Natuzzi S P A Q1 FY2022 Earnings Call

Good day ladies and gentlemen. Thank you for standing by. Welcome to the Natuzzi First Quarter 2022 Financial Results Conference Call. As a reminder, if you would like to join via telephone you may do so by dialing in the following number: (+1) 412-717-9633, then passcode 39252103#. Once again, that’s (+1) 412-717-9633, then passcode 39252103#. In addition to the link provided to join via video. At this time, all participants are in a listen-only mode. Following the introduction, we will conduct a question-and-answer session, instructions will be given at that time. Joining us today from Natuzzi is Chief Executive Officer, Mr. Antonio Achille; the Executive Chairman, Mr. Pasquale Natuzzi; Mr. Jason Camp, President of Natuzzi Americas; and Piero Direnzo, Investor Relations. As a reminder, today's call is being recorded. I would now like to turn the conference over to Piero. Please go ahead.

Thank you, Kevin and good day to everyone. Thank you for joining the Natuzzi's first quarter 2022 financial results conference call. After a brief introduction, we will give room for a Q&A session. Before proceeding, we would like to advise our listeners that our discussion today could contain certain statements that constitute forward-looking statements under the United States securities laws. Obviously, actual results may differ materially from those in the forward-looking statements because of risks and uncertainties that can affect our results of operations and financial condition. Please refer to our most recent annual report on Form 20-F filed with the SEC for a complete review of those risks. The company assumes no obligation to update or revise any forward-looking matters discussed during this call. And now, I would like to turn the call over to the company's Chief Executive Officer. Please, Antonio.

Thank you, Piero. Good morning to the investors in the U.S. and good afternoon to those in Europe. I want to share our performance for the first quarter of 2022. We are successfully executing our strategy and outpacing market growth. Our revenue increased by 17% compared to the first quarter of 2021 and by 43% compared to 2022. We're also shifting towards more branded products. Around 90% of our order flow is now from brands, up by 4 to 5 percentage points from 2021 and 2020. We're concentrating on key geographies, with all three core areas of our strategy showing double-digit growth. North America has seen a 32% revenue increase, Southwest Europe is at 19%, and China is up 14%. Our retail focus is yielding positive results. We added 19 freestanding stores in the quarter, all through franchising; 16 in China, where we have a substantial total of 380 stores, 2 in the U.S., and 1 in Italy. In North America, sales are more than 50% higher than in 2021, indicating that our retail strategy is effective. Consequently, the contribution of retail, including both company-operated and franchised stores, to total revenue rose to 52%, up from 49% in the previous year’s quarter. We are also investing in factory modernization. The pilot we are conducting using 4.0 technology is producing strong results and will lay the groundwork for future factory investments. Additionally, we are enhancing our growth partnerships; we’ve recently established a partnership for developing Asia Pacific with TTF, a public company. We hold a 22% share in our Singapore venture, with an investment of €5.2 million. Finally, we are reinforcing our governance and building a more dedicated team. As you may have seen in our press release, Gilles Bonan, a seasoned executive with previous experience as CEO of Roche Bobois, has joined our Board as an independent member, and the Board has approved a stock option plan that will take effect in the coming months. Overall, this quarter aligns well with our strategic goals, despite facing challenges such as significant inflation in raw materials and higher transport costs, which have persisted beyond COVID. We are closely monitoring these expenses and adjusting our pricing, but this limited our ability to further expand margins this quarter. Additionally, we are currently facing restrictions in China affecting our Shanghai factory, which is a key facility for us. As a result, the initial two months of the second quarter have been impacted by the limited operations of our Shanghai factory. This summarizes our quarter and highlights our progress toward value creation for our shareholders. We wish COVID was our only challenge, but we are now also managing ongoing inflation, COVID restrictions in China, and the war in the Eurozone. I'll stop here to allow more time for questions and answers.

Our first question today is coming from Dave Kanen from Kanen Wealth Management.

The first one is regarding the price list increases that you're taking. In the press release, you said that they'll start to take effect during Q2. So I'm looking past Q2 as an extraordinary event or a temporary period regarding the lockdowns in China and so forth. Looking to the second half of the year and beyond. Given the price increases and the modernization investments or capital expenditures at the factory level to improve efficiency, should we expect higher gross margins, assuming no further increases in inflation in the back half of the year from that combination of price increases as well as some of the investments in technology at the factory level?

Thank you for your question. To answer it directly, yes, assuming there are no further inflation pressures, the response is affirmative. However, we continue to see strong inflation rates. For instance, the European Union just reported an inflation rate of 8.1% for May, the highest since the EU's inception in 1999. To elaborate on our pricing strategy, we typically make decisions at the end of the year for the upcoming year by analyzing expected dynamics for raw materials and costs, including transportation. We implement price increases usually between the third and fourth weeks of January to ensure our pricing supports our target margins based on cost dynamics for the year. This is generally a yearly decision aimed at maintaining our margins throughout the year. However, we've been facing inflationary pressures that are greater than usual for certain months, particularly related to energy costs driven by the situation in Ukraine. Therefore, we continuously review our pricing throughout the year to safeguard our desired margins. While this can't be done every day due to our relationships with partners and clients, we aim to make adjustments a couple of times annually. It's important to note that any pricing decisions made will only impact revenue 2 to 3 months later due to the order fulfillment and revenue recognition timeline. Therefore, we strive for a careful balance to protect our margins and remain cautious with pricing. We closely monitor material cost dynamics, and if inflation remains stable and reasonable, it should sufficiently protect our margins. Nonetheless, the situation has been notably volatile in recent months.

And then, yes, I'm sorry, I believe you're going to address...

Yes, we'll get there too. I think it's good to use this discussion to provide full transparency on our operating model. A second element which caught my attention and that we are acting on is the use of discounts. Given a certain price list, typically, the industry invests in selling discounts, or specific privileged conditions you recognize to your wholesale partners, and sales discounts which are basically the discounts you give at the retail level to your end customer. This has historically been significant for the industry and has been particularly impactful for Natuzzi, which is another way to protect marginality by acting on this. We are reviewing the types of discounts that are allowed and improving our control over these because they are also a way to maintain margin, not only through the listing price but also through the management of commercial discounts and privileged conditions. Sorry, Dave, you were further articulating your question.

Yes. So the second part of it was the investments that you're making in the modernization of your factory for the purpose of gaining cost benefits and efficiencies. When would we start to realize those benefits?

So while pricing is, as you can imagine, more of an immediate decision, capturing the benefits requires two elements: one, investment in the factories, and two, training of our team to work in a different way. We started this pilot called 4.0 back in December 2021, so we are about 5 months in, and it is progressing extremely well. It's based on three concepts: first is simplification of the assortment, second is managing them through our Lean process, which is a kind of continuous flow, and third is integration of the suppliers, which are processes that are quite new to this specific industry while they may be standard for the automotive industry. The pilot is progressing well and delivering results above our internal expectations. This is becoming the new blueprint, a new standard for the new factory we will develop and for the investment we are making to modernize the existing factory. Starting from the second part of this year, we will begin acting on our Italian factory, where the cost of labor is higher and where the benefits of this new technology are expected to be more significant. We anticipate this will contribute to better quality for our clients and importantly reduce production costs.

Can you provide some details on how these improvements will impact margin and what the return on investment is for any capital equipment purchases?

Yes. So we're looking at potentially high single-digit margin improvements in terms of production costs. So I would say this is significant, especially for our industry where the industrial margins are not, let's say, infinite. So it can represent a significant improvement. In terms of timing for investment, this will take place between the second half of this year and next year, with the bulk of the investment occurring in the Italian plants. We also find the ROI attractive compared to the capital use we want to pursue, so it should be a good way to invest the company's resources.

Could you provide an update on the expansion of your North American footprint and the plan to open about 10 direct-operated stores each year? This was a key reason for our interest in your business due to the shift towards higher-margin branded products, which exceed 70%. I haven't heard any recent updates on this. Can you confirm if we are still on track to open around 10 stores annually in North America? Additionally, are there any opportunities in Western Europe or other regions that you could discuss?

Great. So, I’ll kick off with North America. You can see that we did open 2 stores in the first quarter and we expect to be on track to open approximately 10 stores this year by year's end. We are still committed to that growth target of around 10 stores in North America each year.

Great. And then Antonio, can you talk about Western Europe? Is there an opportunity to increase your DOS footprint there?

So, I would say there’s definitely an opportunity to increase both DOS and FOS in the U.K., which is a market where we already have a good established operational base regarding store and brand awareness. There is clearly an opportunity in Spain, where we have team members and 11 stores, along with good brand recognition. I was yesterday in France, and we previously had a strong presence in terms of distribution. Now, we are down to one store, which we are renovating, and we are exploring a way to regain presence. The company distributes well in under-markets. So while there are opportunities beyond the U.S., U.K., and Spain, we need to be focused. My view is that especially in retail, you need to be strong locally to be strong globally. I don't suggest that the company should become scattered, having one store here and another there, as it becomes difficult to manage them, attract talent, and see a return on marketing investments. Therefore, we look at individual geographies in Europe to do this. For franchising, we have opportunities we are capturing. We have just opened a new store in Vienna, in the real center of Vienna, which is a franchising partnership willing to open 10-15 stores in that area. Our franchising model is very attractive. Beyond the U.S., we see franchising in Europe and emerging markets as quite promising. Since, unlike North America and Asia, there's still a significant number of traditional mom-and-pop retail stores; as the industry modernizes, they see in our franchising a perfect plug-and-play business to replace their traditional stores, which are becoming difficult to manage with inflation and supply chain issues.

Okay. That makes sense. I understand wanting to have density in certain markets so that you can make those investments and scale them. So the next question, and then I'm going to turn it over to anyone that is in queue. I don’t want to overwhelm everyone on the call. In the past, we've regarded the China JV as 'a hidden asset.' I’m estimating it has probably a worth of almost $10 per share or more, plus the real estate, yet our stock is not getting credit for it. To me, the core business is trading for zero value. Can you give us an update on your efforts or any initiatives underway to unlock that value for shareholders on the China JV? You don’t have to discuss Vietnam or Singapore, where they are much smaller, but just specifically, China.

Yes. So the discussions we are having with the Board on options to create more value for the joint venture are significant. KUKA, which is listed in Shanghai, and Natuzzi is increasingly focusing board by board. This is becoming more central. I can specifically mention we have agreed on some actions regarding cash reduction and distribution to partners, and also further recognition of some value that Natuzzi is contributing in terms of R&D investment for the joint venture. Those discussions have been agreed upon, but I cannot provide specific individual amounts at this time; it’s an initial step in that direction. Is this the full potential of China for us? The answer is no. As I've mentioned, there are alternatives we are discussing internally with Pasquale Natuzzi, the Chairman, which could include a potential IPO of the Chinese operation, but initial discussions are still in a premature phase. So it's not something that will happen in the next few months, but that option is definitely on the table.

If there are no further questions, I would like to hand it back to management for any additional comments or closing remarks. There are no further questions.

Okay. You have the press release. We believe we are looking at a quarter that represents a positive step towards achieving our plan focused on brand growth, retail enhancement, targeted geographical expansion, and factory modernization. We noted in our press release that China is in lockdown, which is impacting our factories. The good news is that at the beginning of June, authorities confirmed we can return to operating 80% of our total workforce in the factory, which is encouraging. As I mentioned, we are continuing to invest to ensure we meet our top-line expectations for retail and wholesale in a market where consumers seem more cautious. This summarizes our position. I hope to stay connected with you. We are investing further to make our press release clearer. We have also included a session outlining our revenue by geography and the associated growth. We welcome any additional questions offline to Piero. I'm not sure if Pasquale or the Chairman would like to make any final comments beyond what I just shared.

You covered everything. You are fantastic.

Thank you, Mr. Chairman.

Not on my side.

Thank you. At this time, that does conclude today's teleconference and webcast. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.

Thank you.

Thank you. Thank you, everyone.