Natuzzi S P A Q2 FY2021 Earnings Call

In detail, the results of the second quarter and the first six months.

Thank you, Pasquale, and good morning, good afternoon to everyone. I joined the company last June, and this is my first analyst call. I'm working very closely with Pasquale on governance, and thank you for your kind words, Pasquale. Okay. Maybe, Kevin, can you mute the microphone of people who are not speaking? I got a bit of echo. Excellent. Thank you so much. So I was saying, I am very happy to be with you. Today, for me, is an important meeting, not only because it's my first analyst call, but because I interpret my mission as a simple mission. My mission is about creating value for the investor, which I believe today is well represented in this audience, as measured by per share value increase. The other mission is, of course, to satisfy the other shareholders of the company, which I intend to be our final customer. So those are my two priorities, equally important. They are based on a reset of our fundamentals, which we are working hard on with Pasquale. In terms of numbers, I believe you have seen our second quarter numbers by this time. We are reporting strong sales, 76% versus the second quarter of 2020, and 17.7% versus the same period in 2019. So growth is back. It is back for the sector, as Pasquale mentioned. The sector is enjoying positive growth, which we believe can become structural. It's also very good for us. We believe that in many geographies, including the U.S., we are gaining market share. We are growing faster than the market. It is not just about the absolute number of growth, but the quality of growth. As you might know, if you've been following this stock for some time, the company has decided to grow on two main avenues. One is the branded business, leveraging the strength of Natuzzi Italia, which has 60 years of heritage and is entirely manufactured in Italy, and Natuzzi Editions, which is designed in Italy. Its price point is significantly higher, and the production takes place closer to the end market. I am pleased to see the quality of the growth, as the branded business now represents 87% of the total. This is quite an interesting achievement because the company started six years ago with a completely different scheme. It was producing great products at an affordable price point, mostly sold unbranded. So you can imagine the effort and investment we made—roughly EUR1 billion—to move from being a manufacturer to a brand. The second avenue, which is a sign of improving quality, is retail in those geographies where we now have the right team and the right receipt working well. For instance, in the U.S., where our manager, Jason Camp, is attending this call, bringing 25 years of experience from different companies, including Restoration Hardware, he's built a strong team with retail competencies. In this geography, we have our best store pacing at $4 million in sales per year, with a 669% sales like-for-like increase versus 2020 and a 49% increase versus 2019. I would say, significant organic growth, which did not happen by chance. It happened because we have a strong team implementing an effective merchandising retail strategy. This strategy launched what is called a quick program based on advanced analytics, where we analyze data from the previous three seasons to identify the best products in terms of rotation. For those products, we take significant risks in terms of stock to be able to serve the client with very short delivery times, which is a competitive advantage in this turbulent supply chain era. So the branded business is doing well and retail is growing in geographies where we have a focused management team doing what good retailers should do. We intend to deploy this successful model in the remaining geographies. After three months of joining, I see a team with a very clear view of the strategy ahead. The strategy is based on branded business, retail, and three priority geographies: the U.S., China, and Europe. Also, I am encouraged by the fact that Pasquale said this is true not only for me, but also for him, who has been in the business for 60 years. I see an unprecedented level of supply chain disruption affecting raw materials, manufacturing, and shipping. We witness a price increase of up to 100% for raw materials compared to the beginning of the year. Demand is outpacing our manufacturing ability for various reasons, and securing timely shipping with the proper cost is increasingly complex. So this situation keeps us very focused. Our priority is reducing backlog because we want to ensure that our final customers, who trust our brand, do not suffer from this context. It is not just Natuzzi; it is a global challenge the entire economy is facing. We are working hard on this, but we cannot claim to have the solution for Natuzzi next week. This is an important aspect we wanted to share with you transparently, as we should communicate with our trusted advisors and investors. I will stop here because you have seen the rest of the press release, and it will be a better use of your time to address your questions rather than continue this introduction. One other element I might want to highlight is that I spent the first week with Pasquale, working closely to align the full team on the future vision for growth. We have invested a lot of time creating alignment and just ended another off-site with the full management team because we believe this will be a people-led growth acceleration plan. One important element is enhancing communication within the team. Another element to create alignment is the incentive system. We have had in place since the beginning of the year an MBO anchored on short-term results. Our Board approved the definition and fine-tuning of a stock option plan by the beginning of next year for a limited number of managers, including myself, to achieve perfect alignment with shareholders and to serve as a long-term retention instrument with a relatively long vesting period. We don’t have details on that now as it is being finalized, but the Board’s decision is on a clear timeline to complete the stock option plan. In the next analyst call, we will provide more details on this, which I believe will be crucial to create ownership instincts in top management. Let me stop here. Maybe, Kevin, you want to open the floor for questions unless Pasquale has another remark. You are on mute, Pasquale. Can you unmute?

Yes, there you go.

Antonio, you listed complete issues. So we can certainly listen to our shareholders for their questions.

In the next analyst call, we will provide more details on the stock option plan, which is important for fostering a sense of ownership among top management. I'll stop here and suggest that Kevin opens the floor for questions unless Pasquale has another comment. Pasquale, you're on mute. Can you unmute? Yes, now you’re good. Antonio, you covered all the key points, so we're ready to hear questions from our shareholders.

I guess David is trying to come back...

Our first question today is coming from Kyle Travers.

I'm unmuted. Can you guys hear me?

Yes. I can hear you. Please proceed.

I appreciate you taking the time. I had some time over the weekend to go through your press release, and appreciate it. So one question I had, in particular, was about your U.S. stores that I think you said are trending at around $4 million, about over 70% contribution margins. I was curious how many of your stores are headed in that direction? And if you could also remind me just of your total U.S. store count?

Sure. Good morning. We have 13 stores in the U.S. And when we look at our top 6 to 7 stores, those are the locations pacing in the $4 million range. Generally, those stores were pacing at about $2.5 million in 2019, so they are up over 70% to 2019.

Okay. Regarding the other six stores, how long do you think it will take for them to reach the $4 million run rate? When do you anticipate that could happen?

Sure. The average pace of the 13 stores is $3 million, just to give you some ability to do the math. Generally, I think, we see a lot of growth beyond this $3 million to $4 million pace. We expect and hope that our work in talent, merchandising, and marketing will lift all boats. Generally, it's my experience that your best locations grow faster than the average. I hope that answers your question, Kyle.

It does. I appreciate it. I guess just one other question. This is a little broader. And I don’t know if you guys might be able to point me in the right direction, but there are some things that are off-balance sheet. You bought some land, and you have a JV here in China. I was wondering where I could find the Kuka information about their operations and how those are trending? Maybe you guys could summarize the land opportunity and some of the stuff that may not be particularly strategic to the longer-term vision and how much you think you could monetize by selling real estate and some things you are reading through a press release? So two questions there.

Antonio, would you like me to answer this, or would you like to?

Vittorio, I think you're best positioned. You should do it. Then I'd add a bit more general comment on capital efficiency, but please comment on land and then Kuka.

The program to sell non-core assets is progressing as expected, as we anticipated 1.5 years ago. In July of this year, during the first quarter, we sold the foam company and two parcels of land in Italy. We also completed the sale of land in High Point in July. We are making good progress so far. Regarding the Kuka joint venture, the share of profit in the fees is reported below the net finance income. For the first half of the year, they contributed EUR2 million in profit to Natuzzi's consolidated profit and loss, compared to EUR0.9 million in the first half of 2020. I reviewed the results from August and can confirm that progress is being made with both brands in the retail rollout. I'm sure Antonio will provide additional qualitative insights.

No, you did a perfect answer. Just elaborating and linking back to my opening: the whole company is working to increase the value of the share per share. Of course, capital efficiency is an important matter. We are exploring ways to lighten our balance sheet concerning capital. Non-strategic assets are a focus of that effort. We are in advanced discussions to continue this journey while maximizing current value. The JV in China is a different story. It's more strategic and structural. We are exploring ways to ensure that Natuzzi investors get the full value of what is happening there, which is very encouraging because we are growing significantly in terms of the number of stores—roughly 300 stores among the two brands. The performance is doing very well. Our partner is establishing a dual-brand strategy with Natuzzi Italia being a top luxury brand positioned very high and Natuzzi Editions being more affordable. The potential value of this story, considering China's luxury fast growth, can be significant, and we will continue looking at ways to capture this value going forward.

Just for someone new to your story, I think you guys are getting great value, but it would be incredibly helpful for someone on my side to have a little more granularity on what's going on with Kuka. The metrics we always look at are sales and EBITDA. Can you help me understand what your 49% stake is worth? Just so it's clearer, because people new to your story have no self-coverage here, and it's a little harder to do a full sum of parts analysis.

Mr. Kane, your line is now live. Hello, Mr. Kane, you're now at the podium. Please unmute yourself.

Can you hear me?

Yes, please proceed.

Yes, please.

So congrats on the strong growth in Q2, particularly in the U.S. My first question is, are you seeing these strong trends in written orders continue into Q3? We're almost at the end of Q3 here. So just wondering if you can give some color on the trends in sales, whether they're accelerating or staying the same, or what you're seeing? If you can provide some guidance on that?

Yes. I refer back to the press release because, in the intent of providing transparency as suggested by the SEC, we also shared information on our first 36 weeks of written orders. Currently, we are starting week 38, so basically, we are talking about two weeks before now, mid-September. Written orders are up 36% versus 2020 and up 14.5% versus 2019. So the positive momentum continues. Now we are in the ninth month of the year, and the consolidated written orders were still very positive compared to 2020 and 2019. I hope this addresses your question. You can see this information in our press release as well.

Yes, that's helpful. I guess my question is in the U.S. in particular; that's our key growth market. Is there any more detail you can give on how the U.S. is doing over the past couple of months?

Good morning, Greg. I would generally confirm what Antonio shared that the pace of business we're seeing in Q3 is holding through to what we saw in the first half. For the first half of the year, our growth numbers in the U.S. branded wholesale and retail business are growing somewhere between 50% and 70%.

Got it. That's helpful. Can you give a bit more color on our store opening plans? I know in previous calls we discussed six or seven openings in the near term. Could you provide an update on the pace of store openings in the U.S.?

Jason again, that is for you. We don’t provide precise guidance, but I think we can share directionally what our plans are, depending on real estate opportunities. Jason, please, you're clearly better entitled than I.

Sure. When we look at the total number of openings in the region, we expect to open four stores between independently owned and company-operated stores this year, and ten stores by 2022. That’s our target for 2022 across both brands, between independently owned and company-operated.

Got it. One last question from me, and then I will hand it over to the next caller. Could you give an update on some of the other strategies we are pursuing in the U.S. and globally, such as e-commerce? Where are we in the opening of the Mexico plant to serve the North American and South American markets?

So maybe I'll start by tackling these two questions. Regarding e-commerce, we are on track for a global new platform, merging the existing 46 digital platforms present in the brand. This global platform will serve all geographies for Natuzzi Italia and Natuzzi Editions. We plan to be operational for Natuzzi Italia in the U.S. by the end of this year. We are gradually implementing an agile structure, progressing through the phases of completion, and we are targeting this year. Mexico is a top priority, and we are making progress. We are moving a senior team from Natuzzi Italia to the Natuzzi headquarters in Mexico to secure a better pace of implementation. This is among the three or four major priorities for next year. Our goal is to progressively ramp up production in 2022, and that objective is currently confirmed.

That’s incredibly helpful. Congrats on the work done so far. The focus on return on invested capital and profitability, alongside a high-quality product, is appreciated. Looking forward to updates in the next quarter.

Thank you for your encouragement. Pasquale and I share the view that the company’s strong growth instinct should be preserved while including a systematic approach to profit generation and value creation. We are using metrics focused on incremental cash generation, which is crucial to our path forward.

Our next question today is coming from Charles McDulin.

Are you guys able to hear me?

Yes. Please go ahead.

Okay. Sorry about the earlier problems. Regarding the new store openings, it’s encouraging to hear your goal of about ten for next year. Looking out 3, 4 years, how many stores do you think you can have in North America? I’m asking for more color on the statement that branded and DOS stores contributed to a 74% gross margin. Obviously, we’d like that ramp to occur as soon as possible. If you could give a longer-term goal, is that 10 stores per year sustainable?

Jason, why don't you take that one? Then Pasquale and I can provide more color.

Sure. When we look at the combined opportunity of both brands, in both Italia and Editions, honestly, we could probably have almost ten times the number of stores that we do today. So there's a significant long-term runway. We're not going to achieve that over three to four years, but there’s plenty of opportunity for retail growth.

Dave, another comment: Everyone, including shareholders, Pasquale, and myself, is looking with great excitement at what we are achieving in U.S. retail performance. We would prioritize every dollar to continue this journey. However, we must recognize that opening a store is an investment and must happen strategically. Luxury brands ensure careful consideration of their locations along their long-term potential.

Yes. One of the most costly mistakes a company can make is rushing into locations with poor long-term economics. Often, when companies accelerate their rollout, they face significant issues later on. It’s essential for us to focus on A locations with solid financials.

The other element we are not ready to discuss today but may next time is investing in enhancing the retail experience, particularly for Natuzzi Italia. We have defined an exciting new retail format for Natuzzi Italia, rolled out in Shanghai, with great feedback from customers and partners. Next time, we may provide a virtual tour of the new store developed by designer Fabio Novembre, representing the brand’s DNA. We are enhancing our retail experience and investing in training for our sales force for clienteling and storytelling.

Okay. I appreciate the thoughtful approach to expansion. That makes sense.

Thank you.

In terms of gross margin, I know you've seen inflation in raw materials; you passed through about a 15% price increase. Can you give me the timeline on that? What I'm trying to ascertain is if, going forward, you will see an expansion in gross profit on a consolidated basis from these cost increases. For example, if they were passed through in May or June, you may not have the full quarterly benefit. Can you speak to that?

David, let me focus on North and Central America first. We implemented our first price increase in November 2020. Following the raw material and transportation cost trends from China, we executed a second increase in February, and we recently adopted another surcharge for transportation costs in September. This means that in Q4, we will see the full impact of price increases on our profit and loss.

So the price increases you’ve taken recently will positively impact gross profit going forward?

Yes.

David, yes. But please consider that for the time being, it’s a game of running faster than the bullet because we do not yet see a decrease during this crisis. Consider, in your calculations, that I believe we should see some normalization in raw materials. When that happens, it could provide a significant advantage for us. We've raised prices in some geographies and brands by up to 30% in nine months, highlighting the strength of our brand. If and when raw material prices decline, we stand to gain considerably as we will not lower our prices again.

Listen, you learn very, very quickly. All the statements you've made are accurate. Otherwise, I would stop you.

I won't interrupt you, but it needs to be meaningful.

Dave, allow me to add that, on a global basis, material costs have increased significantly. In North America, freight is the most volatile. Antonio references the need to outrun the bullet. Freight is what we are currently wrestling with, and we are operating in historic conditions.

Right.

To add further relevant context, there are short-term effects due to supply chain disruptions that we must defend against as well as longer-term opportunities where we need to readjust. Broader price increases are more related to the short term, and I do not expect this to continue indefinitely. Shipping costs may present a more structural situation. We currently see pricing at historic highs; just recently, a shipping cost jumped from $2,000 to $67,000. I believe that condition is unlikely to continue. We are optimizing our supply chain to enhance sustainability.

You’ve touched on transportation. That was my next question. Transportation costs rose 420 basis points. Following large price increases, the expectation is often for declines. I anticipate over the next 12 to 18 months, we’ll recapture some of those basis points alongside the price increases to elevate gross margin. Is it possible we can achieve a double-digit EBITDA margin down the line?

As you correctly noted, we do not provide guidance, so I cannot affirm or deny that. However, I can say that.

From my experience, I can answer that. We have exported to America from Italy for 40 years, and I have never seen anything like what we're experiencing today. Typically, price increases would be around 10% or 20%. But now, we’re looking at prices that have jumped from $2,500 to over $20,000. This speculative situation is unprecedented.

So we cannot continue with these expenses, but that is merely my feeling.

In terms of transportation costs, we are ceasing purchases and imports from China. The current cost of components does not justify such transportation expenses, driving us to reassess our supply chain. We hope to manufacture everything in Italy, Romania, and our facilities in Brazil and China. This restructuring is essential for sustainable operations.

Thank you.

You have initiatives to mitigate cost inflation regarding transportation and raw materials. You're controlling what you can; that’s good to hear. Mr. Natuzzi, my question is on product development. It seems like you’re moving towards training your sales force in-store to design rooms for customers instead of merely taking orders. Are you planning to increase SKUs in product development to enhance customer penetration?

We have sufficient products and colors available. We need to focus more on selling. The total merchandise we have for Natuzzi Italia, as well as for Natuzzi Editions, can support a lifestyle brand. Thus, our product development investment must be limited, focusing on training staff in-store and enhancing retail merchandising.

You have enough SKUs to meet customer needs, which is reassuring. One last question—what’s the timeline for your e-commerce launch, and could you provide any expectations for shareholders regarding that?

Currently...

Yes, we’re targeting the end of the year for the global launch of a new information and branding platform for Natuzzi Editions and Natuzzi Italia. This new platform will replace the existing 46 platforms in different markets. This platform will also be transactional for U.S. Natuzzi Italia. We’re looking to launch it by year’s end. We’re expediting our efforts to ensure it’s operational and solid before release. We anticipate restructuring our marketing efforts to become more digital-oriented, emphasizing customer activation rather than bare building. Natuzzi enjoys high brand awareness in most growth geographies, including the U.S., where it ranks #1 among European furniture brands. Our communication strategy will focus on customer activation, becoming very visible in the consumer journey, which includes numerous online interactions.

That’s very helpful. Congratulations, and good luck in the upcoming year.

Our next question today is coming from Stanford Wyatt.

I appreciate and will echo previous callers; the additional detail in the press release was helpful, and the focus on return on capital has been great. Just circling back on prior questions, I know you’re not giving guidance, but would you provide any thoughts on long-term EBITDA margin potential?

From a strategic standpoint, we aspire to be a brand company, and I believe Natuzzi Italia can be a luxury vertically integrated business. Industry benchmarks indicate those companies achieve double-digit EBITDA, which is certainly our ambition. We believe in increasing operational efficiency can lead to margins that mirror those successful luxury brands.

That’s great to hear! Just following up, I see you also spent $800,000 to reduce redundancies in your Italian factories. Is there more opportunity there?

We are adjusting following the legacy of our past. The company used to rely on Italian production extensively. However, as Natuzzi Italia continues growing, this strategy remains aligned with our identity. Implementing sustainable production and supply chains is essential, particularly because our workforce environment in Italy is rigid. We have started discussions with HR preceding summer, which are now accelerating to identify sustainable solutions.

Antonio, help me to understand a bit more. You mentioned manufacturing Natuzzi in Italy and the reasons why. We have plants in Brazil, China, and Romania, and are currently organizing reductions in Mexico.

Okay, that will be fine.

Yes, okay.

I'd like to ask about the stock option plan you mentioned. Why is there a wait until next year? I think you are working on many good initiatives right now—why not incentivize the management team immediately?

Thank you for this comment. I joined Natuzzi because I believe the company has terrific upside potential. I aim to achieve this, working hard alongside my team. The stock option plan aligns my interests with that of the shareholders—my best salary is roughly one-third of what I earned as a Senior Partner and Global Leader at McKinsey. The goal is to ensure value creation, not just stock grants. The option plan will establish a strike price based on the 30 days before my joining date. This provides significant motivation for incremental value creation.

That's great to hear. The alignment indicates stability as a shareholder.

If there are no further questions at this time, I would like to pass the floor back to Piero.

Thank you, Kevin. We have no further questions. This concludes the conference call today. Thank you all for participating in the event. Please don’t hesitate to reach out to me for any questions you may have. Have a nice day. Thank you.

Thank you. That does conclude today’s program. You may now disconnect and have a wonderful day. We thank you for your participation today.

Thank you, bye-bye.