Earnings Call Transcript - NTZ Q3 2021

Piero Direnzo, Investor Relations

Thank you. Kevin. Good day to everyone. Thank you for joining Natuzzi's third quarter and first nine months 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 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.

Antonio Achille, CEO

Thank you so much Piero for your introduction. Good morning and good afternoon depending on the time zone to our analysts, investors, and potential investors attending this call. I'm here today with, beyond Piero, three other relevant people who will be involved in our conversation. The first person is clearly Pasquale Natuzzi, who is our chairman and founder, and I work closely with him on any strategy and organizational matter. The other person is Jason Camp, who leads our North America operation and has twenty-five years of experience in the sector. The third one is Vittorio Notarpietro, our longstanding CFO. Let me open the conversation with our press release which has just been released, to say that on one end, we are very pleased to see the growth of our product continue. That has not always been the case in the past; we're now on a positive trajectory with the last few sequential quarters, written orders are even stronger than invoiced sales. Invoiced sales were twenty percent above the third quarter of 2020 and fifteen percent above the pre-pandemic level of 2019. So the demand for our products continues to be strong across most geographies. What's interesting is that the branded products, those sold under our two brands, Natuzzi Italia and Natuzzi Editions, have posted a very relevant growth rate. They are forty percent above 2019 and currently represent nearly ninety percent of what we do. The company, which has gone through different phases in its history, is now clearly focusing on branding and increasing direct access to consumers, and this seems to be paying off in terms of growth. When it comes to fulfilling that demand, we have been experimenting with difficulties in keeping up with increasing demand. This is again a matter of availability of product, workforce in our plants, and third-party producers to meet the demand, which has been showing very positive momentum. These factors have pressed our P&L structure. The company has done a good job in mitigating that. In fact, our gross margin has increased to thirty-six percent versus thirty-two percent in 2020 and twenty-eight point seven percent in 2019. Despite strong increases in material costs, often double-digit increases for materials like leather and wood, we've managed to contain costs and even improve our gross margin by optimizing our purchases and reflecting some of those costs in our retail and selling prices. The challenge has been shipping costs, which are a relevant part of our cost structure. We’ve been able to pass some of these additional freight costs to our partners, but not always in a timely manner. As a result, we absorbed an additional five million Euros in one-off freight costs this quarter. The net result could have included that negative impact and been higher. There’s also an increase in our backlog, which can be viewed positively as it allows us to start next year with some revenue already secured. This backlog has increased by twenty million Euros, arriving at one hundred and ten million Euros. We have a significant backlog that gives us a good boost for next year. At the same time, we need to ensure consistent service levels across geographies. So, what you can read from our numbers reflects a good continuation of our trajectory to regain growth. This could have been even higher if we had managed the supply chain more effectively to fully capture this growth momentum. We are working not only to enhance the output of our supply chain in the short term but also to sustain our mid-term goals, which are significant in terms of top-line growth. We are focused on three main areas: securing material availability, increasing factory output, and enhancing strategic outsourcing. Securing material availability involves pre-booking some materials, especially those with a longer cycle. We are also looking into nearshoring to bring suppliers closer to our factories for some materials of strategic relevance. The second area is increasing factory output. We have production in Italy, China, and Romania. We are carefully working to boost output in each of those plants. In Romania, for example, we have added two lines and hired sixty people. In Italy, we are piloting a factory—this is an innovative approach integrating suppliers with our information systems—and in China, we are continuing to adjust capacity according to output. This is a long-term initiative. In the short term, we are facing complexities linked to higher-than-predicted uncertainties due to COVID. Our Italian factory, for instance, shut down for two weeks during August, which affected our third-quarter production capability. The third area we are exploring is strategic outsourcing. The company has historically produced everything in-house, which will continue for Natuzzi Italia, as we proudly produce in Italy, emphasizing ‘made in Italy’ as a key part of our value proposition. However, for Natuzzi Editions, we recognize the need for a more flexible supply chain model. We are looking at production locations in Romania and Europe for our European market, Shanghai and Vietnam for Asia, and Mexico for part of our North American demand. This transition won't happen overnight but will progressively deliver significant advantages in fulfilling demand. This is a transparent view of our quarter where we continue to enjoy strong demand—it continues as we speak. In the press release, you will see data for the forty-fourth week of the year, with written orders up twenty-four percent compared to 2015 and nineteen compared to 2019. As we speak, we are entering week forty-seven, and the trend of written orders remains robust. I hope to be more specific in the Q&A and be very transparent about the hard work we are doing to evolve, modernize, and enhance our supply chain and production.

Pasquale Natuzzi, Chairman

Antonio, you've been the best analyst that I've met in my life. You understand the strength of our company, the strategy, and your communication is outstanding. I can just confirm what you said and turn the floor over to questions.

Antonio Achille, CEO

Thank you, Pasquale. We don't want to sound overly complimentary before Christmas, but I can confirm that the management team, especially with the Chairman, is working closely on our strategic agenda. Let's open the floor for questions unless Jason or Vittorio feel the need to comment on what I just said.

Jason Camp, President

Ready for questions team.

Vittorio Notarpietro, CFO

Me too. Thank you.

**Operator, **

Thank you. We will now begin the question-and-answer session. Our first question today is from David Kanen. Please go ahead.

David Kanen, Analyst

Good morning. Can you approximate or quantify how much of that backlog is high-margin branded product?

Pasquale Natuzzi, Chairman

The branded business is growing, as Antonio said before, so according to that, the backlog is improving in quality.

Antonio Achille, CEO

My estimate, David, is that roughly the backlog is made up of eighty to eighty-five percent branded product based on the vintage of orders coming in from last year and this year. So, expect a significant representation of branded products in the backlog.

David Kanen, Analyst

I see that backlog was up twenty-one million dollars sequentially from Q2 to Q3. How much revenue do you think was lost due to the two-week shutdown for the factory during August? How much of that was supply chain-related?

Antonio Achille, CEO

Pending the result over these two quarters can be viewed as a picture or a part of a movie. If you look closely, we could have had higher revenues, as we have been fulfilling additional orders that were booked for this quarter. Our backlog is essentially postponed revenue and not lost revenue.

Vittorio Notarpietro, CFO

The delay in delivered sales, compared to previous plans, is significant—over thirty million Euros in potential sales that we didn't achieve due to the disruptions.

David Kanen, Analyst

Can you quantify how much can be attributed to the fourteen lost production days?

Pasquale Natuzzi, Chairman

We experienced production issues across multiple facilities due to the pandemic and excessive transportation costs. Finding vessel space is incredibly difficult now. If we can't ship components, we can't produce the final product.

Antonio Achille, CEO

To qualify the shortage in sales and deliveries, we had challenges everywhere, especially in Vietnam where lockdowns significantly impacted us.

David Kanen, Analyst

Starting in Q4, do you see working down the backlog and increasing revenues, assuming written orders remain robust?

Antonio Achille, CEO

We have a luxury problem—we are trying to empty the backlog but demand is always accelerating. Our demand in the fourth quarter shows no signs of weakness. We are set to see better situations regarding output capacity and marginality.

David Kanen, Analyst

Can you meet the additional demand with output, considering your strategy for growth in North America?

Antonio Achille, CEO

Yes, we have production capacity to meet demand. However, we need to carefully identify ideal locations for new stores to ensure every opening is successful.

David Kanen, Analyst

Can you provide an update on your KUKA JV?

Antonio Achille, CEO

We are engaged with our partnership and discussing how to extract maximum value from the JV, which continues to perform positively.

Vittorio Notarpietro, CFO

The JV has grown significantly, tripling sales since its inception and maintaining strong profits.

Unidentified Analyst, Analyst

Can you give your progress on the Mexico plant?

Antonio Achille, CEO

We are exploring two options in Mexico to support production. The first is a manufacturer for our quick program, aimed at reducing working capital in the U.S. We're targeting a launch in early 2022.

Pasquale Natuzzi, Chairman

We're analyzing the material costs in Mexico, but production is looking more favorable than anticipated. Several strategies are being implemented to meet demand.

Antonio Achille, CEO

We will continue to focus on elevating execution capability. We are committed to maintaining quality production for our brands.

Jason Camp, President

The results in Q3 have been encouraging, with strong performance from our best stores, comparing favorably to last year.

Unidentified Analyst, Analyst

What’s the strategy for e-commerce?

Antonio Achille, CEO

E-commerce offers significant potential for us. We just launched, and initial sales are promising. We're making efforts to promote and integrate online and offline sales channels.

**Operator, **

Thank you. That concludes today's question-and-answer session and today's webinar. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation.