All right, we're in business. Hi everyone, good morning. It's Simeon Gutman. I'm Morgan Stanley's hardline, broadline, and food retail analyst. Welcome to day one of our Global Consumer and Retail Conference. I'm pleased to introduce Arhaus, represented by Michael Lee, CFO. It's an interesting crossroads with a housing, home improvement, home furnishings world that is stagnant but starting to show some signs of life. This is an eclectic growth story with a neat mix of showrooms and product, and it feels like it's getting the short end of the stick from the market in terms of valuation. To start off, I'll ask a question. We will be taking audience questions at the end if there's time. I also want to just read an important disclosure. For important research disclosures, please see www.morganstanley.com/researchdisclosures. With that, I'm going to ask the first question.
Sit down and have our chat. Michael, to start off, for anyone in the audience who may be newer to the Arhaus story, can you give a high-level overview of the business? How would you describe what differentiates the brand in the home furnishing landscape?
All right. Thank you for that. I just want to say upfront, I agree with you. We're undervalued.
Fair enough.
Thank you, Simeon. Yeah, I'm happy to give a quick overview of Arhaus. We are a high-end, high-growth furnishings brand with a resilient business model and a very affluent client base. We design nearly all of our products in-house, and we have an ecosystem of artisans and craftsmen around the world, relationships that our CEO, John Reed, has built up over many, many years, in some cases, many decades. Through these relationships, we have incredible control over design and craftsmanship, allowing us to bring, you know, luxury products to our clients at a great value. One little-known fact is when you come to an Arhaus showroom, nearly 90% of the products in fact, I think a little over 90% of our products you can't find anywhere else, right?
These are exclusive products to Arhaus, which makes the shopping experience, say, one of discovery. You know, with respect to our clients, our clients, I think are really interesting. It, I would call it a differentiator for Arhaus. They're very engaged in the Arhaus brand, and they tend to be affluent. They tend to be very design-forward, and they prioritize quality and long-term investment above all else. We continue to see very healthy demand. We get asked all the time, you know, what's going on with the high-end consumer, what's going on with cancellations, what's going on with engagement levels. You know, it continues to be very positive.
In fact, one of the things we've noticed in our business, when we team up our affluent clients with one of our interior designers, which we provide to them for free, free of charge, the order values on those transactions tend to be four times greater than orders when there is no interior designer involved. It is a real driver of our business. We see a lot of growth ahead. We reach our clients through our omnichannel platform. We have over 100 showrooms across the United States. We operate multiple showroom formats, but I'll save that for later. We also have an e-commerce business. We have an in-home design program, and we have a growing trade business.
When I say trade, just for the next 40 minutes that we're together, trade is a term to describe business that comes to us through a third-party interior designer, right? This is a client that's hired their own designer and working on a project. Those people oftentimes choose Arhaus because of the depth and breadth of our assortment. That is our trade channel, which we're really excited about because that's a big area of growth for us. Just in light of the growth, Simeon, you know, we are investing for the future.
We see a lot of growth ahead, and we are in the midst of a digital transformation at Arhaus to really put in place a scalable digital platform for growth that will allow us to, you know, grow efficiently over time, really targeting to improve EBITDA margins over time, improve our SG&A load over time through really modernization of our tech stack. We are really excited about that. You know, at the end of the day, we are a very differentiated, design-led brand with a very affluent consumer base, and we've got a proven model that we're really excited about. We are focused on really scaling with discipline.
Thanks for the overview. We're going to touch on almost every one of those topics.
Okay.
One, one random one. You mentioned, I mentioned eclectic. You said artisan brand, some of this that John have cultivated over the years. One of the impressions when we were getting to know the brand is, and how do these suppliers scale with you? You're growing rapidly.
Yeah.
They're unique. They're smaller. They're more crafty. How was that a perception that you had when you came to the business?
It's been interesting. I had the opportunity to go to Southeast Asia a couple of months ago to meet with some of our suppliers, and I was just really struck by the engagement and the partnership. I spent 20 years of my career in the wine business, and one of the things I learned from the wine business is that your business begins and ends with your growers. There's a lot of parallels at Arhaus in that regard, in that, you know, our craftsmen and artisans around the world are in many ways our lifeblood to the business. We've taken a very, I'd say, partnership-oriented approach over the years. We don't squeeze our suppliers. We really view it as a partnership. We do collaborate on product design. We do regularly engage with them on product quality, making sure that it hits the Arhaus standards.
Simeon, with the recent tariff movements, we've had suppliers completely pick up and relocate across borders for us to support our business. Absolutely, we've seen many examples where they've been willing to invest behind Arhaus to continue the partnership.
2025 has been a better year than 2024 for the industry. There are more than signs of life, potentially signs of vibrancy. Looking back at how 2025 has played out versus what you expected, what's been the biggest surprise? If you would be willing to share how that sets us up for 2026 .
Sure. Yeah. I wasn't in the industry in 2024, but I will say that, you know, 2024 was a more challenging year for the industry, just managing through an election year with, you know, heightened levels of uncertainty with respect to macro backdrop. In the last two quarters, it's been a real interesting period. A little bit choppy, when you think about the volatility of the business, and I'll come back to that in a minute. When you look at our growth over Q3, it's been, you know, pretty impressive. July we had one of our strongest growth months ever. One of the things we measure in our business is what we call demand, but it's akin to what orders we've received from the customer.
Because of our business model, there's a, you know, sometimes a four to six-week delay between order and receipt. We track orders as a concurrent indicator of demand, right? When we fulfill and deliver to the customer, that's when we recognize revenue. Demand is, in some ways, a leading indicator of what's coming to the P&L. In July, we were up 15.7%, just a real strong growth rate for us in the summer. The summer continued to be very strong. In fact, when you flash forward to September, we do our store-wide sale two times a year, once in January, once in September. September was just an absolute upside surprise for us in that the fall collection was very well received. We released our catalog, our fall catalog, right around that time, and we also introduced our fall collection.
We had our biggest month ever in September. We achieved a number of records during that store-wide sale, which I think are, in some ways, you know, evidence that our strategy is working. We had record levels of newness, and that's been a concerted effort by our product development teams and merch teams to really lean into newness. We had record levels of newness, so the clients are voting that we're doing the right thing. We had record levels of upholstery sales. We had record levels of customization. When we talk about customization, this is an area we're quite proud of. When you come into Arhaus, into a design studio or into a traditional showroom, and you see a piece of furniture, such as a sofa, you may decide, "I love this sofa.
I don't like the fabric." We can walk you to our fabric wall, and we have the largest assortment in the high-end, luxury business for furniture, over 600 fabrics to choose from and over 90 leathers to choose from. We can walk you through, you know, the differences between all of these fabrics, and we can have a custom-made sofa to you in about six weeks. That's a great example of our strategy really coming to life. We achieved record levels of customization in September as well. Consumers are really voting for, you know, the fabrics that we're offering. We also had record levels of trade business in September as well.
That's a great validation, if you will, that we're doing things right when you have third-party interior designers choosing Arhaus and coming to us because we have the best selection, the best variety, the best quality. We're real, real happy with how our Q3 performed. As we flash forward into, you know, 2026, we're in the midst of our planning cycle now, Simeon, but we're really excited about what's coming. We are coming into what will arguably be our largest pipeline of new products in the history of Arhaus. Our CEO, John, has been really pushing on the teams to innovate and to move more quickly when it comes to new product introductions. His efforts have paid off. He can be quite motivating in that way.
We've ended up pulling forward a lot of our innovation into the spring because there's so much momentum in the business. We're really excited about next year.
I want to clarify maybe the cadence of the third quarter and if you're willing to take a gander on how the third quarter's success could translate into holiday season. You mentioned September was great. We talked on the call that there was some descent in October.
Yep.
You also said your regular sale or event September. Was there anything pulled forward? Did the calendar change? Did anything in the competitive environment? Because it still sounds lumpy the way the year, but trending in the right direction.
Yep. Yep. If you look at our demand, our comparable demand through Q3, which is essentially same-store comparable sales on an order basis, orders received, we were up 2.8% through Q3. If you play that out month by month, you will see a bit of a seesaw effect in our business throughout those nine months. You know, some of that is the natural seasonality of our business. We grew in January. We had a fantastic January, September, store-wide sale. Business was a little bit softer in February. March was great. In April, we had the big Rose Garden tariff announcements. Hence, we were down a little bit in April. We were back up in May. Every month since then, it's been a bit of a seesaw.
I think the one that caught maybe more attention during our Q3 call was following a very strong Q3, a very strong September, we had a softer October. In fact, we were down, I think, around 14.8% in October. A few notables on that. Number one, October tends to be one of our smaller months. You tend to see that when you follow a big store-wide sale, the following month tends to drop off. Those are all for obvious reasons. We also made a decision as a management team to modify our promo calendar a bit. In the prior year, there was a business decision to extend the September store-wide sale into October. That was kind of a one-off decision. We talked about 2024 being a tougher year. I think a lot of it stems from that.
This year, we elected to not extend the September store-wide sale to October and to really, you know, get even more focused on our programming timelines. We also did this because with all the tariffs and tariff impacts, we were looking to October to take some price increases. It was really us trying to have a clean break between September, a store-wide sale, and implementing price increases and not having confusion with consumers on the side of pricing. You know, look, the business has been choppy, some of which is just driven by the macro backdrop. I mentioned how our consumers are very affluent. They're not necessarily driven by the same things that, you know, the average American's driven by.
A lot of their purchase behavior comes back to, you know, things like the wealth effect or how much home equity they have. That drives their behavior more than, you know, what's going on with GDP. And, you know, when the stock market has its ups and downs, and you can think about all the ups and downs we had this year with the tariff announcements, we saw a pretty close correlation in our business. That really contributed to the volatility. We don't expect this volatility to continue forever. Without turning this into a political discussion, it's kind of hard to say. We're, in many ways, bracing ourselves for continued volatility. I think we've proven, Simeon, to be quite agile through a very challenging macro backdrop. But, you know, all that being said, I think we still remain very confident about the future ahead.
You mentioned wealth effect, home equity. I want to ask about housing turnover.
Sure.
The connection to the industry's demand and able to detect whether we're in the midst of a replacement cycle or the industry's been soft and we're just beginning to see it crawl back out.
Yep.
Anything related to macro and how much of this could be tied to housing?
It's a great question. We get asked this all the time because you would expect that our business would have a very tight correlation with housing turnover. The reality is that we'd love for housing to turn around. When it does, that will be a further tailwind to our business. We have many, many demand drivers that go well beyond just the, you know, the existing home sales or new home sales. As I mentioned, our demand is really anchored in this affluent client, and they just tend to behave differently. They're much less tied to housing turnover in that regard. They're less tied to things like affordability measures that we look at all the time. They're purchasing effects that are in home equity.
They tend to have a long-term point of view when it comes to investments in their home. We're also seeing a very healthy replacement and renovation cycle. That has continued. Even though people are moving less, they are still investing in their homes. Whether it's a light refresh or a full remodel or a, you know, a designer-led project for their whole home, we continue to see very strong levels of engagement from our consumers. Think about in third homes. This is where we have introduced design studios into those key markets where there's lots of second home ownership. We want to be where those clients are, to provide them with Arhaus design services. You know, those are all factors that, you know, contribute to the demand that's coming in. I am excited about a housing turnaround. I do think it's imminent.
I don't think it's on our doorstep, but we are looking forward to continued improvements into 2026. I will say, when you think about, you know, what brings people in the showrooms, there are many factors on demand that we directly control. I would point to the Fall 2025 collection, clearly a demand driver. We got lots of feedback from our clients on that Fall collection and, the innovation, the design, the quality, the warm tones, the burlwoods, all the things that further differentiate us from, you know, what you might see from our competitors. The customization that we offer continues to be a demand driver. We have our own manufacturing facility in North Carolina, and it's an upholstery manufacturing facility. That's where a lot of the customization comes from.
We continue to improve cycle times with clients so that when they do come in and offer and express interest in a customized sofa, you know, they do not have to wait six months. They do not have to wait four months. We can get them a sofa in six weeks. That continues to be a point of differentiation. There is, Simeon, a number of things that we are doing to bring people in that are, you know, helping to drive demand that is not necessarily tied to housing turnover, but we would welcome it. That being said.
One more on demand.
Sure.
Related to what you said, bringing people in, the Buy More, Save More at the $5,000 price point. That has been a big success this year. Can you talk about big ticket? Is it outperforming because of marketing programs like that? How does it impact the overall mix and product margin?
That's a great question. This is one of our biggest wins this year, the continued strength in our higher ticket transactions. The combination of large project clients, designer-led projects, trade-led projects, as well as the Buy More, Save More program, all contributed meaningfully to our average order value. Just so everyone is aware, the Buy More, Save More program is where we promote to our customers that if they spend X dollars, they'll get Y percentage off their transaction. It's not priced based on individual pieces, but if they put a project together and reach a $10,000 threshold, they can get 20% off their transaction or 30% off their transaction. That's been very effective in marketing because it doesn't in any way impair the value proposition or hurt our brand.
It's simply recognizing that when a client comes in and puts down a big order, that, you know, there's value for that. And we recognize that through discounts. It's been very well received. It's really been, I'd say, our anchor promotion for the last 18 months or so. We have had quite a lot of success with that. When you go back to the ticket sizes of $5,000 and $10,000, they continue to be, you know, very healthy at these transaction levels. It's all the same factors I've mentioned a few times, right? It's the, you know, interior designers, the trade, the promotions. It's had a big impact on our product mix in doing that. We're naturally weighted toward higher AOVs because of the category that we compete in.
We offer large, you know, furniture categories, large pieces. But, you know, with our upholstery program, the customization, you know, these are higher dollar items. And that continues to drive the AOV upwards as well. The big ticket items help us on margin. There's no doubt about that. The more product we source from the U.S., the better our margins typically. The more we source from our own manufacturing facility in North Carolina, the better our margins typically. It's that, you know, ability to customize and trade customers up, that is really us, to protect our margins. You know, generally speaking, it's been a big win for us.
Mm-hmm. What the market knows about Arhaus and AI is largely a function of what you communicate on quarterly calls.
Sure.
Maybe on your website. To dangle the carrot, all things AI, you know, set the record as what Arhaus is doing to implement it. As a side question, you think it has a bigger top-line or bottom-line benefit, more immediate term in the next three years?
Yeah. That's a great question. I know it's a big topic. I'm personally, a believer in the benefits of AI. I use it, both personally and professionally. I consider myself to be very well educated on this. I would say at Arhaus, we're not treating AI as a standalone initiative, right? We're treating AI as an enabler to what we're already doing. In the areas of, you know, the top line, we're using it to help create more personalized and seamless client experiences, you know, in the form of better product, you know, recommendations, helping us to target clients, and to help, you know, support product discovery online. You know, even when you go into, like, the design step of your project, we're using AI to help model out, you know, different visuals as well.
That's been, you know, very helpful for top line, but also customer experience. On the bottom line, look, we're just getting started here. We recently announced a digital transformation. And just as a bit of a backstory, I've done a number of these in my career, very large-scale digital transformations, ERP projects, and whatnot. As I've jumped into Arhaus and helped them to stand up this program, it's been absolutely shocking to me how much more efficient these programs are with AI as the enabler. We announced a $30 million investment in digital investment, digital transformation, that we'll maybe talk about in a few minutes.
The fact that we're able to accomplish this and the timelines that we've laid out, a lot of it comes back to AI and the fact that, you know, the accelerators that they've developed, to either write code or to develop change management collateral or to even summarize meetings and action items, it's just been a real enabler. I see thematically that AI is really just a big enabler, that companies are going to deploy over the next couple of years. We see lots and lots of opportunity, but we're taking a very methodical approach.
Just like we've taken a methodical approach on building our showroom fleet over the years, we're going to take a very methodical approach with AI and make sure we deploy it to the highest use cases across the business, but ultimately, you know, make sure that we capture some of those benefits.
This digital transformation, and you were right, that was the next topic. How does it break down between ERP, supply chain, inventory management? The $30 million looks mostly capitalized. Is there a P&L impact? And one more for you, since you've done a few of these, you know, degree of risk associated with this one inside of Arhaus?
Sure. Yeah. Look, this is one of the most important initiatives that we are undertaking as a company right now. Arhaus has grown quite a lot over the last four years since our IPO. And we have outgrown our technology stack. At the same time, you know, we've got a lot of growth ahead. This is a critical, critical initiative to really set us up for continued growth. There are three major components to this program. The first one is replacing our core, if you will, our core finance and operating systems. That is the longest pole in the tent, if you will, with respect to this program. In addition to that, we are implementing new capabilities in the form of transportation management systems and an order management system.
You might ask, well, why are you doing that at the same time you're doing these other projects? There is a lot of integration between the transportation order management systems with the existing core systems. It makes a lot of sense to do it at the same time. These projects also drive a really strong ROI. You know, we spend tens of millions of dollars a year on transportation. The uplift in capability that we're going to get from a new transportation management system has real meaningful P&L impact. We want to pull that in as fast as possible.
The order management system that we're talking about, there's a lot of complexity to it, but we think it's worth the effort because it's really going to elevate the client experience through their entire purchase journey, and allow us to really re-engineer in many ways how we service our customers. We’re really excited about that. You know, some core investments that we're making. For anybody that's read our 10-K or our 10-Q, you also see that we have several material weaknesses in our financial reporting. You know, one of our big priorities as a company is to fully remediate those material weaknesses and improve our internal control environment across the company. We can't do that today with our existing systems. We can do a lot of things to improve our internal controls, and we're doing that.
We can't get all the way to Bright with our existing tech stack. This new tech stack is going to help us, you know, fully remediate these material weaknesses in due course. We don't have an exact timeline on that. Once these new systems are in place, you should expect to see some progress on that in the future. It's a priority for us as a company. When you think about the economics of this program, it's about a $30 million initiative over the next 18 months. Simeon, you're right. The way this gets accounted for is it's mostly capitalized into cloud computing asset on the balance sheet. Once the system goes live, you start to, you know, depreciate or amortize the asset.
We communicated, the $30 million split is mostly, you know, next year and the year after. I think we said $2 million this year of cash spend, $12 million next year, and $10 million the following year, and then $2, $2, $2 after that through this five-year horizon. That is how the cash flows will flow. We're projecting to go live with this technology in Q1 of fiscal 2027. At that point, we'll start expensing, amortizing the program. It will get amortized from 2027 through 2030, which is the duration of the five-year license agreement with the software providers. The good news is that by 2028, we expect the benefits to start to realize as well. We've communicated really two major sources of financial benefits. I'll say three.
Number one is we see SG&A benefits in the business to the tune of around 50 basis points, a year of, you know, permanent savings by the year 2030. If you do that math, that's worth about $10 million a year.
Mm-hmm.
We think we can start getting that in 2028. Say around $8 million a year in 2028. We also expect to have savings on the transportation side of the house of, you know, $4 million-$5 million a year starting in 2027. We are going to save on software because we are consolidating our tech stack and a couple million dollars of savings in the program for that as well. We are really excited. This is one where, you know, we are going to get it done. We are going to strengthen our controls as a company. We are going to set ourselves up for growth. We are going to drive some good returns out of it.
How do you minimize execution risk? It sounds like 27 is when it flips on.
Yep.
Order management. I mean, ERP, these are scary things for retailers. When will you know that nothing's disrupted?
Yeah. One of the things that's really important is you set these programs up the right way. We have an executive team, four executive team members that are sponsoring this program. Me, along with our Chief Information Officer, our head of client care, and our head of logistics. We've all got our different experiences with these systems. Over the last six months, we've been focused on the foundational work necessary to set these programs up the right way. When you think about where risks are on these projects, it's really around the areas of, do you have dedicated teams or not? If you do not have dedicated teams, that's a major, major risk factor. We have assigned a dedicated team. Do you have a clear scope or not?
We have a very clear scope, and we debated scope over the last six months to make sure that it was very tight, very clear. Do you have executive support on these projects? That's another precursor predictor of success. We have four executive team members that are, you know, overseeing the project. We also have a very engaged board of directors, playing a role of governance on this project as well. You know, at the end of the day, another predictor of success is change management, making sure that you're bringing along the organization on the journey to ensure that you have the employee acceptance and the engagement when these things go live. We have invested in change management as part of this project. I'll give you an anecdote. I'm not going to quote who said it.
Simeon, you just got to take it on faith. When you do these programs, you have system implementers, right? These are people that are party consultants that work with the software provider and the client. In this case, it's Arhaus to deploy this technology. We just had our launch of this in the last month. The system implementer, the leader, came to us and told us after this big three-week-long, two-week-long kickoff event, this is the best kickoff that he's ever seen. Arhaus is doing this the right way. That's how we're going to manage risk. At the end of the day, we don't go live until we have, you know, gotten sign-off from, you know, the entire company. We're going to manage this the right way.
Two more topics in our five and a half minutes.
Okay.
Tariffs and B2B. I'll keep them a little separate. Tariffs first, still on our minds. It feels like there's another wave of pricing. This is not furniture related, but broadly.
Yep.
That needs to come. You've talked about $50 million-$60 million.
Yep.
Of impact in 2026. That doesn't seem terrible relative to your top line. Can you talk about puts and takes, mitigation, vendor concessions, pricing, anything and above tariffs?
Yeah. It's been a busy year with respect to tariffs. I'm really proud of the work that the organization's done, because we're on track to have a pretty good year overall despite, you know, what's been a very volatile situation. Our approach has been, you know, very straightforward. We said from day one, we are going to protect our margins. And we have done that. You know, we're now starting to see flow-through of tariffs onto our P&L. We took pricing starting in October. We've communicated that we'll continue to look at pricing over the next one to two quarters to make sure that we protect our margins every step of the way. We've pulled many other levers, Simeon. We've had sourcing changes.
As I mentioned, I got to meet one of the proprietors of a business that literally picked up shop and moved from one country to another and was in the process of starting up production for us, as one of the sourcing location changes that we had to do in order to minimize tariff impacts. We have got many examples of sourcing diversification, sourcing changes that we have made. It's been very, very difficult. You know, one of the things that we are really proud of is that Arhaus continues to grow as we have added new showrooms, as we have continued to grow our comp growth. We have grown our top line. That means we are buying more product from our suppliers. As we are buying more product from suppliers, they are getting economies of scale.
As part of this negotiation process, our partners have shared with us growth, which makes shift. We have had some concessions in that regard, to help offset the tariffs. For what is remaining, we are passing it through, and we are doing it in a very methodical, surgical way. This is not a one-size-fits-all approach. We are largely taking pricing where items are impacted by tariffs, which means that for our U.S. sourced goods, we have taken very little price. In this exercise, we have also taken price down where we think they were too high. One of the things that is cool about our business being so integrated is, you know, we are one phone call away from our sales team to get real feedback on what our clients are saying. What we continue to hear from our clients is that price is not coming up as an issue.
Where it does come up as an issue, we take a look at it and we make adjustments. Generally speaking, we've been able to, you know, make price adjustments where needed to absorb these tariffs. You know, it's continue wait and see. I don't know if things will change with the upcoming Supreme Court decision. We will take a wait-and-see approach. In the meantime, we're just running our play. You know, we're going to continue to protect our margins every step of the way.
Last but not least, B2B. It's almost a buzzword across home improvement, home furnishing. Seems like a new channel that makes sense while the traditional channel is soft, but also as a growth strategy over the next five years. Talk about, and have you sized it yet? How are you going, building that business?
Yeah. We think it's a massive opportunity for us. I would not say that we're underdeveloped, but I would say we have lots of upside opportunity. We think about the B2B business really in two different ways, right? There's the trade channel that I talked about earlier. This is where, you know, an individual hires an interior designer, and that interior designer comes to Arhaus. But there's also the contract business, which is business that comes from businesses that are looking to furnish, you know, buildings. The Hyatt comes to us and says, you know, we want to furnish a hotel. On the trade side, we are leaning in very hard. We hired a new executive over that team.
We are investing in new technology capabilities to support that team with, you know, things like clienteling, which is how we engage with the trade. We are working on a new trade member program that we think will be more competitive and will better reward trade people for being loyal to Arhaus and really simplify the way we do business. It is a big opportunity. More and more of our business continues to shift in that direction. We're just now stepping on the gas and saying, we're going to go and get more business through this new strategy that we're building out. In 2026, the trade channel is one of our major platforms for growth next year. We will have more to share on that at our next earnings call.
Appreciate all the time. Thank you for sharing part of the strategy, digital transformation, AI. Good luck over the holiday season into 2026. Thank you.
All right. Thanks.