ARHS - NASDAQ

Good morning, and welcome to the Arhaus Second Quarter 2024 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. Please go ahead.

Good morning, and thank you for joining the Arhaus second quarter 2024 earnings call. On with me today are John Reed, Co-Founder, Chairman and Chief Executive Officer; 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 and our 10-Q for the quarter ended June 30, 2024 before market opened today. Those documents are available on our Investor Relations website at ir.arhaus.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 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. 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. Now I'll turn the call over to John.

Good morning, everyone, and welcome to the Arhaus second quarter conference call. Our team delivered another quarter of solid operational execution with several new showrooms opening, successful new product development, and important strategic investments made to support our long-term growth. In the second quarter, we delivered a net revenue of $310 million, net income of $22 million, and adjusted EBITDA of $40 million. During the quarter, we saw demand comparable growth softened to a decline of 3%. On a two-year stacked basis, demand comp growth increased 8.6% in the second quarter, and on a three-year stacked basis, demand comparable growth increased 31.1%. We're very proud of our strong growth over the past several years and expect to continue to grow our demand comps mid-single-digits in the long term, even as there is near-term contraction related to the macro environment. July's demand comp accelerated the second quarter trend with a high-teens decline resulting in a two-year stacked demand comp decline in a low-double-digits and a three-year stacked low-double-digit demand comp increase. Demand metrics in the second quarter were mixed. Our average order value and comp traffic were down. Conversions were down slightly year-over-year, but up sequentially from the first quarter. Transactions in the second quarter were positive and orders over $5,000 and $10,000 continue to grow nicely. We also saw a solid growth in new customers in the second quarter, and the total traffic was up. Total demand in the second quarter increased mid-single-digits. We continue to be very pleased with the new showroom performance and our showroom expansion plans. Dawn will discuss in more detail later in the call, but given the current consumer backdrop and industry tech trends, as well as our own demand comp trends over the past three months, we are adjusting our expectations for the second half of the year and lowering our full-year outlook. While our net revenue and earnings outlook are not what we originally expected for the second half of this year, I am confident that we have the right strategy, the right product, the right marketing to continue to successfully grow over time. We have extensive experience navigating cyclical consumer environments, where we maintain focus on our expense control while our strong debt-free balance sheet allows us to continue to execute our strategic growth plans. During times of economic softening, we have and will continue to invest in product, marketing, and showrooms. As we have done before, we are confident that this approach will enable us to emerge from this cycle in an even stronger position. We will continue to advance our growth strategy by enhancing and elevating our product assortment, expanding our showroom base, increasing brand awareness, and making the strategic investments necessary to upgrade our infrastructure, and improve our business tools to support this growth. Our growing showroom footprint with two primary formats continue to drive brand awareness and our long-term growth. We have opened 8 new showrooms in 6 states so far this year and opened our 100th location. I want to thank our teams across Arhaus for their efforts in achieving this important milestone in our journey. Just since late May, we have opened 3 incredible new showrooms, which are our large format in fabulous centers in California: The Grove in Los Angeles, The Beacon La Costa in Carlsbad, and Stanford Shopping Center in Palo Alto. Today, we have 83 traditional showrooms, only halfway through our goal of 165 traditional showrooms. Our 165 traditional showrooms goal is based on very attractive markets we have identified through our experienced real estate team. We performed robust analytic work and our location lists and have more opportunities that we choose to execute in any given year. Our model is successful in a variety of markets and across all geographies, allowing us the opportunity for significant expansion. In short, we couldn't be more excited about the new location opportunities ahead of us. As you know, we are also thrilled with our smaller design studio concept, and last week opened our second design studio of the year in Peachtree City, Georgia. Our skilled real estate team has identified 100 locations for design studios. And while we are early in our growth journey, with this footprint, we are incredibly pleased with the performance we've seen, with design studios outperforming the balance of the chain. We are on pace to meet our showroom opening goal for 2024 with a design studio in the Lake Norman, North Carolina area and traditional showrooms in Oklahoma City and Corte Madera, California, slated to open later this year. As I mentioned earlier, we are pleased with the performance of our new showrooms and our new showrooms economics. Moving to our brand awareness. This is a significant opportunity as more and more potential clients become familiar with Arhaus. The top two ways we increased brand awareness are through opening new showrooms and recommendations from trends and family. From our nearly 40 years in the industry, we generate our strong recommendations from friends and family because the factors that set us apart in the premium home furnishing industry. Our exceptional product and the value proposition it represents, the unique artisan nature of the aesthetics, the time we take to understand our clients' wants and needs in their homes and matching that with our livable luxury approach, the inspirational and aspirational experience in our showrooms, the ability to match our clients with our complementary in-home designers, and the ease with which we work with our clients' own interior designers, and our focus on creating the best in-home experience in the industry. Speaking of products, we cannot wait for you to see our new fall collections, which will begin arriving in showrooms at the end of the month. At the same time, our fall catalog will start arriving in homes. It is a stunning catalog, and we have meaningfully increased circulation with prospects to drive brand awareness. We are introducing some incredible new collections that build on the success of our -- some of our most popular pieces. You will see stunning new wood finishes that that we are very excited about and new curved takes and wonderful fabrics in our upholstery collections. We continue to focus on offering our clients high design combined with the trademark comfort and functionality that defines livable luxury aesthetics. On our strategic investment front, as we communicated, we are focused on setting the foundation for long-term growth by improving operational efficiencies with upgraded infrastructure, technology, and processes. We are pleased to have implemented our new warehouse management system and continue to refine the opportunities for operational efficiencies. Further, over the next several months, we will begin to deploy a new planning system that will help optimize our inventory purchases and forecast capabilities and a new ERP and our upholstery manufacturing facility that will improve margin visibility and production capabilities. We are continuing to work hard to create a future scalable operating environment that will set the stage for more efficient growth. Turning now to supply chains for the update on ocean freight. All carriers are still avoiding the Red Sea and transit times are two weeks longer on average, which we are planning for in our inventory purchases. Spot rates have increased this summer from container capacity shortages, early peak season shipping and port congestion at the Asian points. During the second quarter, we were able to bring in all of our containers using the contract rate, but have paid some higher spot rates in the third quarter to ensure product availability for our clients. This impact is factored into our revised outlook for the remainder of the year. Together with our vendors, not only did we learn to successfully navigate supply chain challenges during the pandemic, but we confirmed our geographically diverse supply chain is an advantage in our industry. I am pleased to say that with our strong vendor relationship, we are also working together to improve our costs given the current environment. But don't mistake that for cost engineering. We do not reduce our quality to hit a margin target. Before I turn this over to Dawn to discuss our results and outlooks in more detail, I want to thank our teams for striving to provide industry-leading client service every day and for achieving key milestones in advancing our strategic growth initiatives in the first half of 2024. I'm extremely proud of all of you and I'm excited to keep the momentum going. Now I'll turn it over to Dawn.

Thank you, and good morning. Net revenue in the second quarter was $310 million with a 7.1% comp decline. The decrease in net revenue compared to the prior year was driven primarily by the non-recurrence of prior-year abnormal backlog deliveries and the implementation of our warehouse management system in our Ohio distribution center. As John mentioned earlier, our demand comp declined 3% in the quarter, with April's mid-single-digit increase more than offset by mid-single-digit declines in the balance of the quarter. Our second quarter gross margin decreased to $124 million, driven primarily by higher showroom costs as we continue to expand our footprint, lower product margin related to promotional activities, and increased delivery and transportation costs as we continue to invest in our final mile experience. Gross margin as a percent of net revenue decreased to 40.1%, driven primarily by lower product margins, higher showroom costs, and higher delivery and transportation costs. Second quarter SG&A expense increased $9 million to $95 million, primarily driven by higher selling expenses related to new showrooms, increased corporate expenses as we invest in our strategic initiatives to support and drive the growth of the business, and higher warehouse expense related to increased productivity in Dallas and the WMS implementation. Second quarter 2024 net income was $22 million. Adjusted EBITDA in the quarter was $40 million versus $64 million in the second quarter of 2023. Second quarter net revenue of $310 million and adjusted EBITDA of $40 million resulted in a 12.9% adjusted EBITDA margin in the quarter. As we reported this morning, we are lowering our full-year outlook for 2024. While our first half performance was consistent with our expectations, our second half net revenue and gross margin expectations have changed given recent demand trends. We experienced softening demand comps starting in May and the negative trend accelerated into July. We believe this is a reflection of the pullback by the home furnishing consumer that is starting to impact our business. In the past, we've seen that our client has typically been the last to stop shopping and the first to start again during times of economic downturn. Similar to how we've handled other cycles, our uncompromising strategy of new product introductions, marketing investments, and opening new showrooms will allow us to capture market share as the macro improves and as clients return to investing in their homes. Our outlook contemplates a low-double-digit demand comp decline for the remainder of the year. We believe this is especially prudent in an election year when the industry generally experiences slowing year-over-year sales growth in the second half of the year relative to the first half. At the same time, as John mentioned, we are very excited about our fall product launches supported by a robust marketing campaign. As the midpoint of our range implies, we expect net revenue to decline approximately 1% in the second half of the year versus the second half of 2023. On the profitability side, we expect approximately 280 basis points of adjusted EBITDA deleverage in the second half of 2024. We expect about 70% of the deleverage to come from SG&A with the balance in gross margin. The majority of this deleverage is from slowing demand and continued important growth investments. Compared to our prior expectations for the second half, we now expect incremental deleverage from the lower net revenue, which will impact both gross margin and SG&A. Our outlook allows for flexibility around promotions for the balance of the year as well as factors in elevated freight costs. We now expect gross margin deleverage in the second half of the year versus our prior expectation of gross margin inflection. In the third quarter of 2024, we anticipate net revenue in the range of $325 million to $345 million. And at the midpoint, we expect adjusted EBITDA to decline approximately 130 basis points versus prior year. For all other details related to our 2024 outlook, please refer to our press release. In closing, I want to reiterate our strong commitment to our strategic growth strategy despite the current macro challenges. Our long-term growth targets have not changed. We continue to expect long-term total revenue growth in the high-single-digits as we grow showrooms in the mid- to high-single-digit range and comparable sales grow mid-single-digits. We will also continue to improve operational efficiency, driving adjusted EBITDA growth of low-double-digits long term. Our debt-free balance sheet is a meaningful competitive advantage that allows us to make the responsible investments to build on our share gains in the highly fragmented $100-billion premium home furniture market. We continue to navigate the current environment from a position of strength, and we believe we are well-positioned to maintain our client-first service and drive 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.

Ladies and gentlemen, we will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Simeon Gutman with Morgan Stanley. Please go ahead.

Hey, everyone. I wanted to ask, first, just technical on the fourth quarter backing into the comp. It looks like it's down mid-teens. It's just straight math, but I want to make sure that's correct. And then the summer swoon I guess, that's occurred, can you talk about -- has there been a real change in demand? Has it been, I guess, customers may be deferring purchases? And anything you can talk about product categories? Was it outdoor that slowed or it's all the indoor and fall purchases that customers have stopped buying?

Hey, good morning, Simeon. John Reed here. Yeah, first of all, on the last part of that question. No, we've seen the product -- it hasn't been a specific category whatsoever. It's kind of just been across the board. We're seeing nice traffic in our stores. People are just taking a little break right now from buying as much as they had been. Our business has been so strong for so long, and we're still buying, growing leads. Our interior designers are still very, very busy. So there really hasn't been a huge change in that. It's just -- it seems like the summer blues and people are traveling so much. Our customers are certainly that they're taking a little break from what they had been.

And then if I can sneak in a follow-up. I think the press release mentions promotional activity. It may be the first time it's been written. You might have talked about it on calls. But talk about the backdrop and then your approach to it, and how much you're waiting in, in the fall, you have new product coming and how much of the gross margin is also promotions for the back half. Thank you.

Sure. I can take part of that, and Jen can as well. Yeah, the back half -- our product lineup is unbelievable. We're very, very excited about it. We think it's certainly the strongest in the industry. And I've been through these times, we all have for quite a while, ups and downs and so forth. And the way our strategic plan has always been is people pull back in times like this that their business is bad. We kind of do the opposite. We accelerate our new product, our excitement that looks in the stores, refreshing them up. We're bringing a lot of color in the stores. We're doing things that really excite the customer because that's what they want. They want exciting products. They want exciting visits experiences. And if we keep that going, people come back and we really win when business comes back. We've done that every time for 36 years now. Jen, do you have anything to add to that?

Yeah. Hi, Simeon, just to add a little bit more color to that. As you heard, we did get more promotional in Q2 than where we've been in the past. As we've been speaking for last probably almost two years now, we're definitely seeing that heightened promotional activity out there from our peers. I think one of the really interesting things is it's been a really tough macro environment out there for the last year, year of half. We've been hearing a lot of our peers really having to address that. And we've really been an outlier to that. So it's definitely something that we've been monitoring. We're going to be continuing to monitor. As Dawn mentioned, the guide for the rest of the year allows us to be promotional as we see what happens going into fall and Q4. But just echoing what John said, we are really, really excited looking at our fall launch coming here in just a few weeks. A couple of weeks back, at the end of July, we did a sneak preview of some of our fall products. And we're really pleased with the marketing engagement that we saw from consumers there. And we're seeing some positive elements. We're seeing really nice traffic to the website. We're seeing engagement with marketing. We're excited about the product. We're definitely seeing the lower traffic in stores, lower order values in stores than we'd like. We saw that softening in Q2. We're also up against really positive, strong comps last year in May and June. So we're looking at that acceleration of a decline in July quite a bit. But there's a lot of positive coming forward to fall. And as Dawn mentioned, we are ready and able to be more promotional if we need to be, but we are also looking at all those levers we can pull in terms of increasing our marketing spend, making sure the fall product gets out to stores, continuing to open up our showrooms, and really positioning us to be there when this cycle turns around.

Good morning, Simeon, this is Dawn. I just wanted to confirm you're thinking about that correctly from a comp basis in the fourth quarter down that kind of mid-teens is appropriate. And then with regards to your gross margin question in the second half, if you remember, we're lapping the price action skews from last year. So as we think about product margin year-over-year in the second half, there's a little bit of incremental compression layered into the second half relative to last year's second half, driven by some of those container costs that we are seeing elevate. But for the most part, we're -- from a product margin perspective, year-over-year, we think that will be relatively flat. And then from a gross margin perspective, we are anticipating a bit of deleverage on showroom rent versus last year as you think about the continued investment in new showrooms and our growth strategy there.

Thanks, Dawn. Good luck, everyone.

Thank you.

Thank you. Our next question is from the line of Max Rakhlenko with TD Cowen. Please go ahead.

Great. Thanks a lot, guys. So first, John, given your perspective, how long do these cycles typically last on the high end? Are they shorter than the overall market? And then what categories typically inflect first as we do look for signs of improvements ahead?

Good morning, Max. Yeah, I mean every cycle is different. We had the big crash, what was in '08 or something, and which is totally different than COVID, which is totally different than today. So your guess is as good as mine on that. Obviously, there's a lot of news out there. There's election coming up, which has all kinds of cherry news in it. So who knows? I don't know. I do know that we stay focused on what our plan is. We executed our plan very, very well we think better than anyone. And we come out of these things, some of our competition may fall off. And we come out of these stronger and get more and more market share every time. So that's what we're focusing on and that's what we're excited about.

Got it. And then philosophically, how nimble are you with dealing with changing competition in the marketplace? So for instance, if close and peers start to make changes on price that are impacting you, how would you go about maybe reacting, or is that generally not how you're thinking about the business?

Yeah, generally not. We certainly watch the competition very closely. But when we compare product to product, we really don't have any product that we can compare it to as far as quality goes or design goes. So we think the ones we do look at, people are undercutting us. The quality isn't there. It's inferior. So we're not too worried about that. We've got an incredible sales team, the best in the business, incredible army of interior designers who are out there. And customers aren't -- they want a beautiful home. They don't remember two years ago, what they paid for it as long as it's working, it's comfortable, it's not falling apart and so forth. So we stay with that vision and that focus. And we're not going to compromise our quality. We could easily cut quality and take prices down 20%, 30%. But I won't do that. I will not take quality down because in the long run, that goes back to hurt you.

Great. Thanks a lot. Best of luck, guys.

Thank you.

Thank you. Our next question is from the line of Steven Forbes with Guggenheim Securities. Please go ahead.

Good morning. Maybe start with Dawn as a follow-up to Simeon's question. You think through the sort of decremental margin profile implied by the guidance changes, it's really high. And I think that's what we're trying to get our arms around. And so you mentioned promotional activity, you also mentioned freight costs, right, investment in the marketing. Any way to help frame sort of how you had to explain the high decremental margin profile? And then as you think through sort of this promotional activity comment, can you parse it out into the various impacts? I mean how much is being driven by inventory management? Is there any sort of price value correction and/or is it simply just to stimulate conversion given the macro? Thank you.

Yeah. Good morning, Steve. So as we're thinking about the second half, we are expecting deleverage of about 280 basis points versus prior year. So you can think about that as about 70% of that is coming through in SG&A and about 30% of that is coming through in gross margin. On the gross margin side, as you said, there's -- we've left ourselves some operating flexibility around promotions, but we're still feeling good about our product margin relative to prior year. We are seeing deleverage as we're continuing to invest in our growth strategies, which is those new showroom rents are rolling through gross margin. So the balance is in SG&A. And really, our spend as we think about what we guided to three, six months ago versus where we're at today, is still consistent. So we are continuing to invest in new showrooms. We're continuing to invest in our strategic growth initiatives around our planning system, our manufacturing ERP, our warehouse management system. We are going a little bit deeper in marketing in the back half of this year. Really excited to continue to drive brand awareness, increase our spend in prospecting a bit for the September catalog, which is going to be beautiful, and really support the product launches that are rolling out at the end of this month. And then a bit of deleverage on the warehouse expenses dialysis continuing to ramp up in productivity. So I think from a spend perspective, we're consistent with what we said all along. There's just some noise as you think about how that math is all working relative to where we thought revenue would be for the year or six months ago versus where we think revenue will be this year, in the back half now where we think it will be today.

Then maybe a follow-up for John. You think about this sort of lean into share and being very optimistic, right, about sort of the strengthening of the position during a challenging backdrop. Product, obviously, a big focus there. So can you expand on the product pipeline? I mean what are some of the product initiatives that you're excited about, whether it's assortment expansion, breadth, depth? What are you sort of leaning into? Any teases for the fall here or early thoughts on newness coming to spring?

Sure. I can talk big picture about that. We are launching new products in every category, first of all. Very, very excited about the upholstery end of the business, which is the largest category we have. And it drives -- when you think about it, it drives a lot of other purchases, rugs, lamps, end tables, so forth. So we've really focused on that part, and we're rolling out some incredibly strong product, incredibly great designs, some of the most comfortable, best quality things I've ever seen in my lifetime. And we're hitting both sides. We're pushing the envelope as far as on the high end, and we're also -- have some really great kind of starting price point products that we feel will bring new clients in the door and that people are looking to save a little bit of money or not spend is quite as much, then we have that covered. So I think that's probably our most exciting part that I think as we've got the entire gamut of upholstery. And that includes chairs and sectionals and sofas and so on and so forth. And again, that's how I've always seen the business drive, especially when times do dip a little bit, that's usually what -- how we come out really strong.

Thank you.

Thank you.

Our next question is from the line of Seth Sigman with Barclays. Please go ahead.

Great. Good morning, everyone. If you go back and think about the drop-off you've seen in the business the last few months, I guess I'm trying to better understand just the consumer engagement. Any more perspective on how much of that drop-off is actual traffic versus maybe conversion and consumers pushing things out? Do you have a way to measure that? Just trying to think through, is it just deferral that comes back at some point? Just help us frame that a little bit. Thank you.

Yeah, I can start that, Seth. Yeah, people are coming in. They're not as excited as they were 2 years ago when COVID was going on where they would take anything at any price and wait any length of time for it. They just seem to be busy with other things in their life right now, and they're still engaged, they're still coming in. We haven't seen this huge, huge traffic drop. The new stores are doing fantastic. The response is unbelievable, especially out in California. And so, we're going to just keep focusing on that. I don't know if you guys have anything else to say.

Yeah, so interestingly enough, from a data perspective, we've really seen some mixed results around different components. Traffic on a comp basis decelerated in the second quarter. The number of orders over $5,000 and $10,000 were up versus last year, so still seeing some strength there. Number of transactions increased healthily versus last year, but the average order was down slightly. Units per transaction is up, though. So the data is really mixed. So it speaks to what John was saying. The folks are maybe coming in more often to look at things prior to making a transaction. But Jen, anything additional on the consumer?

Yeah. I think Dawn and John said it all. We're seeing a lot. I think we are really pleased with seeing those $5,000 to $10,000 and above orders performing really healthily if you think about consumer behavior when they're buying furniture. And if you have bought a new home or if you are updating and doing a renovation, you have a timeframe, and you have that drive to complete that purchase. But as both Dawn and John mentioned, we're seeing less of that sense of urgency to complete for maybe some of those more less urgent purchases. They're browsing, they're exploring. As I mentioned, we're seeing that heightened traffic to the website. We're seeing that heightened engagement with the product. And as we've always spoken about, we know that that's where a lot of our clients are, doing their exploring, they're engaging with the website before they make that purchase. So there's definitely that interest level. We're just seeing less of that urgency to make the purchase today. And as we've all been saying, I think that's what we are all focused on. That is really at the core of our strategy. We want to be here for our clients wherever they are ready, and continuing to present them all of the great products, the inspiration, the reasons that separate Arhaus apart from everybody else out there in the market. And then we'll be here when they're ready to convert.

That’s helpful. And I guess just a follow up there is thinking about, Arhaus has been able to really navigate a very difficult environment the last couple of years, right? It's been tough out there. And a lot of your peers have been seeing that for some time. So to some extent, it's caught up to you now. And I guess the question we're getting is, why now. I do think if you look at your business on a four, five-year basis, you adjust for all the swings, it's actually much more stable than the big drop-off that you're talking to. But anyway, I guess the real question is what gives you confidence that it's not something more competitive that's changing? What gives you confidence in price points where they are today that they don't need to be adjusted further? Just any more context. Thank you.

Yeah, I think, as you mentioned, we were the first ones to -- or the last ones, I should say, to see this effect of sales slowing down. And our competitors have seen it a lot earlier. All I can say is we're going to come out of it a lot quicker as well. We've always seen these things where we do start them later than our competitors, but we also come out of them a lot quicker because of what we do. We've got an amazing product. We absolutely don't think this is competitors taking our business by any means whatsoever. We look at that backwards and forwards. We're in touch with our stores, our store managers, our top salespeople literally every week, and we've not heard a peep about that one little bit.

I think that the other thing that I would add on to that confidence is we've never seen price be the driving factor of our purchases. And what's interesting, looking at Q2 and particularly going into July, we're actually, although we were more aggressive with our promotional strategy, we're actually starting to see promos be a little bit less effective in driving traffic and conversion. And I think what that speaks to of us is, it's not price that's a factor. Our clients want what they want. They are able to pay for it. And obviously everybody likes the deal, but it's not a question of, if they can get a better price point. They'll make the purchase, and if they can't, they won't. As John mentioned, you can't find the same product with the same quality at our competitors. So it's not a pricing conversation. So we're continuously monitoring that. But I think that speaks to the fact that we're seeing this slowdown across promo and nonpromotional business as something more to the macro level.

Got it. Thank you so much. Good luck.

Thank you.

Thank you. Our next question is from the line of Robby Ohmes with Bank of America. Please go ahead.

Hello. Good morning. Thanks for taking my questions. There's kind of two follow-ups here. Well, the first question is you guys called out that you're pleased with the new showroom performance. And I was just curious, is new showroom performance better than you would have expected relative to existing showrooms in the way they've been performing the last couple of months? And then the second question, just to follow up on the promotional question. Are there any changes to the way Arhaus would be promotional historically? Are there any new things you guys are looking at that you can share with us specifically for this environment? Thanks.

Yeah. The new showrooms are performing very well. We're very excited. The traffic's in there. The response has been absolutely phenomenal, especially out in California where we've focused on opening some incredibly beautiful, most beautiful showrooms we've ever done. And the response is great. So to compare them to other stores we've really come up with a solid, conservative sales plan for new stores. And we're very happy to see how their business is doing. So it's not necessarily comparing them to a store in Cleveland, Ohio or Tampa, Florida or something like that, because they're all totally different markets, different size stores and so forth.

And then to jump in, and if you'll allow me for a second, I just have to do a marketing plug. If you guys haven't visited arhaus.com in August, I strongly encourage you to do so. We've recently launched a campaign celebrating our showroom experience, and it features a lot of incredible imagery from some of these new showrooms that we've opened this year. And it's absolutely, it's stunning, but it celebrates something that we're really proud of as a business as how incredible our showroom experience is and how unique it is. So if you haven't visited, please go check it out. But to touch on your point about just promotional strategy and how we're thinking about the rest of the year and if we're going to make any changes, as I mentioned earlier, and Dawn mentioned, the guide does allow us that flexibility on how we're looking at promos for the rest of the year. We're currently looking at our same strategy of those holiday weekends, Black Friday, those key promotional periods. We've been talking over the last few calls about how we've started lengthening those promotional periods. We're always looking at how we're setting those up, what those look like, how we are optimizing our marketing messaging of those promos. So we are going to continue to do that into the back half. But as of now, really looking at those similar time periods as our ongoing strategy.

Terrific. Thank you.

Thank you, Robby.

Our next question is from the line of Phillip Blee with William Blair. Please go ahead.

Hi. This is Sabrina. Thanks for taking our question. Can you talk about some of the progress your team has made on the internal system investments, and what benefits you expect to gain when the new system launches over the next few months, maybe from inventory purchasing or your forecasting abilities?

Good morning, Sabrina. Yeah, we're excited to continue to invest in the systems that we've been talking about. Our warehouse management system launched in April, and we're continuing to refine that and build on some of the operating efficiencies that we've seen in the system to date. So excited for how that's continuing to progress and as we continue to tweak that. Our planning software is in process as we've said before. And there's a couple of different unlocks and different phases that we'll have with that program. And it's on track with where we expect it to be. So some great opportunities with that is improved demand forecasting to a more granular level, both geographically and then on a SKU basis. So really looking forward to getting some unlocks there, driving some labor efficiencies with the teams here. And so over the next several months, we'll be launching the first phase of that. And then our manufacturing ERP, which is going to provide quite a bit of increased margin visibility and production capability enhancement. So that is also slated to launch over the next several months. As you can imagine, lifting an entire ERP for a manufacturing facility is extensive, and we want to make sure that we're doing it correctly and really thinking through the different benefits and making sure that we are deploying that responsibly. So excited for all those things to launch, no major delays or anything that I would call out here. And so, yes, looking forward to getting those up and running for the team.

Thanks. And then quickly back to the competitive landscape. Have you been seeing a lift from the local independent mom-and-pops going out of business along with maybe other regional brands in the premium space? Any thoughts there would be helpful. Thank you.

Yeah, I don't have any data on that. We're in so many different markets now. That's hard to see. I haven't seen anything locally here. That would be more local marketing and so forth. And I've not seen anything here, and I haven't seen or heard anybody report on anything. Thank you.

Thank you. Our next question comes from the line of Peter Keith with Piper Sandler. Please go ahead.

Hey, thanks. Good morning. I'm going to take the competitor question with a different angle. So you do have a large competitor in the space. It seems like they've tried to knock off some of your product lines. And so maybe as you look at that direct overlap where you've been copied, are you seeing any impact on that area of your business in the last month or two?

Good morning, Peter. To answer your question, no, we have not. We feel, again, our product is a great quality, incredible pricing, and we've not seen any change in those particular products that you may be referring to.

And then maybe for Dawn, I'm just trying to play around with the model and wondering why there's such a large sales and comp drop off in Q4. So if I just take the midpoint of the Q3 comp guide, it seems to imply Q4 comp of a down 9% to a down 20% and Q4 revenues below Q3. I guess, can you walk us through why that is the proper outlook?

Yeah. So mostly it's timing, Peter. As you think about, if we are anticipating a low double-digit demand comp decline, the timing to get that product delivered, there's just a bit of a lag. So really, as you think about the timing of the demand to deliver realization, and then also just remember last year up against a really strong abnormal backlog. So every quarter, as we progressed through last year, we had a higher amount of abnormal backlog that we were delivering. So just the year-over-year compare is still skewed by that component.

Okay. Thank you.

Welcome. Thank you, Peter.

Our next question is from the line of Jeremy Hamblin with Craig-Hallum Capital Group. Please go ahead.

Thanks. And want to come back to the commentary around gross margin. I think, Dawn, you noted that in the back half of the year, you expect some deleverage. I was hoping you might be able to provide a bit more guardrails around what you're expecting Q3 deleverage versus Q4.

Yeah, absolutely. So I think the important thing to note is that the reasons are the same. As we think about the third quarter, and we think about the fourth quarter, continuing to invest in new showroom expansion, continuing to invest in our strategic investments. There isn't necessarily a significant spike in one quarter versus another as we think about the back half. So to the extent that is helpful. I would just continue to note that last year, we would have been getting incremental deleverage, or sorry, incremental leverage last year from the higher abnormal backlogs as we moved through the year. So when you're looking on a margin rate basis in the quarters, just keep in mind that there might be incremental deleverage in the fourth quarter versus the third just driven by the abnormal backlog of last year. And then as we think about the price action skews that we were deploying in June of last year and as those were getting delivered, deliveries of those would have been heavier in the fourth quarter versus the third quarter. So just a little bit of noise there, I would say, between the quarters on timing of deliveries versus when we deployed those price actions.

Got it. And then just want to come back to the traffic trends and conversion here for a second, because I think there was a little bit of mixed messaging in terms of -- sounds like traffic is down. And wanted to get a sense if you could share how much traffic has fallen off May, June, July, just to get a sense for what you're seeing from conversion in those that are more or less window shopping, but not purchasing in the near term.

Yeah, interestingly enough, traffic was down more year over year in the first quarter than in the second quarter. So while traffic, on a comp basis, was still down in the second quarter, it was sequentially up. So interesting, I call it in the mid-single digit decline for the second quarter.

And what about as you started in Q3?

We haven't disclosed that. And so, we're seeing, I would say, no meaningful change in metrics, but recognize that one month doesn't make a quarter either. So we're tracking it, we're paying very close attention to the demand metrics. We look at those on a daily basis to see what's happening in each showroom, but we'll report more on that when we report the third quarter.

Got it. Thanks for the color. Best wishes.

Thank you.

Thank you. Our next question is from the line of Cristina Fernandez of Telsey Advisory Group. Please go ahead.

Thank you. Good morning. I wanted to ask about inventory flow. And if you look at the demand trends you've seen in the past few months, what is your flexibility in adjusting your inventory to remain in a clean position here over the next 6 to 12 months?

Yeah. Again, we've been through many upcycles where we need our partners to make more products. And if we're having a downcycle, then we ask them to make less products. So it's fairly straightforward. We're very, very flexible. We're incredibly meaningful to our suppliers and they're our partners. So they work with us both ways. And ideally, if everything is perfect and everything, they can make exactly the same amount of pieces in every single month, but that just isn't reality. So they're very flexible. We don't see any issues with that. If we get in an overstock position or an understock position, we work with them to fix it and level it out. We've got a great planning team and a great sourcing team and a great product team that are very, very close to the vendors, and they'll do whatever they can in their power to help us out with smoothing out inventory.

And then the second question is going back to the promotions. It seems like you increased promotions in the second quarter and are willing to step them up. How are you balancing, making sure that you don't damage the brand or train the consumer to wait for the promotion, especially if the promotions are not being as effective in driving traffic and conversion?

Yeah. Good morning, Cristina. That's a great question. And that's at the heart of what we talk about and focus on every single day here. I think the way we're approaching that and the way we've always approached that is we right now are looking forward to our fall launch, we're looking forward to the fall product, we're looking forward to the fall marketing. There are two reasons why we increased the investment in our fall marketing campaign: one was to offset what we are starting to see in the macro; but the other is because we love the campaign and the product that we're launching so much, truly believe it is the best catalog that we've ever put out into the market. And we have great, great product that we're really proud of as well. And so, I think to your point, it really is having those conversations and balancing and making sure that we don't lose sight of our long-term opportunity with any short-term decisions or needs that we're making. I think on the flipside, though, we have proven over the last four to five years now that by speaking to and emphasizing the product assortment, the quality, the artists and stories, the differentiation, the showroom experience and everything that we do in the majority of the marketing and messaging that we put out there, it allows us to be promotional when we want to be without damaging the brand, as you mentioned. If that is a balance, that is something we want to do, but our clients are very smart. They know what they want. They know how the markets work. They know how promotions work. And so, we're constantly towing that line. And that's our strategy going into the back half of the year. We're not going to overreact any which way. We're going to keep doing what works for us and what we do best. And we'll be reading our fall launch very closely here in the next two months.

Thank you.

Thank you. [Operator Instructions] Our next question is from the line of Peter Benedict with Baird. Please go ahead.

Good morning, guys. I was a little late to join, so I apologize if either of these have been asked. But my first question is just, could you clarify the revenue headwind from the warehouse management system implementation that went in April?

Yeah, good morning, Peter. So certainly, there was a little bit of an impact, which we had talked about on prior calls, just from a timing perspective. So about one week, call it, of revenue that was shifted into a different time period.

Okay, thanks. And then given the investments you're making in stores and systems, just curious what level of revenue growth you think would be required to hold your EBITDA margins flattish. Obviously in the back half of this year, you guys are pushing ahead with the investments. As a related question, as you think maybe more towards 2025, if a soft demand environment persists, do you continue on that path or do you make any adjustments to try to cushion the margin impact? Thank you.

Yeah. So I would say there's two things that I would call out in response to your question. The first is that we firmly and strongly believe that continuing to invest in showroom expansion, new product introductions, and our marketing campaigns are incredibly important, even in a downcycle. So as we think about the investments in the organization, to come out of a downcycle in a very strong position and take market share, continue to build on our market share gains, we need to continue to invest in those three components in particular. So we will continue to do that. As I think about your broader question, we are still in a growth investment mode. So as you think about the investments we're making in the back office, we've talked about our warehouse management system. We've talked about the planning system, our manufacturing ERP. We've also been assessing over the last several months what other system changes need to be deployed in order to support the size of the organization today and then drive future efficiencies as we continue to scale top line. So I would say near-term investments are going to drive that longer-term margin expansion. But in the near term, we need to be thinking about that. I would encourage you to think about it in that there's going to be additional investments. We've said we're investing $10 million to $15 million this year in our corporate strategic investments. You could anticipate that number will be comparable next year, if not a little bit higher. And we'll give more detail and insight into that as we continue to refine internally and confirm our timing plans on those. The other item that I would just call out, as a reminder, is that on the incremental flow-through of revenue, flow-through down to adjusted EBITDA is between 30% and 40%. So if that's helpful, as you're building out your models, that's the flow-through.

Great. Thanks so much, Dawn. Appreciate it.

Thanks, Peter.

Thank you. Our next question is from the line of Jonathan Matuszewski with Jefferies. Please go ahead.

Hey, good morning. Thanks for taking my question. I wanted to ask about the typical consumer purchase cycle, and I'm sure it varies. But is there a standard decision length that you observe between maybe an initial visit to the website or initial visit to the showroom and maybe when that consumer decides to pull the trigger on a purchase, just trying to think about whether this is a dynamic where consumers are just being more choiceful and maybe just need more time to make a decision, so maybe you'll see that demand flow-through later in the year. But any perspective on that decision process and any changes you've been observing lately. Thanks so much.

Yeah, I can start that, Jonathan, and then Jen can jump in. In the store model, typically folks come in a store, they touch, feel things, they go back, they take swatches home, things like that. And they figure out what they want and need. And then if they need more help, we could put them together with one of our interior designers. So certainly they come back at least twice before they buy as an average. Certainly, there's people walk in and say, hey, I need a sofa tomorrow. And they buy it, and we deliver it in five days or so. But most part, people are more thoughtful. They have to measure. They're not experts at that thing, what colors go together, what rug goes with what fabric on the sofa, things like that. So it's a longer process. And sometimes they'll come back twice, sometimes three times, sometimes four times, depending on the project and depending on how much they -- because a lot of people love this process. They're fixing up their home to be beautiful. And it's a really, really important decision for them. So they take it seriously. And sometimes they buy a little quicker than other times. Right now, they're buying a little slower than normal, but that's the process. And Jen can fill you in on the rest.

Yeah. Hi, Jonathan. No, I totally agree with everything John just said. And I think that what we really look at, furniture is a considered purchase. And you definitely see different behaviors. So we definitely see people who walk in and buy a chair or go to the website and buy decor or soft goods or accessories. But our clients, we believe, are attracted to Arhaus because of the quality, because of the ability to really consider and build out a home for your family for years to come. Our furniture is just built to last. These aren't purchases that people are making and then looking to redo six months later. So I think it's really interesting when you look at the spectrum of those behaviors. One thing I think that's also interesting to remember if you think about Arhaus versus some of our peers in the space as well is to remember that we are more heavily weighted to those larger furniture pieces, those larger average order values. And so, I think that does play around a little bit with a mix of how effective things like promotions are, or how effective those things in terms of trying to drive that spur-of-the-moment impulse purchase. We do see great success with that with people going online, but really it is about allowing, providing that space and that experience for clients truly to take their time and to be inspired and build a home that they can really be proud of.

Helpful. Thank you.

Thank you. Our next question comes from the line of Peter Keith with Piper Sandler. Please go ahead.

Thanks for letting me back in. So two follow-ups. The first one's for John. You've been in this business for quite a number of decades. Have you had a period where you had one or two soft months that were just a hiccup and then the business retraced back to normal trends? Does this seem like a familiar backdrop that you've seen before, or this pace of slowdown is a bit unprecedented?

Yeah. No, I have, Peter. This has happened before. It just seems like it's a hiccup. Typically, it happens in the summer months where folks are focusing on other things. They're outdoors, they're traveling, trying to get all their vacations in with their kids and so forth. And it's not untypical. We haven't seen it lately because of COVID and so forth. So we were all spoiled on seeing double-digit increases every month. But no, I absolutely have seen it in the past, for sure. And then it comes back -- in the past, it typically has come back pretty strong in the fall when people are back in their homes and getting ready for the holidays and so forth.

So that's good for my final question to Dawn. So you've had a really tough July. I don't think of July as a seasonally relevant month for furniture. To your point, it's a vacation month. So with the construct of the guidance, you've taken the EBITDA down 30% for the year, I guess help us understand this. Stacked demand trends coming out of July, you're holding that. And then on the gross margin, it sounds like you've also given yourself some wiggle room to promote. But it could be upside if you don't promote. Just trying to understand the magnitude of this guide down after one soft summer month.

Yeah. So I'd clarify a little bit. We have seen deceleration in the May-June timeframe. That was stronger deceleration than what we would have anticipated in those months. Certainly accelerated into July. So while the second quarter demand comp was down 3%, we've had about 90 days, three months of deceleration. And so, I think it's prudent as we look towards the back half of the year, there's a lot going on with the economy, there's a lot going on with the election, which can be very distracting. So certainly, I don't have a crystal ball. I don't know exactly how the balance of this year is going to play out. I think this is a responsible way to think about the business, think about the trends that we're seeing. We have a lot of additional customer information that we don't share publicly for competitive reasons. And those indicators are telling us that maybe this could persist a little bit longer than just July and August. So I think this is a responsible way to look at the business through the back half. We think that there's a nice opportunity. We want to leave ourselves some wiggle room in the numbers for promotional activity as we move through the year. In a great environment, in a perfect world, we won't need it. And the consumer will return very strongly in a couple of months, but we don't have any evidence that that is going to be the case. So we're just prudently managing as we're thinking about the business, watching the consumer trends on a daily basis, and I think this is a reasonable expectation for the organization at this time.

Okay. And then maybe just one very quick follow up. July is a quirky month for a lot of companies refining their earnings season, you had hurricane, CrowdStrike outage. Anything in that sort that may have impacted that demand comp that you'd want to flag?

Not that we've seen, no. Nothing we can put our fingers on, Peter.

Okay. All right. Thank you very much.

Thank you.

Thank you. Ladies and gentlemen, this concludes our question-and-answer session. I would now hand the conference over to Wendy Watson for her closing comments.

Thank you, everybody, for joining today, and we will look forward to talking to you again next quarter.