Arhaus Inc
NASDAQ:ARHS
Earnings Call Analysis
Q4-2023 Analysis
Arhaus Inc
Arhaus concludes another year of growth by leveraging its unparalleled focus on quality, comfort, and craftsmanship. They engage with some of the world's most talented designers and craftsmen to create uniquely designed products, fostering a strong connection with clients through inspiring showroom experiences and encouraging personal style curation. This approach has not only strengthened client relationships but also fostered a culture of passionate and dedicated team members who played a pivotal role in the company's success.
In the fourth quarter of 2023, Arhaus achieved record net revenue of $344 million despite a 6.8% comparable store sales (comp) decline, evidencing the ability to grow demand comps by 1.6% over one year and by an impressive 91.4% over four years. This was partly due to a strategic decision not to repeat certain promotions to preserve margins. While net income and adjusted EBITDA saw declines to $31 million and $51 million, respectively, the company remains pleased with its overall robust financial performance and demand comp growth.
The full-year result posted a net revenue of $1.3 billion, with a comp growth of 1.4% and demand comp growth of 7.6%. Key drivers of net revenue growth included strong demand across showroom and e-commerce channels, and an abnormal backlog delivery. Strategic investments led to increases in showroom expenses, transportation, and technology, with some balance coming from reduced warehouse expenses and non-recurring costs from previous investments, such as the Dallas Distribution Center setup.
Arhaus underscored its commitment to shareholder returns by announcing a special dividend, fueled by a strong debt-free balance sheet, outstanding cash generation, and year-end cash of $223 million. Anticipated capital expenditure for 2024 ranges between $80 million and $100 million, with a significant portion allocated to showroom expansion projects. Despite an expected full-year adjusted EBITDA margin lower than 2023, strategic investments in the business remain a top priority to drive profitable growth, supported by their solid financial foundation.
For 2024, Arhaus sets its guidance with caution amid macroeconomic uncertainties, projecting a comp growth between negative 4% to negative 2%, net revenue between $1.33 billion to $1.37 billion (3% to 6% growth), and adjusted EBITDA between $185 million to $200 million. Strategic investments for the year include enhancing showroom projects, operational improvements, a new warehouse management system, and further development of e-commerce and in-home designer programs. While significant adjusted EBITDA deleverage is expected in the first quarter of 2024, the company anticipates net revenue growth in the remaining quarters, with an inflection in the second half of the year as a result of completed investments and the positive impact of new showrooms.
Arhaus sets its sights on long-term growth with targets of mid-single-digit comparable sales growth, mid-to high-single-digit showroom growth, high-single-digit net revenue growth, and low-double-digit adjusted EBITDA growth. Undaunted by short-term headwinds, Arhaus's commitment to its strategy, driven by its strong balance sheet, positions the company favorably in the $100 billion premium home furnishing market for continued growth and market share gains.
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Good morning, and welcome to the Arhaus Fourth Quarter and Full Year 2023 Earnings Conference Call. [Operator Instructions] 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 Morse, Senior Vice President of Investor Relations. Please go ahead.
Good morning and thank you for joining Arhaus for the fourth quarter and full year 2023 earnings call. On with me are John Reed, Co-Founder, Chairman and Chief Executive Officer, who is joining us this morning for Italy; and Dawn Phillipson, Chief Financial Officer. After prepared remarks, they will be joined by Jen Porter, our Chief Marketing and e-commerce Officer for the Q&A session. During Q&A, please limit to one question and one follow-up. If you have additional questions, please return to the queue. We issued our earnings press release for the year ended December 31, 2023, before market opened today.Yesterday, after market close, we filed an 8-K to inform investors that we identified an error in our unaudited convinced consolidated balance sheet as of September 30, 2023, related to certain leasehold and landlord improvements prior to Showroom completion being incorrectly included in prepaid and other current assets rather than property, furniture and equipment net. This error resulted in inaccurate cash flows ascribed to the operating and investing activities in the unaudited condensed consolidated statement of cash flows for the 9 months ended September 30, 2023. As such, we will restate our financial statements for the third quarter of 2023 and revise the December 31, 2022 comparative balance sheet that will be included in the amended third quarter 10-Q.For more details, please refer to the 8-K. These documents are available on our Investor Relations website at ir.arhaus.com. As a reminder, remarks today concerning future expectations, events, objectives, strategies, trends or results constitute looking statements. Actual results or events may differ materially due to a number of risks and uncertainties. For a summary of these risk factors and additional information, please refer to this morning's press release and the cautionary statements and risk factors described in our most recent Annual Report on Form 10-K and subsequent 10-Qs as such factors may be updated from time to time in our filing 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 some non-GAAP financial measures and this morning's press release includes the relevant non-GAAP reconciliations. A replay of this call will be available on our website within 24 hours.Now I will turn the call over to John.
Good morning everyone and thank you for joining us on the call today. We delivered a strong fourth quarter 2023 with net revenue of $344 million, net income of $31 million and adjusted EBITDA of $51 million and are very pleased to have exceeded our top and bottom line outlook for the quarter. Turning to our 2023 performance, it was another exceptional year for Arhaus fueled by our long-term growth strategies to one, increase brand awareness; two, expand our Showroom base; three, enhance our omni-channel capabilities and technology; and four, invest in growth to build scale and to enhance long-term margins.Highlights from our 2023 full year results include net revenue of $1.3 billion with our Showroom channel up 2% and our e-commerce channel up 17% on top of growth of 57% and 43% of each of these channels in the full year 2022. Comp growth of 1% and demand comp growth of 8% both at or high end of our outlook for the year, and cycling comp growth of 52% and a demand comp growth of 14% in a full year of 2022 and comprehensive income of $125 million and adjusted EBITDA of $203 million. Given our strong cash generation and balance sheet strength following 2023's outstanding performance, I am pleased to announce our Board of Directors approved a special cash dividend of $0.50 per share payable on or about April 4 of 2024 to shareholders of record at the close of business on March 21, 2024.We are very pleased to be able to return value to our shareholders while retaining the balance sheet strength that will allow us to continue investing in the Arhaus growth. Dawn will cover our fourth quarter and full year 2023 financial results in more detail later on in the call, but I want to congratulate our team for delivering these results. I'm astonished by what our team has accomplished in a short time since we went public on November 4 of 2021. At that time we had 77 Showrooms. Today we have 92 Showrooms, adding almost 20% to our Showroom total, and we expect to add another nine to 11 this year.Over the last three years, we believe the U.S. premium home furnishings market has grown 50%, while our growth has been more than 3 times that of the industry. We have increased our net revenue by 154% or $780 million, increased our net income by 634% or $108 million and increased our adjusted EBITDA by 193%, or $134 million. As impressive as this growth and the execution by our team has been, it is our future potential that is so significant and has me so excited. Going forward, we expect to continue to grow faster than the market by executing on our strategy. Starting with Showroom growth, which is the number one way we expand our brand awareness.In 2023, we completed the largest Showroom -- number of Showroom projects in our history, opening eight new Showrooms, two new design studios and one new outlet location along with eight renovations, relocations and expansion projects. Remember, our new Showroom economics are very strong and we target new traditional Showrooms who generate at least $10 million in revenue by year three, with target adjusted EBITDA margins averaging 32% and average investment payback in two years or less.In 2024, as I mentioned, we expect another year above the record Showroom growth with plans equal or exceed the number of 2023 Showroom projects, including four to six new traditional Showrooms, two design studios, three outlets and to renovate, relocate or expand several existing Showrooms. With wonderful feedback from our clients and the continued word of mouth awareness building around our Showrooms and the incredible product they showcase, we look forward to introducing the Arhaus brand and experience to many more clients over the next several years, especially as we continue to work towards our target of 165 traditional Showrooms.The number two way we expand brand awareness is through recommendations from friends and family. Our incredible product and the value proposition it offers is at the heart of these recommendations and we enjoy persistent demand for our product throughout 2023 driven by the success of many of our newer product collections. We frequently describe traveling the world to seek inspiration, meet with incredible artisans and ensure we continue to delight our clients with beautiful products from across the globe. As Wendy mentioned, I am joining you from Italy today where members of our product development team and I are working on some really exciting new products.Last year I told you I thought 2023 was going to be the best year ever in new product lineup and I think we have exceeded even that very high bar with the product introductions and category expansions in 2024. Our spring and outdoor catalogs and Showrooms are currently showcasing this product and I encourage all of you to go to the Showrooms and spend some time arhaus.com to judge for yourself. During 2023, we also continued to make some important growth investments to enhance our omni-channel capabilities and technology. We are growing our insights from website engagement and have launched our incredible story campaigns online and in print highlighting artisans from Mexico and Italy.These campaigns not only tell our product stories, but they elevate our brand at a time when we are introducing Arhaus to many new clients across the United States. This is also a great time to highlight the volume 2 launch of the story campaign, Bellissimo Segreto, A Beautiful Secret. As a reminder, we developed the story campaign in response to our clients asking to know more about the talented craftsmen behind our beautiful products. The introductory volume of [ storied ] rooted, a story not common highlighted a family of woodworking artisans in Mexico and was released last fall.The current campaign is a testament to our Italian partnerships, some of which we were established decades ago and all of which have been instrumental to building our brand. We are thrilled to continue this series and look forward to telling the Arhaus story through future volumes. We are also continuing to make strategic investments to upgrade the technology that supports our business and long-term growth plans and enhances our capabilities in warehouse management, inventory planning and allocation, and manufacturing, delivery and efficiencies. Our teams have been working around the clock on these initiatives.I'm excited about our technology roadmap and the long-term advantages and expected margin enhancements it will create for us. These investments and enhancements will continue in 2024 and Dawn will give you more detail on the size and scope of these investments. These are near- and long-term prospects combined with the team's strong and disciplined execution of our strategic priorities and buttressed by our debt-free balance sheet has us well-positioned to deliver on our financial and operational goals.As we look to 2024 and beyond I'm excited about the opportunities of our business and our brand, both of which in many ways is still in the early days even though I've been at this for close to 40 years. I generally feel that there are no collections like our collections. There are no people like our people and there is no potential like our potential. Arhaus stands out and Arhaus stands alone. Our product is designed using the best materials and with the unparalleled focus on quality and comfort.We are curious world travelers and our mission to design and craft the best furniture and decor leads us to work alongside some of the most talented designers and craftsmen on earth. Our Showrooms are an authentic expression of who we are. We curate inviting spaces, carefully layered footprints, and compelling digital presentations to take every visitor on the journey of their choosing, always letting inspiration lead the way. With our clients' experience we aim to build authentic relationships, inspiring and supporting our clients at every step in the journey.We encourage exploration, customization and we are never defined by the single style. Instead, we encourage and help our clients curate the unique styles of their homes and I believe we have the best team in the industry. We are a team of designers, dreamers and doers as passionate as we are curious. Finally, I want to personally congratulate our team for a great job of 2023 and thank them for their dedication to Arhaus and our clients. I'm looking forward to what we will continue to build in 2024 and beyond.Now, I'll turn it over to Dawn.
Thank you John and good morning. As John mentioned, we are incredibly proud of our 2023 fourth quarter and full year financial results and our operating performance throughout the year. We delivered a solid fourth quarter that concluded another year of record net revenue and exceeded our expectations for both revenue and earnings. Key items from our fourth quarter 2023 income statement include: net revenue of $344 million with a 6.8% comp decline against a comp growth comparison of 47% in the fourth quarter last year that reflected strong backlog delivery.We were pleased with our demand comp growth in the quarter, which was 1.6% on a one year basis and 91.4% on a four-year stacked basis. Demand comp growth in the quarter was impacted by promotions in November of 2022 that we made a strategic decision not to repeat in November of 2023 to preserve margin. Our fourth quarter gross margin decreased $17 million to $141 million, driven primarily by lower net revenue, transportation costs and Showroom expenses partially offset by lower costs related to the reduction in net revenue.Gross margin as a percent of net revenue decreased 330 basis points to 41%, driven primarily by product mix related to the sell through of SKUs that were price action in June of 2023 as well as increased Showroom costs and transportation investments. Fourth quarter SG&A expense increased $7 million to $100 million, primarily driven by strategic investments in the business to support our growth and increased selling expense related to new Showrooms and higher demand partially offset by lower warehouse expense. Fourth quarter 2023 net income decreased $16 million to $31 million.Adjusted EBITDA in the quarter decreased $23 million to $51 million from $74 million in the fourth quarter of 2022. The fourth quarter net revenue of $344 million and adjusted EBITDA of $51 million resulted in a 15% adjusted EBITDA margin in the quarter. For the full year key income statement items include: net revenue of $1.3 billion, comp growth of 1.4% and demand comp growth of 7.6% on a one year basis and 91.4% on a four year stacked basis. During the year, demand was strong in both Showroom and e-commerce channels as our products and marketing continued to resonate.Our net revenue growth was driven by both our strong demand and the delivery of approximately $75 million in abnormal backlog in 2023. Gross margin as a percent of net revenue decreased 70 basis points to 42%, primarily reflecting higher Showroom expense, transportation investments and credit card fees, which were partially offset by favorable product costs. Product costs improved due to the flow through of container cost favorability versus prior year and promotion management partially offset by the impact from price action SKUs. Full year SG&A expense as a percent of net revenue increased 150 basis points to 29%.The increase was primarily driven by strategic investments to support and drive the growth of our business, including increased expenses as new Showrooms open and we invest in technology and the donation to The Nature Conservancy. These increases were partially offset by lower warehouse expense and the non-recurrence of costs related to the 2022 opening and setup of our Dallas Distribution Center. Full year 2023, net income decreased $11 million to $125 million. Full year 2023 net revenue of $1.3 billion and adjusted EBITDA of $203 million resulted in a 16% adjusted EBITDA margin for the year.I want to reiterate John's appreciation of the exceptional work of our teams across the company over the past year, which was instrumental in driving 2023 strong performance and record net revenue. Turning to this morning's special dividend announcement, one of our competitive strengths is our strong debt free balance sheet and the financial flexibility it affords us. Following several years of outstanding performance, growth and cash generation, and having ended the year $223 million in cash our Board of Directors is pleased to return approximately $70 million in capital to shareholders in the form of a special cash dividend. We are pleased to [ note ] with the special dividends, our growth and strategic investments remain unchanged as we are also in the enviable position of having both a long runway to continue to grow our Showroom footprint and high returns from that growth.Investing in the business to drive profitable growth remains our top priority. We will continue to build on that profitable growth with our planned CapEx investment of $80 million to $100 million in 2024, with the majority allocated to Showroom projects. Next, I'd like to turn to our outlook for 2024. With continued macroeconomic uncertainty and lapping prior year backlog delivery, we have assumed a range for comp growth of negative 4% to negative 2%. As a reminder, we are comping approximately $75 million in abnormal backlog delivery in 2023.While we enter 2024 with a normalized backlog our comp growth metric will not normalize until 2025. For the full year 2024, we expect net renew of $1.33 billion to $1.37 billion, which represents growth of 3% to 6%, comp decline of 4% to 2%, net income of $95 million to $105 million and adjusted EBITDA of $185 million to $200 million. We expect full year adjusted EBITDA margins to be lower than 2023. Deleverage will be most significant in the first half of the year and is driven by comping prior year backlog delivery and strategic investments we are making this year.2024 strategic investments include our robust number of Showroom projects and operational improvements to enhance our capabilities and drive our success long-term. We expect most of the deleverage to come from SG&A with a lesser amount of deleverage in gross margin. We expect to invest approximately $10 million to $15 million in corporate strategic investments this year as we work to streamline operation and drive a best-in-class client experience. Strategic investments for the year, in addition to new Showrooms include a new warehouse management system in our Ohio Distribution Center, planning and allocation software, and a manufacturing ERP.We will also continue to invest in our in-home delivery experience as well as other growth initiatives such as e-commerce and our in-home designer and trade programs. For the first quarter of 2024, we expect net revenue of $260 million to $270 million, a comp decline of 23% to 20%, net of $1 million to $3 million and adjusted of $11 million to $15 million. As the range indicates in the first quarter of 2024, we expect net revenue to be down low teens compared to the first quarter of 2023. This is primarily due to implementation of our new warehouse management system in March and weather-related impacts in January.Quarter-to-date our demand comp in January declined high-single-digits as weather-impacted traffic with February accelerating to mid-single-digit demand comp growth. We expect significant adjusted EBITDA deleverage in the first quarter. Of the deleverage approximately a third is coming from gross margin due to deleverage of fixed cost on the revenue decline and continued delivery of price action SKUs. The balance of the deleverage is in SG&A due to the revenue decline and as we continue to make strategic investments.As our full year outlook implies, we expect net revenue growth in the balance of quarters this year. We expect deleverage in both gross margin and SG&A in the first half of the year with inflection expected in the second half as a P&L impact from the June 2023 price action product is complete and revenue and earnings from new Showroom positively impact our P&L. We will update you on our second quarter expectations when we report first quarter financial performance in May. For all other details related to our 2024 outlook, please refer to press release.We're also reiterating our long-term growth goals. We expect the investments we're making in the near-term will enable us to achieve these goals. Over the long-term we target mid-single-digit comparable sales growth and mid-to high-single-digit Showroom growth leading to high-single-digit net revenue growth and low-double-digit adjusted EBITDA growth. In closing I want to again acknowledge the hard work and dedication of our teams.Our success in 2023 reflects our focus on and execution of our strategy which remains unchanged. We believe our strong debt-free balance sheet is a competitive advantage enabling us to execute our growth plan and make the necessary investments to build on our share gains in the highly fragmented $100 billion premium home furniture. We believe we are well-positioned to meet the needs of our clients in any economic environment and remain keenly focused on driving value for all stakeholders.Thank you and we would now like to open the call up for questions.
[Operator Instructions] Our first question is from Peter Keith with Piper Sandler.
Great results. I want to ask about the system rollouts which are interesting. So ERP systems can send some fear down analysts spines, so talk about the risk of the ERP and then future benefits of the other systems that could come in the next two years?
Good morning, Peter. John here. Dawn's probably got more information on this than I, but we're kind of laying things out in stages. I don't believe we're doing a full ERP system anytime soon. We're doing a warehouse system and then a management planning system and then a totally separate system for our manufacturing plants that manufactures our upholstery. Dawn, do you have anything to add to that?
Good morning, Peter. I think we -- in the fourth quarter of last year, we deliberately -- we hired a consulting agency to help us really evaluate our full systems and business infrastructure and look at not only what we should be really contemplating for revision and updating, but also the sequencing and cadence of that for exactly what you're speaking to. We want to make sure that as we are continuing to grow the top line, that we don't compromise the client experience, certainly, and that we don't compromise operational integrity.So we're certainly being very thoughtful, very mindful. ERPs, I think, send fear down the spines of everyone, implementers and analysts alike. So we are trying to be very thoughtful. We are excited for some of these new systems as we think about the planning and allocation software. Really, that's going to help us just more seamlessly facilitate movement of product through our network, which is going to have not only operational efficiencies, but financial efficiencies once deployed.So we're really excited for that. There are some other systems that we have not yet started, but have mentioned in the past that we're under analysis, like an order management system, which will also do the same thing and help kind of facilitate making sure the product is coming from where it needs to be. So I think overall, we're taking a very thoughtful, prudent, responsible approach, I would say, to systems, enhancements and infrastructure changes, but we're certainly -- we're laser-focused on the operational impact as well.
And then just maybe, Dawn, for a [ little more ] financial technical question. With the warehouse management system rolling out in Q1, I guess it's probably causing a little bit of sales lag. So, Q1, sales got a little bit worse than we thought. Is there a sales shift that you could quantify for us that's going to roll directly into Q2 or maybe also carry into Q3?
We think it's probably about a week worth. So, simple math, you could kind of just take what a typical quarter looks like and divide by the number of the weeks in the quarter. That being said, we also did see some impact on deliveries in January related to weather. So as you think about those drivers who are out there, if there's really icy conditions or snowy conditions that are particularly difficult at times, they will delay those deliveries.So I think as we're thinking about 2024, the first quarter certainly has kind of the lowest year-over-year impact or the least favorable year-over-year impact. And then as we look out to the following quarters, we're pretty excited and we think that as we move through the year, we should see sequential acceleration in the deliveries and net revenue as we move through the year.
Our next question is from the line of Jonathan Matuszewski with Jefferies.
Nice results. First one is just on underlying assumptions for your 2024 comp guide of down 4% to down 2%. Just help us give some color in terms of how you're thinking about large scale renovations, light refreshes, existing home sales, factors like that that you've said have the most weighting on demand for your business. That's my first question.
Go ahead, Dawn.
Good morning, Jonathan. Yeah, so -- as we're thinking about the macro, there certainly continues to be a lot of uncertainty. We do know that our client continues to renovate, continues to refresh their home and a light refresh could be something as simple as painting a room. So we think there's still plenty of that happening.As you think about our market share of just the total $100 billion industry, we have a ton of runway. We're less than 2% of market and so just so much opportunity for us as we continue to open Showrooms, as the marketing team continues to really expand the brand awareness and kind of think outside the box on some of these different marketing campaigns. Jen, do you want to talk about the Italy campaign?
Sure. Hi, Jonathan. Good morning. Yeah, we're really excited. As Dawn mentioned, we're really excited opening up those new Showrooms, but within marketing as well, we're really excited about the new opportunities that we have to not only present Arhaus in a similar way to more people, but also new ways that we're presenting Arhaus out to the audiences. So as John mentioned, we kicked off our stories series with our rooted campaign featuring our Mexican artisans last fall. We just launched our Italy campaign in spring with a big rollout in February.And it really does give us a way to tell those stories, share the craftsmanship, share the things that really make Arhaus unique and special. John talks all the time about how proud we are of our product and what we're delivering to the market. And I think we as a marketing team are just thrilled to really be able to share those stories and let people see into our world. And these are things that we are excited about and have been experiencing for decades. But these campaigns really allow us to go into detail and share those stories with a larger audience. Really, really excited by the responses that we are seeing to those campaigns. We are learning a lot.We are seeing some really great engagement and traffic results, particularly on digital, with those campaigns. So as John mentioned, we decided to start telling these stories because of questions and interests we were getting from current clients. And just seeing existing clients and also future potential clients really engage with them is really, really exciting. So more to come from that, but really excited about what we'll see through the rest of the year there.
That's helpful. Thanks for the color there. And then I guess just a follow up, if we could get an update on anything you're seeing regarding cancellation rates, whether you've seen any deviation there from historical levels. And I guess, relatedly, I think last year you called out at one point consumers choosing to postpone their orders and that kind of having an impact on when revenue may have been recognized or I guess postponed their receipt of deliveries. Are you still seeing that dynamic? Any color there would be helpful.
Yeah [indiscernible]. I'm certain we have not seen any increase in cancellation rates, number one. They hold steady as they have been the last quite a few years. So that's normal case. We're actually doing a little better than we had been, and we're not really seeing people now delaying orders either. Sometimes you see that -- obviously, when people are renovating their homes, as we know, people aren't moving as much as they had been, but people are, at least in our category, renovating quite a bit. And most builders in that have caught up at least telling the clients -- an actual date that they can stick to. So things are getting better in that field. We're not seeing people delaying like we did last year. So we're not seeing that as going to be a factor at all.
Our next question is from the line of Peter Benedict with Baird.
Oh, hey, guys. Kind of a question around kind of the top line cadence, how you're thinking about the recovery over the course of the year. You talked a little bit about some of the macro drivers there, but just maybe unpack that a little bit what you're thinking in terms of just sector demand. You guys have clearly been doing better than the sector, but just your view there and help us understand that maybe the cadence of that $75 million backlog release that you saw in '23 just so we understand the comparisons on that. That's my first question.
Yeah, good morning, Peter. Dawn, you can help me with this. But -- what we're seeing is, as we've been saying all along, last year was strong, very strong. Our new products are just resonating so well. And I think we're just dead on with what people want these days. And it's a very unique product. We think we're way ahead of the curve from our competition on products. So we think people are responding. And as we've opened up so many new stores everyday we're getting more and more new clients coming in, finding out who we are because we're relatively unknown brand, especially on the West Coast, and they're resonating.That's amazing how people walking in who really don't know our brand and are purchasing from us because they just fall in love with our product, fall in love with our Showrooms and fall in love with our designers who are just fantastic. So that part is great. And I'm seeing the lineup of new products and so forth strong. And that's what we're all about, selling great products. And the more we have better products and the more people know about us, the better we're going to be. We'll just continue to grow. Dawn, you want to add on to the other part of that?
Sure. So I think just to reiterate what John was saying, we feel so great about the new product introductions, the marketing materials, the new Showrooms that were opened in the fourth quarter of last year. We're so excited with how those are performing and the clients' engagement within those locations. So as we think about demand in the first quarter, January was a bit soft. February accelerated nicely.So I think as we're thinking about the demand cadence that will impact a little bit in the first quarter, but really feeling great about all of our offerings, how we're engaging with clients and switching to think about net revenue -- as we move through the year, we do expect sequential acceleration. So every quarter we expect net revenue to improve a bit.And that's really going to be driven by new Showrooms that open not only in the fourth quarter of this year, but Showrooms in 2024 are slated heaviest in Q2 and Q3. So we should see some nice benefit in the back half from those openings as well. As we think about backlog in 2023, it's relatively evenly split between first half and second half. It's slightly heavier weighted towards the second half.
That's helpful. And then just maybe on the turn to the sourcing side of things, transportation was a benefit for you guys in 2023. Just curious what you have kind of assumed in your plan for '24. Remind us, kind of the geographic exposure you guys have in terms of where your product is coming from. And just any thoughts on all the activity, the Red Sea, and what that might be doing to your inbound rates on ocean freight?
Yeah. Keep in mind, almost half of our product is made in the United States, which -- we've always made our upholstery in the United States and some other products are being made here. So that takes almost half the business off the table. The other strong parts, where we're strong, in Mexico we buy a fair amount of product, and in Europe we buy a fair amount of products, especially Italy. None of that is affected by the Red Sea at all. Some of the Asian things were, but we just have rerouted them. We're not seeing significant cost increases with that. So we're not -- right or wrong, we're not worried about the Red Sea part of the business. And again, it's maybe 20% of our business that may go through there, if not. So it's not going to be significant.
Yeah, just to layer on there. I think over the last few years, we have seen some slight adjustments in products coming domestic versus international. So the number is a little bit lower coming from domestic these days. It's closer to probably 30% versus the 50% when we IPOed. But to John's point, we have layered in some slight increases in the back half of this year for freight costs related to Red Sea just from a guide perspective.We're cautiously optimistic that we won't see significant increases in the cost, but I think it's prudent just based off of what we know today and what we're seeing to have something factored in there. And then just to reiterate John's point, we are seeing a few week delay in certain containers, but we're managing that really well upfront with the clients and so far, haven't seen any kind of client kind of issue or ordering issue related to the Red Sea delays.
Our next question is from the line of Steven Forbes with Guggenheim Partners.
John, Dawn, Jen, I was wondering if you could expand on what's driving the acceleration in demand trends during February? Is it simply the weather compare month-over-month or is the core accelerating? And any early reads on how the consumer is engaging with the new outdoor collections, noting it may be early. But John, you sound super excited about the product, so really would love to hear your sort of early thoughts on how the consumer engagement is.
Sure. First of all, that February versus January, it was really the first two weeks of January that we were affected. You guys heard the news. I mean, the news scared the hell out of basically everybody in the country except California and Florida, I think, and rightfully so. There was some nasty weather there. Once we got through the first two weeks, we actually saw positive trends for the last two weeks of January and then, of course in the February.So it was kind of a blip with the weather and we're not giving that any worry whatsoever. Our product is strong. It's resonating very, very strongly. As far as the outdoor products, we just launched our new and by far best catalog. Hopefully you've all received it. If not, let us know. We'll get one in the mail to you. But it is by far the best product ever. We had put together, assembled a new outdoor team about three years ago, three and a half years ago, and they are really running at full speed in 2024.So we've got great product. The results so far have been incredible on it. Literally, the catalog just hit days ago. But the response we're hearing from the stores, from our clients is it's fantastic. We've got some very fresh things, things nobody else in the world are doing. And it's great style, incredible quality at a fantastic price. So we think outdoor is going to be strong this year.
Maybe just a quick follow up -- capital structure, extremely strong balance sheet, free cash flow profile. You announced a special dividend, but maybe you sort of give us some preliminary thoughts on the 2025 pipeline. Is there an opportunity here to accelerate store growth? Are you thinking about potentially accelerating store growth or how are you sort of thinking about the right rate of store growth or square footage growth over the coming years?
Right, right. Well, as you know, we've been saying we did quite a bit of new store growth, renovations last year and also this year. Going into '25 and beyond we're shooting to go back to our very well-planned, very strategic growth plan, which is five to seven full size stores a year, and add on a couple more of the design centers as we see fit. So we're not looking to expand beyond what we've been planning all along, and we're going to stick with our strategic plan.
Our next question is from Jeremy Hamblin with Craig-Hallum Capital Group.
Congrats on the strong results. Just want to come back to the last point here on the Showroom growth and just see if we could clarify, make sure that we're interpreting the right way, the mid- to high-single-digit Showroom growth on a long-term basis that you'd mentioned Dawn. So are we thinking about that on a percentage basis or are we talking about still five to seven Showrooms per year, FY '25 and beyond?
Go ahead, Dawn.
Thanks. Yeah, so I think on a percentage basis makes sense. In the near-term, the five to seven feels like the right number adding on -- that's five to seven traditional with incremental design studios on top of that.
And then in terms of just looking at your gross margin profile, I think you had said that you expect to see some nice improvement on that in second half of '24. And it seems based on where your sales levels are falling, maybe fewer pricing action dragging on mix on a go forward basis. Are you planning for kind of a solid step up in your gross margin profile as well as we get into the out years?
So we don't typically guide to gross margin and you haven't -- put out kind of medium, long-term goals for the gross margin. But what I will say is that we feel very good about our product cost. In June of 2023 we did take some price actions really to kind of make sure that our inventory was right-sized primarily. And so we'll clear through those in the first half of this year from a delivery perspective. The second half P&L will benefit having been through that.But as we think about longer term, we are investing in our in-home delivery experience, which that rolls through gross margin, and we'll kind of continue to invest in that as we really focus on making sure that client experience is where we want it to be. And I think over time we'll see how that kind of plays out. And as we have a relatively dynamic strategy, I think as we continue to scale the top line and really drive some of these growth initiatives that we have around our in-home designer program, our trade program, new Showroom expansion, we would expect to see we leverage over time, over long-term on that revenue, right? So the goal is always to scale those fixed costs.It doesn't mean it won't be, it may not be linear, like I said, as we continue to reinvest strategically in some of these areas where we feel we can continue to elevate and really provide that luxury premium experience. But yeah, we remain laser-focused on driving margins and fixed cost leverage across the board.
If I could just sneak a follow up on the pricing actions, what would you characterize the impact on kind of Q4 gross margins in the first half of '24, just from kind of the pricing actions and the impact on mix and gross margin?
Yeah, we haven't really disclosed from the P&L flow through because a bit of that is contingent upon just timing. But what we did say was that we took about a mid-single-digit price decrease when you're looking at it across the full assortment. So we are really pleased to say that those prices have largely normalized back to kind of where we think they should be as a go forward assortment so feeling good about our price position going forward.
Our next question is from the line of Max Rakhlenko with TD Cowen.
Great. So first, I know it's early, but how do you think about the new unit economics in the West Coast galleries? What could those look like compared to what you've outlined for your legacy markets? How much more robust is the revenue side in some of those bigger galleries as costs are higher as well? And then if there's any differences in paybacks that we should be thinking about?
Yeah, I mean, I don't have any specifics, but we do know with the new stores we've already opened on the West Coast in the last year, and the ones upcoming we feel they're going to be very strong. The current ones are already very strong. And the economics, the sales should be stronger than, say, a store in Akron, Ohio, where we have a store. And there's just -- there's more people, more people with money. And our product really resonates on the West Coast. They're absolutely loving it. So we feel very confident about it. Dawn, I don't know if you have specific numbers or [Technical Difficulty]?
Yeah, no, I mean, I don't think we'd want to disclose kind of geographically, but what John says certainly holds true. You would expect larger location in California to perform better than maybe a smaller Midwest market. But we still remain focused on kind of the average adjusted EBITDA contribution for a Showroom at 32%. And then the top line is a minimum of $10 million. So some of those locations may significantly outperform, some may come in a little bit under, but we remain laser-focused on the payback, which is under making sure that we have payback within two years. So feeling good about our overall strategy and Dallas -- opening up that Dallas Distribution Center really unlocked the West Coast for us so excited to continue to develop that geographic region.
Got it. And actually, I was going to ask a question on Dallas, DC, but how is that going? How are those efficiencies? Is that DC now where you need it to be, or is it still ramping? And then what could the [ stem mile ] savings look like as over time, you will be depending less and less on some of those Midwest facilities as you deliver out to the western markets.
Yeah. So Dallas is performing. It continues to, I would say, underperform where we expected it to be at this point in time, primarily because of inventory allocation, which, as we mentioned a little bit ago, we are expecting to get the allocation software up and running kind of early next year. So we won't fully be able to unlock the Dallas productivity until we have the allocation software and order management system in place. So those are kind of two pieces.In the interim, we are shuttling product back and forth as necessary to kind of try to get that inventory allocation in line with where we'd like it to be. So, importantly, we remain laser-focused on making sure the client receives their product on time and that the experience is seamless for them. We're excited to get these systems deployed to unlock the stem savings. Certainly, I remain focused on that. I know the team is as well, but there's a couple of big platforms that we need to implement in order to really unlock it. So more to come in 2025, I would say, on what those stem savings could look like.
Our next question is from the line of Simeon Gutman with Morgan Stanley.
Hey, John. I wanted to ask you about [indiscernible]. You've touched on it a bit in prepared and even in some of the Q&A, putting your design hat on and looking across your product. And it's okay if you're biased, but I am curious about trends, where your product stands in terms of style and price point. I heard you made some price adjustments. Just thinking about where it sits. And I know you also said we're not one design fits all. Can you talk about any specific trends, even within your product assortment that's growing faster than others?
Sure. Yeah, I'd love to. Yeah. Like I said before, I think we're hitting on all cylinders on our product. It's obviously the fun part of the business as consumers are looking for new looks, fresh looks for their homes. And we've gotten into a lot of products, especially in the wood categories that are brand new and upholstery categories where things have gotten softer, have gotten rounder, curvier -- woods have changed, they've warmed up a lot.They've gone away from the dark grays and so forth that were so hot a few years ago. We saw those trends a few years ago and we've been all over it. When they walk to our store and seeing our sales, the new product is really what's getting our clients excited. So we continue to look at work on large collections that we're going to launch and quite a few more in 2024. So as far as the new products as well, the margins are very strong on those.We're setting them where we want to be. I don't want to be and I tell my buyers and so forth that let's not be greedy on margin. Let's get our margin where we can have a healthy business long-term, that we're very profitable, but don't get so greedy that we're going to cut half the clients out. So we think our prices the way we buy things, direct from the manufacturers, right from the factories, right into our warehouse, and from there right to the consumer.You can't get a better business model of giving clients the best value, us getting our great margins, but not being totally greedy. And it works. [ In the end ] customers are happy, they come back, they tell their friends, and our business keeps growing. So yeah, the trends are great. Again, things have gotten softer, curvier -- anything we're doing that's in those tighter -- types of shapes they're doing very well, and I perceive that to continue certainly into 2024 and '25. Hope that helped.
And then maybe one follow-up. Yeah, that's great. My follow up, I think it's more for Dawn. It's got two parts. They're connected to some of the WMS and the disruption in the first quarter. The demand comps, I think, were running positive at the end of last year. Correct me if I'm wrong. So I'm thinking about the anatomy of getting to this mines 20 or so that you're expecting for the first quarter, even with a negative high-single-digit in January.Meaning, is it just comparison based? Why is there not enough throughput from the prior demand comps to get you to a better outcome? And then just related to this, you have this ERP rollout. Can you talk about that in terms of benefits and then any risks that could pose or was the WMS the biggest hurdle in terms of systems investments that could have created some type of disruption to your business?
Sure. So I would remind you that the demand comp has -- that's a clean calculation year-over-year from a comp basis. That is not a clean calculation year-over-year because the base of 2023 has backlog in it. So there's still going to be a divergence between the demand comp and the comp number as we move through 2024 because of the backlog in '23. Once we clear 2024 and we hit 2025, those two will be more in tandem. So there is still some disparity there.With regards to the ERP, I would just remind everyone it is our manufacturing ERP. So it's not kind of the -- it's not the retail ERP. So it has a lesser impact on the overall organization when it comes to its not impacting deliveries, it's not impacting kind of the retail organization's day-to-day. Some great benefits we're going to have some increased visibility to costing, which is going to really give better visibility to the teams, the product teams as they're costing product and just some other operational benefits to the actual manufacturing team. So no significant risk to the overall organization, I would say. We're closely monitoring it, managing it, but it's not meaningful from -- no meaningful risk that we're anticipating.
Hi, this is [ Maddie Chuck ] on for Robbie Holmes. So I think you called out that showroom openings should be heaviest in 2Q, 3Q. And I just wanted to ask specifically on the outlets, you expect three openings this year. It's still a pretty small part of the overall showroom count. But how is demand in response to these outlets? How do the economics compare to the traditional showrooms? And where you -- how are you deciding where to put these?
Sure. Yes. I mean, as we've more than doubled our business in the last couple of years, we just haven't kept up with the outlet growth. So this is really just balancing out what we needed to keep up with the outlet product. The outlet product is sold at a substantial discount. So certainly, the economics are not as strong as a traditional store. But if you look at it as a percent of sales, we're actually not adding anywhere near what we need to add compared to how much our sales growth has happened, which means we're actually doing a better job delivering things, less people are returning things and so forth. So we think we're in good shape. Once we get these three open, it'll just steady things out, so we can move on. And then as far as locations, I believe ones in Colorado, ones in Pittsburgh, and ones in Kentucky. And all three are opening, I think second quarter I believe.
And my last question is about maybe promotions. You dialed back on promotions, which helped margins in November. What are some of your assumptions for the promotional environment in 1Q and the rest of the year maybe just high level?
Yes. I mean, high level, we haven't really changed our strategy from what it has been. We certainly run some of promotions at certain times of the year. We're not looking to change that dramatically at this point. We have plenty of levers to turn on if we need to. But right now it's going to be as is -- as it has been the last year or so. And we do some promotions; we'll do whatever's coming up next memorial weekend, things like that. Well, that's already happened, hasn't it? Yes. So, or no, it's coming up. But anyway, so on and off, we'll do some promotions. But everything is typical of what we have been doing. Is that about right, Jen?
Yes. No, I would agree with that. And Maddie, hi, good morning. What I would add, and this is something that we spoke to on the last call as well. To John's point, our strategy to promotions hasn't changed what we have been doing those really focusing on the messaging of promotions. So we spoke about really focusing in on how we assort our sales section on our website, for example, how we speak to promotions, really paying close attention to those elements. But echo John's point about the overall promotional approach has not changed.
Our next question is from the line of Phillip Blee with William Blair.
Hi, good morning. You guys have done a lot of remodels and relocations over the past few years and plan to continue in 2024. And you've elevated your store experience, which is clearly having a nice tailwind on demand. Can you talk about how many of your showrooms are still in maybe a legacy format and what kind of lift you see following a remodel or reload? Thank you.
Yes. Dawn, I don't have specific numbers, but I think we're about halfway through where we want to be. Does that sound about right, Dawn?
Yes, I think it does.
Yes. So we're trying to do -- again, we don't have a set schedule because a lot of stuff to do with leases, landlords. Do we want to move the store? Do we want to renovate it? When we move it down the Street, across the hall, whatever. So we don't have a set thing. But we are absolutely committed to remodel existing stores that are doing well in good areas that we know we want to stay at. And it definitely helps. We do see a lift in sales. It's a long-term investment. The last thing we want to do is get stale, like you've all seen many retailers gotten, and to a point where it's too late to remodel because there's too many of them to remodel and you just can't do them. So we're staying ahead of that curve big time.We think better than anybody, certainly any of our competitors that I see in remodeling, staying fresh, staying appropriate. And it really, really helps I mean, our clients come in. Again, we're driven by a female client, and they get so inspired, both females and males, they get so inspired when they walk into our stores, they say, oh my Gosh, what did you do this store? This is how I want my home to look. And that's very refreshing. And it sets us up for the future. I mean, that's the biggest thing, sets us up for a great, great, great future for many years to come.
Okay, great. That's very helpful. And then Dawn, maybe a question on inventory is down 11% at the end of the year on a dollar basis. Can you maybe talk about how much is freight and price action versus unit driven and then how you feel about your positioning heading into 2024, particularly around some the newness. And then should we expect more muted inventory growth through the first half of the year? Thank you.
Yes. So we feel great that the price actions that we took in June of 2023 really positioned us pretty well as we exited 2023. There's still a little bit to clear through and have delivered in the first half, which we talked about. So I think we feel good freight has largely, container costs have largely normalized in the inventory relative to kind of the spikes that we saw in 2021 and 2022. So feeling good about kind of where the inventory is sitting as we continue to clear through those price action SKUs in the first half of this year and then really excited for the newness that is going to be launched or that was launched earlier this year and that we have a fall launch as well.And I would say that the team is taking a very responsible approach with buying into that newness. We spoke last quarter around how that backlog that is normalizing slightly higher than it was pre-pandemic, right? As we think about how do we buy into newness and can we make sure that we're getting a really solid read on the business before making meaningful purchases into that product. And we know that clients are willing to wait a little bit longer lead times for that newness because it's exciting, it's different, it's unique. So I feel good about where we'll be positioned in the next quarter and the buy plan for the year.
Our next question is from the line of Cristina Fernandez with Telsey Advisory Group. Please go ahead.
Good morning and congratulations on a good quarter. I wanted to ask about the special dividend and the decision to pay that. Should we think of this as one-time? And then going forward, how would you consider dividends, perhaps a regular dividend or share buyback?
Sure, I can start. This is a one-time thing. We have no plans to continue on a consistent basis. We've done lot of -- we've done great the last couple of years. We are very well planned out how much cash we're going to need this year, next year, the year after, and we felt we could do this in the future very happy to be able to do it on time. Dawn, I don't know if you have anything to add to that.
Yes. I would just reiterate that the Board was really pleased to be able to return capital to shareholders. And we just -- we have a really strong balance sheet. We have a great cash position, the special dividend, which we are considering to be one-time in nature. We don't have plans to do anything additional in the future at this point in time.But we -- interestingly enough, we're in the very fortunate position to be able to do a dividend, a special dividend, and still continue to invest very heavily in the business when it comes to new showroom expansion and some of these other strategic investments in the back office function. So really, really pleased with the performance that we've seen within the company and our ability to return this value to shareholders.
Thank you. And then my other question was on the price action SKUs. I know you can comment on the timing of the deliveries, but where are you as far as like taking the orders from those SKUs? Have you kind of gotten through most of what you wanted to do or there's still more to go here in 2024.
We've cleared through the majority of it from the demand perspective, the order taking perspective. So there's still a little bit left. And it's not -- I wouldn't say it's meaningful. So we're excited to get these kind of products delivered in clients homes and then start to see some nice product cost and gross margin expansion sequentially in the back half.
Thank you. Ladies and gentlemen, as there are no further questions, I would now hand the conference over to Wendy Watson for her closing comments. Wendy?
Thank you, everybody, for participating in our call today, and we look forward to talking to you again next quarter.
Thanks everybody.
Thank you. The conference of Arhaus has now concluded. Thank you for your participation. You may now disconnect your line.
Goodbye.