Table of Contents
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, 20212022
OR
☐

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file numbernumber: 001-41009
Arhaus, Inc.
(Exact name of registrant as specified in its charter)
Delaware87-1729256
(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 codecode)
Securities registered pursuant to Section 12(b) of the Act:
Title of each classTrading Symbol(s)Name of each exchange on which registered
Class A common stock, $0.001 par value per shareARHSThe 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 if any, 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. (Check one):
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 December 1, 2021 136,946,392November 3, 2022 the registrant had 52,947,617 shares of the registrant’sClass A common stock wereand 87,115,600 shares of Class B common stock outstanding.

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Part I - Financial Information
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Explanatory Note
Unless otherwise indicated or the context requires, “Arhaus,” the “Company,” “we,” “our” and “us” refer collectively to Arhaus, LLC and its subsidiaries. On November 8, 2021, Arhaus, Inc. completed an initial public offering (the “IPO”) of 12,903,226 shares of Class A common stock. In connection with the IPO, the Company completed the reorganization transactions described in Note 5 of the condensed balance sheets for Arhaus, Inc. and Note 12 of the condensed consolidated financial statements for Arhaus, LLC. For accounting purposes, the historical results included herein represent the assets, liabilities and results of operations of Arhaus, Inc. since the date of its formation and Arhaus, LLC and its subsidiaries prior to the IPO.

21

Part I - Financial Information
Item 1A.1. Financial Statements of Arhaus, Inc. and Subsidiaries


Arhaus, Inc.
and Subsidiaries
Condensed Consolidated Balance Sheets (unaudited)
(Unaudited, amounts in thousands, except share and per share data)
September 30,
2021		July 14,
2021
Assets
Cash and cash equivalents$— $— 
Total assets$— $— 
Commitments and contingencies (Note 4)$— $— 
Stockholders’ Equity
Common stock, $0.001 par value per share, 1,000 shares authorized, no shares issued and outstanding$— $— 
Total stockholders’ equity$— $— 
September 30,
2022		December 31,
2021
Assets
Current assets
Cash and cash equivalents$145,737 $123,777 
Restricted cash equivalents6,345 7,131 
Accounts receivable, net1,778 228 
Merchandise inventory, net292,571 208,343 
Prepaid and other current assets35,867 28,517 
Total current assets482,298 367,996 
Operating right-of-use assets224,921 — 
Financing right-of-use assets39,062 — 
Property, furniture and equipment, net128,783 179,631 
Deferred tax asset20,948 27,684 
Goodwill10,961 10,961 
Other noncurrent assets235 278 
Total assets$907,208 $586,550 
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable$58,455 $51,429 
Accrued taxes12,706 7,302 
Accrued wages17,498 16,524 
Accrued other expenses33,756 61,047 
Client deposits261,801 264,929 
Current portion of operating lease liabilities39,248 — 
Current portion of financing lease liabilities522 — 
Total current liabilities423,986 401,231 
Operating lease liabilities, long-term263,753 — 
Financing lease liabilities, long-term51,908 — 
Capital lease obligation— 50,525 
Deferred rent and lease incentives2,353 63,037 
Other long-term liabilities4,413 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 Capital187,605 186,209 
Total Arhaus, Inc. stockholders' equity160,795 69,765 
Total liabilities and stockholders' equity$907,208 $586,550 
The accompanying notes are an integral part of thethese unaudited condensed balance sheets.consolidated financial statements.
2
Table of Contents
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,
2022202120222021
Net revenue$872,595 $558,690 $320,030 $203,333 
Cost of goods sold505,561 325,710 183,739 118,522 
Gross margin367,034 232,980 136,291 84,811 
Selling, general and administrative expenses246,767 196,443 89,145 68,266 
Loss on disposal of assets— 466 — 452 
Income from operations120,267 36,071 47,146 16,093 
Interest expense, net3,367 4,091 751 1,365 
Other income(584)— (109)— 
Income before taxes117,484 31,980 46,504 14,728 
Income tax expense27,851 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, basic137,939,577 112,058,742 138,484,495 112,058,742 
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, diluted139,545,802 112,058,742 139,845,333 112,058,742 
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.
3
Notes to Condensed Balance Sheets
(unaudited)

1.     Organization

Arhaus, Inc. (the “Company”) was formed as a Delaware corporation on July 14, 2021. The Company was formed for the purpose of completing a public offering and related transactions in order to carry on the business of Arhaus, LLC and its subsidiaries (“Arhaus”). Following the reorganization transactions described in Note 5, Arhaus, LLC became a wholly owned indirect subsidiary of the Company.

2.     Basis of Presentation and Summary of Significant Accounting Policies

A summary of significant accounting policies applied in the preparation of the condensed balance sheets are as follows.

Basis of Presentation

The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). Separate statements of operations, comprehensive income, changes in stockholders’ equity, and cash flows have not been presented because the Company has not engaged in any business or other activities except in connection with its formation.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the balance sheet. Actual results could differ from those estimates.

3.     Stockholders’ Equity

On July 14, 2021, the Company was authorized to issue 1,000 shares of common stock, par value $0.001 per share.

4.     Commitments and Contingencies

The Company may be subject to legal proceedings that arise in the ordinary course of business. There are currently no proceedings to which the Company is a party, nor does the Company have knowledge of any proceedings that are threatened against the Company.

5.     Subsequent Events
The Company has evaluated subsequent events through the date of the issuance of the condensed balance sheets, and no additional matters were identified requiring recognition or disclosure in the financial statements, except for events described below.

Reorganization and Initial Public Offering

In connection with the IPO, the Company reorganized its ownership structure from a limited liability company to a corporation for the purpose of issuing common stock on a publicly traded exchange. Arhaus, Inc. serves as a holding company that indirectly wholly owns Arhaus, LLC and its subsidiaries. Pursuant to the terms of the Integrated Contribution Agreement by and among the Company, FS Arhaus Holding, Inc. (“FS Arhaus”), a Delaware corporation, Homeworks Holdings Inc. (“Homeworks”) and the unit holders of Arhaus, the following series of transactions were completed on November 8, 2021, which we refer to, collectively, as the Reorganization. These transactions included:

•the amendment and restatement of the certificate of incorporation of the Company, to authorize two classes of common stock, Class A common stock and Class B common stock and to authorize the Company to issue up to 750,000,000 shares of common stock, consisting of 600,000,000 share of Class A common stock, par value of $0.001 per share, 100,000,000
4
Notes to Condensed Balance Sheets
(unaudited)
shares of Class B common stock, par value of $0.001 and 50,000,000 shares of Preferred Stock; and

◦the Company’s acquisition of the units of Arhaus currently held by FS Arhaus, Homeworks, John Reed (“Reed”) through the John P Reed Trust dated April 29, 1985, as Amended (“Reed Revocable Trust”) and the members of management who hold incentive units (“Management Unitholders”), pursuant to the mergers and exchange described below, and the issuance in those transactions of Class A common stock to the holders of FS Arhaus and the Management Unitholders and Class B common stock to Homeworks, Reed and the Reed Revocable Trust.

The following steps describe the transactions that were completed to effect the Reorganization on November 8, 2021:

•Step 1: The Company formed two wholly owned subsidiaries, Ash Merger Sub 1, Inc. (“Merger Sub 1”), a Delaware corporation, and Ash Merger Sub 2, Inc. (“Merger Sub 2”), a Delaware corporation;

◦Step 2(a): Merger Sub 1 merged with and into FS Arhaus, with FS Arhaus surviving the merger, or Surviving Corporation 1, and became a wholly owned subsidiary of the Company and the holders of FS Arhaus received shares of Class A common stock;

◦Step 2(b): Merger Sub 2 merged with and into Homeworks, with Homeworks surviving the merger, or Surviving Corporation 2, and became a wholly owned subsidiary of the Company and the owners of Homeworks, received shares of Class B common stock;

◦Step 2(c): The Management Unitholders contributed their units of Arhaus to the Company in exchange for shares of Class A common stock;

◦Step 2(d): Reed and the Reed Revocable Trust contributed their respective units of Arhaus to the Company in exchange for shares of Class B common stock; and

◦Step 2(e): The Company contributed the units of Arhaus that it owns directly to Surviving Corporation 1 and Surviving Corporation 2 in proportion to the units of Arhaus owned by Surviving Corporation 1 and Surviving Corporation 2; and

◦Step 3: The Company issued shares of our Class A common stock to the purchasers in the IPO.

As a result of the Reorganization, a total of 39,623,041 shares of Class A common stock and 87,536,950 shares of Class B common stock were issued to the former holders of FS Arhaus, the former holders of Homeworks, Reed, the Reed Revocable Trust and the Management Unitholders. Of the total 127,159,991 shares of common stock, 2,520,227 shares of Class A common stock and 596,598 shares of Class B common stock issued to Management Unitholders are subject to certain vesting conditions specified in individual award agreements and were issued as restricted shares with similar time-based vesting provisions as the incentive units that were exchanged for such shares. If the vesting conditions of the restricted stock are not satisfied, such restricted stock will be forfeited and canceled.

On November 8, 2021, the Company consummated its IPO of 12,903,226 shares of Class A common stock at an IPO price of $13.00 per share. Shares of the Company’s Class A common stock began trading on the NASDAQ Global Select Market under the ticker symbol “ARHS” on November 4, 2021.

Revolving Credit Facilities
On November 4, 2021 Arhaus terminated its revolving credit facility dated June 25, 2020, of which there were no borrowings drawn. The termination of the revolving credit facility resulted in the Company paying a $0.6 million early termination fee and writing off the remaining unamortized loan costs of $0.8 million.

On November 8, 2021, the Company entered into a new revolving credit facility agreement (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 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 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 million,
5
Notes to Condensed Balance Sheets
(unaudited)
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 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 (1.75% at origination), whereas the applicable margin is adjusted quarterly based on the Company’s consolidated rent-adjusted total leverage ratio.
6

Item 1B. Financial Statements of Arhaus, LLC and Subsidiaries

Arhaus, LLC and Subsidiaries
Condensed Consolidated Balance Sheets
Statements of Changes in Stockholders’ Equity (Deficit)
(Unaudited, amounts in thousands)
September 30,
2021		December 31,
2020
Assets
Current assets
Cash and cash equivalents$149,246 $50,739 
Restricted cash equivalents5,880 6,909 
Accounts receivable, net360 600 
Merchandise inventory, net170,555 108,022 
Prepaid and other current assets20,380 19,733 
Total current assets346,421 186,003 
Property, furniture and equipment, net137,013 117,696 
Goodwill10,961 10,961 
Other noncurrent assets885 1,284 
Total assets$495,280 $315,944 
Liabilities and Members’ Deficit
Current liabilities
Accounts payable30,383 29,113 
Accrued taxes10,102 7,910 
Accrued wages18,634 9,660 
Accrued other expenses17,412 11,317 
Client deposits260,204 154,128 
Total current liabilities336,735 212,128 
Capital lease obligation50,550 47,600 
Deferred rent and lease incentives76,534 71,213 
Other long-term liabilities51,310 21,094 
Total liabilities515,129 352,035 
Commitments and contingencies (Note 10)00
Members’ deficit
Accumulated Deficit(22,654)(37,761)
Additional Paid-in Capital2,805 1,670 
Total members’ deficit(19,849)(36,091)
Total liabilities and members’ deficit$495,280 $315,944 
Nine months ended
Common Shares in Homeworks Holdings, Inc.Common StockTotal Stockholders'
Equity (Deficit)
VotingNon-VotingClass AClass B
SharesAmountSharesAmountSharesAmountSharesAmountRetained Earnings (Accumulated
Deficit)		Additional
Paid-in Capital		Noncontrolling InterestTotal 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 StockTotal Stockholders'
Equity (Deficit)
VotingNon-VotingClass AClass B
SharesAmountSharesAmountSharesAmountSharesAmountRetained Earnings (Accumulated
Deficit)		Additional
Paid-in Capital		Noncontrolling InterestTotal Stockholders' Equity (Deficit)
Balances as of December 31, 2020645 $— 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, 2021645 $— 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, LLCInc. and Subsidiaries
Condensed Consolidated Statements of Comprehensive IncomeChanges in Stockholders’ Equity (Deficit) (continued)
(Unaudited, amounts in thousands, except unit and per share data)thousands)
Nine Months Ended September 30,Three Months Ended September 30,
2021202020212020
Net revenue$558,690 $344,606 $203,333 $120,501 
Cost of goods sold325,710 214,817 118,522 75,289 
Gross margin232,980 129,789 84,811 45,212 
Selling, general and administrative expenses196,212 105,122 68,137 40,964 
Loss on disposal of assets466 — 452 — 
Income from operations36,302 24,667 16,222 4,248 
Interest expense4,018 9,335 1,339 2,734 
Income before taxes32,284 15,332 14,883 1,514 
State and local taxes1,704 900 500 731 
Net and comprehensive income$30,580 $14,432 $14,383 $783 
Net and comprehensive income (loss) attributable to the shareholders$30,580 $10,058 $14,383 $(686)
Net and comprehensive income (loss) per share
Basic and diluted$0.27 $0.09 $0.13 $(0.01)
Weighted-average number of shares outstanding
Basic and diluted112,058,742 112,058,742 112,058,742 112,058,742 
Three months ended
Common Shares in Homeworks Holdings, Inc.Common StockTotal Stockholders'
Equity (Deficit)
VotingNon-VotingClass AClass B
SharesAmountSharesAmountSharesAmountSharesAmountRetained Earnings (Accumulated
Deficit)		Additional
Paid-in Capital		Noncontrolling InterestTotal 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 StockTotal Stockholders'
Equity (Deficit)
VotingNon-VotingClass AClass B
SharesAmountSharesAmountSharesAmountSharesAmountRetained Earnings (Accumulated
Deficit)		Additional
Paid-in Capital		Noncontrolling InterestTotal Stockholders' Equity (Deficit)
Balances as of June 30, 2021645 $— 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, 2021645 $— 4,158 $— — $— — $— $(27,995)$2,805 $1,945 $(23,245)
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
85
Arhaus, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited, amounts in thousands)
Arhaus, LLC and Subsidiaries
Condensed Consolidated Statements of Changes in Mezzanine Equity and Members’ Deficit
(Unaudited, amounts in thousands)
Nine Months Ended
Mezzanine EquityMembers' Deficit
Class A PreferredClass B PreferredClass AClass B
UnitsAmountUnitsAmountUnitsAmountUnitsAmountAccumulated
Deficit		Additional
Paid-in Capital		Total
Members'
Deficit
Balances as of December 31, 2020— $— — $— 20,939 $— 7,488 $— $(37,761)$1,670 $(36,091)
Net income— — — — — — — — 30,580 — 30,580 
Tax distribution— — — — — — — — (15,473)— (15,473)
Incentive unit compensation— — — — — — — — — 1,135 1,135 
Balances as of September 30, 2021— $— — $— 20,939 $— 7,488 $— $(22,654)$2,805 $(19,849)
Balances as of December 31, 20191,250 $18,206 1,250 $18,206 20,939 $— 7,488 $— $(34,747)$1,367 $(33,380)
Net income— — — — — — — — 14,432 — 14,432 
Tax distribution— — — — — — — — (8,845)— (8,845)
Preferred units dividend unpaid— 2,187 — 2,187 — — — — (4,374)— (4,374)
Incentive unit compensation— — — — — — — — — 226 226 
Balances as of September 30, 20201,250 $20,393 1,250 $20,393 20,939 $— 7,488 $— $(33,534)$1,593 $(31,941)
Nine months ended September 30,
20222021
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 amortization18,319 17,206 
Amortization of operating lease right-of-use asset21,976 — 
Amortization of deferred financing fees and interest on finance lease in excess of principal paid8,731 839 
Equity based compensation2,613 1,135 
Deferred tax assets5,458 — 
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 liabilities456 (732)
Accounts payable10,334 1,698 
Accrued expenses23,682 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 activities58,237 141,190 
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 equivalents21,174 91,336 
Cash, cash equivalents and restricted cash equivalents
Beginning of period130,908 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, LLCInc. and Subsidiaries
Condensed Consolidated Statements of Changes in Mezzanine Equity and Members’ DeficitCash Flows (continued)
(Unaudited, amounts in thousands)
Three Months Ended
Mezzanine EquityMembers' Deficit
Class A PreferredClass B PreferredClass AClass B
UnitsAmountUnitsAmountUnitsAmountUnitsAmountAccumulated
Deficit		Additional
Paid-in Capital		Total
Members'
Deficit
Balances as of June 30, 2021— $— — $— 20,939 $— 7,488 $— $(37,037)$2,097 $(34,940)
Net income— — — — — — — — 14,383 — 14,383 
Incentive unit compensation— — — — — — — — — 708 708 
Balances as of September 30, 2021— $— — $— 20,939 $— 7,488 $— $(22,654)$2,805 $(19,849)
Balances as of June 30, 20201,250 $19,659 1,250 $19,658 20,939 $— 7,488 $— $(24,003)$1,517 $(22,486)
Net income— — — — — — — — 783 — 783 
Tax distribution— — — — — — — — (8,845)— (8,845)
Preferred units dividend unpaid— 734 — 735 — — — — (1,469)— (1,469)
Incentive unit compensation— — — — — — — — — 76 76 
Balances as of September 30, 20201,250 $20,393 1,250 $20,393 20,939 $— 7,488 $— $(33,534)$1,593 $(31,941)





Nine months ended September 30,
20222021
Supplemental disclosure of cash flow information
Interest paid in cash$3,858 $4,006 
Interest received in cash316 — 
Income taxes paid in cash20,579 1,394 
Noncash operating activities:
Lease incentives7,532 4,253 
Noncash investing activities:
Purchase of property, furniture and equipment in accounts payable2,661 (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 contributions62 — 
Capital lease obligation— 2,591 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
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Condensed Consolidated Statements of Cash Flows
(Unaudited, amounts in thousands)
Nine Months Ended September 30,
20212020
Cash flows from operating activities
Net income$30,580 $14,432 
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization17,206 12,682 
Amortization of deferred financing fees, payment-in-kind interest and interest on capital lease in excess of principal paid839 2,522 
Incentive unit compensation expense1,135 326 
Derivative expense29,905 500 
Loss on disposal of assets466 — 
Amortization and write-off of lease incentives(5,890)(6,807)
Changes in operating assets and liabilities
Accounts receivable240 185 
Merchandise inventory(62,533)8,004 
Prepaid and other current assets(647)(424)
Other noncurrent assets— (1,041)
Other noncurrent liabilities335 (80)
Accounts payable1,698 4,288 
Accrued expenses16,221 4,109 
Deferred rent and lease incentives6,958 12,645 
Client deposits106,076 63,779 
Net cash provided by operating activities142,589 115,120 
Cash flows from investing activities
Purchases of property, furniture and equipment(29,531)(11,129)
Net cash used in investing activities(29,531)(11,129)
Cash flows from financing activities
Proceeds from revolving debt— 20,500 
Payments on revolving debt— (9,500)
Payments on long-term debt— (11,220)
Repurchase of incentive units— (100)
Principal payments under capital leases(107)— 
Distributions to owners(15,473)(8,845)
Net cash used in financing activities(15,580)(9,165)
Net increase in cash, cash equivalents and restricted cash equivalents97,478 94,826 
Cash, cash equivalents and restricted cash equivalents
Beginning of period57,648 18,559 
End of period$155,126 $113,385 
Supplemental disclosure of cash flow information
Interest paid in cash$3,877 $6,549 
Income taxes paid in cash$1,292 $1,079 
Noncash operating activities:
Lease incentives$4,253 $1,717 
Noncash investing activities:
Purchase of property, furniture and equipment in accounts payable$(428)$220 
Noncash financing activities:
Property, furniture and equipment additions due to build-to-suit lease transaction$1,040 $— 
Capital lease obligations$2,591 $— 
Dividends - unpaid$— $4,374 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
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Arhaus, LLCInc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1
1. Nature of Business and Basis of Presentation
Nature of Business
Arhaus, LLCInc. (the “Company,” “we” or “Arhaus”) is a Delaware limited liability companycorporation 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 offer merchandise assortments across a number of categories, including furniture, lighting, textiles, décor, and outdoor.We position our retail locations as Showrooms for our brand, while our website acts as a virtual extension of our Showrooms. The Company operated 77 80 Showrooms as ofat September 30, 2021.2022.
At September 30,Arhaus was formed on July 14, 2021 for the purpose of completing an initial public offering (“IPO”) of its common stock and December 31, 2020, allrelated transactions in order to carry on the business of Arhaus, LLC (“LLC”) and its subsidiaries. Pursuant to the corporate reorganization and completion of the Company’s Class A units are ownedIPO 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”Homeworks,” or “Class A Units”) and John Reedthe unit holders (“Reed”Management Unitholders”) through the John P Reed Trust dated April 29, 1985, as Amended (“Reed Revocable Trust”). All shares of Homeworks are owned by the Reed Revocable Trust and related party trustsLLC, a series of Reed. All of the Company’s Class B units are owned by FS Arhaus Holding, Inc., a Delaware corporation. See Note 12 for our discussion of the reorganization of the Company that was consummatedtransactions were completed on November 8, 2021.
Effects of COVID-19 on Our Business
The COVID-19 outbreak2021, 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 first quarter of fiscal year 2020 caused disruption to our business operations.same party before and after the Reorganization and therefore resulted in a change in reporting entity. In our initial responseaccordance with ASC 805-50-45-5, for transactions between entities under common control, the condensed consolidated financial statements for periods prior to the COVID-19 health crisis, we undertook immediate adjustments to our business operations including temporarily closing all retail locations, furloughing employees, minimizing expenses and delaying investments, including pausing some inventory orders while we assessed the status of our business. Our approach to the crisis evolved quickly as our business trends substantially improved during the second through fourth quarters of fiscal year 2020 as a result of both the reopening of our Showrooms and strong consumer demand for our products. We had reopened all of our Showrooms and Outlet stores by June 30, 2020, although currently many of our Showrooms and Outlets continue to conduct business with occupancy limitations and other operational restrictions.
While weReorganization have been ableadjusted to serve our clients and operate our business throughretrospectively combine the ongoing COVID-19 health crisis, there can be no assurance that future events will not have an impact on our business, results of operations or financial condition since the extent and duration of the health crisis remains uncertain. Future adverse developments in connection with the COVID-19 crisis, including additional waves or resurgences of COVID-19 outbreaks, new strains or variants of the virus, evolving international, federal, state and local restrictions and safety regulations in response to COVID-19 risks, changes in consumer behavior and health concerns, the pace of economic activity in the wake of the COVID-19 crisis, or other similar issues could adversely affect our business, results of operations or financial condition in the future, or our financial results and business performance in future periods.
Various constraints in our merchandise supply chain have resulted in delays in our ability to convert demand into net revenue at normal historical rates. We anticipate that the business conditions related to COVID-19 will continue to adversely affect the capacity of our vendors and supply chain to meet our demand during fiscal year 2021. We expect that our supply chain may catch up to demand in the foreseeable future, but business circumstances and operational conditions in numerous international locations where our vendors operate cannot be predicted with certainty.
Depending on the future course of the pandemic and further outbreaks, we may experience further restrictions and closures of our physical operations in our Showrooms, Design Studios and Outlet stores. Although we experienced strong demandpreviously separate entities for our products during fiscal year 2020 and the nine months ended September 30, 2021, some of the demand may have been driven by stay-at-home restrictions that were in place throughout many parts of the United States. The exact impact of future changes to these stay-at-home restrictions cannot be predicted with certainty.
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Arhaus, LLC and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
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.
Unaudited Interim Condensed Financial Statements
The accompanying condensed consolidated balance sheetsheets at September 30, 2022 and December 31, 2021, the condensed consolidated statements of comprehensive income and changes in mezzanine equity and members’ deficitstockholders’equity (deficit) for the nine and three months ended September 30, 20212022 and 2020,2021, the condensed consolidated statements of cash flows for the nine months ended September 30, 2021 2022 and 2020,2021 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, 2021;2022; the results of operations and changes in mezzanine equity and members’ deficitstockholders’equity (deficit) for the nine and three months ended September 30, 2022 and 2021 and 2020; andthe condensed consolidated statements of cash flows for the nine months ended September 30, 2021 2022 and 2020.2021. The condensed consolidated balance sheet as of December 31, 20202021 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, 20212022 and 20202021 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 Company's final prospectus filed with the SEC pursuant to Rule 424(b)(4) under the Securities Actyear ended December 31, 2021.
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Table of 1933, as amended, dated November 3, 2021.Contents
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 and management’s discussion and analysis 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, incentive unitderivative and equity based compensation and a derivative instrument.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 thatsubstantially all client deposits as of September 30, 20212022 will be recognized as net revenue within the next 12 months as the performance obligations are satisfied.
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Arhaus, LLC and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
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 $0.8$0.9 million and $0.8$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 at September 30, 2021 and December 31, 2020, respectively.sheets. The Company recognizes income associated with breakage proportional to actual gift card redemptions.
Fair Values of Financial Instruments
The Company’s primary financial instrumentsinstruments are cash and cash equivalent investments, accounts receivable, payables, lease obligations, incentive unit compensation and a derivative instrument.and equity based compensation instruments. Due to the short-termshort-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, 20212022 and December 31, 2020.2021. See Note 4 for discussion of our derivative, Note 5 for discussion of our lease obligations and Note 76 for discussion of our incentive unitequity 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.
Correction of an Immaterial Error
During the third quarter of 2021,From time to time, the Company recorded an out-of-period adjustment to correct prior period overstatements of property, furnitureinvests in money market funds and equipment, netother Level 1 cash and the cumulative understatement of selling, general and administrative expenses of $3.0 million. The errors were primarily caused by a capital lease asset being depreciated over a longer incorrect useful life. Management evaluated the impacts of the out-of-period adjustments to correct the errors forcash equivalent investments. For the nine and three months ended September 30, 20212022, the Company earned $0.6 million and for prior periods, both individually and$0.6 million, respectively in the aggregate, and concluded that the adjustment was not material to the Company’sinterest income. Interest income is included within interest expense, net on our condensed consolidated annual or interim financial statements for all impacted periods.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 or Updates Not Yet 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, onin its balance sheets. While it will still be necessary for lessees to distinguish between “operating” and “financing” (formerly known as “capital”) leases, and for lessors to distinguish between sales-type, direct financing, and operating leases, these distinctions will primarily affect how a lessee or lessor must recognize expense or income, respectively, in its income statement. The new guidance is effective for financial statements issued for annual periods beginning after December 15, 2021,2021.
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. Early adoption is permitted.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 of this ASU will resultresulted in a material increase$242.0 million recognized as total right-of-use assets and $326.5 million recognized as total lease liabilities on the Company’s
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Arhaus, LLC and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
condensedour consolidated balance sheets for lease liabilitiesas of January 1, 2022. For certain previous operating and right-of-use assets. Whilecapital leases, we qualified as the Company is continuing to evaluate all potential impactsdeemed owner of the standard,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 do not expectderecognized the adoption to have a material impactcost 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 the Company’sour consolidated net earnings or cash flows. The Company plans to adopt ASU 2016-02 in 2022.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 does not expectadopted the standard as of January 1, 2022. The adoption of this standard todid not have a material impact on itsour condensed consolidated financial statements.
3. Merchandise Warranties
The CompanyCompany 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.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,Nine months ended September 30,Three months ended September 30,
20212020202120202022202120222021
Balance as of beginning of periodBalance as of beginning of period$3,326 $3,164 $3,868 $3,020 Balance as of beginning of period$4,724 $3,326 $5,412 $3,868 
Accruals during the periodAccruals during the period5,652 3,211 2,138 1,112 Accruals during the period8,285 5,652 3,181 2,138 
Settlements during the periodSettlements during the period(4,712)(3,306)(1,740)(1,063)Settlements during the period(7,152)(4,712)(2,736)(1,740)
Balance as of end of the period (1)Balance as of end of the period (1)$4,266 $3,069 $4,266 $3,069 
Balance as of end of the period(1)
$5,857 $4,266 $5,857 $4,266 
(1) - $2.4 $3.4 million and $1.8$2.7 million were recorded in accrued other expenses at September 30, 20212022 and December 31, 2020,2021, respectively. The remainder is recorded in other long-term liabilities.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 includesincluded a revolving credit facility of $30.0 million with availability limited pursuant to a borrowing base formulatedformula based on specified percentages of eligible inventory, net of reserves. The Company’s borrowings under the Revolver bearsbore variable interest rates at the LIBOR index rate (“LIBOR”) plus the applicable margin (5.5% at September 30, 2021). In the event LIBOR ceasesceased to be available during the term of the Revolver, the Revolver providesprovided procedures to determine an Alternate Base Rate.
At September 30, 2021, we had no availability on the Revolver based on the borrowing base formula. The Company has the option, subject to terms and conditions, to borrow on the Revolver by means of LIBOR loans. The Revolver has certain financial covenants, including a minimum fixed charge ratio and minimum EBITDA requirements. The Revolver carries a non-use fee of 0.50% per annum. was to expire on June 25, 2023.
Loan costs related to the Revolver of $1.5 million arewere recorded in other noncurrent assets net on the
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Notes to Condensed Consolidated Financial Statements
(Unaudited)
condensed consolidated balance sheets and arewere amortized over the term of the debt on a straight-line basis, which approximatesapproximated 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 iswas 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 loandeferred financing costs for the revolver2021 Credit Facility was $0.6$0.1 million as of September 30, 2021. The Revolver expires on June 25, 2023.2022.
Prior to the Company entering into the Revolver and 2021 Credit Facility, the debt structure (“Prior Credit Facilities”) included a revolving credit facility of $30.0 million (the “Prior Revolver”) with availability limited pursuant to a borrowing base formula based on specified percentages of eligible inventories and accounts receivable.
The Company had the option, subject to terms and conditions, to borrow on the Prior Revolver by means of any combination of Base Rate Loans or LIBOR Loans. The Company’s borrowings under the Prior Revolver bore variable interest rates for Base Rate Loans of the greater of (a) the Federal Funds Rate plus 0.5%, (b) the Prime Rate, (c) the LIBOR Rate plus 1%, and (d) 4.00% and at LIBOR loans at LIBOR plus the applicable margin. The Prior Revolver carried a non-use fee of 0.50% per annum. Loan costs related to the Prior Revolver were recorded in other noncurrent assets, net and were amortized over the term of the debt on a straight-line basis. Amortization expense was $0.2 million and $0.0 million for the nine and three months ended September 30, 2020, and is included in interest expense within the condensed consolidated statements of comprehensive income. The unamortized balance of the loan costs of $0.6 million as of June 25, 2020 were written off as interest expense within the condensed consolidated statements of comprehensive income, as the Company entered into a new credit agreement with different lenders.
The Company’s Prior Credit Facilities also included a term loan of $40.0 million (the “Term Loan”). The Term Loan bore interest at a rate equal to 16.0% per annum, of which 12.0% per annumPrior Revolver was to be paid in cash and 4.0% per annum was to be paid in kind by capitalizing such amount and adding it to the principal amount of the loan each quarter. The Company was required to make a prepaymentterminated on the Term Loan in an amount not less than 50 percent of the Company’s Excess Cash Flow, as defined, on or before May 15thJune 25, 2020 of the year following such fiscal year. Other than the mandatory Excess Cash Flow payments, as defined, which were calculated at the end of each fiscal year, the Term Loan had no required periodic principal payments during the term. The Term Loan facility permitted early principal payments subject to a 1.0% prepayment premium through December 26, 2020, and none thereafter. The Term Loan was paid in full on December 28, 2020.
Financing costs related to the Term Loan were amortized over the term of the Term Loan, on a straight-line basis, which approximated the effective interest method. Amortization expense was $0.5 million and $0.2 million for the nine and three months ended September 30, 2020, and is included in interest expense within the condensed consolidated statements of comprehensive income.
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 iswas 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 iswas treated as a derivative and adjusted to fair value each reporting period. The Company recorded a liabilityderivative expense of $49.5$29.9 million and $19.6$0.1 million at for the nine and three months ended September 30, 2021, respectively, which was included in selling, general and December 31, 2020, respectively, related to the derivative that is classifiedadministrative expense within other long-term liabilities on the condensed consolidated balance sheets.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
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Arhaus, LLC and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
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 Company will continue to evaluate the above assumptions for each reporting period. The fair value of the exit fee has beenwas 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 arewere as follows:
September 30,
2021
Term10 years
Risk-free rate of return1.50%
Volatility40.00%
Dividend yield0%
At December 31, 2020, the Company used a discounted cash flow method and guideline public company method to determine the fair value of equity which was used to calculate the fair value of the derivative liability. The key assumptions used within the valuation as December 31, 2020 are as follows:
December 31,
20200.00%
Term10 years
Risk-free rate of returnDLOM0.90%
Volatility40.00%
Dividend yield0%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, 20212022 and December 31, 2020. See Note 12 for a discussion of the termination of the revolver and the entering into a new revolving credit facility agreement.2021.
5. Leases
The Company leases real estate and equipment under operating and finance leases, some of which are from related parties.parties as discussed in Note 10 —Related Party Transactions. The most significant obligationsobligations under these lease agreements require the payments of periodic rentals, real estate taxes, insurance and maintenance costs. Rent expense for the nine months ended September 30, 2021 and 2020 was $47.1 million and $43.5 million, respectively. Rent expense for the three months ended September 30, 2021 and 2020 was $15.8 million and $14.5 million, respectively. Amortization of landlord improvements for the nine months ended September 30, 2021 and 2020 was $8.7 million and $7.8 million, respectively. Amortization of landlord improvements for the three months ended September 30, 2021 and 2020 was $3.1 million and $2.7 million, respectively. Depending on particular Showroom leases, the Company can also owe a percentage rent payment if particular Showrooms meet certain sales figures. Percentage

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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Notes to Condensed Consolidated Financial Statements
(Unaudited)
Condensed Consolidated Balance Sheet ClassificationSeptember 30, 2022
Assets
Operating lease assetsOperating right-of-use assets$224,921 
Finance lease assetsFinancing right-of-use assets39,062 
Total leased assets$263,983 
Liabilities
Current operating leasesCurrent portion of operating lease liabilities$39,248 
Non-current operating leasesOperating lease liabilities, long-term263,753 
Total operating lease liabilities303,001 
Current finance leasesCurrent portion of financing lease liabilities522 
Non-current finance leasesFinancing lease liabilities, long-term51,908 
Total finance lease liabilities52,430 
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 Classification20222022
Lease costs:
Operating lease costsCost of goods sold$25,798 $8,716 
Operating lease costsSelling, general and administrative expenses4,743 1,955 
Finance lease costs
Amortization of right-of-use assetsSelling, general and administrative expenses1,516 540 
Interest expense on lease liabilitiesInterest expense, net3,758 1,270 
Other lease costs(1)
Cost of goods sold26,764 9,961 
Other lease costs(1)
Selling, general and administrative expenses507 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 2020 was $2.5percentage rent expense calculated under ASC 840 were $15.8 million, $3.1 million and $0.7$1.3 million respectively. Percentage rent expense for the three months ended September 30, 2021, respectively.
We often have options to renew lease terms for Showrooms and 2020other 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 leases8.59
Finance leases22.66
The discount rate implicit within our finance leases was $1.3determined 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 RateSeptember 30, 2022
Operating leases4.39 %
Finance leases9.72 %
Future lease liabilities at September 30, 2022 are as follows (amounts in thousands):
Year Ending December 31,
Operating Lease Liabilities (1)
Finance Lease LiabilitiesTotal Lease Liabilities
Remainder of 2022$12,322 $1,333 $13,655 
202351,708 5,333 57,041 
202446,897 5,153 52,050 
202540,472 5,153 45,625 
202637,826 5,612 43,438 
202734,218 5,423 39,641 
Thereafter146,193 115,168 261,361 
Total lease payments369,636 143,175 512,811 
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 LeasesTotal Future Lease Payments
2022$45,892 $4,673 $50,565 
202343,507 4,673 48,180 
202438,659 4,673 43,332 
202533,125 4,673 37,798 
202629,903 5,132 35,035 
Thereafter129,498 120,390 249,888 
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 leases3,758 
Financing cash flows for finance leases113 
Right-of-use assets obtained in exchange for lease obligations:
Operating leases$43,474 
Finance leases2,018 
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 AClass B
AmountWeighted Average Grant Date Fair ValueAmountWeighted Average Grant Date Fair Value
Unvested at December 31, 20212,520,229 $16.28 596,598 $0.13 
Granted— — — — 
Forfeited— — — — 
Vested(1,009,960)17.38 (596,598)0.10 
Unvested at September 30, 20221,510,269 $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,
2022202120222021
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 $0.1$4.1 million, respectively.
In March,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 AwardsRSU Awards
AmountWeighted Average Grant Date Fair ValueAmountWeighted Average Grant Date Fair Value
Unvested at December 31, 2021— $— — $— 
Granted496,375 5.75 720,411 5.75 
Forfeited(750)5.75 (3,250)5.75 
Vested— — — — 
Unvested at September 30, 2022495,625 $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,
2022202120222021
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 one operating segment and therefore we have one reportable segment that offers an assortment of merchandise across a number of categories, including furniture, outdoor, lighting, textiles, and décor. The assortment of merchandise can be purchased through our retail and eCommerce sales channels.
The majority of our net revenue is generated through sales to clients in the United States. Sales to clients outside of the United States are not significant. Further, no single client represents more than ten percent or more of our net revenue.
The following table shows net revenue by merchandise sales channel for the nine and three months ended September 30, 2022 and 2021, respectively (amounts in thousands):
Nine months ended September 30,Three months ended September 30,
2022202120222021
Retail$727,953 $457,439 $268,988 $166,928 
eCommerce144,642 101,251 51,042 36,405 
Total net revenue$872,595 $558,690 $320,030 $203,333 
8. Net and Comprehensive Income per Share
As a result of the Reorganization and IPO, existing Class A and Class B Unitholders of LLC were issued Class B and Class A common stock in the Company, entered into a lease agreement with a related partyrespectively. The Class A Unitholders received 80,792,206 shares of Class B common stock and the Class B Unitholders received 31,266,536 shares of Class A common stock. Accordingly, all share and per share amounts for a distribution center and manufacturing building, with construction expected to be completedall periods presented in the fourth quartercondensed consolidated statements of comprehensive income and this note have been adjusted retroactively, where applicable, to reflect the Reorganization.
Basic and diluted net and comprehensive income per share for the nine and three months ended September 30, 2022 and 2021, was calculated by adjusting net and comprehensive income attributable to Arhaus, Inc. for net and comprehensive income attributable to noncontrolling interest, and dividing by basic and diluted weighted-average number of common shares outstanding. Management Incentive Unitholders did not participate in the earnings or losses of the Company as of September 30, 2021 and therefore were not participating securities. As such, they were not included within the calculation of basic or diluted earnings per share as of September 30, 2021.
Basic and diluted net and comprehensive income per share for the nine and three months ended September 30, 2022 and 2021, is as follows (amounts in thousands except share and per share data):
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Notes to Condensed Consolidated Financial Statements
(Unaudited)
Nine months ended September 30,Three months ended September 30,
2022202120222021
Numerator
Net and comprehensive income$89,633 $30,276 $36,936 $14,228 
Less: Net and comprehensive 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 
Denominator—Weighted Average Shares Outstanding
Weighted-average number of common shares outstanding, basic137,939,577 112,058,742 138,484,495 112,058,742 
Effect of dilutive restricted stock (1)
1,606,225 — 1,360,838 — 
Weighted-average number of common shares outstanding, diluted139,545,802 112,058,742 139,845,333 112,058,742 
Net and Comprehensive Income Per Share
Net and comprehensive income per share, basic$0.65 $0.11 $0.27 $0.05 
Net and comprehensive income per share, diluted$0.64 $0.11 $0.26 $0.05 
(1) During the nine and three months ended September 30, 2022, 594,312 and 546,164 shares of unvested restricted stock were excluded from the computation of diluted earnings per share because their effect would have been anti-dilutive.
9. Commitments and Contingencies
The Company is involved in litigation and claims that are incidental to its business. Although the outcome of these matters cannot be determined at the present time, the Company believes that the ultimate resolution of these matters will not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.
From time to time, the Company has received inquiries from a number of state and local taxing agencies with respect to the remittance of sales, use, telecommunications, excise, and income taxes. Several jurisdictions are currently conducting tax audits of the Company's records. The Company collects, or has accrued for, taxes that it believes are required to be remitted. The amounts that have been remitted have historically been within the accruals established by the Company. The Company adjusts its accrual when facts relating to specific exposures warrant such adjustment. As of September 30, 2022 and December 31, 2021, we recorded liabilities of $1.2 million and $1.2 million, respectively, in accrued taxes on the condensed consolidated balance sheets for non-income tax matters that were probable and reasonably estimable.
10. Related Party Transactions
Leasing transactions
In November 2000, the Company entered into a lease agreement with Pagoda Partners, LLC, a company of which John Reed, our CEO, indirectly owns 50%, for our warehouse in Walton Hills, Ohio. The base lease term was 17 years with a 5-year renewal option. In August 2020, the Company amended the lease agreement to extend the lease term to April 2024 with the ability to extend the lease in 12-month increments thereafter. The monthly rental payments are $0.1 million. Rent expense was $1.0 million and $1.0 million for the nine months ended September 30, 2022 and 2021, respectively. Rent expense was $0.3 million and $0.3 million for the three months ended September 30, 2022 and 2021, respectively.
In July 2010, the Company entered into a lease agreement with Brooklyn Arhaus, a company of which our CEO and Mr. Beargie, a Director of the Company, own 85% and 15%, respectively, for our Outlet in Brooklyn, Ohio. The base lease term is 15 years with no lease renewal options. The monthly rental payments are $20 thousand. Rent expense was $0.2
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Notes to Condensed Consolidated Financial Statements
(Unaudited)
million and $0.2 million for the nine months ended September 30, 2022 and 2021, respectively. Rent expense was $0.1 million and $0.1 million for the three months ended September 30, 2022 and 2021, respectively.
In September 2014, the Company entered into a lease agreement with Premier Arhaus, LLC, a company of which our CEO indirectly owned 50% during 2021, on a triple net basis for our headquarters building and distribution center, with construction completed during 2016. The base lease term is 17 years, with a 10-year renewal option at fixed rental payments, and with two additional 5-year renewal options at fair market rent. The monthly rental payments range from $0.2 million to $0.5 million during the 17-year base lease term and from $0.5 million to $0.6 million during the 10-year renewal period. In September 2021, the Company amended the existing finance lease agreement to extend the lease term for an additional three years, which included monthly rental payments of $0.6 million. Further, the amended lease agreement provides for the expansion of the Company’s distribution center and monthly rental payments range from $0.1 million to $0.2 million. During the fourth quarter of 2021, the lessor sold its interest in the leased assets to a third party. As a result, the lease is no longer with a related party of the Company. Rent expense was $4.4 million and $1.5 million for the nine and three months ended September 30, 2021, respectively.
In March 2021, the Company entered into a lease agreement with Premier Conover, LLC, a company of which our CEO indirectly owns 10%, for a distribution center and manufacturing building, for which construction was completed in the fourth quarter of 2021. The base lease term is for 12-years,12 years, with a 10-year renewal option and two additional 5-year renewal options at the higher of the minimum base rent or the fair market rent at the time of renewal execution. The monthly rental payments range from $0.2 million to $0.3 million during the 12-year base lease term and from $0.4 million to $0.5 million during the 10-year renewal period. The Company has concluded thatRent expense was $2.8 million and $1.0 million for the lease is an operating lease.
Future minimum rental payments required under operating leases with initial or remaining noncancelable lease terms as ofnine and three months ended September 30, 2021, are as follows (amounts in thousands):2022, respectively.
Year Ending December 31,Third PartyRelated PartyTotal
Remainder of 2021$10,234 $1,143 $11,377 
202240,802 4,596 45,398 
202336,813 4,686 41,499 
202432,614 3,873 36,487 
202528,135 3,455 31,590 
202624,569 3,374 27,943 
Thereafter104,163 25,564 129,727 
$277,330 $46,691 $324,021 

Other transactions
In September, 2014,accordance with the Company entered intochange in reporting entity, the Company’s condensed consolidated statements of cash flows include the payment and receipt of a lease agreement withrelated-party receivable and a related party on a triple net basisrelated-party note receivable between Homeworks and our CEO for our headquarters building and distribution center, with construction completed during 2016. The base lease term is 17-years, with a 10-year renewal option at fixed rental payments, and with two additional 5-year renewal options at the fair market rental payments. The monthly rental payments range from $0.2 million to $0.5 million during the 17-year base lease term and from $0.5 million to $0.6 million during the 10-year renewal period. The Company has concluded that the lease is a capital lease. The capital lease obligation and related asset were valued at $45$0.1 million and were recorded in 2016 when the Company took control of the property. In September 2021, the Company amended the existing capital lease agreement to extend the lease term for an additional three years, which increased the capital lease obligation by $2.4$1.0 million, and includes monthly rental payments of $0.6 million.

Further, the amended capital lease agreement providesrespectively for the expansion of the Company’s distribution center and monthly rental payments that have not been determined as ofnine months ended September 30, 2021. As part ofThe receivable and the amended capital lease agreement, we qualify asfull principal on the deemed owner ofnote receivable, including accrued interest, were paid back to the expansion projectCompany by the CEO in May 2021.
In accordance with the Reorganization, the Company has accounts payable due to significant involvement duringnoncontrolling interests of LLC for state and federal income tax refunds filed for tax periods prior to the construction period under build-to-suit lease accounting requirements. We recorded the cost of the expansion in property, furniture and equipment, net and the offsetting lease financing obligations is recorded in accrued other expenses on our condensed consolidated balance sheets. As of September 30, 2021, we have recognized an asset and recorded a build-to-suit financing obligation of $1.1 million in accrued other expenses. During the fourth quarter of 2021 theReorganization. The accounts payable due to related party lessor sold its interest in the leased assets to a third party. As a result, the lease will no longer be with a related party of the Company. Accumulated amortization was $9.5parties were $1.8 million and $5.3$2.9 million at September 30, 20212022 and December 31, 2020, respectively.
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Notes to Condensed Consolidated Financial Statements
(Unaudited)
Future minimum lease payments at September 30, 2021, for the capital lease related to the Company’s corporate headquartersrespectively, and distribution center, are as follows (amounts in thousands):
Year Ending December 31,
Remainder of 2021$1,168 
20224,673 
20234,673 
20244,673 
20254,673 
20265,132 
Thereafter120,392 
145,384 
Less: Amount representing interest(95,287)
$50,097 
The Company has received certain rent abatements and has scheduled rent increases under various real estate leases. The condensed consolidated statements of comprehensive income reflects rent expenseincluded within accounts payable on a straight-line basis over the terms of the respective leases. A deferred rental obligation of $76.5 million and $71.2 million related to the lease incentives and the straight-line rent expense is reflected in the condensed consolidated balance sheets at September 30, 2021 and December 31, 2020, respectively, in the deferred rent and lease incentives line item.
6.    Mezzanine Equity
In connection with the issuance of the Prior Credit Facilities discussed in Note 4, the Class A and Class B unit equity holders made an aggregate $25.0 million capital contribution to the Company in exchange for 1,250,000 Class A Preferred Units and 1,250,000 Class B Preferred Units, respectively (collectively, the “Preferred Units”). The Preferred Units were issued pursuant to the Third Amended and Restated Limited Liability Company Agreement of the Company dated June 26, 2017 (the “2017 LLC Agreement”), and accrue a 16% per annum (compounded annually) preferred return. The Preferred Units have no voting rights and do not participate in profits or losses. Preferred Unit holders are entitled to receive distributions in excess of tax distributions to Class A and B members in proportion to the accrued and unpaid preferred return and unreturned capital contributions. Further, Preferred Unit holders are entitled to receive proceeds upon a capital transaction before other unit holders in proportion to the accrued and unpaid preferred return and unreturned capital contributions. The Company can redeem the Preferred Units at our discretion, however, because the Preferred Unit holders control the Board and could force the Company to redeem the Preferred Units they are recorded as mezzanine equity within the condensed consolidated balance sheets.
The accumulated 16% preferred return was $15.8
11. Income Taxes
Income taxes were $27.9 million atand $1.7 million in the nine months ended September 30, 2020. On December 29, 2020,2022 and 2021, respectively. Income taxes were $9.6 million and $0.5 million in the Preferred Units were repaid in full includingthree months ended September 30, 2022 and 2021, respectively. The effective tax rate was 23.7% and 5.3% for the preferred return.nine months ended September 30, 2022 and 2021, respectively. The effective tax rate was 20.6% and 3.4% for the three months ended September 30, 2022 and 2021, respectively.
7.    Incentive Unit Compensation Arrangements
In May of 2021,Prior to the 2017 LLC Agreement and 2017 Equity Plan were amended to authorizeReorganization, the Company was a limited liability company under the Internal Revenue Code that had elected to issue up to 967,987 Class G Units. Additionally,be taxed as a partnership and did not pay federal or most state corporate income taxes on its taxable income, but rather its members were liable for their respective portions of the taxable income (loss) of LLC. The income tax provision included state and local tax in accordance with the amendments the authorized Class F and Class F-1 Units that could be issued were reduced to 2,190,514 and 2,190,514, respectively. No changescertain jurisdictions prior to the Company’s Class CReorganization. Subsequent to the Reorganization, LLC’s taxable income flows through to FS Arhaus and D incentive units were made. The Class C, D, F, F-1Homeworks who are subject to U.S. federal and G Units are collectively referred to asstate corporate income taxes. For the “Incentive Units.”
In May, June and July ofyear ended December 31, 2021, the Company granted Class G Units that vest overrecorded a five$17.4 million adjustment to additional paid-in capital related to the Reorganization representing FS Arhaus, Inc.’s investment in LLC. The tax investment amount changed as a result of LLC’s federal tax filing in 2022, therefore the Company recorded a return-to-provision adjustment of $1.3 million to additional paid-in capital for the period ending September 30, 2022.
The Inflation Reduction Act was enacted on August 16, 2022 and includes a new 15% minimum tax on “adjusted financial statement income” beginning with the Company’s fiscal year term2023, a new 1% excise tax on stock repurchases after December 31, 2022, and become fully vested in the event of a change in control, death or disability, as long as the holder of theseveral tax incentives to promote clean energy. While these tax law changes have no immediate
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Arhaus, LLCInc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Class G Units is employed by the Company on the date of such events. Further, certain unit holders who are terminated without cause will have unvested units fully vest upon that event.
The holders of the Class G Units do not share in distributions of operating cash flows. Upon the Class G Unit holder’s termination of employment, all unvested Class G Units are forfeited,effect and the Company has the right to purchase all vested Class G Units at a per unit price equal to the fair market value of Class G Unit determined at the date of such right is exercised as determined by an independent appraisal firm to be mutually agreed to by the Company and unit holder; provided; however, all vested and unvested Class G Units are forfeited without compensation in the event of termination with cause.
The Company has recorded Incentive Unit compensation expense of $1.1 million and $0.3 million for the nine months ended September 30, 2021 and 2020, respectively. Incentive Unit compensation expense was $0.7 million and $0.0 million for the three months ended September 30, 2021 and 2020, respectively. Incentive Unit compensation expense is recorded within the selling, general and administrative expenses line item of the condensed consolidated statements of comprehensive income. Total unrecognized compensation cost for the Incentive Units to be recognized in future periods is $12.3 million at September 30, 2021, and will be recognized over a weighted average period of 4.55 years. The total grant-date fair value of incentive units that vested as of September 30, 2021 and December 31, 2020, were $0.3 million and $0.4 million, respectively.
Incentive Unit activity through September 30, 2021, is as follows:
Class CClass DClass F/F-1Class G
UnitsWeighted
Average
Grant Date
Fair Value		UnitsWeighted
Average
Grant Date
Fair Value		UnitsWeighted
Average
Grant Date
Fair Value
(1)		UnitsWeighted
Average
Grant
Date Fair
Value
December 31, 20201,868,913 $0.57 96,318 $0.83 4,381,030 $0.63 — $— 
Granted— — — — — — 701,965 18.10 
Forfeited— — — — (109,916)0.77 — — 
September 30, 20211,868,913 $0.57 96,318 $0.83 4,271,114 $0.63 701,965 $18.10 
(1) - For each Class F Unit a corresponding Class F-1 Unit is authorized, issued and outstanding. The Class F Units and Class F-1 Units are aggregated for purposes of valuation.
Vested Incentive Units as of September 30, 2021 and December 31, 2020, are as follows:
Class CClass DClass F/F-1Class G
September 30, 20211,653,476 96,318 2,982,442 — 
December 31, 20201,653,476 96,318 2,167,547 — 
At September 30, 2021, the Company’s valuation of the Incentive Units granted in May, June and July of 2021 were measured using the PWERM. The PWERM is a scenario-based methodology that estimates the fair value of the Incentive Units awarded 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 June 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 OPM and applied a DLOM. The OPM estimated the value using the Black-Scholes OPM. The fair value of the Incentive Units have been determined utilizing unobservable inputs and therefore is a Level
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Arhaus, LLC and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
3 measurement under the fair value hierarchy.
2021 Awards
Term10 years
Risk-free rate of return1.50%
Volatility40.00%
Dividend yield0%
The expected term represents our expected time until a liquidity event as of the valuation date. The assumed volatility assumption is based on that of an identified group of comparable public companies over a similar term. The risk-free rate of return is based on the yields of U.S. Treasury securities with maturities similar to the expected term. We used an expected divided yield of zero, as we do not plan to pay cash dividends for the foreseeable future.
The fair values of each class of Incentive Units have been determined utilizing unobservable inputs, and therefore are Level 3 measurements under the fair value hierarchy.
Additionally, a probability distribution of possible future equity values is completed and incorporated into the calculation of respective Incentive Unit fair values. This is necessary as upon the occurrence of a liquidity event in the future, the proceeds thereof will be allocated in accordance with the distribution waterfall defined within the 2017 LLC Agreement.
8.    Segment Reporting
Our chief operating decision maker (“CODM”) is our Chief Executive Officer, 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 1 operating segment and therefore we have 1 reportable segment that offers an assortment of merchandise across a number of categories, including furniture, lighting, textiles, décor, and outdoor. The assortment of merchandise can be purchased through our Showroom and eCommerce sales channels.
The majority of our net revenue is generated through sales to clients in the United States. Sales to clients outside of the United states are not significant. Further, no single client represents more than ten percent or more of our net revenue.
The following table shows net revenue by merchandise sales channel for the nine and three months ended September 30, 2021 and 2020, respectively (amounts in thousands):
Nine Months Ended September 30,Three Months Ended September 30,
2021202020212020
Retail$457,439 $283,286 $166,928 $98,894 
eCommerce101,251 61,320 36,405 21,607 
Total net revenue$558,690 $344,606 $203,333 $120,501 
9.    Net and Comprehensive Income per Share
As discussed in Note 12, the Company reorganized its ownership structure from a limited liability companyexpected to a corporation for the purpose of issuing common stock on a publicly traded exchange. As a result of the Reorganization and IPO, existing Class A and Class B Unitholders of the Company were issued Class A and Class B common stock in Arhaus, Inc., in accordance with the distribution waterfall defined in the Company’s 2017 LLC Agreement. The Class A Unitholders received 80,792,206 shares
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Arhaus, LLC and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
of Class B common stock and the Class B Unitholders received 31,266,536 shares of Class A common stock.

Accordingly, all share and per share amounts for all periods presented in the condensed consolidated statements of comprehensive income and this note have been adjusted retroactively, where applicable, to reflect the reorganization transaction.

Basic and diluted net and comprehensive income per share for the nine and three months ended September 30, 2021 and 2020, was calculated by adjusting net and comprehensive income attributable to Arhaus, LLC for preferred dividends, and dividing by basic and diluted weighted-average number of common shares outstanding (amounts in thousands except unit and per share data). Management Incentive Unitholders and Preferred Unitholders do not participate in the earnings or losses of the Company as of September 30, 2021 and 2020 and therefore are not participating securities. As such, they are not included within the calculation of basic or diluted earnings per share as of September 30, 2021 and 2020.
Nine Months Ended September 30,Three Months Ended September 30,
2021202020212020
Numerator
Net and comprehensive income$30,580 $14,432 $14,383 $783 
Less: Preferred units dividend— 4,374 — 1,469 
Net and comprehensive income (loss) attributable to the shareholders$30,580 $10,058 $14,383 $(686)
Denominator - Basic and Diluted
Weighted-average number of common shares outstanding112,058,742 112,058,742 112,058,742 112,058,742 
Net and comprehensive income (loss) per share, basic and diluted$0.27 $0.09 $0.13 $(0.01)
10.    Commitments and Contingencies
The Company is involved in litigation and claims that are incidental to its business. Although the outcome of these matters cannot be determined at the present time, management of the Company believes that the ultimate resolution of these matters will not have a material adverse effect on the Company’s consolidated financial position,our results of operations or cash flows.going forward, we will continue to evaluate their impact as further information becomes available.
11.    Related Party Transactions
For the Company’s discussionAs of related party transactions see Note 5.
12.    Subsequent Event
September 30, 2022, no unrecognized tax benefits have been recognized. The Company has evaluated subsequent events through the date of the issuance of the condensed consolidated financial statements, and no additional matters were identified requiring recognition or disclosurefiles income tax returns in the financial statements, except for events described below.

ReorganizationU.S. and Initial Public Offering

In connection withvarious state and local jurisdictions. The tax years after 2017 remain open to examination by the IPO,state taxing jurisdictions in which the Company reorganized its ownership structure from a limited liability companyis subject to a corporation for the purposetax. As of issuing common stock on a publicly traded exchange. Arhaus, Inc. serves as a holding company that indirectly wholly owns Arhaus, LLC and its subsidiaries. Pursuant to the terms of the Integrated Contribution Agreement by and among Arhaus, Inc., a Delaware corporation, FS Arhaus Holding, Inc. (“FS Arhaus”), a Delaware corporation, Homeworks Holdings Inc. (“Homeworks”) and the members of management who hold incentive units (“Management Unitholders”)
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Arhaus, LLC and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
ofSeptember 30, 2022, the Company was not under examination by the following series of transactions were completed on November 8, 2021, which we refer to, collectively, as the Reorganization. These transactions included:

•the amendment and restatement of the certificate of incorporation of Arhaus, Inc., to authorize two classes of common stock, Class A common stock and Class B common stock and to authorize the Company to issue up to 750,000,000 shares of common stock, consisting of 600,000,000 share of Class A common stock, par value of $0.001 per share, 100,000,000 shares of Class B common stock, par value of $0.001 and 50,000,000 shares of Preferred Stock; and

•Arhaus, Inc.’s acquisition of the units of the Company currently held by FS Arhaus, Homeworks, John Reed (“Reed”) through the John P Reed Trust dated April 29, 1985, as Amended (“Reed Revocable Trust”) and the Management Unitholders, pursuant to the mergers and exchange described below, and the issuance in those transactions of Class A common stock to the holders of FS Arhaus and the Management Unitholders and Class B common stock to Homeworks, Reed and the Reed Revocable Trust.

The following steps describe the transactions that were completed to effect the Reorganization on November 8, 2021:

•Step 1: Arhaus, Inc. formed two wholly owned subsidiaries, Ash Merger Sub 1, Inc. (“Merger Sub 1”), a Delaware corporation, and Ash Merger Sub 2, Inc. (“Merger Sub 2”), a Delaware corporation;

•Step 2(a): Merger Sub 1 merged with and into FS Arhaus, with FS Arhaus surviving the merger,Internal Revenue Service or Surviving Corporation 1, and became a wholly owned subsidiary of Arhaus, Inc. and the holders of FS Arhaus received shares of Class A common stock;

•Step 2(b): Merger Sub 2 merged with and into Homeworks, with Homeworks surviving the merger, or Surviving Corporation 2, and became a wholly owned subsidiary of Arhaus, Inc. and the owners of Homeworks, received shares of Class B common stock;

•Step 2(c): The Management Unitholders contributed their units of the Company to Arhaus, Inc. in exchange for shares of Class A common stock;

•Step 2(d): Reed and the Reed Revocable Trust contributed their respective units of the Company to Arhaus, Inc. in exchange for shares of Class B common stock;

•Step 2(e): Arhaus, Inc. contributed the units of the Company that it owns directly to Surviving Corporation 1 and Surviving Corporation 2 in proportion to the units of the Company owned by Surviving Corporation 1 and Surviving Corporation 2; and

•Step 3: Arhaus, Inc. issued shares of our Class A common stock to the purchasers in the IPO.

As a result of the Reorganization, a total of 39,623,041 shares of Class A common stock and 87,536,950 shares of Class B common stock were issued to the former holders of FS Arhaus, the former holders of Homeworks, Reed, the Reed Revocable Trust and the Management Unitholders. Of the total 127,159,991 shares of common stock, 2,520,227 shares of Class A common stock and 596,598 shares of Class B common stock issued to Management Unitholders are subject to certain vesting conditions specified in individual award agreements and were issued as restricted shares with similar time-based vesting provisions as the incentive units that were exchanged for such shares. If the vesting conditions of the restricted stock are not satisfied, such restricted stock will be forfeited and canceled.

On November 8, 2021, Arhaus, Inc. consummated its IPO of 12,903,226 shares of Class A common stock at an IPO price of $13.00 per share. Shares of Arhaus, Inc.’s Class A common stock began trading on the NASDAQ Global Select Market under the ticker symbol “ARHS” on November 4, 2021.

Arhaus, Inc. used a portion of the net proceeds received from the IPO to pay the term loan exit fee of $64.1 million in connection with the term loan that was repaid on December 28, 2020, as discussed in Note 4. The Company will record an additional $14.6 million of selling, general and administrative
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Arhaus, LLC and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
expenses in the fourth quarter of 2021 related to the change in fair value of the term loan exit fee as a result of the IPO.

Revolving Credit Facilities
On November 4, 2021 the Company terminated the Revolver dated June 25, 2020 of which there were no borrowings drawn. The termination of the Revolver resulted in the Company paying an $0.6 million early termination fee and writing off the remaining unamortized loan costs of $0.8 million.

On November 8, 2021, Arhaus, Inc. entered into a new revolving credit facility agreement (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 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 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 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 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 (1.75% at origination), whereas the applicable margin is adjusted quarterly based on Arhaus, Inc.’s consolidated rent-adjusted total leverage ratio.state tax jurisdiction.


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MANAGEMENT’SDISCUSSIONANDANALYSISOF FINANCIALCONDITIONANDRESULTSOF OPERATIONS

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis of our financial condition and results of operations together with our condensed consolidated financial statements and the related notes included elsewhere in this Form 10-Q and our final prospectus filed withAnnual Report on Form 10-K for the Securities and Exchange Commission pursuant to Rule 424(b)(4) under the Securities Act of 1933, as amended, dated November 3, 2021 (the “Prospectus”).year ended December 31, 2021. This Quarterly Report on Form 10-Q contains forward looking statements that involve risks and uncertainties, as well as assumptions that, if they do not fully materialize or are proven incorrect, could cause our business and results of operations to differ materially from those expressed or implied by such forward-looking statements. Forward-looking statements can generally be identified by the use of forward-looking terminology, including, but not limited to, “may,” “could,” “seek,” “guidance,” “predict,” “potential,” “likely,” “believe,” “will,” “expect,” “anticipate,” “estimate,” “plan,” “intend,” “believe,” “forecast,” or variations of these terms and similar expressions, or the negative of these terms or similar expressions. Past performance is not a guarantee of future results or returns and no representation or warranty is made regarding future performance. Such forward-looking statements involve known and unknown risks, uncertainties and other important factors beyond our control that could cause our actual results, performance or achievements to be materially different from the expected results, performance or achievements expressed or implied by such forward-looking statements. These risks and uncertaintiesSuch factors include, but are not limited to: ourto, the following risks:
•Our reliance on third-party transportation carriers and risks associated with increased freight and transportation costs; disruption
•Disruption in our receiving and distribution system, including a delaydelays in the anticipated openingintegration of our new distribution centers and manufacturing center; ourthe possibility that we may not realize the anticipated benefits of multiple distribution centers;
•Our ability to obtain quality merchandise in sufficient quantities; risks
•Risks as a result of constraints in our supply chain; a
•A failure of our vendors to meet our quality standards; the COVID-19 pandemic and its effect on our business; declines
•Declines in general economic conditions that affect consumer confidence and consumer spending that could adversely affect our revenue; our ability to manage and maintain the growth rate of our business; our ability to anticipate changes in consumer preferences; risks related to maintaining and increasing showroom traffic and sales; our ability to compete in our market; our ability to adequately protect our intellectual property; the
•The possibility of cyberattacks and our ability to maintain adequate cybersecurity systems and procedures; loss,
•Loss, corruption and misappropriation of data and information relating to clients and employees; changes
•Changes in and compliance with applicable data privacy rules and regulations; compliance
•Our ability to manage and maintain the growth rate of our business;
•Our ability to anticipate changes in consumer preferences;
•Risks related to maintaining and increasing Showroom traffic and sales;
•Our ability to compete in our market;
•Our ability to adequately protect our intellectual property;
•Compliance with applicable governmental regulations; effectively
•The COVID-19 pandemic and its effect on our business;
•Effectively managing our eCommerce business and digital marketing efforts; and compliance
•Compliance with SEC rules and regulations as a public reporting company. These factors should not be construed as exhaustive. Furthermore, the potential impact of the COVID-19 pandemic on our business operations and financial results and on the world economy as a whole may heighten the risks and uncertainties that affect our forward-looking statements described above.

The risks, uncertainties and assumptions referred to above that could cause our results to differ materially from the results expressed or implied by such forward-looking statements include, but are not limited to, those discussed under the heading “Risk Factors”Item 1A. Risk Factors, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, and elsewhere in our final prospectus filed withAnnual Report on Form 10-K for the Securities and Exchange Commission pursuant to Rule 424(b)(4) under the Securities Act of 1933, as amended, dated November 3, 2021 (the “Prospectus”), and the risks, uncertainties and assumptions discussed from time to time in our other public filings and public announcements.year ended December 31, 2021. All forward-looking statements included in this document are based on information available to us as of the date hereof, and we assume no obligation to update these forward-looking statements. In addition, statements that “we believe” and similar statements reflect our beliefs and opinions on the relevant subject. These statements are based on information available to us as of the date of this Form 10-Q. While we believe that information provides a reasonable basis for these statements, that information may be limited or incomplete. Our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all relevant information. These statements are inherently uncertain, and investors are cautioned not to unduly rely on these statements.

The following discussion contains references to calendar year 2020 and the nine and three months ended September 30, 20212022 and September 30, 2020,2021, which represents the condensed consolidated financial results of Arhaus, LLCInc. and subsidiaries for the year ended December 31, 2020 and the nine and the three months ended September 30, 20212022 and 2020,2021, respectively.
Overview
Arhaus is a rapidly growing lifestyle brand and premium retailer in the home furnishings market, specializing in livable luxury supported by globally sourced, heirloom qualityglobally-sourced, heirloom-quality merchandise. We offer a differentiated direct-to-
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consumerdirect-to-consumer approach to furniture and décor. Our curated assortments are presented across our sales channels in sophisticated, family
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friendly and unique lifestyle settings. We offer merchandise assortments across a number of categories, including furniture, lighting, textiles, décor, and outdoor. Our products, designed to be used and enjoyed throughout the home, are sourced directly from factories and suppliers with no wholesale or dealer markup, allowing us to offer an exclusive assortment at an attractive value. Our direct sourcing network consists of more than 400 vendors, some of whom we have had relationships with since our founding. Our product development teams work alongside our direct sourcing partners to bring to market proprietary merchandise that is a great value to clients, while delivering attractive margins.

We positionbelieve in providing a dynamic and welcoming experience in our Showrooms and online with the conviction that retail is theater. Our national omni-channel business positions our retail locations as Showrooms for our brand, while our website acts as a virtual extension of our Showrooms. Our theater-like ShowroomsShowrooms are highly inspirational and function as an invaluable brand awareness vehicle. Our seasoned sales associates and in-home designers provide valued insightexpert advice and adviceassistance to our client base that drives significant client engagement. Our omni-channel model allows clients to begin or end their shopping experiencejourney online, while also experiencing our theater-like Showrooms throughout the shopping process. journey.
We offer an in-home designer services program, through which our in-home designers provide expert advice and assistance to our clients.
have one reportable segment as of September 30, 2022. At September 30, 2021,2022, we operated 77operated 80 Showrooms, 5467 with in-homein-home interior designers. At December 31, 20202021, we operated 7479 Showrooms, 4558 with in-home interior designers.
September 30,
2021		December 31,
2020
Traditional showrooms72 70 
Design Studios2 1 
Outlets3 3 
Total retail locations77 74 
Total square footage (in thousands)1,288 1,258 

September 30, 2022December 31,
2021
Traditional showrooms7271 
Design Studios55 
Outlets33 
Total Showroom locations80 79 
Total square footage (in thousands)1,294 1,288 
For the nine months ended September 30, 2021,2022, we generated $558.7$872.6 million of net revenue, $367.0 million of gross margin as a percent of net revenue of 41.7% and $30.6$89.6 million of net and comprehensive income. For the three months ended September 30, 2021,2022, we generated $203.3$320.0 million of net revenue, $136.3 million ofgross margin as a percent of revenue of 41.7% and $14.4$36.9 million of net and comprehensive income. We have one reportable segment that offers an assortment of merchandise across a number of categories, including furniture, lighting, textiles, décor, and outdoor.
Effects of COVID-19 on Our Business
The COVID-19 outbreak in the first quarter of fiscal year 2020 caused disruption to our business operations. In our initial response to the COVID-19 health crisis, we undertook immediate adjustments to our business operations including temporarily closing all retail locations, furloughing employees, minimizing expenses and delaying investments, including pausing some inventory orders while we assessed the status of our business. Our approach to the crisis evolved quickly as our business trends substantially improved during the second through fourth quarters of fiscal year 2020 as a result of both the reopening of our Showrooms and strong consumer demand for our products. We had reopened all of our Showrooms and Outlet stores by June 30, 2020, although currently many of our Showrooms and Outlets continue to conduct business with occupancy limitations and other operational restrictions.
While we have been able to serve our clients and operate our business through the ongoing COVID-19 health crisis,pandemic, there can be no assurance that future events will not have an impact on our business, results of operations or financial condition since the extent and duration of the health crisispandemic remains uncertain. Future adverse developments in connection with the COVID-19 crisis,pandemic, including additional waves or resurgences of COVID-19 outbreaks, new strains or variants of the virus, evolving international, federal, state and local restrictions and safety regulations in response to COVID-19 risks, changes in consumer behavior and health concerns, the pace of economic activity in the wake of the COVID-19 crisis,pandemic, or other similar issues could adversely affect our business, results of operations or financial condition in the future, or our financial results and business performance in future periods.
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future.
Various constraints in our merchandise supply chain have resulted in delays in our ability to convert demand and recognize asinto net revenue at normal historical rates. We anticipate that the business conditions related to the COVID-19 pandemic will continue to adversely affect the capacity of our vendors and supply chain to meet our demand during fiscal year 2021.2022. We expect that our supply chain may catch up to demand in the foreseeable future, but business circumstances and operational conditions in numerous international locations where our vendors operate cannot be predicted with certainty.
Depending on the future course of the pandemic and further outbreaks, we may experience further restrictions and closures of our physical operations in our Showrooms, Design Studios and Outlet stores. Although we experienced strong demand for our products during fiscal year 2020 and the nine months ended September 30, 2021, some of the demand may have been driven by stay-at-home restrictions that were in place throughout many parts of the United States. The exact impact of changes to these stay-at-home restrictions cannot be predicted with certainty.
How We Assess the Performance of Our Business
In addition to U.S. GAAP results, this Form 10-Q contains references to the non-GAAP financial measures below. We use these non-GAAP measures to help assess the performance of our business, identify trends affecting our business, formulate business plans and make strategic decisions. In addition to our results determined in accordance with U.S. GAAP, we believe that providing these non-GAAP financial measures are useful to our investors as they present an informative supplemental view of our results from period to period by removing the effect of non-recurring items.
The non-GAAP financial measures presented herein are specific to us and may not be comparable to similar measures disclosed by other companies because of differing methods used by other companies in calculating them. These measures are also not intended to be measures of free cash flow for management’s discretionary use, as they do not reflect tax payments, debt service requirements and certain other cash costs that may recur in the future, including, among other things, cash requirements for working capital needs. Management compensates for these limitations by relying on our U.S. GAAP results in addition to using these non-GAAP financial measures. The non-GAAP financial measures should not be
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construed as an inference that our future results will be unaffected by unusual or non-recurring items. WeWe consider the following financial and operating measures that affect our results of operations:
Net Revenue and Demand. Demand. Net revenue is recognized when a client obtains control of the merchandise. We also track demand in our business which is a key performance indicator linked to the level of client orders placed. Demand is an operating metric that we use in reference to measure the dollar value of orders (based on purchase price) measured at the time the order is placed, net of the dollar value of cancellations and returns (based on unpaid purchase price and amount credited to the client). These orders are recognized as net revenue uponwhen a client obtainingobtains control of the merchandise. Because demand is measured net of cancellations, all demand will eventually become net revenue, with appropriate reserves, when delivered to the client.
Comparable Growth. Growth. Comparable growth is the year-over-year percentage change of the dollar value of orders delivered (based on purchase price), net of the dollar value of returns (based on amount credited to the client), from our comparable Showrooms and eCommerce, including through our direct-mail catalog.catalogs and other mailings. This metric is a key performance indicator used by management to evaluate Showroom performance for locations that have been opened for at least 15 consecutive months, which enables management to view the performance of those Showrooms without the dollar value of orders delivered for new Showrooms being included. Comparable Showrooms are defined as permanent Showrooms open for at least 15 consecutive months, including relocations in the same market. Showrooms record demand immediately upon opening, while orders delivered take additional time because product must be delivered to the client. Comparable Showrooms that were temporarily closed during the year due to COVID-19portions of 2021 were not excluded from the comparable Showroom calculation. Outlet comparable locations’The dollar value of orders delivered for Outlet comparable locations are included.
Demand Comparable Growth. Growth. Demand comparable growth is the year-over-year percentage change of demand from our comparable Showrooms and eCommerce, including through our direct-mail catalog. This metric is a key performance indicator used by management to evaluate Showroom demand performance for locations that have been opened for at least 13 consecutive months, which enables management to view the performance of those Showrooms without new Showroom demand included. ComparableFor demand purposes, comparable Showrooms are defined as permanent Showrooms open for at least 13 consecutive months, including relocations in the same market. Comparable Showrooms that were
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temporarily closed during the year due to COVID-19portions of 2021 were not excluded from the comparable Showroom calculation. Outlet comparable location demand is included.

Demand comparable growth provides insight into business performancelevels in a particular period by comparing the dollar value of orders (based on purchase price) placed in that period to the prior comparable period. Although these orders do not result in net revenue until the order is delivered at a later point in time, management utilizes this metric to evaluate core performance.
Comparable growth is an additional measure that management utilizes to compare the dollar value of orders delivered (based on purchase price) in a period compared to the prior comparable period. Since delivery generally coincides with recognition of net revenue, with appropriate reserves, comparable growth trends will more closely track trends in reported net revenue than demand comparable growth trends. While increases or decreases in demand comparable growth will translate into increases or decreases in comparable growth over time, the trends do not necessarily correlate in any particular period. This is partially due to the general lag in time between when an order is placed and when an order is delivered. When the time gap from order to delivery increases, due to supply chain challenges for example, it may take longer for comparable growth to reflect demand comparable growth. Notwithstanding these limitations, management considers it useful to assess both measures together to get a more complete picture of overall performance trends, and believes these measures can be useful to investors for the same purpose, when viewed together with our reported results and other metrics.
Gross Margin. Gross margin is equal to our net revenue less cost of goods sold. Cost of goods sold includeincludes the direct cost of purchased merchandise;merchandise, inventory shrinkage;shrinkage, inbound freight;freight, all freight costs to get merchandise to our Showrooms;Showrooms, credit card fees;fees, design, buying and allocation costs;costs, occupancy costs related to Showroom operations and our supply chain, such as rent and common area maintenance for our leases;leases, depreciation and amortization of leasehold improvements, equipment and other assets in our Showrooms.Showrooms and distribution centers. In addition, cost of goods sold includesincludes all logistics costs associated with shipping product to our clients, which are partially offset by delivery fees collected from clients (recorded in net revenue on thecondensed consolidated statements of comprehensive income)income).
Selling, General and Administrative Expenses. Selling, general and administrative, or SG&A, expenses include all operating costs not included in cost of goods sold. These expenses include payroll and payroll related expenses, Showroom expenses other than occupancy and expenses related to many of our operations at our corporate headquarters, including marketing, information technology, utilities and depreciation and amortization warehouse expenses and marketing expense. Payroll includes both fixed
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compensation and variable compensation. Variable compensation includes Showroom commissions and Showroom bonus compensation related to demand, likely earned before the client obtains control of the merchandise. Variable compensation is not significant in our eCommerce channel. All new Showroom opening expenses, other than occupancy, are included in SG&A expenses and are expensed as incurred. We expect certain of these expenses to continue to increase as we open new Showrooms, develop new product categories and otherwise pursue our current business initiatives. SG&A expenses as a percentage of net revenue isare usually higher in lower-volume quarters and lower in higher-volume quarters because a significant portion of the costs are relatively fixed.
EBITDA. We define EBITDA as consolidated net income before depreciation and amortization, interest
expense, net and state and local taxes.

income tax expense.
Adjusted EBITDA. We define adjusted EBITDA as EBITDA adjusted for items that we believe are not reflective of underlying operating performance in a particular period. We believe that adjusted EBITDA is a useful measure of operating performance as the adjustments eliminate items that we believe are not reflective of underlying operating performance in a particular period. ThisAdjusted EBITDA facilitates a comparison of our operating performance on a consistent basis from period-to-period and provides for a more complete understanding of factors and trends affecting our business.
Because adjusted EBITDA omits certain non-cash items and items that we believe are not reflective of underlying operating performance in a particular period, as well as non-cash items, we feel that it is less susceptible to variances in actual performance resulting from depreciation, amortization and other non-cash charges and can be more reflective of our operating performance in a particular period. We also use adjusted EBITDA as a method for planning and forecasting overall expected performance and for evaluating, actual results against such expectations on a quarterly and annual basis.basis, actual results against such expectations.
The following is a reconciliation of our net and comprehensive income to EBITDA and adjusted EBITDA for the periods presented:

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Nine Months EndedThree Months Ended
(In thousands)September 30,
2021		September 30,
2020		September 30,
2021		September 30,
2020
Net income$30,580 $14,432 $14,383 $783 
Interest expense4,018 9,335 1,339 2,734 
State and local taxes1,704 900 500 731 
Depreciation and amortization17,206 12,682 8,297 4,244 
EBITDA53,508 37,349 24,519 8,492 
Incentive unit compensation expense1,135 326 708 76 
Derivative expense(1)29,905 500 100 167 
Other expenses(2)5,806 2,727 5,188 944 
Adjusted EBITDA$90,354 $40,902 $30,515 $9,679 
___________
Nine months ended September 30,Three months ended September 30,
(In thousands)2022202120222021
Net and comprehensive income$89,633 $30,276 $36,936 $14,228 
Interest expense, net3,367 4,091 751 1,365 
Income tax expense27,851 1,704 9,568 500 
Depreciation and amortization18,319 17,206 6,324 8,297 
EBITDA139,170 53,277 53,579 24,390 
Equity based compensation2,613 1,135 1,224 708 
Derivative expense (1)
— 29,905 — 100 
Other expenses (2)
6,567 5,806 1,909 5,188 
Adjusted EBITDA$148,350 $90,123 $56,712 $30,386 
(1)We repaid our term loan in full on December 28, 2020. The derivative expense relates to the change in the fair value of the exit fee at the end of each reporting period. The Company used a portion of the net proceeds from the IPO to pay the derivative liability on November 8, 2021.
(2)Other expenses represent costs and investments not indicative of ongoing business performance, such as third-party consulting costs, one-time project start-up costs, one-time costs related to the Reorganization and IPO, severance, signing bonuses, recruiting and project-based strategic initiatives. For the nine and three months ended September 30, 2022, these other expenses consisted largely of $4.6 million and $1.6 million of costs related to the opening and set-up of our Dallas distribution center, respectively. For the nine and three months ended September 30, 2021, these other expenses consisted primarily of $5.0 million and $3.5 million of costs related to the Reorganization and IPO and $1.5 million of severance, signing bonuses and recruiting costs. For the three months ended September 30, 2021, these other expenses consisted primarily of $3.5 million of costs related to the Reorganization and IPO and $0.5 million of severance, signing bonuses and recruiting costs,. respectively.
Factors Affecting the Comparability of our Results of Operations
Our results over the past two years have been affected by the following events, which must be understood in order to assess the comparability of our period-to-period financial performance and condition.
Showroom Openings and Closings
New Showrooms contribute incremental expense new Showroom opening expense and net revenue to the Company. In the nine months ended September 30, 2022, we opened three Showrooms and closed two Showrooms. Of the two Showroom closures in the nine months ended September 30, 2022, one was related to a relocation. In 2021, we opened sixten Showrooms and closed threefive Showrooms. In fiscal year 2020, we opened seven Showrooms and closed three Showrooms. AllOf the five Showroom closures in 2021, three were related to relocations with the exceptionin 2021.
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Contents
Financing Transactions
We repaid our Term Loan in full on December 28, 2020. The derivative expense relates to the change in the fair value of the exit fee at the end of each reporting period. The exit fee, which was payable in cash at the time the initial public offeringIPO was consummated, was calculated as 4% of the total equity value of the Company, based on the valuation determined in connection with the initial public offering,IPO, which valuation included, among other factors, (a) the initial public offeringIPO price, plus (b) cash, minus (c) any outstanding indebtedness, minus (d) transaction expenses, minus (e) the equity value of the preferred equity interests of Arhaus, LLC and all subsidiaries received on the closing date of the term loan, minus (f) the value of management incentive units in effect on the closing date of the term loan or issued after the closing date pursuant to management incentive plans in existence on the closing date. For the nine and three months ended September 30, 2021, the derivative expense related to the change in fair value of the exit fee was $29.9 million and the derivative liability as of September 30, 2021 was $49.5 million. $0.1 million, respectively. The Company used a portion of the net proceeds from the IPO to pay the derivative liability of $64.1 million in full on NovemberNovember 8, 2021.
Results of Operations
The following tables summarize key components of our results of operations for the periods indicated. The following discussion should be read in conjunction with our condensed consolidated financial statements and related notes.
Statement of Condensed Consolidated Comprehensive Income Data:
Nine months ended September 30,Three months ended September 30,
(In thousands)2022202120222021
Net revenue$872,595 $558,690 $320,030 $203,333 
Cost of goods sold505,561 325,710 183,739 118,522 
Gross margin367,034 232,980 136,291 84,811 
Selling, general and administrative expenses246,767 196,443 89,145 68,266 
Loss on disposal of assets— 466 — 452 
Income from operations120,267 36,071 47,146 16,093 
Interest expense, net3,367 4,091 751 1,365 
Other income(584)— (109)— 
Income before taxes117,484 31,980 46,504 14,728 
Income tax expense27,851 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 
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Statement of Condensed Consolidated Comprehensive Income Data:

Nine Months EndedThree Months Ended
(In thousands)September 30,
2021		September 30,
2020		September 30,
2021		September 30,
2020
Net revenue$558,690 $344,606 $203,333 $120,501 
Cost of goods sold325,710214,817118,52275,289
Gross margin232,980129,78984,81145,212
Selling, general and administrative expenses196,212105,12268,13740,964
Loss on disposal of assets466— 452— 
Income from operations36,30224,66716,2224,248
Interest expense4,0189,3351,3392,734
Income before taxes32,28415,33214,8831,514
State and local taxes1,704900500731
Net and comprehensive income$30,580 $14,432 $14,383 $783 
Other Operational Data:
Nine Months Ended(1)Three Months Ended(1)Nine months ended September 30,Three months ended September 30,
(Dollars In thousands)September 30,
2021		September 30,
2020		September 30,
2021		September 30,
2020
(Dollars in thousands)(Dollars in thousands)2022202120222021
Net revenueNet revenue$558,690 $344,606 $203,333 $120,501 Net revenue$872,595 $558,690 $320,030 $203,333 
Comparable growth (decline)56.0 %(6.0)%61.3 %(3.7)%
Comparable growthComparable growth53.5 %56.0 %54.3 %61.3 %
Demand comparable growthDemand comparable growth58.4 %12.6 %28.3 %43.7 %Demand comparable growth15.1 %58.4 %15.8 %28.3 %
Gross margin as a % of net revenueGross margin as a % of net revenue41.7 %37.7 %41.7 %37.5 %Gross margin as a % of net revenue42.1 %41.7 %42.6 %41.7 %
Selling, general and administrative expenses as a % of net revenueSelling, general and administrative expenses as a % of net revenue35.1 %30.5 %33.5 %34.0 %Selling, general and administrative expenses as a % of net revenue28.3 %35.2 %27.9 %33.6 %
Income from operations as a % of net revenueIncome from operations as a % of net revenue6.5 %7.2 %8.0 %3.5 %Income from operations as a % of net revenue13.8 %6.5 %14.7 %7.9 %
Net income$30,580 $14,432 $14,383 $783 
Net income as a % of net revenue5.5 %4.2 %7.1 %0.6 %
Adjusted EBITDA(1)$90,354 $40,902 $30,515 $9,679 
Net and comprehensive incomeNet and comprehensive income$89,633 $30,276 $36,936 $14,228 
Net and comprehensive income as a % of net revenueNet and comprehensive income as a % of net revenue10.3 %5.4 %11.5 %7.0 %
Adjusted EBITDA(1)
Adjusted EBITDA(1)
$148,350 $90,123 $56,712 $30,386 
Adjusted EBITDA as a % of net revenueAdjusted EBITDA as a % of net revenue16.2 %11.9 %15.0 %8.0 %Adjusted EBITDA as a % of net revenue17.0 %16.1 %17.7 %14.9 %
Total retail location count at end of period77737773
Total Showrooms at end of periodTotal Showrooms at end of period80778077
(1)See “How We Assess the Performance of Our Business,” for a definition of adjusted EBITDA and a reconciliation of adjusted EBITDA to net and comprehensive income.
Comparison of the Nine Months Endednine months ended September 30, 20212022 and September 30, 20202021
Net Revenue
Net revenue increased $214.1$313.9 million, or 62.1%56.2%, to $558.7$872.6 million in the nine months ended September 30, 20212022 compared to $344.6$558.7 million in the nine months ended September 30, 2021. The increase was driven primarily by increased demand for our products in both Showrooms and eCommerce, as well as elements of our supply chain continuing to catch up with client demand.
Comparable growth was 53.5% in the nine months ended September 30, 2022 compared to 56.0% in the nine months ended September 30, 2021. Demand comparable growth was 15.1% in the nine months ended September 30, 2022 compared to 58.4% in the nine months ended September 30, 2021. Demand comparable growth for the nine months ended September 30, 2021 was positively impacted by Showroom closures in 2020 as a result of the COVID-19 pandemic.
Gross Margin
Gross margin increased $134.1 million, or 57.5%, to $367.0 million in the nine months ended September 30, 2020. The increase in net revenue was driven by increased demand for our product in both eCommerce and Showrooms, as well as elements of our supply chain beginning2022 compared to catch up with client demand. Net revenue for the nine months ended September 30, 2020 was negatively impacted by temporary Showroom closures, occupancy limitations and other operational restrictions, macroeconomic conditions and disruptions across our global supply chain resulting from COVID-19.
Comparable growth was 56.0%$233.0 million in the nine months ended September 30, 2021 compared to a decrease of 6.0% in the nine months ended September 30, 2020. Demand comparable growth was 58.4% in the nine months ended September 30, 2021 compared to 12.6% in the nine months ended September 30, 2020.
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Gross Margin
Gross margin increased $103.2 million, or 79.5%, to $233.0 million in the nine months ended September 30, 2021 compared to $129.8 million in the nine months ended September 30, 2020.2021. Gross margin improvement in the nine months ended September 30, 2021 versus nine months ended September 30, 2020 was driven by the increase in net revenue, partially offsetoffset by $77.7increased variable expense related to the higher revenue, including $115.5 million of higher product costs, and $19.7$38.0 million of increased transportation costs dueand $13.8 million of increased variable rent expense, in addition to the increase in net revenue and $5.4$6.3 million of higher credit card fees related to higher demand during these time periods. Net revenue in the nine months ended September 30, 2020 was compressed due to supply chain constraints and disruption arising from COVID-19.

As a percentage of net revenue, gross margin increased 40040 basis points to 42.1% of net revenue in the nine months ended September 30, 2022 compared to 41.7% of net revenue in the nine months ended September 30, 2021 compared to 37.7% of net revenue in the nine months ended September 30, 2020.2021. The gross margin improvement was primarily the result of leverage as a result of the significant increase in revenue, as certain components of our cost of goods sold are fixed or otherwise do not move in line with revenues. In particular, non-variable Showroom occupancy costs, which are not dependent on revenue levels, were lower as a percentage of net revenue was primarily the result of leverage on fixed Showroom costs over higher net revenue, contributing 410260 basis points to the gross margin improvement. This was partially offset by higher variable Showroom costs and transportation costs, which together increased 240 basis points as a percentage of net revenue.
Selling, General and Administrative Expenses
SG&A expenses increased $91.1$50.3 million, or 86.7%25.6%, to $196.2$246.8 million in the nine months ended September 30, 20212022 compared to $105.1$196.4 million in the nine months ended September 30, 2020. 2021.

The increase in SG&A expenses was primarily driven by a $33.2 million increase in warehouse expenses, a $26.1 million increase in corporate expenses to support the growth of the business, a $9.8 million increase in selling expenses related to new showrooms and higher demand and an $8.4 million increase in new public company costs. This was partially offset by
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the non-recurrence of the derivative expense in the prior year related to the change in the fair value of the term loanTerm Loan exit fee of $29.4 million, an increase in selling expenses of $28.8 million primarily related to compensation, higher corporate and warehouse expenses of $16.2 million to support the growth of the business and higher payroll as payroll for the nine months ended September 30, 2020 was suppressed as a result of the temporary employee furloughs related to COVID-19, increased marketing investment of $6.3 million, one-time costs related to the IPO of $5.0 million and an out-of-period adjustment for depreciation of $3.0$29.9 million.
As a percentage of net revenue, SG&A expenses increased 460decreased 690 basis points to 35.1%28.3% of net revenue in the nine months ended September 30, 20212022 compared to 30.5%35.2% of net revenue in the nine months ended September 30, 2020.2021.
Interest expense,

 net
Interest expense, net decreased $5.3$0.7 million to $4.0$3.4 million in the nine months ended September 30, 2022 compared to $4.1 million in the nine months ended September 30, 2021. The decrease was driven by interest income earned on money market fund investments of $0.6 million.
Income Taxes
Income tax expense was $27.9 million in the nine months ended September 30, 20212022 compared to $9.3 million in the nine months ended September 30, 2020. For the nine months ended September 30, 2021, interest expense was primarily related to our capital lease obligations. For the nine months ended September 30, 2020, interest expense was primarily related to our Term Loan, which was paid off in December 2020, our capital lease obligations, and borrowings on our revolving credit facility.
State and Local Taxes
State and local taxes were $1.7 million in the nine months ended September 30, 2021 compared2021. Prior to $0.9 million in the nine months ended September 30, 2020. This includes state and local tax inReorganization, the locations where we operate. AsCompany was a limited liability company under the Internal Revenue Code that had elected to be taxed as a partnership and did not pay federal or most state corporate income taxes on its taxable income, but rather its members were liable for their respective portions of the taxable income (loss) of LLC. Income tax expense included state and local taxes in certain jurisdictions prior to the Reorganization. Subsequent to the Reorganization, LLC’s taxable income flows through to FS Arhaus LLC was a pass-through entity for the nine months ended September 30, 2021 and September 30, 2020.Homeworks who are subject to U.S. federal and state corporate income taxes.
Net and Comprehensive Income
Net and comprehensive income increased $16.2$59.4 million to $30.6$89.6 million in the nine months ended September 30, 20212022 compared to $14.4$30.3 million in the nine months ended September 30, 2020.2021. The increase was driven by the factors described above.

Comparison of the Three Months Endedthree months ended September 30, 20212022 and September 30, 20202021
Net Revenue
Net revenue increased $82.8$116.7 million, or 68.7%57.4%, to $320.0 million in the three months ended September 30, 2022 compared to $203.3 million in the three months ended September 30, 20212021. Net revenue was driven by increased demand for our products in both Showrooms and eCommerce, as well as elements of our supply chain continuing to catch up with client demand.
Comparable growth was 54.3% in the three months ended September 30, 2022 compared to $120.561.3% in the three months ended September 30, 2021. Demand comparable growth was 15.8% in the three months ended September 30, 2022 compared to 28.3% in the three months ended September 30, 2021.
Gross Margin
Gross margin increased $51.5 million, or 60.7%, to $136.3 million in the three months ended September 30, 2020. Net revenue was driven by
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increased demand for our product in both eCommerce and Showrooms, as well as elements of our supply chain beginning to catch up with client demand. Net revenue for the three months ended September 30, 2020 was negatively impacted by temporary Showroom occupancy limitations and other operational restrictions, macroeconomic conditions and disruptions across our global supply chain resulting from COVID-19.
Comparable growth was 61.3% in the three months ended September 30, 20212022 compared to a decrease of 3.7% in the three months ended September 30, 2020. Demand comparable growth was 28.3% in the three months ended September 30, 2021 compared to an increase of 43.7% in the three months ended September 30, 2020.
Gross Margin
Gross margin increased $39.6 million, or 87.6%, to $84.8 million in the three months ended September 30, 2021 compared to $45.2 million in the three months ended September 30, 2020.2021. Gross margin improvement was driven by the increase in net revenue, partially offset by $30.2increased variable expense related to the higher revenue, including $42.7 million of higher product costs, and $8.5$12.6 million of increased transportation costs dueand $5.4 million of increased variable rent expense, in addition to higher net revenue and $1.5$2.3 million of higher credit card fees related to higher demand during the three months ended September 30, 2021 versus the three months ended September 30, 2020. Net revenue in the three months ended September 30, 2020 was compressed due to supply chain constraints and disruption arising from COVID-19.these time periods.
As a percentage of net revenue, gross margin increased 42090 basis points to 42.6% of net revenue in the three months ended September 30, 2022 compared to 41.7% of net revenue in the three months ended September 30, 20212021. The gross margin increase as a percentage of net revenue was primarily the result of leverage on fixed Showroom costs over higher net revenue, contributing 240 basis points to the gross margin improvement. This was partially offset by higher variable Showroom costs and transportation costs, which together increased 190 basis points as a percentage of net revenue.
Selling, General and Administrative Expenses
SG&A expenses increased $20.9 million, or 30.6%, to $89.1 million in the three months ended September 30, 2022 compared to 37.5%$68.3 million in the three months ended September 30, 2021.
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The increase in SG&A expenses was primarily driven by a $9.1 million increase in corporate expenses to support the growth of the business, $7.7 million increase in warehouse expenses and a $2.1 million increase in new public company costs.
As a percentage of net revenue, SG&A expenses decreased 570 basis points to 27.9% of net revenue in the three months ended September 30, 2020. The gross margin improvement was primarily the result of the benefits of leverage as a result of the significant increase in revenue, as certain components of our cost of goods sold are fixed or otherwise do not move in line with revenues. In particular, non-variable Showroom occupancy costs, which are not dependent on revenue levels, were lower as a percentage of net revenue, contributing 430 basis points to the margin improvement.
Selling, General and Administrative Expenses
SG&A expenses increased $27.1 million, or 66.2%, to $68.1 million in the three months ended September 30, 20212022 compared to $41.0 million in the three months ended September 30, 2020. The increase was primarily driven by higher corporate and warehouse expenses of $7.6 million to support the growth of the business, an increase in selling expenses of $6.8 million primarily related to compensation, one-time costs related to the IPO of $3.5 million, increased marketing investment of $3.4 million and an out-of-period adjustment for depreciation of $3.0 million related to our capital lease.
As a percentage of net revenue, SG&A expenses decreased 50 basis points to 33.5%33.6% of net revenue in the three months ended September 30, 2021 compared2021.
Interest expense, net
Interest expense, net decreased $0.6 million to 34.0% of net revenue$0.8 million in the three months ended September 30, 2020.2022 compared to $1.4 million in the three months ended September 30, 2021. The decrease was driven by interest income earned on money market fund investments of $0.6 million.
Interest expenseIncome taxes
Interest expense decreased $1.4 million to $1.3Income taxes were $9.6 million in the three months ended September 30, 20212022 compared to $2.7 million in the three months ended September 30, 2020. For the three months ended September 30, 2021, interest expense was primarily related to our capital lease obligations. For the three months ended September 30, 2020, interest expense was primarily related to our Term Loan, which was paid off in December 2020, our capital lease obligations, and borrowings on our revolving credit facility.
State and Local Taxes
State and local taxes were $0.5 million in the three months ended September 30, 2021 compared2021. Prior to $0.7 million in the three months ended September 30, 2020. This includes state and local tax inReorganization, the locations where we operate. AsCompany was a limited liability company under the Internal Revenue Code that had elected to be taxed as a partnership and did not pay federal or most state corporate income taxes on its taxable income, but rather its members were liable for their respective portions of the taxable income (loss) of LLC. Income tax expense included state and local taxes in certain jurisdictions prior to the Reorganization. Subsequent to the Reorganization, LLC’s taxable income flows through to FS Arhaus LLC was a pass-through entity for the three months ended September 30, 2021 and September 30, 2020.
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Homeworks who are subject to U.S. federal and state corporate income taxes.
Net and Comprehensive Income
Net and comprehensive income increased $13.6$22.7 million to $14.4$36.9 million in the three months ended September 30, 20212022 compared to $0.8$14.2 million in the three months ended September 30, 2020.2021. The increase was driven by the factors described above.
Liquidity and Capital Resources
Liquidity Outlook
Our primary cash needs have historically been for merchandise inventories, payroll, marketing catalogs, Showroom rent, capital expenditures associated with opening new Showrooms and updating existing Showrooms, as well as the development of our infrastructure and information technology. We seek out and evaluate opportunities for effectively managing and deploying capital in ways that improve working capital and support and enhance our business initiatives and strategies. As of September 30, 2021,2022, we had cash and cash equivalents of $149.2$145.7 million. At September 30, 2021, we had no availability on the Revolver based on the borrowing base formula.
In November 2021, we entered into the 2021 Credit Facility with Bank of America.America, N.A. and the lenders party thereto. 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$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$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$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 (1.75%(1.50% at origination)September 30, 2022), whereas the applicable margin is adjusted quarterly based on the Company’s consolidated rent-adjusted total leverage ratio. At September 30, 2022, we had no borrowings on the 2021 Credit Facility.
For the nine months ended September 30, 20212022, our principal sources of liquidity were cash flows from operations, including client deposits. We believe our operating cash flows will be sufficient to meet working capital requirements and fulfill other capital needs for at least the next 12 months, although we may enter into borrowing arrangements in the future or if conditions change.future.
While we do not require debt to fund our operations, our goal continues to be in ato position the Company to take advantage of the many opportunities that we may identify in connection with our business and operations. We have pursued in the past, and may pursue in the future, additional strategies to generate capital to pursue opportunities and investments, including new debt financing arrangements. In addition to funding the normal operations of our business, we have used our liquidity
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to fund investments and strategies such as supply chain expansion and growth initiatives. In addition, our capital needs and uses of capital may change in the future due to changes in our business or new opportunities that we choose to pursue.
Capital expenditures

WeHistorically, we have invested significant capital expenditures in opening new Showrooms, and theseShowrooms. In 2022, our recent distribution center footprint expansion has also been a focus of our capital expenditures. While our capital expenditures vary year to year, they have increased in the past and may continue to increase in future periods as our distribution centers become fully operational and we open additional Showrooms. Our capital expenditures include expenditures related to investing activities and cash outflows of capital related to construction activities to design and build landlord-owned leased assets, net of tenant allowances received. Given the pace at which business conditions are evolving in response to the COVID-19 health crisis, we may adjust our investments in various business initiatives including our capital expenditures over the remainder of fiscal year 2021.
Certain lease arrangements require the landlord to fund a portion of the construction related costs through payments directly to us. New Showrooms may require different levels of capital investment on our part in the future.
In addition, we continue to address the effects of the COVID-19 pandemic on our business with respect to real estate development and the introduction of new Showrooms. A range of factors involvedincluded in the development of new
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Showrooms may continue to be affected by the COVID-19 health crisispandemic including delays in construction, as well as permitting and other necessary governmental actions. In addition, the scope and cadence of investments by third parties, including landlords and other real estate counterparties, may be adversely affected by the health crisis. Actions taken by federal, state and local government authorities, and in some instances mall and shopping center owners, in response to the pandemic may require changes to our real estate strategy and related capital expenditures. In addition, we may continue to be required to make lease payments in whole or in part for our Showrooms in the event that may bethey are required to close in the future in the event ofdue to resurgences in COVID-19 outbreaks or for other reasons. Any efforts to mitigate the costs of construction delays and deferrals, retail closures and other operational difficulties, including any such difficulties resulting from COVID-19, such as by negotiating with landlords and other third parties regarding the timing and amount of payments under existing contractual arrangements, may not be successful, and as a result, our real estate strategy may have ongoing significant liquidity needs even as we make changes to our planned operations and expansion cadence.
Credit Facilities
Refer to Note 4 — Long-Term Debt and Note 12 — Subsequent Events in to our condensed consolidated financial statements for further information on our Revolver and 2021 Credit Facility, respectively.

Cash Flow Analysis

The following table provides a summary of our cash provided by operating, investing and financing activities:
Nine Months Ended September 30,Nine months ended September 30,
(In thousands)(In thousands)20212020(In thousands)20222021
Net cash provided by operating activitiesNet cash provided by operating activities$142,589 $115,120 Net cash provided by operating activities$58,237 $141,190 
Net cash used in investing activitiesNet cash used in investing activities$(29,531)$(11,129)Net cash used in investing activities(36,950)(29,533)
Net cash used in financing activitiesNet cash used in financing activities$(15,580)$(9,165)Net cash used in financing activities(113)(20,321)
Net increase in cash, cash equivalents and restricted cash equivalentsNet increase in cash, cash equivalents and restricted cash equivalents$97,478 $94,826 Net increase in cash, cash equivalents and restricted cash equivalents$21,174 $91,336 
Net cash provided by operating activities
Comparison of the Nine Months Endednine months ended September 30, 20212022 and September 30, 20202021
Net cash provided by operating activities was $142.6$58.2 million in the nine months ended September 30, 20212022 compared to $115.1$141.2 million net cash provided by operating activities in the nine months ended September 30, 2020.2021. The increasedecrease in our net cash provided by operating activities in the nine months ended September 30, 20212022 was primarily the result of increasedimpacted by several factors: lower change in client deposits resulting from improved delivery of backlog orders and lower demand comparable growth of 15.1% versus demand comparable growth of 58.4% in the nine months ended September 30, 2021; higher inventory levels related to strong client demand, the impact ofdemand; and higher non-cash items in the current period, particularlyperiod. The non-cash items include the amortization of operating lease assets and lease incentives, interest and deferred tax assets that were partially offset by the non-recurring derivative expense in the prior year related to the change in the fair value of the term loanTerm Loan exit fee, which reduced our net income without any corresponding adverse impact to our cash generation and an increase to accrued expenses. This wasgeneration. These items were partially offset by decreases in cash related to the changes in working capital, which were primarily driven by increases in merchandise inventory caused by forecasted client demand.accounts payable and accrued expenses.
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Net cash used in investing activities
Investing activities consist primarily of investments in capital expenditures related to investments in retail Showrooms, information technology and systems infrastructure, as well as supply chain investments. Investing activities also include strategic investments made by the Company.
Comparison of the Nine Months Endednine months ended September 30, 2022 and 2021 and
For the nine months ended September 30, 20202022, net cash used in investing activities was $37.0 million primarily due to investments in Showrooms, supply chain expansion and information technology and systems infrastructure.
For the nine months ended September 30, 2021, net cash used in investing activities was $29.5 primarily due to investments in Showrooms, the purchase of an airplane, information technology and systems infrastructure, and supply chain.
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For the nine months ended September 30, 2020, net cash used in investing activities was $11.1 million primarily due to investments in Showrooms, information technology and systems infrastructure, and supply chain.chain expansion.
Historical capital expenditures are summarized as follows:
Nine Months Ended September 30,
(In thousands)20212020
Net cash used in investing activities$29,531 $11,129 
Proceeds from sale of property, furniture and equipment— — 
Total capital expenditures$29,531 $11,129 
Landlord contributions11,140 9,940 
Total company funded capital expenditures$18,391 $1,189 
Comparison of the Nine Months Ended September 30, 2021 and September 30, 2020
Nine months ended September 30,
(In thousands)20222021
Net cash used in investing activities$36,950 $29,533 
Less: Landlord contributions11,373 11,140 
Total capital expenditures, net of landlord contributions$25,577 $18,393 
Total company funded capital expenditures, net of landlord contributions increased by $17.2$7.2 million in the nine months ended September 30, 20212022 compared to the nine months ended September 30, 2020.2021. This increase was related to our new facilityfacilities in Dallas and North Carolina, the opening of new Showrooms the purchase of an airplane, and information technology and systems infrastructure. infrastructure upgrades.

We anticipate our total company funded capital expenditures to be $32between $40 million to $34and $50 million in fiscal year 2021,2022, primarily related to the expansion of our new facility inBoston Heights distribution center and the opening of our North Carolina the purchase of an airplane,and Dallas distribution centers, the opening of new Showrooms, and information technology and systems infrastructure.infrastructure upgrades.
Net cash used in financing activities
Financing activities consist primarily of borrowings related to credit facilities, dividends, repayments of preferred unitsprincipal payments on our finance leases and tax distributions to members.the shareholders and noncontrolling interest holders of LLC.
Comparison of the Nine Months Endednine months ended September 30, 2022 and 2021 and
For the nine months ended September 30, 20202022, net cash used in financing activities was $0.1 million due to principal payments on finance leases.
For the nine months ended September 30, 2021, net cash used in financing activities was $15.6$20.3 million, duewhich related to $12.4 million of shareholder distributions and $7.9 million of tax distributions to members.
For the nine months ended September 30, 2020, net cash used in financing activities was $9.2 million. Payments on the term loan used $11.2 millionnoncontrolling interest holders of cash. Revolver borrowings net of payments were $11.0 million. Tax distributions to members were $8.8 million.LLC.
Off-Balance Sheet Transactions
As of September 30, 2021, other than operating leases and letters of credits, which are typical in a retail environment,2022, we did not have any otherno material off-balance sheet arrangements.
Critical Accounting Policies and Estimates
OurAccounting policies and estimates are considered critical when they require management to make subjective and complex judgments, estimates and assumptions about matters that have a material impact on the presentation of our financial statements and accompanying notes. For a description of our critical accounting policies related to revenue recognition and leases have not materially changed from those disclosedestimates, see Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and Estimates” in our final prospectus, dated November 3, 2021 (File No. 333-260015) filed withAnnual Report on Form 10-K for the SEC pursuant to Rule 424(b)(4) under the Securities Act of 1933, as amended. Our critical accounting policies related to revenue recognition, goodwill and fair value are as follows:
Revenue Recognition
Net revenue consists of sales to clients, net of returns, discounts, and rebates. Net revenue and cost of goods sold is recognized when performance obligations under the terms of the contract are satisfied, and the control of merchandise has been transferred to a client, which occurs when merchandise is received by our clients. Net revenue from “direct-to-client” and “home-delivered” sales are recognized when the merchandise is delivered to the client. Net revenue from “cash-and-carry” Showroom sales are recognized at the point of sale in the Showroom. Discounts provided to clients are accounted for as a reduction of sales at the point of sale. Sales commissions are incremental costs and are expensed as incurred.year ended December 31, 2021.
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A reserve is recorded for projected merchandise returns based on actual historical return rates. We provide an allowance for sales returns based on historical return rates, which is presented on a gross basis. The allowance for sales returns is presented within other current liabilities and the estimated value of the right of return asset for merchandise is presented within prepaid expense and other assets on the consolidated balance sheet. Actual merchandise returns are monitored regularly and have not been materially different from the estimates recorded. Merchandise returns are granted for various reasons, including delays in merchandise delivery, merchandise quality issues, client preference and other similar matters. We have various return policies for merchandise, depending on the type of merchandise sold. Merchandise returned often represents merchandise that can be resold. Amounts refunded to clients are generally made by issuing the same payment tender as used in the original purchase. Merchandise exchanges of the same merchandise at the same price are not considered merchandise returns and, therefore, are excluded when calculating the sales returns reserve. The allowance for sales returns is included within accrued other expenses line item on the consolidated balance sheet.

All taxes assessed by a government authority that are both imposed on and concurrent with a specific revenue-producing transaction and collected by us from clients are excluded from the measurement of the transaction price. As a result, sales are stated net of tax.

Shipping and handling is recognized as activities to fulfill the performance obligation of transferring merchandise to clients, therefore the fees are recorded as revenue. The costs we incur for shipping and handling are included in cost of goods sold, and the costs of shipping and handling activities are accrued for in the same period as the delivery to clients.

We collect various taxes as an agent in connection with the sale of merchandise and remit these amounts to the respective taxing authorities. These taxes are included within the accrued taxes line item of the consolidated balance sheet until remitted to the respective taxing authority.

Client deposits represent payments made by clients on orders. At the time of purchase, we collect 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.
Goodwill
The recoverability of goodwill is evaluated annually or whenever events or changes in circumstances indicate that the fair value of the reporting unit is less than its carrying amount. Circumstances that may indicate impairment include, but are not limited to, deterioration in general economic conditions, limitations on accessing capital, or other developments in equity and credit markets; industry and market considerations such as deterioration in the environment in which we operate, an increased competitive environment, a decline in market dependent multiples or metrics, a change in the market for our products or services, or a regulatory or political development; cost factors that have a negative effect on earnings and cash flows; overall financial performance; changes in management, key personnel, strategy, or clients; a sustained decrease in share price in either absolute terms or relative to peers.

We perform our annual goodwill impairment testing in the fourth quarter by comparing the fair value of a reporting unit with its carrying amount, limited to the total amount of goodwill of the reporting unit. We establish the fair value for the reporting unit based on the discounted cash flows to determine if the fair value of our goodwill exceeds its carrying value. We will recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value.
Fair Value
Our primary financial instruments are accounts receivable, payables, lease obligations, incentive unit compensation and a derivative instrument. Due to the short-term maturities of accounts receivable and payables, we believe the fair values of these instruments approximate their respective carrying values at September 30, 2021 and December 31, 2020.

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We have 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 our 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.
Recent Accounting Pronouncements
See Note 2— Recently Issued Accounting Standards to our condensed consolidated financial statements.statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risks, which include significant deterioration of the U.S. and foreign markets, changes in U.S. interest rates, foreign currency exchange rate fluctuations and the effects of economic uncertainty, which may affect the prices we pay our vendors in the foreign countries in which we do business. We do not engage in financial transactions for trading or speculative purposes.
Foreign Currency Exchange Risk
We believe foreign currency exchange rate fluctuations do not contain significant market risk to us due to the nature of our relationships with our vendors outside of the United States. We purchase the majority of our inventory from vendors outside of the United States in transactions that are primarily denominated in U.S. dollars and, as such, any foreign currency impact related to these international purchase transactions was not significant to us for the nine and three months ended September 30, 20212022 and 2020,2021, respectively. However, since we pay for the majority of our international purchases in U.S. dollars, a decline in the U.S. dollar relative to other foreign currencies would subject us to risks associated with increased purchasing costs from our vendors. We cannot predict with certainty the effect these increased costs may have on our financial statements or results of operations. We currently do not use derivative instruments to manage this risk.
Interest Rate Risk
We are primarily exposed to interest rate risk with respect to borrowing under our Revolver2021 Credit Facility and as of September 30, 2021,2022, we have not drawn upon the Revolver. On November 4, 2021, we terminated our Revolver and entered into the 2021 Credit Facility. Based on the interest rate onin the 2021 Credit Facility and to the extent borrowings were outstanding, we do not believe a 100 basis point change in interest rates would have a material impact on our financial condition or results of operations for the periods presented. We currently do not use derivative instruments to manage this risk.
Impact of Inflation
Our resultsInflation generally affects us by increasing our cost of operationslabor, material, transportation, and financial condition are presented based on historical cost. While it is difficultour general costs. We have historically been able to accurately measure therecover these cost increases through price increases. However, we cannot reasonably estimate our ability to successfully recover any impact of inflation due to the imprecise nature of the estimates required, we believe the effects of inflation, if any, on our historical results of operations and financial condition have been immaterial. We cannot assure you, however, that our results of operations and financial condition will not be materially impacted by inflationthrough price increases in the future. We currently do not use derivative instruments to manage this risk.
Emerging Growth Company Status
We are an “emerging growth company,” as defined in the JOBS Act. Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have elected to use this extended transition period to enable us to comply with new or
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revised accounting standards that have different effective dates for public and private companies until the earlier of the date we are no longer an emerging growth company or affirmatively and irrevocably opt out of the extended transition period provided in the JOBS Act. Accordingly, our condensed consolidated financial statements may not be comparable to companies that comply with new or revised accounting pronouncements as of public company effective dates.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our Chief Executive OfficerCEO and Chief Financial Officer (“CFO”), management has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) as of September 30, 2021.

2022. Based uponon their evaluation as of September 30, 2022, the CEO and CFO have concluded that evaluation, our Chief Executive Officerdisclosure controls and Chief Financial Officer identified threeprocedures were not effective at the reasonable assurance level because of the material weaknesses in our internal control over financial reporting described below.
Based upon that evaluation, our CEO and CFO identified four material weaknesses in our internal control over financial reporting.
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Material Weaknesses in Internal Control Over Financial Reporting
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected on a timely basis.

•We did not design and maintain an effective control environment commensurate with our financial reporting requirements. Specifically, we lacked a sufficient complement of professionals with an appropriate level of accounting knowledge, training and experience to appropriately analyze, record and disclose accounting matters timely and accurately. Additionally, the lack of a sufficient number of professionals resulted in an inability to consistently establish appropriate authorities and responsibilities in pursuit of our financial reporting objectives, as demonstrated by, amongst other things, insufficient segregation of duties in our finance and accounting functions. This material weakness contributed to the following additional material weaknesses.

•We did not design and maintain accounting policies, procedures and controls, or maintain documentary evidence of existing control activities to achieve complete, accurate and timely financial accounting, reporting and disclosures, including adequate controls over the period-end financial reporting process, the preparation and review of account reconciliations and journal entries, including segregation of duties and assessing the reliability of reports and spreadsheets used in controls.

•We did not design and maintain effective controls to address the identification of and accounting for certain non-routine or complex transactions, including the proper application of U.S. GAAP of such transactions. Specifically, we did not design and maintain controls to timely or appropriately account for our incentive unit plan.

These material weaknesses resulted in a restatement of our previously issued annual consolidated financial statements as of and for the years ended December 31, 2020 and 2019 principally related to selling, general and administrative expenses and other long-term liabilities, and misclassifications in the balance sheets and statements of comprehensive income. These material weaknesses also resulted in an immaterial out-of-period adjustments recorded as of and for the periodyear ended September 30,December 31, 2021 principally related to property, furniture and equipment, net andnet; selling, general and administrative expenses.expenses; and misclassifications in the balance sheet and statement of cash flows. Additionally, each of the material weaknesses could result in misstatements to substantially all of our accounts or disclosures, which thenthat would result in a material misstatement to the annual or interim consolidated financial statements.

statements that would not be prevented or detected.
•Lastly, we did not design and maintain effective controls over information technology, or IT, general controls for information systems that are relevant to the preparation of our financial statements. Specifically, we did not design and maintain: (i) program change management controls for financial systems to ensure that information technology program and data changes affecting financial applications and underlying accounting records are identified, tested, authorized and implemented appropriately; (ii) user access controls to ensure appropriate segregation of duties and that adequately restrict user and privileged access to financial applications, programs, and data to appropriate Company personnel; (iii) computer operations controls to ensure that critical batch jobs are monitored and data backups are authorized and monitored; and (iv) testing and approval controls for program development to ensure that new software development is aligned with business and IT requirements.
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These IT deficiencies did not result in material adjustments to our consolidated financial statements,statements; however, the deficiencies, when aggregated, could impact maintaining effective segregation of duties, as well as the effectiveness of IT-dependent controls (such as automated controls that address the risk of material misstatement to one or more assertions, along with the IT controls and underlying data that support the effectiveness of system-generated data and reports) that could result in misstatements potentially impacting all financial statement accounts and disclosures that would not be prevented or detected. Accordingly, management has determined these IT deficiencies in the aggregate constitute a material weakness.

Remediation Activities
With the oversight of senior management and our Audit Committee, we have designed and begun to implement a remediation plan which includes:
•Updating our policies and procedures to establish and maintain effective segregation of duties for our finance and accounting staff in relation to journal entries, reconciliations and other applicable processes.

•Designing and implementing internal financial reporting procedures and controls to improve the completeness, accuracy and timely preparation of financial reporting and disclosures inclusive of establishing an ongoing program to provide sufficient training to our finance and accounting staff.
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•Enhancing the design and operation of user access control activities and procedures to ensure that access to IT applications and data is adequately restricted to appropriate personnel.
•Hiring additional competent and qualified technical accounting and financial reporting personnel with appropriate knowledge and experience of U.S. GAAP and SEC financial reporting requirements, including non-routine and complex transactions, to design, execute and/or provide appropriate oversight of activities related to internal control over financial reporting, or ICFR.

•Implementing additional program change management policies and procedures, control activities, and tools to ensure changes affecting key financial systems related to IT applications and underlying accounting records are identified, authorized, tested, and implemented appropriately.

•Designing and implementing a formal systems development lifecycle methodology and related program development controls to ensure significant IT change events are appropriately tested and approved.
•Enhancing the design and operation of control activities and procedures within the computer operations domain to ensure key batch jobs are monitored, processing failures are adequately resolved, and recovery capability is tested.
•Identifying and evaluating key IT dependencies including key reports, automated application controls, interfaces, and end user computer facilities.

Although we have developed and begun to implement a plan to remediate the material weaknesses and believe, based on our evaluation to date, that the material weaknesses will be remediated in a timely fashion, we cannot project a specific timeline on when the plan will be fully implemented. The material weaknesses will not be remediated until the necessary internal controls have been designed, implemented, tested and determined to be operating effectively. While the Company cannot provide an estimate of costs expected to be incurred in connection with implementing this remediation plan, these remediation measures will be time consuming, incur significant costs to both implement and maintain, and place significant demands on the Company’s financial and operational resources. In addition, we may need to take additional measures to address the material weaknesses or modify the planned remediation steps, and we cannot be certain that the measures we have taken, and expect to take, to improve our internal controls will be sufficient to address the issues identified, to ensure that our internal controls are effective or to ensure that the identified material weaknesses will not result in a material misstatement of our consolidated financial statements. Moreover, we cannot provide assurance that we will not identify additional material weaknesses in our ICFR in the future. Until we remediate the material weaknesses, our ability to record, process and report financial information accurately, and to prepare our consolidated financial statements within the time periods specified by the rules and forms of the SEC, could be adversely affected.
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Changes in Internal Control over Financial Reporting
Other than as described above with respect to ongoing remediation efforts, there were no changes in our internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f) during the quarter ended September 30, 20212022 that have materially affected, or isare reasonably likely to materially affect, our internal control over financial reporting.

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Part II - Other InformationInformation
Item 1. Legal Proceedings
From time to time, we have and we may become involved in legal proceedings arising in the ordinary course of business, including claims related to our employment practices, claims of intellectual property infringement and claims related to personal injuries and product liability for the products that we sell and in the Showrooms we operate. Any claims could result in litigation against us and could result in regulatory proceedings being brought against us by various federal and state agencies that regulate our business. Defending such litigation is costly and can impose significant burdenburdens on management and employees. Further, we could receive unfavorable preliminary or interim rulings in the course of litigation, and there can be no assurance that favorable final outcomes will be obtained.
We are currently not a party to any legal proceedings, the outcome of which, if determined adversely to us, would individually or in the aggregate have a material adverse effect on our business, financial condition or results of operations.
Item 1A. RISK FACTORSRisk Factors

In addition toThere have been no material changes from the other information discussedrisk factors disclosed in this report, please consider the factors described inPart I, Item 1A “Risk Factors” in our registration statementAnnual Report on Form S-1, as amended (File No. 333-260015) (the “Registration Statement”) which could materially affect our business, financial condition or future results. There have not been any significant changes with respect to10-K for the risks described in our Registration Statement, but these are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may adversely affect our business, financial condition or operating results.year ended December 31, 2021.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On November 3, 2021, our registration statement on Form S-1 (File No. 333-260015), which was filed in connection with our IPO, was declared effective. At the closing of the offering on November 8, 2021, we sold 12,903,226 shares of our Class A common stock, which did not include the exercise by the underwriters of their option to purchase up to 1,935,484 additional shares. Our sale of 12,903,226 Class A common stock at our initial public offering price of $13.00 per share, resulted in net proceeds to us of approximately $151.4 million, after deducting underwriting discounts and commissions of $10.4 million and estimated offering expenses of approximately $5.9 million. As disclosed in the registration statement, we used a portion of the net proceeds received from the IPO to pay the term loan exit fee of $64.1 million in connection with the term loan that was repaid on December 28, 2020 and the remainder will be used for general corporate purposes. None of the expenses associated with the IPO were paid to directors, officers, persons owning ten percent or more of any class of equity securities, or to their associates, or to our affiliates.None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Mine Safety Disclosures
None.
Item 5. Other Information
None.
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ItemItem 6. Exhibits and Financial Statement Schedules

Exhibit
No.		DescriptionFilings Referenced for Incorporation by Reference
Amended and Restated Certificate of Incorporation of Arhaus, Inc.November 10, 2021 Form 8-K, Exhibit 3.1
Amended and Restated Bylaws of Arhaus, Inc.November 10, 2021 Form 8-K, Exhibit 3.2
Credit Agreement, dated November 8, 2021, among Arhaus, Inc., certain subsidiariesForm of Arhaus, Inc., as the Guarantors, BankNotice of America, N.A., as the Administrative Agent, the L/C Issuer,Award (Restricted Stock Unit and the Swingline Lender, and the lenders party thereto.Performance Share Unit)November 10, 2021June 30, 2022 Form 8-K,10-Q, Exhibit 10.1
Form of Performance Share Unit Award AgreementFiled herewith
Form of Restricted Stock Unit Award AgreementFiled herewith
Form of Director Restricted Stock Unit Award AgreementFiled herewith
Employment Letter (Tim Kuckelman)Filed herewith
Certificate of Chief Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002Filed herewith
Certificate of Chief Financial Officer Pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002Filed herewith
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002FiledFurnished herewith
Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002FiledFurnished herewith
101.INSXBRL Instance Document (the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document)Filed herewith
101.SCHInline XBRL Taxonomy Extension Schema DocumentFiled herewith
101.CALInline XBRL Taxonomy Extension Calculation Linkbase DocumentFiled herewith
101.DEFInline XBRL Taxonomy Extension Definition Linkbase DocumentFiled herewith
101.LABInline XBRL Taxonomy Extension Label Linkbase DocumentFiled herewith
101.PREInline XBRL Taxonomy Extension Presentation Linkbase DocumentFiled herewith
104Cover Page with Interactive Data File (formatted as Inline XBRL with applicable taxonomy extension information contained in Exhibits 101)Filed herewith
*    The certifications furnished in Exhibit 32.1 and 32.2 hereto are deemed to accompany this Quarterly Report on Form 10-Q and will not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, except to the extent that the registrant specifically incorporates it by reference.
†    Certain schedules and exhibits to this agreement have been omitted in accordance with Item 601(a)(5) of Regulation S-K. A copy of any omitted schedule and/or exhibit will be furnished to the SEC on request.

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.authorized on this 10th day of November, 2022
ARHAUS, INCINC.
By:/s/ Dawn Phillipson
Name:Dawn Phillipson
Title:Chief Financial Officer
(Principal Financial and Accounting Officer)

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