Arhaus, Inc. (NASDAQ:ARHS) Q4 2023 Earnings Call Transcript March 7, 2024
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 morning, and welcome to the Arhaus Fourth Quarter and Full Year 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow formal remarks. Please note that this call is being recorded, and the reproduction of any part of this call is not permitted without written authorization from the company. I will now turn the call over to your host, Wendy Watson, Senior Vice President of Investor Relations. Please go ahead.
Wendy Watson: Good morning, and thank you for joining Arhaus for the fourth quarter and full year 2023 earnings call. On with me are John Reed, Co-Founder, Chairman and Chief Executive Officer who is joining us this morning from Italy; and Dawn Phillipson, Chief Financial Officer. After 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 year ended December 31, 2023, before market opened today. Yesterday, after market closed, we filed an 8-K to inform investors that we identified an error in our unaudited, condensed consolidated balance sheet as of September 30, 2023, related to certain leasehold and landlord improvements prior to showroom completion being incorrectly included in prepaid and other current assets rather than property, furniture, and equipment net.
This error resulted in inaccurate cash flows ascribed to the operating and investing activities in the unaudited condensed consolidated statement of cash flows for the nine months ended September 30, 2023. As such, we will restate our financial statements for the third quarter of 2023, and revise the December 31, 2022, comparative balance sheet that will be included in the amended third quarter 10-Q. For more details, please refer to the 8-K. Those documents are available on our Investor Relations website at ir.arhaus.com. 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-Qs as such factors may be updated from time to time in our filings with the SEC. The forward-looking statements are made as of today’s date, and except as may be required by law, the company undertakes no obligation to update or revise these statements. We will also refer to certain non-GAAP financial measures and 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 thank you for joining us on the call today. We delivered a strong fourth quarter 2023 with net revenue of $344 million, net income of $31 million, and adjusted EBITDA of $51 million, and are very pleased to have exceeded our top and bottom line outlook for the quarter. Turning to our 2023 performance, it was another exceptional year for Arhaus, fueled by our long-term growth strategies to one, increase brand awareness; two, expand our showroom base; three, enhance our omni-channel capabilities and technology; and four, invest in growth to build scale and to enhance long-term margins. Highlights from our 2023 full year results include net revenue of $1.3 billion with our showroom channel up 2% and our e-commerce channel up 17%, on top of growth of 57% and 43% of each of these channels in the full year 2022.
Comp growth of 1% and demand comp growth of 8%, both at or above the high end of our outlook for the year and cycling comp growth of 52% and a demand comp growth of 14% in the full year of 2022. Net and comprehensive income of $125 million and adjusted EBITDA of $203 million. Given our strong cash generation and balance sheet strength following 2023’s outstanding performance, I am pleased to announce our Board of Directors approved a special cash dividend of $0.50 per share payable on or about April 4 of 2024, to shareholder holders of record at the close of business on March 21, 2024. We are very pleased to be able to return value to our shareholders, while retaining the balance sheet strength that will allow us to continue investing in the Arhaus growth.
Dawn will cover our fourth quarter and full year 2023 financial results in more detail later on in the call, but I want to congratulate our team for delivering these results. I’m astonished by what our team has accomplished in the short time since we went public on November 4 of 2021. At that time, we had 77 showrooms. Today, we have 92 showrooms adding almost 20% to our showroom total, and we expect to add another 9 to 11 this year. Over the last three years, we believe the U.S. premium home furnishings market has grown 50%, while our growth has been more than 3x that of the industry. We have increased our net revenue by 154% or $780 million, increased our net income by 634% or $108 million, and increased our adjusted EBITDA by 193% or $134 million.
As impressive as this growth and the execution by our team has been, it is our future potential that is so significant and has me so excited. Going forward, we expect to continue to grow faster than the market by executing on our strategy. Starting with showroom growth, which is the number one way we expand our brand awareness. In 2023, we completed the largest showroom number of showroom projects in our history, opening eight new showrooms, two new design studios and one new outlet location, along with eight renovations, relocations, and expansion projects. Remember, our new showroom economics are very strong and we target new traditional showrooms who generate at least $10 million in revenue by year three, with target adjusted EBITDA margins averaging 32% and average investment payback in two years or less.
In 2024, as I mentioned, we expect another year above the record showroom growth with plans equal or exceed the number of 2023 showroom projects, including four to six new traditional showrooms, two design studios, three outlets, and to renovate, relocate or expand several existing showrooms. With wonderful feedback from our clients and the continued word of mouth awareness building around our showrooms and the incredible product they showcase, we look forward to introducing the Arhaus brand and experience to many more clients over the next several years, especially as we continue to work towards our target of 165 traditional showrooms. The number two, way we expand brand awareness, is through recommendations from friends and family. Our incredible product and the value proposition it offers is at the heart of these recommendations and we enjoy persistent demand for our product throughout 2023 driven by the success of many of our newer product collections.
We frequently describe traveling the world to seek inspiration, meet with incredible artisans, and ensure we continue to delight our clients with beautiful products from across the globe. As Wendy mentioned, I am joining you from Italy today where members of our product development team and I are working on some really exciting new products. Last year, I told you I thought 2023 was going to be the best year ever in new product lineup and I think we have exceeded even that very high bar with the product introductions and category expansions in 2024. Our spring and outdoor catalogs and showrooms are currently showcasing this product and I encourage all of you to go to the showrooms and spend some time on arhaus.com to judge for yourself. During 2023, we also continue to make some important growth investments to enhance our omni-channel capabilities and technology.
We are growing our insights from website engagement and have launched our incredible story campaigns online and in print, highlighting artisans from Mexico and Italy. These campaigns not only tell our product stories, but they elevate our brand at a time when we are introducing Arhaus to many new clients across the United States. This is also a great time to highlight the volume two launch of the story campaign Bellissimo Segreto a beautiful secret. As a reminder, we developed the story campaign in response to our clients asking to know more about the talented craftsmen behind our beautiful products. The introductory volume of stories rooted a story not common, highlighted a family of woodworking artisans in Mexico and was released last fall.
The current campaign is a testament to our Italian partnerships, some of which we were established decades ago and all of which have been instrumental to building our brand. We are thrilled to continue this series and look forward to telling the Arhaus story through future volumes. We are also continuing to make strategic investments to upgrade the technology that supports our business and long-term growth plans and enhances our capabilities in warehouse management, inventory planning and allocation, and manufacturing, delivery and efficiencies. Our teams have been working around the clock on these initiatives. I’m excited about our technology roadmap and the long-term advantages and expected margin enhancements it will create for us. These investments and enhancements will continue in 2024 and Dawn will give you more detail on the size and scope of these investments.
These are near and long-term prospects combined with the team’s strong and disciplined execution of our strategic priorities and buttress by our debt free balance sheet has us well-positioned to deliver on our financial and operational goals. As we look to 2024 and beyond, I’m excited about the opportunities of our business and our brand, both of which in many ways is still in the early days. Even though I’ve been at this for close to 40 years, I generally feel that there are no collections like our collection, there are no people like our people and there is no potential like our potential. Arhaus stands out and Arhaus stands alone. Our product is designed using the best materials and with the unparalleled focus on quality and comfort. We are curious world travelers and our mission to design and craft the best furniture and decor leads us to work alongside some of the most talented designers and craftsmen on earth.
Our showrooms are an authentic expression of who we are. We curate inviting spaces, carefully layered footprints, and compelling digital presentations to take every visitor on the journey of their choosing always letting inspiration lead the way. With our clients’ experience, we aim to build authentic relationships, inspiring and supporting our clients at every step in the journey. We encourage exploration; customization and we are never defined by the single style. Instead, we encourage and help our clients curate the unique styles of their homes and I believe we have the best team in the industry. We are a team of designers, dreamers, and doers, as passionate as we are curious. Finally, I want to personally congratulate our team for a great job of 2023 and thank them for their dedication to Arhaus and our clients.
I’m looking forward to what we will continue to build in 2024 and beyond. Now, I’ll turn it over to Dawn.
Dawn Phillipson: Thank you, John, and good morning. As John mentioned, we are incredibly proud of our 2023 fourth quarter and full year financial results and our operating performance throughout the year. We delivered a solid fourth quarter that concluded another year of record net revenue and exceeded our expectations for both revenue and earnings. Key items from our fourth quarter 2023 income statement include net revenue of $344 million with a 6.8% comp decline against a comp growth comparison of 47% in the fourth quarter last year that reflected strong backlog delivery. We were pleased with our demand comp growth in the quarter, which was 1.6% on a one-year basis and 91.4% on a four-year stacked basis. Demand comp growth in the quarter was impacted by promotions in November of 2022 that we made a strategic decision not to repeat in November of 2023 to preserve margin.
Our fourth quarter gross margin decreased $17 million to $141 million, driven primarily by lower net revenue, transportation costs, and showroom expenses, partially offset by lower costs related to the reduction in net revenue. Gross margin as a percent of net revenue decreased 330 basis points to 41%, driven primarily by product mix related to the sell-through of SKUs that were price-actioned in June of 2023, as well as increased showroom costs and transportation investments. Fourth quarter SG&A expense increased $7 million to $100 million, primarily driven by strategic investments in the business to support our growth and increased selling expense related to new showrooms and higher demand, partially offset by lower warehouse expense. Fourth quarter 2023 net income decreased $16 million to $31 million.
Adjusted EBITDA in the quarter decreased $23 million to $51 million from $74 million in the fourth quarter of 2022. The fourth quarter net revenue of $344 million and adjusted EBITDA of $51 million resulted in a 15% adjusted EBITDA margin in the quarter. For the full year, key income statement items include net revenue of $1.3 billion, comp growth of 1.4%, and demand comp growth of 7.6% on a one-year basis and 91.4% on a four-year stacked basis. During the year, demand was strong in both showroom and e-commerce channels as our products and marketing continued to resonate. Our net revenue growth was driven by both our strong demand and the delivery of approximately $75 million in abnormal backlog in 2023. Gross margin as a percent of net revenue decreased 70 basis points to 42%, primarily reflecting higher showroom expense, transportation investments and credit card fees, which were partially offset by favorable product costs.
Product costs improved due to the flow through of container cost favorability versus prior year and promotion management, partially offset by the impact from price action SKUs. Full year SG&A expense as a percent of net revenue increased 150 basis points to 29%. The increase was primarily driven by strategic investments to support and drive the growth of our business, including increased expenses as new showrooms open and we invest in technology and the donation to the Nature Conservancy. These increases were partially offset by lower warehouse expense and the non-recurrence of costs related to the 2022 opening and setup of our Dallas distribution center. Full year 2023 net income decreased $11 million to $125 million. Full year 2023 net revenue of $1.3 billion and adjusted EBITDA of $203 million resulted in a 16% adjusted EBITDA margin for the year.
I want to reiterate John’s appreciation of the exceptional work of our teams across the company over the past year, which was instrumental in driving 2023’s strong performance and record net revenue. Turning to this morning’s special dividend announcement. One of our competitive strengths is our strong debt free balance sheet and the financial flexibility it affords us. Following several years of outstanding performance, growth and cash generation, and having ended the year with $223 million in cash, our Board of Directors is pleased to return approximately $70 million in capital to shareholders in the form of a special cash dividend. We are pleased to know even with this special dividend, our growth and strategic investments remain unchanged, as we are also in the enviable position of having both a long runway to continue to grow our showroom footprint and high returns from that growth.
Investing in the business to drive profitable growth remains our top priority. We will continue to build on that profitable growth with our planned CapEx investment of $80 million to $100 million in 2024, with the majority allocated to showroom projects. Next, I’d like to turn to our outlook for 2024. With continued macroeconomic uncertainty and lapping prior year backlog delivery, we have assumed a range for comp growth of negative 4% to negative 2%. As a reminder, we are comping approximately $75 million in abnormal backlog delivery in 2023. While we enter 2024 with a normalized backlog, our comp growth metric will not normalize until 2025. For the full year 2024, we expect net revenue of $1.33 billion to $1.37 billion, which represents growth of 3% to 6%, comp decline of 4% to 2%, net income of $95 million to $105 million, and adjusted EBITDA of $185 million to $200 million.
We expect full year adjusted EBITDA margins to be lower than 2023. Deleverage will be most significant in the first half of the year and is driven by comping prior year backlog delivery and strategic investments we are making this year. 2024 strategic investments include our robust number of showroom projects and operational improvements to enhance our capabilities and drive our success long-term. We expect most of the deleverage to come from SG&A with a lesser amount of deleverage in gross margin. We expect to invest approximately $10 million to $15 million in corporate strategic investments this year as we work to streamline operations and drive a best-in-class client experience. Strategic investments for the year, in addition to new showrooms, include a new warehouse management system in our Ohio distribution center, planning and allocation software, and a manufacturing ERP.
We will also continue to invest in our in-home delivery experience as well as other growth initiatives such as e-commerce and our in-home designer and trade programs. For the first quarter of 2024, we expect net revenue of $260 million to $270 million, a comp decline of 23% to 20%, net income of $1 million to $3 million, and adjusted EBITDA of $11 million to $15 million. As the range indicates, in the first quarter of 2024, we expect net revenue to be down low-teens compared to the first quarter of 2023. This is primarily due to the implementation of our new warehouse management system in March and weather-related impacts in January. Quarter-to-date, our demand comp in January declined high-single-digits as weather impacted traffic, with February accelerating to mid-single-digit demand comp growth.
We expect significant adjusted EBITDA deleverage in the first quarter. Of the deleverage approximately a third is coming from gross margin due to deleverage of fixed costs on the revenue decline and continued delivery of price action SKUs. The balance of the deleverage is in SG&A due to the revenue decline and as we continue to make strategic investments. As our full year outlook implies, we expect net revenue growth in the balance of quarters this year. We expect deleverage in both gross margin and SG&A in the first half of the year with inflection expected in the second half as the P&L impact from the June 2023 price action product is complete and revenue and earnings from new showrooms positively impact our P&L. We will update you on our second quarter expectations when we report first quarter financial performance in May.
For all other details related to our 2024 outlook, please refer to our press release. We are also reiterating our long-term growth goals. We expect the investments we are making in the near-term will enable us to achieve these goals. Over the long-term, we target mid-single-digit comparable sales growth and mid to high-single-digit showroom growth, leading to high-single-digit net revenue growth and low-double-digit adjusted EBITDA growth. In closing, I want to again acknowledge the hard work and dedication of our teams. Our success in 2023 reflects our focus on and execution of our strategy, which remains unchanged. We believe our strong debt free balance sheet is a competitive advantage, enabling us to execute on our growth plan and make the necessary investments to build on our share gains in the highly fragmented $100 billion premium home furniture market.
We believe we are well-positioned to meet the needs of our clients in any economic environment and remain keenly focused on driving value for all stakeholders. Thank you. And we would now like to open the call up for questions.
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Q&A Session
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Operator: Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. [Operator Instructions]. Our first question is from Peter Keith with Piper Sandler. Please go ahead.
Peter Keith: Hi, thanks. Good morning, everyone. Great results. I want to ask about the system rollouts, which are interesting. So ERP systems can send some fear down analyst spines. So talk about the risk of the ERP and then future benefits of the other systems that could come in the next two years.
John Reed: Good morning, Peter. John here. Dawn has probably got more information on this than I, but we’re kind of laying things out in stages. I don’t believe we’re doing a full ERP system anytime soon. We’re doing a warehouse system and then a management planning system and then a totally separate system for our manufacturing plants that manufactures and upholstery. Dawn, do you have anything to add to that?
Dawn Phillipson: Yes. Good morning, Peter. I think we — in the fourth quarter of last year, we deliberately — we hired a consulting agency to help us really evaluate our full systems and business infrastructure and look at not only what we should be really contemplating for revision and updating, but also the sequencing and cadence of that for exactly what you’re speaking to. We want to make sure that as we are continuing to grow the top-line, that we don’t compromise the client experience, certainly, and that we don’t compromise operational integrity. So we’re certainly being very thoughtful, very mindful ERPs, I think send fear down the signs of everyone, implementers and analysts alike. So we are trying to be very thoughtful.
We are excited for some of these new systems as we think about the planning and allocation software, really, that’s going to help us just more seamlessly facilitate movement of product through our network, which is going to have not only operational efficiencies, but financial efficiencies once deployed. So we’re really excited for that. There are some other systems that we have not yet started, but have mentioned in the past that we’re under analysis, like an order management system, which will also do the same thing and help kind of facilitate making sure the product is coming from where it needs to be. So I think overall, I — we’re taking a very thoughtful, prudent, responsible approach, I would say, to systems, enhancements, and infrastructure changes, but we’re certainly — we’re laser-focused on the operational impact as well.
Peter Keith: Okay. Thank you. And then I just say, Dawn, for a little more financial technical question. With the warehouse management system rolling out in Q1, I guess it’s probably causing a little bit of sales lag. So Q1 sales got a little bit worse than we thought. Is there a sales shift that you could quantify for us that’s going to roll directly into Q2 or maybe also carry into Q3?
Dawn Phillipson: We think it’s probably about a week worth. So, simple math, you could kind of just take what a typical quarter looks like and divide by the number of the weeks in the quarter. That being said, we also did see some impact on deliveries in January related to weather. So if you think about those drivers who are out there, if there’s really icy conditions or snowy conditions that are particularly difficult at times, they will delay those deliveries. So I think as we’re thinking about 2024, the first quarter certainly has kind of the lowest year-over-year impact or the least favorable year-over-year impact. And then as we look out to the following quarters, we’re pretty excited. And we think that as we move through the year, we should see sequential acceleration in the deliveries and net revenue as we move through the year.
Peter Keith: Very good. Thank you so much.
Dawn Phillipson: Thanks, Peter.
Operator: Thank you. Our next question is from the line of Jonathan Matuszewski with Jefferies. Please go ahead.
Jonathan Matuszewski: Good morning and nice results. Thanks for taking my questions. First one is just on underlying assumptions for your 2024 comp guide of down four to down two. Just help us give some color in terms of how you’re thinking about large scale renovations, light refreshes, existing home sales, factors like that that you’ve said have the most weighting on demand for your business? That’s my first question. Thanks.
John Reed: Go ahead, Dawn.
Dawn Phillipson: Good morning, Jonathan. Yes, so as we’re thinking about the macro, there certainly continues to be a lot of uncertainty. We do know that our client continues to renovate, continues to refresh their home, and a light refresh can be something as simple as painting a room. So we think there’s still plenty of that happening. I think we also — if you think about our market share of just a total $100 billion industry, we have a ton of runway. We’re less than 2% of market. And so just so much opportunity for us as we continue to open showrooms, as the marketing team continues to really expand the brand awareness and kind of think outside the box on some of these different marketing campaigns. Jen, do you want to talk about the Italy campaign?
Jen Porter: Sure. Hi, Jonathan, good morning. Yes, we’re really excited. As Dawn mentioned, we’re really excited opening up those new showrooms, but within marketing as well, we’re really excited about the new opportunities that we have to not only present Arhaus in a similar way to more people, but also new ways that we’re presenting Arhaus out to the audiences. So as John mentioned, we kicked off our story series with our rooted campaign featuring our Mexican artisans last fall. We just launched our Italy campaign in spring with a big rollout in February. And it really does give us a way to tell those stories, share the craftsmanship, share the things that really make Arhaus unique and special. John talks all the time about how proud we are of our product and what we’re delivering to the market.
