Earnings Call Transcript - NTZ Q1 2024

Operator, Operator

Good day, ladies and gentlemen. Thank you for standing by. Welcome to Natuzzi's S.p.A. First Quarter 2024 Financial Results. As a reminder, you can join the conference call live via telephone by dialing into the following number +1-412-717-9633 then Passcode 39252103# in addition to the link already provided 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 for you to queue up for questions. 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; Mr. 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 like to turn the 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 2024 first quarter financial results. After a brief introduction, we will give room for the 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 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 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. Welcome, everyone, and good morning to those joining from the US and good afternoon to those from Europe. I will start by highlighting some of the figures from the first quarter of 2024 and then provide more transparency on the strategic and operational agenda that my team and I are focusing on. We closed the first quarter of 2024 with invoice sales that align with the previous year at around EUR84.5 million. If we look at that split by geography, the US and China, as well as the remaining geography, are above last year's sales. However, Western Europe and emerging markets reported lower sales compared to last year. Clearly, when we talk about emerging markets, we include Russia, which continues to be affected by significant geopolitical turbulence, and we also consider the Middle East. In terms of sales, it's worth noting that sales from directly operated stores have increased by EUR20 million, reaching EUR20 million, which is a 13% increase compared to the same period last year and a 10% increase from 2022, which was a very strong year. This achievement is not by chance; it stems from our continued execution of our strategy to become a more retailer-centric company. This is especially true for North America, where directly operated sales surged nearly 30% compared to the first quarter of 2023 and 32% compared to 2022. The retail and the US are vital to our future development strategy. Another significant highlight is our improvement in gross margin. We reached nearly 37%, which is about 1.5 percentage points above 2023 and almost 7 percentage points above 2019. This improvement is crucial and reflects our strategy of value creation. The gross margin and the sales levels resulted in an operating profit of EUR0.6 million, compared to a loss of EUR0.9 million in 2023 and a loss of EUR3 million compared to pre-COVID levels in 2019. It's more challenging to compare operating profit across years due to one-off support measures and restructuring that affected those figures. We're continuing with our restructuring; in the first quarter, about 94 positions were terminated, bringing our total reduction since 2021 to nearly 18%. This is an overall profile of the quarter, and I won't delve too much into the context, as you are all seasoned investors and are closely following the current events in the market. Clearly, the markets have not yet bounced back due to high interest rates that are significantly impacting us given our reliance on real estate. However, I would prefer to communicate more explicitly what we're working on within the management team, particularly our eight pillars. The first is expanding margin and lowering our breakeven point. We have improved our gross margin by seven percentage points since 2019. This has been achieved despite our factories in Italy not being fully saturated and regardless of the unprecedented inflation during 2021 and 2022. If we were to normalize for these circumstances, our margin improvement would be more in the 10 percentage point range. This is important because we've reduced the procurement of the company by around EUR100 million in required revenue to break even on an annual basis. This means that as we achieve growth, that growth will be healthy in terms of margin conversion and cash conversion. This is not the end of the story; we continue to work towards expanding margins and are confident we will meet our internal goals to maintain this trajectory in the coming years. The second pillar we are focusing on is leveraging our brand strength in the context of low traffic. We recently commissioned an independent market research survey that reconfirms the strong positioning of Natuzzi among both European and domestic brands in markets like the US, where Natuzzi ranks as the top European brand. This is also true for China and many European markets. Building this kind of awareness today would cost us EUR100 million, if not a billion, in each of those geographies, which is an inherent asset we possess. In a low-traffic situation, we are increasingly leveraging our brand strengths to drive foot traffic in our directly operated stores and those of our partners. We are adopting a more active digital approach in the early stages of the consumer journey. Another way we are leveraging our brand strength is through contract trading, which provides an organic way to grow our business without requiring the opening of new stores. We established a new division about a year ago, and the quality of discussions we are engaging in, especially regarding contracts, is very promising, as confirmed by intriguing international talks from the Middle East to Europe and the US, showcasing both our brand strength and our ability to deliver appealing designs for living spaces. We are excited to report more specific wins as we progress in this area, although it is premature to share detailed information now. The third pillar we are focusing on is retail, and Diego Babbo's involvement in this call emphasizes that. As I mentioned, retail sales from directly operated stores grew nearly 4% this quarter. Looking at retail as consumers perceive it, which includes Natuzzi's freestanding stores, regardless of whether they are operated directly by us or via franchises, the share of that business in our total business has grown by around 25 percentage points since 2019, from 40% to 65%. This reflects a strong and steady acceleration towards being a consumer-centric, retail-focused company. We have been managing retail before fully understanding how to do it, but the work done by the Global Retail Division has been significant in terms of tools, training, merchandising, and approach. Retail is an area where we continue to invest. I’m pleased to report that the new retail format, focused on sustainability and that Natuzzi Italia presented at Milan Design Week last April, has been well-received globally, from China to emerging markets to the US. This concept is fundamental to developing a more immersive brand experience in the over 200 stores we have for Natuzzi Italia. This concept also includes design studios where clients, designers, and architects are welcomed to continue their journey with Natuzzi Italia. Wholesale remains a critical dynamic component of our revenue, especially in markets like the US. The fourth pillar of our efforts is to enhance the quality of our relationships with wholesale partners and customers. To that end, we launched what we call the reimagined gallery format. Historically, Natuzzi has operated with galleries, which are shop-in-shop retail environments. However, these environments often left the customer experience open to interpretation by our retail partners. With the intent of evolving into a more consumer and brand-centric company, we standardized these environments to the reimagined gallery concept, which conveys a more comprehensive experience of our brand. This innovation has been well-received by our partners, not just in the US, where we have 29 deals of this type, including important accounts that previously ceased distribution of Natuzzi products but have decided to reinvest, but also in other geographies, including Germany. This applies particularly to Natuzzi Editions and extends to Natuzzi Italia, where the preferred channel remains freestanding stores. The fifth element we have focused on is our collection. Natuzzi Italia’s recent showcase at Milan Design Week has been pivotal in presenting the maturity of our collection, which has strongly leveraged our brand DNA. Orders and feedback reflect a promising reception of this new collection. Our time to market is relatively high for the industry, as the process from when collections are purchased by partners to their final presentation to consumers takes time. However, we are confident this fresh collection will enhance brand experience and support sales. The sixth pillar is geography. Natuzzi operates globally in over 100 markets, which is definitely an advantage; however, discussions with the Board have emphasized the necessity of strengthening our local positioning to achieve a strong global presence. We identified three macro opportunities: the US, which has been pivotal in our historical success and central to our future strategy; China, where we now operate about 340 stores between the two brands; and Europe, where we are working to re-enter countries that had previously significant Natuzzi footprints but have been neglected. Germany is a notable example, where we recently signed an agreement to reopen 22 galleries in the coming months. The seventh pillar pertains to restructuring and automating our factory and the restructuring of our SG&A. We have discussed this extensively in prior calls. We aim to reduce our expenses while investing in consumer experience, marketing, and retail. This process will continue, albeit at a pace conditioned by regulatory frameworks, particularly in Europe. Lastly, we are actively exploring the sale of non-strategic assets as high interest rates make such sales challenging. In summary, we are focusing on short-term cash management while keeping our attention on what will create more mid-term value, considering the strengths of our company, our globally recognized brand, and our nearly 700 stores. I will stop here to take your questions and will also engage Carlo for discussions on working capital and cash management.

Operator, Operator

Thank you. Our first question today is from David Kanen from KWM LLC. Your line is now live.

David Kanen, Analyst

Hi, guys. Are you able to hear me?

Antonio Achille, CEO

Yes, we do.

David Kanen, Analyst

Okay. Well, first, I'd like to congratulate you on the green shoots I’m seeing. There are many encouraging signs in the financial results you reported. I'd like to dive a bit deeper to gain a greater understanding. I'm encouraged by the improvement in gross margin as well as the management of operating expenses. It sounds like you have a number of growth initiatives underway, including expanding your network of directly operated stores in North America. But you also mentioned this agreement with galleries in both North America and Europe. Can you speak to the incrementality of these galleries in Europe and North America? And you spent some time talking about the joint venture in China. Is that an area, despite the furniture depression we're facing, where you also expect to see some growth before a potential reduction in interest rates and normalization in housing? There's a lot I’ve given you there, so I'll let you respond.

Antonio Achille, CEO

Thank you, Dave. To ensure we're capturing all the questions effectively, I'll address one at a time, starting with your first question. Thank you for your encouraging remarks regarding the direction the company and team are taking amidst headwinds. Regarding the galleries in China, we are indeed focusing on enhancing the quality of interaction with our customers. This, in retail, maximizes brand immersion by allowing us to create and display holistic living solutions that include more than just our furniture, covering areas like dining and bedroom design. The spaces we create also welcome designers, which is a positive long-term direction, especially for Natuzzi Italia. At the same time, we recognize that certain regions in the US can benefit from these galleries, particularly in retail environments where directly operated stores would not yield adequate returns. We want to capitalize on this opportunity while maintaining quality. The reimagined gallery concept aims to achieve two goals: creating a profitable environment for retailers and enhancing consumer experience with our brand in multi-brand settings. The investments in these reimagined galleries are thoughtfully sized, ensuring adequate retail returns for our partners.

David Kanen, Analyst

Should we view this as investors as an incremental growth opportunity for the gallery business year-over-year with the distribution set to grow?

Antonio Achille, CEO

The short answer is yes, but let me provide more context. Not all the galleries we're opening are entirely new accounts; some represent previously inactive accounts with which we're restarting engagement. For instance, Germany, where we are reopening 22 galleries, represents fully incremental business. In the US specifically, part of the new galleries involves converting space in department stores that weren't optimally displaying our brand. Thus, you can interpret this as organic growth that serves to elevate the quality of distribution at existing accounts alongside new gallery openings. This approach aligns with our intent to enhance customer interaction while capturing growth opportunities.

David Kanen, Analyst

Can you hear me?

Antonio Achille, CEO

Yes, we can.

David Kanen, Analyst

And then here's a question for Carlo. We know that at some point, the housing market is going to improve. In North America last year, there were just over 4 million homes sold, significantly below the long-term average of around 5.5 million. The correlation between furniture sales and housing transactions is quite strong. So do you expect to see gross margins exceeding 40% with the growth initiatives underway as we reach toward $100 million in revenue?

Carlo Silvestri, CFO

Thank you very much for your question. Based on our previous quarters' performance, we are advancing toward that goal. Our focus on price discipline alongside retail enhancement will contribute towards reaching the 40% mark you mentioned.

David Kanen, Analyst

What can you share regarding the joint venture in China and how these changes might yield growth in the next year?

Antonio Achille, CEO

Regarding China, the governance of the joint venture remains unchanged, but we have established a greater legitimacy that enables us to drive key decisions about store and retail merchandising more actively. Our influence is based on competence and collaboration rather than power dynamics. We can now analyze JV performance at the store level, which has allowed us to engage more effectively with JV partners. For example, we increased participation at events like the Milan Design Week, where key JV partners showed up, something we did not achieve the prior year. Such collaborative efforts are crucial, especially for a brand aspiring to manage itself globally, which is crucial for a company like ours. While there are challenges in the Chinese market, we believe in our growth potential despite the existing turbulence, drawing on optimism based on our current strategies.

Operator, Operator

Question is coming from Corey Pinkston from Waterways Capital Advisors. Your line is now live.

Corey Pinkston, Analyst

Good afternoon. Can you hear me?

Antonio Achille, CEO

Yes, we do.

Corey Pinkston, Analyst

Well, I want to echo what David said. I've been a supporter of your company for quite some time. I want to commend you, Pasquale, and the team for your impressive execution considering the macro headwinds across your industry. The operating leverage you're creating, combined with your transparency, is commendable. I'm particularly interested in your strides towards achieving a gross margin of 40%. I am curious about how you're navigating retail expansion and the initiatives on the commercial side, even amidst the current environment that may restrict CapEx. In light of these developments, could you expand on the ability to support growth without compromising on core areas of investment?

Antonio Achille, CEO

Thank you, Corey, for your support. I appreciate your recognition of our executive team's efforts. To address your question, we are focused on two avenues to enhance margins: organic growth and optimally managing our operational framework. In terms of organic growth, we are showcasing our brands in stores that now achieve $5 million to $6 million in sales, compared to $2 million before in 2019. Significant progress has resulted from diligent management, and we acknowledge that there is more potential growth to be had. We continue to work to ensure that our operations allow us to provide an integrated margin above 70%. We are also reducing SG&A and operating on a tight management strategy. Although we haven't deviated from our overarching strategic plan, we are safeguarding cash to maintain a robust position while continuing to explore opportunities for growth.

Corey Pinkston, Analyst

Thank you, Antonio. I find it impressive how, despite the challenging environment, you and your team continue delivering outcomes in retail. My last question revolves around raw material costs. Have you seen any alleviation or softening in raw material prices recently?

Antonio Achille, CEO

Regarding raw materials, we're observing a more normalized landscape in most inputs we deal with, including fabric, leather, and metal components, compared to last year's inflationary trends. Most materials are aligning with our internal expectations. However, the transport of goods has been affected due to geopolitical issues, which may induce some tension in transport costs. We remain vigilant regarding our margins and continue assessing our pricing structures, which is an area where we see potential for margin expansion.

Corey Pinkston, Analyst

Thank you. That clarification is helpful.

Antonio Achille, CEO

Thank you, Corey. Kevin, shall we proceed with another round of questions?

Operator, Operator

Sure. We have one question in the queue. Our next question is coming from Kirby Newburger from Benjamin F. Edwards. Your line is now live.

Kirby Newburger, Analyst

Hello, gentlemen. Can you hear me?

Antonio Achille, CEO

Yes, we do.

Kirby Newburger, Analyst

Antonio, during our previous conversation, it struck me how significantly the average sale has increased, especially in the US. We're seeing projects from clients like hotels, country clubs, and airport lounges. Are these orders typically customized, and do they provide higher margins compared to standard sales?

Antonio Achille, CEO

Thank you, Kirby. I appreciate the opportunity for individual discussions with our investors. Regarding your question, our growth in the US, especially for Natuzzi Italia, has been notable. We’ve shifted from selling individual products to collaborating with clients on designing comprehensive living solutions. Regular retail sales are significant, but projects leveraging our contract business open new avenues for growth. This contract avenue includes larger B2B opportunities, particularly in hotels and upscale buildings. While margins are typically lower in competitive contract spaces, we strive to have a balanced offering where a sizable portion of our products comprise Natuzzi Italia sales in these contracts. The elevated sales we've seen have been a result of this strategic shift.

Kirby Newburger, Analyst

Could you provide a breakdown of the sales contribution from Natuzzi Italia compared to the contract business?

Antonio Achille, CEO

To clarify, contracts are a portion of our Natuzzi Italia sales, and for Q1 2024, Natuzzi Italia sales totaled EUR29.5 million, which includes contract sales, while Natuzzi Editions was EUR46.5 million. We may enhance transparency around the contract division in the future as it matures, but for now, those sales are integrated within Natuzzi Italia figures.

Operator, Operator

Thank you. We have reached the end of our Q&A session. I'd like to turn the floor back over for any further or closing comments.

Antonio Achille, CEO

Thank you to everyone for being with us today. I’ll pass it over to Pasquale for any final remarks.

Pasquale Natuzzi, Founder and Executive Chairman

Antonio, firstly, I want to commend you for addressing all the points raised and answering the questions effectively. It’s essential to communicate to our shareholders that we're actively training and guiding our team in China on brand management and supporting them in restructuring the JV. Incremental changes are underway, which is crucial. We acknowledge room for organic growth, with ongoing improvements in our stores and consumer experiences across regions, including merchandising and training. The progress we've made over the past 8 to 10 months has been appreciated by our customers who have engaged with us, and I endorse our direction alongside the management team. Thank you for the insightful questions from our shareholders; it underscores their care for our company.

Antonio Achille, CEO

Thank you, Pasquale, for your closing remarks. Kevin, I believe we can wrap up the call now.

Operator, Operator

Thank you. That concludes today's webcast. You may disconnect your line at this time. Have a wonderful day. We appreciate your participation today.