Lonza Group AG (LONN) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the Lonza Q3 2024 Qualitative Update Investor and Analyst Conference Call and Webcast. I'm Sandra, the Chorus Call operator. [Operator Instructions] The conference is being recorded. [Operator Instructions] At this time, it's my pleasure to hand over to Philippe Deecke, Chief Financial Officer. Please go ahead, sir.

Good morning, good afternoon and a warm welcome to our Q3 qualitative update. These calls are intended to provide a general business overview, so we will not be sharing numbers relating to our financial performance. Instead, we will share full financial updates during our full year results call in January. Today, I will start by sharing a view on the group and our growth projects, then provide a short update on each division. We will then have time to take your questions. We reported a Q3 performance aligned with the full year trajectory and expect sales in Q4 to be higher, which is typical due to batch release timing at year-end. Despite the persisting pressure in Capsules & Health Ingredients, we are confirming our outlook '24 with flat sales growth in constant exchange rates compared to prior year and a core EBITDA margin in the high 20s, which is 27% to 29%. This guidance reiterates our position already explained at half year, where we will have higher absolute CDMO sales at a less high margin compared to H1. Remember that while sales would be higher in H2 than in H1, CER growth will be lower as we are lapping a high base in H2 2023, which included the COVID termination agreement with Moderna. Turning to our growth projects. Overall, we are making solid progress at our site in Stein, Switzerland, construction of our large-scale commercial drug product facility is progressing well, and we are on track to start operations in late 2026. We expect to start commercial GMP manufacturing in late Q4 at our new highly potent API facility in Visp, Switzerland, with sales contribution set to increase significantly in 2025. Also in this, we are on track to commence technical operations at our large-scale mammalian drug substance plant in Q4. The site is fully contracted and will reach peak utilization by 2029. Due to customer demand, the facility will also house N-1 perfusion technologies. Full commercial GMP manufacturing will commence in H1 2025, with production ramping up over the course of next year. Due to the phasing of our spend, CapEx as a percentage of sales may be slightly below the initially guided 25% for the full year. A key driver for this is lower maintenance spending across the sites and some customer-driven changes in specifications. Now let's take a look at each of our divisions in turn, starting with Biologics. There was good commercial momentum across the Biologics division with a strong level of contract signings across the business over the year. Improvements in the biotech funding environment have resulted in an uptick in early-stage RFPs. This provides a promising sign for future overall pipeline growth and clinical demand in our mammalian and drug product services businesses. Looking at selected business units, bioconjugates saw strong growth supported by the ramp-up of new assets. The mammalian business units saw good momentum from growth projects ramping up and strong operational execution in the base business. Our acquisition of the large-scale commercial facility in Vacaville, California, closed successfully on the first of October, and the integration is progressing well. We are seeing strong demand and continued contracting interest for the high-quality capacity in this asset. The site joins Lonza with a strong regulatory and quality track record and is well positioned near San Francisco pharma and biotech hub. We will provide further financial details on the acquisition as part of our full year reporting in January. We can reconfirm that the P&L impact for 2024 is expected to be insignificant. Turning to our Small Molecules division. We continue to see strong commercial demand with good visibility, supported by high levels of committed business. The division is further supported by our continuing portfolio shift to high-value and complex small molecules and the strong growth of our highly potent API offering. Sales are expected to be higher in H2 versus H1 due to campaign timing and supported by strong operational performance. Looking at our Cell & Gene division. Strong operational performance in commercial manufacturing is driving momentum in our Cell & Gene Technology business. There has been continued customer interest in our commercial offering. And in Q3, we announced a long-term supply agreement with Vertex to manufacturing gene-edited therapy, CASGEVY, for sickle cell disease and beta thalassemia. We expect a rising sales contribution from CASGEVY over the course of 2025 and beyond. The agreement with Vertex is a representative of our ambition to increase the number of commercial products in our portfolio, and we expect to add further commercial molecules in the midterm. We are also encouraged to see the improved biotech funding environment is translating into an increased number of RFPs, but these are not expected to materially support revenues in the near term. Our bioscience business continues to experience market headwinds, which have impacted sales, but we are managing profitability through a strong cost discipline. Finally, turning to the Capsules & Health Ingredients division. We continue to observe softer demand for pharma hard capsules due to continued destocking phase, in line with the market. While the latest data on orders is encouraging, it points more to a recovery in 2025. In the U.S., demand for nutraceuticals has recovered after a long period of post-pandemic destocking. However, overcapacity makes this market more competitive. To mitigate market developments and protect margins at least partially, the division has undertaken a cost management and productivity program, alongside its continued commitment to customer value. We also continued the rollout of our market-leading D90 manufacturing technology, which will improve our cost position. To close, I will summarize by saying that we are in line with the expected trajectory towards our outlook '24. We remain well positioned to capture value by maintaining our focus on building our pipeline and growing our commercial offering, while managing our costs and continuing to drive operational excellence. Before I hand over to Sandra to host the Q&A, let me remind you that Lonza will host an investor update on December 12, 2024 in Basel, Switzerland, where Wolfgang and I look forward to interacting with you, in person. The event will cover our group strategy update, including priorities going forward. This reflects the work we have undertaken as a leadership team, together with the Board since Wolfgang Wienand started as a CEO in July 2024. You can file all details and registration information on the Lonza website. With that, I would like to thank you for your time. Sandra, over to you.

[Operator Instructions] First question comes from James Quigley from Goldman Sachs.

I have a quick question on the Visp sites. Now it's fully contracted. Are you still confident in the peak sales -- that peaks in 2029 will fall within the 1 to 1.1 average peak sales CapEx range? Also to what extent are the uncertainties around some of these contracts, for example, are some late-stage Phase II or Phase III development. So could they still carry some trial risk? How should we think about the ramp-up towards peak sales in the Visp site?

Yes. James, thank you for your questions. Yes, happy to confirm that the site is fully contracted. We've had it constructed for a while now. Remember, this is a multipurpose asset. So we can do a whole range of different in this facility. It will host as well N-1 perfusion, so even more versatile so that we can really accommodate all type of molecules in there. So. It is fully committed. I think if something would happen to any of the customers. As usual, we would have time to backfill this as this is highly sought-after capacity. In terms of the ramp up towards peak sales, I think as you probably know from these large facilities, tech transfers will happen over time, and we will be introducing molecules over time as well. I think probably you can take our CMD 2023 description of how large-scale assets ramp up as a guide, if you need to model.

The next question comes from Charles Pitman from Barclays.

Two quick ones, please. Just a clarification to start with. I think you mentioned that CapEx is expected to come below the originally guided target for FY '24 due to changes in customer priorities. I was wondering if you could just give us a little bit more color on what those really look like? And then just secondly, how should we think about the impact to Cell & Gene therapy margins as a result of this contract with Vertex you've announced? Does that kind of derisk what you've already stated? And is it in line? Or is it potentially incremental?

Yes, Charles, thank you. Let me take them in order. So I think for CapEx, I think, as we mentioned for -- during our H1 call, CapEx will be slightly below the 25% we guided. I think we are now confirming that this will be below. I think in terms of -- I didn't say change priorities, I said change in specification of customers. So when we build assets with customer needs or special customer needs, usually, the companies are developing this with us. And so their process is not fully fledged if you want. And so then the scale-up of this process into a full facility sometimes needs change. So when this change happen, it basically pushes out a little bit the construction, and this is what happened in individual cases. So it's not priorities, it's specifications. In terms of Cell & Gene margins and the impact of Vertex, as we communicated back at our CMD and since then, is that the strategy really for Cell & Gene is to move more into a commercial portfolio. I think today, the portfolio is heavily weighted on clinical assets. And so we mentioned we want to have a handful of commercial products over time, and this is one of them. And therefore, the margin and the sales contribution of CASGEVY is part of the outlook that we provided back at the CMD. So this is part of the strategy. I think we're very pleased to be part of the CASGEVY journey with Vertex, but this is not coming on top of whatever guidance we gave.

The next question comes from Thibault Boutherin from Morgan Stanley.

Just a question on Vacaville. I know that you have closed the deal and you have the facility. Can you share some details on the timeline in terms of when you expect to generate first revenue from Vacaville. And also if you can share some color on the volume commitment from Roche for 2025 and the capacity utilization? I think in the past, you shared the 30% capacity utilization figures. So is it still the right way to think about this?

Yes. Thibault, happy to talk about Vacaville. Obviously, we're very pleased to have been able to close early in October, on October 1. I think the integration is going well. I think the teams are now operating together between the site team and obviously, our global teams. So this is all going very well. We're very pleased with the continuation of the work. Now in terms of financials, not much has changed, obviously, over the last three weeks. So for us, the utilization that we expect for next year is still around the 30% we communicated earlier, which would be exclusively based on Roche demand for the site. And for the further out years, we will need to wait to get firm commitments from Roche. So we're still waiting for the firm commitment from Roche. This should come later this year. But for now, the assumption is the 30% we mentioned, which leads to the numbers we've been sharing all along of 1 to 2 points of growth by 2028.

The next question comes from Jack Reynolds-Clark from RBC Capital Markets.

Two very quick ones for me, please. So the first is on in terms site closures. I think you closed a couple of smaller sites in China and the U.S. But I was wondering how much of a headwind this is have on H2 or 2025 sales growth. And the second question is just around the productivity measures you mentioned capsules. Could you just kind of run through some details of kind of what's involved there.

Yes, sure, I'm happy to take the question. So I think the site closure, we mentioned two site closures. One was Hayward, a small clinical site in California, which we decided to close as we now have clinical capabilities in our Portsmouth site, which include all scales on the East Coast. And we now obviously also have Vacaville on the West Coast for large-scale manufacturing. So there was really no need for this older smaller site. In terms of headwinds, I think this was fully assumed in our guidance. And therefore, there's no change from that and no impact from that. We've progressed well and are well on track to finish. As we said, these things take long because you do honor certain contracts and decommissioning takes time. The second site, we mentioned, as you said, was Guangzhou in China, again, a small clinical site, which had DS and -- drug substance and drug product. Also there, I think the decommissioning and the closing down of the facilities is going as per plan. Again, the impact relatively small because these were -- this was an underutilized site. Therefore, not a big impact. If at all, you'll see a small tailwind on the cost base in '25 as we won't have these sites in our cost base anymore. But again, two relatively close small sites. So I'd be surprised if you would see difference, nevertheless, the right thing to do and focus our volumes on the other sites in the network. In terms of productivity for capsules. This is a highly fixed cost business. And so what you can do is usually limited, but I think we are working obviously on reducing headcount that we have in some of our sites. If we don't need some of the lines, then we would basically most fall a few lines so that we can quickly start them up again when demand comes back, as we have seen for nutraceutical. So this is what we're doing there. Then a lot of work on procurement. We mentioned new ways of procuring gelatin, also on the energy front. So these are kind of the key costs of the capsules business, energy, gelatin and people.

The next question comes from Richard Vosser from JPMorgan.

Just a question on contract momentum. Could you just give us a little bit more color on the sort of phasing how that's going? Whether contract momentum is picking up now in the second half since the first half results? And how the Vacaville closure is affecting contract momentum? Is that making it easier to sign new projects now you control it?

Thanks, Richard. So I think corporate momentum is certainly a positive story in 2024. I think especially on the commercial side, we have seen very strong interest for our offering. Of course, Vacaville is part of that. Remember before Vacaville, our large-scale assets in biologics were basically sold out. And so we could only resell the contracts that were ending. So this was limiting our ability to bid and to go after larger contracts. So Vacaville certainly has helped. In general, as you saw, we signed a larger contract earlier this week. And together with Vertex and many, many other contracts that we have signed, we will have a quite a substantial amount of signed contracts by the end of the year. The good thing is this is a broad-based signing success, if you want, because we have this, obviously, in our Biologics division. We also see good signing and good contracting in small molecules, and we have good contracting in the Cell & Gene division. So overall, we're quite pleased with that progress. And the bigger number is obviously driven by commercial contracts, but we also see a lot more RFPs on the clinical side of things. Now in terms of revenue, this will not be a big revenue driver. As you know, early-stage contracts are usually smaller in size, but they are very important for us to drive our portfolio and to basically create our own pipeline of future commercial molecules. So I think both sides, the early stage is picking up, and the commercial side is actually strong across all divisions.

The next question comes from Charlie Haywood from Bank of America.

It's just a slightly bigger picture question. Obviously, there's been a bit of noise around concerns on the shift to higher yields on the mammalian side. So you adding your N-1 capacity to the West side, which looks like it's slightly delayed the launch timing. I guess, what prompted you to make the decision to add that technology now given you've known about what Vacaville would offer for a few months? Was that waiting for Vacaville to close? Or have you seen any significant changes in demand there that's made you make that decision?

Thanks, Charlie. So we had N-1 already available, which has decided to have even more and N-1 ready and make this also part of our Stein facility in this. So I think, of course, new developments, people are making use of the latest technology. And so you need both. And we believe that there is no either/or. We will need N-1 capacity, and we will need a regular non-N-1 capacity as well. So this, I think, I wouldn't say it's a shift in our ideas. So we were not waiting for something special to happen. When you do these large additions, I think you need to time it well so that you don't disturb any of the other work happening in the facility. So it's more of an engineering timing than it is of a customer demand timing.

The next question comes from Patrick Rafaisz from UBS.

Two quick follow-ups, please. One is on Vacaville. And Philippe, you mentioned the contribution this year will be insignificant. But is it insignificant just because of the timing of invoicing? Or are there other reasons why there will be only a very insignificant contribution? And the second follow-up just on the capsules business. You mentioned the competitive pressure that continues. Can you comment on whether that has changed H2 versus H1? And can you maybe comment about price cost that segment as well?

Yes, Patrick, let's take Vacaville and then capsules. So I think on Vacaville, you're right. I would call this timing of revenue recognition rather than timing of invoicing, but this is correlated. So yes, I think the work continues in the facility. But obviously, it takes time for batches to be produced, quality released and therefore, invoiced. So this is the reason there's no other reason for the minimal or insignificant impact in '24. In terms of capsules, the pressure is mainly on -- or is on the nutraceutical side of things. Remember, on the nutraceutical side of capsules, the capsule is usually not registered as part of the drug master file and so changing is much easier than it is on the pharma side. And so you see that suppliers are now playing between different suppliers more than they were probably 2, 3 years ago. But that's not a difference between H2 versus H1, this is a difference from 2, 3 years ago to now. I think the pharma side is not impacted by that because there -- I think the change is more difficult and customers are more sticky to the capsules that they're using.

The next question comes from Max Smock from William Blair.

It's Christine Rains on for Max Smock. Two quick ones for us as well. First, you mentioned that 3Q performance was in line to deliver on your full year outlook. But just wondering if it was in line with expectations in terms of what outperformed and tracking ahead of what you factored into your 2024 guide and what is underperforming? . And then quickly on CHI, I believe, previously, you've mentioned or implied that you'd be willing to divest. Have you had any conversations along those lines yet? And are you actively exploring this idea at all?

Yes. Christine, great to meet you. So I think in terms of overall underperformance in Q3, I think I wouldn't limit it to Q3. But you know, I think we've been fairly consistent this year that certainly our CHI division has been underperforming. I think we've explained the situation there, and we now see the business probably returning more into 2025. So that's certainly one area that -- where we see underperformance. We've also mentioned our bioscience unit, which is a smaller part of our business, but nevertheless, we are seeing some market headwinds in that smaller part of our business. So these are probably the two places where we see underperformance. And yes, we're happy to see that the CDMO businesses are performing well and therefore can offset that, of course, to maintain our guidance. In terms of CHI, I'm not sure what conversation we have had where we were mentioning such a move. No, there is no conversation to be had. I think we are regularly, as a company, reviewing our portfolio every year. And whenever things come out of that discussion, then we take the respective step and would inform the market. But I cannot confirm any of the discussions that you alluded to.

The next question comes from Falko Friedrichs from Deutsche Bank.

Can you add a little bit more flavor on the recovery path for the bioscience business? And to what extent could we assume that this normalizes next year?

Yes, Falko, I'm happy to do so. So I think as you maybe know our business in Bioscience is a combination of smaller businesses, niche businesses, I think, out of that. We're seeing two that are a little bit weaker. One is our media business, and the other one is our cell discovery business. So these two are dependent on very early-stage work, and they've basically seen less level of investment, which also leads to less start of the need for us -- for our services. So I think this is normalizing. I think the business -- it's not that it's getting worse, it's actually stabilized, but we expect the return to growth probably in 2025.

The next question comes from Paul Knight from KeyBanc. The next question from Yifeng Liu from HSBC.

This is Rajesh Kumar for Yifeng. Just thinking through the Vacaville facility. Can you run us through what sort of utilization do you need to get to make acquisitions return accretive for you? And when you look at acquisitions, what sort of return hurdles do you set up when you're doing such capital allocation decisions? So obviously, you have to trade with the duration, the returns and the strategic importance. So if you can run us through the thinking behind it and what sort of revenue and utilization you need for Vacaville to become return accretive? That would be very interesting to understand.

Yes. So look, I think Vacaville is not so different from a capacity that we would build ourselves. You can see this as kind of accelerated CapEx because instead of building for 3, 4 years, we basically bought a site that is already operating. So I think we always have the aim to run these commercial assets at high or very high utilization. And this is what we will ultimately need. I think, again, I mentioned that in the call before, but if you go back to our CMD '23, you see the progression of such assets. So I think we are expecting high utilization. This is not -- we don't need max utilization to be accretive, but this is certainly the ambition we have for the site. So from that point of view, this is what we're looking at. In terms of hurdle rates, again, if this is the case of Vacaville, we will always compare this to the hurdle rates we have for our internal organic build. And so here, we've had -- for organic investments we have an IRR of 15% or more and we want a ROIC of 30% at peak. So this is what we use as a hurdle for organic. If we do like in this case, an accelerated CapEx investment, you could assume that we would need this at least. So that's maybe just as a guide. Now obviously, there's always a strategic component. Is it the direct location at the right time, et cetera. But this is roughly the returns we would expect. Sandra, maybe we take one last question.

Okay. The last question is a follow-up from James Quigley from Goldman Sachs.

It's just one on the ADC opportunity market, you signed another contract essentially recently in the space. What is the latest from a market share perspective for Lonza across the approved ADC, also what are you seeing in terms of the clinical pipeline coming through? And in terms of the trend, is there a trend towards ADC customers sort of consolidating all of the 4 parts to 1 player like Lonza or is it still pretty much depending on the drug?

Thanks, James. Good to have you at the beginning at the end of the call. So I think, look, ADC, we're still very pleased with the -- both the development in the industry, but also our role -- the role that Lonza is playing in that industry. We are clearly a leader or the leader in commercial manufacturing for ADC. On the clinical side of things, the level where we started that, you can almost only lose share because there's a lot of new players coming in. So that's actually not a surprise. Our offering is quite unique and actually is very attractive for customers. So as you say, we have all pieces in our hands since the acquisition of Synaffix. We also have a linker technology on-linked technology, so we get access to ADC development very early in their life cycle, which is a big plus. Second, we are now also adding ADC to the finish, which would be in '27. So I think this is really unique. And what we hear from customers that having this out of one hand is for them, clearly a benefit. So on one hand, the industry is still doing well. We see the pipeline growing. I think if you look at market data, the pipeline and the value of ADC drugs in the future keeps on growing quite significantly, and we will be playing a major role in that. So this is underlined by the contract we signed this week by the investments that we're doing in conjugation, but also in general math that are needed for ADCs. So overall, a great story. With that, thanks a lot, everyone, for your great questions, and we look forward to talk to you mid-December again. Thanks, everyone.

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