Natuzzi S.p.A. (NTZ) Q1 2018 Earnings Report, Transcript and Summary

Please stand by. Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Natuzzi First Quarter 2018 Conference Call [Operator Instructions]. And as a reminder, today's call is being recorded. Joining us today on the call from Italy are Natuzzi's Chief Executive Officer, Mr. Pasquale Natuzzi; 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. And now I'd like to turn the conference over to Mr. Direnzo. Please go ahead, sir.

Thank you. Good morning to our listeners in the United States and good afternoon to those of you connected from Europe. Welcome to the Natuzzi's First Quarter 2018 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. This time, we have prepared a short presentation that will give you more insight about the evolution of the Natuzzi brand. This presentation can be found within our Investor Relations website under the Presentation section. The presentation is called Natuzzi Community Issues. I do invite you to have a look at it to better appreciate the work the company has been doing in building a lifestyle brand. Then 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 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 Securities and Exchange Commission 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'd like to turn the call over to the Chief Executive Officer. Please, Mr. Natuzzi.

Good afternoon in Europe and good morning in America. I'm Pasquale Natuzzi, Chairman of the Group, and I'm pleased to be with you today. As expected, the first quarter and satisfactory result were caused by three factors: the currency dynamics that lowered revenue by 8.2%, following, in particular, the devaluation of U.S. dollars versus euro; the increase in the cost of some raw materials, the difficult retailer business environment evident in North America market; as well as persisting difficult macroeconomic environment in some major country in Europe. Nevertheless, we have positive elements such as the introduction of a new product line that had a great visibility on the qualified press and media. Agronomist and Oceanographer in collaboration with the Marcel Wanders, then the Colosseo sofa integrated with the raw materials [indiscernible] LG SIGNATURE and the Torsion sculpture table in solid olive wood developed by Mario Bellini, those are [indiscernible]. Our recent fair in High Point and Milano were highly successful. DOS network is significantly improving quarter-after-quarter. Our CFO will explain how the DOS like-for-like channel grew by 22.6% at constant exchange rates. Last, but not least, the finalization of the agreement with Jason Furniture, Kuka, is moving as planned. So despite the challenges that we have been facing, the above-mentioned elements make me feel encouraged and positive about the future of our company. I would like now to introduce Vittorio Notarpietro, our CFO, who will take you more deeply into the numbers. Okay, and then I will be here available for any question you would ask. Thank you.

Thank you, Mr. Natuzzi. Now let's go a bit deeper into 2018 first quarter key numbers. Net sales were EUR117.7 million, up 1.6% versus first quarter last year. Gross profit was 31% of net sales, improving from 27.2% of the Q1 2017. Operating result has been minus, has been negative by EUR3 million versus minus EUR10.2 million in Q1 last year. And net loss per share improved to EUR0.09 versus EUR0.20 loss last year. Let's say something about currency. As expected and anticipated in our previous conference calls, currency movements played an important role during the period. In fact, following the strengthening of the euro versus major currencies, our sales, especially those denominated in U.S. dollars, were negatively affected by total of EUR7.7 million, which means an impact of 8.2% mentioned by Mr. Natuzzi a few seconds ago. On the contrary, our operating costs were favored by the stronger euro by EUR4.7 million. So that the net impact on the operating results was a minus EUR3 million. To better explain Q1 2018 numbers under constant exchange rate, let me just you give some examples of the cross rates of some major currencies in which Natuzzi invoices shipped its products in the first quarter 2018 versus the first quarter of last year. Euro versus U.S. dollar was $1.23 in Q1 2018 versus $1.06 in Q1 last year. It means a U.S. dollar devaluation of 15%, 1-5 percent, versus euro. Canadian dollar devaluated by 10%, Australian dollar devaluated by 11%, Japanese yen devaluated by 10%, Chinese renminbi devaluated by 6.5% and United Kingdom pound by 2.7%. Such currencies represent almost the 58% of our total sales. Let me underscore that the difference in the currency exchange, at least euro versus U.S. dollar rates has been narrowing in the second quarter 2018. As of today, the cross rate is even better, but this is due to the political situation in Italy and European Union, for which we're not so happy. If we look at the average exchange rate for the second, third and fourth quarter of last year and considering the current levels in the currency market, we should have a more favorable comparison for the current and probably for the next quarters 2018. Despite currencies, our business odds, and in fact we reported slightly increasing sales for the period. Thanks to our Natuzzi branded sales that increased by 2.5% or by 10% under constant exchange rate. As far as private label business is concerned, sales increased by 3% in the period, while under constant exchange rate would have been increased by 2.4%. Let's say something more about retail. Within the Natuzzi branded sales, we are pleased to see improvements in our retail network, consisting today of 64 directly operated stores and 20 concession in United Kingdom and Mexico. This is a further evidence that our strategy focused on investments in retail are proving to be the right direction. Net sales of our DOS chain were EUR15.2 million, up 26.1% versus first quarter 2017. Also thanks to the new openings. The trend in our retail network business is even more evident on a like-for-like store network. If we consider only those 58 stores existing both in Q1 2018 and in the same period of the previous year, we saw sales of EUR13.1 million -- of EUR13.1 million, which is an increase of 17.3% under current exchange rate or 22.6% under constant exchange rates. At the same time, thanks to the activities implemented over the last few quarters, our DOS profitability improved as compared to the same quarter last year. For example, Italy's DOS chain Divani & Divani, in spite of a difficult economic environment, turned from a loss in Q1 2017 to a little profit in Q1 2018. The same-store stores acquired in Florida last year, new business acquired in Mexico has been profitable too. Chinese, Spanish and Swiss -- Switzerland like-for-like numbers turned firm to be positive. We are now focusing on our DOS chain in United Kingdom in order to address the business and record profitability. We will continue to increase the number of DOS, according to the cash available of costs in those markets where we already have our retail organization to leverage on the investments already done. We are still very much in the midst of a huge transformation of the company toward the retail. At the same time, we know that, today, most of the company business is still wholesale business. So we understand that it is of a crucial importance that we transfer to our wholesale customers, the main ingredients that are making our DOS successful. Store location in retail parts, store sites, the adequate merchandising, marketing tools, retail excellence, ceremony and so on. That's the way to let them be more profitable and to let sales grow for everybody. Nazzario will shortly add some more flavor on this. We also need higher volumes from our unbranded division. During the last 6 to 9 months, we have been redesigning our private label collection to get more efficiency production, get economy of scale and, more importantly, present new models with more appealing functions and price points, which were missing. The first reaction of top clients during the recent sale in High Point has been positive. We expect to see an improving trend later in the year, starting from Q3 2018 as these are generally long lead time efforts. Gianni is available too to give an update on the current state of the Softaly business. We reported, for the first quarter 2018, a gross margin equal to 31%, mainly affected by adverse currency movements as such. Under 2017 first quarter exchange rates, gross margin would have been equal to 33.1%. It's important to say that the company has put in place some selected price increases in 2018 to face new currency situation and some increasing raw material costs. In 2017 first quarter, we reported a gross margin of 27.2%. Net of the EUR9.3 million accrued in the labor cost, gross margin would have been 35.2% of sales. So let me comment on the same basis the 2 numbers. The decrease in gross margin from 35.2% in Q1 2017 to 33.1% this year depended on several factors, among which production mix between private label and Natuzzi. In fact, during the quarter, the number of seats produced by our plants increased by 4.5%. However, while Natuzzi seats produced and shipped in the period were substantially in line with Q1 2017. We shipped 10.5% more of private label units with a lower gross margin vis-à-vis Natuzzi. Secondly, the increase in cost for some material used such as foam, oil-related products in general and woods, leather price, instead, continues to be stable. Thanks also to our different sources of supply. Third, labor costs as a percentage on net sales increased a little bit, again, net of the EUR9.3 million accrued last year for legal risk. Also because some extra costs in our plants to speed up shipments. Then other SG&A, which were the main problem we had last year. We had a long discussion with investors In fact, this quarter, other SG&A were EUR22.7 million or 19.3% on sales, improving from EUR23.9 million or 20.6% on net sales reported last year. We achieved this improvement notwithstanding the further investments made in Q1 this year in expanding our DOS network. This improvement in SG&A was made possible thanks to our cost-reduction activities. For instance, we closed our trading subsidiary in Belgium and the office we had in India. We also reduced the personnel in some of our trading subsidiaries abroad. So while investing in retail, we will continue to revise our overhead structure at the headquarter and abroad to get further through subsidies. As said, in 2015 first quarter, we reported an operating loss of EUR10.2 million versus an operating loss of EUR3 million this year. Under constant exchange rate, operating result was reported at breakeven. As of the end of March 31, 2018, our cash was equal to almost EUR45 million from EUR55 million at the end of last year. As stated in the press release, toward the end of the first quarter 2018, we needed to speed up our operations in order to meet the delivery days requested by some of our customers. This has, on one hand, lowered our backlog and generated additional turnover for the quarter. At the same time, such acceleration in production concentrated at the end of the quarter has increased the level of trade receivables, thus using cash of EUR10.8 million in Q1 2018 that more than offset the cash flow generated by lower inventories EUR2 million and a better accounts payable management, which gave EUR1.6 million in cash. During the quarter, we also paid EUR0.7 million as onetime termination payment in connection with the reduction of some managerial positions in headquarter and abroad. As anticipated by Mr. Natuzzi, the partnership with Kuka to expand our retail presence in China continues as planned. Kuka shareholders' meeting just approved the agreement and parties should be in a position to start making business in the following weeks. We expect a significant contribution to our result from this partnership. In the meantime, we must tackle the current business scenario, which has been challenging for both branded and unbranded business, especially in North America. This means that we have set a below-than-usual trend in written orders in March and April this year. As a result, second quarter sales and results of operation may be affected, while we should have a recovery from Q3, third quarter this year. Gianni, Nazzario and of course Mr. Natuzzi will be pleased to answer your questions about the good job recently done and the expectation for the foreseeable future. Thank you.

[Operator Instructions] And we do have a question from Dave Kanen at Kanen Wealth.

So a couple brief questions. First, the agreement with Kuka. Could you speak to the -- how we should look at that in terms of the margin impact of those revenues? And quarterly -- initially, how will that scale up? Will it be a small amount at first and gradually increase as we build out their store network? Or will it have an immediate impact? And then if you can address the margin impact that it will have on our consolidated results?

David, this is Vittorio. Of course, we -- the decision taken some months ago is because we want to aggressively accelerate the retail development in China. We have speaken about an important number of stores to be open, thanks to the cooperation with a strong player in China. You know David that we will not consolidate -- we will have a minority, okay, on that. So we will have the 49%. We will not consolidate the entire value chain in our financial statement. But having said that, first, the new volumes, the addition of volumes that we expect from the cooperation will give us a leverage on our fixed cost, which is the problem of this company. We will have additional volumes in our plants in China, which has huge fixed cost. And we will have additional volumes for Natuzzi Italia for the Italian plants and Italian headquarter, which is huge, as you know, already. And then we will get the 49% of net income of the company contributing to the EPS of Natuzzi. So let's start the agreement. We're still waiting for some final approvals from local authorities. As soon as possible, the new board will be there. Of the new board, we will have the top management of Natuzzi, and they will start -- they will be executing the aggressive retail development that we put in place in the business plan we did in the last month. Obviously, will be a step-by-step process, but we will be aggressive over there.

So will the revenue be small initially when you start this agreement? In other words, are they going to start building out a store network or they already have a number of stores that they're going to a retrofit, if you will, to the Natuzzi Italia brand and then -- and immediately start generating sales in existing retail footprint?

We will, there's a new distribution chain, we have some stores in China, of course, that we are operating. But the plan is to open a new chain to develop Natuzzi Italia, Natuzzi Editions in the entire Chinese and Greater China territory. So this will be done starting from, let's say, the end of this year, but better in 2019. As I said before, in the next weeks, we should conclude the agreement, get the closing and then we will start analyzing, discussing and building out the new business.

[Operator Instructions] It appears we have no additional questions at this time. So we will go ahead and conclude today's call. Once again, I'd like to thank everyone for joining us, and thank you for your participation today.