Natuzzi S P A Q3 FY2024 Earnings Call

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Natuzzi Conference Call for the Third Quarter and First Nine Months 2024 Financial Results. As a reminder, interested parties can join the call live via telephone by pressing +1-412-717-9633, then passcode 39252103# in addition to the link already provided to join via the webcast. Once again, if you'd like to join via telephone, please press +1-412-717-9633, then passcode 39252103# in addition to the link already provided to join via the 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 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 of the Board of Directors; Mr. Carlo Silvestri, Chief Financial Officer; Mr. Diego Babbo, Chief Retail Officer; 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. Good day to everyone and thank you for joining the Natuzzi's conference call for the 2024 third quarter and first nine months. 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 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 SEC for a complete review of those risks. The company assumes no obligation to update or revise any forward-looking matters discussed during this call. And now I would like to turn the call over to the company's Chief Executive Officer. Please, Antonio.

Thank you, Kevin, for opening the meeting, and thank you, Piero, for reminding our rule of conduit. Good morning to those joining from Europe and good morning to those joining from the US and good afternoon to those joining from Europe. As usual, I will provide some background to the numbers that we share with you. Then I will ask Carlo to provide some more specifics on the financial performance and then I will have Diego Babbo share with us the progress we are making on the retail front. As you have seen, we closed the first nine months of the year with sales in line with last year at EUR243.9 million. As you know, the sector continues to face strong headwinds, and most of the companies listed in our sector reported negative sales compared to the previous year. However, our branded business has confirmed to be stronger than the average. In fact, it has been growing 6.3% versus 2023 and 20.8% from 2019. This growth in our direct-operated stores and branded sales firmly supports our direction to become a branded retail company. Regarding the P&L information, it’s important to highlight that, from a P&L perspective, in the first nine months of the year, we incurred EUR4.8 million in one-off severance restructuring costs. When reading the P&L correctly, you need to remember that according to IFRS rules, out of those EUR4.8 million, EUR4.1 million are included in the cost of sales, affecting margin readings. The remaining EUR0.7 million is accrued in selling and administrative expenses due to severance for a particular group of employees. The restructuring is a significant aspect of our story. We are focusing heavily on becoming a branded retail company while managing the legacy from a time when Natuzzi had a much stronger industrial footprint due to its participation in the volume business. In the first nine months of the year, we let go of 538 employees, leading to a total reduction since the beginning of 2021 of 1,110, approximately 26% of the total workforce. This restructuring was conducted ethically and selectively. When we analyze the gross margin, for the first nine months, we reported 35.8%, which is the same figure compared to 2023. In contrast, in 2019, the margin was 29%. If we exclude the severance costs, the margin for this year's first nine months would have been 37.4%, compared to 36.3% in 2023 and 30% in 2019. Thus, even in a context where, as we will comment later, the third quarter has been significantly soft for us, we have an additional 7.4 percentage points in margin compared to 2019. This was achieved by improving the quality of sales, as our branded business now represents 93%, and the efficiencies we mentioned previously are yet to be fully realized. Moving on to financial costs, the total financial costs were EUR7.4 million, which is a notable difference compared to 2023, where they were EUR5.6 million, and relatively in line with 2019, which reported EUR7.7 million. This varies because we utilize finance for our working capital as is standard practice, especially in an environment with higher interest rates. Even in 2024, we are continuing to invest according to our priorities. Specifically, we invested EUR5.4 million primarily in our manufacturing facilities and for the US market, where we recently opened a new store in Denver. Consistent with our strategy, we are keen on freeing up resources by divesting from non-strategic assets. We previously announced that following a careful process with our internal committee, we decided as a board, with the CEO, to sell the shareholder High Point and have received a first installment of EUR3.8 million for that sale. I'm also pleased to update that we signed a contract for the sale of a non-strategic land in Romania, near our existing factory, where we had no operational plans. The anticipated completion of this sale is in 2025, with a projected value of EUR2.9 million to EUR3.1 million. We've already received our first installment as confirmation from the buyer for this transaction. These represent two near-completed transactions. We are actively looking to sell non-strategic assets, including our tannery and other minor assets in our balance sheet. Our cash position is significantly lower than our opening position; we started the year with EUR33.6 million and ended September with EUR17.1 million. Regarding cash dynamics, we used EUR5.1 million in operations, of which EUR6 million was earmarked for reducing the workforce. Under IFRS principles, cash used for severance is categorized under operating activities, hence the positive difference of EUR0.9 million represents cash generated from our operations. Therefore, our operations are generating cash. Cash used in investment activities accounted for EUR5.4 million, while cash used in financing totaled EUR7.1 million. We also noted a EUR0.4 million adjustment due to changes in exchange rates, and a positive contribution of EUR1.5 million from adjustments in bank overdrafts. Cash continues to be a priority, and it’s worth noting that the positive impacts from the High Point transaction and the Romanian land sale will not yet be reflected. We have reported a better deal flow in the last 10 weeks and are monitoring our cash situation weekly on both short and long-term bases, feeling no risk on this front. In the third quarter, our top line trends compatible with last year, with sales slightly above 2023 by 0.1%. Again, branded sales are outperforming. I want to briefly mention the ongoing efforts from the CEO, Pasquale as Executive Chairman, the board, and our team as we navigate this market phase. The first priority is retail, which remains crucial for us to improve performance and brand representation. We have made significant efforts in this area, including enhancing our retail format for Natuzzi Italia and implementing new IT tools that improve communication with clients and architects. Diego will provide some interesting highlights regarding the rollout of these initiatives in our directly operated stores and franchises. Our DOS are becoming exemplary for franchises concerning modern retail standards, which we want to showcase to both improve brand representation and performance. During the first nine months, we have opened in Denver — an opening that took longer due to our determination to embed the latest concepts in our infrastructure fully. We added five new Natuzzi Italia stores in the US, reflecting our commitment to increasing our presence in this market as one of our highest priorities.

Thank you, Antonio. Good morning, good afternoon to all the attendees. As Antonio was mentioning, in the corporate retail division at Natuzzi, we have spent the last months addressing key goals. We have focused on completing our guidelines, reflecting our model to elevate the customer experience, and most importantly, ensuring a high level of adoption of these guidelines. Our efforts also included enhancing the performance of those stores through the implementation of the new store concept, as Antonio was mentioning. Let me share with you no more than three slides that could help me to describe better the scenario. As you can see on the left side, some images of the new store concept for Natuzzi Italia, which has been already adopted in nine out of 39 directly operated stores around the world, and we are committed to invest in future upgrades for the remaining stores. This has been done with the goal of creating a more engaging shopping environment to retain customers through a more environmentally sustainable and cost-effective store concept, which also aims to highlight our brand heritage and roots by using materials and colors inspired by our Apulian landscape and ultimately to boost sales and revenues through layouts that encourage higher spending. Also visible is the image of Divani&Divani in Italy, where we have undergone the same journey, upgrading eight out of 10 directly operated stores to develop a cohesive and distinctive store design that reflects our brand values and distinguishes us from competitors, given the fierce competition in the Italian market. Additionally, we have adopted a set of tools embedded in this concept aimed at increasing conversion rates, including point-of-purchase materials, in-store communications, and more. However, it's not solely about the in-store concept; digital tools also play a significant role. We have invested considerable resources to define and implement digital tools across our network. To date, we have achieved full installation of these systems across our network of directly operated stores, enabling us to utilize real-time traffic measurements for informed decision-making and improved store layout and staffing. We are leveraging dashboards like Power BI to track key metrics, identify trends, and implement strategic adjustments. We are also creating a pleasant shopping atmosphere with in-store music tailored to our brand identity. Recently, we launched a state-of-the-art room configurator, enabling customers to personalize their purchases, leading to increased satisfaction and sales. While we have established a robust framework, it remains imperative to elevate our franchise stores to the same level of excellence as our directly operated stores regarding tool adoption and guideline adherence. To facilitate this, we are working to integrate franchise stores into our systems and implement all developed tools. Notably, from January '23 until the end of the last quarter, previously disjointed stores are now fully connected to our order management system, enabling us to better measure their performance. Moreover, over 100 stores outside our DOS now have traffic counters installed, enhancing our ability to measure traffic. Integrating with our system ensures informed business choices and fosters a high-performing retail environment that aligns our partners and enhances overall operational efficiency. Our commitment to these objectives underscores our dedication to providing exemplary service and maintaining the highest standards.

Thank you, Diego. This session is designed to go beyond the standard package of a press release because we really want you to get to know our management. Diego has been a pillar of the retail transformation we are implementing, overseeing the full retail business, which includes both directly operated and franchise stores. As mentioned, franchise stores are operated by third parties, and we aim to provide a consistent experience for customers while sharing our expertise from managing 600 stores. I will now pass over to Carlo, who will provide commentary on the third quarter and the nine-month evolution of gross margin and profitability, which remains an absolute priority.

Can you hear me? Yes. Sorry. I will give you some insights about the third quarter, starting from our sales. As Antonio mentioned, the overall third quarter was affected by a weak business trend during the summer period. Overall, our sales were 0.5% up compared to the third quarter of 2023, with branded sales slightly increasing in proportion versus last year. However, we saw changes in the mix among our brands, with Natuzzi Editions and Divani&Divani compensating for the decrease of Natuzzi Italia, which affected our absorption of fixed costs. Looking into our 2024 gross profit, the major factors impacting it include labor costs, which increased by EUR1.8 million compared to the same period last year. This increase was impacted by the exit of 2,076 employees in China due to the closure of our Shanghai plant and the move to Quanjiao, which carried a severance cost of EUR2.9 million. This directly affected our cost of goods sold. Additionally, we made inventory clearances that positively impacted our cash by EUR4.8 million since the beginning of the year, and the transition of production from Shanghai to Quanjiao incurred extra costs during the current period. However, when we exclude the severances, as Antonio noted earlier, the gross margin would have been 35.7%, compared to the 31.8% reported, and showing an improvement over the 35.5% of last year. Most importantly, this represents an increase of more than five percentage points compared to the 30.5% reported in the third quarter of 2019. Examining the other factors impacting our P&L for a more coherent understanding of our numbers, we see a decrease in selling expenses from EUR21.6 million to EUR20.3 million this year. This decrease is also a result of our ongoing portfolio management in our directly operated stores. During this period, we closed one store in Spain and one in Switzerland, while also factoring in the opening of four stores in the US last year and the new store in Denver this year—contributing to the reduced costs but improved portfolio performance. On the administrative expenses side, the EUR8.5 million reported contains EUR0.5 million for redundancy packages aimed at reducing our workforce in Spain and Switzerland. Excluding such costs, we achieve savings in this area. Thus, if we consider all these factors, the operating loss would have been EUR400,000 during this period compared to a loss of EUR1.1 million in the third quarter of 2023. Regarding finance costs, I want to highlight that the net exchange rate impact relates solely to trade receivables and payables, not to our hedging policy against exchange rate risks. This concludes my comments on the third quarter.

Thank you. We'll now be conducting a question-and-answer session. We have a question coming from Kirby Newburger. Your line is now live.

Yes. I don't know if you can speculate on this, but there is talk that the next presidential administration in the United States is going to implement some tariffs. Do you all have a feel for how that might affect you?

Thank you for the question. I will take it. Of course, we have no way to predict what decision the new administration will take. What I can assure you is that we are preparing ourselves to deal with potential logistics and tariff evolutions optimally. Let me elaborate, as this is a significant advantage for Natuzzi: we do not rely solely on one source of production and are gradually establishing multiple sources to navigate these circumstances. For instance, we are progressively using Vietnam, with plans to operationalize it starting in Q1 2025. This will provide us with another platform to serve geographies like the US, aligning with our larger clients. As you know, Vietnam does not impose tariffs compared to China, while producing out of China incurs a 14% duty disadvantage. It’s worth mentioning that we have facilities in Italy, which we might consider utilizing if tariffs become problematic for certain geographies like North America. In conclusion, while I cannot predict the administration's actions, Natuzzi’s footprint equips us well to adapt, as we have in the past during logistics spikes by shifting production between plants.

Thank you.

Thank you. Next question is coming from David Kanen. Your line is now live.

I'm afraid, Dave, you're on mute. I still see you muted. Kevin, is there any way you can unmute Dave? Okay, now you can go ahead.

Thank you for taking my questions. I have a few, and then I'll go back into the queue to allow other people to post questions. The first one, Antonio, is you referenced order flow improvements in Q4 subsequent to quarter-end Q3. Could you just comment on that a little bit? We heard the same from RH in their call yesterday, and I'd appreciate some color on what you are seeing.

Certainly. Since week 14, which encompasses the last 13 weeks, we are observing a positive trend compared to previous weeks. I won’t speculate too much, as we didn't do so in our press release, but it’s evident that the outside situation remains volatile. However, the last ten weeks have consistently reported better performance compared to earlier weeks. Moreover, we still hope for positive movements from the new administration regarding tariffs. A significant highlight is China's recent implementation of a stimulus package which includes specific support for the furniture industry. We are also noting a better inflow of orders recently in China. So, while I wouldn’t predict, I thought it was important to share this emerging signal amidst the headwinds.

Thank you. The second question is about the move from Shanghai South. You mentioned an approximate 30% savings. Can you remind us of the timeframe for that move and when we can expect to see the impact reflected in the P&L?

The official closure of Shanghai was at the end of September, hence we are discussing it in this call regarding the first nine months of the year, where we ceased operations at that plant and let go of workers. The Quanjiao factory was operational with a few lines already; it is currently ramping up capacity. Typically, we see that a factory reaches full efficiency within 12 months, so we should see substantial materialization of benefits during 2025.

Okay. Do you anticipate any costs or gross margin improvements from this production shift in China? If you could quantify that for us, would you expect improvement of 100 basis points, 200 basis points, or 300 basis points to gross margin?

I understand your need to model these parameters. While I can’t provide precise numbers, as variable costs also encompass materials and other factors beyond labor and rent, our estimates indicate improvements could lie between 200 basis points and 300 basis points.

Okay, thank you. That’s very helpful. You also spoke about the new commercial division, particularly in Dubai. Can you outline the size of that opportunity? This seems potentially incremental; could you quantify your internal goals for this division?

I appreciate your interest. While we usually refrain from providing specific guidance, I'll share that the new division is intended to build an incremental business. We have created a five-year business plan for this division, focusing on contract services rather than direct sell to customers. Our target encompasses partnerships with real estate developers and hospitality sectors, which represent substantial potential. Comparing historical benchmarks, Italian companies engaged in similar activities have built significant contract businesses. Although we do not produce a majority of our business through contracts like others, we anticipate material contributions to our revenue stream. I can express optimism about its prospects, with the division adding at least an eight-figure figure to our financials—likely measures in the tens of millions at a steady state.

Understood. Thank you for that insight. Lastly, you mentioned that without restructuring charges, we were profitable at about EUR1.3 million on EUR75 million in revenue, which is impressive. With the cost savings already achieved, is it reasonable to expect sustained profitability at revenue levels above EUR75 million, EUR80 million, EUR85 million, etc.?

You’ve performed the calculations correctly. Our breakeven point has significantly lowered from over EUR100 million down to the range you mentioned, approximately EUR75 million to EUR85 million per quarter. Thus, once we cover our fixed costs, additional revenue will contribute considerably to EBITDA and cash flows. I’m cautious not to make over-promises, but if we reach the quarterly revenue figures discussed, we anticipate noticeable cash generation and improved margins.

Thanks, I look forward to you achieving those targets and the profitability they promise. Have a wonderful holiday season, and I look forward to our next conversation.

Thank you, Dave. Kevin, do we have any other questions in the queue?

There are no further questions at this time. It appears there are no further questions at this time.

Thank you, everyone. I will leave the final remarks to Pasquale, who is a fantastic partner in this venture, as he genuinely supports the integrity of our brand while assisting us in its evolution. Please, Pasquale, share your final greetings.

Thanks, Antonio. First of all, thanks to you, Diego and Carlo, for the presentation, which has been very clear. As always, I am here with all of you, facing challenges. I am confident about the future of the company. Despite the challenging global economic situation, we have heavily invested this year in improving our retail system division, our wholesale division, and digitalizing all our systems with CRM. We have developed a new product and marketing plan which is yielding excellent results wherever our products are delivered. In conclusion, despite the challenging environment worldwide, we are confident that with our plans and programs, we will improve our business, no question about it. I’m lucky to have a great management team, which is crucial. Lastly, I would like to express gratitude to our shareholders who continue to support us—we will do our best to meet their expectations. Thank you, everyone, and Happy Holidays, Merry Christmas, and a wonderful New Year to all.

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

Thank you, everyone.