XXL ASA

OSE:XXL

Earnings Call Transcript 2018-Q4

[Tolle O. R. Grøterud, Interim Chief Executive Officer]

Good morning, and welcome to the XXL ASA's results presentation. My name is Tolle Grøterud, and I'm the Interim CEO, and I will have the pleasure of guiding you through today's presentation. We are sorry for the weak results development. The whole management team is working every day to improve the situation, gross margins and the sales development. Gladly, we have seen good progress in this respect the last month. I will first take you through our results and key drivers; and then our CFO, Stein Eriksen, will take us through the financial update, followed by a Q&A session. Our Chairman, Øivind Tidemandsen, is also present, and he will be joining us for the Q&A part as well. Øivind founded XXL back in year 2000, opened the first store in 2001, is involved in several other successful retail concepts in the Nordics and has been a hard-core retailer his whole life. He's acting in the daily operations as well. And then for the media, there will be an opportunity to perform separate interviews after the presentation.We are delivering very disappointing results for the fourth quarter, and again, we are really sorry about it. Let me be the first to say that this is purely in the hands of the management team, and we are solely and together responsible for the results. And we are doing our utmost to correct our mistakes, and we are using most of our energy on actions and adjustments. At the same time, let there be no doubt that the strategy plan that we presented to you last quarter stays firm. This is well founded in the board and in the management team. All members in the management team have their own long-term strategic projects to deliver on. They are committed to the plan, which is also shared widely within the organization. And we are focused and highly motivated to delivering on the plan, on making XXL the omnichannel champion.The weak results in the quarter are driven by poor campaign management and lack of smartness and routines in pricing. This resulted in significantly reduced gross margins. After a tough summer season with low volumes, XXL decided to hold back a bit on costs, both on personnel and marketing. This was the right strategy in the summer month, that lasted too long; and also with lagging effects in the push for marketing, leading to low traffic and volumes going into the autumn season and especially the October month.XXL decided to push volumes in the campaigns in November and specifically in the Black Friday activities. And commands were given on full throttle on volumes, resulting in low to negative gross margins on many products. Mistakes in the way we follow competitors' campaigns and overall lack of smartness in the pricing strategy. XXL lost around NOK 40 million in -- on gross profit in the Black Friday activities alone compared to the year before and ended up with a negative EBITDA effect in total. Over the time period, XXL was too aggressive on pricing and adjustments, and it takes a bit time to correct it, and you have some lagging effects, so the low gross margin also continued into December. This was especially the case in the Norwegian operations. Let there be no excuses that this happened in a period with several internal management changes. Both our long-lasting CEO, Fredrik Steenbuch; and the Group Commercial Director and Co-Founder of XXL, Jarle Bråten, stepped down. Some routines and experience were lacking in the transition phase. XXL has, for a long time, been all about growth and top line focus. We have grown into new markets, categories and with many new employees. And we have to admit that we had some issues with routines and responsibilities and in the on-boarding and training of new positions in the organization.All in all, the quarter ended with a revenue growth of 2% to NOK 2.6 billion, driven by negative like-for-like growth of 4.1% or 3.5%, adjusting for cannibalization effects in several stores in Norway. E-commerce continued with strong growth of 28.6% and represented about 20% of total sales in the quarter. This had also a negative mix effect on the gross margin with around 1 percentage point. Overall, gross margins were significantly lower, as explained, down 5.8 percentage points to 36.2%, resulting in an EBITDA of NOK 115 million.For XXL, it's now time to go back to deliver on the core concept and by further improving and strengthening it by innovation, automation and then reaching the customer experience over time. Internally, we call it back to basic but into the future. The internal mentality is reversed a bit from pure top line focus to balance between growth and profitability. We have changed and centralized the pricing policy and authorizations, and we are back to smartness in pricing. It is not all about volumes. We have to focus on additional sales and up-sales in all channels; traction on hotspots and bestsellers in stores and online; and we are strengthening the campaign planning. So to give you an example. Last year, we used 48 DMs out of 52 DMs on campaigns we call partikjøp on those price discounts. And also with that sales towards soft goods play to a large extent on the price only. But this is not XXL. XXL has broad assortment with a wide range of products for all sports at many price points and also the high end of the range. And we have competence through category salesmen. We focus on branded goods, brands that the consumer wants in the Nordics and in Austria. We have service stations for the gear in all stores and the central warehouses. We deliver services and inspiration to our customers. XXL is the real sport chain. We're an El Dorado of sporting gear, with attractive prices always every time in all stores and online. We have adjusted and changed a lot the last couple of months. We have redefined and strengthened many routines, and inside ourselves found our DNA. We are in the industry as the game-changer, the winning concept with the lowest OpEx, yielding the highest profits that we will use to further strengthen the business model to gain stronger positions and to give solid returns to our shareholders over time. And we are very pleased that the short-term actions, the focus on changes we have made are already showing progressions and results. Volumes and gross margins developed positively towards the end of December, resulting in a strong cash flow on par with last year. The liquidity reserve ended at NOK 700 million and with the leverage ratio of 3.48x, which is below the original covenant from the banks. However, due to the poor Q4 results, we have proactively agreed on new covenants going forward. Revenues increased by 1% in January 2019 to NOK 762 million, and this is despite an exceptionally good conditions last year. We saw good winter conditions in Finland and Austria, more mixed in Norway and Sweden, but the conditions improved also here last part of the month. For January, we saw a solid improvement in gross margins year-over-year. And this is also the case going into February.Growth drivers in the quarter. The revenue growth of 2% is driven by growth from new stores, partly offset by a negative like-for-like of 4.1% for the group. But when excluding for the cannibalization effects in several Norwegian stores, the negative like-for-like was 3.5% for the group and 4.9% for the Norwegian operation. Sweden and Finland posted more stable like-for-like figures, however, driven by good growth from E-commerce, and the like-for-like are still in negative -- like-for-like stores are still in negative territory. Denmark and Austria continued to deliver solid growth in the quarter. And Austria already represent 5% of the total sales of the group with 4 stores and E-commerce on that. Remember, a lot of the sales in the quarter were concentrated around big campaigns with high discounts, leading to lower revenues and like-for-like figures as well. Gross margin development, I have to say I feel really embarrassed about this slide. It contains very weak numbers. Gross margins are significantly down in all markets, and it's mainly due to the poor campaign execution. We had 2 aggressive price discounts, and we did not follow up and adjust it sufficiently. And this, unfortunately, lasted too long and hampering the gross margins into December as well. But there are also some other main points to address. Still lower supplier bonuses received due to the downscaling of the inventory is around NOK 20 million, with a negative effect of 0.8 percentage point on the gross margin for the group. And the strong growth from E-commerce versus stores is also yielding negative effects on gross margin due to lower-margin online than in the stores. This effect is around 1 percentage point negative effect on the gross margin this quarter.The negative like-for-like in the stores in the Nordics are impacting the cost leverage of the operation, leading to higher OpEx percentage in all of the Nordic markets. However, both Denmark and Austria are showing improvements with higher sales volumes and, thereby, scaling the operations. In addition, in the HQ and Logistics segment, there is onetime effects of around NOK 10 million or 0.4% of group sales, leading to an overall very weak and disappointing EBITDA, negative like-for-like growth in the stores in all markets, significantly lower gross margins in all markets and the EBITDA for the group also impacted by negative EBITDA of NOK 18 million versus NOK 9 million in Austria.Norway. We opened 4 new stores in Norway during 2018 and 1 new in the fourth quarter, Storo in Oslo. Lack of cold and snow compared to good winter conditions last year impacted the sales. And the like-for-like growth was down 5.9%, however, impacted negatively by the cannibalization effects from all the new store openings. So when adjusting for this, the like-for-like was down 4.9%. E-commerce continued to deliver strong growth, but this also impacted the gross margin negatively. However, the main explanation behind the results development is driven by the poor campaign management and pricing strategies, leading to a drop in the gross margin. This lasted also into December. XXL saw lower gross margins going into the Black Friday, but Black Friday was the real kicker. Negative like-for-like, combined with the -- such low gross margins, gave a rather horrible development in the EBITDA, margin down 9.4 percentage points.Sweden. Sweden is still a volatile and discounting market, also influenced by lack of good seasons and cold and snow compared to the last year. XXL delivered a 3% growth in local currency, driven by growth from new stores. Like-for-like was slightly negative. Gross margin decreased by 5.2 percentage points, whereof 2 percentage points are related to reduced amount of the supplier volume bonuses, and around 1 percentage point is due to the negative mix effects from E-commerce. The rest is explained by high campaign activities. OpEx increased a bit due to negative like-for-like in the stores and, combined with significantly lower gross margins, lead to an EBITDA of 3.9% in the quarter. Like-for-like was positive in Finland of 1.4% in local currency, and it's driven by the strong growth from E-commerce. This is achieved compared to Q4 last year, which experienced good selling conditions and strong overall Finnish performance. This quarter, the gross margin declined 2.4 percentage points, whereof 1.5 are related to the lower supplier bonuses. The rest is explained by mix effects of strong online growth. Negative like-for-like growth in the stores contributed to a bit higher OpEx percentage. As a result, the EBITDA ended at NOK 20 million in the quarter or corresponding to an EBITDA margin of 4.4%. Looking at the market data, it is clear that we, as stated earlier, had lower momentum going into the quarter, especially in Norway, with savings in marketing during Q3 and associated lagging effects from this. Volumes improved, of course, during the aggressive campaigning period. And overall, XXL ended the year with a strong Christmas sales period and again gained market shares in all markets. XXL Denmark continued the strategy with aggressive campaigns to take volumes in the market and achieved scale in operations. This proved successful both on a volumes and OpEx percent but hit the gross margin. The lower gross margin is also influenced by changes in the sales mix. We are selling more capital goods with higher freight costs. And the EBITDA was negative NOK 3 million. But XXL has a high focus on improving the gross margin and to deliver positive EBITDA for 2019.Austria. We are constantly working on improving and adapting our offering in Austria by introducing more local brands, testing out marketing catchment areas and mix, training of the employees in the XXL culture and adapting well-functioning solutions from the Nordics. And this has improved the sales volume, and the revenue growth in the quarter was 71.2% in local currency. E-commerce continued to be a large part of sales and amounted to around 25% of sales in the quarter. This has, of course, a negative effect on gross margin since there are much lower gross margins online than in the stores, even more so in Austria, where the freight costs are higher and also the return rate. It is still early days for XXL in Austria, and we are investing through campaigns and price. The OpEx improved from 47% to 39.6% due to the increased sales volume, but the EBITDA was negative of NOK 18 million. It is still high marketing spending when ramping up in 3 large cities with limited immediate synergies. However, we expect further increase in scale benefits when opening new stores in cities where we are already present today. And the city location in Vienna, Mariahilferstraße, is soon to open. And we are evaluating 1 or 2 more stores in the same cities as we are today for new store openings in 2019.As of 1st of February 2019, we are changing the local management team with a new Managing Director, Magnus Kreuger. He's a senior omnichannel retailer from our Swedish operations. He has held several leading positions for many years, including store manager, operations manager and E-commerce manager. And he will, of course, join our established team of highly competent Austrian employees and help us achieve black numbers in Austria in 2020.The former MD, Patrick Verwilligen, he will act in a position with focus on store locations and further store expansion. XXL has over the years built a strong market-leading position in the Nordic online sports retail markets. And we are seeing good uptake also in Austria, even when supported by only 4 stores. Norway, 8.5 million visits in the quarter, impressive and market leading; Sweden, 6.1 million visits, higher than all main sports competitors; strong position in Finland, backed by 3.8 million visits in Q4 alone. HQ and Logistic costs increased to NOK 115 million in the quarter, of which NOK 10 million is related to onetime effects and equals around 0.4% of group sales. The lower sales volume in the quarter and also the concentrated sales to heavy campaign periods are paying its toll on the efficiency in flow of goods. In addition, XXL has recruited several new central positions, including buyers, technical resources and IT. XXL will continue to invest in this field, including automization and technical solutions to be able to create the winning omnichannel player. However, this will be done in a controlled manner, and these investments amounted to NOK 66 million in 2018, which is below the guidance of NOK 70 million to NOK 90 million.For the year 2018, XXL delivered growth of 9% to NOK 9.5 billion. E-commerce contributed with a solid growth of 38%, offset by negative like-for-like growth in the stores. Overall, the year had a positive start with good winter conditions but was negatively impacted by a long and warm summer and autumn season and by the poor internal execution in the fourth quarter. The latter also hampered overall EBITDA development significantly, and the year ended at an EBITDA margin of 5.7%. Despite the significantly lower results than expected, the cash flow is on par with last year. We are constantly working on strengthening the e-commerce and omnichannel offering, and many new solutions have been introduced during the year. And the long-term strategy remains firm, delivering on the plan on making XXL an omnichannel champion.Priorities going forward. The first one is to drive like-for-like growth. This is a very important parameter for us, maybe the most important one. Even though we are preparing for limited like-for-like in the stores in the coming years, XXL has historically been really good at developing the concept, assortment and categories, contributing to the like-for-like over time. And we will, of course, continue to do so in the future as well. We will work on broader assortment online, assortment that could be sold both in stores and online. Data collection and personalization will improve sales over time. And we will fine-tune the store rollout plan going forward. The most important for us is that we will open stores in larger cities and focusing a lot on new potential stores in area where -- areas where we are already present. This will maximize the scale benefits for marketing and personnel training. We only have some few business cases left in Norway and Finland. But in Sweden, we have more to do. And we see from analysis that we are doing very well in areas nearby XXL stores and also good uptake on E-commerce revenues when we open stores in new areas. Let me remind you, we are not in Malmö, the third-largest city, and we have more things to do in the big cities as well, so I think Sweden could be another 6 stores. In Austria, we have only 4 stores, and we believe there is room for 10 to 15 more stores. At the same time, we are testing out downscaling some stores to less square meters and inviting in a good neighbor. And we have currently a test running in Moss in Norway, and the early indications are promising.The next one, we want to protect the gross margin even though we see that market dynamics and the mix effects will work in the opposite direction. One of the important long-term projects here is to introduce an artificial intelligence system in 2019, and that will start to give effects in 2020. This will replace the old min/max calculations used in today's ERP system and is really about how we distribute the products to the right places at the right time. It is all about being more fact and data-driven in the replenishment and buying processes. We will also be working on shipment and return costs, for utilizing the omnichannel features for having large stores spread where people live. Deliver on the OPEX25 project; we introduced the OPEX25 project over at 5-year time period in the strategy plan, and it stays firm. This will be done by a combination of top line growth and by challenging the -- all cost lines. We will reorganize the marketing and get scale also in the E-commerce organization. And we will negotiate all these contracts and lease terms, and we have hired own resources to only focus on this. AI in the value chain will give benefits for store logistics and simplify the store operations. Then we will improve and create the best in-store omni experience. We are working on a new store concept, [ Version 5 ]. And we think there are a lot of opportunities related to tech and optimization, and that will be important efficiency tools for the employees. We will introduce immediate collect, selling goods from different stores, online assortment in the stores, automated return systems. We will test out queue-free solutions and self-service pickup stations. We will soon test out a new automated self-service pickup concept that will significantly reduce the handling cost in the store and improve the customer experience related to collect at store.We see that we have a large upside in Sweden from tests. We see that we have a stronger brand value in Finland and Norway. There are really 3 areas that we want to focus on. It's to improve the local assortment, we will open more stores in the larger cities, and we will increase a bit on the marketing spending.During the quarter, we have worked on many new digital initiatives. The first one is that we have improved the omnichannel solution that, I guess, most of you are familiar with. It is now rolled out in all markets. And recently, we started out testing -- to test selling products from the total XXL stock in all stores as well. This will improve the sold-out situation and broadening the available assortment. Yes, it is costly to send goods from different stores, between stores, packing online orders in stores, but bear in mind, we are selling a lot of products for phaseout, and the solution is optimizing the value chain over time. In light of the very campaign in Q4, we have also made several adjustments and strengthened the algorithms that control the gross margin, which products to be sold, price limits and which store to pick from and so on. Personalized landing pages, as we can see in the picture on the slide as well. All banners, products and categories, they are now personalized based on user behavior and sales transaction history, cookie-based. This is not only improving the relevancy for the customer, it also enhances the efficiency for our technical department. The solution is rolled out in Sweden and recently also in Norway. And we see solid lifts in the conversion rates and average order values as well as, significantly, savings in the front-end content production.We also use customer behavior data as input to segment automated customer communications or the newsletters. We have developed a new CRM model that gives us a single point of view of the customers in all channels. A new AI and data science platform will automate and improve product recommendations online over time and drive relevancy and aftersales as well. In the quarter, we also started to use RFiD for outbound deliveries, which improved flow of goods and tracing of parcels. We will evaluate this as the -- as a tool for inventory and stock control in the stores as well. All these digital initiatives are giving benefits for the XXL omnichannel model. As you know, XXL has already gained a market-leading position in E-commerce in the Nordics, showing almost 50% yearly growth since 2014, the year of the IPO. Although E-commerce is becoming a gradually larger part of the business, our store base is still the fundament and a solid profit base. All of our like-for-like stores were profitable in 2018 despite the challenging year. We see that we have a solid growth online also when we open new stores, proving the strength of the XXL omnichannel concept, a concept that still works. XXL is the winning concept both in terms of market shares and customer recognition. A couple of weeks ago, we received a study made by the state-owned Norwegian Consumer Council, Forbrukerrådet, ranking XXL as the best sports retail chain in Norway on consumer-friendly solutions. Please take a moment to read it. Our Q4 numbers, they are clearly below our own expectations and ambitions. The results are very weak, driven by poor execution. We are sorry. It is embarrassing. The responsibility is in the hands of the management team, and we are working on many initiatives, both short and long term, to improve the results. And some have already started to give good effects, and we are on the way of delivering on the strategy on making XXL the omnichannel champion. So thank you, and I then hand over the floor to you, Stein, for the financial update.

[Stein Alexander Eriksen, Group Chief Financial Officer]

Yes. Thank you, Tolle, and good morning, everybody. I just want to say also that we are disappointed by the development in the quarter, and I will take you through some more details around the financial performance of XXL in Q4 and in 2018. If we start with the group P&L. As we can see from the chart, XXL had operating revenues of NOK 2.6 billion in the fourth quarter, an increase of 2%, all driven by new stores and significant growth in E-com. The like-for-like growth was negative with 4.1% in the quarter. And as also, as we can see, the operating income ended at NOK 64 million, significantly below last year, as you can see, of NOK 283 million. And the main, main explanation is the drop in gross margins, down 5.8 percentage points in the quarter, down to 36.2%. And I'll try to give you some more flavor regarding the reduction in gross margins. We -- or Tolle already mentioned Black Week. The Black Week, we lost NOK 40 million in profits or in gross profit, explaining around 1.6 percentage points of the drop. Then we had negative effects in the end of November going into December, explaining another 1.9 percentage drop. Also, we had lower supplier bonuses, around NOK 20 million in the quarter, explaining another 0.8 percentage points. Tolle mentioned the negative effects from higher E-com growth. That's another 1 percentage points. And then we have other negative effects of 0.5 percentage points. Looking at the net financial costs, they ended at NOK 9 million, which is NOK 4 million above last year, mainly explained by a difference in the currency effects. If you then look at 2018 full year, we delivered 9% income growth. Also here, all the growth was explained by new stores and the growth in E-com. Like-for-like was negative with 0.3%. Also here, I mean, as you can see, the operating income ended at NOK 352 million versus NOK 668 million last year and was mainly explained by a weak Q3 and an even worse Q4, and the latter explaining 70% of the total profit loss in the year as a whole. So as you can see, Q4 was quite a quarter where we lost significant profit compared to last year. Once again, the explanation is gross margin. I'd just go through briefly through the bridge here also, 2.2 percentage points down, supplier bonuses explain 0.7 negative mix; from E-com, another 0.6; Black Week, 0.5; and carryover effects into late November, December, another 0.5. Net financials was NOK 57 million, NOK 15 million above 2018. Also here, mainly it's related to currency effects of NOK 12 million and some higher other financial costs. Estimated tax rate of 20% and ending then with a net profit of NOK 236 million for the year as a whole. Okay, moving into the balance sheet and cash flow. Tolle already mentioned it. Despite the significantly lower results, cash flow ended up on par with last year. And this was mainly explained by reduced inventory buildup versus last year, explained by good sales the couple of last weeks in December month. Inventory per store went from NOK 39.4 million last year to NOK 37.1 million this year. We still aim to get around NOK 35 million by the end of 2019. XXL has proactively obtained new covenants going forward with its lending consortium. And the reason for the new covenants is that the EBITDA and cash flow, as you probably know, is very backloaded, with most of the cash flow coming into Q3 and Q4. And since the covenants are based on the 12-month rolling EBITDA, the carryover effects from a weak Q3 and Q4 will also affect the leverage ratio in the -- in going forward. As a part of this program, there would be no share buyback and no dividends before Q4 2019 as the earliest. Also commenting on the new covenants, be aware that the agreement with the banks is that all IFRS 16 effects will be cleaned out. Estimated IFRS effects are in the Appendix but is estimated that it had a negative effect on profit before tax with NOK 50 million to NOK 60 million. Due to strong cash flow in December, the net interest-bearing debt ended at NOK 1.9 billion, giving a leverage ratio of 3.48x, which is below the original covenants. And we ended up with a liquidity reserve of NOK 0.7 billion.Okay, moving over to the long-term objectives. As Tolle said, they remain firm. We aim to open 6 to 8 new stores. And some of you have probably noticed that we have changed this from what we communicated in Q3, where we communicated 7 to 10 stores. That's because we see we have a very good E-com growth. We still expect the like-for-like to be low single digits, and we still expect the E-com to be up to 30% of total revenues in 2023. And believe me, we don't expect gross margins to be like in 2018. We believe them more to be in -- we believe them to be declining but not like in '18. But as Tolle said, we need then to work more on our OpEx, and we still aim for the OPEX 2025. And we expect the EBITDA margin to be stable compared to 2017. Yes, moving over to look at the country perspective. Same as what we said earlier, Norway, low 20s; Sweden and Finland, we expect low double digits; and Denmark and Austria, we aim for high single digits.Outlook, current trading. XXL in January, 1% sales growth. And we had very tough comparator in Norway and Sweden in the first half of January, but we saw improvements at the end of the period. In Finland and Austria, I think it's fair to say that the winter conditions has been very good, also affecting the sales positively in these 2 countries. The already mentioned short-time action has given positive effects on the gross margin, both versus December 2018 but also versus January 2018. Yes, we aim -- or sorry, we have signed 5 new lease agreements: 2 in Finland, 2 in Sweden and 1 in Austria. And we aim for 6 to 7 new stores in total for 2019. And the CapEx, we believe it to be in line with the existing growth strategies. We believed or aim for CapEx around NOK 200 million, which is below the levels in 2017 and '18.Summary. Disappointing results in Q4, and this also affects the 2018 results. But we see that the short-term actions has given improvements, especially on the gross margin. And the liquidity reserve was NOK 700 million. And we have proactively agreed on new covenants going forward. And our long-term strategy remains firm. We still believe XXL has the best prerequisites. As Tolle mentioned, remember, both profitable stores, all like-for-like stores profitable in 2018, except for a horrible year and a very high E-com share, so we still believe XXL will be the omnichannel champion.

[Tolle O. R. Grøterud, Interim Chief Executive Officer]

Okay, thank you, Stein. Thank you, Stein. Øivind, if you will join us. Then 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 question to one at a time. So please go ahead. There are no questions from the audience. And we are ready to take questions from those of you listening in on the phone. We kindly ask you to introduce yourself [Operator Instructions]. I then call upon the conference host for further introductions.

[Operator]

[Operator Instructions] And we have the first question coming through from Simon Irwin from Crédit Suisse.

[Simon William George Irwin, Director]

First question is about inventory. Can you just talk about the composition of the inventory in terms of age, in terms of seasons where you're kind of under or overweight, and what your expectations are in terms of being able to normalize inventory levels through the year?

[Stein Alexander Eriksen, Group Chief Financial Officer]

Yes. Should I answer that one? The inventory, I can give you a split of the inventory. If you look at the age composition, 5% is older than 2 years. 10% is between 1 and 2 years. And then the rest is less than 1 year. Looking at ambition next year, I mean, we definitely have ambitions that we want to continue to reduce the inventory. We aim for between NOK 150 million to NOK 200 million in reduction in inventory in 2019.

[Simon William George Irwin, Director]

And is that likely -- is that inventory reduction likely to have an impact on supplier bonuses? Or do you think that they would normalize in that environment?

[Stein Alexander Eriksen, Group Chief Financial Officer]

It's a good question. We expect around NOK 15 million in negative effect on the supplier bonuses next year related to the inventory buildup.

[Simon William George Irwin, Director]

That's year-on-year...

[Stein Alexander Eriksen, Group Chief Financial Officer]

Year-on-year, yes, yes.

[Simon William George Irwin, Director]

Obviously on [ quota ], on the lower base from that from the last year.

[Stein Alexander Eriksen, Group Chief Financial Officer]

Of course, that's the estimate, right? So still to be seen, but that's our best estimate.

[Simon William George Irwin, Director]

That's 15, you said, 1-5?

[Stein Alexander Eriksen, Group Chief Financial Officer]

15, 15, 1-5, yes.

[Simon William George Irwin, Director]

Yes, okay. And can you just give us a sense of how local markets are in terms of kind of promotional pressure and how you're seeing the market over the next few months?

[Tolle O. R. Grøterud, Interim Chief Executive Officer]

Yes, I think we haven't seen any major changes. We haven't seen good conditions in most markets now. And a lot of the Q4 is also driven by ourselves. So there is no change in any markets, I will say.

[Simon William George Irwin, Director]

Okay. And what's behind your confidence in terms of getting Austria to positive EBITDA by -- I think you said by 2020? Can you just kind of talk us through it?

[Tolle O. R. Grøterud, Interim Chief Executive Officer]

Yes, I think the first one is that we want to open some more stores in the areas where we are already present, and that will give scale benefits in terms of marketing. And we can also use some of the personnel from other stores to rotate into the new stores, which is really good. So we should see improvements already going into 2019 significantly, I will say. And then we are -- and then we should be on the route to be on more black numbers in 2020. We have also, of course, made a lot of adjustments to the Austrian operations in terms of local assortment, concept elements, the training of the employees and so on. There's a lot of things that we also think will give benefit over time. So...

[Simon William George Irwin, Director]

Yes. And where are we in terms of any further senior management appointments?

[Tolle O. R. Grøterud, Interim Chief Executive Officer]

Yes, I think we have really motivated the management team that stands behind the strategy plan. And we are actually more to increase it because we are looking for a new CMO or Marketing Director. And going back to the concept that we all know about and the DNA, it's a good process for many of us, I think, so -- and with also Øivind being part of this, I feel that the team is stronger than ever before.

[Operator]

The next question comes from Tushar Jain from Goldman Sachs.

[Tushar Jain, Research Analyst]

My first question is on Black Friday. Just want to understand what kind of improvements are you planning to do on the Black Friday. Apart from that, [indiscernible] are you trying to change any sort of assortment there you're going to offer and the level of discounting?

[Øivind Tidemandsen, Chairman]

Well, first of all, I think we have to -- what should I say, this year, we -- was calculated. When we was buying for the season, we actually had the Black Friday [ woolen ] included in that preordering system. And that's not so smart because then you take all the reduction in prices on your own books. So the next time we will -- we haven't planned for this in our preordering. We will sit down with our suppliers and get good prices, so they are sharing the cost of Black Friday. That's the major change. But in addition to that, of course, it's all about smartness in pricing and so on, so it's a little bit change in the tactics as well.

[Tushar Jain, Research Analyst]

Got it. Second question, just on a broader base, I mean, your assortment still remains quite valid dependent. Is there something you are thinking more from a medium-term perspective to make it sort of less volatile based on underlying [indiscernible] or still will remain the case?

[Øivind Tidemandsen, Chairman]

Well, we are dependent on the 4 seasons, but basically, we are focusing the most on the hardware. And I think that has also changed a little bit in the last. We were -- we maybe have been focusing too much on clothing and these things, which are a little bit more challenging. And because -- if the hardware, okay, if you don't sell all the skis for the season, you can sell them next year. There's not that big change in models and stuff. But clothing is different. So this is one issue. But the second and even more important is that we are reducing the preorders for the season, and we are putting pressure or we have deals with those suppliers that they have to share the risk because we cannot predict the weather. So we have to have more sharing model between all the risks. So let's say, before, we was almost buying 100% of what we thought we would sell in preorders for the season. Now it's between 70% and 80%, and that's a huge difference.

[Tushar Jain, Research Analyst]

Makes sense. Just one -- last one question. In terms of the operating expenditure, specifically in Finland, it grew by roughly 300 basis points in the fourth quarter. Is it just the negative operating leverage in the business plus some E-commerce? Or there's something else going on that we should be aware of in terms of operating expenditure?

[Tolle O. R. Grøterud, Interim Chief Executive Officer]

No, it's -- it is basically the leverage coming from the negative like-for-like in the stores also where we are in some lease contracts ending the period with lower rents, so that has a small negative impact. But that has been the case the whole year.

[Operator]

The next question comes from Magnus Råman from Handelsbanken.

[Magnus Råman, Research Analyst]

The first question is on the leverage ratio covenants. Can you talk about the levels here and the duration of this new agreement and, perhaps also, to what extent interest rates cost will be affected by the new agreement?

[Stein Alexander Eriksen, Group Chief Financial Officer]

Yes, it's like we said, we have agreed with the banks with the new covenants going forward. That means that we will have higher covenants or leverage ratios for Q1 and Q2 and then normalizing back on Q3 and Q4. Your next question regarding the interest expenses, we expect them to be in the range between NOK 15 million to NOK 20 million higher for 2019.

[Magnus Råman, Research Analyst]

Sorry, can you repeat that, the interest rate costs?

[Stein Alexander Eriksen, Group Chief Financial Officer]

NOK 15 million to NOK 20 million.

[Magnus Råman, Research Analyst]

Perfect. Okay. All right. It's for the full year?

[Stein Alexander Eriksen, Group Chief Financial Officer]

Full year, yes.

[Magnus Råman, Research Analyst]

Yes, right. Okay, that's clear. So I mean, you plan to reduce inventories further. I mean, it helped the cash flow going up in Q4. And you talked about 200 -- NOK 150 million to NOK 200 million reduction plan for 2019. I guess that also relates to the planning for the cash flow for the full year relating to the covenants then and normalizing again in the second half of the year. But can you talk a little bit about to what extent this reduction in inventory might affect top line? I mean, for example, here in January, we had quite good winter conditions. Do you think that you had sufficient ski gear in different sizes and so on in order to grasp that opportunity in full?

[Stein Alexander Eriksen, Group Chief Financial Officer]

We'll specify that the NOK 150 million to NOK 200 million is the like-for-like reduction in the inventory. Regarding your comment if it will reduce the top line, I guess, Øivind and Tolle can fill out, but I'm pretty sure that it won't affect the top line. I mean, we still have a big inventory. I think also, we have to look at the assortment that we are having today. We probably need a broader assortment on some categories. But on other categories, we have to look at how many SKUs we have in the existing assortment. I mean, XXL has -- we have increased the assortment especially on some categories during the last 3, 4 years quite significantly. So I'm pretty sure it will be better both for the guests or the customers and for XXL to try to narrow the assortment within some sectors. So I'm pretty sure it will not affect the top line going forward.

[Øivind Tidemandsen, Chairman]

Well, we -- in certain categories, we have a lot of products which are quite similar. And there, we can reduce the number of SKUs quite much. And then we could be even better in getting rid of old stocks. As we said, we have 5% which has older than 2 years. I don't think anyone will miss those items if we get rid of them, for instance. But also, as I've said, we are not -- I mean, part of our stock is overstocked from not selling out the summer or the winter, so it stays to the next year. And with this new way of having the preorders not as much as we expect to sell, but rather have with the suppliers an agreement saying if it's snowing more than the normal or the winter condition are good, we are -- they have to supply us with, let's say, we are -- with 20% more than we put in orders, as an example. So we have, what you call it, kind of a, a possibility to buy -- or they have to deliver more than we actually are putting orders, fixed orders. So we have this possibility of adapting to the season, which is -- which we think will help a lot with the inventory.

[Magnus Råman, Research Analyst]

That's helpful explanations. And Øivind, I remember in December that you mentioned that XXL cannot become a outlet model. And in relating to that and relating to that question, in terms of staffing in store, do you think that you have the right staffing to maintain a satisfactory customer experience? And also looking out in the coming years, when you plan to reduce OpEx to sales, does that include further cutback on staffing or not?

[Øivind Tidemandsen, Chairman]

Not in the different departments with the sales staff. We think we have good staff, very educated and skilled staff. And I also feel that the motivation among the staff is very good. The way we are building our stores is that we have 6, 7 departments, and we have specialists in those departments. If you're looking on other sports retailer, the staff, maybe it's 4, 5 people on the floor, and they have to know everything, from fishing equipment, to skiing, to tents or whatever they have in the stores. And they have to be specialists in all those fields. But in XXL, then we -- you are, first, if you are in the ski and bike department, that's all you have to focus on, and that's where we educate them and so on. If you are in the outdoor department, you're just focusing on the outdoor equipment and learn about these things, and we educate them that way. So I think we have a great advantage in this way. Also, we have our services department, which actually are doing a lot for the -- us to be kind of a specialist store. There's no other competitor in the Nordics which has this in every store. That's a unique thing in XXL. You buy your skis in XXL, we can fix the skis for you. If you have a racket -- tennis racket, and you need to string, restring it, you can go to an XXL store and get it done. That's unique things.

[Magnus Råman, Research Analyst]

And -- all right. And then just a final question on the gross margin. You mentioned you have 100 bps from lower margins in E-commerce. I guess that backward calculation since you're at 15% penetration roughly now means that gross margins should be 600 or 700 basis points lower in the E-commerce sales. Is that something you expect to continue at the same level going forward when you grow the E-commerce?

[Øivind Tidemandsen, Chairman]

No, we think we will be able to increase our margin in the E-commerce, and we think we have actually had too many offers to increase our turnover in the E-commerce. And we will -- like for the stores, we will kind of take the feet off the gas pedal a little bit in that perspective. And we're working with ways to improve the basket, E-commerce basket.

[Tolle O. R. Grøterud, Interim Chief Executive Officer]

Yes.

[Øivind Tidemandsen, Chairman]

I really don't want to give you all the details there, but we have a lot of different actions.

[Tolle O. R. Grøterud, Interim Chief Executive Officer]

And please remember, in the cost of goods online, it's freight and return costs which is, of course, the big element and the difference between the store gross margin and the E-commerce gross margin.

[Magnus Råman, Research Analyst]

And I guess, I believe you are at an average basket size of around NOK 1,000 or something, quite high basket size that covers shipping costs, I guess, better than some fashion retailers that are maybe at half that ticket size. What are your remarks to that?

[Tolle O. R. Grøterud, Interim Chief Executive Officer]

Yes, it's the mix of what we sell, so you're right in the numbers.

[Operator]

And the next questions come from Petter Nyström from ABG SC.

[Petter Nyström, Lead Analyst]

Two questions from me. Firstly, on Denmark, when do you expect black figures in Denmark?

[Tolle O. R. Grøterud, Interim Chief Executive Officer]

We expect Denmark to go towards black figures in 2019, in line with what we said when we enter into Denmark.

[Petter Nyström, Lead Analyst]

And then a question on like-for-like. If we exclude E-com, store like-for-like is obviously negative. Can you shed some lights on the development between store traffic and basket size?

[Tolle O. R. Grøterud, Interim Chief Executive Officer]

Øivind, that's for you.

[Øivind Tidemandsen, Chairman]

Between store basket and?

[Tolle O. R. Grøterud, Interim Chief Executive Officer]

Guest traffic and the basket size on stores.

[Øivind Tidemandsen, Chairman]

On the stores?

[Tolle O. R. Grøterud, Interim Chief Executive Officer]

The like-for-like development in the stores, is that what you're asking about? What's the driver?

[Petter Nyström, Lead Analyst]

No, I mean, I understand that the like-for-like in the stores is negative...

[Tolle O. R. Grøterud, Interim Chief Executive Officer]

Yes.

[Petter Nyström, Lead Analyst]

But that's probably a function of both the basket size and the traffic. Can you say something about the development on those 2 things?

[Øivind Tidemandsen, Chairman]

Basically, the traffic.

[Tolle O. R. Grøterud, Interim Chief Executive Officer]

Yes, mostly traffic.

[Øivind Tidemandsen, Chairman]

It's not -- the basket size is not -- you cannot see a trend which is down on the basket side. It's -- the traffic is...

[Petter Nyström, Lead Analyst]

The driver?

[Øivind Tidemandsen, Chairman]

The main driver for this.

[Operator]

[Operator Instructions] There is no questions coming through, so I will hand the call back to you. Thank you.

[Tolle O. R. Grøterud, Interim Chief Executive Officer]

Thank you. So that ends our session. I thank you all for participating, and have a nice day.

[Operator]

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