Earnings Call Transcript
MILLERKNOLL, INC. (MLKN)
Earnings Call Transcript - MLKN Q4 2022
Operator, Operator
Good evening, and welcome to MillerKnoll's Fourth Quarter Earnings Conference Call. As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Kevin Veltman, Senior Vice President and Integration Lead for MillerKnoll. You may begin.
Kevin Veltman, Senior Vice President & Integration Lead
Good evening. Joining me today on our fourth quarter earnings call are Andi Owen, Chief Executive Officer; Jeff Stutz, Chief Financial Officer; and John Michael, President of the Americas Contract. We have posted the press release on our Investor Relations website at millerknoll.com. Wherever any figures are presented on a non-GAAP basis, we have reconciled the GAAP and non-GAAP amounts within the press release. Before I turn it over to Andi for a brief overview of the quarter, I would like to remind everyone that this call will include forward-looking statements. For information on 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 filings. 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 Andi.
Andrea Owen, Chief Executive Officer
Thanks, Kevin. Good evening, everyone, and thank you so much for joining us. It has been an extraordinary year in our company's history, and Jeff and I are looking forward to discussing our fourth quarter results with you. Just over a year ago, we began the journey to become MillerKnoll, transforming our industry and creating one of the most influential design companies in the world, and we've accomplished a great deal. To date, we completed the organizational and global design process, introduced a unified sales team and the MillerKnoll dealer network in North America. And we've made meaningful progress toward our goal of delivering $120 million in cost synergies, having captured $66 million in run rate cost synergies at the end of our fiscal 2022. We delivered strong results this past year while simultaneously contending with a very volatile macroeconomic environment. Across our global operations, we've taken decisive actions to mitigate supply chain disruptions and inflationary pressures while investing for the future. We remain focused on the strategic priorities that guide us as we drive meaningful growth across our global business. Our team delivered fourth quarter and fiscal year 2022 results that reflect both the strength and potential of MillerKnoll, and we're confident that our unique combination of contract and retail businesses and our collective of brands will continue to enhance our ability to compete and grow as we move through fiscal year 2023 and beyond. Jeff will take you through the details of our fourth quarter performance. Before I hand off to him, I wanted to comment briefly on the progress we're making in a few key areas. We achieved several critical integration milestones in the fourth quarter. And most notably, on June 1, we launched our North America MillerKnoll dealer network. Customers now have access to our full portfolio of brands through a unified dealer network, giving them more choice and creating more opportunities for our dealer partners. This has always been one of the most compelling reasons for creating MillerKnoll, and we've already seen our dealer partners leverage the full portfolio of our solutions to secure significant wins in several regions across North America. We're also making excellent progress building the international MillerKnoll contract dealer network to cross-sell the MillerKnoll collective of brands. Our international dealer cross-sell pilot now includes 32 dealers from 17 countries on three continents. We'll expand our pilot into the Middle East and Africa later on this year. Earlier this month, we held our first Annual MillerKnoll Design Days. Along with our dealers and cross-brand sales teams, we welcomed the design community and customers to a series of events, exhibits and showroom tours at our approximately 70,000 square feet of showroom and retail space in Chicago. The design and innovation pipeline is robust across our collective of brands. We introduced more than a dozen new products at Design Days, including new task seating solutions from both Herman Miller and Knoll, new textiles from Maharam and Knoll Textiles and innovative new sit-to-stand desk from Geiger, sofa and lounge seating at Muuto and new cafe tables and stools from naughtone. At the same time, we've made considerable progress building our commitment to our people, planet and communities. Early in the fourth quarter, the Diversity in Design Collaborative launched its first formal initiative called Designed By. Based in Detroit, Designed By was created to raise awareness of design as a viable career path for underrepresented high school students and include a series of special events and speakers. We also introduced our 2030 sustainability goals in the quarter. These goals are shared across our collective of brands and build upon our history of environmental stewardship. They are targeted at reducing our carbon footprint by 50%, designing out waste and stopping the use of single-use plastics and sourcing better materials by using 50% or more recycled content and purchasing materials that are responsibly and sustainably produced. Our teams across the globe work hard every day to have a positive impact on our communities and the planet, and these goals will push us to do even more. We are united across brands and regions in our commitment to sustainability, and I'm excited to see how we activate our plans to make a difference across the collective. Our MillerKnoll team has delivered exceptional results this past year even amidst a challenging backdrop of macroeconomic pressures. We enter fiscal year 2023 from a position of strength and with a great deal of momentum. We're focused on delivering against our strategy to stand up MillerKnoll, create a differentiated omnichannel customer experience, accelerate growth across channels and geographies and use our business ultimately as a force for good. With that, I'll turn it over to Jeff, who will discuss our results in detail before we open it up for questions.
Jeff Stutz, Chief Financial Officer
Thanks, Andi. Good evening, everyone. I certainly appreciate you joining us today. Our fourth quarter results reflect the outstanding efforts of our global teams to fuel positive momentum for our business and overcome the ongoing impact of macroeconomic pressures. Our supply chain mitigation efforts helped return lead times and reliability to near-normal levels for almost all products and geographies. Strong production levels across our global footprint helped drive the highest sales volumes of the fiscal year. Consolidated net sales in the fourth quarter of $1.1 billion reflects an increase of 77% on a reported basis and 23% organically over the prior year. Notably, our international business saw record sales of $136 million in the quarter, an increase of 28% over last year on a reported basis and up 37% organically. Consolidated demand continued to exceed prior year levels with orders of $1 billion, up 47% over last year on a reported basis and an increase of 4% organically. Customers are seeking premium and custom solutions that deliver the workplace experiences and amenities their employees are demanding and the breadth and depth of our portfolio continues to resonate. Along those lines, brands like Holly Hunt, Spinneybeck FilzFelt, Geiger and our textiles brands continued to see strong demand in the quarter. With that, I'll turn to the retail business. Retail is coming off a very strong fiscal year 2022 where we saw record orders and sales levels. Despite the strong performance for the full year, during the fourth quarter, order levels declined by 12% compared to last year as consumers shifted their spending to travel and other experiences and faced the uncertain economic environment. Despite these near-term pressures, new orders for the retail segment were up 63% on a two-year stack basis compared to the fourth quarter of fiscal 2020. And excluding the workplace category, which creates tougher comparisons given the pandemic-driven growth last year, the two-year order growth for retail was 77%. The retail investments we're making in product assortment expansion, new stores and studios and e-commerce platforms are bringing new customers to our brands and positioning us for long-term growth. We opened eight Herman Miller stores in the fourth quarter, including three in Japan and one DWR retail studio. We have three store openings planned for the first quarter of fiscal 2023. We also introduced a new HAY website in the U.S. and began a series of global website launches for Herman Miller and Herman Miller Gaming in native languages to further extend our reach outside of North America. Gross margin of 34.8% at the consolidated level was 160 basis points lower than the same quarter last year, primarily driven by higher commodity costs and inflationary pressures. On a sequential basis, consolidated gross margin improved to 180 basis points as we began to see the impact of price increases, flow-through orders in the fourth quarter. We expect additional traction from these price increases will drive further margin expansion in future quarters. Reported operating margin for the quarter was 5.2%, while adjusted operating margin was 6.5% compared to 7.3% in the prior year. Consolidated operating margin improved sequentially by 230 basis points from the prior quarter. And the sequential expansion in operating margin this quarter was driven by improved operational performance, the realization of integration savings, price increases and well-managed operating expenses. We reported diluted earnings per share of $0.28 in the quarter and adjusted earnings per share was $0.58 in the quarter, which compared to $0.59 a year ago. For the full fiscal year, net sales were $3.95 billion, a year-over-year increase of 60%. On an organic basis, net sales increased by 14% compared to the prior year. Our net loss per share for the full year totaled $0.37. But on an adjusted basis, earnings per share for the full year totaled $1.92 compared to diluted earnings per share of $3.07 in fiscal 2021. At the end of the fourth quarter, our liquidity position reflected cash on hand and availability on our revolving credit facility totaling $527 million. We expect first quarter revenue to range between $1.08 billion and $1.12 billion, and adjusted earnings per share between $0.32 and $0.38. This guidance reflects the impact of an additional week of sales based on the company's accounting calendar, which is required periodically to realign the company's fiscal periods with the calendar months. And the guidance also considers the near-term inflationary environment that we are navigating and the actions we're taking to help mitigate these pressures, as well as the expected timing of shipments from our backlog. With a backlog that's 45% higher than last year organically, we enter the first quarter on a strong foundation. However, it's important to point out that we are seeing the expected timing of shipments extend further than normal and have reflected that in our guidance. We have a great deal of momentum as we continue to extend the full benefit of MillerKnoll to our customers. We're confident in our strategy and we're well-equipped to navigate this period of macroeconomic uncertainty from a position of strength. Our collective of brands can meet the needs of both our contract and residential clients around the world, and we will continue to capitalize on the unique opportunities in front of us as we unlock the full potential of MillerKnoll in fiscal 2023. And with those prepared remarks, we'll now turn the call over to the operator and we'll take your questions.
Operator, Operator
Thank you. Our first question comes from Steven Ramsey with Thompson Research Group. Your line is open.
Steven Ramsey, Analyst
Good evening. I would like to clarify a couple of things regarding the supply chain. You mentioned some normalization, but there are also reports of extended lead times for shipments. Can you explain how these factors relate to each other and if they are affecting specific segments differently?
Andrea Owen, Chief Executive Officer
I would say on the whole, Steven, and I'll turn it back to Jeff since you made the comment on lead times extending. Supply chain volatility continues, but it has improved for us. So, as we've seen our own lead times internally get back to normal levels, we're certainly encouraged by that. That's not to say we aren't seeing some suppliers experiencing their own supply chain issues, but we have seen on the whole much improved customer experience both on the contract and retail side. Jeff, what would you add?
Jeff Stutz, Chief Financial Officer
I agree. It's important to differentiate between our own domestic manufacturing lead times and those of our main suppliers, which have shown improvement. However, for certain products manufactured overseas that we import, which impact our retail business more significantly, we are still encountering longer lead times. There remains port congestion in several areas, particularly from Asia, and the ongoing conflict in Ukraine continues to disrupt some suppliers in Eastern Europe. This is an area where we are experiencing the impact. Additionally, the longer lead times are largely influenced by customers refining their designs and being more deliberate about their choices, as well as some individuals being cautious due to concerns about the supply chain situation.
Steven Ramsey, Analyst
Very helpful. Let me dovetail nicely into my next question. On the strong pickup of customer visits, dealer sentiment being high, what drove that stark improvement in customer visits in the quarter? Is it converting to action on the part of customers as fast as maybe pre-COVID levels? Or do you think the process to purchase is maybe a little different right now, but then normalizes over time? Just curious how kind of it's playing out right now, and where you see it going.
Andrea Owen, Chief Executive Officer
We've noticed an increase in customer visits, which can be attributed to several factors. As people return to a collaborative work environment for the contract side of the business, we've seen heightened activity among dealers and the A&D community. People are actively engaging with one another, both at work and socially. These visits, particularly during Design Days, are much more focused compared to previous events. Visitors are arriving with specific project ideas and are reevaluating their spaces, with a recent survey indicating that 93% are considering changes. However, it's worth noting that people are also modifying designs more frequently than before. While our design teams and A&D firms are indeed busy, they are adapting to the hybrid work model and spending additional time refining their designs. John, you interact with many customers; do you have anything to add?
John Michael, President of the Americas Contract
To add to that, we see that over 93% of customers recognize the need to make changes in their space. They are finding it increasingly difficult to bring workers back to the office. Some companies that initially believed they wouldn’t need to make significant changes are now realizing they must take action to create an appealing office environment that attracts employees. Regarding Design Days, the number of appointments and traffic through our showrooms surpassed pre-COVID levels, demonstrating that the visitors were not just browsing but were engaged with real projects needing decisions and information.
Steven Ramsey, Analyst
Very helpful. And then, last thing from me quickly. Herman Miller stores outpacing expectations. What areas are outperforming or performing better than expectations? Why is that? And then, do you expect that to continue as you open more stores this year?
Andrea Owen, Chief Executive Officer
I think what we're finding in the Herman Miller stores is that it's easy to set up. It has a small square footage, is profitable to run, and is efficient. Customers are responding not only to the workspace products but also to the Herman Miller brand overall. We have many iconic residential designs that are resonating well too. We're seeing strong performance across all products from a workspace perspective and the lifestyle products are also doing well in the Herman Miller stores. We're very excited about all aspects of this business. Additionally, it requires minimal inventory, which enhances efficiency and productivity.
Operator, Operator
Thank you. Our next question comes from the line of Reuben Garner with Benchmark Company. Your line is open.
Reuben Garner, Analyst
Thank you. Good afternoon, everybody.
Andrea Owen, Chief Executive Officer
Hey, Reuben.
Reuben Garner, Analyst
Jeff, can we discuss the pricing and cost issues? I know you've been facing another wave of inflation. I've noticed that some of your competitors are implementing surcharges to navigate this phase of temporary pressures. Have you considered additional pricing measures beyond surcharges? What are your thoughts on this? Have you made any new pricing announcements?
Jeff Stutz, Chief Financial Officer
Thanks for the question, Reuben. We haven't made any additional announcements, but pricing is a constant topic of discussion, and we do plan to implement more increases. We will provide more details soon, but nothing has been publicly announced. Regarding inflationary pressures, we are experiencing cost rises in most areas, although we are seeing some relief in steel prices, which have been improving since early May. That's a positive development. However, transportation costs, particularly diesel prices, continue to impact us significantly. In the past, we've tried using surcharges, but we didn't have much success with that approach. We believe that increasing list prices and managing discounts is a more effective strategy.
Reuben Garner, Analyst
Okay. Got it. Please continue, Andi.
Andrea Owen, Chief Executive Officer
No. I was just going to say one of the most important things as we look at this price/cost equation to remember, is as we start to see our price increases kick-in, we continue to see margin improvement quarter-over-quarter as we get the benefit from those. So, we're happy to see that.
Reuben Garner, Analyst
What's included in the guidance for next quarter regarding price and cost? Are we close to achieving balance, or is there still some progress to be made, impacting the following quarters?
Jeff Stutz, Chief Financial Officer
We expect our sequential guidance for Q4 to include around 140 basis points of benefit from price increases. However, not all of that will translate directly into margins. The midpoint of our guidance is 35.2%. We anticipate some additional sequential pressure from freight and transportation costs due to recent diesel price trends and ongoing port congestion, which has made inbound freight for our retail business challenging. Therefore, we expect about 50 basis points of pressure at the midpoint of our guidance. Additionally, we estimate around 10 basis points of pressure from other non-steel commodities. The remaining margin pressure, roughly 40 basis points, could be attributed to mix and various other factors. Overall, we expect a significant sequential benefit from pricing.
Reuben Garner, Analyst
Great. I have one more question. Regarding the integration, it seems like there has been good progress on the cost side. Can you share what you are observing so far in the early stages regarding revenue dissynergies and any potential revenue synergies? It might be early for that part, but any insights you can provide, especially with the recent steps taken to integrate the two, would be appreciated.
Kevin Veltman, Senior Vice President & Integration Lead
Yeah. Reuben, this is Kevin. I'll start with. So, cross-sell, as we mentioned in the release, June 1, we kicked off an exercise to bring MillerKnoll dealers and put those in place in North America. So, really we're just starting to kick off that exercise with a big focus on being able to transact business across all of the brands across North America. And so, in the early days of that. We've had some level of dealer flips to date, but within the expectations that we had at the start of when we did the modeling around the deal. John, I don't know if you'd add anything to that.
John Michael, President of the Americas Contract
Thanks Kevin. From a cross-sell perspective, we are about four weeks in and we're seeing momentum build each week. This is something our dealers have been anticipating for several months. We executed a well-coordinated ramp-up for cross-selling that included dealer activation, virtual training sessions, and in-depth product discussions. The highlight was Design Days, where the strength of the MillerKnoll brand collective was showcased for our dealers, customers, and designers. As we assess the initial success of cross-selling, we feel optimistic and expect it to gain further traction in the upcoming weeks.
Reuben Garner, Analyst
Great. Thanks guys and good luck going forward.
Andrea Owen, Chief Executive Officer
Thanks Reuben.
Operator, Operator
Thank you. Our next question comes from the line of Budd Bugatch with Water Tower Research. Your line is open.
Budd Bugatch, Analyst
Thank you for taking my questions. Congratulations on completing the first year of integration, and I wish you all the best moving forward. Jeff, I would like to ask a few questions about the balance sheet. It appears that inventories have increased significantly since the third quarter. Can you discuss the quality of the inventory? I understand that most of it is typically in work in progress, but with the addition of retail, is that increase primarily in retail?
Jeff Stutz, Chief Financial Officer
No, it's a great question, Budd. I would say it’s really two areas. Retail is definitely a contributor to this. There’s a decent amount of investment in inventory for the retail business, particularly in high-quality products that are not terribly seasonally sensitive and tend to be high volume. There’s also some investment in new products as part of the retail team's strategy to build out new assortments, but we have no concerns about the quality of the inventory. Retail is one component, but the international business is another significant area to highlight, mainly due to the order growth that business has experienced. You may recall that orders in the international sector were up about 77% last quarter and were up year-on-year again this quarter. Our international business has had a terrific year, and as a result, has seen its backlog and inventory levels increase accordingly. So, you're right; inventories are up. We plan to manage that down by adjusting future inventory purchases, but there are no concerns about moving the inventory.
Budd Bugatch, Analyst
And just to clarify regarding international, is it related to the international contract or international retail?
Jeff Stutz, Chief Financial Officer
Yeah. I meant the international contract. Thanks for clarifying. Yeah.
Budd Bugatch, Analyst
Okay.
Andrea Owen, Chief Executive Officer
And if I can add to that, Budd, just from a historic perspective on the retail business. Debbie and the team have done an excellent job managing through more aged inventory, getting the outlet businesses to a place where we're really working through anything that might be liable. And our inventory levels are actually below pre-pandemic levels right now. So, we feel good about where we're investing in the quality of that inventory.
Budd Bugatch, Analyst
Okay, that's great. Regarding the mix we discussed, Jeff, you mentioned 40 basis points of mix. This is the same challenge we faced last quarter, where we saw significant growth in retail seating, making it difficult to compare with the upcoming quarters. Is that where the mix issue is originating?
Jeff Stutz, Chief Financial Officer
Yes, Budd. Essentially, I'm referring to the fact that retail orders were slightly lower this quarter. Since retail typically has higher gross margins and we experienced decreased order levels, the overall business mix involving retail contributes to this situation, with the significant factor being the higher margin task seating.
Budd Bugatch, Analyst
Should we expect retail volumes to remain around a 10% decline for the next couple of quarters until the issue is resolved with consumers spending on other goods instead of retail for the home?
Jeff Stutz, Chief Financial Officer
Budd, we're not providing any guidance beyond Q1. The market factors are unlikely to change quickly, so we'll need to address that. We have just opened eight stores and will have three more opening in the first quarter, which will contribute a little, even if it's small at the start. We are implementing several initiatives, and I believe Debbie and the Retail team are working on new products to enhance our offerings and investing in stores. These efforts should help, but we are currently facing real market pressures that we will likely contend with in the near term.
Budd Bugatch, Analyst
Okay.
Andrea Owen, Chief Executive Officer
I would emphasize that the retail business is still in its early stages. In the last couple of years, we had a significant increase related to workspace that needs to be adjusted for. I prefer examining the two-year stack comparison for retail, as it provides a clearer picture of the business's underlying health. When factoring in workspace for a two-year comparison, we're seeing about a 63% increase, and about 77% without it. All the other categories, excluding the COVID-induced work-from-home trend, are doing well. It's important to consider this. While total growth might decline due to current environmental factors as people shift towards travel and experiences, I believe this business will keep growing from a category standpoint in a two-year stack comparison. Additionally, I wanted to mention something else. Please go ahead, Budd.
Budd Bugatch, Analyst
Go ahead. I'm sorry. I am good.
Andrea Owen, Chief Executive Officer
No. I would just say as we think about Debbie and the initiatives that she has in place with the retail team, from a marketing standpoint, from a customer data standpoint, we believe that many of them will offset a good portion of these macroeconomic pressures just because of the newness of this business and the categories that we still have to exploit.
Budd Bugatch, Analyst
And to make sure I do understand something about retail, are you in the customer's home at this point in time? Are you doing design projects in the home? Or is it pretty much all in-store and online?
Andrea Owen, Chief Executive Officer
We are doing all of the above. And we are relaunching our trade program. We're relaunching our interior design program online. So, we are doing all of the above. We have a very, very strong interior design capability in our stores and we use that in a variety of ways, so for sure.
Budd Bugatch, Analyst
Gotcha. A couple of more questions if I could. The net leverage ratio for the debt, my calculation was just over 3. Is that right? I mean, it was down nicely from the last quarter. Or have I got it wrong? And what's the secured lien first leverage ratio, or if I got the name right?
Jeff Stutz, Chief Financial Officer
So, Budd, the key point that I think is important to understand is that our bank covenants give us credit for the synergy plans that we have in place. So, if you account for the synergies that we are targeting, we were at, I think, 2.6 net debt to EBITDA leverage at the end of the quarter. You might be doing it without the inclusion of the targeted synergies that we have in our sights moving forward. So that could be the difference there.
Budd Bugatch, Analyst
No. I had the $120 million. That's what they give you credit for, right? That's the targeted synergies. Or is it more?
Jeff Stutz, Chief Financial Officer
No. It's $120 million, but the net debt to EBITDA for the quarter was 2.6.
Andrea Owen, Chief Executive Officer
Yeah. We can take that offline, Budd, if your calculations are different.
Budd Bugatch, Analyst
Well, certainly happy to do that. And can you give us maybe the interest expense? Because I know it's embedded in that other item. What was the interest expense in the quarter?
Jeff Stutz, Chief Financial Officer
$12.8 million in the quarter. This is based on a rolling four-quarter calculation, and we can discuss the details further. Just to clarify, that's on a rolling four-quarter basis. In the quarter,
Budd Bugatch, Analyst
Yeah. Okay. Yeah.
Jeff Stutz, Chief Financial Officer
Okay.
Budd Bugatch, Analyst
Okay. Well, we're certainly happy to take that offline. And my last question is, I just wanted to make sure I understood the EPS add-back. Are you adding back $0.11 for taxes? I didn't quite understand the language on that.
Jeff Stutz, Chief Financial Officer
This year has been somewhat unique because our effective tax rate on a GAAP basis for the fourth quarter is nearly 50%. On an adjusted basis, it's 21.5%. One reason for this discrepancy is that for the full year, due to integration-related charges, we are in a net loss position. In a net loss situation, we face limitations on utilizing certain credits like foreign derived intangible income and foreign tax credits. Therefore, when we calculate adjusted EPS, we assume those credits are not limited, leading to a significant tax adjustment to arrive at the adjusted EPS for the quarter. It may be confusing, but it's important to understand.
Budd Bugatch, Analyst
You left me with the impression that it's a unique year. I think we can discuss that offline. Thank you very much. Good luck.
Jeff Stutz, Chief Financial Officer
Fair enough.
Andrea Owen, Chief Executive Officer
Thank you, Budd. Happy to reconnect. Appreciate it.
Operator, Operator
Thank you. Our next question comes from the line of Alex Fuhrman with Craig-Hallum. Your line is open.
Alex Fuhrman, Analyst
Hey, guys. Thanks for taking my question here. First thing I wanted to ask about, I guess, is the retail business. Andi, if you could talk a little bit about that. Obviously, you saw a tremendous growth during the COVID era business in your direct-to-consumer business. That's been slowing down in recent quarters. And it seems like it was approximately flat year-over-year in the quarter you just reported, but pretty impressive considering the extraordinary growth you experienced during COVID. What should we be expecting over the next couple of quarters? Is it inevitable just that as you lap that extraordinary growth, we're going to see a couple of down quarters before that business starts to make new highs again? Or is potentially the impact of opening a few new retail locations going to blunt the impact of those comparisons?
Andrea Owen, Chief Executive Officer
Yeah. It's a great question, Alex. I think we should still look to the retail business to hold steady despite the macroeconomic pressures. I think as I said before, we're really looking at those two-year stack comps to normalize for that workspace blip. I think Debbie and the team are really being thoughtful about the category expansion. There are several categories that we have not been in before, whether that's rugs or artwork or even expansions of certain living rooms or dining room products. So, I think there's a lot of new product extensions that we'll be adding in. There's also new capabilities. So, we've been investing in technology. We've been investing in new ways to track our customers. So, I think many of the things that an established retail business might have had, we have been building over the last couple of years that will give us leverage to acquire new customers, which is what we desperately need to do to market to them in different ways and to also fulfill those categories that we haven't had before. So, I don't anticipate that we are going to see the explosive growth in the retail business that we did over the last year, but I do expect that we will continue to see that core base business continue to move in the right direction as we build sort of the base of a strong retail business. What would you add to that, Jeff? Anything?
Jeff Stutz, Chief Financial Officer
I think that's great. Yeah.
Andrea Owen, Chief Executive Officer
Okay.
Alex Fuhrman, Analyst
That's really helpful. Thanks Andi. And then, just one more if I could, for the team on gross margin. It looks like now with the guidance in Q1, several quarters of pretty solid improvement relative to the 33% or so gross margin rate that we saw in the third quarter, I know it's tough to have visibility multiple quarters out and you're only guiding to the one quarter. But just as you think about what you know today given labor costs, material costs, what you've got in terms of already announced price increases that maybe have or haven't been fully realized in your business. I mean should we think of this kind of, call it, 35% or so gross margin that you're guiding to in Q1 as being a base that you would hope to be expanding off of in future quarters? It seems like there are so many dynamics pushing and pulling in both directions. Just curious kind of based on what we know right now, what would you expect the base case on gross margin to be in the second and third quarter of the year?
Andrea Owen, Chief Executive Officer
I mean, Alex, we definitely expect it to be a base that we expand off of. And I'll caveat that by saying provided nothing else happens in the world that could impact that from a macroeconomic standpoint. But as you look at the price lag, particularly in the contract business, we have not realized all of the price increases that we've put in place yet. We planned for more if we need to, to offset cost increases. So, I think it's fair to say that's a good base to build off of. Jeff, I know you have something you want to add to.
Jeff Stutz, Chief Financial Officer
I agree with you, Andi. I want to emphasize that we would be very disappointed if that outcome doesn't occur. As I mentioned last quarter, I believe that we've implemented sufficient pricing changes, and we are considering the need for more if necessary. Our goal is to return this business to levels at or above what we experienced before COVID, and we are currently not there. Therefore, we should expect to see a steady improvement in margins as we progress through the rest of the year. Your point is valid, Andi; we need to consider overall economic conditions. Our assumption is that we won't be facing an industry-wide recession. As long as we can achieve some continued growth in volume, we fully expect that margins will keep increasing.
Andrea Owen, Chief Executive Officer
And I think the one thing we can't forget about too is we are integrating and we have a much larger supply base. We have the ability to leverage and integrate those supply chains. So that's an advantage that we have as we think about margin as well and just efficiencies along that way.
Alex Fuhrman, Analyst
That’s great. Thank you both very much.
Andrea Owen, Chief Executive Officer
Thank you, Alex.
Operator, Operator
Thank you. Our next question comes from the line of Greg Burns with Sidoti & Company. Your line is open.
Greg Burns, Analyst
Good afternoon.
Andrea Owen, Chief Executive Officer
Hi, Greg.
Greg Burns, Analyst
I just want to follow-up on…
Andrea Owen, Chief Executive Officer
Hi, Greg.
Greg Burns, Analyst
Hi, regarding the retail business, I recognize that you're facing challenging comparisons post-COVID and with remote work. However, we've noticed some competitors mentioning a decline in demand and increased discounting, along with other factors suggesting a general slowdown in discretionary consumer spending due to inflation. Are you concerned about this affecting your business moving forward? Additionally, do you still feel confident in the level of investments you are currently making, considering the inflationary environment?
Jeff Stutz, Chief Financial Officer
Yeah. Greg, this is Jeff. I'll start by saying that we are certainly aware of the current economic conditions and consumer sentiment. Historically, when the stock market declines, our target retail customers tend to be sensitive to that, and the stock market has not performed well lately. Additionally, inflationary pressures are impacting consumers. This is something we are paying attention to. However, I also want to emphasize that there is significant potential for our business to continue to grow. We recognize numerous opportunities to expand beyond North America, and there are several markets within North America where we currently lack a physical presence. Furthermore, there are categories where we are not well represented, and our team is actively working to enhance our presence in those areas. Therefore, we have many reasons to believe in our ability to grow. While it might not be realistic to think we can completely counteract broader macroeconomic trends, we feel confident about our current business position compared to the past. From an earnings standpoint, our performance is positively contributing to our overall operating margins. We have an excellent team in place, and we believe we can navigate this challenging period and emerge even stronger.
Greg Burns, Analyst
Okay. Are you seeing higher discounting or anything else that might give you concern about the margins going forward?
Jeff Stutz, Chief Financial Officer
No, not from a discounting perspective. The margin pressure we're experiencing is mainly related to transportation and the mix shift. We will eventually anniversary that, but the mix shift has been unfavorable for us throughout the fiscal year as we compare against what many would consider the best margin mix, which includes a lot of high margin retail task chairs. Therefore, the primary factors affecting our margins are mix and transportation pressures, not discounting.
Greg Burns, Analyst
Okay. On the contract side of the business, it seems there hasn't been any slowdown in demand. Is the demand you're experiencing now similar to the pent-up demand from COVID, and as we move past it, are we beginning to see some of that release? We're also noticing some forward-looking indicators, such as a decrease in CEO confidence and other factors. Looking ahead, are you observing any signs of softening on the contract side of the business?
Andrea Owen, Chief Executive Officer
Greg, we lost you. John, why don't you take that first part of his question?
John Michael, President of the Americas Contract
Sure. In terms of what we're seeing relative to demand, I think the CEO confidence metric that you talked about obviously is real. But if you look at some of the metrics that are more closely related to our industry, like the Architectural Billings Index, that's still in a very positive place. Anecdotally, as we work with and talk to design firms, they are all very busy and looking to hire. But I do think one thing we've seen is sort of waves of demand coming out of COVID. If you think back to this time last year, there was a tremendous amount of pent-up demand after we all had our first round of vaccinations. We've now been through a year where we've had a couple of waves of variants where there's been some stopping and starting. But as I mentioned earlier, I think a number of companies that thought maybe they didn't have to do much in terms of changing their space to accommodate the new work protocols have realized that they are going to have to make some changes. So, we're seeing the activity across a larger number of companies than we would typically see in a normal economic environment.
Greg Burns, Analyst
Okay. So, no forward-looking indicators that you would say anything is kind of softening on that side of the business?
John Michael, President of the Americas Contract
None that I would point to at this point.
Greg Burns, Analyst
Okay. And regarding the additional week in the guidance, how much did that extra week contribute to revenue and earnings for the forecast?
Jeff Stutz, Chief Financial Officer
Greg, it's about $79 million in revenue for the extra week. Operating expenses would be around $24 million. From an earnings perspective, it would likely be somewhere around $0.02 to $0.03.
Greg Burns, Analyst
Okay. All right, great. Thank you.
Jeff Stutz, Chief Financial Officer
Thank you.
Operator, Operator
Thank you. I'm showing no further questions in the queue. I would now like to turn the call back over to Andi for closing remarks.
Andrea Owen, Chief Executive Officer
Thanks Tawanda. Thank you everybody for your interest and for your support, and we look forward to updating you again next quarter. Enjoy the weekend and happy 4th of July. Bye everyone.
Operator, Operator
Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.