Natuzzi S P A Q4 FY2022 Earnings Call

Thank you, Kevin. Good day to everyone. Thank you for joining Natuzzi's conference call for the fourth quarter and full-year 2022 financial results. 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 United States Securities and Exchange Commission 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 and Kevin, for the kind introduction. Good morning and good afternoon to all the attendees of this 2022 fourth quarter and fiscal year press release. I would like to start with an overview of how 2022 closed for us. Then, I will let Carlo Silvestri, who has been announced already joining our group from Ferragamo, our new CFO, to comment more specifically on figures regarding the fourth quarter and fiscal year. So, we closed 2022 internal revenue at €468 million, which is 10% more than last year and some 20% more than 2019. If we go back to 2020, that is an increase of 40%. So we added €140 million business from 2020, which was clearly affected by COVID. So I would say high single-digit top line increase. This can also, in parallel, continue working on gross margin. As you may remember, 2022 was dominated by a strong inflection in general cost and raw materials. We were working to protect our marginality, which is currently 5 percentage points above what it was in 2019. So we were able to protect and expand our marginality. In terms of EBITDA, in terms of operating profit, that resulted in €8.4 million, which could have been a higher figure, could have been close to €13 million if we didn't have to do accrual for very specific one-off elements which will be commented by Carlo later in this section. So, in general, the trajectory is going north on the two fundamental elements that we have in our long-term plan, which are top-line growth and margin and profitability expansion. At the same time, as a proxy of value creation, we expanded our cash flow from operations, which was close to €19 million in 2022. That figure compared to €0.5 million in 2021 and €4.7 million in 2019. So again, through discipline, we're trying to have also time on working capital even though, as our business has been growing, we've been able to enhance the cash flow generation from operations. Our cash position was pretty much the same as the previous year, so we are dealing with €54.5 million in terms of cash, which is significantly higher than what we need from operations. I also remind you that we don't have long-term debt. So in a situation of uncertainty like the one we are all facing in the industry, I believe that should convey a positive message to the investors. Looking a bit more at the quality of what we have done, I am pleased to report that we are continuing executing the journey initiated by Pasquale Natuzzi of transforming the company into a brand retailer. We set some long-term targets to measure that trajectory, and I was surprised to anticipate that some of those targets were reached ahead of our plan. For instance, in 2022, 92% of our total sales came from branded products compared to 89% the previous year. That is a significant transformation because Natuzzi originally started more as an operator and manufacturer, and the percentage of branded products was not dominant. We set ourselves a target to reach a majority of sales generated by branded products, and we are ahead of that target. If we measure our brand's strength in the eyes of the consumer, which means measuring it at sell-out, the brand is an €830 million brand. If we consider what we do in terms of the retail multiplier, the brand is on pace to become a €1 billion retail brand. This is a useful figure to compare with players in the industry that are pure retailers. The other division we are working on is continuously working on retail. Retail for us is an objective to accelerate growth, expand marginality, and have better control of the brand. Jason, do you want to mute because we're hearing your message coming in? If you can kindly mute, thank you. So, at the end of 2022, the percentage of total sales done through retail, either directly or through franchising, was 61% compared to 53% of the previous year. We are well on track with our objective to complete our retail transformation. We surpassed 700 freestanding stores carrying either Natuzzi Italia or Natuzzi Editions. I believe with this global coverage, this is one of the highest figures in terms of the number of stores distributing a single brand in the industry. Much of the work we are currently doing is to organically expand the performance of these stores. We continue seeking opportunities to expand our network, and I will discuss our plans for accelerating the opening of additional stores directly operating in the US. Recognizing that one of the less capital-intensive opportunities we have to grow the top line is to make those 700 stores perform better in terms of sales per square meter and marginality. We are currently putting in considerable effort into this organization, which led us to create a new division aiming to establish a common methodology that can become a competitive asset for our directly operated stores and those operated by our franchisees. I'm happy to report that we continue strengthening our team. Carlo has been long-awaited and announced in a separate press release. We recently brought on another senior executive, Scott Kruger, who is now in charge of the wholesale business in North America. North America is a special market because distribution is still a relevant part. Natuzzi is one of the most recognized brands in that channel, actually first in internal brand awareness among European brands. We see a parallel opportunity as we build the retail to continue serving that market. We realized we wanted to change gear, so there has been a change in leadership. We also recognized we want to increase our representation across the states, and we are onboarding agencies with very positive results. These are not exclusive agencies, but they will bring among their lines also Natuzzi. I was in the US very recently, two weeks ago, and I was particularly pleased to see how well this opportunity is received by top agencies. I definitely see opportunities to create business in their accounts with Natuzzi, which is a very well-respected and inspirational brand for the large retail in the US. So that is another area where we're working. I believe that you, as we are, are interested in the future. The future remains, I would say, difficult to read. As you know, we are clearly in the durable furniture industry, entering a transitional phase after two years dominated by booming demand and difficulties in fulfilling that demand. The wind changed to headwinds mid-2022. We don't see yet a clear change in trajectory; in the sense that demand remains weaker than it used to be in the previous year, both at wholesale and in terms of traffic in our stores. Looking at the first weeks of the year, we do see encouraging signs in a few geographies, like China, especially for our Natuzzi Editions business, which has returned to growth, and also in the US, especially for Natuzzi Editions. So we are cautiously optimistic that the bottom has been reached, and we can hopefully see a recovery in demand. That is our hope, but at the same time, we are planning and acting as if this negative phase of the economy should last. What does that mean? We are very cautious about spending SG&A and our cash position. Regarding the cash position, we continue actively seeking opportunities to sell non-strategic assets chiefly in the US and in Italy. We are actively working on those assets, and I hope that in the coming conversations, we can report some positive outcomes in that sense. Let me stop here for a more general overview of what has been so far and also our mindset. Our mindset is reflected in our long-term plan, which is to exploit the potential of this brand and group, continuing the growth of both the brand and achieving that through retail. So our long-term plan has not changed, and we have the highest confidence that we can achieve it. At the same time, we must recognize that for the industry, the shift has been pretty brutal, and we are managing our group to ensure we navigate these negative circumstances without affecting our overall goals contained in our internal strategic midterm plan.

Thank you, Antonio. Good day, ladies and gentlemen. Let me first briefly introduce myself since this is my first conference call with the Natuzzi group. Before doing that, allow me to thank Mr. Natuzzi and Antonio for this incredible exciting opportunity and my team for the great support I’ve received so far. Now, going back to the figures after the closing comments from Antonio, I will start with an overview of the 2022 fiscal year with some hints for the fourth quarter. In 2022, total revenues were at €468.5 million, up by 9.6% versus 2021 and by 21.1% versus the pre-pandemic 2019. During the year, we were also able to recover from the major supply chain disruption of January 2021, and gradually we benefited from the reduction of our order backlog. Talking specifically about the gross margin, we achieved 35.1% versus 36% in 2021 and 29.7% in 2019. As a reminder, in 2022, our industrial operations were deeply affected by both spike in energy costs and the inflationary environment. Together, the company decided to protect the margin, and during the year, we applied price increases all over the world. This was fully effective only in the last part of the year, where we did achieve in the last quarter a margin of 37% compared to the yearly 35.1%. Talking about the cost of sales, it is important as Antonio was mentioning that we recorded a €2.2 million accrual not related to our core operation but related to the labor costs for restructuring our Italian operations. If we exclude these from the fourth quarter of 2022 when it was recorded, the gross margin for the last quarter would have been 38.8%. Operating expenses that, as Antonio was mentioning, are always a focus for the company to find efficiencies, including selling and administrative expenses, impacted 33.3% on our revenues compared to 34.8% in 2021 and 35.5%. Regarding detailed expenses, it is important to underline that we see a decrease in the impact of transportation cost over total sales, now impacting 11.9% versus 12.8% in 2021. Talking about FX, although it was not related to our core business, we recorded two main factors. The first one is a cost of labor related to our stock option plan for €1 million, and the other one is a €1 million contingency for a legal dispute over a land in Brazil. Therefore, the operating profit in 2022 landed at €8.4 million compared to €4.9 million in 2021 and versus an operating loss of €22.5 million in 2019. Excluding these non-core business phenomena, we would now compare a €12.9 million operating profit equivalent to 2.7% of revenues versus 5.8% in 2021. The spike in interest provoked an increase in our finance cost, which landed at €8.5 million versus €6.8 million in 2021. It is essential to also underline that within these €8.5 million, there are €2.8 million related to the rental contract and the application of IFRS 16. The last quarter was impacted by the FX effect. We did not change our strategy practices and hedging techniques just due to the reversal of the euro, US depreciation, and we recorded a €2.4 million loss in the last quarter. But over the year, we achieved a €2.4 million positive result. Talking precisely about our joint venture in China, the difficult business remained over the year, and in the end, the significant slowdown in activities resulted in our profit dropping to €400,000. I would just remind you that we own a 49% stake in our joint venture. In 2021, we recorded a profit of €3.6 million. Nevertheless, talking about the joint venture, it is crucial to highlight that, even in this challenging year, we remained profitable. Making a last reference to Antonio's comments, cash for us is extremely important. We maintained our cash position at €54 million, which is vital to underscore that our operations were able to achieve a positive cash flow of €18.7 million that we did invest €9 million in capital expenditure and in repayment of a long-term loan. This is overall the picture of our performance in 2022, and I would like now to give room to the Q&A session.

So I guess I'd like to call out what I would call the encouraging signs. If we add back the nonrecurring item, the labor costs that affected gross margin, we would have been nearly 39%. And then there were some nonrecurring items, extraordinary items in the OpEx line whereby we would have had a significant operating profit. So I'd like to just call that out. What's exciting is as we grow and scale the business, we see significant leverage in the financial model. Now that being said, it would have been nice just to show after all of these items have bigger profits, but it is encouraging. So in the past, you guys have called out backlog in written orders. We know that traffic is down at the retail level. Could you give us some sense of where backlog is currently? I believe last quarter, I'm going by memory, it was around $80 million. And then also what type of declines are we seeing in written orders given the weaker housing market economic backdrop?

So thank you for your question. I might take this one. The reason we are putting a lot of emphasis in the past on the backlog is that it was a main obstacle for us to deliver the revenue we could have delivered; and second, because it was becoming a visible barrier to maintaining the level of service to our clients we aspire to. The backlog has now returned to what can be defined as a physiological level, which is around €60 million, which is what we typically need to do proper planning of the factories. In terms of written orders, the year, as I mentioned in my press release, started at a level below our expectations. What is somewhat positive is that if you read these first 14 weeks, dividing by two, the last seven weeks saw a relatively stronger turn versus the previous one. But clearly, we are facing a level that is not in line with what we want to have and aspire to have, especially in light of our production capacity. I will just remind you that Natuzzi Italia is produced globally in Italy where we have a significant workforce and substantial production capacity with five factories. Especially for Natuzzi Italia, the level of orders we are receiving does not allow us to fully occupy those factories. That is the main element we are working to improve, both as a combination of opportunities to sustain our growth ambitions and also as a need to keep our factories busy at a reasonable level. So that's a bit of a long answer. Inventory is back to standard levels. I don't have the figure in front of me, but it's around €55 million to €60 million. When talking about pace of orders, as I mentioned before, we remain below expectations, and it's a different situation among regions. We have China, which is operating mostly through franchising, where we see a recovery of the Natuzzi Editions business, while Natuzzi Italia is quite stalled there, and the recovery is slower. Natuzzi Editions North America is above budget but below last year. Europe presents a more mixed picture overall. I believe Europe is currently the continent that is more difficult to predict because its economic environment continues to struggle to find a way out of the recent challenging months. I think we will see the first recovery coming from the US, while China's situation is a combination of market conditions and the actions we are taking. I think turning points for Western Europe are less predictable in terms of timing.

Okay. To summarize, the significant improvement in gross margins is driven by a shift towards higher-margin branded products instead of wholesale. Previously, you mentioned plans to open 10 direct-owned stores in the US, which would support further growth in direct ownership and positively impact the profit and loss statement through higher-margin offerings. You have also discussed Factory 4.0. I noticed in your press release a delay in some planned investments for Factory 4.0, which I believed were supposed to enhance gross margins, as well as a reduction in the number of store openings in North America from 10 to six. I would suggest considering accelerating these efforts. While I understand the focus on conserving cash, divesting non-core assets and real estate could speed up the transition to higher-margin products and improve efficiency in the factory. During this economic downturn, we could take strategic steps to achieve better long-term operating results compared to Q4. I would appreciate your thoughts on this. If these investments are expected to improve operating profit, why would we be holding off?

No. Strategically, we fully align with the Board and the Chairman. We are committed to our retail strategy in 2023. We have confirmed six significant openings, including a flagship location of 10,000 square feet in the Golden Mile near downtown, as well as locations in Atlanta, San Diego, and the first for Natuzzi Editions. We are maintaining our pace while addressing the constraints you mentioned. One approach to tackle these financial limitations is through the sale of non-strategic assets, with the largest asset currently in focus. We are actively working on that. While I can't provide exact details yet, I hope to share positive news soon. Given the high-interest rates, selling real estate is challenging since the loan-to-value for buyers isn't favorable. However, due to our determination, this capital could be reinvested to enhance factory efficiency and open more U.S. locations. We remain focused on our strategy and are in the process of finalizing our plans to achieve these goals.

Okay. So you're reiterating those plans to continue with Factory 4.0 and to continue to open branded DOS stores in North America then?

Correct. I don't know, Jason, if you want to make any comments. And again, I think as I mentioned before, it is a dual strategy when it comes to retail because, yes, we want to open new stores. But we also want to increase like-for-like sales because we see that among our 52 directly operated stores, there is still a significant variation in performance. Some of those variations are justified by structural elements. The company has been opening stores for several years. Some locations may have initially seemed ideal but may not be now. Other factors are structural. Nevertheless, we want to improve the productivity of our stores. Therefore, when we discuss retail, the goal is new openings and enhancing the productivity of existing stores. That will help facilitate new openings given the current economics, which are attractive. By the way, if any investors want to open a franchise, you’re welcome. One of our stores typically has a payback in 16 to 18 months, and then it starts generating double-digit EBITDA. Working on organic improvement will also shorten the payback of those investments. We're also focusing on that as a way to encourage additional franchisee partners. So, Jason, do you want to provide any input on the US retail outlook?

Sure, I'd be happy to, Dave. First, looking forward, as the release suggested, we've got six DOS planned for this year, all of which will be Natuzzi Italia, adding volume to our flagship factory in Italy, plus various facilities across the US, mostly Natuzzi Editions. So, a total of nine openings projected in the US for the year. I would say that as we look at our like-for-like performance, we finished 2022 flat compared to 2021 from a like-for-like retail performance. Obviously, a stronger start to the year and a slower finish, but what’s important is that when we assess our current pace of business over the last three to six months, those like-for-like stores are still up between 40% and 50% compared to 2019. So while many retail businesses have reset down to levels closer to 2019, our like-for-like performance has been reset to a much higher average. This gives us confidence in the future strength of our growth as we open new units.

Okay. I appreciate you calling out the focus on organic growth or same-store sales, and that's the critical metric. A couple more questions, and I'll go back to the queue.

So David, sorry to interrupt you. To provide some context, in stores where we change the team leader and manage our levers more accurately, the results are amazing. For example, consider two stores. One is Westfield, a Natuzzi Italia location in London in a high-end retail park. This store is performing 68% better than last year. It was already a strong period historically, and it's significantly exceeding our internal budget. This success is due to the team change. Madison is another example; despite its iconic location, it had not been as productive in sales as we wanted. With a new team and focused management, Madison is now one of the top-performing stores in the US. This shows why we focus on improving performance in existing stores while also expanding our footprint. Achieving this would address many of our goals. Sorry, Dave. I hope I didn’t frustrate you by interrupting.

No, no, I appreciate that context. I mean, that's actually been my belief and assumption that there is a tremendous opportunity to increase average unit volume when I compare you to your peers. So I appreciate that call out. So, just two more quick questions. How much cash is in the China joint venture? That’s the first one.

Just a clarification, and then I'll let Carlo answer. The joint venture, as part of a listed company, can report the last certified figure, which was reported in the 20th. So please, Carlo and Piero, share the figure.

So the joint venture reported €33 million in terms of cash. This has been the result of sales, dividend distribution, and capital reduction against the last part of the year, an increase in the purchase of stock, the joint venture, and a decrease in orders. Those are the results, but we still have €33 million.

Okay. When you say €33 million, is that the total, and our portion is roughly half of that? Or are you saying after 49% it’s €33 million?

It's the total, but these are referring to un-audited numbers that are not published by the joint venture.

Okay. And then it's the total, but these are referring to un-audited numbers that are not published by the joint venture.

Just for clarification, it’s crucial. By looking at the total active balance sheet of the joint venture, you'll find that between fixed assets and cash, the total hasn't changed significantly. The distribution method changed, leading to a reduced cash amount in favor of inventory investment. Therefore, there has not been a cash loss but a change in how we utilized that cash.

I understand. If you could take a stab at gross margin post-Factory 4.0, I know we've deferred or postponed some of those investments, but I'm thinking longer-term, one or two years out. It seems we could get to a low 40%, maybe 42% type of gross margin. What would the impact be if we fully deployed Factory 4.0 at the current revenue run rate? Would we reach the low 40s or not quite yet?

I can answer this in a more elaborate way, but it’s a complex reality. We have four primary production areas that are directly operated: Italy, Romania, Shanghai in China, and Salvador de Bahia. Each of these production facilities has very different production costs based on labor cost, efficiency, utilization of the factory, and material costs dependent on production locations. Additionally, we plan to outsource from Vietnam, which has strong duty advantages for US servicing. The first way to reduce production costs and improve margins is optimizing our production locations. For example, moving a production unit from China to Vietnam results in an average of 15 to 18 percentage points in margin improvement, primarily due to labor cost and duties. Thus, production location optimization significantly contributes to our margin enhancement. For Natuzzi Italia, produced entirely in Italy, we are deploying Factory 4.0 technology in that production segment. However, I don’t have a precise figure for short-term expectations. Clearly, the 4.0 initiative proved beneficial during our pilot projects. It’s vital now to maintain adequate factory utilization since factories carry fixed costs. To maximize benefits from Factory 4.0, we must ensure the factories operate at optimal levels. A good level of utilization for us means over 85% in utilization to minimize production costs. If we were in a situation of full factory utilization like last year, Factory 4.0 would have provided incremental benefits as stated earlier, leading us to accelerate investment. Currently, the focus lies on commercial strategies to regain growth momentum, which is essential for fulfilling factory capacity.

Yes. Okay. I really don't have any more questions. I'm just going to make a comment: I think we're in agreement here, but you pointed out that there's an opportunity to grow same-store sales in your direct-operated stores. I would encourage you to be even more aggressive during this economic soft patch. Ultimately, as you said, you have more control. You don't have as much control with a third-party retailer selling Natuzzi products, whereas you can better train your people and align them to affect same-store growth. And we know, as you said, having factories at fuller capacity improves gross margins. Selling branded products is likely in the mid-70% gross profit range, so I would encourage you guys again to be offensive and accelerate the deployment of stores in North America. That's all I have, guys. I'm encouraged by the operating profit, excluding the one-time items. I'm sure come the end of the year, we'll be examining a better economic backdrop. Thank you.

Thank you, Dave. Also, I appreciate your ongoing dialogue. It's highly supportive for us to prioritize our strategies. Your investment in our company gives you the perspective to understand our trajectory and challenges well. Your contributions are particularly valuable to us.

Thank you. There are no further questions at this time. I will now turn the floor back over to management for any final or closing comments.

Thank you for all your attention. As mentioned before, we will focus on our priorities. I must say our team is very cohesive. We are aware of headwinds in the market. We're not alone; we're placing particular emphasis on our fundamental cash position to ensure we can navigate this turbulent time without compromising our long-term objectives. I look forward to reconnecting with you either through individual conversations for more insights or in our next press release for the first quarter of 2023. From my side, thank you. I don't know if Pasquale wants to provide any final words.

Antonio, you did a good job, and Carlo. Thank you very much. The speech was very well done. Thank you very much to our shareholders. We are all committed to overcoming any difficulties as much as we can. Thank you again.

Thank you again.

Thank you very much.

That does conclude today's webcast. You may disconnect your lines at this time, and have a wonderful day. We thank you for your participation today.