The a2 Milk Company Limited (ATM) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the a2 Milk Company Limited Fiscal Year 2020 Results Conference Call. [Operator Instructions] I would now like to hand the conference over to David Akers, Head of Investor Relations. Please go ahead.

Thank you, and good morning, everyone. Thank you very much for joining the call today. On the call, we have our Chief Executive Officer, Geoffrey Babidge; Chief Financial Officer, Race Strauss; and Susan Massasso, Chief Growth and Brand Officer. We also have in the room in Sydney, Lisa Burquest, our Chief People, Safety and Sustainability Officer; and Jaron McVicar, General Counsel. Dialing in also is Peter Nathan, our Chief Executive from Asia Pacific, and we also have our other ExCo members on the line as well. Geoff and Race will present our full year results. And as always, there'll be time for questions at the end. And with that, let me hand over to Geoff.

Well, thanks, David, and hello to everyone. It's great for us to have the opportunity to have this call with our shareholder and investor group this morning. Well, look, clearly, we, as a company, are very pleased to report that the a2 Milk company made significant gains in revenue and earnings in FY '20. Particularly, we had strong performances across all key product segments and across all key markets. I'm making reference to Slide #5 in the pack that's gone out, which obviously indicates that our total revenue was $1.73 billion, an increase of just under 33% and EBITDA, $550 million, an increase also of the same amount. This is clearly an excellent result and in line with the guidance we provided in April. In fact, can I say, excluding the discontinued operations from the U.K., our EBITDA margin was 31.9%, which was at the higher end of guidance. Operating cash flow was strong at $427 million, and we had a very pleasing closing cash balance of $854 million. You will note, as shown on Slide 5, that the marketing investment was $194.3 million, it was marginally below the $200 million guidance. And that was, in fact, because the team achieved some efficiency in spend, particularly in the month of June, and there were some savings that flowed through. But it was not in any way a reflection that we were not fully expanded consistent with the plan that we had in place, particularly in both China and the U.S. Group infant nutrition revenue came out at $1.42 billion. Clearly, that is the powerhouse of the business, and that was up 33.8% on the prior year. Pleasingly, as we indicated, our China label infant nutrition business, our sales more than doubled. And our revenue in the U.S.A. also nearly doubled. And look, I'll hand over to Race to take you through some more detail in respect of the financial slides. Thanks, Race.

Thank you, Geoff, and good morning, everybody. So taking you through the financials in a bit more detail. At the top of the table on Slide 6, we presented our headline results for the year, which include a discontinued operations of the U.K. Our 32.8% increase in revenue to $1.73 billion, reflects significant growth across our core markets and our product categories. On this slide, we've also summarized our P&L from continuing operations. So you can reconcile to our commentary in the income statement in the accounts. On a continuing operations basis, gross margin of 56.0%, is up 1.2 percentage points on the prior corresponding period. Key factors to this were the improved price yield, positive effects of currency movement, which were partially offset by COGS increases related to infant formula. We also continued to invest significantly in marketing during the year, particularly in China in the second half. Volume costs were also up, reflecting the continued capability build, especially in market in China and in the U.S.A. The increase in admin and other costs incorporates our investment to deepen our consumer insights and costs to support business expansion. These were heavily weighted to the first half, and we expect the composition and level of external resourcing to moderate. Slide 7 shows our performance on a geographic and segment basis for revenue and EBITDA. We're pleased to report revenue growth in all geographies and all product segments. Interesting to note is the growth in our liquid milk segment of 29.7%, in addition to the 33.8% growth in IMF. Our cash position has continued to strengthen. We had $854.2 million of cash on hand at the end of June. This was driven predominantly by the growth in revenue and earnings. The improvement in working capital was due to the timing of invoicing and payments to key suppliers, which has since unwound. Later in the presentation, we'll discuss our ongoing review of capital allocation. Slide 9 summarizes our key financial metrics for the group revenue, EBITDA and EPS, including discontinued operations. It should be noted that basic EPS has also increased 33.5%. We have summarized the impact to the business as a result of COVID-19 on Slide 10, and how we responded and adjusted our approach in a number of areas. The key callouts are as follows: the safety of our people and our partners remain paramount throughout. COVID-19 caused varying levels of uncertainty and complexity in managing supply chain. We were well supported by our strategic partners in this regard, and we've had no material disruptions to our supply chain. Additionally, we observed changes in consumer behavior. In particular, some pantry stocking and shift from off-line to online purchasing in China, which we were well equipped to handle given our strong online presence. We adjusted our sales and marketing program in China in the second half to align to changing consumer behavior. There were also some savings in SG&A, travel and recruitment costs. Overall, in our view, COVID-19 had a modest positive impact in FY '20 on both revenue and EBITDA. There continues to be uncertainties, and we'll continue to monitor and manage accordingly. And with that, I'll hand back over to you, Geoff.

Thank you, Race. And look, we're now on Slide 12, which just is clearly a reminder to everyone of our 3 strategic priorities and enablers to drive growth. Nothing new in that. As everyone knows, we've had a very consistent strategy, which we are continuing to build on. Moving on to Slide 13, obviously gives a summary of our Asia Pac business. And as indicated, that business delivered substantial strong growth. Our revenue for Asia Pac in total was $1.66 billion, up 31.5%. And as indicated, the ANZ segment revenue was $965.7 million. And China and other Asia revenue effectively $700 million. On Slide 14, the left-hand chart on the slide shows our infant formula sales by channel for the past 5 years. The chart on the right highlights how the mix between channels is evolving with our China-based retail sales now accounting for 48% of our total infant formula sales. A very pleasing trend, again, consistent with the strategy that's been in place for some time and a very good work being undertaken by the team under Li Xiao in China. Slide 15. We just wanted to call out and remind people about the very strong, and in our view, appropriate positioning that we have for our infant nutrition range. The significant growth that we are achieving, in our view, is very much a direct result of the approach we've taken, which focuses on our one brand, two labels strategy for infant nutrition. Our China label range has a super premium positioning, in particular, in the higher-tier cities and MBS, as we indicate, whilst our English label is premium-priced and is appropriate, therefore, particularly for the reseller and online channels. We're very confident with our strategy, and we're very confident that it will continue to provide significant growth opportunities moving forward. On Slide 16, we just give an indication, some of the examples of the activities we've undertaken. Investing behind the brand in Asia Pac. As you all know, there was a substantial uplift in spend that occurred during FY '20 in support, particularly about infant nutrition business in China, and we're very pleased with the new initiatives that were put in place, which we continue to review and enhance moving forward. Slide 17. And here, we, in fact, provide information in respect of our market share in MBS and the CBEC channels over the last 12 months. During the year, we, in fact, determined that Nielsen for MBS and Smartpath for CBEC present a clearer indication of our share growth in those channels. And we'll be reporting on this information moving forward. On Slide 18, that shows a little more detail on our performance in respect of China label. We're very pleased with this growth, as I said earlier, which is in line with our strategy. You'll also note that Stage 4 was launched in December, and we've been rolling out a new tamper evident lid across stages 1 to 4 of the China label. Pleasingly, Li Xiao and his team expanded the footprint of MBS stores up to just over 19,000 by year-end, which was a very good -- which was very good performance, and the team will continue to expand the footprint into FY 2021. Slide 19 shows, again, the continued strong growth of English label, as indicated, it showed growth of 40% through cross-border e-commerce and a very credible growth across Australian retailers and resellers, up 14.1% to a total of $745 million in respect of that category. Slide 20 makes reference to the Asia Pacific liquid milk and other nutritional products grouping. Look, we're very, very pleased with the double-digit revenue growth that Peter and his team achieved in the fresh milk business in Australia. And you'll note that we achieved a record market share of 11.3% MAT, and we remain the market-leading brand in fresh milk in Australia. A very, very pleasing performance. In other nutritional products, we also grew revenue by just under 30%, and we see significant opportunity for further growth of nutritional products, particularly into the market in China. On Slide 21, we make reference, obviously, to our business in the U.S. And Blake and his team delivered very strong revenue growth, meeting our expectation of around 91%, which is very pleasing. We also increased our marketing investment and our brand awareness more than doubled. Obviously, as a result of that, investment that did deliver an increased EBITDA loss in the year, as indicated on the slide. It is important to note that the impact of COVID-19 on the U.S. market overall has been significant, particularly in Q4, for our business, there was some impact. And we are seeing as a result of the economic uncertainties, if you like, and the high unemployment rates, that's having some impact on the view of consumers. And particularly, we are seeing some focus towards them being more value conscious. As a result of that, we have determined to adjust our FY '21 sales and marketing plans accordingly. And as indicated in the commentary and on this slide, our focus will shift from broadcast advertising to a greater emphasis on in-store activation, account-specific pricing and promotional activity in response to the trends that I indicated that we're seeing from consumers. The outcome of this shift will be growth in volume. However, our net revenue growth will, of course, be impacted by the higher levels of trade spend. Overall, as a result of the changes I just mentioned, however, we expect an improved EBITDA outcome for the U.S. business for FY '21. The U.S. continues to be a strategically important market for the company, given the significant and growing premium milk segment and as a result of the significant growth in our brand awareness, this provides a platform for further product expansion over time. We also make reference, of course, of the recent initiative in respect of the Canadian licensing agreement with Agrifoods, and product is just starting to flow in Canada, a2 Milk through that initiative, which we're very pleased about. There's a couple of slides which gives some further background in respect of the matters that I raised relating to the U.S. and on Slide 23, some further background in respect of the new packaging that's being launched, which we're very pleased about and the advertising campaign that ran through the FY '20 year. So look, I'd like to hand back to Race just to talk through the next couple of slides. Thanks, Race.

Thanks, Geoff. Turning to Slide 25. As I mentioned earlier in my presentation, with our strong operating performance over a number of years, we now have a significant cash balance. As we have said previously, we are continuing to prioritize investment in growth initiatives ahead of returning capital to shareholders. During the period, we progressed a number of opportunities with regard to our ambition in the IMF manufacturing participation. This will complement our existing partnerships. We will update you on this in due course. A significant review of our capital allocation framework was undertaken in the second half, to enhance the discipline and allocation of our capital. We see 3 critical elements to be considered as part of the capital framework for the business going forward. Firstly, we will invest to grow the core business in existing markets, which includes investment to build our business in China, participation in IMF manufacturing and in infrastructure to support growth. The second focus area is investment to expand the boundaries. This could be from expanding in an existing market with a new product, or within an existing product into a new market. We would also assess complementary M&A to drive further growth in core markets. Thirdly, we need to ensure we maintain a level of balance sheet strength and flexibility, including maintaining a conservative cash balance to manage through an uncertain environment. With any excess cash flow thereafter, we would consider shareholder returns. We are pleased with the progress we have made in FY '20 in building a sustainable business. We are committed to reporting against the TCFD framework by the close of FY '22. We are also committed to measuring and reducing our direct and indirect greenhouse gas emissions, and we will continue to report on our progress. In FY '21, we will be redirecting the value of the offsets for our indirect emissions into The a2 Impact Fund. This will allow investment in more tangible programs that will benefit our business and reduce our impact on climate over time. There is additional detail on this in our annual report, and we look forward to providing further updates in due course. And with that, I'll hand back to Geoff.

Thanks, Race. So look, we're now moving to Slide 28 of the deck, which relates to our outlook for FY '21. So look, a few points to note. Obviously, we've called out, as you would expect, that the reality is there continues to be uncertainty relating to COVID-19, including the potential for moderation of economic activity, no surprises there. This could impact consumer behavior in our core markets as well as participants within the supply chain, most notably in China, we thought was relevant to make reference to. Overall, for FY '21, however, we are anticipating continued strong revenue growth, supported by our continued investment in marketing, and organizational capability. The majority of the growth in respect of the internal team is now behind us in the sense that it's substantially in place. But there is still some further growth that will occur, for example, within the team in China and with a number of internal admin roles. We're not proposing to provide revenue guidance at this time. However, we are providing guidance, that for FY '21, we're expecting the EBITDA margin to be in the order of 30% to 31%, as indicated. And reflecting the items, the particular items that we called out on the slide. I also wish to highlight that for FY '21, CapEx is expected to be during the year, progressing up to an amount in the order of $50 million due to our ERP investment. And the capital projects that have been announced in the report supporting fresh milk processing in Australia. And finally, on that slide, as indicated before, the Board has a continued medium-term EBITDA target as previously advised, which remains unchanged in the order of 30% in the medium term. So on the basis that we've been through the slides and highlighted some key areas, I'd like to hand back to the operator to facilitate Q&A. Thanks very much.

[Operator Instructions] Your first question today comes from Shaun Cousins of JPMorgan.

Maybe a question for Peter Nathan. Peter, could you maybe talk a little bit about your comfort levels with inventory in China of infant formula and maybe in the broader daigou channel, there's been fairly consistent feedback that there's a more elevated level of inventory? And how do you see this sort of impacting the path of revenue growth for the first half '21, please?

Sure. We're comfortable with our inventory levels. As we indicated, there was some wind out of pantry stock in -- from COVID, due to the COVID impact, which we believe has largely occurred. There has also been a shift, no doubt from retail daigou through to corporate daigou. So there's been a reasonably strong shift there in the last few months. But yes, we are comfortable with inventory levels at this point.

So there shouldn't be any impact? So all the feedback that we're getting around 3 to 4 months worth of inventory relative to usually say 1 to 2 is off. Is that what you're suggesting?

That's correct.

Yes. Okay. Fantastic. And then maybe just in regards to market share, I'm just curious if though you do have the Kantar market share number just given that while you provided a neat breakdown there of MBS and CBEC, we don't have an enormous amount of history for that there. So would you be able to sort of indicate where your market share is based on the previous Kantar data that you previously cited?

We've indicated that we're looking to provide these 2 market share data points. It's fair to say that no other major player does provide Kantar due to the -- some of the inconsistencies that we've come across in terms of the coverage. So therefore, we've noted that in our assessment, in our analysis, and therefore, as we've indicated, we won't be providing Kantar going forward.

Okay. And maybe just finally, maybe one for Blake or for Geoff. In terms of the United States and the sort of milk business there, can you talk a little bit about what do you think comes first, breakeven or the USD 100 million revenue target and how you're seeing rate per store perform, please?

Yes. Look, we -- as we indicated, we had some very solid growth in per store sales, which we're very pleased about. Look, to your point, we are particularly focused on the growth of this business. I think you see the level of investment that's been made during FY '20 is indicative of that and the marketing support. We will continue to support the growth of the business and the brand. But being mindful that there has been, if you like, some change in consumer dynamics that we need to respond to, and that we've been communicated to us through retailers in the U.S. and hence, the activity that we're proposing has been highly welcomed by retailers as being appropriate for the time being. Now just so happens that we think this is going to be more efficient in respective level of spend as we move into FY '21. And that's the reason why we are outlining a reduction in the level of investment, i.e., the EBITDA loss for FY '21 compared to '20. But look, I think it's fair to say we are particularly focused on achieving the milestone that we've set, the initial milestone of what we believe is appropriate, a scale for the liquid milk business. But we continue also to be extremely focused on how we spend shareholder money and what is appropriate in respect of that investment in any market at a point in time. So I would say to you that we are still prioritizing growth first and EBITDA second but we are obviously closely continuing to monitor the level of investment we're making. Because I know shareholders and management want us to -- we want to have that discipline. So it's neither an either/or, ideally, at the end of the day, it's a bit of both. But the bias is towards supporting continued growth in the appropriate way.

Your next question comes from Chelsea Leadbetter of Forsyth Barr.

Geoff and team, if I can come back to sort of consumer behavior and the channel mix changes that you've talked about and called out in China. Can you give us maybe a bit of an update or, I guess, thought process on -- you've called out you think the unwind in pantry stocking is kind of behind you. But how are you thinking about channel shifts from here? And what are you sort of seeing in your most up to date, sort of, trading insights about what's going on there? And I guess the second line to that is how are you actually managing getting product to where it needs to go at the moment in China? Can you give us an update on what's going on with respect to supply chain and timing of getting product around the market?

Look, I think I'd like Peter in the first instance to respond to that, Chelsea.

Yes. Hi, Chelsea. Yes, with respect to channel mix, as we indicated that retail daigou, there has been a shift away from retail daigou on the basis that there have been fewer tourists, there have been fewer students, many of which were sort of the arms and legs for daigou. So that channel, there is no question retail daigou has shifted. And as we indicated, a lot of that has gone into corporate daigou. Some has gone into the other channels. And as Geoff indicated and you would be aware from previous presentations that we've been prioritizing the MBS channel for some time, and it's pleasing to see us deliver on that. We'll continue to invest very heavily in that channel to grow share in that channel. So therefore, as we've always said, we do benefit from a multichannel strategy, and that will continue to be the case. Channels will continue to ebb and flow, social e-commerce, I should say, has improved share. There has been a slight softening of a2. So there's going to be shifts. There's no question about that. And we believe we can respond to those shifts, and we believe we've demonstrated that with these results. Sorry, your second part of the question, Chelsea, if you can refresh my memory?

Sure. Just in terms of actually getting products, I guess, firstly, into China, but also around China and what you're seeing or what's changed over the past few months?

We haven't experienced any real issues with respect to fulfilling product into China. So that hasn't been a major concern. It was in the early part or the back end of the half in the early part of October, there was more issues, particularly when COVID was more prominent in China, but subsequent -- given the fact that impact has wind significantly, in terms of China is largely back to normal, the physical stores are largely back to normal. So China itself is in a pretty different space to probably what we're seeing in ANZ, for example.

Okay. I appreciate the color. And just lastly for me. Geoff, are you able to -- or are you prepared to give us a degree of -- or an indication of the marketing spend that you are factoring or thinking about for the year ahead? And your EBITDA margin guidance?

Chelsea, just a couple of things. By the way, in respect of your prior question, just remember, as we indicated, by the way, in respect of the COVID impact, we clearly had some benefit in Q3. We had some pantry stocking. We had some wind out of that, but we are clearly at the deal for Q4, and we see that as probably continued a little bit into July and maybe tailing out in August, Peter, for unwinding the pantry stock just to round out that particular question. Look, in respect to marketing, I mean, we don't go out and give indications by line of our internal budget situation, but you can assume that there is some consistency in respect of level of spend relative to revenue that we would take into account and setting the budget for FY '21.

Your next question comes from Marcus Curley of UBS.

A couple of questions from me. Could we just start with CBEC, you obviously provided some updated market share data there. If I look at the second half implied number, it looks like you're just under 23%. I just wondered, Peter, if you could talk to where you exited. And by the look of things, it probably suggests that there's scope for further share gains across what you achieved in FY '20 and FY '21?

We would expect to continue to build market share with CBEC as we would with all of our market share growth within each channel. On the basis, as we indicated, a continuation of our one brand, two labels and one brand, three channels strategy. So therefore, as Geoff just indicated, we'll continue to invest heavily in marketing at relatively consistent levels to revenue. So therefore, that will be the key driver across all of our channels. So yes, we would expect to continue to grow share within CBEC, and we're very pleased with the results that we delivered.

And Peter, how important is a wider direct relationships in that aspiration of growing share in CBEC?

Sorry, I'm not quite sure of the intent of your question. Sorry, can you...

So how important is widening the direct relationships with the CBEC players in driving that increased market share?

Well, we are investing more in resources to manage our CBEC channels. So we do have a greater degree of capability and capacity within management of that channel. So in that regard, yes, we are improving our relationships on an ongoing basis with the online retailers. And that's very important to us. And yes, we'll continue to clearly improve on an ongoing basis in that regard.

And then just secondly, on the MBS footprint, obviously, you talked to slightly tougher 6 months in terms of the growth in that footprint. Is it fair enough to assume that the business can go back to sort of the run rate of -- you have 4,000 stores a year as we look into '21 and '22?

We're driving volume through MBS, there's obviously 2 factors. One is same-store sales growth. The other is improving the size of the footprint. We believe we need to do both. So it's not just about getting more doors. We have experienced some very strong same-store sales growth. We are very conscious of the fact that we don't have even share across the market. So some cities, some provinces, some chains. We have far stronger growth than others, which gives us great comfort that we can lift the bar across the board. So we do have great capacity to build same-store sales growth within the network. And that is more of a focus for us than driving additional foot -- store numbers. However, we need to do both.

And sorry, just one more. In the accounts, you referred to some of the finished stock held back for further testing. You had to see whether it meets quality specifications. Can you talk a little bit to that? And does it relate to the Hong Kong consumer article that was put out a couple of days ago?

No, definitely -- sorry.

Yes. You kickoff, Peter, I'll finish up.

Sure. I would just go to say, no, definitely doesn't have any relationship to the article that was circulated in the last few days. So we're entirely comfortable, 100% that we meet all our regulatory requirements with our product and there's no bearing on that, but I'll hand back to Geoff just to cover off the back end of that question.

Yes, Marcus. Look, the -- look, that inventory issue was simply us being prudent at year-end, that there is some product that passes particular testing protocol in New Zealand. It relates to China label product, but I don't -- in a couple of instances, it only just passes the minimum requirement for a particular ingredient. We determined it appropriate just to hold that product to retest it to be satisfied that the testing outcomes when it arrives in China continues to be appropriate. And on that basis, we've actually had product delivered, which does tick the box within our supply arrangements, but we're just being prudent in that regard as to having that retested again prior to release. We are clearly -- I think that's just simply an indication that, a, we continue to be prudent. We're very focused obviously on the absolute highest quality, of course, of consistently being delivered into the China market, and it's reflective of that. And we're hopeful maybe some of that was on -- that was presently on hold, we'll tick the box and be released. So that's what that's about. Obviously, we haven't called the amount out because it's not material in respect of the bottom line. But it was a little shaving of the final EBIT that the sales margin just at the year-end, maybe compared to your expectations or others. But look, that's what it is. And as Peter said, unrelated to the matter you just raised in the last couple of days.

Your next question comes from Richard Barwick of CLSA.

Can I just talk about the COVID impact? You obviously talked to the sales benefit but also a cost benefit. I'd be particularly interested if you are able to give some sort of quantification around the cost benefit. Particularly, I guess, as it pertains to -- you talked about inability to travel and so on. So just to get a sense of that magnitude would be great.

Sure. Thanks, Richard. Hope you're well. We think that we probably saved $2 million to $3 million in terms of travel. But know also that we did, as part of COVID, we helped in terms of our donations, we've -- helping with the vaccinations, which, of course, offset a lot of that cost as well. But we think there's around $3 million in SG&A. So in travel savings in SG&A.

And the other one I wanted to ask around probably for Peter. Obviously, you're talking about the shift away from the retail daigou into the corporate daigou just be interested to hear your thoughts, Peter, does that make it easier? Or does it make it harder to actually manage and track the inventory through the value chain? Interested to hear your thoughts on how you view that and actually doesn't make a change at all?

Look, it does make it a little bit easier. I've got to say. Not significantly, but it does make a little bit easier. And you are correct that or, as I said, restating the firmer point to that, that is no doubt if that shift has occurred, and it still is unclear about where that will end up. But as we indicated, there's a couple of very key drivers of that with the COVID impact in Australia.

Okay. And then the last one, obviously, we're talking about the focus on same-store sales growth within the MBS stores. And also, you mentioned there's quite a range of outcomes that you're seeing. What do you actually have to change there? What do you do in the stores where you feel like there's the most improvement, what actions are the ones that you need to take?

Some of it's due to the strength of distributors within certain cities and certain provinces. So what we're doing is making sure that our distributor network is brought up to the same standard. To ensure that we have, as you would know, about 63 distributors. So there's a variation of capable distributors. There's also been -- sorry, repeat myself, what we have done is very closely measured each of the impacts of stores, be it investment in our in-store promoters, be it our investment in in-store signage, be it our investment in mainstream media because what we have done is also very carefully tracked the impact of mainstream media, be it TV and digital online as well to ensure what impact that has on various provinces and cities. We've also had, what we call city attack activity. So that's specific intensive activities per city to roll out to improve brand awareness. So all of those activities, we measure very carefully and then we measure by store, we also indeed measure the impact of our in-store promoters. So there's variations, including the impact of those. So there's a number of impacts. And -- but as I indicated, the pleasing thing is that there is a variation so that we do have much stronger shares in certain stores and certain chains, certain provinces and others. So that's a good thing because it gives us comfort that there is upside.

Okay. And actually, just one more on the MBS. It would have a sense like there was at least a temporary impact on MBS as in the shutdown in China and people were shopping more online and elsewhere. Is there any sense that that's a lasting hit to MBS? Do you think MBS have actually lost, as a channel has lost share to online? Or is that just a temporary glitch and it's gone back to business as usual?

We do believe it's a temporary glitch. It's also fair to say that we did call out that a lot of our MBS stores were able to fulfill product in any event through COVID, through direct deliveries to consumers. So yes, we do believe, however, that broadly, it's a temporary glitch.

Can I also just make an additional comment. It would be remiss of us not to do so, that particularly during COVID and particularly in respect of ensuring that the supplier product, Peter, to the MBS store was maximized in the circumstances of COVID in China in the second half. We certainly need to call out the work done and the great support provided by China State Farm, our distributor in China that imports the product, warehouses it on our behalf, interfaces with our distributors, which, of course, are managed by our team, but they really performed extremely well, Peter, in assisting our business and get product to consumer. So I would just like to, again, recognize that in respect of how we performed in MBS, particularly during second half of FY '20.

No, I totally support Geoff's comments, and they clearly reinforce the value that they provide as a wonderful and very productive partner.

The next question is from David Errington of Bank of America.

Geoff, just tiding up on this provision that you took on your inventory. That the provision, I'm assuming you took against your EBITDA number, you said it wasn't material enough to call out, but what are we looking at here, $5 million to $10 million? Is that the sort of number that you took against your profit for this area that's likely to be, as you call, very prudent and effectively taking a hit to profit that may not necessarily need to be there. Can you call out what the sort of number it'll be, $5 million to $10 million?

David, you're pushing me a bit, but to help you out, look, you could say it's in the range of between $5 million and $10 million.

Yes. And so that's likely, I mean, given how conservative you guys are, that's likely to come back this year. I mean it's not material, but considering...

Seriously, the reality is, until we've done the new testing, we can't make that call. And by definition, if we had any further information, we couldn't have booked some part of that provision, as you would appreciate, David. But that's the position that we obviously had to come to at year-end at the end of June. The matter only really arose during recent weeks of closing or coming to the close of the year. We are hopeful that the product in retesting will tick the box. And so there may be some of that provision able to be released. But realistically, the very clear judgment call that we needed to make was what was appropriate at 30 June. So that's the position we've taken. By the way, that was inventory on its way, which we took a provision for. Correct. Race?

That is correct. That is correct.

Okay. And I'm trying to get my head around this, probably you'll direct this to Peter, but I'm trying to get my head around the performance in the second half of the MBS relative to cross-border e-commerce. Based upon your comments that there was a move more to the off store rather than on store. But your numbers actually show different where you had a slowdown, clear slowdown in the number of store count, yet there was no slowdown at all in the growth of sales of China label. You're still growing at 100% in that second half, which means, correct me if I'm wrong, but you've probably had an acceleration of like-for-like store growth. Well, it means that -- but then when you look at the English label on cross-border e-commerce, it looks like it slowed a little bit in that second half. So I mean, I thought your first half growth was 58%. And I think the full year growth was 40%. But it looks like your MBS stores are just hitting the cover off the ball in store, in particular. Is that the right way of looking at it? Or am I seeing numbers wrong?

Look, I think you're pretty well on the money, David. I'll let Peter make a couple of comments. One thing I will say in respect of the CBEC market share in Smartpath, of course, that pertains to the platforms we supply. And clearly, there is presumably some additional reseller product that finds its way through cross-border e-commerce, which, by definition, is not our direct sale, if you like, it's a secondary or indirect sale. And so that is not reflected in the Smartpath market share for a2. So I would probably say to you, therefore, that our share of our brand, Peter, on CBEC is higher than, for example, the 21.5%, I'll say that. The second point, and Peter will add is, look, yes, we did have a very credible performance in MBS, for a whole pile of reasons. Li Xiao and his team were growing the -- continuing to grow in respect of number of stores. The support from China State Farm and getting product through. All of those things were happening. But Peter did say that there is a particular focus on us, particularly achieving uplift in per -- in sales per store as opposed to growth in-store numbers. And to an earlier question, Peter and Li Xiao and the team will continue to grow the footprint of stores. But I would suggest to you that we are probably more of the view that it's a 70-30 rule it could apply. I mean we're not going to go and in any way, attempt to get coverage over the potentially 100,000 stores that are out there. But Peter, you might just like to add anything further to David's question?

Sure. Yes. No, thanks, Geoff. Yes, so one of the answers to your question, David, is respect to social e-commerce. So social e-commerce is a channel which has grown in prominence significantly over the last 12 months, the key retailer being Pinduoduo. And they're not in these numbers. They're not supplied directly by us, but they tend to procure staff from when [ one of four ] ways. So therefore, that partially does answer the question on CBEC shares. With respect to MBS, again, I mean, if you think about the chain situation, for example, there's about 10 to 12 major chains in China and MBS. And our share is very significantly due to the fact that we didn't have the resources to manage the each chain in the way in which we would have liked. We are now getting those resources. So therefore, that indicates there's same-store sales potential within the chains. And if you think about, again, the 19,000 stores that we distribute to through our distributors, I should say. Again, it's -- given the sheer number you can easily get your head around the fact that there's very significant potential to grow same-store sales growth by having micro activities and focused activities on each individual store. So that's repeating some of the themes. But I think the chain example is something that probably may help you understand the potential that we have, given the fact that of those major chains, we still have very significant variation in market share.

And it looks like it was really coming through in the second half, you really getting some great traction, Peter. It sounds -- that's what it looks like in the numbers.

We're very we're pleased with the traction, David. We have been focusing investment on this channel for some time. The beauty of it is, we've still had a very low share within the channel, growing, I guess, but still 2%, clearly, there's a lot of upside.

And Geoff, I can't let you go without questioning on your admin and other costs. I mean a $30 million increase. Can we -- can I put into the model that's going to be flat this year? Or is it going to continue to rise?

Look, I'll just ask Race, David to respond to that question.

So David, the -- as Geoff mentioned earlier, that the majority of those increases about building capability in terms of people has happened, but a lot of it happened, obviously, as we went through the year, with a chunk of it in the second half. So that does need to annualize. So you need to be -- you need to be careful about keeping those costs flat. But the underlying increase in people numbers will not be increasing. Note that with regards to our professional services, that was heavily weighted in the first half. That was down significantly in the second half. And as I've mentioned previously, we are moving to build up internal capability. Have built up a lot of that internal capability, so we won't be seeing the continuation of such costs going forward, but you will have to include the annualization of the cost incurred.

Your next question today comes from Sam Teeger of Citi.

Many of your competitors are pursuing localization strategies in China. And when you talk about wanting to participate in manufacturing, how likely is it that you would manufacture in-country in China?

Well, look, Sam, thanks for the question. And it is a priority, as we indicated in February that we're examining a number of opportunities for us to participate in infant formula manufacturing capacity and capability. I think it is fair to say, firstly, let me again state, however, that we've got very strong and very pleasing relationships with our existing suppliers, obviously, particularly similar in respect of infant. And it's not about that. It's not about a problem with that. It is about, obviously, our views about continued growth. The importance of diversification of supply as we continue to get larger. You would assume that, that is a risk fact that the Board reflects on. And so the issue of multiple sites is relevant to that as well. And this company, building up some better understanding in respect of what happens within the manufacturing supply chain. I think it is fair to say that you could make an assumption that it is more likely that our initial focus would be on augmenting or something complementary within a supply base out of presumably more likely New Zealand or Australia initially. But that the issue of a potential investment in China is certainly, I could say, been a part of our consideration. But I would probably suggest to you that, that could be a follow-on once we've determined the appropriate footprint that would occur within the market, either New Zealand or Australia, as I mentioned.

Right. And then can you give us an update as to when you think the new GB standards will come out? And what type of grace period do you expect that you'll have to comply?

Look, I think you appreciate that, that's a moving feast. Obviously, our team is very closely monitoring what's happening there. We continue to work towards the timetable in respect of our -- of the current license relating to our brand in conjunction with Synlait, and the renewal of that towards the back end of calendar '22. There is clearly some indication that the GB standard scenario may result in an extension of that time frame. And look, we're obviously monitoring that end, working closely with the authorities to be on top of that. I mean, look, that's really our position. By the way, also in respect of our group, we continue to strengthen our team in respect of the whole issue about regulation within China and within Susan and her team, we bought on a number of new people, which are also adding to our skill set within our business to assist us as we move forward in respect to those processes. But look, at this stage, we continue to run a program in conjunction with Synlait, which is focused on back end of '22. There, if you ask me today, I would say there is some likelihood that, that will extend, but I probably can't say any more at this time.

Right. And then just -- sorry to go back to the inventory provision. Given you guys aren't a manufacturer, what stops you from just recouping that off Synlait?

Well, as I indicated, the issue is that, that product has satisfied the specification testing that has been conducted in New Zealand, and we need to be satisfied that it also we'll satisfy the testing protocol, which I'll say to you, that they may be slightly different in China. And once we've resolved that matter, we have taken up a provision and if it's appropriate that, that cost be shared in another way, obviously, you would assume we would look at that at the time. This is an issue that came up towards, as I mentioned, the close of our year-end and we decided, a, that was the appropriate thing to do in respect of that inventory because of our focus on quality. And we would hope, as I said earlier, that maybe some of that will be able to be released. But if there is an appropriate reallocation of how that cost is borne, that's obviously something we'd look at down the track.

Got it. And final question, any appetite to consider other types of infant formulas, such as organic or goat, just so you can contest a larger part of the market?

Well, look, we did make -- as we've indicated, make some clear reference to what we believe is the strength of our portfolio. The focus on a limited number of SKUs. And I know a number of people on this call have got a view or what about the potential to widen that. It's certainly not an issue that we haven't considered internally. But we are very comfortable both with the SKUs. And quite frankly, a very clear focus on dairy a2, we believe it brings all the benefit. So look, we're not saying we're totally closed but our focus certainly for the immediate term is on the existing product portfolio, which I mentioned. And of course, all of the benefit of the a2 protein is there, Sam, and as compared, for example, even to goat, as you know. So no, we're pretty happy with the portfolio.

Your next question today comes from Anna Guan of Wilsons.

Most of my questions have been answered previously. So perhaps just one residual one for Race, if I can. So if I look at second half '20 GP margin, it's come down quite a bit versus first half '20, notwithstanding, I guess, the favorable FX impact. But clearly, you guys called out, I guess, the headwinds around higher raw material costs and also trade spend. But I'm just wondering, how should we think about FY '21 GP margin relative to second half '21 -- second half '20, I should say?

Sure. Thanks, Anna. So you're right in that we -- with regards to the '21, what we're going to be seeing is we are expecting -- we're going to get some benefit from our price increase. Which will be annualized, but we are expecting to see GDT milk prices are going up. We've -- obviously, during the COVID period, the milk prices actually held/increased. And as you'd appreciate, we locked in our prices early. So '21, we will get the -- sorry, we will get the headwind of higher milk prices, also things like lactoferrin, which we know are going up. We also have the lid that we talked about in China label. Now that actually happened in the middle of the year. So we will get the annualized cost impact of that flowing through into '21. Similarly, as we've talked about, we will continue to invest in our marketing. And we won't get the benefits that -- well, it is unlikely we would get the benefits of some of the FX that did flow through into this year as the New Zealand dollar weakened to a fairly significant level. It's unlikely that would repeat itself. So therefore, I would not expect certainly any increasing to the margin.

Your next question comes from Adam Fleck of Morningstar.

I was hoping to dig a bit more into China and specifically across the different stage products. I think you said on a call back in November that Stage 4 English label was about 8% of total English label. I guess my question is, has that changed materially? And then, of course, as you've launched the new China label Stage 4, I know it's early, but any initial takeaways on the growth and take up there?

Peter?

Yes. So Stage 4, clearly, we believe is -- remains a strong opportunity for us to grow the segment and also grow our share within the segment. So Stage 4 and beyond really is how we would put it. And Stage 4 has continued to grow as a percentage of our business, but we -- and we do believe, as I indicated, that it represents future growth opportunity.

Great. That's helpful. And then maybe just moving away from China, but sticking to the Asia segment briefly. You mentioned Korea. It's been a couple of years now. You've been in Korea broadly, but it's the first half you've offered a2 Platinum. So any updates on that geography more specifically? Are you seeing a similar uptake from consumers like you did in China, for instance?

Korea is clearly a much smaller market opportunity than China. So I just want to point that out. Having said that, the -- off a very low base, we are pleased with the consumer offtake that secured, particularly in the last 2 to 3 months.

Your next question comes from Adrian Allbon with Jarden.

Just wondering if you could provide us some insight from your research and people on the ground. I guess one of the things that is shifting in the a2 story is there -- I guess when you look at your multinational competitors, lots of them have SKUs now launched in market. Can you give us a sense of how like the a2 proposition has been perceived with those additional SKUs then in the market? And any shifts that you're sort of seeing in terms of marketing support or requirements from retailers and the platforms for your own business?

Peter, you could respond first.

Sure. As we've indicated, we've always expected competition in the A1 free space. So we've been clear about that for some time. That has occurred. It did start to occur about 2 years ago. So it's nothing new in that respect. Comments I would make is that, yes, there have been a lot of flows at end of the market. At this point, none have been successful at all. Having said that, we're not saying that they can't be successful. We would like to make the point that they haven't at this point in time. The other major point we'd like to make is that, again, our brand is the key driver for our business. Now part of the makeup of the brand is the fact that we are all A2 or A1-3. That's by no means all of the brand proposition. So we'll continue to invest in brand. That's going to be the driver for our business. A1 free or A2 at its core. And so I think that's probably the key points that we'd like to make there. And we continue to obviously grow our market share in the space of A1 free competitors that we believe will continue to look at the opportunity but again, they are coming from behind the pack. They faced a very strong competitor with first-mover advantage benefit. They also face the fact that they do have some compromise in the way they can message out based on the fact that the majority of the business does contain A1.

And Adrian, pay the -- again, your comment about the brand. Let's also not forget the importance of sourcing, where the product comes from also. We see very important, the heritage of the brand is from New Zealand. Again, we see that as an element to go to the brand value proposition, which Peter happened to mention. So it's not just about the A1-3 proposition, notwithstanding, obviously, The a2 Milk Company knows presumably more than any other company about that. And we are the innovators in the category. But look, as Peter has said, we're very comfortable with the brand proposition we've got, the growth that we're creating -- that we're achieving, Adrian. And the fact that there is -- there are some who are attempting to enter the A1 free space is not a surprise to us.

Okay. Can I just ask a couple of follow-ons? As part of the potential higher forward investment down the supply chain also sort of related to some of the competitor moves, I guess, trying to get some milk pull access in the Australia and New Zealand part of the world in terms of your thinking?

Obviously, all of the matters pertaining to participation in the supply chain are relevant to our thinking. And milk supply is part of that, Adrian. But it's just one component of the input to that process. As I said, we are keen to increase our participation in all aspects of the supply chain. But in a way that is complementary to our existing arrangements.

Okay. And then can I just ask a clarification just on -- just some of the messaging in that U.S. segment, where you're referring to shifting, I guess, some of the brand marketing more so into trade marketing. Is that sort of magnitude -- would -- you do expect to redeploy that magnitude of money into the Chinese market? Sort of, I guess, referencing a question that Chelsea asked earlier in terms of what sort of benchmarks we should think about for the brand marketing component for '21?

Well, let me be clear, we don't look at one bucket and decide how to allocate it across China or the U.S. We build from the bottom up. I think it is fair to say that what we've called out is that there will be some increased trade market -- trade pricing and trade costs that will be netted off from gross revenue in FY '21, which, by definition, will mean that the marketing expense line in consequence of that will be lower. That doesn't necessarily mean, however, we're going to necessarily reduce the marketing back at overall. But as I said, we're not directly going to call out, obviously, the budget for FY '21.

Your next question comes from Jonathan Snape of Bell Potter Securities.

Yes. Just a quick one really for Race around the CapEx numbers that you called out, the $50 million. Are you able to, I guess, segment it between what's ERP? How much of it's to the acquisition of the -- to Kyvalley assets and then the expansion of that facility?

Sure, Jonathan. So look, roughly speaking, we would expect our ERP to be around the $15 million mark. We would expect a similar investment around our investments in our milk processing. So those 2 -- sorry, let me repeat that. We would expect our milk processing to be in excess of $20 million, and our ERP would be around the $15 a month. So that's the sort of the main breakdown. And then we've got various other IT projects making up the $50 million.

Okay. And the ERP in the IT spend, how quickly do you expect to amortize that?

Well, we will amortize that based on the rules allowed us for the accounting standards.

Yes. Okay. Can I just ask, around that Kyvalley acquisition, I know there's a bit of commentary in annual report around it that you've entered kind of arrangement where they're going to manage the assets on your behalf for an ongoing fee. When you're looking at infant formula and your involvement in the supply chain, is that the kind of way we should be thinking about how you would look to structure arrangements in that space as well, where you put the capital on the ground and maybe give somebody who has the expertise to manage it on your behalf?

So look, to answer that question, firstly, Kyvalley, you need to look at it as being structured based on the specifics of the relationship that we've had. Kyvalley, in fact, has been this long-term contract milk supplier to the business that was in place prior to the Australian business in its current form being kicked off in 2007. They're a long-term valued supplier. We've been talking with them for some time about the need for them to both upgrade existing plant and capacity to meet our increasing needs, based in Victoria is supply in the southern states. They currently manage the asset. We saw this as the most appropriate arrangement to assist them in that moving forward. So that's specific to that. We've indicated in respect of infant formula. Our objective is to participate in and I think you can read from that, that we'd like to understand more about how obviously the manufacturing of infant formula occurs. Again, I repeat, in a complementary right way to our existing arrangements. So I think you would expect that we'd like to have some involvement but we also acknowledge that we're coming from a situation where, obviously, we don't currently have a skill base relating to, for example, manufacturing or manufacturing, obviously, a highly -- a high-quality product such as infant formula. So we will be extremely focused on putting in place the appropriate business model to manage through that risk issue.

Great. And look, maybe just a follow-on to that, Geoff, if I can. Obviously, the MBS has been a pretty good growth channel for you guys and the PRC label sales have been really strong. And as it grows as a proportion of mix of your business, how important do you think it is for you guys to actually own your product registration in China?

Look, we're very comfortable with the arrangements that we have in place with Synlait. And we're very focused on working with Synlait, of course, in respect of the renewal of the license in the appropriate time frame, as we spoke to earlier. That's our #1 focus. In respect of the medium to longer term, clearly, we will have aspirations to potentially have more than one China label. And how that is structured moving forward, obviously, will be to some extent informed. Should there be some form of participation that we have in manufacturing capabilities. So obviously, it's something that we would think about as part of moving forward. It's not an issue for us in the short term. We're very comfortable where we sit. But in the medium to long term, clearly, we would have aspiration, as I said, for potentially a second China label.

Your next question comes from Xavier Waterstone of QuayStreet.

I just had a couple of quick ones on the substitutability of marketing and trade spend. I noticed some of the $124 million sales delta for Australia and New Zealand, $116 million came from 1 customer. And also the trade and promo allowances outstanding on the balance sheet increased by about $20 million. Could you just talk a little bit about what the pay away of gross sales was in FY '20 versus FY '19, if that stayed the same or picked up a bit?

I'm trying to understand the point of your question. Can you just repeat what your key part, please?

Sure. So pretty much talking about the sales delta for Australia and New Zealand, it's about $124 million. And $116 million is from a single customer. And you've had the trade allowances on the balance sheet go up by about $20 million. Just wanted to explore a little bit more about the trade allowances and volume rebates, that kind of thing. And whether you've seen the level pick up or stay the same as a proportion of gross sales.

So I'm not sure whether you're talking about the individual customers. But of course, our rebates or allowances would naturally be going up as we grow our business. Remember, a lot of those rebates are based on -- their variable based on turnover. So that is definitely the -- explaining the increase. There is no material changes to any of our rebate arrangements, if that's your question. But certainly, with regards to the single customer, that is something we'll have to take off-line because there is no clarification of that at this time.

Okay. And the second part, I was just looking at the incremental margin. It looks like the incremental margin for EBITDA on ANZ was about 62% versus the group gross margin of 56%, which seems a bit high. Just wondering to know if you could unpack that a bit.

Well, one of the things you have to consider is where we spend our marketing in terms of -- we get the halo effect, especially linked to the daigou. So we might -- we do actually charge our marketing through predominantly the China segment as well, which benefits Australia. And as I said before, the second half margin was impacted by significant second half marketing spend. So that plays into it a little bit. And as I also said earlier, there were price increases during the year, and that would play into the margin as well in terms of the increase for the year.

Your next question comes from Aaron Yeoh of Goldman Sachs.

Race, just a quick question for you. Just -- could you just clarify that comment you made about gross margin next year being kind of broadly sort of flat. In terms of the gross margin we should be thinking about, is that kind of net of the provision that you've taken? And then could you just give us a bit more detail around the FX benefit that you received in terms of which cross rate it came from this year? And then into next year, should you guys sort of be receiving any kind of data set with regards to the recontracted agreement with Synlait?

Sure. So let me try and address that multifaceted question. So in terms of our margin for next year, as I said, I'm expecting it to be broadly in line. So there are a couple of factors that are going each way with it. As I've said, we will have our increases in our raw and packaging material prices. We -- obviously, some of that offset by price increase. There will be some benefit from the negotiated Synlait contract that was renegotiated and announced to the market last year as our volumes increased. But as I said, we're also incurring the full annualization of the China lid. So therefore, you have to put these contra factors together, which will ensure that our margin maintains fairly constant. With regards to the FX comment, as you'd appreciate, we have cross rates with the U.S. dollar, with the renminbi to the U.S. dollar, with the U.S. dollar to the New Zealand dollar and with the Aussie dollar back to the New Zealand dollar. And as the weakened New Zealand dollar occurred during the year, we did get a minor benefit. I'm not expecting next year that the New Zealand dollar will weaken to the same proportion that it did in FY '20.

Okay. Great. And just a question for Geoff. In the last quarterly update, you made a comment about the domestic online part of your business. And perhaps maybe that being an area where you might be a little bit behind the competition. Just wondering if you can make any comments or Peter, just with regards to sort of how you see that channel evolving and whether you think that is kind of a more sort of permanent -- the growth that channel has seen is a bit more of a permanent feature of the industry?

Well, I'll answer that before Peter and say, yes, we are behind where we'd like to be, aren't we Peter? And we are focused on doing more in respect of that channel, domestic online. Peter, anything to add to that?

Not really. There's -- Geoff. No, we're conscious of that. Again, further upside, I think, Aaron, for us. We deliberately didn't participate in the channel in the early days, more -- we're conscious of the potential price destabilization of that channel, but now we have managed -- we've worked out how to manage that dynamic. So on that basis, yes, we do recognize there's an opportunity.

At this time, this concludes the question-and-answer session. I'll now hand the call back to Mr. Babidge for any closing remarks.

Well, thanks, everyone, for being on the call and some very good questions. And look, I think on behalf of the team and the Board. Hopefully, this has been informative for you. As I indicated earlier, we're very pleased with the very strong performance we've achieved in FY '20. We don't take it for granted. There was, however, a lot of hard work by our team to navigate through challenges. Particularly pertaining to the supply chain and working with our key customers. And so that management should be -- management is pleased in respect of that. Clearly, we'd like to think that we've continued to indicate the healthy underlying fundamentals of our business. The strong performance across our key products and core regions and as I said, the excellent performance of our team in every market. So look, thanks again for listening in. We obviously look forward to your continuing support and interest in the company. So thank you very much.