SEC Filing | Arhaus

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arhs-20220930

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


☒			QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2022


☐			TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number: 001-41009

Arhaus, Inc.

(Exact name of registrant as specified in its charter)


Delaware						87-1729256
(State or other jurisdiction of incorporation or organization)						(I.R.S. Employer Identification No.)

51 E. Hines Hill Road, Boston Heights, Ohio

(Address of Principal Executive Offices)

44236

(Zip Code)

(440) 439-7700

(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:


Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Class A common stock, $0.001 par value per share	ARHS	The Nasdaq Global Select Market

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.


Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☒	Smaller reporting company	☐
		Emerging growth company	☒

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒

As of November 3, 2022 the registrant had 52,947,617 shares of Class A common stock and 87,115,600 shares of Class B common stock outstanding.

Table of Contents


		Page
Part I - Financial Information		2
Item 1.	Financial Statements of Arhaus, Inc. and Subsidiaries	2
	Condensed Consolidated Balance Sheets (unaudited)	2
	Condensed Consolidated Statements of Comprehensive Income (unaudited)	3
	Condensed Consolidated Statements of Changes in Stockholders’ Equity (Deficit) (unaudited)	4
	Condensed Consolidated Statements of Cash Flows (unaudited)	6
	Notes to Condensed Consolidated Financial Statements (unaudited)	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	21
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	31
Item 4.	Controls and Procedures	31
Part II. Other Information		34
Item 1.	Legal Proceedings	34
Item 1A.	Risk Factors	34
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	34
Item 3.	Defaults Upon Senior Securities	34
Item 4.	Mine Safety Disclosures	34
Item 5.	Other Information	34
Item 6.	Exhibits	35
Signatures		36

Part I - Financial Information

Item 1. Financial Statements of Arhaus, Inc. and Subsidiaries


Arhaus, Inc. and Subsidiaries Condensed Consolidated Balance Sheets (Unaudited, amounts in thousands, except share and per share data)


	September 30, 2022		December 31, 2021
Assets
Current assets
Cash and cash equivalents	$	145,737	$	123,777
Restricted cash equivalents	6,345		7,131
Accounts receivable, net	1,778		228
Merchandise inventory, net	292,571		208,343
Prepaid and other current assets	35,867		28,517
Total current assets	482,298		367,996
Operating right-of-use assets	224,921		—
Financing right-of-use assets	39,062		—
Property, furniture and equipment, net	128,783		179,631
Deferred tax asset	20,948		27,684
Goodwill	10,961		10,961
Other noncurrent assets	235		278
Total assets	$	907,208	$	586,550

Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable	$	58,455	$	51,429
Accrued taxes	12,706		7,302
Accrued wages	17,498		16,524
Accrued other expenses	33,756		61,047
Client deposits	261,801		264,929
Current portion of operating lease liabilities	39,248		—
Current portion of financing lease liabilities	522		—
Total current liabilities	423,986		401,231
Operating lease liabilities, long-term	263,753		—
Financing lease liabilities, long-term	51,908		—
Capital lease obligation	—		50,525
Deferred rent and lease incentives	2,353		63,037
Other long-term liabilities	4,413		1,992
Total liabilities	$	746,413	$	516,785
Commitments and contingencies (Note 9)
Stockholders' equity
Class A shares, par value $0.001 per share (600,000,000 shares authorized, 51,437,348 and 50,427,390 shares issued and outstanding as of September 30, 2022 and December 31, 2021, respectively)	51		50
Class B shares, par value $0.001 per share (100,000,000 shares authorized, 87,115,600 and 86,519,002 shares issued and outstanding as of September 30, 2022 and December 31, 2021, respectively)	87		87
Accumulated Deficit	(26,948)		(116,581)
Additional Paid-in Capital	187,605		186,209
Total Arhaus, Inc. stockholders' equity	160,795		69,765
Total liabilities and stockholders' equity	$	907,208	$	586,550

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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Arhaus, Inc. and Subsidiaries Condensed Consolidated Statements of Comprehensive Income (Unaudited, amounts in thousands, except share and per share data)


	Nine months ended September 30,				Three months ended September 30,
	2022		2021		2022		2021
Net revenue	$	872,595	$	558,690	$	320,030	$	203,333
Cost of goods sold	505,561		325,710		183,739		118,522
Gross margin	367,034		232,980		136,291		84,811
Selling, general and administrative expenses	246,767		196,443		89,145		68,266
Loss on disposal of assets	—		466		—		452
Income from operations	120,267		36,071		47,146		16,093

Interest expense, net	3,367		4,091		751		1,365
Other income	(584)		—		(109)		—
Income before taxes	117,484		31,980		46,504		14,728
Income tax expense	27,851		1,704		9,568		500
Net and comprehensive income	$	89,633	$	30,276	$	36,936	$	14,228
Less: Net income attributable to noncontrolling interest	—		17,499		—		8,231
Net and comprehensive income attributable to Arhaus, Inc.	$	89,633	$	12,777	$	36,936	$	5,997

Net and comprehensive income per share, basic
Weighted-average number of common shares outstanding, basic	137,939,577		112,058,742		138,484,495		112,058,742
Net and comprehensive income per share, basic	$	0.65	$	0.11	$	0.27	$	0.05
Net and comprehensive income per share, diluted
Weighted-average number of common shares outstanding, diluted	139,545,802		112,058,742		139,845,333		112,058,742
Net and comprehensive income per share, diluted	$	0.64	$	0.11	$	0.26	$	0.05

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


Arhaus, Inc. and Subsidiaries Condensed Consolidated Statements of Changes in Stockholders’ Equity (Deficit) (Unaudited, amounts in thousands)


	Nine months ended
	Common Shares in Homeworks Holdings, Inc.						Common Stock						Total Stockholders' Equity (Deficit)
	Voting			Non-Voting			Class A			Class B
	Shares	Amount		Shares	Amount		Shares	Amount		Shares	Amount		Retained Earnings (Accumulated Deficit)		Additional Paid-in Capital		Noncontrolling Interest		Total Stockholders' Equity (Deficit)
Balances as of December 31, 2021	—	$	—	—	$	—	50,428	$	50	86,519	$	87	$	(116,581)	$	186,209	$	—	$	69,765
Net income	—	—		—	—		—	—		—	—		89,633		—		—		89,633
Adjustment to deferred tax asset impact of Reorganization from partnership to a corporation	—	—		—	—		—	—		—	—		—		(1,278)		—		(1,278)
Shareholder capital contribution	—	—		—	—		—	—		—	—		—		62		—		62
Equity based compensation	—	—		—	—		1,009	1		597	—		—		2,612		—		2,613
Balances as of September 30, 2022	—	$	—	—	$	—	51,437	$	51	87,116	$	87	$	(26,948)	$	187,605	$	—	$	160,795

	Nine months ended
	Common Shares in Homeworks Holdings, Inc.						Common Stock						Total Stockholders' Equity (Deficit)
	Voting			Non-Voting			Class A			Class B
	Shares	Amount		Shares	Amount		Shares	Amount		Shares	Amount		Retained Earnings (Accumulated Deficit)		Additional Paid-in Capital		Noncontrolling Interest		Total Stockholders' Equity (Deficit)
Balances as of December 31, 2020	645	$	—	4,158	$	—	—	$	—	—	$	—	$	(28,422)	$	1,670	$	(7,689)	$	(34,441)
Net income	—	—		—	—		—	—		—	—		12,777		—		17,499		30,276
Tax distribution	—	—		—	—		—	—		—	—		—		—		(7,865)		(7,865)
Shareholder distribution	—	—		—	—		—	—		—	—		(12,350)		—		—		(12,350)
Equity based compensation	—	—		—	—		—	—		—	—		—		1,135		—		1,135
Balances as of September 30, 2021	645	$	—	4,158	$	—	—	$	—	—	$	—	$	(27,995)	$	2,805	$	1,945	$	(23,245)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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Arhaus, Inc. and Subsidiaries Condensed Consolidated Statements of Changes in Stockholders’ Equity (Deficit) (continued) (Unaudited, amounts in thousands)


	Three months ended
	Common Shares in Homeworks Holdings, Inc.						Common Stock						Total Stockholders' Equity (Deficit)
	Voting			Non-Voting			Class A			Class B
	Shares	Amount		Shares	Amount		Shares	Amount		Shares	Amount		Retained Earnings (Accumulated Deficit)		Additional Paid-in Capital		Noncontrolling Interest		Total Stockholders' Equity (Deficit)
Balances as of June 30, 2022	—	$	—	—	$	—	51,360	$	51	87,116	$	87	$	(63,884)	$	187,640	$	—	$	123,894
Net income	—	—		—	—		—	—		—	—		36,936		—		—		36,936
Adjustment to deferred tax asset impact of Reorganization from partnership to a corporation	—	—		—	—		—	—		—	—		—		(1,278)		—		(1,278)
Shareholder capital contribution	—	—		—	—		—	—		—	—		—		19		—		19
Equity based compensation	—	—		—	—		77	—		—	—		—		1,224		—		1,224
Balances as of September 30, 2022	—	$	—	—	$	—	51,437	$	51	87,116	$	87	$	(26,948)	$	187,605	$	—	$	160,795



	Three months ended
	Common Shares in Homeworks Holdings, Inc.						Common Stock						Total Stockholders' Equity (Deficit)
	Voting			Non-Voting			Class A			Class B
	Shares	Amount		Shares	Amount		Shares	Amount		Shares	Amount		Retained Earnings (Accumulated Deficit)		Additional Paid-in Capital		Noncontrolling Interest		Total Stockholders' Equity (Deficit)
Balances as of June 30, 2021	645	$	—	4,158	$	—	—	$	—	—	$	—	$	(33,992)	$	2,097	$	(6,286)	$	(38,181)
Net income	—	—		—	—		—	—		—	—		5,997		—		8,231		14,228


Equity based compensation	—	—		—	—		—	—		—	—		—		708		—		708
Balances as of September 30, 2021	645	$	—	4,158	$	—	—	$	—	—	$	—	$	(27,995)	$	2,805	$	1,945	$	(23,245)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

Arhaus, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited, amounts in thousands)


	Nine months ended September 30,
	2022		2021

Cash flows from operating activities
Net income	$	89,633	$	30,276
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization	18,319		17,206
Amortization of operating lease right-of-use asset	21,976		—
Amortization of deferred financing fees and interest on finance lease in excess of principal paid	8,731		839
Equity based compensation	2,613		1,135
Deferred tax assets	5,458		—
Derivative expense	—		29,905
Loss on disposal of property, furniture and equipment	—		466
Amortization and write-off of lease incentives	(224)		(5,889)
Changes in operating assets and liabilities
Accounts receivable	(1,550)		240
Merchandise inventory	(84,228)		(62,533)
Prepaid and other current assets	(11,249)		(715)
Other noncurrent liabilities	456		(732)
Accounts payable	10,334		1,698
Accrued expenses	23,682		16,259
Operating lease liabilities	(22,586)		—
Deferred rent and lease incentives	—		6,959
Client deposits	(3,128)		106,076
Net cash provided by operating activities	58,237		141,190

Cash flows from investing activities
Purchases of property, furniture and equipment	(36,950)		(29,533)
Net cash used in investing activities	(36,950)		(29,533)

Cash flows from financing activities
Issuance of related party notes	—		(1,000)
Proceeds from related party notes	—		1,000
Principal payments under capital leases	—		(106)
Principal payments under finance leases	(113)		—
Shareholder distributions	—		(12,350)
Distributions to noncontrolling interest holders	—		(7,865)
Net cash used in financing activities	(113)		(20,321)
Net increase in cash, cash equivalents and restricted cash equivalents	21,174		91,336

Cash, cash equivalents and restricted cash equivalents
Beginning of period	130,908		64,002
End of period	$	152,082	$	155,338

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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Arhaus, Inc. and Subsidiaries Condensed Consolidated Statements of Cash Flows (continued) (Unaudited, amounts in thousands)


	Nine months ended September 30,
	2022		2021
Supplemental disclosure of cash flow information
Interest paid in cash	$	3,858	$	4,006
Interest received in cash	316		—
Income taxes paid in cash	20,579		1,394

Noncash operating activities:
Lease incentives	7,532		4,253

Noncash investing activities:
Purchase of property, furniture and equipment in accounts payable	2,661		(428)

Noncash financing activities:
Adjustment to deferred tax asset impact of Reorganization from partnership to a corporation	(1,278)		—
Derecognition of build-to-suit assets as a result of ASC 842 adoption	(31,017)		—
Property, furniture and equipment additions due to build-to-suit lease transactions	—		1,040
Capital contributions	62		—
Capital lease obligation	—		2,591

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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Arhaus, Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited)

1. Nature of Business and Basis of Presentation

Nature of Business

Arhaus, Inc. (the “Company,” “we” or “Arhaus”) is a Delaware corporation and is a premium retailer in the home furnishings market, specializing in livable luxury supported by heirloom quality merchandise. We offer merchandise in a number of categories, including furniture, outdoor, lighting, textiles and décor. Our curated assortments are presented across our sales channels in sophisticated, family friendly and unique lifestyle settings. We position our retail locations as Showrooms for our brand, while our website acts as a virtual extension of our Showrooms. The Company operated 80 Showrooms at September 30, 2022.

Arhaus was formed on July 14, 2021 for the purpose of completing an initial public offering (“IPO”) of its common stock and related transactions in order to carry on the business of Arhaus, LLC (“LLC”) and its subsidiaries. Pursuant to the corporate reorganization and completion of the IPO in November 2021, the Company became a holding company for LLC and its subsidiaries.

In connection with the IPO, the Company reorganized its ownership structure from a limited liability company to a corporation. Pursuant to the terms of the Integrated Contribution Agreement by and among the Company, FS Arhaus Holding, Inc. (“FS Arhaus,” “Class B Units,” or “noncontrolling interest”), a Delaware corporation, Homeworks Holdings Inc. (“Homeworks,” or “Class A Units”) and the unit holders (“Management Unitholders”) of LLC, a series of transactions were completed on November 8, 2021, which we refer to, collectively, as the “Reorganization.” LLC and Homeworks were identified as entities under common control, in which both entities are ultimately controlled by the same party before and after the Reorganization and therefore resulted in a change in reporting entity. In accordance with ASC 805-50-45-5, for transactions between entities under common control, the condensed consolidated financial statements for periods prior to the Reorganization have been adjusted to retrospectively combine the previously separate entities for presentation purposes.

Basis of Presentation

The condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The accompanying condensed consolidated financial statements include our accounts and those of our wholly owned subsidiaries. Accordingly, all intercompany balances and transactions have been eliminated through the consolidation process. Certain reclassifications have been made to prior years' condensed consolidated financial statements to conform to the current year's presentation.

The accompanying condensed consolidated balance sheets at September 30, 2022 and December 31, 2021, the condensed consolidated statements of comprehensive income and changes in stockholders’equity (deficit) for the nine and three months ended September 30, 2022 and 2021, the condensed consolidated statements of cash flows for the nine months ended September 30, 2022 and 2021 and the related interim condensed consolidated disclosures are unaudited and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements.

In management’s opinion, the accompanying condensed consolidated financial statements contain all adjustments, consisting of only normal recurring adjustments, necessary for a fair statement of the Company’s financial position at September 30, 2022; the results of operations and changes in stockholders’equity (deficit) for the nine and three months ended September 30, 2022 and 2021 and the condensed consolidated statements of cash flows for the nine months ended September 30, 2022 and 2021. The condensed consolidated balance sheet as of December 31, 2021 included herein was derived from audited financial statements, but does not include all disclosures required by U.S. GAAP.

The results for the nine and three months ended September 30, 2022 and 2021 are not necessarily indicative of the operating results to be expected for the full fiscal year or any future period. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. Therefore, these condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2021.

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Arhaus, Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited)

Use of Estimates

The preparation of our condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The accounting estimates and other matters included within our condensed consolidated financial statements and notes to the condensed consolidated financial statements are revenue recognition, including a reserve for merchandise returns, goodwill and fair value of financial instruments which include, but are not limited to, accounts receivable, payables, lease obligations, derivative and equity based compensation instruments.

Client Deposits

Client deposits represent payments made by clients on orders. At the time of purchase, the Company collects deposits for all orders equivalent to at least 50 percent of the clients’ purchase price. Orders are recognized as revenue when the merchandise is delivered to the client and at the time of delivery the client deposit is no longer recorded as a liability. The Company expects substantially all client deposits as of September 30, 2022 will be recognized as net revenue within the next 12 months as the performance obligations are satisfied.

Gift Cards

The Company sells gift cards to clients in our Showrooms and through our website. Such gift cards do not have expiration dates. We defer revenue when payments are received in advance of performance for unsatisfied obligations related to our gift cards. The liability related to unredeemed gift cards of $0.9 million and $0.9 million at September 30, 2022 and December 31, 2021, respectively, is recorded in the accrued other expenses line item of the condensed consolidated balance sheets. The Company recognizes income associated with breakage proportional to actual gift card redemptions.

Fair Values of Financial Instruments

The Company’s primary financial instruments are cash and cash equivalent investments, accounts receivable, payables, lease obligations, a derivative and equity based compensation instruments. Due to the short-term maturities of cash and cash equivalent investments, accounts receivable and payables, the Company believes the fair values of these instruments approximate their respective carrying values at September 30, 2022 and December 31, 2021. See Note 4 for discussion of our derivative, Note 5 for discussion of our lease obligations and Note 6 for discussion of our equity based compensation instruments.

The Company has established a hierarchy to measure our financial instruments at fair value, which requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Observable inputs represent market data obtained from independent sources, whereas unobservable inputs reflect the Company’s own market assumptions, which are used if observable inputs are not reasonably available without undue cost and effort. The hierarchy defines three levels of inputs that may be used to measure fair value:

Level 1Unadjusted quoted prices in active markets for identical, unrestricted assets and liabilities that the reporting entity has the ability to access at the measurement date.

Level 2Inputs other than quoted prices included within Level 1 that are observable for the asset and liability or can be corroborated with observable market data for substantially the entire contractual term of the asset or liability.

Level 3Unobservable inputs that reflect the entity’s own assumptions about the assumptions market participants would use in the pricing of the asset or liability and are consequently not based on market activity but rather through particular valuation techniques.

From time to time, the Company invests in money market funds and other Level 1 cash and cash equivalent investments. For the nine and three months ended September 30, 2022, the Company earned $0.6 million and $0.6 million, respectively in interest income. Interest income is included within interest expense, net on our condensed consolidated statements of comprehensive income.

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Arhaus, Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited)

2. Recently Issued Accounting Standards

New Accounting Standards Adopted

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-02, Leases which, for operating leases, requires a lessee to recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in its balance sheets. While it will still be necessary for lessees to distinguish between “operating” and “financing” (formerly known as “capital”) leases, these distinctions will primarily affect how a lessee must recognize expense in its income statement. The new guidance is effective for financial statements issued for annual periods beginning after December 15, 2021.

The Company adopted ASC 842 as of January 1, 2022, using the modified retrospective approach by applying the transition provisions at the beginning of the period of adoption. Comparative periods will continue to be presented in accordance with ASC 840. The Company elected the package of practical expedients permitted under the transition guidance, which allowed the Company to carryforward the historical lease classification, lease identification and initial direct costs. The Company did not elect the “Land Easements” or “Hindsight” practical expedients. Additionally, the Company made the following accounting policy elections in connection with the adoption:

•Exclude short-term leases from our consolidated balance sheets; and

•Include both the lease and non-lease components as a single component and account for it as a lease.

As a result, the Company measured the right-of-use asset and lease liability for operating and finance leases as of January 1, 2022, using the remaining portion of the lease term that was determined under ASC 840. The adoption resulted in $242.0 million recognized as total right-of-use assets and $326.5 million recognized as total lease liabilities on our consolidated balance sheets as of January 1, 2022. For certain previous operating and capital leases, we qualified as the deemed owner of the construction project due to our significant involvement during the construction period under build-to-suit lease accounting requirements within ASC 840. As part of our adoption of ASC 842, we derecognized the cost of these construction projects of $31.0 million, which were previously recorded in property, furniture and equipment, net with an offsetting obligation in accrued other expenses on our consolidated balance sheets at December 31, 2021. See Note 5 — Leases for additional information.

In October 2020, the FASB issued ASU 2020-10, “Codification Improvements.” The amendments in this update represent changes to clarify the Codification or correct unintended application of guidance that are not expected to have a significant effect on current accounting practice. The amendments in this update affect a wide variety of Topics in the Codification and apply to all reporting entities within the scope of the affected accounting guidance. ASU 2020-10 is effective for annual periods beginning after December 15, 2021 for non-public business entities. Early application is permitted. The amendments in this update should be applied retrospectively. The Company adopted the standard as of January 1, 2022. The adoption of this standard did not have a material impact on our condensed consolidated financial statements.

3. Merchandise Warranties

The Company warrants certain merchandise to be free of defects in both construction materials and workmanship from the date the performance obligation was fulfilled to the client for three to ten years depending on the merchandise category. The Company accounts for merchandise warranties by accruing an estimated liability when we recognize revenue on the sale of warrantied merchandise. We estimate future warranty claims based on claim experience which includes materials and labor costs to perform the repairs or replace products. We use judgment in making our estimates. We record differences between our estimated and actual costs when the differences are known.

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Arhaus, Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited)

A reconciliation of the changes in our limited merchandise warranty liability is as follows (amounts in thousands):


	Nine months ended September 30,				Three months ended September 30,
	2022		2021		2022		2021
Balance as of beginning of period	$	4,724	$	3,326	$	5,412	$	3,868
Accruals during the period	8,285		5,652		3,181		2,138
Settlements during the period	(7,152)		(4,712)		(2,736)		(1,740)
Balance as of end of the period(1)	$	5,857	$	4,266	$	5,857	$	4,266

(1) $3.4 million and $2.7 million were recorded in accrued other expenses at September 30, 2022 and December 31, 2021, respectively. The remainder is recorded in other long-term liabilities on our condensed consolidated balance sheets.

We recorded accruals during the periods presented in the table above, primarily to reflect charges that relate to limited merchandise warranties issued during the respective periods.

4. Long-Term Debt

On June 25, 2020, the Company entered into a credit agreement (“Revolver”), which included a revolving credit facility of $30.0 million with availability limited pursuant to a borrowing base formula based on specified percentages of eligible inventory, net of reserves. The Company’s borrowings under the Revolver bore variable interest rates at the LIBOR index rate (“LIBOR”) plus the applicable margin (5.5% at September 30, 2021). In the event LIBOR ceased to be available during the term of the Revolver, the Revolver provided procedures to determine an Alternate Base Rate. The Revolver was to expire on June 25, 2023.

Loan costs related to the Revolver of $1.5 million were recorded in other noncurrent assets and were amortized over the term of the debt on a straight-line basis, which approximated the effective interest method. Amortization expense was $0.4 million and $0.1 million for the nine and three months ended September 30, 2021, respectively, and was included in interest expense, net within the condensed consolidated statements of comprehensive income. On November 4, 2021, the Company terminated the Revolver of which there were no borrowings drawn.

On November 8, 2021, the Company entered into a new revolving credit facility (the “2021 Credit Facility”). The 2021 Credit Facility provides for, among other things, (1) a revolving credit facility in an aggregate amount not to exceed at any time outstanding the amount of such lender’s commitment, (2) a letter of credit commitment in an amount equal to the lesser of (a) $10.0 million, and (b) the amount of the revolving credit facility as of such date, and (3) a swingline loan in an amount equal to the lesser of (a) $5.0 million, and (b) the amount of the revolving credit facility as of such date. The aggregate amount of all commitments of all lenders under the 2021 Credit Facility is $50.0 million, which may be increased pursuant to the terms of the 2021 Credit Facility. The 2021 Credit Facility contains restrictive covenants and has certain financial covenants, including a minimum rent-adjusted total leverage ratio and a minimum fixed charge ratio. The 2021 Credit Facility bears variable interest rates at the prevailing Bloomberg Short-Term Bank Yield index rate plus the applicable margin (1.50% at September 30, 2022), whereas the applicable margin is adjusted quarterly based on the Company’s consolidated rent-adjusted total leverage ratio. The 2021 Credit Facility expires on November 8, 2026.

At September 30, 2022 and December 31, 2021, we had no borrowings on the 2021 Credit Facility. Deferred financing costs related to the 2021 Credit Facility of $0.3 million are recorded in other noncurrent assets on the consolidated balance sheets and will be amortized over the term of the 2021 Credit Facility on a straight-line basis, which approximates the effective interest method. Accumulated amortization related to deferred financing costs for the 2021 Credit Facility was $0.1 million as of September 30, 2022.

Prior to the Company entering into the Revolver and 2021 Credit Facility, the debt structure (“Prior Credit Facilities”) included a revolving credit facility (the “Prior Revolver”) and a term loan (the “Term Loan”). The Prior Revolver was terminated on June 25, 2020 and Term Loan was paid in full on December 28, 2020.

The Company’s Term Loan had an exit fee clause which allowed the holder of the Term Loan to receive either $3.0 million upon repayment of the Term Loan or a payout equivalent to 4.0% of the total equity value of the Company. The 4.0% of

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Arhaus, Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited)

the total equity value of the Company payout was payable upon a change of control, qualified IPO or sale of all or substantially all assets of the Company. In connection with the repayment of the Term Loan on December 28, 2020, the holder informed the Company they would decline the option to receive the $3.0 million and elect to receive a payout equivalent to 4.0% of the equity value of the Company. The exit fee was treated as a derivative and adjusted to fair value each reporting period. The Company recorded derivative expense of $29.9 million and $0.1 million for the nine and three months ended September 30, 2021, respectively, which was included in selling, general and administrative expense within the condensed consolidated statements of comprehensive income. The Company used a portion of the net proceeds from the IPO to pay the derivative liability on November 8, 2021.

At September 30, 2021, the Company’s valuation of the derivative liability was measured using the probability-weighted expected return model (“PWERM”). The PWERM is a scenario-based methodology that estimates the fair value of the derivative based upon an analysis of future values for the Company. The Company considered two different scenarios:(a) remain private; and (b) IPO. Under the remain private scenario, as of September 30, 2021, the Company estimated the enterprise value by weighting the guideline public company method and the discounted cash flow method, and then relied on the option pricing method (“OPM”) and applied a discount for lack of marketability (“DLOM”). The OPM estimated the value using the Black-Scholes OPM. The fair value of the exit fee was determined utilizing unobservable inputs and therefore is a Level 3 measurement under the fair value hierarchy. The key assumptions used within the Black-Scholes OPM as of September 30, 2021 were as follows:


			September 30, 2021
Term			10 years
Risk-free rate of return			1.50%
Volatility			40.00%
Dividend yield			0.00%
DLOM			24.70%

The assumed volatility assumption is based on that of an identified group of comparable public companies. The fair value of the exit fee has been determined utilizing unobservable inputs and therefore is a Level 3 measurement under the fair value hierarchy.

The Company was in compliance with all applicable debt covenants at September 30, 2022 and December 31, 2021.

5. Leases

The Company leases real estate and equipment under operating and finance leases, some of which are from related parties as discussed in Note 10 — Related Party Transactions. The most significant obligations under these lease agreements require the payments of periodic rentals, real estate taxes, insurance and maintenance costs. Depending on particular Showroom leases, the Company can also owe a percentage rent payment if particular Showrooms meet certain sales figures.

The following table summarizes the amounts recognized in our condensed consolidated balance sheets related to leases as of September 30, 2022 (amounts in thousands):

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Arhaus, Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited)


	Condensed Consolidated Balance Sheet Classification	September 30, 2022
Assets
Operating lease assets	Operating right-of-use assets	$	224,921
Finance lease assets	Financing right-of-use assets	39,062
Total leased assets		$	263,983

Liabilities
Current operating leases	Current portion of operating lease liabilities	$	39,248
Non-current operating leases	Operating lease liabilities, long-term	263,753
Total operating lease liabilities		303,001

Current finance leases	Current portion of financing lease liabilities	522
Non-current finance leases	Financing lease liabilities, long-term	51,908
Total finance lease liabilities		52,430
Total lease liabilities		$	355,431

The components of lease cost recognized within our condensed consolidated statements of comprehensive income for the nine and three months ended September 30, 2022 are as follows (amounts in thousands):


		Nine months ended September 30,		Three months ended September 30,
	Condensed Consolidated Income Statement Classification	2022			2022
Lease costs:
Operating lease costs	Cost of goods sold	$	25,798		$	8,716
Operating lease costs	Selling, general and administrative expenses	4,743			1,955
Finance lease costs
Amortization of right-of-use assets	Selling, general and administrative expenses	1,516			540
Interest expense on lease liabilities	Interest expense, net	3,758			1,270
Other lease costs(1)	Cost of goods sold	26,764			9,961
Other lease costs(1)	Selling, general and administrative expenses	507			170
Total lease costs		$	63,086		$	22,612

(1) Other lease costs includes short-term lease costs and variable lease costs.

Rent expense, amortization of landlord improvements and percentage rent expense calculated under ASC 840 were $47.1 million, $8.7 million and $2.5 million for the nine months ended September 30, 2021, respectively. Rent expense, amortization of landlord improvements and percentage rent expense calculated under ASC 840 were $15.8 million, $3.1 million and $1.3 million for the three months ended September 30, 2021, respectively.

We often have options to renew lease terms for Showrooms and other assets. The exercise of lease renewal options is generally at our sole discretion. In addition, certain lease agreements may be terminated prior to their original expiration date at our discretion. We evaluate each renewal and termination options at the lease commencement date to determine if

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Arhaus, Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited)

we are reasonably certain to exercise the option on the basis of economic factors. The table below summarizes the weighted average remaining lease terms as of September 30, 2022.


Weighted Average Remaining Lease Term (In Years)						September 30, 2022
Operating leases						8.59
Finance leases						22.66

The discount rate implicit within our finance leases was determined at the time of lease commencement. However, the discount rate implicit within our operating leases is generally not determinable at the time of lease commencement and therefore the Company determines the discount rate based on its incremental borrowing rate. For all operating leases, the Company utilized a market-based approach to estimate the incremental borrowing rate (“IBR”), which required significant judgment. The Company estimated the base IBR based on an analysis of (i) yields on the Company’s 2021 Credit Facility, as well as comparable companies and (ii) unsecured yields and discount rates. The Company applied adjustments to the base IBRs to account for full collateralization and lease term. The table below summarizes the weighted average discount rate used to measure our lease liabilities as of September 30, 2022.


Weighted Average Discount Rate	September 30, 2022
Operating leases	4.39	%
Finance leases	9.72	%

Future lease liabilities at September 30, 2022 are as follows (amounts in thousands):


Year Ending December 31,	Operating Lease Liabilities (1)		Finance Lease Liabilities		Total Lease Liabilities
Remainder of 2022	$	12,322	$	1,333	$	13,655
2023	51,708		5,333		57,041
2024	46,897		5,153		52,050
2025	40,472		5,153		45,625
2026	37,826		5,612		43,438
2027	34,218		5,423		39,641
Thereafter	146,193		115,168		261,361
Total lease payments	369,636		143,175		512,811
Less: Amounts representing interest	(66,635)		(90,745)		(157,380)
Total	$	303,001	$	52,430	$	355,431

(1) Includes leases with related parties. See Note 10 — Related Party Transactions for amounts leased from related parties.

At September 30, 2022, the Company has entered into leases for the expansion of our Boston Heights distribution center, Showrooms and equipment which have not yet commenced with expected lease terms ranging from 5 to 23 years. The aggregate minimum rental payments over the term of the leases of approximately $166.7 million are not included in the above table.

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Arhaus, Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited)

Future minimum lease payments for operating and capital leases under ASC 840 at December 31, 2021, were as follows (amounts in thousands):


Year Ending December 31,	Operating Leases (1)		Capital Leases		Total Future Lease Payments
2022	$	45,892	$	4,673	$	50,565
2023	43,507		4,673		48,180
2024	38,659		4,673		43,332
2025	33,125		4,673		37,798
2026	29,903		5,132		35,035
Thereafter	129,498		120,390		249,888
	320,584		144,214		464,798
Less: Amounts representing interest	—		(94,064)		(94,064)
Total	$	320,584	$	50,150	$	370,734

(1) Includes leases with related parties. See Note 10 — Related Party Transactions for amounts leased from related parties.

Supplemental cash flow information related to leases for the nine months ended September 30, 2022, is as follows (amounts in thousands):


	Nine months ended September 30, 2022
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows for operating leases	$	35,587
Operating cash flows for finance leases	3,758
Financing cash flows for finance leases	113
Right-of-use assets obtained in exchange for lease obligations:
Operating leases	$	43,474
Finance leases	2,018

6. Equity Based Compensation

The following tables summarize the activity of the Company’s management incentive unit awards granted pre-IPO for the nine months ended September 30, 2022 and their equity based compensation expense for the nine and three months ended September 30, 2022 and 2021, respectively (amounts in thousands):


	Class A			Class B
	Amount	Weighted Average Grant Date Fair Value		Amount	Weighted Average Grant Date Fair Value
Unvested at December 31, 2021	2,520,229	$	16.28	596,598	$	0.13
Granted	—	—		—	—
Forfeited	—	—		—	—
Vested	(1,009,960)	17.38		(596,598)	0.10
Unvested at September 30, 2022	1,510,269	$	18.10	—	$	—

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Arhaus, Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited)


	Nine months ended September 30,				Three months ended September 30,
	2022		2021		2022		2021
Equity based compensation expense - management incentive units pre-IPO(1)	$	2,073	$	1,135	$	684	$	708

(1) Total unrecognized equity based compensation for the management incentive unit awards granted pre-IPO to be recognized in future periods is $9.5 million at September 30, 2022, and will be recognized over a weighted average period of 3.60 years. Equity based compensation expense is recorded within selling, general and administrative expenses on our condensed consolidated statements of comprehensive income.

On August 2, 2022, the Compensation Committee (the "Committee") of the Board of Directors of the Company approved grants of performance stock units (“PSUs”) and restricted stock units (“RSUs”) under the Arhaus, Inc. 2021 Equity Incentive Plan (the “2021 Plan”) to certain of the Company’s named executive officers and other key employees (“Award Recipient”). The Committee also approved RSU awards to certain members of the Board of Directors.

Each RSU represents a contingent right to receive one share of the Company’s Class A common stock upon vesting. The RSUs granted to Award Recipients vest in one-third increments on each of the first, second and third anniversary of the date of grant, provided that the Award Recipient continues to serve the Company through the applicable vesting date (“Continuous Service”). If the Award Recipient’s Continuous Service terminates for any reason other than death, disability or in connection with a change in control (as such terms are defined in the 2021 Plan), unless the Committee determines otherwise, all RSUs that are unvested at the time of such termination shall be forfeited and canceled immediately without consideration. The RSUs issued to certain members of the Board of Directors will vest on the one-year anniversary of the grant date. The Company accounts for forfeitures as they occur.

Each PSU represents a contingent right to receive one share of the Company’s Class A common stock upon vesting. The number of PSUs earned will be based on the Company’s financial performance as measured against pre-established target goals for cumulative demand revenue and cumulative adjusted EBITDA (the “Performance Goals”) over the period beginning on January 1, 2022 and ending on December 31, 2024 (the “Performance Period”). PSUs will vest as of the end of the Performance Period (December 31, 2024) subject to the Award Recipient’s Continuous Service, but will not settle and payout until the number of PSUs earned is determined by the Committee. The Award Recipient may earn between 0% and 200% of the PSU target award based on the Company’s achievement of the Performance Goals. The Company accounts for forfeitures as they occur.

The fair value of each PSU and RSU is based on the grant date market price of $5.75. The aggregate grant date fair value of the PSUs and RSUs granted during the nine months ended September 30, 2022 was $2.9 million and $4.1 million, respectively.

The following table summarizes the activity of the Company’s PSU and RSU awards for the nine months ended September 30, 2022, and their equity based compensation expense for the nine and three months ended September 30, 2022 and 2021, respectively (amounts in thousands):


	PSU Awards			RSU Awards
	Amount	Weighted Average Grant Date Fair Value		Amount	Weighted Average Grant Date Fair Value
Unvested at December 31, 2021	—	$	—	—	$	—
Granted	496,375	5.75		720,411	5.75
Forfeited	(750)	5.75		(3,250)	5.75
Vested	—	—		—	—
Unvested at September 30, 2022	495,625	$	5.75	717,161	$	5.75

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Arhaus, Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited)


	Nine months ended September 30,				Three months ended September 30,
	2022		2021		2022		2021
Equity based compensation expense - PSUs(1)	$	238	$	—	$	238	$	—
Equity based compensation expense - RSUs(2)	$	302	$	—	$	302	$	—

(1) Total unrecognized equity based compensation for the PSUs to be recognized in future periods is $3.2 million at September 30, 2022, and will be recognized over a weighted average period of 2.25 years. Equity based compensation expense is recorded within selling, general and administrative expenses on our condensed consolidated statements of comprehensive income.

(2) Total unrecognized equity based compensation for the RSUs to be recognized in future periods is $3.8 million at September 30, 2022, and will be recognized over a weighted average period of 2.55 years. Equity based compensation expense is recorded within selling, general and administrative expenses on our condensed consolidated statements of comprehensive income.

7. Segment Reporting

Our chief operating decision maker is our Chief Executive Officer (“CEO”), who reviews financial information presented on a consolidated basis for purposes of making decisions, assessing financial performance and allocating resources. We operate our business as