Ermenegildo Zegna N.V. (NYSE:ZGN) Q4 2023 Earnings Call Transcript April 5, 2024

Ermenegildo Zegna N.V. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning or good afternoon and welcome to the Ermenegildo Zegna Group FY 2023 Financial Results Call. My name is Arden and I will be your operator today. [Operator Instructions] I will now hand the call to Paola Durante to begin. Ms. Paola, please go ahead when you’re ready.

Paola Durante: Thank you. Thank you and good morning, good afternoon to everyone. And thank you again for joining the Ermenegildo Zegna financial conference call on 2023 full year results. All the materials that were discussed in the presentation and the press release that was sent previously. You can find it on our Group website at ermenegildozegnagroup.com. I'm very happy to say that today with us we have the leadership team of the Group, including our CEO, Mr. Ermenegildo Zegna;, our COO and CFO, Gianluca Tagliabue. And we have also Lelio Gavazza here with us in Milano, CEO of Thom Browne and -- TOM FORD; and Mr. Rodrigo Bazan that has connected, I believe, from Los Angeles, but he is also here with us. Before beginning, I need to point out a little few things that are little bit boring, but we need to do it.

We make -- during the call, we will make certain forward-looking statements. Our actual results may be materially different from those expressed or implied by these forward-looking statements. Also, I remind you that statements are subject to a number of risk and uncertainties including those described in our SEC filing. Please refer to the forward-looking statements cautionary included at Page 2 of our presentation.

Ermenegildo Zegna: Good morning, good afternoon. Thank you Paola, and thanks to join us in today's conference call on Zegna Group fiscal year 2023 results. Today, as usual, I would like to give you a brief update on our results from last year, discuss the main accomplishments and project we undertook. And finally briefly comment on what we are looking forward to this year. I do believe that '23 was a milestone year for the Ermenegildo Zegna Group. We completed the acquisition of TOM FORD FASHION, which has reached our group with a third brand that is perfectly complimentary to our portfolio. On top of this great addition, the Group also achieved outstanding results. Group revenue in '23 as we shared back in January,. reached €1.9 billion, up 28% and up 19% on an organic basis.

Our adjusted EBIT reached €220 million with an adjusted EBIT margin of 11.6%, 100 [ph] basis points from 2022. And most importantly, our net profit more than doubled compared to 2022. I think it has been a great achievement. I'm also very proud of the progress we made on our sustainability commitments. Caring for nature and the communities around us is a founding value of the Group. And I'm pleased to say that we delivered on the sustainability commitment we set for 2023. Last year, we formalized the adoption of a group diversity, equity and inclusion policy and signed 87% of our employees on topics touching on DE&I. We are on track to reach by '26 50% of key raw material certified is traced and lower impact. We continued our investment in renewable energy.

97% of energy used in our European operation now comes from renewables. In 2023, we have installed photovoltaic panels on the rooftop of two additional production facility. But it is only the beginning, as I always say, this is the beginning of the journey and we have still lots of work to do. Nevertheless, I'm proud of how far we have come and for what it has taken to get there. Now I want to take a moment to talk about the heart of our business -- the three brands in our [indiscernible]. First, Zegna brand. 2023, we continue to build on our successful Zegna One brand strategy globally. As you know, the Americas and EMEA are ahead on the journey, but we are also starting to reap some rewards in other market, in particular China. And one of the market where the journey started later is exactly Greater China.

We do recognize that '24 still be challenging there due to geopolitical and macro environment, and as we further roll and develop our customer base, but we see important positive signs, especially the fact that demand for our highest end product is strong and improving. We are extremely focused on and committed to this region to further reinforce brand awareness of Zegna as the leader in luxury menswear. Talking now about product of Zegna brand. In February, we launched the SECONDSKIN collection globally, a selected number of SKUs, including leather outerwear and the SECONDSKIN Triple Stitch, our iconic that made the finest leather out of SECONDSKIN. The drop has performed very well in all regions, including China. Looking at distribution, we are even more committed in reinforcing our D2C channel.

We will continue to streamline our wholesale distribution also converting some more brand store in concession. Finally, one very exciting event coming up for the Zegna brand will takeover in April, where -- sorry, we will take over Milan in April with event [ph]. During the [indiscernible], we will launch a new Oasi Zegna at Piazza Duomo and present a Born in Oasi book, which gathered a unique vision of our founder. We are doing best at the moment when all eyes will be on our great home city, Milan, [indiscernible]. Next is Thom Browne. In the year 2023, in which the brand celebrated 20th anniversary, Thom Browne revenue reached €380 million, topping a strong 26% compounded average growth rate since the brand became part of the Group. A very nice run, I would say.

But the journey just started and we still have a margin [ph] to do. The brand has huge potential across markets and product to go beyond the €500 million that was my initial target. Finally TOM FORD FASHION, the new join in our Group crown, we do believe that there is a huge potential of TOM FORD FASHION. This confirmed through every conversation ahead with Lelio about the brand cover in the world, whether it is landlords with clients, with luxury experts around the globe. They all agree that the brand has room to develop in particularly linen wear and in leather goods segment. The brand has created an artistic direction is strong. You've seen that in the reception of Peter Hawkings collection to date. CEO Lelio Gavazza is here today with us.

He is forming a team, starting with Head -- with new Heads for Asia and for the Americas. We're also making sure that the brand can leverage our Group infrastructure, including our supply chain know-how for both men's and linen tailoring for CRM and customer engagement system and develop the TOM FORD FASHION store footprint. We have secured some 8 to 10 stores as of this year, and we'll start with renovating few of them. Before I hand over to Gianluca, let me mention an important project. I'm particularly proud of evolving our Filiera. What is our Filiera? It's a new terminology in Italia and start to translate in English. However, it's our fully owned and fully integrated supply chain made of the finest high-end Italian textile platform integrated with unique luxury manufacturing capacity, really unique, a unique project in luxury.

To reinforce this Filiera, we've recently approved an important new project in Parma, I would call it a breakthrough project, a cutting-edge center for excellence which will primarily produce men's shoes and leather goods designed by famous architect Gianmaria, Antonio Citterio, who designed our current headquarter in Milan, the facility will sit on a 10 hectare plot of land and function also as an important research and development training center, including our academy. When full and running, the center will employ more than 300 people, and we produce a significant portion of good shoes primarily for Zegna, but it will also serve the other brands. Let me now conclude by saying that although '24 will be a volatile year, we remain extremely confident that our path is well traced.

Uncertainties can create amazing opportunities. If you have a clear vision and are able to react immediately and firmly being ready to take [indiscernible] by executing perfectly around the world. I would like to take the opportunity to share with you some of the actions that we have been working on with our management team. Number one, we are enforcing our team talent with some key additions in important markets. We will continue to invest on our brand focusing on key priorities, both in terms of marketing and store opening and remodeling. BTC and CRM, two very important part of our evolution are our mantra. It will be even more in the forthcoming months. For Zegna, for Thom Browne and for TOM FORD, we have to know better and be closer to our customers.

Loyal customers are more loyal in challenging times. And in the meantime, we have to stay tuned to our people in stores. They are our first ambassador. We will continue to streamline our wholesale doors, if anything, even more aggressively than initially planned. Last but not least, we are working on continuing to improve store productivity and sell-through, where we’ve gained a very important step. Let me conclude by reaffirming that our Group is in custodian of our entities, probably is to protect them since we've been around 114 years. These are our Group ambitions alongside those committed to you at the recent Capital Market Day, which confirm today. And this is also thanks to the best in region. We have three authentic brands unique Italian luxury Filiera and focused, accountable and responsive management team in united family with 114 years of heritage.

And last but not least, a clear vision that guides our actions. With that in mind, let me turn over to Gianluca that go into the financial in detail. After this Rodrigo, Lelio and Gianluca and myself, we will take your questions. Thank you very much.

Gianluca Tagliabue: Thank you, Gildo. Good morning, good afternoon, everybody. So let me move to Page 13 of the presentation where you find the Group revenues evolution over the past 3 years. Preliminary revenues for full year '23 were already disclosed at the end of January. So there is no news and therefore, I will not spend much time on this page. Just let me underline the full year '23 revenues have been in a very good year for our Group with almost 28% reported growth, thanks to a double-digit contribution from Zegna and Thom Browne and from the newly added TOM FORD FASHION segment, which contributed to €235 million revenues. I remind you also that TOM FORD FASHION has been consolidated for around 8 months last year. Let's move to Page 14.

Before commenting the numbers, I would like to remind you that since 2023, we have changed the way of reporting our P&L, adopting the bi-function presentation versus the previous by nature. We believe that this way to represent numbers not only reflect better the way we look at our business, but also can help you understand more our company. For this reason, in the next pages, I will comment the actual numbers underlying their drivers by each P&L line. Let's start from gross profit. In 2023, consolidated gross profit rose by 32% to a €1.2 billion mark with a margin of 64.3%. The 210 basis point improvement from last year has been largely driven by a better channel mix as you know, DTC gross margin is higher than the wholesale one, but also by better price/mix and by the scale effect, in particular, in the supply chain side, which helps better absorbing the industrial fixed costs.

Channel mix is estimated to justify about half of this gross profit margin step up. An important point to underline related to the TOM FORD FASHION consolidation. You remember that on April 28 of last year, we acquired for roughly an enterprise value of €150 million cash free, debt free and on the basis of normalized working capital. The 85% of international, the only company that manages the TOM FORD FASHION business under a 20 plus 10 license agreement with the Estee Lauder Companies. The purchase price allocation so-called afterwards PPA of this transaction has been allocated to the assets acquired, including inventories, customer orders and the license agreement itself, generating some PPA-related charges, both at cost of sales and at the SG&A level.

Because of this PPA, in 2023, gross profit we accounted for €15.6 million higher cost of sales related to the step up of inventory value and the amortization of the value allocated toward this backlog. The majority of this 15.6 -- €15.6 million charge is actually related to the inventory. This amount will be largely accounted in 2023 financial with a smaller sales in 2024. In fact, this year, '24, we will account the remaining and last €3 million to €4 million of this kind of charges in the cost of sales. After that this smaller effect in '24, we will not incur additional costs related to PPA on the cost of sales. Moving to SG&A, they reached in 2024 €901 million with a 47% incidence on revenues about €200 million higher compared to full year '23.

Let's dip down on this increase of G&A, and I would like to underline a couple of important factors. The TOM FORD consolidation contributed to more than half, some €124 million to this absolute increase. This amount includes also the royalty fees that TOM FORD pays to order. In addition, it includes the second part of the PPA that I mentioned before exercise and this part is related to the amortization of the right of use of the license agreement, which gets amortized over 30 years. In 2023, for the 8-month consolidation, the license amortization was equal to €2.2 million and in '24, the amount will be in the tune of €3 million on a 12-month basis. The second relevant item that is important to underline is the impact on SG&A deriving from the acquisition of the Thom Browne South Korean business.

I remind you that since July '23, Thom Browne started to manage roughly the 17 stores in that market. And as you know, retail generates higher gross profit, but also on the other side, higher selling expenses compared to the wholesale business. On the other side, it's important to remark that the Zegna segment helped offsetting some of the above mentioned negative effect by contributing itself with a positive leverage on SG&A. Just a final comment for those that might have not known the Group for long, given that this is the first time we report 2021 SG&A expenses. In 2021, SG&A expenses included some €200 million arising from the business combination with the SPAC that led to the listing of Zegna Group at the end of 2021. So that is the reason of this curve, which presented a high number in '21.

Let's move to marketing expense. Marketing expense on Page 16 increased to a 6% incidence on revenues in line with the management plan to further invest on its brand equity value. We remember that this 6% incidence is also affected by B2B components within our business, which requires very little or no support at all by marketing, and this is the case of textile and third-party brands that together represent roughly 10% of group revenue. So when we look at 6% incidence, we have to bear in mind that this 10% comes with very limited marketing dollars. Page 17, here is the report of our consolidated statement of P&L. I believe we have already thoroughly commented line by line, the ones above the operating process. Let me make here a couple of comments at this point below operating profit on financial income and expenses and on taxes.

Starting from the financial items. In full year '23, net financial expenses, including foreign exchange losses. In 2013, they were negative for a combined amount of €36 million versus €49 million negative in '22. So this €13 million positive swing from '22 to '23 arises mainly from three factors: first, lower liabilities from the on ground put option related to better ForEx, this put option is expressed in dollars and related to higher interest rates, which reduced the net present value of the put itself. And this to components more than offset the higher intrinsic fair value of the cost deriving from higher expected results of TOM FORD looking forward in the years to come. The second component that generates the positive swing and positive reduction of financial components is the lower hedging costs that we incurred this year.

And the third, higher returns from financial assets versus 2022. This effect more than offset the financial cost that emerged with the warrant redemption that occurred in the beginning of 2023, which I recall generated a €22 million charge in our P&L. And as information, the financial expenses, which might help also the analysts to model their projection. The financial expenses related to bank loans and lease liabilities under the IFRS 16 rule were this year in the region of total €30 million. I call out the last points of attention, the €3 million negative related to results from investments accounted at equity value, they refer mainly to TOM FORD results in the 4 months before our acquisition and they are related to the deal related costs incurred by the target company before closing.

Therefore, this line is expected to return positive from 2024. Finally, let's talk about taxes. This year -- last year, in '23, we had a favorable effective tax rate in the region of 20%, which has been influenced by a positive tax ruling and by the recognition of DTA connected to some tax losses previously generated. I can anticipate that looking forward for the Group, we have in mind the normalized tax rate on the disclosures with 30% rather than 20%. Moving to Page 18, the adjusted EBIT metric, which is our key metric in terms of analyzing the performance. As Gildo already commented in full year '23, our adjusted EBIT reached €220 million with almost a plus 40% increase versus last year, and this was part of our own expectation. Adjusted EBIT margin rose to 11.6% notwithstanding the dilution effect from the TOM FORD consolidation, which for full year '23, you can roughly estimate slightly higher than 1.5 percentage points about of which -- of which about us are coming from the previously mentioned PPA effect on cost of sales.

The difference between the adjusted EBIT, €220 million and the operating profit, €208 million, that is €12 million is referring to adjustments that in the reported P&L are almost entirely accounted for in the SG&A line. Please, I remember again that all this €12 million adjustment do not include the charges related to the PPA because it's not allowed to have the PPA charges accounted for as an adjusted item. So they are part of our adjusted EBIT. So the adjusted EBIT discounts, the PPA effect good or best -- at best on our P&L. Let's look at the results by segment. Moving to Page 21, Zegna segment. As you know, this segment includes both the Zegna brand, products and the textile division of third-party brands. This generated €1.3 million -- €1.3 billion revenues before intergroup revenue elimination that amounts to €33 million, and those are sales of either finished products or textile to TOM FORD and Thom Browne.

And it came out with an adjusted EBIT margin of 14.6%, thanks to higher gross profit margin, a lower incidence positive leverage on SG&A. Both these effects were supported by the strong 25% organic growth in Zegna brand DTC, which has helped to boost our store productivity, as we said in New York by almost 50% up in 2 years, 2023 versus '21 and was also supported by positive absorption of fixed cost in supply chain and textile operations by the increased volume of business. This important increase in adjusted EBIT margin arises notwithstanding the decision to enhance the marketing expenses for the Zegna brand, which was disclosed in our prior conversations. Page 23, Thom Browne segment. The segment reaches -- reached €380 million before eliminations with a 15.5% adjusted EBIT margin.

This good result is linked to the positive performance in both channels with DTC channel at plus 20% organic on full year '23 and wholesale on a plus 15% organic in full year '23 after a strong year-end in wholesale with Q4 wholesale delivery that reported a plus 40% organic versus Q4 '22. Two words, finally, on the TOM FORD FASHION. Page 25, results were in line with the expectations impacted at adjusted EBIT level by the already mentioned PPA and by the royalty fees. It is important to us outline, in particular for 2024, that our priority remains to invest in the business and to set the basis for a successful organization led by the CEO Lelio Gavazza. On the next pages, we summarize some key results of our consolidated statement of financial position, balance sheet.

So let's look at Page 27 here. I just call out a couple of elements on the line related to noncurrent assets because it is the one that is seeing most of growth. So in that line, the growth comes from the following factors. There is a €96 million right-of-use asset coming from the TOM FORD license agreement. So in the PPA, we allocated at time of closing €99 million of right-of-use assets, which gets amortized over 30 years. At the end of the year, it came down to €96 million. Then there is a goodwill of €24 million related to the Thom Browne South Korea business taken over midyear. And then the rate increase of right-of-use assets related to leases, the IFRS 16, whose growth is mostly driven by the addition of TOM FORD FASHION retail network and related leases within our consolidated revenue.

Let's go to Page 28, where we commence trade working capital. Trade working capital increased in '23 to a level of €449 million, 23.6% of revenues, driven by the normal increase in business, but also by our decision, as you have already seen, in the semiannual numbers of '23 to invest in Zegna and Thom Browne plastics, which are continuated [ph] collections across the season. This investment impacted inventories in particular, in the first months of '23. And in fact, if you compare year-end inventory and June inventory '23, they are basically in line. So it means that we have plateaued and now we start normalizing. We have been already started normalizing the spike coming from this one-time investment on continuity collection. In addition, you should consider that the incidence of revenues on vis-à-vis trade working capital has been penalized by a mathematical factor given that the addition of working capital coming from TOM FORD, €52 million is compared to only 8 months of revenues of TOM FORD.

For the future, our goal is to move gradually towards a 20% incidence of trade working capital analysis [ph]. Page 29, you see a new non-IFRS metric that we introduced, also listening to your succession is the free cash flow metric. And let me comment this nice €72 million free cash flow generation, which we recorded last year, largely driven by our improved operating profit results. Last year, CapEx was equal to €78 million, around 4% of revenues, but I would like to reiterate what we already commented in New York Capital Markets Day and the fact that for '24 and also '25, our CapEx should increase as a percentage of revenues, slightly above the 5% threshold, given that we are investing in-store openings and remodeling and also in the breakthrough project mentioned by Gildo of the new factory in Parma, actually -- this is actually more than a factory, it will be a center of excellence now in creativity, where we will somehow celebrate our skilled artisans that every day produce luxury shoes for Zegna and for the group in an amazing environment which will enhance the workforce welfare.

Finally, Page 30, and this is the bridge of the net financial investments, which starting from a cash surplus at the end of last year lands basically as a neutral net debt to net cash position with a slight net financial investments of €11 million after an incurred investment in subsidiaries and where the bulk of majority of this amount come from TOM FORD FASHION. With this in mind, let me leave the floor to Gildo for final remarks on outlook and current trading.

Ermenegildo Zegna: Thank you, Gianluca, for the clear presentation. And let me complete the first part of this call with some remarks on quarter 1 trend of this year, anticipating a question that I'm sure you will ask us. As you know, we are going to publish quarter 1 revenue on April 23. So detailed inflows and questions on Q numbers should be discussed in that occasion, not now. But let me give you here some highlights to help you better understand trends and actions, which we believe might not have been completely understood. Quarter 1 '24 revenue result reflects three main trends. Number one refers to our decision taken a while ago but are involved today to further streamline the wholesale distribution, in particular at Thom Browne.

We felt that in the current environment, it was the right decision to anticipate some action that we’ve initially planned over a longer period of time. Secondly, we are seeing some higher-than-expected volatility in Asia, mainly in Greater China and mainly for Thom Browne. For Zegna, the trend in the region largely reflects the one brand strategy, and we see signs confirming that we are moving into the right direction, even if the strategy has yet to be fully completed. For Thom Browne, the trend in Greater China has been influenced by the challenging environment, but also by the need to reinforce the retail organization. On the other side, I have to say that I'm very pleased to see all the other markets for Zegna, in particular the United States and some key markets like Japan for Thom Brown, growing sound double-digit DTC growth, confirming the strength of our brands.

As a result, Q1 revenue are expected to grow in the region of 10% constant ForEx while organic performance is expected mid single-digit negative due to wholesale revenue of Thom Browne expected to be down high double-digit of a very challenging comparison base. However, looking at full year 2024 and considering revenue consensus numbers, I feel confident that they are achievable. And I'm sure we are taking the right actions to deliver them. Regarding our mid-term guidance, as already said, I confirm that this guidance is unchanged and confirmed. Thank you.

Paola Durante: Thank you. Thank you, Gildo. And I leave now the operator to open for the Q&A session. Thank you, operator.

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