Arhaus, Inc.

Q3 2023 Earnings Conference Call

11/2/2023

spk02: Good morning, and welcome to the R-House third 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 call is being recorded, and the reproduction of any part of this call is not permitted without written authorization from the company. I will now turn the call over to your host, Wendy Watson, Senior Vice President of Investor Relations. Please go ahead.
spk16: Good morning, and thank you for joining our house's third quarter 2023 earnings call. On with me today are John Reed, co-founder, chairman, and chief executive officer, and Dawn Phillipson, chief financial officer. After prepared remarks, they will be joined by Jen Porter, our chief marketing and 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 and our 10Q for the quarter ended September 30th, 2023 before market opened today. Those documents are available on our investor relations website at ir.ourhouse.com. A replay of the call will be available on our website within 24 hours. As a reminder, remarks today concerning future expectations, events, objectives, strategies, trends, or results constitute forward-looking statements. Actual results or events may differ materially due to a number of risks and uncertainties. For a summary of these risk factors and additional information, please refer to this morning's press release and the cautionary statements and risk factors described in our annual report on Form 10-K and subsequent 10-Qs as such factors may be updated from time to time in our filings with the SEC. The forward-looking statements are made as of today's date, and except as may be required by law, the company undertakes no obligation to update or revise these statements. We will also refer to certain non-GAAP financial measures, and this morning's press release includes the relevant non-GAAP reconciliations. Now I will turn the call over to John.
spk09: Good morning, everyone, and thank you for joining us today. I first want to call out and thank our teams across our house. for delivering another quarter of strong performance. We are very pleased to have reported demand comp growth of 11.7% in the third quarter, a testament to the execution of teams across the company that are developing and delivering our heirloom quality artisan crafted furniture, assisting clients in our inspirational showrooms and via our e-commerce channel to find and purchase the special pieces that will make their spaces a home. The teams that are continuing to elevate and grow our brand and ensure a first-class in-home delivery experience. And the teams that support all of the client-facing and product-facing functions. Thank you. I am so proud of all of you. Many of you have asked why our house is consistently outperforming the industry. The why is our passion and our people. We love designing and working with our incredible vendors to produce beautiful furniture that can be enjoyed for generations. Our new collections are some of the most popular we have ever introduced, allowing us to expand these collections into categories and new finishes. We love creating aspirational showrooms where clients can imagine their home of their dreams and expanding to new locations where new to our house clients can experience our brand of livable luxury. We are passionate about our products and our clients' experience, and this is reflected in our performance. Third quarter highlights include net revenue of $326 million, net and comprehensive income of $20 million with a margin of 6.1%, and adjusted EBITDA of $34 million with a margin of 10.3%. We experienced strong demand across all regions, products, and channels. Moving to profitability, as we communicated last quarter, we saw an expected year-over-year reduction in earnings driven primarily by costs and expenses related to our accelerated new showroom openings and our important donation to the Nature Conservancy. Some new initiatives I'm excited about that will elevate our client experience include new processes, and some key hires to provide an enhanced final mile delivery experience and more in-home designers as we continue to grow this service. We are also focusing on growing our trade business where we see lots of opportunities in 2024 and beyond. Turning to the showroom growth, we have a very busy week, opening two traditional showrooms tomorrow, one in Coral Gables, Florida, and one in Huntington Station, New York. This will bring our year-to-date new showroom opening to eight. And then in December of this year, we plan to open three additional California showrooms, Los Gatos, Palm Desert, and Newport Beach. We are very proud of how our new showrooms perform right out of the gate. And I wanted to remind you that there is a lag before we begin to see financial benefits at our income statement due to the normal timing between when a client makes a purchase in our showrooms and when that purchase is delivered to the client and recognizes revenue. Additionally, our new showrooms are reflected in our report, Demand Comparable Growth. After they have been open for 13 months, and in our reported comparable growth after they have been open for 15 months. We have tremendous white space to continue to grow our showrooms' footprints across the United States, and we expect to accelerate our new showroom openings to five to seven new traditional showrooms annually, plus design studios. In 2024, we are targeting another new and sizable new showroom growth with six to eight new traditional showrooms two new design studios, two to three new outlet locations, and approximately ten relocations, expansions, or renovation projects. These new showrooms are in excellent locations, as varied as the Grove in Los Angeles to a new development in Oklahoma City. In closing, as we finish out 2023 and begin to look at 2024, We are focused on continuing to expand our collection of globally inspired, heirloom-quality, artisan-crafted furniture, on growing our showroom footprint with several exciting new locations, and on making the investment to support our growth for many years into the future. I'm excited about the future of our house, and I look forward to continuing to share our journey with you. Now I'll turn it over to Don.
spk08: Thank you, and good morning. As John described, we are very pleased with our third quarter performance. Key items from our third quarter 2023 income statement include net revenue of $326 million, up $6 million, or 1.9%, with a 2.1% comp decline versus Q3 last year when comp growth increased 54.3%. Demand comp growth was 11.7% on a one-year basis and 99.5% on a four-year stacked basis. Gross margin decreased 4% to $131 million in the quarter. The gross margin decline was primarily due to the sale of price action products that were receipted with higher container costs, increased fixed showroom costs as we expand our showroom footprint, and higher delivery costs as we elevate our in-home delivery experience. Gross margin as a percent of net revenue decreased 250 basis points to 40%, primarily reflecting higher fixed showroom costs and the higher product and delivery costs. Third quarter SG&A expense increased 20% to $107 million. The increase was primarily driven by the $10 million donation to the Nature Conservancy, higher selling expense related to new showrooms in demand, and increased corporate expense to support the growth of the business. Third quarter 2023 net income decreased 47% to $20 million. Adjusted EBITDA in the quarter decreased 41% to $34 million from $57 million in the third quarter of 2022. Let me now move to our outlook and how we're thinking about the remainder of 2023. As we announced this morning, we have raised the midpoint of our full year 2023 outlook for net revenue, net income, and adjusted EBITDA to reflect our year-to-date performance. Our full year 2023 guidance is outlined in our press release. This implies an outlook for the fourth quarter of net revenue of $321 to $341 million, a comp decline of 15% to 9%, Net income of $19 to $24 million. And adjusted EBITDA of $40 to $45 million. Assumes demand comp growth is in the low single-digit range. For all other details related to our results and outlook, please refer to our press release. Thank you for your attention, and we would now like to open the call up for questions.
spk02: Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press Start 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the Start key. Thank you. Our first question comes from the line of Stephen Forbes with Guggenheim Securities. Please proceed with your question.
spk07: Good morning, John, Dawn, Wendy. Maybe just to start, Dawn, the demand trends you mentioned up low single digits. As we think about the fourth quarter guidance here and the strength in demand that you've seen year to date, maybe just rephrase to us how we should expect the backlog to work through or flow through the income statement here over the next couple quarters.
spk08: Morning, Steve. We've spent a lot of time over the last few months really digging into more granular information than what we've had in the past. What that's really enabled us to do is get a better handle on the backlog, the abnormal backlog that has been a result that started in 2020 and is carried forward. You know, we do expect to be through the abnormal backlog by the end of this year. So we're really pleased with that. We feel good about our strategy, our outbound capacity, our inventory buys. There's really a few reasons for a higher normalized backlog number that we're seeing reflected in the information that we have available to us. You know, the first component is we're really prudently buying into newness. So as we're thinking about newness, clients are typically willing to wait a little bit longer. We're also deploying some pretty good discipline because we don't know exactly in a particular collection which finish might take off and which finish might not. So we have certainly our own beliefs and assumptions, but really being prudent in how we're purchasing into newness to preserve some working capital flexibility, that will result in a bit higher normalized backlog going forward and kind of what we've seen over the last few years. The second piece that's driving a higher normalized backlog number is as we think about showroom cadence and just the number of showrooms that we're opening, In years, we're opening a high number of showrooms that are often heavier weighted towards the back half and even in the fourth quarter. As we talked about earlier, we have five showrooms opening in the next eight weeks. That will also result in just a higher carry forward of normalized backlog as we exit this year. So as you think about the timing between when demand is recognized in showrooms versus when deliveries occur and are rolling through net revenue, that's certainly a component. And then the last piece that I would call out from a normalized backlog perspective is just there's a higher volume of clients today that are engaging in home-related projects. And whether it's a light refresh of paint, flooring, whether it's more robust renovations, there's a higher number of clients who are engaged in those. So there's a client timing preference that is also resulting in a higher normalized backlog. So again, we entered this year anticipating that there was about $100 million of abnormal backlog. The majority of that is still abnormal, but we would expect to deliver that product by the end of the year. And then, you know, the component that is just normalized backlog will roll into next year. And then, you know, as we think about next year's revenue, that will also have a higher normalized backlog number, which would then roll into 2025. So we feel really good in general about client lead times and getting product to clients in their homes when they'd like it. But the backlog number is going to be a little bit higher than perhaps what it was in 2019 and prior.
spk07: Maybe just a follow-up for either you or John. A lot of focus around growth retail as it pertains to predictability around year one sales and margins. So I was curious if you can maybe remind us or inform us how the 2023 class of stores is performing relative to those performer targets for sales and margins and how you're thinking about the 2024 class as it pertains to those sort of performance productivity targets as well?
spk09: Yeah, sure, Steve. I can take that. To answer your question, the new stores, we are very, very happy with. They've been performing well at or above our expectations, and we certainly see the new stores that are coming on board here shortly to do the same. You know, a lot of them are in big, big markets, where we think we will capitalize a lot of business. Others are in more mid-sized markets that, you know, we always find we do very well, we're very profitable in. And, yeah, we're happy with the whole group. Thank you. You're welcome.
spk02: Thank you. Our next question comes from the line of Seth Sigmund with Barclays. Please proceed with your question.
spk11: Hey, good morning, everyone. My first question was really around pricing. Last quarter, you talked about a mid-single-digit average price decrease. I think there were some temporary factors in there. There were other changes that would potentially continue. I'm just curious, how did that play out? How is that playing out? What's your view on pricing from here? Thank you.
spk09: Yeah, I can take that. Good morning, Seth. Yeah, I think, as Don mentioned, Before, with the container pricing and so forth and all this inventory we had at higher cost, we kind of whittled that down to a point where we thought we could be a little more aggressive with some of our pricing. And it wasn't certainly across the board by any means. It was just on some selected pieces. But as we did that, we're happy with the performance. We've seen sales go up on certain collections, and we think we're at a perfect spot right now to be very, very competitive and hit our margin plans.
spk11: Okay. Just to follow up on that point, is your sense that others in the industry have also taken steps to refine pricing or lower pricing on the back of those lower costs? And then my follow-up question is around the gross margin, just trying to understand some pressures this quarter related to those pricing actions. How do you think about that going forward? Are you kind of through that already and You could start to see more of those freight savings come through. How should we think about that? Thanks.
spk08: Good morning, Seth. So, you know, as we think about the gross margin pressures from the third quarter, When we were talking in the second quarter, we had said we felt like the freight benefits that are flowing through would offset some of these price reductions. And there's a couple of things that caused that not to be exactly as anticipated. So, you know, the primary reason is that the mix shift, the product mix shift really skewed a bit more towards these price action skews versus what we originally anticipated. So we saw that those items were really resonating with clients at these price points. So great news is that we are clearing through the product a bit faster than anticipated that we wanted to. The bad news is that there is a little bit of gross margin compression related to that that was unanticipated at the time. And I think as we're thinking go forward, keep in mind if demand is written, and we had great demand in the third quarter, that takes some time to flow through the P&L and to be delivered. So I would expect some margin impact from these pieces over the next few quarters as product is being delivered. And then keeping in mind that we're not through all of the inventory that we would like to be through. So, you know, demand will continue selling. Um, a lot of these products that we took price actions on, they are, they were receipted at those higher freight costs. Um, And then just keep in mind that all of this is factored into the guide already. So just an added piece there. And then from the market perspective, we closely track and monitor competitors and what they're doing. We still believe that our value proposition is excellent and industry leading. So we really remain focused on that and making sure that our value proposition is where we want it to be. So we're comfortable at the moment with how we're positioned in the market.
spk11: Okay, great. Thank you both.
spk02: Thank you. Our next question comes from the line of Max Recklingo with TD Cowen. Please proceed with your question.
spk05: Great. Thanks a lot. So first, can you frame how much of the strong demand in 3Q came from new products versus the core versus some of the end-of-life or other products that you took price actions on?
spk08: Morning, Max. You know, we don't want to get that granular. I think what's important to note is that we have a good handle on the inventory with regards to price action SKUs. Clients responded to it a little bit faster than anticipated. We did have a phenomenal September with our marketing campaigns that really resonated with clients. So, you know, overall, we're pleased with the demand that we saw, and everything, you know, all the different components that you're asking about is factored into the guide for the fourth quarter, certainly, and then as we move forward and report and guide to 2024, it will be factored in as well. But, Jen, do you have any context you'd like to add on the marketing campaign?
spk01: Yeah, good morning, Max. Yeah, just to sort of emphasize the point that Dawn just made, we were really, really pleased with the results of our fall campaign. So our fall catalog and collection launch hit at the end of August and just saw incredible consumer response to that, both in terms of engagement and driving traffic into stores and onto the site to purchase those new products. We're also continuing to see really, really strong engagement with our ongoing collections that weren't part of the price action process, our top sellers there. As you may remember, we launched our Rooted campaign in early August of Q3, which was telling the story of one of our incredible vendor partners down in Mexico, one of our top collections that really has been performing well with clients for a couple of years now, and being able to share that additional knowledge and detail and storytelling about what makes that truly special really resonated with the business. So, you know, we're really, really happy and really happy with the client health we're seeing across both new and existing clients reacting to both those price action skews, but also excitingly for all the new products and the product that wasn't included in that category.
spk09: Yeah, and Max, I'll just add something to that as well on the product side. The current product, you know, existing product that we've had is doing great. You know, we're not seeing a slowdown on most, if any, of the current product that we've had, you know, that we've had for a while. And then on top of that, the new product has just been a home run as well. So, you know, we're happy with the whole mix of products. We think we're certainly kind of leading edge on the design side, and people are really resonating with it. But our core products are doing well. You know, over the last four years, we're up 99%. Yeah. So you can see if you do the math on that, that, you know, people like our product in the last two years, we're up almost 28%. So it's, um, it's been a nice, um, a nice ride here and we think we're hitting on all cylinders.
spk05: Got it. That's very helpful. And just sticking with that last point that you made. So you're meaningfully out copying peers and taking significant market share. What is your sense of how your awareness levels are now trending? And do you feel that you're starting to move in the right direction? And then ultimately, over the medium term, where do you think that that can go as I think you used to do surveys where you were still meaningfully behind, Peters?
spk01: Yeah, Max, great question. The simple answer is yes. We definitely think our brand awareness is growing. I think there are a number of factors driving that. First and foremost are the new showrooms that we've been opening this year and are going to be continuing to open aggressively into next year. As I mentioned before, new showrooms and showrooms in general are the number one way that people new clients are discovering our house as a brand. So as the teams are really focused on opening up these incredible spaces in new markets and filling out existing markets, we're really pleased with what that's doing to increase awareness. In addition to that, building off of what John was just saying about people like our product, they're really responding to it. Our teams have really been focused on all aspects of service, on quality, on making sure that clients continue to have that incredible experience. And the number two way that new clients are discovering our house is through recommendations from friends and family. So that is incredibly important to us. It's something we're really proud of. We really work very hard to maintain It's one of the reasons we are putting so much effort into the storytelling and into being able to showcase how special our product truly is and really focused on ensuring that clients are happy so that then they're sharing their love for the brand with their friends and neighbors and families for years to come. In addition to that, I think... We've been doing a lot of things right for the last few years and for the decades before that. We had an incredible brand awareness opportunity four years ago. We continue to have an incredible brand awareness opportunity now. We're making really good progress towards that, but there's a very long runway for us to continue to do that. As we continue to open up new showrooms, we continue to get better at telling our stories We continue to get better at creating that really omni-channel experience. We know our showrooms are the best showrooms out there. Our teams are incredible, and we've been working really hard to bring that same experience and emotional connection to life online through OurHouse.com, through digital advertising, through social media, and all of those channels. And we think we've done a really great job at that over the last few years, but we have so much more to come. I'm really excited about what the team's working on and how we can continue to build that. So short answer is yes, brand awareness is growing, but huge potential for that to continue to grow in the future.
spk05: Great. Thanks a lot. Best regards.
spk01: Thank you.
spk02: Thank you. Our next question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question.
spk15: Hey, guys. This is Jackie Sussman for Simeon. Thanks so much for taking our question. I guess first, you know, the demand comp has been very healthy the past couple quarters, you know, despite a negative low single-digit actual comp. I guess at what point will demand comp translate into positive actual comp And I guess, you know, along those lines, you know, is the outbound capacity issue getting incrementally better or anything like that? Thank you.
spk08: Morning, Jackie. So, you know, we talked last quarter about the outbound capacity, and, you know, in particular around Dallas and how Dallas was a bit less productive than what we had originally planned by this point in time. The good news is that over the past several months, we've made some system changes that have really alleviated any kind of delivery constraints that we have. with regards to Dallas. Now, it doesn't mean that Dallas is as productive as what we would expect at this point in time, but it does mean that Ohio and North Carolina are compensating based off of some systemic and inventory allocation components that we're still working through. So that's the good news there. With regards to the comp, keep in mind that the base for the demand comp and the base for the comp coming out of 2022 are very different. So if you remember, we pushed through a significant amount of the backlog, the abnormal backlog last year, which was about $150 million. That was all pretty much driven in the second half. So keep in mind that that baseline is just going to skew the numbers from a math perspective. But we feel really good about our demand, how our product is resonating, our marketing touch points. So, you know, some of this noise and the numbers will shake out as we, you know, normalize and kind of lap the normalized backlog number next year.
spk15: Got it. Thanks so much. And if I can squeeze in one more, just on SG&A, I think that came in a lot better than at least what the market was expecting. I guess, you know, Is there, you know, any way, did you adjust anything on the SG&A line intra-quarter based on what you were seeing in the environment or were there kind of broader cost reduction efforts done, you know, independently of what you were seeing in the quarter for this quarter?
spk08: You know, we're constantly evaluating our cost structure and, you know, it could be anything from timing of new hires to systems deployment changes just based off of operations and how things are flowing, not necessarily to drive to a specific cost number, but we're a dynamic business. Things are changing and can be fluid. I still feel good about the expenses that we have in place. Some of the systems initiatives will shift just based off of changes in the business, which then accordingly changes how that flows through the P&L from a timing perspective. In general, we haven't made any significant SG&A shifts relative to what we would have anticipated last quarter or the quarter prior. Great. Thanks so much. You're welcome.
spk02: Thank you. Our next question comes from the line of Peter Benedict with Baird. Please proceed with your question.
spk12: Good morning, everybody. First question is on gross margin and kind of some of the commentary as we look forward. You mentioned the response to the price action items. You've obviously got a lot of stores opening, so the fixed occupancy costs are going to be going up. I'm just curious, that third quarter level of 40%, is that kind of a new kind of baseline that we should be thinking about as we look at over the next few quarters? That's my first question.
spk08: Yeah, so, you know, good morning, Peter. We don't guide to gross margin. I think there's a, you know, there's a lot of things happening in that margin line item, you know, first being the product cost related to the price action SKUs that were receipted at the higher container cost. You know, that'll take a few quarters to kind of work through to get the inventory where we want it to be before we then take any additional price action. You know, delivery costs, I think, is something that we are actively really investing into. So as we think about the in-home delivery experience, that's really our last touchpoint with the client on any particular order. And we want to make sure that that experience is really seamless and beautiful as we're entering their home. So accordingly, we've hired an SVP of Final Mile. She joined us about six months ago, and she has some really great experience ideas and ways to invest that we think will really elevate the client experience. So we're pleased with kind of the results that we're seeing to date on that from a client experience perspective. And, you know, we will continue to invest in that side of the business over the next, you know, several quarters. And then, of course, the showroom rents as we are opening new showrooms. John mentioned earlier that we have a pretty exciting slate for next year as well. So just keeping in mind that those expenses start to roll in up to 12 months prior to any top-line benefit. You know, it's a little bit of a moving target as you think about the showrooms that are opening today with all those expenses. A lot of them are in California, and so those are heavier rent expenses, and we will start to see some nice top line come in on those over the next several quarters. But then we do have additional showrooms next year that we'll be rolling in. So, you know, so I guess those are just some of the kind of puts and takes that I would encourage you to think about.
spk12: Okay, thank you. And then just a question on kind of CapEx and cash. The CapEx plan for the year was taken down a little bit, just I'm not sure what was driving that. Maybe you could help us understand that. And then you're kind of the end of this quarter, probably over 20% of your market cap is in cash. Good position to be in. But just curious, is there a point in time where you kind of look at the cash balance and say, hey, there's something we want to do with this? Or just curious your thoughts on that front. Thank you.
spk08: Sure. So, you know, CapEx reductions are really just timing related. So, as we think about showrooms opening, showroom spend, and the timing of which is we're working through when we take possession of 2024 locations and when we start spending on those. So, it's really just timing. There's no change in strategy. So, as we look out to next year, you know, it's just a flow between years. And then with regards to the cash balance, you know, we are focused on reinvesting back into the business for growth. We have a ton of white face opportunity. We have a lot of opportunity beyond showroom expansion as well. John mentioned the trade program, which we're looking at. at how we can really kind of dig in there and build that business and grow that opportunity. So, you know, I would say more to come on that, but we internally are having a lot of discussions on what is the best use of that capital to drive a nice return for the organization.
spk12: Great. Thanks so much. Good luck.
spk08: Thank you.
spk02: Thank you. Our next question comes from the line of Jeremy Hamblin with Craig Hallam. Please proceed with your question.
spk10: Thanks, and congrats on the strong momentum in the business. So I want to come back here to performance in the quarter. And your e-commerce business was up 26% versus the retail side of the business, down 2.7. Just in terms of thinking about the pricing actions and that interplay between e-comm and your retail store channel, is that a reflection of the pricing actions being maybe more powerful on the digital side of your business? I wanted to just understand, you saw a pretty significant reacceleration here in Q3 in that channel of business specifically.
spk08: Morning, Jeremy. So I would encourage you to remember that what's reported from a channel perspective in the queue is really based off of delivered. So less about kind of the underlying demand trends in the organization and really more around just timing of deliveries. But with that being said, certainly some of your commentary is valid. So I'll pass it over to Jen and she can talk about the e-comm drivers.
spk01: Yeah, good morning, Jeremy. Yeah, I mean, we're really, really pleased with e-commerce. We've seen strong traffic, strong conversion, strong engagement, strong sales, to your point. We definitely do see our clients respond to and react to price actions digitally. You know, if they find them, they come in. We also spoke on our last call about the team really focusing on how we are merchandising and displaying pricing actions and sale products on our site. So we're really pleased with the reaction and engagement there. So definitely seeing a response there. I do think that that is somewhat... stronger on e-comm and digital channels than in retail just because it's more prevalent. It's easy for that consumer to find their way to the sales section and see all that product and shop it directly. Having said that though, we are incredibly happy with how clients are responding to our full price product on eCom as well. We're seeing really great engagement with that product. We're seeing really great sales in that product on our eCom channel. We also know that the majority of our clients who are ultimately making purchases in our retail showrooms are starting their journey or at some point continuing their journey on eCommerce as well. So from where we're looking at, we're seeing a really healthy growth about eCommerce business. It's been really strong all year. We're happy with the Q3 performance. And, you know, one of the things we've talked about for the last couple of years is growing e-comm not only as a sales channel, but also as that omnichannel presence to uplift our total company business has been a real focus since the relaunch of our site about two years ago now. And the teams continue to look at that. But overall, we're really happy and we're going to continue to focus on building that channel out going forward.
spk08: And I would just add to that that even with the price action that we've taken in mid-June, we have seen really nice lifts in AOV. So I think that also kind of lends to the strength of our newness and kind of core business that was not price action.
spk09: And just one last thing on e-com is as we open these new stores and new clients find us, we see in those areas our e-com business go way up as well. So the new store and renovation stores and so forth really helps drive the e-com business as well because people come in the stores, they sit on things, and they go home and order it online. And that goes both ways. We know people that have come in the stores have already been on the web and study our product and so forth. So it really works in conjunction, and we're very happy with the performance of both the stores and the e-com business.
spk10: Great. And then just a clarifying question here, you know, still significant noise around backlog. So I think prior commentary had indicated that kind of excess backlog delivered in Q4 of last year was about $40 million. And so if we look at the midpoint of your guide here for Q4 331 versus, you know, kind of 316 last year adjusted for that excess backlog delivered, In terms of that upside, and obviously if you have positive written order growth, are we kind of apples to apples? Are you kind of implying that the business would be positive X the normalization of backlog or however you prefer to characterize it?
spk08: So I think one point of clarification is that last year we had about $150 million of abnormal backlog in the second half of the year. The $40 million is not the only backlog that was in the fourth quarter. That was the portion of the abnormal backlog that we hadn't anticipated, that flowed through a little bit quicker than anticipated due to Dallas opening so strong. So I think, you know, keeping in mind that of the, you know, 150 million, 40 was expected in 2023, but pulled into 22. The balance of 110 million of backlog would spread over, you know, Q3 and Q4. So just a clarification point there, which I know backlog has been a bit confusing to folks. So hopefully that's a little bit helpful. You know, if we think about this year, we will still have some abnormal backlog deliveries in the fourth quarter of this year. So I think a little bit of noise in 2023 from backlog against a little bit of noise in 2022 of backlog. I think, you know, great news is that we'll be through it all by the end of this year. And then in 2024, we can, you know, have a clean slate and really continue really just be back to a normal business cadence. So we feel good about that. But hopefully, did that answer your question? Is there more I can elaborate on?
spk10: No, I think by the end of the year, you know, it sounds like it will be cleared through the abnormal backlog.
spk08: Thank you. Yes. Thank you.
spk02: Thank you. Our next question comes from the line of Jonathan Matuszewski with Jefferies. Please proceed with your question.
spk04: Great. Good morning, and thanks for taking my question. First one was just on the demand comp guide. Just curious if you could give us a justification for that, you know, coming off of the strong 12% demand comp in 3Q. Curious whether kind of that low single digit is reflective of what you're seeing in October. or just conservatism in anticipation of slowing in November and December. Thanks.
spk08: Morning, Jonathan. So, you know, we're really pleased, of course, with the third quarter demand comp. We're very pleased with what we saw in October, which was above the low single digit that we're guiding to for the fourth quarter. You know, as we think about November and December, in November of last year, we had some promotions that we will not be comping this year. So as we think about the price actions that we've taken in June and just overall overall portfolio, you know, we're being a little bit strategic in the promotional cadence for November. So keeping that in mind, along with just general macro uncertainty around the consumer, which I guess persists for a several years now. Um, but you know, just, just kind of being conservative in our view of what may happen in the fourth quarter. Um, that being said, you know, our product continues to resonate. The marketing continues to resonate. So pleased with, with what we're seeing. Um, I would also just remind everyone that we are not a holiday driven business from a demand perspective. While we do have a holiday assortment, um, that's not a significant driver of our business. And, um, you know, most folks aren't purchasing, um, sofas or desks as, as holiday gifts. So, um, Just a little added context there.
spk04: That's helpful. And my follow-up question is on the potential for membership. Some of your competitors offer this. You could argue the backdrop to the consumer and housing in 24 would maybe not be ideal for launching that. But on the other hand, your brand is clearly on fire. So would you say you're more or less likely to pursue membership than you were a couple of months ago? And if you are more seriously contemplating it, what would be the aspects that attract you to that? Thanks.
spk08: Thank you, Jonathan. So we have a lot of active debate over our pricing strategy internally and have for several years now. The question is, what is the right time to deploy a new pricing model? And membership model is one of a few of them that we're discussing and looking into. But we, you know, until we have a better handle on when we would want to deploy a new pricing strategy, I think we're going to kind of keep that a little bit close to the vest at the moment. So I absolutely agree that, you know, we are actively engaged in what a pricing model and what our pricing strategy should be, but nothing to note at this point in time for you.
spk04: Great. Thanks so much.
spk02: Thank you. Our next question comes from the line of Christina Fernandez with Telsey Advisory Group. Please proceed with your question.
spk14: Hi, good morning. Jonna, on your comments, you talked about a couple of initiatives for next year. I think there were new process for delivery, the trade business, interior designers. So I wanted to see if you could expand on sort of, you know, exactly what, you know, what are your thoughts on being able to grow those businesses and what are you going to do differently?
spk09: Sure. Good morning. Yeah, as I mentioned, the trade business is one we're focusing on. We've seen some really nice growth in that business in the last couple of years. And so it's one that we think there's a lot of white space there. You know, these are outside trade members who basically have their own businesses. And we're finding, you know, if they can come to us and do kind of a one-stop shop We give them the service they need. They're really responding well. So we think that's a great business. Our own interior designers, as we added or started that program, I don't know, four years ago or so, we continue to grow it. We continue to add more interior designers to stores because they just can't keep up with the demand. So we're seeing some really nice growth there, and we're focusing on that as well. Certainly, as we mentioned, we're opening more new stores and renovating more stores than ever in the history of the company. So that, you know, we see driving our business as well, big time, is when we open a new store or we renovate or move, you know, an existing store with the old design model to the new design model, we see a great lift in sales on those as well. So those are kind of the three things we're focusing on, not to mention the, you know, the furniture, the product, which is what we're all about. We have great products. We execute right. If we show it off right, our business continues to grow. We've got an incredible design team as well as product team, sourcing team that continues to come up with new product and product that really resonates with our clients. Really, when you think about it, that's why we're in business. You buy People buy furniture from us and we deliver it to them and we make their homes a much better place than they were. And so every day we focus on the product as well.
spk14: On the product side, any categories that you're looking to expand in 2024, whether it's outdoor or any others you want to call out?
spk09: Um, yeah, we're working, we're looking across all the categories. As you mentioned, outdoor is one that we had focused on during COVID and we continue to grow it. And, um, the growth on it's been really, we've been very happy with it. Um, with that, you know, we kind of look at each room in the house and say, how can we grow the dining business? How can we grow the living room, you know, great room business. And, um, A lot of it is finding really great products and then expanding on the skews of those products to fit everybody's needs because everybody's room is a different size, a different shape, different configuration. So if we have a coffee table in one size or we carry it in five sizes, we see a nice lift in the product as we expand out product that people love. And we generally start rather conservative And then we see it's working, then we'll jump on it and, you know, catch up to carry it in many different sizes and SKUs and even finishes and so forth. So that's a great way to grow the business as well.
spk14: And then one last question. I wanted to see if you can talk about the company's kind of broader sustainability initiative. Should we think about the donation to the Nature Conservative? you just did it one time, or is this going to be a recurring program and next year we could see, you know, other donations, whether it's to the same organization or others?
spk09: Yeah, we've had a lot of debate on that. And as you guys all know, our world is burning up. And, you know, we feel compelled to help if we can. With that said, we don't have any plans right now for 2024. To repeat what we did. It was kind of a one time opportunity that that we really didn't want to pass up and but we're always keeping our eyes open. But right now I think in the plan and the budget that gone publishing here soon internally. We don't have that in the plan.
spk02: Thank you. Thank you. Our next question comes from the line of Peter Keith with Piper Sandler. Please proceed with your question.
spk03: Hey, good morning, everyone. Nice results here. I wanted to just kind of reflect back on your strategy around Labor Day weekend where I think you extended the number of days around your advertising. And industry-wide, we do continue to hear about these peaks and valleys of holiday weekends being bigger and the troughs being lower. How should we think about your success for Labor Day weekend? And then carrying that forward, do you see more opportunity to extend, I guess, your visibility in advertising on upcoming holiday weekends?
spk01: Good morning, Peter. Good question. As you mentioned, that heightened promotional environment is still out there. The lengthening of times around those key selling weekends, we continue to see that happening. We are pleased with the results of Labor Day. As we spoke about on our last few calls, we do have that subset of our client who is very promotionally driven. In the growth stage, we want to be part of that consideration set, so we're really happy just lengthening the time of the marketing of that promotion for Labor Day. Looking forward to November and December, as Dawn mentioned earlier, we're not expecting to accelerate our promos over last year in any way. we do anticipate, similarly to last year, that the Black Friday promo is being pulled forward earlier, earlier in November. If you look out in the industry, we're seeing brands start their Black Friday promos in October of this year, so it's definitely happening there. So I think you can expect to see that earlier conversation about promo around the Black Friday weekend, similar to what we did last year. But we are not expecting to accelerate our promotions and are actually decreasing a little bit from what we did last year.
spk03: Okay, thank you. I guess my second question would be to Dawn. And Dawn, I know you're not a company that guides quarterly, but we came back into an implied Q4 guide. You've even detailed that in the press release. So the heart of my question is just the margin decline in Q4. It seems like it's going to get worse in Q4 than it was in Q3, and that's without the $10 million charitable donation. The demand trends are great, but there's just a lot of noise in your margins right now. So I was wondering if you could just maybe just take a step back for everyone and help to highlight the brushstrokes of what's pressuring margin. And is the margin decline in Q4 – ideally sort of the trough with the declines. And as we get through some of these timing dynamics, that the margin decline should be less meaningful in the quarters to come for 24.
spk08: Yeah, good morning, Peter. So, you know, keep in mind that from a margin rate perspective, last year has significant impact and we saw some really nice leverage on the backlog delivery. So, you know, artificially inflated just from a timing perspective when we're looking at the comparative. As we look forward over the next several quarters, years, and think about what's going to be impacting the business, in the near term, certainly the price actions in June that we took, those will continue to have an impact as we're right-sizing the inventory and kind of clearing through the end-of-life inventory. Showroom occupancy certainly will continue to persist as we think about the strong opening cadence that we have for next year that we're really excited about, which will have long term. It's the right thing for the business to do, and it will have benefit. It's just timing related there as well. And then, you know, we've always said that we expect margin expansion, but it may not be entirely linear for us. So as we think about all of the areas of the business that we're reinvesting back into, you know, we're really taking our time to make sure that as we're scaling the organization from a billion to two billion and beyond that. we can grow it more efficiently. In the near term, that does cause some compression. We talked a little bit about the in-home delivery experience and how we're trying to elevate that. Over time, that's going to have great results great impact on the business as you think about just the word of mouth, that brand awareness component. You know, as we think about within SG&A, as we think about the investments that we're making in the business to really drive the back office, which you know, often isn't as exciting to talk about as product and showrooms, but it's very important to us. So, you know, as we're thinking about our warehouse management system that deployed in our North Carolina facility this year, as we're looking to deploy that in first quarter next year in our Ohio facility, you know, there's always, anytime we deploy a system like that, there, there will be a little bit of noise in the top line and, As you think about for a warehouse management system, you have to close the facility for a few days to do the inventory conversion and just some of the systemic components. We're also working on our planning software, which is going to be vastly critical for us as we think about inventory allocation. and making sure that we can have drive efficiencies in line haul expense and moving product, very heavy, very bulky, very large product through the network. We're also in the process of deploying our manufacturing ERP, which is going to be really critical to give us great visibility to our operations there. from a bill of materials perspective, from just a process perspective. So lots of really great things, but in the near term, these will compress margins. We do expect expansion longer term, though, and we're really excited as we continue to grow that top line, what that's going to look like from a financial perspective. But we're trying to give ourselves a little bit of breathing room to do the right things for the organization, the right things for the client. And long term, it's going to be, I think, really great for the organization as a whole.
spk03: Okay. Just to round that out, I appreciate all the growth investments, but you did mention two big timing dynamics with backlog and you get five new stores coming in. So again, is Q4 potentially the worst of the year-on-year declines to the best of your visibility on sales trends?
spk08: You know, we haven't guided to anything for 2024 yet, so I don't want to kind of get out over my skis there. But, you know, certainly the math would indicate that the year-over-year component would be quite significant in the fourth quarter. Yes.
spk03: Okay. All right. Sounds good. Thanks, guys.
spk08: Thanks, Peter.
spk02: Thank you. Our next question comes from the line of Philip Lee with William Blair. Please proceed with your question.
spk06: Hi, everyone. Thank you. Given the big year ahead for new showrooms and refreshes, can you maybe speak a bit about the changes you've made to them over the past several years that have had a direct benefit on productivity versus pre-pandemic levels, maybe from a physical location but also inside experience? And then should we expect rent per square foot to continue to accelerate quite a bit on these higher-profile locations being opened? Thank you.
spk09: Sure. I can talk about the renovations and how it's working. Yeah, four years ago, we had dramatically changed the looks of our stores. It made them a lot more user-friendly. Just a lot more emotionally driven with that when folks walk in they they love all the you know furnishings the way we're designed things we put in design studios we put in. fireplace rooms things that just just warm up the warm up the store quite a bit so as we as we've been doing that you know, as I think we mentioned as leases come up. We will decide, do we want to keep the store and renovate it, we want to move the store. In either case, normally we will renovate a store when a lease comes up if we do decide to keep it. If not, we'll move it. But we see an impact in not only customer sales, but also our clients tending to come back again and again and hop on the web and order more. So it's been a nice, nice change. I think we have a lot of product a lot of renovations and moves coming up this past year and a lot more, I believe, in 24. So it's a very good thing. And it just elevates our brand to a point where, you know, the product just looks better. And when it looks better, you know, the clients tend to buy it. So it really sets us apart from the competition as well. You know, we think the way our stores look is really, really enticing, and we hear it all the time. And certainly new stores, when people walk into them, they're kind of blown away because they've never seen anything like it. And we'll hear that for truly years to come in all our stores as new clients come into them. So it's been a very, very good thing.
spk08: And just from a kind of tax bill perspective – In our filings, we do not break out showroom rent versus other leases. So that rent number, that lease number that you're seeing in there is for everything from computers to rent to distribution center. So keep that in mind. Now, from a just kind of operational standpoint, strategic perspective. We are opening showrooms that are a bit more expensive from a rent perspective. We do believe that those showrooms will have a higher top line, though. So, you know, we're looking at the opportunities very holistically from an investment perspective.
spk06: Okay, great. And then one quick follow-up. Can you provide maybe a bit more color on inventory? We saw declines this quarter. How should we think about the go-forward rate balancing new showrooms and new products versus cycling through some of the higher-cost price action SKUs? Thank you.
spk08: Yeah, so we continue to work through the inventory assortment. I think we feel good about how we're handling newness. We feel good about the core assortment, our best sellers. We do still have a little bit, pockets of inventory were a bit long. Still continuing to work through the inventory that over the last two years we haven't really focused on from an end-of-life perspective, so continuing to work through that to get the inventory levels right-sized to where we'd like them to be. We have a new kind of, you know, we're continuing to refine our planning organization and our planning processes. And honestly, the strategic viewpoint at which we take the, you know, an inventory approach. So more to come on that, I think, is we also are working to deploy the demand forecasting software with regards to planning and certainly allocation software with planning. But overall, we feel pretty good about our inventory, recognizing we do have some pockets that we're still trying to clear through. So... So, yeah.
spk06: Great. Thank you.
spk02: Thank you. Thank you. Our final question comes from the line of Vicky Liu with Bank of America. Please proceed with your question.
spk13: Good morning. Thank you for taking my questions. This is Vicky on for Jason Haas. The first question is related to the cadence through the third quarter. So given the strong marketing campaign, did you see an acceleration through the third quarter?
spk08: Are you referencing an acceleration of demand through the month of the third quarter? Is that the question? Yes. You know, so we try not to parse it out too much, certainly, because we know that one quarter does not make a month. And we do feel very strongly and invest deeply into our marketing campaigns and are pleased with how those performed. I mean, a lot of those catalogs went out in the end of August. But, yeah, I mean, I think overall we're just pleased with the consumer response to the product.
spk13: yeah yeah thank you that's helpful um and then as we think about the showroom openings for next year um i know you have great pipelines coming up how should we think about like the selling expense um per store and how does it compare to this year um you know as we as we're
spk08: Looking out towards those, we're still refining the timelines. We certainly have a timeline today, but we know that showrooms can shift within the year, which then can have an impact both as we look higher and stuff up those locations. But I would say typically, just looking at the cadence here, it's not that dissimilar from 2023.
spk13: Okay, yeah, thank you.
spk09: Thank you.
spk02: Thank you. We've reached the end of our question and answer session, and I would now like to turn the floor back over to Wendy Watson for closing comments.
spk16: Thanks, everybody, for joining us today, and we look forward to talking to you again next quarter.
spk09: Thanks, everybody. Have a great day.
spk02: This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation.
Disclaimer

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