Purple Innovation, Inc. Q2 FY2022 Earnings Call

Good day, everyone. And welcome to the Purple Innovation Second Quarter 2022 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. Today's call is being recorded. And it is now my pleasure to introduce your host, Cody McAlester of ICR. Please go ahead.

Thank you for joining Purple Innovation’s second quarter 2022 earnings call. A copy of our earnings press release is available on the Investor Relations section of Purple’s website at www.purple.com. I would like to remind you that certain statements we will make in this presentation are forward-looking statements. These forward-looking statements reflect Purple Innovation’s judgment and analysis only as of today and actual results may differ materially from current expectations based on a number of factors affecting the Company’s business. Accordingly, you should not place undue reliance on these forward-looking statements. For a more thorough discussion of the risks and uncertainties associated with the forward-looking statements to be made in this conference call and webcast, we refer you to the disclaimer regarding forward-looking statements included in our second quarter 2022 earnings release, which was furnished to the SEC today on Form 8-K as well as our filings with the SEC referenced in that disclaimer. We do not undertake any obligation to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise. Today’s presentation will include reference to non-GAAP financial measures, such as EBITDA, adjusted EBITDA, adjusted net income and adjusted earnings per share. A reconciliation of these non-GAAP financial measures to the most comparable GAAP financial measures is available within the earnings release, which can be found on our website. With that, I’ll turn the call over to Rob DeMartini, Purple Innovation’s Chief Executive Officer.

Thank you, Cody. And good afternoon everyone. With me on the call today is Bennett Nussbaum, Purple’s Chief Financial Officer. As you saw from our earnings release issued earlier today, we reported a meaningful improvement in adjusted EBITDA compared with the first quarter on similar revenue. While we had expected to deliver quarter-over-quarter increases in both revenue and profitability, the selling environment has become more challenging over the last several months. Given the deterioration in the overall market demand, we are especially pleased with the approximate $10 million recovery in adjusted EBITDA to near breakeven in the second quarter, in line with our expectations. This performance compared with Q1 results we reported roughly 90 days ago reflects the work we’ve done since the beginning of this year to get our cost structure in the right place and be profitable at these revenue levels. With respect to revenue, like the rest of the mattress industry, we’re facing a continued shift in demand away from home-related categories at a time when inflation is also pressuring consumer discretionary spending. We’ve seen estimates that domestic mattress volumes are down 20% to 25% year-to-date, and Purple has experienced a similar pullback over the first six months of the year, in addition to a shift in spending habits from online, a position of strength for Purple, to in-store where we are still in early stages of developing our capabilities. Bennett will review the numbers in more detail in a moment. But from a channel perspective, e-commerce was in line with our expectations, which is encouraging, given the recent industry trends and our purposeful reduction in advertising spend. Showroom performance improved quarter-over-quarter, primarily driven by the addition of six net new locations added in the second quarter as well as new doors from Q1 ramping up. And wholesale revenue was also up quarter-over-quarter, driven by roughly 700 net new doors we added in 2022. As I think about my first six months with Purple, I’m encouraged by the progress we’ve made, building the framework for sustained growth and consistent operational results. The quarter-over-quarter improvement in profitability we reported today underscores how much healthier the Company now is compared with the start of the year, even as the macro environment is delaying our top-line recovery. While we still expect further positive progress quarter-over-quarter, given the current external headwinds, we’re adopting a more conservative view of the remainder of the year. We’re adjusting our full year revenue guidance to $570 million to $590 million and adjusted EBITDA to a negative $15 million to a negative $5 million. Despite our revised outlook, we remain confident that our four strategic initiatives: operational excellence, brand elevation, channel development, and accelerating innovation remain the right building blocks for sustained profitable growth. I’ll detail some of the progress we’ve made this quarter and expect to see in the coming quarters with these initiatives before our Q&A section. But overall, we’re encouraged with the direction the company is headed. I’ll now turn it over to Bennett who will review the financials in more detail after which I’ll provide an update on the strategic initiatives ahead of our question-and-answer session.

Thank you, Rob. For the three months ended June 30, 2022, net revenue was $144.1 million, down 21.1% compared to the $182.6 million in the prior year period. This decrease was due to a number of factors, including a challenging comparison to a stimulus-assisted second quarter of 2021 coupled with changing demand for home-related products, inflationary pressure on consumer wallets, and our intentional decrease in advertising spend, which was down 56% compared with a year ago. By channel versus prior year, wholesale net revenue declined 5.9%, primarily driven by lower door productivity that was partially offset by opening approximately 1,000 net new doors. Direct-to-consumer net revenues declined 29.8%. Within DTC, e-commerce declined 39.2%, in part reflecting the aforementioned pullback in ad spend. This was partially offset by a 150% increase in showroom net revenue, driven largely by the opening of 27 net new showrooms over the past 12 months. Gross profit dollars were $48.8 million during the second quarter of 2022, compared to $81.7 million during the same period last year, with gross margin at 33.9% versus 44.7% in the second quarter of 2021. The decrease in gross margin from the prior year can be attributed primarily to lower revenue and a higher proportion of wholesale channel revenue, which carries a lower gross margin than revenue from the DTC channel, and unfavorable cost absorption from lower-than-planned production volumes in prior months. Additionally, the decline in gross margin reflects the impact of elevated levels of materials, labor, and overhead costs, partially offset by benefits realized from our workforce restructuring. Wholesale net revenues comprised approximately 43% of net revenue for the quarter, compared with approximately 36% in the same quarter last year. Operating expenses were 42.3% of net revenue in the second quarter of 2022 versus 46.1% in the prior year period. The decrease in operating expenses as a percent of net revenue compared with the prior year period was driven primarily by our intentional reduction in advertising spend to improve marketing efficiency and stabilize profitability in the current environment, and the restructuring of the marketing organization that happened at the beginning of the second quarter of this year. Advertising spend for the second quarter was reduced by $24.1 million year-over-year and $4.8 million from the first quarter of 2022. Net loss for the quarter was $8.3 million compared to net income of $2.6 million a year ago. As previously disclosed, based on the SEC statement dated April 12, 2021 regarding warrants issued by SPACs, we determined that our outstanding warrants should be accounted for as liabilities and recorded at fair value on the date of the transaction and subsequently remeasured to fair value each reporting date. For the three months ended June 30, 2022, we recognized a non-cash gain of $0.3 million associated with the change in fair value of warrant liabilities. For the three months ended June 30, 2021, the Company recognized a non-cash gain of $4.9 million associated with the change in fair value of warrant liabilities. On an adjusted basis, net loss in the second quarter of 2022 was $8.5 million or $0.11 per diluted share based on an adjusted weighted average diluted share count of 83.2 million compared to an adjusted net income of $3.6 million or $0.05 per diluted share based on an adjusted weighted average diluted share count of 67.3 million in the prior year period. Adjusted net income has been adjusted to reflect an estimated effective income tax rate of 31.7% for the current year period compared to a 25.4% rate for 2021. EBITDA for the quarter was a negative $8.8 million compared to a positive $3.9 million in the second quarter of 2021. Adjusted EBITDA, which excludes certain non-cash and other items we do not consider in the evaluation of our ongoing performance and as detailed in today’s earnings release, was negative $0.3 million compared with positive adjusted EBITDA of $11 million a year ago, and negative adjusted EBITDA of $9.6 million in the first quarter of 2022. Moving to our balance sheet, as of June 30, 2022, the Company had cash and cash equivalents of $41.2 million compared with $91.6 million at December 31, 2021 and $62.7 million at March 31, 2022. The $21.5 million decrease from the end of quarter one was driven primarily by cash used in operations of $8.5 million and capital expenditures of $13 million, primarily related to showroom expansion. In addition to the $41.2 million in cash at the end of the second quarter, we also have the full $55 million amount available under our credit facility and we believe our cash is adequate for the next 12 months and beyond. Inventories at June 30, 2022 were $84.9 million, a decrease of 14% compared with $98.7 million at December 31, 2021 and a decrease of 19.8% compared with $105.8 million at March 31, 2022. The decrease in inventory since the end of quarter one was driven by a reduction in both manufactured as well as resale finished goods and raw materials as we right-size our production and inventories due to the current demand environment. Turning now to our current outlook. Recent inventory trends and the strengthening of certain macroeconomic headwinds have caused us to take a more conservative view of the rest of 2022. We now expect net revenue to be in the range of $570 million to $590 million, compared to our prior range of $650 million to $690 million with the change primarily reflecting a reduction in projected wholesale volume to reflect the aforementioned change in industry trends. For the second half of the year, we expect gross margins to improve compared with the second quarter levels and anticipate exiting 2022 with gross margins between 37% and 38%. In terms of profitability, we now expect adjusted EBITDA to be between negative $15 million and negative $5 million compared to our prior guidance of $21 million to $27 million dollars. Now, I’ll turn it back to Rob.

Thank you, Bennett. While the current macro environment has proven to be more challenging than we’d have anticipated, I remain confident in the progress we’ve made against our four strategic initiatives so far in 2022 and the benefits they’ll provide in future periods. I want to close today with an update on our progress this quarter, starting with operational excellence. The work we are doing to improve execution is aimed at driving more effective and efficient capacity utilization, delivering higher product quality, and enhanced returns on the capacity investments we’ve made. Eric Haynor, our new Chief Operating Officer, has hit the ground running since joining in June, building on the work the team has made with raw material and operational cost improvements. Previously, many of our raw material purchase contracts were exposed to potential inflationary pressures. While not a significant factor for most of the history of this company, the inflationary dynamics of the current environment have begun to impact our raw material costs. We’ve been able to offset some of these inflationary impacts with a series of negotiations on our larger spend items as well as some value engineering to structurally reduce costs in our component purchases. Looking ahead, we have a pipeline of procurement and innovation projects that will enable continued input cost reductions. Operationally, we undertook a reduction in force in our plants that reflected our continued improvements in productivity as well as the current supply and demand balance. This action has positioned us with a sustainable structural plant cost position, in line with current demand expectations. We also began to work to consolidate our operations from our Alpine, Utah facility into our two primary facilities in Grantsville, Utah and McDonough, Georgia. This will streamline our overheads and allow us to allocate pillow and seat cushion production closer to our customer base, like we’ve done with the mattresses to realize greater logistics efficiencies. Our second strategic initiative is brand elevation through more effective marketing. We’ve discussed the evolution we’re driving with Purple advertising, expanding beyond our historical performance-centric vehicles to full funnel advertising that will build more awareness of and preference for Purple, creating new demand in all our sales channels. In the second quarter, we delivered the next step creative we’ve talked about in our last call, a campaign called Overnight Success, launched three weeks ago in linear and connected TV, premium online video, and across all social media channels. Overnight Success also includes a toolkit of campaign assets our wholesale partners can tag and run to leverage Purple’s brand power to increase their share of demand. Though it’s early, the campaign has received a positive response from key partners, and we see new creative quickly matching and surpassing performance metrics compared to recent and historical Purple advertising. In addition, during the second quarter, we completed our brand positioning work, which tested extremely well in qualitative testing. This important work has created an ownable, differentiated, and highly consumer-relevant positioning for Purple that will serve as the foundation for all advertising and go-forward brand communications starting in the later part of 2022. Shifting to our third initiative, developing and expanding our direct channels. Starting with our showrooms, these concepts that showcase our full product line with consistent premium presentation continue to perform well while acting as a north star for our wholesale partners. We ended the second quarter with 40 showrooms after opening 6 net new locations during the quarter, with plans to add 14 more showrooms over the remainder of the year. We’re excited about this emerging growth vehicle for the company, and see a clear path to a store footprint of 200 over time. Wholesale, the second and larger component of our brick-and-mortar retail strategy, continues to be an area of improvement this quarter. At the end of Q2, we were selling through approximately 3,200 wholesale doors, having added 77 net new doors in the quarter. As I mentioned last quarter, while our plan is to selectively open additional doors going forward, our priority is now improving productivity of our existing doors to grow market share and enhance the profitability of the channel. To do so, we identified 3 areas where we could make impactful improvements. First, we focus on improving wholesaler incentives and strengthening our margins for our partners. We believe that we can do this without negatively impacting our margins, as we increase operating efficiencies across the company. We’ve begun working with our wholesale partners to ensure they have a vested interest in Purple helping grow their business. Secondly, we are now working in a more closely aligned manner with our wholesale partners to meet merchandising timelines to make sure that we’re working together to drive demand for Purple. The July 4th holiday was the first major holiday promotion where we were able to meet deadlines to lock in promotions and messaging, and as a result, be included in all available trade merchandising. While more than one holiday will be required to earn our partners’ trust, this was proof that we’re able and willing to work together. Additionally, we’ve already lined up trade merchandising and promotional offers for the next two major holidays, a significant improvement from where we were just three months ago. Lastly, we need to develop synergistic approaches to wholesale product with our partners, to ensure a mutually accretive product that simultaneously drives traffic and margins. We’ve been actively meeting with our major partners to enhance relationships and start conversations around channel-specific product. As a result, we’re now developing a product roadmap that reduces channel conflict and places products in the channels where they can be most effective. Our fourth strategic initiative is product innovation. Purple was built on innovation and intellectual property that improves our consumers’ comfort and sleep. I’m pleased to say that with the addition of Jeff Hutchings as our new Chief Innovation Officer this quarter, we once again have a strong innovation engine that has historically driven our company. Our near-term focus has been on revitalizing our immediate product pipeline with fresh introductions as quickly as possible. In Q2, we developed and began deploying an improved cross-functional new product introduction process that ensures predictable, accelerated execution of our product roadmaps. Team collaboration, speed of execution, and quality results are all at new highs as evidenced by our first new product launch in quite some time, which is slated for later this fall. We have much more to share on the new product in the coming months, but I’m encouraged about the market opportunity we’ll be able to address later this year. I don’t want to overpromise here, but we are accelerating innovation, and we’ll be ready to share this with you shortly. In addition, we’ve been working hard on product innovation and developed a new 3-year product roadmap that outlines our new product introductions for 2022, 2023 and the next two years beyond, setting the stage for a consistent stream of new products from Purple going forward. Looking ahead in Q3 and Q4, we’ll implement our new innovation strategy, process and roadmap to accelerate our output of our authentic innovation with a new emphasis on disciplined, predictable execution and delivery while continuing to amplify the disruptive heritage of the Purple brand. Let me close with a word of gratitude and continued dedication for the hard work of each of our employees. The last six months have not been easy, but we’re starting to see the benefits of our hard work already. I’m encouraged by the responses we’re getting from our consumers directly and from our wholesale partners. Wholesalers want us in their doors. Despite the tough macroeconomic environment for everyone, we expanded into 700 net new doors so far this year. Our direct consumers are also responding positively, evidenced by the stabilization of our e-commerce business that we’re starting to see, and the fact that our comp showrooms are performing better than the overall market. We have a great product and the interest is out there. With our continued work on our strategic priorities, I’m confident we’ll see quarter-over-quarter improvement that will lead us through this challenging environment, and position us to capitalize on the many long-term opportunities ahead for this company. Thank you. Cody, do we want to go to questions?

We’ll first hear from Brad Thomas of KeyBanc Capital Markets.

My first question was going to be about getting more details on some of the revenue trends. Could you share what the productivity has been at some of the Purple stores, including their revenue rates, and provide some insights on the 13 stores that you've had open for a year or longer? What do the same-store sales look like for those showrooms?

Our showrooms are experiencing pressure similar to that seen in the overall category, but at a rate that is approximately half of what we observe in wholesale. I don’t have a long-term track record for our comparable store business yet. Currently, the year-over-year comparison indicates a decline of around $100,000, possibly a bit more, but still above the minimum performance standards we have set. You had a couple of other questions. Did you also inquire about wholesale?

Yes. And we’ve viewed that very much as a bright spot, the productivity of those Purple stores. So that’s very helpful color. Can you talk a little bit more about the incremental wholesale doors and what you’re seeing so far out of the productivity of them? I don’t know if I’ve heard it. Where does the door count stand today? And how things been going in the doors that have opened a bit more recently for you?

Sure, Brad. First of all, regarding door count, I want to clarify some numbers. We added approximately 1,000 doors in the first half of the year and reduced about 250 due to a negotiated exit from a customer where our performance varied by store. The net gain for the quarter was just over 700 doors, bringing the total active count to nearly 3,250. The performance across our network is improving with our new stores, but overall it remains soft, reflecting a decline in the category of about 20 percent. While our door productivity isn’t down that much, it has decreased 15 percent on a comparable basis from last year. The newer stores, especially those supported with a more comprehensive plan, are performing better. However, it's the stores we've operated in the longest with limited inventory that face the most challenges.

And maybe just one last one here for me. Rob, you talked about how you’re refining your partnership with wholesalers and trying to lean into that partnership and encourage the RSAs to pitch Purple as aggressively as hopefully they are willing to. You’ve really made this point, got one major holiday weekend to look at the 4th of July. But can you talk a little bit more about the learnings about where you are today? And how much work do you think you may have to do to improve that effectiveness of Purple sell-through in your wholesale partners?

I believe the main issue, which may explain why our longest-standing partnerships are underperforming, is that we need to educate the retail sales associates about how to effectively sell our product. We have been successful in attracting customers, but if they enter the store without a strong preference for us or any other brand, it's crucial that the sales associates can convey the technology clearly and concisely to encourage customers to try our beds. The experience of lying on our product can be quite polarizing; people either love it or find it uncomfortable, but it can lead to sales from that point. We need to ensure sales associates can adapt to this because our product looks and feels different from what most customers are accustomed to. This situation reminds me of the challenges faced by the memory foam category about ten to fifteen years ago, as it was also a product that felt very different. We must focus on training these associates so they feel confident discussing our product; if they lack that confidence, they are likely to steer customers toward other options.

Next, we’ll hear from Seth Basham of Wedbush Securities.

This is Matt McCartney on for Seth. Just a couple of quick questions. Could you maybe talk about your current brand position and whether pricing might have to come down a little bit, especially in light of some of the discounting we’re seeing in the market right now?

There has been a significant amount of discounting in our category, and we experienced more of it in Q2 than we initially expected. I can explain the reasons for this, but I don't want to address that just yet as we need to improve on communicating the value and benefits of Purple. Currently, we are conducting tests in our e-commerce business that are showing promising results when we focus on branding rather than just high discounts. We need to give this approach time to see if it can effectively convey our promotional message without it being overly distracting at the outset. That said, you will notice a decrease in gross margins for Q2, primarily due to some strategic discounting on the Purple Mattress aimed at understanding the significance of the $1,000 price point. This promotion is still active, and later I will explain the rationale behind it. We need to analyze how much potential business we may have lost due to price increases over the past year and the impact of changing that price point.

Just one more for you. The reduction in advertising has been pretty drastic. Just wondering, are we reaching a steady state there? And is there any update you can share on the online customer acquisition landscape?

Yes. We are aiming for a steady approach and plan to maintain consistent spending similar to what you’ve observed recently, particularly in Q2. I believe strongly in proactive and effective marketing and spending to boost volume. Despite a significant cutback, with improved planning and better tools, we are achieving a steady flow of quality sessions even with this reduction. You can also see this in our total brand search, where we're remaining competitive with the leading brand in the category. Although we do not engage in wholesale, analytics indicate we are the second most searched brand on the internet over the past quarter, the last six months, and into the year's end, which has persisted despite the decrease in advertising. We want to increase our advertising expenditure, but we want to ensure it's effective. So far, we've been successful in identifying the less effective strategies and retaining the most effective ones.

Next, we’ll hear from Bobby Griffin of Raymond James.

This is Alessandra Jimenez on for Bobby Griffin. First, could we just dive a little bit into gross margins? What is baked into your assumption that second half gross margins will improve from that Q2 level?

I think in the press release we mentioned that we expect to end the year with gross margins around 37% to 38%. That represents an improvement of about 3 points from our current level, potentially 3 to 4 points.

Yes. So what exactly are you getting more benefit from, pricing, efficiency in manufacturing, maybe some related aspects?

It’s not pricing. At this point, the pricing is all reflected. It is a flow-through of raw material savings that we have already confirmed and will flow through, and then quite frankly, a little bit that hasn’t been confirmed but will flow through. And then that’s a little bit off of what we said last quarter, and that’s because of the volume challenges that we’re facing, that is overhead absorption kind of soaking up some of the...

And then maybe could you talk about how the Georgia facility is stepping up to date?

Yes. Eric Haynor, our new Chief Operating Officer, is actually at the factory this week and next. It’s a good facility, and it’s going to be a great asset. As I mentioned previously, I think we brought it into the equation a bit earlier than necessary, and it hasn’t had the right leadership on site yet. I expect that to be resolved this month, and with Eric in charge, I’m confident it will be. It will challenge Grantsville in terms of productivity. So, we believe it’s the right location to have it, as we stated last quarter. Even with its significantly reduced volumes, it more than offsets the shipping costs we would incur if we sent everything from Utah. I’m convinced it’s a permanent part of our portfolio and will be a valuable asset moving forward.

And then lastly for me, maybe can we highlight like what level of sustainable quarterly revenue do you think you need to generate positive free cash flow? Is that $25 million more quarter, $10 million more? What do you think to get that positive free cash flow?

Yes. I mean, we’re close, and I kind of sit up there. We had the cost structures right. I think $15 million more would get us over that line.

Brian Nagel of Oppenheimer has our next question.

I have a couple of questions. First, looking at the results and the reduction in guidance for the rest of the year, which follows a previous decrease, I’d like to know from you, Rob, as you observe the business trends, did things turn out worse than you anticipated? Is this mainly due to macroeconomic factors, or are there internal challenges at Purple that perhaps weren’t fully acknowledged at the beginning?

I believe this adjustment is mainly due to macroeconomic factors. To be fair, the adjustment in the first quarter was likely more influenced by our internal challenges. However, this situation is definitely linked to macro factors, particularly our wholesale door performance. This doesn't simplify things; it's just quite isolated. Our e-commerce business has stabilized, and despite facing some challenges in the category, our showroom business is performing better than those challenges. The real issue lies in the productivity of our wholesale doors, and we need to address that. We have plans to tackle these issues, some of which are already in place while others are still forthcoming, but that is the source of the adjustment.

With regard to the wholesale doors, are you noticing any significant trends related to geography or other segments of the business that could help identify the current pressure points?

We’re not seeing any macro trends geographically. I can say that where customers let us see our performance within their footprint and we can get the retail sales associates up against it, we’re able to improve those results. And so, we’re aggressively encouraging our customers to share that information with us. But no macro geographic differences that we’re seeing right now.

And then the final question, again, a follow-up to those two. You’ve laid out a very compelling and aggressive repositioning strategy for the brand and the company. As you observe the more difficult macro environment unfolding, does it change your view on the timing or intensity of some of the initiatives you’re undertaking?

I believe the overall structure remains unchanged. I need to be a bit more patient. We need to ensure that our balance sheet can support our efforts, and we are confident that it can. However, I would prefer to see progress come more quickly. I recognize how hard our team is working, and I want them to witness this company grow again. We are observing internal indicators of progress, but from my perspective, I am looking for tangible results. Given the current challenges, it is difficult to achieve that right now.

Atul Maheswari, UBS.

Rob, I have a question regarding revenue and a follow-up on gross margin. Looking at the revenue guidance compared to 2019, the first quarter showed a compound annual growth rate of 20%, the second quarter decelerated to 12%, and now the guidance suggests a mid- to high single-digit growth for the latter half of the year. My question is, are you already noticing a significant decline compared to 2019 in the third quarter so far, or are you just being cautious and anticipating a substantial slowdown later this year?

Let me respond to your question in a different manner since I didn’t catch everything in your query. Based on the overall guidance we are providing, we anticipate that future quarters will follow a similar pattern to the last two, influenced by macroeconomic factors regarding category strength. I don’t have the quarterly figures for 2019 available, only the total for the year. Were you comparing these to the 2019 quarters?

Yes, comparing them to 2019, it seems like the latter half of this year would suggest a significant decline compared to 2019. So the latter half of 2022...

Total revenue in 2019 was $430 million. I don’t see how it could be a step down in the second half. We’ll have to follow up. I’m sorry, I just don’t have that information in front of me right now, but we will follow up with that.

Yes, we’ll take that offline. My follow-up question is regarding the drop in gross margin. While we expect some improvement in the latter half of this year, we still anticipate ending the year at 37% to 38%. This is significantly lower than the 44% we achieved in 2019. What are the key factors contributing to this gap? Can you provide some quantification? Is most of it due to material inflation and some related to channel mix? Additionally, how much of this gap do you think you can close over the next couple of years, and what structural factors might hinder you from reaching that level?

So if I look at gross margin in ‘19, it was at 44.1%. I would think there’s 3 components, and I’ll have to go offline to size these for you, but the single biggest one is channel mix. And the business in ‘19 was 62% DTC. We’re now a little bit higher than that. So to me, it’s channel mix. It is certainly catching up with some of the input costs that we think we have done now. And then it’s absorption with the second factory. And there may be some others, but I’m sure those are the three biggest drivers. The channel mix, I think, is ours to live with. 60-40, something like that is probably something we’ve got to be prepared to handle. The absorption and the input costs, we’ve taken the action on the input cost and the absorptions. We got to get the volume up, and we should be able to get to those margin historical performances certainly at the ‘19 level. And we’re not throwing the talent on that whatsoever. It’s just taking us longer because of the top-line challenges to get that absorption number right, to get all those input costs fully flowing through. Bennett, I think I missed something?

Next, we’ll hear from Keith Hughes of Truist.

So encouraging signs on talking about new product launches with the 3-year roadmap. First, to your comment, can you plan to launch product or products in the second half of this year? And do you have any kind of approximate time when?

I’m not quite ready to specify the exact timing, but we are actively pursuing new products, and you can expect a continuous flow of them sooner rather than later.

And then one other very small question. In the adjusted EBITDA number, there’s a vendor separation fee. Can you talk about what that was? And is that something we’re going to be seeing any more of those?

Yes. Go ahead, Bennett.

Yes. We have been focusing on improving our functional excellence and operational efficiency. We had a contractor doing great work for us, but we decided to hire Eric Haynor as our new Chief Operating Officer. Looking ahead, we found it more beneficial to end our relationship with the outside contractor and have Eric take over. Ultimately, paying this fee will be a much better financial decision than continuing with our current contractor.

Matt Koranda of ROTH Capital.

Just curious if we could talk about trends within the direct business, maybe the cadence of growth on a monthly basis year-over-year throughout the second quarter, as you reined in marketing expense? And then just any preliminary sort of commentary around the direct revenue growth on a year-over-year basis quarter-to-date?

Yes. The spending cuts began to take effect at the end of Q1 and continued through Q2. Our volume faced challenges early in the quarter, but it has shown some modest improvement since then. The key takeaway is that it has remained relatively stable and predictable, which we find encouraging. As I mentioned earlier, we measure a quality session by whether a user clicks beyond just the first page on our website. We have maintained quality sessions at about 90% of our peak level while only spending about 30% of what we used to. This positive trend gives us confidence to keep investing in more quality sessions and to work on increasing the conversion rate.

I am just curious if you could provide a bit more information about the wholesale customer exit you mentioned. How significantly is that affecting the revenue outlook for the year? Additionally, in terms of door count, what does that suggest about the expected decrease?

Yes. So, door count is higher net of the reduction. The reduction was about 240 stores, and I mean this respectfully, but neither us or the customer are going to miss that volume.

I have one last question regarding the gross margin recovery. You mentioned a three-point improvement expected by the end of this year, and part of that has already been implemented. It seems like it's a matter of timing for the flow-through, and there are still some actions to take. Would you say it's about 50-50 in terms of what's been addressed so far versus what still needs to be done? Additionally, when you refer to achieving 37% to 38% by the end of the year, could you clarify if we should anticipate reaching that run rate by the end of the fourth quarter, or should we model 37% to 38% for the fourth quarter itself?

I think it’s fair to model that in the fourth quarter. We do have about half of that captured and the other half still ahead of us, but it’s not unidentified ahead of us. We know how we’re going to get there. And it is fundamentally a combination of some of that work that Bennett referenced a few minutes ago, as well as Eric’s steady hand on how to run a plant safely and effectively for high quality and just the right output when you need it. So we are confident that that will happen.

And next, we’ll hear from Jeremy Hamblin of Craig-Hallum.

This is Jack Cole on for Jeremy. You guys talked about inflationary pressures impacting raw material input costs. Just how much of these costs and maybe freight costs increased on a year-over-year basis? And then, could you maybe speak a little bit more to the expectations going forward with some of those negotiations and the procurement pipeline you touched on? As it sounds like you guys do have a pretty good grip on those going forward.

Our costs last year increased by about 25% in raw materials and freight, and we've seen them rise a bit during the first and second quarters. However, we are beginning to observe some improvement. There's been a slight decrease in international freight costs, and we're also noticing some softness in domestic freight costs. With more stable oil prices, we expect costs to stabilize for the remainder of the year. That's our current outlook.

And our final question for today will come from Curtis Nagle of Bank of America.

Starting with our own stores, we plan to open about 14 more for the rest of the year, based on previous comments, along with approximately $11 million in capital expenditures. Why not take a more cautious approach? I understand that the fundamentals are improving, but considering the fixed costs and negative cash flow, along with the uncertain environment, it raises some concerns. Also, regarding the guidance on EBITDA, what can we infer about the cash position at the end of the year? Does that indicate any need for working capital at the facility?

Let me address the store question, and I’ll have Bennett respond to the cash question. It's a valid point. Firstly, the showrooms are showing positive signs, performing better than the overall category and closely aligning with our previous projections despite these challenges. We remain optimistic about that channel in the long run. Regarding the second part, Curtis, I'm sure you recognize that store development is a process that needs continuity; it's difficult to halt and restart. We have solid locations, and the 14 stores have been under development for at least six months now. We are committed to our partners and are striving to advance our showroom business as much as possible. We believe this is a worthwhile investment. They've been performing well even amidst these challenges, and we will continue to invest at that rate.

Yes. If you analyze the cash flow, we believe we have sufficient cash for the remainder of the year even without utilizing the line of credit at this moment. In the first half of the year, we spent a significant amount of cash mainly due to our EBITDA loss in the first quarter, along with high other payables at the beginning of the year as we invested heavily in advertising and increased inventories last year. Now, our payables have decreased to a more manageable level. Additionally, we have started to streamline our inventories, which have reduced. Therefore, for the rest of the year, if we can maintain a steady or improved EBITDA and slightly increase our CapEx spending, we believe we have enough cash to sustain us for the remainder of the year, and that's our perspective moving forward.

And at this time, I’d like to turn the call back over to our presenters for any additional or closing comments.

Yes. I would just like to say to the team on the phone. We appreciate your interest in the company. We are very optimistic that we will get through these difficult headwinds and get this company growing again, and we’re available to help you understand anything further as you see fit. Thank you.

That does conclude today’s conference. Thank you all for your participation. You may now disconnect.