Earnings Call Transcript - NTZ Q4 2023

Operator, Operator

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Natuzzi Conference Call for 2023 Fourth Quarter and Full Year Financial Results. As a reminder, interested parties can join this conference call live also via telephone by dialing in the following number +1-412-717-9633 then Passcode 392-52103#. In addition to the link already provided to join the video. At this time, all participants are in a listen-only. 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 today are Mr. Antonio Achille, Natuzzi's Chief Executive Officer; Mr. Pasquale Natuzzi, Founder and Executive Chairman; Mr. Carlo Silvestri, Chief Financial Officer; and Mario de Gennaro, Chief HR, Organization and Legal Officer; Mr. Diego Babbo, Global Retail Division 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.

Piero Direnzo, Investor Relations

Thank you, Kevin, and good day to everyone. Thank you for joining the Natuzzi's conference call for the 2023 fourth quarter and full year financial results. After a brief introduction, we will give room for a question-and-answer session. Before proceeding, we would like to advise our listeners that our discussion today could contain certain statements that constitute forward-looking statements under United States 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 last 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.

Antonio Achille, CEO

Thank you, Piero, and good morning everyone and good afternoon to people who are connecting from Europe. Let me start to briefly discuss the figures of the last quarter of '23 and the full year of '23. Then, I will provide together with my colleague, an understanding of what we are doing in our long-term objective. So starting from the last quarter of the year, we reported a decline in sales. It's important to consider this decline in perspective versus 2022, where throughout the year and especially in the last quarter of 2022, we had a stronger backlog. If we net the performance of 2023 last quarter from that effect, the decrease is still significant but is in line with what we observe in the industry in general, given a very tough market for durable goods and furniture in 2023. Despite these clearly tough market conditions in 2023 last quarter, we worked to accelerate our transition to becoming a brand retail company. In particular, in the last quarter, we have reported sales from branded goods in excess of 92%, which means that basically our entire sales are composed of branded sales either Natuzzi Italia or Natuzzi Editions. The percentage was 85% at the beginning of 2021, so a step acceleration. Equally regarding retail, that if you wish is the natural consequence of becoming a brand company. Retail on total sales has been nearly 60%. Diego, can you put that on silence, please from 52, which was the reported in 2021? I will discuss later, but I believe this is a very important element because Natuzzi is completing a transformation as investors or other people interested in our story. Now we should really, in full, look at Natuzzi as a company which has been investing for more than 20 years to establish itself as a globally recognized brand, especially with Natuzzi Italia in the high-end segment of the market. This also implies that we had to invest and we will comment later, also with the help of Diego, to evolve our tools and organization really to control this retail and branded business in a manner that before was not required by the company. The other area which becomes evident in 2023 last quarter and more in general in the full year is that we are executing and accelerating on our restructuring plan and effort. In 2023 last quarter, in fact, we accrued EUR5.9 million of one-off restructuring costs for intervention that will become, from a cash perspective and from a benefits perspective, fully visible in the following year. In the last quarter, our gross margin, net of this one-off restructuring activity has been of 36.2%, which compares with 38.8% in the last quarter of 2022 and compares with 34.6% in the last quarter of 2019. So we are still on the trajectory of improving margin. Clearly, the effect of having sub-utilization in the factory has a partial impact on the margin. These key figures on the last quarter of 2023. Looking at the full year, I would say the key underlying elements that apply to 2023 are pretty similar, in the sense that for us as for the majority of the people we compete with publicly, the result 2023 has been a year where after two years of very strong demand, given the implications of real estate and low consumer confidence, we witnessed a lot of postponement in purchasing. Again, this caused a decrease that if compared with 2022, net of backlog is significant but in line with what we observe from competitors. We discussed about restructuring. Let me give you a few numbers to illustrate the size of what we're talking about. In 2023 only, we reduced our team, especially from the factory by 514 units, which brings the total reduction from the beginning of 2021 to 759 units equivalent to 17.5% of the total workforce, which I believe is a significant achievement because in most of the jobs where we operate, starting from Italy, there are very rigid labor laws. Every step needs to be accurately planned and executed. And we did so avoiding any kind of turmoil in our environment. This restructuring will produce yearly benefits of EUR22.5 million in running benefit and labor cost compared to 2021. In 2023, we also kept investing some EUR12 million, of which EUR4.6 million in retail, we opened nine new stores, and EUR7.2 million in the area of factory enhancement. So these are the key highlights on numbers and figures on which then our CFO will provide some other details. In opening the Q&A, I would like to give you a more holistic and strategic perspective. It is clear and evident that the results reported in 2023 are an effect of adverse market conditions for furniture. The figures are well below our mid-term target and our potential. Having said that, there are tricky messages I would like to share and elaborate on. The first one is now that we have already completed the transformation to become a branded company. As I mentioned, nearly 93% is branded, which is a huge achievement considering that the company has been investing 20 years to arrive at this point. The second element is that we have invested to excel in distribution. Distribution for us is both the retailer where we mean the U.S. direct to retail in franchising and, which is very important for us, wholesale of branded products that we distribute through a format called gallery, which again is a controlled format where we express the right merchandising and the last element, as I mentioned, the transformation which we've been working on very hard to prepare in the last few months in this year is getting to a pace that we will continue and accelerate in the following year. To get some more detail, talking about the retail front, we now have 680 stores with the Natuzzi banner, being them Natuzzi Italia or Natuzzi Editions, being them U.S. or franchising operator. From a customer perspective, those are stores. We have approximately 600 galleries, which are store-in-store. For us, both deserve equal attention. For the first area, the stores, we have worked very hard to learn how to do retail and really control the sales at a sellout level. Doing so required quite a significant program of investment, because historically, the store was just an account number. We didn't really have an understanding of what was happening in the store. Now we have a very timely and punctual understanding of what's happening in the store in terms of people getting in, people buying, and what they buy, and this for our transformation to become a consumer-centric company is invaluable. To support this knowledge and progressively spread it across our market, we created not only systems but an organization. In particular, some 12 months ago, we created an organization called the Global Retail Excellence Division, which aims to absorb best practices, codify them, and make them available first to our directly operated stores but progressively also to our dealers, because we want the experience and the productivity at the dealer level to be energized. Let me invite Diego Babbo for a brief illustration of some examples of what we do under this chapter of the Global Retail Division.

Diego Babbo, Global Retail Division Officer

Thank you, Antonio. Good day to everyone. Just briefly, let me introduce myself while I'm attending this call for the first time. On top of my previous experience in the retail downstream within the old company sector, I've been working for more than 20 years now in this company, embracing many roles within our retail environment from purchasing to construction and development. I can witness the effort that Natuzzi put in place to sustain the transition from manufacturer to retailer and a lifestyle brand, which had to do with cultural and mindset evolution for the majority of us, supported through the adoption of new tools and routines. This is exactly what the retail division established last year is about. Our goal is to set up appropriate retail processes and guidelines to generate consistency within the brand experience and ultimately increase store profitability. Our willingness is to partner with each regional manager in assisting him or her to achieve their retail network expected performances. Let me give you examples of some recent achievements. We have recently launched a state-of-the-art 3D room configurator, which is allowing a more efficient interaction at the store level within the local trade community. We have also revised the compensation scheme for the store manager and design assistance, which together with the launch of a sales contest for the global DOS network is intended to boost performance and a sense of belonging for our end. We are also cherishing our store staff by addressing their training needs through a brand new online platform boosted with an artificial intelligence-driven multilingual live translator, which will allow for the first time ever to reach all our network. On top of the classroom sessions with more than 300 attendees already set up. Leveraging our store staff has already proven to achieve very good results in some of our more representative stores with double-digit growth, for instance, in our ambassador stores in New York and Madrid. Back to you, Antonio.

Antonio Achille, CEO

Thank you, Diego. Just in synthesis, I mean to make a long story short, the Global Retail Division has the objective to improve organic performance because they have to fix that with 600 stores, and then we'll discuss all of the stores in China, the upside potential that we have by simply working on organic growth. Then I mentioned branded wholesales. As anticipated, 40% is still distributed within wholesale branded products. That for us is still a very important strategic part of the business. So for that, we developed what we call the Natuzzi commercial excellence program. What it's about? Basically, two things: One is standardizing the format so we define a new brand gallery format. It's a kind of business card of Natuzzi in a multi-brand environment. Given the confidence we have in our brand, we want to have a special role in positioning on the floor, which means that the shopping environment and the brand presentation need to fully express the potential of the brand like it happened in our stores. We really invested in these topics, again with organizational people appointed. Secondly, the commercial excellence program aims at daily improving the performance of our commercial team. We have 304 people with different roles in the organization, some direct employees, some other agents, which are dealing with clients and dealers. So we are standardizing the methodology they should approach these dealers, but also, we are setting very clear productivity targets and budgets by dealer that can be managed centrally, as Natuzzi is a very spread organization and we realized that we needed to reinforce control from the center. On the retail front, it is very important to show a concrete sign of our commitment to that. In 2023, a year where a lot of companies cut investment, we actually opened nine stores, of which six in North America. A store name can be very different. The stores Natuzzi opened 30 years ago are very different from what we opened now, especially in the North American market. We really strive to have senior locations and retailer infrastructure environments. An example is Manhasset, which is on Long Island, known as the Miracle Mile because it really connects Manhasset to the Hamptons, and is one of the areas with the highest productivity. There we opened an absolute flagship, which is a very iconic new store and is an example of what we are now doing when we talk about new stores for Natuzzi Italia. These are major investments in appropriate locations to fully express the potential of the brand commercially and from a brand perspective. Shifting gear to the restructuring. Before that, let me provide some comments on individual markets. Now as we know, as we discussed, we're operating under market conditions. Let me provide some insight into the most important markets of U.S., China, and Europe. In the U.S., our focus remains very high. We believe is one of the highest priorities and opportunities we have, where the company is listed, and is where the company found its way of doing business. We opened 632 branded stores, one franchising, and an additional seven galleries. There is quite an interesting pipeline of new gallery openings as we speak. We also stabilized the organization with Lou Mossotti taking on the baton from Jason Camp, as announced in the press release of March 7. Lou Mossotti has more than 20 years of experience in North America and has been with us for over two years, really coming from the same team as Jason Camp. Scott Kruger is developing the branded wholesale business. To accelerate this effort, we have now 24 independent agents covering the states where we did not have a direct representative. This is based on the belief and certainty that the U.S. is a large opportunity, made up of significant states. Currently, Natuzzi is no longer distributed, but we've been distributed successfully for more than 30 to 40 years, and there is a clear business case for coming back. The other market where I would like to provide some background is China. Out of the 680 stores, more than 346 are in China. First, I want to provide some insight on how to read the number of stores and the productivity of stores. The stores belonging to the JV, where we don't have the majority, are not consolidated. When assessing the productivity of retail, it is important to carve out those stores because for the Natuzzi Italia stores, which are 96, we report in our P&L. For the Natuzzi Editions stores, which are the majority, we report in our P&L only the cost of production plus a mark-up. As a financial shareholder, we take full benefit of the growth of the JV. In the journey of becoming a global retail company, we recognized that the JV needed to be more integrated. This happened through our direct presence; for instance, I've personally been to China, and so has Pasquale, several times. The team is now really working with the same approach when it comes to retail, merchandising, and visual presentation. We are very excited to welcome 24 top dealers on Natuzzi Italia to the upcoming Milano Design Week, which is a special opportunity for brand positioning. This year will be extraordinary as Natuzzi celebrates its 65 years of heritage, and not many companies can reach that milestone. China is now integrating our IT system, and we can see the performance at dealer levels. This is a significant achievement and serves as the foundation to increase the performance of our China operations through our JV team sitting in Shanghai. Regarding the two largest markets, I was anticipating the restructuring. Restructuring for us is crucial. It comes from the journey we are taking. We have to mention that Natuzzi was historically a massive production platform, producing also for other third parties. Just to name one was a client a few years ago, IKEA. This reflects the capacity of production but also the capabilities to shift from producing that kind of product to focusing on high-market goods. One of the implications is that we no longer need that much capacity. Executing a restructuring is never easy; in Italy, it is almost impossible. However, we are achieving it step by step, and it is becoming visible in numbers. We let go of 759 people, of which 260 are in southern Italy. Typically, when you touch this kind of subject, you encounter strikes, but we achieved this without any strikes. We're looking at net savings of EUR22.5 million. I'd like Mario, who has been a significant driving force in leading us through this restructuring, to provide more insight into what we've achieved so far and what we aim to accomplish with the full restructuring of our operations.

Mario de Gennaro, Chief HR, Organization and Legal Officer

Thank you, Antonio. Good day to everybody. Just a few words before introducing myself, as it's my first time joining this event. I have over 30 years of experience in different contexts such as large corporations like Unilever and other listed companies, and I'm quite comfortable managing situations requiring deep experience in heavy industrialization, like in Italy but not only in Italy. In all my experience, I have always managed restructuring, change management, and transformation projects. Antonio has already highlighted the most crucial figures of our transformation journey, so I don't want to repeat them. What is important for me is to underline that this is not just a reduction plan; we are managing a fair approach to redundancy and an important transformation for the rest of our colleagues. In particular, we are managing an important training program for all our people, upskilling and reskilling for the digital challenges we will face in the next future. In Italy, during 2023, we provided more than 100,000 hours of training for our colleagues to realign their competencies, not only in the commercial side but also in the factories, because we have invested significantly in creating a way of managing our production in terms of 4.0 transformation. Another important point, as Antonio said, is that we have to deal with different legislation. In some cases, it's simpler to manage a reduction of workforce; in others, it's more complex, and we must approach everything with the usual ethical and cultural attitude that Natuzzi has. Indeed, this is also the reason you see an acceleration in 2023 for the number of people we supported in their exit. This is due to the fact that we spent several months negotiating a good agreement with the Italian government, the local governments in other countries, and the unions to manage redundancy without any claims or strikes. This will be our approach in the next few years. In Italy, we are using a specific measure that can be considered a sort of early retirement, and this is the reason you see that we accrued the entire cost of redundancy for those people, but the cash out will occur over the next five years. Thank you, Antonio.

Antonio Achille, CEO

Thank you, Mario. I'm sure there might be questions later on. I suggest Carlo briefly comment on some of the figures we mentioned and then we open up for the questions that I'm sure our audience has.

Carlo Silvestri, CFO

Good morning, everyone. Thank you, Antonio, Mario, and Diego for your notes. I will quickly go through some of the numbers. As Mario was mentioning, we are talking about EUR74 million of restructuring costs; it has to be noted that the accounting principles impose us to accrue such labor restructuring as soon as the corresponding liability arises towards our employees, and the majority of such liabilities arose in the fourth quarter. So in short, it was planned, but we could not prove it in the previous quarter. From the financial perspective, we have paid almost half of it, and the other half will be paid in the next five years. This, of course, impacted the way we want to look at our gross margin. Antonio provided a homogeneous comparison by deducting all the impact of this restructuring cost in the previous year's last quarter. I will provide it for the full year. If we neutralize this effect, 2023 closes with a gross margin of 36.3% versus 2022 at 35.6%, 2021 at 36.2%, and 2019 at 31%. So confirming the improvement and cost control we achieved in gross margin in the previous year. How did we achieve that? Not only because we managed to align the level of purchases to consumption to the new sales volume, but also because we did achieve better inventory management and continuous renegotiations of the supplier conditions. This goes for all the industrial costs that we manage according to better cost-controlling activities. Briefly talking about operating expenses, particularly about selling expenses and administrative expenses, we can see in our numbers that the selling expenses have included expansion in terms of retail network and hiring to improve the quality of our personnel. We were able to almost compensate for the lower volumes, and the overall selling expenses passed from 26.7% in 2022 to 27.8%. Also in this case, through various negotiations, especially regarding transportation costs. For administrative expenses, we had an increase overall of EUR2.1 million, bringing us from EUR7.7 million in 2022 to EUR11.4 million. This will need our attention, and we are working on it as it will be one of the focuses for the managers in 2024. However, this can be partially justified by how we invested in 2023, specifically EUR400,000 for further digitalization and EUR800,000 for accruing workforce reductions. Lastly, our net finance cost accounted for EUR9.3 million in 2023, compared to EUR8.5 million in 2022. We lowered our average outstanding bank debt by 7%, but were negatively impacted by the average increase in interest from EUR4.4 million in 2022 to EUR6.2 million in 2023. I will now leave the floor for questions.

Operator, Operator

Our first question today is from Dave Kanen from Kanen Wealth Management.

Dave Kanen, Analyst

The first one is in regards to China. I know the government has been working on different stimulus measures, including lowering interest rates. Have you started to see an inflection there where things have bottomed and they're starting to turn up?

Antonio Achille, CEO

Let me comment on China because I feel equipped. Dave, I spent, I believe, three months out of six in China. During those months, we were really visiting stores, so I visited 70 stores. A fair share of those are in what we call furniture malls, which you can visualize as what in the U.S. would be a department store, where each floor contains a different category of furniture. The traffic is still very low. China is a market that needs to find its way to full recovery. I believe you are very insightful; you have witnessed what happened to Evergrande and are following what's happening with much larger firms, which are reportinga 30% loss of Gucci in China. For durable goods, you can imagine it's even more sensitive, given the loss in spending compared to fashion. In summary, for Natuzzi Editions, which is more our affordable brand, we see some initial signs of rebounds, but for Natuzzi Italia, not yet. We are working to best use the upcoming Milano Design Week to reengage with our key dealers. We are confident that the strength of Natuzzi in China will definitely pay off because we are by far the largest distribution company. Our competitors have only a few dozen stores, while we have 350. So we are highly confident China will provide a strong upside. The exact timing of when this will become strongly visible on our P&L is still uncertain in terms of weeks and months, primarily because of the macroeconomic and consumer environment in China.

Dave Kanen, Analyst

In the rest of the world, especially North America, have you started to see stabilization or with written orders, a little bit of an improvement to start 2024?

Antonio Achille, CEO

In North America, we see signs of improvement regarding the performing area of the business. They are performing stronger in 2024. We are still dealing with a tail of overstocking in the channel, but compared to China, I think it’s legitimate to expect a faster rebound in the U.S. We also, as we speak, Mario is in the U.S. Again, we are closely monitoring what we can do to better support our team. Starting today, this week will be the high point market for the wholesale branded business, where again, we believe we have a very strong and compelling offer to bring to the market. On the retailer side, we are working one-on-one to bring quickly up to speed the new openings on the historical stores, and performance has definitely improved. For instance, if we take the first three stores in terms of productivity, and assess them against the first 10 stores in productivity in North America, the growth improvement is in the range of 50% for the top 10 and 70% for the top three stores compared to 2019. This means we have made tremendous progress in managing stores in the U.S. The first three stores are now pacing at EUR4 million and above per year, indicating a very strong trend of improvement.

Dave Kanen, Analyst

Yes, I'm a big believer in you guys expanding your North American footprint and becoming vertically integrated. To that point, I know that you have some non-core real estate up for sale in specifically in High Point and in Italy. Assuming that those assets are liquidated or that capital comes back to you, will you be redeploying that capital into expanding your North American footprint? It seems like you get the most bang for your buck there.

Antonio Achille, CEO

The answer is absolutely yes. It’s important to share with the broader audience that we are discussing the sales of non-strategic assets, which include High Point, a tannery in north Italy, and some other minor assets that the company has on the board for approval. In the board, it has been agreed that in accordance with our long-term strategy, the priority for potential disinvestment will be reinvesting in North America retail. The other priority will be supporting our long-term transformation. Our strategy to create value for shareholders is very clear: prioritize retail, especially in North America, and reduce the cost base of our factory in Italy. So, Dave, if we have additional funding, we'll dedicate that to those priorities.

Dave Kanen, Analyst

Thank you for that clarification. Regarding the 514 person headcount reduction and the $22.5 million in savings, does that number primarily show up in cost of goods sold going forward, or is some of it in selling expenses?

Antonio Achille, CEO

It's a combination, but I'll let Mario and Carlo comment more precisely. In particular, workers getting the cost of goods sold where accounts fall into services. I will let Mario and Carlo clarify further.

Mario de Gennaro, Chief HR, Organization and Legal Officer

As you said, Antonio, obviously, we are improving our contribution margin — first contribution margin being more efficient in the factory. Obviously, we are also reducing our central staff, which will have a positive impact in our G&A over the next few years.

Antonio Achille, CEO

To tell you, the investment the company made over the last 20 years and this restructuring really change the ability to achieve EBIT and cash conversion. We lowered the breakeven from about EUR150 million to EUR100 million due to a better mix, as we are selling branded goods instead of unbranded, plus all the hard work of reducing the cost base. Now, we need to focus on sales. If we reach the sales we aspire to, there will be huge upside from an economic and investment standpoint.

Carlo Silvestri, CFO

To be more precise, we have only EUR1.1 million that we are impacting on administrative and selling expenses; all the rest is in the cost of goods sold.

Dave Kanen, Analyst

One more question before I go back into the queue. Carlo, if I could ask, let's say over the next two years we add 15 or 20 new direct-operated stores here in North America. In theory, that would give us about $15 million to $20 million incrementally per quarter of revenue. That would give us roughly $65 million to $80 million a year at a $4 million average unit volume. At $90 million to $100 million in revenue, with the headcount reduction and some investments in automation at the factories, would we achieve a 40% gross margin or better?

Carlo Silvestri, CFO

May I, Antonio, or you?

Antonio Achille, CEO

The question was with you. But David addressed it directly to you regarding your capacity as CFO. I'm happy to comment as well.

Carlo Silvestri, CFO

Yes, we are moving in the direction of improving margins, of course, by absorbing fixed costs better. So, 40% is a goal we are aiming toward. If we add those sales — and even more if we achieve them.

Antonio Achille, CEO

Again, Dave, we don't provide guidance, but it's fair to do some high-level modeling. For our integrated sales for Natuzzi Italia, we have a contribution margin of 65 to 68% with the current sales productivity. If you build a $100 million target with that productivity and that margin, by definition, it would surpass 40%, since we're already targeting 40 organically, with the same business structure.

Dave Kanen, Analyst

It sounds like we're well positioned during the next upturn. Hopefully, the Federal Reserve here in the U.S. cuts interest rates, and we're starting to see somewhat of a bounce in housing; there's more inventory. We'll keep our fingers crossed that this spring things start to improve.

Operator, Operator

If there are no more questions at this time, I would like to invite any closing comments.

Antonio Achille, CEO

I will make my closing comment and then invite Pasquale, who is the person who created the company and the one who will celebrate 65 years with it, to provide any final remarks. Listen, for me, the story is very clear. Tough year, but we know what we are doing. We're very committed and confident about the upside. This company is very different; you're investing in a brand retail company. The awareness of this company is strong and terrific. I don't do any valuations on our market evaluation, but I believe there is significant upside potential. Thank you for being with us as investors. Thank you for joining us today on this call. I'll let Mr. Pasquale, our Chairman, make any final remarks if he wishes.

Pasquale Natuzzi, Founder and Executive Chairman

Okay. Antonio, thank you very much for the detailed explanation of what we are facing. Thank you also to Diego Babbo, Carlo, our CFO, and our Human Resource Manager. I feel very confident about the management today. Even in this difficult business environment, with the wars in Ukraine and the Middle East and low consumer confidence, we believe strongly in what we are doing and are very confident about the future. I thank everyone for attending this conference call. We are very committed to delivering better results for all our shareholders. Thank you again.

Operator, Operator

Thank you. That does conclude 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.

Antonio Achille, CEO

Thank you.

Pasquale Natuzzi, Founder and Executive Chairman

Thank you.