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Edited Transcript of BGA.AX earnings conference call or presentation 28-Aug-19 1:00am GMT

Full Year 2019 Bega Cheese Ltd Earnings Call

North Bega, New South Wales Sep 12, 2019 (Thomson StreetEvents) -- Edited Transcript of Bega Cheese Ltd earnings conference call or presentation Wednesday, August 28, 2019 at 1:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Colin Griffin

Bega Cheese Limited - CFO & Company Secretary

* Maxwell Roberts

Bega Cheese Limited - Chairman of the Board

* Paul van Heerwaarden

Bega Cheese Limited - CEO

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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

* Michael Peet

Goldman Sachs Group Inc., Research Division - Executive Director

* Paul Jensz

PAC Partners Securities Pty Limited, Research Division - Executive Director & Senior Industrials Analyst

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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 Full Year 2019 Results Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Mr. Max Roberts, Chairman of Bega Cheese Limited. Thank you. Sir, please go ahead.

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Maxwell Roberts, Bega Cheese Limited - Chairman of the Board [2]

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Thank you, and very good morning, everyone. And welcome to the results announcement for Bega Cheese for the full year 2019 financial year. I'm Max Roberts, Chairman of the Board. And with me today is CEO, Paul van Heerwaarden; and CFO, Colin Griffin. Paul and I will present the full year results; and Paul, Colin and I will be available to answer questions following this presentation.

But before I begin, I'd just like to mention, Barry Irvin, our Chairman, who's on extended leave due to health issues. I wish him all the best for his recovery, and I know he will be back in this seat for the 2020 half year results presentation, and I strongly suspect he's listening in at the moment.

Ladies and gentlemen, it's important to say upfront that Bega Cheese has delivered a solid result in what has been a challenging year. Both the dairy and FMCG industries have experienced major structural changes in competitive domestic and international environments. While we've maintained a strong competitive position, the ongoing drought resulted in a significant reduction in Australia's milk pool and higher costs across our business. The challenges in dairy and international trade required us to maintain our focus over the year on productive investments, efficiencies and developing markets that support our strong underlying profit contribution.

The acquisition of the Koroit facility in August 2018 provided significant processing capacity and capability into our network and an extra 300 million liters of milk supply. We welcomed over 100 employees with the acquisition and are benefiting from their significant experience and capabilities. Due to Koroit, we are now better able to meet the growing industry challenges, adding important flexibility, geographic diversity and scale to our network.

I should also mention the closure of the Coburg cheese site in February. It was difficult for those affected, but this rationalization was essential. Our new toll processing arrangement for cheese production has utilized existing capacity in the industry and had a positive impact on our network.

Bega raised $200 million through an institutional placement and share purchase plan finalized in October 2018. It resulted in the issue of 27.8 million shares. The funds from the capital raising were applied in reducing total debt following the acquisition of the Koroit facility. Finally, we look forward to the value to our business of the Enterprise Resource Planning system, a competitive system implemented in full year 2019, and the new ERP system is an important factor in our future growth.

The next slide puts the 2019 financial year into context, and it's about transformation to becoming The Great Australian Food Company and it's been great to see the significant growth in development since our ASX listing in 2011. I've been on the Bega Board for 36 years, and I've seen Bega become The Great Australian Food Company. The move from a supply-driven co-op to a market and customer-focused organization has been challenging but ultimately rewarding for the entire group. Since 2011, the focus has been on establishing corporate-wide foundations, diversifying our range of products and strengthening our customer relationships and market shares. And also, looking to the future, we're now focused on investing, innovating, optimization and strategic alliances that will continue this transformation process.

The next slide details where this growth plan will take place. We are committed to an effective and efficient supply chain network, increasingly diversifying our products and channels to markets and prioritizing investment in important long-term initiatives. The acquisition of Bega Foods in 2017 provided Bega Cheese with a new sales and marketing capability. We've launched some exciting new products in 2019, such as gluten-free VEGEMITE, a range of Simply Nuts peanut butter and a portfolio of products under the new Farmer's Table brand.

The acquisition of Koroit has complemented our range of consumer dairy product, providing us with new capacity in butter and milk powders in consumer formats. The Koroit facility has also expanded our processing capacity and improved access to a strong and growing milk pool in Western Victoria. This facility has strengthened our dairy network and will allow us to realize further savings from manufacturing optimization and efficiency programs. To gain the most value from our integrated supply chain, it's important that we align milk supply with our asset capability and capacity across our network.

I'm pleased to say that we've continued to invest in our manufacturing network with increased automation and improved yields. The continuous improvement program, which commenced in 2018, has continued in 2019 and has generated significant savings across our supply chain. And that program will now extend to other aspects of our supply chain and cost base as we respond to challenging dairy supply markets.

Bega Cheese continued to invest in growth projects. During 2019, the company invested in new consumer lines at the Port Melbourne facility. We also increased the capacity of our lactoferrin plant at Tatura and commenced construction of a new lactoferrin plant at Koroit. We are diversifying our revenue streams with strong growth in 2019 in our international branded consumer goods business and expansion of our customer base in nutritionals.

As part of our early growth phase, Bega Cheese relied on long-term strategic alliances to support scale and investment. As the business diversify and invested in new sales and marketing capabilities, we've become less reliant on those traditional alliances. As we further diversify our customer base and become more relevant in global markets, we expect to form new strategic alliances and partnerships, building on our reputation of supplying high-quality products and creating shared value.

And I think it's worth emphasizing Bega values. During 2019, the Board and the executive team reviewed and refreshed the values of Bega. These values are important not only for our employees, but to our customers, our suppliers and the communities in which we operate. The values are: passion for the customer, invest in our future, support each other and grow our people. Bega has a proud history built on maintaining a strong reputation amongst a wide range of stakeholders, from farmers, our workforce of over 2,000, our consumers, our suppliers and the Australian public and our customers in many parts of the world.

I'll now hand over to Paul to take us through the financial results and the details of the operational performance. Paul?

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

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Thank you, Max, and good morning, everybody. And before I start, I too would like to mention Barry and wish him well in his recovery.

I'm now on Slide 6, covering revenue analysis. And overall in FY 2019, I'm pleased to say we saw strong growth in our core branded consumer and food service business, in both the domestic and international markets. Our strong performance in export dairy ingredients and branded product, which continues to grow, represents 31% of revenue. Having Koroit in our network with the capacity to process 900 million liters of milk into a range of milk powders and other -- butter products has been and will be fundamental to our servicing domestic and international retail, food service and nutritional customers.

The nutritional and bionutrient business has provided strong profit growth with our ongoing diversification of product categories, customers and markets. The increasing trend into goat milk infant formula led to a processing deal with Bubs. And the demand for organic infant formula is also continuing, which sees us working with both domestic and international customers on new formulations and supply, which will be launched during FY 2020. We've also launched into the domestic market new brands of dairy and spread products, which I will talk about in more detail later.

Slide 7, which covers the performance highlights. And in a very challenging year in the Australian dairy industry, I'm pleased to report that Bega Cheese generated a record normalized earnings before interest, depreciation and tax of $115.4 million in FY 2019, being an increase of 5% over the prior year. On a statutory basis, Bega Cheese generated EBITDA of $89.5 million, being 3% below the prior year. Milk intake increased by 308 million liters to a total record 1.06 billion liters during the year, and we manufactured a record 280,405 metric tonnes of dairy and other products.

Bega Cheese generated record revenue of $1.42 billion in FY 2019, which was up by 13%. Export sales increased by 4% to $442 million, with the group exports to key markets in Southeast Asia, Japan, China and Middle East representing the majority of our export business.

In looking at the reconciliation of normalized results, transaction costs related to the Koroit acquisition, the closure of the Coburg facility, legal costs relating to mitigation and management information system deployment all resulted in material abnormal costs to the business. We provide more details on these items in the annual report.

On a statutory basis, the group generated net profit after tax of $11.8 million in FY 2019, being down 59% largely as a result of high depreciation and amortization from recent capital investments, interest from higher borrowings throughout the year to fund acquisition costs and working capital and a higher effective tax rate from the tax treatment for acquisition costs.

Looking now to the balance sheet, which at the 30th of June 2019 was in good shape with total assets of $1.489 billion, total liabilities of $663 million and shareholders' funds of $826 million. Trade receivables and other receivables decreased by $42 million from the prior year with the introduction of a trade receivables facility from March 2019, significantly reducing the balance as we derecognized $188 million of eligible trade receivables as at 30 June 2019.

As foreshadowed in the first half FY 2019 interim report, the significant seasonal build-up of inventory at the half year was managed down in the second half. Although at 30 June 2019, inventory was still up by $63 million in the prior year, primarily as a result of the Koroit inventory. Property plant and equipment and intangible assets increased materially during the year, also largely as a result of the Koroit facility acquisition.

Net debt totaled $288 million at 30 June 2019, being an increase of $42 million. The group continues to have the strong support of its banks, Rabobank and Westpac, who fund our syndicated debt facility, with Rabobank also providing an inventory facility and a trade receivables facility. I'll now move on to our cash flow.

Including proceeds from transactions relating to the trade receivables facility, which generated inflows of $188 million, the group generated net cash flow from operating activities of $100 million. As mentioned earlier, the most significant cash outflow in the period related to the acquisition of the Koroit facility, which cost $251 million before acquisition costs.

I'll now move on to group sales on Slide 11. Bega Cheese has had a history of steady growth in revenue, with FY 2019 continuing this trend. Group sales have increased by 13% to $1.42 billion in FY 2019, which was largely due to revenues associated with the Koroit acquisition. Other key growth initiatives during the year included a further diversification of our customer base in nutritionals and innovation in our branded consumer goods business.

It is important to note that the Mondelez Grocery business that we acquired had a limited innovation pipeline when we -- when it was acquired 2 years ago. We're now starting to see the benefit of our investments in new product development. During the year, we launched 41 new products -- branded products or product variations. We also launched 3 brands: Simply Nuts, Farmer's Table and Modern Chef, which is an exclusive brand developed for Woolworths. For the first time, these brands expand our retail offerings to cream cheese and butter in the domestic market.

The launch of gluten-free VEGEMITE during FY 2019 has made this iconic Australian product available to even more consumers. The licensing of the VEGEMITE brand also saw the successful launch of Arnott's Vegemite Shapes, providing further promotion and income generation.

Bega Simply Nuts was launched in the high-growth all-natural peanut butter segment. Our product is made from 100% Australian peanuts sourced from our Kingaroy facility. The range has strong momentum heading into FY 2020. Kingaroy continues to play an important strategic role by providing high-quality Australian peanuts as an ingredient for our peanut butter and snacking products. The Picky Picky nut snacking range is now available in Coles, and the Dairymont food service brand was also relaunched during the year in the domestic market.

Early in May this year, the Federal Court of Australia ruled on Bega Cheese's right to continue to use its trade dress associated with the peanut butter products acquired from Mondelez. Legal proceedings continue as a result of an appeal by Kraft.

Since the closure of the Coburg facility in March, we continued to develop our domestic and international cheddar and mozzarella cheese business, sourcing cheese from our other dairy sites and through our new external toll manufacturing agreement. The agreement has provided increased capacity in our network, removed significant costs and importantly avoiding capital expenditure.

Now turning to Slide 13 on the dairy commodity and farm gate milk prices. Our dairy ingredients business implemented significant changes whilst managing domestic drought conditions and global commodity market challenges. Commodity price volatility was evident early in the year with high European inventory, softing skim milk powder pricing and lower Asian demand depressing butter prices. As the year advanced, the tightening of supply led to increases in commodity prices of butter, powder and cheese. This improvement during the 2018 spring peak milk period combined with a weaker Australian dollar supported seasonal rebates and milk price increases for our dairy suppliers.

With the acquisition of Koroit, our milk intake was a record 1.06 billion liters. Koroit provided an additional 300 million liters over and above our FY 2018 base milk supply, which remained at approximately 750 million liters. This is a great outcome in what is a very competitive market. Whilst we expect continued pressure on margins during this drought cycle, we intend to counter this with continued improved efficiencies across our network.

I will now move to providing an overview of our operations and sites. As the company grows, we consistently focus on maintaining the most efficient manufacturing footprint and logistics network possible and making the necessary ongoing changes to ensure we remain globally competitive. The closure of our Coburg facility and the subsequent entry into the toll processing arrangement was part of our broader ongoing consolidation program.

As mentioned earlier, a core component of our success has been the sustained focus on continuous improvement. We achieved significant savings in FY 2019 from a range of initiatives, including waste reduction, yield improvement, capacity enhancement, labor efficiency and overhead reduction. Safety performance continues to improve year-on-year with a 15% reduction in the total recordable injury frequency rate.

Our recently implemented new ERP system replaced 4 separate systems and required an enormous effort and commitment from every part of the company. Importantly, this new system provides a platform for supply and network efficiencies and information systems that will support our ambitious plans well into the future.

With the acquisition of Koroit and the closure of Coburg in FY 2019, Bega now has a stronger, integrated and flexible dairy manufacturing network. This network provides opportunities to create further value by consolidating the manufacture of certain products on our most efficient assets, such as butter and certain powder products, and to help optimize the value we extract from milk solids.

Bega Cheese continues to invest in a range of capital projects to maintain and enhance our asset base, to provide a safe workplace for our people and to improve our sustainability performance. We also continue to invest in growth and efficiency projects with investments to support innovation in our customer -- consumer goods business during the year, including a new dips line and the Simply Nuts jar line at Port Melbourne. The company also commissioned an upgrade to the lactoferrin plant at Tatura during the year.

Moving on to Slide 16 and our approach to corporate social responsibility. Over the past year, we have developed a comprehensive sustainability framework aligned to the United Nations' Sustainable Development Goals to ensure we are constantly improving and meeting community, customer and shareholder expectations. Our key focus areas with detailed and targeted performance measures out to 2030 include: improving food nutrition, in particular, the reduction in salt; supporting an increase in the diversity of our people; a reduction in greenhouse gas emissions; improved water conservation; and a reduction in packaging waste.

We've established an ambitious energy reduction program with initiatives across all sites, which are targeted to deliver up to 20% reduction in energy use over 4 years. We've seen improvements in gender diversity in FY 2019, with women now representing 46% of our staff in professional roles, up from 36% in the prior year. We will continue to focus on further increasing diversity across the business.

As a member and signatory to the Australian Packaging Covenant Organization, we achieved leadership level for post-consumer recovery and waste diversion criteria. As a regionally focused business, the sustainable use of water has always been important for us. We will continue to ensure effective water management in our operations, including initiatives to reduce water consumption and decrease wastewater. A highlight in FY 2019 was the reuse of 38% of water used in our manufacturing operations.

Moving to Slide 17. Our entry into retail dairy and other spreads will provide further growth in profitability along with our continued growth in international markets. Whilst total milk production across Australia is forecast to further decline in FY 2020, continuing the pressure on margins, we are already seeing this pressure with record opening milk prices announced by all processors in recent months. Whilst aggressive competition for milk will continue, Bega Cheese is well placed to maintain strong supplier relationships through our 9/3 seasonal milk pricing initiative, the Bega Supply Premium and our strong reputation in the marketplace amongst farmers. We remain focused on growth through investment and other profit improvement initiatives. Our ongoing focus on working capital management will continue to ensure our balance sheet is resilient.

I'll now move on to Slide 18 and our priorities. Ladies and gentlemen, in everything we do at Bega, we ensure that we are relevant to our customers and that we are globally competitive. The pressure on earnings in FY 2019 will continue in the new financial year, and it is imperative that we focus on executing our growth initiatives and further rationalization and optimization of our manufacturing footprint and logistics network.

In FY 2020, we will continue to invest in our brands, develop new products and extend our reach as we grow our customer -- consumer and food service markets in Australia and overseas. Our product innovation pipeline developed since early FY 2018 and our marketing and execution capability will support this growth. Our capital investment program will focus on reducing the overall supply chain costs and support growth categories with increased capacity and capabilities. This includes the new lactoferrin facility at Koroit, which is scheduled to be commissioned in early 2020 and will provide positive return in the second half of FY 2020 and into FY 2021.

We will continue to firmly defend the legal actions brought by Fonterra in the Supreme Court of Victoria due to be heard in late 2019. This case relates to the rights to use the Bega brand in Australia and our cross claim on Fonterra regarding the nonperformance of their obligations in accordance with the Bega trademark licensing agreement.

As I look to the future, I expect the competitive challenges impacting the dairy industry to continue, which may provide further potential consolidation opportunities. We remain focused on diversifying and aligning our milk supply to ensure long-term success. Notwithstanding these challenges, I am confident in our strategy and capability to accelerate our growth plans and reset our cost base in FY 2020. Importantly, in FY2020, we will continue the transformation we began a couple of years ago to become The Great Australia Food Company.

Thank you, and we will now take any 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 the line today of Michael Peet from Goldman Sachs.

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

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Just firstly, Paul, maybe on the milk intake expectations for FY '20. Could you just give us a sense whether you think you'll be able to hold those liters collected from last year roughly and maybe a bit of a sense between the north and the west, what's happening at the moment?

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

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Thanks, Michael. And certainly, there's a lot of big changes moving around and a lot of changes that we've seen along across the dairy supply complex. We are seeing some potential softening overall in Australian milk supply. But if you look across different regions, you'll see different stories across those regions. In New South Wales, in Queensland in particular, we see some further softening. Northern Victoria, it's going to depend how water pricing rolls through in the coming months and the confidence of farmers out there. We are seeing -- in other regions, we're seeing good spring conditions. There's a lot of subsoil moisture and a positive outlook in some of those areas. In other areas, it's particularly tough, and we're still trying to get over it. So the short answer is it's too early to really understand what the season is going to shape up like in terms of supply. We are coming off a very significant decrease in parts of the country, particularly in the second half of FY 2019. For example, Northern Victoria was down about 30%. So we're watching that very closely.

In terms of what we're doing to whole milk, as I've mentioned and Max also mentioned, the competitive environment is very tough at the moment. We have maintained our Bega Supply Premium, which we introduced in 2018. That's been reasonably successful in attracting and holding farmers. And we've also, during the recent months, launched a new 9/3 milk pricing system, which is supporting more of a seasonal price for those farmers, providing more cash flow upfront and a stronger spring price. And that's the early stages with that, assuming that to be very successful. But to answer your question, in short, it's too early to see will that's all going to play out [for the year].

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

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Okay. Great. And just on the food business, the spreads business. I mean you split out the revenue there, I think, on Page 40 of the annual report. I think it was $223.5 million, down 12%. Can you -- I know you don't split out EBITDA there. But can you just give us a sense of were you able to sort of grow margin there a bit as you focused on more profitable business? And then just a sense of going forward, as you're releasing obviously new products and things, can you grow the earnings on that spreads business this year?

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

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Absolutely. And it's -- that includes also just a broader nondairy grocery business, or I should more accurately refer to the branded consumer business. We have seen some of the products in our portfolio that are not contributing. We removed them from the product portfolio. So we have seen some decrease there.

The growth in the new products that are launched has been very strong, particularly with the Simply Nuts product. The gluten-free VEGEMITE has also been very positive. And we're seeing some growth, too, in other sectors, including ZoOSh, for example.

We are very much focused on growth categories where we are seeing better margins, and that certainly -- we'll see more of that into 2020. I should point out that we indicated back with the acquisition of the Bega Foods business in early FY 2018, our target for earnings from that business, which as you mentioned, we don't disclose separately. We did flag in February 2018 that we saw a 12- to 18-month delay in terms of us being able to achieve those sorts of targets. And whilst that's been -- had some challenges for us, particularly in the court case with Kraft and some other challenges with retailers, we are seeing some positive signs now where we work towards those sorts of levels in the time frame previously indicated.

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Operator [6]

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Your next question today comes from the line of Josh Kannourakis from UBS.

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Josh Charles Kannourakis, UBS Investment Bank, Research Division - Research Analyst [7]

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Max, Paul and Col, just a few questions. I'll try and jump through them quickly. Just firstly, on the COGS side of things. Obviously, opening farm gate prices are higher this year. Just trying to understand, as you roll into this year, how you offset them? And as you mentioned, in terms of some of the supplier investment you had in '19, how -- what do you -- how do you expect that to go directionally that sort of $28 million into sort of '20? Like, do you expect that to increase significantly? Or was '19 particularly the large year for that as well? Just trying to understand those balancing items.

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Paul van Heerwaarden, Bega Cheese Limited - CEO [8]

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Josh, you're referring to just the impact of milk price increases there, primarily. Is that right?

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

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Yes, that's right. But also your loyalty payments and impact of that in '19 and how that sort of rolls into '20 as well?

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

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Yes. So it's just worth spending a bit of time on that Bega Supply Premium, which we did implement about 18 months -- a couple of years ago now to -- as we saw competition for milk really starting to tighten up. So that was the investment, just to remind everybody, of $0.50 a kilo for 3-year contract that was paid upfront. The primary purpose of that was to get cash into the pockets of farmers at a time when they were dealing with significant dry conditions through the order of 2017, and the outlook was not particularly positive for them as they looked forward to FY 2018.

We saw that as an investment in actually securing that milk volume at a time when we were seeing extra capacity coming online in Northern Victoria and in Western Victoria. And as things are going to really toughen up and tighten up, we need to be prepared for that, and we need to hold on to milk. That's been quite successful as what we've outlined in 2019. We think that this might actually going to be tough for us, though, Josh, in 2020 because competition has intensified further.

So that investment, which is basically brought into the accounts in that COGS line represents, I think, about $0.17 a kilo. And the majority of that milk was operating underneath that BSP program as well. So the impact of that, Josh, was around about $30 million a year if we amortize that over the 3-year period. And that effectively indicates a sort of level of margin pressure that we've seen in the business and we might see further margin pressure in FY 2020.

In answer to your question, how do we recover this? That's predominantly through -- so there's a lot of dynamics, as you can imagine, in a market like the milk market. And one of those dynamics includes the global commodity pricing.

As flagged in the report, we saw the skim milk powder intervention stocks which kicked in, in late 2015. They built up to about 400,000 tonne by the end of last calendar year. And a lot of that product was getting towards its use-by date.

We saw the European Union's finally settle that stock down by January this year, so about 6 to 7 months ago. And that effectively took the -- that sort of artificial ceiling off the skim milk powder price, which was around about USD 1,800 to USD 1,900 a tonne. It quickly increased by about 25% to USD 2,500 a tonne, which is where the market is today. So that's had a significant uplift in our business and across the whole dairy complex. And we've also seen, obviously, the U.S. dollar depreciate. Well, the Australian dollar depreciated, I should say, against the U.S. dollar, which has provided further benefit in that.

So a lot of milk price increases we've seen over the last 2 years. And it is worth pointing out that milk prices this year, opening milk prices are a record. They are fundamentally being recovered by those higher prices. We're also seeing in the retail market, Josh. And Colin might add a comment on that more later, but we are seeing pressure on margins, there's no doubt about it, and that could increase.

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

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Got it. And just to understand as well, I think you're paying quite a bit of in the way of water rebates, especially up in Northern Victoria across the period. So just to understand as well how that's -- how you sort of see that playing out over this -- over the start to this year. Obviously, some improvement in conditions in water markets but still reasonably tough.

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

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Look, they're very tough, the water markets. And we're seeing -- particularly up in Northern Victoria, we're seeing demand from permanent water use and environmental flows basically aligned with the supply last year. That's what's forced prices up, well over $600 a MG. The breakeven -- and it's different for different farmers, but the breakeven level for temporary water up in Northern Victoria is sort of in the $250 to $300 a MG level. So once we're getting up to the levels of $550 to $600, which we were seeing sort of coming up at back end of Christmas, that was putting the significant pressure on our suppliers out there. And that is one of the main reasons why we've seen this 30% decrease in milk production across Northern Victoria for the industry.

It's worth noting that the support payments that we made, which totaled around about $4 million, which are included in our results, obviously, the $115.6 million (sic) [$115.4 million]. We were making those payments during the year. As you've seen, this will unfold. And it's worth remembering that as we were coming into spring last year, water prices were about $100 a MG. There was a bit of feed around in Northern Victoria. And as the drought started to unfold further in New South Wales and Queensland, a lot of that scene went over the border into New South Wales and Queensland. And when it really started hitting hard in Northern Victoria and water prices went up, there was actually a shortage of feed as well, which has just exacerbated the pressure on farmers there.

So we felt those payments, Josh, were very necessary in a period where there was a significant change in the on-farm conditions, and we had to respond quickly to that. What we've done this year is we recognized the increased challenges in Northern Victoria, and we built into our base price, additional pricing to recognize those cost challenges and risks associated with milk production in Northern Victoria.

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

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Got it. Just one final one. Maybe for Col. I guess just trying to get some context, Col, around as we head into the first half '20 result, the inventory moves that we're expecting or any changes to the sort of historical inventory moves in periods. I'm just trying to understand a little bit more around cash flow and whether you can give us a bit more just confidence around how we should look at sort of the net debt positioning, and how you'll be using the try to or save both facility into that end -- first period and into FY '20?

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Colin Griffin, Bega Cheese Limited - CFO & Company Secretary [14]

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Yes. Thanks, Josh. We, obviously, did experience in half December '18 a significant increase from the June period in buildup in inventory. Obviously, we explained that, that the half year result was being driven by the Koroit acquisition where we originally, at 30th of June, had no inventory associated with that asset. And then quickly through the seasonal peak, build up a quite significant value in inventory from the milk at the Koroit facility. And we called out, at that time, it would take us into the second half to take -- effectively, to top off that inventory at half year.

That process has flowed through, from our point of view, felt very well. We're pretty comfortable with the process of liquidating that inventory. We were in a situation last year where having bought the asset, we hadn't had a transition of customer relationships with it. We had to establish our own direct supply with those customers, and that caused a bit of a lag in the process. This lag won't apply going into the current seasonal peak. We have customers that are familiar with our products. We've had certification of our ability to supply them to their quality standards, which was a procedural issue as we took control of that facility. And we've got pretty intense forward-demand plan for the products we'll make over the next 3 to 6 months in the peak.

So we run into this year with a better experience and a better depth to customer base for that particular line of business at Koroit as well as we started with nil inventory at the 30th of June '18 for that asset. And today, we start with a more reasonable tranche of opening inventory, which we'll continue to sell-through in the first couple of months of this financial year.

From a cash flow management point of view, yes, it is traditional for us to have a buildup in working capital as we head into spring, as we take on more milk and pay farmers for that milk along the way, manufacture to milk supply push and then deal with the inventory to customer timing over the course of the -- into the back end of the first half of the year and then into the third and fourth quarter.

We're pretty, I think, well placed to project that sort of outcome. We've got a pretty good understanding of the payment cycle and the sales cycle and the cash receipts cycle through that journey. And with the 12 months worth of experience with Koroit, we've got that pretty well embedded into that traditional process as well.

So we track our cash on effectively daily basis, keep nice and tight control over that and make sure we've got facilities in place to meet our immediate and ongoing requirements. In certain -- historically, in certain periods around seasonal processes, if we've identified an issue around capacity with established seasonal borrowing facilities with our traditional lenders, Rabo and Westpac, they're very, very supportive of us, have been for many, many, many years. And in relation to seasonal facility for agri business, Rabo and Westpac, in particular, are experts in this space and can make those types of facilities available to us.

Having said that, we've got significant headspace in the facilities that we have in place at the moment. We've gone to some depths in the annual report to articulate how the facilities have a total limit of seats and how the amortization or maturity of those lines roll out, and also commented a little bit about how the trade receivables has been brought in towards expanding of working capital as well.

So in short, Josh, we've got a seasonal periods we head into. We know that there's a working capital implication for that, and we're planning our cash flows and facility structures to accommodate that.

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

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Okay. And just it's a very high level. If you look over the year, I know a lots of moving parts, but should we expect at least some sort of deleveraging over the next 12 months to continue?

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Colin Griffin, Bega Cheese Limited - CFO & Company Secretary [16]

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We're not anticipating an increase in leverage outcomes by the end of the financial year.

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Operator [17]

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Your next question comes from the line of Jonathan Snape from Bell Potter.

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Jonathan Snape, Bell Potter Securities Limited, Research Division - Senior Industrials Analyst [18]

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Look, just 2 questions. First of all, just on the milk supply. I know you just spoke about Koroit. Is there any way you could just model and spell out kind of what the intake volumes were for Tatura and Bega?

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Paul van Heerwaarden, Bega Cheese Limited - CEO [19]

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Hey, Jonathan. Paul here. Just broadly, Bega's been relatively flat for us year-on-year. We'll push on a little bit more milk into Bega out of Gippsland and probably push a bit more cheese out of the facility there. But overall, milk volumes held reasonably steady.

Northern Victoria, certainly, there was a significant decrease in the second half, just consistent with what we saw across the industry. So we're certainly seeing some decreases there, Jonathan, of milk supply in Northern Victoria.

Just to sort of complete the picture, we were closing Coburg around the same time. We had extra milk in the system out of Gippsland that we will be able to push up to fill that gap. And as we've already discussed in previous updates, we have been able to transfer cream out of Koroit at minimum freight cost as required to Tatura if we need to top-up milk for our cream cheese business there. So that was certainly an initiative that we kicked off, particularly in the fourth quarter as we started to see production go up even further of this.

Certainly, Western District originally filled rather the third -- the 300 million plus the extra 100 million liters we had down there in any event Gippsland, good growth. Some of that into Bega, as I summarized. Some of that up into Northern Victoria in the second half and particularly the fourth quarter, with the closure of Coburg to deal with the shortages happening in that region.

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Jonathan Snape, Bell Potter Securities Limited, Research Division - Senior Industrials Analyst [20]

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Okay. Since Koroit processed, what about 400 million liters?

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Paul van Heerwaarden, Bega Cheese Limited - CEO [21]

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Approximately. Just -- we picked it up 6 weeks into the year, Jonathan, but it was a bad order.

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Jonathan Snape, Bell Potter Securities Limited, Research Division - Senior Industrials Analyst [22]

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Okay. Great. And look, Colin, just one for you. The trade and other payables, I think, it's Note 13 on Page 58. The trade receivables facility continuing involvement liability in there $22 million. Is that like a first loss ratio or something on the new facility you've opened up?

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Colin Griffin, Bega Cheese Limited - CFO & Company Secretary [23]

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Yes. It's an event as a result of the way the facility is structured. And in liaison with PwC, we had an undertaking to record that. But there's 3 components of the trade receivables facility. This is the actual trade balance we did recognize and sell to the financiers. And then there's our 10% retained interest in that -- in the trade receivable, if you like. And then there's the obligation and undertakings of us to provide back to the banks the net outcome of the receivables that they're entitled to in that process. So those -- the cash generated from the derecognition, the balances and asset on the balance sheet and the obligations with the liability on the balance sheet all link and relate to that trade receivables to give effect to the overall financial return for the financier. The Rabobank can make the facility Rabo first and then through to ourselves for our continuing interest in part of the receivables ongoing.

Just to make that a little clearer, we derecognized the vast majority of the receivable but still have a continuing ownership interest in part of the receivable. And as the cash comes in, we offset our component of the receivable and put that into cash for the 10% or so that we retain as an interest in the receivable.

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Operator [24]

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Your next question comes from the line of Paul Jensz from PAC Partners.

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Paul Jensz, PAC Partners Securities Pty Limited, Research Division - Executive Director & Senior Industrials Analyst [25]

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Just first for you, Paul. With the product mix and responding to the price, milk prices going up, what flexibility do you got there, Paul, with the improvements that you're putting through Koroit and perhaps some of the moves you can do?

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Paul van Heerwaarden, Bega Cheese Limited - CEO [26]

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There's quite a bit more flexibility and capacity, Paul. It's worth also pointing out that, that's also provided us with significant improvement in efficiency. So we've got a couple of products that we've been making for years at Tatura, including a bit of butter and also some MPC, the milk protein concentrate powder. We've got that capability at Koroit, and we've been able to transfer the production of those 2 product streams under the one plant. So we're not sort of duplicating assets. So we've also got -- that's also provided us with good efficiencies across the supply network.

In terms of the product mix, what we're really starting to see the benefit of now is the benefit of the variety of SKUs we can get off those powder that drives at Koroit. So a lot of different-spec premium powder products that we can start to achieve good returns on out of even just the base commodity prices, which is a capability that we haven't seen in our business at Tatura.

We did a little bit of that over the years, Paul, but that's really got an enhanced capability at Koroit, which we're starting to see the benefit of. And that includes some of the growing-up milk powders, (inaudible) powders, with even just higher-spec skim milk powders, for example.

The big benefit out at the Koroit, apart from just the cream transfer that I mentioned in regards to Jonathan's question, is the retail packing at that site. So the ability to do other branded products, which we've released is covered in the presentation, but also contract manufacturing and private-label product, both in terms of 1-kilo sachets and retail butter. And the flexibility of that line is -- the capacity and efficiency on that line is certainly providing us with very good opportunities. And to the point where we were struggling to find extra capacity on that line, I think we've done quite a lot of business on it, which was picked up early on, which is positive.

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Paul Jensz, PAC Partners Securities Pty Limited, Research Division - Executive Director & Senior Industrials Analyst [27]

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And maybe the final question for me is just around the relationship with Fonterra and the court case that's ongoing. Could you give us an update there as well, Paul or Max?

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Colin Griffin, Bega Cheese Limited - CFO & Company Secretary [28]

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Yes. Paul, I can give a...

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Paul Jensz, PAC Partners Securities Pty Limited, Research Division - Executive Director & Senior Industrials Analyst [29]

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Sorry, Col?

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Colin Griffin, Bega Cheese Limited - CFO & Company Secretary [30]

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I can give you a little bit of feedback on that, generally, the relationship with Fonterra. Fonterra is one of our most substantial customers. We've been in a very close alliance with them where both businesses depend on one another's success for that relationship to prosper.

We've been -- we're, obviously, through the litigation process that's commenced a little while ago. There was a few rocky mountains in the relationship as we navigated the front end of that. But it's really pleasing to see that Fonterra has been looking for ways to very positively engage with Bega Cheese and certainly keep a strong relationship with us. And we've been very pleased with that decision. They are an important customer, they are our custodians over the use of our brand in the Australian market, and they also have significant volume they can direct to us to support Bega Cheese business in Australia.

In terms of the litigation, we continue to receive significant and strong advice as to where we're heading in this particular matter. We work very hard to make sure that we understand that advice, and we analyze its advantages to our position or issues we should be concerned about.

And in seeking and receiving and assessing that advice, we remain committed to defending the matters that have been brought against us and protecting what we believe to be our right to use the Bega brand in Australia beyond the license right issued to Fonterra. And also working hard to make sure that Fonterra is doing its best to keep the Bega brand in cheese positioned well for the future for that brand as well. Yes. We welcome continuing positive discussions with Fonterra.

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Paul Jensz, PAC Partners Securities Pty Limited, Research Division - Executive Director & Senior Industrials Analyst [31]

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Are there any timings with court cases upcoming? Because I think it was supposed to be resolved reasonably soon in the next 6 months or so?

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Colin Griffin, Bega Cheese Limited - CFO & Company Secretary [32]

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The quarterly attendance is at court and finalization of the documentation ready for that are all unfolding effectively as we speak. And the court updates the sector to have been attended and addressed before the end of the calendar year.

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Paul van Heerwaarden, Bega Cheese Limited - CEO [33]

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This is set down for November, Paul, a couple weeks. And both sides think that will be sufficient time to hear the case. But if it's not completed, we might end up going into the January races period and it might extend into February. In any event, if it does its full course with the legal case, we wouldn't expect an outcome until sort of March-April based on what we've been told.

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Paul Jensz, PAC Partners Securities Pty Limited, Research Division - Executive Director & Senior Industrials Analyst [34]

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And maybe the minor thing to clear up is, I still see Kraft sort of peanut butter on IGA stores, and they haven't decided whether they're going to come back and contest the ruling, I think. So is there any finality to that issue?

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

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I hope, Paul, you're pushing the Kraft line behind the Bega line at the back of (inaudible). Basically, the -- as we've indicated, Kraft has appealed the case, payable, so requested a stay, which basically is a way they say to the court. If they were forced to remove from the shelf today, it would be very damaging to them if they were to win the appeal. And so they received a stay, which was granted, which allows them to stay in the market until such time if the appeal is heard.

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Paul Jensz, PAC Partners Securities Pty Limited, Research Division - Executive Director & Senior Industrials Analyst [36]

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And is there a date for that, Paul?

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

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We're still finalizing this thing. There's been some changes with representation of counsel, as we understand it. And I think there's also potentially a change in the court timing. So we're still trying to find a date. We were told, Paul, that, that would possibly be before Christmas, but that may now extend into February, but we'll build -- we don't know the date at this point.

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Operator [38]

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Your next question comes from the line of Belinda Moore from Morgans.

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Belinda Moore, Morgans Financial Limited, Research Division - Senior Analyst [39]

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Can I ask a few questions, please? Just firstly, on lactoferrin. Can you just clarify, looks like you're expanding it at TMI. Where your volumes are? And then post the expansion of Koroit, where your total volumes will be?

Secondly, can you sort of quantify maybe the savings at Coburg? And then, I suppose, the savings you're targeting more broadly in '20 across the initiatives you've talked about today?

And then thirdly, just roughly, where did Koroit's EBITDA fall in FY '19, please? And how you're seeing that sort of in '20?

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Paul van Heerwaarden, Bega Cheese Limited - CEO [40]

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I want to start with the last one, Belinda, but the -- we're not disclosing separately the EBITDA of the Koroit facility. That's incorporated into the overall reporting. We will say that what we saw at the start of the year, start of the financial year, is a very good opportunity for us with the acquisition ended up playing a very important role in our network, particularly going back to Jonathan Snape's question regarding milk volumes. It provided a very important source of additional cream to support our cream cheese business. So we look at it in terms of our overall dairy network because we do move a lot of solids around, and we do optimize milk in different ways across that network, subsequently look at it overall.

In terms of your first question, we've expanded lactoferrin to an annual capacity of, I think, around 20 tonne now out of the Tatura facility.

I remember when I started with the business about 10 years ago, we've done about 8 or 9 times through that facility. So we've been able to progressively debottleneck that facility, Belinda, and get that up to this sort of level, which is about, we would say, at its highest capacity without significant additional spend.

The Tatura -- the Koroit facility, rather, which we'll expect to commission in the first half of next calendar year, has a stated capacity of 35 tonnes. So that would bring our total capacity to 55 tonnes across the whole network.

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Belinda Moore, Morgans Financial Limited, Research Division - Senior Analyst [41]

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Okay. Sorry. Just while we're on lactoferrin, how should we sort of think about the ramp-up and sales profile of the 35,000 tonnes, please?

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Paul van Heerwaarden, Bega Cheese Limited - CEO [42]

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So I wish it was 35,000 tonnes.

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Belinda Moore, Morgans Financial Limited, Research Division - Senior Analyst [43]

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I'm sorry, 35. Just 35...

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

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Belinda, you're the first person to get tonnes and dollars per tonne wrong. So if it's 35, it's 35 tonne. As we stated at the time we made the announcement regarding the investment, we had also entered into a multiyear deal with a major international company for the supply of product. And that represented a significant portion of that volume. So we will see that ramp up fairly quickly.

And without going into too much detail, we are supporting the ramp up of that product out of Tatura. So that is expected to be a fairly seamless process as we commission the plant and the offtake. So this is a large multinational company that's buying a lot of lactoferrin around the world. This speaks into their overall procurement program, and we're comfortable with that.

The additional volume, we've certainly got more demand than supply for that. And we're just waiting a few months before we make any firm commitments on all of that volume. We just want to make sure that we execute a smooth transition.

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Belinda Moore, Morgans Financial Limited, Research Division - Senior Analyst [45]

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I'm just sorry, the last question was just around potential sort of quantifying maybe the cost savings at Coburg. And then also, what sort of level of cost savings that you're targeting in the '20 year, please?

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

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Look, the -- we haven't provided the detail on the cost side, which is out of Coburg. Suffice to say that there's reasonably significant costs of running a site, notwithstanding that it's sort of a relatively small site. So we've eliminated a reasonably significant level of overheads through the running of that site and been able to get the benefits of incremental capacity through the toll processing agreement. So we're not quite in numbers, but that has been a -- that has reasonably material positive impact on the business in addition to freight savings that we've also got through the network.

The overall cost program too has had significant impacts. But it's worth noting that, that's in the context of significant increases across the network in the last couple of years with energy and insurance, in particular, as well. So overall, it's been beneficial for us, and it's been absolutely necessary for us to remain competitive.

As we look out to 2020, Belinda, and beyond, we are continuing those programs, as Max outlined earlier. But it is important as we settle down following 2 major acquisitions in Koroit and Bega Foods in the last couple of years and also the acquisition of PCA in January last year, and the implementation of the new ERP system, a lot of change has happened in 2 years. And we are certainly going into the start of this financial year looking at reviewing our overall structure and cost base. And that's not just limited to our manufacturing sites and logistics network, but also just our overheads across the business and where there are opportunities for us, particularly with the new ERP system, to start to exploit further savings in that space.

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Belinda Moore, Morgans Financial Limited, Research Division - Senior Analyst [47]

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That's very helpful. Colin, if I can just ask one more. Colin, how should we sort of view your CapEx budget in '20, please, noting, obviously, there's the growth of CapEx as well in that for lactoferrin.

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Colin Griffin, Bega Cheese Limited - CFO & Company Secretary [48]

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There's a couple of CapEx that were commenced in the current year that will carry over. The lactoferrin plan, in particular, will continue construction through the first half of FY '20 and will consume a reasonable amount of CapEx.

Having said that, that we have been spending a reasonable amount of money ongoing year-on-year for the Project One ERP software development and implementation program. And we are in the phase of go-live at the moment and dealing with the exit of the majority of the incremental cost that project will -- have been incurring. So we save a little bit on intangible investment in software in FY '20. We'll incur a reasonable chunk of the $36 million of spend for the Koroit lactoferrin plant. And beyond those 2 more material deltas, it's business as usual around CapEx. We have had an ambition to be around of that depreciation, all things being equal. But obviously, in the current period, our focus is going to be equally on making sure we've got sustainable milk supply and securing milk supply. And we're controlling costs as we do that, and we'll manage cash through CapEx along the way there as well.

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Operator [49]

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Ladies and gentlemen, unfortunately, we have run out of time for any further questions. I would now like to hand the conference back to the Chairman, Mr. Max Roberts. Please go ahead.

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Maxwell Roberts, Bega Cheese Limited - Chairman of the Board [50]

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Thank you very much. And again, our sincere thanks to all participants and to those hook up. A pleasing result for us and a result that is a result of a lot of hard work put in by a lot of people.

I should thank the staff of Bega Cheese, of which there are over 2,000 now from centers as far north as Tolga, right down into Koroit. And it's those people that have made a huge difference and made a huge commitment to Bega. Suppliers are -- farmers are -- I'm reluctant to say doing it tough because that's what farming is all about. And I must admit I'm an optimist as far as the dairy industry is concerned because I think it has a great future.

To shareholders, thanks for their support as well. And also, obviously, to the many, many customers that are all over the world.

I think we can look forward to another year of progress, perhaps more about making sure that what we've got works very well and returns those profits that are so needed. And as I say, we're looking forward to another successful year and further development of the Great Australian Food Company. Thank you to all the participants, and thank you to all those that have made this a success. Thank you.

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Operator [51]

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