Natuzzi S P A Q2 FY2024 Earnings Call

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Natuzzi Conference Call for 2024 Second Quarter Conference Call Financial Results. As a reminder, anyone interested in ongoing this call live can join via telephone by dialing +1-412-717-9633, then passcode 39252103. In addition to the link already provided to join via video. Once again, if you’d like to join via phone, please dial +1-412-717-9633 then passcode 39252103. At this time, all participants are in a listen-only mode. Following the introduction, we'll conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for questions. Joining us on today's call are Mr. Antonio Achille, Natuzzi's Chief Executive Officer; Mr. Pasquale Natuzzi, Founder and Executive Chairman; Mr. Carlo Silvestri, Chief Financial Officer; and 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 the Natuzzi's conference call for the 2024 second quarter financial results. After a brief introduction, we will give room for the 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 law. 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, Kevin, and thank you, Piero. Good afternoon to the listeners joining from Europe and good morning to those joining from the U.S. I would like to start with a brief introduction to what has been the second quarter in terms of sales. As you have seen, we reported sales slightly increasing versus the same period in 2023, which is not something we are particularly excited about. But definitely, we need to put it in the context where not only our sector has been very soft. To our knowledge, most of our direct competitors reported negative comps, and in general, durable and consumer spending are very much depressed. I believe that one of you is following what's happening in another interesting industry, the automotive, where there is a serious double-digit decrease in orders. So, we interpret the fact that we have been able to defend our top line. And then if we look at the brand, the sales have actually been 3% above last year, which is a sign of resilience of our company and also a testament that our brand journey is very much appreciated and understood by our partners and is increasing with new partners like real estate developers. I would like to highlight a few elements of our strategy, which has been very consistent through the cycle. The first element is our effort to continue improving the way we reach our consumer. As you know, Natuzzi has taken the gigantic task of transitioning from a manufacturer to a brand retailer. A key element is improving the quality of the relationships that we have with our final customers, which can only happen in an environment where we can control the customer experience. Here, retail, which is, of course, the channel where this customer experience can be better controlled, is now becoming very important. Roughly 70% of total sales are happening in retail, with Directly Operated Stores (DOS) and Franchised Operated Stores (FOS) up to 45% in 2019, which was still a good year to compare before the pandemic. So, it's an increase of 23 percentage points, which I believe is very significant. This speaks not only to the fact that we are reaching our customers better, but it also reflects the very intense work we have been doing to transform our competencies. Clearly, it's a very different job to be a producer than to be a retailer. There has been a lot of effort over the last few months that Pasquale, myself, and the whole organization has been doing to equip Natuzzi with competencies in the area of retail design, merchandising, and customer experience, which are new competencies for the group that we were not focused on just four or five years ago. As part of the retail, I would like to highlight the performance of our directly operated stores, which have been growing 6% versus last year, and in particular, the performance of our directly operated stores in the U.S., which have been growing roughly 33% versus last year. Again, this is a clear confirmation of what we have been reiterating in this conference call: the U.S. is central to our strategy, and retailing in the U.S. is fundamental to our strategy. I am pleased to announce that we have opened a new DOS in the U.S. in Denver, a location that has been very carefully selected as it is in downtown on First Avenue, very close to other furniture brands that we consider to have the right affinity for Natuzzi Italia, which include Roche Bobois, Restoration Hardware, West Elm, Crate & Barrel, and Room and Board. Our experience has shown that it is very important to be part of a district populated with brands having a similar positioning. With this new opening, we now have 23 stores in total, of which 18 are directly operated and four are franchised in the U.S. This will remain a priority for us, both in terms of organic growth and in terms of potential new openings. Let me switch to another geography that is central to our strategy, which is China. As you know, more than half of the total stores we have are in franchising in China. We consolidate line by line since we are in a minority Joint Venture (JV) with Kuka. Over the last few months, we have increasingly supported our partner in China on an operational level. So, we are really teaming up with different departments to help the JV team make the right choices regarding merchandising and marketing. Personally, I have been very active there in the last few months, immersing myself in the retail reality. Last year, in August, I had the pleasure of witnessing the christening of a new project, the Hangzhou store. As you know, Hangzhou is a city located one hour north of Shanghai, a very beautiful city. We wanted to ensure that the Hangzhou store became a flagship fully controlled in terms of design by our team. In the partnership, our partner was quite autonomous in some choices regarding retail. In the spirit of creating a very high consistency in the presentation of Natuzzi Italia globally, we agreed with our partner that significant openings like Hangzhou need to be integrated with our work. What this means is that the retail merchandising and design of the store have been managed by our newly created retail excellence division. The opening event in Hangzhou was a success. About 40 dealers joined from our market. It is still very early, but it is encouraging to see that after nine weeks of operations, the Hangzhou store is performing at double the rate of our other remaining directly operated stores in China, which encourages us to say that we have now learned the job. We have made significant investments in defining what we call our internal brand retailing guidelines, which set very strict parameters in merchandising, retail, and selling. We feel we have the legitimacy to guide our partners more strictly because we believe that doing the right things will yield very good payoffs. In closing on retail franchising and direct operator stores, we now have 681 stores. We believe that this is a very solid platform to regain growth as market conditions stabilize. Meanwhile, there has been significant effort in improving the quality of our gallery, which we've called reimagining the gallery, recreating its concept from the ground up. As you remember, galleries are shop-in-shop experiences ranging from 1,000 to 3,000 or even 4,000 square feet. In some geographies in Europe, they are even larger, but they still function as shop-in-shop formats. Our objective is to deliver a brand experience that is immersive. A dedicated team has redesigned the layout and merchandising so that we can convey the experiences of the brand while remaining modular and cost-effective for our partners who need to co-invest in this format. This is the format we are working with, especially in the Point market, which is one of the opportunities we offer to our partners who want to invest in a location for Natuzzi Italia where the potential does not support a full-scale store. This new concept has been extremely well received. We have opened about 43 new galleries, and we have reengineered 25. This is an effort we are going to progressively roll out to the 600 galleries we have globally.

Antonio, I’m sorry, but we also opened 47 or 48 Natuzzi stores in 2024.

So, Piero, regarding the numbers we opened and closed, the net balance is pretty much stable. It is also relevant to visualize the journey of Natuzzi, noting the significant distance we've covered. We have transitioned from operating with very few selective relationships to displaying our products in a more controlled manner. Most of our partnerships involve larger retailers in the U.S., while the remaining customers contact Natuzzi through a well-qualified distribution channel where the brand and merchandising can fully express their potential. Regarding the area we are excited about, trading contracts play a significant role. Let me clarify what we mean by trade contracts. Trade represents the business we conduct primarily through our stores, mainly Natuzzi Italia, where the final buyer, rather than being an individual consumer, is an architectural designer who is working for the end consumer. This type of business is where we can deploy our strategy of Natuzzi Italia to sell projects, rather than just products. This is incrementally interesting, as in the U.S., for example, this line of business represents about 20% of the revenue from our stores compared to the revenue generated from retail consumers. These contracts are mostly routed through our stores. The second type of contract is relatively new for our company but is quite significant for many Italian brands that Natuzzi Italia competes with. Contracts involve business where the buyer is typically a retail chain or real estate developer. This presents different dynamics since an individual contract can be substantial. The contracts can involve the design of spaces and units and can include supply beyond our upholstery, incorporating fixed furniture as well. This is a fascinating new arena for us. There is a strong trend in the market for real estate developers who aim to integrate a brand as an additional layer of value. This trend has started with fashion brands like Armani and Bvlgari. However, those brands may lack the design competencies we have. Natuzzi can seize this opportunity by offering our full range of design capabilities. I can confirm that we have already undertaken three significant projects, two in the Middle East and one in Central America. They are notable in terms of size and have been significant milestones for us because they demonstrate our ability to engage in a competitive market that requires design capability, project management skills, and the capacity to manage additional partners for fixed furniture. To facilitate and accelerate this business unit, we recently established a dedicated business unit that will manage trade and contracts. This move reinforces our commitment to growth and profitability in this new segment of the market. Moving from the top line to the structure of our P&L, I want to discuss the work we've done on margins. I'm particularly proud of what our team has achieved. Compared to 2019, we increased our gross margin by 11 percentage points. This was done despite facing turbulent years, including 2021 and 2022, characterized by high inflation and shortages of materials. More recently, we witnessed a spike in transportation costs from our various locations. I believe 2023 has been challenging for many companies trying to maintain historical margins, but our group has been able to increase margins by 11 percentage points. Even during this quarter, we continued this positive trend, reporting a gross margin of 38.1% compared to 36.4% a year ago, indicating a 1.7 percentage point increase within just 12 months. This is especially remarkable given that we also accounted for severance costs in this quarter, while without them, the gross margin for the first quarter would have been up to 39.3%. This means we achieved almost a three-percentage point increase compared to the previous year's quarter, which I find quite significant. This blended gross margin reflects our operations, especially in our Italian factories. If we were to consider proper saturation, we could add an additional 3 or 4 percentage points more to our gross margin. When we analyze the integrated gross margin for retail, we see numbers ranging from 65% to 68%, considering retail margins combined with production margins. The fourth point I want to highlight is something we have strategically managed: we have not resorted to any layoffs, which I believe is a significant achievement considering we operate in a highly unionized market. We have been hardworking despite a reduction of our workforce by roughly 900 people, representing a 20% decrease over three years. In the first six months of the year alone, we have reduced our workforce by 170 units. This has been a pre-planned reduction, and I would assert that this was our approach before facing any negative economic circumstances. Our evolution as a company is moving from being volume-centric to a more value-oriented business, which necessitates a shift in production strategies and the skills we require in our teams. This agile approach has been managed ethically and respectfully, but it remains part of our midterm plan. To give you an idea of our productivity improvements, even with our workforce reductions, revenue per employee has increased by 30% since 2021, representing a significant productivity boost for us. Last point I want to mention before addressing I point is the quality of our leadership team. I previously mentioned how interesting and challenging it is to transform a company that has been working as a vertically integrated manufacturer for five decades into a retail brand company, which has been the vision Pasquale had some 20 years ago but is accelerating now. Talent plays a crucial role at all levels, particularly at the store level, but also in emerging areas such as merchandising, retail, and marketing, which all present an opportunity for learning and growth. To continue elevating our capabilities in the retail and consumer space, we are pleased to have Nicola Internullo join our team. Nicola is a veteran of the luxury industry who has worked with esteemed names like Loro Piana, LVMH, and L'Oreal. Most recently, he was the HR Director for Blackberry for North America, a region critical to our development. He has joined us to accelerate this transformation into a retail and branded company, and he will be teaming up with Mario, who remains our director, possessing extensive knowledge in transformation and structure. We believe this collaboration will effectively equip us to meet our new challenges. Having discussed routine matters, I would like to address another point. As you know, I announced an agreement with our Board to divest a strategic asset as part of our strategy to become a more agile company and free up resources to reinvest in the business. One asset we identified as non-strategic, while still vital as a location for our showroom, is High Point. High Point has been on the market since 2019, with increased activity in 2021 when we brought in two leading commercial real estate brokers. The prevailing high-interest rates have hindered the closure of negotiations with potential U.S. buyers. However, we have recently received interest from our insider shareholder, Pasquale, who has been central to the origin of this building, which is an iconic structure designed by Mario Bellini, a globally respected architect, who has approached us regarding potential acquisition. Our governance includes a committee tasked with evaluating transactions involving related parties, comprised of three independent board members. They conducted necessary activities and requested an independent evaluation of the building, which concluded that the transaction terms proposed were at market value. Consequently, during our last Board meeting held last week, we reached a consensus about the sale, which aligns with our strategic intent to dispose of non-strategic assets. These procedural steps are still ongoing, but unless complications arise, we expect the sale to occur within this year, with the gross amount of the transaction being $12.1 million. Naturally, no commission fees are involved. This sale is structured as a dry sale. In the past, we explored sales-leaseback options, which were not viewed positively by myself and the Board due to the significant liabilities they would impose. Thus, I want to clarify that this is a straightforward sale. In terms of the cash proceeds from this sale, it will enable us to initiate a fairly rapid expansion in the U.S. once conditions stabilize. We are looking at additional growth opportunities for new openings in North America. To reiterate, we have not strayed from our strategy. We are committed to expanding Natuzzi, particularly Natuzzi Italia’s presence through direct operator stores. We have recently completed five openings, including four last year and one this year, and we will continue to seek additional opportunities in 2025. There is substantial growth potential for directly operated stores in the U.S., and this is one area where the proceeds from the High Point sale will be allocated.

The offer we received from our major shareholders is $12.1 million. While I can’t disclose the net book value right now, rest assured that the offer exceeds our net book value, allowing for all cash proceeds to reflect in our accounts.

Will this cash enable a fairly rapid expansion in the U.S. once conditions stabilize? What kind of growth in new openings do you expect in North America?

As previously mentioned, we are open to introducing Natuzzi editions to the U.S. and that the digital opportunities we have still need a thoughtful approach. I see the potential in distributing both Editions and Divani & Divani in the U.S. We're open to exploring those channels carefully.

I appreciate the constructive approach you're taking during this frustrating retail environment. I’m hopeful that as interest rates decline, we’ll see a reversion to the mean.

In other words, we have moved from focusing on product to focusing on projects. Customers now come to us with a designer to shape their homes, which leads to higher average order volumes. Collaboration with architects has become vital.

I want to express gratitude for your constructive conversation today, which highlights the hard work our team undertakes each quarter amidst challenging conditions. Our board team is cohesive; we work diligently to strengthen the company despite strong headwinds, and we believe upcoming stabilizations will further assist us. Thank you, Kevin; you may open the floor for questions.

Our first question today is coming from David Kanen. Your line is now open.