It's been nearly a year since Italian furniture maker Natuzzi (NYSE: NTZ) promised investors that it would achieve "at most a 3% margin" this year. By mid-year, the firm was already making good on its promise, and good news -- judging from the numbers Natuzzi reported for its third quarter 2006 last week, it remains on track to keep its word.
Granted, when you look at the quarter stand-alone, the results were far from pretty. Despite selling 10% more units (called "seats" in industry parlance) this quarter than last, total sales (by value) for the quarter rose only 7.7%. The reason: Most of the growth came from the firm's discount line of products, "Italsofa," sales of which rose 18.8%. This explains why the dollar value of sales didn't measure up to the volume increase.
It also explains why gross margins were down nearly 390 basis points sequentially, and 80 points year over year. Sell lots more stuff at lower prices, and this cannot help but squeeze your profit margins. By the time we worked our way through all the costs of running the business, just 0.5% remained of Natuzzi's net margin for the quarter. Still, even that anemic result meant that Natuzzi has achieved a 3.2% net margin on its results year to date.
The real question, though, is whether the firm can maintain this performance. As noted in our pre-earnings Foolish Forecast, going into this quarter, Natuzzi was far from certain that it could maintain that performance. To the contrary, new CEO Ernest Greco had warned that the firm's recent sales gains had been "mainly sustained by the existing backlog that has decreased materially over the past few months." That sentiment, unfortunately, remains intact. According to Greco's comments last week, the firm's rising sales have "not been accompanied by a similar order flow. In fact . the Group has been reporting a decrease in the order flow which could lead us to an adjustment of the production level."
Translated from the original Italian, what Greco is saying is that:
1. The firm's backlog is drying up, threatening future sales growth.
2. Lacking new sales to fulfill, the company is thinking of cutting production. And as we've seen at manufacturers as similar as furniture makers Hooker (Nasdaq: HOFT) and Stanley (Nasdaq: STLY), and as dissimilar as boat builders Marine Products (NYSE: MPX) and Brunswick (NYSE: BC) in recent quarters, cutting volume does horrible things to a firm's margins because fixed costs get spread out over fewer and fewer products.
Foolish takeaway
Natuzzi seems to believe it can still make its 3% net margin this year. As for next year, though, barring a sudden wave of demand for high-priced, haute couture leather furniture, Natuzzi's margins could be in serious trouble.
What did we expect out of Natuzzi last quarter, and what did it produce? Find out in:
Hooker, Stanley, and Marine Products are all Hidden Gems recommendations. Discover Tom Gardner and Bill Mann's latest stellar small-cap selections with afree 30-day trial.
Fool contributor Rich Smith does not own shares of any company named above.
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