Brian Walker - President, CEO & Director Jeffrey Stutz - Executive VP, CFO & Principal Accounting Officer Kevin Veltman - VP, IR & Treasurer.

Matthew McCall - Seaport Global Securities Steven Ramsey - Thompson Research Group Gregory Burns - Sidoti & Company.

Good morning, everyone, and welcome to this Herman Miller, Inc. Second Quarter Fiscal Year 2018 Earning Results Conference Call. This call is being recorded. This presentation will include forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements.

These risks and uncertainties include those risk factors discussed in the company's reports on Form 10-K and 10-Q and other reports filed with the Securities and Exchange Commission. Today's presentation will be hosted by Mr. Brian Walker, President and CEO; Mr. Jeff Stutz, Executive Vice President and CFO; and Mr.

Kevin Veltman, Vice President, Investor Relations and Treasurer. Mr. Walker will open the call with brief remarks, followed by a more detailed presentation of the financials by Mr. Stutz and Mr. Veltman. We will then open the call to your questions. [Operator Instructions]. At this time, I'd like to begin the presentation by turning the call over to Mr.

Walker. Please go ahead..

Good morning, everyone. Thanks for joining us today. I'll start with a brief overview of our quarterly results, followed by highlights of our progress and the strategic priorities for the business. I'll close with the perspective on the current economic backdrop before turning it over to Jeff and Kevin for more information on the financial results.

We saw a second straight quarter of better-than-expected demand patterns with consolidated orders up 9% over last year on a reported basis and up 10% organically. In fact, the $629 million in order actually this past quarter reflects an all-time record level for Herman Miller.

We were particularly pleased to see this order growth come from all segments of the company, helping to boost our ending backlog by double digits from this time last fiscal year, putting us in a good starting position as we enter the second half of fiscal 2018.

Sales of $605 million were consistent with our expectations at the start of the quarter, driven by growth from our North America, ELA and Consumer segments.

Although we did feel some negative pressures at the gross margin level, the organization, again, did an excellent job of managing operating expenses during the quarter and delivered adjusted earnings per share of $0.57, an increase of 6% over adjusted earnings per share of $0.54 in the same quarter last year. To sum up my business.

Our North American international segments both delivered solid results this quarter, highlighted by impressive order growth in double-digit operating margins. The Consumer segment once again posted a strong quarter of top line growth, which spanned its multi-channel footprint.

Operating profitability in this segment was, again, muted by the impact of several recently opened studio locations that are still in the early phase of maturity. Our demand patterns of this business are very encouraging, and we have growing confidence the operating performance will begin to improve as we move to the second half of the fiscal year.

The Specialty segment has really two stories, two groups doing well and two groups not meeting our goals. Geiger in the Herman Miller Collection are performing to our expectations with strong order growth and profitability.

Maharam continue to be an important contributor to profitability for the segment, although through the first half of the year has not delivered the top line growth we had expected.

In response, Maharam team has mobilized around a range of growth initiatives that we believe will drive improvement, including multiple new product launches, plan for the coming months as well as improving the depth and market coverage of its sales team.

To be frank, the fourth business within the Specialty group, Nemschoff, is falling short of the growth and profit targets we set for the first 6 months of this fiscal year. We put a new leadership team in place who are energizing the product pipeline and improving quality and operational reliability.

This team is clear on their goals and while we are confident we have the right pieces in place, it will take some time for these changes to be fully implemented and realized. Now with that overview of the quarter, I'd like to update our progress on the 5 key priorities we are focused on across Herman Miller.

As a reminder, these 5 priorities remain, scaling our Consumer business; realizing the next generation of our Living Office proposition; leveraging our dealer ecosystem; delivering on our cost and profit improvement goals; and the continued commitment to product and service innovation.

While we continue to make progress across each of these priorities, let me provide some highlights on this quarter. We are scaling our Consumer business by expanding the real estate footprint of Design Within Reach studios, increasing the mix of higher-margin, exclusive product designs and growing the catalog, contract and digital channels.

We are encouraged by the progress as our Consumer business delivered a 6 straight quarter of comparable brand growth as our efforts to accelerate revenue growth for this business are paying off. In addition, we are continuing to work we discussed last quarter with an outside partner.

This effort is ultimately aimed at driving operational excellence across our Consumer business in ways that will both improve the overall customer experience and optimize our value proposition in key areas. We are currently developing detailed implementation plans of this work and expect to realize benefits begin in the fourth quarter.

Specifically, we are targeting price optimization strategy across our product assortment, strategic sourcing initiatives, logistics enhancements and improved studio effectiveness.

As a specific example on logistics front, we are enhancing our shipping program to be more competitive in the market, increasing repeat business through an improved customer buying experience and lower overall operating costs. Some of these changes pressured our Consumer margins this past quarter.

Going forward, however, we expect to begin realizing savings from increased shipping consolidation, renegotiate the logistics costs and lower customer return levels.

Early results from this work have helped drive improvement in our net promoter scores from around 150 at this time last year to nearly 60 today, a meaningful move towards the ambitious targets that our Consumer team has established in their Drive for 65 campaign.

In addition to our core strategy to scale the Consumer business, these actions to improve operational excellence will play an important part in reaching our goal to increasing operating margins for the Consumer segment above 8% by fiscal 2020.

We expect this operational excellence work will ultimately contribute benefits of $10 million to $20 million towards achieving that goal.

In realizing the next generation of the Living Office framework, we have been launching new technology solutions and using research to quantify the positive impact of organizations from applying our Living Office concepts.

Still in the early days of development, our Live OS digital architecture provides real-time data insights for individuals in organizations to help improve workplace performance and achieve wellness goals.

We have 5 tiles and installations with key customers currently in place and are building a strong sales pipeline of Fortune 1000 companies as we're ready for the full launch. We're continuing to make progress on our cost-savings initiative targeting gross annual savings of $25 million to $35 million by fiscal '20.

Our annual savings run rate sits at $18 million for the second quarter and the teams continue to work on a number of initiatives designed to meet our overall target.

As a reminder, our rationale year is threefold, one, help offset potential inflation; two, free up operating headroom to fund growth initiatives; and three, support our goal of increasing consolidated operating margins at or above 10% by fiscal '20.

Despite the progress we're making in this area, our consolidated operating margin backed up a little compared to the second quarter last year. This was mainly due to the gross margin pressures that we felt this past quarter.

With that said, we remain confident in achieving this operating margin target aided by the range of cost-savings initiatives that are still to be implemented as well as the margin expansion opportunity in our Consumer business that I discussed earlier. Finally, we are also working to fully leverage our dealer ecosystem.

We have a great team working to increase our share of dealer wallet in the ancillary product category of the market in area we've great potential based on current workplace planning trends. We group our brands and products to service category under the name Herman Miller elements.

The team is concentrating its initial efforts on building awareness of the breadth of our products across all of our brands and providing a range of digital tools to aid ordering, specifying and visualizing our entire offering.

Products across our Herman Miller group of brands that fall under the elements of umbrella had contributed meaningfully to the growth we've experienced in recent quarters. And our strategy moving forward is aimed at protecting the leadership we've developed in this category.

More broadly, we are continuing to drive our leadership in the seating category in partnership with our dealers through a number of product launches in the past year, including the remastered Aeron, Verus and Taper task chairs.

In addition, our product development pipeline includes a number of exciting additions in this space, which are scheduled for introduction over the next 2 years. Before Jeff reviews the financial results for our Business segments, let me provide some context in the current economic backdrop.

While industry sales and order levels in North America have bounced around in the near term, better than expected GDP growth, strong confidence measures and positive trends in service sector employment and architectural billings activity provide a supportive economic environment.

With Congress and the White House moving toward a new tax bill, reform has a potential to be an industry tailwind through higher employment levels and investment spending. Within our own operations, it offers the potential for improved cash access and generation through repatriation and lower rates.

On the North American Consumer front, high consumer confidence, low unemployment, strong equity markets and historically low interest rates combined to provide a generally positive backdrop for consumer furnishings in North America.

While the international picture is stable overall and global economic growth continues, pockets of disruption persist in some key areas. U.K.

still faces uncertainty tied to Brexit; economic and political pressures in oil producing regions, including the Middle East contributed to ongoing uncertainty there; and the current geopolitical problem in North Korea represents an obvious threat. Closer to home in Herman Miller, we are once again named #1 brand and inspires by Contract Magazine.

And for 11 straight years, we have earned a perfect score on the Corporate Equality Index. Such awards are not only measures of progress, but they are evidence that our culture of design, innovation and inclusiveness is strong. They're encouraged by the strong demand level in the past 2 quarters.

The energies of our global multi-channel business remain laser focused and are missioned to deliver inspiring designs to help people do great things. With that overview, I'll turn the call over to Jeff to provide more detail on the financial results for the quarter..

Okay. Thank you, Brian. Good morning, and happy holidays, everyone. Consolidated net sales in the second quarter of $605 million were 5% ahead of the same quarter last year. On an organic basis, which excludes the impact of foreign currency movement and dealer divestitures, consolidated net sales were 6% higher than last year's level.

Orders in the period of $629 million were 9% above last -- the same quarter last year and up 10% organically. Our backlog last year included approximately $9 million in orders related to dealers that have subsequently been divested.

Excluding the impact from those divestitures, the ending backlog for the quarter was 15% higher than last year's level and gives us a nice tailwind as we enter Q3. Within our North American segment, sales were $331 million in the second quarter, representing an increase of 5% from the same quarter last year.

New orders were $341 million reflecting an increase of 6% from the year ago period. On an organic basis, we posted year-over-year revenue growth of nearly 9%, while orders were 8% higher than the same quarter a year ago. Higher order levels were led by large project activity during the quarter, although we saw increases across all categories.

Sector results showed fairly broad-based growth led by financials, communications and the manufacturing sector. Our ELA segment reported sales of $113 million in the quarter, an increase of 5% compared to last year on a GAAP basis and up 3% organically.

New orders totaled $118 million, which is 18% higher than last year's level on a reported basis and up 16% organically. The year-over-year organic growth was broad based across all regions with particular strength in Europe, China, Mexico and the Middle East.

Sales in the second quarter with our Specialty segment were $74 million, a decrease of 3% from the year ago period. New orders in the quarter of $77 million were 9% higher than last year.

The increase in orders was driven by strong project activity for Geiger and the Herman Miller Collection, partially offset by lower demand levels for Nemschoff and Maharam.

While there was some carryover impact from the supplier quality issue at Nemschoff that we discussed last quarter, segment profitability during the quarter was also impacted by higher-than-normal warranty levels for Nemschoff and closeout activity at Maharam related to certain discontinued textile lines.

The Consumer business reported sales in the quarter of $87 million, which is an increase of 9% from last year driven by strong growth across our studio, catalog, e-commerce and contract channels. New orders for the period of $93 million were 12% ahead of the same quarter last year.

While operating earnings for this segment remain constrained in the near term by the rollout of new studio locations that take time to fully mature along with other investments that we believe are necessary to support our longer-term growth potential, we see a path to operating margins near double digits for this business over the long term.

During the quarter, we estimate the unfavorable impact to operating earnings related to the drag from new studios that have not reached full maturity was approximately $2 million. Consolidated gross margin in the second quarter was 36.7%, which is 100 basis points below the same quarter last year.

In addition to labor and outsourcing expenses tied to the capacity challenges we mentioned last quarter for certain high-demand products, we also experienced higher levels of discounting partially tied to a larger mix of large projects, unfavorable product mix and to a lesser degree, higher steel cost during the quarter.

I would note that the year-over-year impact of steel cost was lower than in -- that we experienced in past quarters and is expected to be somewhat minimal in the third quarter. Operating expenses in the second quarter were $170 million compared to $167 million in the same quarter last year.

The increase was driven primarily by higher variable selling costs and incentive compensation levels. As Brian noted, we also made good progress on our cost-savings initiatives.

A portion of these savings were earmarked to help fund growth investment such as the increased occupancy and staffing costs related to new DWR studios and new product development and marketing.

And I stated before, the walk toward our ultimate goals for profitability will not be an even one as required investments for growth are not necessarily linear with our cost-reduction plans. However, we do feel very good about our progress that we're making related to this priority.

Restructuring actions involving certain workforce reductions that were announced in the second quarter resulted in the recognition of severance and outplacement expenses. We also recognized other charges related to our consulting fees associated with the profit improvement initiative for our Consumer business.

Combined, these amounts totaled approximately $2 million in the second quarter. On a GAAP basis, we reported operating earnings of $50 million this quarter. Excluding restructuring and other charges, adjusted operating earnings in quarter were $52 million or 8.6% of sales.

By comparison, we reported adjusted operating income of $51 million or 8.8% of sales in the second quarter of last year. The effective tax rate in the quarter was 30.5% and this compares to an effective rate of 32% reported and the second quarter of last year.

The tax rate in the quarter was at the low end of our expected range due to our favorable mix of earnings. And finally, net earnings in the second quarter totaled $34 million or $0.55 per share on a diluted basis.

Excluding the impact of restructuring expenses and other charges, adjusted diluted earnings per share in this quarter were $0.57 compared to adjusted earnings of $0.54 in the second quarter last year. With that, I'll now turn the call over to Kevin, who will give us an update on cash flow and our balance sheet..

Thanks, Jeff. Good morning, everyone. We ended the quarter with total cash and cash equivalents of $115 million, which reflected an increase of $35 million from last quarter. Cash flows from operations in the period of $63 million were comparable to the $64 million generated in the same quarter last year.

Capital expenditures were $15 million in the quarter and $40 million year-to-date. We anticipate capital expenditures of $85 million to $90 million for the full fiscal year. Cash dividends paid in the quarter were $11 million, and we repurchased $6 million of shares during the quarter. We remain compliant with all debt covenants.

And as of quarter-end, our gross debt-to-EBITDA ratio was approximately 0.8:1. The available capacity on our bank credit facility stood at $392 million at the end of the quarter, which includes $150 million set aside to repay in the private placement notes that are due in January 2018.

Given our current cash balance, ongoing cash flows from operations and our total borrowing capacity, we continue to be well positioned to meet the financing needs of the business moving forward. With that, I'll now turn the call back over to Jeff to cover our sales and earnings guidance for the third quarter of fiscal 2018..

All right, Kevin. We anticipate sales in the third quarter to range between $565 million and $585 million. We estimate the year-over-year favorable impact of foreign exchange on sales for the quarter to be in the area of $5 million.

On an organic basis, adjusted for dealer divestitures and the impact of foreign exchange translation, this forecast implies a revenue increase of 9% compared to last year at the midpoint of the range. We expect consolidated gross margin in the third quarter to range between 36.5% and 37.5%.

Given our strong order pacing in Q2, we anticipate less of the relative seasonal slowdown in factory production that we normally experience around the holiday period and in the month of January. Operating expenses in the third quarter are expected to range between $166 million and $170 million.

As we outlined in our press release last night, our earnings per share estimate for the third quarter is based on existing U.S. tax regulations and an assumed effective tax rate of between 29.5% and 31.5%. On this basis, we anticipate earnings per share to be between $0.46 and $0.50 for the period.

However, with that said, assuming the tax bill passed by Congress earlier this week is ultimately signed into law, the impact would be meaningful to our effective tax rate for the upcoming quarter and in future periods.

While we have a profitable and growing international business, the fact is, we still drive more than 75% of our revenue from businesses in the United States. Accordingly, the proposed rate changes will have a significant impact on these earnings.

We currently estimate the loss change will reduce our full year effective tax rate for fiscal 2018 to between 26% and 28%. Now to be clear, this represents a blend of both old and new tax rates and excludes the impact of onetime adjustments that would be recorded in the third quarter related to the adoption of the new law.

This would include factors such as revaluation of net deferred tax liabilities and recognition of taxes associated with the unrepatriated foreign earnings. Given the complexity of these items, our team is currently in the process of working through the estimates.

And while we believe our longer-term effective tax rate will be lower still, more time is needed to work through the details. With that overview, I'll now turn the call back over to the operator and we'll take your questions..

[Operator Instructions]. Our first question comes from Matt McCall with Seaport Global..

So maybe talk about the top line a little bit. Specifically, we've had some concerns about kind of the dealer trends and some of the non-core products and maybe some new competitors coming into the space or having more of an opportunity. Clearly your top line doesn't indicate much pressure there.

Just curious about the trends you're seeing at the dealers, specifically with new competitors in some of those new product categories.

Are you seeing those trends change? And have you fully -- there's been a lot of new products, saw a lot of those at NeoCon, but have you fully kind of addressed the gaps and that's may be one of the reasons that you're seeing this outgrowth?.

Matt, it's Brian. Look at -- I mean, I think that your question ties right into our objective that we started to talk about last year as one of our priorities of dealer ecosystem. And I'd say, to be frank, this is not -- wasn't really new last year in the sense we hadn't been working on it.

It was more of a recognition that we had made a number of efforts over maybe 4, 5 years to change the mix of our products as we predicted the foreplay was going to change.

That was the impetus for the overall strategy of the Living Office as we thought it was going to change the Living Office, not only helped us give a framework to help to talk to our dealers and customers about it, it also was a key driver of our product development and acquisition strategy.

Last year, we started to talk about the dealer ecosystem because we believe that it wasn't going to be good enough simply to have the products in the portfolio, but that we had to increasingly make it easier for the dealer and the customer to interact with sum total of our portfolio in a way that made us and the overall group of Herman Miller capabilities more favorable to them.

So I think if you look underneath our numbers, well, I wouldn't declare that we're 100% through any transition towards where the market is going. I'd say we've made good progress.

I think if you look at the areas of our business that are aligned with the faster-growing new categories, some people will talk about that is certainly in this area of ancillary products, we call those elements, i.e., that is the area outside of the traditional workstation as well as you look at the elements of the new workstations that are growing the fastest, things like height-adjustable tables.

You look at areas like performance seating, which is still growing nicely. Certainly, our growth rate in those categories, and I would include the minority investment we have in naughtone, that those categories are growing significantly faster than our overall growth rate.

So I think you do -- like a lot of people have talked about, you do have a, in some ways, I guess, a tale of 2 tapes going on. You have the more traditional workstation business that is growing at a -- in a slower rate and you have those new areas growing in the faster rate.

I think we have done a, I would call it, a reasonable job of resetting our portfolio to where we think the puck is going. However, that includes products in DWR. At the same time, we believe there is still remain significant room for us to add additional products that help us add that foreplay continues to change.

You'll see some of those coming out of development in the next year or so as well as that as we look at future M&A targets, we are still looking for things that enable us to get to those new areas. So I think we're encouraged by where we are. We don't think that job is done. There is more work to go do.

And I think you combine that with a pretty good set of projects. So it's good to win projects, but if you have -- if you win the projects, but you don't have the right portfolio, you don't get as much of the squails, if you will, as you need. And I think what you're seeing, I think, today is where we've done a decent job of being set on both of those.

By the way, that's not just in North America.

I think Andy Lock and his team have done an incredible job internationally that while the mix hasn't been as abrupt as of a change in markets outside of the U.S., he's done a really good job of positioning the portfolio in Europe, Latin America and Asia as well so that we're positioned much better than we were 4, 5 years ago..

Okay. All right. That's very helpful, Brian. Maybe so it's the way to think about it. I'm just looking back at some of the growth rates in, obviously, you're seeing the pickup in organic growth this quarter.

Was there a period where we did see some share loss with invested dealers, specifically you did see some share loss in those faster-growing areas and you are able to address them and now maybe this is evidence that you're seeing that share regained?.

Well, I think, I've looked at -- there is no doubt that I think we lost some share of the wallet, if you will, with the dealer. I wouldn't tell you that we're back to where we were or where we would like to be. But I would say, we have started to regain some ground there. And I think, Matt, it's through a combination of efforts.

It's sales teams aligned in the right thing, additional products in those categories as well as having some focus on how to help the dealers understand and really activate the portfolio. What's happening in some way is the foreplay is becoming more complex, and so the choice process is harder.

And the dealers are trying -- the dealers and their designers and their salespeople are really trying to deal with a much more diverse set of choices to make. So we're really focused on trying to help them make that choice.

If you want a concrete example of where, I'd say, something that we started a number of years ago, that to be frank, even our dealers didn't think what's important then, the Herman Miller Collection has become a fairly significant business for us.

When we started it, people looked at if we were celebrating some classic products and probably thought it was more of a marketing exercise. That business has grown substantially both in revenue and in margin. That's also growing. By the way, on the other side, it's growing in the Consumer business.

Steve Gane has done, I think, a very, very credible job of repositioning Geiger so that the fact that's growing part of Geiger today is not their traditional private office products, but actually the products that are going into ancillary and you can see this.

By the way, some of those products are also being sold at DWR with things like Striad that has done a phenomenal job, the landscape product; and the Tuxedo that we launched two or three years ago; the SAYL product that we launched [indiscernible] times ago; the Crosshatch product.

So you can see if you look product line by product line, the hard thing about these areas, it isn't like the old days that you launch one $50 million to $100 million product. You have to launch $23 million products, right? So it doesn't come in big chunks.

It comes in a steady stream of innovation and that's what we've been trying to do for the last number of years, is to build bulk in those categories. Does that help? There's some color to it..

It does. I guess, you said, you talked about the share of wallet and you did lose a little, maybe you've gained a little back.

Can you put any numbers to that to give us an idea of how far it's fell and how far you've been able to come back?.

Don't know if I've got a number at the top of my head today, Matt. I would guess, I mean, if you look at it and, by the way, this is a round number. We'd typically said that an average dealer when systems were at their height, we might have run 65% in a dealer. I would say, that number today would probably look more like 55%-ish.

Now some of what's happened by the way is not just that we're selling less to the dealer. In fact, we're probably selling similar amounts. It's fact that they've grown into other categories. They've also grown in things that, I would say, are around the space, right? They've added things like carpeting, and they've things like flooring.

Some of them gone into areas like movable walls that we don't play in. So they've also got into some new categories, which are, by the way, great for us because the more that they are a -- more complete provider, we also want to be part of their ecosystem that they need to solve the customer's full needs.

Now that also creates opportunity for us as we look at the areas that look like they are growing for them and that fit our capabilities that we can also look at some of those areas as future investment and growth potential for us..

Okay. All right. That's very helpful. And I'm going to sneak one more in. The gross margin outlook for Q3 looks a little bit better, year-over-year looks little better sequentially. I think, Jeff, I think you -- they called out less of a seasonable slowdown just given the strength of orders.

But is there anything else that would call out? And you've talked about some pressures -- some specific pressures in some of the segments.

Is there anything else you would call out? And as we start to look out next year, following year, some couple years of some gross margin pressure, should we expect gross margin expansion to return?.

Yes. Matt, this is Jeff. I guess, I couldn't tell from your question if you were asking for further commentary on the Q3 guide. So let me start there.

As I see in my prepared remarks, I talked a little bit about -- I talked about the fact that we will have a little less of that seasonal dip in production levels in our factories in Western Michigan here that we normally see in Q3, not to say that it won't, if we won't see some of that seasonality.

But it'd be less so just because of a strong order entry that we've seen and the big backlog that we're going into the third quarter. So that helps a little bit and it helps speak a little to the sequential trend and that year-over-year trend that you just outlined.

I think more broadly when you step back and you look in the second quarter gross margin performance, we talked about all these points on the call, but maybe just a highlight.

We mentioned the fact that project sizes, in general, were higher this quarter than they were a year ago, naturally, Matt, you know this, but just to point it out, those generally come with a higher level of discount. And so you expect that to roll to your margin as a bit of pressure on the percentage. So we did -- definitely feel the effect of that.

Matt, I think, Brian talked about that rotation that we're seeing in product mix into some of these other categories, some of the newer products that are less mature, and therefore, coming kind of out of the gate, come at lower gross margin. So we definitely felt the effect of that in the quarter.

The other thing that we didn't talk a ton about, I think I maybe alluded to it on the prepared remarks, is channel mix in our business.

And if you look across some of the -- our segments like, take Consumer as an example, one of the things that they're facing is a -- one of the larger and faster-growing elements of their business is their -- is the DWR contract arm of that business.

And it's growing meaningfully double digits and that comes with just a different gross margin structure. So that is factoring into the -- overall blend of that business is performance. Those are some of the big factors I talked about steel pricing less of an issue for us going forward, borrowing any major market shifts..

Jeff, maybe the one thing I'd add is if you look at a longer term, one of the areas that we are working hard to raise gross margins from where they are today is in the Consumer business. I'd say, we've actually invested the other way today in this way, Matt.

So invested -- we made a decision this past quarter that our shipping terms needed to be more competitive. By that what we did is we went to a flat rate white glove charge versus what was a percentage of order plus an upcharge for white glove. We did that aid to be more comparable to the marketplace.

We also did it to drive more customers to white glove because we know that the satisfaction of the customer in the delivery is much greater when they choose white glove. But often we saw them choosing down. And so we actually took less freight revenue as a result.

We think that will be partially offset by a new logistics model where we're doing more consolidated shipments, much fewer drop shipments, which drive a lower cost. We also have been working hard, as I mentioned in my opening comments around renegotiating some of our terms around that.

Those 2 things combined, we think, will pull some of the drop in freight revenue back. Of course, what we're ultimately hoping is that it will drive more gross revenue as well as fewer returns and those kind of things. We won't see some of those impacts. In fact, we are -- we thought we would be further along in some of the consolidation.

We made a decision to go faster. We won't see some of the improvements from those things probably until we get into the fourth quarter or maybe first quarter of next year.

As I also mentioned, we're also doing some other work within that business around what we call price optimization and supply chain optimization that we think will drive some additional benefits there.

I think the one segment that will continue to feel margin percentage pressure probably is in that core contract business where, a, it's a very competitive marketplace, always has been; secondarily, we know we are trying to make sure that we have a full portfolio of price points so that not only can we get a product categories by use type, but that we have a broader price spectrum.

We think that is more of a bell-shaped curve that enables us to make sure that we can play more fully across customer segments. Some of that will drive lower percentages. But I think as you saw this quarter, we might get lower percentages, but we're trading that off a bit for more dollars..

Our next question comes from Kathryn Thompson with Thompson Research Group..

This is Steven Ramsey on for Kathryn.

I guess, for sales guidance, what are some of the key factors for hitting either the high-end or the low-end of sales guidance?.

Steve, this is Jeff. Let me start, Brian and/or Kevin fill in if you want to add any color. I would tell you, one of the things that comes to mind just off the cuff, Brian talked about it on his opening remarks, our international business. Their performance to the first half has just been remarkable.

And if you look at one of the things, really -- I mean, really good just overall operational execution by that group getting really good traction.

I would tell you that if there was one thing that probably surprised me most to the good in the quarter was the traction of that business has seen across, as I mentioned on the call, earlier most of the regions that they serve.

The question becomes, well, does that continue? And how long will we continue to see that level of momentum? Unknowable at this point. So obviously, we guide to arrange for that reason. But that was a positive for us in the second quarter. They got a great backlog, but it's hard to make the call.

That's one element that I think is a bit of an ex factor for us as we move forward. The Consumer business, again, we're seeing really good traction, have continued expectations as they're going to see the benefits of all the strategic moves that they've made and the investments they've made across their various channels.

So expectations will be that, that continues again. Can you see it accelerate? That will be another factor. Brian, [indiscernible] to add anything..

I think the other thing you just have to recognize is when you have a business this quarter and the core contract was 50% -- 56% projects, in many cases you got to go get those projects. You got to win. You got to be included down to the short list and then you have to build it and ship it. And that's -- we got a lot of business to still go get.

So you're looking at what's in your funnel, what you think, how your win rates are progressing. We, obviously, had a good first half in that regard. But there is a lot of movement within the quarter and timing matters as well. I mean, we might win the projects.

I mean, as an example, I heard about a significantly large project this morning, nothing I would talk about specifically. But a good-size project that we think will ship in the fourth quarter. But the things can move around depending on timing of buildings and those kind of things.

So there's always got to be some range to the forecast, simply because a lot of the business is not booked yet. And even in the Consumer business, this quarter cannot be tricky at times based on weather because you get a lot of weather events in the Northeast, in particular.

And we saw that a couple of years ago, where a lot of the Northeast was shut down with weather. So we're not counting on weather. But I'd say, those are the factors you have to think about as you try to build the forecast, as you're trying to be within a range of--.

See, one other thing I would add -- this is Jeff. I talked about in our guide, the potential impact of tax reform. Our guide does not contemplate any kind of additional or incremental boost from that, but that's a -- obviously getting a ton of headline talk these days about the potentials, stimulative effect of that proposed tax law change.

And that's another one of those factors that -- I think net-net, we look at this and think it's probably overall a very good thing for our business. At least, in the near to medium term, that's another factor that's out there as well as a potential positive..

All right. And then on the Consumer segment, on the operating cost-reduction plan, you guys are executing on how do you even just philosophically balance operating cost containment or reduction in the Consumer segment as you build it out for growth and seeing as you talked about long-term, double-digit operating margins there.

Can you kind of frame the margin trajectory over a 1- to 3-year time frame?.

Well, first, it's not about -- we haven't talked about cost reduction. What we've talked about is profit optimization. So very little of this is to do with taking structural cost out effect that business runs, I would say, somewhat considerably lean from what they're trying to do. So it isn't about taking cost out.

It is about optimizing the way we operate the business, making sure we're doing a sophisticated job as we can around things, like price optimization, looking at supply base, looking at the way we do logistics. It's those kind of areas that are most important in the work that we're doing.

We are looking at how do we spend our dollars between physical expansion and digital expansion. Certainly, the world, as you all know, is moving more and more towards digital. And we've seen that as well both within DWR and Herman Miller.

This past quarter, we launched a new e-commerce store for Herman Miller -- hermanmiller.com, which is on the same platform as DWR. We're now using some of the same techniques and using that same team. So, I think, it's not about reduction of things like promotion or forward expansion as much as it is.

We're pulling the other levers that enable us to drive better profitability. As we said, we think we'll start to see some of the benefits from that in the fourth quarter of this year. And then, I think, once we get through that, we'll have a better ability to tell you the exact timing.

Beyond that, as we get to the end of the third quarter about how we get with the ramp is towards that sort of 8% operating goal. We feel pretty good about where we're at. The team has developed, I would say, beyond just broad plans. They've actually got detailed implementations.

In fact, we've already started some of the implementation steps over the last 2 or 3 weeks. Jeff and I are doing reviews every 2 weeks with the team and the steering team to look at their progress. I think he and I would both say, we have growing confidence. There is a fair amount of work to go do.

I think when we get to the end of the third quarter, we'll have a better ability to kind of give a more detailed look at where that's going to go from a timing perspective..

Our next question comes from Greg Burns with Sidoti..

What percentage of your business currently comes from, I guess, will you characterize as maybe legacy systems? And is that business still growing just slower rate because I know some other competitors in the space are seeing declines in that portion of the business?.

Greg, the systems business, which I think -- it's hard because people keep trying to bring up these categories and the categories themselves are also blurring. So kind of depends on what you include in traditional systems because our traditional products. I would argue, ergonomic seating has been a traditional business for us.

It's a significant business and its growing, okay. If you look at filing, filing as an overall category, where filing and storage is continuing to grow. It's morphing a little bit from metal to wood. I would argue that today, metal is probably a flat to slower-growth business, where wood is growing very, very rapidly.

If you look at traditional workstations, workstations are still a very significant part of the business. For sure, handle-based systems or frame- and tile-based systems are flat to declining. So we're selling less and less panels.

What we are -- what you're seeing though the rotation in that world is more towards things like height-adjustable tables and benching applications and integrated spine applications. So it's not that the category itself is necessarily -- it is declining as part of the footprint.

So we've been saying that if you look back when I joined the business 20 some years ago, the workstation part of a foreplay was may be 75% of the foreplay. That's probably today on a new project in a more progressive company that's probably 50%, okay.

But at the same time, it's not as if there are workstation or work points as we would call them, that are outside of the traditional workstation.

So as an example, if you came to Herman Miller, yes, there'll be a lot of people working in workstation, there'll also be areas that are kind of more grouped things, kind of a, say, a counter-type table or something to that, that people are sitting around on more a temporary basis.

So you're just seeing a difference in the application of the products that takes in the way it's thought about.

Is that make sense?.

Okay.

And then, in terms of Nemschoff, how would you characterize the strategic importance of that business? And relative to its size and maybe the potential upside from turning it around, how do you view may be longer-term other strategic alternatives for that business and maybe a time frame on assessing that?.

Well, first, Nemschoff is a business. It's an important part of our overall health care offering. That enables us to be in the lobby, the patient room, in other areas like that, that we wouldn't have on the Herman Miller product portfolio.

And I'd also say it to you, if you've listened to all the commentary we've had today plus from our competitors, the area that's growing very fast in some ways are these ancillary and upholstered products. Well that's exactly what Nemschoff spends probably 75% of its business in an -- is an upholstered and soft goods.

So therefore, we think it is wise and smart to continue to turn that around because it's a big chunk of capacity. The industry is struggling to have enough capacity in those categories. Nemschoff is still seen as a quality player with a good design heritage.

And we think it's got the ability to either produce products or other parts of our business and/or expand into other areas like education. So there is a good amount of improvement that we think we can bring to that business.

I'd put it in a magnitude of, if you got to a good sport, it could improve EBITDA in the consolidated basis probably by around $3 million, maybe, $4 million at the top-end. So it's significantly, it's not like it's overwhelming. Last quarter, it was upside down. And this quarter was a little down, a little better.

I think, it's going to take us 12 to 18 months to get to where we want to be.

The great news is Steve Gane who has that business reporting to him, when he joined us, he built a very detailed plan around what to do with Geiger that included the people that he needed, the products that he needed, the culture that he needed, it took us a number of years.

Now we see Geiger in the collection as one of our stars, and Steve is there building a similar plan for Nemschoff. And I think, he has got through the first phase, which is getting the right people on the bus. He is starting to work on the product side, and I'm confident he will get there.

We're just going to have to be patient enough to let him do what I think he is very capable of doing..

And I'm not showing any further questions at this time. I'd like to turn the call back over to our host..

Well, thank you all for joining us on the call today. We appreciate your continued interest in Herman Miller and look forward to updating you next quarter. On behalf of all of us at Herman Miller, I want to wish you and your family the wonderful holiday season. Have a great day. And we'll see you next quarter..

Well, ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day..