new products?

So, it's a little bit difficult to separate the original Purple mattress from the new ones in terms of conversion rates, because we're targeting an audience and they are coming into the space. They look and we're able to track this. They're able to look on our website and we see that they're going to the original, they're going to new, they're bouncing back and forth. And so it's a little bit difficult to separate those. But I would say that we have seen a decrease in conversion. Terry alluded to that in his commentary before the Q&A, that with the higher-price-points model, it's more of a considered purchase even than it was. And so, we've taken that to a new level and we do see those conversion rates dropping off.

Got it. And as you think about the advertising spend outlook going forward, paring back your initial expectations, but where are the places you're paring back most? Are you still focused on top of funnel brand advertising to drive awareness or not so much anymore?

No, we have been leaning more and more toward brand than we had historically. And we believe that that's the right move for us. As we set ourselves up for long-term success, we needed to invest in general brand awareness. You can call that top of funnel, but we’ve separated some degree, our marketing efforts into brand, top of funnel, and bottom of funnel. And as we try to optimize our marketing spend, we are focused on bringing in people into the funnel and converting them as quick as possible, but we are also taking initiatives that from a more brand broad -- and brand awareness perspective such as television advertising. Those are going to pay dividends in the longer run and they're a little bit more difficult to quantify in the short-term.

Fair enough. And then switching gears here, thinking about your wholesale growth being a little bit slower than you anticipated in your 2018 outlook, now how much of that is Mattress Firm versus other retailers?

Mattress Firm is a significant player. They are the majority of where our focus is right now, but they are not the majority of our wholesale business. Over time, we expect to expand into several different wholesale - retail partners through our wholesale channel, but there is no doubt Mattress Firm is going to be a major player in that space. We're very encouraged by the expansion that we've seen here in Q2, and we'll continue to see in Q3, but we aren't sharing exact percentages at this time with the wholesale channel.

Fair enough. In terms of the revision to your wholesale outlook for the year though, is that due to slower rollout with Mattress Firm more so than with other retailers?

It's a combination, and it really is just a difference in expectation of what we had expected was possible and where we're at today. But Mattress Firm has been slower than we anticipated. I don't necessarily want to speculate on why they have had a lot of changes going on, on their side of the business, and we're encouraged by what's happening right now and look forward to continued partnership with them. We do have plans to continue those discussions and further the test [ph].

Fair enough. One last question, and I'll turn it over to others. Thinking about your manufacturing operations now, few more snafus, it sounds like how do you feel about your ability to manufacturing more efficiently for the balance of the year?

Yeah, great question. We did have some issues as we ramped up the production of the new models, quality control as well as just some of the processes in place. We were forced to ramp up the new model manufacturing quicker than expected, which is a good thing, I mean, that the new models we're selling better than what we had anticipated. But we have made changes and we feel encouraged by the change we've made, we only have significant headwinds going out path Q2. We will have some in Q2, a little bit of headwind, and that is related to some of the same activities that we had going in Q1 related to just some inefficiencies and the manufacturing process. Those have now been resulted, but we will have some impact in April as well as the additional freight costs, we were flat packing those mattresses, which is really just the new design required some modifications to the rolling process. We work through those, and we will have - we are rolling those now. But we will have some impact gross margin in Q2 headwind. But Q3 and Q4, we anticipate will go very smooth from the manufacturing standpoint.

Very good. Thank you and good luck.

Thank you.

Thank you. Our next question comes from the line of Bobby Griffin with Raymond James Financial. Please proceed with your question.

Hi, guys, good afternoon. I appreciate, you're taking the time to answer my questions.

Thanks, Bobby.

I guess, firstly, I want to touch on with the revenue guide reduction from the last time we spoke, you gave some good detail on a few of the reasons why you are cutting back some of the expectations? But can you maybe provide some color on which one of those three that you listed off is driving majority of the reduction?

Yeah, you bet. The majority of this reduction, and I would just put it in this order, in order of priority, definitely diminishing returns on our ad spend. So just the pure cost to acquire a customer coupled with lower conversion rates right now is increasing that cost. So just couching that in terms of lower marketing effectiveness is the way we have to put it. And it does come down to a competition, the increase in the CPM. The need to expand our audience and how quickly we can do that at a profitable rate, could we grow faster, yes, we could, but we would be driving losses. And so the steps we take - we are taking right now, we believe are the right thing for the business in the long-term. That's going to enable us to be healthy and sustainable and be breakeven to positive. Second will be the wholesale channel, comparison to the forecast, this is actually in terms of a percent of the wholesale piece, a bigger change, in other words, it's a bigger drop. But in terms of the overall picture, we are primarily a direct consumer business right now. So that's the lion share. And then finally, our focus on international has come down a little bit. We've planned on rolling that out faster although you may recall last quarter, we talked about pushing that out. We are just pushing that out further. We realize that we need to focus and win in the U.S. But in terms of our long-term outlook, we have originally said - had originally said 30% to 50% growth over the medium-term of three to five years, we still believe that's the case. This is changing in forecast for this year, it's not changing our forecast for the long-term in anyway. We still believe in the long-term future of this business.

Okay. I appreciate that detail. And just a follow-up, I guess, on some of the conversations, but advertising costs, and correct me, if I'm understanding this not correctly, but you saw a kind of step-up since the last time we spoke in March with raising ad expense. I guess, what is your guidance or EBITDA guidance kind of assume for competition around key words and that's have a stuff going forward. Are you factoring another step-up, are you kind of considering the run rates that we're right now will maintain flat?

Yeah. We're expecting that on a year-over-year basis, we're going to continue to see increases in the CPMs with our primary digital partners. And that is the change in our forecast from previous, I think part of that is just the strong economy, the trends in digital advertising, so many more brick-and-mortar type businesses are pushing and pushing more digital marketing. And in this auction environment, it's just causing those prices to go up. And then again like I mentioned our competitors are getting better and better, and mimicking what we have historically done. And that's taking advantage of things, that we have been taking advantage of that in the past that's causing our prices to go up. So we're adapting. Our marketing team is phenomenal that being agile and trying to keep those cost down. If you were to see in our Facebook cost for example, double and even triple digits on a year-over-year basis. Our cost have not gone up, and we still be an effective at driving sales, as you look at Q1 we exceeded our expectations there. But it is putting a cap on what we feel we can do at a profitable level, in terms of just the overall effectiveness for the long-term or for the rest of the year. We are going to continue to adjust our marketing activities such that we can be profitable. And I feel like that something that we can and we'll do despite the fact that we see these increases.

Okay. I appreciate the detail. And then lastly for me, with one quarter of kind of wholesale rollout now behind you guys. Are you noticing anything different in kind of the profitability the two channels that's worth going out for us?

It is more profitable on the bottom line, we have a lower gross margin of wholesale, but we do have a slightly higher contribution margin, which is a nice tailwind to the bottom line. And so we expect as we continue to rollout more and more wholesale business. But that's going to drive profitability. And as we look at our long-term models that's a key to getting there. As we look at the short-term for DTC, it's going to be tough to be driving high profit, and the wholesale channels, what is going to enable us to do that.

Okay. I really appreciate the detail. Best of luck in the coming quarters.

Thanks, Bobby.

Thank you. [Operator Instructions] Our next question comes from the line of Brad Thomas with KeyBanc Capital Markets. Please proceed with your question.

Hey, good afternoon, Terry and Mark. Thanks for taking my questions.

Hey, thanks, Brad.

Let's see there. I wanted to just circle back on the DTC rollout of the additional models, you referenced to conversion rate being lower with that rollout. I guess, just to be clear and ask you directly, do you observe it to have any net positive to have added these additional models onto the website?

There's no doubt, that we're giving a tailwind on our gross margins from those, they have a slightly higher gross margin. And so we've seen that benefit in terms of the change in conversion relative to the sale. It's honestly a little bit tough to bifurcate and tell you exactly what that is. But what I can tell you is going forward, we anticipate making tweaks, changing the way we bring people into the website, changing the way we promote those new models in such a way that we will be able to measure that and maximize our return on having the new models on the site. So that could range anywhere from taking a model off from times and testing it all the way to something more extreme and putting them on a different site, but we'll continue to test refine and improve, there is no doubt that we able to sell those new models online effectively. And that's something that we had a questions are going in, there are very high price relative to the general bed-in-a-box industry. And our sales begun much better than expected in terms of Q1. But we're early on, we only launch them in the second week of February. And we've continued down the path like we always do a test refine and scale, and we continue to refine. So I can't really tell you exactly where it's going to end up. But I am encouraged by the results.

Great. And then just trying to get a better understanding of how you're thinking about growth as we move through the year. I know, you are getting into specific numbers on the different channels between DTC and wholesale. But I guess, can you help us think about what rate of growth you're now expecting out of that DTC channel as we move into 3Q, 4Q, it looks like you're still at least probably clocking in at a double-digit growth rate, might just still be in 30% or 40% range in the back half of the year? How are you thinking about that growth rate?

Yeah, absolutely. The growth rate for the back half of the year is going to be somewhere in 40% to 50% growth rate. So let me just give you a little color, we would expect as of right now that we're giving guidance for Q2, Q3 to be slightly higher and then the balance fall to Q4. So that should give you at least an indication generally speaking of what the rest of the year will look like.

Got you. And so for 4Q, if you back out the retail side of things, you think DTC is probably still 30% or north of there?

Yes. Absolutely. Yeah, we still expect DTC to be the lion share regardless of the rollout with Mattress Firm or other retail partners. It's going to be the lion share for the remainder of 2018.

Great. And just on the topic of competition, the online part of the market continues to evolve it a very rapid pace, the traditional players are doing some different things. I guess, when you look at the competitive landscape? Are there any particular players, you feel like maybe putting more pressure on you or just everyone, in terms of those advertising cost in the competition?

Yes. But I'm not sure I want to give them credit. There is a handful. The biggest players and the biggest spenders frankly are the ones that put the most pressure on us, right. And so the cash purse of the world that are just spending so much money, basically the top five competitors are putting a ton of pressure. And then there is a host of smaller ones. But it's really just a question of whose spending the most, and that's what we feel the pressure. Whose mimicking us in the most common way, so those that are targeting more video than not, we'd also be putting pressure on our cost, those that are following our strategies are the ones that we feel that pressure from.

Got you. And then just on the topic of input costs and raw materials. Is that something that you're feeling the effects of it late? Obviously, many others in the industry are seeing increases in the petrochemicals and the steel prices. What you are all seeing?

Yeah. So we only have good visibility through the end of Q2, right. But for Q2, we are not seeing a significant change in any of our input. The biggest input for us, we have commodity exposure foam, first of all. And we saw foam for us increased fairly dramatically over the course of Q2, Q3 of 2017. And then moderated and flattened out in Q4. And we've seen that continue to stay the same. Steel coils, we're relatively new in pushing any type of volume with steel coils. And we have our expenses pretty well set for the remainder of Q2 and we're not expecting any dramatic changes for steel coils or headwinds in Q2. Mineral oil, which is another major input, as you know, we do feel a little bit of pressure there from a commodity standpoint. But for Q2, we don't expect it to be a measurable impact to our cost of sales. The only other item will be textiles and that's been flat, so.

Great. And maybe I can squeeze in one last one for Terry, that I think everybody will be interested in hearing was - it's just if you have any sense of update on maybe the timing that you think you might have in announcement of a new CEO.

Brad, I just can't outguess the process. I really would like to have some guidance. It's very active right now. And we will keep everyone informed. But there is just no way to put a hard schedule or even a decent guess on that. We would say it's starting to…

Well, I appreciate you. Let me ask anyway. It sounds good.

Yes, it is going well. I mean, I'm seeing results. I just - we're not to a point where we can say, we think it will be 20 days or 50 days or any number.

That's great. All right, well, thank you guys so much.

Thanks, Brad.

Thank you. Our final question comes from the line of Peter Keith with Piper Jaffray. Please proceed with your question.

Good afternoon, guys. It's actually Bobby on for Peter. How are you?

Hey, Bobby.

Just going back to the top-line guidance, I appreciate what you guys have given so far. Is it more fair to say that lowering guidance on that, that you did, just a matter of getting the - further clarity on the business as you're growing it out or are there have been some things that have really changed from an operational standpoint, if you could touch on over the past couple of months. Thank you.

Yeah, you bet. So nothing major in terms of the operations. We do have the new mattress models and that has caused us to take a look at the conversion rates. Like I mentioned, we'll continue to refine the model around how we sell those. But overall, our marketing is what's driving this business and we're choosing to operate in a profitable fashion as the dynamics of the industry and the competitive landscape are changing. It's really that drives breakeven or positive growth so that we can sustain this business that's driving them. And we're just adapting to the conditions. But overall, we're really pleased with what we've been able to do in the last quarter. From an operational standpoint, from a manufacturing standpoint, yes, we've had challenges. You'll recall we had challenges with our white glove delivery service. We are working through all those kinks [ph]. I'm very encouraged by the progress we're making. So we're a new business. We've only been around 2.5 years in this current form. And there is a lot of growing pains when you're growing this fast, but we're getting the operations in place for getting the marketing dialed and we're getting our ability to forecast out as well.

All right, great, I appreciate it. And just also quickly around advertising, I remember like last quarter, that as well ship be based on your manufacturing capacity and the backlogs that you're having. So how is that kind of settling out right now, just the timing of getting ad spend and capacity on the same page?

Yeah, so, let me just address capacity and then I'll talk to the shipping. So capacity, we are doing extremely well. We brought on an additional Max machine that is - it's firing on all cylinders right now. And we have plans to continue their expansion throughout this year to make sure that we have the capacity we need as we grow, and then we can capitalize on opportunities and changes in the environment. In terms of shipping, we do have what I would term a backlog. But it's not a backlog from a capacity standpoint. It's a backlog from the ability to get the white glove delivery service from that time of transaction, all the way into the consumers' hands. And we were struggling. We had a lot of growing pains in terms of bringing in on that third-party delivery service. But that is improving. We did have a backlog, quote unquote, backlog from a delivery standpoint at the end of March, in the neighborhood of $7 million, which you can see on our financial statements. That's up from $3.2 million as of December 31, so effectively there was a roughly $4 million loss of sales in the period from that. But as you look out into the future, we do expect that we will continue to have a rolling impact, and not necessarily pick up in Q2 that $4 million. Anywhere from 5 to 14 day delivery timeline of those sales of those new models from when we actually make the sale. But we're encouraged by what's happening from a shipping standpoint. We are making improvements. And we still will. One of the big issues was the flat packing, just due to the modifications and getting the new mattress models rolled. We've resolved that. We're now shipping all of those models, which makes everything easier. It makes the trucking from us to our third-party more efficient. It makes the delivery easier for the delivery partners. So that's now going well, but we did have some serious growing pains.

All right. Great. Thank you and good luck.

Thank you.

Thank you.

Thank you. Ladies and gentlemen, I would now like to turn the call back to management for closing comments.

I just want to point out, as Mark said we still have our mid- and long-term guidance the same as it was. We are reducing the short-term guidance. But that doesn't mean Purple is on the road. Purple is growing. It's thriving. It's very healthy. We are doing the right things to keep Purple on track. And we feel our investors out there and we want to support everything it takes to make Purple as successful as we hope to be. So mid- and long-term we're still on track, short-term we did change the guidance, but we're still working to EBITDA - we're growing as fast as we can with that given EBITDA negative. So, I guess, we're shooting for no EBITDA. But that's a very big step ahead of most of our competition right now and it makes us healthy as long as we don't lose money.

So thank you all for joining. We appreciate your time.

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.