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Herman Miller Inc (MLKN 0.04%)
Q2Â 2020 Earnings Call
Dec 19, 2019, 9:30 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good morning, and welcome to Herman Miller's Second Quarter Earnings Conference Call. [Operator Instructions]
I would now like to introduce your host for today's conference, Kevin Veltman, Vice President of Investor Relations and Treasurer.
Kevin Veltman -- Vice President of Investor Relations and Treasurer
Good morning, everyone. Joining me today on our second quarter earnings call are Andi Owen, our President and Chief Executive Officer; Jeff Stutz, our Chief Financial Officer; and Jeremy Hocking, President of our International business. We have posted yesterday's press release on our Investor Relations website at hermanmiller.com. Some of the figures that we'll cover today are presented on a non-GAAP basis. We've reconciled the GAAP to non-GAAP amounts in a supplemental file that can also be accessed on the website.
Before we begin our prepared remarks, I will 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 we issued last night as well as our annual and quarterly SEC filings.
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 now turn the call over to Andi.
Andrea Owen -- President and Chief Executive Officer
Thanks, Kevin. Good morning, and thank you all for joining us. Today, I'll begin by highlighting of our quarterly results, followed by sharing our latest progress toward our strategic goals. I'll then turn it over to Jeremy to provide an update on our international business, after which Jeff and Kevin will cover the financial results of the quarter in detail. Sales for the second quarter were 3% higher than last year, led by our North America and Retail businesses. This revenue performance fell short of the expectations we set coming into the quarter, driven by softer-than-anticipated order pattern, which ultimately closed the period down 4% from last year's level.
To be clear, while we're never happy to deliver growth rates below the goals we set, our view of the business and our near-term opportunities remains bullish. This industry is inherently project-driven. And this past quarter, we felt the impact of a pause in project activity. This was aggravated by a very difficult growth comparison in the second quarter of last year, when we posted orders of $705 million, an all-time record high for our business, representing year-over-year organic growth of 10%. In fact, that amount exceeded the highest volume quarter in our history by over $25 million. When establishing our guidance at the start of the quarter, we considered these tough comparisons, what we didn't anticipate was the impact that the mixed macroeconomic and geopolitical environment in recent months would have on project activity. U.S.-China trade tensions and Brexit uncertainty persists. And in North America, the Architectural Billings Index and BIFMA industry order levels have been choppy in recent months. We believe these factors contributed to lower-than-expected demand levels in the quarter.
To be sure, the order patterns we experienced in Q2 have a direct impact on our revenue guide for the upcoming quarter. With that said, as we look further ahead, we remain encouraged on our outlook for the business. Our sales force is optimistic, given the number of new business opportunities they see on the horizon. Customer business activity has increased sequentially this quarter over last. And overall, order levels have improved nicely in the first two weeks of the third quarter. We also note that job growth, unemployment levels and consumer spending remains strong, which collectively are positive factors for our business. Beyond the next quarter, we continue to believe our strategic priorities position us well for sustainable, profitable growth. And I'll share more on our progress in a moment.
Despite the challenges we faced this quarter on the top line, we are very pleased with the level of profitability that we delivered. Consolidated gross margin improved 180 basis points over last year. Favorable price and cost dynamics, along with our own profitability improvement efforts, are driving these gains. At the same time, our teams continued to manage operating expenses very well. As a result of these factors, we delivered another quarter of adjusted operating margin expansion.
We reported earnings per share on a GAAP basis of $1.32 during the quarter. In addition to certain restructuring and other special charges, GAAP earnings included a non-cash gain of $30 million related to the acquisition of the remaining shares of naughtone during the quarter. Excluding these items, adjusted earnings per share of $0.88 reflected an increase of 17% over the same quarter last year.
As I mentioned, our four strategic priorities are guiding our long-term value creation plans. As a reminder, they can be summarized as follows. First, we're being very intentional about unlocking the power of One Herman Miller to fully leverage our amazing portfolio of brands and global capabilities. Second, we're building a customer-oriented and digitally enabled business model in both the Contract and Retail spaces. Third, we have a range of initiatives focused on accelerating profitable growth in each of our business segments. And finally, we're reinforcing our commitment to our people, our planet and our communities in a more integrated and deliberate way than ever before.
I'd like to share a few highlights of our progress this quarter. As you know, we announced two important transactions during the second quarter. At the end of October, we acquired the remaining shares of naughtone. Subsequent to the end of the quarter in early December, we closed on the purchase of an additional 34% interest in HAY, giving us the majority ownership stake.
While Jeremy will share more about these transactions, I would like to highlight the fact that these growing design brands are a valuable addition to our Herman Miller Group. We were also honored to receive recognition on several fronts this quarter. Our efforts around total societal impacts were acknowledged by three influential groups. The National Minority Supplier Development Council recognized Herman Miller as the 2019 Corporation of the Year for companies under $10 million in sales for our leadership and supplier diversity. We were also named to Investor's Business Daily's first-ever list of the top 50 companies for environmental, social and governance values.
And finally, Newsweek named us one of their Most Responsible Companies of 2020. Similarly, a key element is unlocking the power of One Herman Miller. It's continuing to drive industry-leading innovation across our portfolio of brands and products. Confirming our focus here, TIME magazine named our Cosm high-performance task chair to its list of the 100 Best Innovations of 2019. While we were honored by this recognition, we're also leaning forward on innovation. Our recently launched headway line of conference tables addresses an important global market opportunity and delivers a sleek, seamless style, combined with customizable technology capabilities.
On our goal to better serve our dealers and our end customers through digital enablement, we continue to gain traction this quarter on the new digital platform that we've branded Scout. We've been rolling out new tools for our North America dealer network to help them improve their design and selling processes. We've also launched a platform with a 100% of our certified dealers in North America, who created over 1,300 projects at the tool during the quarter, an increase of 150% over the same quarter last year. Building on the success, we expect to launch an international version of this capability by the end of the fiscal year.
On the digital front for Retail, we've just completed important foundational work to define an extensive number of unique customer journeys through our e-commerce platform. This work will ensure that customer-centric design is at the forefront, as we begin meaningful updates to our e-commerce architecture. These are a couple of ways that we are working across each aspect of our operations to ensure that we are as easy to do business with as possible. With our focus on accelerating profitable growth, our North America profitability improvement initiatives continues to deliver benefits to our bottom line. We are at the low-end of our targeted gross savings of $40 million to $45 million by the end of FY 2020, with run rate benefits of approximately $40 million in the second quarter.
Finally, we're excited to announce that we have named Debbie Propst as President of Herman Miller Retail, a true industry veteran with a proven track record for building profitable brands through digital transformation. Debbie will lead Herman Miller's Retail business across our portfolio of brands, including Herman Miller, Design Within Reach and HAY.
John McPhee will be stepping down as President of Herman Miller Retail, but he will play an important role over the next few months to ensure a smooth leadership transition. While we look forward to Debbie's fresh perspective, as well as her knowledge of consumer behavior within the interiors and furniture industry, we also want to thank John for his many contributions and wish him all the best in the future. As we work across all of our priorities, we remained focused on our ultimate goal of creating inspiring designs to help people do great things.
And with that, let me turn it over to Jeremy Hocking, who will share more about our international businesses.
Jeremy Hocking -- President of our International business
Thank you, Andy. Good morning, everyone. It's a pleasure to join you today. International has been a key driver of accelerating profitable growth for our business. We've delivered annual organic sales growth of 8% per year over the past five years, including last year, where we grew sales of 13% organically, with an adjusted operating margin for the business of 12.3%.
While the growth in international last year creates more difficult sales growth comparisons this fiscal year, demand levels in the second quarter also reflected the uncertain global picture in our inherently more volatile international business. In addition to global geopolitical tensions, we've seen a softer economic picture in Mainland Europe and Mexico impacting demand in those regions. Helping to mitigate these pressures, we've continued to expand our gross margins this quarter, with an increase of 60 basis points over last year. An important contributor to that expansion has been the consolidation of our China manufacturing facilities.
Looking ahead, there are a number of initiatives that we believe position us well for the future. The acquisition of the remaining shares of naughtone helps expand Herman Miller's global offering in the fast-growing area of collaborative and ancillary products, which we can leverage across our global dealer network. Similarly, increasing our ownership position in HAY, directly aligned with our priority to accelerate profitable growth. Through our continued partnership with HAY's Co-Founders and creative directors, Rolf and Mette Hay, we will make HAY's well designed, high-quality products accessible to contract in retail audiences around the world.
We look forward to accelerating this partnership by exploring cross-distribution opportunities between our respective distribution channels. At the same time, we're leveraging the brands of the Herman Miller Group to bring new products to our regions that will help with one of our key initiatives to expand our share of our global dealer wallet. The addition of the Crosshatch family of seating from Geiger, as well as the lean a chair from Design Within Reach, a great recent examples of unlocking the power of One Herman Miller globally.
We believe our international business will remain an important growth driver for Herman Miller. Not only will we continue to add dealers to our global network, we believe we can gain meaningful share with our existing dealers as we expand our product offerings. At the same time, we have great teams in each of our regions, who are leveraging the One Herman Miller mindset to further build our growth orientation in the business.
With that overview of international, I'll now turn the call over to Jeff for more discussion of our financial results for the quarter.
Jeff Stutz -- Chief Financial Officer
Okay. Thank you, Jeremy. Good morning, everyone. Consolidated net sales in the second quarter of $674 million were 3% above the same quarter last year. New orders in the period of $675 million were 4% below the prior year level. As Andi mentioned, our order levels this quarter had a difficult comparison to the record levels reported in the year ago period, but we believe demand levels this quarter were also impacted by persisting macroeconomic and geopolitical uncertainties.
Within our North America Contract segment sales were $451 million in the quarter, representing an increase of 4% from last year on a GAAP basis in an organic increase of 3%. New orders of $435 million in the quarter were 5% lower than last year and reflected fairly broad-based declines across project sizes. From a sector standpoint we saw lower demand levels and business services, communications and healthcare sectors, partially offset by growth in the U.S. federal government and information technology. Our International Contract segment reported sales of $118 million in the quarter, roughly flat with the second quarter of last year. New orders of $126 million were 8% below the same quarter last year on a reported basis and 7% lower organically. It's important to note that the international business faced particularly challenging order growth comparisons for the quarter as Jeremy pointed out. To put this in perspective in the second quarter of last year, the international business posted organic order growth of 15%. Now tough comparisons aside this quarter, this business has been a key contributor to our growth in recent years and factors heavily into our strategy for driving continued profitable growth in the future.
With that background lower year-over-year demand levels were experienced in Mexico, Southeast Asia, China and the Middle East this quarter. These declines were partially mitigated by new project growth in the UK in India. Our retail business segment reported sales in the quarter of $105 million, an increase of 6% from the same quarter last year. New orders in the period of $113 million were up 3% on a year-over-year basis. Similar to International retail also faced tough prior-year comparisons with 16% order growth last year. Sales growth this quarter was primarily driven by growth from Design Within Reach contract, e-commerce, new studios and outlet stores.
From a currency translation perspective, the strengthening of the U.S. dollar relative to year ago levels was a headwind to sales growth in the quarter. We estimate the translation impact from year-over-year changes in currency rates had an unfavorable impact on consolidated net sales of approximately $2 million in the period. Consolidated gross margin in the second quarter was 37.9%, which reflected an increase from 36.1% in the same quarter last year.
The gross margin expansion was primarily driven by favorable price realization and lower steel costs along with continued progress in our ongoing profit improvement efforts. These benefits help mitigate gross margin pressures at the consolidated level from tariffs and within our retail business from increased net freight expenses. While we continue to bear higher year-over-year tariff expenses our results this quarter also reflected the benefit of approximately $1 million related to certain components imported from China, the qualified for our retroactively applied exclusion, it was granted by the Office of the U.S. Trade Representative.
Going forward, we estimate the growth impact associated with all tariffs on Chinese imports will range between $4.5 million and $5.5 million per quarter. Importantly, as we've noted in previous calls, we believe we have fully offset these pressures through a range of actions including pricing, supplier negotiations and leveraging our profit improvement initiatives. Operating expenses in the second quarter of a $189 million compared to $182 million in the same quarter a year ago. The current quarter included $1 million of special charges primarily related to transaction expenses associated with the HAY and naughtone investments. By comparison we recorded special charges totaling $5.9 million in the second quarter of last fiscal year. Exclusive of these items the year-over-year increase in operating expenses of $11 million resulted mainly from higher variable selling expenses investment in digital initiatives and expenses in our retail business related to marketing, as well as occupancy and staffing for retail studios opened since last year.
Restructuring charges recorded in the second quarter of $4 million related to actions associated with our profit improvement initiatives including a plan initiated during the quarter to optimize our manufacturing footprint of our Nemschoff operations across both its Sheboygan facility and other Herman Miller manufacturing facilities. Restructuring charges recognized this quarter also reflect expenses associated with targeted workforce reductions made within our North American operations.
On a GAAP basis, we reported operating earnings of $62 million in the quarter, compared to operating earnings of $53 million in the year ago period. Excluding restructuring and other special charges, adjusted operating earnings this quarter were $68 million or 10.1% of sales. By comparison, we reported adjusted operating income of $59 million or 9.1% of sales in the second quarter of last year. The effective tax rate in the second quarter was 14.3%. The rate this quarter was reduced by the impact of a $30 million non-taxable gain recognized in connection with the acquisition accounting for naughtone. This gain was recorded within other income and excluding the impact of this gain, the adjusted effective tax rate for the quarter was 21.6%.
Finally, net earnings in the second quarter totaled $79 million or $1.32 per share on a diluted basis compared to $39 million or $0.66 per share in the same quarter last year. On an adjusted basis, earnings per share this quarter totaled $0.88 compared to adjusted earnings of $0.75 per share in the second quarter last year.
With that brief overview, I'll turn the call over to Kevin, who will give us an update on our cash flow and balance sheet.
Kevin Veltman -- Vice President of Investor Relations and Treasurer
Thanks, Jeff. We ended the quarter with total cash and cash equivalents of $177 million, which was $18 million higher than cash on hand last quarter. Cash flows from operations in the second quarter were $90 million reflecting an increase of 53% over the same quarter last year. Increased earnings and lower working capital, primarily due to lower accounts receivable were the key contributors to higher operating cash flows in the quarter. Capital expenditures were $20 million in the quarter and cash dividends paid in the quarter were $12 million share repurchase activity was modest during the quarter as our capital deployment was focused on funding, but not one investment of $46 million in reserving funds for the $79 million required to close the HAY transaction at the start of the third quarter. We remain in compliance with all debt covenants and as of quarter-end, our gross debt-to-EBITDA ratio was approximately 0.9 to 1. The available capacity on our bank credit facility stood at $266 million at the end of the quarter. Given our current cash balances ongoing cash flow from operations in total borrowing capacity we remain well positioned to meet the financing needs of the business moving forward.
With that, I will turn the call back over to Jeff to cover our sales and earnings guidance for the third quarter of fiscal 2020.
Jeff Stutz -- Chief Financial Officer
Okay. Thanks, Kevin. We expect sales in the third quarter of fiscal 2020 to range between $672 million and $692 million. This outlook includes a full quarter of sales for both HAY and naughtone, which on a combined basis, are expected to contribute approximately $48 million in revenue for the quarter. From an organic perspective, the midpoint of this range implies a revenue increase of 3% compared to the same quarter last fiscal year. We expect consolidated gross margin in the third quarter to range between 36.5% and 37.5%. This midpoint gross margin forecast is a 130 basis points higher than the third quarter of fiscal 2019, reflecting net price realization, lower steel prices and net benefits from our ongoing profit improvement initiatives.
The forecast also contemplates 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 $194 million and $198 million. This range includes an estimated $14 million from the full quarter consolidation of both HAY and naughtone. We anticipate adjusted earnings per share to be between $0.68 and $0.72 for the period and our assumed effective tax rate is between 21% and 23%.
With that, I'll now turn the call over to the operator, and we'll take your questions.
Questions and Answers:
Operator
[Operator Instructions] Our first question comes from the line of Steven Ramsey with Thompson Research Group. Your line is now open.
Brian Biros -- Thompson Research Group -- Analyst
Hey, good morning. This is actually Brian Biros on for Stephen. Thanks for taking my questions. I want to start with the -- consolidated gross profit came in slightly higher than the guide, where you guys called out favorable pricing, the lower steel and the profitability initiatives. I was wondering if you could, I guess, one, quantify those just to give a sense of the pieces that arrived to the 180 basis point gain? And then maybe some additional color on when you will start lapping the lower steel costs?
Jeff Stutz -- Chief Financial Officer
Hey, Brian, this is Jeff. Yes, I'll take a start here and Kevin, maybe you can pull the data on steel and answer that second part. So I'll frame this up in big and, look, big buckets for you Brian. So the 180 basis point improvement really pricing, the impact of the price actions I'm going to break this by the way on a gross basis. So I'm going to break out the impact of tariffs from pricing. Obviously, the pricing actions we took were a little larger than normal as a result of the tariff situation. So in total, about somewhere between 120 and 130 basis points of year-over-year benefit in gross pricing flow through. Tariffs offset that to the tune of about 40 basis points, OK, year-over-year. Commodity prices in total, with the largest contributor, of course, being steel pricing being, to your question, being down year-over-year. You get about 50 basis points of benefit there.
And then the remainder I would point to a combination of some freight drag in the retail business, but offset by some mixed benefit, including channel mix, we write one of our larger revenue growth segments being retail just has structurally higher gross margins than the rest of the business. So that's a factor in the numbers, as well as some production leverage and higher production volumes across much of the business. So that nets out should get you to close to that 180 basis point improvement year-over-year.
Kevin Veltman -- Vice President of Investor Relations and Treasurer
And then, Brian, this is Kevin. On the steel front, this quarter implied in our guide for next quarter, steel cold rolled has been running about $200 favorable per ton. It'll start to work its way down in Q4 a little bit and it's really more Q1, Q2 of next year that we'll start to lap that full $200 a ton.
Brian Biros -- Thompson Research Group -- Analyst
Got it. I appreciate all the color. One more from me right now. I guess, still on the gross profit, but now for the early guide for Q3. I guess, could you just talk about some of the drivers or assumptions that would get us from the low-end to the high-end of the gross margin guide for Q3?
Jeff Stutz -- Chief Financial Officer
Yes, Brian, Jeff again. I would say, on a year-over-year basis, our guide would be -- imply a fairly similar kind of puts and takes in terms of basis point movement year-over-year, as I just walked you through for Q2. Obviously, we're starting -- Q3 is always a seasonally lower gross margin quarter, mainly because you tend to have lower factory production levels, both here in our plants in the U.S., as well as internationally. So you're already starting from a lower kind of factory production leverage perspective. That's probably the biggest factor outside of any changes in the pricing environment, which we don't see and it certainly aren't factored into our guide. But production volumes in the U.S. and -- within our international business can swing gross margins in our business up and down depending on if you get better leverage or less leverage than you anticipate. That's probably the single biggest factor that I would point to. But by and large, the guide is predicated on fairly similar trends as we saw this quarter in terms of the commodity pricing, similar price flow-through.
Brian Biros -- Thompson Research Group -- Analyst
Understood. Thank you. I'll pass it along.
Operator
[Operator Instructions] Our next question comes from the line of Greg Burns with Sidoti. Your line is now open.
Greg Burns -- Sidoti -- Analyst
Good morning. Please discuss the order pattern or the trends you saw this quarter among the softness [Phonetic] broad-based localized in any particular region of the business any additional color you can give us there? And was it something you saw throughout the quarter? Or did it sort of materialize at a later point during the quarter? Thank you.
Andrea Owen -- President and Chief Executive Officer
Hey, Greg, this is Andy. From a timing perspective, we really saw the softness in the first part of the quarter in September and October. Part of this was the price increase we had in the prior quarter, which we believe really pulled about $7 million to $10 million of volume into Q1 from Q2. And then as we turned into November, we started to see orders start to rebalance and November was flat. And then as we look into the first few weeks of this quarter, we're seeing a nice pickup in orders. So we really do think, it was a little bit of an air pocket in September and October and the first part of the quarter. Jeff, would you add anything to that?
Jeff Stutz -- Chief Financial Officer
Okay. [Indecipherable] No, I think that's right up.
Greg Burns -- Sidoti -- Analyst
Okay. And any more granularity you can give us on the improvement in the orders? I mean, are you -- in the first few weeks, are they up year-over-year, or are you seeing -- what kind of growth are you seeing in terms of the improvement in the orders?
Jeff Stutz -- Chief Financial Officer
Yeah, Greg, this is Jeff. We obviously have two weeks of data, but we're up about 3.5% year-on-year at the consolidated level through those first couple of weeks. So a nice improvement certainly over the trends we saw in total over Q2.
Greg Burns -- Sidoti -- Analyst
Okay. And -- OK, so obviously, that's a positive trend. Is there anything else you could point to that maybe gives you confidence that this was an air pocket and then demand -- the demand outlook remains very positive for the industry as a whole and...
Andrea Owen -- President and Chief Executive Officer
Yes, Greg, as we look at the funnel across all of our businesses internationally and in North America, we're seeing really strong funnel month in in the four-month funnel. So that gives us a lot of reason to be optimistic.
Greg Burns -- Sidoti -- Analyst
Okay. Great. Thanks.
Jeremy Hocking -- President of our International business
And Greg, I might -- Jeremy, I don't know if you want to add anything just in qualitative terms on your business -- because I know your business had, particularly difficult comps to start Q2 improved a bit, so.
Sure. I think one of the really positive things, I speak and you can tell it from my accent, we just got through a general election in the UK, it's a huge amount of relief in that market. And I think that the FTSE bounced 2.25% straightaway. And this is a sense that some real estate transactions that have been held up in that particular market could get release. So I think we're feeling good about that. Clearly, some progress in U.S.-China negotiations always helps as well. So I think the team and I was catching up just yesterday are feeling somewhat more optimistic right now than they were six to eight weeks ago. So that's pretty good.
Greg Burns -- Sidoti -- Analyst
Okay. And then just switching to the retail business. I know there was some initiatives going on there through the new distribution facilities, some things that were maybe transitory that would improve margins. What's the status of those items and then still operating at a loss here. What's your view on getting this business back to profitability?
Andrea Owen -- President and Chief Executive Officer
Yes. I think if you look at the warehouse in that DC move, I think, we've had our last charges to that and they were not as large as they were in the prior quarters. Going forward, we won't see that again. I think, as we continue to invest in growth here, the biggest investments for us are really around digital. So we have a really multi-year strategy around upgrading our sites across all of our brands and geographies. So that will have a single flexible architecture. We believe that allows our business going forward for HAY, particularly as well as DWR will come from digital. And then investing in store growth, we've been doing that. We will continue to do that.
So I would say, our view to single operating margin improvements in single-digits is still optimistic. But I would say, with the change in leadership and as we look forward to growing HAY, now that we have majority ownership, we'll still continue to invest, but we're very confident that we'll get to the operating margin in positive territory in the next few quarters.
Greg Burns -- Sidoti -- Analyst
Okay. Great. Thanks. Is there anyone else queued up.
Kevin Veltman -- Vice President of Investor Relations and Treasurer
No, go ahead, If you have another question, Greg.
Greg Burns -- Sidoti -- Analyst
Okay. Nemschoff, you did talk about it in the -- on the call, but I think there was some commentary in the press release. Could you just give us an update on that business? I'm just trying to want to better understand, is there something -- is the healthcare market just more challenging, or is there something structurally specific Nemschoff that is causing that business to lag?
Kevin Veltman -- Vice President of Investor Relations and Treasurer
Yes, Greg, good question. So, look, it's -- this Nemschoff is -- I want to be really clear. Nemschoff, we -- the product that we get out of the Nemschoff business are really important to our healthcare business. And so I want to be upfront with that as a starting point that this is an important component of a very impressive overall healthcare offer for Herman Miller that doesn't change. What we have been focused on and this is not new news. We -- this has been a work in progress for sometime is getting that business leaner, so that it can operate profitably and that has not been the case consistently over the years that we've owned that business. And so there has been a big push. This latest round of announcements was aimed at just that.
And so I'm going to be a little -- because we do have some continued ongoing negotiations. I'm going to be a little careful on sharing too much in the way of detail. But what I can tell you is, the actions we've taken prior to this second quarter that we're reporting and obviously, including the actions we're taking this -- in Q2 have the business at a point today where it's profitable and, obviously, the goal is to improve upon that. So we're heading in the right direction. It has been a journey for us. But I think we're feeling pretty good about where we stand.
Greg Burns -- Sidoti -- Analyst
Okay. And then the operating margin is very strong in North America. You've gotten a nice improvement in the gross margins there, too. So I just wanted to maybe get a sense of your view on further margin improvements, maybe specifically in North America, are we confident where that business should be operating? And then on a consolidated basis, kind of your view on what kind of margin leverage you would expect to drive out of the business? Thanks.
Jeff Stutz -- Chief Financial Officer
Yes, Greg, so this is Jeff again. With respect to -- again, the North American business has been performing very well. As you well know, we have been focused heavily on profit optimization for the last couple of years. And in very specific terms over the last, I'd say, 12 to 18 months, within the North American contract business. And much of that work has been focused on the gross margin line and just making sure that we're -- we have the right pricing strategy in general, but then also that we're working with our supplier partners and making sure that we have a fair arrangement on both sides of that equation. And I want to stress that we have very important long-term partners and suppliers that we value. And so that's been an ongoing conversation.
And I think made really good progress over that time on the margin improvements as always in this business. The -- so much of it does depend on top line performance to get the kind of leverage that you can get in short versus if you get the volume flowing through. So that's important. And we've had a -- notwithstanding this -- the second quarter order patterns. We've had a pretty good run over the last year or so.
And I think, as we look forward, we continue to be optimistic that we can keep those factories running and generate the kind of profit leverage that we've been able to show in the past. So on the North American front, things are working quite well. We're always -- we're never done. And we have a great supply management team and the folks that are -- they lean in on what we call a Herman Miller Performance System or HMPS. And so that's ongoing. And so we expect continued benefit from that, but that top line performance will ultimately dictate. At the consolidated level, we continue to have opportunity, look, the business. While we're getting good pricing flow-through, there's always inflationary pressures that the business is facing be it wage-based inflation, healthcare inflation and other factors. We often talk about commodities, but that's not the only important part of the equation.
And so we will continue to look for opportunities to put reasonable kind of a cadence of price increases in place to help offset those. Some of those are already in place and plans for. And that will -- we expect to help if we get the kind of the typical flow-through you get from those price -- those pricing actions. And obviously, a lot of it depends on what happens with commodities which has been in the -- our talking points for sometime now.
And then within retail, as Andy said, we've got a big effort to improve the overall profitability of that retail business, which no secret has been facing pressures from reduced net freight revenue over the past year or so. We're working on that. And with the new leadership with Debbie coming onboard, I'm sure she is going to come in and you give us some new ideas. Andy, I don't know if you'd add anything to that.
Andrea Owen -- President and Chief Executive Officer
Yes. I would add to that, Greg. Just as we learned a lot in the last couple of years from our project optimists work and our contract side of the business, we're launching that same effort in the retail side of the business, because we believe there is obviously room for improvement there. So that will be a big help, too.
Greg Burns -- Sidoti -- Analyst
Okay. Great. And then lastly, in terms of the investments in HAY, the increased investments in HAY and naughtone. Why was now the right time to kind of step up your investments there? And then for each, maybe you can highlight some of the more immediate value creation opportunities now that you do have a controlling interest in those? Thank you.
Andrea Owen -- President and Chief Executive Officer
Yes. So let me just start at the beginning. I think now is the right time. If you start with naughtone, it's been an incredibly successful contracts brand around the globe. We feel like having majority ownership now to the number of things. As Jeremy pointed out, it really helped us enter international markets, but one of the highest growth areas for naughtone is also North America. So I'll let Jeff talk about some more value creation around naughtone. And then HAY, we believe HAY tremendous opportunity around the globe from a contract perspective, but also is an incredibly compelling retail solution in North America. And as we've minority ownership for quite sometime, we've been unable to really accelerate the growth potential of its brand, both in bricks-and-mortar and retail and also online. Now that we have that ownership and partnership with Rolf and Mette, we feel like we can really put the gas on the fire what this brand can do for us in North America and we're excited to get started.
Jeff Stutz -- Chief Financial Officer
Yes. Greg, this -- the only thing I would add to that is, this is true for both HAY and naughtone. Both of these businesses address a sweet spot in the market right now for us in the area of ancillary furnishing, and they are both -- have a track record of impressive growth. And it's part of their Herman Miller family at this right moment in time, where that is where much of the market attention is going. And so it just adds to what is already a pretty impressive overall portfolio and makes us that much more competitive. And I think, Jeremy, I don't get anything to add to that.
Jeremy Hocking -- President of our International business
I would add that we're still, I think, really only beginning to see the penetration of HAY into our contract channels in North America. So a lot of upside still go there. And in Europe, where HAY, a very strongly established kind of darling of the architecture and design community. We think this is a great opportunity to explore further kind of integration and sharing of distribution channels.
So they got some wonderful dealers and wholesalers in each market across Europe. Many of those companies, I think, are going to be very interested to discuss the opportunity to distribute Herman Miller products in that channel, as well as maybe Herman Miller dealers in some markets today that are not selling HAY. So there's plenty of upside we think for this brand, both in North America and in Europe.
Greg Burns -- Sidoti -- Analyst
Okay. Great. Thanks for the color.
Andrea Owen -- President and Chief Executive Officer
Thank you.
Operator
And I'm not showing any further questions in queue at this time. I'd like to turn the call back to Andi Owen for closing remarks.
Andrea Owen -- President and Chief Executive Officer
Great. Well thank you all for joining us on the call today. We really appreciate your continued interest in Herman Miller, and we look forward to updating you again next quarter from all of us here at Herman Miller, we want to wish you and your families, a very, very happy holiday season. Thank you.
Operator
[Operator Closing Remarks]
Duration: 39 minutes
Call participants:
Kevin Veltman -- Vice President of Investor Relations and Treasurer
Andrea Owen -- President and Chief Executive Officer
Jeremy Hocking -- President of our International business
Jeff Stutz -- Chief Financial Officer
Brian Biros -- Thompson Research Group -- Analyst
Greg Burns -- Sidoti -- Analyst
