Earnings Call Transcript - NTZ Q4 2021

Operator, Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Natuzzi Fourth Quarter and Full Year 2021 Financial Results Conference Call. As a reminder, in addition to the link already provided to join via video, interested persons can also join this conference call live via telephone by dialing in the following number: (+1) 412-717-9633, then passcode 39252103#. Once again the number is (+1) 412-717-9633, then passcode 39252103#. At this time, all participants are in a listen-only mode. Following the introduction, we will conduct a question-and-answer session and instructions will be provided at that time for you to queue up for questions. Joining us on today's call are Natuzzi's Chief Executive Officer, Mr. Antonio Achille; the Executive Chairman, Mr. Pasquale Natuzzi; Mr. Jason Camp, President of Natuzzi Americas; and Piero Direnzo, Investor Relations. As a reminder, today's call is being recorded. I would now like to turn the conference over to Piero. Please go ahead.

Piero Direnzo, Investor Relations

Thank you, Kevin. Good day to everyone. Thank you for joining Natuzzi's fourth quarter and full year 2021 financial results conference call. 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 SEC for a complete review of those reasons. 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.

Antonio Achille, CEO

Thank you, Piero, and good morning, good afternoon to everyone attending. I might briefly recap the key messages from the press release where Pasquale Natuzzi, Executive Chairman and I share our view on the ending of 2021 and key highlights on the fourth quarter. As you’ve certainly noted from the press release, we ended 2021 on a positive note. Top line sales have been 30% above the previous year 2020, and we exit 2021 stronger than the year before COVID. In terms of top line, we reported a growth of 10.4% versus 2019. In addition to these, we closed the year with €114.4 million portfolio orders, which is above last year by some €10 million. We could have closed in terms of top line even on a higher number if we didn't see such a stronger headwind from supply chain disruptions. 2021 also reported an improvement in gross margin where we closed at 36%, which is almost 7 points above 2019 where it was 29.7%. This was despite the need to overcome a spike in most of the raw material, which sometimes has been double or triple-digit in terms of price increases during the year. We ended 2021 with a profit of €4.9 million, compared to a loss of €10.6 million in 2020 and a loss of €22.5 million versus 2019. So we improved in terms of operating profit by €27.4 million versus 2019 and €15.5 million versus 2020. In terms of EBITDA, we closed the year with €24.9 million compared to €12.3 million in 2020 and €1 million in 2019. I often refer to 2019 because I believe that provides a more solid metric of comparison, as it was not affected by COVID. If we look at EBITDA, which is clearly an important metric in terms of value creation compared to 2019, the company improved by €23.9 million. Our cash position has also improved. We closed the year with €53.5 million versus €48 million in 2020 and €39.8 million in 2019. So I would say, overall, it was a year with strong momentum in the market, which provides some early signs that our strategy of focusing on retail and the brand, initiated by Pasquale a decade ago, is starting to show some results that are also satisfying for potential investors. We want to provide some brief highlights on how the year has started. In terms of order flow, the year started quite positively. Order flow, which means the orders we receive, not the invoices, sales are up 32% at week 12 and this is also a result of the strong momentum we are getting in retail in the U.S. where Jason will elaborate. Overall, we’re also posting the results for the fourth quarter. We are pretty much in line with the same trajectory with the exception of operating profit. At the level of operating profit, we reported an operating profit which was positive by €0.6 million, but was lower than what we wanted to achieve mostly because we suffered from a significant increase in transportation costs, especially towards North America, which we could only partially recover through our client invoicing. We reported in the fourth quarter €6.5 million of extraordinary one-off transportation costs versus North America. That's a bit of the key highlight for the economic performance. Other key messages I would like to share. Together with Pasquale, the Board, we continue working on the organizational side. As you might remember from our last discussion, we implemented an organization that is now centered on the brand. We now have two divisions. One which is fully responsible for the strategic merchandising of Natuzzi Italia, and one which is fully responsible for the strategic merchandising of Natuzzi Edition. Those divisions are increasingly exchanging views and opinions with regions to come up with the best distribution strategies we need to reach. Additionally, we created a division for furniture. As you might remember, we began our strategy to become a total lifestyle brand. We want to add a very convincing offering of furniture to our traditional strengths in upholstery. For this reason, we created a business unit. We have a new manager coming in next week who will be bringing substantial experience in the furniture sector. This is part of the idea of strengthening our leadership team. Other information I want to share with you pertains to our manufacturing evolution. The most important achievement that we are very satisfied with is the result of the pilot for our plant here in Italy. We're testing really state-of-the-art technology borrowed from the automotive sector, something that is not yet commonplace in our industry, which is providing very exciting results. Once stabilized, these technologies will be the standard base for all our direct factories, not only in Italy, but also in China, Brazil, and Romania. To note on our joint venture, as you're aware, we have been in a JV since 2018 with Kuka Furniture for the commercial development of China. In that JV, Natuzzi S.p.A. holds a minority of 49%. Hence, we don't consolidate line by line. The JV is proceeding very well on all dimensions. Last year, we added 84 new stores in franchising. We're generating profits that are more than double that of last year, and the JV maintains a significant cash position that we are discussing how to make accessible for this pension plan on Natuzzi S.p.A. Another positive highlight that will be subjected to a specific press release is that we eventually closed, as planned, a joint venture for the development of the rest of Asia Pacific with a very prominent player in the region, which acquired 20% of Natuzzi Singapore for an investment of $5.3 million. This JV will be a platform for commercial development in the rest of Asia Pacific, and will also serve as a basis for strengthening our local operations. Let me stop here and provide an executive summary of what you received, and I welcome your questions and observations.

Operator, Operator

Thank you. David Kanen, your line is now open.

David Kanen, Analyst

Great job in transforming the company. So first question is in regard to transportation costs, which were up quite a bit. We track a number of companies in the logistics area and what we're seeing is signs of declines. Could you comment on that and what you're seeing?

Antonio Achille, CEO

Let me comment first. Thank you for the call out, David, for the position we’re in. In taking your question on transportation, let me quickly comment on the fourth quarter events and what we are witnessing. In the fourth quarter, we experienced a strong spike in transportation, especially toward North America. Our strategy is to transparently pass over these costs to our partners in the form of freight surcharges. What happened in the fourth quarter is that the speed of increase in freight costs did not allow our system to adjust rapidly enough. But now we have corrected that by making some of these price adjustments regarding freight surcharges more automatic. Regarding what's happening, we do see a flattening of those costs. The situation remains very fluid because, as you are aware, we are experiencing significant turbulence caused by the ongoing war and related issues, particularly in China. The price of oil is above $100. So at the moment, we see some stabilization in certain geographies, but we remain very vigilant because we cannot definitively say that the situation has been stabilized or not. Pasquale, having been in the industry for 60 years, I'm sure you've seen more of this turmoil. I don't know if you want to comment on transportation prices as well.

Pasquale Natuzzi, Executive Chairman

No, I've never seen in my 60 years of experience anything like last year and obviously even this year. Transportation is really complicated; it's very complicated because the prices are unpredictable. Unless we are willing to pay very high prices and sign contracts. To be honest, during this uncertain time, we are closely monitoring the business, at least from the transportation cost perspective.

Antonio Achille, CEO

What we made very clear to every business responsible is that the margin is the top priority, especially in light of such a strong portfolio order flow and also strong fourth quarter demand. So every business leader, and of course the U.S. is very important in that aspect, has really been incentivized to pass on these kinds of extra freight surcharges in a timely manner. We're paying a lot of attention to avoid surprises at the end of the quarter, as we experienced last year. This is a bit of how we are reacting to the situation, but very clearly, Pasquale mentioned the dynamic nature of the issue.

Pasquale Natuzzi, Executive Chairman

You explained it better than I, Antonio. Well said.

Antonio Achille, CEO

No, no, no, Pasquale.

Operator, Operator

As there are no further questions at this time, I'll turn the floor back over. David, your line is now live.

David Kanen, Analyst

I apologize for the follow-up questions, but I have quite a few notes. Regarding your backlog, I observed that even with the increase in written orders, the backlog rose by about $4 million sequentially. In Q1, orders increased by around 31%. We own a European furniture company based in the UK, and they recently informed us that their lead times from Asia have decreased from 20 weeks to 13 weeks. This suggests that there are signs of improvement in the supply chain and logistics bottlenecks. Could you comment on this in relation to Natuzzi? Is it reasonable to expect that in the next three to six months, we might see you begin to reduce your backlog? My calculations indicate that if you continue to write orders of approximately €115 million or more, and if we normalize the backlog, we could see significant revenue growth. Can you provide insight on this, and whether you are noticing a decrease in lead times, or if there is an expected timeline for that?

Antonio Achille, CEO

I think it’s also a matter of reading carefully what others announce because the backlog is clearly a function of two elements: how fast you're able to pull orders out, which means how fast you're able to accelerate your production, and how much additional running water gets into the sink. For Natuzzi, we were extremely positively surprised by the strong start of the year. The water— the additional running water has been strong. In terms of additional production, we have a very articulated production footprint, which will constitute an advantage long-term. We have been able to catch up quite substantially. However, since last week, the production in China, which is crucial, especially for Natuzzi Edition for North America, is affected due to COVID. As you probably know, this is a broader issue. For example, Foxconn, which produces the screens for iPhones, has halted production near Shanghai, impacting Apple as well. We are working very hard. We need to recognize that while the additional running water seems to not stop, the opposite is true for production. For instance, we were not expecting these lockdowns in China due to stringent measures being enacted. It’s already been the second week that the government has postponed the reopening of the Shanghai area. For us, there’s no immediate solution to that, as reorganizing the supply chain in another district, such as Vietnam, is not an overnight process. So, to your question, Dave, we are really working hard, because not only will that mean additional revenue, but will also lead to better service to our customers and clients. Currently, we haven't been able to reduce lead times for special orders. We're addressing this challenge seriously but cannot say it's all resolved at the moment.

David Kanen, Analyst

Okay, thank you for that update. And I noticed that branded product represented 88% of revenue for the quarter. I know branded traditionally has much higher margins, around 70%. Do you expect branded to exceed 90% at some point this year? Additionally, regarding our blended gross margins, can you speak to how the investments in technology and automation will affect our gross margins in the future, especially considering the company's increasing share of branded products?

Antonio Achille, CEO

Thank you, Dave. This allows me to answer a bit in a structured manner regarding margin expansion, which I believe is very relevant to U.S. investors. We see three main avenues for margin expansion, and you touched on a key point. The first is the brand mix. As you pointed out, we continue to increase the relevance of the branded business compared to the unbranded. Just to put it in perspective, Natuzzi Italia has a margin that is 10 percentage points higher than the unbranded business. Each dollar we shift from unbranded to Natuzzi Italia significantly improves our margins. As you mentioned, we are at 88% branding, and we developed a five-year plan where reinforcing the branded business is central. We expect to continue marginally increasing the relevance of the branded business in this year, and we have a strict cutoff that we will not accept any unbranded business that doesn't meet our minimum profitability standards. Last year, we dropped some significant clients that did not meet our new minimum profitability requirements on their branded business. The second avenue for margin expansion is retail. I will later ask Jason to comment, but retail is especially increasing in North America where well-performing stores combined with manufacturing margins lead to integrated margins exceeding 70%. This is also central to our five-year business plan. The third lever is what you mentioned; we are looking to enhance efficiency and digitalization in our production. Through the pilot for our innovative manufacturing process, we are finding opportunities to significantly improve productivity and efficiency. In agreement with Pasquale, we've also learned to simplify our product offerings, a key factor for resolving inefficiencies in the supply chain. We expect that the combined effects of simplifying collections and enhancing production efficiency will yield productivity gains in several percentage points. Those are the three levers we are activating to achieve margins that are more attractive for any investors in this company. I hope I addressed your question. Jason, could you comment on retail performance in 2021 and some initial highlights from 2022?

Jason Camp, President of Natuzzi Americas

Sure. Happy to do so. For the first 12 or 13 weeks of the quarter, North American retail showed a strong performance. Our 12 company-owned stores, on a comparable store basis, grew about 25% in order flow compared to the year before, almost doubling compared to 2019. Our top six stores, which last year were pacing at $4 million, are now pacing at $5 million. We are very pleased with our start and working hard to ensure the rest of the year continues this positive trend.

David Kanen, Analyst

Okay, thank you for that update, and congratulations. To finish my question, Antonio, do you expect that in 2022, branded products will surpass 90% of your overall mix? Or is this more of a 2023 event?

Pasquale Natuzzi, Executive Chairman

Antonio, you are on mute.

Antonio Achille, CEO

Sorry, guys. Historically over the last few years, we have added 1 percentage point of branded business each year. I expect this trend to continue in 2022, at the very least.

David Kanen, Analyst

Okay. Given the JV in Singapore looks promising, I will save that for another call. Can you comment on the China JV? It appears there's a significant amount of cash there now, and it's performing exceptionally well. My analysis shows we may have $10 to $12 of value in the China JV, while our core business, a $500 million to $600 million profitable growing business, seems to be transitioning at no cost to us. Can you discuss the potential for monetization, perhaps a spin-off or other ways for Natuzzi shareholders to realize value from these exceptional results?

Antonio Achille, CEO

Thank you, Dave, that is clearly a central topic. It is part of the Board's discussions and the ongoing talks we are having, especially with the Executive Chairman. You are correct; China shows very positive news for everyone and is on a fantastic growth trajectory. We discussed a three-year plan and expect to accelerate the growth. Now we must see how COVID will affect 2022 in the short-term. Long-term, there is a lot of confidence in delivering. Currently, the JV has around €62 million, approximately $67 million in cash, about 30% of the total revenue of the JV. This level of cash is crucial for the company's needs. The future business plan anticipates increasing cash levels, not decreasing them. The important question is how to best value this cash for the benefit of Natuzzi S.p.A. shareholders. We envision two potential approaches sequentially. The first is to reduce the cash level through a capital reduction so this cash can be utilized for Natuzzi S.p.A.'s priority needs, including opening more stores and accelerating factory restructuring. This topic has been discussed with the Board. As you can expect, we are working to find an agreement with our counterpart. A first proposal has been made, and we are still iterating on that discussion. I believe it could be a good option to pursue an IPO. We've brought this idea to our partners, who are a listed company (Kuka), and they are receptive to exploring this avenue. While we do not anticipate this happening in the current year, it remains an ambition. Additionally, I know Pasquale shares my excitement about the potential to list the company in China separately, capturing the story of a branded European company growing double digits in top-line margins while holding a leading position in the market. This could be a very natural and advantageous scenario for translating the JV's value.

Pasquale Natuzzi, Executive Chairman

You covered everything, Antonio.

Antonio Achille, CEO

Thank you, Pasquale. But to reassure you and the other investors, we are not overlooking this matter. It's evident, and I know you're well-versed in the dynamics of China. The minority stake's execution speed relies on how quickly agreements can be reached with our counterpart. Hence, it isn't entirely within our control.

Operator, Operator

Our next question today is coming from George Melas from MKH Management. Your line is now live.

George Melas-Kyriazi, Analyst

Congratulations on the transformation of the business; it's truly impressive. Thank you for providing detailed reporting on all aspects of the business. I believe you're making a genuine effort to educate us, and I appreciate it every time. I have two quick questions. First, could you update us on the progress regarding manufacturing in North America and Mexico? Secondly, Jason, congratulations on an excellent 2021 for U.S. retail. Could you share some insights into your plans for 2022 and 2023?

Antonio Achille, CEO

Okay. George, I might start on Mexico. And then I'll leave Jason to comment on retail. We are heavily looking into Mexico. Keep in mind that Natuzzi has a 60-year history, so when we make a direct investment decision, we consider these across cycles. This ensures that we’re making opportunities for investors that are not just for the next three months or the next 30 years, especially regarding direct investments. It is important to note that Mexico, considering today’s extraordinary logistic costs from Asia, presents a compelling opportunity. However, we remain cautious about Mexico and are rather determined. Presently, we have started production through outsourcing with a leading player, FurnMaster, a listed Danish company, which operates in the Monterrey area for a subset of products under the Natuzzi Editions quick program. We are testing this with 12 top partners to ensure that this meets our quality standards, which we invest a lot of time into, and is also commercially viable. Should it work, this quick program will set a standard for a larger number of clients in North America and drastically reduce logistic time from 16 weeks to 4-5 weeks. When considering direct investments, we want confirmation from our outsourcing experiences that it makes financial sense, not only for this current cycle—where it’s clear it would due to lower transport costs—but also for the longer-term. That said, we are currently active in outsourcing, and we remain operational with our clients. As for direct investment, we are exploring opportunities but are not yet committed to any direct investment.

Jason Camp, President of Natuzzi Americas

Good morning. Happy to do it. If I understand your question, you are interested in the pace of our retail store count growth in the U.S. As we mentioned, we have 12 Natuzzi Italia stores that we manage and consolidate the full retail sales and P&L in the U.S. These stores had impressive performance this year, up 25% compared to '21 and nearly double compared to 2019. From a store opening perspective, considering our total store count across both brands, whether independently owned or managed by us, we have around 20 stores in North America between Natuzzi Editions and Natuzzi Italia. We plan to open about 10 stores a year for the next 3-5 years, and we are on track for this year. This summer, we will issue a dedicated press release about our store openings and specific locations going up in Q3 and Q4. We opened two Natuzzi Editions stores in the first quarter, one in the Dallas Metro area and the other in the Palm Springs area. I hope that answers your question, George.

Antonio Achille, CEO

To reiterate, Jason, we’re not in the business of advertising, but we have weekly retail meetings where every country presents their retail dynamics. We had one last Friday, and I was quite encouraged by seeing several projects where clients came to our stores not just for upholstery pieces or sofas, but for comprehensive solutions for their homes, which is increasingly becoming a regular way for us to do business. Michele Griner, our Retail Manager for North America, presented two projects, both above $800,000 each, and the average order ticket in those scenarios has been approximately $100,000. We have now an average order value for Natuzzi Italia, which stands at $8,500 and is growing. We have clients who are buying comprehensive solutions rather than just a piece of furniture. This is of course a very interesting avenue for growing store profitability. Perhaps, Jason, if you have any additional insights to add, you may feel free to do so.

Jason Camp, President of Natuzzi Americas

A major part of our strategy involves building our strength and reputation to bring our brand to life in an inspiring way. This means ensuring we cultivate talent in our stores and showrooms capable of designing complete rooms and sometimes entire homes for customers. This initiative helps us enhance customer loyalty and increase our average order size, which is vital to our growth strategy.

George Melas-Kyriazi, Analyst

Yes. But at the same time, other distribution channels continue to grow as well. You are maintaining and even expanding on those channels. For example, if I look at galleries, galleries represented €157 million in '21, compared to €137 million in 2019. That shows nice growth across the portfolio of distribution channels. Could you comment on that?

Antonio Achille, CEO

George, based on the data we presented, the weight of retail, which includes U.S. direct-operated stores and franchising, is significant. In 2021, this segment made up 49.2%, an increase from 43% in 2019, representing a 6 percentage point increase. When considering total sales, which encompasses the rest of our business, it has remained stable in 2021 compared to 2019. However, as overall business increased, the percentage of revenue from that segment decreased. Our movement toward the U.S. retail sector is quite clear. A well-executed gallery, which presents our brand properly, is favorable for us. Our aim is to elevate distribution from a mere product-focused approach to a more experiential approach. We continue to increase the weight of retail in our distribution strategy.

Operator, Operator

Our next question is coming from Robert Marcin from Penn Capital. Your line is now live.

Robert Marcin, Analyst

Thanks, guys. Could you comment on how the U.S. store openings went last year and whether we hit our target or not?

Jason Camp, President of Natuzzi Americas

Last year was a year where we opened one store: a Natuzzi Italia store with a great partner in the Dallas market. I can confidently say that this store is performing above our modeled expectations, and the momentum is building for this year in terms of store openings.

Robert Marcin, Analyst

Did store openings spill over from last year into this year? Is the 10-unit number realistic, or does that need to be adjusted given the combination of two years?

Jason Camp, President of Natuzzi Americas

It is fair to say we had intended to open more stores last year than we did. I believe we now have the team and broker network in place to operate at the pace we've set moving forward.

Robert Marcin, Analyst

Thank you. The shareholders look forward to those 70% gross margins flowing through the income statement as quickly as possible. My second question pertains to margins in general. The last time I participated in this call, I asked if you might consider providing an intermediate-term margin target for us. I looked last quarter—just so we could have a general sense of where the business might settle when it is executing optimally on all fronts, and when we’re out of pandemics, wars, and oil shocks. Some companies do lens this intermediate target just to illustrate their anticipated earnings under optimal conditions. For context, I recall Restoration Hardware achieving 17.5% after-tax margins, while Facet Furniture generated 3.6%. I would assume you would aim closer to the former than the latter when the business is operating efficiently. Can you provide any insight into your potential operating or net margin target for the next 3-4 years?

Antonio Achille, CEO

I remember your question quite well, and I understand your appetite for this type of information. Let me be transparent; we approved a 5-year plan around four weeks ago, which sets our trajectory. Pasquale, myself, and the entire team are committed to this plan, which includes not only strategy but also numbers and P&L expectations over the next five years. Ultimately, we have internal expectations and targets driven by substantial top-line growth, aiming for double-digit growth over five years, alongside achieving margins that, as you mentioned, will be in the high single digits rather than low. Providing guidance is a delicate matter, and we want to ensure it conveys the correct direction to investors. As it stands, the global situation remains uncertain. Delivering an accurate forecast for the current year is challenging as we encountered strong initial momentum, but events are continually shifting, such as the war; it is contaminating not just Europe but affecting China and the reopening landscape. We are firm in our plan for substantial growth and margin improvements as aligned with European peers in the branded business we are operating in. While we are deliberating on precise numbers, we take your request seriously and will work towards addressing it in the next call.

Robert Marcin, Analyst

Thank you. At the very least, we have a 5-year plan that entails significant growth and margin improvement. I hope the Board includes compensation bonuses for senior management aligned with this plan.

Antonio Achille, CEO

Okay.

Operator, Operator

As there are no further questions at this time, I'll hand it back to management for any closing remarks.

Antonio Achille, CEO

Thank you, Kevin. It seems there are no further questions at the moment, so we can conclude the conference call right now. Thank you, everybody, for joining the call. If you have any further questions or concerns, please reach out to me via email or a call. Thank you all. Goodbye.

Operator, Operator

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