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Edited Transcript of TKTT.PA earnings conference call or presentation 29-Apr-20 9:00am GMT

Q1 2020 Tarkett SA Earnings Call

Nanterre May 18, 2020 (Thomson StreetEvents) -- Edited Transcript of Tarkett SA earnings conference call or presentation Wednesday, April 29, 2020 at 9:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Fabrice Barthélemy

Tarkett S.A. - Chairman of Management Board & CEO

* Raphaël Bauer

Tarkett S.A. - Group CFO & Member of the Management Board

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Conference Call Participants

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* Jean-Francois Granjon

ODDO BHF Corporate & Markets, Research Division - Analyst

* Keith Brian Hughes

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Steve Levy

MainFirst Bank AG, Research Division - Analyst

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Presentation

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Fabrice Barthélemy, Tarkett S.A. - Chairman of Management Board & CEO [1]

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This is Fabrice Barthélemy speaking. Let me start with a word of hope. I hope you and your families are doing well in these challenging times. That doesn't make your work any easier, I believe. So I hope you're all well. I will share this presentation today with Raphaël Bauer, our CFO.

Without any more introduction, I'd like to turn on directly into the -- our Q1 numbers. You saw that our sales -- reported sales were down 2.2% versus Q1 2019, and that is 2.9% organically versus last year. We had a rather promising start of the quarter in all regions, and we experienced a very sharp drop of activity as of mid-March in several regions, mostly in Europe and mainly in the south part of Europe where activity was severely reduced as of mid-March, but the rest of Europe, Germany and the Nordics, carried on pretty well. So mostly Italy, Spain and France were affected. We were affected also as of mid-March in certain geographies in North America, although we had a very promising start of the year.

In Asia, you know that China is a small market for us. But even in that small market, February was very low. What is noticeable is that as early as in March, we saw a rebound of activity, and March this year was nearly at the same level as March 2019. In spite of this reduction in volumes, our EBITDA margin is stable, thanks to a solid level of productivity and also some easing on raw material prices and costs.

Let's move on directly to the situation today related to the COVID-19 pandemic. As the lockdown measures are taking their toll across the world, we've seen a drop of activity in all regions since mid-March. Some sites have had to shut down temporarily, mostly to give us time to adapt with the social distancing and hygiene measures and sometimes in line with also instructions from local authorities. All the sites that have been shut down have reopened since. The duration of the shutdowns was, in most cases, 1 to 2 weeks. And as of today, the vast majority of our sites are running, sometimes at a reduced capacity to align, of course, with the lower demand. That's for the plants. As far as offices and sales teams are concerned, we switched to remote work in all support functions, and in some countries, we've used reduced working time or temporary layoffs, depending on the local schemes, to adapt to the lower level of demand.

What is very critical for us since the beginning of the crisis is to ensure business continuity, of course, complying with local regulations, but ensuring that we can serve our customers in all cases. So the first focus has been on health and safety with measures to ensure that we could apply social distancing in the plants, applying special disinfection measures, quarantine every time we find an employee who has been tested positive, adapting shift patterns to avoid having too many people at the same time. And I have to say, I've been very positively surprised by the speed and reactivity of the teams worldwide. And we've been so reactive that actually all sites have been enabled to keep shipping. Even when we had to shut down factories, the warehouses that were -- that are attached to these factories have kept operating, and we've been able to continue shipping to our customers to satisfy their needs.

Since the beginning of the crisis as well, we've made sure we maintain a very solid and constant customer relationship. Our systems and IT systems are very efficient, and they allow everyone to work from home remotely and namely all the customer service teams who are normally working from an office but who have been able to continue working from home, taking orders, advising customers, informing customers about the stock situation, making sure that we kept a constant relationship with these customers. So I'm very impressed by how -- eventually how smooth it has been because all this was implemented over 1 weekend in March where nearly worldwide, everyone switched from an office-based work to a home-based work.

And the result is that business is carrying on. I mean although we are seeing today a lower activity, we keep winning projects, and that's because our customers, our partners are also implementing the same types of work patterns. In the workplace and support segments, you see examples on this slide, architects and specifiers have also moved to remote working. They managed to receive the samples at their homes. And all our teams have found creative ways to ensure that our customers receive the best service, and we have now won also some projects that were completely specified from remotely without any direct or physical interaction with our customers.

This was very important also in the case of field hospitals because we've had to provide product and sometimes installation services in a matter of days. We have our role to play directly in the fight against the virus. And you see on that Slide 6, examples of field hospitals and care centers, temporary hospitals that have been set up extremely quickly in all countries in the world. Sometimes, these projects are of a massive scale. I give the example of the ExCel exhibition center of London, it's nearly 100,000 square meters, which, in our business, is an extremely large project, and that was provided and delivered in a matter of days. The reason for this also, let's keep in mind, is that our products offer an excellent performance in terms of hygiene, in terms of maintenance, with the ability to be installed in a very short period of time and in an efficient manner.

In some cases, we've done product donations. In some cases also, and as you see on that Slide 7, Tarkett employees volunteered to install these field hospitals themselves. And that has allowed the installation to be even more efficient and even more speedy. In some also other cases, we used our facilities to make essential products completely outside of our normal activity. You see in the U.S., we've produced sanitizer bottles in a factory that makes components for running trucks at Beynan. We're also sewing gowns for medical staff in one of our facilities in Georgia in the U.S. So every effort counts, and all our teams have been really committed and motivated to make sure that in this exceptional circumstances, they were making any effort -- every effort to manage those projects.

Of course, we've also had, very early in March, a strong focus on preserving cash and liquidity and on reducing our cost base. Some of the actions were already launched in 2019 and we're -- some of them, we're also commenting when we launched our strategic plan. We have a saving program to reduce SG&A. That is well on track, and that will be also, in some cases, accelerated. Overall, we have managed to save -- to have cost reductions, SG&A and productivity of about EUR 8 million in the first quarter. So it's in line with our plan. And we've maintained CapEx for a selection of productivity projects like automation.

On top of that, we've had to adapt the cost base to a lower activity, and that's essential in our business because we have a manufacturing cost base. And when volumes are lower, we try to flex our cost as much as possible, so using different schemes in different countries, temporary layoffs, reduction in working time, we call it furlough also in the U.S. We've frozen most hirings, except in very critical functions. We've reduced drastically all discretionary costs. And in some cases, we've frozen or canceled projects. And of course, the top management is participating to the effort with a reduction in its fixed compensation. And the Board of Directors also has offered to reduce their compensation for this year.

In terms of cash, we are refocusing our CapEx program on safety and productivity projects. We are unlikely to add extra capacity, but some of the projects that were already started last year will be finished, of course, this year. We expect that we will be able to reduce our overall CapEx expenditure to EUR 80 million this year compared to EUR 125 million last year. So it's a significant reduction that will have a positive impact on our cash flow. And I want to -- of course, we manage our working capital very strictly. We take advantage of taxes and so forth, charges deferral. And I'd like to also emphasize that Tarkett is one of the first companies in -- among the French-listed companies to cancel its dividend. We announced that cancellation on the 18th of March, of course, to preserve cash but also as a sign of solidarity and corporate citizenship. And our controlling shareholder, Deconinck family, was extremely supportive of this initiative.

As I conclude this part, and before I hand over to Raphaël who will go into more detail, I'd like to end this part on a word of confidence. You've all read already in our press release that we anticipate a sharp reduction of our activity in Q2. But at the same time, we are very confident in Tarkett's ability to navigate this crisis and to rebound. We have a balanced portfolio between geographies, markets and channels. And that's an advantage in a crisis because, in other words, we are not overexposed to a given channel or a given geography. A good example of this is what we experienced in Europe since mid-March where the slowdown of demand was much sharper in South Europe, Italy, Spain and France, than it was in Germany or Nordic countries, to the extent that, in March, we continued to grow in the Nordic countries. So that overall, it's -- we believe it's an advantage.

We also have a local business model. So at the beginning of the crisis. We were not impacted by imports from Asia because we are very little -- we have a little reliance on long distance in ports. We manufacture regionally. We have raw material supplies that are also regional, and that is an advantage in this time. Our manufacturing processes are also fairly flexible. It is processed, but they are flexible in 2 ways. First, they can -- they allow a fairly easy application of social distancing measures because our production lines are fairly long, and work positions are not all at the same place. So it's easier than in some assembly operations, for example, in other industries. And also, we have the ability to stop and restart our lines as a way also to adapt to the changes in the level of demand.

We also expect that in the future months, there will be increased investment in health care and aged care segments. And that's a segment where we have a leadership position. And we have the right products, the right solutions for these segments to answer to the needs of the health care facilities. This has been demonstrated with the short-term activity with the temporary hospitals. But in the more longer term, it's certainly an advantage on which we can capitalize. And we also have a strong commitment to a circular economy and to the decarbonation of economy, and that commitment will remain and, if anything, will become stronger. One example of this, also related to the field hospitals, is that these field hospitals, in most cases, will be recycled. The flooring we have provided will be recycled at the end of the use of these field hospitals, which we hope will not last too long. With that, we have, I believe, a strong base to benefit from a recovery and to navigate the crisis and the months going forward.

With that, I would like to hand over to Raphaël who will go into more detail into 2 areas: one is financial for Q1 and, of course, our liquidity position for the months to come.

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Raphaël Bauer, Tarkett S.A. - Group CFO & Member of the Management Board [2]

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Thank you, Fabrice. Good morning, everyone.

I'm moving on to Slide 11, looking at the sales evolution of the quarter. As Fabrice commented, Q1 got off to a good start in line with our expectations but was really penalized by the last 2 weeks of March. Therefore, organic growth in the quarter is minus 2.9% compared to last year, and that's largely owing to the lockdown measures in Europe and the first shelter-in-place orders in the U.S. in the second part of March. So all segments are down, but EMEA has been the most impacted.

And I propose we move on to Slide #12 to look at EMEA segment. Organic growth is down 3.7%. And as we commented earlier, France, Spain, Italy, so Southern Europe was the most affected region. Germany performed better on the quarter. And the Nordics are up. In Sweden, for instance, there was no such -- strict lockdown such as in South Europe, and activity is maintained. So as you can see, reported growth is down 4.7%, and that's the effect of negative currency evolutions in the Nordics with the Norwegian krone and the Swedish krona. In terms of manufacturing situation, we had to stop temporarily some factories. But as we speak, we've been able to restart them, and we are producing at the right capacity in Europe to serve the existing demand.

Looking now at North America on Slide 13. We -- activity has been slightly better than our expectations. And I want here to underline that the commercial carpet tile business that was difficult in the end of last year has improved and was slightly growing in the quarter. But by the end of March, we've been also penalized in North America by the shelter-in-place measures that were implemented, slightly later than Europe, yet, it had also an effect. In terms of manufacturing footprint, we had to shut down temporarily our site in Canada, in Québec to comply with the local regulations. All the sites in the U.S. are producing. And again, we are able to serve the existing demand.

Moving on to Slide 14. In the CIS, Asia Pacific and Latin America segments, there is, of course, a variety of situation depending on the geography. Fabrice commented on Asia that is down on the quarter, and that is weighing on the segment. China was down in February due to the lockdown, but March is almost back to a normal level in China, so that's encouraging. In the CIS and in Russia, in particular, over the quarter, volumes were slightly above last year. And in Latin America, we grew well, both with good volumes and also increased selling prices, to offset partially the decrease of the currency in Brazil, the Brazilian real. But in these 2 regions, in CIS and Latin America, it's in April, that activities started to be penalized by the lockdown measures.

Let's now move to Slide 15 with our last reporting segment, Sports. Let me remind you that the first quarter for Sports is a seasonally low quarter, and there is little activity in that part of the year. And also last year, comparison basis is quite high. The first quarter of 2019 was up 19% compared to the same quarter in 2018. Once we said that, this year, our activity was penalized in Europe by the lockdown measures, and we had to stop some installations of fields in countries such as France or Spain. In North America, tough, it's slightly up over the period.

So as you can imagine, all this slowdown in volume had a negative effect on EBITDA, and we can move on to Slide 16 where we present the evolution of the EBITDA of the first quarter of last year to the first quarter of this year. It's relatively stable and the margin is stable because we were able to offset most of the negative effect from the lower volumes that you see in the first column, minus EUR 9.5 million, and that's mostly coming from the last 2 weeks of March. We were able to mitigate that impact, both thanks to lower purchasing prices, and that's coming mainly from lower prices in the oil derivative product that we purchased, PVC and plasticizer, for instance, but also a very good level of cost reduction, EUR 7.7 million cost improvement over the quarter, particularly in SG&A.

We already commented in previous communications that we had launched end of last year already a review of the cost of our support functions, and we are starting to see the benefits of the actions identified in that process. And we are also, in the quarter, starting to benefit from the fast reaction to cut discretionary spendings. The action, already commented by Fabrice. In this current context, we are strengthening all these cost cutting actions, and we'll see the benefit of that in the second quarter.

We are also very much cash conscious, and we are taking all necessary actions to protect our liquidity. So moving to Slide 17, I want to really remind all of us that we do have a solid level of liquidity. As you can see here, at the end of March, we have a gross amount of debt of EUR 887 million and EUR 217 million in cash. So that's a net debt of EUR 670 million, which is an increase compared to where we were end of December last year at EUR 547 million. But that's a normal increase, that's our usual seasonality in our activity, and that's mostly due to the necessary inventory increase that we need to make in the first half of the year. So there is nothing abnormal in that level of take at this stage. And I want to remind you also that when we look at the debt, we do have extended maturity with no significant debt repayment. So liquidity is solid. We have EUR 443 million of undrawn credit lines that are confirmed, and that's a revolving credit facility. So added to the cash that we have on hand at the end of March, that's EUR 443 million -- that's EUR 660 million of liquidity readily available.

In the current situation, we expect a significant slowdown in activity in the second quarter and, therefore, an impact on EBITDA. We have announced beginning of April that we have suspended our target of leverage ratio. For the very same reason, we have initiated discussions with our banks to waive the financial covenant on the revolving credit facility line for the 2 test periods of 2020. We have actually chosen to discuss a full package with banks, the waiver of covenants -- the waiver on covenants. But also, in parallel, even though we have a good level of liquidity, we are also looking at additional credit facilities to be on the safe side. We are looking at the PGE in France, so a state-backed credit facility. We could benefit from around EUR 70 million on that PGE program. And we are also considering an additional revolving facility. So discussion with banks are making good progress, and we have a strong support from our banks.

I will now hand over back to Fabrice to comment on the outlook.

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Fabrice Barthélemy, Tarkett S.A. - Chairman of Management Board & CEO [3]

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Thank you, Raphaël. So of course, you will understand that giving an outlook for the rest of the year is not extremely easy. What is certain is that our activity today is penalized by the spread of the pandemic and the lockdowns that are still in place in many countries. So we expect the biggest impact to be in the second quarter. It's not our habit to give -- to report on monthly activity, but we believe it's important to give you an order of magnitude, of an idea of what type of impacts we are experiencing right now.

In April, we expect our activity to be in the region of minus 40% compared to April 2019. Of course, there are some variances by region. I think we commented also before that as countries are taking different types of measures the impact can be more or less important on the economic activity, mainly in Europe, with South Europe being further down compared to this minus 40% and Northern Europe being better. Also, when you look at the America, in the U.S., some regions like the Northeast are more impacted than others like the Midwest. Of course, we will maintain a very strong focus on cost reduction and cash preservation. We also expect that raw material prices will help us mitigate the impact of the lower volumes. With the current oil price or the oil price much lower than it was last year, we will have a positive impact from those raw material prices. As a consequence, the -- overall, we still expect that the adjusted EBITDA will be negatively affected in Q2 and for the full year.

Our priorities remain the same in 2020, #1 is to protect the health and safety of our employees and also of our partners, people who deliver products on site, the transportation company, et cetera. We want to ensure the continuity of production, which is very important, and to keep giving the required level of service to our customers. We continue to drastically reduce costs to mitigate any negative impact. We manage cash very tightly to preserve liquidity. And we will pursue the strategic initiatives of the Change to Win plan, which remain mostly relevant: reducing costs; focusing on commercial segments; changing the culture of the company, being more customer-driven; and of course, with a strong commitment to a circular economy and decarbonation.

With that, I would like to thank you very much for your attention. And Raphaël Bauer and myself are ready to take whatever questions you would have.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Steve Levy from MainFirst.

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Steve Levy, MainFirst Bank AG, Research Division - Analyst [2]

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I have several questions. The first one is on the raw material. Do you think that you would be able to keep the positive impact from the fall of raw material in the future and for how long? Just to have an idea about your sensitivity about that. About your clients, have you seen any increase in defaults? And what is your view, the level of inventory they have at the moment? The third question is just to better understand how full time work and employment has been integrated. Out of the SG&A reduction, have you integrated the subsidies from the French state for full time employment? Or can you give us an idea about the level of variable and fixed costs on a quarterly basis that we can have in mind for the second quarter? And I think I'm done.

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Fabrice Barthélemy, Tarkett S.A. - Chairman of Management Board & CEO [3]

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Thank you, Steve, for your questions. So on the raw material side, today, it's a bit difficult to quantify exactly the tailwind in the second half. We can reasonably say that positive impact should be at least EUR 15 million in the second half of this year. Clearly, our strategy is to keep selling prices at their current level. This is what we did successfully in the previous downturns. And I was also at Tarkett in 2008, 2009, and at that time, we were successful in keeping the prices at the same level. This time, it's a bit different. So we cannot say exactly what H2 will look like, but this is clearly the strategy.

In terms of clients, we have not seen yet any increase in client defaults. We had a very slight increase in customer past dues at the end of March, but most of them were actually paid in the first days of April. You know also that we have implemented last year a factoring scheme, and with that factoring scheme, there is a credit insurance facility. So everything we had factored, actually at the end of March is credit insurance. We start seeing some reductions of credit limits by the credit insurers. But so far, this is not having any impact on our business because demand is also reducing accordingly. But of course, this is a topic we monitor very closely by having constant dialogue with our customers. And of course, every time there is a customer that appears to be more risky, we have different credit policy.

On the temporary layoffs and employment, you would -- you won't be surprised to hear that there are as many different schemes as there are countries. The French scheme is one of the most generous ones, to be fair, both for the employees and for the companies. So we apply it, and we have decided towards the last days in March, seeing what type of reduction in demand we are going to face, we have applied in our French site, including the headquarter, some temporary layoffs, not fully but overall about half of the employees have been laid -- not half of the employees, but employees have been laid off for half of the time in France. France is one among many other countries, and it's only less than 6% of our activity and our workforce. So in each and every country, we apply the schemes that are decided by the local governments. And the only thing I can say is that in many parts of the world, they are less favorable than they are in France.

You had a question, I'm so sorry, on the proportion of fixed and variable costs. It's fairly -- when you take our P&L, about half of the costs are directly variable, so material transportation. The other half is essentially fixed as long as we don't take clear actions. So this is why -- this is wages, this is outside cost, this is maintenance, this is energy, to some extent, rent, et cetera. So we are taking actions on all these cost lines. We mentioned temporary layoffs. But of course, we are also reducing demand, freezing some projects to make sure that we lower the cost base as much as possible. But still, the reduction in volume is having an impact on our profit.

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Steve Levy, MainFirst Bank AG, Research Division - Analyst [4]

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Can we -- just to follow up this one, on the second quarter, the magnitude should be higher or equivalent compared to your first quarter...

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Fabrice Barthélemy, Tarkett S.A. - Chairman of Management Board & CEO [5]

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The magnitude of what?

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Steve Levy, MainFirst Bank AG, Research Division - Analyst [6]

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The drop in profitability for the second quarter. I'm just trying to see how I can have an idea about the profitability, the leverage on the second quarter in order to -- on your profitability. So the idea is to see whether or not we can get -- how much we can lower our estimate for the second quarter and how much you can say out of it.

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Fabrice Barthélemy, Tarkett S.A. - Chairman of Management Board & CEO [7]

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So the -- we only gave an indication of the level of activity for April. And I mean you understand that the economic -- the pandemic situation is fluid, the economic situation is also fluid. What is sure is that we will reduce cost by much more than the -- what we announced initially. So we had an envelope, our target of cost reduction of EUR 30 million for the whole year. It will be well above that. And likewise, you saw EUR 8 million of productivity and cost reduction in Q1. In Q2, it will be much higher than that. I cannot give you a precise number, but you should also expect that given the magnitude of the reduction in volumes, the profitability, the EBITDA margin will not be maintained in Q2 at the level it was in Q2 2019. It's not reasonable to expect that you can drop volumes by up to 40% and keep exactly the same margin because, as I mentioned, there are costs that are much more difficult to flex in the very short term. Long term, we can take different measures. But in the very short term, you cannot flex by 40% every cost line.

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Operator [8]

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Your next question comes from the line of Keith Hughes from SunTrust.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [9]

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A question on the April results you've seen so far. Are you seeing a large variation in the declines in April amongst products? Or are they all fairly similar to this negative 40% you discussed in the slides?

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Fabrice Barthélemy, Tarkett S.A. - Chairman of Management Board & CEO [10]

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Keith, thank you for your question. Right now, we see much more difference according to geographies and countries than according to products. So we see geographies that are down by more than 40%, take Italy, for example, on all types of products and all kinds of segments, and others that are behaving much better. And generally, it's also on all types of products.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [11]

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Okay. And final question, if you look at your production scheduling going into May, will you be taking more downtime than you did in April or a fairly similar amount?

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Raphaël Bauer, Tarkett S.A. - Group CFO & Member of the Management Board [12]

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Right now, in several countries, we see some signs of easing the lockdowns and some signs of job site resuming, customers like builders resuming their activity during the course of May. So we expect May to be still a difficult month. We don't expect a very sharp recovery in May, but at least stabilization is what we see today.

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Operator [13]

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Our next question comes from the line of Jean-Francois Granjon.

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Jean-Francois Granjon, ODDO BHF Corporate & Markets, Research Division - Analyst [14]

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Yes. Jean-Francois Granjon from ODDO BHF. I have the same question relating the Q2. The question is, do you expect the same trends to improve in May and June or limited improvement? The second question is, could you give us some more color regarding the logistic costs? You mentioned in the press release that you expect some increase for the logistic costs. And the last question, for the -- what is your vision or expectation for Q3, Q4? Do you see improvement, stabilization or not? And do you see a strong recovery or improvement in 2021?

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Fabrice Barthélemy, Tarkett S.A. - Chairman of Management Board & CEO [15]

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Jean-Francois, thank you very much for your questions. In Q2, today, we believe that April and maybe at least some part of May should be the bottom of the crisis in our sector. So we -- as I just said, we don't expect a sharp recovery in May. But we see, even in countries that were deeply affected by lockdowns, such as South Europe, you see a willingness of our customers to restart up sites, to reopen distribution outlets. So that should play in a positive manner. Now opening distribution outlets is one thing. Whether there is traffic in those outlets is something else. June is a bit far to have a precise expectation, but we believe that June should be better than April and May.

In terms of logistic costs, logistic costs, we don't give precisely the value of logistic costs, but it's a few percentage points of our sales. And the reason for increase in those costs is not like before fuel price, actually, fuel prices are going down right now, but more the difficulty that the transportation companies have to organize transportation, finding drivers, managing borders because custom controls have been reinstated in many parts. So even if customs stay open for products, it takes longer. Managing also safety procedures, every time they load and unload, related to health and safety. So that -- we have to admit that it creates an over cost for them. So that's the reason for our increase in cost, but we don't expect it to have a very -- an extremely material impact on our accounts.

Now Jean-Francois, for the rest of the year, I think we are -- we don't talk anymore about forecast. We talk about scenarios because the main driver of this crisis is not financial, it is sanitary and medical. And actually, what will determine the way -- one of the things that will determine the way our end markets behave in the coming quarters will be how we will be able to control the pandemic. So we make different scenarios about the shape of the recovery. Of course, it differs also in terms of end-user segments. We expect that health care, aged care will recover better and faster than hospitality or cruise ships. But we have those scenarios, and we make sure that for any set of hypothesis, we have the right measure in place and the right trigger points. And we will be ready to adapt to any scenario. But clearly, no one can say today whether Q3 and Q4 will be a clear recovery close to 2019 level or if there will be a significant drop in activity, it's too early to say that.

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Operator [16]

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There are no further questions from the phone lines at this time. We have received questions from the web. Four questions from Charles-Louis Scotti from Kepler Cheuvreux. Question one, what kind of incremental margin shall we expect on lost sales in FY 2020? Question two, how much Spain, France and Italy represent in terms of sales, how much is Nordic countries and Germany? Question three, are your clients asking for price reduction because of the collapse of raw materials, how are your competitors behaving? Question four, do you expect a catch-up effect in H2 projects delayed, or will clients simply cancel their orders? Question five, have you renewed your factoring program, or shall we expect a significant WCR outflow this year?

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Fabrice Barthélemy, Tarkett S.A. - Chairman of Management Board & CEO [17]

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Thank you. Raphaël will take the first 2 questions.

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Raphaël Bauer, Tarkett S.A. - Group CFO & Member of the Management Board [18]

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Yes. Charles-Louis, thank you for your questions. On the incremental margin, as Fabrice commented, short term, we have 50% of our cost -- around 50% of our cost are directly variable costs, such as raw materials and freight. So this means we need to take actions on the other parts. So we have taken significant actions on this cost with thorough measures, in particular, for labor, with postponing project also. In factories, we are very much cost conscious, making sure we spend rightly on maintenance, for instance. So we will closely monitor on that. But let's -- let's all be aware that the magnitude of the sales decrease makes it difficult to use the usual operating leverage. And I'll remind that in average, our operating leverage is between 35% and 40% for flooring division at least.

Looking at the country size in Europe, you know that France is around 5% of group sales. So France is about 15% of the EMEA. The largest geography per se is the Nordics in EMEA. It's a bit larger than France. And within the Nordics, it's comprised of Sweden, Norway, Finland and Denmark. But Sweden is the largest country. And Spain and Italy are smaller, actually quite smaller than France, between, yes, 1% to 2% of group sales each. Fabrice, do you want to add some color here?

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Fabrice Barthélemy, Tarkett S.A. - Chairman of Management Board & CEO [19]

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Yes, sorry. Absolutely, so the follow-up -- following question was on selling prices. And the answer is so far, no, we have not received any requests from our customers to reduce prices. Just to be precise, what we sell today has been, in most cases, specified several months before, so any pressure on price should not have any immediate effect on our accounts, probably not in -- certainly not in Q2. And with distribution, we also operate with price lists that are negotiated once a year. So we don't expect also any change during the course of this year. In terms of the catch-up or the expectation of a catch-up in H2, we are very cautious. I think it's much too early to plan on the material catch-up. As I said -- as I commented before, the main input will be how fast we can exit from the lockdowns and how fast the economic activity will be able to resume normally. So I think the expectation of a very significant catch-up would not be very reasonable. So we are monitoring this. And maybe in some segments, again, such as health care, there will be a positive impact for us, but not in all segments.

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Raphaël Bauer, Tarkett S.A. - Group CFO & Member of the Management Board [20]

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On factoring and working capital, shall we -- I would answer the factoring question, but let me remind everyone about the seasonality. The way our business is organized, in the first half of the year, we increase our working capital by around EUR 100 million. And that's what we -- we've seen that trend so far in March, end of March. If we look historically at our free cash flow in the first half, it has always been comprised between minus EUR 60 million and minus EUR 80 million. So of course, the second quarter of this year will be atypical and working capital level will partially adjust to lower activity.

But I want here to flag a few important points, among which is factoring. Factoring, at the end of March, we have factored EUR 130 million. This amount, directionally, in the second quarter, we expect it to decrease, both because customer balances will decrease due to lower activity and also due to the fact that we sell to the factor up to the credit limit from Coface for each customer. And those credit limits for some of our customers are being revised downwards due to the current environment. So we expect a significant decrease from the factored amount. It's difficult for me to give you a magnitude of the figure, where it could be, but we should expect an impact on cash in the second quarter.

We are, of course, looking at working capital, very cautious with inventories, not to overproduce. So we control our inventory level. But let's be clear, inventory level short-term cannot decrease as fast as sales are decreasing. So you should take all that into account to model the working capital evolution, in particular in Q2.

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Operator [21]

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Your next question comes from the line of Pierre Bosset from HSBC. Do you expect some changes in the competitive landscape in the flooring market, bankruptcies? Some players are owned by PE fund, for instance, [Kofer] paid 10x EBITDA for Gerflor in January 2020. Whilst Gerflor is going to be impacted by the fact that sport competitions have stopped. Question two, is there some flooring product easier to clean or more resistant to coronavirus? Would you expect change in the demand by products, i.e., less carpet, more resilient flooring? Question three, could you provide breakdown in percentage terms of your end-user market between those who are resilient, health care, education; those which are directly impacted and will take time to recover hospitality; and the rest, i.e., those impacted but which should recover relatively quickly?

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Fabrice Barthélemy, Tarkett S.A. - Chairman of Management Board & CEO [22]

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Pierre, thank you for your question. On competition, it's difficult to comment on our competitors. Some of them are listed, some of them aren't. It is true that some other firms started this year with a less positive outlook than ours. So they will have more problem. But I cannot comment on any competitor specifically. Of course, we are watching this space, and we are making sure that we win every single project we can win. And that's why I am extremely proud and encouraged by the recent commercial successes we've had in our various markets.

To follow up on your question on the product categories, it is a very interesting question. We believe that our products are very well positioned to answer to increased procedures and expectations for hygiene and cleanliness. And that's namely resilient products or PVC, linoleum, that are mostly used in health care and also in education facilities. And they offer an easiness to be maintained and cleaned, so very good resistance to the chemicals used to clean and a very good resistance to wear as well. And as you know, also, the ability to install and to ensure a continuity to a ceiling of the floor, we need continuity between the floor and the wall, which, for example, ceramic tiles, I cannot give you because in ceramic tiles, you have some grouts and joints. So this is why in the U.S. and in Europe and in many other countries in the world, all hospitals are equipped with resilient products.

Let's not ignore also the fact that carpet tiles in the office environment have also a very -- potentially, a very good impact on the indoor air quality. We have some ranges that we call AirMaster in our product offering that actually capture the microparticles in the air, the very fine dust in the air, and that the -- this fine dust is captured by the carpet and is, therefore, subsequently removed through vacuum cleaning. As we hear that the virus can be also carried by fine particles, we believe that this consciousness about indoor air quality can be an advantage. And of course, the rest, well, these are our biggest product lines, but things like wood laminate or rubber tiles, for example, that we sell in -- also in health care in the U.S., have a positive impact. So we are fairly positive on our ability to really promote the impact of our brand and product categories on hygiene and indoor air quality.

We don't provide a breakdown of -- to your third question, of our activity by end-user segment. But clearly, health care, education, are historically big segments for us. I'll remind you that about 70% of our activity is on professional commercial segments, with 30% on residential. Hospitality is likely to be one of the segments that will be the most severely affected, but it's a small -- a very small part of our business, a few percentage points, mostly in North America, a little bit in Europe and the rest of the world. So we are not overexposed to that segment. And we are fairly encouraged by the fact that we have a good balanced exposure to the various segments. But you would be surprised that even in hospitality, we are -- there are projects happening at this time because also some hotel owners are taking the opportunity of having temporarily closed hotels to accelerate some renovation projects. So there is still activity.

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Operator [23]

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Your next question comes from the line of Wouter De Blaere from AlphaValue. Question one, on the ongoing talks with banks, it seems to be taking a while. Is it from the bank's side, they are perhaps waiting on government guarantees to be clearer? Question two, could you give some more color on why you would need an -- sorry, an additional liquidity line viewing there's an undrawn facility of EUR 443 million open? Question three, do you see an uplift in residential sales for renovation, for example, viewing that people are at home nowadays with more time for DIY, perhaps? What's the role of online sales play in here?

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Fabrice Barthélemy, Tarkett S.A. - Chairman of Management Board & CEO [24]

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Thank you. I'll let Raphaël answer the first 2 questions.

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Raphaël Bauer, Tarkett S.A. - Group CFO & Member of the Management Board [25]

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Yes. So speaking about banks, as I commented, we have chosen to make a package negotiation. And the first main topic of that discussion with banks is the covenants for the revolving credit facility, June and December covenants. And in addition, we are negotiating additional facilities, government-backed loan and an additional facility. So that's the whole package that we are discussing. It's making good progress, but it's fair to comment that as you probably imagine and know, comments -- banks are very busy as we speak, and credit committees, in particular, are very busy. But we are seeing good support from our banks, and that's progressing well.

You're also asking about the additional liquidity. And it's true that we have a solid liquidity. However, we don't know what would be the extent of the difficult situation post COVID-19, and we want to be as secure as possible when it comes to liquidity. We want to be also sure that we will be able to have the liquidity to finance the working capital need that we will have going forward when activity will restart. And if beginning of 2021 is doing better, we will need again to increase inventory in particular. So we want to be in the best position to anticipate all of that, hence, the additional liquidity plans we're looking at.

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Fabrice Barthélemy, Tarkett S.A. - Chairman of Management Board & CEO [26]

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To your question on the home refurbishment and DIY, it's a good question, actually, you could expect that people spending more time at home would start renovation projects. To be fair, we haven't seen a big uptake so far. One of the factors is that in many countries, actually, DIY stores or physical locations have been shut down or had the restrictions in their openings. They have developed their click-and-collect options, but it's not happening everywhere. So we -- essentially, and back to the question we had earlier, we saw activity in residential segments more or less in line with the overall activity in each of the markets. So for example, the south of Europe was depressed in commercial, and it was very close to the same reduction in sales in residential. And conversely, in the Nordic countries, the strong activity we experienced was both in commercial and residential segments.

We have seen, though, everywhere an uptake in Internet sales through either traditional retail or DIY or sometimes also through pure players. And in -- we've seen volumes on channels multiplied by sometimes as much as 5x. But let's not overreact to that because it starts from a very small basis. Flooring products are not the easiest one to ship. And you know that there have been difficulties also in shipments and deliveries from Internet sales. And they are bulky and heavy products. So they are not the easiest ones to ship easily. But still, it's -- for us, it's a strategic direction to make sure that we benefit as much as possible from this trend -- or increased trends in Internet sales.

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Operator [27]

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Your next question comes from the line of Huihong Wang from Aegon Asset Management. Could you please also comment on the following? See, in the larger major private placement Schuldschein debt you have, will you soon start the covenant waiver process with these lenders as well?

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Raphaël Bauer, Tarkett S.A. - Group CFO & Member of the Management Board [28]

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I will answer that question, Raphaël speaking. Thank you very much for your question. As you rightly point out, part of our financing is private placement, Schuldschein for a bit more than EUR 600 million. Let me remind all of us that for Schuldschein private placement, we do not have any covenant at the end of June. The covenant measure is at the end of December. So we will start discussing with Schuldschein investors more towards the end of the year when we will have more -- a little bit more visibility on what the lending end of December could be.

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Operator [29]

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Your next question comes from the line of Pierre Rousseau from Barclays. Question one, SG&A savings, do you have an FY estimate given the recent action you have taken? Question two, you have mentioned in the past that you were open to more restructuring reorganizations to restore margins and returns if needed, do you think some of the current adjustments you have made could be maintained in the longer term: capacity closures, internal reorganizations, reduction in the workforce? Question three, Capex, could you comment on which projects are maintained and where, are you able to restart the projects halted quickly, and shall we expect higher CapEx in 2021 if the activity returns to normal?

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Fabrice Barthélemy, Tarkett S.A. - Chairman of Management Board & CEO [30]

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Thank you, Pierre. So maybe the first question on full year estimate, it will depend -- the level of cost-cutting and the productivity actions will also depend on the level of activity. So that's why we are not giving a number today because it will depend on how much demand we see in Q3 and Q4. What is sure is that it will be significantly north of EUR 30 million that we had announced that was in a stable business as usual environment. So some -- right now, we are only taking short-term measures that can be reversed. So we used temporary layoffs. We reduced working time. We reduced compensation. So that's clearly the type of actions we take. Like I said before, long term, everything is flexible. So if it turned out that we -- the scenario on which we have to work is much more depressed than what we would think today, we'll take more measures. That will be adapted also to the situation in each economy and each country. The recovery might not be the same in North America, in certain parts of Europe, and it certainly would not be the same, also depending on end-user segments. So we'll take -- we'll have a response that will be adapted to the problem. And so far, we know exactly how to specify the problem depending on different geographies or segments.

In terms of CapEx, what we are doing right now is that we are -- we haven't stopped any project that was launched and nearing completion. We are maintaining those projects. So some new lines that were being installed will be finished. And for example, in rigid LVT where we have in-sourced products from Asia into Europe, these investments will be finalized in the coming weeks. Of course, most of the large capacity projects that we had were finished in 2018 and 2019. So we were -- even before the crisis, we had indicated that the level of CapEx would be lower in 2020 than it was in 2019. Right now, we believe that EUR 80 million is probably -- is an achievable level. And what we are maintaining for sure is everything related to automation, everything related to safety where we have quick paybacks and it's the right thing to do. For 2021, it's too early to have a view on the activity in 2021. But I think it's fair to say that we are unlikely to see a V-shaped rebound, making it necessary to invest massively in new capacity. So we have ample capacity. And you ask me the question today, so I answer today based on what I know today. There should not be an increase in CapEx next year compared to the EUR 80 million we have -- we are forecasting for this year.

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Operator [31]

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There seems to be no further questions from the web. We will go back to the telephone. You have a follow-up question from the line of Steve Levy from MainFirst.

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Steve Levy, MainFirst Bank AG, Research Division - Analyst [32]

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Just one question about the demand for local product. Just wondering if you already have feedback from your clients looking for products locally compared to imported products? And do you see in the future the rise for local products increasing?

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Fabrice Barthélemy, Tarkett S.A. - Chairman of Management Board & CEO [33]

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We don't have any -- thank you for this question. We don't have any direct feedback yet because, to be honest, everyone, both manufacturers, but also distributors, everyone is very busy managing this crisis. So I'm not -- they have not changed their strategy overnight. But personally, I am absolutely convinced that there will be both a pragmatic pressure and also a social pressure on distribution to resource as much as possible from Asia into Europe or North America because they are experiencing today the difficulties of long-distance imports, and there is also going to be more and more pressure to relocate production in Europe. And Tarkett is very well positioned because I mean we only have 2 factories in Asia right now, in China, but they are dedicated to the Chinese and Asian markets. So every -- all our manufacturing facilities are located in Europe, in Russia, for Russia and Eastern Europe market; and in North America. So we have -- we have a good card to play there, and we will strongly advocate this with the large distributors, the DIY and all our customers who source directly from -- sometimes from Asia to make sure that they see the advantage of -- that they can have sourcing from our plants in Europe and North America, among which the advantage, a very short -- much shorter lead time, much more flexibility and overall, a better service as well.

I think there is a question on -- that I can see on the web on Russia. With the current devaluation of ruble against the euro, would you have to increase your selling price locally? And with the drop in oil price, would you expect a sharp drop of volume in Russia? That question is from Pierre Bosset.

So Pierre, yes, with the current devaluation of the ruble, we have increased our prices actually at the beginning of April, which also explains why the volumes were sustained in March because customers, to a large extent, anticipated those price increases. With the drop in -- the question of Russian economy is very, very relevant. And we see that a drop in oil price will have a negative effect on the Russian economy. What plays in the right direction for us is, first, that we have a strong position. We have localized and more and more localized manufacturing and sourcing in Russia. And compared to the previous downturns that we've experienced, Russia and Eastern Europe is a much lower exposure for the group, so we are more balanced geographically. And still -- and another point I want to stress also is that, that division, Russia and the CIS countries, is the one where we have the lowest breakeven points, so -- and where we have a very strong commitment and flexibility of the teams to flex the cost base. So we will remain profitable in that region.

So as these were the last questions, I believe it's time to conclude. Let me remind 2 topics. The first one is that we are committed to health care and the safety of our employees and together, at the same time, ensuring the continuity of business in all regions and whatever level of activity we have. And we are very proud that we have been successful to doing that.

The second point is that we are anticipating very clearly a sharp drop in demand in Q2. We indicated the level that we are seeing in April of minus 40% so that you can have a rough idea of the extent of the downturn that we are experiencing. At the same time, we are very encouraged by the fact that we took early decisions and early actions to reduce costs vigorously to preserve cash and we are already seeing the results of these actions. We also have a strong liquidity. We have the support from the banks.

And finally, this crisis will not last forever. There will be a recovery. We don't know the shape of the recovery exactly, but we believe that with our exposure to a variety of geographies, of end segments and with the product categories that we supply, we will be in a good position to navigate through this crisis and to exit the crisis stronger.

I'd like to thank you -- all of you very much for your attention and to wish you a good day, stay safe and be well. Thank you very much.