Arhaus, Inc.

Good morning and welcome to the R House fourth quarter and full year 2023 earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow formal remarks. Please note that this call is being recorded and the reproduction of any part of this call is not permitted without written authorization from the company. I will now turn the call over to your host, Wendy Watson, Senior Vice President of Investor Relations. Please go ahead.

Good morning, and thank you for joining our house 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 from Italy, and Don 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 31st, 2023 before market opened today. Yesterday, after market closed, We filed an 8K to inform investors that we identified an error in our unaudited condensed 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 nine months ended September 30th, 2023. As such, we will restate our financial statements for the third quarter of 2023 and revise the December 31st, 2022 comparative balance sheet that will be included in the amended third quarter 10-Q. For more details, please refer to the 8K. These documents are available on our investor relations website at ir.ourhouse.com. As a reminder, remarks today concerning future expectations, events, objectives, strategies, trends, or results constitute forward-looking statements. Actual results or events may differ materially due to a number of risks and uncertainties. For a summary of these risk factors and additional information, please refer to this morning's press release and the cautionary statements and risk factors described in our most recent annual report on Form 10-K and subsequent 10-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. 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 EVA of $51 million, and are very pleased to have exceeded our top and bottom line outlook for the quarter. According to our 2023 performance, it was another exceptional year for our house, 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 above the 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 50 cents per share, table on or about April 4th of 2024, to shareholders of record at the close of business on March 21st, 2024. We are very pleased to be able to return value to our shareholders while retaining the balance sheet's strength that will allow us to continue investing in the Our House growth. Don 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 the short time since we went public on November 4th 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 9 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 three times that of the industry. We've increased our net revenue by 154%, or $780 million today. 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 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 Our House 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 on ourhouse.com to judge for yourself. During 2023, we also continue to make some important growth investments to enhance our omnichannel capabilities and technology. We are growing our insights from web site 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 our house 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 Story 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 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 R-House 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 Don 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's no potential like our potential. Our house stands out. And our house 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, 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 are 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 dedicated dedication to our house 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 growth 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 actioned 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 skews. 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's 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 with $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, even with this special dividend, 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 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 entered 2024 with a normalized backlog, our comp growth metric will not normalize until 2025. For the full year 2024, we expect net revenue 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. De-leverage 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 de-leverage to come from SG&A with a lesser amount of de-leverage and gross margin. We expect to invest approximately $10 to $15 million in corporate strategic investments this year as we work to streamline operations 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 income of $1 million to $3 million, and adjusted EBITDA 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 the 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 costs on the revenue decline and continued delivery of price action skews. 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 the P&L impact from the June 2023 price action product is complete and revenue and earnings from new showrooms 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 our press release. We are also reiterating our long-term growth goals. We expect the investments we are 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 on our growth plan and make the necessary investments to build on our share gains in the highly fragmented $100 billion premium home furniture market. 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.

Thank you. Ladies and gentlemen, we will now be conducting a question and answer session. If you would like to ask a question, please press star and 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star and 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 star keys. Ladies and gentlemen, we will wait for a moment while we poll for questions. Our first question is from Peter Keith with Piper Sandler. Please go ahead.

Hi, thanks. Good morning everyone. Great results. I want to ask about the system rollouts which are interesting. 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. John'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. Don, do you have anything to add to that?

Yeah, good morning, Peter. I think in the fourth quarter of last year, we deliberately 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, you know, making sure the product is – is coming from where it needs to be. So, you know, I think overall, you know, we're taking a very thoughtful, prudent, responsible approach, I would say, to systems enhancements and infrastructure changes. But we'll certainly, you know, we're laser focused on the operational impact as well.

Okay. Thank you. And then I just paid Don 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?

You know, we think it's probably about a week worth. So, you know, simple math, you could kind of just take what a typical, you know, typical quarter looks like and divide by the number of weeks in the quarter. That being said, you know, we also did see some impact on deliveries in January related to weather. So, if you think about those drivers who are out there, if there's really icy conditions or snowy conditions that are particularly difficult to you know, at times they will delay those deliveries. So, you know, 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, you know, we think that as we move through the year, we should see a sequential acceleration in the deliveries and net revenue as we move through the year.

Very good. Thank you so much.

Thanks, Peter.

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

Good morning and nice results. Thanks for taking my questions.

First one is just on underlying assumptions for your 2024 comp guide of down four to down two. 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. Thanks.

Go ahead, John.

Morning, Jonathan. Yeah, so, you know, 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, you know, a light refresh could be something as simple as painting a room. So, you know, we think there's still plenty of that happening. You know, I think we also, if you think about our market share of just the total $100 billion industry, we have a ton of runway. You know, we're less than, you know, 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 expand 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. You know, 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 our house in a similar way to more people, but also new ways that we're presenting our house out to the audiences. So as John mentioned, we kicked off our storied 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 our house 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. As John mentioned, we decided to start telling these stories because of questions and interest we were getting from current clients. Just seeing existing clients and also future potential clients really engage with them is really, really exciting. 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. Then I guess just to follow up. 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, you know, last year you called out at one point, you know, consumers choosing to postpone their orders and that kind of having an impact on when, you know, revenue may have been recognized or, I guess, postpone their receipt of deliveries. Are you still seeing that dynamic? Any color there would be helpful.

Yeah, I don't believe, I'm certain we have not seen any increase in cancellation rates, number one. They hold steady as they have been for the last quite a few years. So that's a 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, you know, obviously when people are renovating their homes, as we know, you know, people aren't moving as much as they had been, but people are, at least in our category, you know, renovating quite a bit. And most builders in that have caught up, at least, you know, telling the clients of 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.

Thank you.

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

Oh, hey, guys. Thank you. Thanks for taking the question. Good morning. 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. Don, you can help me with this one. But, you know, what we're seeing is, as we've been saying all along, you know, last year was strong demand 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, you know, we think people are responding. And, you know, as we've opened up so many new stores, every day we're getting more and more new clients coming in, finding out who we are because we're a 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, you know, 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, you know, 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. Don, do you want to add on to the other part of that? Sure.

Sure. So, you know, 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, you know, engagement within those locations. So, as we think about demand in the first quarter, you know, January was a bit soft. February accelerated nicely. So, you know, 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, you know, all of our offerings, how we're engaging with clients, and, you know, switching to think about net revenue, you 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, you know, 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. Thank you. And then just maybe on the turn to the sourcing side of things, you know, 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 uh, where your product is coming from. Um, and just any thoughts on, on all the activity, uh, the Red Sea and what that might be, uh, doing to your, uh, to your, uh, inbound rates on ocean freight.

Thank you. Yeah, we have, I mean, keep in mind almost, almost half of our product was made in the United States. Um, which, you know, we've always made our upholstery in the United States and, and, and some other products are being made here. So that takes almost half the business off the table. Um, The other strong parts, you know, where we're strong is in Mexico we buy a fair amount of product, and in Europe we buy a fair amount of product, especially in Italy. None of that is affected by the Red Sea at all. Some of the Asian things were, but we just have rerouted them. And 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 that. 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 IPO'd. 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. You know, 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, seeing a few, you know, week delay in certain containers, but we're managing that really well up front 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.

All right. That was super helpful. Thanks so much, guys. Good luck. Thank you.

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

Good morning. 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, um, you know, we were affected just, I mean, you guys heard the news. I mean, the news scared the hell out of it. Basically everybody in the country except California and Florida, I think. And, and frankly, so there was some, some nasty weather there. Um, once we got through the first two weeks, we actually saw, um, positive friends, um, 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 put together and 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, and fantastic price. So we think Updore is going to be strong this year.

Thanks for that. Maybe just a quick follow-up, right? Capital structure, extremely strong, balance sheet, free cash flow profile. You announced a special dividend, but maybe 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. And last year and also this year, going into 25 and beyond, you know, 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.

Thank you. You're welcome.

Thank you. Our next question is from Jeremy Hamlin with Craig Hallam Capital Group. Please go ahead.

Thanks. 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 or 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, Don. You know, so in term, are we thinking about that on a percentage basis or are we talking about, you know, still five to seven showrooms per year, FY25 and beyond?

Go ahead, Don.

Thanks. Yeah. So, you know, I think on a, on a percentage basis makes sense in the near term, the five to seven feels like the right number adding on, you know, that's five to seven traditional with incremental design studios on top of that.

I see. Okay. That is that's helpful. And then in terms of just looking at your gross margin profile, I think you'd 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 like kind of a solid step up in your gross margin profile as well as we get into the out years?

We don't typically guide to gross margin, and we 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 costs. 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, you know, 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, you know, You know, 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're really, you know, we would expect to see leverage over time, over, you know, 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 and then in the first half of 24, just from kind of the pricing actions and the impact on mix and gross margins.

Yeah, we haven't really disclosed from the P&L flow through because a bit of that is, you know, 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.

Great. Thanks for taking the questions. Best wishes.

Thank you. Thank you.

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

Great, thanks a lot. 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 that... 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. The economics, the sales should be stronger than, say, a store in Akron, Ohio, where we have a store. There's more people, more people with money. And our product really, really resonates on the West Coast. I mean, they're absolutely loving it. So, you know, we feel very, very confident about it. Don, I don't know if you have specific numbers or anything, but

Yeah, no, I mean, I don't think we'd want to disclose kind of geographically, but what John says certainly holds true. You know, you would expect, you know, 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, you know, we remain laser focused on the payback, which is, you know, under, you know, making sure that we have payback within two years. So feeling good about, you know, our overall strategy. And, you know, Dallas, opening up that Dallas distribution center really unlocked the West Coast for us. So excited to continue to develop that, you know, 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 products 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 that the team is as well. So, but we just, there's, you know, there's a couple of big platforms that we need to implement in order to really unlock it. So more to come, you know, in 2025, I would say on what the STEM savings could look like.

Great. Thanks a lot and best regards.

Thank you.

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

Hi. Good morning, everyone. Hey, John, I wanted to ask you about newness. 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 and where your product stands in terms of style and price point. I've, you know, I heard you made some price adjustments just thinking about where it sits. And I know you also said like, we're not a, you know, one, one design fits all. Can you talk about any specific trends even within your product assortment that's growing faster than, than others?

Um, sure. Yeah, I'd love to. Uh, yeah, I mean, I, like I said before, I think we're hitting, hitting on all cylinders on our products. Um, It's obviously the fun part of the business as consumers are looking for new looks, fresh looks for their homes. And, you know, 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. You know, woods have changed. They've warmed up a lot. They've gone away from the 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. And so, yeah, when we walk to our store and seeing our sales, the new product is really what's getting our clients excited. And so we continue to look at work on large collections that we're going to launch and quite a few more in 2024. Um, so as far as the new products as well, the margins are very strong on those. Um, you know, we're setting them where we want to be. I don't want to be, and I tell my, you know, buyers and so forth that let's not be greedy on margin. Um, let's get our margin where we can have a healthy business longterm and we're very profitable, but don't get so greedy that, um, you know, we're going to cut, cut half the clients out. So, um, You know, we think our prices, the way we buy things, direct from the manufacturers, you know, 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, you know, the best value, us getting our great margins, but not being totally greedy on them. And, you know, it works. And then customers are happy. They come back. They tell their friends. And our business keeps growing. So, yeah, the trends are great. You know, again, things have gotten softer, curvier. You know, anything we're doing that's in those types of shapes are doing very well. And I perceive that to continue, certainly in the 2024 and 2025.

And then maybe one follow-up. Yeah, that's great. Thank you. 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 minus 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 you know, throughput from the prior demand comps to get you to a better outcome. And then just related to this, you know, you have this ERP rollout. Can you talk about that in terms of, you know, 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? Thank you.

Sure. So, you know, I would remind you that the demand comp has, you know, 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 2023. 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, you know, I would just remind everyone it is our manufacturing ERP, so it is not kind of the – it's not the retail ERP. So we – you know, it has a lesser impact on the overall organization when it comes to – you know, it's not impacting deliveries. It's not impacting – you know, kind of the retail organizations 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. you know, the product teams as their costing product and, you know, 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, you know, no meaningful risk that we're anticipating.

Okay. Thanks, everyone. Good luck. Thank you.

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

Hi, this is Maddie Check on for Robbie Holmes. Thanks for taking our questions. 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 changing? response to these outlets? How do the economics compare to the traditional showrooms? And how are you deciding where to put these?

Sure.

Yeah, I mean, as we've more than doubled our business in the last couple 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 output product. The outlet product is, you know, 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. We think we're in good shape once we get these three open, you know, just steady things out so we can move on. And then as far as locations, I believe one's in Colorado, one's in Pittsburgh, and one's in Kentucky. And all three are opening, I think, second quarter, I believe.

Thank you. Thank you. That's really helpful. Um, and then just my last question is about, um, maybe promotions. You dialed back on promotions, which helped margins, um, in November. What are some of your assumptions for the promotional environment in one queue in the rest of the year? Maybe just high level.

Yeah. I mean, high level, we haven't really changed our strategy from what it has been. Um, You know, we certainly run some promotions at certain times of the year. We're not looking to change that dramatically at this point. You know, we have plenty of levers to turn on if we need to. But, you know, right now it's going to be as is, as it has been the last year or so. And, you know, 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? Yeah, so... I know 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?

Yeah, 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, though, is really focusing on a messaging promotion. So we spoke about really focusing 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.

That's super helpful. Thank you.

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

Hi, good morning. Thanks for taking my question. 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 a reload? Thank you.

Yeah, Don, I don't have specific numbers, but I think we're about halfway. do where we want to be. Does that sound about right, John?

Yeah, I think so.

Yeah. So, you know, we're trying to do, again, we don't have a set schedule because a lot of this has to do with leases, landlords. You know, do we want to move the store? Do we want to renovate it? Do we want to 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. You know, 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, 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 to 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, Don, maybe a question on inventory. It was 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 of the newness. And then should we expect more muted inventory growth through the first half of the year? Thank you.

Yeah, so, you know, 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, you know, in the first half, which we talked about. So, you know, I think we feel that freight has largely – container costs have largely normalized in the – you know, in the inventory relative to kind of the spikes that we saw in 21 and 22. So feeling good about kind of where the inventory is sitting as we continue to clear through those price action fees 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, you know, we have a fall launch as well. 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 as we think about how do we buy into newness and you know, 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, you know, where we'll be positioned, you know, in the next quarter and, you know, the buy plan for the year.

Great. Thank you. Best of luck.

Thank you.

Thank you. Our next question is from the line of Christina 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

uh dividends um you know perhaps a regular dividend or or share buyback sure i can start um you know this this is a one-time thing um we have no plans to continue on a consistent basis um you know we we've got a lot we've done right the last couple years um you know we've very well planned out how much cash we're going to need this year next year the year after and uh We thought we could do this in the future. I'm very happy to be able to do it one time. Don, I don't know if you have anything to add to that.

Yeah, I would just reiterate that the board was really pleased to be able to return capital to shareholders. And 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 but, you know, we interestingly enough, we're in a 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 cues. I know you can comment on the timing of the deliveries, but where are you as far as taking the orders on those cues? Have you 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, you know, 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, you know, start to see some nice product costs and growth margin expansion sequentially in the back half.

Thank you, and best of luck for this year. Thank you.

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 our house has now concluded. Thank you for your participation. You may now disconnect your lines.