Natuzzi S P A Q2 FY2023 Earnings Call

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Natuzzi 2023 Second Quarter and First Half Financial Results Conference Call. As a reminder, anyone who would like to join this conference via telephone may do so by dialing +1-412-717-9633, then passcode 39252103#. In addition to the link already provided to join via video. As a reminder, if you’d like to join via telephone it’s +1-412-717-9633, then passcode 39252103#, in addition to the link already provided. At this time, all participants are in a listen-only mode. Following the introduction, we'll conduct a question-and-answer session, and instructions will be provided at that time to queue up for questions. Joining us on today's call are Mr. Antonio Achille, Natuzzi's Chief Executive Officer; Mr. Carlo Silvestri, Chief Financial Officer of the Natuzzi Group; Mr. Pasquale Natuzzi, Founder and Executive Chairman; Mr. Jason Camp, Senior Vice President of Retail for North American Market; and Piero Direnzo, Investor Relations. As a reminder, today's call is being recorded. I'd now like to turn the conference call over to Piero. Please go ahead.

Thank you, Kevin, and good day to everyone. Thank you for joining Natuzzi's conference call for the 2023 second quarter and first half 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 might 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 thank you, everyone, for joining our second quarter press release on 2023 results. Let me start by providing some facts about the market. I believe that the fact that most analysts in our sector still refer to 2019 to compare 2023 data speaks for itself. We've been through an unprecedented cycle that brought the sector from potentially one of the most positive moments in its dynamics to a very difficult situation. If we look at what's happening around the globe in the real estate market, we do see signs of continuing uncertainty. I believe everyone has read with interest the news about the CEO of Evergrande being put under physical restrictions. We see that the continuing tension on the debt side because of high interest limits the purchase of new houses, which is a primary driver for the industry. I want to share these elements to put into perspective our 2023 second quarter performances. As you have seen by now, unfortunately, our top line has been suffering versus 2022, quite seriously, in terms of decrease and also in terms of sales. Total sales are below 2019. It's still important to note that if we look at the branded invoice sales, which is in a sense the strategic direction the company is heading to, the sales are above 2019, approximately 5% above 2019. Currently, our business is composed of more than 90% brand sales, which means sales done under the name of Natuzzi Italia or Natuzzi Edition, which are our dominant brands. This is important to us because we have made it clear in our long-term strategy that we are here to fully leverage the strengths of our brands and act in higher price point segments of the market. Another element that is important to share is that despite the very low sales, we have been working to compensate at the gross margin level for the tensions on production costs, which have necessarily been higher because of lower utilization of our factory. As you know, Natuzzi is vertically integrated, which means we have fixed costs not only in retail but also in the factories. Despite the non-saturation of our factory, we achieved a 36.4% gross margin compared to 31.4% in 2022. When looking at a normalized year, we were at 27.8% in 2019, so versus 2019, the company increased by 9% in gross margin despite the impact on production costs of reduced sales volumes. How this has been achieved? This has been achieved through better discipline in terms of pricing and better cost management. In 2023, we didn't implement any price increases. The last price increase was put in place in June 2022 for the U.S. market, so it's been almost a year without any price increases. However, what we did, especially in 2022, was to carefully review all our pricing to ensure there were no situations where a specific market or specific partner benefited from price conditions that didn’t allow us adequate margins. In terms of costs, we, of course, made considerable efforts to contain the costs of our raw materials and their utilization. I remind you that gross margin does not include the cost of transportation, which has been deflationary this year. However, in this gross margin, we don't take advantage of that. This allows us to achieve operating breakeven in the second quarter of 2023. It's important to note that this compares with a loss of nearly EUR8 million in 2019 with a sales base that was about EUR10 million higher than in 2023. What does this mean? It means that by diligently working on our cost structure, we lowered the breakeven to EUR20 million less in sales per year, which, as you will see, is a kind of underlying theme of this press release. To be explicit about this journey, while our sales are below aspirations due to market conditions, we are trying to accelerate the optimization of our operational machine so to extract more value, more cash when, as I’m sure growth will come back. Let's look at cash. Cash at the end of the period, in June 2023, was EUR44.5 million, compared to EUR54.5 million at the end of 2022. Here, despite the challenging year, we continued investing in critical areas. We invested EUR10.6 million, of which EUR5.3 million went to optimize the Italian factory and EUR2 million to open direct stores. Operating activities were positive despite the lower level of sales at EUR1.6 million. As you can understand by now, we do not anticipate a quick turnaround in the market cycle, at least by the end of the year. In this market context, we believe that cost and capital efficiency are of paramount importance. For this reason, we launched a set of initiatives to reduce costs and improve working capital discipline, which Carlo will comment on later in more detail; this includes optimization of our SG&A structure to be more agile. It's important to remind that since 2021, we have been undergoing a silent restructuring despite operating in a highly unionized country like Italy, we have already reduced our overall workforce by 577 units, including both our headquarters and factories, and we will continue in this direction. To streamline and make our organization more agile, we are also simplifying and streamlining our operations. This starts from the collection; we have this philosophy of fewer but bolder product launches in the market rather than operating with several launches, which was the company's approach when distribution was primarily wholesale. In terms of growth, our priority remains organic growth. One distinctive asset for the company is the addition of 700 stores. We believe that this is the foundation for our strategy because if we make these stores more productive, we will gain more sales momentum and better utilize the investments we have made directly as well as those made by our partners. Out of these 700 stores, approximately one-half are located in China, and I will expand on China later. So what are we doing to improve retail? We are enhancing our talent pool. We have built a central retail division that captures best practices from individual markets like the U.S. and develops them. We also invested in improved IT systems that help us to closely monitor retail performance, which is now the standard we use to engage in discussions with store management, and then up to the country manager level. We want to excel in retail management to be a credible partner to our franchisees. As you know, about 600 out of 700 stores are operated by franchisees. Clearly, that is where we expect the benefits to come from as well. Every effort we make in our directly operated stores ultimately aims to become a credible partner for our dealers, enhancing their own performance. To support organic growth, we also strengthened our marketing team. We hired a retained individual, Daniele Tranchini, who has significant experience from senior agency positions, including Walter Thompson and Publicis. He is already making a considerable difference in shaping our unique story across different markets. Regarding two important geographies: the first one is China. As you all know, especially the investors and analysts who follow us, we are in a joint venture with Kuka. We don't consolidate line by line because we own 49%. However, our aspiration is not to consider China as merely a financial investment but as part of our operations to ensure that China benefits from our experiences, especially in managing brands effectively. Since the start of my tenure, travel to China has been nearly impossible for the last three years. However, we have visited China twice since May last year for extended periods, including two weeks with significant members of the organization, including our Chief Brand Officer and our Chairman, Pasquale. I have taken full responsibility to support our China operations in partnership with our joint venture. In China, the dynamics have drastically changed not just in the furniture sector but across the board. I've mentioned the complications surrounding Evergrande, which was the market leader in real estate, and has experienced a 90% drop in market cap, facing severe challenges. We have worked to strengthen relationships with our joint venture team to ensure they benefit from our brand, merchandising, and retail knowledge. According to our Board, I am planning to return to China in the next few weeks for at least two to three weeks to support this process. In the U.S., our second important market is positioned as our potentially largest single opportunity and has been central to the story of the success of this group. We believe it can return to being as significant as it has been. To ensure we are closer to our business, we are focusing on two channels with skilled managers. I already mentioned in the last press release that we were excited to have Scott Kruger join us to lead the wholesale and gallery business, which continues to dominate our total business in North America. Jason is well known for his retail capabilities, and he is focusing entirely on retail, where the future growth lies, particularly for Natuzzi Italia. To ensure that the services provided to these two business units are optimized, we have asked a senior manager from the group, Ottavio Milano, to oversee functions such as finance, customer care, and HR to create streamlined and more agile services for Scott Kruger and Jason Camp. They remain in charge of running and building the business. In closing, even in a year that has proven challenging, we have not slowed down on new openings. We have opened seven new stores, six of which are Natuzzi Italia located in prime positions for our city development strategy, including San Diego, Miami, Fort Worth, Manhasset, Atlanta, and Houston. Additionally, we opened one Natuzzi Editions in Frisco. Our brand, especially Natuzzi Italia, has elevated along with our retail initiatives. We are seeking flagship locations that serve as strong representations of our brand. If you have the chance, I encourage you to visit our new European Store in Manhasset, a great example of our strategy, located on Miracle Mile. The store is 10,000 square feet over two floors, featuring signature architecture and design, reflecting the quality we aspire for from our locations. In conclusion, it's evident that the current situation is unlikely to change in the near future. We view the circumstances as persisting until year-end, and potentially extending into the beginning of next year. Our strategic direction is clearer than ever. We aim to invest in our brand with a focus on organic growth and retail in our core markets: China, the U.S., and in Europe, particularly Italy and the U.K. At the same time, we want to continue and accelerate efforts to reduce costs and enhance our organization’s agility. Although we typically do not provide guidance, I want to express our confidence in the strength of our brand and our long-term growth potential. We represent a brand with over 60 years of heritage, which is a significant asset that cannot be replicated. We believe this is crucial and will be a key factor in achieving our mid-term objectives. With that said, I'll stop here and open it up for questions regarding this initial strategic introduction.

Thank you. Your line is now live.

Good morning. David Kanen, thank you for taking my questions. Are you able to hear me clearly?

We do. At least I do.

So I guess at a high level, the call-out here is at EUR83 million in revenue, we were actually operating profit neutral and generated a little bit of cash, which is impressive given the cost containment, the increase in gross margin and then the prospects for the future. So that being said, I'd like to understand or drill down a little deeper on the new branded stores, the direct operated stores that you've been opening. My question is for Jason. When you look at all of these new stores you've opened: Atlanta, Manhasset, Long Island, Houston, Fort Worth, et cetera. Can you give me a sense as to what those stores will run rate in annual revenue, Jason?

Dave, good morning. Listen, three of those openings have occurred in the last 45 days. I think it's premature to predict an annual run rate on these openings. But based on the quality of traffic we're seeing, we expect these stores to perform above our network average for Natuzzi Italia.

Okay. And just as a reference point, Jason, what is the network average?

Just shy of about 3 per unit.

Okay. So these new stores should be your internal plan, is it EUR4 million plus or is it closer to slightly above EUR3 million?

We're watching these new locations closely and will align on budgets per location as we get closer to year-end. For public consumption purposes, I think I have already said as much as I can.

Okay. So it seems clear to me that given the production per location and the high marginality, it's critical. And I've had these conversations before and I know that you acquiesce to them. But it seems critical that we open up more direct-operated stores. Can you provide an update? I know that we need to preserve our balance sheet, but at the same time, opening these DOS stores puts us in a position over the next two years to get revenue back over EUR100 million per quarter, where it seems we could generate meaningful operating profit. So Antonio, my question is: we've had a non-core asset in North Carolina that has meaningful value that could potentially subsidize the net 10 stores, if not more than that. Can you provide an update on that and just reiterate that this is a top priority to open these DOS stores, hopefully getting to 15 or 20 additional in the next two years?

Thank you, Dave, for the question. I'll answer in two sentences. We confirm that opening in the U.S. for Natuzzi Italia is a strategic priority. We are discussing this in the context of our 2024 budget, which includes the necessary investment statements. However, the principle is to safeguard this intent. Regarding the dismissal of non-strategic assets, we have made some progress. We are considering options; I cannot provide further details, but there has been positive evolution. We hope to have news on that front, which, I remind you, is a decision for our Board since it exceeds my autonomy. We have been diligent with all assets we see as relevant including our non-core assets in Italy and High Point in North America. We have made progress with offers for these assets, which are pending final due diligence or approvals from our Board. We are not dormant on this aspect.

Thank you for that update. My perspective, while I don't have a crystal ball, is that there’s a high likelihood that interest rates will need to be lowered during 2024, possibly even in the first quarter. At that time, we may see mortgage rates decrease, which has a strong correlation with housing demand and, consequently, furniture sales, putting us in a position to grow organically. I would like to see more stores opened by the end of 2024, enabling us to start doing EUR90-100 million per quarter, generating significant profitability given your leaner structure and higher gross margin profile. I just wanted to reiterate that I hope you all keep an aggressive stance on expanding these promising markets in North America.

Apologies for interrupting, David, but given your points, I want to emphasize that we want to have sufficient expertise in our organization. We aim for Jason to focus entirely on business development so that he can operate without being burdened by operational concerns. We plan to expand our network. Unfortunately, there are significant changes in the U.S. landscape affecting many brands, and some companies that were once thriving are at risk of exiting the market. For example, Mitchell Gold is filing for Chapter 11 bankruptcy. We are considering various avenues to accelerate growth on an individual store basis. So we are aligned on this front.

Okay. The next question is for Jason concerning the organic growth initiatives at our directly operated stores. Jason, could you elaborate on some of the opportunities you think exist to drive meaningful same-store sales growth at your current small fleet of North American stores?

Absolutely. I would say that over the last six months, the like-for-like sales in the 13 stores we have are running around 44% above 2019 levels. We are working to establish a solid base compared to pre-pandemic times. Looking forward, I see two significant opportunities. One is building talent in those stores to capitalize on any incremental trade and design project business. Our average order is up around 20% year-over-year compared to last year. We are committed to developing a team that can engage in more design project work, offering complete solutions to both direct clients and trade partners. In addition, we have an opportunity with our headquarters team to analyze our product assortment and add complementary items in living spaces to increase the average ticket size and sell more items to both our existing clients and an expanding customer base. That is our strategic focus.

Thank you. I’ll return to the queue so other people can ask questions. Thank you.

One thought I had based on your earlier question is that we could perhaps have a special conference not limited to quarterly results to provide more detail about what we are doing. We can organize a session with our retail division to thoroughly explain these initiatives. Additionally, I mentioned our new IT systems that provide exact data, which, in my experience, are among the best I've seen in 23 years as a consultant in retail. For everyone interested, we can set up an informative session to share these initiatives in detail to address the broader statements made.

Sure. Thank you for that.

If I may, Antonio and Jason, first of all, thank you very much for the way you've explained the company’s performance and concerns. Also, thanks to David for his optimism, which is crucial to us. Certainly, what we have created is a lifestyle brand, which is not easy to achieve in the furniture industry. Few have accomplished this, as far as I know. There is Natuzzi and others, but no other brands have managed to create such a significant presence. Now promoting a lifestyle brand also requires a strong retail component to showcase how attractive it can be for consumers. I must say we have made substantial progress on lifestyle branding and retail, thanks to Jason and the team in other geographic areas. Today, we need to be both optimistic on one hand and realistic on the other. Consumer confidence is quite low everywhere; there is no geography showing enthusiasm for buying. This is due to reasons everyone is aware of, and I don’t need to elaborate further.

Thank you, Pasquale, for your comments, especially for recognizing our entrepreneurial patience and enthusiasm. Thank you so much.

Kevin, I suggest our team take some time to process everything. Let's allow them to explore their thoughts and formulate questions. I’ll ask our CFO, who joined about a year ago, to share more about what I usually refer to as transformation, but which I view as restructuring due to its significant impact.

Hi. Thank you, Antonio. Good day, everyone. As Antonio anticipated, I will give more context on our transformation process that we have already begun. Allow me to say that we, as top management, are fully aware that given our sales performance, the current structure is no longer sustainable. It is crucial for us to create an architecture enabling us to be more agile and resilient in volatile markets. We have analyzed all of our operating expenses, including selling and administrative expenses. In general, I won’t dive deeply into what Antonio has already mentioned regarding our improved margin. However, I can say that on the operating expenses front, we benefited from a general decline in transportation rates that counterbalanced the increased costs associated with establishing the U.S. business and further strengthening it. Our analysis has indicated that we need to intervene on both the industrial and selling and administrative sides. We began this process a few years ago and will continue to monitor and collaborate closely with our operations department to identify opportunities to improve our margins and develop a more agile and adaptive industrial model. We're continuing our work with our outsourcing partners in Vietnam while decreasing workforce numbers in China and Romania to align with current demand levels. Similarly, reductions in the Italian operations and upgrades to our plants will continue as part of the plan. What’s becoming critical to discuss now is our work on the SG&A structure, where we initiated an in-depth analysis of our processes to identify maximum optimization and operational cost reductions, including personnel cuts, for significant savings to accelerate these actions. To give you more concrete examples, we are analyzing operations and aiming to reduce complexity. One initial program involved our Natuzzi Editions cover codes offer, reducing it from 150 to 253 options. This change will streamline purchasing, stock management, and communication, thus enhancing retail experience. As we implement these findings, we plan to extend this approach to other markets and to Natuzzi Italia, under Mr. Natuzzi's guidance, without compromising quality or variety for customers. We have specific programs in place to incentivize stock depletion. Additionally, we're shortening our supply chain processes to get our sourcing closer to relevant manufacturing sites, saving delivery time. We are also reviewing forecasting algorithms to better align with recent trends and coordinate with purchasing to find opportunities for inter-company transfers that optimize financial supply and demand. Recently, we centralized group credit management at HQ level to reduce positions abroad. This change has yielded positive results in reducing group DSO, enabling better cash flow forecasting. As you can see, we have initiated a spectrum of activities, and analysis is ongoing to establish a better future setup that will yield significant savings. This is what we have achieved operationally. To be more specific concerning net finance costs, we reported EUR2.7 million in finance costs, with EUR1.6 million from interest expenses and bank charges. Compared to last year, where we had EUR1 million, we now stand at EUR1.6 million, a reflection of interest rates more than doubling. We worked to selectively utilize our lines and credit facilities. We will explore every opportunity to improve working capital while striving for the self-financing necessary in this period, to allocate more cash for investments focused on retail and growth.

Thank you, Carlo. Of course, this is becoming a detailed discussion, and we should keep our strategic focus on the priorities shared: priority number one remains retail expansion, closely followed by priority number two, which is reducing SG&A. We will keep reporting on these two priorities in our follow-up discussions during our next quarterly review or interim press release. Kevin, perhaps you can remind the audience to provide any additional questions or curiosities they may have.

Certainly. We do have a follow-up from David Kanen, whose line is now live.

Quick question: given the mix now and transitioning increasingly towards branded products, hypothetically at EUR100 million per quarter in revenue, is it reasonable to assume with the initiatives taken thus far that gross margin could reach around 40% or better? This question first for Silvestri. Thank you.

Thank you. I think your assumption is directionally right.

Okay. Thank you, guys. Good luck.

Thank you. Thank you very much.

I'll turn the floor back over to you, Antonio.

Thank you, Kevin. Once again, thank you all for being so attentive and following our story. We have high confidence in what we represent, which is an incredible brand with significant potential due to the strength of our brand. We are confident that we will navigate these challenging circumstances and emerge stronger financially. I would suggest Piero reach out to Kevin to arrange a follow-up conversation on retail that can be organized for those interested. Once we have contact information for interested parties, we will make this public. Should you wish to connect, I'm available for follow-up conversations in accordance with our public company obligations. Thank you once again, and have a wonderful day.

That does conclude today's webcast. You may now disconnect. Have a wonderful day. We thank you for your participation today.

Thank you, all.