Natuzzi S P A Q3 FY2023 Earnings Call

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Natuzzi 2023 Third Quarter Financial Results Conference Call. As a reminder, interested persons can join the conference call by dialing +412-717-9633, then Passcode 392-52103#. Once again, to dial in by phone, please dial +1-412-717-9633 and then Passcode 392-52103#, in addition to the link already provided to join the video webcast. 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 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 the North American market; and Mr. Piero Direnzo, Investor Relations. As a reminder, today's call is being recorded. I'd now like to turn the conference 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 third quarter 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 filing 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 today’s call. And now, I would like to turn the call over to the company's Chief Executive Officer. Please, Antonio.

Thank you, Kevin, and thank you, Piero. Good morning, good afternoon to everyone. I hope our audience from the US enjoyed a joyful Thanksgiving last week. Let me briefly illustrate the development of this year focusing on the third quarter. As you've seen, sales in the third quarter have been significantly below what we reported in last year's same period and 15% below what we reported in 2019, which we keep using as a parameter of comparison given the seasonality of the last cycle. It's important to detail the difference between 2022, because 2022 benefited from a significant amount equal to EUR28.3 million from previous quarter backlog. As you will remember, due to the unprecedented spike in demand in the aftermath of COVID, we struggled, as all the industry did, in fulfilling the demand, resulting in the backlog that during 2022 helped us to keep busy on the top line. So, if we compare the 2023 third quarter with what we can call a normalized third quarter of 2022, the decrease has been around 15%. The component of our business which has been clearly more affected, due in part to some clients leaving us but also consistent with our strategy, is the unbranded component of our business. As a reminder for those participants that might not know Natuzzi in depth, we are now a branded retail group, but historically, we also produced unbranded products. Currently, almost all our sales, around 94%, are conducted under the Natuzzi brand. When compared to the third quarter of 2019, it was 78%, indicating an increase of 16 percentage points. This confirms that despite the unprecedented times we live in, we are not deviating from our long-term strategy to become a widely recognized brand. We are focused on leveraging our 65-year heritage, which also carries higher margins. This direction is where we want to invest. Another important element is that since week 29 of this year, we have witnessed a change in direction, with weekly order flow higher than that of 2022 for 19 consecutive weeks now. We are closing week 47, and we are reporting order flow above 2022 or previous periods. This interruption of a 15-month cycle where fresh orders were below the same period of the previous year is encouraging, but it is too early to say if this is a structural turning point. Our gross margin has been at 35.4%, which is above the average over the last three years. This comes as a result of our relentless focus on pricing discipline and cost management, which has compensated for the disadvantage in absorbing fixed costs with lower volumes. Overall, these factors led to an operating loss of EUR1.3 million in the quarter, which is certainly not what we aimed for, but putting it in perspective, we managed to achieve EUR74.9 million in sales compared to a loss of EUR8.7 million reported in 2019 on higher sales of EUR88.1 million. This indicates that we are on a trajectory to strengthen our operating model and lower our breakeven point. When growth returns, we will be better positioned for profit and cash conversion. Talking about cash, this quarter has been positive from operations, generating EUR2.3 million compared to the negative cash flow of EUR4.2 million from the previous year. This again provides evidence of our model's resilience, even under extreme circumstances like what we are currently witnessing. We have continued to invest in retail, contributing EUR1.8 million, and in restructuring and modernization of our factories, contributing EUR1.1 million, which aligns with our long-term priorities. Although the demand remains soft across the industry, our strategy involves enhancing brand retail while still modernizing our factories. The current humanitarian crisis in the Middle East does not help, but we remain focused on ensuring that Natuzzi, with its 65-year heritage, can emerge even stronger from this crisis. We've reduced our workforce by 649 employees since 2021, including a net reduction of 72 employees in the last quarter. While this step is significant, we are simultaneously strengthening our organization. We've also begun collaborating with Brian Waidelich, a former executive from Mitchell Gold and Bob Williams, who successfully led a $90 million business and is now aiding our global retail division. Our retail front has seen growth, opening 1.9 million square feet of retail space this year. We've opened five new flagship stores in primary locations, including Atlanta, Houston, and San Diego. Furthermore, we handle non-strategic asset dismissals, including potential sales of our tannery and some fields near Greensboro. This has been a consensual decision with our Board to focus on retail and core geography, particularly North America, and to accelerate our restructuring efforts. To conclude, I want to emphasize three key takeaways from this quarter and year: first, the market remains challenging, yet we have demonstrated resilience and improved cost management; second, we are committed to our long-term strategy of prioritizing branded retail and restructuring; and third, it is encouraging to note the positive order flow from week 29 this year compared to the same period in 2022. With that, I will open the floor for initial questions about the third-quarter results.

And we have a question coming from Dave Kanen from Kanen Wealth Management. David, your line is now live.

Hi, good morning, guys. I appreciate you taking the questions. A follow-up on the statement that you made: your focus is on ‘accelerating the restructuring’ and then building out the North American DAS footprint, which makes perfect sense to me. So my question is, in order to fund and accelerate that, what do you think is the time frame for the disposal of some of these non-core assets, particularly High Point?

Thank you, David, for your encouraging words and your specific question. At this point, we are carefully looking at the market. We have an ongoing discussion with a potential buyer and we are close to entering the due diligence phase, which will be the final stage of a potential disposal. However, it is important to note that until both parties agree on the terms, they can decide that it is not the right time or terms to complete the transaction. But we've done our homework internally, and we are actively discussing the last part of this potential transaction with a buyer. I cannot disclose further details, but that is the current status. Regarding other assets, we are a bit behind the curve, but we are actively scouting the market for potential buyers.

Okay. I have several questions, so my apologies in advance for monopolizing. But in terms of the new stores you highlighted in Atlanta, Houston, San Diego, and Manhasset, how many of these stores did not contribute in Q3, and can you quantify the revenue we may pick up in Q4 incrementally? I'm assuming these stores probably have an average unit volume of $4 million to $5 million, which seems to be the average on new stores. If you could give me color there, that would be helpful.

Okay. I will start, and then I will ask maybe Jason or Piero to add finer details. When we open a new store, there is a careful process which includes geo-market studies to ensure that the catchment area and competition is suitable for operating a store. For us, it's a very strategic decision, and this includes our five-year business plan, aiming for breakeven between 14 and 18 months. Of course, in the initial phase, we do not have the full benefits while incurring costs for the team. So those stores are still in this ramp-up phase. Jason, could you provide any precise figures on those five new openings in 2023?

Sure. It's important to remember that these stores are largely based on a special order and import model, leading to a timing difference between written orders into our factory versus delivered revenue. Revenue typically begins to flow regularly about four to five months after the store opening, barring any locally stocked products in our Quick Time assortment. Therefore, as you consider your models, you should anticipate that early 2024 will have a more considerable impact on our North American revenues.

Okay. Just to clarify, you’re indicating that while you’re currently taking written orders at the new stores, they will only show up in revenue about five to six months later when the product is shipped. Can you provide some flavor for—or to quantify the written orders you’re seeing at the new stores and if they're performing up to your plan?

I can’t provide individual store volumes today, but overall, we are excited with the progress being made. When entering new markets and hiring new teams, we typically see stores that ramp to full maturity, with year two performance usually stronger than year one. Our stores are seeing positive momentum in terms of written orders.

Okay, that's helpful to understand the cadence of revenue recognition and the opportunities we have ahead. Moving on, Carlo, the operating loss was quite small despite soft revenue, and it appears that you've done well in managing selling and administrative expenses. If revenues increase by $15 million back to $90 million, how much would selling expense go up? How much of it is variable? If you could help me understand that in terms of dollar amounts.

Regarding cost discipline, if we increase our volume, all the fixed parts within selling and administrative expenses will not significantly change. Therefore, the selling expense will only increase due to the variable portion, including rent, sales commissions, and transportation costs. We estimate it would go up by around 20% in that range.

So selling expenses would increase by about 20% if we had a $15 million increase in revenue?

Yes, that's correct.

And administrative expenses should remain flat?

Correct.

Okay. That's helpful. So it shows that when you get that flow-through on revenue, there's quite a bit of leverage in the financial model to generate profit. Lastly, Antonio, you mentioned that written orders have turned positive versus the last 15 months. Could you provide a bit more detail on what that improvement looks like in terms of percentage or magnitude?

The improvement is in single digits, especially with branded versus unbranded products. Geographically, the US has become more dynamic recently. Central and South America have shown resilience as well, whereas China has been more conservative post-pandemic. We are more integrated in our operations now, which gives us hope for positive outcomes from that region too.

On the topic of cash in China, how much is in the joint venture right now and what flexibility do we have in accessing that cash?

Regarding cash, I want to refer to Piero, as I know the figure but want to ensure I can disclose it appropriately before the 20F. I suspect we cannot disclose it now, right?

You're right; we cannot disclose cash figures now due to our partnership with another listed company.

So I cannot disclose the figure. The group has been accruing cash, but due to investments, liquidity has shifted more towards fixed assets rather than cash. As mentioned before, we can't provide the exact figure due to our JV agreements.

Okay. And one last strategic question for you, Jason. It appears your focus is heavily on the living room, while competitors offer a broader suite for the dining room and bedroom. Is there a plan to expand into these areas, creating opportunities for double or triple average unit volumes?

Yes, David, you are correct. We are focused on Natuzzi Italia and Natuzzi Editions. In Natuzzi Italia, we are pursuing a lifestyle presentation in stores with a comprehensive approach. While historically strong in the living room segment, we aim to expand into bedrooms and dining rooms as consumer needs shift. Our strategic partnerships will help us to produce high-quality products for these areas as well.

Thank you, guys. I appreciate your time.

Thank you, Dave.

We have a question from Steve Emerson from Emerson Investment Group. Your line is now live.

Thank you for taking—hold on, let me hit video. Can you hear me?

We hear you perfectly. We don’t see you, but we hear you perfectly.

Antonio, thank you very much. I met with you at the LD Micro conference last year.

I do remember, Steve; nice to see you again.

Could you discuss some of your objectives next year? Some metrics you hope to achieve? Also, what percent of your revenues in the US are now met with fairly quick or domestic inventory?

Thank you, Steve, and nice to reconnect. Let me begin with the mid-term vision for Natuzzi. Though the current market conditions are challenging, we still have visions of growth. According to independent surveys, Natuzzi ranks first in brand awareness among international brands in the US, UK, and Spain, and second in China. Our goal is to align revenues with our brand status, which represents a significant opportunity for us. Now, regarding next year, we are finalizing our budget, but in light of market conditions, we will adopt a cautious approach, especially in the first part of the year.

From the retail side of the business, I estimate that over 20% of our written orders are from sales already available in the US. In contrast, about 75% of our orders are special orders from our supply chain.

Thank you. I was looking for more concrete metrics like how many US Natuzzi stores do you expect to build next year, etc.

I can't provide a specific figure because it depends on how the year develops. In terms of full potential, we can aim to double or even triple our presence in the US market beyond our current 40 stores. The speed of this development depends on our ability to invest efficiently and our commitment to opening quality stores. While we want to aim for 8 to 10 stores per year long-term, I cannot confirm that just yet for 2024 due to cautious budgeting.

Did you say eight to eight or eight to ten?

Eight to ten.

Got it. And just to follow up on Dave Kanen's question regarding the breakdown of revenue, what percent of your revenue is from living rooms versus other areas?

For North America, living room sales account for about 80% of total sales for Natuzzi Italia, and over 90% for Natuzzi Editions.

And what is your objective going forward in terms of sales from non-living room products?

While we will always lean towards upholstery sales, our long-term goal is to achieve a 60-40 or 70-30 split with non-upholstery products, in line with market demand.

Thank you very much.

It is my pleasure. Thank you.

We have a follow-up from David Kanen. David, your line is now live.

Hi, guys. On the backlog you used to disclose numbers that were more relevant when we had supply chain issues during COVID. What was our backlog as of September 30? And how does that compare with June 30?

The backlog is at a physiological level. If you cover the data, you're free to disclose it; otherwise, we can do it as a follow-up. We are at a physiological level now.

June was EUR56 million. The current backlog is EUR54 million.

So it's about the same?

Yeah.

Okay. Thanks, guys.

Thank you. We have reached the end of our question-and-answer session. I'd like to turn the floor back over for any further or closing comments. If there are no further comments, at this time, I'd like to conclude today's teleconference. Thank you all for joining us today. You may now disconnect and enjoy the rest of your day. We do thank you for your participation.

Thank you.

Thank you.

Thank you.