Lonza Group AG

Ladies and gentlemen, welcome to the Q1 Qualitative Update Conference Call and Live Webcast. I am Sandra, the Chorus Call Operator. I would like to remind you that all participants are in listen-only mode and the conference is being recorded. The presentation will be followed by a Q&A session. You can register for questions at any time by pressing star and 1 on your telephone. For operator assistance, please press star and 0. The conference must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Mr. Pierre-Alain Ruffieux, CEO. Please go ahead, sir.

Thank you, Sandra. Good morning, good afternoon, and welcome to our first quarterly qualitative update. As you will recall, we have scheduled this meeting to have a touchpoint between our half-year and full-year financial reporting. We are intended to provide a general business overview so we will not be discussing our financial performance today. As usual, we will share our full financial update during our half-year call on July 21st. Today, I will start by sharing a view of the overall group and our macroeconomic context, then provide a short update on each division. After that, our CFO, Philip Dick, and we'll answer any question you have. Let me start by saying that our group performance after the first three months is in line with the trajectory we expected. This means we are confirming our Outlook 2023 at high single-digit constant exchange rate sales growth and a core EBITDA margin of 30% to 31%. As we forecasted when we reported our full year results in January, we anticipate a strong second half of the year balancing a softer H1. Let's now take a moment to look at our macroeconomic context. In Q1, we have seen a number of macroeconomic factors influencing our business in different ways. In line with the wider industry, we are observing soft demand for early stage services and capacity, driven by constraints in biotech funding. We began to see this in 2022, and the banking crisis earlier this year has continued to limit access to capital for biotech. However, Commercial supply make up around 70% of Lonza's CDMO business, and here we continue to see a strong interest. Turning to our growth projects, we are making good progress with capex spending being on track. We are also pleased to have started operation in two new facilities in VISP for fill and finish and bioconjugates. we were happy to see that FDA approved the first oral live biotherapeutics from Ceres Pharmaceutical. The scale-up of this novel therapy will be supported by Bactera, our joint venture with Christian Hansen. Now, let's take a look at each of our divisions. In biologics, we see strong underlying sales growth versus Q122, excluding the prior year alakose termination fees and mRNA sales. There is a lower demand for early-stage offering, driven by biotech funding constraints, but we see solid demand for long-term, large-scale programs across mammalian, microbial, and antibody drug conjugates. This is supported by advanced commercial discussion with large pharma and well-funded large biotech. Weaker performance in China is driven by low interest from our international customers and a challenging local market. Looking at our growth project in Q1, in this, the tech transfer for the first commercial product of our new drug product line is ongoing, and we have completed an extension of our conjugation facility. We also commence the construction of our new 500 million commercial drug product facility in Stein. Finally, in January, we mentioned two growth projects that were delayed by a couple of quarters. Since we updated the schedules in 2022, the projects are now continuing to progress as planned. In small molecules, a solid Q1 builds on the momentum of H2 last year. This is supported by good demand visibility. While industry funding challenges have caused a slight decrease in inquiries, the number of new customer signings remains consistent with previous years. We are also pleased to see a continuing portfolio shift to more high-value and complex small molecules. Let's now turn to the cell and gene division. In bioscience, cell growth is aligned with expectations and driven by good demand and pricing power. In cell engine therapies, the biotech funding challenges have impacted preclinical and phase one demand. This has led to a reduction of new inquiries and placed pressure on margin and growth in Q1. Nonetheless, we remain committed to this base, which continues to hold strong long-term commercial potential. In the capsules and health ingredient division, we have seen continuing strong demand for pharma capsules. We are also pleased with our progress on pricing, which has allowed us to mitigate some of the increase in the price of gelatin, a key raw material for our capsule business. However, excess manufacturing capacity has been driven by lower demand for nutraceuticals in the U.S. as customers reduce their inventories ahead of a potential economic downturn. This means that the division saw some pressure on top and bottom line in Q1. In January, we announced our intention to start a share buyback. As planned, the program commenced early April and is currently scheduled to complete in H1 2025. The buyback is executed via a second trading line on the Swiss exchange. Finally, I want to confirm that we will host our Capital Market Day on the 17th of October. This will replace our quarterly qualitative update for Q3. The event will be hosted in our site in VISP, and we will take you on a tour of our facilities. To close, I will summarize by saying that we are in line with the expected trajectory towards our outlook 2023. And as we anticipated in January, our H2 performance looks set to be stronger than H1. Looking at our industry fundamentals, we are well positioned to capture value with a strong focus on quality, our broad range of offering, our global asset base, and our technical expertise. With that, I would like to thank you for your attention, and I will now pass back to Sandra for the Q&A session.

We will now begin the question and answer session. Anyone who has a question or a comment may press star and 1 at this time. The first question comes from Matthew Weston from Credit Suisse. Please go ahead.

Thank you for taking my questions. Two, please, if I can. The first is around the cadence of the first half versus the second half. You flagged that there is weakness in cell and gene, but also in the capsules and healthcare business. Can you tell us if that's been offset by a stronger than expected performance in the other businesses, or whether or not you now need the second half of the year to be, I guess, even stronger than you previously anticipated? And then the second question, we've recently seen more positive data in Alzheimer's. It's always been an area for Lonza where investors have been interested about the potential for CDMO to get involved in manufacturing. Can you just update us as to where you are, as to any role Lonza may play in the manufacturing of late-stage Alzheimer's drugs in the near future? Thank you.

Thank you, Matt. Maybe let me take the first question before handing over to Pierre Alain for the Alzheimer's question. So I think, first of all, I'd like to reiterate that we are confirming our outlook for 2023, and we won't be going much deeper into the divisional mix. As we've said before, Lonza is a stool with many legs, and it's not uncommon to have headwinds in different parts of the business and upsetting them in other parts. We don't necessarily need to have a strong imbalance between H1 and H2, but as an entire portfolio, we're happy to reconfirm 23, knowing that we have the headwinds you mentioned before.

Thank you, Philippe. Regarding Alzheimer's, I think like everybody and every patient, we were very pleased to see a second study having a significant impact on patients. I think there is no doubt Now two therapies showing efficiency. I think as you know, both therapies require significant amount of protein, which again is going to be very positive for the industry. If you make some calculation, and here again I would not speculate for the future, but the capacity utilization driven by these two drugs are going to be definitively in the high single digit rates of total capacity. And even without being bullish on that, and clearly we believe this will really increase the utilization rate and be positive for the industry. I'm not going to be more specifically on any discussion with company we may have because obviously it's not for public disclosure.

Many thanks indeed.

The next question comes from Vinit Agarwal from Citi. Please go ahead.

Hi, Vinit here from Citi. Thanks for taking my questions. So maybe, again, coming back to the guidance, just trying to understand if this is something that you had big into your forecast, the softness that you have seen in certain pockets. I guess what I'm trying to understand is what biotech funding assumptions have you used for second half of 23 and then maybe even for 24? Do you expect the funding environment to remain fairly similar to where we are today? and still confident of achieving the guidance, or does it need to improve significantly to meet those targets? And then maybe just on the same topic, on the biologics early stage projects, can you just help us understand if this sort of impact, is it something you have started to see only recently, or has the weakness been there for a bit longer now?

Yeah, thanks, Vineet. Let me take one more stab at it. So I think probably all of us are looking at the same data in terms of biotech funding and early stage company funding. And you've seen that this goes in waves, but you've probably seen that the overall funding is down versus prior year, probably around 30% or so on the data we are looking at, and certainly way off from the peaks that we saw in 2021. Now, compared to a couple of years back, we're probably just about at the same level, maybe slightly below. In terms of what we assumed for 2023, we probably assumed to have some pick up again, which we don't see yet coming and we won't be necessarily speculating on if that's not going to come in Q3, Q4, or maybe slightly after that. So yes, I think there is weakness in this business, which is mostly visible in our cell and gene therapy business, so a part of our cell and gene division. That's certainly a place where we have the most early-stage business that needs to be more frequently replenished. Now, as Pierre-Alain said, we still believe this is a very interesting field of the CDMO business, and we will continue to be playing in that field and continue to grow in that field. You also wanted to know the impact on biologics. I think, as you know, our biologics business is very different from the cell and gene therapy business in the sense that it is much more commercially weighted, with over 70% of our revenues and margins coming from commercial stage business. And so, yes, we do have early stage business in our biologics division. However, the impact is, of course, much less.

Thank you, Philippe. On the biologics part, I would like to stress that at LHONSA, we are definitely positioned as a premium CDMO. And certainly on the biologics part, while we see a decrease in inquiry, we still have a fair winning rate. So again, without trying to don't play that, we see the impact more in cell and gene therapy than in biologics.

Thank you.

The next question comes from James Quigley from Morgan Stanley. Please go ahead.

Great. Thanks for taking my question. So the first one's on fill and finish and drug products. So your plant just opened up in VISP. So what are your ambitions with respect to fill and finish? You've had development capabilities since around 2016, 2017. How important has that been to differentiating your offering now that you also have large manufacturing facilities? And what are you expecting in terms of a ramp up for this plant and then also coming into 2026 when you have the larger scale capacity in Stein? And then can you talk a little bit also about the price and volumes dynamics that you're seeing across the different divisions from biologics through to consumer and nutrition? Thank you. Yeah.

Thank you, James, for the question. Clearly, on fill and finish, I think we are overall very happy with our progress in this business. As you recall, we started to invest a lot in formulation, having good progress on that, followed by the acquisition of capacity from Novartis for clinical manufacturing, and we continue on this trend. So according to that, we are really developing as we planned, by building a strong base of early phase customers, getting synergies when we make a drug substance, also offering the drug product offering, which is really key for us. And we see a lot of demand for high-quality fill-and-finish services. So we are on that one, and we are happy with the developments. Regarding REMPAP, REMPAP is probably in the range, as we have mentioned, multiple times of two years. So we are now transferring the first product. We will soon come with the next transfer. And then you have the classical putting the batch on stability, going for submission, and getting approval. So here it's really executing according to plan. So for us, to wrap up the topic, Fill and finish is really a strategic decision we have made. We are investing from early development to commercial. We are making very nice progress on building our commercial facilities, so I would say it's fully on track. I'm not sure I fully understand your question regarding price and volume dynamics. Can you perhaps clarify it?

Sure. It's just basically asking what you're seeing in terms of price and volume, maybe across the whole portfolio. You said high single-digit growth. What element of that is price for this year, for the 2023 guidance versus volume? And are there any sort of areas of your business that you're seeing a greater impact on price or a more limited impact in terms of your subdivisions?

Thank you, Philippe. We'll take that one.

Yes. Hi, James. So I think, first of all, I'd say that on the pricing front, you know, this is pretty much going as per plan. If you remember, we have two very different types of businesses. One is a more product business, which we see in our capsules business in our bioscience business unit. There, of course, the pricing is easier or faster to get through, and we're taking the price increase that we had planned to take, and we see actually good pickup from that. Now, looking at our CDMO business, the approach is different, obviously, because we have a lot more long-term contracts where price is usually negotiated at the beginning of the contract and is included in the contract clause, and there as well we're making the progress we wanted by having adjusted several of the contract prices that we could adjust. So it's going as per plan. We do not disclose a detailed price-volume mix for the company. Again, something that we can certainly take offline, but is a very complex thing to do in a CDMO business. Of course. Thank you very much.

The next question comes from Richard Vosser from J.P. Morgan. Please go ahead.

Hi, thanks for taking my questions. First question on your growth projects. Clearly, you've let us know that your equipment is in-house. How's the ramp-up going there? Are those coming online a little bit faster than expected, potentially? Or, yeah, how's the ramp-up? And then just thinking about China, you mentioned, of course, a difficult market in the local market and

the you know the multinationals not not ordering at the moment maybe to give us a little bit more color and how you think about the timelines to that turning around thanks very much thank you richard regarding china again i would like to to remind you of the big picture i think lonza is sales below five percent in china split in in three businesses so we are making capsules for the local market and this business is doing well. We have also a chemical facility for intermediates and it's doing well. And my comment was more towards the small-scale disposable biotech facility we are having in China. And here again, during the pandemic, basically none of the customers were able to fly over there and so we really see a real slowdown. So we are now looking at the recovery, and we will comment more later this year. For the growth project, you are correct. I think we were getting all the equipment in-house, which were delayed. We mentioned that during the previous call. And we are currently very happy with the ramp-up validation and starting of operation. So basically, it's happening according to plan. Thank you very much.

The next question comes from from UBS. Please go ahead.

Thank you, and good afternoon, everyone. Just a question on H1, where we had various one-off impacts last year that we need to consider or take into account if you look at the current H1. And in particular, I'm thinking about the small molecules business with the phasing issue. Point of view, do you think could something like that reoccur or are we back on normal track and we should just add back the delayed revenues into H1 from H2, just from a modeling perspective?

Yes, Patrick, let me take that one. So I think we were clear last year already that the volume in H1 were moved into H2 2022. So from that point of view, the year was whole for our small molecule divisions. Now, can something like this always happen? Of course, it can always happen. Currently, we don't see this repeating, so we're very confident with the performance in small molecules today.

Great, thanks. The next question comes from Max Schmock from William Blair. Please go ahead.

All right, thank you for taking our questions. First one for me, and apologies if I missed this, I just wanted to confirm that the guide that you laid out for 2024, that midterm guide, is still intact. And then I also wanted to follow up on a prior question around Phil Finish. I'm curious if some of the issues with the major competitor that we've seen in this space and the explosion of demand that we've seen for obesity drugs, whether or not those have changed your views around capital allocation at all. Obviously, I know you were building out a lot internally, but given the significant opportunity, And, in fact, you pointed to a three-year ramp-up time for some of these new facilities. What are your thoughts about potentially acquiring some assets that could increase your footprint and still finish more aggressively here near-term? Thank you.

So thank you, Max. Definitely our mid-term guidance is intact and it's confirmed, so no change at all on that. Regarding issue with competitors, you know, I think, It's just underscoring the importance of quality. For fill and finish, having modern facility allowing to provide good service to customer is key. And I think it's why we have decided to invest in this field, providing good quality service, which is needed, and having synergy with our business. So our plan has not changed. Yes, we always try to ramp up as fast as we can by doing it the right way. And there is some timeline we cannot compress during ramp-up, so basically making validation batches, performing stability, as well as getting the approval of health authority.

I think, Pierre-Alep, I can add, in terms of acquisitions, of course, we're always looking at available capacities. The reason why we decided to go organic is mainly because of the quality of assets that we see on the market, what we can do with them. Do they have the right flexibility for a CDMO business and the right quality, or do they require a lot of investment and renewed maintenance? So I think we are not objected to buying capacity. We've mentioned that before, that our M&A strategies are around large capacities or early technologies, but there's not a lot of good assets on the market.

Got it. Very helpful. Thank you.

The next question comes from Paul Knight from KeyBank Capital Markets. Please go ahead.

Thanks very much for your time. Are you finding that in the selling gene side of the business, the approval outlook we hear is pretty robust, very strong for 2023? Are you seeing that yourself as maybe some significant approval change globally?

I think we are hearing similar things. You know, these treatments are really helping patients in areas where there is no other medical treatment. Generally, the success rate of clinical is high in Phase III. You see good success rates, good impact on patients, and we continue to see a positive outlook for that. Yes, the pipeline currently, or all pipelines, the pipeline in Phase III is mainly early phase, but we have seen last year a couple of approvals we were very proud of, and we continue to work with a couple of treatments which are in late stage. So we don't see any changes based on the funding. I think the funding is more impacting new ideas, which obviously face much more difficulties to get money.

Okay. And then our last question would be, we understand in the industry that customers approach Lonza as much as you approach them. are you still having a lot of your expansions already largely pre-booked? And what level does that pre-booking mean? Is it when you build, do you have 60 or 80% booked or what is that trend right now?

So this has clearly not changed because as we mentioned, for large asset, We want to make sure that we have the vast majority of the capacity committed before we build. We never provide an exact figure, and it can depend from asset to asset, but it's probably in the range of what you have mentioned. So it's the vast majority of the capacity being booked, and this is not going to change. For early pipeline asset, obviously you don't have pre-booking for 10 years. but we make sure we have the right pipeline of projects before committing to that. So the level of risk for our asset has not changed.

Okay, thank you.

The next question comes from Peter Welford from Jefferies. Please go ahead.

Thanks, Timmy. I've just got three very quick ones. Firstly, just with regards to stocking in terms of both your levels of, I guess, consumables, et cetera, that you're using, and equally from the customer side, how are you doing with regards to both utilising existing stocks to perhaps return to normal pre-pandemic levels? And equally, have you seen any signs of any of your customers reducing their stocks that they have on hand. Secondly, then, just on cell and gene, I wonder if you can perhaps tease out what percentage, if any, do you think of the impact is due to clinical trial holes, failures, et cetera, rather than funding? I guess I'm just curious, do you think the vast majority of this impact is funding or actually is a sizable part also the attrition that perhaps is higher than anticipated? And then just finally, just on the inquiries, I heard you say that you've got a slight decrease in inquiries. Just to be clear, was that relevant to the small molecule business, but where you've got consistent signings overall, or was that for biologics? Because I think you also mentioned a shift to higher value molecules. Thank you.

So thank you, Peter, for the question. I will briefly take two of them and let the stocking for Philippe. So regarding the number of inquiry, We have seen a decrease overall of inquiry, but we still win the same number in small molecules, so no impact on molecule pipeline. We see a small decrease also in biology with very little decrease, and basically the most impact is on cell and gene. To your question on cell and gene, no, it's a dual effect. You always have a certain attrition rate due to clinical, and this has not changed. It's not better than before or worse than before, but the main difference is funding. So we still have the same failure rate in phase one as before, but obviously you get less new customers coming with new ideas and new projects. And this is really the main reason for the decrease we see. Philippe, do you take the stocking?

Yes, Peter. So on this talking, just to reiterate what Pierre Alain said in his introductory remarks, I think we do see inventory reductions in our capsules customers. So that's the place where you would see some correction in inventory. We do not see this in the rest of our CDMO business. So that's certainly good news. We don't see these movements. Now, we are continuing to be committed to reduce our inventory. We did increase inventory levels during the COVID pandemic to ensure availability of our raw materials and ensure that we could produce the batches for customers. And we've committed to reduce that level by about a month over the next 18 months. And so we're tracking onto that. We are utilizing raw materials that were purchased earlier. And therefore, we will see a decrease in our day's coverage of inventory over the next 12 to 18 months.

Actually, we are able to do so because we see a more reliable supply from the big supplier. So, operators, we will take the last question.

The last question is a follow-up from Mr. Matthew Watson from Credit Suisse. Please go ahead.

Thank you. That's kind. It's a question regarding your customer concentration, actually. I noticed in the annual report that we've seen a very significant increase in over the pandemic of your single largest customer from basically 5% to going up now to over 9%. Now, I know you're going to be very sensitive about discussing customers, but I would love to understand whether that increased concentration is something unusual associated with the pandemic, and we're likely then to see it come down as business normalizes. If you can say whether it was associated with M&A, so essentially two big customers have merged, or whether actually you're just seeing a single customer emerge and be 10% of your business, and what you can then do to mitigate that risk.

Thanks for the question, Matthew. I would like to reiterate that we believe we have a very healthy base of customers. Again, 10 customers representing 50% of the sale, with many of them having multiple products. We see a little of all what you have said. Many of our biotech, small biotech customers get acquired one day or the other by a big pharma. So this is part of the consolidation. We see also customers moving a product to a full commercial. So then we see big ramp up and it could be a lot of money when it's expensive product like ADC or antibodies. So we see that. We don't see the need to mitigate that because, as I mentioned, many customers, many products, a long-term contract, which is for us a very robust and solid base of customers.

Many thanks indeed.

With that, I would like to thank all of you for the question, and thank you, Sandra, for hosting the call. As a final overview, we are confirming our Outlook 23. This is clearly supported by a strong industry fundamentals and a good momentum across biologics and small molecules. We are looking forward to speaking to you again at our half-year results on July 21st. In the meantime, I wish you all a great day. Merci.

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