Arhaus, Inc. Q2 FY2023 Earnings Call

Good morning, and welcome to the Arhaus Second Quarter 2023 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 conference 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.

Good morning and thank you for joining Arhaus second quarter 2023 earnings call. On with me today are John Reed, Co-Founder, Chairman and Chief Executive Officer; Jen Porter, Chief Marketing and eCommerce 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. Jen will discuss Rooted, our most recent marketing campaign, and Dawn will cover our financial performance and outlook for the remainder of 2023. After these prepared remarks, we will open the call for questions. 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, 2023, 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-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. I will now turn the call over to John.

Thank you, Wendy. Good morning, everyone, and thank you for joining us today. It was another great quarter for Arhaus and our business continues to be incredibly resilient. We continue to win with our clients and in the second quarter, we again saw exceptional demand comp growth. It is notable that the 11.6% demand comp stacks on a 22.5% demand comp in the second quarter last year. In terms of cadence, we started the quarter in April with a flat demand comp, which accelerated with May and June up mid-teens to low 20s. We are seeing strength in all categories and in all regions. We also have a strong start to the third quarter with demand comp growth in July up high single digits. Turning to highlights for the second quarter, while continuing to execute our strategic initiatives and growth plan for the year, we delivered net revenue of $313 million, net and comprehensive income of $40 million with a margin of 12.8% and adjusted EBITDA of $64 million with a margin of 20.4%. Note that revenue was below our expectations for the quarter, impacted by delivery delays primarily focused on these three factors: First, slower deliveries out of the Dallas distribution center as we continue to optimize product assortment across the three distribution centers; second, a temporary reduction in productivity as we implemented various new systems, including a new warehouse management system to drive future efficient growth. And third, some clients are also asking us to delay deliveries as they complete home-related projects. As we have gone from one distribution center to three in the past two years, it is critical that we continue to implement the system capabilities, processes and talent to enable us to move product through our supply chain more efficiently as we scale for growth. Some of the factors that slowed revenue in the second quarter will continue into the second half of this year. And as a result, some of that net revenue originally expected in 2023 will be pushed to 2024. This is offset by our stronger-than-anticipated demand growth. As a result, midpoint for our year net revenue outlook is unchanged. Dawn will discuss in more detail this later. Moving to profitability. We saw a nice earnings benefit from the impact of lower freight costs to our gross margin in the second quarter. This benefit is enabling us to pass through some of the lower pricing to our clients with a particular focus on ensuring we remain top of mind competitively. It is also allowing us to optimize our assortment as we make way for new product launches in the fall and address areas where we need less inventory on hand. Additionally, with our stronger earnings in the second quarter, we are raising our full year net income and adjusted EBITDA outlook. Turning to an update on our share growth for the year. We are successfully scaling our showroom footprint along with executing our renovation, relocations and expansion projects. To date, we have opened five new showrooms in 2023, two new design studios in Asheville, North Carolina and Naperville, Illinois, two traditional showrooms in Topanga, California and Peabody, Massachusetts and a new outlet location in Dallas. We are very pleased with the strong performance of our new showrooms and proud of how they showcase our incredible product. For the balance of the year, we expect to open six additional traditional format showrooms, a West Hartford, Connecticut location in the third quarter and five new showrooms in the fourth quarter; Coral Gables, Florida, Huntington Station, New York and three new showrooms in California. An additional planned California showroom opening has been pushed to 2024. Our renovation relocation and expansion projects are all proceeding as expected. I encourage all of you to visit one of our showrooms and experience our product for yourselves. We also continue to grow our in-home designer program. We are focused on the growth of this program as the average order value we enjoy from our in-home designer assisted sale is four times our company average order value. I founded Arhaus team more than 35 years ago with the objective to source wood sustainably and to create airline quality furniture, with the hope that it will be passed down from generation to generation and not end up in landfills. I've always been passionate about preserving our planet. And now more than ever, we must do our part to help slow down global warming. I am proud to announce a $10 million commitment to the Nature Conservancy to support their efforts to protect the critical rain forest in Borneo, Indonesia. Our donation will directly support the Nature Conservancy and their local Indonesian affiliate YKAN, as they embark on an ambitious project to pilot solutions to drive more attractive and self-sustaining economics in forestry. We are proud to support these efforts, and we hope others will join us. We know that the environment is critical to our business, our employees and our clients and certainly the planet. And we know that we must take bold action now. We look forward to sharing this incredible journey with you, and we are confident that together, we'll make a difference. Finally, I want to thank my team for their continued focus on providing an incredible product assortment and amazing omni-channel experience and client-first service as well as executing our showroom openings and enhancing strategic systems that will allow us to scale for long-term growth and success. It is their execution that makes me confident in our ability to capitalize on the significant opportunities ahead of us. Now I'll turn it over to Jen to discuss Rooted, our latest marketing campaign.

Thank you, John, and good morning, everyone. I'd like to take a moment today to celebrate our latest campaign Rooted, which launched yesterday across our channels. Last year, we sent a team of writers, videographers and photographers to Mexico. The goal of the trip was unique to visit artists and our long-time partner Javier, and to capture the magic happening in his workshops. From the beginning of our partnership, Javier's handcrafted furniture has been different, distinctive. Working only with salvaged and sustainably sourced wood, he sees a specialness of every log and lets that organic imperfection drive his inventive designs. As our businesses have grown together over the years, so has our collaboration. Our sense of style has evolved and refined. We developed new collections and expanded our offerings into new spaces at the home. Rooted is a truly immersive campaign that tells Javier's story, his family, his process and his passion for the trees. It is also Volume 1 of a story of who we are. I encourage you to visit arhaus.com to experience the campaign for yourself. We are so proud to partner with Javier and with all of our artisan partners around the world to offer our clients the most beautiful and the most unique handcrafted furniture collections. We hope you enjoy the stories within Rooted as much as we enjoy telling them, and we look forward to continuing to share the stories which make Arhaus so very special. In addition to Rooted, we have some great marketing initiatives launching in Q3. Our new content experience on arhaus.com entitled Unabridged launched this week. Here you will find the wonderful stories of our Artisan partners alongside design inspiration, partnerships and much, much more. We will also be launching our fall campaign in just a few weeks, offering hundreds of new products and expansions of some of our best collections. We cannot wait to hear client feedback and share more updates with you on upcoming calls. For now, I'll pass over to Dawn Phillipson.

Thank you, and good morning. As John described, we are pleased with the performance in the second quarter. Key items from our second quarter 2023 income statement include, net revenue of $313 million, up $7 million or 2.2% with comp growth of negative 0.8% and demand comp growth of 11.6% on a one-year basis and 102.3% on a four-year stacked basis. Gross margin increased 5% to $140 million in the quarter, driven by our higher net revenue and lower product costs, partially offset by higher fixed showroom costs and higher credit card fees related to increased interest rates and demand. Gross margin as a percent of net revenue increased 140 basis points to 45%, primarily reflecting favorable product costs, partially offset by higher fixed showroom costs and credit card fees. Second quarter SG&A expense increased 4% to $86 million. The increase was primarily driven by higher corporate expenses to support the growth of our business and higher selling expenses related to new showrooms and strong demand, partially offset by lower product storage fees as we have expanded our warehouse capacity. Second quarter 2023 net income increased 10% to $40 million. Adjusted net income in the second quarter of 2023 increased 3% to $40 million compared to adjusted net income of $39 million in the second quarter of 2022, primarily driven by the factors just described. Adjusted EBITDA in the quarter increased 5% to $64 million from $60 million in the second quarter of 2022. Second quarter 2023 net revenue of $313 million and adjusted EBITDA of $64 million resulted in a 20% adjusted EBITDA margin in the quarter, an increase of 70 basis points year-over-year. Let me now move to our outlook and how we are thinking about the second half of this year. As the midpoint of our narrowed net revenue range implies, we expect second half net revenue to be down mid-single digits versus the second half of 2022 with the higher-than-anticipated demand comp growth we are experiencing, offset by the factors John described earlier that affected our Q2 net revenue growth. We expect to see demand comps increase in the low to mid-single-digit range in the second half of the year. On the profitability side, the freight benefits we are realizing enable us to increase our full year net income and adjusted EBITDA guidance while also funding the pricing adjustments John described and our $10 million donation to the Nature Conservancy. We expect adjusted EBITDA margin to be down approximately 750 to 850 basis points in the second half of 2023 versus the second half of 2022 due to reduced leverage as compared to the second half of 2022 when we benefited from substantial backlog deliveries, higher showroom rent impacted by both the number of new showrooms and strong revenue, higher showroom staffing, investments to enhance omni-channel and technology capabilities including information technology and warehouse management systems infrastructure and the previously mentioned donation to the Nature Conservancy. Accordingly, as we announced this morning, for the full year 2023, we are narrowing our net revenue outlook with our midpoint unchanged and increasing our net income and adjusted EBITDA outlook. We expect full year net revenue of $1.25 billion to $1.29 billion, representing growth in the range of 2% to 5%, full year comparable growth in the range of negative 2% to positive 1%, net income of $102.5 million to $112.5 million and adjusted EBITDA of $187.5 million to $197.5 million. For all other details related to our results and our 2023 outlook, please refer to our press release. In closing, we are pleased with the first half of 2023. We believe our strong debt-free balance sheet, coupled with a strategic growth plan to build on our share gains in the highly fragmented $100 billion premium home furniture market, position us to weather any economic cycle and emerge in an even stronger position, poised to deliver on our longer-term growth plans and drive value for all stakeholders. Thank you for your attention, and we would now like to open the call up for questions.

Our first question is from Steven Forbes with Guggenheim.

John, Dawn, this is Julio Marquez actually on for Steven Forbes. Just a quick question. Given the ongoing strength in underlying demand trends, I was hoping you could give us a brief preview on your real estate plans for 2024 as well as the new product pipeline. And as a quick follow-up, how is the mix of in-stock versus special order sales evolved over the past couple of years? And what infrastructure-related investments are still outstanding over the, I guess, intermediate term to ensure the customer experience is where it needs to be.

Yes, regarding new stores for 2024, we're on track with our plan to open five to seven stores a year. We'll explore opportunities that may arise and potentially adjust our numbers based on finding the right real estate and deals. In terms of special orders, the mix is aligned with our expectations and performing strongly. One of the unique aspects of Arhaus that gives us a competitive edge is our custom upholstery offerings. Owning our upholstery factory allows us to provide customers with a wide range of excellent fabrics and styles that stand out in the market. We can also custom order and deliver quickly for our clients, and we're pleased with this segment of our business. Is there a third part?

Yes, could you provide any updates on infrastructure-related investments in the short to intermediate term?

You cut out there for a second. Was that a question about systems or infrastructure? Okay. So yes, we're excited. We have numerous opportunities to enhance our systems infrastructure. As we've grown over the years, we recognize there are more efficient ways to operate, and we have a strong management team driving changes that will facilitate strong, efficient growth. Looking ahead to the next several months, we have a warehouse management system deployed in one of our distribution centers and are working on deploying another in our main Ohio facility. We're eager to see how this progresses in the coming months. Additionally, we have several smaller initiatives. We've previously discussed planning software programs and various other projects aimed at driving efficient growth within the organization.

Our next question is from Jonathan Matuszewski with Jefferies.

The first question was just on the guidance framework for the second half. Historically, you've suggested the bulk of your demand is driven by light home refreshes and then also more complex contractor-assisted refreshes and a smaller piece is driven by existing home sales. So I just wanted to get your underlying assumptions for those three drivers in the second half. Curious how you're thinking about whether those stay consistent with recent trends, improve or worsen? That's my first question.

Jonathan, this is Wendy. Yes, I mean, those are the primary drivers. We never know exactly how they're going to play out from time to time. But our assumptions are that they will continue, those same factors will continue to be the primary purchase drivers related to housing for our clients. Understanding too, we have all of this incredible product that's coming in. But I would say our assumptions, in general, have not changed regarding those three factors.

Okay. Got you. And then my follow-up question is just on pricing. You've done three rounds of hikes over the last couple of years relative to peers, you haven't been as aggressive. So I thought John's comments about lower supply chain costs, enabling lower price points for clients was interesting. Maybe if you could just expand upon the lower price points that you're passing along to customers, that would be helpful. Is it being driven by more promotionality in the industry, competitor actions, et cetera?

Sure. Sure. Yes, I mean, we've always run our business in the belief of giving customers a great value for their money. We have a little different business model than most people out there, and that is we buy direct from manufacturers. We cut out all the middlemen, the wholesalers, the salesmen and all that kind of stuff that a lot of people build into their price. So we've always felt that if we can give our customers and clients a better value, if prices go down, we do, if the prices go up, we raise prices. And we raised prices for quite a while there. The better value as we're getting now is really in the freight cost. It's container costs that have come way down compared to certainly a year ago, 1.5 years ago. So the things that were impacted with that, we're looking at every price as we can take them down a little bit and still withhold our margins, which obviously is number one, we'll do it. And if that will help our volume because prices have come down a little bit, it's great. But we're doing it very selectively and we're not trying to chase customers with lower prices or anything and it seems to be working for us. So that's what we're going to keep marching at that. I don't see container costs coming down more than they are now because they're very, very low. So I would think in the future prices will be more maintained. We're not going to have to raise them or lower them. So that's kind of what the future looks like.

Jonathan, I have just a couple of other points that you might find helpful. So we implemented the price actions in mid-June. So limited impact of those in the second quarter. Overall, on the full assortment, it's about a mid-single-digit price decline. But keep in mind that most of those are temporary as we're looking to right-size the inventory assortment. And as we're thinking about how to make way for newness within the assortment as the newness season is coming up for us. So really excited for that. And those were the two points.

Our next question is from Simeon Gutman with Morgan Stanley.

This is Jackie Sussman on for Simeon. Just on the timing of deliveries, I guess how important is it for your business to be more consistent with that timing of deliveries? Do you think you're impacting the brand in any way? And kind of what's the path to marry up the demand and the actual comp?

Sure. So for the delivered sales, like we mentioned, there have been a couple of impacts in the second quarter that were impacting our ability to deliver the demand that's been written kind of to the level that we had anticipated originally. We're working through the second half to be able to fulfill those orders based off of client timelines as well. So I would say more to come on the alignment of those two. I think when you're looking at just the demand comp percentage and the comp percentage, keep in mind, the base is going to be very different looking at last year. So there's going to be some noise until there's a lapping of normalization. But we're working pretty diligently to get product delivered into the clients' homes in the second half of this year, particularly in advanced holiday seasons and folks really want their homes looking perfect.

Jackie, to address your question about any potential impact, we are selling handmade heirloom-quality products, which are not commodities. Therefore, if it takes a couple of extra weeks for our products to reach customers, that's perfectly acceptable. We have not experienced any cancellations due to delays. It's crucial to understand that our clients are willing to wait for our products because they know these items will last for many years. They are unique and cannot be found anywhere else in the world, so they are willing to wait. While they might appreciate receiving their orders a couple of weeks earlier, they are not concerned about the wait.

Got you. And just a quick follow-up. I guess, on new store productivity, can you remind us what year one productivity looked like in new space as a percent of an average store and how are new galleries tracking on that?

We target a minimum revenue of $10 million and an adjusted EBITDA contribution of 32% for traditional showrooms. We are pleased with the performance of our new showrooms in relation to these metrics, as they have started off very strong. We have found that we perform exceptionally well in any market we enter, whether it is urban, suburban, in a mall, in a lifestyle center, or as a standalone. We have confidence not only in the showroom experience but also in the marketing efforts we implement when opening a new location. We take pride in how our new locations are performing currently.

Our next question is from Peter Benedict with Baird.

So Dawn, can you talk a little more about maybe the second half outlook, help us understand your view on gross margin versus SG&A. Certainly, it looks like gross margin will be down or SG&A is going to be up a bunch. Just trying to understand what the puts and takes are there? And any kind of call out around 3Q versus 4Q, just as we set the expectation for the back half? That's my first question.

So while we don't guide to gross margin or SG&A, I'd be happy to provide some clarity on some of the components. So within the gross margin line item, we did talk a bit about freight is coming down and we're seeing that starting to roll through the P&L. So that's some nice relief there. We're offsetting that with pricing actions that we've taken for the inventory assortment. Other items rolling through there of particular note are the new showrooms as we're opening six new showrooms in the back half. Keep in mind that those are in more expensive locations and have rent in advance of opening. We also within a couple of months prior to opening, we're starting to staff those locations as well. And there's no corresponding top line revenue impact. So that's important. Now it sets us up really well for 2024 and beyond for these new showrooms, but does have a near-term impact to this year. We're also seeing a little bit of compression still in credit card fees, as you can imagine with the interest rates where they are and with demand accelerating that impacts those line items. Within SG&A, so staffing as the new showrooms roll through SG&A, but we're also expecting some variable compensation increases. Keep in mind that our showrooms are commissioned based off of demand versus GAAP revenues a little bit of a disconnect there. So as we're working to get the delivered revenue out the door, there could be some just variances there on a percentage basis. We're also investing in systems, right? So as we've talked about the warehouse management system, the planning systems. We're talking about an order management system. So a lot of those in advance of actually turning on the system, there's a lot of cost and implementation fees that go along with those. So yes, so I think we're investing for growth. We're excited about where these systems are going to take us over the next kind of 12, 18, 24 months and how we're going to be able to grow the business and support the growth that we've seen, but certainly a kind of a near-term compression. And then just as we're thinking between quarters, again, we don't really give quarterly guidance at this point. But I don't know, Wendy, do you have maybe any additional context?

We hope for a balanced split. In the third quarter, we'll launch new products, refresh our showrooms, and roll out a major fall marketing campaign, which could provide some uplift in the fourth quarter depending on delivery. Overall, I see them as quite even.

And then, I guess the next question would just be around the COO.

Peter, another point to mention is that in SG&A, we will have a donation to TNC, which is expected to take place in the fourth quarter.

Yes. We've got a great team driving that part of the business. And the COO mutually agreed, it just wasn't a great fit to take us forward. So we're going to keep moving on. We'll figure out what our plans are for the future. But we've got a great, great team on the ground that can execute and we'll move forward with them and keep things going.

Our next question is from Seth Sigman with Barclays.

I wanted to follow up on the price adjustment conversation. So it's really difficult to compare apples to apples versus your competitors. But do you have a feel for following some of these adjustments, what the price gaps look like? And maybe just any other commentary around what's happening competitively from a price and promotional perspective?

Yes. So we're constantly evaluating where we're positioned within the competitive set, making sure that our value proposition is exactly where we would like it to be, making sure that we're kind of top of market with regards to that. So we feel really comfortable some of these price adjustments that we've taken that would not be temporary that would be more permanent based on what we know today. We feel great about how those position us within the market. And I think as we're looking across the assortment, we have really unique product at really great quality. So I think we're really pleased with how we're positioned in the market, but we're constantly evaluating that as well. Jen, do you want to talk at all about the promotional cadence your team?

Yes. I believe regarding promotions, as I mentioned in earlier calls, we are still experiencing increased promotional activity. Our promotional strategy has not changed, and we are very satisfied with it. It's important to note that we have traditionally run promotions during holiday weekends, especially the three-day weekends. Towards the end of last year, around Black Friday, we noted that these sales periods were extending. As we focus on growth, we aim to be remembered and included in consideration for customers who are more responsive to promotions. We have lengthened some of our promotional periods; for example, what used to be a three to four-day promotion during the July 4 weekend may now extend to over a week, aligning with current market trends. Our goal remains to enhance brand awareness, knowing that certain customers are promotion-driven. We want to be top of mind when they're shopping. Other than this adjustment, our strategy remains unchanged, and we are pleased with how it's performing.

And just a reminder that those price changes went into effect in mid-June.

Is there something specific you would point to that you guys are doing or do you think maybe that's the market, just any more context there?

Seth, this is Wendy. You broke up a bit. Can you repeat the question?

I apologize for that. The acceleration you observed in the middle of the quarter was quite significant, both on a year-over-year basis and also over multiple years. Is there something specific you would like to highlight, or do you believe it is driven by the market?

I believe we're contributing to the positive momentum, and there might be a market aspect involved too. We are consistently implementing the strategies we've discussed over the past few years. We are very satisfied with our showrooms and their aesthetics. Our products are making a strong impact and staying relevant. Over the years, we've continued to introduce new offerings, which sets us apart from some competitors. We are always assessing our marketing efforts to explore better ways to engage clients and encourage responses. I feel confident that we are following through on our plans and will keep doing so. We're genuinely proud of our achievements and the efforts of our teams in driving these results.

Our next question is from Max Rakhlenko with TD Cowen.

So first, gross margin was up nicely in the quarter, but I just want to confirm that the lower prices will not result in gross margin pressure down the road? And then how much do you think the pricing impact will have on 2H and then just the elasticity that you've seen over the past handful of weeks?

Yes. So as we've mentioned, we're reinvesting the freight savings, some of the freight savings as they're flowing through the P&L into some of these price actions that we've taken. We feel now is the right time to really evaluate, dig into our inventory assortment and make sure that we are positioned how we want to be positioned heading into the back half of this year, into next year and then go forward, especially as there's renewed focus on our supply chain footprint with multiple DCs. So we're spending a lot of time reviewing and analyzing that and we think it's an opportunistic time to take some pricing action to drive those units, especially given that there's the ability to do so without margin impact given the freight rolling through the P&L. We also said that the freight savings are enabling us to contribute to the Nature Conservancy, which we're really excited about and proud to partner with. So we're feeling good about that. Sorry, was there a second part of your question?

Just the elasticity that you're seeing. So how are customers reacting to the price cuts?

Yes, I think I can answer this in a slightly different way. The consumer response has been positive. Price is not the primary factor for our clients. There is a segment of our client base that will make purchases, possibly waiting for promotions or sales during holiday weekends. Our clients select products based on aesthetic appeal, quality, and how well they fit into their homes and lifestyles. We've received great responses to some of the products we are showcasing, and we are presenting them in new ways. As we work to move inventory through the supply chain, pricing is one factor, but engaging with clients around these products is equally important. For example, we're changing how they are displayed on our website. Overall, clients are engaging with the products regardless of price point, and we are really excited about that.

Can you remind us about the new offerings planned for the second half of the year and your thoughts for next year? I know you usually follow a schedule, but I'm curious if you're planning to stick to it or if there might be any adjustments. Additionally, what are your thoughts on the timing of the book rollout?

Yes, I can answer that, Mak. As you know, I think our demand sales are up less 33% over the last 24 months. Clearly, our product is resonating with our clients, and we've got great product. So during the pandemic, I had our merchants not slow down, designing, developing, sampling new products. So when we came out of the pandemic, we could pull the trigger on those, and they were ready to go, and we're seeing a lot of that. We think that is a big part of why we're doing so great. I know it is. It's because we've got great, great products. So the future, we're things steady. We shoot for about 20% newness a year, and we're staying steady with that point. We're looking at every single category that we carry and trying to just get better and better every day. We've got such a great merchant team, great design team, and they're very passionate and so talented that they love working on products and so do I. And we keep coming out with better and better things that we think our cutting-edge people have never seen anywhere else. Take a look at this Rooted campaign that Jen just alluded to, that's one of our key partners that we did roll out some really cool new product with this fall or rolling out right now, I should say, that we know is going to be a home run. And so yes, we're staying on course.

And Mak, I would also add that, that newness that's coming in is coming in at really exciting margins. So we're really proud of how we're able to price these pieces within the market.

Can you maybe just elaborate on that, if you don't mind, just that last comment.

I think we prefer not to delve too deeply into specifics, primarily for competitive reasons. However, I can share that when considering the overall assortment and pricing, we have new items arriving at strong price points and excellent margins. Additionally, we mentioned the mid-single-digit price adjustments we implement. I want to clarify that most of these adjustments are temporary and depend on stock levels. While the mid-single-digit adjustments apply across the assortment, we have different supply levels in various categories, which affects our pricing strategy. Overall, it's difficult to model this precisely, but we are focused on managing margins and feel confident about our positioning with clients as well as from a profit and loss perspective.

Yes. And just to add on to that, from a merchant side, we work on new products and roll out new products that are going to be profitable. I'm not interested in chasing cheaper products, let's cheapen the quality of the products so we can sell more, so we can hit a lower price point or say we cheapen it so we get a higher margin, that's absolutely not what we do. But we keep the quality is absolutely good as possible, great design and we analyze the product. I mean, we go through hundreds of products that we pass on because maybe we can't get the margin on. It's cool stuff, but we feel it's overpriced. So anything we do roll out to Dawn's point, is a great product at a great value, and we're getting a good margin on it because that's number one, and that's just our philosophy and how we merchandise products.

Our next question is from Jeremy Hamblin with Craig-Hallum.

Congratulations on the impressive results. You recently achieved your best gross margin rate, and while you expect it to slightly adjust in the second half of the year, it appears there has been a significant and sustainable improvement in your long-term gross margin outlook. I would like to understand how scale and vendor relationships contribute to this. It seems you're still aiming for a gross margin that is higher than it was a few years ago, even with mid-single digit price adjustments. Can you provide any additional insights on this perspective and discuss what you see as the main drivers of this sustainability in gross margin?

Yes. So I think you articulated that nicely and that there's a lot of opportunity as we continue to scale the business. And what we've said in the past is that we expect to grow Adjusted EBITDA, but it may not be a linear path. So as you're thinking about those margin rates, we're investing in our showroom footprint. Those are costly in advanced, 6 to 12 months in advance of actually opening the showroom. We're also lapping particularly in the back half of this year in Q4, in particular, we're lapping some really strong backlog delivery last year. So keep in mind that last year, we saw great leverage on those fixed expenses that we're not going to have that same benefit this year. So I think it's just important to keep in mind, in 2022, the backlog was about $150 million, and what we've said is that the flow-through rate on that was between 35% to 45%. So, really strong flow-through on that, about $100 million in backlog delivery in 2023 or 2024, depending on how the back half of this year plays out. So as you're thinking about longer term, backlog is certainly going to play a role, a significant role in those rates. But we are positioning the Company really well to continue to grow as we're investing in talent. We're investing in systems we’re investing in processes. And certainly, in products as we continue to work really closely with the vendors around pricing those pieces. So I think more to come on that from a larger perspective, but we're excited about where the Company is heading, and we feel really good about how we're going to be able to deliver over the near and medium term.

I'm following up on the new showroom openings. The upcoming locations are primarily coastal markets with slightly higher household incomes. Regarding the $10 million target you mentioned, are the expectations for unit-level economics higher, considering that rent costs in those areas are likely elevated? Should that target be adjusted upward to achieve the desired unit-level economics?

Yes, you're exactly right. So we're targeting a 32% Adjusted EBITDA contribution in year three for all of our showrooms. Now that's an average. So as we're thinking about some of these showrooms, particularly in California, California showroom, depending on the demographic, which location we're going into is going to perform better than perhaps like an Akron-Canton might in Ohio. So we're very laser-focused on the financials of each location. And we're really pleased with the deals that we've been able to get and the performance that we expect and anticipate coming out of or entering some of these new markets and then adding new locations within existing markets. So we're definitely focused on the financial performance of each location.

Our next question is from Peter Keith with Piper Sandler.

Congrats on that demand acceleration, it's pretty impressive. Maybe just first kick it off to Jen on the Rooted campaign. I did notice that earlier this week, it's a really impressive video. So maybe just give us the plan on how do you raise the awareness of that, push that out to customers to help increase that profile of the Acacias and Polanco collections because it does seem like it could drive quite a bit of interest.

We are thrilled with the campaign. As I mentioned, it launched earlier this week and can be found on arhaus.com, our website, in our stores, on our social media channels. We're doing some advertising out in the market to prospect for new clients. You might be getting introduced to Arhaus for the first time, working with some of our partners and influencers to get that message out as well. So we're really excited to see how this plays out. I think what is so incredible about this particular campaign is it's really expanding on the stories and what is special about our health and what we have known since the beginning. I think one of the great things that we hear from our design consultants and interior designers is clients want to know the stories of the artisans behind the products that they are buying. They want to know where they come from, how they're made, how they're crafted, what materials are made out of, any sustainability elements to that. And so we've always loved telling these stories on a one-to-one basis in showrooms, but this is our ability to really do it, like you said, on a broader scale. We also have printed a limited edition, incredibly beautiful book that will be going out to some of our top clients will be available in our showrooms. And it's just an absolutely stunning work of art. As I mentioned earlier on the call, we really sent some incredible artists and creators to Mexico to capture the story of some incredible artists and creators in Mexico. And it's just been a really incredible synergy watching that all come together. And we're really excited to start seeing reactions from both our clients, from our internal employees and then from new people who are getting to know us for the first time. I think the other two things I just want to note is, as I mentioned earlier in the call, this is Volume 1. So we have a lot of stories to tell, a lot of elements, a lot of partners, a lot of products that really combine to make Arhaus incredibly special. So looking forward to continuing this campaign in the future, and then our fall campaign launches in the next few weeks, as I mentioned, the fall catalogues will be hitting homes in about two weeks here. And that is incredible. That is showcasing all of the product and the stories and the details. And so just really excited for that sort of want to punch there of layering this additional storytelling element onto our marketing initiatives.

So we've seen really nice flow-through on the freight front primarily as we're thinking about gross margin. So for us, even within the organization, we have a little bit of challenges in seeing and forecasting exactly how that freight impact is going to flow through just because it's SKU dependent. And that's really contingent upon what client is purchasing at what volume. So we've been a little conservative in how we're thinking about freight flow through in the P&L, I think.