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Edited Transcript of BGA.AX earnings conference call or presentation 2-Mar-20 10:59am GMT

Bega Cheese Ltd Earnings Call

North Bega, New South Wales Mar 25, 2020 (Thomson StreetEvents) -- Edited Transcript of Bega Cheese Ltd earnings conference call or presentation Monday, March 2, 2020 at 10:59:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Barry Irvin

Bega Cheese Limited - Executive Chairman (Leave of Absence)

* Paul van Heerwaarden

Bega Cheese Limited - CEO

* Pete Findlay

Bega Cheese Limited - CFO

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Conference Call Participants

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* Belinda Moore

Morgans Financial Limited, Research Division - Senior Analyst

* Jonathan Snape

Bell Potter Securities Limited, Research Division - Senior Industrials Analyst

* Josh Charles Kannourakis

UBS Investment Bank, Research Division - Research Analyst

* Mark Topy

Select Equities Pty Ltd., Research Division - Institutional Research Adviser

* Michael Peet

Goldman Sachs Group Inc., Research Division - Executive Director

* Phillip Kimber

Evans & Partners Pty. Ltd., Research Division - Executive Director of Consumer

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the Bega Cheese Limited Half Year 2020 Results Conference. (Operator Instructions) I must have advise you that today's conference is being recorded.

I would now like to hand the conference over to your first speaker today, Executive Chairman of Bega, Barry Irvin. Thank you. Please go ahead.

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Barry Irvin, Bega Cheese Limited - Executive Chairman (Leave of Absence) [2]

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Thank you, and hello, everybody. It's nice to be rejoining you after an absence of some 8 months. I think perhaps before we start the half year result, I will -- there are many shareholders online that sent me good wishes while I was unwell, and I thank you all for the support and kind comments while I was away. It is good to be back. So I have with me today, Paul van Heerwaarden, the CEO; and Pete Findlay, the CFO of Bega Cheese. I will share the presentation with them. And of course, you're welcome at the end to ask any questions to any of us.

I will start with a rather disappointing beginning, I guess, to this results conference, and I apologize for the delay in holding the conference. I think it's subject to a separate announcement on the ASX. But I think for most listeners, I would be aware that we went into a trading halt late last week when we discovered that there was a potential misstatement in the 2019 earnings. We have done the work and restated those earnings this morning. I would say that Peter and Paul will elaborate further on the misstatement, I would say, which I think is important is that the misstatement was combined to a particular period of last year. We continue to investigate the core reasons why. But in broad terms, they are to do with the acquisition of Koroit and the transition arrangements we had during the initial running of that facility then a further -- and that was regarding, I guess, third-party accounting services being provided to us, then we had a further

(technical difficulty)

more manual system before then, having a number of transitions to our new M3 system. The Board obviously takes this matter very seriously, and it will be subject to an independent investigation as to why it occurred as we said in the announcements released today and last week, the -- it is confined to 2019. We're very confident in the validity of the half yearly result for 2020 and our outlook for 2020.

Having said that, I'm also pleased to, I guess, discuss the strategy that Bega Cheese has been on for quite some time and the importance of that strategy and positioning us for both now and in the future. We have indeed often spoken about the transformation from a business-to-business business to a business-to-consumer business. And we've also talked about the fact that we need to be sure that we're evaluating all our ingredients wherever possible to maximize the returns we get. There has been strong revenue growth in our branded spreads and dairy categories, which we're pleased to report. And if ever there was an example of the importance of a diversified milk pool and indeed infrastructure this year, one of the worst droughts that I have ever seen, and I think it's well documented -- had demonstrated that. We had significant drought impact in Northern Victoria and in the Bega regions and the Gippsland regions. Fortunately, we had less harsh farming conditions in Western Victoria, where our Koroit facility is. So that strategy of looking forward and seeing where the potential challenges are and also looking forward and seeing where we can value add is continuing to play well for us, and it continues to give us confidence about this business into the future.

There has been this year, I guess, as a consequence of the drought and the diminishing milk pool, significant margin impact in our dairy ingredients with reduced volumes and strong competition for milk, and that has been particularly so in Northern Victoria impacting our Tatura milk industry segment. In addition to that, and again, particularly affecting Tatura has seen the softening of infant formula demand out of China, which has been reasonably well documented over recent months.

We do continue to look to add value to the products we received, and I'm pleased to report that the Koroit lactoferrin facility is scheduled for commissioning in April. It's on schedule, and we look forward to that adding substantial capacity to our business in producing lactoferrin, and in fact will make us one of the largest producers of lactoferrin globally.

It will be no surprise to anybody listening that we've had a very busy period of acquisition in the last number of years, and that has really led us to the point where we see the need for an organizational and process review that, while separate to the issue that we had around the restatement of account, it does demonstrate that we need to make sure that we have a very -- as much as possible a simplified management structure and processes that allow us to monitor and grow the business well and indeed make sure that we're getting maximum value out of the acquisitions that we've made and how they're being integrated into the business.

So that review is underway. I'll let Paul discuss it further as it has been initiated during my absence, but I think that it will create -- it will improve the business. It will help with consolidation, and it will continue our path to making sure that we've got an infrastructure and management structure and a supply chain and customer model that creates value well into the future.

I'll just take you to the next slide. It does continue to talk about the story of growth. And as I've said, really, from 2017 on, we've been thinking about how we take the next step in transformation for this company, which has been the addition of some of Australia's most iconic brands, particularly Vegemite whilst also making sure that we are adding value to our dairy products with the ambition [of what we see]. The dairy products that are appropriately sent into a retail pack are sent there, and the rest are converting into the highest value possible.

We have accelerated some of the changes in the business as we face the challenge of a diminishing milk pool and changes in where our milk is coming from. We continue to align our milk supply with our manufacturing input, and we continue to make sure that we are innovative in a way in which we think about doing our business, and that includes things like bringing in toll processing both us receiving -- us having some of our products toll processed and indeed us toll processing for others. I think all those things mean that what we're trying to do is maximize the utilization of our infrastructure but avoid capital where we can as we now consolidate and grow this business. I will speak briefly on Bega values, and then hand over to Paul.

I mean, obviously, we continue to have a deep passion for the people that we're selling our products to whether they be in Australia or around the world, and we make sure that we are adapting to changes that are occurring within our customers' business and indeed, in the retail environment, we are focused on that continued investment in the future. And I think really the examples of some of the new products that we're launching, and I would maybe refer to something like Simply Nuts, which has been a very, very successful launch for us, a natural peanut butter, but I'd also refer to that lactoferrin facility that we are soon to commission where the focus is on creating value.

Support for each other has always been a key tenet of this company from the very earliest of days. And while I won't dwell on it too much, clearly, during New Year's Eve and through the early days of this new year, Bega came under significant threat from fire with many of our staff, many of our farmers deeply affected. The company did all it could to support those people from making sure that all our field staff were on the ground out there where they could, sometimes out of contact with the company, trying to assist and look after our farmers, organized generators, organized feed, we shut our plant down so our volunteers that were [part of] the bushfire, they could go in and dedicate themselves to looking after others and also in particular our own properties. It was a significant challenge. While I was still on leave, I was delighted to see the value of the company come to the fore. And they -- and that cultural support and making sure that your community, your staff and your suppliers were all cared for really showed through over those few days.

Of course, we continue to look to develop and grow our people. And as we do this process review, and as we look to ensure that we have all the resources we need, we know that we will continue to create great opportunities for a number of young people coming through our business that will be the future of the business.

That all said, Paul, I think I will hand over to you to talk about the highlights for the first 6 months of this financial year.

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Paul van Heerwaarden, Bega Cheese Limited - CEO [3]

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Thanks, Barry, and good morning, everybody. In terms of the key highlights in the business, if we turn to Page 5 of the presentation, I'll just quickly go through some of the key numbers. Revenue increasing 14% to $741 million, a combination of factors here regarding the growth in our core branded business both domestically and internationally. But I should also point out that listeners will recall that at the end of last half for FY '19 -- the first half, rather, we had a significant buildup in inventory. So we're seeing the comparative impact of that coming through with the higher revenue numbers compared to the same period in FY '19. The revenue in export markets is increasing, which is very much part of the strategy that Barry referred to just earlier in the presentation.

Our statutory EBITDA relatively flat at $39.3 million. We have seen a softening in the first half earnings compared to the previous year, with EBITDA of -- normalized EBITDA of $48.5 million, which is down 16%, and we'll talk about that in more detail later on. Suffice it to say, the pressure from the milk pricing and volumes particularly in Northern Victoria has impacted that result. Decreases in working capital, 53% primarily around the debtors financing and other working capital management initiatives that Pete will go through in his balance sheet update and, indeed, a decrease in debt for similar drivers.

Production decreased reasonably significantly, 10% down to 154,000 tonnes. Again, milk volumes form part of that, but also the nutritionals markets in China softening that Barry mentioned in the first slide and some softening in some of the private label business have contributed to that decline. Whilst our direct milk volumes are down, particularly in Northern Victoria, we have been very focused in the last 2 years on asset utilization and manufacturing footprint and in particular working with others in the industry to avoid capital and to process milk using other assets. And indeed, processing milk for others when the opportunity presents itself. We have seen a net decrease in milk processed through our facilities by 4.6% compared to the previous year whilst our direct milk supply is down quite a bit more than that. We had been able to make that up through the toll processing arrangements that we've put in place. I will talk about milk in further detail later on in the presentation.

The revenue analysis. This is a regular slide that we present. I'm now on Page 6, just providing the breakdown between different parts of our business. You can see there that our packaged goods and our spreads business, so the branded business is really starting to kick in and contribute a lot more to the performance of the business and the diversification that Barry talked about in the earlier slides. Exports at 31%, as you may recall that we were up at around 40% a couple of years ago. The acquisition of Koroit has, in the short term, driven some more weighting towards commodity of dairy products and also domestic sales, but we're starting to see that sort of revert back to that growth trajectory to a larger portion of our sales in that branded and packaged foods business. We have seen growth across all categories. And I should point out, on the revenue slide, we've seen the growth primarily due to that inventory buildup that started to flow through in the comparative. So whilst production is down, revenue was up in that still important dairy category that we operate in.

Moving over the page, I'll just pass on to Pete, and I should formally introduce Pete, too, and welcome him to the company in his first investor presentation. It's fair to say, Pete has had a fairly busy time coming into the business with a few challenges, and particularly in recent weeks dealing at the half year close and also the accounting errors and restatement that we've had to go through in recent days. So Pete, if you can take us through the financial measures.

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Pete Findlay, Bega Cheese Limited - CFO [4]

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Right. Thanks, Paul. So obviously, a lift in revenue for the half-on-half comparison. A lot of that due to the full half ownership of Koroit that was purchased in mid-August in the prior year. So we get that flowing through. Also some growth around our international foodservice business, in particular, our branded foodservice business, which continues to do very well.

Impacting on our bottom line this year was reduced milk volumes, which Paul has talked about, really in Northern Victoria. And actually in fact across the rest of our regions, milk volumes remained reasonably stable, so a good result there but obviously impacted in Northern Victoria. And our nutritional volumes, particularly the higher-margin product into China, we were able to mitigate that with new business in other areas, but at a lower volume. So offsetting those, that downside was strong global commodity pricing particularly towards at the end of the half, which has come through, and we're seeing some good pricing there.

If we have a look at the normalized result, the 2 key areas there were the continuation of legal costs, in particular, around our Fonterra case and also the bedding down costs of our ERP system. The good news is that those costs, in particular, relating to the ERP system will dissipate next year and would reduce that normalized gap moving forward.

Also able to get some benefit around our cost structure running into the second half. And that's really the precursor to assessing our future consolidated cost structure that Barry touched on before, but we're getting some benefits to that already. That will continue throughout the second half of the year and into next year.

If we turn to the balance sheet, you'll see, obviously, the significant movement around our borrowings. That was predominantly generated by the off-balance sheet trade receivables facility that we put in last year, and that stands at around about $130 million at the moment. You'll note there the very good performance on inventory, and that was really pulling down our inventory levels at the Koroit facility around bulk dairy products and also some cheese inventory levels across some of our facilities there.

A lift in property, plant and equipment there, just the increased spend with Koroit coming on in the second half. It's also worth noting that with our banking facilities late in December, we actually rolled 2 of our tranches of debt over for another 2 years. And by working with our financiers and having their support, we've also increased our leverage ratio for the next 12 months, back up to 3.75x, which has given us plenty of headroom as we go through the lowest point in our earnings cycle at June. So that was actually a good result.

I'll move on to the cash flow. You'll see the receipts from customers are obviously bolstered off the back of the higher revenue number and the full year of Koroit coming in. You'll see there our intangible payments continue to flow through at around about $10 million. And that's really just a continuation of the ERP system, which as I said, will tail off in 2021, and you'll see the increased CapEx, which is really around the Koroit facility, which will also tail back to normalized levels in 2021 as well. So all in all, a reasonably strong cash performance from the business.

The next page is around the restatement. So effectively, what's happened -- just sort of building on what Barry said, what's happened is that we've had some transactions on our balance sheet that weren't cleared, and so we've -- and that was really between intercompany balances there predominantly, there was about $9 million of intercompany balance that needed to be cleared, so we have an overstatement of our -- understatement of our cost of sales and an understatement of our trade and other payables. There was also one other adjustment that we've picked up around an overstatement of inventory that was about $1.5 million. So overall, the impact was about $10.5 million to EBITDA and at a retained earnings basis after tax, $7.4 million. We do detail that in Note 10 of our financial statements.

Obviously, we've now bedded down that system. And so the flow of transactions that help lead to that issue, we believe, had been cleaned up moving forward. We've also worked through a full reconciliation with PwC as at the half year, and we now have a clear balance moving forward as well. We certainly don't see any impact on next -- on this year's earnings based on that restatement. And so we actually feel comfortable with where we're at based on the work that's being done over the last couple of weeks.

Paul, do you have anything further to add?

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Paul van Heerwaarden, Bega Cheese Limited - CEO [5]

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No. Just to confirm that it's in the announcement and we've referred that here. So Barry referred to the various changes that were taking place with systems through the transition and acquisition of the Koroit business. This is in no way intended to be an excuse of what happened. It's just explaining some of the reasons that were taking place with the systems and as we're going through a transition service arrangement with the vendor on systems and accounting processes. And at the same time, going through a phased implementation of our own ERP system. There's a discrete period of time when these errors have occurred. And as Pete said, we're working very closely with our auditors and reviewing -- reviewing that, have been able to isolate the area -- the error rather to that period of time and satisfied ourselves that there is no ongoing impact.

As Barry said, there is an independent review that will take place. And in the fullness of time, we'll hopefully understand in more detail what happened and ensure that it's been well documented and understood.

Just moving on to Slide 12 and just getting into some color and movement regarding just the consumer brand business that we do talk about a lot, because it is a big part of where we're heading in the future of the company. It is part of the ongoing growth and diversity of the business, and it's pleasing to see this ongoing pipeline of innovation, product development starting to come through. And we've spoken about that in the first half last year and also the year-end results as we started to see some of these product innovations around gluten-free Vegemite and the Simply Nuts products that Barry referred to earlier also coming through.

In more recent times, we have launched Farmer's Table butter. That's off the back of Farmer's Table Cream Cheese that was launched earlier. Ongoing strong growth in our international branded business, that's both foodservice branded and consumer branded goods. Pleasingly, we've seen some only small but modest revenue growth in Vegemite. That's a very stable business. It's a brand that we're very proud to own, and it's a brand that we will continue to invest in, in terms of promotional advertising activities. And you know that we'll have seen the tremendous support that we put in behind Australian Open, and in particular, our association with Ash Barty, which is now in its third year, and it's certainly been very, very good for the brand and very good for us. Unfortunately, it wasn't good enough for Ash since she didn't win the final, but we'll work on that next year and perhaps that's with a new variation of Vegemite we're coming out with, which is a 40% less salt product that we'll start to see hitting the supermarket shelves soon.

Peanut butter. That has been a very good initiative for us as we acquired the Mondelez grocery business back in 2017. That's been well documented that we dealt with some fairly significant challenges with Kraft looking to enter the market. We've described them previously as the peanut butter wars, and we've had a court case that has been going on for some time now regarding that matter. And we announced 12 months ago that we were successful with that case. It's under appeal, and we await the outcome of the appeal for that case in the coming weeks and months. The core range remains very solid. The key growth section of that category in natural peanut butter has really driven good growth within our business. So we're very proud of that, that we have launched some new SKUs in that range in recent times.

Moving on to Slide 13, and we'll just cover off as we always do just broadly what's happening globally in dairy commodities markets. And you can see by the chart, which is -- and for those of you who are not familiar with the chart, a number of you will have seen it time and time again as we present these results, it's an index of prices for Australian -- a basket of Australian dairy goods. And the chart goes back to year 2013. The chart started many, many years ago back in 2001 at 100. What you can see there in particular is the red line, and that's basically charting the ups and downs of the global prices impacting the Australian dairy industry throughout that period. And what you can see from the right-hand side of that chart, the red line is up around the peak that it was back in 2014, which was up around the level it was pre-GFC back in 2008. So we have progressively, since those tough years back in 2015, where we had that significant softening post deregulation in the European market and the moratorium into Russia, et cetera, that impact us through that period, and we've started to see that recovery over the last 4 years, and it remains strong.

It's clearly very full pricing. We keep a very close eye on that bottom bullet point, global supply growth, because that is fundamentally what's driving the complex. And if we have a look at the 4 major exporting regions around the world, and I should probably qualify that more now, Barry, as the 3 major exporting regions, which is New Zealand, Europe and the U.S., we are seeing soft supply in all of those markets despite these relatively high prices in New Zealand. We've seen impact of drought and in some areas, flooding. Europe is certainly facing a lot of challenges regarding environmental controls and other challenges that they have in new their economies. And similarly in the U.S., a number of pressures that are basically keeping a lid on supply. So we're not seeing the sort of supply growth that we'd normally see with these prices. It's global supply growth below 0.5% year-on-year, whereas demand is growing at slightly stronger than those rates. So we're seeing reasonably good prices through the remainder of the calendar year, notwithstanding any shocks. We have seen in recent weeks the impact of the coronavirus, which has probably taken about 10% of some of the core powder commodity pricing that's being traded and future markets are also reflecting that. But we've still, despite that, seen strong prices through for the remainder of the calendar year. And as is the case, we'll keep a keen eye in the Northern Hemisphere winter -- summer, spring, sorry, into next year in about 12 months' time and just start to see what sort of supply recoveries we might start to see in the next year.

We're also getting good assistance with the dollar down around $0.65 is well coming through. So the key story, though, is the impact of the drought, as Barry described. It's the worst that he's seen, and that's pretty common around the industry to hear that -- to hear those comments. We're seeing significant pressure on water prices, grain prices and hay prices. Dairy Australia, last year, we saw a 5% decrease in milk supply, national milk production. Year-to-date to December is 4.3%. We are seeing some slight improvement with the recent rains that have come through. It's across a lot of the production regions, and that's providing some level of confidence, and there's no doubt that the prices are providing some support for that sort of production volumes as well, but it's fair to say that we're in very challenging conditions in the dairy industry. At the same time, we're starting to see over the last couple of years some excess capacity coming to the market. So there's a lot of challenges there. So year-on-year, we've seen about an 8% to 9% drop in milk production, and we continue to deal with that, which I'll cover in the next couple of slides.

In terms of the operations review, I've covered that in the earlier slide in terms of the production decrease down to 154,000 tonne. As I've also covered, the milk processed down 4.6% compared to the same period in the previous year. Direct milk intake down 13%. Pete mentioned earlier that, that was particularly in the Tatura milk segment, where we've seen a significant decline in direct milk intake in Northern Victoria. Across our other regions, it's been relatively flat and aligned with the previous year.

Very disappointingly, our safety record has deteriorated during the first 6 months with a total reportable injury frequency rate increasing to 8.6. That was off the base of about 5. We are seeing just increased incidents across some of our sites. There's a few reasons for that. We are seeing across those sites, which we're very focused on dealing with business, and that's certainly a key focus also for the Board.

The organization and process review, that's something that we have announced previously. We are well engaged with that process. We will start to see and indeed have started to see some benefits flow through to the P&L. They are substantially in the second half and are substantially offset by the costs for that transition. We are seeing some benefit in the second half, and that's reflected in our earnings guidance. We do expect a material improvement in our overhead cost structure as we hit FY '21. That's been partly driven by a number of factors. But clearly, as Barry said before, we've had a series of acquisitions in recent years. And as we've bedded those down, we're now taking the opportunity to actually consolidate some of our processes and also simplifying our structure. That's also been enabled with the go-live of the remaining sites on the M3 system, which was completed in July earlier this financial year.

Moving on to our manufacturing sites, so I'll just finish here before handing back to Barry. As you would know, we operate a network of dairy and secondary processing sites across Victoria, New South Wales and Queensland. We have been progressing the rationalization of our manufacturing in the last couple of years. If I go right back to 2017, that commenced with the sale of the Dairymont site and one of the infant formula dryers to Mead Johnson. That was about 3 years ago now. We've also, with the acquisition of Koroit, been able to consolidate a lot of our manufacturing and closed down some of our production lines across the network including that of Tatura and including the closure of the Coburg site, which was announced in March last year. That sale has been completed. We'll see the funds flow through in the second half. That have already flowed through last month. We have -- also, we're completely out of that site. We have retained a number of the key pieces of equipment on that site and may consider deploying them at a later date. And we've taken some of the pieces we get there and installed in other parts of the manufacturing network or we disposed of them.

The ongoing rationalization across the dairy sites, as we discussed before, as part of our strategy, looking out to 2023, the diversification of the business outside of dairy. We've included in that a view that there has been a shifting of production that's been taking place over many years, indeed, since deregulation that we need to respond to. That response is needed to be accelerated in recent times as we're dealing with the drought conditions and that ongoing rationalization with the work on the toll processing arrangements will continue over the course of the next couple of years. We also are looking at our secondary processing footprint, which includes our cheese packing and nondairy grocery business and a range of opportunities there, which includes, in the case of dips and tubs, these are cream cheese-based products, bringing some of that production in-house and then also looking at consolidating that production into one line, an example of an initiative that we've implemented recently. But we continue to look very closely at our secondary processing consolidation and putting plans in trying for -- setting that up for the future.

As Barry mentioned earlier, the lactoferrin facility at Koroit is on track to be scheduled in April. You'll recall that we did sign a multiyear contract with a large multinational company for offtake for that agreement, which will also commence in the fourth quarter, and we'll see the full benefit of that coming through to the FY '21 P&L.

I will now pass you back to Barry to take us through the remainder of the presentation.

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Barry Irvin, Bega Cheese Limited - Executive Chairman (Leave of Absence) [6]

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Thank you, Paul, and thank you, Peter. I guess as I opened this conference, I talked about the fact that I had been away for a while. I've been ill for a while, and I suppose when you have that time away, you do have the opportunity to reflect on what we've been endeavoring to achieve over the last number of years, but particularly in the last 3 to 5 years. And I think that we often talk about the business and -- with regard to its history and the traditional segment of Bega Cheese and Tatura milk industries and those dairy manufacturing facilities. But as we think about the business going forward, and we have mentioned that we are reviewing our segment structures, and I thought it might be worthwhile sharing with investors the discussion, I suppose, that I immediately had when returning and talking to the executive team.

And it really is about the 2 core things that this business seems about. And if you think about how we've developed pre-2017, pre the purchase of what is now known as Bega Foods, we had limited investment in brands. We had and still have in place an arrangement with Fonterra regarding the marketing of the Bega brand in Australia. We had established a presence internationally, but it was felt that we could do more with the people we're working with internationally, and we had minimal direct investment in supporting brands and relied on large contract manufacturing relationship, which in themselves were beginning to evolve and change as those arrangements that built the company were now something that weren't common in the industry, and indeed, where people were looking for shorter-term arrangements with less security.

So we've been working on building that brand growth engine, and it's meant the extension of the Bega brand into new categories. It's meant the acquisition of Vegemite. It's meant developing that sales and marketing contribution -- capability, sorry, investment in brands and strengthening international presence in branded and foodservice not just ingredients. And as mentioned earlier, we see the benefit of that, particularly that investment in the growth in branded and foodservice business internationally and being in double digits and being -- and we'll still continue the opportunity there.

Our focus is to increase the growth of our brands, improve branded margins and expand that portfolio. And we do, indeed, have the infrastructure in place and the capability in place to achieve that. So when we look to the future, we're very much in a key part of our business, see that branded -- our branded business will be vitally important to us going forward and will complement, if I take you to the next page, how we manage our milk pool and what we're seeking to achieve with that. And again, if I was to just give a short history again, pre-2017, we had 2 core dairy regions in Bega and Tatura with some presence in Western Victoria and Gippsland but needing to freight that milk a very long way to facilities outside that region -- those regions. And interestingly, whilst it might not be obvious to many, Tatura and Bega are on the exact same latitude line in Australia. And generally, when one is in drought, the other is in drought. And so obviously, we began to think about that on a number of levels, inclusive of the impact of climate change and how that may affect our key dairy pools. We also recognize that Coburg cheese plant in the suburbs of Melbourne is very constrained. And our nutritional business was, whilst successful, is reliant on a high number -- a small number of high-volume customers, and we wanted to -- endeavor to derisk that.

So where we sit today, we've successfully acquired Koroit. We did divest a dryer in Tatura. We've looked to focus on toll processing, both providing it and indeed, accessing it. And that's all about now focusing on capital efficiency for the business. Our dairy manufacturing sites integrated and will be further integrated to make sure we maximize the value of milk. We've expanded our nutritional capacity and our customer base through the addition of Koroit and indeed through some initiatives through our traditional facilities at Tatura. And we will be, post the commissioning of the lactoferrin facility, be a significant global producer of lactoferrin. So the focus, which has been important this year, but will be even more important as we look forward, is those diversified milk regions, high-value dairy ingredients directed to consumer goods. So in other words, if our -- our great endeavor is to produce products like cheese and have them all going into branded consumer goods packages. And we want all our dairy ingredients destined for high value. And indeed, we want to be able to exploit our dairy ingredients by having the capability to produce such products with lactoferrin.

Our focus will be to have that network of sustainable milk -- network of facilities and sustainable milk regions, dairy products that support a high-value branded portfolio, growth in that international consumer and foods brand -- consumer and foodservice business, diversified Australian -- a diversified customer base, which -- and I will speak a little bit more at the end of this presentation on COVID-19, but a diversification of the customer base, domestic and international, a variety of products with a variety of destinations and a strong supply chain is demonstrated into -- the value of which is demonstrated in circumstances like these. And we still think there is great opportunity in the micronutrient space, which we think we are only just beginning to develop scale capacity, if you like, that will see us be able to further invest in that area.

I touched on a little earlier around our values, but we do look to align ourselves with sustainable development goals from the United Nations. And in the list here below the ones that particularly, I guess, Bega focuses on, beyond, if you like, the value we place in the communities in which we operate and the support that we give those communities. We're obviously very, very focused on food nutrition and good health and well-being. And Paul mentioned the soon to be released low salt Vegemite and indeed the Simply Nuts products that are seeing us focus not only on consumer expectation but on those globally-identified needs that we should embrace.

That includes things like diversity, inclusion and equality, and we continue to look to make sure that as we -- that we have those in mind as we consolidate but strengthen our workforce. Of course, climate action is extraordinarily important and the work that we do, both on our manufacturing folks but in working with our farmers around sustainability, around revegetation, around the health of watercourses. All of those things make an extraordinary difference as we look forward. And of course, it is well documented that packaging and the approach to packaging and recycling is important, and we are -- we obviously work with industry organizations to improve our performance there.

So I think it's just a brief light touch on what we're trying to do, but I think it's important for investors to realize that we are very conscious of the sustainable development goals issued by the United Nations, and we look to work towards them beyond what we look to do ourselves as far as our responsibility to the communities we operate in and the Australian community in general.

So if I take you to the next slide. I think it is probably appropriate that I talk about, I guess, what I'm observing as I return to the business. And I think the transition, despite some of the short-term challenges that we're having, is progressing well and that path to a diversified brand company is well established and indeed well resourced with the infrastructure that we -- the infrastructure and the people that we require. It is a very competitive supply chain, particularly in milk, but we are comfortable that it's very much aligned with demand. And I think when we talk about a 13% reduction in direct milk intake this year, we should not forget that in the previous year we actually increased direct milk intake by 41%. So there is a -- in terms of, I guess, my view of our supply chain, I do take a long view in terms of the -- both the competitive circumstances and environmental circumstances, as in the impacts of drought, and it can sometimes be floods, that will affect any particular year around supply.

We think that the dairy industry will face and will continue to face some ongoing structural change and cyclical challenges. Well, I've mentioned the intense competition for milk, but we would also say that we are used to working in that -- in an environment that can be challenging around milk supply. Unfortunately, it has been challenging for a great many years. And we are well placed to work with others and work with our farmers to make sure we maximize the value of the milk supply that both comes to Bega whilst also assisting farmers to be sustainable in their operations.

We do have a stable balance sheet after a significant period of corporate activity, I think as we've been mentioning a little in this presentation. We see that the task over the next 12, 18 months to 2 years is to consolidate those businesses, get the corporate structure to recognize some earnings opportunities and cost-out opportunities that we have following that -- following a period of significant corporate activity.

As far as our priorities are concerned, we do have an organization and process review underway, and that was underway for the reasons that Paul spoke. Without continuing to dwell on it, it is fair to say that there will be an independent review done of the circumstances around the misstatement or around the restatement. And we're very keen to make sure that -- whilst we have isolated the issue, that all appropriate controls are reviewed and in place for the future. So as Pete said, we are confident that it was relating to FY '19 and not relating to the period that we are in now or the forecast or the performance of FY '20. We will continue to invest in brands and markets, and we will -- and we do see great opportunity, as I said, both domestically and internationally. We have a -- now we have an established new product development pipeline coming through to the business. And I think it would be fair to say that when we initially purchased Bega Foods, people would be right to observe that there was a period of hiatus where we weren't seeing new product launches occur. We're now -- having owned that business for a couple of years now, have a pipeline of new product, which is of course important for a branded food business. There is the opportunity for further rationalization of supply chain and manufacturing footprint, and we will continue to review that to make sure that we are optimizing our returns.

There is ongoing dairy industry consolidation. And I think it's well documented, the Mengniu purchase of Lion Dairy & Drinks in recent -- well, approved in recent weeks. And we are -- we continue to be able to work with the existing industry players to try and indeed achieve some of the things that we've talked about earlier around capital avoidance and manufacturing utilization. There is -- there remains overcapacity in the Australian dairy industry, and that therefore means that those discussions need to be ongoing. It doesn't necessarily mean that there needs to be significant corporate activity, but I think activity that improves supply chains and maximizes utilization of facilities is something that we are well placed to work with.

We do have this ongoing need to make sure that we protect our milk supply and indeed diversify the current supply, as we do see some of the shifts either because of the drought or just because of change in farming circumstances across the country. We'll be very pleased to commission the lactoferrin plant at Koroit and pleased to report that, that is indeed running to schedule and has been a very smooth building -- build project.

Just to touch on COVID-19. There has been -- there is obviously -- it's headlining each news bullet and every day. And we're, of course, very acutely aware of ensuring that we are across any potential direct impacts or consequences from the COVID-19 spread. It is fair to say that we're in close contact with customers to monitor the impact on their business as well as our own, and we're talking to our supply chain and third-party service providers to ensure that we are well informed of any issues that may be confronting the business. At this stage, apart from what Paul mentioned earlier around the observation that there's been a slight softening in global markets for dairy ingredients, we are not seeing significant material impact to our business. We're -- and to a certain extent, it could be argued that, that strategy of a diversified customer base, where you export to around -- over 40 countries around the world, is proving itself valuable at this stage, our domestic business as well as, of course, a big part of our business, as Paul outlined earlier. So at this stage, whilst we continue to monitor COVID-19 carefully, we are not seeing any material impact on our business. And we are looking forward and discussing with customers what may be the impact in coming months. And we're not identifying anything material at this stage, but of course, we're very conscious of what may be happening in the market. And we're also very conscious of ensuring that our staff, customers, suppliers are all safe. And we're adopting all the recommended procedures around any COVID-19 outbreak that might occur.

That said, ladies and gentlemen, I think, unless there's any further comments from Paul or Pete, we're happy to go to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Michael Peet from Goldman Sachs.

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Michael Peet, Goldman Sachs Group Inc., Research Division - Executive Director [2]

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Firstly, Barry, welcome back. I just wanted to -- first question, just on the restructuring benefits. Could you maybe give us a sense of which buckets the costs are going to come out or, I guess, the savings come from in terms of cost-out versus maybe mix? It sounds like there's a big change here with mix and toll processing coming as well, but any sense of just the split on that as we go forward?

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Paul van Heerwaarden, Bega Cheese Limited - CEO [3]

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It is really across the board. So it's across the entire supply chain network. So you will see it across the board in terms of that savings. In terms of the mix that we're talking about, that's obviously very much in the dairy side of the business. We should say too and flag that we are looking at -- and it's outlined in the more detailed documentation, looking at our segment reporting and looking to make changes to that segment reporting that are more aligned with the FY '23 pages that Barry presented earlier regarding the business. And we'll start to see that also pretty evenly across those 2 units. The type of savings are very much around a simplification of processes but also a consolidation of areas of the business, including our logistics and storage networks, right toward a range of other services from product testing and other services across the business. That really does impact the entire supply chain and a lot of the back-office duties.

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Michael Peet, Goldman Sachs Group Inc., Research Division - Executive Director [4]

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And Paul, would you be able to make any comment on the actual dollar million saving here? Or will you in the future maybe give us a guide there?

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Paul van Heerwaarden, Bega Cheese Limited - CEO [5]

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Look, we haven't been providing any numbers as such, Michael. We would call it out as a material item impacting the FY '20 results and -- FY '21 results moving forward. And the impact on the FY '20 numbers, I've outlined earlier just in terms of a slight benefit, but the benefit that we are seeing starting to accrue is being offset by the costs which are in our normalized results and in our earnings guidance.

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Michael Peet, Goldman Sachs Group Inc., Research Division - Executive Director [6]

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Okay. And just another question, just on the current divisional structure. Obviously it's going to change, by the sounds of it, clearly, but just Tatura, a big drop in margin there for the reasons you've explained. But is it -- is there a little bit of a shift here to Koroit in terms of profitability? And I'm just sort of trying to think about Tatura in the second half and how that might look.

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Paul van Heerwaarden, Bega Cheese Limited - CEO [7]

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Look, the reasons for the decline in the first half, which is as we've outlined with milk reductions which have been heavily hitting Northern Victoria, they will continue into the second half. We are putting in a number of initiatives in place around shift structures and certainly taking a number of those what we've described as fixed manufacturing overheads where we can. And also I should point out, Barry mentioned on the -- one of the slides the shift away from our focus on concentration of high-volume nutritional companies. We have been progressing in a number of initiatives around businesses not reliant on fresh milk and also diversifying the customer mix and importantly too, Michael, the country mix away from China. So that process is starting to show some benefits. We'll see a little bit of that in the second half in Tatura, but we won't start to see the full impact until FY '21 and onwards. So in short, ongoing pressures in the second half but a number of initiatives in place to actually deal with that and set that up properly for -- as we get into FY '21.

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Operator [8]

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Your next question comes from Josh Kannourakis from UBS.

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Josh Charles Kannourakis, UBS Investment Bank, Research Division - Research Analyst [9]

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Obviously, welcome back, Barry. So just a couple of questions following on from Michael. Firstly, on the first half, second half view, can you maybe just talk -- you obviously mentioned on the infant formula side but also just maybe in terms of the skim milk powder, butter mix. Just how that's going to play out, I mean, in terms of your volumes sold in the -- realized in the second half versus first half.

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Paul van Heerwaarden, Bega Cheese Limited - CEO [10]

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Sure. So Josh, you will have seen the earning guidance that was provided has been reaffirmed recently of $95 million to $105 million normalized EBITDA for the year; and our first half normalized result close enough to $50 million, sort of $48 million, just above $48 million. So broadly speaking, that's sort of flagging first half to second half will be reasonably aligned in terms of the contribution. In terms of your second question, we -- by this stage and certainly by about January, February, for 2 reasons, one is we normally sell a lot of those commodity-based products forward several months. So we tend to have reasonably good cover on them. And secondly, a lot of the milks that we get, as you'd understand, is more weighted to the first half. So we have a natural bias towards the first half in that commodity exposure in terms of volume, but also by the time we hit this time of the year, we've actually got a reasonably full built -- book. So you'd say that there's minimal exposures sort of for the remainder of the year in those commodities. And in the case of fats or butter, a good portion of that now, Josh, has gone into retail and foodservice products and also supporting our markets into Japan for both cream cheese and high fat. So less exposure there in the second half also in bulk butter.

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Josh Charles Kannourakis, UBS Investment Bank, Research Division - Research Analyst [11]

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Got it. So just to confirm on the SMP side of things: minimal sort of commodity exposure for the rest of the year, most of that sort of...

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Paul van Heerwaarden, Bega Cheese Limited - CEO [12]

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Yes. Look, there'll be some, but we've -- we typically start get into a rhythm of our protein going into more of our higher-value products as we sort of get into quarter 4. So that's from a production perspective. And then from a sales perspective, we're typically reasonably well covered. We did see -- just to put some numbers on it in terms of the market. We -- and it's worthwhile just reflecting on this. If we go back to sort of Christmas 2018, so this is just as the intervention stocks in Europe were coming right down. They had about 3 years of age on them, some of that stock. So that was a significant amount of skim milk powder. And prices in Europe of about EUR 1,700 a tonne; and in this part of the world, Oceania, about USD 1,850 to USD 1,900. The European Union are clearing that stocks at bids as low as EUR 1,100 to EUR 1,200. That was -- so there was this overhang in the market that we've been dealing with since March -- well, probably late 2015, I should say. So the caps came off in 2015, in March, but -- that period. And it didn't recover really quickly. So we -- as we entered into this year, we were seeing prices of $2,600, $2,700. And indeed they hit over $3,000 in more recent times. So futures market out 3 months, Josh, is back down to about $2,650, and GDT a bit higher than that. They're still very good prices. And what we're seeing in terms of softening in commodities, we're seeing in depreciation in the dollar, some improvements in the currency side. So all in all, it's in a reasonably strong position.

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Josh Charles Kannourakis, UBS Investment Bank, Research Division - Research Analyst [13]

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Got it. Just a question on Bega Foods and the foods business, obviously some positive commentary around that, just in terms of the magnitude versus that original guidance or the impact on this period versus the sort of original guidance. So how are you sort of looking -- I think historically you've said you're on track to sort of reach that 40-plus EBITDA by sort of '21 mark. Has that sort of come a little bit earlier? Or is the contribution improved a little bit in that regard?

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Paul van Heerwaarden, Bega Cheese Limited - CEO [14]

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Yes. Look, it's fair to say that that's been taking us longer than what we originally anticipated. And that was clearly heavily impacted with the peanut butter margin pressure that we've got through Kraft and the likes. We're still targeting that sort of result into next year, Josh, but we've got a fair bit of hard running to do to get there, still. But some things are lining up nicely. One of the keys in that, of course, is what Barry described before in terms of that innovation pipeline really starting to kick in. And we didn't have that for the first 18 months of operation. And we really started to see that in the second half of last financial year and then, with the addition of Koroit, just starting to see around that retail side -- so this is in terms of butter and some of the retail powders. We're just starting to see good momentum in growth in that space. So we're still intending to head towards that target for next year, but as I said, we do need to run hard.

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Josh Charles Kannourakis, UBS Investment Bank, Research Division - Research Analyst [15]

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Great. Just one for Pete just on the numbers. Pete, can you just run through the sort of CapEx and D&A profile, how you see that sort of playing out over the next couple of years?

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Pete Findlay, Bega Cheese Limited - CFO [16]

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Yes. So it certainly spiked this year with Koroit, they -- sort of they were at around the high 50s, but it should come back down to sort of a mid-30 -- 30 to mid-30s sort of level moving forward prior to when you have a -- sort of significant changes happening in the business.

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Josh Charles Kannourakis, UBS Investment Bank, Research Division - Research Analyst [17]

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Got it. And Pete, just on the D&A side as well, can you give any sort of context around how we should be looking at that over next couple of years?

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Pete Findlay, Bega Cheese Limited - CFO [18]

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Yes. Outside the lump on Koroit and the new ERP system, D&A will pretty much stay stable for how it's been historically. So I would envisage it will probably rise a little bit, probably sit sort of around that $25 million to $30 million amount.

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Josh Charles Kannourakis, UBS Investment Bank, Research Division - Research Analyst [19]

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That's including Koroit, or not including Koroit.

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Pete Findlay, Bega Cheese Limited - CFO [20]

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Not including Koroit. Koroit will be depreciated over, I think, it's a 10-year period.

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Operator [21]

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Your next question comes from Mark Topy from Select Equities.

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Mark Topy, Select Equities Pty Ltd., Research Division - Institutional Research Adviser [22]

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Welcome back, Barry, as well. Just to be clear on the debt situation, firstly, and the receivables book, I think it was mentioned it's $130 million. I'm just wondering in terms of total balance now and I'm just trying to recall the cap we placed on that, how you see just the debt position going forward in terms of target debt and also managing that facility.

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Pete Findlay, Bega Cheese Limited - CFO [23]

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Yes. So I mean the target -- so net debt just over $300 million. I mean I think there's significant opportunity to pull that down naturally. So we've got $300 million of inventory. We've actually got quite a significant inventory review happening at the moment and looking to consolidate a lot of our storage there. We'll probably get payables creep up a little bit in this half. So we'd like to think that there's probably close to $50 million of opportunity there over the next sort of 12 months. We also have got a review of our properties in place at the moment and how we might sort of realize benefit from those to have that balance sheet. And then of course, on the other side, the earnings side, if we're talking about leverage, we've sort of communicated the lift that we would like to get in the business next year, with the Koroit facility, lactoferrin facility, coming online; and also these cost savings that Barry and Paul talked about. So just from an organic point of view, we think we can reduce our leverage ratio substantially over the next sort of 12 to 18 months just by focusing on working capital and our earnings profile. That's where we're sort of seeing at this stage.

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Mark Topy, Select Equities Pty Ltd., Research Division - Institutional Research Adviser [24]

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Yes, sure. I guess perhaps some in the market think holistically about the debt combined with the Rabo facility, so I suppose it's around trying to get the...

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Pete Findlay, Bega Cheese Limited - CFO [25]

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Sorry. Around the debt facility. It'll -- I think...

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Mark Topy, Select Equities Pty Ltd., Research Division - Institutional Research Adviser [26]

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I'll say.

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Pete Findlay, Bega Cheese Limited - CFO [27]

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It's slightly more expensive than our other debt. So as we were to get those -- we've sort of got around that $160 million, circa $180 million of capacity, we think, if you look at the run rate of that debt, but as we look to get working capital benefits that we've spoken about, we would probably reduce that level of that facility.

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Mark Topy, Select Equities Pty Ltd., Research Division - Institutional Research Adviser [28]

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So it's sort of drawn to -- or it's at about $170 million, $160 million at the moment. Is that what you're saying?

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Pete Findlay, Bega Cheese Limited - CFO [29]

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Yes, yes.

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Mark Topy, Select Equities Pty Ltd., Research Division - Institutional Research Adviser [30]

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Okay. Yes, got it, okay. And just from a milk supply, I guess, to some extent, the sort of season now is backwards looking. So looking into 2021, and there is talk that, I suppose, farmers are now starting to ramp up. It was -- even going into '21. How quickly -- or how do you see that process in terms of milk supply going into '21 as a forward thought and taking pressure off the system in terms of supply going forward?

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Barry Irvin, Bega Cheese Limited - Executive Chairman (Leave of Absence) [31]

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Well, Mark, look, it's Barry here. Certainly farming circumstances have eased substantially following that rain. And so good seasons and good prices, we'll see farmers respond. And I think it's probably fair to say that in Northern Victoria, we'd like for some [big] rain that's there for this week actually fall because the same storages are still not where you would like them to be. So I think there's still some pressure in the system, but importantly, we've seen an improvement in grain crop and improvement in seasonal conditions. You -- and prices remain relatively stable. There's the opportunity for supply growth. And I think what was mentioned earlier around some of the coastal regions, that supply has been relatively stable this year. The only caveat I would add, Mark, is that I still see it being highly competitive for milk into next year. We would need a genuine increase in supply to start seeing some of that competition ease a little. And I think, while I think there's good opportunities in Victoria, I am not sure that those same opportunities exist in, say, New -- or Central and Northern New South Wales and Queensland. So there's still a strong demand for milk to satisfy those markets.

So yes, look, much more positive environment, Mark, maybe some -- I think, if things keep rolling this way, you might expect some increase in the milk for next year. Is it substantial enough to make a difference? I think we'd want to see another year or 2 out from there to actually be able to feel confident that the supply dynamics have changed.

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Mark Topy, Select Equities Pty Ltd., Research Division - Institutional Research Adviser [32]

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And obviously in terms of the farm gate going into '21, I suppose, thinking about as well...

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Barry Irvin, Bega Cheese Limited - Executive Chairman (Leave of Absence) [33]

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Yes, definitely. But if you have a look at sort of Paul's answers earlier around what we're seeing in commodities and what we're seeing in currency is giving good indications that farm gate pricing at this stage is looking quite strong for the industry. And that means that it's good to see strong pricing for the farmers, but it also see -- mean there's strong competition for milk.

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Mark Topy, Select Equities Pty Ltd., Research Division - Institutional Research Adviser [34]

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Great. And just to come back to the peanut butter. I'm just wondering. It seemed to me that you have been able to moderate the amount of discounting in the supermarket. I'm just wondering -- and also I think you've spoken about trying to get price increases or some reflection of higher commodity price through supermarkets as well. I'm just wondering how you see that. Or has there been some benefit from that side of things?

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Paul van Heerwaarden, Bega Cheese Limited - CEO [35]

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With -- on the commodity price? I'm sorry, Mark, what's the last one...

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Mark Topy, Select Equities Pty Ltd., Research Division - Institutional Research Adviser [36]

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In -- so in supermarkets, whether you've seen some price increases. Because obviously supermarkets are talking. They talk in terms of pricing, price increases and reflecting higher input costs perhaps.

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Paul van Heerwaarden, Bega Cheese Limited - CEO [37]

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Yes, yes. It's fair to say, Mark, that we have seen over the last 12 months reasonably good price increasing across that consumer index. So if you have a look at Coles and Woolworths, for example, there has been a reasonably good response in key market pricing overall for the impact of the drought across the board, more particularly back into peanut butter. Still some pressure there in the core range just in terms of pricing. So that's where we continue to compete fairly heavily. A lot of our growth, though, is coming in that new sector in natural. And that is providing just in the portfolio, as that's growing at a higher rate, improved pricing returns in that space for us.

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Mark Topy, Select Equities Pty Ltd., Research Division - Institutional Research Adviser [38]

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So that's sort of a product mix sort of gain, I suppose, from that point of view, you get the new [rate] for the higher price, yes.

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Paul van Heerwaarden, Bega Cheese Limited - CEO [39]

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[Coupon rate], yes. We are seeing some cost recovery as well, but we are seeing more of a benefit in that product mix.

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Mark Topy, Select Equities Pty Ltd., Research Division - Institutional Research Adviser [40]

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Okay. And just lastly, just if I thought about -- if thinking about plant capacity utilization, if you like, would it be fair to think that Tatura has probably had its issues over the last 6 months? Or can you give us some feel of plant capacity across Koroit and Tatura and some of the other plants as well in terms of how things are sitting?

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Paul van Heerwaarden, Bega Cheese Limited - CEO [41]

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Look, Koroit is certainly sort of traveling according to plan. So as documented in the [announcement, we've had -- that plant operate] 1 billion liters in a year under previous ownership. We're operating at reasonably good capacity at that site, and we're very happy with that, where that's at. At Tatura, as you point out, with the decline -- so on the Tatura end, look, we focus on where the money is, so cream cheese and our high fat business. As we've discussed, we've been pushing plenty of cream up North to keep those customers in supply. That's been strong. And parts of the nutritional powder have taken a bit of a hit up there, Mark. So we are seeing some opportunities there. And then on the butter floor, we've closed down butter. We've transferred that to Koroit, one of our higher-value protein powder products. We've discontinued production of that in Tatura, and we're reallocating that dryer into produce goat products and organic products. So we're using capacity there where we can in higher-value products, and we're focused on production of our higher traditional dairy products up there.

Fair to say we've got a big commodity dryer up there which we haven't been utilizing at anywhere near the same capacity as we have in previous years, but that's actually -- at current pricing and commodity markets, particularly up in Northern Victoria for milk pricing, that's a benefit. We'd be losing money if we were putting a lot of milk through that dryer for those sorts of products in the current market, whereas down at Koroit that works for us.

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Operator [42]

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Your next question comes from Phillip Kimber from Evans & Partners.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division - Executive Director of Consumer [43]

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Welcome back, Barry. First question is, can we get a -- just broadly a sort of waterfall chart on the EBITDA line? So it fell $9 million year-on-year, but Tatura is down $23 million, which means everything else is up about $14 million. Was that evenly split between Koroit and Bega Foods in a dollar sense? Or was Koroit a bigger part of that incremental step-up in that, in the overall Bega Cheese business, which is the sort of balancing item to get those numbers?

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Paul van Heerwaarden, Bega Cheese Limited - CEO [44]

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Yes, look, it's pretty even, Phil. I think it's probably a little less to Koroit on if we're looking at sort of in an index of 100, but we did see Bega Foods continuing to grow. We've also seen in our longer-term contract packing business, so our core business that we've had in place for many years. You may recall it's been well documented since the loss of the Coles private label business back in January 2017. We have seen a lot of pressure in that part of the business. We have come off a low last financial year, and we're starting to see improvements in margins from a couple of perspectives. One is just some growth in some areas and developing a broader range of customers that we're utilizing the assets for, including some export customers that we're producing products and packing cheese for, but also a number of sort of cost initiatives that we've been able to put in place to improve margins. So we've actually seen that core contract packing business come off the bottom of the cycle. And it's had -- in the context of the last 3 years had a reasonably strong first half. So it's a combination of that and the Bega Foods business that is certainly driving a big part of that growth from that side.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division - Executive Director of Consumer [45]

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Sure. And then if we look at Tatura...

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Paul van Heerwaarden, Bega Cheese Limited - CEO [46]

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I should also point out -- sorry, mate. We -- Coburg. So the benefits of the Coburg closure and the toll processing arrangements in the first half compared to the first half of last year, mate, when we were fully operating the Coburg facility. So that's also driven a reasonably material benefit into the Bega sector that does not show up in the Tatura numbers.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division - Executive Director of Consumer [47]

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Yes, okay. And then on Tatura, obviously a weak result, which you've explained. I mean it sounds like it's going to be weak again in the second half. What needs to change to get that back -- maybe not for -- to peak numbers but to get it back to sort of a decent level of profitability? Is it just that Northern milk pool has to improve? Or are there some other things that you can do to improve Tatura back to a reasonable level of profitability?

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Paul van Heerwaarden, Bega Cheese Limited - CEO [48]

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Yes. Look, getting milk back up would certainly be the ideal, but we are not planning for a significant increase in -- up there. We're prepared to respond to that opportunity if it presents itself, but we need to make sure we protect margins at the same time. So what were -- the 2 key initiatives that we've got in place, which I've touched on earlier, Phil, is just resetting our cost base. That's part of the direct cost base on site regarding shift structures, overheads, et cetera; and then that broader split that Mike Peet asked about earlier on in the phone call regarding the broader cost savings initiatives. The second part is what I referred to earlier, which is just diversifying our customer base around nutritionals and expanding our product portfolio there away from conventional dairy milk. And that covers both in terms of the product mix but also the customer and country mix there as well. And that started. That started in the last 12 months. You'll recall the announcement we made this time last year with the Bubs deal. There's been a couple of other deals since. And we're continuing to progress those, but they take time. And we'll start to see kicking a lot more in FY '21, but it will probably realistically be FY '22 before we start to see the full recovery in that part of the business, I think, on that side. But it will be progressing towards those sorts of numbers for that stage.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division - Executive Director of Consumer [49]

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Okay. And lastly -- and I know Michael's question. You sort of set out you're not going to quantify, but you broadly talked to some of the cost savings. I mean, if I'd -- you say it's a material improvement. Are most of the cost savings not in cost of goods sold but rather in what you might call SG&A or cost of doing business, basically the difference between gross profit and EBITDA, which from memory is close to I think total expense of $200 million a year? Is that where the bulk is going to be? Just to give us a bit of a sense. When I hear the word material, I'm thinking 5% to 10% type improvement, flat or higher. And is that with the same cost base?

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Paul van Heerwaarden, Bega Cheese Limited - CEO [50]

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You're very, very good at your job. And sometimes I'm not too sure if I'm in the witness stand or a politician, but I'm not going to hone in on your materiality comment. I apologize for that. We will provide further details when we're in a position to, but to answer your fundamental question: A lot of that will be seen in that below-the-line number. I did refer in response to Michael's question earlier some supply chain logistics costs that we'll be consolidating and you'll see some of those appearing above the line, but the majority of them will be below the line.

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Operator [51]

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Your next question comes from Jonathan Snape from Bell Potter.

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Jonathan Snape, Bell Potter Securities Limited, Research Division - Senior Industrials Analyst [52]

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Look, just a couple of questions, if I can. Just first of all, on the restated numbers in the second half in particular. Divisionally, is most of that taken up in your Koroit or the Bega Foods line? Or is there some kind of spread you can give us on where we should be adjusting those historical divisionals?

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Pete Findlay, Bega Cheese Limited - CFO [53]

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Yes. So it's in Koroit, Jonathan. So...

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Jonathan Snape, Bell Potter Securities Limited, Research Division - Senior Industrials Analyst [54]

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All of it is Koroit.

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Pete Findlay, Bega Cheese Limited - CFO [55]

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Yes.

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Jonathan Snape, Bell Potter Securities Limited, Research Division - Senior Industrials Analyst [56]

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Okay. And just looking at the movement then in the inventory values. They look like they went down about $1.5 million, but the revenues didn't move in the restatement, so that kind of implies that, I guess, the value per tonne came down. Has that had a corresponding benefit into the 2020 year in that you're carrying your inventories at a lower cost relative to what you realized it? Or is it flowed through with no benefit?

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Pete Findlay, Bega Cheese Limited - CFO [57]

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No. It -- the majority of the error was a misstatement on an internal transfer. So it was an internal sale. So we're not really seeing any benefit from the majority, the $9 million. The $1.5 million of inventory, it would be immaterial, the amount that's flowing through this year.

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Jonathan Snape, Bell Potter Securities Limited, Research Division - Senior Industrials Analyst [58]

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Great. And just on the divisional lines for this result. The eliminations of the old, I guess, corporate bit was a gain in this half. Is there any particular reason that there was a positive contribution from -- at that level EBITDA-wise?

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Pete Findlay, Bega Cheese Limited - CFO [59]

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That would probably be around the cost savings that we're starting to get out of our corporate cost structure. So that's really some of the structural savings that are starting to apply.

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Jonathan Snape, Bell Potter Securities Limited, Research Division - Senior Industrials Analyst [60]

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Okay. So you'd expect that that's going to be negligible in the second half then, I would think, as well. There shouldn't be any outflow, in other words. Because I think it was like a $3 million outflow last year.

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Pete Findlay, Bega Cheese Limited - CFO [61]

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No.

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Jonathan Snape, Bell Potter Securities Limited, Research Division - Senior Industrials Analyst [62]

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All right. And look, just lastly, on the milk volumes, I know you've kind of given the group totals and talked about production numbers but -- and kind of said it was weighted towards Tat, but just how much was Tat's volume down year-on-year in terms of milk collections? And what was kind of the production volume down? I guess what I'm trying to figure out is how much of it is milk volume and how much of it was infant formula coming back in terms of its move?

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Paul van Heerwaarden, Bega Cheese Limited - CEO [63]

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Sorry. Jon, can you just repeat that last question on infant formula?

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Jonathan Snape, Bell Potter Securities Limited, Research Division - Senior Industrials Analyst [64]

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Yes. I'm trying to figure out what your percentage change would have been on infant formula as well in terms of base pattern or what kind of stuff you do, how far it went backwards in terms of milk volume.

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Paul van Heerwaarden, Bega Cheese Limited - CEO [65]

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Yes. So on -- yes, yes. So on the -- look, on the milk volumes, we're not specifically calling out the reduction up there, but it was -- that's where the material part of the reduction was in our business update, Jonathan. We are, as I mentioned before, continuing to move cream up into that facility to keep our key value-adding products going along. So they're actually maintained at reasonably similar levels to the previous prior period comparison, but the major change that we'll see up in Tatura on the dairy complex is in regards to commodity powders and any bulk butter that we were producing up there. So significant decrease in milk but just being -- seeing those commodity products, value-added products, being retained in line with the previous year.

On the nutritionals side, as Pete mentioned earlier, we are seeing a decline in the -- some of these sort of higher-margin businesses that was coming through. And that certainly had a decent impact in that first half compared to the prior period, particularly from the Chinese market.

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Jonathan Snape, Bell Potter Securities Limited, Research Division - Senior Industrials Analyst [66]

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So if you're trying to, I guess steal a term from Phil, do a waterfall for Tat and do a linear, how much would have been milk supply versus infant in terms of that year-on-year fall?

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Paul van Heerwaarden, Bega Cheese Limited - CEO [67]

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It would be about half and half.

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Operator [68]

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Your next question comes from Belinda Moore from Morgans.

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Belinda Moore, Morgans Financial Limited, Research Division - Senior Analyst [69]

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Just in terms of the farm gate milk price, how are you seeing that's going to end the financial year, please? Secondly, any guidance you can give us on how you're seeing net debt at year-end? And then thirdly, could you just remind me when that Bellamy's contract comes up for renewal?

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Paul van Heerwaarden, Bega Cheese Limited - CEO [70]

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So I'll work backwards, if that's okay. The Bellamy contracts runs out to 2023. That's been extended out too. The net debt guidance, if we had a look at where we were 12 months ago, where we had that significant spike in debt, you may recall that was mainly treated with a significant increase in inventory, which is back into more normalized levels. As Pete outlined earlier in response to Mark's question, we are looking at further tightening up those inventory levels and other aspects of working capital. So we do look at that debt number and think that we can improve on that as we head into the year-end figure.

In terms of milk price outlet -- pricing outlook, for your first question, that's something that we obviously keep a very keen and constant eye on and talk about on a regular basis. And we need to be very careful in terms of what we say in response to that, but we are seeing that the remainder of the year will be competitive, and we may need to respond to that. There has been some softening. So whilst we don't see the softening having a material impact in the results of us or any of our competitors in the second half, it does start applying to sentiment in terms of how does that actually position us for the next 2 years. So we -- as we start to get into the final stage of the financial year, we'd look to see how we position ourselves for that, to move into the coming financial year as well, but -- yes.

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Operator [71]

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Thank you for the questions. I would now like to hand the conference back to Barry. Please continue.

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Barry Irvin, Bega Cheese Limited - Executive Chairman (Leave of Absence) [72]

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Okay. Thank you, everybody. And thank you, Paul and Pete, for your support in the presentation.

I think it's good to outline a business that's got plenty of opportunity in the future and facing the challenges that we have at the time.

Before I wrap up, I just do want to acknowledge that Max Roberts stood in this chair for me over the period that I was unwell and, I think, has been important in terms of -- along with the rest of the team, in terms of demonstrating that the company has got the stability and the strategy in place to go forward in all circumstances.

So thank you very much, everybody. I look forward to catching up with a number of you over the coming days and weeks. And I thank you for your patience in listening into the call. Thank you.

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Operator [73]

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Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may all disconnect.