Thank you for joining Purple Innovation's fourth quarter 2018 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 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 fourth quarter 2018 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 measure can be found within the earnings release and in 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 Joe Megibow.

Thank you, and good afternoon, everyone. With me on the call today is Mark Watkins, our CFO.

During the fourth quarter, my first quarter as Chief Executive Officer of Purple, our organization took important steps toward preparing the company for improved financial performance and scaling the business for growth. Our top line results reflect some initial progress, while fourth quarter profitability highlights that there is still much work to be done.

I'm going to discuss the main drivers of our fourth quarter performance, and then walk through the key priorities for 2019. Mark will then review the numbers in more detail and outline guidance.

Starting with revenue, which came in at $78.5 million, up 25% from a year ago and slightly above the midpoint of our guidance range. The strong year-over-year increase came primarily from growth in our wholesale channel as we significantly expanded our physical reach throughout 2018.

I spoke last call about the importance of establishing a broader brick-and-mortar presence in order to allow our customers to experience our mattresses firsthand before buying. As an innovative new bed, with highly differentiated technology, we wholeheartedly support potential customers' desires to experience our bed for themselves prior to purchase.

After launching Purple at retail through a limited test with Mattress Firm in late 2017, the company has made meaningful strides toward building a larger retail network, especially during Q4 when we significantly increased our door count. At the end of 2018, our mattresses were on display and sold through over 700 stores, including more than 450 Mattress Firm stores as well as several other leading names like Macy's, Furniture Row and Bed, Bath & Beyond.

A recent expansion puts over 60% of our target demographic within 30 miles of a store where they can experience the difference between our mattresses and the competition. On top of the recent expansion, we've experienced very good sell-through for our products which led to strong replenishment orders in the quarter and good momentum early in the new year.

In terms of our direct-to-consumer business during the holiday quarter, we experienced success in a number of areas in marketing. In December, we rolled out our very first-ever cash discount promotion on our original mattress resulting in Cyber Monday being our largest sales day in history, up more than 40% year-over-year, with Black Friday as our second-largest day ever.

During December, we tested expanding the promotion to all of our mattresses which resulted in a nearly 40% increase in units during the promotion period while still driving margin accretion. More on the brand front, we successfully implemented our cross-channel promotion with Disney for their new Wreck-It Ralph movie.

We were able to drive hundreds of millions of impressions from takeovers on YouTube, Internet movie database, Yahoo!, AOL and Disney social properties. We also finally launched our first twin-sized mattress offering which began shipping in late December.

Industry-wide, twin mattresses are the second highest volume in units behind queen mattresses, so we are optimistic about its success. Throughout Q4, however, we continue to manage marketing spend to cash and shifted a majority of the marketing spend to direct response and lower funnel marketing tactics which reduces overall traffic levels into Q1.

Below the revenue line, we started to attack our expense base and the operational inefficiencies in our manufacturing, supply chain and delivery processes. First, we reduced our headcount by more than 10% to better align our cost structure with the size of the business.

As I mentioned last earnings call, we had begun to focus on our larger suppliers and fulfillment partners in Q4, we have already successfully negotiated improvements that we believe will result in more than $7 million annually. As for production, we have been very focused on labor efficiencies through a combination of automation, production line improvements and sourcing preassembled components.

Through these efforts, we were successful in reducing our variable labor cost per unit by almost half from Q3 to Q4. For fulfillment, we have successfully migrated all of our heavier fulfillment to XPO and pilot facilities and saw a dramatic improvement in our fulfillment processes and reliability.

We have also begun serious work on corporate controls around quality, compliance, sourcing and process accuracy, including standard MSAs and dual-sourcing vendor strategies. We also completed the work on a bottoms-up S&OP model in Q4 that is finally aligning production and demand across all functions.

This new model and process rolled out early in January. All that said, we were still challenged in Q4 in production and fulfillment, running a backlog on many core products through the entire quarter, which continued to contribute to higher-than-industry average cancellation and return rates.

In early January, I'm thrilled to report that we appointed John Legg as Chief Operating Officer. John has over 20 years of experience in manufacturing and supply chain management in the wholesale, retail and direct-to-consumer sectors.

We believe that John's work, especially with consumer-facing companies, make him a great fit for this role. John had been consulting with us for over 6 months, and we are thrilled that he agreed to join us full-time.

Since he came on board about 2 months ago, John has gracefully transitioned into an ownership role and has been very well received by the team. For 2019, the plan is to accelerate the early progress we made in Q4, executing the initiatives aimed at expanding Purple's market share and driving profitable growth.

We expect 2019 to be a foundational year as we build out our growth platforms and capabilities. Our key priorities are in four areas: product innovation, omnichannel retailing, organizational effectiveness and brand development.

We have kicked off more than a dozen initiatives across these areas, and it has been great to see the company come together cross-functionally. For product innovation, the first of the 4, core initiatives include improvements in our manufacturing processes, such as launching our max 5 machine midyear, as well as Italian-built automation equipment.

Improvements in our fulfillment capabilities include leveraging regional 3PL warehouses, institutionalizing a product life cycle management process and flushing out an appropriately-sized innovation team. For omnichannel retailing, we will continue our efforts to service the customer, wherever and however they want, including an anticipated more than doubling of our retail partner doors, significant improvements to our website and are exploring brand showrooms.

For organizational effectiveness, we continue to aggressively hire for key roles as well as maturing and building our core functions. We have recently signed on a consulting firm to assess our control and processes across the company in an effort to both reduce waste and more importantly, improve accuracy, which we have been challenged with throughout 2018.

And finally, for brand, we are working with an outside brand strategist to better align our brand positioning and creative with the unique benefits of our products. In 2019, we have already had a few successes across these key areas.

For example, in production, we have successfully deployed a 3-inch mold on one of our max machines which has improved the quality and throughput. I'm also thrilled to report that through John Legg's efforts over the last few months, we have increased our production throughput such that we have had 6 consistent weeks maintaining output that previously was only achievable for a few weeks over all of last year.

With these efforts, we have caught up on our backlog and are running a production surplus, which we expect to maintain for the rest of the year. For product innovation, we launched our new Plush Pillow, which we believe is our most accessible pillow yet, with novel zippers on each side that allow the pillow to expand and collapse, providing highly personalized variations in softness or firmness.

The launch far surpassed our expectations, and we completely sold out our initial production run in under 2 weeks, more than 6x the expected sales. I'm also thrilled to report that a significant number of purchases were made by existing customers, which reinforces our belief in the strength of our brand and our customer satisfaction.

To help support our strategic initiatives in working capital, we recently finalized $10 million of additional financing with our existing lenders. While I am confident that we are on track towards running a sustained cash flow positive business, this additional funding provides us with greater flexibility to execute our growth plans.

Before I wrap up my remarks, I want to thank Mark for his hard work and dedication to helping lead Purple through its first year as a public company. Mark has been instrumental in identifying and addressing the challenges that face a young, high-growth company like Purple, the business is on much more solid footing thanks to his efforts.

As we announced earlier this year, Mark has decided to step down as CFO at the end of this week. On behalf of the entire organization, and me personally, we wish you the best in your future endeavors.

I'd also like to announce that we are in the process of retaining Craig Phillips from FTI's Office of the CFO practice to help in the transition. Craig brings decades of experience in manufacturing and cost accounting, and we are confident that once we bring Craig and FTI on, we will continue to mature our business while we search for a full-time CFO.

And with that, I'll turn it over to Mark Watkins, our CFO.

I appreciate the kind words, Joe. Despite the fact that I am leaving Purple for personal reasons, I sincerely have never been more optimistic about Purple's products and opportunities for growth.

Now with that said, I'll turn to the fourth quarter results. For the three months ended December 31, 2018, net revenue was $78.5 million, up 24.5% compared to $63.0 million in the prior year period.

The revenue increase was primarily due to continued wholesale door expansion, combined with higher replenishment orders following strong sell-through during the quarter. In addition, our higher price mattress models, which we initially launched in our wholesale channel in Q4 of 2017 and in our online direct-to-consumer channel during the first quarter of 2018, contributed to the year-over-year increase in net revenue.

Gross profit dollars were $26.8 million during the fourth quarter of 2018 compared to $25.9 million during the same period in 2017, with gross margin at 34.2% compared to 41.1% in the fourth quarter of 2017. There were several factors that contributed to the decline in gross margin, with the 2 largest being a shift in sales mix, to more units sold with wholesale pricing and higher return and discount rates it, which widened the spread between gross and net revenue.

Wholesale channel revenue comprised approximately 25% of net revenue for the quarter compared with approximately 4% last year and compared to approximately 16% in the third quarter of 2018. Gross margins were also negatively impacted by a higher freight costs associated with the white-glove delivery service for our heavier mattress models, and increased costs incurred to make necessary improvements in the area of quality and fulfillment.

These headwinds were partially offset by the higher product margins from the new mattress models. Operating expenses were $32.0 million in the fourth quarter of 2018 versus $30.4 million in the prior year period.

This increase is primarily due to higher general and administrative expenses, associated with supporting top line growth as well as expenses associated with being a public company. Marketing and selling expenses, as a percent of net revenue, improved 690 basis points to 33.0% from 39.9% in the fourth quarter of 2017, driven by improved efficiencies in our marketing initiatives as well as higher net revenue from the wholesale channel.

During the fourth quarter, we reported an operating loss of $5.2 million compared to an operating loss of $4.5 million in the fourth quarter of 2017. After adjusting fourth quarter 2018 results for merger transaction costs, legal fees, equity incentive compensation, severance and CEO search cost, adjusted operating loss was $4.3 million compared to an adjusted operating loss of $3.4 million in the fourth quarter of 2017.

Net loss for the quarter was $5.4 million compared to a net loss of $4.6 million in the prior year period. EBITDA for the quarter was negative $4.5 million compared to negative EBITDA of $4.2 million in the fourth quarter of 2017.

Adjusted EBITDA, which excludes the same nonrecurring costs I just mentioned, was negative $3.7 million versus negative adjusted EBITDA of $3.2 million last year. Turning to our full year results.

Net revenues for 2018 were $285.8 million, up 45.2% compared to $196.9 million in the prior year. Gross profit dollars were up 32.4% to $112.6 million in 2018 compared to $85 million in 2017, with gross margin at 39.4% compared to 43.2% last year.

The decrease in gross margin was driven primarily by an increase in return and discount rates, increased freight costs, a shift in sales mix to more sales with wholesale pricing and manufacturing inefficiencies. These headwinds were partially offset by the higher product margins of our new mattress models.

For the full year 2018, wholesale channel represented approximately 15% of total net revenues compared to approximately 3% in 2017. Operating expenses were $129.5 million for 2018 versus $93.8 million in the prior year.

This increase is primarily due to higher marketing investments to expand brand awareness and drive consumer demand for our products, and to a lesser extent, higher general and administrative expenses associated with supporting growth and being a public company. In addition, operating expenses included $3.5 million of onetime nonrecurring costs related to business combination transaction with Global Partner Acquisition Corp.

as well as litigation cost, CEO search and severance costs. We reported an operating loss of $16.9 million in 2018 compared to an operating loss of $8.7 million in 2017.

Adjusted operating loss was $12.9 million compared to an adjusted operating loss of $6.9 million in the prior year. Full year net loss was $19.6 million compared to a net loss of $8.8 million in the last year.

For 2018, EBITDA was a negative $14.7 million compared to negative $8.0 million in the comparable period of 2017. Adjusted EBITDA was negative $10.7 million versus adjusted EBITDA of negative $6.1 million a year ago.

Moving to our balance sheet. As of December 31, 2018, the company had cash and cash equivalents of $12.2 million as compared to $3.6 million at the end of 2017.

The increase since the end of 2017 reflects the funding from the business combination with GPAC, along with the term debt finalized on February 2, 2018, which was partially offset by working capital needs of inventory and increased receivables from growth in our wholesale channel as well as capital expenditures. As Joe already mentioned, we recently closed an additional financing in the amount of $10 million for a 5-year term loan with Coliseum Capital Partners and Blackwell Partners.

The summary of the terms are included in the 10-K we filed today, and the details of the loan, as reflected in the amended and restated credit agreement, were disclosed in an 8-K filed in February 27. This brings the total principal indebtedness to $35 million and extends the maturity date for all loans under the initial Coliseum credit agreement to five years from the close of this most recent funding.

Due to the amendment of the term of the original $25 million loan, which took place in February 2018, generally accepted accounting principles under extinguishment accounting, require us to expense the unamortized outstanding debt issuance costs and discount from the original $25 million loan. In addition, we will expense a portion of the value of the incremental warrants awarded at the closing of the $10 million loan, bringing the total noncash expense that will be recognized in the first quarter of 2019 to approximately $9 million.

Net inventories totaled $22.9 million at December 31, 2018, compared with $13.3 million at the end of 2017. The increase to inventory as of December 2018 compared to 2017 was due to an expanded product line, the growing demand for our products and the stocking of new models at third-party regional distribution centers.

Compared to the end of the third quarter, inventories were down $5.7 million or approximately 20%. The decline in inventory on a quarter-over-quarter basis was due to improved inventory management, solid holiday sales in response to promotions and higher-than-expected unit sales within our wholesale channel.

Now turning to our guidance. For the full year 2019, we anticipate net revenue in the range of $350 million to $375 million, with adjusted EBITDA in the range of positive $3 million to $8 million.

For the first quarter of 2019, we anticipate a slower top line growth rate than the full year growth rate, with investments being made in the first and second quarters that we believe will drive higher growth rates in the back half of the year. These investments include a new brand campaign and other marketing initiatives, along with continued improvements in our supply chain and overall capabilities.

We anticipate an adjusted EBITDA loss for the first quarter, with improving bottom line performance sequentially throughout the year. Regarding gross margin for 2019, we anticipate an improving trend during the year, with the first quarter being modestly higher than the fourth quarter of 2018.

With that, I'll now turn the time back to Joe for his closing remarks.

Thanks, Mark. As I said in our last earnings call, we have a lot of work to do, but I continue to remain very optimistic.

As Mark just guided, we anticipate running an EBITDA-positive business this year while maintaining healthy growth rates. I want to reiterate that this is a foundational year.

It will take a few more quarters to turn the business, which is what we have built into the plan. Most importantly, now that I am 5 months into the role, I can state from direct experience that I'm very proud of the team and have very high confidence in their ability to execute, not only on the fundamentals, which are consuming much of our time right now, but also on the work beyond our current products where we continue to identify both short-term and long-term opportunities ahead of us.

We all continue to be highly motivated by our mission of helping our customer feel and live better through our unique comfort technology. And with that, we are now ready to take questions.

My first question for you guys is just understanding the margin changes in the fourth quarter a bit more closely. Specifically talking about the gross margin changes.

You called out two primary factors, Mark. Can you give us more color as to how big the shift was from your channel mix relative to how big the shift was from the returns and whatnot?

Yes. So --

Actually, Mark, before -- hey, it's Joe here. I just -- go ahead.

No, go.

The line was closed before. Mark, I think you mentioned the 10-K filed earlier today.

I just want to clarify for those in the phone than the 10-K will be filed soon. I also just want to get out that John Legg stepped in and has joined as our COO as well as Craig Phillips, so they are both present as well.

And sorry about that. Go ahead, Mark.

Yes. So thanks for the question, Seth.

We did mention there's primarily two factors driving the gross margin decline in Q4. The biggest 2 being our sales mix shift.

We shifted from approximately 16% of our sales being wholesale in Q3 up to 25% in Q4. We do expect that shift to continue to take place, so there will be margin pressure going into 2019.

That is the biggest reason. The other reason is a continuation of what we've talked about in the past which is a higher return rate.

I would like to mention, however, that we are seeing some improving trends on the return rate, but we did discount a little more heavily in the quarter as well. And so when you factor in the higher return rate and the discounts, that gross to net gross ratio has a wider spread, and we do have all the cost associated with fulfilling those orders, returning those orders, et cetera, without the benefit of actually getting that product back and selling it.

So in terms of overall impact, that's making up roughly 2/3 of the impact, with the other pieces being some manufacturing inefficiencies and increased freight cost. We did experience, during the fourth quarter, some unique items related to our fulfillment partners.

We made a transition away from our -- one third-party logistics provider for white glove delivery service, and have brought on 2 new partners, which Joe mentioned in his prepared remarks, XPO and Pilot, both of which we expect to benefit the bottom line, benefit our margin going forward. But due to the fact that we made those transitions during the fourth quarter, we did see some negative impact as we cleaned up some of the inventory associated with moving it back and forth and just cost of making that transition.

Going forward, Seth, we do believe that we have some benefit from freight. We do believe that some of the items that Joe mentioned in terms of our production efficiencies are improving.

However, as also I mentioned in the prepared remarks, first quarter is a little bit of still a turnaround. And then we expect some improving trends on gross margin throughout all of 2019.

Got it. Okay, that's really helpful color, Mark.

Just taking that 1 step forward, if we think about the gross margin trajectory for this business, where do you guys see yourselves being in 2 to 3 years' time? What's the mix of wholesale to retail that you're expecting?

And where do you expect margins to be to support this business?

Yes. So wholesale, we have a lot of opportunity right now, which we're clearly capitalizing on.

I would expect this year we'll be north of 30% of our business through wholesale, which obviously, as Mark was just saying, creates some margin pressure as there's a few hundred basis points of difference in margin there. Longer term, I think we'd settle something on the low end of that, more of the 70-30 range.

I think we've got a healthy wholesale channel business that we intend to continue to support. We think it's great for our customers and it's worked well for our retail channel partners.

We will be continuing to revitalize our direct-to-consumer business as well as, as we continue to do with more product expansion, creates other opportunities as well. So again, I think we are going to have a little more margin pressure in the short term as we flex up a little more on wholesale and work through some of these manufacturing and sourcing challenges, but we fully expect it to improve over the next 2 to 3 years.

And then my last question, I'll turn it over. Just thinking about the brand initiative that you have.

I wanted to elevate the Purple brand to the more premium marketplace. How does that juxtapose with the news to implement some discounting, and do you think that could take away from that initiative?

Sure. So we're being cautious with how we're discounting, and we've been discounting in one form or another since we launched.

It's just a question of in what form, whether it's the product giveaways whether it's -- as we tested recently, some actual cash off. Industry-wide, it's very competitive, and there's much, much deeper discounts in general.

And even what we've seen, and we've been watching closely on the more premium side of the business, there are appropriate periodic seasonal promotions that go on. So I think that suggests that we are not going to have any kind of discounting or promotion activity, would put us out in a very unusual position in the market.

What we're just trying to make sure is that, as we continue to go up, up market and get rewarded for the premium product that we are, that we are making sure our promotional strategy and discount strategy is appropriate with a more premium brand, and I think there's a lot of market reference points on how to do that well.

Mark, wanted to wish you all the best as you move on to other things.

Thanks, Brad.

Thanks, Brad.

So wanted to talk about the outlook for revenues. Obviously, you're guiding us towards revenues growing at a little slower rate in 1Q, and then accelerating as we move through the year.

I guess, Joe, can you help us think about what's going to drive that revenue growth? How much is B2C versus wholesale?

How much is new products versus existing products? What do you see is driving that acceleration in revenue growth?

Yes. So first thing, I think, I can't articulate this enough, we have a lot of demand out there that we've been unable to meet, and we have largely been throttling our growth against our ability to produce in a timely manner.

And we've had a lot of challenges there. And we've seen it in our return rates, in our cancel rates.

We've seen it in social media and consumer comments. So there's nothing new here.

With John coming on board, and he's put some great new leadership and team underneath him, we have really focused on producing a quality scale operation on sourcing, on manufacturing, on fulfillment. And as I mentioned in the prepared comments, we hit a terrific milestone with him the last few weeks, which is, we've officially gone from being in a constant state of catch-up, and running a backlog in all products and most painfully in our core products, to a place where we are now running a surplus.

And that goes alongside our ability to do much better planning, so part of what John's team has developed is a true S&OP model, where we are able to much more effectively manufacture into expected demand in a timely way. So some of this has just been turning the spigot back on, especially in wholesale, where we have store and door openings that are ready to go, and we've just been trying to make sure we do it in a responsible manner, where we can meet the needs of both our retail partners and our customers.

So there's a lot built in there, and this is -- it's been painful, but it's a great problem to have, and one that we believe we have now solved. Once we get back there -- yes, there's obviously only so much, that's a one-time lift there as we can now meet our existing demand.

The rest comes in with more in the back half of the year, as we look at improving our product assortment, as we look at the brand refresh that I've mentioned several times now, as we look at rebuilding how we communicate with the new messaging and a refreshed website and refreshed content around that, there's a -- we've been working with a variety of our partners out there on the marketing side and some very smart people. It's unanimously viewed that there is a lot of upside we have, as we just clean up our operations on the marketing and direct-to-consumer side, and there's just lift we're going to be able to take from that as well.

Got you. And Joe, just to dovetail off of that and connect to Seth's question about margins.

What are you seeing in terms of customer acquisition cost? And where do you think those go here in 2019?

And what kind of opportunities do you have to get more efficient with the marketing?

Yes. I mean, it's a combination.

We -- this year, we built just a really solid, bottoms-up operational plan that I'm really proud of the work we did to go into that. And part of it is not just looking at what the acquisition cost is, but what are we doing in terms of organic traffic, overall conversion rate, average order size, as we're playing with our price points as well.

So I think on the, on just the acquisition cost, it continues to be expensive. We're seeing some of our peers out there on the Internet side of mattress sales pulling back a little bit.

And just categorically, we're seeing some softening in the market overall, which hopefully will help with some of just the general marketing expenses out there. But really, we're looking at a different way, with just how do we get much smarter with our spend.

How do we find better and more-qualified customer pools? How do make sure we're getting conversion rate that's appropriate for our marketing, which we just have not been getting at the levels that I believe are right for us.

As well as, again, in terms of making sure that on those expensive price points, we're getting the highest average order value we can. So again, I just think it's a much more nuanced situation, and one where rather than just fighting the head-on option marketplace, it's how we're working our money better in general.

Mark, all the best as well from me. I wanted to just look at the contribution margin dynamic between wholesale and direct, and how that could play out over time.

And there's probably a lot of nuances, but maybe with just broad brush strokes, is the contribution of margin do you think, just looking out, going to be greater on the wholesale side or direct? And -- or is it possible that you could be indifferent to which channel products are sold?

Sure. Thanks, Peter.

Good to hear from you. Joe here.

I'll start and Mark can perhaps provide a little more color. Right now, we're continuing down our strategy of, call it, that more frictionless channel view of let's just get the product to the customer wherever they see fit.

And it has been incredibly effective for us to get the product out on the floor with our retail partners, where customers can touch and feel the bed. It had been the biggest demand signal we heard, that I'm just still not sure, it's such a different kind of bed, where can I feel it for myself?

I mean, we've done -- our latest TV ads have played into that concept. So as long as we've been able to keep margins close -- close is a subjective term, but I mean we're in fighting chance of being close, I think it's worked really well for us.

What we're seeing now though is as it's become a much more significant part of our business, the delta between the margins through wholesale and margins through direct are starting to become more -- flow through more, and we're seeing that. And it is a few points of difference, so that is creating some margin pressure overall.

Right now strategically, we're perfectly okay with that. As really, this is part of our brand building and penetration strategy out there.

And as we improve margins in general at the product level, which is part of the assortment refresh that we're looking at, I think some of that will be able to work itself out. But it is in the short term for sure, there is some pressure there.

I don't know, Mark, if you want to add any color.

Yes, so maybe getting into a little bit more of the nuts and bolts of the contribution margin. As you look at gross margin, obviously, it is less on a wholesale pricing than a retail price.

The marketing dollars associated with acquiring that customer, the attribution of that marketing dollar is very difficult. And so we do believe that we have good contribution margins at wholesale.

But as we look at what happened over the last quarter, we included a new button on our website, which is Try in Store. We immediately saw uplift in our sell-through at retail, which is very positive, and obviously shows that we are attracting those consumers to our site, and then directing them off to one of our retail partners to purchase that mattress.

We believe there's an uplift across the board, but the contribution margin, because we are sharing with that retail partner, and them acquiring the customer, show-rooming the product where applicable, or sharing in the cost of advertising, we believe the contribution margin is solid, but getting to a true attribution is difficult. So overall, we believe it's the right model to have this omnichannel strategy, and we'll continue pursuing it.

Okay, that's very helpful feedback. And Joe, you were sharing some interesting stats around the pillow that just launched and it sounds like it was quite successful.

Were there any changes that were made under your tenure around that pillow launch that maybe from you or from people you work with that you think drove some improvement that we could look to for future product launches?

If you're asking me to pat myself on the back, I'll try to do that as delicately as I can. The -- no, well, I think there was a big change that I helped bring into the organization, which is we don't need every single one of our products to itself be an innovative tie-in with our hyper-elastic polymer and those core technologies, or just be an accessory, like a power base or a frame.

But there is an opportunity for us to service our customer with the same spirit of innovation and the same support of the brand platform that we have. And that was a slightly different lens to look through as we stopped thinking of ourselves as just around a manufacturer of a few products, and more into really a retailer brand with an assortment of products to service our customer.

So I think directionally, I think that's more of where we're heading, and it's early days with this new product. But so far, it appears that there definitely was market demand for a product like that.

So -- and I think again, as you think about managing a retail assortment, you're going to see more of us pushing in the direction of what a vertically integrated retailer looks like versus a manufacturer who happens to do retail.

Okay. One last one for me on the modeling question.

So we can get to the Q1 EBITDA decline, and you kind of framed up the gross margin in Q1, so to get to the full year EBITDA guide, we certainly need to pivot from EBITDA margin and year-on-year decline to now pretty healthy increases. Where are the key levers in the P&L?

Is that primarily around gross margin? Or are there some expense lines that you would expect to see leverage as well?

So we do expect to see just operating leverage in general as revenue increases. But a large part of the increase will come from gross margin at that line.

So some of the benefits that we expect to see over the course of the year, definitely some manufacturing efficiency improvements. We are implementing new automation equipment.

We actually have it sitting in our facility finally, which is encouraging, so getting that up and running. As well as Joe mentioned, all of the improvements that John Legg and his team have made over the past several months and seeing production just improve to hitting solid, sustainable levels that will enable us to meet all of the demand.

So that's one of the items. Sourcing is another big one.

Again, I believe Joe mentioned that, we have not done a fabulous job in the past of sourcing and we've got some great resources internal that are going through the process of renegotiating, finding new vendors and we expect sourcing to pay some dividends for us in terms of improved margin over the course of the year. We also mentioned the freight.

Freight outs, so delivery to our consumers. They had changes over to XPO and Pilot have been very positive from a cost perspective, and we see other opportunities from the cost of delivery perspective for improvements throughout the course of the year.

And then we continue to expect to improve our return rates. And as those return rates continue to come down, which we're seeing early indications that they are, that will also benefit the gross margin.

A few things to the opposite side, some of the takes would be a continued expansion of the wholesale channel. And we do see some input cost in terms of labor increases for production.

But net-net, we expect to continue to improve throughout the year.

Two others, Mark. We, again, we are looking to continue to expand and refresh our assortments and part of what we are building is ways to both improve margins in general and the price points and the cost of goods as well as -- I've been calling it, design for fulfillment, making sure that as we design product, we are designing with fulfillment cost in mind.

Again, we have nothing to announce at this point, but there are some things we expect to happen later in the year that will improve that. And the other one is just marketing in general.

We are assuming that as we improve the effectiveness of our brand messaging and significantly invest in better -- a better set of website and landing pages and the marketing techniques around that, that we will see improvements in conversion rates, which means we'll be getting more efficiency from our marketing dollars, which will improve the margins as well.

Mark, can you give us the wholesale penetration for 2018 for our model, or we can kind of tune everything up? We have 3Q and 4Q, but we don't have 1Q and 2Q.

Yes, I actually can. So as we look at how wholesale penetration proceeded throughout the year, Q1 was 6%, Q2 was 11% and then Q3 was 16% and Q4, 25%.

Okay, I appreciate it. And then in terms of the return rates, my next question, I guess, around gross margin.

But in terms of the return rates and the shipping headwinds, the large models going through are too heavy for UPS. That's in the guidance to continue all of 2019?

Or does the guidance assume -- so reengineering of the product for better fulfillment? How do I think about that?

And then also, secondly, what was the impact from the higher return rates in 4Q? And was that a sequential improvement versus 3Q, I guess?

Yes. So we -- and there's actually two sides to the, call it, the logistics or freight side of direct-to-consumer.

So one is, what are we doing to make sure that we can FedEx as much as possible? And we are expecting some changes at the product level as we continue to expand our assortment and refresh our assortment.

That is a big lever that we have. The other is a little more nuanced, which is, are we making sure the customer is getting the appropriate value equation in terms of the value-added services we provide with white glove.

We have been exploring on -- if we were to reduce the price and take white glove away where there's an option, because on our premium mattresses, we give the -- we don't have to use freight, we can use FedEx on the smaller beds. And how do we actually position that to the customer to make sure that, again, it is a fair value exchange in terms of taking the old bed away and getting the added service of setting the bed up.

So we're exploring ways to make sure that we optimize that value equation, both on the outbound and any return costs associated with that. And what we're finding is yes, as with most things, there is an elasticity curve on that, and different offers do resonate with customers differently, and we expect to see some wins there as well.

And then, Bobby, on your question of the sequential return rate from Q3 to Q4, we did see a drop in our return rate. Of course, this is accrual accounting, so there's a little bit of nuance here, but between 200 and 300 basis points, so fairly significant.

As we're implementing these initiatives, we're seeing them take hold and working very well. Those were offset in the quarter, however, by higher discounting.

And so that's where -- when we talk about gross margin, we didn't see that benefit flow through in the quarter. But as we go through 2019, it gives us some confidence that we've got some tailwinds there.

Yes. One other point that I did not bring up in the prepared remarks, but I probably should have, we also -- your -- discounted promotion is certainly one lever that moves conversion up, but we've also discovered that just financing in general is a really powerful lever.

We've had some really good success with our existing financing partners, but we've also recognized that, especially if you compare most direct-to-consumer sites financing options to most brick-and-mortar financing options, there's still a little bit of a disparity. And we see a lot of opportunity to continue to invest in ways to provide a way to allow our customers to buy a more expensive considered purchase, but be able to pay that off over time.

Okay. And then, I guess, on the return rates, it's good to see that it's sequentially improved.

I mean how far above kind of the historical norms are we now as we enter -- as we now go through the first quarter, 300, 400 basis points? Or are we still a little bit higher than that above the historical average?

By historical, do you mean kind of 2016, 2017 levels?

I guess the better side of it is versus where you consider a healthy return rate for the business, I guess, is a better way to put it through.

Yes, I'd say we're still a couple of hundred basis points above where we believe ideal is.

Yes. I mean, we know what industry averages are.

We're above that. I don't see any reason that we should -- I mean, there's no reason we shouldn't be aspiring to be below industry averages and there are some fundamental elements to our product and business that should allow for that.

Obviously, return rates that on transactions through brick-and-mortar tend to be lower than those online, which is what you see in nearly any vertical, and we're accounting for that. But in both channels, we still see opportunity for improvement.

And I will say the evidence has been that when we sell through brick-and-mortar, our return rates have been much more in line with industry averages, which is a very positive sign.

Thank you. And thank you, everyone, for joining.

So I'll just -- I'll reiterate, as I said in the last call as well, this is an execution story, and we clearly have a lot of work to do. I'm just over 5 months in.

I'm very, very thrilled with the progress to date. I think the team has come together, and we're moving things forward.

We've got a real differentiated product that we're all proud of, that's resonating with both our customers and our retail channel partners. We've got a brand platform that continues to work and consumers actually love and engage with, and we think there's ways to continue to make that better and resonate our product differentiation better, and we've got a team coming together.

We have a lot of hiring to do still, but that team that's here is really starting to buy into this vision. They're coming together, and it's helping us really move the ball forward, so really pleased with that.

So with that, we will wrap things up. Thank you very much.