Edited Transcript of LONN.S earnings conference call or presentation 21-Jan-20 10:30am GMT

The current business structure has 2 segments: LPBN and LSI. LPBN is subsegmented in 2 businesses, the pure CDMO business services and the product business. The CDMO service portfolio comprises 3 businesses, reflecting 3 different technology platform: small molecule or chemical synthesis; mammalian and microbial fermentation; bio — micro — sorry, mammalian and microbial fermentation; and cell and gene technologies. The product business portfolio has 3 sub-businesses: bioscience, capsule systems and a small nutritional ingredients business.

After completing the Capsugel acquisition, we then split the entity, placing one part in LPBN, another part in LSI. This setup created problems, and we have decided to reunify the capsule business into a single entity. LSI has completed a reorganization last year to create a clear and focused setup along 2 distant business models: microbial control solutions and specialty chemical services.

The carve-out of Lonza’s Specialty Ingredients segment is progressing in line with plan and completion is currently expected by mid of the year. We’ve had a team — a core team of 40 employees working on the carve-out since the program started in June 2019. The carve-out’s workstreams are shown here. All workstreams are in full execution mode and progressing according to time lines and agreed milestones.

In setting up the corporate structure, all legal entities are now either fully dedicated to LPBN or LSI. The employee allocation to either LPBN or LSI was completed at the end of 2019. We have also initiated the preparation of the carve-out financials to reflect LSI on a stand-alone basis. In full year 2019, related carve-out [rated] cost amounted to CHF 19 million, which had a 30 basis point impact on core EBITDA margin.

A further focus in 29 (sic) [2019] was on the execution of significant investment projects. They have all been designed to secure continued profitable growth and meet future market demands. We are investing in growth opportunities in our core LPBN businesses. These include capacity and geographical expansions as well as new technologies, supporting the full life cycle management of molecules.

In 2019, CHF 786 million of CapEx or 13.3% of sales has been invested to finance key projects on clinical and commercial biologics, bioconjugates, small molecules and cell and gene therapies. Our Ibex offering is progressing with 4 commercial customers, including Sanofi and Portola. However, our planned projects are largely expected to contribute to continued growth in LPBN beyond the Mid-Term Guidance 2022. This is because facilities ramp up over several years before full utilization and profitable level are achieved.

And now I hand over to Rodolfo, who will take you through the financials. Rodolfo, please.

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Rodolfo Savitzky, Lonza Group Ltd – CFO [2]

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Thank you, Albert. Welcome to everyone here in Zürich. Welcome as well to those who have joined on the phone.

So here, you can see a snapshot of our financial highlights for 2019. We are pleased to report 6.8% top line growth, resulting in CHF 5.9 billion sales. Our core EBITDA grew as well by 7.2%, up to CHF 1.6 billion. We have delivered on our guidance both in sales and profit with a stable 27.4% core EBITDA margin, up 10 basis points compared to previous year, this in a significant investment year.

Our margin benefited from the new IFRS 16 accounting standard on leasing, as Albert mentioned. This resulted in 60 basis points incremental margin for Lonza Group. However, this was largely offset by costs related to the divestment of the Water Care business and the carve-out of our Specialty Ingredients segment. These 2 effects amounted to 50 basis points dilution.

So we were able to maintain our margin despite growth investments in our Pharma Biotech & Nutrition segment. Our margin was supported by our operating leverage in the double-digit growing pharma-based business. And it was also enhanced by ongoing efficiencies in our manufacturing operations as well as productivity gains across the group. Our investments in pharma have led to increased operational expenses in growth projects. And this is partially explained by the 7.2% increase of employees compared to 2018.

Two other important KPIs, core EPS and return on invested capital, also increased significantly versus prior year. We are pleased to have achieved a strong 13.4% diluted core EPS increase and a 9.1% return on invested capital, more than 110 basis points ahead of the previous year. These strong results reflect our positive profit performance in an exceptionally low tax rate of 10%, 8 percentage points below prior year. The tax rate was positively impacted by a combination of country profit mix and favorable onetime items, including first effects of the Swiss tax reform, which will be fully effective in 2020. Now for the future, we confirm our tax guidance of below 20% tax rate.

All figures mentioned here relate to Lonza’s continuing operations. They exclude the Water Care business, which we divested early in 2019. They are in reported currency and are compared with the same period in 2018. They are also on a like-for-like basis to reflect the realignment of our segments.

Now let’s take a glance of our — at our 2 segments. We start with LPBN, which had very strong performance last year. Sales were up 11% with strong results in biologics. This more than compensated for a contraction in the nutrition capsules. Core EBITDA margin decreased slightly by 30 basis points to 32.9% and by 90 basis points, excluding the favorable impact of IFRS 16. This margin erosion reflects the impact of higher operating expenses to support investments in growth initiatives. In turn, these were partially offset by positive operating leverage and operational efficiencies.

The particularly strong growth of our cell and gene technologies also had a dilutive effect on margin. We’re focusing on profitability improvement measures in 2020. And this will help secure both margin and growth levels in 3 key modalities, for Lonza is well established. These are viral vector, autologous and allogeneic gene and cell therapies.

Our Specialty Ingredients segment reported weaker sales than anticipated in H2 2019. We ended the year with a 3.2% decline in sales on the back of overall softness in global end markets and in line with industry peers. On a positive note, our core EBITDA margin increased by 50 basis points. And this resulted in a margin of 17.8% or 20 basis points improvement, excluding the effect of IFRS 16. Here, productivity gains, cost control measures and price increases more than compensated for the lower sales, higher raw material costs and scheduled site maintenance.

Now Albert has already briefly mentioned our investment projects. And in this slide, you can see that Lonza’s past performance trajectory is mainly based on the investments we made 10 years ago. After meaningful investments in 2009, we have invested an average of 8% of sales in CapEx between 2011 and 2018. During this period, we experienced growth and profitability based on existing assets, alongside improvements in operational and commercial excellence.

Now in 2019, we increased the level of CapEx to 13.3% of sales. And this was needed to meet the increasing breadth and scale of market demand and to support our long-term growth trajectory. We anticipate that the 2019 elevated CapEx will be replicated in 2020. But from 2021, we expect to return to a normalized level of around 10% of sales based on our existing project pipeline. Our growth CapEx, of course, also drives growth in operational expenses as we have seen.

Now let me turn to our operational free cash flow in 2019. As discussed, we saw increased CapEx spending behind the growth initiatives in LPBN. Net working capital had a year-on-year increase to support growth but with higher days of inventory across several business units. In addition to the business growth, one inventory driver was extending the value chain in small molecules by producing intermediates. We are currently working on plans to achieve an improved level of inventory in the future while continuing to serve our customer needs.

So let me summarize. Lonza achieved an operational free cash flow before acquisitions of CHF 399 million. Then if we include the proceeds from the disposal of Water Care, our operational free cash flow amounted to CHF 995 million. This, of course, was mainly used to finance our dividend, interest, taxes and to pay back debt.

Now my final slide. Here, I wanted to share the trajectory of our net leverage over the last 3 years. I’m pleased to confirm that we have delivered on our guidance. Net debt-to-core EBITDA ratio was decreased to 1.83x by the end of 2019, outperforming our guidance of below 2x. Our S&P rating has been confirmed at the beginning of the year, BBB+ with stable outlook. And this strong rating allowed us to refinance over CHF 2 billion of term loans in September.

We have benefited now from tighter pricing and substantial improvements in structural flexibility. Our objective for the future is to maintain our strong investment-grade rating in this area. So I hope you agree that our results for the full year are both positive and encouraging for the future. We’re entering 2020 with a strong balance sheet to fund our high-return, risk-managed investments and to support our future growth.

And with that, I pass it over to Albert. He will cover highlights on the segments, starting with LPBN.

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [3]

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Thank you, Rodolfo. Let me begin by summarizing our CDMO services business in LPBN.

Lonza announced several new customers and projects in 2019, spanning from biotech companies to big pharma. This list is not exhaustive as we cannot disclose most of our customers for reasons of confidentiality. At group level, we can say that we serve several hundreds of customers globally, and with that, millions of patients.

Let’s take a look into the performance of our CDMO services business more specifically. Our highly potent active pharmaceutical ingredients offerings have made a positive contribution with a number of new long-term contracts signed with customers, including AstraZeneca, among others. Small molecule sales were up double digits in 2019. Mammalian and microbial saw ongoing strong momentum for its clinical and commercial offerings. We signed several commercial agreements for new and existing assets and have meaningful visibility for the mid- and long term. Double-digit sales growth were also achieved with mammalian and microbial business. Commercial capacities for 2020 are largely committed. We also have good visibility for the clinical offerings, which are much more short term in nature.

I want to take a moment to focus on our cell and gene technologies business. Cell and gene technologies delivered the highest number of new customer wins ever in 2019. Last year, we signed a significant number of clinical and commercial contracts with new customers, including, among others, Cellectis, Prevail and DiNAQOR. The business also signed new contracts with existing partners, including Mesoblast and Gamida for commercial supply.

Now let’s look at some of our investment highlights for 2019 in the LPBN segment. Let’s start with Ibex solution. We confirmed a major multinational pharmaceutical company as new Ibex Dedicate customer. This agreement relates to the manufacture of a commercial microbial-derived product and comes as an addition to other Ibex Dedicate partners, including, among others, Sanofi and Portola. Our integrated service offerings in preclinical and clinical also gained traction. In this area, we announced Genmab and Alector as new customers.

On HPAPI and bioconjugates, AstraZeneca signed a long-term manufacturing agreement with us for the delivery of a number of products containing high-potent active pharmaceutical ingredients from our Visp site. To meet increasing clinical launch and commercial market demand, Lonza started an expansion of its bioconjugation in Visp. This has been developed in parallel with the successful commercial approval of several antidrug conjugates produced at the site. The acquisition of the Novartis Stein facility for drug product manufacturing was completed to complement our existing development services with sterile, fill and finish offerings. We are now able to cover the full product life cycle.

At the end of 2020, a new mammalian fermentation site will be operational in China. The site will provide development and manufacturing services for early to late clinical and commercial launch projects. The new site will house a 17,000-square meter multiproduct facility, employing single-use technology with significant adjacent expansion land secured. Alongside the investment listed here, we also deliver further capacity expansion with our multipurpose 6,000-liter bioreactor in Portsmouth coming online also at the end of this year.

Allow me to spend a few words on the lengthy build and return process for any biotherapeutic projects. CHF 1 CapEx investment is expected to translate into more than CHF 1 revenue annually after year 6 or 7. This allows the necessary time for construction, ramp-up, validation, approval, start of operations and full utilization of a facility. This means that our planned projects are largely expected to contribute to continued growth in LPBN beyond the Mid-Term Guidance 2022.

This shows that the decision to invest in a new biologic drug manufacturing facility must be taken years in advance of any solid market data and before clinical Phase III trials are completed. In other words, forecasting is almost — precise forecasting is indeed just impossible; not almost impossible, it is impossible. You either invest in advance and you have capacity available or you were too late and you are missing business opportunities.

In 2019, we also invested significantly in innovation. 4 of our highlights are presented here. Protein expression, we have announced the next stage of the evolution of a GS Xceed toolbox. As the format of innovative therapeutics proteins become more complex and harder to express, we are looking for new solutions. In March, we started to bring our single-box Cocoon autologous cell therapy manufacturing device, sorry for this complicated phrase, as a pilot project with the Sheba Medical Center, the largest hospital in Israel. We made good progress in 2019 and the Sheba Clinical Medical Center anticipates dosing the first patient with Cocoon during the second quarter of this year.

In 2019, a strategic joint venture was agreed between Lonza and Danish company, Chr. Hansen, for developing and manufacturing live biotherapeutic products for pharma and biotech customers. The 50-50 controlled legal entity has approval to start operation under the name of BacThera. While Chr. Hansen contributes its extensive knowledge in manufacturing bacteria strains, Lonza bring its strong capabilities in drug delivery technologies. But as it means, they brings the strains of the bacteria, we bring the vehicle to bring this bacteria into the (inaudible) into anaerobic environment.

I will now turn to our product business in LPBN. Let me summarize our 2019 business performance. Our bioscience business for media, cell culture and the toxin detection testing solution and quality control software saw increasing demand based on favorable market trends in drug discovery and cell therapy. Our pharma hard capsule business saw good demand for specialty polymer. The business was supported by new product launches but challenged by difficult market condition in the U.S. Sales were up low single digits. Our nutritional capsules business was negatively impacted by increased competition. The business started to implement commercial countermeasures with first impact in Q4 last year and carry on, on expected 2020. Nutritional capsule sales declined low single digits. Finally, our small nutritional ingredient business experienced soft sales in 2019.

We now move from LPBN to Specialty Ingredients, LSI business. In the second half of 2019, end markets did not come back as expected, especially electronics and automotive in Asia remaining soft and vitamin B3 suffering from African swine fever. Supply chain disruptions in 2018 became worse beginning of last year with a major incident in China. This impacted supply globally for important raw materials and specifically impacted the supply of BIT, which is used in some of our key products.

LSI started to operate its 2 distinct units, comprising one leading portfolio for Microbial Control Solutions, MCS, and a division of Specialty Chemicals Solutions, SCS. Let us first focus on Microbial Control Systems or Solutions. Professional hygiene and home care saw positive performance with continued strong sales. In most market segments, sales were up last year. Personal care saw an uptick in H2 with our antidandruff platform for hair care. Wood protection experienced stable demand but saw an increasing competitive environment and pricing pressure, especially in the U.S. market.

Within material protection, Lonza’s oil and gas industry solutions performed strongly. This includes corrosion inhibitors and bioscience. Polymer and textile faced softer market demand from the automobile industry. Paints and coatings also showed good performance, driven by pricing management. Sales were up high single digits. Crop protection faced ongoing customer destocking after a dry 2018 summer in Europe, aggressive competition from China and further dry weather in 2019.

Within LSI, we will now move to Specialty Chemicals Services. The Specialty Chemical Services business was negatively impacted by negative cycles in some end markets. Total sales were down. The demand for consumer electronic was weak, impacting particularly the composites business. Custom manufacturing closed at the same level as the previous year. Lower volumes in industrial intermediates resulted from competitive pressure in China and external supply chain challenges. Finally, demand for hydrochemical ingredients was down. And the vitamin B3 business was impacted by lower volumes due to the African swine flu in Asia and low prices at the beginning of the year because of overcapacities.

The specialty ingredients sector is in a time of significant change with new opportunities, primarily driven by an increased demand for environmentally friendly and sustainable products. We continue to innovate and expand our presence in the personal care markets. Our antidandruff platform was successfully expanded in 2019 with a new offering. In wood protection, we have developed an effective formulation to protect engineered wood against termites, a threat especially in North America with wood being the primary construction material for private housing. We focus on bioactive and innovative ingredient for skin rejuvenation and have launched several new products.

We now turn from a review of past performance and focus on our outlook for the future. We are able to provide this outlook for full year 2020: high single-digit sales growth with Pharma Biotech & Nutrition; low single-digit sales growth in Specialty Chemical Ingredients; and sustained core EBITDA margin. As a final note, I also want to confirm that Lonza’s Board of Directors is actively searching a new CEO. We expect the process to be successfully completed with a candidate to be announced during H1 2020. We’re also pleased to confirm our Mid-Term Guidance 2022. The outlook 2020 is the next step in achieving this mid-term guidance with all necessary building blocks being in place.

Let me conclude with key priorities for this year: deliver our budget and the building blocks to reach the mid-term guidance; finalize the carve-out by mid of this year; focus on the execution of our key growth initiatives; continue with our current efforts regarding our innovation pipeline; identify, develop and retain top talents; short-term and long-term value creation; and finally, we will review the future plans, the future alternatives for LSI.

This is the end of our presentation. And we are ready to listen and to answer to your questions.

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Questions and Answers

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [1]

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Daniel, the first hand, the competition.

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Daniel Buchta, Bank Vontobel AG, Research Division – Research Analyst [2]

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Daniel Buchta from Vontobel. Maybe two questions to start with. I mean you have your 2020 guidance saying stable core EBITDA margin, but roughly 300 basis points left to reach the mid-term guidance. Can you help us bridging a little bit what the drivers then in the next — in the late — 2 later years are to get to the 30.5% margin? And then you were mentioning on one of the last slides, to review future plans for Specialty Ingredients. What could these future plans be? And help us understand that a little bit.

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [3]

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If you don’t mind, I’ll start with the second question and you take the first question?

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Rodolfo Savitzky, Lonza Group Ltd – CFO [4]

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Very good.

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [5]

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Well, we have initiated and we are carrying out the carve-out process. The carve-out basically is to bring clarity, transparency between 2 businesses, which have almost nothing in common: chemical on one side, pharmaceutical on the other side. So the first purpose of the carve-out is to bring transparency. At the same time, if you look at our heavy investments, almost CHF 700 million, CHF 800 million, mainly in LPBN, it is clear that the long-term strategic focus will be on LPBN. So if we combine the both, now carved out, bringing transparency, high investment on LPBN, at one point in time, and this will happen this year, we will review the strategic alternatives for LSI.

Now this exercise will start at the Board level. It has not yet started. But we will review during this year which direction for this business. We keep it, we make a spinoff, we can sell it or we can go for the IPO. So don’t speculate for the time being because we have to do this work internally. It will start now. It will take some time. And at one point in time, we will inform you into what direction we think this business should be. This is where we are today. Carve-out is key. Carve-out will be implemented, strategic future for LSI start to be in our brainstorming session at Board level. Rodolfo, you take the first one?

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Rodolfo Savitzky, Lonza Group Ltd – CFO [6]

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Yes. So when we say there are 3 — there are clear building blocks to reach the Mid-Term Guidance 2022, we refer to main — 3 main building blocks. Number one relates to the pharma business. And here, you have very strong operating leverage. What does that mean? This is a business that is growing high single digits as we are guiding. And this year, it grew double digits. And you have a relatively fixed cost structure. So with the continuation of the positive growth momentum and this fixed cost structure, you get a significant uplift in margins. The second important part in the — in terms of building blocks is, of course, we are reinvesting significantly behind growth initiatives. We have said that whenever you put CapEx, you also need to invest in OpEx. We’re talking about a range of 10% to 15% OpEx to CapEx. But of course, this is a discretionary decision. And we have highlighted that ’19, ’20, these are investment years and that we will return to more sustained, lower levels of investments in the future.

So of course, when you reduce the level of investment, this automatically significantly reduces the drag on margin. And then last but not least, the carve-out in LSI helps the business reach a level of autonomy, where they can rightsize their organization to fit a specialty chemical operations. And here, over time — of course, not tomorrow because we’re going through finalizing a carve-out, a recovery, but there’s a significant opportunity for increased operational efficiency, organizational efficiency. And of course, that will allow this business to comfortably cross the 20% core EBITDA margin that we have guided for 2022. So with these 3 elements, we have all the building blocks to reach our guidance.

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [7]

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I think the next question was the second-fastest person that is here. We have to respect the order.

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Patrick Rafaisz, UBS Investment Bank, Research Division – Director and Chemical Research Analyst [8]

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Patrick Rafaisz from UBS. Three questions, please. The first is a follow-up on the strategic options for LSI. Will there be a decision that the Board takes and the new CEO will then just execute? Or are you waiting for the new CEO to discuss? That’s the first question.

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [9]

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The answer is very short. We don’t wait.

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Patrick Rafaisz, UBS Investment Bank, Research Division – Director and Chemical Research Analyst [10]

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Good. All I needed to know. And the second question on cash flow and CapEx. You overshot a bit, right, on the 11% to 13% range. And it looks like you’ll be above that again in 2020. What changed here?

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Rodolfo Savitzky, Lonza Group Ltd – CFO [11]

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Well, should I take it?

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [12]

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No. You could — I may comment afterwards, but you can start the answer, yes.

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Rodolfo Savitzky, Lonza Group Ltd – CFO [13]

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Yes. I mean we guided 11% to 13%. At the end of the day, we ended with 13.3%. I would say, I mean we — I would consider that to be in line with the guidance. And I would say, at the end, these are a couple of years of investments. And you know how the investment straddles between the 2 years can vary a little bit.

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [14]

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I’d add only one thing. Don’t underestimate 2 things for Lonza. First of all, the amount of CapEx, we are close to CHF 800 million. We were used to CHF 300 million recently. And the second point is the complexity, the complexity in the investments in mammalian, in microbial, in antibody conjugates and cell and gene therapy. Those are very, very complex projects. And if we start with CHF 100 million and we end up with CHF 110 million, what the hell, we have to make these investments. Don’t underestimate the complexity as well. What I want to make, the amount and the complexity. And we come from CHF 300 million to CHF 800 million. This is stretching massively the organization. And there may be such deviations, fair enough. It’s not dramatic for us.

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Patrick Rafaisz, UBS Investment Bank, Research Division – Director and Chemical Research Analyst [15]

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Okay. And then the last one, Rodolfo, you talked about tax, the tax rate in 2019. Can you quantify the one-offs here and add a bit more color, the positives here that have benefited your tax rate?

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Rodolfo Savitzky, Lonza Group Ltd – CFO [16]

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Yes. Without getting into too many details on the tax, what I can say is, yes, as usual, there were a number of one-offs. But interestingly, the majority netted out. So I would say the net impact of the one-off was relatively limited. One of them was, let’s say, the first steps of the Swiss tax reform, but again with a very limited impact. The majority of the tax effect was related to a change in the mix of our country profits. We had this year higher profits in some of the lower tax jurisdictions and the opposing effect in the higher tax jurisdictions. So this is mainly related to country mix. And this is something that, as I also alluded in my presentation, will not be sustained. So we continue to guide for a tax rate below 20% for the coming year.

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James Patrick Quigley, JP Morgan Chase & Co, Research Division – Analyst [17]

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James Quigley, JPMorgan. In LPBN, how are you thinking about the competitive landscape now? So ADCs, you’re very strong with 3 out of the 5 commercial products. And so that’s an area you’re very strong in. But are there any other areas where competitors are catching up to you which may impact your ability to take advantage of the market growth? That’s the first question. Second question, broadly on the margin, if you exclude the investments, what would the margin expansion have been? Just to give us an idea of what the underlying margin expansion is. And then I think I’ll leave it there.

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [18]

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Can you bring Slide 16, please, Kristin? I’d like to use one slide to answer to your first question. I think it’s 16. No? This one? This one. Can I have the pointer? I’d like to start with this slide. This is for me the most important slide if you want to understand our business and our competitive position and what we are doing. On the right-hand side — thank you. On the right-hand side, you have the list and a simplified list of the technical platforms we are active in: chemical synthesis; mammalian and microbial fermentation; bioconjugates, by far, the market leader in term of technology and business size; cell and gene, you have to segment, cell is not only cell. It is cell autologous and allogeneic, viral vectors for gene technology. We have cell culture, we have the media and we have the delivery forms. There is not a single competitor in the CDMO world offering this breadth of technologies.

So number one, we have the largest — we have access to the largest portfolio of technologies. This is unmatched. Secondly, this is unmatched because we decided to go for a transversal strategy and not a vertical. We could, to some extent, being vertical and say, “We focus our efforts and investment only in cell and gene therapies.” It’s not good enough. We want to be the CDMO player having access to the most important technologies. Now what does it mean as well? With this list of technologies we have, we have access to hundreds of molecules every year. As a comparison, a pharma company will develop, will be working at 60 to 70 molecules a year. We have hundreds of molecules. We have the largest molecule portfolio in the preclinical, clinical phases in the world. Now people makes often the comparison with WuXi. I gave only one figure and I never underestimate competition.

On mammalian fermentation, we have a capacity of more than 200,000 liters more. WuXi has 50,000 liters. Before they reach the 200,000 liters, we will have maybe [400,000] liters. In other words, it will be very difficult or extremely expensive, for example, for a WuXi to have access to our capacities. This is not cheap business. This is hundreds of millions. So first answer, we have the best technology platform and we have the largest experience worldwide as a CDMO player across this important list of technologies. This is key to understand why we are doing so well in LPBN. We have this know-how, we have the capacities and we invest a lot. And the other question was on the margin. I can’t remember.

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Rodolfo Savitzky, Lonza Group Ltd – CFO [19]

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Yes. You want me to…

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [20]

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What was the question?

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Rodolfo Savitzky, Lonza Group Ltd – CFO [21]

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To elaborate on the margin impact of the investment…

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [22]

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Well, I’ll give you one example. I go into maybe a detail here. But I’d take the risk to give a number. If you take 2019 and we take 3 main investments, the Ibex biopark, we take the investments in Portsmouth for additional 6,000 liters in mammalian technology and we take Guangzhou, China. For these 3 key investments, we spent around in CapEx last year CHF 380 million to give you an order of magnitude. Only these 3 investments: Ibex, Portsmouth and China.

For this CHF 380 million CapEx, we needed around CHF 60 million in OpEx; sales, 0. This year, for these 3 projects, we will need additional CapEx of around CHF 240 million, CHF 250 million. Sales will be at best CHF 60 million this year for these investments. And the OpEx, because we are close to the ramp-up phase, the OpEx will go up to CHF 140 million, CHF 150 million, this year the impact on the margin. I repeat it, next year, these key figures, CHF 380 million in CapEx, around CHF 60 million in OpEx, no sales. This year, even more, even again CHF 300-plus million in CapEx, the OpEx go up because we are close to start the production, CHF 140 million, CHF 150 million, and there will be sales at best, for this investment in this year, best CHF 60 million to CHF 80 million.

This is how it works. It takes 3 to 4 years to build the plants. Your OpEx is increasing with the years. And only after 5 — year 4 or 5, you start making sales, not before. This is the life cycle of an investment in this business. So when we say we can maintain the operating margin next year, it means we do a lot of efforts on the productivity because we have this extra cost, OpEx, to support the CapEx investments. This is the most important slide. Sorry to insist, if you want really to understand the business of Lonza, key. Indeed, we should go on each single technology in details. What our strengths, where is competition and so on, we should do it maybe 1 day. Yes? This is, sorry, I repeat, very important.

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Remo Rosenau, Helvetische Bank AG, Research Division – Head of Research [23]

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Remo Rosenau, Helvetische Bank. If we assume for the sake of scenario analysis that LSI would leave Lonza at some stage, then you would obviously have to redefine your targets 2022. Now that is only 2 years away. Then you could say, “Well, it’s a different company now. We now set targets 2025.” Or will you adjust [the depth] these 2022 targets that we could still check if you will reach them?

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [24]

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Well, first of all, you — the impression I have, and I apologize if I am wrong and if I heard some of you. I have the impression you want to have this guidance on 2022, so you give the guidance. On the guidance 2022, we feel comfortable that we have the right building blocks. And in these individual building blocks, we are doing the right things to achieve that, Remo, yes. But it’s the way we see it ourselves.

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Remo Rosenau, Helvetische Bank AG, Research Division – Head of Research [25]

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Okay. Let me ask it from another angle. If you would redefine the targets without LSI for 2022, is it a fair assumption to think that the margin improvement potentially will be a bit lower? I mean now we talk about 300 basis points. But without LSI, it’ll be probably a bit less than 300 basis points up just taking the other part.

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [26]

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Well, I am prudent because Rodolfo said it and I took the example on purpose. Don’t underestimate these high operating expenses linked to the CapEx investment. And next year — this year, it will be around CHF 140 million, CHF 150 million. We will not generate sales at all, 0. But they’re on top of the rest. And if we can maintain the margin, I think it’s an excellent result. So at one point in time, the sales will move up. It will start in 2021, 2022. Sales will go up based on these funds, CHF 300 million, CHF 400 million and then the margin will go up, yes. Otherwise, we do a poor job. Let’s be fair. But I don’t have the numbers exact, Remo. But this is a business logic. We are suffering now because of these high investments. And with delay, we will be enjoying fantastic growth rates in sales and margin-wise, hopefully. So my successor will enjoy the sales growth.

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Holger Blum, Patinex Management AG – Analyst [27]

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I got the mic. Holger Blum, Patinex Management. A question on the LPBN business. Maybe you can talk a bit more about the product business and the trends there. You just were saying soft demand in nutrition. Maybe you can give more some granularity there and then also on the growth rates of the CDMO and the absolute size versus the product business within [LPBN].

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [28]

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The first question is related to LSI in general or to…

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Holger Blum, Patinex Management AG – Analyst [29]

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No, to LPBN, to the division. You have the CDMO business, which seems to doing terrific. And then on the other hand, the products business, it sounded more muted. Maybe you can…

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [30]

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We are lucky to be, let’s be fair, in a very healthy business environment. Biologics, bioproducts, bioprocessing are growing annually at 8%-plus and we are in this business. So when we say that we have been able to grow double digit, it means we are benefiting and we are capturing a big portion of this growth, which is offered by this market. So we are, to some extent, outperforming the market with our growth rates. Bioproducts, bioprocesses is around 8%. We’re on top of 10%. So we are doing better than the market.

On the product side, the largest business is the capsule business. And last year, we did not perform well. The total business sales were rather flat, nutritional sales were down and the pharma side of the business was up. So we did not — we underperformed the market with the capsule. And you know the size of this business, because of the Capsugel acquisition, it’s around CHF 1 billion. And with CHF 1 billion sales, we have not been able to capture basically what the market was offering. External reasons, but let’s be fair, also internal created reasons.

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Holger Blum, Patinex Management AG – Analyst [31]

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Okay. And the outlook there, you expect an improvement or…?

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [32]

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No. We are putting in place measures to correct this sales trend, which we don’t like. And yes, we should be able this year to develop to generate positive sales growth with the capsules business, which was not the case last year.

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Holger Blum, Patinex Management AG – Analyst [33]

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And then the last question while you have the technology slide still on, what are the missing pieces in that technology list that you want to fill and that although then leads to the stronger balance sheet and acquisitions?

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [34]

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Okay. It’s not an easy one. But I say to simplify, if you take the product life cycle of a drug, starting from discovery to commercialization, first of all, we will not and we are not in the discovery phase. This is the job of the Novartis of this world with institute startups. Our business start just after this discovery phase. And we end up with drug substance in the commercialization. What we cannot offer today is the drug product. Because we don’t have the fill and finish facilities for commercial volumes. This is the only thing we are missing if we want — if we don’t want to be in the discovery phase and if we don’t want to commercialize finished drug but only produce. We are missing one element. This is fill and finish for commercial volumes. Otherwise, we have a fantastic portfolio technology platform of — a fantastic portfolio of technology, sorry. Yes?

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Mark Douglas Purcell, Morgan Stanley, Research Division – Equity Analyst [35]

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Sorry, I wanted to stick with the (inaudible) as well. I take the hint. It’s Mark Purcell from Morgan Stanley. I had two questions. The first one is, is there a possibility that CapEx remains higher for longer because your guidance is based on existing pipeline as opposed to emerging pipeline? So for example, I’m thinking Alzheimer’s and the aducanumab and they all follow — and the other antibodies in development, that’s a very active area, which could require hundreds of thousands of liters of capacity depending on where we go with the FDA and the political agenda there.

I’m thinking about your new technologies suddenly being winners in an area like multiple myeloma. At the moment, it’s just sort of 4-, 5-horse race in terms of the technologies. It may (inaudible) autologous NK cells which emerge as the winners. So just some thoughts in terms of things that are not currently within your pipeline which may mean that, for the right reasons, OpEx stays stronger for longer. Cocoon maybe another one. And the second one was just going back to Holger’s question. In terms of building more capacity and capabilities, would you be interested in acquiring technologies assets within protein discovery?

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [36]

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Start with the first question and state one word, Alzheimer. If Alzheimer — if any technology is accepted by the FDA on Alzheimer, this is an industry problem because the industry will be missing capacities anyway. Now if Alzheimer is coming through, I hope that the winner will come to Lonza and say, “Can we together build up capacities? We share the costs and we share the benefits.” If Alzheimer comes, I suspect nobody will be able on its own to satisfy the volume demand and they will need a partner. And hopefully, we will become this partner and then we have to invest clearly. There will be — there is already today missing capacities. If Alzheimer come, it’s fantastic for us.

Now our new technologies, I will not like to answer specifically as you asked. But I want to say the following. We are convinced that there will be more and more breakthrough technologies. And these breakthrough technologies will be — will get an accelerated approval at the FDA level. Why? Because this breakthrough technology will be the only one being able to cure cancers. And this will come. And I suspect the speed of new breakthrough technologies linked with approval will accelerate. And then we have to make up our decisions in which area are we going to invest. But if you take the fantastic improvements of genomics, you will not have a blockbuster for diabetes in the future. Genomics will be segmenting diabetes in different categories. And then you will have different technologies, different assets needed for different segmentation of diabetes. This is fantastic. But this will require additional CapEx, yes.

So there will still be room for large blockbusters. But I believe in the future, there will be less and less blockbusters and more and more fragmented, smaller volume drugs, and they will require specific investments. Did I answer? So if the need for CapEx is there because we are successful, welcome, we invest, assuming you generate enough cash for them. Sorry, it’s a general answer, but the only way I can. But I’m convinced breakthrough comes and acceleration of approval will come as well.

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Mark Douglas Purcell, Morgan Stanley, Research Division – Equity Analyst [37]

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And the second question — that is very useful. And the second question in terms of investing deeper into protein discoveries, so vertically integrating down as opposed to up.

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [38]

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We prefer horizontal for the time being. Thank you. I have to take the last question because there are question on the phone, correct? So it’s the last one from the room, sorry.

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Carla Bänziger, Bank Vontobel AG, Research Division – Analyst [39]

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Carla Bänziger, Vontobel Asset Management. I have two questions as well. I’m not sure whether I understood you correctly before. Did you indicate — or is there a change in how you build facilities compared to the former management, which always said that they only do it when they have the contract and they have the commitment? And the second one is around the operating cash flow. So it’s probably one for Rodolfo. So before CapEx, can you maybe indicate the split between LSI and LPBN just that we get a feeling for the cash flow generation?

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [40]

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You start with the second one and I’ll think about the first one.

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Rodolfo Savitzky, Lonza Group Ltd – CFO [41]

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So your question, Carla, is before the CapEx, so meaning operating cash flow between — look, if you exclude the CapEx, the level of cash conversion of both businesses is similar.

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [42]

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Did you answer?

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Rodolfo Savitzky, Lonza Group Ltd – CFO [43]

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Yes.

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [44]

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Okay. To your first question, this is a fundamental question and because it is — it has to do with Lonza philosophy but also with the market. And I’ll start with the market. I said it during the introduction, it is impossible to forecast precisely the need, the demand for specific drugs. First of all, you invest before having the market data. Secondly, only for biologics, you get the security, yet your drug will be good only in the late phase of clinical Phase III. So you — if you want to have access to business, you must pre-invest in capacities.

Now what are we doing with Ibex? And this is the Ibex concept. We invest in the infrastructure, where we could install capacities rapidly. So we have empty capacities in the infrastructure. If you take Ibex building 1 in Visp, one wing is already installed with equipment to produce and one wing is empty, completely empty. And we will build, equip — put in place equipment in the second wing only when we have contracts. But the infrastructure is there.

What does it mean? The difference between having access to this infrastructure and a greenfield buildup capacity is 2.5 years. So we are giving to the pharma industry an advantage of 2.5 years because we have pre-invested in the infrastructure. The equipment will come only when we have a signed contract. Is that clear? Make the distinction between pre-investment infrastructure and the equipment investment, which come only along with the contract. It’s clear? Because my job — our job is not to confuse you, it’s to clarify. So where are the question from the — how does it work? I don’t know. Kristin, there are questions from — no?

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Operator [45]

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The first question from the phone comes from Jo Walton from Crédit Suisse.

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Jo Walton, Crédit Suisse AG, Research Division – MD [46]

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I have three questions, please. Firstly, on LPBN, your guidance for 2019 was for high single-digit sales growth. In the second half of the year, you managed to produce 12% sales growth. As you look forward into 2020, you have highlighted that a lot of your capacity is already earmarked. I just wonder what opportunities there could be for you to show double-digit sales growth again in 2020 rather than a decrease that you are currently forecasting.

My second question relates to the corporate charges. As you move to carve out and potentially get rid of the LSI business, how should we think about the remaining CHF 100 million a year of corporate expenses? Is there anything that could happen there? Would some of those go with LSI? Or would they have to remain in your existing business?

And finally, to help us modeling, I know you’ve told us that the tax rate would be below 20%. Of course, it was only 10% in 2019. The current consensus appears to be about 17% for next year. Are you happy with that? Does that correctly, broadly speaking, reflect this reversal that you’re saying of the tax rate by geography? It’s just that below 20% is still not particularly precise to help us in our modeling.

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [47]

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Okay. Thank you for the questions. I’ll start with the first question, LPBN growth rates, why only high single digits in our guidance? I mean, yes, we delivered double-digit growth rates. I think the — what is missing, at least for me, to be sure and able to guide with double digits is to have — to make sure that the capsule business will come back to nice growth rates in the future. When this — if this is the case, remember, it is CHF 1 billion sales out of CHF 2.2 billion sales in LPBN. If we are back to sales growth, low single digits with LPB — with the capsule business, then we may take the risk to guide with double-digit sales growth. Rodolfo, if you don’t mind, the financial aspects?

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Rodolfo Savitzky, Lonza Group Ltd – CFO [48]

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Yes. So I take the next couple of questions. So on the corporate expenses, of course, as Albert said, we’re in the early stages of planning different options regarding the strategic review. We have done some preliminary analysis. And naturally, the objective is to eliminate stranded costs in the event where we say we want to separate the businesses. But this is difficult to reduce to 0. So we expect, let’s say, a range of between 25% and 35% at this particular stage of stranded costs. But again, it’s very early related to the corporate numbers, and this is something that, of course, has to be refined. And the objective is this is a number that we would like to reduce.

And then on the second question regarding the taxes, well, again, the guidance is below 20%. Now you say the current number you put on the table is 17%. Look, I would say, given the tax performance of our company, I would not be surprised if eventually below 20% would be close to the number you mentioned. But again, it’s early right now. There’s a lot of elements that play into the tax planning. So the guidance, the official guidance remains below 20%.

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Operator [49]

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The next question comes from Patrick Wood.

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Patrick Andrew Robert Wood, BofA Merrill Lynch, Research Division – Director in Equity Research and Head of the EMEA MedTech & Services Team [50]

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I have three quick ones, please. The first one would be on the cell and gene therapy business. Your ideas for how to get margins up in this business, is it just the case of the business model developing over time on the autologous side? Or is there something else going on? So one, cell and gene therapy margins and the plans there. The second, small molecules, double-digit growth, which is a lot better than I was expecting. A little bit of color there would be helpful on how we should think about that business going forward. And then finally, on the CEO candidate, if you could just pick one thing, what would you say the single most important factor that you’re looking for it?

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [51]

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Okay. I start with the last question because I still remember it, CEO. The emphasis in the search and in the selection of the final candidate will be on his management skills. We want a humble person, combined with ambition. We want an integral person, open, transparent, communicative, building up teams, asking dissidents to give their views. So the main emphasis will be on the soft side, on the human side of the management skill side.

On the first question, cell therapy margin. If you ask the question, I suspect you know how it works today in this area. It is a manual process. You have up to 50 individual steps, all individual, with humans making mistakes. Then you have the very complicated supply chain between the patient, the manufacturing, the multiplication of the cells, the transfer of the cell to the patient. This is a very, very delicate, expensive process. So the industry will have to and is working at automating these processes. Once this is achieved, it will really certainly become a highly profitable business. But today, it’s clear, this is not profitable. It’s too much manual work, delicate work, with big — a lot of problems and supply chain is highly complicated. And sorry, I missed the question in between. I can’t remember it. Sorry for that.

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Patrick Andrew Robert Wood, BofA Merrill Lynch, Research Division – Director in Equity Research and Head of the EMEA MedTech & Services Team [52]

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The final one was on small molecules, the growth there in double digits, very good. Just a little bit more color will be great, please.

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Rodolfo Savitzky, Lonza Group Ltd – CFO [53]

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Double digit in small molecules, if you could provide more color on that.

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [54]

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Well, the demand is very strong. We have the assets. And I mentioned in my introduction, the HPAPI, the highly potent, this is gaining in traction. We are one of the unique player here with this HPAPI manufacturing know-how. And this is the reason behind this wonderful size growth. The market is strong, and we have the technology and the assets to meet the demand.

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Operator [55]

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The next question comes from Peter Welford from Jefferies.

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Peter James Welford, Jefferies LLC, Research Division – Senior Equity Analyst & European Pharmaceuticals Analyst [56]

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I’ve got two left. First, we’ll just return to the CEO. I appreciate your comment on the soft side that you’re looking for. But with regards to the business set, I guess, are you looking for someone who is more experienced in the pharma biotech? Or are you looking for someone who can also understand sort of conglomerate structure and the chemicals? I guess coming back to your comments that the focus is absolutely on the pharma and biotech, I guess is it being made clear to the CEO that, that obviously, therefore, is the skill set that’s required? And presumably, does it make sense to — for the Board to reach a decision internally on the future before appointing the new CEO?

And then secondly, just on the margin, I guess just trying to understand the impact of the employees that you’re hiring. Obviously, I think you hired around 1,000 people this year. You made the point there’s only around 500, if you like, on average, and you’re doing a similar number next year. So I guess when we think about 2021 therefore, we’ll obviously have the full roll-on effect of all these additional employees as well. So I guess just when we think about that, how should we think about the headcount going into ’21? And is this now the end, if you like, of the hiring period or the significant hiring period this year? Or should we continue to see significant further future increases to employees in future years?

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [57]

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Thank you for the questions. CEO technical profile, ideally, I put it on purpose and strongly ideally, 20 years-plus experience in the pharmaceutical industry, strongly knowledgeable on biologics, cell and gene therapy, somebody who has been able to manage a complex organization because we are complex and the market is complex, somebody who’s demonstrated the capability of change management, somebody who is extremely well connected in the world of biologics, startups, institutes, big pharmas. This is, on one side, the ideal type of experience we would like to find out.

On the employees, as long as we invest 12%, 13% of sales, we need people. And we need people before the plant startup because we have to train the people. So we have pre-investment as well in people. And this trend of hiring hundreds of people on annual base will continue this year and next year, and then it should slow down. Keep in mind this investment process, where we need to invest before we produce to qualify, to train the people. And when we start producing, we need an extra, of course, OpEx on employees to manage the brands.

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Operator [58]

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The next question comes from Falko Friedrichs from Deutsche Bank.

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Falko Friedrichs, Deutsche Bank AG, Research Division – Research Analyst [59]

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Can you hear me?

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [60]

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We can almost hear you but not good enough.

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Falko Friedrichs, Deutsche Bank AG, Research Division – Research Analyst [61]

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Okay. Is it better now?

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [62]

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Now we hear you very much.

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Falko Friedrichs, Deutsche Bank AG, Research Division – Research Analyst [63]

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Okay. Perfect. It’s Falko from Deutsche Bank. And I would have three very quick questions left. Firstly, what should we expect in terms of carve-out-related costs in 2020? Secondly, in the nutritional hard capsule business, how do you plan to go up against rising competition? Thirdly, what makes you confident to have a fully restored supply of BIT by the end of the first half of the year? How good is your visibility on that?

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [64]

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Well, BIT, we are convinced because we negotiated new contracts, and there are — of course, you develop alternative. We’re convinced if there are no incidents in China, we will have access to the volume we need on BIT, mainly for the LSI business, paintings and in personal care. The driving competition, I don’t understand. It is on — in general, on LPBN or — your question on driving competition? I missed it. Do you have it?

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Rodolfo Savitzky, Lonza Group Ltd – CFO [65]

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I think he mentioned capsules, but I — it was…

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [66]

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The competition in capsules? Can you repeat your second question, please?

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Falko Friedrichs, Deutsche Bank AG, Research Division – Research Analyst [67]

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Yes. So in the nutritional hard capsule business, in your release, you mentioned that there’s rising competition that led to the declines.

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [68]

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Okay. Now the main competition on nutritional capsules is coming from India and China. They are selling nutritional capsules, empty capsules for around USD 1.20, USD 1.30 for 1,000 units. And the market price for these same capsules in Europe, in North America is around $3.50. So we’re facing a price — aggressive price competition from India and China on pricing. This is one of the reasons for the issues we faced with the business in 2019. And the carve-outs?

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Rodolfo Savitzky, Lonza Group Ltd – CFO [69]

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Yes. So basically, we commented for 2019, the amount was CHF 19 million, the carve-out cost. We expect a similar amount in 2020, around that level.

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Albert M. Baehny, Lonza Group Ltd – Independent Chairman & Interim CEO [70]

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So these are the last — sorry, so thank you for your question. We end up the Q&A session now. We offer you another last question in the room and then we go for a drink, no alcohol. Any questions? Otherwise, thank you for coming. Thank you for the questions, and we can share further thoughts and questions during lunch. Thank you very much.

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Rodolfo Savitzky, Lonza Group Ltd – CFO [71]

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Thank you.