Arhaus, Inc. (NASDAQ:ARHS) Q1 2024 Earnings Call Transcript

Arhaus, Inc. (NASDAQ:ARHS) Q1 2024 Earnings Call Transcript May 9, 2024

Arhaus, Inc. beats earnings expectations. Reported EPS is $0.1074, expectations were $0.02. Arhaus, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good afternoon, and welcome to the Arhaus First Quarter 2024 Earnings Conference Call. [Operator Instructions]. I will now turn the conference over to Wendy Watson. Wendy Watson, please go ahead.

Wendy Watson: Good morning and thank you for joining the Arhaus first quarter 2024 earnings call. And with me are John Reed, Co-Founder, Chairman and Chief Executive Officer; and Dawn Phillipson, Chief Financial Officer. After your prepared remarks, they will be joined by Jen Porter, our Chief Marketing and eCommerce Officer, for the Q&A session. During Q&A, please limit to one question and one follow-up. If you have additional questions, please return to the queue. We issued our earnings press release for the quarter ended March 31, 2024 before market opened today. As a reminder, remarks today concerning future expectations, events, objectives, strategies, trends or results constitute forward-looking statements. Actual results or events may differ materially due to a number of risks and uncertainties.

For a summary of these risk factors and additional information, please refer to this morning’s press release and the cautionary statements and risk factors described in our most recent annual report on Form 10-K and subsequent 10-Q as such factors may be updated from time to time in our filings with the SEC. Forward-looking statements are made as of today’s date and except as may be required by law, the company undertakes no obligation to revise or update these statements. We will also refer to certain non-GAAP financial measures in this morning’s press release includes the relevant non-GAAP reconciliations. A replay of this call will be available on our website within 24 hours. Now I will turn the call over to John.

John Reed: Good morning, everyone, and welcome to the Arhaus first quarter conference call. I wanted to begin the call today by congratulating our team on a solid start to 2024 and for staying focused on executing our key priorities, both large and small, that are driving and supporting our four-pronged strategic growth strategy. The market opportunities we have is substantial, and we have a proven strategy with established initiatives to capitalize on it. We are highly motivated to execute on these initiatives, increasing brand awareness, expanding our showroom base, enhancing our omnichannel capabilities and technology, and investing to upgrade our infrastructure, improve our business tools and support our growth. Our ongoing commitment to build on our progress across these initiatives is paying clear dividends through sustained results quarter after quarter.

At the same time, our debt-free balance sheet and the flexibility it affords us remains a competitive advantage as we maintain our focus on expense control and prudent capital deployment. In the current environment, I get a lot of questions about how we are continuing to do so well with luxury home sales well below pre-pandemic levels, and mortgage interest rates expected to stay higher for longer. The answer, as we see it, is many of our clients are staying in their home and they want to enjoy them. So they’re remodeling, refreshing or simply replacing their furniture. Our in-home and trade designers have never been busier with projects ranging from small to large. Our clients’ appetite to make their home a better place to live continues to be strong.

And given our clients’ demographics, our clients are going on their European holidays or summer or enjoying a cruise, but they are also improving their homes at the same time. Many of our design projects include assisting our clients with their second and third homes as well. So we are very pleased with the state of our consumer and with the latest data showing both luxury home sales and listings increasing in this quarter. We are optimistic for the balance of this year and into 2025. As you know, I’m very enthusiastic about expanding our showroom footprint and how that continues to drive brand awareness and our long-term growth. Since our last call, we opened a new design studio in a wonderful location in Greenwich, Connecticut. It’s already performing exceptionally well.

Later this year, we are adding design studios in Peach Tree, Georgia and Huntersville, North Carolina near Lake Norman. We are proving out our design studio concept and it’s working very well. We develop the concept before the pandemic, a smaller footprint showroom, perfect for second home markets in affluent pockets such as Princeton, New Jersey within or outside large markets, locations where a lower square footage is preferred, staffed with in-home designers, and the latest high-tech design tools to assist clients in managing their home. In October of 2020, we opened our first design studio in Carmel, California. We expect to have 11 by the end of this year with a long runway ahead of us. We also recently opened Arhaus The Loft outlet in Pittsburgh.

We are adding two more of Loft locations this quarter, one in Denver and one in Florence, Kentucky, just outside of Cincinnati. And in just a few weeks, we’ll be opening an amazing new showroom at The Grove and Los Angeles. We expect it to be one of our flagship locations and cannot wait for clients to see it and experience it. As we have discussed, we have significant growth opportunities on the West Coast. In addition to the growth, we are opening three more showrooms in California this year, Carlsbad, Palo Alto and Corte Madera. We are also opening our first Oklahoma showroom this year. What is so gratifying and exciting for me and the Arhaus team is how well our showrooms perform in such a varied locations across United States, and we are not quite halfway through our goal of 165-plus traditional showroom locations.

Turning to products. Product is one of our key competitive advantage and a big differentiator. Our design, merchandising, and sourcing teams continues to delight our clients with incredible new products. Our product reflects our livable luxury aesthetics and then simultaneously eclectic family friendly and full of warmth and comfort. Our pieces have a unique handcrafted steel and are designed using the best materials and an unparalleled focus on quality. This confidence in our product comes from both client reaction and consistent performance. Clients are loving our spring new product introductions, with newness this year outperforming the incredible reception we had last year’s new spring product. We are also very proud of the depth of our styles and selections.

I mentioned that our showrooms perform well across regions, but one of the keys to this is the breadth of our product across traditional, transitional, and modern aesthetics. Alongside our new products, our iconic bestsellers continues to be well bestsellers. We are able to consistently improve refresh these designs with beautiful new fabrics, shapes, finishes and sizes and present them in new inspiring ways across all channels. We believe our product is an incredible value. And based on our demand trends, our clients seem to agree, and we cannot wait for you to see and experience the new product we are coming up with this fall in our showrooms catalog in arhaus.com. On our strategic growth initiative fronts, there are two areas I want to call out.

One, we just launched the new warehouse management system in our Ohio DC, representing a tremendous amount of work across several of our functional areas. This is a key piece of the system upgrades that will enable us to improve our operational efficiencies and mostly set the foundation for long-term growth. Congratulations to our team. Second, I also want to call out our Final Mile team. Over the past year, we have made several improvements to our Final Mile and in-home delivery processes that are evident in better execution and delivery performance with some of the highest client survey scores we have ever received. We are extremely busy delivering our consistent results and client first service while growing and investing in the business requires unrelenting commitment, and I am extremely grateful for the hard work our team put in each day and every day.

In the first quarter, we delivered net revenue of $295 million, net income of $15 million, and adjusted EBITDA of $29 million. As we reported this morning, we are pleased to have exceeded our top and bottom-line outlook for the quarter as teams executed well and first quarter benefited from the shift in our new warehouse management system implementation to April from March. We are on track to deliver on our first half and full year outlook. Moving to demand. It’s truly remarkable what our teams are achieving in the current macro environment. As we continue to meaningfully outpace the industry, our first quarter results are highlighted by February’s mid-single digit and March’s high single digit demand comp growth, more than offsetting January’s weather related high single digit demand comp decline.

Our demand comp in April was up mid-single digits. Before I turn the call over to Dawn to discuss these results and our full year outlook in more detail, I wanted to reiterate our confidence in the outlook for our company for the balance of 2024, which we reaffirm this morning. Our future is bright. We believe our strategic competitive advantage positions us to continue to capitalize on the aspiration of our clients to live in beautiful and curated spaces with our unique artisans crafted furniture, I’d like to extend a warm welcome to John Moran, who joined us as Chief Operating Officer on Monday. Prior to joining us, John was Chief Operating Officer of Canada Goose and brings a wealth of experience in operational execution and supporting transformation growth across the functions.

He is an important addition to our leadership team as we scale the business and realize the significant potential for growth. As I said last quarter, I generally feel there are no collections like our collections. There are no people like our people. There’s no potential like our potential. Arhaus stands out. Arhaus stands alone. When I founded Arhaus almost 40 years ago, I could not imagine the Arhaus we have today with the incredible potential we still have. Now I’ll turn it over to Dawn.

Dawn Sparks: Thank you, John, and good morning, everyone. Net revenue in the first quarter was $295 million with a 9.5% comp decline against the comp growth comparison of 21% in the first quarter last year. Our prior year included significant abnormal backlog deliveries that did not repeat this year as we caught up on deliveries in 2023 and have returned to a normal backlog. We were pleased with our demand comp growth of 1.3% in the quarter as we continued to see strength in average order value and in orders over $5,000 and $10,000. We’re also pleased the demand penetration of our in-home designer program continues to increase. Our first quarter gross margin decreased to $115 million, driven primarily by lower net revenue and higher showroom costs as we continue to expand our footprint.

Gross margin as a percent of net revenue decreased to 39%, driven primarily by the higher showroom cost, deleverage related to lower revenue, and increased transportation costs. First quarter SG&A expense increased $14 million to $97 million, primarily driven by increased selling expenses related to new showrooms and demand strength, increased corporate expenses as we invest in our strategic initiatives to support and drive the growth of the business, and increased warehouse expense as our Dallas location continues to increase productivity. First quarter 2024 net income was $15 million. Adjusted EBITDA in the quarter was $29 million versus $55 million in the first quarter of 2023. First quarter net revenue of $295 million and adjusted EBITDA of $29 million resulted in a 9.9% adjusted EBITDA margin in the quarter.

Next, as we reported this morning, we are pleased to reaffirm our outlook for full year 2024. Our expectations for how the year will progress have not changed since we initially provided our outlook in March apart from the warehouse management system going live in April rather than in March. As a reminder, we expect full year adjusted EBITDA margins to be lower than 2023. We expect about 85% of the deleverage to come from SG&A with a lesser amount of deleverage in gross margin. Deleverage is driven by comping prior year backlog delivery and strategic investments we are making this year. Strategic investments include corporate strategic investments of $10 million to $15 million to enhance our operational capabilities and drive our success long term, as well as investments in other growth initiatives such as e-commerce and our in-home designer and trade program.

The $10 million to $15 million in corporate strategic investments includes our new warehouse management system, planning and allocation software, and new manufacturing ERP at our upholstery facility, and our in-home delivery experience. To add further color, we also wanted to note that we expect to have higher expense at our distribution centers this year as productivity improves in Dallas. In the second quarter of 2024, we anticipate net revenue in the range of $310 million to $320 million. We expect approximately 900 basis points of adjusted EBITDA deleverage in the second quarter. Approximately one-third is from a gross margin pressure, primarily due to higher short-term costs related to growing our showroom footprint, investments in in-home delivery program, and to a lesser extent, the impact of price action product in our P&L.

The balance of the deleverage in SG&A primarily due to new showrooms, strategic growth investments, and supply chain costs from the continued ramp of our Dallas distribution center. Given the new warehouse management system implementation shift from March to April, we expect the earnings upside relative to original expectations in Q1 to be offset in Q2, with our anticipated first half financial performance in line with full-year expectations we shared in March. As I noted last quarter, we continue to expect the net revenue growth in the balance of this year. We expect the deleverage in both gross margin and SG&A in the first half of the year to inflect in the second half. As the P&L impact from the June 2023 price action product is complete, revenue and earnings from new showrooms positively impact our P&L, and we continue to expand our brand awareness and drive market share expansion.

We will update you on our third quarter expectations when we report second quarter financial performance in August. For all other details related to our 2024 outlook, please refer to our press release. In closing, I want to thank our team for their focus and execution of our strategic growth priorities and investments. I’m so proud of what we are accomplishing while delivering solid financial performance and retaining our balance sheet strength. We believe our four-part strategic growth strategy and our strong debt-free balance sheet are compelling competitive advantages, enabling us to make the necessary investments to build on our share gains in the highly fragmented $100 billion premium home furniture market. We are navigating the current environment from a position of strength, and we believe we are well positioned to delight our clients while maintaining our unwavering commitment to driving value for all stakeholders.

This concludes our prepared remarks. With that, I’d like to thank you for joining us this morning and we are happy to take your questions.

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Q&A Session

Operator: [Operator Instructions]. Your first question comes from the line of Philip Lee with William Blair.

Unidentified Analyst: Hi. This is Sabrina on for Philip. Thanks for taking my question. Can you talk about some of the progress our team has made on those internal system investments like the e-commerce capabilities and enhanced design and trade programs, and any early signs of improvement and how that will flow through for the rest of the year?

Dawn Sparks: Yeah. Good morning, Sabrina. This is Dawn. We’re really excited for how we’re progressing through on some of these systems. We’ve talked about warehouse management system, which we deployed, and I’m starting to see some nice efficiencies in the warehouse there. So pleased with that. It’s still a little bit early days for the other systems that we talked about with regards to our planning and allocation program. Our manufacturing ERP is well underway during the design and launch portion. In-home delivery investments that we’re making, we’ve seen some really great changes in our client survey responses. So really, really pleased with the investments that we’re making in these areas, really to help the organization get to the next level, drive some efficiencies.

Well, from a financial efficiency perspective, we need to get all these systems deployed and launched. And then of course, there will be a learning curve as the teams all adopt the new software platforms and as we — then we’ll start to see some financial efficiencies. We mentioned last quarter that we are evaluating our full systems infrastructure and platform. So we will continue to do that. These new systems that we’re launching — in the process of working through and launching, we’re certainly excited about and confident that the business needs those. But we’re also continuing to look at different things like inventory management platforms, vendor management platforms, financial system packages. So more to come on those in coming quarters as management continues to refine our expectations for the organization and what those will look like but pleased with that.

Jen, did you want to add anything on the e-commerce investments we’re making?

Jennifer Porter: Yeah. Good morning. To echo Dawn, we’re really excited about what we’re doing on e-com as well. We’re into year three now with our new platform. And we continue to learn and deploy and optimize the site, honestly, pretty much every single day. So really, really pleased with the results that we’re seeing on e-com, both in terms of sales and also some of the improvements that we’re making in terms of getting traffic to the site and engages when people are on the site. And I think what’s really great about those enhancements to e-commerce, as a token in the past, we know majority of our clients are engaging with us on arhaus.com, regardless of where they end up transacting. So as we’re seeing and monitoring these results and getting a more complete picture of our clients, their behavior, what they’re responding to, it’s really just such a great tool, not only to drive conversions and sales.

And we’re seeing some really nice improvements there in terms of sales, but also getting people to really understand Arhaus brand differentiation and the product assortment, which as John mentioned, we’re so excited with the new products that came in and really seeing people being able to engage and in-store and online as well. So lots, lots of enhancements, a lot that you may see if you’re on the site every single day, a lot of you may not see because they’re happening behind the scenes. But a lot has been going on and a lot more on continuing to come this year into the future.

Unidentified Analyst: Great. That’s really helpful. And then a quick question on what the new product assortments. Could you provide some color on AOV trends throughout the quarter, if there’s any specific product assortment or items that have been particularly resonating with consumers recently?

John Reed: Oh, gosh. Yeah, there’s a lot. Yeah. I mean, the great thing about our business is it’s a fashion business. Things are always trending. We’re not trendy where we get in and out of things in one season. Things can last for last years. But we’re seeing people are wanting more color in their homes. Shapes are softer, more curvy, was getting a little fresher, lighter not so dark, and grade type of things. So it’s constantly evolving. But yeah, we really have had some great new products that we’ve launched some last year, some this spring. And then as we said on the call, very excited about this fall coming up. We have a lot of new products. The photo team is busy shooting everything as we speak and getting ready to launch fall probably in September.

But yeah, it’s a moving target. But coming out of COVID and so forth, people are changing, and things were again pretty straight, dark, kind of sterilized column. In my opinion, now they’re a lot brighter, lighter, more comfortable with curvy type products, and then that’s what we’re going after.

Operator: Your next question comes from the line of Steven Forbes with Guggenheim Partners.

Julio Marquez: Good morning. Thank you for taking my question. This is Julio Martinez on for Steve Forbes. Just to follow up on product. Can you expand on product and store assortment expansion plans for 2024? And is there any way to maybe help better understand how you’re thinking about new product contribution growth over the next coming years? And a quick follow-up after that. Thank you.

John Reed: Yeah. I mean, one of our focuses is to offer a broader arrangement of styles, textures, colors, and so forth. It’s a big country out there. There’s different taste in Alabama and Cleveland and L.A. Although core pieces are always bestsellers everywhere, there’s different case. Some markets are more modern. Everything has gone fairly modern contemporary over the years. We’re seeing a big slug of people who are coming back to a little merchant transition or even some traditional pieces. So our focus is to take each category we carry and offer a broader assortment. We’ve been testing some really different product and like two or three stores across the country, then the response has been phenomenal. So it’s something we’ll probably grow.

And on top of that category as we just keep growing — upholstery is big, big business. All the wood products from living rooms to bedrooms, of course, which is a massive business for us. And people have four, five bedroom, sometimes 10 bedrooms, and they want different assortment to be able to furnish the entire house. So we’re working hard to just expand our look and our feel and taste. But it all fits under the Arhaus brand. So it all coordinates goes together and so forth. On top of that, we’re really working hard to bring in color between the core pillars and throws things like that, and things that can really brighten up our room without making a big commitment to upright bold pattern, sectional, or something. So that’s something we’re really, really growing and going after pick time as well, and you’ll see more of that actually in the fall than today.

Julio Marquez: Great. Thank you. Very helpful, actually. And is there any way to think about how the upholstery mix has changed over the past few years? And maybe if you can contextualize how much is being made within Arhaus manufacturing facilities versus the third party?

John Reed: Yeah. The Arhaus part is a significant part of the business. It’s not quite half of the business, but close to that. And again, whether we’re making it in our facility or down the street and a couple of the other domestic facilities in North Carolina, it’s all great product. And the different shapes and forms and so forth is one that we’re working with all of our manufacturers on. So it’s working in harmony. We’re thrilled to be back and getting custom, which is a huge part of our business and the upholstery business back to a really short window of lead time where it was out at 28 weeks, I think a couple of years ago. We’re much, much quicker now down, I think, five, six weeks or so to get into the customer’s home, which we’re pretty proud of. They’ve been working really hard and making that happen.

Operator: Your next question comes from the line of Jeremy Hamblin with Craig-Hallum Capital Group.

Jeremy Hamblin: Thanks, and congrats on the strong momentum in the business. I wanted to just come to the warehouse management system update, the shift here, and thinking about the impact on Q2. So think the best guess on the total delivered revenue in the quarter, if that’s in the range of $25 million or something along those lines? And then whether or not why has it gone smoothly into expectations, are you having any lingering impacts that’s resulting in delays on deliveries? I wanted to just see if you could put a little more color around that.

Dawn Sparks: Sure. So as it pertains to the second quarter, we’re launching the WMS at the start of the quarter. Certainly, it provides us with a little bit more flexibility to make up any timing shifts related to the revenue impact from the warehouse closure. So we feel good about what we’ve guided in the $310 million to $320 million net revenue range for second quarter. As it pertains to the actual implementation, it’s gone as expected. We pushed it from March to April prudently to be ensure that we were as prepared as possible just from a back-office perspective. And we never expect to be software platform implementations to go smoothly, so we prepare as best we can. And we’re very fortunate that we have a very dynamic and flexible leadership team that is constantly evaluating what different options we have available to us when things pop up.

So we navigated it very from my perspective. From the client perspective, really a non-issue. So clients are getting their product when they expect, and that’s exactly what we want. These back-office system implementation should not negatively impacts the client experience in any way.

Jeremy Hamblin: Got it. And then just a quick follow-up here. The pricing actions that were taken last summer, in terms of how long you expect that to linger in terms of flow through to your gross margin, what point would you expect the gross margin to no longer be impacted in a material way from the pricing actions?

Dawn Sparks: Sure. So we did see some impact in the first quarter from the price actions that we took in June of 2023. We expect a lesser amount in the second quarter. And then we expect by the end of the second quarter to really have cleared through any meaningful impact, which we noted we’ll see some inflection in the second half of the year. One of those is due to the price action component clearing through the P&L. So all of those SKUs are back to the — the ones that we have a home and the go-forward assortment, they’re all back to their pre-price actions on pricing. And so we feel good about how we’re positioned as we head into the last three quarters there.

Operator: Your next question comes from the line of Simeon Gutman with Morgan Stanley.

Simeon Gutman: Hey, good morning, everyone. I wanted to ask I guess two-part question. First, I know the COO higher — I know he started, but I think in the news about a month and a half ago, we talked about it. Can we talk about, John, the role, the need for that role? And then as part of it, can you give us a lay of the land in the next call it one to three years warehouse DC capacity systems upgrade? Dawn teed a few of these up, I’m just curious what to expect as you scale this business going forward.

John Reed: Yeah, sure. As we’ve been speaking of, we are launching a lot of new systems, and we brought the new COO to really help orchestrate all that. Then you’ll be the guy that’s orchestrating the IT side to the planning side to the implementation side to the warehouse side of logistics and so forth. So one great thing about that for me is I get to spend time on what I love, which is finding great product and keep driving the business forward. And I don’t have to be in a 19 meeting about the systems, which I am going to be having about. And so far, he has been doing a phenomenal job just for the very short time he’s been here. So it’s something that I think the team is looking for, that leadership. He’s got a lot of experience in this field and world, and we’re excited to have him be the orchestrator of it.

Simeon Gutman: I guess as part of that, any more capacity that’s needed and then other things — I don’t know if it’s automation, but other enhancements to the distribution center you have?

John Reed: Right now, we’re in good shape. Now that we implemented the system, we have enough capacity. We’ve got a great team up there. All three of our large distribution centers here. And we’re going to just work out — if there’s any small kinks in this system, we’ll get those worked out over the next few weeks, and everything is good to go to start growing.

Simeon Gutman: Can I ask as a follow-up, hopefully? The other one was part of a longer question. Just the backdrop for furnishings, you’ve had some weather volatility. Can you talk about, I guess, the biggest ticket items in your in your product assortment, diagnosing the consumer? There’s been a lot of chatter about weakening more on the lower income side in the last, call it, three to four weeks. Curious if there’s any of that? Does it feel like the industry has bottomed in terms of demand that’s reverted post-COVID and now bouncing along the bottom or maybe even getting better?

John Reed: I’m not an extra in what other people do. All I know is our business, and it’s very strong. We’ve not seen anything changed in the last four, five, six weeks at all. That’s first I’m hearing of that. So yeah, I can’t answer that. I stick to what we’re doing and executing our plan and coming out with incredible product, executing it well, getting into customers’ homes who are delighted with the systems we’re using and how we’re delivering it to them. And then they’re telling their friends and neighbors, and they’re coming in and buying it. So I don’t know. I’ve not heard anything about things or bottoming out, especially on the lower end.

Simeon Gutman: Thanks, John.

Jennifer Porter: Yeah. And just to add into that, looking specifically like at our consumer and our customer base, we haven’t seen any notable differences or changes as we speaking. Our customer now has really stayed very steady since 2019 pre-pandemic. We’re continuing to see that going strong, Looking at all of our stats and things that we share, we’re still seeing that through a 50:50 split between new and existing. Have been really, really pleased with the response, particularly from our prospects and new customer acquisition activities. As Dawn mentioned on the call earlier as well, we’re really pleased about the value about customers coming in as well. So as John mentioned, we really got to focus on doing what we are doing. Our product is working. Our messaging is working. Our showrooms are working. So we’re focused on that and continuing to see good results.

Operator: Your next question comes from the line of Cristina Fernandez with Telsey.

Cristina Fernandez: Hi, good morning. I wanted to ask about the competitive environment in promotions, any change you’re seeing? Some of your competitors also are introducing a lot of new product. And in the promotions, anything that we should picked up leading up to the important Memorial Day weekend?

Jennifer Porter: Hi, Christina. Good morning. Yeah, so we continue to see that elevated promotional market out there, which is really interesting. We start to see some of those being loyal. They follow and starting already very early in the month. In terms of what we’re doing, what we’re looking at, as you just referenced and John and Dawn mentioned, our product is working, our customers are spending money. We’re really, really pleased with that from a marketing and branding perspective where we’re really focused on continuing that put out, that messaging around brand differentiation. We’re continuing to introduce Arhaus to new clients. We’re continuing to focus on sharing the product and really letting that shine and letting our clients take that journey and make that decision.

And our promotional strategy has really remained the same. And we’re still seeing results when we run promos around those — in terms of shopping weekends. As I’ve spoken about on prior calls, we have lengthened those promos. It’s no longer really just doing the three to four days right around the promo but seeing that be a little bit longer. And we’re really happy with what we’re seeing. So in terms of what we’re doing, we’re just focusing on continuing our strategy of doing what we’re doing, and we are monitoring it very closely. And as I mentioned, it’s working for now. So we’re really happy with that.