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Edited Transcript of XXL.OL earnings conference call or presentation 23-Oct-19 6:30am GMT

Q3 2019 XXL ASA Earnings Call

Oslo Oct 30, 2019 (Thomson StreetEvents) -- Edited Transcript of XXL ASA earnings conference call or presentation Wednesday, October 23, 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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* Gard Aarvik

Pareto Securities, Research Division - Analyst

* Markus Borge Heiberg

Kepler Cheuvreux, Research Division - Equity Research Analyst

* Martin Stenshall

Danske Bank Markets Equity Research - Senior Analyst

* 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 third quarter 2019 for XXL ASA. My name is Tolle Grøterud, and I'm the Interim CEO. And first, I will take you through an operational update, including a brief session on the ongoing strategy plans; and then our CFO, Stein Eriksen, will take us through the financial update, followed by a Q&A session; and our Chairman, Øivind Tidemandsen, will also participate. For media, there will be an opportunity to perform separate interviews after the presentation.

So let me first start off by saying that we are disappointed about the third quarter results, especially the sales trend in Norway. We are pleased with the commitments from the shareholders regarding new capital, and we find the solution the best for the company at the current state, and we hope for support at the EGM on 6th of November. But going forward, it will be crucial for XXL to succeed on delivering on balance sheet improvements through operational performance and actions, especially to gain control over and to reduce the inventory situation.

The trends seen in 2019, with weak sales development, but partly then compensated by stronger underlying improvements in the gross margins, continued also into the third quarter. We commented on trying to obtain a better balance at the second quarter presentation. And we did more aggressive campaigns towards the end of the period, with good response online but with limited effects on the sales volumes in the stores. However, this impacted the gross margins negatively. And September turned out to be a challenging month for us, especially in Norway, where we see a low -- where we see a slow retail market and also with discount activities from many players.

The Finnish operation delivered yet another strong quarter with solid sales growth, margin expansion and also gaining market shares. EBITDA ended at NOK 132 million and with an elevated leverage of 4.2x, slightly below the covenant of 4.25. However, this is a challenging situation over time, as the management team has focused on being below the covenant levels, and this may have affected sales negatively as well.

So XXL, therefore, decided on strengthening the balance sheet with commitments for new equity of around NOK 500 million and subsequently also new bank agreements with increased covenants for 2020. This is not a liquidity issue as the reserves ended at NOK 600 million, up NOK 200 million from last year. And we now believe we have the necessary headroom going forward, but inventory reductions will be key focus also in the upcoming phase.

As I said, we are disappointed about the sales development in the quarter and with the continuous negative like-for-like growth. At the same time, we see that we are operating in a more sluggish Nordic markets with negative growth in Norway and Sweden. The Finnish market has some growth year-to-date.

We see that we are operating in a more mature market after several years with strong growth. Online players and outlets, they are still gaining sales momentum. We still see store closures in the market with the chains that are under reconstruction and heavy discounting activities related to this. But over time, we believe that capacity in the physical markets will continue to decrease and that is a clear positive for us.

Looking at the market data. After gaining market shares in Norway in the first quarter, we are disappointed about the sales trend and by losing market shares. I'm glad to say that a new MD in Norway is finally in place. He started in XXL in October. André Sørensen comes from the position as Head of Retail Operations in Elkjøp, leading Nordic electronic retailer. He has extensive experience as store manager, operational manager, head of the megastore concepts and more.

Anders Kjellén, who has been in 2 positions for a while, he will now only have the role as Retail Director and still be on the management team of XXL. André Sørensen, alongside the other MDs in the other countries, will report directly to Anders Kjellén as before.

In Sweden, we are regaining some momentum, fueled by more marketing spending in the quarter, and the market is still very volatile. But fresh market statistics revealed that XXL is now the #2 player in the Swedish sports retail market after 8 years in operations.

We have also signed a new MD in Sweden, and he will start from March 2020. Anders Lindblom, he comes from the position as Head of Operations in Elgiganten. He has been a retailer his whole life, a store manager, a sales manager and a regional manager and also Head of Operations. And we are very much looking forward to having him on board in XXL. We continue to gain market shares in the Finnish markets.

So a few words on the current trading. October has started on par with last year on revenues, with okay growth in Sweden, but Norway is still lagging on sales. But the trend with higher underlying gross margins continues. Remember, October is a small retail month and the most important for Q4 is the upcoming Black Friday activities and the Christmas sales, of course.

So looking at the different segments, again, we are not satisfied with the like-for-like development. This is partly compensated by higher underlying gross margins, but the EBITDA decrease in Norway and Sweden is driven by the negative like-for-like that are affecting the overall scale in the operations. We see a positive development in Austria, and the gross margin improved by 2.8 percentage points in the quarter and the cost percentage is trending down as well, leading to NOK 4 million lower loss this quarter.

XXL still lacks some scale in Austria, and the results are impacted by high HQ costs, which accounts for around 4% of sales, and marketing costs, which is around 14% of sales. The 2 stores that are in the like-for-like are both cannibalized by a city store in Vienna that we opened in the second quarter this year.

We have higher ambitions on sales over time, and we are still in the establishing phase of building our position. We do not see any additional store openings in Austria this year but plan for 2 additional in 2020. That will also be in the Greater Vienna area with scale benefits. We are delivering on the strategy of rolling out city by city first and expect 2020 to be on the route to black figures in the Austrian operations.

Denmark, as we said at the second quarter, we have initiated adjustments to the operations to significantly reduce the cost base to be able to reach breakeven. And the market expanding and campaign activities were reduced, and that impacted, of course, the sales volumes immediately but also improved the gross margins and the cost base. And we have made further changes in Denmark that will have positive effects on the cost base short term, including moving the operations from Denmark to the Norwegian e-commerce operation.

There are mainly 3 areas for XXL now. One, top line improvement, especially in Norway. We see that fewer players are gaining momentum, and we need to innovate to stay in the forefront. We see that our e-commerce site is behind many competitors. We will improve, and we will launch new front-end sites. We will increase the assortment online to match the pure players.

We are omnichannel, and we will utilize it to deliver faster than the pure players. And we have for many years had a standstill in the store concept, and we will make innovations and launch a new store concept because it should be fun and inspiring visiting an XXL store. And that is why we have also now introduced or will introduce a new category in water sports through the acquisition of West Systems. There are too many customers visiting XXL that experience sold-out situations and lack of relevant sizes have been a problem. We will focus on always having the best-selling products and sizes available.

Number two, inventory control. In order to strengthen the control and speed up the inventory reductions, the Board of Directors has immediately placed the mandate with the CFO and the finance team of XXL. And we have the medium-term ambition of reducing the inventory down towards NOK 25 million per store.

Third, improved reputation. There has been a lot of negative media attention directed at XXL lately. And we have started to strengthen the leadership through internal routines and control. We are sorry for all the incidents and wish they did not happen. We are still awaiting the external investigations, which is reporting directly to the Board and their findings and conclusions. We will for sure act accordingly, and we will work on rebuilding the reputation.

We are now systematically working on how to improve XXL. It will be hard work, and we will allocate resources to do it. So to be continued at the Q4 presentation, we will update you more on the revised strategy plan.

In the last year's strategy plan, we talked a lot about building the omnichannel champion, and that strategy stays firm as XXL has a unique opportunity to take this position. We are already the market leader in the Nordics with market-leading stores. Few large and identical stores with online inventory to be used for pickup and returns with service points and showrooms for field and inspirations. Market-leading e-commerce platform with high traffic that are scaled for growth, and it's fully integrated with the store network.

And we have synergies in the integrated backbone to -- only to highly efficient warehouses with robotics. We are sharing one ERP system only in the group. We have one customer service function, one HQ with support functions. They are sharing the marketing and the purchasing, and they have the same training setup. And in the end, it is the same dynamics in the store and online.

So with that, thank you, and I leave the floor to you, Stein.

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

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Well, thank you, Tolle. I will take you through the financial figures for the third quarter of 2019. Before I start going through the Q3 numbers, I thought saying some words about the capital raise and the new bank agreement.

As communicated on the 15th of October, XXL has, in order to strengthen the balance sheets, obtained commitments for private placement of new shares in the amount of approximately NOK 400 million directed to the largest shareholders of the company. Also, the Board of Directors will propose a subsequent offering of approximately NOK 100 million to the shareholders not allocated shares in the private placement.

The subsequent offering is fully underwritten by Altor. The subscription price in both the private placement and the subsequent offering is NOK 15 per share, and both are subject to approval by an extraordinary general meeting to be held on the 6th of November 2019. The Board of Directors has considered the private placement in light of equal treatment, obligations and is of the opinion that the proposed private placement is in compliance with these general requirements.

Also -- and something that must be seen in light of the capital raise, XXL has agreed with its bank consortium new covenants in 2020. The net debt over EBITDA, excluding IFRS 16 effects, shall be 4x and potential impact from liquidation, sale of inventory outside of its existing distribution channels and main markets. Also no distribution of dividends or share buyback prior to December 2020.

Then, we move over to the Q3 figures. As you already know, we are disappointed with the Q3 numbers. Our results are hampered by the negative growth in several of our markets and especially in our most profitable market, Norway. Norway alone stands for NOK 51 million out of the NOK 58 million in EBITDA decrease and especially September proved to be a challenging month.

Going through the P&L. The negative results are clearly affected by the lower sales. The margin growth we had earlier this year was not as high in Q3, due to higher campaign activities in Norway but without a corresponding top line increase. Also, the margins were once again hampered by lower supply volume bonuses of NOK 13 million in the quarter. XXL had high OpEx percentage, once again driven by the lower sales together with 4 more store openings compared to last year.

Also, we had higher marketing costs in the quarter, especially in Sweden, however, compensated with a release of provision related to option program to key employees of about NOK 19 million. Negative sales combined with higher OpEx had strong impact on the EBITDA delivering NOK 132 million versus NOK 190 million last year.

Gross margin, most of the markets had improvements in gross margins versus last year, despite being negatively affected by the supplier bonuses. Especially strong as you can see on the chart here in Finland and Austria, while Norway was affected by a September month with more campaigns.

Moving over to OpEx. Group OpEx was up by 2.6% to 31.9% year-on-year, driven by the negative like-for-like growth of 4%. In the quarter, we also had 4 more stores compared to last year. Decreased costs in HQ and Logistics segment, partly explained by the release of the already mentioned option program of NOK 19 million.

Austria showing improvements, but still lacks scale to cover up for the increased -- or the high HQ and marketing costs, summing up to 18% of turnover. We believe with a more normal level of HQ and marketing cost that Austria is on the right path to deliver black numbers.

EBITDA. As I said, EBITDA decline of NOK 58 million, where Norway is the main contributor with -- down with NOK 51 million and Sweden down with another NOK 25 million. Finland had strong growth in the quarter. And measured in EBITDA, it's now our second biggest segment despite 12 fewer stores compared to Sweden.

Austria, as I said, is slowly approaching breakeven, but we need more scale in Austria going forward. Tolle already mentioned Denmark. We cut marketing costs quite significantly in Q3. And in order to see black numbers, we will move the operations from Denmark to Norway in Q4.

Moving over to net debt and cash flow. As you can see, the net debt moved from NOK 2 billion in second quarter to NOK 1.9 billion in Q3 2019. And you see the reduction is mainly explained by the EBITDA of NOK 132 million but also sale of own shares that contributed with NOK 77 million.

If you look at the cash flow -- operational cash flow and that's, as I said, NOK 163 million, that's down compared to last year of NOK 93 million. And the decrease versus last year was, of course, mainly related to the lower results, the buildup of inventory versus build down last year and partly contracted with higher payables. We have chosen not to use cash discounts to our suppliers in September, which gives us a positive effect on the payables.

Liquidity reserves ended at NOK 0.6 billion, that's up with NOK 0.2 billion compared to last year and also reducing our debt from NOK 2.1 billion to NOK 1.9 billion. And as you can see, the debt compared to last year is down. However, the lower earnings put significant stress on the covenant calculation, ending at 4.2 right below the covenant of 4.25.

So to sum it up, we are disappointed with the results in Q3, especially the negative like-for-like growth of 3.6% and especially the weak performance in Norway, somewhat contracted with solid development in Finland. We had an EBITDA decline of NOK 58 million and a leverage ratio of 4.2, which is right below the covenant of 4.25. We are pleased to have obtained commitments for NOK 500 million in new equity and also pleased to have new covenants for 2020.

Priorities going forward. As Tolle told it, we have to regain sales momentum. We have to speed up the reduction of inventory, and we have to strengthen the leadership through improved routines and control. We will give a more updated outlook in the Q4 presentation as well as a revised strategy plan. Thank you.

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

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Thank you. Then, we open up for questions, first from the audience present here in Oslo. So please wait for a microphone. And we finally ask you to introduce yourself and limit the question to one question at a time. So please go ahead.

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Questions and Answers

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Gard Aarvik, Pareto Securities, Research Division - Analyst [1]

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Gard Aarvik, Pareto Securities. Could you say something about the average age on the inventory and the type of goods, which mainly make up the large inventory?

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

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Shall I?

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

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Yes. Take it.

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Stein Alexander Eriksen, XXL ASA - Group CFO [4]

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The age of the inventory is more or less the same as last year. And of course, we still have the winter products that we have -- that we communicated around NOK 250 million to NOK 300 million last year. As you know, we have lower sales, which has put pressure. So we haven't managed to downscale the purchasing as fast compared to the lower sales.

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Gard Aarvik, Pareto Securities, Research Division - Analyst [5]

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Okay. Second question. Could you perhaps elaborate a bit more on the type of channels you see outside the existing sales channels which could be relevant to sell inventory to?

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Øivind Tidemandsen, XXL ASA - Chairman [6]

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Yes. I mean there is a lot of options, outlets throughout Europe, which could be -- that we could sell some of the stock to, for instance, but we don't have any concrete plans. And we will -- also, it's important for us that we are doing this in cooperation with our suppliers so we don't get bad [results] with the supplier. So we have to do it in a way that both, we and the supplier, are agreeing on.

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Markus Borge Heiberg, Kepler Cheuvreux, Research Division - Equity Research Analyst [7]

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Markus Heiberg from Kepler Cheuvreux. So considering the new debt situation, do you plan to utilize the gross margin more actively to gain sales momentum and get rid of inventory? Because now you, obviously, have more headroom. You have --- don't have to care so much about the EBITDA.

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Øivind Tidemandsen, XXL ASA - Chairman [8]

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We will, of course, try to do that also in a way that our suppliers are accepting. But of course, the top line in Norway is challenging. And we tried in September to lower the margins, but we didn't get the effect that we hoped for on the top line. So it's a little challenging.

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Markus Borge Heiberg, Kepler Cheuvreux, Research Division - Equity Research Analyst [9]

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Yes. So especially online, I think, is very disappointing that you're not growing online and that is, obviously, because of prices and marketing, should be.

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Øivind Tidemandsen, XXL ASA - Chairman [10]

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Yes.

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Markus Borge Heiberg, Kepler Cheuvreux, Research Division - Equity Research Analyst [11]

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So how do you plan to address that issue going forward because online is kind of the -- I think the most important channel for going into the future?

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Øivind Tidemandsen, XXL ASA - Chairman [12]

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What we see is that when we are -- have a more aggressive price policy online, that gives effect. So for instance, in September, we had the growth in online sales despite 40% increase in September last year in Norway. So the online channel will be used to reduce the inventory.

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Tolle O. R. Grøterud, XXL ASA - Interim CEO and Strategy & IR Director [13]

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And we have actions to improve the e-commerce side of the business. We have new sites coming up. We will broaden assortments to be matching the pure players and so on. So there are a lot of initiatives related to the e-commerce offering, of course, which I agree with you it's key to have a speed on the online side.

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Øivind Tidemandsen, XXL ASA - Chairman [14]

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Our plan is also to introduce next-day delivery as pickup at store within year-end this year. So we will have a faster delivery time than, for instance, our pure player competitors.

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Tolle O. R. Grøterud, XXL ASA - Interim CEO and Strategy & IR Director [15]

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Any other questions from the audience? Okay. 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. So we currently ask you to introduce yourself and limit the number of questions to one at a time. So I'll then call upon the conference host for further directions.

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Operator [16]

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(Operator Instructions) The first questions come from Tushar Jain from Goldman Sachs.

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Tushar Jain, Goldman Sachs Group Inc., Research Division - Research Analyst [17]

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So I have 3 questions, but I'll go one at a time. Just wanted to understand, first of all, how are you buying for next year. Should we expect supplier bonuses to be a headwind for the gross margin next year? That's my first question.

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Stein Alexander Eriksen, XXL ASA - Group CFO [18]

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I mean I can answer that one. I think you should calculate lower supplier bonuses also in Q4 as we, of course, need to reduce the purchasing going forward. And at least, my ambition is to reduce the inventory also, of course, going into Q1 and Q2. So the answer is yes. You can calculate on lower supplier bonuses.

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Tushar Jain, Goldman Sachs Group Inc., Research Division - Research Analyst [19]

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Got it. And second question is on Norway. I mean your discount responded online, but store did not. Just wondering if you can give a little bit more color around, was it the discounts weren't deep enough or the product category was not tried. If you can give a little bit color what happened in stores in Norway.

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Tolle O. R. Grøterud, XXL ASA - Interim CEO and Strategy & IR Director [20]

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Yes. What we did was to actually be a bit more aggressive on all week or the weekly campaign throughout September. But then in the end of September, we have a special campaign, which we call (inaudible). It's for the newsletter subscribers. We actually increased the discount from 25% to 30% on the apparel side.

But we saw really good growth actually online, but limited increase in both traffic and sales in the stores compared to basically the day before or the day after. So there is a lot of discounts in the market from both the physical chains that are under reconstruction and also from pure players. So the discounts in the market is -- was quite frequent, I will say, in September.

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Tushar Jain, Goldman Sachs Group Inc., Research Division - Research Analyst [21]

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Got it. And my final question on Black Friday. You lost a significant amount of money last year. I'm just wondering what's the strategy for this year is for Black Friday, and how you're approaching it.

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Øivind Tidemandsen, XXL ASA - Chairman [22]

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Well, we are not planning to lose that much money. So we will try to be a little smarter in what we -- in our offers. But of course, we want to -- it's an important period also for the top line. So we will have strong offers, but we will do it a little smarter than we did last year, so we will have more profit during that week. I cannot be more detailed because we have some competition out there.

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Tolle O. R. Grøterud, XXL ASA - Interim CEO and Strategy & IR Director [23]

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Okay. Then we take the next one or have I lost them?

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Unidentified Company Representative [24]

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(inaudible)

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Tolle O. R. Grøterud, XXL ASA - Interim CEO and Strategy & IR Director [25]

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Okay. Him or the lines?

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Unidentified Company Representative [26]

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(inaudible)

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Tolle O. R. Grøterud, XXL ASA - Interim CEO and Strategy & IR Director [27]

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Okay. We try to reconnect with the phone.

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Operator [28]

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(Operator Instructions) This is the operator. Is this the host for the XXL?

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Tolle O. R. Grøterud, XXL ASA - Interim CEO and Strategy & IR Director [29]

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Yes, that's great.

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Operator [30]

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This is the host. I will now transfer you directly. One second. Please hold the line. And we now have the host back again in the call. So I will now repeat for Martin Stenshall from Danske Bank.

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Martin Stenshall, Danske Bank Markets Equity Research - Senior Analyst [31]

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I'll just repeat my question. Basically it relates to net finance costs going forward. So could you please comment on to what extent we should expect increased net finance costs, given the extended covenants?

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Stein Alexander Eriksen, XXL ASA - Group CFO [32]

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I think you can expect decreased finance costs since we are going down on the interest scale of about NOK 30 million next year.

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Operator [33]

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I am so sorry. This is the operator. It sounds like the phone line is really poorly at the moment. So if you could just please repeat or swap your microphones, please? Thank you.

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Tolle O. R. Grøterud, XXL ASA - Interim CEO and Strategy & IR Director [34]

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And maybe you should repeat the answer?

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Stein Alexander Eriksen, XXL ASA - Group CFO [35]

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Yes. I said...

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Operator [36]

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Thank you.

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Stein Alexander Eriksen, XXL ASA - Group CFO [37]

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Yes. I said you can expect decreased interest expenses in 2020 due to lower interest rates and also lower debt. So you can expect around NOK 30 million in lower interest rates in 2020.

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Operator [38]

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Martin, did that answer your question? Martin, you are still on talk. Can you please confirm that that was your end of the question or would you like to ask another question? (Operator Instructions) It doesn't look like we have any more questions from the participants over the phone. So I will now hand the call back to you again. Thank you. Oh, no, sorry. Martin is back. I'm going to transfer back Martin into the call.

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Martin Stenshall, Danske Bank Markets Equity Research - Senior Analyst [39]

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So I just would like to continue with a question regarding how to get the inventory down towards NOK 25 million per store. And Øivind, you mentioned that you could seek opportunities to sell to outlets throughout Europe. Could you please provide some more comments on what kind of discounts we could be looking at, if you were to proceed with that optionality?

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Øivind Tidemandsen, XXL ASA - Chairman [40]

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That will be a matter of discussions. And so I can't really give you a number there, but I think the most important thing here is that we are working internally with our inventory. We have to reduce the value of the inventory in each store. We are actually shipping out, and we have quite big stores in the Nordics and there's too much inventory in each store.

So we have launched artificial intelligence program, so that we are shipping out the right products to the right store in the right numbers. That's the main thing. And of course, we also have renegotiated our terms regarding buying. So we are not taking the same risk as we did before. We put too much orders that we could -- that compared with what our prognosis were regarding our buying. And we have now lowered that risk, put more risk towards the supplier because we cannot predict the weather or a lot of things better than they are.

So now we have a shared risk situation with our suppliers. Before, we took too much risk. That's the number one key. Then, we will reduce the number of SKUs. We have too many duplicates in some part of our assortment. So we are reducing the SKUs, and we are buying more of what we're selling more of. It's kind of quite simple, but it's important, this change.

So this is how we are changing how we're buying. And then we are changing how we are shipping out to the stores, keep more products in the warehouse and send it when it's sold to the different. Remember, we have different seasons. We have different -- I mean the fishing is quite different from the seas, the stores at the sea compared with inland. So there's very different what is selling where. And all this has been manually done before. This is now done automatically, which will have a huge impact in the inventory in the stores.

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Tolle O. R. Grøterud, XXL ASA - Interim CEO and Strategy & IR Director [41]

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Maybe we lost him again? All right.

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Operator [42]

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I think Martin is on mute at the moment. Martin, your phone line is still active. Do you want to continue asking questions, Martin Stenshall? I will then close Martin's line again. (Operator Instructions) It could be that Martin is showing up again. Let's see. (Operator Instructions) There is no further in the queue. So I will now hand the call back to you again. Thank you.

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Tolle O. R. Grøterud, XXL ASA - Interim CEO and Strategy & IR Director [43]

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So thank you. And sorry for the big problems with the lines, but that ends our session. So we thank you all for participating, and have a nice day. Thank you.