Arhaus, Inc. Q2 FY2022 Earnings Call

Good morning, and welcome to the Arhaus Second 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. Ladies and gentlemen, I will now turn the conference over to Ms. Wendy Watson, Senior Vice President of Investor Relations. Please go ahead.

Good morning, and thank you for joining Arhaus' second 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. Dawn will cover our financial performance and outlook for 2022. And then, they will be joined by Jen 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 year ended June 30, 2022 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 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 participating in our second quarter call. We had another great quarter, our third as a public company, and we are excited to share our results. This morning, we reported record quarterly net revenue of $306 million, a 66% increase from Q2 last year, with our retail channel up 69% and our eCommerce channel up 54%. Top growth was 65.2%, and demand comp growth was a strong 22.5%. Net and comprehensive income increased 436%, and adjusted EBITDA increased 76%. Our second quarter performance is particularly notable on top of last year's very strong second quarter performance that included comp growth of 71% and demand comp growth of 73%. So our two-year demand comp stack for the second quarter is over 95%. Despite ongoing macroeconomic, geopolitical concerns including high inflation, rising interest rates, and ongoing global supply chain challenges, demand for our product remains strong, driven by our passionate approach to design and development. We seek inspiration from all around the world and are thrilled with our clients' response to our unique and artisan-crafted assortment. When the pandemic began in the spring of 2020, we continued designing and developing our products, which allowed us to continue to introduce new collections across our portfolio throughout the past year. We know and stay true to what we do well. We are also keenly focused on our client experience. Our showrooms are designed to inspire, highlighting the beauty of every piece of furniture and décor within them. Our design consultants are available to help in any way and undergo rigorous training on our product designs and quality so they can thoughtfully guide our clients through the process of furnishing and decorating their homes. As you can see from our results, this is clearly resonating. And we take the showroom and website experience a step further by offering complementary in-home designer services to our clients, which result in an average order value that is over three times the company average. We are also very proud of our trade designer program, which continues to grow as we have responded to the needs of the design community on both the frontend with our aesthetics, quality, and education; and on the backend with the room design software. We opened two new showrooms during the quarter in Colorado Springs and in White Plains, New York. We continue to be pleased with the strong opening performance and the quick ramp-up of our new showrooms. Additionally, our design studios continue to exceed our expectations. And we are excited to expand this format in two to three additional markets over the next several months. During the second quarter, we also launched a partnership with The Surf Lodge in Montauk, New York, redesigning and outfitting the property's beachfront and private dining deck with artisan-crafted furnishings from our outdoor collection. Community and timeless designs are what inspire us at Arhaus, and we are thrilled to celebrate these values through our partnership with The Surf Lodge. Regarding our supply chain, both inbound and outbound logistics continue to improve and our lead times are coming down steadily. We expect lead times to continue to improve over the rest of the year. As we discussed last quarter, we believe our new distribution facilities will help alleviate our backlog, reduce our lead times and support our growth over the next 7 to 10 years. Our North Carolina distribution center opening went better than expected and has played a large part in our first half net revenue outperformance. Our Texas distribution center is open, and we are intentionally ramping up at a slower than expected pace as we work to ensure a seamless integration. We also expect the expansion of our Ohio distribution facility to be complete near the end of this year. Looking forward into Q3, we cannot wait to launch our fall 2022 collection. We've called our fall campaign the Arhaus Home, and I cannot think of a better title to celebrate this incredible collection of furniture and décor, including hundreds of new arrivals and featuring some key home trends such as rich, textured boucle fabrics, carved and sculptured forms, reading, and the focus of celebration on natural materials and color. This collection is one of the strongest we've ever launched. From the beauty of our materials to the handcrafted artisan design of our furniture and décor, we believe our product is truly special within the market, and clients seem to be agreeing. Our Style issue catalog will arrive in our clients' homes and our new products will be in the showrooms by the end of August. As a reminder, we operate in a highly fragmented $60 billion home furnishings market in the United States. Our clients, who are predominantly from high-income households, continue to invest in their homes, and we are executing our growth strategy by opening showrooms, making the investment to build brand awareness and grow our omni-channel footprint, enabling us to gain market share. Our current momentum gives us confidence in our performance for the remainder of the year. And we are raising our full-year outlook, as Dawn will discuss. In closing, I want to congratulate and thank our teams for their incredible execution and hard work. In the last year, we have grown our product selection, introduced newness across all categories, posted record sales, doubled our production capacity, moved from one distribution center to three, opened new showrooms, and produced excellent overall results. I have always believed that our people and their passion set Arhaus apart. I am proud to work alongside each of you. Thank you for everything you've done and continue to do to make Arhaus and the team the best in the business. Now, I'll turn it over to Dawn.

Thank you, John. We are pleased to deliver second quarter 2022 net revenue and earnings that exceeded our expectations. Key items from the income statement include net revenue of $306 million, comp growth of 65.2% and demand comp growth of 22.5% on a one-year basis and 95.4% on a two-year stacked basis. This growth was driven by increased demand for our products in both showroom and eCommerce channels, as well as delivery of orders in the backlog as our supply chain continues to improve, and deliveries from our new distribution center in North Carolina exceeded expectations. Our second quarter net revenue significantly beat our internal expectations with upside across demand comp and delivered orders in both showroom and eCommerce channels. Our second quarter gross margin increased 71% to $133 million in the quarter, driven by our higher net revenue, partially offset by higher variable costs related to the increase in net revenue and higher credit card fees related to demand. Gross margin as a percent of net revenue increased 110 basis points to 43%, reflecting our ability to leverage our fixed showroom occupancy costs over higher net revenue, partially offset by higher transportation costs and variable rent expense. The year-over-year gross margin expansion in the second quarter also beat our internal expectations, primarily driven by lower than expected product and container costs, as well as leverage on fixed costs. I'm very proud of the hard work across the company managing our gross margin during a time of high inflation and supply chain complexity. Second quarter SG&A expenses increased 20% to $83 million and decreased 1,060 basis points as a percentage of net revenue to 27%. The increase in expenses was primarily driven by investments to support the growth of our business, including increased warehouse and corporate expenses as new showrooms open and we expand distribution capacity, as well as public company-related costs. These were partially offset by the non-recurrence of a prior year derivative expense. The expense decrease as a percentage of net revenue was driven by leverage on fixed costs on the 66% net revenue increase and the non-recurrence of the prior year derivative expense. Second quarter 2022 net income increased 436% to $37 million. Adjusted net income in the second quarter of 2022 increased 42% to $39 million compared to adjusted net income of $28 million in the second quarter of 2021. Adjusted EBITDA in the quarter increased 76% to $60 million from $34 million in the second quarter of 2021. Net income and adjusted EBITDA also significantly exceeded our internal expectations, driven by higher revenues and better gross margins. Turning to the balance sheet and cash flow. As of June 30, 2022, cash and cash equivalents were $145 million and the company had no long-term debt. Net merchandise inventory was $272 million, up 31% from December 31, 2021, and up 100% year-over-year as we continue to build inventory in response to strong ongoing client demand and as inventory value increased due to higher freight and product costs. While our inventory dollars are growing due to inflationary conditions, our inventory units are growing at a significantly lower rate. We remain comfortable with our inventory levels. For the six months ended June 30, 2022, net cash provided by operating activities was $41 million, and net cash used in investing activities was $20 million, with landlord contributions of $7 million. As a result, total capital expenditures net of landlord contributions were approximately $13 million in the first six months of 2022. As we announced this morning, we are raising our full-year 2022 outlook to reflect our second quarter outperformance. We have also recalibrated some of our revenue, cost, and margin assumptions for the second half of the year. We now expect full-year net revenue of $1.173 billion to $1.193 billion, full-year comparable growth in the range of 43% to 48%, net income of $92 million to $98 million, and adjusted EBITDA of $173 million to $180 million. Breaking this down a bit, as I mentioned, we significantly beat our internal expectations for net revenue and earnings in the second quarter. We are raising our net revenue outlook for 2022, reflecting our first-half outperformance while slightly adjusting our second-half net revenue assumptions due to an intentionally slower ramp-up of our recently opened Dallas distribution center. Recall that this will add over 800,000 square feet to our distribution capacity in key regions for our long-term expansion. And as we are growing from one to three distribution centers in less than a year, we want to ensure the integration is as seamless as possible and will meet our high standards for client experience. We are very pleased with what we are seeing in the early part of the third quarter. Demand continues to be strong, though a moderation from the levels in Q2. We're also raising our full-year earnings expectations while recalibrating cost assumptions for increased marketing spend and increased warehouse costs. We are continuing to see very attractive returns on our marketing dollars even with the higher industry-wide costs. The warehouse cost increases are the result of higher product storage costs due to the more gradual ramp of the Dallas DC than we originally projected, as well as certain Dallas DC costs that are higher than originally anticipated. Our outlook assumes continued year-over-year inflation in product and transportation costs. We have lowered our full-year expectations for capital expenditures net of landlord contributions to a range from $55 million to $65 million, as some new showrooms have experienced construction and permitting delays. Please keep in mind these delays are temporary and will have no impact on 2022 revenue given our backlog. Regarding backlog, just a reminder that it is driven by both demand and deliveries. We currently anticipate our backlog to be normalized by mid-2023. Against this backdrop, we are mindful of current macroeconomic conditions and we believe we have the experience, flexibility, and balance sheet strength to address and weather cyclical environments. In the past, we have exited cycles with strong demand and having gained market share. For all other details related to our updated 2022 outlook, please refer to our press release. In closing, we are very encouraged by our strong performance in the first half of 2022 and excited about the remainder of the year, as well as our long-term growth opportunities. Thank you for your attention, and we would now like to open the call up for questions.

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. Our first question will come from Peter Keith from Piper Sandler. Please go ahead.

Hi. Thanks. Good morning, everyone. Great results here. I think you're kind of bucking the trend on overall demand while there are concerns around the economy and recession. Could you maybe just kind of frame up, as your business has been around for a while, how you guys have done in past economic downturns and any comparisons you might see to the current environment?

Sure, Peter, that's a great question. It's nice to hear from you. Yes, we have navigated several recessions over the past 30 years, and I'm pleased to say we've managed them effectively. Our strategy during these downturns has always been to focus on growing our business. We concentrated on developing new products that would truly engage our clients. This approach was more offensive compared to our competitors, who often pulled back and reduced marketing efforts. While we encountered some minor challenges during recessions, particularly during the Great Recession, we recovered well and did not experience significant sales declines. Once the economy began to improve, we saw substantial growth and increased our market share. Naturally, we managed expenses where necessary and adjusted our inventory, but our proactive approach proved successful every time, especially during recoveries from recessions.

Good morning, Peter. This is Dawn. To add a little more context to John's comments, in 2008, we had a positive comp of 2%. In 2009, we had a negative comp of 13%, and then came out strong in 2010 with a 20% comp growth. So to further elaborate on John's point, we're a different company today than we were in 2008 and 2009. In the long term, we view all expenses as variable, but we feel we're really well positioned with our balance sheet strength to weather the uncertainties that lie ahead for the next 6 to 12 months.

Okay, that's helpful. And on the demand comp, again, it's kind of bucking the trend for everything we're hearing out there, even with premium home furnishings. You called out the two-year around at 94. I think if we were even looking on a geometric basis, it's even over 100. But we'd like to look at a lot of things on a three-year basis. Where's the demand comp on a three-year basis if you happen to have that in front of you?

On a demand comparison basis, the two-year figure is 95.4, and the three-year comparison is 90.7. For revenue comparison, the three-year figure is 116.9%.

Okay. Thanks so much and good luck.

Thanks, Peter.

Thanks, Peter.

Thank you. Our next question is from the line of Curtis Nagle from Bank of America. Please go ahead.

Great. Thanks very much for taking the question. So maybe one just in terms of what you guys are seeing from a supply chain and cost perspective. It didn't sound like that was something that was like a material tailwind. The context of pretty strong gross margins, but better than expected. But I would love to just hear kind of how that's trending and where things are relative to prior expectations for the rest of the year?

Good morning, Curt. The constraints in the supply chain are easing from a gross margin perspective. Year-over-year, product and container costs have remained relatively flat, which is encouraging. As we look ahead to this quarter, we've mentioned in previous quarters that we anticipated costs would rise a bit more. However, we observed stabilization in the fourth and first quarters, and it's great to see that stabilization continue into the second quarter. It's worth noting that we are experiencing some offset due to fuel surcharges in transportation on the outbound side, so it's important to consider this as we evaluate the remainder of the year.

Okay, that's very helpful. And then I want to clarify some points in terms of design studio. So it sounds like we're getting a couple incremental new builds coming up relatively soon. I guess just confirming that that is true, that these are the ones that maybe you weren't expecting previously, and I guess just if that's the case, what's driving that increased investment in this concept? And how should we think about going into 2023? Again, I think kind of what we looked at previously was this was more kind of a long test and learn. So, yes, I would love to hear your thoughts on that.

Yes, I take responsibility for that decision. I initially wanted to hold off, but after reviewing the results, we felt we could manage a few more. The opportunities in real estate emerged unexpectedly, and they were appealing deals in strong markets. Therefore, we opted to pursue them. We plan to open two to three locations by the year's end. For the next year, we haven't finalized how many we can open annually, but we should have clarity on that in the upcoming quarter. Given the current circumstances, we believe two is a sufficiently ambitious target, and we will reassess the market in the next few months before establishing a formal plan.

Okay, fair enough. Congrats. Thanks very much. I appreciate it.

Thanks, Curt.

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

Great. Thanks for taking my questions and nice quarter. First question is just on the complexion of the comp in 2Q. Curious if you could give us any color in terms of how much price contributed and maybe how transaction growth was looking, and any commentary on units per transaction just to help us understand the growth? That's my first question. Thanks.

Good morning, Jonathan. So AOV was up nicely in the quarter. We're really pleased with what we're seeing there. That's driven both by price increases filtering through that were deployed last year. We also saw a nice uptick in our in-home designer program. The penetration of that program continues to expand and AOV continues to be over three times that of our average AOV for the company. So we're really pleased with how that program is performing. Number of transactions are up healthily as well, so really pleased with those numbers. Units per transaction, traffic also both up nicely. So really just pleased with all the metrics that we're seeing and the consumer response to our product and our marketing and our showrooms.

Great, that's helpful. And then just my follow-up is on pricing. It sounds like you guys have been less aggressive in passing along price than some of your competitors. Curious if you guys are seeing in terms of new customer acquisitions, maybe an outsized increase in customers with presumably maybe higher household income, maybe potentially trading down? Any commentary on what the new customer that you're acquiring looks like, if it's any different than in the past would be helpful? Thanks.

Yes, I can discuss the price increases, and then Jen can address whether the customer base has changed. We implemented price increases as needed due to rising costs from our vendors and suppliers. Additionally, as container costs increased for incoming and outgoing shipments, we adjusted our prices accordingly. We believe we are in a good position with our current pricing and still have the capability to make further increases if necessary. Overall, we are satisfied with our pricing strategy. Recently, we haven't experienced significant price increases from vendors; the last few months have been rather stable. Vendors have adjusted their prices and appear content with their current levels. Container costs have decreased slightly compared to last year, although they remain higher than they were three years ago. We can only be so pleased about the costs for containers. It's worth noting that half of our products are manufactured in the United States, which has insulated us somewhat compared to many competitors who depend heavily on imports. Consequently, they may have raised their prices a higher percentage than we have because we haven’t needed to make those adjustments as much. Jen, would you like to add something?

Yes. Hi, Jonathan. This is Jen. Yes, speaking directly to the new customers in the demos, we really haven't seen any changes in the customers who are coming in. They're spending more, which is great to see. We continue to see that. But in terms of who they are, we're really not seeing any impactful changes there. And that goes the same for channel there. They're coming in as well. So showrooms versus eComm, we'll continue to see really nice strong results.

Thanks so much. Best of luck.

Thank you.

Thank you. Our next question comes from the line of Adrienne Yih from Barclays. Please go ahead.

Good morning, John, Dawn, and Jen. Congrats, really nicely done. John, I was wondering if you can talk about the cadence across the quarter. I believe last quarter you said it was pretty steady across the three months in Q1. And then this is sort of a question it's more philosophical or how much, if at all, do the macro housing data points factor into your business forecast? That's probably for Dawn, or John if you want to comment on that, like pending home sales, housing starts. There seems to be a long duration between seeing those data points and kind of where you are in your kind of growth curve? Thanks so much.

Yes, I can start with that I don't look at those every day and worry about them too much. All I focus on is executing our plan, executing having the best product anywhere in the country. And it's a $60 billion business, and we're a very small part of that. So if we could get a couple more percent from our competitors, we're doing great. So that's what I focus on. Dawn, I don't know if you have more facts than I.

Our customer base is increasingly influenced by stock market volatility. The strong demand we experienced this quarter suggests that, during this period, there is a reduced correlation compared to historical trends, which is an interesting observation for us. Demand appears to be less related to housing starts and more to stock market fluctuations. In terms of how demand fluctuated throughout the quarter, April was the peak month, while June saw a slight decrease, though nothing significant that would indicate a shift in actual consumer behavior.

Okay. John, I have a quick follow-up. I'm trying to understand the strong demand and the strong demand comparison, along with some moderation as we progress into the third quarter. However, the comment that backlog won't normalize until mid-calendar 2023 indicates that there will continue to be long lead times for delivery. So, is there any improvement in the time between booking and actual delivery when revenue is recognized? I'm trying to understand how these factors relate to each other.

Yes, so product lead times are shortening really nicely. We're pleased with the majority of our lead time. Special order upholstery is still a little bit longer than what we would like it to be and longer than pre-pandemic.

Not as half of what it was.

Yes. So as we think about the constraints, it's really around getting Dallas ramped up and being able to put the capacity towards pushing that product out of the distribution centers and delivering it into the client's home. So it is a rolling backlog. So keep in mind that clients aren't waiting six-plus months for product. It is rolling, and we are able to deliver more today than we were even six or eight months ago. So really pleased with the performance that we're seeing out of North Carolina, the productivity there. And the distribution center is phenomenal, and has certainly outpaced our original expectations for that facility. Dallas is coming up a little bit slower. So that's the constraint. But if you recall when we talked a few months ago, our longer-term or our long-term goals were really for backlog not to normalize until '24 and beyond. So we're pulling that up earlier than what we anticipated at the time of the transaction. And then lastly, I just encourage you to keep in mind that backlog is a function of both the delivered and the demand. So as demand continues to be strong, it refills the pipeline, so therefore pushing out the backlog a little bit longer.

Super helpful. Thanks so much, and great job.

Thanks, Adrienne.

Thank you. Our next question comes from the line of Steve Forbes from Guggenheim Partners. Please go ahead.

Good morning, John and Dawn. I wanted to focus on the customer experience. Maybe high level, John, if you can, is given the strength in demand, you think about just the scaling of the business over the past three years. I would love it if you just give an update on your current thinking around investment needs of the business, inclusive of people, technology, infrastructure, sort of where is your sort of mind in terms of making sure the investments are ahead of the growth here?

Sure. As you know, we invested in the logistics side of the business with these new warehouses and so forth. Now we're focusing on putting some sophisticated systems in place to help us manage the different warehouses and so forth and putting a management warehouse system in place and so forth. So we're investing in things like that. We're hoping to invest in a new planning system again, so we can plan our inventory more efficiently as we're growing and get into more warehouses. Other than that, we're investing in new stores, new locations. Not only new locations, but going back and renovating older stores or moving older stores that have been proven to be very successful and are worthy of our new look and our new design that has proven to be a huge success for us. So we're going back and remodeling some existing stores quite a few every year that I'm excited about as well as the new stores.

Steve, I'll add on a little to that. We are really pleased with the growth we're seeing and we're being prudent in how we're investing in the business for growth. You can see it in some of the SG&A spend that we're investing in to ensure that the business can support the level of growth that we've seen and the growth that we anticipate. At the same time, we recognize that over the next 6 to 12 months, a lot could change. There's a lot of uncertainty out there. So we're being fiscally responsible with our growth needs and trying to balance the potential macro factors that could impact the business with supporting the growth that we anticipate.

Thank you. And then maybe just a follow-up breaking the comment John you made around remodels. So curious if you could just give us an update on the current store network and sort of how you view it, right, from an investment needs standpoint, and whether we should view the next 12-month period as a period of time where you may focus on your remodeling the existing store network versus new stores, or how you sort of balance those two in the current macro environment?

Yes. As we mentioned, we're planning on five to seven new stores a year plus, in addition to that, a few design studios. So at least this year, we're going to do two or three. So I don't have a count on what stores we're renovating right now. But we're looking at them. As leases expire, and going back to landlords, and if we want to stay in this space, then renegotiating leases, trying to get some landlord contribution if we are going to remodel or if we need to move it down the street or across the street or something, then we'd look at that. So it's an ongoing fluid situation that we're looking at one lease, one location at a time.

Thank you.

Thank you. Our next question comes from the line of Peter Benedict from Baird. Please go ahead.

Hi. Good morning, guys. Thank you for taking the question. I have a couple. First, just on the cost and pricing dynamics, it sounds like there's certainly some relief you're seeing on the cost front, stabilization, something's coming down. John, you also mentioned you've got some ability to kind of move price in case you need it. I'm just curious what the outlook over the balance of this year assumes in terms of pricing? Is there anything else you plan to take? And then in the event that costs continue to come down or moderate, is there a situation where you would maybe take some price back on any product or do you think you're at levels that you can sustain? That's my first question.

Yes, I also want to mention that the dollar has appreciated significantly. We have successfully negotiated discounts with some of our vendors. In certain cases, we make payments in euros, and the strength of the dollar works in our favor there. Overall, the dollar's strength has allowed us to secure some discounts. Currently, we do not plan to implement any further discounts. While it is an option available to us, we believe we are providing great value to our customers. We have no intention of raising prices at this time, as we are satisfied with the current levels. We recognize that aggressive pricing strategies could alienate a segment of the market, and that is something we are very mindful of. For now, we are content with our pricing structure.

Peter, we have revised our forecasts and guidance to incorporate the stabilized decrease in container costs that we've observed over the past three quarters. As you consider the latter half of the year, please note some expenses that need to be accounted for. We have adjusted our model to reflect the changes in container costs. With three quarters of stabilization, it seems appropriate to modify those assumptions. Additionally, keep in mind that Dallas is reaching its peak productivity in the third quarter. As we analyze expenses, the second quarter included some of those costs, but we anticipate an increase in expenses during the third quarter as we have opened the facility, although shipping volumes are still low due to the gradual ramp-up. Furthermore, we have intentionally allocated more funds towards marketing, which Jen can elaborate on, and we are optimistic about our plans in that area. Jen, would you like to take it from here?

Yes. Hi, Peter. As Dawn mentioned, we are increasing our marketing spend slightly in the latter part of the year. A good way to understand this is that as our revenue grows, we will allocate more resources to marketing and data support for long-term growth. We are really pleased with the results so far. Our marketing expenditures are always based on targets aimed at generating returns, and we can be flexible in how we allocate these funds across different campaigns and channels. We have been satisfied with our results this year and are looking forward to our new fall launch. John referred to it earlier, and we are very excited about this launch, which includes many new products and marketing narratives that align well with current industry trends as we approach fall. All of this will be released in the coming weeks before the end of August. We are eager to see how the combined increase in investment, along with our strong product offerings and compelling content, will perform in the market.

That's great. That's helpful. And Jen, just to stick with you here for a minute, and color you can give us on kind of your eCommerce efforts and the impact that the upgrades that you've made over the last year have been having, what's been particularly effective? And then what's next on the horizon there? It's obviously an ongoing process to improve the digital side of your business. But what's been working specifically? And then what should we be expecting over the next 12 to 24 months on that front? Thank you.

Yes, great question. We continue to be really, really pleased with the performance of the new sites. I believe I mentioned for Q1 that we're seeing really positive results in terms of traffic and conversion and clients' time on site and how they're engaging with our content. And we've seen that really continue nicely into Q2 as well. As you mentioned, it is a really exciting and continuous process. We had the initial great reveal of a new site launch back in December. And then it has been a constant learning, updating, elevation, and testing process ever since then. And really, we anticipate that to continue definitely through the next 12 to 24 months, as you mentioned, and then beyond that as well. I think some of the things that we are really seeing working are, our clients are engaging with our content more. And I think that is a combination of both the logistics, if you will, of a site itself, ease of use, our ability to understand the analytics and really see how clients are engaging with the site and optimize our content and our journey, and all of those possibilities based upon real-time learnings, which was the big thing we were excited about moving to the new platform. I think we are seeing our product content and storytelling really engage a lot of the AI-assisted merchandising capabilities, and the ability to share specific content with clients has been working really well. I'm not going to get into too many more specifics there, because I don't want to give away all of our secrets. But we are very excited for what we're seeing. We just launched about a week or two weeks ago, we added UTC onto the homepage, so really being able to show our product in clients' homes. That's something that we know works incredibly well for us on our social channels. So we're really excited to bring that into the commerce experience as well. So there are a lot of things happening there. I think the key things that we are working on are really looking at those conversion optimization capabilities, the way that we are presenting and merchandising our product, all of the analytics capabilities on the backend, and really have exciting runway over the next 12-plus months and continue to optimize that and learn what we can do more in the future.

That's very helpful. Thanks so much, and best of luck.

Thanks, Peter.

Thank you. Our next question comes from the line of Simeon Gutman from Morgan Stanley. Please go ahead.

Hi. Good morning, everyone. I wanted to ask first about Dallas, and understand that it's going to be a cost headwind in the second half. Is there any quantification around that? And then, is it limiting your ability to write orders? I couldn't tell if you were implying that it was hurting sales as well.

No, not one little bit.

Yes, Simeon. So Dallas, we learned a lot in the opening of our North Carolina facility. Dallas is over twice the size of that facility. It's also operated by a third party. So as you can imagine, the processes and the systemic implications of that are a little more robust than opening a facility that we have full control over. And our system is seamlessly integrated already. So as we were evaluating the facility, it just made sense to us to make sure that the client experience is consistently that luxury experience, that premium experience, and that a slower ramp-up of that facility on the outbound side makes a lot of sense to make sure that that experience is what we want it to be. There's no implications for demand. As I mentioned, we're really, really pleased with how North Carolina is shipping product out. So relative to expectations eight months ago, there are some puts and takes there between the two, but we think it's the right thing to do for the business and the client to have a slower ramp of Dallas.

The second question has two parts. First, I’m curious about the gross margins for the second half, excluding Dallas. Specifically, I want to know about the markup and shipping costs related to gross margins outside of Dallas. Additionally, regarding the fall product release, will fall consistently be a time for new product launches? What percentage of the merchandise will be replaced, and are you increasing your SKU count?

Sure. So I'll start there, and then I'll pass it over to John for the second portion of your question. As I mentioned, we have recalibrated the model to bring down container costs for the balance of the year. So we're pleased with what we're seeing there and think that now is the right time to make that change. We do anticipate continued fuel surcharges on the outbound side. So those have continued at the level that you would expect. So we don't guide to gross margin. We don't guide on a quarterly basis, but those are some of the higher puts and takes that you can think about. I'd also call out variable rent expenses is certainly a component. So as we continue to drive that revenue number higher, the variable rent will also play a role. John?

Yes, in terms of our products, we're launching our fall product now, and we're very excited about it. I’m not sure about the exact number of SKUs, but it's a significant amount. We are very optimistic about the product and believe it is very strong and sellable. Looking ahead, our next major rollout will be at the end of the year as we transition into the winter and spring season, starting with indoor products and then moving to our exciting outdoor products after the holidays. We are continuing as planned and are very happy with the product's performance, which we consider to be extremely strong.

And Simeon, just to add some color to that as well. I think one of the exciting things for us as we talk about new product and adding to the assortment is when you look at the marketing campaign elements around those launches. So, for example, when I was speaking about the outdoor catalog and product launch back in early Q2 and now talking about the fall campaign launch in conjunction with the new product going into fall, we really see a very strong response from clients and potential clients about that infusion of newness into the assortment. Clients love to engage with it, be inspired with it, visit the showrooms to experience it. But ultimately, as clients start to engage with us as they look for design consultants and our interior designers, it's really about finding those perfect products that work for them, their style, their families, their lifestyle. And so it's really interesting. We see a really nice halo effect when we're talking about new product. We're seeing sales results across our entire assortment within the business as well.

Thanks, everyone.

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

Good morning and congratulations on the quarter results. I wanted to ask about the competitive landscape, any changes that you've seen over the past couple of months? And in relation to that, what should we expect from Arhaus as far as promotions around key events for the back half of the year?

Yes, I can start. Jen can help me with that. But we have no changes in our marketing. We're continuing to roll out incredible product that's really well priced. We're not planning on any big promotions or anything that we haven't done in the past. So everything is kind of as is in that regards.

Yes, Cristina, to add to that, we are definitely observing promotions from our competitors. However, as John mentioned, we are quite confident in our strategy. We are paying close attention to everything happening around us and will continue to do so in the future. We are also seeing strong results, with clients responding exceptionally well to our product and marketing. Our focus remains on optimizing our efforts, and we will keep monitoring the environment. At this moment, we feel good about our position.

Thank you. And then my follow-up is I wanted to ask about the store opening cadence you alluded to, some delays in opening stores. So should we still expect like five to seven of the larger showrooms for this year, or have some of those got pushed into 2023?

Yes, we have three planned to open this year, but three have been delayed until next year. I'm not sure how many we have opened so far this year.

We've opened two this year. We anticipate two to three design studios over the next several months. The expectation for those would, as John said, be by the end of the year. But perhaps due to timing, they might shift slightly into the first quarter a little bit. More remains to be seen there. But three that we had anticipated opening this year will shift into early next year.

Right. So we are planning on over a two-year basis to stay with our plan of five to seven. So that will be 10 to 14 over '22 and '23, plus design studios.

Ms. Fernandez, has that answered your question?

That's it for me. Thanks.

Thanks, Cristina.

Thank you. Ladies and gentlemen, we have reached the end of the question-and-answer session. And now I would like to turn the conference over to Ms. Wendy Watson for closing comments.

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

Thank you. The conference of Arhaus, Inc. has now concluded. Thank you for your participation. You may now disconnect your lines.