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Edited Transcript of CVT.NZ earnings conference call or presentation 22-Aug-19 10:30pm GMT

Full Year 2019 Comvita Ltd Earnings Call

Aug 27, 2019 (Thomson StreetEvents) -- Edited Transcript of Comvita Ltd earnings conference call or presentation Thursday, August 22, 2019 at 10:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brett Donald Hewlett

Comvita Limited - Independent Director

* Neil John Craig

Comvita Limited - Non-Executive Chairman

* Scott Coulter

Comvita Limited - CEO

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Presentation

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Operator [1]

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Good day, and welcome to the Comvita Limited Full Year Results 2019 Conference Call. Today's call is being recorded.

Hosting the call today is your Chairman, Neil Craig. Please go ahead.

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Neil John Craig, Comvita Limited - Non-Executive Chairman [2]

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Well, thank you. It's Neil Craig here, in the room -- good morning, everyone. In the room, we've got Julianne Keast, the CFO; Scott Coulter, CEO; and we've got Executive Director, Brett Hewlett.

Before I go into the actual results, I just want to give a background to why we are 3 days later than we had announced we're going to -- that we were going to put the results announcement. With the share price below the value of the noncurrent assets and with the strategic review in full swing, we thought it was a unique opportunity to, if you like, clean the balance sheet of some impaired goodwill and sort of that process is not straightforward. So the last 3 days of -- really to go -- a function of the complexities around the good loan clean up process of several, what I call CGUs or cash-generating units. And of course, the auditors have to give technical sign-off on that route. We raced to get it there on Tuesday. We couldn't quite get there, and so we decided to give ourselves a breathing space to make sure we get everything right.

We also had a little bit of complexity around the China valuation. It's not straightforward and, obvious, boards just need to get comfortable around that we had those valuations correct. So that's a bit of a background there.

So today -- and I'm going to talk to slides that have been already put onto the marketplace, and we're going set -- we're going to mention the slide numbers as we go through.

Slide 3 is -- we're going to cover the results, including the goodwill impairments of some of our apiaries and all of the leased assets, the goodwill assets. Sales and markets, we'll cover our decent inventory position as well as cash flow and update on capital program. We'll update you on the improvements of supply business looking ahead. And Brett will spend a bit of time on the strategic review, which I'm sure you're all interested in.

So I'll now flip through to Slide 5, which is a summary of the key elements of the result. We had revenue of 171 -- sorry, $171 million versus $178 million in the prior year, and an operating loss of $7.6 million. Obviously, this was quite disappointing or extremely disappointing. As a part of the strategic review, we -- also topic I just mentioned, nonoperating charges, predominantly (inaudible) all goodwill of a net $20.1 million, most of them are apiary and all of lease assets mainly, which added together gives a reported loss of $27.7 million.

Our net position -- our debt position was lower than what we reported at the same time last year with debt of $89 million versus $92 million in the prior period and $104 million at the half year. But the pleasing point, which I'll need to point out is that we generated net $21.6 million of positive operating cash flow, and we completed a number of relatively large infrastructure projects, including the building of the new warehouse, and I think I would call that as a $14 million project, additionally in Propolis capability and capacity upgrades for our Paengaroa production facility as well as significant plantings to monitor honey plantations and also not on those notes is the day collected, which is like a clean bee breeding operational, a very high-quality business layout.

I'll flip you through now to, where are we? Slide 6 really is a -- just is a bit more detailed summary of the financial results. You can look at that in your own time. Nothing new on that page.

Slide 7, which is, excuse me for a second, yes, is a summary of the fair value of assets and the impairment. We thought it was the wise or the right thing to do, if you take through -- take you through the impairment process, we looked to -- we basically decided we'll -- with the review going through any skeletons from the balance sheet, covered and the equipment, what's really impediments improving -- with the improvement of performance of full year '20 and beyond. So we're constructively with our auditors are taking a conservative position on fair value of assets, as I said, the [non-winding] write-downs are $20.1 million and we've taken into account into last year. It's been agreed that the auditors clear the way for a more focused receipt of that strategy.

After 3 bad harvests and some very difficult trading years as a result of the great (inaudible), it was prudent to write-down the value of our apiary assets, which is in 2 parts. The one charge on the goodwill of Kiwi Bee. Kiwi Bee is the [9 albeit] a large apiary business. That write-down is $2.19 million. And also a write-down of our protracted joint venture at the top of the South Island of $2.3 million. The protracted profitability is sort of symptomatic of the bee keepers in the lower New Zealand. Profitability has been particularly impacted compared with our other apiary businesses by the changes to the MPI regulations. Now Scott is going to talk about that later on, as they are quite material in the context of our results.

In Australia, we own an Olive Leaf Extract business, we acquired it in 2007. And while this business sells extremely well in Australia, we think it's actually having a good -- really good winter at the moment. And the Board believes in the future opportunities for the product with some clinical trials on blood sugar management of cardiovascular disease for our focus so. In cardiovascular, our focus for Manuka honey in our key markets means we have lowered the short-term growth expirations for this product. And accordingly, we have written off goodwill associated with the original purchase of $15.6 million. What I'm really saying here is that actually, this is a really, really neat business for us. We just want to -- we're sort of putting it, I suppose to the side and turning our focus on honey and Propolis. But we really, really like the prospects of Olive Leaf in the long term.

On slide -- I'm moving through now to China acquisition. And very much a positive story, this one. The acquisition of our 49% stake in that China distribution joint venture on the 1st of July 2017 from our long-term partner, 4 point -- just over 4 million shares in Comvita is a significant step in mitigating the change in the regulatory landscape and providing an excellent platform for future growth and for consolidation of back-office costs in the region. Or really our 100% owned China distribution business is showing strong sales growth this financial year, now that we have greater control on pricing, marketing and the products we sell into China. There's been quite a few complexities around accounting treatment for acquiring the remaining 49%, which we had outlined in the presentation. I won't cover these now, but we are happy to answer questions on them.

The former CBEC channels that -- yes, cross-border e-commerce channels into China, such as JD Talk and Aquila have become increasingly important. There are many diagou customers now buy off these platforms rather than smaller traders.

Right. So what I'd like to now cover off, I want to just to give you a Chairman's view of the year. Now we've been discussing this morning, we will put this transcript up on the stock exchange, and we'll also put this transcript and brief, around the strategic review process up on the stock exchange announcement platform, where you've got a clear picture. I'll just read it carefully and please, listen.

To recap, we entered the 2018/'19 financial year with an optimistic view around the 2019 honey season, together with a forecast upward trajectory of sales, particularly into the U.S. and China. What transpired was: In a supply, a third poor Manuka honey production season in a row from a combination of weather events impacting production and overstocking of hives by the industry. Overstocking came from new players entering the perceived gold rush and existing apiary businesses chasing high-quality UMF honey. We reduced our fixed cost structure component of the apiary business, which is called Kiwi Bee, materially, but not enough to counter the 2 impacts mentioned. So that's the background of the $6 million loss in that business.

In response, and anticipation of the 2019/'20 harvest, which commences in October this year in Northland and runs through to February in King Country, we have further reduced our apiary costs. But more importantly, analyzed our extensive historical production data to limit hives only to sites where honey production is more reliable, season upon season. The first material quantities of our high UMF Manuka plant will also start to positively help our Kiwi Bee.

A big, but less publicly visible impact on Comvita's cost of goods, and hence, profitability comes from the MPI, Ministry of Primary Industry, certification standards introduced in early 2018, defining what can be exported as Manuka Honey. These standards, while not perfect, were materially beneficial for the industry in eliminating cowboys from exporting packed honey, but they also had some unintended consequences that impacted Comvita in 2019 -- 2018/'19. In our view, additionally MPI certification must be put in place to remove the definition of Multifloral Manuka honey. And Scott will talk about that a little bit later on, because it is a very important matter. And I'll just step through the transcript on putting out to the market, some more material around Manuka honey production. We have also anticipated the shortage of MPI-compliant honey, with positive action over 3 years on building a high-quality UMF honey inventory and only purchasing non-Manuka honey where we get -- need to in order to maintain long-term relationships. This was evident in our unimpaired honey inventory, which is currently at $132 million, which covers off honey in market.

Apart from Manuka honey held in markets, ready for sale around the world, all of this inventory is stored in our new state-of-the-art climated-controlled warehouse at Paengaroa.

On the sales side, we expected our fledgling North American sales to large supermarket chains, digital through Amazon and various other customers be in the range of the mid-$20s millions and ended up being just $13 million. This was entirely a function of being optimistic or overly optimistic that one supermarket chain in the U.S. would recommence purchase in the second quarter of 2019 financial year. What transpired was no orders until around 9 months later than expected, as a direct result of overstocking of a competing brand. Our first 2019 orders were only delivered in June this year, and we expect regular orders from now on.

At the same time, as we were grappling with no orders from our biggest customer in the states, we realized early in 2019 financial year that our own pricing strategies into China were not providing the right signals and incentives to our New Zealand and Australian diagou customers reselling into China, nor our direct customers through our 51% JV in Shenzhen, or our cross-border e-commerce platforms we were selling to directly. This exercise of realigning pricing and marketing programs involved protracted negotiations with a number of parties and wasn't complete until the final quarter of 2019 financial year. So we now have an ongoing tactical approach, so this wouldn't happen again, if you like, and to maintain a competitive and cohesive pricing in all channels into Asia.

On the 1st of January 2019, China implemented a new regulations on the diagou traders. This created added costs on diagous and a good deal of uncertainty on them of what other regulatory issues might impact their sales in the future. The impact on Comvita has been a more volatile and less predictable sales pattern through this channel. Long term, the China -- the diagou channel will remain important and a valuable outlet for Comvita products. However, this volatility has driven Comvita to reduce its reliance and diagou sales in the future.

2020. Looking ahead. The 1990 -- 2019 financial year finished profitably in the last quarter as most significant marketplace sales issues had been resolved. Even so, further hiccups in Hong Kong riots and volatility with diagou sales from New Zealand regulatory changes resulted in revenues slightly lower than we had projected. Sales in the first quarter of 2020 are already tracking much better than the final quarter of 2019, notwithstanding the quarter is a vacation time in the Northern Hemisphere, and therefore, normally our lowest sales period.

Our focus over the next few months will be repositioning Comvita to produce sustainable and growing profits. We will have some relatively small one-off costs as with the help of some outside consultants, we reposition the business for sustainable profits. This will come from, summary: Concentration of sales and marketing efforts in our core markets of China and Greater Asia and North America, while our other smaller markets all continue to contribute to profits; we'll -- it comes from coordinating our sales approach into China centered on our China distribution company, Shenzhen; reducing our overhead costs across the board, both in New Zealand and offshore; reducing our cost of goods for our core ingredients of Manuka honey and Propolis. As noted earlier, ensuring Kiwi Bee is profitable under all reasonable scenarios. And of course, we eventually start getting contributions from Manuka honey programs -- planting programs that are going on in the UMF line up.

Strategic review. Well, Brett's going to cover this off, probably, later on, but I'll just give you a short hint on it. At the beginning of June 2019, the company announced that it had to establish a special committee -- subcommittee to conduct a review of the underperforming assets of the business as well as structural, balance sheet, leadership and organizational considerations. Leader of review, Brett Hewett, who has been in charge of this, and really his comments are that early in the process, we've looked to draw any skeletons the balance sheet covered and deal quickly and any impedance to improving performance in 2020 and beyond.

I'll probably just slip through my notes on this and Brett can cover this all later on when he talks about -- specifically to that review. But you'll hear -- you'll see that it won't be until our annual meeting that we have come up with absolute conclusions and any structural changes that may or may not be necessary. On the same time as we announced a strategic review, which is the 6 of June, we announced that Scott Coulter, our CEO, will be stepping down. The Board can confirm that a search for a new CEO from outside of Comvita is well underway. The time frame for announcing a new CEO will mainly be dependent on current employment circumstances of that individual. However, given Brett Hewlett's past role of Comvita for -- of 10 years as CEO until I think early 2016, we have been very fortunate, with the help of some outside specialists, to be able to hand through to any new CEO, a business that will be unshackled from legacy assets and legacy issues and fit to produce sustainable profits.

The goodwill, as I said before, the goodwill write-down taken -- that has taken into account in our own 2019 statements is sort of all about that clean sheet process.

Finally, I want to talk about the share price, and it's a little bit unusual for the team of any listed company to talk about the share price, but my day job is being involved in the industry, and I'm very confident of the impact on individuals that own shares in Comvita. So we're very conscious of it. The sharp decline in the share price from the 1st of December in -- 1st of December 2019 until $2.60 today. The share price decline weighs very heavily on the Board. We acknowledge the share price is a function of our successively missing financial forecast or the expectations of analysts. This decline was exacerbated by our shares being removed from NZX50 Index on the December 21, 2018, based on a review of market capitalization relative to other listed companies by Standard & Poors. We estimate in fact that one day at the 21st of December, a circa 1.5 million shares were effectively for sale as Comvita shares were mandated by several institutions to be sold, simply because Comvita was removed from the S&P/NZX50 Gross Index. At that time of the year, a couple of days before Christmas holiday, until the end of the January, the stock market transaction volumes are very light, with virtually no retail investors or institutions in the market. That resulting share price overhang combined with successive negative honey season updates has weighed very heavily on Comvita shares, and Comvita shares, of course, are very illiquid anyway. Throughout the period from January 2019 through to today, restricted persons, and definitely directors and executives and other insiders have been restricted by the Board policy from transacting in Comvita share for around 20 trading days for various reasons. There has been, therefore, very limited leadership to the market from those that know most about Comvita.

So let's give you a little bit of a summary of why we've said that'd be really in the marketplace. We are cognizant that the sustained recovery in the share price will only occur, we need to gain the confidence of investors that the company will be trading profitably on a sustainable basis, and the Board is committed to achieving this.

So I'm just going to hand through to Scott Coulter now and -- to go through the right remainder of the presentation, and we'll finish off with Brett Hewlett covering off the strategic review.

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Scott Coulter, Comvita Limited - CEO [3]

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Thanks, Neil. And I'm going to start on Slide 9, for those people following the presentation. Shareholders will recall that we started to report on the operating performance of our supply and branded businesses and [more than the] marketing gain, another actual picture of performance of the 2 distinct parts of our business. As can be seen from the table, both the supply business and the branded business are behind last year's performance and that there are clear reasons for this. The branded business had the Costco pipeline full in the prior year. And as we will see Costco having started ordering from us again later in FY '19 as they worked through inventory from this pipeline following an overhang from another brand. And we also have much larger sales in Australia and New Zealand as we started to negotiate with and supply that cross-border e-commerce platforms directly. This factor was also combined with the tightening of the rules for diagou, which certainly had an impact in our second half year, and I'll talk a little bit more about that later.

And then our apiary business, good things come in 3s. So I don't know, but the third period of harvest in a row -- and that obviously impacted our profitability significantly. And again, we'll give you a little bit more flavor of apiary as we go through the presentation.

So if we move on to Slide 11, just going to give a summary of global markets and sales. And it's really important to understand currently, when we reported on our China revenues in the FY '19 year, because we were consolidated in China, the numbers reported in our headline sales numbers are simply the inventory transfers from Comvita in New Zealand to the joint venture. Although these sales appear to have increased from $12 million to $26 million, they don't give a true representation of what's going on in the China business. And the other thing, those stats move up and down with seasonal relativity, and inventory holding and are not as important as understanding what's going on in the China business itself.

We've included the sales in the China entity in the summary, so we've included both sets numbers in that summary, and we believe this is rather much more important number. It's also important to note that in FY '20, because we've now acquired the remaining 49%, we can now consolidate a report on the sales, simplifying the future analysis of performance. And from our perspective, it will be much easier and clearer to tell you how we're doing in China. Our Australian and New Zealand businesses also now includes direct cross-border e-commerce. And while this was behind last year at $69.6 million versus the prior year at $82.6 million. There are a number of factors that have influenced this change, and I'll talk more about that shortly.

In Asia, we've continued to see growth in Hong Kong, Japan and Korea. We grew our sales 12% to $41.3 million compared to the prior period, a really good result. And our sales out of North America was $13.4 million, it's actually pleasing, given the prior period included the run-off pipeline for the Costco. And I think as a result of this pipeline for Costco didn't order, as we mentioned before, until late in FY '19.

And in Europe, we've really struggled this year. We've had a poor year. It hasn't been satisfactory. Sales reduced and we've taken a number of steps to improve performance in this market, and I'll cover that in a little bit more detail shortly.

So if you move to Slide 12 on China. On the 1st of July, we completed the acquisition of the remaining 49% of the China joint venture. And as I mentioned, it's a really important step because we are able to consolidate revenues across the group. And that's really important, notwithstanding the fact we can consolidate that China is our biggest market and our largest consumer base as well. So it's a really critical step for Comvita. And the business -- the China business itself has again performed well with sales and profitability continuing to meet our expectations.

As we had mentioned before, one of our key strategic challenges has been to maintain consistent consumer pricing across the network into China, i.e., consisting of pricing across retail stores, e-commerce channels, cross-border e-commerce and the great channel from Australia and New Zealand. It's a really big challenge. That's a big challenge for all companies. And as the world gets more transparent through e-commerce, consumers are more and more able to compare pricing across different channels. We have made good progress inside China, both in our retail business, which is showing same-store growth of 8%, which is pretty good. And our e-commerce business is also -- inside China is also growing very strongly. We demonstrated double-digit growth across the key promotional periods of Singles' Day 11/11 and 6/18. Our strategy has been to strengthen our direct to China business through the China distribution company, which we now own 100% of as well as supplying a cross-border e-commerce platforms directly.

As we've stated before, we believe that more and more the China regulators will push the grey channels to officially sanction them, where they can collect tax and more effectively monitor food safety. We also believe that targeting cross-border e-commerce players directly means we will ultimately have more control of how our brand is marketed and promoted.

We firmly believe that the stronger we are inside China, the stronger that our flow and effect in the diagou market will be. We're continuing to build a strong platform for both inside China and have hired new key roles in retail, marketing and e-commerce to help drive our strategy. We've also increased our marketing investment in line with strategy.

So if you move to Slide 13, and we'll talk about Australia and New Zealand, and we do talk about these very much as one market these days. Our focus in Australia and New Zealand is to build our margins for UMF honey, so when we create demand to the Chinese consumers, that's not at the expense of lower-margin sales elsewhere in our network. We've also aligned promotional planning across China and Australia and New Zealand to ensure they're synchronized. So effectively, we treat them, as I said before, as single marketplace. Our strategy is to target growth inside China offline and online, where the Comvita brand is really strong. And also move to consumption-based sales in Australia and New Zealand. The strategy is starting to impact with the drop in Australia and New Zealand sales and they're now starting to convert to China and CBEC sales.

Over time, we expect this trend to continue with sales inside China and CBEC to rise and the diagou market in Australia and New Zealand to reduce. We're in the middle of this transition and it's been painful, but necessary. There are no shortcuts. Our future is inside China and we're determined to make it work, even though if it is at the cost of some short-term earnings. Right now, as CBEC and China sales picking back pretty close to ANZ in terms of sales revenue, and we expect CBEC in China to exceed the risk of the ANZ business in FY '20. A shift of significant proportion over the last 3 years, and when we look back 3 years ago, we had a lot of our profit and sales coming from grey channel.

So we've really started to move where our products are sold. And indeed, the regulatory pressure on the diagou has already began to play out with the first steps taken by the Chinese regulators to register and tax diagou. On August 31, the Chinese government passed a comprehensive e-commerce law that came into effect on January 1, 2019. The law specifically regulated the conduct of 3 group's platform operators, that's Taobao, et cetera; and platform operators, those that operate shops on platforms; and any other types of e-commerce businesses, including WeChat, stand-alone e-commerce sites, et cetera.

These businesses are facing increased scrutiny, paperwork and in the case of large platforms have to step up the internal procedures for particularly product authenticity and IP rights. Mom-and-pop retailers on WeChat and Taobao need to register and pay income taxes for the first time, putting them on par with local brick-and-mortar retail stores. This has driven some diagou customers to cross-border e-commerce sales channels and a number of diagou to leave the trade, and we expect this trend to continue.

So if we move on to Slide 14 in Asia. We achieved good growth in Japan, Korea and Hong Kong, and you can see that there are -- all those markets are growing nicely. Our team in Japan has been very successful partnering with the online retailer Rakuten. We're now focusing on building broader distribution, both in the digital space and in bricks-and-mortar stores, and Japan remains a really good opportunity for growth. A very big, wealthy market.

Hong Kong increased its sales distribution through Mannings pharmacy chain and 2 additional sales from 2 additional retail locations. Current issues in Hong Kong, as Neil mentioned, did affect sales at the end of FY '19 and it's definitely affecting Hong Kong sales in the first quarter, and we'll need to take steps to adapt accordingly. Korea grew strongly with good growth in e-commerce in particular. Korea has also made good progress in the duty-free market at the airport. Korea has some of the largest duty-free buyers in the world. With the completion of the China acquisition, there's some really good opportunities for back-end integration or the back-office integration to improve productivity and reduce our cost base, and this will be an FY 2021 opportunity.

If we move on to North America, which is Slide 15. While our North American sales appear to have fallen, the drop has wholly to do with the pipeline full of product and to Costco. Costco achieved $13.5 million more inventory last year than they did -- and so the year before than they did in FY '19, which affects the U.S. comparison. But if you have a look at the prior year underneath this which has excellent growth, where our sales in FY '17 were only $3.8 million. We've really had a step change in the U.S. As per our strategy, we focus on building out our U.S. distribution into the natural and specialty markets. This year, we secured 1 the top 10 natural products brokers, [President's Marketing] who will represent us in the U.S. Our sales in Amazon continued to progress, and we grew again during FY '19. During FY '20, we're going to transition from Vendor Central, where Amazon set the price, to Seller Central, where we set the price, to pave the way for broader distribution in the U.S. We have targeted the kid's market with 3 exciting new products based on Manuka honey. And our modern day Soothing Lollipops have been listed in Whole Foods, the U.S.' largest metro product retailer for our U.S. winter launch as well as greater than 1,000 CVS stores. These products are going into warehouses now for a September launch, so it's happening right now.

And Costco have begun ordering again. So we have an exclusive position with Costco in Canada and we're the only brand in Canadian stores. Canada has also been the first market to see our new packaging and our rate of sale has been excellent. Costco is one of the largest natural products and -- product retailers in the U.S. and stocks lots of premium and super-premium brands. Our strategy has been to work with Costco so to improve our brand recognition in the U.S. And I don't know how many people I have met and said, "Hey I saw your product in Costco." So it's a really good way of market entry, you get your brand seen and recognized. They are a tough retailer to deal with, but in terms of getting our footprint established in the U.S., they've been great. We expect the full year effect of both Costco U.S. and Costco Canada to be reflected in FY '20.

Slide 16, as I mentioned before, we had really disappointed results in Europe, although we think the changes we made will set us up well for FY '20. We went through quite a bit of transition in this market during FY '19 with a change in management. So now we're more focused on Europe rather than just the U.K., and we also integrated the back office with the rest of our markets to lower our cost base. In Europe, in particular, in Germany, which is Europe's largest Manuka honey market, new listings in Amazon DE and with Drogerie Markt or DM. DM's a Germany's largest retailer when measured by revenue. And our UMF honey has just been listed. So if you can check this slide you should be able to see us, where it just listed in the last couple of days. We've also several products listings [deeper] in Austria which is one of the largest farms to change there across 600 stores. So we are going to see a real transition from our business in that part of the world into Europe.

On Slide 17, a little bit about segmented product revenue. People will note that functional foods has dropped from $132 million to $108 million and stock accounts for that 78% (sic) [68 %] of our sales, but their drop was mainly to do with Costco and the ANZ sales drop, plus there is some non-Manuka honey plans in there that we've rationalized.

If we move on to Slide 18, and I'm just going to talk a little bit as well as Neil mentioned a word about the MPI standard. They brought on new regulations for Manuka honey in 2018, a new standard for Monofloral Manuka honey and new standard for Multifloral Manuka honey. Comvita supports the move by MPI to establish clear and robust management for Manuka honey, but the standard needs some changes. As mentioned, while the MPI brought on the legislation for exporters, it doesn't manage the standards for the New Zealand market. And we've been accounting the desired scenario, we don't have to have the same standard for Manuka honey in New Zealand that you do for exports. That's not a good look when you're trying to convince your trade partners to adopt and help police you new standard. Comvita adopted the standard for both export and locally made products as soon as it came in.

We've also seen the unfortunate rise of Multifloral Manuka honey, which is now growing into reasonable export volumes because it's cheaper than Monofloral Manuka and unfortunately, some consumers and export markets just don't understand the difference.

The Multifloral Manuka definition is not well accepted by our trading partners as in markets like Europe, honey is even Monofloral, so the Monofloral honey, where you can call it by its floral source, or it's not and you can't. UMFHA, the UMF Honey Association, to their credit, ensure that honey sold under the UMF banner was true to label and could only be Monofloral honey. The impact on the industry and the honey procurement market has been significant. Firstly, the high-UMF honeys, UMF 10, 15 and 20, pricing stayed relatively stable through this change, and as expected, the definition has not impacted this part of the market.

For UMF 5+, some aspects of the procurement market have changed. One of MPI's markets is called [turnip] varies in some parts of the country. And if you're lucky and have enough turnip , your honey, it can be quite valuable. In other parts of the country, not so much. The cost of these honeys has been relatively stable, but there's been a lot of additional costs for manufacturers, as testing and formulation costs increased. And as Neil mentioned before, [pre-tax our] investment in the South Island does not fare well under this new MPI standard because some of the areas where we had our apiary, it had fairly low turnip levels.

For non-Manuka honey, the definition took the heat out of the pricing but also brought non-Manuka back to pricing levels more in line with global honey prices. Prices dropped from $8 to $12 a kilogram to $4 to $5 a kilogram as honeys that were brown and looked like Manuka honey but weren't, could no longer be sold as Manuka. The impact of this is significant. All the apiaries targeting Manuka produced non-Manuka honey as (inaudible), including us. So the profitability of almost all New Zealand apiaries has fallen as a result, this is without running 3 bad winter years.

For us, the realignment of these prices, and they had -- the monofloral prices impacted -- the non-Manuka impacted our apiary performance this year, but we have really -- we have very strong demand for the this type of honey out of places like China. So now that the prices have come down, actually, we can really recreate that market, so it's a good opportunity.

And as a result of the MPI changes, competition for sites that have produced high-quality Manuka has really intensified, as have the costs of running an apiary while the revenues fell. The industry and MPI have more work to do to ensure consumers get genuine Manuka. But long term, we believe high-UMF honey is still supply limited, and creating new sources of supply is critical to the industry.

Over the last 12 months -- so at the same time, we've got lots of changes in value channels, et cetera. We have got a -- there's been quite a few people clearing noncompliant inventories in the domestic market because, of course, you could. There's been a lot more competition at the UMF 5+ end of Manuka as Multifloral Manuka impacts the Monofloral Manuka sales at this end of the market. So it's been a really tough period for the honey industry and Comvita. But long term, we believe our focus on quality and higher-UMF honey will pay off.

Now I'll just hand over to Brett, and he's got a couple of additions to that, and then we'll carry on.

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Brett Donald Hewlett, Comvita Limited - Independent Director [4]

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Look, thanks, Scott. Look, I don't -- you've covered it pretty comprehensively. I suppose just from my perspective and the board's perspective, I guess, we are all concerned, as all stakeholders and shareholders are, around any decline in the demand for Manuka honey. And there, obviously, are rumors and speculation that the Manuka honey has tanked in some way. Look, I can just reconfirm from my analysis that it definitely has not. It's stronger than ever actually, and it's actually showing amazing resilience. There's been some pretty bizarre behavior, a portfolio of brands that have entered the market and a lot of bad press, I guess, around quality and standards. There's no doubt the MPI standards have been quite disruptive to the industry, both on the supply side, so the way that beekeepers are targeting different qualities of honey, and they've had to scramble to adjust how they arrange themselves in the market, and also on the sales side. So it has been a very disruptive time.

The reality is that for a lot of industry players, less capable industry players, you could say that they have been retrenching and there have been 1 or 2 that have actually exited all together. I guess that's what probably fueled some rumors around problems.

Comvita is in a very different situation. We've been involved in exporting premium foods for more than 45 years. And over the last 20 years or more, we've been leading the global story of Manuka honey and in the process, brought considerable value for the domestic honey industry. We should actually all be reminded that it was actually Comvita's role in commercializing the IP purification of Manuka honey as a miraculous healer of wounds that first put Manuka honey on the map and so started the gold rush. The consumers' desire for Comvita Manuka honey and the willingness to pay a premium for it has not abated. So there's a lot of confidence there felt around our -- Comvita's ability to grow and push that market further and further. And as Scott said, we're well placed in a number of markets to do that.

On the subject of sort of markets and how we go, Comvita is currently reassessing where and how it sells market by market and channel by channel. We are reviewing how we're organized in each of our target markets, and we're optimizing our structures for -- to ensure consumer intimacy and profitability. We're actually very well on underway to achieving the optimal structure in our newly acquired China distribution business. This has been the first target of our review.

Probably, that's enough from me, Scott. You can pick it up from here.

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Scott Coulter, Comvita Limited - CEO [5]

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Thanks, Brett. So we're going to move to Slide 19 now as we discuss '20 inventory, debt, cash flow. So our inventory finished FY '19 in a very strong position. Our total inventory as at 31 December was $132 million compared with $116 million at 30th of June '18.

Finished goods rose to $49 million compared to the prior period of $26 million. Note, this change was due to the consolidation of the China inventory at year-end, due to our acquiring full control of the China business late in the financial year. And if you look at it on a comparable basis, the total finished goods inventory for the group would have been the same as last year at $26 million. So we haven't done a really big buildup of finished goods, we've just bought the China inventory and then consolidated it. Our service levels remain high at 95%, so we're running a pretty good supply chain.

Raw material inventories dropped from $89 million to $84 million, and it's been a focus of a high level of scrutiny through the audit. A good proportion of our raw materials are high-UMF Manuka honey. Note that it has been the third poor Manuka honey season in a row, and we're happy to have secured enough inventory to satisfy our full year expectations.

Trade receivables are down, reflecting improved collections from our larger customers. And our net debt is down to $89 million, which was $104 million at the half year and $92 million at the same period last year. And of course, we're just really at the end of quite a big capital works program, which I'll talk about. As mentioned previously, we've used debt to fund inventory and our capital program, and we will be taking a real strategic focus on optimizing our working capital. We've certainly got some more work to do to reduce our net debt over the next 12 months. But given an average harvest, we should be able to further improve our debt position.

Over the 6-month period, we have a positive operating cash inflow of $22.1 million. This was a similar-sized outflow for the same period prior year. We also invested $17.8 million in capacity building, including a state-of-the-art warehouse at Paengaroa that enabled consolidation of our warehousing activities across the group. Our warehouse has been -- largely been completed. We also acquired a stake in Apiter, our long-term Propolis supplier and manufacturer, and we also acquired a queen breeding unit, Daykel Apiaries. So it was really a unique opportunity to acquire a queen breeding unit that will really, we believe, improve the productivity of our apiary.

I'll now move to Slide 23, and let's talk a bit about the honey crop. It does feel a little bit like Groundhog Day, 3 in a row. Again, it was well down on expectations. It's been another tough harvest year that's significantly impacted our profitability. The weather and honey harvest prior to Christmas was very poor, with below-average results from all the northern apiaries that really get their honey pre-Christmas. And the post-Christmas results were patchy. But some areas like Whanganui had a really good year. So weather just plays a really important role in Manuka honey collection.

New MPI standards, as I mentioned, place additional competitive pressures, leading to overcrowding and cost pressures on wild land sites having good-quality Manuka. As Neil mentioned earlier, we have done a lot of analysis on the performance of all our sites so that we've only kept the most productive. We are double cropping a minimum of 5,500 hives this season, and we're also providing alternative sources of revenue through things like pollination where it's practical to do so. We have a timing difference for the hives between pollination and producing Manuka.

We would also note that Kiwi Bee is really important to us, but our third-party supply base also represents 65% of our honey supply. So we still outsource 65%, we aren't totally reliant on Kiwi Bee for all of our Manuka honey.

I'll move on to Slide 24 and talk about plantations. Our best defense against continuing to compete on wild-sourced Manuka honey is to grow our own with scale. We planted 2,100 hectares during FY '19 with 2.3 million trees. And in total, we planted 4,100 hectares of plantation with Manuka, which when they fully come on stream should produce combined annual harvest of around 115 tonnes of high-grade Manuka honey, a significant step change in our -- the ability for us to acquire this high-UMF honey.

Our breeding program continues to advance. We've now propagated third-generation high-performing cultivars and have 2.7 million trees currently in nurseries, ready for planting next winter.

Moving to Slide 25. On 2nd of July, we completed the acquisition of 20% of Apiter, a Uruguayan Propolis supplier for the past 12 years. This investment removes our future supply constraints for this key ingredients and provides us with manufacturing capability, including a new medical-grade laboratory and production plant.

With the combination of these in-sourced and Uruguayan-sourced Propolis, we've actually got the ability to step change our Propolis sales by up to 5x, a really big and important step. Propolis, for those who aren't aware, is a product extracted from the beehive based on plant sap from certain tree types which is used in Asia to support immunity. And Apiter is unique that it has access to good supplies of very high-quality royal Propolis with very high flavonoid levels. And the reason Propolis from Apiter is so important to us, their Propolis is very similar to what's found in New Zealand, mainly because Uruguay has a very similar latitude, so there's the same intensity of sunlight, which means that trees produce the goodies that help people to support their immune system.

We talked about -- I'll move to Slide 26, olive leaf extract. Our olive leaf extract facility, we've introduced sustainable farming practices. We've done a lot of work on it to improve our productivity, and we've got a lot of capacity to grow our supply without significant additional CapEx.

And I'm going to hand over again to Brett here just to talk about a couple of additional points.

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Brett Donald Hewlett, Comvita Limited - Independent Director [6]

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Look, thank you, Scott. Look, obviously, in Comvita's history, we've come from an environment of chronic supply constraints. And over the last 10 years and more, we've invested considerable resources to ensure that we have a secure supply of floral materials, that's Manuka honey, Propolis and olive leaf, and there's a lot of assets associated with that investment. And of course, it's been the subject of a big part of the review that I've been involved in.

Probably the first thing to highlight is that today, we have in place enough supply chain initiatives to ensure that we can meet our aspirational demands for the highest-quality raw materials for at least the next 5 years, so we're in a very secure position. As we've made those investments, though, it's probably fair to say we haven't had enough scrutiny around running them efficiently and productively, and the notion of tweaking the assets is really much where we're shifting focus. So we want to evolve the attention to taking costs out of the supply chain, improving harvest yields and productivity. Clearly, there's a lot of opportunities to improve in the honey harvest area in particular.

And when it comes to productivity improvement, Manuka honey harvest, none are better placed than Comvita. Our investments in developing the plantation model, the breeding programs we've had around Manuka honey -- Manuka trees, I should say, we're now into our third generation of plant cultivars. And we can employ -- deploy technology and investments we've made around queen bee genetics and those sorts of things also to improve productivity.

So as we transition from wild-sourced honey to plantation honey, we're already starting to see a significant improvement in yields and also the potency of our Manuka honey. The reality is that the current methods competing for the deployment of hives on smaller wild strands of Manuka honey spread over very vast areas of New Zealand, is bit by bit becoming less and less economically feasible, so we have to make that move.

Just to comment on the asset impairment because there has been -- most of the impairments have been around the supply side. I should just highlight that those are -- those impairments have been around the intangibles and goodwill predominantly. Very few assets, the core assets themselves have actually been impaired in value. But we still see the potential to extract more value from them and just improve productivity and efficiency, and the entire Board is very confident that we can very much be successful in this endeavor.

So back to you, Scott.

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Scott Coulter, Comvita Limited - CEO [7]

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So I'll just move very quickly through Slide 28 on strategy. We have 3 pillars to our strategy, obviously, focusing on raw materials supply. As Brett mentioned, we're now -- the business is shifting from building supply capacity to now focus on efficiency, cost of goods. And also moving to be forward facing, building profitable distribution and increasing our investment in our brand and marketing.

I think, Brett, if I can then just pass back to you in terms of -- Brett is going to talk a little bit about the strategic review, and then we'll move over to Q&A.

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Brett Donald Hewlett, Comvita Limited - Independent Director [8]

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Let me just sort of bring it to a conclusion, I guess. I've already taken the opportunity to expand quite a lot on what we're underway with. But clearly, we are looking at also an organizational change and a restructure, creating 2 separate business units, one under supply, which will move from being a cost center to a profit center. As I've said, try to find as many ways as we can to sweat those assets and get into a more productive and profit-making supply business. And they -- we'll also be seeking other revenue opportunities around licensing of intellectual property, ingredient sales and other avenues that we see that we can increase revenue from a supply ingredients business.

On the demand side or on the brand side, the focus here is very much around optimizing delivery to market and optimizing the way that we are arranged in market to ensure that we are getting the best possible profitability and returns from the way we sell to our consumers.

There will be a change to the way we're organized that will result from this, but we're still, obviously, working through that process. Of course, we're also in the search for a new CEO, and there are other senior positions that we also are looking to fill. We'll be able to update everybody as we get closer to the AGM.

Back to you, Neil, if you want to wrap it up

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Neil John Craig, Comvita Limited - Non-Executive Chairman [9]

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Yes. Well, that's probably about everything we wanted to put out there until we had some questions. But the only other change, which is also -- only other thing I wanted to announce today, which is already in the market, is that Murray Denyer has had to step aside from the business as director. He's a very prominent commercial lawyer and we're very lucky to have him. His health is requiring he must step aside and look after himself. And luckily -- and also quite luckily, we've had Bob Major, who lives locally. Bob is a very, very experienced director with a big, long career in China and was able to step up. So he's agreed to take a Board seat. He'll come up for election at the annual meeting, but is already, as of today, a director of the company.

So Bob, a bit of background there. Bob -- from 1983 to 2009, Bob was Fonterra's manager in China, and also he had roles in Latin America and the Middle East. But he's had many director roles, run also here at Kiwirail, Gibb Holdings, BioVittoria and Miro Trading. He's the Chair of the High Value Nutrition National Science Challenge and the Avocado Primary Growth Partnership. Previous roles with the Westland Milk Products, Sealord, Barker Fruit Processors and Chair of Mud House Wine Group.

So I'll just throw this open for questions now on anything that's been raised or anything that's concerning you around Comvita. Thank you.

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Questions and Answers

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Operator [1]

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(technical difficulty)

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Neil John Craig, Comvita Limited - Non-Executive Chairman [2]

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Can't hear you. We cannot hear you. Neil Craig here.

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Operator [3]

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(technical difficulty)

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Neil John Craig, Comvita Limited - Non-Executive Chairman [4]

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Cannot hear you.

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Unidentified Company Representative, [5]

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Is the facilitator for the conference call online? We can't -- don't have any -- we can't hear the caller.

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Operator [6]

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(technical difficulty) I will disconnect and reconnect. (technical difficulty)

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Neil John Craig, Comvita Limited - Non-Executive Chairman [7]

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There's a lot of interference on the line, and we're struggling to hear anybody, unfortunately. I don't know if anyone can hear us. I apologize for the length of the diatribe, but we thought it appropriate to spend a lot of time explaining the difficult year and the way forward.

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Operator [8]

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And I apologize for that. You do have a person in the queue.

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Unidentified Analyst, [9]

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This is [Jack] (inaudible). I'm just confirming, am I the person in the queue?

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Neil John Craig, Comvita Limited - Non-Executive Chairman [10]

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Yes. You are talking now, we can hear you.

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Unidentified Analyst, [11]

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Excellent. Fantastic. The first one for me is just sort of, I guess, thinking about the performance in the apiary. And if we go and look at the biological assets section of the balance sheet, it shows there number of hives was down around kind of 17.5%. But despite, obviously, scaling back the business, it's lost kind of $6.9 million rather than $6.2 million last year. And obviously, clearly, kind of a third challenging year, but with some kind of structural factors like the MPI definition and overcrowding it. I'm just wondering to get a sense, do you have confidence in that business returning to potential profitability in FY '20. Or is that more to do with the long run transition away from small wild Manuka sites that are likely to turn their business around.

Sorry, could you (inaudible)?

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Scott Coulter, Comvita Limited - CEO [12]

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[Jack], yes, it's Scott here. And I'll give you my view and perhaps turn it to Brett to add anymore. But we're still -- our acreage is in a transitional phase. And what we're really focused on over the last couple of years and even more change this year is building the productivity of the apiary itself. But we do see a transition of that business on to plantation sites where we believe there'll be a step change in productivity. That's only -- it was really -- those are just starting to come on stream now. What we've done in the apiary, as I mentioned, was we're trying to use the same hives and double crop more effectively, you're optimizing your capital, and we want to make sure that we target sites that give us good returns. There has been a lot of change that we've made that will be reflected in FY '20. So there were some savings last year that missed -- there is actually a better underlying performance for the apiary, and that should start to flow through. But our real focus is on -- our Kiwi Bee business is there because we wanted to produce its Manuka honey and -- but we don't want it write big -- leave ink marks over our results. So we are really focused on bringing that back to breakeven as soon as we can.

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Brett Donald Hewlett, Comvita Limited - Independent Director [13]

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And probably if I can just add, look, there is -- the change in standards and -- has meant that there's a smaller pool of good sites where you can still obtain good-quality honey. And the competition amongst beekeepers around those good sites has gotten more and more intense. So look, there's no doubt that there's pressure on the industry overall. And if it wasn't for the fact that we had plantations available to us and we weren't focusing on improving the quality of the land sites that we placed our hives on, you just wouldn't be able to get that productivity improvement that we are aspiring for.

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Unidentified Analyst, [14]

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Yes. And so is it a fair characterization in that we should think about the apiary business as being kind of roughly breakeven at this early stage in the transitional period. And then kind of progressively, as plantation Manuka and kind of other site selection and cost initiatives phase through that, that will kind of build earnings over time?

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Brett Donald Hewlett, Comvita Limited - Independent Director [15]

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That's a good way of looking at it, exactly right. That's the way we view the business. And unfortunately, we were just unsuccessful in achieving that last year, but we're a lot more confident we can pull it off this year.

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Unidentified Analyst, [16]

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Got it. Okay. That's very useful. Thinking about Costco and there was a reference to really phasing back into sales mode from June this year. Could you provide a little bit of detail on what the level of sales that is returning into Costco? And just maybe the cadence of the kind of selling cycle as well where they're kind of regularly purchasing kind of smaller quantities on a monthly basis or is that still kind a multi-month kind of process where there's big chunks of revenue that kind of phase on the various different points during a year?

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Scott Coulter, Comvita Limited - CEO [17]

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Yes. [Jack], I'll take that question. So first of all, the way that we've treated Costco is based on the consumption basis. And now we have the consumption data from the stores, so that makes it a lot easier to predict what it's going to be. Costco do order in lumps, and the reason for that is they order in full containers. And a full container of Manuka honey is something like $1.5 million. So your -- if your container goes on the 30 of the June or the 1st of July, it does make quite an impact. But -- so we're not doing consumption-based supply. They're certainly relatively lumpy, but we calculate that when we look at our outlook. I won't be able to give an estimate of what the effect of sales are other than that we've got a pretty clear view on that because we're buying consumption data from the stores.

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Unidentified Analyst, [18]

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Okay. No, that makes sense. Next one for me is, there was a reference to kind of back-office efficiencies in Europe as well as, I guess, potential costs out as you consolidate the China business and bring things into kind of a single entity. Are you able to give us a steer on what you think is achievable from a costs out perspective, either through those kind of back-office domains or, I guess, through other kind of strategic initiatives?

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Brett Donald Hewlett, Comvita Limited - Independent Director [19]

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Yes. First, if I can answer that, [Jack], look, it wouldn't be fair to speculate on those just yet. We're obviously in the middle of a review, and we'll be able to update everybody a little bit later. Certainly, close to the AGM, we should be able to give more flavor to that. But obviously, we're looking at all those opportunities on how we could organize ourselves and how we could rationalize and optimize our structure.

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Unidentified Analyst, [20]

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Yes. Understood. No, that's fine. Brett, just a final one from me. In terms of working capital and where that's likely to go from here, is there anything that we need to be aware of, either from a kind of an inventory level or kind of receivables level that's likely to track further upside from an operating cash flow perspective in FY '20?

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Brett Donald Hewlett, Comvita Limited - Independent Director [21]

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Look, we're sitting pretty well with our inventory. I know it's a little bit scary when you see the number, but keeping in mind that the lion's share of the raw materials anyway is Manuka honey, and we're very comfortable with the quality of that. We've got about roughly a year's supply in the cupboard ready to go. So as we refresh with new season's honey and so on, we're able to manage that inventory very well.

As far as any additional cash flow from that, that would only come probably if we start to reduce it. We don't see it growing much more than that. We would like to keep it well within that 1 year of inventory, raw materials that is. There will be an impact, which we're still working through to fully understand. The China business, as we combine those businesses, China JV rolling in, there is an inventory hole that we've got in China. And as we sell that through, there will be a profit elimination that will have to be wound out from that. So there will be -- unfortunately, we don't get any benefit from a profit point of view for the inventory that we sell in China that we acquired at the time of business combination. So we'll explain a little bit more about the impact of that probably around the AGM once we understand that better. I'm not sure if that answered your question

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Unidentified Analyst, [22]

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It does.

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Operator [23]

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(Operator Instructions) And at this time, there are no further phone questions.

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Neil John Craig, Comvita Limited - Non-Executive Chairman [24]

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Okay. We'll just hold it for 30 seconds in case. But look, anybody that wants to talk offline, the numbers are, of Brett and myself, on the stock exchange announcement, and most of you have Scott's numbers anyway. So just feel free to call us, and we'll be as open as we possibly can.

Just a reminder, we will -- unlikely to be any further guidance announcements until the annual meeting. And hopefully, at that point, we've got another -- a further update on the strategic review. And you never know, we might even be further advanced on the CEO, new CEO position.

So thank you, everybody, for coming on the call. And I know that was extremely lengthy, but we wanted to give as much information as we can out there. We will put some of the transcript material into the market later on today just to -- because it was a lot more lengthy than normal, and that'll give you a chance to go over it and study it. So thank you very much, everyone, and have a good day.

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Operator [25]

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This concludes today's call. Thank you for your participation. You may now disconnect.