Natuzzi S.p.A. (NYSE:NTZ) Q1 2019 Earnings Conference Call May 28, 2019 10:00 AM ET
Pasquale Natuzzi - Chief Executive Officer
Vittorio Notarpietro - Chief Financial Officer
Nazzario Pozzi - Chief Officer of the Natuzzi Division
Gianni Tucci - Chief Officer of the Softaly Division
Piero Direnzo - Investor Relations
Conference Call Participants
David Kanen - Kanen Wealth Management
Please stand by. Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Natuzzi Conference Call for the First Quarter 2019 Financial Results. At this time all participants are in a listen-only mode. 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 on today's call are Natuzzi’s Chief Officer Mr. Pasquale Natuzzi; the Chief Financial Officer, Mr. Vittorio Notarpietro; Mr. Nazzario Pozzi, Chief Officer of the Natuzzi Division; Mr. Gianni Tucci, Chief Officer of the Softaly Division; 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.
Good morning to our listeners in the United States, and good afternoon, to those of you connected from Europe and Asia. Welcome to Natuzzi's first quarter 2019 conference call. After a brief introduction, we will give room for a Q&A session. Mr. Pasquale Natuzzi, together with the top management team will be glad to answer your questions.
Before proceeding, we would like to advise our listeners that our discussions today could contain certain statements that constitute forward-looking statements under the United States Security 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 20-F filed with the SEC for a complete review of those risks.
The company assumes no obligation to upgrade or revise any forward-looking matters discussed during this call.
And now I would like to turn the call over to the Chief Executive Officer. Please, Mr. Natuzzi.
Thank you. Good morning and thank you for joining us today. I would like to talk about two important areas this morning. First, where we are, and second, where we are going and the specific steps we are taking to get there.
I would describe the first quarter 2019 as perfect storm. Sales of Upholstery Furniture through traditional channels continued to decline and the position of U.S. tariffs on Chinese goods had a significant threshold on price.
Natuzzi Group suffered an almost 9% decline in total revenues and showed an operating loss of €3.0 million. But within this result are some very strong signs of the impact of our efforts on a turnaround.
Our gross margin improved from 28.2% to 30.1% despite the decline in sales of €10.4 million. This is the result of a great efficiency in production and the logistics coming from our new management team, and the continued improvement in both our mix of business and in our DOS network.
Our branded sales grew to 76.7% of total, up from 75.1% in the same quarter 2018. We will continue to follow such direction. While these are not the results we have in mind, I'm encouraged by the very strong sign that we are taking the right strategy and that our efforts are finally bearing fruit.
Our customer base continued to shift in the price focus at the same lower end and total experience at the higher end. The Natuzzi customer is one who seeks a high-end lifestyle, combined with high-end retailer experience; the result of our direct retail sales proved this observation. As such, we will continue our efforts to build out both our direct operating store as well as a network of MONO-BRAND franchising for both Natuzzi Italia and Natuzzi Editions. This represents the best path to grow and the higher margin we desire.
At the same time, we will continue to eliminate unprofitable business in our private label like Softaly. We will no longer make sales that are not profitable and we will recover the working capital from this business to devote to the accelerated growth of our retailer structure.
This is an effort that has been underway for the past several quarters, but I have decided that we will now accelerate this transition. This would allow us to reconsider the structure and management of our entire organization as we shift from wholesale business to retail business. We will seek efficiency in the structure [ph] and cost of our company on a global basis as we go forward.
Lastly, let me comment briefly on tariffs. The trade war between the U.S. and China is a real issue for our industry, fortunately we do not own our Chinese manufacturing plant and we are able to consider moving production closer to the market we serve, notably the United States and Europe.
We would be considering a new manufacturing option with a focus on efficiency and margin as we continue the transformation in the high-end branded lifestyle experience. We remain dedicated to returning our company to stronger profit and we will stay on our current course; as the results say, we are going in the right direction.
If there are questions I would be very pleased to answer to all of you. Thank you.
In the meantime Mr. Natuzzi, let me go through some more details about the number. Numbers are numbers, but let me go through some detail in order to check if something progressed in Q1.
First quarter, as said was negatively impacted in large part by the uncertainty surrounding tariffs. As a result, the revenues declined in the quarter by roughly €10 million compared to last year. Even though mitigated by better mix and price increase, so far sales expressed in terms of volumes which are ceased [ph], went down by 16% in quarter while we had the stable business with furnishings.
Brazilian and Romanian plants are okay with the capacity utilization. We have instead the redundant workers in Italy, but we are addressing that as said in previous quarters, with a new scheme agreed with Italian authorities that allow us to shift our first significant portion of the production to Romania.
China plants have the impact of lower sales deriving from tariffs, but already reacted by lowering workforce, variable and even some fixed costs. All the plants increased their productivity, that’s the main reason for the improvement of gross margin. So, the production efficiency is improving even in difficult times.
Thus, the directed operated stores chain has been under development, and has until now incurred a net loss. We have assumed control of several stores previously run by third parties and restructured their operations. As these of course have been largely completed, today our DOS looks like this. In Q1, we had 65 point of sales, of which 39 Natuzzi Italia DOS, 14 Divani&Divani by Natuzzi Store, and through Natuzzi Italia concessions.
In Q1 the operating profit of the entire DOS chain was €0.7 million or 4.1% of net sales. Spain, where we operate, 11 stores brokeven. France, where we recently opened two stores to enter the market, showed a small loss. U.K. still loss making – U.K. I mean, and so we have in Q1 closed down the concessions we had and started restructuring the four stores business.
In Switzerland we operated three stores which almost brokeven in Q1. The four Natuzzi Italian DOS in Italy shows as more loss. Divani&Divani DOS in Italy, after difficult years show the very positive results; thanks to the new format, new merchandising, and new management.
Florida, six consolidated stores plus one just opened in Sarasota is growing quite positively. Mexico three stores plus 12 concessions is improving, both show profits. And finally, the United States of America DOS, which said by Mr. Natuzzi is and will continue to be the most important market for Natuzzi. So the DOS chain in the United States of America showed in Q1 a dramatic improvement from last year first quarter. The USA 5 DOS chain is finally profitable.
In addition the 55 like-for-like stores shows a 7.6% increase in sales and a turnaround from a loss to positive EBITDA; so retail is improving too.
Rest of the year, our fiscal budget for 2019 includes the following areas of focus. A significant improvement in the DOS chain, a better mix including some price increase, lowering raw material price, especially leather, a positive contribution by shift in production from Italy to Romania, a better performance of our plants and reduced expenses resulting from the phase out – progressive phase out of unprofitable customers.
In Q1 we have done what we planned, however the weak order flow of the last eight, nine weeks likely will affect our results in Q2, 2019. But in these days we have the spring Congress here in Santeramo and we are meeting all our clients worldwide. I'm sure Nazzario will elaborate on that. In spite of Q2 order flow difficulties, we will continue as said by Mr. Natuzzi to stay on the path.
Our JV with KUKA in China is progressing. They are doing the planned rollout for Natuzzi Editions and Natuzzi Italia stores. In Q1 2019 the contribution of JV to Natuzzi has been €0.4 million profit, while last year in Q1 the full EBITD impact was €0.2 million. We believe we have chosen the right pattern in China and are encouraged.
The company has €49.1 million by the end of the quarter and we are focusing on the working capital. The increasing focus on the more profitable branded business will reduce the overall complexity. The lower complexity will result in lower working capital needs. In doing that, we will continue to operate on the reduction of our fixed cost basis, SG&A included.
Thank you so much.
[Operator Instructions]. Our first question is from David Kanen with Kanen Wealth Management. Please go ahead.
Good morning, thanks for taking my questions. So in terms of the softness that’s seen during Q2, is that coming from all lines of business or is it primarily Softaly? And if it’s impacting DOS, you know can you give us some idea of how much? And then my second question is, in the agreement with Italian government allowing you to shift some of your production over to Romania, should we anticipate better gross margins because of that?
Pasquale Natuzzi speaking David. The decline in order flow is coming from the United States, primarily; but even a little from the rest of Asia Pacific and China. But from China and Asia Pacific, you know in April, we have a very important fare in Milano, Salone del Mobile where we show Natuzzi Italia, as we do primarily Natuzzi Italia business in Asia Pacific and China.
So, the customer, they came to Milano and they placed the order in April, and we started just one week ago, a Congress in Santeramo where we invited to all the franchisee customer that have a store. They come and they spend one, two, three days with us here choosing the new product, making new media plan, a new marketing plan. So from China, the high-end business, we are already recovering the business.
While in the United States we have Natuzzi Italia store and we are performing very, very, well. We have two customers -- two cluster of distribution and customers in America. One, they embrace the brand. For example, I know that you live in Florida probably, and we have Baer's; Baer's is a very important customer for us. We do $7 million business and they buy Natuzzi Edition, and they have a gallery. So they embrace the brand, because they do very well with our brand.
Other customers, do what [inaudible] we have many of those customers that we classify as A customer, where we make a good margin and they leverage our brand. That business is doing well. The business that is suffering is primarily with the, what we call mass merchant. Those are distribution channels, that for them price is the issue, is the only issue, there are no other ones. And so consequentially, because we have been forced to increase our price since the tariff went up 10%, we increased our price by 5%, and then when the announcement for the additional increase was another 15%, we increased another 10%.
So to make sure, 10% plus -- 5% plus 10% is 15%, but because the impact on the price, on our price list will be only on manufacturing cost, not on transportation, on marketing, on regional commercial costs, so the impact on tariff based on our price increase, that will damage 1.5% to 2% our margin.
So the mass merchant customer, they didn’t accept the price increase. They moved to Vietnam, they moved to Cambodia, they go somewhere lease. You know, they don’t – I mean the price for them, and this is exactly what we are planning to do, you know to take off out from Softaly or private label, okay.
Okay, so but your higher-end branded product Natuzzi Italia Editions with your A customers and DOS is doing well; is that what you are saying?
Absolutely yes! I mean, yes. I mean Natuzzi Italia made in Italy is growing in America. Our retailer is growing, is making wonderful progress. We are havng also a business with -- trade with the designer, architect community. I mean our DOS and even our franchisee store are performing very well everywhere in the world, not only in America, and we are planning obviously to focus on brand, Natuzzi Italia and Natuzzi Editions, and primarily on the retailer distribution.
Okay, and then in terms of cost savings going forward, could you give me more color on that Vittorio?
The answer is, yes, shifting from Italy to Romania gives us benefit of costs. In order to get there, we had a very rude discussion last year with Italian authorities. At the end, we got a new scheme that is allowing us, allowed us already to shift a portion of production from Italian plants to Romanian Plants. Labor cost makes a difference, so the answer is yes. Now, it’s time to get more you know orders in order to fulfill that plant and the profit and loss.
Okay, thank you.
[Operator Instructions]. Our next question is from Gio Denisie [ph] who is a Private Investor. Please go ahead.
Hello everyone. Good morning! Can you hear me?
A - Pasquale Natuzzi
Sure Giovanni, pleasure.
Okay guys, I have several questions this afternoon, okay. I will limit myself to four. So I will just make the first two questions now, and after that I will step-up in the queue if there will be time after.
So my first one is related to the improvement of cost consequently to the shift of the production to the Romanian plants. So I would like to know, so where are your, which is your target for the gross margin improvement this year? So we should expect an improvement in the range of I think absolutely more than 30%, but I think in which range like 32%, 33% again in terms of improvement in gross margin of your total net sales.
And the second one is related also to the Italian workforce that clearly as you stated several times is redundant. So I know that your Italian employees are more or less 2,500. Okay, you say that it is redundant, but which is the rate, the percentage of this redundancy. So we should say that – can we say that at least 500, 600 of these employees are redundant or the percentage is less or more. And which is the rate of – like natural pre-think for age limit, like people go to pension or reach pension schemes, etcetera. Like you have this pre think at the rate of 50 per year or 60 per year, which rate more or less. If you can add some color on these two points please.
I will try to do my best, let’s start from you know the average age of this company. We are in the 50’s, so we are too far from the pension, okay, so we don’t expect people to leave the company because of that.
About redundant workers, this is something that we can say, because it’s official that what we agreed with Italian union last year. In our Italian plants we have almost 1,600 people. Last year we got for 500 of them to go to a new scheme, which is you know a new organization of work, giving them the possibility to be trained in order to you know take some skills for some production steps that are currently done by third parties. I mean and would inform you know steps, production steps. So the answer is around 500 in production.
As far as the gross margin is concerned, you know this is also related to the volumes. Let me say that the gross margin which are the drivers for the gross margin and then you would be capable to understand how far we are considering also the Q2 that will be unfortunately lower than expected.
With you know quite stable volumes that we had in mind for 2019, we had in mind to increase our gross margin by around 2%, 3% okay, that’s the goal we had in mind before the lowering of order flow in recent weeks. This factored not only the shift, but also the improvement of the DOS chain and further improvement which is coming and some price increase and some you know lowering in the raw material prices. Then we had also in mine and we are progressing in that direction, lower cost per quality and some advantage from foreign exchange. I think it’s enough, isn’t it?
Yeah okay, okay. Thank you.
And we have no further question in the queue. [Operator Instructions]. And we have another question from Giovanni Denisie who is a private investor.
Okay guys, can I go ahead with my other questions. So the first one is related to the profit of joint venture in Q1. So the progress in the joint venture with KUKA in Q1 you said and also what percent of that you had a profit €3.4 million in Q1. It is okay, this is profit on the base of equity of the joint venture.
A - Pasquale Natuzzi
Yes, you are right. [Cross Talk]
I would like to know if you have, because I found it in the last NRA, but if you have also the operation cost of the joint venture in Q1, and this second question is related to the manufacturing reorganization of which Mr. Natuzzi was suggesting. So you know the tariff increase in the U.S., so we should expect this reorganization as the opening of new facilities or maybe a new facility or rather than like an improvement or enlarging of the production lines in existing facticity of the group. Thank you.
Let me start first with your question about JV. Yes, this quarter we have on an equity matter basis 0.4 in a contribution to our profit and loss, which is showed in that line of profit and loss, which is the 49% of net profit of the company. Last year the contribution to the EBITD, the full contribution, because last year we fully consolidated the company was 0.2 at the EBITD level, so they are doing better. And then Mr. Natuzzi, about you know the development of our production footprint vis-a-vis the recent tariffs you know, things that are changing.
A - Pasquale Natuzzi
Okay, let’s start from which markets are strategic for us. China is an important market for us, because we have a plan that in the next five years we should have around more than 500 sold all together between Natuzzi Editions and the Natuzzi Italia. Today we are close to 200, so we have a plan to open additional 300 stores. So consequentially we need to keep the production in China to support the growth of our Natuzzi Edition business in China. So we should stay there, absolutely because we have already 150 Natuzzi Editions store.
We are planning to open additional 300 or even more and consequently we need to have a Natuzzi Editions production in China. Obviously while we will be there for the domestic business, we will also leverage the manufacturing knowhow and production, supplying the rest of Asia Pacific, and that has to do with Asia, rest of Asia and China.
Regarding Italy, we’ll keep always doing Natuzzi Italia production, because made in Italy is very, very important for the consumer, for our target.
Romania manufactures Natuzzi Editions. So far it’s still manufacturing some Softaly and the not to add more Natuzzi Editions. We will focus on Natuzzi Editions, because our margin are higher and the focus from you know low margin customer editions.
America is an important market for us. We are there since more than 40 years. We have a very high brand awareness. Brand recognition is very high. Consumer, they go in the store, they want to buy Natuzzi product.
So we are considering based on our strategy which markets are important, which markets we want to grow for the next three years and then we should also decide the production footprint. It's something that you know management is working on that issue, okay.
Okay, okay, thank you very much. So actually it – it’s still a work-in-progress. You didn’t decide yet in which direction to move to improve your manufacturing. Okay, thank you, thank you very much.
And there are no further questions in the queue.
Okay, since there are no further questions, therefore this concludes the conference call today. Please feel free to contact us should you need further information. Thank you and have a nice day.
This concludes today’s call. Thank you for your participation and you may now disconnect.