Lonza Group AG

SIX:LONN

Earnings Call Transcript 2022-Q2

[Operator]

[Starts Abruptly] presentation will be followed by a Q&A session. [Operator Instructions] The conference must not be recorded for publication or broadcast.

At this time, it's my pleasure to hand over to Mr. Pierre-Alain Ruffieux, CEO. Please go ahead, sir.

[Pierre-Alain Ruffieux, CEO]

Thank you. Good morning, good afternoon, and thank you for joining us for half year results presentation. I’m pleased to be joined today with Philippe, our CFO. As you will always seen this morning we published a solid set of results for the half year. And we are looking forward to sharing more detail with you over the next hour.

Let’s take a look at our agenda. I’ll start with an overview of our performance for H1 before handing over to Philippe for his summary of our financial. Finally, I will take you through the performance of each of our divisions, and say a few word about our continuing priorities for the remainder of the year. Once, we have completed the presentation, there will be plenty of time for us to answer your questions.

Let's start with our group overview. We are pleased to report that sales have grown by 16.8% at constant exchange rate and stand at CHF3 billion for the half year. We have generated CHF987 in CORE EBITDA corresponding to margin of 33.1%. Alongside this solid financial performance, we are progressing according to plan with our growth investment. We have recently announced a strategic investment to construct a new Fill & Finish facility in Switzerland. This is due to be completed in 2026. More on this later.

A word on our macroeconomic context. In the first half of 2022, many markets have seen issue including rising inflation level and supply chain disruption. Nonetheless, I’m please to report that obviousness continued to solid performance during uncertain time. I want to take this chance to thank our colleagues across the Lonza Global business. We work tirelessly to mitigate the impact of these challenges to ensure all customers receive their order on time. With the commitment and support, we have remained on track and can confirm our outlook 2022.

Looking at a wider market context. The healthcare industry is a supplier of essential goods and services, meaning it's less sensitive to economic fluctuation. We continue to see strong demand for CDMO services and specific interest in agile business model and end-to-end offering. We are working to capture this demand with flexible model like our Ibex offering and providing end-to-end solution by completing our value chain in key business area.

Here is a reminder of our business priorities for 2022, which we shared during our full year results presentation in January. This priority remains unchanged. We are continuing to support long term growth in line with our planned CapEx spend. This will ensure, we remain able to meet customer need and drive long term success. We also maintain our focus on operational excellence and innovation while driving progress toward our ESG target and navigating the macroeconomic context.

Focusing on our growth strategy, I want to share a few detail on our new investment in Fill & Finish. This CHF500 million of planned CapEx allow us to complete the value chain in Biologics. Once construction is finished in 2026, we will provide a full service offering from drug product formulation to clinical and commercial manufacturing. So new facility will mean all customer can partner with Lonza for a fully integrated offering, including commercial drug product manufacturing. As well as our investment in Fill & Finish, we have also made a series of further CapEx commitment. Currently, we are on track with our plan to invest around 13% of sales in CapEx for the full year.

On this map, you can see a selection of new investment, highlighted in blue. In Small Molecule, we have up proven expansion -- an expanded innovation offering at our site in Tampa, Florida and a new early clinical facility at our site in Bend, Ohio. The map also shows selected CapEx project, but has come online in the first half. Executed investment include an extension of our highly potential API capacity in Nansha in China, which will have to accommodate demand from new customer. We have also opened a new facility for our customer [indiscernible] an additional mRNA commercial capacity in O'Baoia park in Visp.

Finally, in Capsules & Health Ingredient, we have established new capsule production line at sites, including Pueblo in Mexico, Greenwood and Colmar in France. While expanding our capacity and capability, we continue to ensure that sustainability remains at the heart of our approach to long-term value creation. Since the beginning of this year, ESG target have been incorporated in our employee and executive remuneration policies. This is designed to ensure that sustainability is valued by all our people as a core component of a wider business success.

Looking to our first -- to highlight in the first half, we have completed an investment to recycle water from -- for steel production at a site in Visp. This will enable us to achieve a 20% annualized reduction in water usage across Visp operation. More widely, we currently have more than 100 ESG projects across the Lonza Global network. Collectively, this critical mass of employee activity and engagement will support us in continuing to deliver sustainable business outcome.

I will now hand over to Philippe to take up through the detail of the half year financial.

[Philippe Deecke, CFO]

Thank you for the introduction, Pierre-Alain. It's a pleasure to be here with you all today and share a more detailed look at our financials for the first half. As a reminder, all financials relate to our continuing operations. Our growth rates are reported actual exchange rates, AER, while sales growth is reported at constant exchange rate, CER.

Let's start by taking a look at our financial highlights. Our solid performance reflects continuing demand across our portfolio of offerings. In the first half, we have seen rising inflation levels, energy supply issues and supply chain challenges. In this uncertain context, our business has remained on track and delivered in line with plan. As Pierre-Alain mentioned, our sales remained robust at close to CHF3 billion, reflecting 16.8% sales growth.

Sales growth has been driven by sustained demand across end markets. It has been supported by the ramp-up of growth projects in mRNA, Mammalian and Small Molecules. Our revenues in Biologics were also supported by a large customer cancellation fee. Such cancellation fees are integral to the CDMO business model. They provide compensation for lost time and allow us to time to reallocate capacity should a customer decide to stop a program. As we continue to work on filling the freed-up capacity, the impact of the fee looks like to be more or less neutral for the full year.

The last comment on our sales. Remember that as communicated before, third-party sales of utilities and materials to our former Specialty Ingredients business contributed 3 percentage points to sales growth. However, it also caused a dilutive impact on margin of almost 1 percentage point. As expected, benefit on growth will fade going forward as it has now been more than a year since the divestment of the Specialty Ingredients business, which took place on the July 1, 2021.

Our core EBITDA margin of 33.1% is only slightly below the high base of H1 2021. The margin has remained robust against the impact of inflation and a normalized cost base post COVID-related slowdown in the prior year. This has been supported by a combination of the customer cancellation fee, growth projects and productivity. More on this on the next slide. Finally, we have also seen a small but favorable exchange rate impact on sales and margin due to the stronger U.S. dollar. Also, this was partially offset by a weaker euro and British pound.

On this slide, let me deconstruct the evolution of our core EBITDA margin. Our margin of 33.1% was supported by the positive impact of some larger growth projects in ramp-up phase in Biologics and in Small Molecules. New facilities in ramp-up phase deliver lower margins than the group business when they first come online. However, the diluted impact for H1 2022 was smaller than H1 2021, creating a year-on-year positive impact. Growth projects evolve through different life cycle phases and our project portfolio changes. So impact on the margin will vary from period to period.

Next, we saw a positive effect from operational excellence and productivity improvements across divisions and the positive phasing effect of the customer contract termination fee. However, they were offset by more normal levels of business activity and associated spend compared to the lower spending in H1 2021 caused by COVID restrictions. Inflation also set positive effects to a limited extent, largely driven by rising cost of energy and materials. We are actively managing any inflationary impacts through a combination of commercial and operational measures. As is common in the CDMO industry, most of our raw material costs are passed through to customers at a low margin. Inflation is, therefore, passed on, but the higher cost base creates a small margin dilution.

Moving down the chart, we have seen an adverse business mix as faster-growing modalities ramp up profitability. There have also been fewer positive one-off item than in H1 2021. And finally, I've already mentioned the low margin sales to our former Specialty Ingredients business of CHF76 million, which impact margins negatively.

Turning now to divisional performance. We see continued momentum across all four divisions. Specifically, Biologics reported 26.2% sales growth and a margin of 37.3%. This was supported by the ramp-up of large growth projects in Mammalian and mRNA. It was also supported by the customer cancellation fee, although this will become neutral across the full year of 2022.

Small Molecules saw sales decline by 20.3%, while margin grew 2.6 percentage points to 29.9%. The sales decline was due to the phasing of major shipments of contracted products to customers. This means that some contracted volumes available for sale in H1 will only be shipped and recognized later this year. We will look at this in more detail in a moment.

Our Cell & Gene division delivered good performance, which was supported by our Bioscience business and Cell & Gene Technologies. The division showed a positive margin evolution of 6.3 percentage points to 22.4% and a sales growth of 23.4%, including a one-time event. When the one-time event is excluded, the margins are broadly in line with H1 2021.

Finally, CHI continues to show strong performance with a 4% increase in sales and a stable margin at 35.2%. The division delivered strong results while it managed both inflationary pressures and supply constraints. Going back to the sales phasing in Small Molecule, let me give you more details on the dynamics and why we remain confident in the underlying business. In our CDMO business, we make to order. Everything we manufacture is contracted by a customer, meaning it will be sold.

Depending on contractual provisions, customer pickup timing can vary. And so it is not uncommon for shipments and therefore, sales recognition to shift from one period to the next. This is a characteristic of the CDMO offering in which customers benefit from working with their CDMO partners to agree shipping time lines. We are pleased with the underlying business momentum in Small Molecules where we see record high level of committed customer orders, continued high asset utilization and increased margins.

Turning to our CapEx across the first half. You will see here that we are continuing with our planned investment program and to capture attractive market opportunities. We have invested CHF841 million in the first half and 80% has gone into growth investments. Pierre-Alain has already taken us through many of the publicly announced CapEx programs. These form part of a wider growth project portfolio of 30 larger projects across eight modalities and 10 location. This diversified approach to growth ensures we can manage risk by maintaining a healthy balance across our businesses.

Looking across the portfolio, we maintain a focus on Biologics, which continues to present a significant and sustained market opportunity. Executing on growth projects remains a priority for the business. We continue to maximize value by applying stringent financial return threshold, a fully ramped-up asset as an expected ROIC of more than 30% and a project IRR of 15% to 20%. Across the portfolio, we are able to manage risks through a combination of customer commitments, a strong pipeline of opportunities and long contract durations. In this context, we are currently happy to confirm our planned full year CapEx at around 30% of sales. Also, the final number depends on inflationary impact in the second half.

On this slide, you can see our operational free cash flow. Free cash flow is negative in the first half '22 and down compared to H1 2021, fully reflecting the acceleration in capital investments behind our planned growth project. The increase in our net working capital reflects both the higher finished goods inventory in Small Molecules and the necessary inventory buildup across the business to ensure we can maintain customer delivery schedules. This increase was needed to manage the continuing supply chain fragility, which has led to uncertain delivery patterns and longer lead times.

In this context, we are supporting our customers by prioritizing on-time delivery above inventory optimization. This approach has enabled us to safeguard batch production and minimize the number of loss batches. In addition, the discontinuation of a legacy factoring program also negatively impacted free cash flows. As a reminder, EBITDA in the first row of the table and Other in the fourth row reflect the CHF284 million non-cash Gamsenried environmental provision in H1 2021. Underlying operational cash generation across our business before growth CapEx remain robust, and we maintain a strong balance sheet with CHF200 million of net cash.

Before I hand back to Pierre-Alain, I would like to provide you now with our expected dynamic across the full year of 2022. On this slide, you can see the key known drivers for H1 and H2 sales growth and margin. Overall, we are delivering according to plan and expect the underlying business to perform similarly across the two halves.

Looking at H1 sales and margins, we see some net positive effects from items that will not repeat in H2. As I mentioned earlier, the positive impact of third-party sales to our former Specialty Ingredients business will not repeat in H2. This is because these sales were reclassified as third-party after the closing of the LSI divestment on July 1, 2021, creating a higher base. The customer cancellation fee has also accelerated sales revenue that would otherwise have been spread across the entire year. As we do not expect to fill the release capacity within the year, the positive H1 impact will be neutralized for the year.

Looking at H2, we expect to ship the Small Molecule orders that were replaced from H1 on top of a normal second half for Small Molecules. We also anticipate some manageable headwinds from inflation in H2 and expected higher cost in corporate similar to the pattern you observed in the last year. Overall, we currently forecast that growth and margin for H2 will come in lower than in H1. Nonetheless, we remain confident in the strength of our business and can reconfirm our outlook 2022, assuming no unexpected adverse events.

With that, I will close and hand back to Pierre-Alain.

[Pierre-Alain Ruffieux, CEO]

Thank you, Philippe. Now let's take a moment to provide a business update on of each of our four division. Let's start with the Biologic business. Here, we have seen strong customer demand for commercial capacity. Specifically, we have seen continued high interest driven by the flexibility of our Ibex offering in Visp (ph). As Philippe has explained, we see a softer divisional margin for the half year versus H1 '21. However, the division has delivered 26.2% sales growth at constant currency, helped by some favorable phasing versus half year 2021.

Moving to Small Molecule. We see lower sales resulting from the phasing of major shipments to customers. However, this has been sustained momentum in new programs signed over the first half. We have also continued to expand our divisional capacity with the successful execution of investment in Nansha, Bend and Tampa, all of which are now in the ramp-up phase. In H1, despite lower sales, the divisional margin reached 29.9%, which is an increase of 2.6 percentage points versus H1 '21. This improvement has been driven by a combination of high utilization, growth project and portfolio mix.

Turning to the Cell & Gene division. We are pleased to see continued growth across the division. Our Cell & Gene technology business has remained profitable since it first reported a positive margin in Q4 last year. In H1, the business has continued to focus on the scale-up of late-stage clinical and commercial product. In our Personalized Medicine business, we continue to drive the commercialization of our Cocoon platform. In H1, we launched our second generation Cocoon instrument, which offer a new magnetic selection process. This is designed to improve cell purification and deliver greater value to users. Including a onetime event, we have achieved 23.4% sales growth at constant currency and the margin increased to 22.4% versus half year 2021. Excluding this onetime effect, margin evolution for the division is broadly stable versus last year.

Finally, let's take a look at Capsules & Health Ingredients. The division continues to drive this value shift by focusing on specialty capsule. It is also on track to deliver 260 billion annualized capsule capacity by the end of the year. In H1 '22, we have also introduced our innovative titanium dioxide-free white hard capsule, which will help our customers to meet new regulatory requirement for consumable goods in Europe. In H1 2022, we delivered 4% sales growth at constant currency compared to H1 '21. The division also delivered high margin versus the first half of 2021.

As we come to the end of our divisional update, I would like to take a moment to review the main point of our presentation. We've achieved a solid financial performance in an uncertain environment and we can reconfirm our full year outlook and midterm guidance. Our priorities remain unchanged. In H2, we will continue to grow our business while delivering on our target through operational excellence. In addition, we will ensure our success is sustainable by focusing on our innovation and ESG priorities.

With that, thank you for your time and attention. Now we will take a 2-minute break to set up the video for the Q&A session. I will hand over to operators and look forward to seeing you in a moment. Thank you.

[Operator]

The first question comes from Daniel Buchta from ZKB. Please go ahead.

[Daniel Buchta, ZKB]

Yes. Thank you very much. Maybe the question from my side, I mean if I look back at your Capital Markets Day last year, you confirmed that the old mid-term guidance until 2023 is still valid in the core EBITDA margin of 33% to 35% and given how you see the current macro environment and also your industrial trends, and can you confirm that this is still valid? Or maybe in that -- related to that, did the inflation somehow change that? I mean I'm a bit confused on your comments regarding inflationary impact. On Slide 12, you mentioned that you have seen some inflationary impact that you couldn't pass on, but my understanding was all the time that with maybe a very short time, like this is not a bigger issue for Lonza. Can you clarify that one? Thank you very much.

[Philippe Deecke, CFO]

Yeah. Hi, Daniel. Thank you for the question. So first of all, I can confirm that we are sticking to our mid-term guidance, both for '23, but obviously, as well for 2024, as was mentioned in the presentation. In relation to inflation, we do experience inflation for the large part. We can mitigate that inflation either through what you mentioned pass-through clauses for materials, for raw materials, but as well for conversion costs, which include other materials and wages. We can pass this to customers through contract clauses around inflation.

The contract laws are usually attached to a PPI or a CPI index, and at every anniversary of this contract, we can adjust the conditions. So this is what we're doing today. So this applies to our CDMO business. We also have a product business around our CHI division and our Bioscience division, where, of course, we do not have these long-term contracts and we do not have these clauses. And so in these businesses, the way to address inflation is by working on being more productive and as well working on commercial terms, i.e., looking at price increases, which is also what we're doing.

So we have really two parts of the business, one part where we can more clearly pass on inflation or address inflationary pressure and one piece where we need to go through the regular route of price increases as we're seeing in many industries. So there's always a little time lag, and this is why there is an inflationary impact that remains. But this does not change our guidance for this year, it doesn't change our midterm guidance for '23 and the midterm guidance for '24.

[Daniel Buchta, ZKB]

Thank you very much.

[Operator]

The next question comes from Matthew Weston from Credit Suisse. Please go ahead.

[Matthew Weston, Credit Suisse]

Thank you very much. It's a question about the onetime items. I'm really trying to understand the underlying profitability in the first half, please. So if possible, could you quantify the onetime item in Biologics in the first half? And if you're not comfortable giving us an explicit number, can you at least give us a steer on what the normalized EBITDA margin would be in the first half if we exclude the onetime in Biologics, but also the onetime item in Cell & Gene therapy, which is identified in the interim report? Many thanks.

[Philippe Deecke, CFO]

Yeah. Thank you, Matthew. So the -- I would try to correct the term onetime item. I think if we think -- talking about the termination fee, this is not a onetime item. It's something that is common in the CDMO business where we get this cancellation or termination of programs all the time. Now granted this one, which was made public is a larger one. And I think on sales, this is roughly an impact of 3% on our sales with the respective EBITDA impact. Now bear in mind that this is merely an acceleration of sales and of margin rather than upside to our business. So this is the larger one that was in Biologics.

And then the second one that is truly a one-time item, which is in Cell & Gene, this one is relatively small for the group and non-material for the group, neither for really for our growth rates nor for our margin, but it's relevant for you to get an understanding of our Cell & Gene performance. And therefore, we did mention that onetime item.

[Matthew Weston, Credit Suisse]

Many thanks, indeed. Can I just ask to clarify, 3% of group sales or 3% of Biologic sales?

[Philippe Deecke, CFO]

3% of group sales.

[Matthew Weston, Credit Suisse]

Many thanks, indeed. I’ll jump back in the queue.

[Operator]

The next question comes from Christina Rand (ph) from William Blair. Please go ahead.

[Unidentified Participant]

Hi. Thanks for taking question. My question is just on the sterile Fill & Finish build. When do you expect the new facility to come online? And what do you expect the annual revenue potential or annual volume units to be? Thanks.

[Pierre-Alain Ruffieux, CEO]

Thanks for your question. So we expect the facility to start production in 2026. We don't communicate specific figures for sales, but we stick to our general guidance that in average our CapEx every time we invest $1, we will make $1.1 sales.

[Unidentified Participant]

Thank you.

[Operator]

The next question comes from Vineet Agrawal from Citi. Please go ahead.

[Vineet Agrawal, Citi]

Hi, there. Can you hear me?

[Pierre-Alain Ruffieux, CEO]

Yes. We can.

[Vineet Agrawal, Citi]

Okay. Great. Vineet here from Citi. Just on Biologics. When thinking about the top line for the second half versus first half, can we still expect it to grow when you the compare the two half, or it will be more due to the cancellations seen -- you did in the first half? If you could provide some color there, that would be great. And then just if I can squeeze in one more on the antibody drug conjugates. Can you update us how many commercial projects you are involved in? And what does the group revenue look like from these products? And then been just related to it, how do you see the commercial development opportunity from this now occur, where we are seeing a significant increase in their activity? Thank you.

[Pierre-Alain Ruffieux, CEO]

Philippe, will you take the first part, and I will take the one on commercial bioconjugate.

[Philippe Deecke, CFO]

Yes. So you were a little bit difficult to hear. I think the connection was not too great. But I think there was a question around the impact of the cancellation fee, which I think we addressed just before with Matthew, and if we can still expect to grow in both half for the Biologics division. So of course, yes, the growth will be there. And I think the underlying performance of the Biologics division is unchanged.

[Vineet Agrawal, Citi]

I'm just asking if you can grow second half versus the first half?

[Philippe Deecke, CFO]

Please say that again.

[Vineet Agrawal, Citi]

I just wanted to check if you can still grow the second half revenue versus the first half revenue in the Biologics?

[Philippe Deecke, CFO]

Yeah. So again, we're not guiding on half years, and we're not guiding on divisions. But I think the underlying performance of the division is unchanged and healthy.

[Pierre-Alain Ruffieux, CEO]

And can you please repeat your question on bioconjugate commercial because the line was really not good.

[Vineet Agrawal, Citi]

No, I just wanted to check if you could update us how many commercial products you are involved in and what does the base revenue look like from these products? And how do you see the commercial development opportunity from the these type of growth where we are seeing significant increase in their activity?

[Pierre-Alain Ruffieux, CEO]

So we don't report the exact number of commercial bioconjugate we have. But what I can tell you is we are really leading the space on commercial bioconjugate, and we have also a strong pipeline on product in clinical development with that. On margin, like always, we continue to work out with innovation and continuous improvement to continue to drive that, but we don't provide detail on margin within the division.

[Vineet Agrawal, Citi]

Thank you.

[Operator]

The next question comes from Charles Weston from RBC Europe. Please go ahead.

[Charles Weston, RBC Europe]

Hello. Thanks for taking the question. Mine also relates to the cancellation. If the contract is contributing essentially 1.5% sales for the full year, does that mean that there is likely to be a 1.5% or potentially more headwind for next year that might affect Biologics growth? And I just wanted to follow-up and just seek clarification on the corporate EBITDA cost, which I think you guided to have similar weighting H1 to H2. So would that mean roughly minus 50 for the second half, please?

[Pierre-Alain Ruffieux, CEO]

Okay. So Charles, I will take the first part of your question. Basically, our cancellation fees in a contract is here to help us during the transition if it's short term. So again, our business is to resell capacity. And generally, within six months to 18 months, we are able to sell capacity. And in this case, it's clearly the intent. Do you want to take the corporate?

[Philippe Deecke, CFO]

Yes. I'll just add one thing because I think Charles was mentioning 1.5% uplift for the year. When we say neutralized, it's just basically replaces business that we would had with the customer, and it all came in H1 and will not come in H2. So it's truly part -- if you want, it's integral part of our guidance for the year. It's just -- everything came into H1 and nothing in H2. So I just wanted to make that point. It's not really an upside for the year. On your question around EBITDA for corporate, I think you got it about right. I think we're not guiding on corporate costs, but I just wanted to give you a feel for what you see in the first half in our numbers versus what you'll see for the second half.

[Charles Weston, RBC Europe]

Understood. And sorry, the question was actually not about this year's revenues, which I think I understood was neutralized. It was about next year, but I think I understand from Pierre-Alain that you're expecting to have essentially filled the capacity, let's say, by the end of this year, so have essentially -- have replaced those sales for 2023. Is that correct?

[Pierre-Alain Ruffieux, CEO]

In fact, we generally replace sales within a period of six to 18 months depending on the product, correct.

[Charles Weston, RBC Europe]

Okay. Thank you.

[Operator]

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

[James Quigley, Morgan Stanley]

Hello. Thanks for taking my questions. Just another one on Cell & Gene therapy. So you outlined the Cocoon technology to Galapagos at the end of June. So presumably, that's the reason for the onetime payment. So again, looking at the margin, it seems to be around CHF20 million to CHF25 million. Would that be sort of in the right ballpark? And then also related to your new technology in Cocoon, does Galapagos have any first right of refusal for the new technology? Or is that open for further negotiations with other parties?

And then when you think about taking a step back in Cell & Gene therapy, when you think about the modality in general, how are you seeing sort of the bigness momentum here? We've not seen sort of a lot of positive clinical data in the field recently, perhaps just the exception of the J&J and Legend CAR-T product. But what are you seeing in terms of new project starts into the funnel and project churn as we sort of move forward and any impact from biotech funding in this area, particularly? Thank you.

[Pierre-Alain Ruffieux, CEO]

Philippe, you'll take the first part?

[Philippe Deecke, CFO]

Yeah. Sure. I think the onetime payment takes basically the -- both the sales and the margin roughly back to where it was in H1 2021. So that's roughly the impact it has. We're still very pleased with the margins of the different parts of Cell & Gene, but we didn't want to have you getting all excited.

[Pierre-Alain Ruffieux, CEO]

Regarding the momentum, yes, we have seen a small decrease of requests in some areas, but still a very healthy and good growth. We are especially pleased to see the transition of some of our program from clinical to commercial, making good progress. So again, offering in every segment of Cell & Gene therapy, we believe we can have a significant impact. Regarding your question on Cocoon, we see a lot of interest on Cocoon, really addressing mainly two issues with the Cell & Gene therapy manufacturing. One aspect is cost. And the other aspect is the consistency and [indiscernible] first time due to many operators and manual tasks. So on good track and more to come on this topic.

[James Quigley, Morgan Stanley]

Great. And I've got a follow-up again on the Galapagos refusal on the second-generation Cocoon, and then you mentioned about projects moving into commercial phase. So could you give us a quick high-level idea of what the clinical versus commercial split is today in Cell & Gene therapy and how that might change over the next sort of five years?

[Pierre-Alain Ruffieux, CEO]

Okay. The number of Cell & Gene therapy on the market completely approved is very limited. Today, if my count is right is seven or eight. You see a huge number of product in development. I think we communicate at Lonza, we have more than 160 program. And these programs are progressing. So we mentioned we will be very happy to see one or two approval a year, but this is basically more in the hand of our customers and in our hand. But we see a nice maturation of the portfolio.

[James Quigley, Morgan Stanley]

Thank you very much.

[Operator]

The next question comes from Keyur Parekh from Goldman Sachs. Please go ahead.

[Keyur Parekh, Goldman Sachs]

Hi. Thank you for taking my questions. I have a clarification to your comments, Philippe, about the onetime impact and then I have a question. So if I look at your comment about 3% of top line, that's about CHF100 million. On your EBITDA for the quarter, I'm presuming that's 100% flow through to your EBITDA. So excluding the CHF100 million contribution in EBITDA, your growth in EBITDA would have been close to 5% year-over-year. Are my numbers and math correct? Or am I missing something in the way I have understood your commentary so far?

Secondly, as I look at your two businesses, where you are talking about product mix. The first one is Biologics and the second one is on kind of Cell & Gene therapy. Should we expect the new product mix to be the case going forward? Or is there something onetime in nature about the products mix shift in the first half, and these businesses revert to your more classical product mix over the course of the second half and into '23? Thank you.

[Philippe Deecke, CFO]

Yes. So I'll take the first one. So your -- the logic is right. However, I think you got the number -- is too high for our first half. The impact is not so much. So I think you just would take a little bit off of that, but the logic is the right one, yes.

[Pierre-Alain Ruffieux, CEO]

Regarding product mix, in the CDMO business, in the opposition to the capsule and the Bioscience medium, we have had a small number of customers with large campaign. And obviously, not all the campaign is the same value, both in Biologics and Cell & Gene therapy. So while we see long term an increase and a better margin, you may have a campaign which has a lower margin. So depending on which product we sell this quarter or this half of the year, we see a fluctuation. So it's definitively a lumpy business, but the direction is clear and in line with our long-term guidance.

[Keyur Parekh, Goldman Sachs]

But perhaps I could just go back to Philippe. Philippe, given we are all getting so confused about these numbers, is there a reason you can't be more transparent and just help us with what those actual numbers are?

[Philippe Deecke, CFO]

No, not really. I think -- usually, we don't comment too much on these cancellation. Otherwise, we'll start having to discuss many, many things. This one being a big one, I think you saw the announcement that was put out by the customer himself. And I think you probably can expect roughly half of that to have impacted the first half.

[Keyur Parekh, Goldman Sachs]

Thank you.

[Operator]

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

[Peter Welford, Jefferies]

Hi. Thank you. I've got really a question with regards to the filling of capacity. And I guess the question really relates partly to Cell & Gene and partly to Biologics. On the Biologics, I guess, given you're talking about needing to resell the capacity and I guess the sort of way in which you're talking about this seems slightly more cautious than usual, particularly given the demand you're obviously seeing in this market.

Can you just perhaps talk us through, is this capacity engineered in a way that means it's particularly difficult to resell and it's tailored to the customer perhaps more than usual? And perhaps you can just talk us through because in general, you're talking about very high demand, and certainly what we hear in from the industry is that's the case. So can you just talk us through there for whether -- what it is in this case that perhaps gives you a bit more word to caution with regards to your ability to potentially fill this capacity.

And I guess it's similar with Cell & Gene in terms of -- could you just talk a little bit about the -- what you're seeing in the industry for demand for Cell & Gene? Particularly I guess here, I'm thinking a lot of the new orders are presumably often from smaller companies. So could you just both talk about the demand you're seeing from those companies given the funding environment, but also whether or not you as a company consider that when you consider taking on a customer and whether or not you are skewing more towards some of the larger companies now who have cell and gene capabilities? Thank you.

[Pierre-Alain Ruffieux, CEO]

Thank you, Peter. So regarding refiling our reselling capacity, I mentioned six months to 18 months. Basically, when it's a larger capacity, you may have to do a -- tech transfer because ongoing customers have reserved the slot and they are ready. So customers which need a capacity within the next six months, they are already booked. So it's why I mentioned this window. But to ensure you, we have no concern at all to resell it. And this is more the general window, including tech transfer.

On Cell & Gene therapy aspect, we probably have seen a little less demand for early project, but the win rate and the number of customers we are getting, we don't have seen changes. So again, looking back at the funding, as you referred, we have seen like you, a decrease in the funding, but it's still very healthy and it's a level of '18, '19, and we continue to see solid project coming. The difference compared to last year, perhaps the company making a mid-two CAR-T for the sixth time, they have more challenge to get the funding from VC. But no changes in terms of win rate and getting new projects within our facility.

[Operator]

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

[Patrick Rafaisz, UBS]

Yeah. Thank you and good afternoon everyone. I have a question on your EBITDA bridge for the group where you mentioned growth project impact with less dilution here, contributing 190 basis points. Going back to H1 2021, I think you were talking about 130 bps of dilution in Biologics. So this number looks a bit big, also when we put it into the context of full year '21, where you talked about 100 bps dilution. Can you maybe add a bit more color?

And I'd just sneaking another one on Cell & Gene. Also just wondering, right, we know that Cell & Gene became EBITDA breakeven in Q4 last year for the first time. So a bit surprised to see that the underlying margin was flat year-on-year even though we should have two positive EBITDA quarters or at least break even in the mix, which we didn't have last year. Thank you.

[Philippe Deecke, CFO]

Thank you, Patrick, for the question. So on the EBITDA bridge for gross projects, I think, as we mentioned, the impact year-over-year will very much depend on which growth projects are ramping up how quickly and how profitable these sales are at that point in time. And so we are very fortunate, I think, in this first half to have several growth projects that have ramped up nicely, quickly and as well in a very profitable way. And so not only the sales coming from these assets has improved, but also the underlying margin for these assets has improved.

And so you're basically going -- coming from a place where last year, we had the dilution to something that is much less dilutive to the group today. And so these growth projects are basically in a much nicer shape and much larger than they were in H1 2021. So this is the way things work. Again, and the projects are not only in Biologics. We mentioned before, they are as well in Small Molecules, projects that we've mentioned in the past usually ramp up quicker than the Biologics projects.

[Patrick Rafaisz, UBS]

And that also includes the termination, the contract terminations, but also in the growth project impact?

[Philippe Deecke, CFO]

If you look at the bridge, as I mentioned before, the contract termination fee would be in the productivity and operational excellence category.

[Patrick Rafaisz, UBS]

Okay. Got it. Thanks.

[Philippe Deecke, CFO]

Okay. Now on the Cell & Gene, I think, again, we're very pleased with the overall development within Cell & Gene. We have different business units. And so the margins are still progressing. We can also report that the Cell & Gene technologies would still be even without the one-timer would be still breakeven.

[Operator]

The next question comes from Dominic Rose from Intron Health Research. Please go ahead.

[Dominic Rose, Intron Health Research]

Hi. This is Dominic from Intron Health. My question is another one on inflation. I was hoping you could help me to quantify it a bit better. So can you let me know what approximate percentage of your cost base that you think is exposed to inflation? And what percentage of this do you think has to be automatically? Thanks.

[Philippe Deecke, CFO]

Yes. So on inflation, we have several aspects. I think the biggest part of our cost base is our wages, salaries of people. And this, I think, honestly, you don't feel the inflation rapidly because usually salary adjustments are slow to happen. So from that point of view, a large part of our costs do not have yet an inflation impact in it. The second largest point are materials. And again, a large part of the materials we buy are passed through to our customers and the piece that is not passed through, again, has -- is more in our products business and would be then adjusted through price increase. So there, yes, we do see an impact.

And then I think something that I mentioned, I just want to make sure we all understand, even pass-through raw materials have a dilution effect on our margin because the base of these raw materials increases. And therefore, the low margin that we make on these pass-through raw materials just create a small dilution. So the two biggest buckets, if you want, Dominic, is wages where you don't see inflation yet, but you're likely to see in '23. Materials, a large part of it is passed through. The other part is regular materials that we need to offset inflationary impact through price increases.

[Dominic Rose, Intron Health Research]

Okay. Thanks. That’s great.

[Operator]

The next question comes from Richard Vosser from JPMorgan. Please go ahead.

[Richard Vosser, JPMorgan]

Hi. Thanks for taking my questions. One question just on the Small Molecule deferral. Just wondered if you could give us some help on the impacts on the margin of the deferral of that revenue. Does that have a margin impact that's negative? And would that be a similar amount in the other direction compared to the onetime impact that we've been discussing on the contract termination fee? Just some help there would be great.

And then I had one question, if I can, just on the Fill & Finish facility that you're building. You normally build facilities with an anchor customer. And I wondered whether there was such an anchor customer here in terms of the Fill & Finish facility. And given antibody drug conjugates has been a very large and growing area for you. I wonder whether that might also be connected to the Fill & Finish facility. Thanks very much.

[Pierre-Alain Ruffieux, CEO]

Okay. Richard, I will start with the Fill & Finish before giving to Philippe. So basically, what we see for new investment, we find a way to de-risk it. And there is two ways of de-risking it, anchor customer or pipeline. That one is based on the pipeline. I think we were quite clear. We have built a lot of capacity in Fill & Finish formulation development. We have also now since a couple of years, clinical facility, and we have a strong pipeline of customers and it's why we are doing now the commercial facility. Definitively, having the drug substance in multiple technologies, including drug conjugates, it's really helping us, and we believe it's a strong advantage to have drug substance as well as drug product. But we don't have an anchor customer as we may have said in the past, for example, for large-scale mammalian. Philippe?

[Philippe Deecke, CFO]

Sure. So Richard, on the Small Molecule deferral, yes, the delay in sales will create more sales and higher growth of sales in the second half and will, of course, also help the margins.

[Richard Vosser, JPMorgan]

Thanks very much. Very helpful.

[Pierre-Alain Ruffieux, CEO]

We will take the last question, please.

[Operator]

The last question for today comes from Daniel Jelovcan from Mirabaud. Please go ahead.

[Daniel Jelovcan, Mirabaud]

Yes. Hello. Also on Small Molecules, I'm a bit puzzled. Of course, you mentioned the phasing for the minus 21% top line reduction, but you talk about high utilization and portfolio mix. So I mean, maybe I don't understand, but why is the capital utilization higher when you have lower sales? And the part B of this question is the portfolio mix, you mentioned as a margin driver. So does that mean that the delays or the phased orders are with very low margin? And so in other words, when they come on stream in the second half, the margin could be diluted mix-wise from this? Or do I view that in the wrong way? Thanks.

[Pierre-Alain Ruffieux, CEO]

I think, Daniel, I'm not sure you see that in the right way. So let's try me to explain again. Basically, production was at a very high utilization rate. So we have manufacturing full speed. And this has an impact, having a very high margin, because first of all, we have really very good absorption, and we are utilizing the capacity fully. On top of that, we have a good mix of camping good products, so it's pushing the margin up. And the only difference is one major shipment. We have not been able to do it in H1 and will take place in H2. That's the key message for Small Molecule. It's why high utilization rate, a good mix of product and one shipment which is postponed from H1 to H2.

[Daniel Jelovcan, Mirabaud]

Okay.

[Pierre-Alain Ruffieux, CEO]

With that, I would like to thank you all of you and wish you a good rest of the day. Bye-bye.