Arhaus, Inc. — Q3 2022 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2022. Arhaus is a premium home-furnishings retailer operating 80 Showrooms at quarter-end. Unless noted otherwise, financial amounts below are in millions of dollars.
Financial performance
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Net revenue | $320.0 | $203.3 | $872.6 | $558.7 |
| Gross margin | $136.3 (42.6%) | $84.8 (41.7%) | $367.0 (42.1%) | $233.0 (41.7%) |
| Income from operations | $47.1 (14.7%) | $16.1 (7.9%) | $120.3 (13.8%) | $36.1 (6.5%) |
| Net income | $36.9 | $14.2 | $89.6 | $30.3 |
| Adjusted EBITDA | $56.7 (17.7%) | $30.4 (14.9%) | $148.4 (17.0%) | $90.1 (16.1%) |
Q3 revenue increased 57.4% year over year; nine-month revenue increased 56.2%. Retail contributed $269.0 million and eCommerce $51.0 million in Q3. Comparable growth was 54.3% in Q3 and 53.5% for nine months; demand comparable growth was 15.8% and 15.1%, respectively, both lower than in the prior-year periods.
Gross-margin rates improved by 90 basis points in Q3 and 40 basis points for nine months. Management attributed improvement mainly to leverage on fixed Showroom costs, partly offset by higher variable Showroom and transportation costs. SG&A rose in dollars but declined as a share of revenue to 27.9% in Q3 and 28.3% for nine months. Nine-month net income comparisons also reflect the higher corporate income-tax burden following the 2021 reorganization and IPO; the prior-year business had largely been taxed as a partnership.
Cash flow, balance sheet and debt
- Operating cash flow was $58.2 million for the first nine months, versus $141.2 million in 2021. The company cited higher inventory, lower growth in client deposits, and improved delivery of backlog orders as factors.
- Investing cash outflow was $37.0 million, primarily for Showrooms, distribution-center expansion, and technology. Company-funded capital expenditures, net of landlord contributions, were $25.6 million.
- Cash and cash equivalents were $145.7 million at September 30, 2022; restricted cash was another $6.3 million. Inventory was $292.6 million, up from $208.3 million at December 31, 2021.
- No borrowings were outstanding under the $50 million revolving credit facility. The facility expires in November 2026 and has financial and other covenants; the company reported compliance at quarter-end.
- ASC 842 adoption added $355.4 million of lease liabilities at September 30, 2022 ($303.0 million operating and $52.4 million finance). The company also disclosed approximately $166.7 million in future minimum rent for leases not yet commenced; these amounts are not current funded debt.
- Client deposits were $261.8 million, generally collected at a minimum of 50% of an order’s purchase price. The company expects substantially all quarter-end deposits to be recognized as revenue within 12 months as orders are delivered.
Outlook, risks and notable items
- Management expected fiscal 2022 company-funded capital expenditures of $40 million to $50 million, mainly for distribution centers, Showrooms, and technology. It said operating cash flows should meet working-capital and other capital needs for at least the next 12 months.
- No revenue or earnings guidance is stated in the provided filing text. Management noted that supply-chain constraints had delayed conversion of demand into revenue and expected pandemic-related vendor and supply-chain capacity effects to continue during fiscal 2022.
- Risks cited include supply-chain and transportation disruption or cost increases, vendor capacity and quality, weaker consumer confidence or spending, inflation and the ability to pass costs through pricing, competition, Showroom traffic, cybersecurity, and COVID-19-related disruption. Most international inventory purchases are denominated in U.S. dollars; the company does not use derivatives to manage foreign-exchange or interest-rate risk.
- There were four disclosed material weaknesses in internal control over financial reporting, involving the control environment and staffing, accounting policies and reporting controls, complex transactions including incentive-unit accounting, and IT general controls. Disclosure controls were therefore deemed ineffective at the reasonable-assurance level. Remediation was underway, but management gave no completion timetable and cautioned it might not be sufficient.
- The company reported no legal proceedings expected to have a material adverse effect and no material off-balance-sheet arrangements. It had $1.2 million of accrued liabilities for probable and estimable non-income-tax matters; several state and local tax audits were ongoing.
- Prior-year results included a $29.9 million derivative expense related to a former term-loan exit fee; the liability was paid at the November 2021 IPO. The current period also included distribution-center start-up costs within adjusted EBITDA adjustments. Adjusted EBITDA is a non-GAAP measure and excludes specified items.
Investor verification points
- Assess whether demand growth and backlog conversion can sustain reported revenue as demand comparable growth slowed materially from 2021.
- Track inventory levels, operating cash flow, client deposits, and delivery performance for signs of working-capital pressure or supply-chain normalization.
- Review gross-margin resilience against product, freight, occupancy, and other variable-cost inflation.
- Monitor planned capital spending, distribution-center expansion, and the $166.7 million of commitments for leases not yet commenced.
- Follow remediation and independent validation of the four material weaknesses; the filing does not provide a firm remediation deadline.
- Distinguish lease liabilities from borrowings and consider covenant terms and variable-rate exposure if the revolver is drawn.