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Edited Transcript of XXL.OL earnings conference call or presentation 19-Jul-19 6:30am GMT

Q2 2019 XXL ASA Earnings Call

Oslo Jul 23, 2019 (Thomson StreetEvents) -- Edited Transcript of XXL ASA earnings conference call or presentation Friday, July 19, 2019 at 6:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Øivind Tidemandsen

XXL ASA - Chairman

* Stein Alexander Eriksen

XXL ASA - Group CFO

* Tolle O. R. Grøterud

XXL ASA - Interim CEO and Strategy & IR Director

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Conference Call Participants

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* Magnus Råman

Handelsbanken Capital Markets AB, Research Division - Research Analyst

* Oliver Schüler Pisani

Nordea Markets, Research Division - Analyst of Consumer Goods

* Silvia Borsetti

* Simon William George Irwin

Crédit Suisse AG, Research Division - Director

* Tushar Jain

Goldman Sachs Group Inc., Research Division - Research Analyst

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Presentation

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Tolle O. R. Grøterud, XXL ASA - Interim CEO and Strategy & IR Director [1]

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Good morning, ladies and gentlemen, and welcome to the Results Presentation of the Second Quarter for XXL ASA. My name is Tolle Grøterud, and I'm the Interim CEO.

First, I will take you through an operational update. Then our CFO, Stein Eriksen, will take us through the financials followed by a Q&A session. Our Chairman of the Board, Øivind Tidemandsen, will also participate. And for media, there will be an opportunity to perform separate interviews after the presentation.

Let's see. Let me first start off by saying that the recent attention from the media has affected all of us in XXL. We are proud of our culture. And even though we, in general, have high scores in service from our employees, there are indications and part of our culture that we need to correct and recreate. We wish they did not happen, and we want to say sorry to all the parties that have been offended by any of these actions. The new management team has already started the work with corrective actions. Initiatives has -- that commenced already early this spring to make sure that this not occur again. I wish we used our time and efforts on our customers and improving our own concept rather than the partly obsessed focus on our competitors.

Going into the results. The trend from the first quarter continued into the second quarter with weak sales development, partly compensated by strong underlying improvements in the gross margins. Due to the lower purchasing volumes in the quarter, the amount of supplier bonuses were NOK 30 million lower than in the same quarter last year. When XXL buy products, we receive bonuses from suppliers at certain volume steps and on the side contribution to marketing or sales activities. All this depends on the supplier agreements. They are booked on a running basis based on the volumes bought. So in the quarter, XXL decided to stop purchasing in several categories, and as a consequence, we received lower bonuses from the suppliers.

And the driver behind this strategy is the key focus in the quarter of reducing the inventory situation. And despite the weaker sales, the inventory was reduced by NOK 114 million compared to a buildup of NOK 146 million in the same quarter last year. And at the same time, XXL was able to lift the gross margin from 38.5% to 39.2%. And the EBITDA ended at NOK 143 million or around NOK 173 million when we exclude for the lower supplier bonuses.

XXL has seen an elevated leverage ratio the last quarters, partly due to the poor Q4 results last year, which is a part of the calculation on a 12-month rolling basis. And as a consequence, XXL has negotiated new waiver agreements with the banks containing new covenants. So naturally, the management team has focused on being well below these levels and to maintain a satisfying liquidity position. This may have affected sales as well. The leverage ratio ended at 4x, which is well below the obtained covenant of 4.5x. And the liquidity reserve amounted to NOK 0.5 billion, which is in line with last year.

We are disappointed about the sales development in the quarter and with the continuous negative like-for-like, even though we see that we are operating in a more sluggish Nordic sports retail market with negative growth in all core markets, and also surprisingly slow market in June, especially in Norway.

As you remember, XXL shifted the mentality a bit going into 2019 with more focus on profits than pure top line. And this proved to be the right strategy in Q1, where we saw gross margin that more than compensated for declining like-for-likes, producing a higher EBITDA. And even XXL gained market shares in most markets, including Norway. So this strategy then continued into Q2 but now also with the combination of reducing the inventory. This had a negative impact on the sales volume, and the latter was especially the case towards the end of the quarter due to less replenishment of goods and also partly products in seasonal demand. Remember, last year was the opposite, many aggressive campaigns to drive volumes but on the expense of the gross margin. The negative like-for-like growth also affected the cost leverage of the operations. However, XXL has commenced many adjustments and cost reductions to mirror the lower sales trend. And the cost base in the quarter was on par with the same quarter last year despite 5 additional stores.

We are not satisfied with the sales development, and we are at all times working on optimizing the balance between the growth and the profitability as well as then reducing the inventory in a controlled way. I will soon come back to our top line actions.

But before that, some words on the current trading. Although Norway is still lagging a bit on sales, all markets have higher gross profit so far compared to last year. And consequently, July has started above last year. July is the most important month in the quarter, and normally it is around 40% of the EBITDA in Q3. (technical difficulty)

We are hearing some music as well.

Growth by markets. XXL delivered a negative growth of 6% in the quarter. We are not satisfied with this and we are working on the balance between growth and profits. However, prioritizing gross margin this quarter as well as reducing the inventory influenced the overall growth and sales volumes both in the stores and online. E-commerce is delivering stable revenues but it continues to be an increasing part of the total operation and now it's around 16%. Transparency, pricing and also a bit less campaign push and the overall increased focus impacts the growth rate directly on the e-commerce part, but we have solid and good improvements on the gross margin also on the e-commerce operation.

The revenue growth of the group is driven by the negative like-for-like of 11%, then partly offset by growth from new stores that we opened last year, or so far this year. The like-for-like is also impacted by some cannibalization effects in Norway and Finland. On a positive note, Austria is delivering a positive like-for-like and also here with, significantly, cannibalization effects when we have opened 1 new store in Vienna where we have stores from before.

This slide has [not a low end] intentional underpinning of our own results. But to put them into context, we are operating in a Nordic sports retail market in decline, and so far this year, in all the Nordic markets.

Looking at the market data for Q2, isolated. After gaining market shares in Norway in Q1, we were disappointed about the sales trend in the second quarter. There are some fluctuations between months. A large campaign moved from June last year to May this year and has an impact of around 10 percentage points on the growth in that month. In addition, we have 2 less sales days in June. But nevertheless, we are losing some share this quarter.

In Sweden, we are losing momentum and we have for a while. This is addressed and high on the agenda. We will perform a deep customer and branding survey, including assortment, and initiate actions accordingly. In addition, we will implement all other new solutions and improvements that are going on across the group, of course. But unfortunately, we are again in a process of recruiting a new MD for Sweden who will form up the direction of delivering on the strategy of bringing the Swedish operation back to 2016 results level.

We have, over the years, built a very strong position in the Finnish market, and we continue to gain market shares. Over the years, XXL has built a strong and market-leading position online, helped by the strong position of the stores. And that is what -- this is what it's all about, stores and online playing together and strengthening the customer proposition as the omnichannel retail.

Traffic figures. This quarter, they are influenced by the changed focus toward gross profit. However, XXL is still the market leader in traffic in all developed markets, which is showing the strength of the concept even under more difficult market conditions.

If we look at the different segments. Again, we are not satisfied with the like-for-like development showing a deep decline in Norway and Sweden, while on the positive side, 2% growth in Austria. And this is partly compensated by the significantly higher underlying gross margins, excluding the lower supplier bonuses. The EBITDA decrease in Norway and Sweden is driven by the negative like-for-like, which is affecting the scale in the operations.

Austria. We opened a new store in the beginning of April in Mariahilferstrasse, in the city center of Vienna, and contributing with good sales figures together with the positive like-for-like growth despite cannibalization effects. At the same time, we see a solid margin improvement in Austria, perhaps a bit too strong. We are still in the establishing phase, and we have higher expectations to top line in Austria, and we will be more aggressive short term to build our position.

The new store is also contributing to scale in marketing and headover costs in Austria. And the OpEx declined from 56% to 45% in the second quarter this year. At the time being, we do not see any additional stores in Austria -- store openings in Austria this year, but we have 2 coming up in the first half 2020 also in the Greater Vienna area. So there will be no more immediate synergies in 2019, but we are delivering on the strategy of rolling out city-by-city first. And we expect 2020 to be on the route to black figures in the Austrian operations.

Denmark, very disappointing development in the quarter. The marketing mix has proved more difficult this quarter, leading to a drop in the traffic and also partly explained by an increased margin focus also here. But nevertheless, this cannot continue, and we have initiated adjustments to the operations and to significantly reduce the cost base to be able to break even. And we need to see positive figures in 2020.

HQ and Logistics. We have actively reduced costs at the HQ to mirror the weaker sales trend. The lower amount of incoming goods at the central warehouses has also a consequence and reduced purchasing volumes contribute positively on the costs. In addition, we have lower bonus payments in accordance with weaker results than expected. However, do not expect the absolute costs to sustain at this level in the coming quarters. We have several new recruitments in the marketing department coming in, as well as some other senior positions.

We are currently working on adjusting the balance between growth and profitability, and we need more speed on the top line. So we will have more focus on pricing and campaigns going forward to try to capture more of the volumes in the market. We will use the online-first approach. Winning online will make the stores stronger as the sales are highly linked.

Pickup and collect-at-store, return-to-the-store, inspirations and price checking online. We are in the phase of building a new and more active price monitoring tool to work also both ways. Collect at store and same-day delivery will be tested out later this year to increase traffic to stores. New and frictionless and customer-friendly solutions will be available. We will even have fitting rooms for the online customer in the store close to the pickup robots, no queues, self-checkouts. At the same time, we will broaden the assortment online to be available for all customers at all times.

We want to improve the positioning over time as the specialized store in selected categories and elevating the quality perception of the assortments. And this has a lot to do with our profile and branding, how we treat the products and work with the brands, content and inspirations and new services and the best guarantees. Remember, we have workshops in all our stores, and we will introduce more services.

And then during the second half, we will launch new e-commerce sites with higher quality on pictures, text, content, video, improved search and filter functionality and more.

OPEX25. We acknowledge that the lowest cost position in the industry is the key competitive advantage of XXL, and that allows us to have the price leadership and gain market share over time. So key focus in the strategy of XXL is to scale down the costs over time, and we need to reverse the recent trend of increased cost percentages. In the quarter, we have reduced costs, mirroring the weaker sales. And it's on par -- the cost base is on par with last year despite 5 new stores. However, the OpEx percentage increased from 30.6% to 32.6%, mostly driven by the negative like-for-like growth which is impacting the cost leverage. And consequently, growth and especially e-commerce development is crucial in reaching the ambition of OPEX25.

2019 forms up a transition year where we are investing and building a platform that will yield positive effects on efficiency in the operation and costs for the next coming years. And I will soon talk about the initiatives that we have already introduced.

On housing costs, we will reduce the rollout pace of new stores, with a focus on Austria and Sweden. A new yearly level is probably more like 4 to 5 stores max. We will negotiate existing contracts with an ambition of more flexible contracts and lower rent levels, and the downsizing of smaller revenue stores will continue. And we will see these effects. They will, supposed to be [and give] gradually increased effects over the coming years.

We are also in the process of reorganizing the marketing function of the group. The new Marketing Director, he is in place. And he has also recruited several new specialist positions during the quarter, including CRM, SEO, content and social media. And we will restructure and insource digital competence, and we have a clear ambition of a more efficient marketing organization in the years to come.

And today we are setting a new target. We want to reduce the inventory down towards NOK 25 million per store, medium term. And by achieving this, we will significantly improve the flow of goods, cost position and strengthen the heart of our operations. Focus will be on the core concept, and that is why we are closing down louds.no. And we are adjusting the operation in Denmark to reach breakeven on a significantly lower cost base.

And as you will see, we are introducing new digital solutions on a running basis. The first one is a new stock solution, a never-out-of-stock feature in-store, opening up the assortment for all stores and the central warehouse for sale in all stores. We tested it out for a while and then we piloted it in the Norwegian stores for the shoe and sportswear department. And in the first 2 weeks, we saw more than 200 customers receive sold-out products from the central warehouse or another store. It still need more -- some more training and adaptation by the store employees, but over time, customers could also order in-store using their own screens or using their mobile, of course. And work has been done on the size range, and the main focus is, of course, on the most sold items. We will now, in Q3, continue to roll this out to all other countries as well.

Last quarter, I talked about the automated pickup solutions that we have introduced in some stores in Norway, locker solutions for smaller stores and the tower solution with robotics for the larger stores. As the first Nordic retailer, we installed the first tower in the store of Alnabru in late April. And I hope you have all tested it out because we have delivered more than 3,500 parcels since the mid-May with no queues and very good customer feedback and satisfaction. And in addition, we see only minor operational overhead. So we will roll this further out to more stores in 2019 and 2020. This solution clearly demonstrates the omnichannel strength, shop online and pick up in seconds in the store. And soon, you could even try out the products you have bought in our fitting rooms just beside this robot tower. And this will, of course, then reduce the handling time and costs for the employees, thus also the return rate online.

We have self-service cashiers planned for this summer. And the Klarna Instore is already introduced, and that has improved the credit sale efficiency in-store. And this has resulted in a good growth on the credit sales and also then significantly reduced the handling time for the store personnel. Before, on average, 7 minutes. Today, 60 seconds.

Finally, we have now started to introduce an artificial intelligence system in our supply chain. This is a system for replenishment of goods and using algorithms on data from all sources in XXL and potentially more. And the results from the pilot in some stores in Norway, they are really promising. More goods will be allocated to the central warehouses and sharing more availability for the products online. And this is key for growth. Remember, online first. At the same time, it will reduce costs of sending parcels from stores to the online customers as well as handling time for the store employees. And the system will further lead to more accurate purchasing volumes and potentially higher margins due to less clearance activities and more control over the store inventory. And this is most important for us when we introduce collect-at-store and the same-day delivery. And in the end, it will contribute to better campaign planning and further costing. Improved flow of goods is the most important thing because it saves time for all parties in a retail organization, drive down costs and give strength to the supply chain.

I have talked about improving the positioning and the assortment development of XXL, and I will give you an example using sleeping bags. We started off by using famous, high-quality Norwegian brands, then increasing with Swedish and Finnish brands when we entered those markets. Then we went into Austria and introduced several new brands for all XXL countries. Then just recently, we have signed up with more high-quality specialist brands and niche brands to strengthen the El Dorado of sleeping bags in XXL and to lift the positioning. And then, I guess you all wonder how will this harmonize with the overall strategy of reducing the number of suppliers and SKUs and the inventory per store down towards NOK 25 million. So I leave that to Stein to explain. However, the concept is to broadening the assortment on relevant categories to be able to attract and meet demand on most price points and to most customer segments. At the same time, we will take out duplicates and we will diversify the assortments.

Today, we have most of the assortment on the mid-range part and styles. They are also partly cannibalizing on each other. So in sum, we will reduce the number of SKUs at the same time as we are broadening the assortment. And how will we do that? By using the central warehouse and the online channel, wide selection online to match our pure-play competitors, more limited assortment in selected stores. Up until now, XXL has really only had the store assortment online. Now it's time to broaden the assortment online and reduce the number of SKUs in the stores. To be able to do so, we have to elevate the way we present the products by offering better e-commerce sites with inspirations and content, features and quality. We will win on efficiency, fast deliveries and to match specialists on the online assortment.

So with that, I turn the floor to you, Stein, for the financial update.

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Stein Alexander Eriksen, XXL ASA - Group CFO [2]

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Well, thank you, Tolle. And good morning, everyone. Yes. So I will now take you through the financial results for XXL for the second quarter.

Before I start, please be aware that all the numbers in the presentation are excluding IFRS 16 effects. And the summary of these effects, you can find separately in the appendix and also thoroughly disclosed in the report.

Okay. So moving on to the key financial figures for the second quarters. I think these are the main points. Tolle has already mentioned it, but we had an EBITDA decline of NOK 42 million explained by, one, the lower supplier bonuses of NOK 30 million related to the inventory build-down; and two, negative top line growth of 6% in the quarter hitting the EBITDA with a negative effect of NOK 44 million, but partly counteracted with continued focus on gross margins being positive of NOK 32 million. So net negative effect of lower sales was NOK 12 million. I think the key takeaways from this slide is that we need some more speed on the top line, and short term, more focus on pricing and campaigns with priority on e-com. And on medium, long term, as Tolle mentioned, we have already several ongoing initiatives.

Moving over to the gross margins. I think it's fair to say it's overall pretty good development in gross margins compared to last year despite -- I mean we have a negative mix effects of 0.4 percentage points related to higher e-com turnover and reduced growth in Norway; and the fact that we have NOK 30 million lower in supply bonuses, that also hits the gross margin. So adjusted for this, it's fairly good. The mentioned bonuses affected Norway with around NOK 10 million. It affected Sweden with NOK 13 million and Finland with NOK 7 million. And these effects slightly -- it gives us more setback in gross margins in Finland and Sweden year-on-year.

Then let's have a look at the cost side. Overall, Tolle already mentioned it, we are fairly happy with the development in OpEx. We had 5 more stores, but we ended up on the same OpEx level as in Q2 2018. We had improvements in HQ and Logistics segments, which was partly explained by lower salary payment accruals to our own employees. In Norway, we managed to reduce the OpEx base with around NOK 10 million despite lower revenues and 1 more store, and we have managed to adopt the cost level to reduce the income. But as you can see, this is not the case in Sweden where the cost base has increased both in millions and in percentage of sales. We saw improvements in Austria with scale benefit from more stores versus last year. And as I said, in million krones, we were on the same level as last year, but of course the percentage is higher due and all driven by the lower income in the quarter.

Moving on to the EBITDA margins. The EBITDA margin as a whole is, of course, affected by the lower sales and the lower supply bonuses. I want to comment specifically on Sweden. As you can see, a setback in both EBITDA margins and absolute EBITDA levels, down from 8.4% last year down to 4% this year. And this is explained by lower sales, lower supplier bonuses and higher OpEx. And it's fair to say that, that's a bad combination. So we are disappointed with the development in Sweden. But as Tolle said, it's also being addressed. Austria is slowly turning -- approaching breakeven, but we expect to see the first signs of black numbers in 2020. Denmark, developing in the wrong direction, and as Tolle mentioned, being addressed.

As a CFO, I was very pleased with the positive cash flow in the quarter, especially the positive changes in working capital. Just to mention to you, since the IPO, XXL has always had a negative development in working capital between Q1 and Q2 of around NOK 200 millions. While this year, we had a positive development in working capital with NOK 52 millions. And even more importantly, this reduction is driven by the inventory build-down of NOK 114 million. So the cash -- positive cash flow resulted in lower net debt ending at NOK 2 billion versus NOK 2.1 billion in the first quarter.

Operational cash flow in the quarter ended at NOK 133 million, which is an improvement of NOK 291 million versus Q2 2018. And the big delta is explained by a build-up of inventory last year of NOK 146 million and the inventory build-down of inventory this year of NOK 114 million. And this gives us liquidity reserves of NOK 0.5 billion, the same level as last year, and net debt ending at NOK 2 billion and giving a leverage ratio of 4.05, which is well within the renegotiated covenant levels. So as I said, we are happy with the working capital in the quarter. But I think it's also fair to say that going forward, XXL has to increase and step up the work to fix our working capital.

On the right-hand side here, you see working capital in percentage of sales on a 12-months rolling basis dating back to 2015 until Q2 2019. And it's quite obvious that it has not been a very positive development. And this needs to be addressed. Especially, as you can see on the right-hand side here, the inventory in percent of sale has been very negative, tying up almost NOK 1 billion more in capital versus the levels in 2015. We need to much -- we need to work much, much harder with our balance sheet and especially the inventory levels. And therefore, we have, as Tolle said, put down an ambition to reduce our inventory down towards NOK 25 million per store within the end of 2022. And that means freeing up cash with more than NOK 900 million.

So how are we going to do this? Well, first of all, we need to start to cut in our SKUs, stock-keeping units, from around 25,000 SKUs in 2018 down to 20,000 SKUs in 2020. And this is already an ongoing process. Then second, we are cutting 20% down on our suppliers from around 440 suppliers of goods down to 350 suppliers. And this is also an ongoing process with effects hopefully from 2020. Then we need to implement new routines and systems. Tolle already mentioned, we will get better control of inventory with the implementation of a new artificial intelligence system, replenishment system, and we have an ambition to have the whole system up and running in the year of 2020. We have to reduce our internal prognosis to better reflect the reality that XXL is experience lower growth rates. This is already executed. Reduce the number of preorders, this is also being implemented. And we need a more balanced risk-sharing with our suppliers, and this is ongoing. Then before, we have also talked about downsizing stores. This is a project ongoing. And our first downsized store in Moss in Norway has reduced its inventory with 25% or NOK 9 million without any top line consequences but with better profits due to more healthy inventory. And we aim for more downsizing next year.

So we are confident that these actions will give us power to reduce inventory in percentage of sales from 36% down to 26% in 2022, increasing the turnover rate from about 2% up to 2.7% and reducing the days in stock of 50.

So I guess some of you then ask, what can we expect going forward if the inventory is reduced and how will it affect the supplier bonuses going forward? Well, I think in short term, and that means 2019, we don't expect any bigger effects because of the long lead times and actions being implemented as we speak. But in longer term, of course, a build-down in inventory can result in lower supplier bonuses. But our ambition is, of course, to increase the rotation on our existing stock based on lower number of SKUs and thereby maintain the level of purchased goods. And also, I want to remind you that a reduced inventory will result in a more healthy stock, which again means sales with better margins. We already see that in our smaller stores. Today, we have lower margins because of too high inventories. So therefore, our ambition is not to decrease our margins but to increase it.

So handing over to Tolle for some final remarks.

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Tolle O. R. Grøterud, XXL ASA - Interim CEO and Strategy & IR Director [3]

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Thank you, Stein. We are delivering disappointing sales this quarter in a more sluggish Nordic sports retail market, partly then compensated by strong gross margin improvement. Key focus has been on the too high inventory level, and we have successfully reduced it in the quarter, leading to good headroom against bank covenants and a liquidity reserve on par with the same time last year. The lower purchasing volumes had a significantly negative effect of around NOK 30 million with a direct effect on both the gross profit and the EBITDA.

Main priority now is to regain the sales momentum. We will have more focus on pricing and campaigns. Overall, it is about improving the customer experience online and in the stores, new efficient store solutions, relaunch of the e-commerce sites, deliveries and positioning to attract new customer segments as the specialist sports retailer in selected fields. And then our long-term objectives and the strategy plan remain firm, and we will update you more at the Q3 presentation in October. Thank you.

So then we open up for questions. And also, Øivind, the Chairman, will participate in this session. So we open up for questions first from the audience present here in Oslo. So please wait for a microphone, and we kindly ask you to introduce yourself and limit the questions to one question at a time. So please go ahead.

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Questions and Answers

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Unidentified Analyst, [1]

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So the inventory [is not good] -- thank you for the presentation, it was very clear. Your priorities looks consistent. So the inventory is down despite low like-for-like. What kind of product categories did you sell out? And what did you stop purchasing? And how do you see this progressing through Q3?

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Øivind Tidemandsen, XXL ASA - Chairman [2]

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Well, it's not any significant areas that's -- it's down on all categories, basically. I think the -- third quarter, I think the inventory will be approximately at the same level as this quarter because these actions that we have started will not have any influence on these short terms. It will be -- because all the goods now are bought, which are coming this fall, is bought 6, 8, 9 months ago. So it will be -- 2020, you will start to see the effects of [Relex] and all these other initiatives that were done.

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Unidentified Analyst, [3]

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And secondly, Austria performed, I think, better than many expected. How do you see Austria progressing? And how many stores do you think are sufficient to have the scale you need to reach the margin targets? Because you're up to 5 stores, and even in Sweden and Finland, you're struggling with scale. What kind of scale do you need in Austria? Can you comment on that?

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Øivind Tidemandsen, XXL ASA - Chairman [4]

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Well, around 8 stores, we should reach breakeven.

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Tolle O. R. Grøterud, XXL ASA - Interim CEO and Strategy & IR Director [5]

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I mean, I think, the Austrian market is some 10-plus stores in total, 10 to 15 maybe.

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Oliver Schüler Pisani, Nordea Markets, Research Division - Analyst of Consumer Goods [6]

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Oliver Pisani of Nordea Markets. So to start off with the -- I think you delivered quite soft numbers for June despite easy comps year-on-year. So could you perhaps elaborate on if that development has continued into July, which also was characterized by at least -- or should be characterized by easy weather comps, to some extent?

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Tolle O. R. Grøterud, XXL ASA - Interim CEO and Strategy & IR Director [7]

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Yes. July, we are seeing better figures for most markets, but Norway is still lagging a bit on sales. But we are seeing good margin uplift in all markets. So in total, July looks to be above last year's levels. June, yes, we are agree with you. June was a tough month for us. Also a bit surprising because it was a tough month also last year.

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Øivind Tidemandsen, XXL ASA - Chairman [8]

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But also, it's important then to remember, it's 2 sales days less in Norway, which is about 8%. So that has some effect on the figures.

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Oliver Schüler Pisani, Nordea Markets, Research Division - Analyst of Consumer Goods [9]

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Yes. Makes sense. And second question then. When it comes to e-commerce, delivering in e-commerce declined in this quarter. So how should we think about that going forward? And is there any risk that this focus on price and gross margins over sales hits your e-commerce franchise particularly hard since you have such high price transparency in that segment?

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Øivind Tidemandsen, XXL ASA - Chairman [10]

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Yes. And that's one of the things that we actually are adjusting because we cannot have this happening for a long time. So we are working on a new monitoring system to monitor our competitors and adjust our prices more efficiently than we are able to do now to better follow our competitors and have better actions on those things. Because it's not only about their strategy, it's also our ability to actually follow all the adjustments in pricing.

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Oliver Schüler Pisani, Nordea Markets, Research Division - Analyst of Consumer Goods [11]

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Right. And would you -- sort of in a base case, would you expect to come back to growth in the e-commerce franchise within a reasonable amount of time? In the second half 2019, for example?

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Øivind Tidemandsen, XXL ASA - Chairman [12]

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Yes. It would -- it should be increasing during this second half. Just one correction about this because we have this Black Friday situation where we gave away a lot of goods for almost free. That might influence a little bit on the e-com total turnover, so...

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Unidentified Analyst, [13]

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[Mark Strud]. Just quick question on the online channel. You're about to -- you want to cut the number of stock-keeping units and at the same time grow the assortment online. How do you see that happening?

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Øivind Tidemandsen, XXL ASA - Chairman [14]

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It's -- as Tolle said, we are having too much SKUs in around our mid-range, and we will take away quite a few of those and kind of stretch them out and put in more higher-quality products. That's the easiest way to explain it. Also, we have a lot of -- or actually some categories that we are actually will reduce quite much because we don't think they are kind of helping us being a sports specialist. Like we have quite a few shampoos and all this stuff around in the store which we want to take away to have a clear sports profile.

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Stein Alexander Eriksen, XXL ASA - Group CFO [15]

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If I can just fill in also. I mean by the end of Q2, we had an inventory of NOK 3.3 billion. Around 1/3 is on the central warehouse. I mean, so if you increase the inventory in the central warehouse with 1 -- NOK 200 million, that's okay. But it's the other 2/3 that's in the store, that's where we have to work, right?

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Tolle O. R. Grøterud, XXL ASA - Interim CEO and Strategy & IR Director [16]

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Yes.

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Stein Alexander Eriksen, XXL ASA - Group CFO [17]

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Yes.

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Tolle O. R. Grøterud, XXL ASA - Interim CEO and Strategy & IR Director [18]

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Any other questions? Then there are no more from the audience, and we are ready to take the questions from those of you listening in on the phone. (Operator Instructions) So I'll ask the telephone -- the conference host for further introductions.

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Operator [19]

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(Operator Instructions) And we do have a question from Simon Irwin from Crédit Suisse.

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Simon William George Irwin, Crédit Suisse AG, Research Division - Director [20]

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I have a few questions for you, but I'll start with Denmark. Why do you carry on with Denmark? I mean if it's loss-making and it seems to have been a problem from day 1, you don't have many stores, so why do you kind of keep on persevering with something that seems so noncore and yet seems to suck up so much time and money?

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Øivind Tidemandsen, XXL ASA - Chairman [21]

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Very good question. And we will not continue with Denmark if we are not very rapidly seeing a breakeven there.

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Simon William George Irwin, Crédit Suisse AG, Research Division - Director [22]

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Okay. And if you think about having more pure online ranges and the whole process of kind of defining ranges going forward, which does sound quite complicated, why would you not have a number of these range extensions purely on a consignment basis rather than taking stock risk with products and brands that you haven't sold before?

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Øivind Tidemandsen, XXL ASA - Chairman [23]

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We will basically have this in our central warehouse and with a very -- we won't take big risks on this inventory. We will just have a few pieces in the warehouse and then get -- deliver as we sell. The reason why we want to have it and control it in our own warehouse is to make sure everything goes right. Because if we had 300 and -- or a lot of different suppliers that was supposed to ship products on behalf of us, the logistics will be very, very complicated. And it will -- our customer satisfaction would be on risk. And that's the worst risk we want to take.

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Simon William George Irwin, Crédit Suisse AG, Research Division - Director [24]

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Okay. Can you just talk about the age and quality of inventory? Because obviously, while reducing the overall amounts, the inventory is clearly necessary. Is there a danger if you stop buying that you simply sell through all of the more recent inventory and your overall inventory age continues to worsen?

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Øivind Tidemandsen, XXL ASA - Chairman [25]

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Yes. We are following that very closely. And for instance, in this quarter, we don't see any age difference on the inventory than the last quarter. So -- and the fact that we actually have higher margins this quarter despite reducing our inventory, I think that also tells that our inventory has good quality.

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Simon William George Irwin, Crédit Suisse AG, Research Division - Director [26]

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Okay. And can you just explain why you think the markets are so sluggish? I mean if it's been [your view] of kind of getting past [any] weather, that there must be an underlying demand issue outside of that. Do you have any sense of why that is the case?

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Øivind Tidemandsen, XXL ASA - Chairman [27]

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Actually, we are very surprised ourselves because we thought -- last year, it was kind of, especially in Norway, unique weather conditions. This year, you can't really blame the weather. It's been perfect weather for retailers. But still, we think the market is very weak. And we haven't really figured out why yet, to be honest.

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Simon William George Irwin, Crédit Suisse AG, Research Division - Director [28]

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Right. Is there any sense that there's just a lack of innovation in the -- perhaps within core categories? And do you see any difference between kind of consumable categories, which effectively get worn out pretty quickly, and longer-term assets, either tents and bikes and stuff like that? And there are actually people who've gotten what they need so that the overall kind of market capacity has simply declined because -- simply because of the lack of innovation in must-have new product?

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Øivind Tidemandsen, XXL ASA - Chairman [29]

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Well, it might be. But overall, it's kind of a trend that people are more active. So it should be something which are gaining XXL. So it's -- of course, innovation helps always. We have seen a really good effect on, for instance, e-bikes especially in Norway, which of course has boomed the market for a while. Might be that this trend is no -- I mean everybody more or less has got it. You will have a little decline in these fields. But it's a little bit surprising for us. And we don't really have an exact answer. We need some more market figures to really conclude. And those market figures are -- we are waiting for them. They will come a little later.

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Operator [30]

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(Operator Instructions) The next question comes from Tushar Jain from Goldman Sachs.

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Tushar Jain, Goldman Sachs Group Inc., Research Division - Research Analyst [31]

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Just one question relating to Sweden. I just like to get a little bit of a sense on the margin structure. How do you see that evolving in Sweden? Is it because the market has currently been declining, you're still seeing discount? So do you expect the margins to currently decline in Sweden? And what other initiatives can you do to stop that given the management [created that also] that is happening?

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Øivind Tidemandsen, XXL ASA - Chairman [32]

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It's, of course, a little bit complicated to answer, but we can increase our market spending in marketing. Sweden is the mark that we are using and -- or we are using less market spending in Sweden than in Finland and Norway. That could be one issue. We are also looking on our assortment to see if we have to adjust our products range more to the Swedish market than we have done. And also it's, of course, a matter of management, how we're -- and our culture and all these kind of internal initiatives that actually are influencing on the sales and our ability also to have good margins.

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Operator [33]

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The next question comes from Silvia Borsetti from Crédit Suisse London.

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Silvia Borsetti, [34]

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It is just a follow-up on Simon's earlier question with regards to market environment. Obviously, it seems to be a very difficult retail environment in the Nordics for sporting goods. And presumably a lot of your smaller counterparts and peers are struggling, presumably even more than you do, at the top line. I was wondering if you could give some color on any potential sign of consolidation in the market, especially in Norway and Sweden, please.

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Tolle O. R. Grøterud, XXL ASA - Interim CEO and Strategy & IR Director [35]

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Yes. We see some signs of consolidation. We have seen some on the, actually, on the online side with some peer players consolidating. And we also see, on a running basis, store closures in all markets. And we -- that is nearly on a weekly basis. So...

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Silvia Borsetti, [36]

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Do you see any countries [in the] accelerated? And then whether that should give you any advantage given your scale, let's say, in the next 6 to 12 months?

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Tolle O. R. Grøterud, XXL ASA - Interim CEO and Strategy & IR Director [37]

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Yes. We still at least see the same pace of store closures, so -- and they are not coming up again, so yes.

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Operator [38]

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(Operator Instructions) The next question comes from Magnus Råman from Handelsbanken.

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Magnus Råman, Handelsbanken Capital Markets AB, Research Division - Research Analyst [39]

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Many of the questions have been answered, but I have a question about your leverage ratio. I mean you mentioned here that you're happy with your inventory reduction sequentially and the working capital release. But still, the leverage ratio is actually rising sequentially. So although I know your main plan is for reduction below the reinstated 3.5x leverage ceiling in Q4, do you have a backup plan for strengthening the balance sheet should it be needed?

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Stein Alexander Eriksen, XXL ASA - Group CFO [40]

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I mean, as you know, the cash flow in XXL is very backloaded, so most of the positive cash flow in XXL comes in Q4. So I mean now with the covenant in Q3, we feel we are confident of coming below 3.5 in Q4. Also, remember that we have sold some own shares that we got paid for last week. That also helps the net debt in Q3.

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Magnus Råman, Handelsbanken Capital Markets AB, Research Division - Research Analyst [41]

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That's right. But I guess it's a rather minor contribution on the total picture. Do you deem that you would need an earnings recovery compared to the current run rate on your earnings growth? And -- or do you think you will make it solely by reduction in inventory and improvement to working capital?

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Stein Alexander Eriksen, XXL ASA - Group CFO [42]

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I mean we -- it's difficult to predict the inventory by the end of the year, right? But I think the best guess now regarding inventory in Q4 is around the same level as in Q2. So -- and with that, we feel confident that we will be below the covenant in Q4. But we need some more speed on the top line. That's fair to say.

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Magnus Råman, Handelsbanken Capital Markets AB, Research Division - Research Analyst [43]

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All right. And speaking about top line, I just come back to what you started out the presentation with, commenting on the negative news reports related to, call it, ESG issues for you. You deem that these news reports have had any effect? Can you see any negative effect on sales in Sweden or in any other markets?

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Øivind Tidemandsen, XXL ASA - Chairman [44]

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It's, of course, very difficult to really read the effect of the different things. But I would guess that it has had some effect on our top line because it's been so many articles and negativity. So it would be strange if it wouldn't affect us at all.

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Magnus Råman, Handelsbanken Capital Markets AB, Research Division - Research Analyst [45]

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Right. That's helpful. And do you deem that the main issue is that you have been misinterpreted in media? Or do you deem that you have issues that you need to address?

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Tolle O. R. Grøterud, XXL ASA - Interim CEO and Strategy & IR Director [46]

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Yes. I think we have -- many of these things that have came out, we are, of course, sorry about them. We should correct them. That's not the way we want to act. And we have already started this process. We started in, it actually in early spring. So of course, this is something we need to correct. We...

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Øivind Tidemandsen, XXL ASA - Chairman [47]

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We already have corrected these issues, of course. Yes.

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Operator [48]

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(Operator Instructions) There is no questions coming through over the phone, so I will hand the call back into the room again. Thank you.

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Tolle O. R. Grøterud, XXL ASA - Interim CEO and Strategy & IR Director [49]

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So okay. That ends our session. So I thank you all for your participation, and happy summer holiday.

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Operator [50]

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Thank you for joining today's conference. You may now replace the handset to end this call. Thank you.