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Edited Transcript of NTZ earnings conference call or presentation 11-Apr-19 2:30pm GMT

Q4 2018 Natuzzi SpA Earnings Call

Santeramo (Bari) Apr 19, 2019 (Thomson StreetEvents) -- Edited Transcript of Natuzzi SpA earnings conference call or presentation Thursday, April 11, 2019 at 2:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Pasquale Natuzzi

Natuzzi S.p.A. - Chairman & CEO

* Piero Direnzo

Natuzzi S.p.A. - IR Manager

* Vittorio Notarpietro

Natuzzi S.p.A. - CFO

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Conference Call Participants

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* Garrett Larson

* Giovanni Danisi

* Michael Feder

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Natuzzi Fourth Quarter and Full Year 2018 Conference Call. (Operator Instructions)

Joining us on today's call from the Natuzzi store in Milan are Natuzzi's Chief Executive Officer, Mr. Pasquale Natuzzi; the Chief Financial Officer, Mr. Vittorio Notarpietro; Mr. Nazzario Pozzi, Chief Officer of the Natuzzi division; and Mr. Gianni Tucci, Chief Officer of the Softaly division; and from the Natuzzi headquarters, 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.

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Piero Direnzo, Natuzzi S.p.A. - IR Manager [2]

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Thank you, Arnam. Good morning to our listeners in the United States, and good afternoon to those of you connected from Europe and Asia. Welcome to the Natuzzi's Fourth Quarter and Full Year 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.

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 will 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 update or revise any forward-looking matters discussed during this call.

And now I would like to turn the call over to the CEO. Please, Mr. Natuzzi.

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Pasquale Natuzzi, Natuzzi S.p.A. - Chairman & CEO [3]

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Good morning, everyone, and thank you for participating in the Natuzzi conference call.

As already communicated last November, the first 9 months of 2018 were very difficult for us due to the [unfortunate] issues we faced in the supply chain. This explained most of the operating loss of EUR 15.2 million we reported at that time. We have reacted to that and reinforced some key management position that is already in the operation, with professionals coming from primary industrial players. In particular, we had these new hirings, and they are, indeed, Mr. [Aldo Anarti] with an extensive experience in aerospace industry as the Chief Process, Innovation and Product Development Officer. The operation department is now led by Mr. Antonino Gambuzza with 25 years of experience in manufacturing and engineering industry as the new Chief Operating Officer of the group. And we hired Mr. Umberto Longobardo with a deep experience in the fashion industry as the new Chief Quality and Customer Care Officer; and Mr. [Paolo DiMaggio] from the automotive industry as the new Global Procurement [Exercise] Expert.

We immediately started working together, checking a list of the KPIs on a daily basis, and the first improvement started to arrive almost immediately during the fourth quarter of 2018 and have continued in the first months 2019.

These are delivered through a better and efficient (inaudible) delivery of our product, so we didn't have delays in the production and the invoicing process, as occurred in the past. Furthermore, the strict collaboration among managers has also led to finding a new solution to further improve the overall supply chain process.

The senior management is in place and extremely confident about the contribution that can be derived from the job and recovery efficiency. We also hired a new Human Resource Director from a primary industrial player in Italy. The name is Michele Onorato, which has made already great job with achieving the agreement with the Italian government and national unions that allow us to reduce the cost of labor in the Italian plants and, starting from April 1, 2019, to shift the volumes of production from the Italian plants to Romania plant. That's related to Natuzzi Editions production because the Natuzzi Italia product will be manufactured still in Italy, where we have higher margin. Obviously, while the contribution -- the margin we have doesn't allow us to manufacture in Italy. So that's the reality.

As a result, the overall labor cost in the production plants will improve accordingly starting from the second quarter 2019, and it will improve the company margin. This is, by far, the most important news for Natuzzi for this year and going forward.

At the same time, I would like to remind you that we transformed our group from a manufacture company in the lifestyle brand. This does require a huge investment over the years, which led to the worldwide brand awareness that the Natuzzi name has made over time on a global scale. Such company transformation has been pursued also through huge investment on mono-brand stores. In fact, there are evidences of such transition.

If you give a look at today's performance, we clearly see that the retail mono-brand store business, which represents almost 50% of the entire business, is growing, allow us to control the [brand level] and margin. As the result [and learning curve] we have done in the retailer business in the recent years, we intend to increase the percentage of our controlled distribution going forward.

The wholesale, on the contrary, is characterized by strong competition on price, putting high pressure on margin. For this reason, we would sell the unbranded product only to selected customer with acceptable volumes and margin. Like what I just said, going forward, we intend to focus on the retail-based strategy that is on the development of the mono-brand store network, both directly and franchising operations. We are very well positioned for this, and this will deliver an effective return of the investments made on the brand over the last years -- few years -- or many years, I should say, and that journey has been done so far. A lot still to do, but now we have clear in mind the path to move forward. I'm confident that, for the reason I just explained, we would be capable to overcome the turnaround and create value for the company and for our shareholders.

Thank you very much, and we are here available for any questions. Thank you.

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Vittorio Notarpietro, Natuzzi S.p.A. - CFO [4]

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Thank you, Mr. Natuzzi. Let me give you, our listeners, more numbers about this year and the last quarter.

Let's start explaining the path on Natuzzi 2018 full year profit and loss we derived from the joint venture agreement signed last year in China. On March last year, Natuzzi signed a joint venture and share purchase agreement with one of the leading players in the upholstered furniture in China, which is the KUKA Group. Such agreement aimed to expand Natuzzi's retail network in China mainland, Hong Kong and Macau, providing for the contribution by Natuzzi of exclusive distribution rights to perpetually use the Natuzzi Italia and Natuzzi Editions trademarks into one of Natuzzi's Chinese subsidiaries, whose name is Natuzzi Trading Shanghai, and a total investment of EUR 65 million to sustain the expansion of the Natuzzi retail network in greater China by means of the acquisition of a stake in Natuzzi Trading Shanghai Ltd.

Following such agreement finally executed on July 27 last year, Natuzzi has lost control of the former wholly-owned subsidiary, Natuzzi Trading Shanghai, in which each of Natuzzi and KUKA Group now owns a 49% and 51% stake, respectively. In accordance with IFRS 10, at the day when control over Natuzzi Trading Shanghai had been lost, which is July 27, 2018, Natuzzi has, one, the recognized assets and liabilities of Natuzzi Trading as the carrying amount of total or net assets of EUR 2.6 million; two, recognize the fair value of the consideration received from KUKA for a total amount of EUR 65 million, out of which EUR 30 million represented the consideration received by Natuzzi for the transfer of the 23.5% stake in the subsidiary, while EUR 35 million represented the subscription by KUKA Group of Natuzzi Trading Shanghai capital increase, resulting in KUKA acquiring an additional 27.4% stake and diluting Natuzzi's investment in the former subsidiary; three, recognized the 49% retained interest in Natuzzi Trading Shanghai at its fair value estimated in EUR 48 million.

So in fact, in consolidated statements of our profit and loss of the transaction I described before, has been the recognition of a gain of EUR 75.4 million. Of course, the fair value of Natuzzi Trading Shanghai has been estimated through a third-party independent appraiser based on a discounted earnings method.

Now let's get back to the ordinary operations of the company. As said by Mr. Natuzzi while commenting on the results of the first 9 months 2018, we explain the main factors affecting results: one, a weak wholesale business; two, raw material price increase; three, our efficiencies in the Romanian and Italian production plants; four, some extra costs in the logistic processes; five, unfavorable exchange rate. But at the same time, we clearly stated that the retail operations were improving already, raw material prices' upward trend was changing, and we were adopting measures to address the supply chain. So the company agenda for the fourth quarter 2018 has been organized on the basis of the items just mentioned, of course.

Let's analyze the Q4 2018 results. The consolidated gross margin was 27.4% from -- so lower than 28.9% in the previous fourth quarter because it included EUR 5.6 million of restructuring costs pertaining to workforce reduction program at the Italian operations. (inaudible) the cost of sales, net of the aforementioned costs, and also thanks to a favorable trend in raw material pricing in Q4 last year, gross margin would have improved at 32% of revenues.

In the fourth quarter, we have also seen the first tangible result of the action implemented in the meantime in the supply chain. The favorable trend in raw material prices had been confirmed in Q4 2018. For retail, the direct retail business has continued to improve. As of today, the DOS, directly operated points of sales, are 56, of which 39 Natuzzi Italia, 15 Divani&Divani by Natuzzi as well as Natuzzi Italia concessions in Mexico. And we just closed 8 loss-making concessions in U.K., House of Fraser, to be precise.

During the fourth quarter of 2018, net sales generated by the direct retail division were EUR 16.8 million, up 4.4% over the same period of last year, with positive sales number in the U.S.A., plus 46%; Italy, plus 19.5%; and Switzerland, plus 20.2%.

Q4 2018 sales on a like-for-like basis were EUR 12.9 million, up 36% from EUR 11.6 million in the last quarter 2017, thanks to the performance of our DOS located in U.S.A., Italy and Switzerland. As a result, the group reported again an operating loss of EUR 8.9 million versus operating loss of EUR 6.3 million in 2017 fourth quarter. But excluding the EUR 6.9 million of the costs elating to the restructure of Italian operations, for 2018 fourth quarter, the group would have reported operating loss of EUR 2 million, so improving from the previous 9 months 2018.

On this basis, let's now have a look to 2019. The business environment and global economy are still quite difficult almost everywhere. Uncertainty about tariffs between China and U.S.A. are still there, and Brexit consequences are unpredictable. As said before by Mr. Natuzzi, we continue our strategy while we are changing the industrial footprint between Romania and Italian.

Now along with the new production allocation between Italy and Romania explained by Mr. Natuzzi, [which shows] the other main pillars of 2019, we do not expect a significant increase of business volume in 2019. We will focus on the quality of the business. Indeed, we have planned a further improvement in the like-for-like performance in the retail chain, where we have opened 6 stores in 2018. We're planning a modest growth in the branded sales, whereas as far as private label is concerned, we will focus on a few selected primary customers delivering reasonable margins.

As a consequence of Natuzzi's primary focus on branded sales, the mix is expected to be more favorable. In addition to that, we also put in place some price increase. The raw materials cost is going down as expected. And finally, the continuous job of the industrialization of the prototype R&D department is progressively improving the cost of quality and will contribute to improving the overall production efficiency. Finally and differently from last year, exchange rates are more favorable this year versus 2018.

[All in all,] together with the further rationalization of our overhead cost structure, will contribute to the return to a positive EBITDA in 2019, which is the management goal for this year.

Thank you. Now Mr. Natuzzi and Mr. Pozzi will be happy to answer your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We will take our first question from Garrett Larson from Kanen Wealth Management.

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Garrett Larson, [2]

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My first one is, you mentioned a $6.9 million cost in OpEx. So on a go-forward basis, what should we expect OpEx to be? Number two, it looks like you had a onetime expense impacting gross margin. I think it was EUR 5.6 million. Can you just quantify that? And then going forward, should we expect that gross margin to get back into the low 30 percentage range? And then I just had one follow-up after that.

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Vittorio Notarpietro, Natuzzi S.p.A. - CFO [3]

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Okay. Let me be more precise. The 6 million -- EUR 6.9 million restructuring cost is the sum of EUR 5.6 million in the operations or in the cost of goods sold plus EUR 1.3 million in SG&A. The total is the EUR 6.9 million. This was linked to a [step] of that was closed in December 2018 in order to incentive people to lay the company -- to lay off the company. We incentivated about 60 people by the end of last year, and we accrued another EUR 1 million that we want to spend this year in order to reduce the cost in the -- in our structure (inaudible).

Going forward, we have -- I have to come back to the plan that Mr. Natuzzi explained -- to the agreement that Mr. Natuzzi explained a few minutes ago. We have 1/3 of our workers in Italy that are redundant versus the Natuzzi Italia today on the floor. With this agreement for the next foreseeable future, we will reduce this redundancy by the sustain of the Italian government. So that's the plan for the redundancy cost.

As far as the gross margin is concerned, of course, we are aggressive this year in terms of improvement of our gross margin. Let's say it this way. If you consider the Q4 2018, net of those, let me say, restructuring costs, the gross margin is already in the area of 32% instead of the reported 28%. That's more or less the goal we have in mind for the full year in 2019.

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Garrett Larson, [4]

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And then one on KUKA. Do you expect KUKA -- the KUKA deal to contribute to revenue this year? Or when do you anticipate that? And then what is the anticipated increase in China store count for KUKA year-over-year?

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Vittorio Notarpietro, Natuzzi S.p.A. - CFO [5]

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That's a great question. This year, obviously, we are discussing with them. But they have for 2019, we are still fine-tuning some of these operational steps in order to let the JV, joint venture, work. But the plan that the Board of this company approved, which is the basis of the agreement, is very aggressive for the next years. Just in 2019, they have a goal to open in China additional 60 stores. And they are -- normally, they are quite on time with their plans.

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Operator [6]

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We take our next question from Giovanni Danisi from Seeking Alpha.

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Giovanni Danisi, [7]

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First of all, correct me if I'm wrong, but I think that this quarter and the quarter to come, the 2, 3 quarters to come probably, will be quite challenging in (inaudible) because I think that -- so last year, you sold to China directly and China accounts for, I think, around 10%, 15% of your net sales. And this year, you are selling to China through your joint venture. You are actually selling through your joint venture with a markdown probably. So dependingly, from the markdowns from (inaudible) to which you sell into the joint venture, you'll say China should -- going to be weak so smaller than last year. So this could be quite difficult to compare the quarters so -- because we are -- we don't have kind of apple-to-apple comparison. So I think that basically, it should be a little bit more than, so what they appear in sales. Correct me if I'm wrong. And also, I would like to know if I got it good. So you assigned a fair value of around EUR 48 million to the joint venture. You said or I didn't get it good. And another one is about this 60 stores that KUKA is planning to open. These 60 stores will be directly operated stores or just franchisee?

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Pasquale Natuzzi, Natuzzi S.p.A. - Chairman & CEO [8]

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This is Natuzzi. Regarding the opening of the store, approximately, we expect in China to open 50 franchisees and 10 would be operating directly from the company, okay? So the rest (inaudible).

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Vittorio Notarpietro, Natuzzi S.p.A. - CFO [9]

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Yes, EUR 48 million is the entire fair value of the 49% of the company in China. Yes, you got precisely. About China, therefore you're right because prices differ in the 2 years. So this year, we will [exercise] in order to explain better, to give the best representation. But let me say something about the deal structure. While they're consolidating the business, we also -- they're consolidating the cost of that structure. So [don't see just sales] but also the impact of minor cost on the structure of the company, one.

As far as Natuzzi Italia is concerned, yes, there is a different calculation in the agreement -- I mean, the price. But as far as contribution margin is concerned, we are still there. A very positive contribution margin of Natuzzi Italia upholstery shifted to the (inaudible) also. So yes, we obviously are -- we have reduced a little bit on the company price. But at the end, the name of the game is the 50 stores that this year and the other stores that, that kind of people in China will be able to open in the next years, volumes is what we need in order to leverage the company. And that's why Mr. Natuzzi agreed to this joint venture agreement because we understood the need to have a Chinese partner in order to accelerate volumes in the midterm.

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Operator [10]

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(Operator Instructions) We take our next question from [Nick Crasses] from [CT Capital].

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Unidentified Analyst, [11]

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Yes. My accounting questions have been answered.

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Operator [12]

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It appears there are no further questions at this time. I would like to turn the call back to our host for any additional remarks.

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Pasquale Natuzzi, Natuzzi S.p.A. - Chairman & CEO [13]

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Well, I guess there's no further questions. Are there? Okay?

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Operator [14]

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(Operator Instructions) And we just have a question. We take our next question from Michael Feder from Feder Group.

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Michael Feder, [15]

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I don't actually have a question. I just want to make an observation. As you know, I follow the company very closely, and I continue to believe that your transformation to a lifestyle brand, your focus on mono-brand retail, which you can control, your focus on only those private label customers that will be profitable is exactly the direction that you should be going. I remain very hopeful, as do we all, that the economy will help us all see the results of those actions in the near future. But I commend you all on your strength and conviction to move forward during these tough times, so thank you.

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Pasquale Natuzzi, Natuzzi S.p.A. - Chairman & CEO [16]

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Well, we appreciate that you share our strategy. Thank you, Michael.

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Operator [17]

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(Operator Instructions) We take our next question from Giovanni Danisi from Seeking Alpha.

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Giovanni Danisi, [18]

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Yes. Just one follow-up if I can. Maybe you would like to speak about -- to add some color of the -- about the performance of your Natuzzi Edition wholesale operation in the fourth quarter. That came in, I think, worse than expected. There was some particular challenge there maybe, I don't know, or was a problem of difficult comparison or maybe other environmental problem for the fourth quarter that has been difficult all over the world for all companies, actually. And because actually, for what I can see, the wholesale operation about Natuzzi Edition, performance even worse than Softaly in the fourth quarter. So this is kind of, I don't know, surprising. So maybe you could add some information about it.

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Pasquale Natuzzi, Natuzzi S.p.A. - Chairman & CEO [19]

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The strategy of (inaudible) is to activate all the shareholders and the listeners regarding the [active] a way of interpreting our business. Before, we used to have Natuzzi Italia and Natuzzi Editions. In Italy, we are Divani&Divani. It's a chain of stores, Divani&Divani by Natuzzi; and then Softaly, which was pure retailer -- no, pure wholesaler, I'm sorry, pure wholesaler for the big guys, big distribution, okay. Today, because the retail represents almost 50% of the business, so we dropped Softaly. We are just retailer division and retailer collection, which is separate from the wholesaler collection. We have 2 collections. Natuzzi Italia is made in Italy. Then we have a wholesaler collection is made in China, Brazil and Romania. And then wholesale, we have multi-brand stores that we supply product, and they have a gallery inside. There is a space branded Natuzzi. And then we are also -- we are distributing product to pure wholesalers. Again, the division retailer, which includes Divani&Divani, which is comparable with Natuzzi Editions, is performing well, the store -- the mono-brand store.

The wholesaler, because of the competition, the price pressure and the margin, we are intentionally refocusing a little bit in order to focus our -- and dedicate our energy primarily on retailer, which is what really gives us -- is giving us a good response, good result.

So [do we have a difficult year] is that the numbers are not, I would say, (inaudible) quarter, Natuzzi Editions, let's say, which is primarily a wholesaler, except for China and Brazil, where we have a store, and now we just started to open the store -- very successful store in United Kingdom of Natuzzi Editions. And a big part of the business in Natuzzi Editions is wholesaler. And probably -- not probably, I'm sure that our wholesale business is not performing well, but that's because we are -- we don't want to reduce our margins. I mean, we are not willing to work with low margin, with price pressure. Did I answer your question?

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Giovanni Danisi, [20]

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Yes. So just for better clarifying, so it's kind of intentional, intentionally choice like to reduce the volume of the wholesale part no matter if it is Softaly or Natuzzi Editions or Divani&Divani?

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Pasquale Natuzzi, Natuzzi S.p.A. - Chairman & CEO [21]

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No. We have 2 -- Divani&Divani and Natuzzi Editions retailer are the same, just the logo -- just, I mean, the name of the distribution is different. But again, we have 2 -- we have a factory and collection dedicated for retailer and then wholesaler. Within retailer, we have Natuzzi Italia and we have Natuzzi Editions, which is the equivalent of Divani&Divani. We are trying to simplify the understanding of our business. We have retailer and wholesaler. We used to be 100% wholesaler company. And 15 years ago, we transformed, as I said in my speech, from a manufacturing company to a lifestyle brand, huge investment also in the retail division. And today, we realize that the future of the company is just retailer in order to get the return on the investments that were done on the brand and on the learning curve of the retailer.

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Operator [22]

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That concludes today's question-and-answer session. I would like to turn the conference back to our host for any closing remarks.

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Piero Direnzo, Natuzzi S.p.A. - IR Manager [23]

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Yes. Thank you, Arnam. So it seems that there are no further questions. Therefore, this concludes our conference call today. Please, as usual, feel free to contact us should you need further information. Thank you, and have a nice day. Goodbye.

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Operator [24]

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This concludes today's conference call. Ladies and gentlemen, thank you for your participation. You may now disconnect.