Good morning and welcome to Arhaus Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the 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. You may begin.

Good morning and thank you for joining Arhaus’ third quarter 2022 earnings call. On with me today are John Reed, Co-Founder, Chairman and Chief Executive Officer; and Dawn Phillipson, Chief Financial Officer. John will start with a summary of the main points we made in this morning’s press release, along with operational details. Don will cover our financial performance and outlook for the remainder of 2022 and then they will be joined by Jenn Porter, our Chief Marketing 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 and our 10-Q for the quarter ended September 30, 2022 before market opened today. Those documents are available on our Investor Relations website at ir.rhouse.com. A replay of the call will be available on our website within 24 hours. 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 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. I will now turn the call over to John.

Good morning, everyone, and thank you for joining us today. We are pleased to report another strong quarter with record net revenue and significant year-over-year earnings growth. Our team once again executed extremely well in a very dynamic macro environment, satisfying our clients, supporting our growth strategies and managing our profitability. Turning to some highlights for the third quarter results. One, net revenue of $320 million, a 57% increase over Q3 last year with our retail channel up 61% and our e-commerce channel up 40% in the quarter, comp growth of 54.3% and demand comp growth of 15.8% and Net and comprehensive income increased 160% and adjusted EBITDA increased 87%. Our net revenue performance for the quarter was better than expected from both demand in the quarter and continued delivery of our backlog. Our net income and adjusted EBITDA were also much better than expected, primarily driven by the strong net revenue and leverage on fixed costs. Demand comp growth in the third quarter was a robust 15.8%, significantly exceeding our expectations. In the early part of the fourth quarter, we are continuing to see solid demand with mid-single-digit demand comp growth off a strong prior year Q4 demand comps. This is consistent with our longer-term expectations for comp growth and demand comp growth. Turning to our operational developments in the quarter, our product and marketing continues to resonate with our clients. We are pleased with the fall campaign and just launched our new holiday campaign last week. Regarding supply chain, on the inbound side, we continue to see moderation of the bottlenecks that we have impacted our industry since the start of the pandemic, and our lead times are coming down steadily. We are seeing lower freight cost persist, although fuel prices remain volatile. On the outbound side, as…

Thank you. As John described, our business continues to be resilient, and we are pleased with our operational and financial performance in the third quarter. Key items from our third quarter 2022 income statement include net revenue of $320 million, comp growth of 54.3% and demand comp growth of 15.8% on a 1-year basis, 44.1% on a 2-year stacked basis and 87.8% on a 3-year stack basis. During the quarter, we saw strong demand in both showroom and e-commerce channels. Our net revenue growth was driven by both demand and the continued delivery of orders in our backlog related to our increased distribution capacity and continued improvement in product lead times. Our third quarter gross margin increased 61% to $136 million in the quarter, driven by our higher net revenue, partially offset by higher variable costs related to the increase in net revenue, including product, transportation and variable rent expense as well as higher credit card fees related to increased interest rates and demand. Gross margin as a percent of net revenue increased a better-than-expected 90 basis points to 43%, reflecting our ability to leverage our fixed showroom occupancy costs over the higher net revenue, partially offset by higher variable rent and transportation expense. Third quarter SG&A expense increased 31% to $89 million. The increase was primarily driven by investments to support the growth of our business, including higher corporate and warehouse expenses as new showrooms open, and we expand distribution capacity as well as public company-related costs. We expect incremental expense from our expanded distribution center footprint in the near term to be approximately $40 million on an annualized basis. SG&A expense as a percentage of net revenue decreased 570 basis points to 28%, driven by leverage on fixed costs on the 57% net revenue increase and the non-recurrence…

Thank you. [Operator Instructions] Our first question is from Curtis Nagle with Bank of America. Please proceed.

Good morning. Thank you so much for taking the questions. So I just wanted to talk about setup, I guess, into next year. You guys are way outperforming the industry in terms of demand, products resonating, right? That’s in the face of all sorts of macro uncertainty. What do you think the positive – what keeps positive going? Is it just the momentum you have now? What are the biggest headwinds? And do you think you can keep up that mid-single-digit demand comp growth in line with 4Q and your long-term targets for next year?

Good morning, Curtis, John here, John Reed. Yes, we are sticking with our original plan, which was during COVID, we focused on working on new great products, rolling out collections, they have now gotten certainly in the stores. We’ve gotten inventory behind them. And it seems like our product is resonating with our customers. That’s what retail is about. If you have the right product, the right product at the right price that your customers want, they are going to buy. And so we’re going to stay focused on that, and we think we will be okay going into ‘23.

Okay. Understood. And then just as a follow-up, I guess, kind of a similar question around just how to think about transportation costs for next year, right, still elevated, I guess, fuel surcharges is still an issue, but as contracts we said and freight costs have gone down, I think shipping to. Should that not be a tailwind for gross margins into next year?

Morning, Curtis, this is Dawn. So we will provide a little further context on 2023 when we report the fourth quarter. But I would just remind you that container costs, while they are coming down this year, will take some time to flow through our P&L just given the timing, and we use our inventory as at landed cost, which includes those container costs, so more to come when we report the fourth quarter, but we feel like we have a decent handle on what that will look like next year.

Okay. Thank you.

Our next question is from Simeon Gutman with Morgan Stanley. Please proceed.

Hi, this is Jacquelyn Sussman on for Simeon. Thanks for taking our question. Just quickly on the kind of discounting and promotional environment. What are you guys seeing? And can you please talk about your assumptions, I guess, for the fourth quarter and the beginning of ‘23?

Yes. Hi Jacque, this is Jenn. So as we’ve been saying, we’re definitely seeing promotional activity pick up within the market. Looking at our strategy through Q3, we were in line with where we were last year, which is much lower promotional activity versus 2019, and we continue to feel very strong with the results of that. As you heard today, going into the peak November holiday sales period. We’re definitely seeing promotional activity pick up even further within the market. And we are a bit more promotional than we were last year, which is really in a proactive effort to pull forward some of that promotional activity earlier in the month, in line with the trends that we’re seeing with other retailers. Looking forward, we aren’t really seeing this as a shift in our promotional strategy for a long-term basis. This is more of a reaction to what’s happening in this peak holiday sales period. So we’re going to be monitoring very closely, obviously, as we move forward. But right now, our plan is to stay in line promotionally with where we’ve been year-to-date as we look forward into next year. One thing I will note is just the promotion that we did turn on and have been running. We’ve seen a really nice reaction to that, which we think in part is we have been so quiet all year. And as John mentioned, we have the product, we have all cylinders firing on that side. So it’s really nice just to see that we do have this great lever if we ever need it in the future. But for now, looking into next year, we still feel really good about focusing on getting the product into the stores, having our marketing hit and paying our attention there.

Got it. That’s really helpful. And just quickly one more on the complexion of the 54.3% comp, is there any color you can give us to like price versus underlying transaction growth in the quarter were underlying transactions positive? And how does that compare maybe to ‘19 levels?

Jacque, this is Dawn. So 54% is on a delivered basis. So as we think about the components of the demand comp in the third quarter, that’s where we would talk more about average order number of transactions. And both of those were up really nicely. Units per transaction, was also up really nicely, so still seeing some nice strength from the consumer base as it pertains to our product offerings in the market in the third quarter. So we are really pleased.

Got it. Thanks and good luck this quarter.

Our next question is from Jonathan Matuszewski with Jefferies. Please proceed.

Hey, good morning and great quarter. First question is on market share. You guys comped 54% this quarter. The premium furniture market is not growing near that pace. So just wanted to get your updated thoughts on where you think that share is coming from? Is there evidence of elevated challenges at some of your smaller players that you think is driving market share gains or do you think it’s more of a function of certain larger competitors moving more upmarket, just wanted your updated thoughts there? That’s my first question. Thanks.

Good morning, Jonathan, I can start this up if Dawn wants to pitch in. But I guess my answer is we really don’t focus on what our competitors are doing. I mean we certainly know what they are doing, but we focus on our business and executing everything that is planned in our business right and continue to be hitting on all cylinders. Everything is working from getting the product in here to getting it delivered to having the right product that customers obviously want a fantastic value, incredible quality. And I don’t have any clue what smaller people doing or the big guys are doing. But we know – what we’re doing is working and we’re going to keep doing it.

Got it. That’s helpful. And then I guess just my follow-up, Dawn, on the 4Q comp guide, would be great just to get any sense of kind of the macro and housing assumptions underlying that forecast in terms of what you guys are expecting to drive the midpoint of the 4Q guide? Thanks so much.

Sure. So keep in mind that 4Q guide is on the delivered side versus the demand side. So I just want to clarify there. We continue to see that we don’t have an incredibly strong correlation with the housing market. It is a factor, but it’s not the driving factor. Stock volatility continues to be kind of what we’ve seen historically as a driving factor of the demand comp. So, that being said, we’re really pleased with what we’re seeing from the consumer response like we said in the third quarter and fourth quarter to date as continuing just to invest in our marketing programs, which we know are resonating really well with clients and making sure the product is on point. So just continuing to execute on those key core strategies that we have and not deviating.

Got it. Best of luck.

Thank you.

Our next question is from Steven Forbes with Guggenheim Partners. Please proceed.

Good morning, John, Dawn and Jenn. Just wanted to follow-up on a couple of questions before, I think it was around the company’s performance. I don’t know if you can sort of comment on high level sort of what you’re seeing in your customer demographic profile that may help explain the outperformance if there is any changes in AOV trends or the typical trade area, right, that the store pulls from I think we’re just looking at the performance here and trying to find sort of an explanation for what’s driving the strength. I think this acceleration in the multiyear stack of comp is certainly a standout. So I don’t know if you have any sort of high-level thoughts on what you’re seeing in your customer data that would help explain it?

Yes. Hi, Steve, this is Jenn. I mean looking at the customer data, we’re continuing to see our customers really acts and demo wise be the same as they have been. We’re paying very close attention to that. We’re digging in. Honestly, we’re as curious as you are looking there. But we have really strong customer identify. So looking at new versus existing or continue seeing that look really nice with that value still being around that 50-50 mark I’ve spoken before in terms of sort of the net worth, income demos, age, all of that. We’re seeing that staying consistent with where we’ve been for the last few years. So we’re definitely paying very close attention. And as we’ve spoken to, our clients are out there. They are seeing what they want. They are liking their product and they are willing and able to pay for it. So we’re continuing to focus on getting that message out. If we see anything in the future, we will definitely share with you. But for now, nothing noteworthy to report.

And then maybe just a quick follow-up for Dawn, it looks like the fourth quarter EBITDA margin is being guided down year-over-year. I don’t know if you could just help us better understand the anticipated margin pressure. It seems like it might be in the product margin side with promotions, but anything specifically to call out in expenses and/or growth that we should note?

Yes. So well, we don’t guide on a quarterly basis. I think the additional context that’s going to be really helpful for you to think about is the Dallas distribution center. So it’s a very expensive, very large facility that is adding to our expense structure year-over-year. So we feel pretty good about our strategies to execute top line out of that facility. I’d also say we talked last quarter about the marketing investments, and we’re being really thoughtful about kind of getting in front of any macro softening that might be occurring, which, as you can see from our numbers in the third quarter, we feel pretty good about how those came in, but there will be a bit more marketing investment in the fourth quarter, just preemptively staying top of mind as clients. So those are probably the two components I would call out for you to think about.

Thank you. Best of luck.

[Operator Instructions] Our next question is from Cristina Fernandez with Telsey Advisory Group. Please proceed.

Yes. Good morning and congratulations on a good quarter. I wanted to see if you could talk about inventory. With inventories building across the industry in demand environment being a little bit more uncertain, how are you thinking about inventory flow going forward? Should we expect the inventory to increase from here or level off?

Yes. So we feel pretty great about our inventory position today. Keep in mind that the inventory dollars are factoring in those higher transportation costs on the inbound side as well as some higher product costs that we’ve seen from vendor price increases over the last 18 months or so. But on a unit basis, we’re pretty confident with where we’re at. I’d also say we have a pretty nice pipeline of backlog orders to deliver, which should give us good visibility into where we need the inventory levels to be for really the next 8 months or so. So we feel confident in our inventory strategy, and we feel good about where the inventory is positioned today

And then going back to the demand in the quarter, anymore color you can share about how the quarter progressed and any product categories that outperformed relative to the overall company?

Yes. I think it’s been pretty steady. We didn’t see any pop in any categories or anything. It’s the core products and again, the products that resonated with our customers are the ones that are selling. And it’s been pretty steady all year for that matter on what the bestsellers are. What our clients are buying. We’re seeing a nice lift in some of the categories that are add-ons to the core products. In other words, rugs, lighting, so forth, which give us a great additional sale because as people are buying, say sectional, if we can add on the lights, the rugs, it can literally almost double the ever sale. So we’ve done a really nice job. Our team has on expanding those categories, and we’ve seen some great growth in those categories. As well as the outdoor category, we’ve seen some nice growth on throughout the summer. That, of course, is winding down now, but it will be picking back up soon. We’re after the first of the year again.

And then, Cristina, just on the dispersion of the comp within the quarter, we saw some moderation in September, but it was still up really nicely year-over-year. So nothing really notable there, but very, very pleased with how the quarter performed and how it trended throughout the quarter as well.

Thank you.

Our final question is from Peter Keith with Piper Sandler. Please proceed.

Hi, thanks. Good morning, everyone. I have on the call a little bit late, so I apologize if these are repetitive. But I wanted to just think about pricing going forward. There is a lot of discussion in the furniture industry around excess inventory and markdowns, prices coming down over the next 6 to 12 months. Obviously, you guys are a bit of a different animal out there. But how do you think about your pricing going forward as you’ve taken pricing here a couple of times over the last 18 months, do you anticipate maintaining price? Or do you think there probably some moderation in your overall pricing?

Good morning, Peter. Yes, we certainly, as everybody has, we’ve seen cost increase over the last 18 months or so. We’ve adjusted our prices we don’t see – we kind of see us holding steady as where we’re at right now. We have seen a nice decrease in container cost and current product coming in. But as Dawn said, a lot of the product we own, and we do have a good amount of product, not excessive by any means, but the right amount of product, so we can service our customers and clients on a timely basis. So we’re happy with our inventory levels. We’re able to service our customers a lot quicker than we were. I do see out there in some of the industry that some people are still way out on inventory and other people have excess, so they are trying to clear that out. We’re in good shape. We don’t have excess so we’re not turning to clear anything out. And we see pricing holding steady. We will look once we clear out the inventory that we own it, the higher container costs, we will look to even adjust our prices a little bit if we can to sell more units, but that’s down the road.

Okay. Helpful. And then just lastly, just on the unit growth outlook. A lot of other growth-oriented retailers have talked about opening delays from permitting HVAC. What are you guys seeing out there right now as you’re playing the openings for 2023?

Yes. We’ve had a couple of stores that were planned for 2021 that are falling into the beginning of 2023. I think we have a good handle on it now. We just have to plan longer because we know things like parts for HVAC and so forth are going to take 6 months to get in and so forth. So we’ve got a great team that’s building our stores, they are all over it. They are way out in front of it. So we think the dates that we’re committing to, we think we’re going to be able to hit pretty well. And they are longer than, of course, we’d like or anything, but the dates we are committed to, we feel confident we will get them open at those dates. My real estate team might kill me for saying that, but that’s about what we’re seeing right now.

Okay. Sounds good. Well, best lucks the real estate team and everyone else there. Thank you.

Thank you, Peter.

We have reached the end of our question-and-answer session. I would like to turn the conference back over to Wendy for closing remarks.

Thank you, everybody, for your participation in the call and interest in our Arhaus. We look forward to talking to you again next quarter.

Thank you.

This does conclude today’s conference. You may disconnect your lines at this time, and thank you for your participation.