MillerKnoll, Inc.

Good evening, and welcome to the Miller-Knowles Second Quarter Earnings Conference Call. As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Antonella Pilo, Vice President of Investor Relations and FP&A.

Good evening. Thank you for joining our call. We have posted the press release on our Investor Relations website at HermanMiller.com. Wherever any figures are presented on a non-GAAP basis, we have reconciled the GAAP and non-GAAP amounts within the press release. I would like to remind everyone that this call will include forward-looking statements. For informational factors that could cause actual results to differ materially from these forward-looking statements, please refer to the earnings press release as well as our annual and quarterly SEC filing. Any forward-looking statements that we make today are based on assumptions as of this date and we undertake no obligation to update these statements as a result of new information or future events. At the conclusion of our prepared remarks, we will have a Q&A session. Today's call is scheduled for 60 minutes. With that, I'll turn the call over to Andy.

Thanks, Antonella. Hi, everyone, and Happy New Year. Joining me today are Jeff Stutz, our CFO, John Michael, our President of the Americas Contract Organization, Debbie Probst, our President of Global Retail, Chris Baldwin, our group president, Miller & Noll, and Kevin Beltman, our senior vice president and our integration lead. Our performance in the second quarter demonstrates the power of Miller & Noll and the strength of both our strategy and our business fundamentals. In bringing together the best of Herman Miller & Noll, we've created a stronger and more resilient organization built for long-term success. Throughout the quarter, we built positive momentum and continue to see strong demand around the globe. Order levels were up in all four reporting segments again this quarter. Both our retail and our contract businesses continue to grow, and we're bringing new customers to our brands with growth initiatives like gaming, store and studio openings, and an expanding e-commerce presence. As it relates to this last point, this past quarter, we launched new Herman Miller e-commerce sites in France and Germany, and both have exceeded our early expectations for sales and order activity. We've leveraged learnings from our previous website launches to create an exceptional online shopping experience for consumers in both countries, and we'll continue to benefit from our growing digital presence around the world as we move forward. That said, we're facing many of the same challenges as the rest of the industry, including inflationary pressures, supply chain challenges, and labor shortages. We benefit from the increased size and reach of our large organization, and we're leveraging our global distribution, production, design, and sales capabilities to combat all of these pressures. We've leaned into the expertise and partnerships that exist across our collective of brands to build inventory positions of select high-demand products and increase our shipping capacity. We're making sure of progress in our integration journey, and we remain focused on unleashing the power of all of our collective of brands. At the close of the second quarter, we had implemented $43 million in run rate savings, and we remain confident that we will deliver our cost synergies target of $100 million within two years of closing. In fact, as our teams completed integration planning, they've identified additional synergy opportunities, and we now expect to increase run rate savings to $120 million by the end of year three. This meaningful progress, along with our robust integration roadmap, gives us confidence that we will achieve our planned cost synergies, even with the inflationary and supply chain pressures that we're contending with every day. We've achieved several important and symbolic milestones in the quarter. We finalized the company name change and are officially operating as Miller Knoll. We're also trading under our new stock picks for MLKN. We completed the important work to create our new Miller Knoll organizational structure, which involves selecting talent and integrating the teams into a new operating model designed to capture efficiencies across the organization, while also strengthening the unique position of each of our individual brands. One of the most compelling reasons for creating Miller & Ohl is our combined portfolio and distribution network. Miller & Ohl will have the largest and most capable dealer network in the world. Our customers will have more choice in terms of both product and partners, and our dealers will have access to the most comprehensive suite of products and services in the industry, enabling them to sell more and better meet the needs of every customer. Creating a Miller & Ohl dealer network is our top priority, and we are well on our way. We have Miller and Old Dealer pilots in process in both Texas and Arizona. And we'll use what we're learning in these pilots to inform the plan for operationalizing the phone network, which is on track to occur by mid-calendar year 2022. While the world continues to wait and see the full impact of the Omicron variant, faking new variants feels like the new normal to us. Our research and customer feedback tells us that executives across a variety of industries still have a strong desire to bring their teams back together this year. And what's more... Most employees want the flexibility and the option to return to the office as well, just not the same office they left in 2020. Employers recognize their workplaces need to be reimagined and redesigned to meet the changed expectations of the post-pandemic workforce. Miller & Owe is the leader in providing adaptable solutions to create innovative, productive environments for the workplaces and the homes of our clients. We have the insights, the products, the services, and the tools to help our customers create high-performing spaces that solve for their unique needs. So we're continuing to collaborate with experts from around the world to make both returning to the workplace and working from home healthier and more productive. And we're using our own firsthand experiences with hybrid workplaces and our global insight partnerships to inform the future of work. Our business is strong. We're powered by the preeminent portfolio of brands in the industry, and we are built for growth. And we're confident but there is tremendous opportunity ahead for Milanol and all of our stakeholders. So with that, I'll turn it over to Jeff, who will cover a bit more about our results before we open it up for your questions.

Thank you, Annie. Good evening, everyone. During the second quarter, we drove growth across every segment and every region of the business, and we were able to leverage the breadth and depth of the organization to combat some of the macroeconomic pressures we faced in the quarters. Even with those challenges, we had a strong quarter and were confident about the future, including our ability to deliver on the cost synergies associated with the NOAA acquisition. Consolidated net sales of just under $1.03 billion were up 64% on a reported basis and 11% organically over last year. Our ability to ship orders this quarter was impacted by the supply chain disruptions that our industry is facing, which we estimate adversely impacted net sales by approximately $50 million in the quarter. Orders in the quarter of $1.16 billion were 84% higher than last year. And on an organic basis, orders of $796 million reflected sequential improvement of 6% compared to the first quarter and were up 26% over the prior year. As mentioned earlier, the strong demand was seen across all reporting segments. Global retail had another strong quarter with orders up almost 21% over the prior year and sales growth for approximately 18%. The America's contract segment saw strong demand in all regions and sectors, with notable momentum in the middle and southern regions of the U.S. Net sales in this segment increased 4%, while new orders improved 29% on a year-over-year basis. The Knoll segment reported similar growth rates, with year-on-year sales and orders increasing 5% and 30% respectively. Both the Knoll workplace and residential categories contributed to this growth in the quarter. The international contract segment also saw strong orders and sales across all regions and brands, with orders up 30% and sales up 23% over the same quarter last year. Demand in Europe, including the UK, was especially strong, with orders in Europe up 42% over last year. Adjusted gross margin was 34.8% compared to 39% last year. Similar to what we reported to you last quarter, the year-over-year margin decline was driven by the impact of rising commodity costs, particularly steel, and other inflationary pressures in the categories of labor and transportation. In response to these margin pressures, we have been aggressive in the area of pricing, having implemented or announced multiple contract list prices since May. While we have realized some of this benefit to date, the impact has thus far been limited and will take time to layer into our results. This has been contemplated in our outlook for the third quarter. Now, with that said, you should know that these increases are ultimately geared to offset the cost pressures that we're seeing across the business. And in the meantime, we're carefully managing what we can control across the business as we work to mitigate the impact of these macroeconomic pressures. Adjusted operating margin in the second quarter for the consolidated business was 5.9% compared to 11.7% in the prior year. And it's worth highlighting that our global retail business has continued to deliver solid profitability despite the underlying costs, challenges, and tough year-over-year comparisons that segment is facing. In addition to order growth of 20%, the retail segment reported adjusted operating margins of 11.3% this quarter. We reported a consolidated net loss per share of 5 cents. And on an adjusted basis, excluding special charges associated with the integration of Knoll, earnings per share in the second quarter were 51 cents. So with those brief opening comments, we'll now turn the call over to the operator, and we'll take your questions.

Thank you. To ask a question, you will need to press star 1 on your telephone. We ask that you please limit yourself to one question and one follow-up question. You may then return to the queue. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question will come from Stephen Ramsey with Thompson Research Group. Please go ahead. Hi, good evening.

Maybe to start with on organic orders, how much of this is pricing driven and how much of it is volume and how do you expect that to play out in the next several quarters? I guess what I'm getting at is if, Jeff, you could share a little bit more on the pricing commentary and how that flows through reported results.

Well, good evening, Stephen. Good to hear from you. Happy New Year. Yeah, let me – I'll start with maybe just the order trends in the quarter because I think the crux of your question is, you know, have we seen meaningful pull ahead in order activity in advance of some of these increases? And, you know, what was really encouraging for us is as you looked across each of the three months of the quarter, order pacing was actually remarkably consistent. And so from my perspective, you know, for the increase that we had in the October-November timeframe, there was not a meaningful pull-ahead impact from that increase. Intra-quarter orders, for example, in the Americas were, you know, we started off up 22%. We were kind of mid-to-high 30% growth in October and high 20%, you know, close to 30% in November for a total increase in the quarter of 29%. You know, the Knoll business was even more consistent than that, close to 30% almost on the nose in each of the months of the quarter. similar. Retail had some movement in the quarter. Debbie can speak to this if you'd like to go further, but it had more to do with the timing of some of the promotional events this year versus last year. If you adjust for that here, too, retail order activity was quite consistent. So what I would tell you, Stephen, is that the price increases early in the summer months and then again in October-November timeframe didn't seem to have much impact. Now, what I will also mention is that the increase that we we have planned for january february time frame we did start to see some of that pull ahead in uh in the last couple of weeks um but it's not out of line with historical levels um let me pause there is that helpful on the on the order trends yes yes that is and then was trying to get a sense for in that orders dollar number uh how much of that is is pricing driven and and kind of try to get a sense for in the next

couple of quarters, if the price increases you have successfully implemented, start to impact results?

Yeah, this is the challenge. And again, we've got to talk about this in two pieces. We have the positive side of this is the retail business we fully expect will benefit from price actions much sooner than the contract business. And as we've talked with you in the past, right, it's just a different animal. in the retail business. On the contract side, the challenge that we have, and this is, I think, pretty consistent from what we're hearing across the industry, we're somewhat the victim of the good news in terms of the solid demand. Demand has outpaced our ability to produce and ship by such a margin, by such a wide gap, that the backlog we have is going to take us a little time to work through it. And that backlog currently, as it exists today, has I would say a mix of the last two price increases in it. Obviously, none of the increase that will go into effect this month and in February. So the punchline to this, Stephen, is it's going to take us, we think, a good part of the second half of this fiscal year to work our way through that. And frankly, there's just not a tremendous amount of pricing benefit in that backlog. There's some, and it will ramp up as we move through Q3 and into Q4, particularly the later part of Q4. But really, it'll be kind of early next fiscal year where we really start to see the benefits of that flow through. Retail is a bit different. I think our expectations is that the retail side of the business, we're going to see gross margin improvement steadily increase as we move through the back half of the fiscal year. I think in rough numbers, gross margins for that business were maybe just under 44% this quarter. Expectations is we can move that as much as a couple hundred basis points over the spread of the next six months, and then improve it from there into FY23.

Okay, yes, that's very helpful. And then On that orders and shipments gap, is the growth rate of orders, you know, even beyond the quarter, is it still exceeding shipments? And to add on to that, is the rate of shipments going to increase at a faster pace than orders in Q3, or is it a little bit beyond that, that the pace of shipments can accelerate and reduce that backlog?

Well, I'll give you my thoughts on this, and then Chris and John, please feel free to chime in if you have views on this. Debbie, I assume, again, the retail business is a little bit different. I think, Stephen, from my perspective, first of all, we've not seen a meaningful change in demand since the end of the quarter. So that's a positive, right? In fact, we saw some, as I mentioned, what we believe to be some pull ahead of order activity recently. in December that would be ahead of that January price increase. So the momentum continues, and it's been remarkable when you consider the effect of COVID and some of the disruption that that seems to be creating socially around the world, yet demand has been really, really strong and it's pretty broad-based. Your question about will orders, will revenue in orders converge, I mean, you know, we don't know that, of course. I think our expectation, just based on conversations with customers, what we're hearing from design firms, folks are busy. And a lot of companies are still kind of formulating their plans for return to office as we move into even mid-calendar 22. So I think our expectations right now are for continued momentum on the order front. The challenge for us is throughput. Much of it is labor-driven. And we're doing a whole raft of things, as you would hope, to try to improve our ability to ship more. It's going to take us a little time to do that, but that's really among our chief focuses as a business and leadership team right now. John and Chris, feel free to add.

Thanks, Jeff. Hi, this is John. I think you said it well, Jeff. I think our expectation in terms of order pacing based on some of the leading indicators that we see is we expect the order pacing to continue on a pretty robust pace. And I think to your point from a production perspective, we have the capacity from a production perspective to match from a revenue and an order perspective. But as Jeff said, there's a number of factors impacting our ability right now, whether that's impact of COVID, supply chain issues, et cetera, et cetera. But as those hopefully smooth out over time, I think we'd expect production and then revenue and orders to be more closely matched.

Yeah, the only thing, this is Chris, the only thing to add, Stephen, is that our production output, I'm going to cover the international business, is increasing. And so we are shipping out more than we did sequentially. And the good news is, And also the challenge is that the orders are continuing to increase at an even faster rate. So we'll keep the production output growing, and it may be that in the future we'll be at the same rate as the orders. But in the near term, while the supply chain challenges are here, it's clear that we'll be slightly constrained.

And then on the retail side of the business, Our backlog is historically high, largely due to longer lead times than expected on third-party inbound products. And so sales as a percent of demand in Q2 was at 84%. We expect that to improve in Q3 and have seen some improvement there in that ratio in December already.

Great. That's helpful. That's helpful. And one more quick one maybe to add on to it. with the strong results there, can you kind of ballpark or quantify no residential in relation to Herman Miller residential and if the trends are as good there and if the factors that may cause any gap between the two?

Yeah, this is Chris. I'll take that one. So the trends are just as good. In fact, the trends for Knoll's residential business are quite strong, as you could expect with the power of now Miller Knoll and DWR and e-commerce. So clearly the former Herman Miller residential business is larger than the former Knoll business. But the Knoll business on the residential side is increasing dramatically. Great. Thank you.

Thank you. Our next question will come from Ruben Garner with the Benchmark Company. Please go ahead.

Thanks. Good evening, everybody. Hey, Ruben. Hey, Ruben. Maybe let's start with the guidance. So, Jeff, can you walk us through the bridge from what you just reported in earnings to the guidance for Q3? It looks like a similar top line number, I think if I'm looking at this correctly, and so some sequential margin pressure, is there mix in there or is the price cost situation getting worse before it gets better? Can you just kind of go through the puts and takes?

Yeah, great question, Ruben. Let me start, I'll start with, there's some commentary, I think, both in gross margin and operating expenses that stand out here that I think are worth highlighting. And by the way, all of this commentary on our outlook, and this is true while we're not guiding for the full back half of the year, I might mention one of the potential benefits of having this strong backlog and kind of a strange benefit of some of the production throughput issues we're having is that it does buy perhaps a little bit of time if we can see some input costs come back in line or in favor. Now, we don't expect that in a meaningful way on the steel front, but there are all kinds of other cost pressures that we're facing. We may actually be able to benefit from that, particularly as we move into Q4, but set that aside for a minute. Our guidance for the third quarter, from a gross margin standpoint, we guided to a range of 33.2 to 34.2. At the midpoint of that, you're at really 33.7. So that's a sequential decrease, obviously, from what we just reported. The couple large factors that are impacting us, they're really commodities and freight and labor. The same major drivers that we saw in Q2, we are expecting continued pressure, particularly on the commodities front. We estimate about 60 basis points from commodities. That's principally steel prices. We're still, believe it or not, working our way into the elevated full market price of steel. And without making predictions, I would tell you that if steel prices were to stabilize where they are now, as we work through Q3, we're kind of fully baked into the market price of steel. So that would be a benefit for us as we move forward beyond Q3. So commodities are 60 basis points. Freight and transportation and labor account for, we estimate, about another 30 basis points of pressure. And then that really tells the story. There are some other moving parts. We think mix might be a bit adverse, just pure product mix across the business. but we think that pricing benefit from our recent price increases will help offset that. So those kind of neutralize one another. But those are the major moving parts in our assumption around gross margin at the midpoint of the range that we're guiding. And then operating expenses, you'll see that we're guiding an uptick here again at the midpoint of that range, just for narrative purposes. That puts it at about $310 million. There's really kind of four main categories of operating moving parts there. The first one is really a bit of a phenomenon related to Q3 and often the early part of Q4. It's really more of a timing issue with some of our calendar year benefit programs. The accounting for those programs tends to front end load. Some of those are calendar year based and it tends to front end load some of the costs associated with those benefit programs. Things like vacation accruals and health savings account programs to be more specific. So that accounts for maybe upwards to $5 million of the sequential increase. The benefit there is, you know, that tends to even out as we move through the course of the calendar year, so we should see, you know, the opposite effect of that as we move toward back half of calendar 22. Incentive bonus plans we expect might be a tick higher in the third quarter as we move toward measuring ourselves against the back half targets that we've established. Investments in retail, digital, you know, program marketing dollars, we expect to increase a bit to help continue to drive momentum and order activity. And then this last one I'll mention to you is in our guide. We're going to do everything we can to manage this one, but there's some incremental selling-related expenses, including T&E, that are a factor in that as well. And offsetting all of those items, which if you were to say all of what I just said, call that $20 million as an estimate, we expect... to layer in incremental synergies related to the integration work that we're doing. So the net change there at the midpoint is about $16 million.

Okay, perfect. And just a quick clarification there. On the synergies, are those showing up all in the null, quote-unquote, segment, or are they spread out over the different businesses? How is that being recognized as – laid out as you recognize them.

Hey, Ruben, this is Kevin. The synergies are coming really across the patch, across all of the businesses as we've looked at how do we bring Miller & Noll together. And so you see some of the benefits from synergies hitting each of the segments.

Okay. Next question for me is on the international profitability. Can you talk about the difference for you guys in your international business? I assume that a lot of the inflationary pressures that they're facing or that you're facing in the Americas are similar, you know, inputs or I assume steel is, as an example, elevated in Europe as well. How you're able to maintain the margins over there? What are the differences in the business models? Anything else that you can add?

Yeah, Chris, let me start, and then you chime in if you don't mind. Yeah, Ruben, you know, the one thing I always – this is actually something we're super proud of. I mean, the international business has been a shining star in our business for several years now, and it's really showing up in a big way the last couple of quarters. There are some differences, and I think Chris will probably unpack some of these a little further, but in terms of the cost pressures and inflationary pressures and supply chain pressures that we're feeling in North America vis-à-vis – outside of North America. You know, we in fact really aren't feeling the same magnitude of commodity pressures internationally as we're seeing in North America. And then you add to that the fact that the labor constraints that we're feeling in our production facilities in North America are not nearly as significant in our international operations. And then, Chris, the last thing I'll say is, you know, we tend to have a fairly favorable overall product mix With our international contract business, it tends to tilt a bit more towards seeding, which is a good thing in our business. Task seeding is a high margin product. And for many, many years, that's always been true for the international business. But for so many years, we didn't have the base level of volume pushing through those factories to really be able to leverage those overhead costs. And in recent years, we've seen a real change. The volumes have grown. Our operations teams have done brilliant work. They're much more efficient now. And that's translating to better profitability. Chris, go ahead and add whatever you'd like.

It's hard to add much to that, Jeff. That was pretty comprehensive. The only thing that I might add, note that sales in the quarter are 80%. So because we were able to get a better labor position internationally, we were able to get increased throughput through the factory. So we also were able to protect that are there. I mean, the steel is there, steel increased costs, you know, and things like that, but we were able to grow, which helped.

Okay, I'm going to sneak one more in if I can, guys. Sure. Back to the Americas, the pricing, the backlog situation, I think you mentioned profitability and the backlog being... Is there a point where maybe you don't take as many orders because you're not able to keep up and the profitability isn't as attractive as normal, or do you view it as a longer-term positive to just take anything that you can at this point? How do you guys weigh that?

Yeah, I'll let John add any insights he has here. He's closer to the customer side of things than I am. But what I will tell you is that with our most recent price increase, as I mentioned in my prepared remarks, I think it's super important that you all at least are on the same page with us, that we've geared these price increases with the idea that commodity input costs, labor costs, while they likely are going to remain elevated, that they stabilize, but that it does not assume that they come back down. Now, that could happen in some cases. And in that case, we think we benefit from that. But we've geared these price increases such that they're set to ultimately offset what is currently a very elevated cost environment. So orders that we take from here forward will largely be reflective of this series of price increases that we've put in place. And we actually feel quite good about taking that business John, please, add whatever else you have.

Hi, Ruben. It's John Michael. I would just add to what Jeff said. I think in the short run, as we're waiting for the price increase impact to begin to layer into new orders, the other way we address those challenges is through our discounting methodology and just making sure that from a day-to-day discounting perspective, looking at accounts and project, et cetera, that we're being or being smart about our discounting methodology and making sure that the discounting methodology will obviously over time begin to regulate demand in such a way that it matches our ability to produce. So I think it's just one more lever that we pull to try and balance out those two.

Great. Thanks, guys.

Thank you. Our next question will come from Bud Bugich with Water Tower Research. Please go ahead.

Good afternoon, and Happy New Year to everybody, and I look forward to a year where the pandemic recedes into the background, and I hope we all get there. Forgive me for going on the cost issue. I was trying to make sure I was trying to understand how to walk from, um, the margin profile we had, let's just say in America's, which I think was down, um, 700 basis points, I think, or so in the, uh, in, in gross margin, what, what's the walk to get you to from 35, six to 28%, how much of that is cost and how much of it are other things?

Well, Bud, this is Jeff. Let me first talk at the consolidated level, and my caveat here would be the categories of commodities, freight, and labor are most acute in our North American manufacturing operations. And so at the consolidated level, in Q2 from a year ago until the Q2 we were just reporting, we had 240 basis points of commodity pressure year on year. We had 90 basis points of freight and transportation pressure. We had roughly 90 basis points of labor and overhead pressure. Mix accounted for another close to 50 basis points. And on that point in particular, I would remind you that we benefited last year with tremendous task seeding mix, particularly on the retail side of the business. So that one is a little less tied to the Americas segment. And then we've got some, but not a terribly meaningful amount of price benefit that helped offset that to the tune of about 30 basis points. So, Bud, I guess the best way I can answer the question in quantified terms is to talk about it consolidated. But what I would just emphasize is commodities, if it's 240 basis points at the consolidated level, it's more than that at the American segment level. And the same would be true for freight and labor.

I totally understand that. I was just trying to reconcile that to the 60 basis points, and I think it was 30, 30, 30 for freight labor and transportation that I heard a few minutes ago.

Well, yeah, and that's, by the way, but just so that we're not talking past each other, I was just giving you the walk for Q2 year over year. My earlier comments were with respect to our guidance going forward into Q3 and And that makes sense to you, right? So in other words, we think we're going to get another 60 basis points of pressure from commodities as we move from Q2 into Q3, and that's at the consolidated level.

But my comment was still – Is it 240 or incremental to the 240?

It would be – it's incremental, yeah, another 60 basis points over and above what we felt in Q2. I see.

So then that would get you to 300 basis points in the third quarter. That's what I was trying to walk to. Yeah. Okay. That's great. That's very helpful. And I do understand that the Americas is significantly or is meaningfully more than the pressure elsewhere. And I know how hard that is to factor that. For my follow-up, let's make sure I want to talk about the backlog. And it looked to me like orders outstripped the backlog. revenues of sales by 130 or so million dollars. So that's just added to the backlog, right? That goes into the backlog.

That's correct. Yeah, our backlog ended the quarter at 967. And you're absolutely right. The change from beginning of quarter was about that 130 million.

Okay. So the beginning backlog was 967? Ending backlog was 967.

Okay. And that's $130 million higher than where it began. Okay.

All right. And that's great.

And I appreciate that. And obviously, best of luck and best of wishes to everybody going forward. Thank you. You as well, bud.

Thanks. Thanks, bud. Thank you. Our next question will come from Greg Burns with Sedoti and Company. Please go ahead.

I just wanted to follow up, I guess, again on the price-cost gap you're seeing. Is there any way you could quantify what it was this quarter, what you expected to be next quarter, and over what timeframe, given the price increases that you're layering in, when you expect that to be completely offset?

Male Speaker Yeah, Greg, good evening. I'm going to, let me take a stab at your question, and I think this is what you're asking, and I'm just going to kind of recap a couple of the numbers that I just mentioned. In terms of basis point impact on gross margin, from year-ago levels, we had, about 30 basis points of improvement due to net price benefit. Yet, we saw a pretty meaningful decline in overall gross margin performance. And so that 30 basis points was not enough to offset all those other pressures that I mentioned, commodities, freight, labor, and so forth. Is that helpful?

Yeah, I guess. I mean, I'm just kind of wondering what's the path like? Is do you expect the gross margins in the third quarter to be the low? And then given the price increases, if everything else stays constant, should we see, you know, kind of a steady sequential increase in gross margins over the next few quarters? Like how, when do we get back to neutral?

Yeah, no, I think that's the second part of your question. And it's a great one. And I would say if you allow us to just assume for a minute that we don't see further degradation in the cost environment, which are already pretty at a fairly elevated level, then I think it would be fair to expect improving margin profile moving out of Q3 into Q4 and beyond. Certainly we expect that in retail, and there's no reason to believe that as we improve our ability to ship more product work through this backlog, we should feel even more pricing benefit flow through. Now, it's not going to be a rapid improvement, we don't expect, but you should see improvement. I think if you want to think of it in terms of pre-pandemic margin levels versus where we are today, you'd probably argue on a pro forma basis for the consolidated business, a more accurate pre-pandemic gross margin level would be somewhere around 37%. That's kind of going back to FY19. you know, we fully expect that with the pricing that we've done, we can work our way back there. And in fact, it won't be into the early part of FY23 likely, but we think late Q1 into Q2 of next year, we should be able to get there and arguably better than that, given the performance of retail and frankly, the underlying cost performance and the synergy work that we're doing.

Okay. And can you just talk about how you hedge steel or you know, how you've purchased it, just because steel's come off pretty meaningfully from the peak, at least from what I'm tracking. So can you just talk about how that potential benefit might flow through? Like, do you buy it, like, six months out? Like, how does that work?

Yeah, generally speaking, Greg, we don't really formally hedge with, like, derivative-type hedging steel prices, but what we do is, is we buy on a lag to the market. And because we buy a decent amount of steel, we get a bit of a discount off of the published market price of steel. And so you're right. Steel has come down off the highs. I think the latest, don't exactly quote me on this, but it's something just north of $2,000 a ton for steel. It was as high as, Kevin, you might have the number, 21 or 2,100 plus. So it has come down a little bit. But what we do is we buy on a lag. So it tends to be about three months, about 90 days. And as a result, we kind of, in a period of inflation, we lag into that over the course of many months. And then as prices start to come back down, the opposite happens. It takes us a little while longer to work to stabilize and then start to realize the benefits of a declining steel market. So that's why I mentioned earlier, I think if you assume for a minute that steel stays roughly where it's at today, we should kind of level out, or if you will, peak in Q3. And then from there, we should start to see some relief from steel prices.

Okay. And just lastly, in terms of the dealer, the network integration, can you just talk about what's involved in the The pilot programs you have going on in Texas and Arizona, is that just allowing them to sell the full products across all the brands? What is involved in those, and are you seeing any early benefits from those?

Hi. Sure, I'll take that one. This is John Michael. I think we've seen a number of benefits. Before I get to that, though, in terms of what's involved, it's really working through the readiness and training of both the Miller-Knoll sales organization as well as the dealer sales organization so that the legacy Knoll dealers are trained up on the Herman Miller products and how to go to market and position the products and conversely how the legacy Herman Miller dealers are trained up on the Knoll products and how to go to market and really what's the compelling value proposition for the market for customers, for influencers, et cetera, of this amazing collective and portfolio that we have right now. We've learned a lot in both instances in terms of what works and what we need to improve upon in terms of training the sellers to get them ready and also really making sure the support staff that supports them, interior designers, project managers, et cetera, are up to speed as well. So I think it's really informed a lot of the work that we're doing for a broader readiness and rollout over the next several months. And we're looking forward to it, and I know the dealers are ready for it.

Okay, great. Thank you.

Thank you. Our next question will come from Alex Furman with Craig Hallam Capital. Please go ahead.

Great. Thanks very much for taking my question. It looks like retail continues to show – really strong growth can you talk a little bit more about what's been driving that growth uh in terms of e-commerce and your stores and how long do you think that growth can continue into 2022 and beyond hi alex this is debbie thanks for asking um we're really pleased with the continued growth we're seeing in our retail segment the predominant

driver of this growth is continued assortment expansion. And we're seeing growth across both the brick and mortar and e-commerce channels and across all of our brands. And with assortment expansion being the predominant growth lever, we feel like that will continue to be a scalable opportunity for us, coupled with optimizing some of the other investments that we're making in our business like the improved POS, some of the marketing investments we're making on CRM, and how we're using customer data to drive our marketing performance, and ongoing investments in the overall infrastructure to improve customer service. So we continue to outlook with retail growing at double-digit humps, and we're excited and confident about that. Are you there, Alex?

Thank you. Thank you very much for that. And a quick follow-up, if I could, is how much of that double-digit growth as you look forward do you expect to come from e-commerce versus continued brick-and-mortar growth and presumably opening more stores over the next few years?

We'll continue to open stores. I don't know about the pacing that we have been opening stores. You know, we opened an additional two stores in Q2. We'll open three more in Q3. And the confidence that we have from these store performances, we open them, remains very strong. And these stores, predominantly through the Herman Miller brand, are really proving to be a strong point of customer acquisition for us, allowing us to engage with a new audience as a result of some of the adjacencies we have with these stores. And we're engaging with customers who care about their physical well-being and their overall physical performance. And those are customers that we believe we can continue to engage in beyond the pandemic trends. So we will continue to invest in new stores, but our base business remains very strong. You know, we had double-digit comp growth as well as double-digit total growth. So the improvements that we're making in our site experience, in our marketing optimization, and our assortment are driving the base business as well.

Great. That's really helpful. Thank you very much.

Thank you. Our next question will come from Rudy Yang with Barenburg. Please go ahead.

Hey, guys. Happy New Year, and thanks for taking my questions.

Hi, Rudy.

So I guess just on run rate synergies, you're now expecting $120 million after year three. Is that more because of greater success than you initially expected in recognizing those synergies this quarter, or were there separate opportunities you uncovered? And I guess if that's the case, could you provide some more color on what is now expected to help drive that additional $20 million?

Yeah, Rudy, this is Kevin. So as the teams have been working through the integration planning, our original targets were for the $100 million by the end of two years after closed. And as we've talked in the past, a lot of those savings were coming from org structure and procurement types of savings. As the teams dug in, they started to look deeper into other categories like manufacturing or logistics, some other procurement opportunities that maybe have a little longer lead time. And so as we looked at it, we identified we actually see $120 million of opportunity, but that incremental $20 million is some of those longer lead time opportunities in the manufacturing areas or supply chain types of areas. But it was a grounds-up review by the teams looking at not just what could they do within two years, but were there opportunities, if given a little more time, that we could get after as well.

Got it. I appreciate that. And then secondly, just to kind of get a little bit more color on retail order patterns. I guess I'm just curious as to how the patterns in terms of product mix have changed as hybrid working has emerged over the last year. Are you seeing customers now accept the reality of work from home more, and as a result, they're kind of pulling the trigger on more essential products such as seating, which obviously is a higher margin product for you guys, or are ancillary and other alternative home office products starting to, I guess, now become more popular?

So in the retail business, we have seen a decline in our overall performance seating as a percent to our total business year over year. However, that is more than offset by our gaming business, which is within a seating category, obviously just targeting a different audience. However, we're really pleased with the growth that we're seeing in some of our other core categories, predominantly retail. upholstery, seating and dining, and outdoor where we have very high penetrations of private label products within those categories too. And therefore, you know, some great opportunities in terms of margin enhancement within those categories as we continue to localize our sourcing capabilities. So despite the fact that we have a slight decline in true performance seating, We are very confident in the growth that we're seeing in the rest of our categories, which are double-digit growth numbers across all those categories, with the exception of rugs at 9% growth.

Great. That's super helpful. I appreciate it. Thank you, guys.

Thank you. I'm showing no further questions in the queue at this time. I would now like to turn the call back over to management for any closing remarks.

Thank you, and thanks, everybody, for joining us today. We really appreciate your continued interest in Miller & Oll, and we look forward to updating you again next quarter. Happy New Year. Bye, everyone.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.