Earnings Call Transcript - NTZ Q1 2023

Operator, Operator

Ladies and gentlemen, please stand by. Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Natuzzi 2023 First Quarter Financial Results Conference Call. As a reminder, you can join this conference live via telephone by dialing into the following number +1-412-717-9633, then passcode 39252103#. In addition to the link already provided to join via video. At this time, all participants are in a listen-only mode. Following the introduction, we'll conduct a question-and-answer session, instructions will be provided at that time. Joining us on today's call are Mr. Antonio Achille, Natuzzi's Chief Executive Officer; Mr. Carlo Silvestri, Chief Financial Officer of the Natuzzi Group; Mr. Pasquale Natuzzi, Founder and Executive Chairman; then Mr. Jason Camp, President of Natuzzi Americas; 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.

Piero Direnzo, Investor Relations

Thank you, Kevin and good day to everyone. Thank you for joining Natuzzi's conference call for the first quarter 2023 financial results. 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, Piero, and good morning, good afternoon to our respective investors and analysts. Before we get started, let me also introduce our Treasury Director, Marilena Scaramuzzo, who is joining us together with Piero and Carlo to handle potential questions on the financial side of our analyst presentation. As we published in our press release, the first quarter sales were clearly below our ambition and significantly below 2022's first quarter. I remind you that 2022's first quarter was one of the strongest that we ever recorded. However, that doesn't fully describe the situation. The current situation is characterized by a very challenging business environment. Globally, real estate, which is one primary source of new demand for our business, is very much frozen given the high interest rates. In general, consumers have turned away from durable goods, preferring more instant pleasure, such as holiday dining out. Unfortunately, this is a context we see across the industry, even though we understand the industry is cyclical, so we deeply believe that there will be a return to normality in due course. Beyond what we are experiencing globally, we clearly have two geographies that deserve further examination. If we look at our performances, 75% of the absolute negative delta is driven by two regions, North America and China. North America is accounting for a negative delta of 11.7 million versus the first quarter of 2022. If we look closely at the North American business, most of the decrease comes from the wholesale business, especially the unbranded part of the business. The unbranded part of the business, while still present, is a minority for our business. In 2019, the first quarter in North America accounted for 8.3 million, in the first quarter of 2022 for 6.5 million, and in the first quarter of the current year, it accounted for 1.8 million. So it's roughly one-fourth of what it used to be three years ago before the pandemic. This is because we do not intend to divest from this market. On the contrary, we are opening outsourcing operations in Vietnam to be more effective, but we want to do it in a value-accreting manner. For the branded part of the business, we are going through significant restructuring of our team. We are empowering our team and have hired a senior executive, Scott Kruger, who comes with more than 30 years of experience in the sector. We are also expanding our geographical coverage mostly through multiline agents to be cost effective but to have a more comprehensive coverage of the country. We believe that this will give us, and we already see from our last data point, a positive momentum. Even though, it will take time as we are still experiencing that large retailers are in a destocking phase. That is for North America. And we have here Jason who I'm sure will provide more explanation. So North America has been dragged down mostly by the wholesale business, whereas retail is up versus 2019 and is performing in line with our expectations. China is the other geography that deserves further discussion. China is down 10 million compared to last year. I have spent time with the core executive team over the last 10 days in China. I was there with the Chief Brand Officer for Natuzzi Italia, Pasquale Junior Natuzzi, and the Chief Brand Officer for the Natuzzi Edition business, Cosimo Bardi. Beyond visiting stores and meeting dealers, we have had serious meetings with our joint venture counterparts. I remind you that we are in a minority joint venture where we own 49%, and our partner Kuka owns 51%. We used this time with the joint venture to critically review the business and identify what the short-term and mid-term actions are to regain growth. In China, we have 384 stores, mostly franchisee. Of those, 101 are with the Natuzzi Italia brand, and the remaining are with Natuzzi Edition. It's quite evident that the Natuzzi Italia business is the one that is below our expectations in terms of fresh orders. Here, we have clearly highlighted two reasons. The first is the outstanding inventory during 2022. Both our joint venture and our dealers in China placed significant orders of Natuzzi Italia inventory because the momentum was very good in terms of new orders. From a supply chain perspective, there has not yet been a normalization of the supply chain. As a result, the joint venture and dealers, in order not to miss sales, stocked quite significantly, which has now left us with inventory to absorb. This has allowed the joint venture to perform relatively better than what we see at the selling level, which is our sales to the joint venture as manufacturer. The second issue we have openly addressed, and where we have a clear action plan, is that in the new context of a more selective Chinese consumer, we need to create better retail execution in China. This is similar to what we are doing in the U.S. with our franchisee. We agreed to have a more systematic integration of systems, IT systems, and practices for both our U.S. operations and Natuzzi Italia and the franchisee. This means when we deal with the franchisee, we don't provide only goods, but also methodologies for merchandising and running a store effectively. These actions will be implemented in the next few weeks and months, and we hope to see a rebound in sales for the Natuzzi Italia part of the business in China. Furthermore, the Natuzzi Edition business is still growing versus 2022 according to our internal expectations. This gives a very high-level perspective of what's happening in terms of top-line results by the major geography. Despite all the difficulties, we are progressing towards our long-term plan, which, as you remember, focuses on core markets and growing through retail and brand. The retail business's total sales moved from 41% in 2019 to 61.7% in 2023. We have added 20 percentage points of retail to the total weight of our business. As a reminder, we define retail as both directly operated stores and franchises. This was a strategic decision because managing the brand effectively requires managing the retail operation. Thus, especially for Natuzzi Italia, this was an actively considered direction. In fact, looking at the weight of retail on total Natuzzi Italia sales, the percentage has increased to 85%, which is typical for a vertically integrated company. Another important element to highlight is the percentage of total branded sales, now at 92.3% versus 76% in 2019. Again, we are executing on the idea of becoming a branded company. While we do not want to neglect opportunities in the unbranded business, which has historical significance for the company, we do want to do so with adequate margins. Speaking of margins, you will see that in the context of declining sales, we were still able to expand our gross margin. The gross margin for the quarter was 35.6% versus 30% in 2019; nearly six points of margin have been added. The margin would have been almost 37% without considering €0.9 million of accrual we made for rightsizing our sales force. Even in a context where it is easy to become aggressive with pricing and discounting, we are trying to be very disciplined. We conduct regular benchmarking to ensure we remain competitive. It is worth noting that these margin improvements were achieved in the first quarter without implementing any further price increases. I'm sure you recall that in 2022 and 2021, due to high inflation, we were compelled to make price adjustments. However, in the first quarter of 2023, we did not implement any price increases, and we still managed to enhance our margins despite the fact that, as I mentioned before, Natuzzi Italia—typically the highest margin part of our business—decreased more than the rest of the operations. I believe that the margin increase we saw was a deliberate effort focused on margin protection. Regarding our fixed cost structure, this area has seen work done, but more work is still needed to be completed because we were responding during the quarter to slow demand. However, the nature of fixed costs requires time for material savings to manifest. This is an area where Carlo and our HR department are looking to implement significant alternative strategies to optimize our organization both centrally and regionally. In closing, as it is typically of interest, I will give you a sense of how our cost base is changing. The underlying costs are mostly showing positive dynamics. Transportation costs are decreasing significantly, especially from China and Vietnam to North America, and are also decreasing—though to a lesser extent—from Italy to North America. This will be beneficial to our margins moving forward. Regarding raw material costs, in general, we have a positive outlook. Wet blue leather is decreasing. Similarly, even though to a lesser extent, motion mechanics and wooden frames are also down. Polyurethane costs are slightly increasing. In general, our raw material cost base is improving. However, you do not see that reflected in the first quarter numbers because we are mostly working with inventory. The cost of materials currently embedded in our production reflects earlier quarters. Therefore, while we do not provide guidance, it is clear that this trend should play in our favor in terms of expanding margins. Strategically, we are pursuing a dual approach—our main focus is regaining growth. We are rigorously examining all dimensions of our business organization and business model to uncover potential gains in all geographies and channels. The other key element is cost control, especially concerning fixed costs. In terms of investment, we still prioritize strategic directions, so the retail expansion continues. In the first quarter, we opened in Miami, which was a kind of buyback, and San Diego. We also opened one joint venture in the U.S. and another in China, in addition to five franchises: three in China, one in the U.S., and one in Australia. Notably, for the U.S. franchises, we do not invest capital. We are focused on protecting those investments. The other dimension keeping us focused is our short-term financial position, where all the different stress tests confirm the solidity of our group. As you know, we have zero debt, and we are very stringent in our cash management. That is an overall view of the quarter. While we expect the market to not renew these negative conditions soon, we are preparing for a challenging situation. However, we have begun to see some initial positive signs in certain geographies, especially in retail. Let me stop here for any high-level questions before Carlo provides a more accurate reading of our business by geography and channel. If you have immediate questions for me, I can take them or I can take them after Carlo, Piero, or Marilena provide the detailed overview of our business.

Operator, Operator

We expect the market to not renew these negative conditions soon, and we are preparing for a challenging situation. However, we have begun to see some initial positive signs in certain geographies, especially in retail. Let me pause here for any high-level questions before Carlo provides a more accurate reading of our business by geography and channel. If you have immediate questions for me, I can take them now or after Carlo, Piero, or Marilena provide a detailed overview of our business.

Unidentified Participant, Analyst

Good.

Antonio Achille, CEO

There is an investor, please.

Unidentified Participant, Analyst

Good morning. Thank you for taking my questions. I was surprised to see that, despite the decline in revenue, when I add back the restructuring charge, it appears you were actually breakeven on an operating basis. This reflects the improvements you've made in terms of margin, which is encouraging for the future. That said, have you noticed any improvement in written orders, particularly in North America and China recently? Is this the lowest point for written orders, or are conditions still very challenging? Could revenues continue to decline from this level?

Antonio Achille, CEO

So, Jason can provide more details on North America specifically. The situation remains challenging. Comparing this year to last year, the last eight to ten weeks have shown noticeable improvement, especially since last year started off strong but then softened significantly. Initially, our performance was more negative compared to last year, but current trading is showing signs of improvement. The overall situation is still tough, as we are putting in significant effort for every sale and not seeing high traffic. Unfortunately, this is a trend that affects the entire industry, not just our company. The industry as a whole is experiencing low traffic. While last week's trends have improved, this is mainly due to a softer comparison period from last year's shift in momentum around April. I will let Jason elaborate further on North America. Regarding China, although the traditional results were positive, they should be considered in the context of the recent lunar new year, which boosted the results. Natuzzi Italia needs some adjustments in merchandising and retail operations before we can expect a turnaround. For Natuzzi Edition, we had successful promotional events, leading to higher sales and order flows compared to last year. Jason, please share your insights on North America.

Jason Camp, President, Natuzzi Americas

Good morning, Dave. From a written order standpoint, Q1 of '22 was our retail peak. In fact, it was almost 10% above any quarter we had ever had in our history from a retail perspective in North America. What we're most focused on today is that revenue reporting to you and in North America, those revenues on a retail basis often come four to five months after the orders are written because we import nearly all our sales from Italy or China. In general, our start to the year on a written basis has been healthier and stronger than how we finished '22. So our year-to-date business is healthier and stronger compared to the back half of '22. Additionally, if I look at our retail business's health against 2019, on a like-for-like or comp basis, we're running almost 30% above 2019's figures. In summary, that retail business, while still relatively small, is poised to potentially double 2019 levels when assessed in total.

Unidentified Participant, Analyst

That's very helpful. From my perspective, the ongoing expansion of your branded presence in North America and similar markets in Western Europe is crucial for the company's success and shareholder value creation. Can you provide an update on the plan for the rest of the year and 2024, considering you mentioned opening three stores in Q1? Previously, we talked about a goal of eight to ten stores, either through direct operations or a mix. Is that still the target, and will there be a possibility to accelerate that or finance it through sales of non-core assets, particularly real estate? Thank you.

Antonio Achille, CEO

As Jason indicated, yes, for 2023; however, I’ll let Jason elaborate further. Additionally, if you agree, Jason, I'll provide a brief comment alongside Carlo on the sales of strategic assets. Jason, would you like to provide an update on the pace for 2023 and elaborate on our opening plans?

Jason Camp, President, Natuzzi Americas

Our store opening count is on plan for 2023. In general, we're aligning for 2024. Simply stated, we're on track to achieve our goals for 2023 and are working on aligning our strategy for 2024.

Antonio Achille, CEO

As Jason mentioned, the direction of our plan, which was approved by our Board, represents a formal commitment towards our Board members. Nothing has changed. The priority for brand retail and core market in the U.S. remains firmly in place. There has been no redirection in our plan. Regarding the sales of non-strategic assets, this is also a priority. We are actively engaging in discussions with potential buyers, especially concerning our largest asset, where we are hoping to reach a precise outcome. Of course, with current interest rates, the loan-to-value for potential buyers has decreased. Therefore, we will not accept offers that are significantly below optimal. However, should there be a fair evaluation change of the asset, we are aligned with our Chairman and shareholders that it is an opportune moment to pursue these opportunities.

Unidentified Participant, Analyst

Okay. Just to recap, although revenues were disappointing, what is encouraging is the fact that we were more or less breakeven on an operating basis. When we return to EUR100 million plus in revenue, it seems as though we're positioned to generate meaningful operating profit. So I commend you on that and continue your good work of improving margins, holding the line on expenses, and expanding our North American footprint. Thank you.

Antonio Achille, CEO

Thank you, Dave. I think it's a better overall perspective. If we were simulating, what would have been the EBIT at EUR100 million—which is not particularly exciting—because our plan clearly targets a higher goal for this year. That said, it would yield a significant margin and EBIT compared to our current EBIT conversions. If there are no further questions, I suggest Carlo provide comments or insights from our colleagues or the Chairman, and I recommend Carlo take us through the more technical aspects of this press release.

Carlo Silvestri, CFO

Good day, ladies and gentlemen. I will cover the data reported for the first quarter 2023 and provide insights on what Antonio mentioned regarding the quality of our sales and other P&L assets. In the first quarter 2023, the Natuzzi Group reported revenues of €86.1 million with a gross profit of €30.6 million and an operating loss of €900,000. Financial costs amounted to €3.4 million, and the share of profit from our investments in the JV channel was €1.8 million, leading to a loss before tax of €3.2 million and a net loss after tax of €3.3 million. Summarily, we reported revenues of €86.1 million alongside a loss of €2.3 million. To give better perspective on our performance, we will reflect on the first quarter of 2022 and 2019—to emphasize that 2022 was the last quarter of an 18-month expansionary phase post-COVID. Overall, our sales, excluding other revenues focused on our core business, reached €84 million, marking a decrease of 26.2% versus 2022 and 16.9% versus 2019. In 2019, we recorded €100.1 million and for 2022, €113.8 million. Looking at our branded delivery sales—including Natuzzi Italia and Natuzzi Edition—we were flat at €77.5 million versus 2019, while decreasing by 21.6% compared to 2022. Between both brands, Natuzzi Edition saw sales surge and was compensated by decreases in Natuzzi Italia. If we focus on our branded sales performance, our business is now at 92.3% versus 86.8% in 2022, and 76.7% in 2019. Regarding our retail strategy, we've noted a 23.9% sales increase versus 2019, even amidst overall decreased performance. This indicates that the focus on retail is still in place. For our wholesale business, we are not exiting; we are adapting our strategy to protect margins in our unbranded division. We will focus on selected distributors, with expectations of results developing later. As Antonio highlighted, we have implemented a new agile structure in the U.S. that has just commenced operations. A quick recap shows that based on the €84 million retail level, we have recorded 61.7% versus 54.8% in 2022 and 41.4% in 2019. Concerning China, the market remains challenged but the company remains profitable, focusing on inventory destocking. Together with the JV team, this has enhanced our performance by €1.1 million, shown as an equity method in our P&L. Marginality today stands at 36.6%, up from 34.3% in 2022 and roughly from 30.1% in 2019. The combined effect results from sales/mix, channel/mix, and decreasing tariff influences. Overall performances indicate an ongoing focus on margins and challenges concerning operating expenses and financial costs. We remain vigilant about these challenges and continue to optimize working capital and control costs, particularly with discretionary expenses. Specific attention is required for our finance costs; we have noted an average interest rate spike of 52% in Q1 2023 compared to Q4 2022. We are working to address the increase in financing costs from €2.1 million versus €1.8 million in 2022. These are areas of ongoing concern for our company. Lastly, regarding our cash situation, we currently stand at €48.3 million, resulting from €5 million invested in working capital, €3 million in CapEx, and €1 million allocated to reduce our workforce. Those are all the comments related to our P&L. If there are any questions, please let us know.

Operator, Operator

Thank you. I would like to invite any final remarks from Antonio and Carlo.

Antonio Achille, CEO

Thank you, Kevin, for moderating our conversation as effectively as usual. I also thank everyone for attending our conversation over the last 45 minutes. We have been, and will remain, exceptionally transparent regarding our business. We genuinely believe in the potential of this group. When we interact with our dealers, partners, and even our end customers, we are confident that our mid-term goal is wholly achievable, and this company deserves it. Simultaneously, we must recognize that we encounter substantial headwinds that will lead to an 18-month or longer shift in executing our plan. However, in terms of direction and goals, we have not altered our confidence in this company's potential. Thank you very much, and unless the Chairman or our colleagues wish to make additional comments, I appreciate the time you dedicated to us today.

Pasquale Natuzzi, Founder and Executive Chairman

My comment is straightforward. The business environment is complicated, and there is no question about that, as there are tensions between China and America, and tensions between Russia, China, and Europe. Certainly, all these tensions negatively impact consumer confidence. We are a company with a very strong and clear direction. Today, our team is more united, strong, and prepared to professionally face this situation, and I am entirely confident about the company's future despite the current environment. Thank you very much to everyone for attending this call, and we hope to provide you with better news in our next one. Thank you very much 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.

Pasquale Natuzzi, Founder and Executive Chairman

Thank you.

Antonio Achille, CEO

Thank you. Bye-bye.