Synlait Milk Limited (SML) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to Synlait Milk Limited's Half Year Results Conference Call. My name is Hannah Lynch, I'm the Head of Strategy and Corporate Affairs here at Synlait. I'll shortly hand you over to our CEO, Grant Watson; and our CFO, Robert Stowell, who will provide a short overview presentation of today's results. We'll then open the line for Q&A. [Operator Instructions] If you have any follow-ups after the call, please feel free to reach out to me directly. Over to you, Grant.

Thank you, Hannah, and again, welcome to our half year results and investor presentation. In terms of the key takeaways from our update today. There are 5. The first is that our two-year recovery will now take up to 3 years. And while underlying momentum is lifting in the business, the recovery will take longer than planned. The second is the operational stability and cost challenges have impacted performance. There's been a range of economic and climatic factors that have impacted the stability of Synlait's daily operations. Number three, re-registration for China market access continues to progress. We are on track for re-registration and commencement of production in Q4 of FY '23. Number four, business unit diversification builds. We've delivered strong performance through both our consumer and Ingredients business units, and we have now commercialized UHT cream up into China. Number five, executive leadership team transformation is well progressed. We are lifting the capability, the culture, and the accountability of our leadership team. I'd now like to hand over to Rob Stowell, our CFO, to take us through our financial performance.

Thank you, Grant. Good morning to all those online. There's no doubt this has been a very tough 6 months to navigate, not only the fact that we've had 4 big programs to manage concurrently with our ERP implementation project, China SAMR registration, the multinational customer Pokeno upgrade in the launch of our Ghana UHT cream brand into China, but we've also had to deal with the ongoing supply chain disruption, tight labor market and of course, inflationary pressures all at the same time. However, even with these short-term challenges, there are bright spots in our results. I'll try to highlight these throughout the summary. If we turn to Page 4, results at a glance, revenue is down 3% to $769.8 million. Revenue was impacted by our ERP implementation. NPAT is down $23.1 million to $4.8 million. However, it's important to look through these numbers as there were one-off factors in both 6-month periods. Our normalized NPAT was $8.9 million versus last year's $15.7 million. We did thereby adjusting out the sale and leaseback of our Richard Pearse Drive buildings in Auckland. They were completed last year. The second is by adding back the one-off SAP in derivative costs across both years. EBITDA on a normalized basis is down $3.1 million to $55 million. The base milk price is forecasted at $8.50 per kilogram in milk solids, which is still relatively high by historical standards. But as we all know, farmers have experienced rapid cost inflation, tight labor market and rising interest rates also. Operating cash was down $242 million to negative $125 million, again, a very big drop from last year, mainly due to the impacts of our ERP system implementation and the challenges around product release and sales. CapEx tracked down by 27% to $33.5 million. Pleasing to see there's further step down as planned. Net debt is up 32% to $518.6 million. Again, this is disappointing to see our debt come back up again after the progress that we've made in previous periods. However, a lot of this corresponds to the ERP system challenges we've experienced in the first half and also some of the cost increases that we've seen. We just turn to Page 5. This slide unpacks the results in a little bit more detail. If you cast your eyes across to the bridge on the right-hand side, you can see it takes our adjusted NPAT from last half-year to our adjusted NPAT of $8.9 million this year. I'll quickly summarize the key factors. Ingredients delivered a $2.2 million margin loss due to the volume impacts of roughly 48% less Ingredients products coming through in the first 6 months. This was mainly due to our ERP challenges, and this had a negative impact of $16.8 million. To counter that, we had positive margin impacts from the excellent skim/AMF stream returns that we received in the first 6 months. This was also in light of the strong FX gains that we had last year. So this is a really positive result, and will mean that this bar will turn into a positive bar in our second half and a big shout out to our Ingredient sales team on some excellent selling practices this year. If we turn to Advanced Nutrition, margin reduction of $1.3 million. This was again -- there's 2 parts to this. The first part is, we've had a positive volume impact of $7.2 million. This was from a further 3,600 of packaged infant formula, offset by slightly lower [ letter ] volumes in the first half. The negative margin impact of $8.1 million is driven by a couple of things. Firstly, the lagged nature of our pricing -- infant pricing model. Also the large increases in manufacturing overheads across people, milk [ leach ], energy and R&M are really hitting this business unit, offset by some higher volumes of base powder. So again, disappointing to see that with a down arrow, but mainly due to this rapid cost inflation that we're seeing coming through. Consumer Foods, which includes Dairyworks is a really positive story. We've seen a $9.4 million margin growth here, and really good to see this part of the business performing better. The main explanation here is we've had a large margin uplift, which is down to several factors. One, the pricing mechanism is working for us this year as opposed to last year, where it worked against us. The other factors are operating with much lower overhead costs and the ongoing idling of the Temuka cheese plant has had its full effect coming through into this year. So it's a really good news story there. Milk trading, and look, this area is becoming more and more important for us as we trade milk in both the North Island and the South Island. And also this year, it's -- we've had a lot of cream sales due to the fact that we're pushing our skim milk powder lead bucket. Again, this is -- these contracts have performed well for us this year. The sales -- the adjusted sales SG&A costs have increased $11.6 million. We'll come to this in another slide shortly, but the material drivers are really across employee costs, travel, insolvency, logistics and general inflationary pressures. We've also split out the recurring ERP costs. We've estimated the ERP system is going to cost us around about $10 million per annum, $6 million of which is depreciation and the other $4 million is really around support costs and licensing. So there's a $5 million that we've pulled out for this half. And of course, interest costs. The interest costs have really increased mainly due to wholesale interest rates lifting, and this doesn't include the fact that we've increased our inventory levels due to the ERP implementation. So there's a fly-through of the half-year results and the key moving parts. If we move to Slide 6, revenue and sales volumes. Overall, the reported revenue was down 3% or $20.8 million. This slide simply gives more detail on the key movements, so I won't dwell on it. Other than to say, you can see the most dramatic drop comes from Ingredients being down 41% to $172 million. Also to note is our Advanced Nutritional business revenue was up 32% or $56 million. We turn to Page 7, reduction and inventory volumes. Overall production reduced 5% or 6,500 metric tonnes. This was mainly due to the Ingredients volumes being driven down by higher production of infant base powder displacing Ingredient products. Also, our milk process was down 1.6% due to us maximizing the skim milk powder lead bucket, meaning we sold Synlait Cream to other processes for periods during the first half when we were at capacity. Closing inventories were up 22% due to the ERP challenges constraining sales in the first half. We've now got those challenges well under control. In Advanced Nutrition, there was a healthy increase of 110% in volumes for both consumer packaged and infant base powder production as we successfully supported the a2 Milk company, both for sales and stock build for the SAMR registration date. In Consumer, we had a relatively stable volumes of production. In foodservice, we made 328 metric tonnes of foodservice UHT cream as we started to commercialize this business. Reports back from market are that the product is of a high quality and demand is very strong. Hence, we expect a much stronger second half volume build. Raw materials inventories are up 62% due to the following 3 reasons: Cost of raw materials have been pushed up significantly by global inflation, highly also, predicted base powder manufacture, customer is preparation and cheese holdings requiring another 25% of volume holdings. We also increased our safety inventory in some areas where we were seeing risk. We turn to Page 8, gross margin performance. In total, our gross margin was up 18% from $12.6 million on last year. This is another bright spot in our results, now sitting at $81.7 million, up from $68.1 million last year. This slide really repeats a lot of the SAMR information that we have on Pages 5 to 7. However, it gives more detail and shows the impact by each business unit on a per metric tonne basis. So I won't go into further detail on this call but the information is there. Page 9 is really explaining what's happened to our cost. So you've got the SG&A cost and the manufacturing cost performance. So as mentioned earlier, we have been impacted significantly by rising costs, and we've given visibility to what is driving the makeup of those costs in both manufacturing and SG&A. And in short, there are many reasons, but the main themes are as follows: we have increased our people costs in response to a very tight labor market, we're somewhat felt in it necessary to give market-based pay increases to retain and attract new talent. Supporting the a2 Milk company with Stock [ through ], we employed 3 extra shifts to meet the demand required by the 21st of February and ongoing. We've also started to build resource and the readiness of our Customer Is Business and open eye, and we've continued to make changes to our executive leadership team. We have had extra costs incurred on our ERP implementation. While we went live on the 1st of August, we've had to spend more than anticipated on hypercare and stabilization phases of the project, this was critical as we sought to assist staff get product out the door. While there are several other factors such as increases in travel, higher levels of R&M due to a couple of one-off events in -- and the overwhelming driver to our costs have been pushed up by strong inflationary pressures. The key focus over the next 12 months will be how we can further mitigate these increases in costs. If we turn to Slide 10, our cash flow and net debt. Look, I'll be blunt, cash flow and net debt reductions have been challenging through the period with either constrained sales, increases in costs and further invested in raw material inventories. This has meant our debt has risen $176.7 million from where we were a year ago. And saying this, while we feel like this is kind of 1 step forward and 2 steps back, we still remain comfortably within our banking arrangements. Key points to note on this slide, our operating cash loads were $242 million down on the previous half year due to reasons already mentioned. We have continued to reduce capital expenditure. We have wound up our ERP project and are in the tail end of the works at Pokeno upgrade. Operational CapEx came in at a similar level to last half year, which is around about $18 million. Net debt is up to $518 to $518.6 million since last July. This is high due to the timing differences and Ingredients business, inventories of raw materials and cost increases. While we have been comfortably within our limits reducing this debt level is important to us as we continue to be a focus in the medium term. You'll also see that we've given some guidance around our debt ratio, we're now guiding to between 3x and 3.5x for FY '23. And as to our guidance statement just over a week ago, we see EBITDA being lower and debt being higher as at 31 July 2023. In regard to our banking facilities and debt structures, our banking syndicates made up of both ANC and BNC have continued to be hugely supportive over the last 6 months. We have our facilities up for renewal at the end of this year and our retail bonds a year after. We are well into this review on how we optimize our debt funding models over the few years. To be clear, to the audience. We are not looking at equity options. We will be able to give you more details on the direction of our thinking at our Investor Day on the 8th of May. Look that's a wrap on the financials. I'll hand back to Grant to take us through the business update.

Thanks for that, Rob. I'll start off with an update around our Advanced Nutrition business. We had Naiche Nogueira join the business as Director of Advanced Nutrition in January. He is already making a fantastic impact within this business unit and across the leadership team generally. In terms of our multinational customer, at Pokeno, operationally, the site is now ready to go. There has been a delay, however, in terms of our first lot-to-stock. And this effectively is a result of a change in customer phasing from current source origin to SAMR manufacturing. From a CapEx perspective, we continue to be on track as previously communicated. Lactoferrin demand remains strong as does pricing. In terms of Nutritional-based powders, we're working through a number of opportunities both in China and in the Southeast Asia as well. One of the things that Naiche and his team are working through at the moment in terms of base powder is a full market mapping and segmentation exercise as it relates to channel, category and geography. And we'll give you more of a sense of that at our Investor Day on the 8th of May. In terms of consumer-packaged infant formula, we continue to work very hard and well with the a2 Milk company to help enable the growth, and very good examples of this would be their growth plans for the China market, but also opportunities into the U.S.A. A brief update on the SAMR re-registration process. Currently, we're expecting the audit process to be completed in Q3, that we would get our re-registration and commence production in Q4 and the product would be in market Q2 of FY '24. In terms of Ingredients, as Rob mentioned, the shipping of Ingredients products was very much impacted in the first half and especially in the first quarter of the year. What I can say is our shipping rates are back to normal levels. And in fact, in January, our shipping rates were near an full-time records. The Ingredients organization delivered very, very strong performance. And in fact, gross margins 81% higher in the first half of this year compared to the first half of last year. We're expecting all products to be shipped and sold to take place in the second half of this year. In terms of customers and forward focus, we've signed up a major Chinese customer from an Ingredients perspective already in FY '23, and the focus there is to find the right balance between contracted customers and selling on the spot market. In terms of consumer, Tim Carter, who is the CEO of Dairyworks is now also the Director of all consumer products that are produced at Synlait, and that ensures that we've got greater coordination and greater utilization of capability across the business. Dairyworks continues to deliver very, very strong market share performance. We've seen a $1 million savings for this financial year over last financial year as a result of the new warehouse and distribution center that we put into play last year. We continue to idle the Temuka Cheese plant and plan to have a clearer view on the future of that site in the second half of this financial year. In terms of our beverage facilities at Dunsandel, we've had very, very good engagement with a number of multinational customers. And in terms of consumer beverage and foodservice cream, we expect to have this facility 70% utilized in FY '24. From a foodservice perspective, Abby Ye joined the business in March and is already making a fantastic contribution to the business. Abby heads up foodservice, but also heads up the China market geography. We've commercialized sales into China for the JOYHANA foodservice cream, and we're expecting a strong ramp-up of that in the second half of FY '23. And just a reminder, our partnership is with Savencia, and many of you may not have heard of Savencia, they are, in fact, the 12th largest dairy company in the world. Similar to that of Naiche, Abby is going through a process at the moment of completing a full market map and segmentation of opportunities as they relate to China and foodservice, but also across our other 3 business units. In terms of on-farm excellence, for the first time, this role now sits at the leadership team level. So Director of On-Farm Excellence & Business Sustainability is with Charles Ferguson, Charles joined us in early February. So a real focus there, not just on milk supply, but driving very strong relationships with our farmer suppliers. In addition, we have formed a Synlait farmer supply leadership team, which we're working very, very closely with ranging from the strategic direction of milk supply, but also in terms of prioritizing -- sorry, the key technical execution that we need to focus on. Worth acknowledging also is Cyclone Gabrielle and the flooding events in the North Island that took place in recent times, certainly from a safety perspective, albeit it did have a significant impact of our team, both in terms of Synlait and farmer suppliers were safe and accounted for, but acknowledging the challenges with roading, Internet and power outage disruptions. We collected all milk and more importantly, ensured the welfare of [ Kalson farm. ] I can briefly touch now on priorities and outlook. We remain very, very focused on our key priorities. Nothing is more important to us right now above and beyond health and safety and food safety than ensuring that we get the SAMR license through for the benefit of the a2 Milk company and ourselves. But also ensuring, as I've mentioned, supporting the overall growth agenda of the a2 Milk company. On boarding our multinational customer Synlait, Pokeno is a key priority, making sure that we move from stabilizing our SAP enterprise resource platform to actually delivering benefits that were always intended with SAP, improving operational stability, and we've touched on a range of different dynamics there that we're working hard to address. And of course, ensuring that we've progress our ELT transformation to lift capability culture and accountability of that team and to have that cascade through the organization. Lastly, if I can touch on our guidance statement. As we updated the market on the 17th of March, the guidance we're providing is net profit after tax between $15 million and $25 million, acknowledging some key challenges across the business with Advanced Nutrition demand, operational stability and the impacts of our ERP go-live. But also, it's important that we do call out the strong momentum and performance of our Ingredients business and our consumer business and that we're now underway with our UHT foodservice cream. We will continue to manage a range of risks across the business and certainly not limited to the SAMR re-registration, the UHT volume ramp-ups, on-boarding the multinational customer at Pokeno, a very tight labor market and operating in -- with very high inflationary cost pressures. Of course, these factors could impact Synlait's current guidance, and we are working very, very hard to ensure that there's more upside than downside. We'll look to provide a further update on our performance on the 8th of May at our Investor Day up at Pokeno. And just finally, a reminder of that agenda for the day, the opportunity to take a tour through the site. There will be presentations from each of our executive leadership team, and there will be a governance session with our Chair, Simon Robertson. So on that note, I'd now like to open the call up to questions.

[Operator Instructions] Your first phone question comes from Matt Montgomerie from Forsyth Barr.

I might just start with quite an open-ended question. I'm just trying to further understand the events of the last 3 to 4 months, a little bit more. If we cast our minds back to early December at the AGM [ Southern Island ] business was churning along okay. Late December guidance was that it would be constrained to the first half, and it was more or less a timing issue. And then the reasonably material downgrade came last week. It appears to be Advanced Nutrition driven. So I'm just trying to understand further the mismatch here between, I guess, what you're saying and the fact that you're key customers' guidance hasn't really changed. And just a broader explanation on this dynamic, particularly the margins within that business, and why they're so depressed versus history? And despite the last results, sort of reiterating that you think you can get back to normal levels for that business line?

Yes. Thanks, Matt. Let me kick off with an overview of your question around demand and then I'll hand to Rob in terms of margins. So 2 factors have played out in terms of demand reduction. One is a reduction in demand for this year. The other is a delay in go-live with our multinational customer. And so if I can talk to the latter first. Effectively, in the last couple of weeks, it was confirmed to us that there would be a delay in go-live, and that's just to do with how that's configured the first markets that we'll start selling product into. So that's recent news to hand it in terms of the majority of our demand in Advanced Nutrition obviously comes through the a2 Milk company. We had an indication in late January that relative to the demand forecast, we're working with that, that would be reduced. That was formalized during February. And the process that we ran there is that we took those formal demand signals, ran them through our integrated business planning process, looked to understand the impact of those. Some pressure testing, as you can imagine, with the customer, an update of our forecast and then as soon as we've done that, we informed the market. It's worth making 2 points really clear. The a2 Milk company have not reduced their demand forecast with us post them going to the market with their midyear results. So just to be crystal clear on that. The second, and it's a little bit more complicated, but the shape of our P&L and the dynamic of our P&L is very different from that of the a2 Milk company. I'll give you one example as it relates to the volume component of the P&L. We have 4 volume factors that create value in our business. One is making base powder for the year we're in. The second is canning the product. The third is selling that completed product. So that's within this year. So we had a demand reduction there. And the fourth dynamic is we have a view on the first half of our next financial year. And that determines what base powder we produce this year. And relative to the numbers we were working to, we reduced our demand in that space. So our dynamics are very different. The shape of our P&L is very different. We've gone through a robust integrated business planning review. We've gone through a robust forecast update. And as soon as we completed that exercise, we informed the market of the impact of that review.

Thanks, Grant. I'll just talk to the margins. So, first of all, there's quite a few moving parts here, Matt. The first thing I'll touch on is the way we run our costing models at Synlait is we run a counterfactual model. So what that means is our ingredients costs are driven off a theoretical ingredients producer costs. So we adjust those costs each year by normal rates of inflation and various other things. What we've seen this year -- and the other key point I'll make is all other costs get routed through to the nutritional business. So what's happened this year, we've had a number of costs less, mainly an employee cost but also in a whole lot of other areas. So the nutritional business unit is getting lumbered with those costs. That's the first piece. You can argue whether theoretically that's the right thing to do, but that's how our costing models work here at Synlait. The second piece is with the rapid increase in raw materials and other input costs, they have -- our pricing models work on a lag basis. Those -- our pricing doesn't fully cover those. Initially, that will wash through over future months. So our margins have been, I guess, have been squeezed through that process as well. So they're the key factors that have squeezed our margins in nutritionals.

Great. I just ask one more and this is obviously for you, Grant. I just want to sort of double click on the comments around forecasting mechanisms or your business integration plans within the business and just acknowledging that there's been a couple of instances of this over recent time. Yes. I mean, I suppose it's particularly important to is the business that tends to diversify. Just trying to understand exactly what is going on behind the scenes and the work that is done or you guys conduct through this demand signaling or forecasting process?

Yes. Look, we run a monthly rhythm, Matt. So we pick up demand signals effectively on the first day of the month. We then work through a full demand review. Then we work through a full supply review. Then we do a reconciliation of both, and that includes an update in numbers. And then we finish the month off with a management business review, which effectively looks at historical performance, but more importantly, a view of future performance. So that runs over a 4-week cycle. The other thing that we have in the mix there is a product management review, which effectively looks at our innovation pipeline and available capacity that we have across all of our plants. So it's the Oliver Wight Class A program that we operate to, and it does the heavy lifting. It's a very robust process.

Your next question comes from Adrian Allbon from Jarden.

Just, can you hear me okay?

We can.

Maybe just to simplify -- I mean, it's obviously a reasonably long and sort of complicated answer to Matt's question, but if we were trying to attribute a $30 million NPAT change, which is roughly $50 million debt down to $20 million. Like -- and just listening to what you're saying and also just going through your statement, in terms of [ loose ] buckets, could we put $10 million against the SAP event, like sort of split 50-50 OpEx and sort of revenue loss? And then sort of if I do that, you can -- and then sort of the inflationary interest costs another 15% and then sort of the demand change, multi-net stuff about $5 million. Would that -- is that sort of broadly an okay split of the 30%?

Yes, Adrian, I'll have a go at this. Look, what I will say is roughly 75% of the impact here is due to both demand and related production changes that are required. And I'm not just talking about demand, obviously, for this financial year, but I'm talking about demand in FY '24, which we look forward at and when we're making our base powder decisions, as Grant mentioned previously. We have had a big impact from SAP and inflationary stuff, but it's probably more in the -- around 25%, maybe somewhere between 25% to 30% sort of range. If that makes sense, they're the buckets that we're working to.

Okay. So it's around the other way then to sort of -- yes okay. So sort of less than 10% on the SAP and 20% on the sort of -- 20% on the change in demand and then the inflationary stuff punching through?

Yes, correct.

Just in terms of -- obviously, the debt is pretty high. Just going through some of that stuff as a kind of like broadly speaking, there's about $40 million of that related to the increase in a2 inventory and then sort of [ ACM ], the sort of finished goods across the ingredient side, which is obviously related to the SAP stuff and hopefully, you're trying to work down quite quickly.

Yes. Most -- a lot of it -- the number that you're talking to sounds closer to the on the Ingredient side. There's kind of 3 buckets that I've been working to; one is, obviously, the ingredients phasing, which we absolutely expect to catch up in the second half. The second is we actually have paid out more advanced rates to farmers this year also than we had done the previous year. So that's a component and the few components around the costs increases and obviously, a little bit on the interest cost as well. So they are the 3 buckets.

Okay. And then just coming back to where Grant started, I suppose, with the sort of the 2-year recovery now 3. Like out of the sort of -- out of that attribution stuff, like what are the elements that run on into the sort of the 2 becoming 3? Or what are the key ones for us to sort of be aware of?

Yes. So I think where I'd start is you've got, obviously, your demand, essentially what's happening is our demand is kind of delayed or moving out. So that's the first component. We have obviously started to set up our cost structures in FY '23 to service slightly higher demand, so we need to -- we'll have to manage it true. At the same time, we're seeing underlying costs move up quite aggressively. We hope we can try and manage that, but that's the case. And then we've got the interest costs kind of coming in on that higher debt level. So that is obviously offsetting with some really good performance in the Ingredients business and Consumer Foods business. But it's really probably from what we expected, Adrian, around demand slowly lifting up year-on-year. When we started this recovery, it just hasn't really picked up or it's been delayed from what we anticipated. We also haven't seen the base powder business, which we've spoken about with regards to China, getting some of that base powder business that hasn't eventuated as quickly as we kind of expected or anticipated.

Okay. And then if I can just ask 2 final ones. Just on your lower base powder, I guess, into first half '24. Is that like -- is there a macro view around birth rates? Or is that more of a function of cycling off this inventory sort of crossover for the label changeover?

That's clearly an update from a2 around their customer demand relative to what we had in our model. So in terms of market dynamics and market growth, and we're talking 5 months out next financial year, a2 Milk Company are better to talk to what they believe will play out into this year and for next year.

Okay. And then -- sorry, just on the Pokeno customer, just obviously because it has slipped a few times. Like what commitments do you actually have like for that starting up at the end of the year and obviously critically into '24, what sort of contractual commitments do you have?

Yes. Look, we can't get into the details of the contract, but that's got really, really strong demand signals, and we play a really important part in terms of providing that supply to them. So look, as much as there is a delay by a quarter, which we're not happy with. It is what it is. And our challenge is to work with them to ensure that we catch up lost volumes within the first year or 2 of that go live.

All right. I'll leave it there. I'll be stuck on a few more.

Your next question comes from Stephen Ridgewell from Craigs Investment Partners.

Just a first question on the FY '23 guidance range for $15 million to $25 million. Just wondering if you can share with us a little bit more the early answers you've made for continual inflationary and cost of debt bridges in the second half? And are you confident that you've now made sufficient allowance for those pressures.

Stephen, Rob here. Look, yes, we have. We do anticipate there being probably some unknown cost that might pop out in the second half. And so we've allowed for that. We've allowed for some mix revision for revenue and cost around stabilization for SAP and those sorts of things. And saying that, and it's in our guidance statement, there's still a lot of moving parts here. We're ramping up our UHT cream business. We're going through the December order process, and we're building inventory for a2 on that. There's a lot of pieces which need to come together. So that's why we've been cautious with our guidance range.

Okay. And then maybe just one more for you, Rob. You had to provide a little bit more comfort that someone is on track to get the net debt to EBITDA down to 3 to 3.5x. I know that's in your guidance statement. But from our back of the envelope numbers that implies net debt of around about $350 million to $400 million, down from sort of $518 million or so you've just reported. I mean how do you kind of bridge the net debt from where you are now to the kind of lower number in the second half? I know we had some seasonality in the business, but I think it maybe a little bit more explanation would be helpful to provide that comfort around your finances.

Yes, It's a good question. Look, the $350 million to $400 million range, you see it being at the higher end of that range. We will see -- we haven't sold much ingredients in the first half. We need -- that will come through in the second half and would debottleneck those constraints there. That will come through. And we do also have quite a bit happening in our second half with regards to production of base powder production of Lactoferrin sales. So there's quite a lot of activity there. We are conscious that we've also got higher costs coming through, but we've modeled it all out. That's where we think it's going to land. So we're fairly confident we'll hit within that range.

Okay. And maybe just one last one for me for Grant. I mean I guess just following up on Adrian's questions around the Pokeno and you attributed it to the customer delaying when they want to ramp up. I mean, can you just -- just very -- can you give us some confidence that the delays at Pokeno have not any kind of production issues at on the Synlait side? I mean is Synlait able to produce the plant-based infant formula product of the quality and volume that your customer requires. Can you give us some comfort there, please?

Yes. Good clarifying question, Stephen. We've jumped through every hurdle, passed every audit to date, and we are good to go. So the next big milestone for us is first blocks of stock and then looking to ramp up. And again, look, we're disappointed in the delay, and we will push hard to recover that volume within the first year or 2. But operationally, we're good to go.

Okay. That's helpful, Grant. And then I guess -- and I appreciate this [indiscernible] relationship, and it will depend how quickly that customer ramps up. But if all goes well from here, would you hope to be pretty [indiscernible] at Pokeno by some point in FY '25? Is that what you'd be planning for?

Yes, Stephen, I'll answer that. Look, obviously, there's a lot of water to go under the bridge, but yes, FY '25 would expect to be very -- quite a lot follow are at the moment, that's for sure. But we see our projections show a steady build from FY '24 into FY '25 is the best way to explain it. The numbers are good, solid, robust numbers.

Your next question comes from Nick Mar from Macquarie.

Just following up on the sort of base powder impacts. Can you just remind us, sort of, I guess, how much color a2 gives you in terms of forward demand versus what you guys have to make assumptions on? We obviously went through this in FY '21, which was part of the problem, and you sort of [ see ] the line your process is to take less risk, and it seems like there's been a challenge there again. Can you just talk through that in a little bit more detail?

I won't get into too much detail Nick. But look, we get -- the arrangement we've got with a2 is that we get a 12-month rolling forecast off them every month. So that's what we work to. And if the information changes, then we change our models accordingly.

Right. So in sort of January, February, you would have had out to February next year. So you were just taking a view on the balance of what FY '24 in terms of what you were producing for ahead of their demand and hence, changing downwards?

Yes. In terms of base powders this year, this financial year for next year, it's more around understanding the second half of this calendar year. So less about the first half of next calendar year. So as I said, we work through an update of the demand from August through until December and off the back of that relative to what we had in our model, we have reduced our base powder production in this financial year.

Yes. So just to be clear, you already had an update from a2 for that part of the August to December, but then your model was already telling you a different number to them and you had to revise it down or the a2 model came down towards a number lower than what you had already previously had. It just doesn't add up if you already had 12 months of data, and you're saying that you've taken too optimistic a view previously and had to revise that down for a period you already had a forecast from a2 from?

Yes, I'm not quite sure where you're going with that Nick. We had a view of demand that we were working to -- for the a2 business, let's just say, for the entire calendar year. Late January, we got an indicative update that was firmed up in mid-Feb. We reran the numbers and effectively that related to a reduction in demand for the second half of this financial year and the first half of next financial year.

Okay. And then just in terms of the ingredients, is the majority of that contract you haven't taken the price risk on the excess inventories?

Yes, Nick, Rob here. It is. So we're about 95% contracted at this point in the year. So really, the big job for us is making sure we get that product on ships and export it before July.

And have there been any sort of kind of penalties from potential delayed shipments of that -- those orders due to the SAP issues you've had?

Really good question, and we were concerned about that, particularly in the first quarter, but we've managed to write that out with no material discounting or cancellation of contracts, which is pleasing and probably testament to the relationships that we've got with those customers.

Your next question comes from Marcus Curley from UBS.

I just wondered if we can talk a little bit about the costs, like to be fair, when I look at the result, the costs look to be a much bigger delta than the volumes. And yes, I'm sort of interested to understand a little bit more about whether all these cost increases were effectively planned. So specifically, I just wonder if you can talk to the increase in SG&A and SAP costs. So that lift of $17 million in a half, you would expect to annualize that into the full year and then ongoing?

Yes, really good question. Probably the best way to explain it is we did plan for a lot of these costs. So we knew we were going to do an SAP implementation, we knew it would be a wee bit bumpy, but actually it turned out to be a lot bumpier than we first anticipated. And so those costs definitely increased. We also had some higher people costs, but just not to the extent that we've seen come through. And then we've had other areas like energy, our milk collection because of the fuel costs. We've also had the CO2 shortage and those costs have really probably come through higher than anticipated really. And so my view on these costs is, obviously, some of these will have to continue with into the future, but there's a lot of work that we could go and to see how we can do things differently, to see how we can take cost out, et cetera, going forward. So that's a piece of work that was started and we'll carry on into our budget process where we do a zero-based budget approach as well.

And so just for the guidance, is it fair enough to assume that yes, the $17 million is annualized?

No, I wouldn't annualize it. I think there is an element of one-off in there, but we need to work through it, do a little bit more work on it.

And I suppose the other element of cost increase came through the nutritional gross margins. And I just wondered whether you could call out, Rob, how -- what the quantum was when you talk about the delays to the adult product and the nonrecourse costs, which have gone up, first time I've heard of nonrecourse costs. But could you call out how much collectively those were, which were obviously within the gross margin?

Probably, I don't have all those numbers absolutely to hand, but what I will say, some of our traditional pricing contracts, we have the ability to pass on some cost to the customer around raw materials and such and other costs that we can't, so they sit with us and so that is obviously impacting us here. We also have an element of the increase in the cost, you could argue, should be allocated to the Ingredients business unit, the way we account it has gone through into nutritionals. Most of it's gone through to the nutritionals actually. So we simply need to just try and manage these costs and make sure at least that we can either reduce them or manage them such that they don't continue to erode margins going forward.

And I see in the notes just on the gross margin or cost of goods sold, there's a $7 million increase in provisioning, which sounds like it's all related to nutritional both infant formula and adults. So, yes. Is that going to repeat? Or is that sort of a one-off limited to the first half?

Yes. No, that's in the financial statement. So debt related to -- and it's in the financial statements, actually debt related to essentially some raw materials that we wrote down because they were either close to expire or expired and as a result of the past demand fluctuation. So we should not see anywhere near the level of that sort of provisioning going forward, both because we see -- we've got demand at least either stable or increasing rate. We've got new customers coming on board, and we'll manage that far better with our new ERP system as well.

The other call out within that is production issues with trials. One would assume that's the new adult customer. And so is that the same sort of bucket of costs, which you're referring to when you talk about the costs associated with the delays to the start to the adult?

Look, a lot of those costs, you're right. There is a lot of costs which through these projects that aren't all capitalized, both for the customers' project and even the SAMR registration process. However, we do try and capitalize a lot of these trial costs to the balance sheet and amortize them over the length of the registration. So that's generally how we account for it. Accounting rules dictate that we actually we can't you can't capitalize 100% of those costs. So there some of those costs are washing through as well.

And then just secondly, I suppose, when you provided the update a couple of weeks ago, I suppose it was an expectation of some level of extra detail around what you're assuming around infant formula volumes. Obviously, nothing as I can see within the release. I just wondered, you want to talk to what's in the guidance for infant formula volumes or whatever else you'd like to point to, but I suppose it sort of felt a little light in terms of disclosure around there relative to what we said previously.

Yes. Look, at this stage Marcus, we won't provide any more granularity in that regard. We'll certainly look to provide more of an update on the 8th of May. The critical component in all of this is for us to be really clear on all elements of demand across the 4 business units, and we've got some more work to do to make sure that we're really confident around what that looks like for FY '24 and beyond. Thanks for that Marcus. I think we've got time for one more question. Otherwise, we'll leave it at that. Thank you very much.

Your next question comes from Richard Barwick from CLSA.

Grant and Rob, just wanted to clarify, I guess, with the talk that this is the 2-year turnaround is now 3 years. Can we actually -- or do we need to change the definition of what this turnaround actually looks like? So previously, you couched it in terms of an NPAT back to a pre-FY '20 level. So roughly $70 million or $70 million plus is what the turnaround should look like. But in some of the drivers that you're talking about all the factors you're talking about operating costs being up significantly. So does the turnaround NPAT, -- is that still the right level to think about it? Or do we need to adjust that down for these higher operating costs?

Yes. Thanks for that question, Richard. Let us give you a clearer position on that when we get together on the 8th of May and look, I acknowledge that previously we talked about an exit run rate from this year related to historical profitability in FY '19. And look, I think we need to let that go. Let us work through particularly the demand elements of our forecasting and give you a clearer position of that in early May. Great. Thank you for your time today. We look forward to connecting with many of you on the one-on-one calls and meetings we had planned throughout the week.

Thank you. There are no further questions at this time. That does conclude our conference for today. Thank you for participating. You may now disconnect.