Lonza Group AG

SIX:LONN

Earnings Call Transcript 2022-Q4

[Operator]

Ladies and gentlemen, welcome to the Lonza Full Year Results 2022 Investor and Analyst Conference Call and Webcast.

I am Sandra, the chorus call operator. I would like to remind you that all participants will be listen-only mode and the conference is being recorded. The presentation will be followed by a Q&A session. [Operator instructions]

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, Sandra. Good morning and good afternoon to all of you and thank you for joining us for our full year results. Today, I'm joined by Philippe Deecke, our CFO. We are pleased to share with you a strong set of results, which underline our performance and progress in 2022. We are looking forward to sharing the detail of our performance in our presentation before moving to the Q&A.

Looking at our agenda, I will start with an overview of our performance in 2022 before handing over to Philippe to talk through our financial. Finally, I will take you through the performance of our division and also say a few words about the outlook 2023 and our midterm guidance.

Let's start by taking a look at the group results. We delivered a strong financial performance in 2022. Sales grew by 15.1% at constant exchange rate and stand at CHF6.2 billion. We also generated a core EBITDA of CHF2 billion, delivering a margin of 32.1%. This underlines the skill and commitment of our people we have worked to produce vaccine drug substance to control the pandemic, while also continuing to grow our business.

We have remained focused on the long term growth and success by accelerating our investment. Last year in 2022, our c CapEx reached 30% of sales. This investment is securing long term growth in the year to come and consolidating our leading position in the CDMO industry.

As we move beyond pandemic sales, we anticipate delivering high single-digit sales growth at constant currency with a margin of 30% to 31% in '23, sorry. Looking at our performance without the covering peak sales, we can clearly see the strength of our underlying business. This allow us to confirm our 24 midterm guidance at low-teen sales growth and core EBITDA margin within the 33 to 35 corridors.

Finally, following the divestment of our Specialty Ingredients business, we have committed to return to pre-divestment leverage. We are continuing our focus on organic investment and attractive bolt-on M&A.

Today, our strong balance sheet and outlook enable us to return excess capital to shareholders via a share buyback program up to CHF2 billion. We are also proposing a share dividend increase of alpha franc to CHF350 per share.

Our full year results for '22 reflect another successful year and a strong cumulative performance. Year-on-year, between 2020 and 2022, we have delivered double-digit sales growth and continues to EBITDA margin improvement. These indicators confirm our strong position in the CDMO field and sustained market fundamentals.

Our performance is also supported by a broad portfolio of customers and high proportion of long-term commercial contracts. We continue to invest to support our long-term growth and success and this is reflected in our CapEx investment program.

Let's now take a moment to review our customer base as well as our CapEx project. Over the course of 2022, we signed around 115 new CDMO customers and around 375 new clinical and commercial programs. As you can see on the slide, 90% of all sales are focused in the EMEA and Americas.

Turning to sales by customer type. We had the 60-40 split between sales to meet small mid pharma customers and large pharma customers. Finally, our top 10 customers continue to represent around alpha. We definitively have a unique, broad and diverse customer base, benefiting from long-term relationships. This number clearly show Lonza leading position in the industry.

Now let's move to our gross project portfolio. The map here shows an update of our CapEx project. New investments are marked in white and investment brought online are marked in green. One example of this is our two new bioconjugate [indiscernible]

Looking to '23, we continue to invest at the same pace. This level of investment will enable us to capture high value opportunity in the area of sustained market demand. It will also allow us to build on our strong market position and deliver long-term success. Since 2019, we have invested in 21 new assets, each with the value of more than CHF50 million. Of this program, eight are still in construction, while 6 are in ramp-up and 7 are already operational.

As we are telling you about our growth, we also want to show it to you. To capture the scale of our growth beyond the number, you would see two image of our bio parking Switzerland. The two large facilities are Ibex 1 and Ibex Solutions 2. The first of these is now largely contracted, while the second is on track to be delivered on budget and on schedule.

As well as delivering strong business performance, we have also continued to deliver on our sustainability commitment. In 2022, our ESG targets were incorporated into our global employee and executive remuneration policies. This is designed to ensure our people maintain their focus on responsible business. We continue to make progress in reducing energy, water and green gas emission intensity. In 2022, we reduced greenhouse gas emission intensity by 13%, energy intensity by 6% and water intensity by 10% compared to 2021.

Finally, we are proud to be recognized by Ethisphere as one of the world's most ethical company for the second year in a row. I would like to take a moment to place Lonza in this industry context. The wider CDMO industry is very attractive and continue to show double-digit growth driven by the biopharma market and an increase in demand for outsourcing.

In this space, we have a unique position with a diversified customer base and long-term commercial contract. This form 70% of our business, giving us a strong visibility on the year to come. With our rises CapEx program, we are securing our long-term growth and at high margin. The expertise of our people is another source of competitive advantage, and we continue to invest in retaining and leading and developing the best talent. We are well set to drive growth and capture value as a leading CDMO in the health care industry.

Before moving to the next section, I would like to share a short recap on 2022. We delivered a strong financial performance at the high end of our outlook. We are also continuing to invest heavily in our long-term growth. We have largely been able to manage inflation through price adjustments in our product business and inflation clauses in our CDMO contract. Clearly, our strong performance confirmed our robust business model and healthy market fundamentals.

I will now hand over to Philippe to take us through the detail of the full year financial.

[Philippe Deecke, CFO]

Thank you, Pierre-Alain. Good morning and good afternoon to you all. Before we start our financial review, let me remind you that all financials relate to our continuing operations. Growth rates are reported actual exchange rates with the exception of sales growth, which is reported at constant exchange rates.

First, let's take a look at our H2 and full year financial highlights. As we have already seen, the group has delivered a strong full year performance in line with outlook. Sales growth at 15.1% is supported by strong momentum in the underlying business so inflation related to pricing and a peak in COVID-related sales.

The COVID business was strong in both volume and margin. Core EBITDA grew 19.8% leading to a year-on-year margin improvement of 1.3 percentage points. This increase was supported by a combination of growth projects ramping up and productivity improvement in the base business. We will come back to this in a moment.

As expected, we saw slower reported sales growth and margin in H2 compared to H1. This is mainly because H1 included the Allakos cancellation fee, the impact of which was reversed in H2. Also in H2, we saw a reduction in the positive effect on sales from the low-margin third-party sales to Arxada, our former specialty ingredients business.

Turning to our margin evolution; let's take a look at the graph on the right and deconstruct the different drivers. At the top, you can see our positive margin progression was supported by our growth projects. This is something we saw already in H1 2022. For the full year, the margin dilution from this project was less than in 2021. This was due to the fast ramp-up of both COVID-related mRNA assets and new small molecule facilities.

We continue to see margin uplift from productivity and operating leverage in our base business. But this year, it was largely offset by the residual impact of increasing inflation. We are actively managing inflation impacts through price increases in our product business and applying inflation clauses in our CDMO contracts. We are also working on procurement and supply chain initiatives to manage the rising cost of raw materials. Taken together, these initiatives have helped us to contain inflation impact at less than one percentage point.

Moving down the graph. Our business mix was more favorable this year, mainly helped by royalty revenues and the lower growth in Cell & Gene. One-offs were largely neutral for the full year.

Finally, this is the last time we see a meaningful year-on-year dilutive impact of third-party sales to Arxada. going forward, we expect these low margin sales to remain more or less stable.

Now let's take a look at the performance of our divisions. In Biologics, we saw strong continued momentum in sales growth and margin. This was supported by a strong underlying business growth projects ramp up in Mammalian and bioconjugates as well as a profitable mRNA contribution.

In small molecules, sales growth for the full year recovered as expected after customer shipments delayed in H1 were delivered in H2. We are also pleased by the margin improvement, which passed 30%, supported by the ramp-up of new assets, focusing on complex molecules and highly potent APIs.

In the Cell & Gene division, we saw a mixed performance between our business units. Bioscience delivered a strong performance driven by price increases and sustained demand. The good performance was partially balanced by the divestment of smaller noncore businesses as we focus bioscience on drug discovery and biomanufacturing.

In our Cell & Gene technologies business unit, we saw softer sales growth compared to a high base in 2021. This was due to some product failures and delays to customer programs. We are also seeing some softness in the cell and gene market coming from the slowdown in funding. However, despite these short-term challenges, the business remains attractive and positive margin was maintained.

Finally, in CHI, good sales growth was driven by price increases and demand for pharma capsules. The softer margin was driven by residual inflation and production delays at one side caused by supply issues.

As Pierre said, our CapEx reached 30% of sales in 2022. That's just under CHF1.9 billion. Of our total CapEx spend, 85% was invested in growth projects. All our investments continue to meet strict approval criteria. They are backed by an internal rate of return between 15% and 20% and a return on invested capital of 30% or more at peak. As in the past, we continually work to mitigate investment risk to a diversified portfolio of assets supported by anchor customer or a strong pipeline.

You can see from the bar chart that we have invested in growth across our divisions with a clear focus on biologics. This is where we continue to see many opportunities with attractive risk return profiles.

Looking at our free cash flow, you will see that we have delivered a negative free cash flow of CHF465 million. This was due to our high CapEx investments and an increase in inventory. Inventory levels have increased from about six months pre-pandemic to seven months today to ensure we can deliver the products to our customers despite the more unreliable supply chains. However, we are now confident to bring supplies down closer to prepandemic levels, and we plan to consume excess inventories over the next 12 to 18 months.

Underlying cash generation remains robust with free cash flow before gross CapEx at CHF1.1 billion, implying an 18% cash conversion. Our return on invested capital, ROIC, remained strong at 11.4%. That's 0.7 percentage points up from the prior year. This was driven by core EBITDA growth of 19.8% and partially offset by a five percentage points increase in our effective tax rate, which now stands at 15.9%, around the lower end of our guided range.

Turning to leverage. Versus prior year, we see a slight increase from minus 0.6 to minus 0.1. The balance sheet provides significant headroom for organic growth investments, bolt-on acquisitions and the return of excess capital. We will come back to this in a moment.

Looking more widely at our leverage, it's worth noting that we remain committed to our strong investment-grade rating of BBB+ over time. At Lonza's AGM on the 5th of May this year, we are pleased to propose a dividend of CHF3.50 representing an increase of 17% or CHF0.5 versus the dividend for 2021.

Our strong balance sheet and confidence in the cash generation outlook also supports our planned share buyback program mentioned earlier by Pierre. Let me give you some more details. Today's announced share buyback will allow us to return excess capital to shareholders and return to our target leverage faster. The share buyback is not changing our priorities in our capital allocation strategy. Our foremost priority remains our accelerated organic investment plans, followed by the acquisition of attractive bolt-ons.

Our M&A focus is both in the field of technologies and manufacturing capacities. The planned buyback of up to CHF2 billion will commence in H1 2023. This comes at a time when we consider our stock to be undervalued given our strong business fundamentals and differentiated position in the industry.

It will be executed over a 24-month period via second trading line on the sixth Swiss Exchange. For sure, this share buyback program does not impact our ability to invest in organic growth and selected bolt-on acquisitions, while maintaining our strong investment-grade rating.

With that, I thank you for your time, and I will hand back to Pierre.

[Pierre-Alain Ruffieux, CEO]

Thank you, Philippe. Now let me take you through the different division. In 2022, the Biologics division delivered 21.7% sales growth versus full year 2021. Customer demand remained high 2022, reflected by a strong pipeline of commercial agreement. Specifically, in a new agreement with GSK, we will commence activity to manufacture a marketed product in our 20K [ph] Mammalian facility.

This marks the beginning of a wider strategic partnership with GSK. We made good progress on the growth project for the division. However, there has been softer demand for a new facility in Guangzhou, China due to local market challenges.

Also, two growth projects in biologics are delayed by a couple of quarters, mainly due to supply chain constraints. Across the network, we work to extend our divisional offering with innovative capabilities. These include new bioconjugate facility, extended early development services, complex protein services and mRNA early phase offering.

Turning to our small molecule business. We saw sales growth of 5.9% for the full year. This was driven mainly by new manufacturing capacity coming online for ADC payload. We are very pleased to see new capacity coming online successfully, further increasing our share of hyper tontine complex small molecule. This supports our plan to focus the division on higher-margin niche, which has led this business to improve margin by 10 percentage points over the last 5 years.

Looking at the Cell & Gene. The division reported a core EBITDA margin of 16.7% and sales growth of 13.6% versus full year 2021. A strong performance in BioScience was driven by robust demand for testing and media. This was partially offset by the divestment of some small and non-core business. Our Cell & Gene technology business supported customers in gaining FDA approval for two new commercial therapies manufactured at our Houston side.

The business unit also experienced some headwind with delay in clinical trial and customer product challenge. In personalized medicine, the business remains focused on driving its R&D agenda and scan it is manufacturing. Looking at specific projects, our Cocoon platform is now enabling the manufacturing of multiple clinical cell therapy.

Finally, let's take a look at Capsule and Health Ingredients. In 2022, we saw sales growth of 5.9% compared to full year '21. This was mainly driven by price adjustments and continuing demand for pharma capsules. Our strong performance in pharma was partially balanced by softer demand for nutritional capsule in markets, including US and China. Our innovation agenda within the division was supported by the launch of our new end protect capsules designed to target the delivery of acid sensitive APIs.

The margin of 33% is softer than full year '21. This has been driven by inflation and partially offset by pricing adjustments and productivity improvement. As we conclude auto on the division, I would like to take a moment to focus on 2023.

Our 2023 sales growth is driven by a robust underlying business partially offset by a reduction in COVID related sales, which peak in 2022. Therefore, we are anticipating high single-digit growth. As you can see from the graph, excluding COVID, we have a consistent year-on-year double-digit growth.

Turning to the '23 margin outlook. We anticipate a core EBITDA margin of 30% to 31%. Besides the COVID contraction just mentioned, which also impact margin we see headwinds from residual inflation and the slower ramp-up of two new biologics assets. This effect will only be partially offset by our continued productivity in our base business, operating leverage and price increase.

On this page, you will see the summary of our outlook for 2023. Please note that the performance will be weighted towards the second half of the year due to the headwind from COVID results-related peak sales in '22 and the ramp-up of new assets in H2 '23. We will also maintain CapEx at around 30% of sales to support our long-term growth.

We are pleased to confirm our midterm guidance of low-teen sales growth and core EBITDA margin within the 33% to 35% range. This is supported by the strong visibility on growth projects and utilization rate of our asset. We will also see productivity gain speed from our Lean program.

At the second half of 2023 will be stronger than the average of the year. Looking at the business today, we believe we are uniquely positioned in the CDMO market for the following reason. Our site network and geographic footprint is either help to meet our customer needs at a global and local level. Our long-term success is fueled by our growth investment. Our business is set up with the right mix of technology and capability to address our customer complex demand.

Finally, our value proposition is clearly enhanced by the unique technical expertise as well as regulatory. Taken together, this will allow us to maintain momentum in the coming years.

Before moving to the Q&A session, two information regarding investor communication. Commencing this year, we plan to hold more frequent qualitative updates. This is a chance for us to connect, share company news and answer your questions.

In Q4, we will also host the Capital Market Day and we'll provide more details closer to this time. This will be a chance for us to share our divisional strategies and provide an updated midterm guidance. Now that COVID restrictions are behind us, we are also planning to as a visit to our facility in Visp, so you can see our business in action.

With that, I thank you for your time and attention. Now we will take a two-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 couple of minutes.

[Operator]

[Operator instructions] The first question comes from Richard Vosser from JPMorgan. Please go ahead, sir.

[Richard Vosser, JPMorgan]

Hi. Thanks for taking my questions, or question. Just a question on the contribution of the various headwinds that you're seeing this year to the margin contraction the relative contribution of the ramp-up of those growth projects, the inflation headwind particularly, energy and also thinking about the 2024 margin target of 33% to 35%, that implies sort of maybe a 250 basis point margin expansion. So what changes between '23 and '24 to allow the margin to increase and the relative importance of the ramp-up of those growth projects and reversal of maybe the energy cost? Thanks very much.

[Pierre-Alain Ruffieux, CEO]

Thank you, Richard. Philippe, you take that one.

[Philippe Deecke, CFO]

Yes sure. Happy to get us started. So thanks Richard for the question. So I think in terms of 2023, we're not going to quantify the drivers individually, but I think you’ve seen that we're talking about residual inflation. We've seen that in '22 and we see this despite inflation increasing in '23, partially because of the energy prices that you mentioned.

We will still be able to contain most of that and have only a residual of that. We have a little bit of headwind coming from our mRNA business, which we mentioned before as well. And then, yes, I think we have still very strong productivity, online productivity, but we're facing couple quarter delays on these two sides which is waiting on our margins for '23.

So without going into the details of quantification, these are really the key drivers. Don’t forget that we also have our mix, which is historically been a negative on margin year-over-year. And now looking at '23 and moving to '24, I think again it's too early to give you detail on 2024, but we have strong visibility today as Pierre-Alain was mentioning on our growth asset coming online on the capacity utilization of these assets. And so we feel very confident that this will be a major driver for '24. And I'd like to remind you beyond maybe what Pierre-Alain was saying, that this is a bulky business.

So if you look back at our numbers, you'll see that several points of margin can swing between half year and half year. So we feel very confident about the 2024 and therefore, our confirmation of the midterm guidance.

[Operator]

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

[Vineet Agrawal, Citi]

I hope -- Vineet here from Citi. I hope you guys can hear me clearly. One, just a clarification on this slowdown in the ramp-up of a couple of biologic projects. Has any impact already been absorbed in 2022 or it's all in 2023?

The second question is on the growth project portfolio. I was just wondering if there is a sort of time line that you can provide for your 20-plus growth project portfolio. So maybe you could say where the 6 projects are in the ramp-up stage? When do you expect them to move to operational stage? And of the 7 projects that are already operational, what percentage would you say are more closer to the peak sales?

[Philippe Deecke, CFO]

No, thank you. So as we mentioned, we have 21 projects since -- start 21 projects since 2019, six of them in construction, six of them in ramp-up and six of that what we're considering in production. I mentioned two of them to be slightly delayed. The impact slightly 2022 and will impact early part of 2023, but we will catch up by the end of the year. So basically, it was some delay in getting some equipment and starting them following the COVID, yes, impact on supply chain.

Otherwise, we don't provide too much detail on each project, but you can reconciliate that with some of the project I mentioned on the CapEx map around the world. Regarding peak sales, we stick to previous message or a complex asset need almost three years to go at big sales, but for some smaller assets, and we mentioned Bioconjugate suites or small molecule and the active API this could go faster.

[Pierre-Alain Ruffieux, CEO]

Just to confirm for Vineet, it's three years post the end of construction.

[Operator]

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

[James Quigley, Morgan Stanley]

One on CapEx. So in 2023, CapEx is going to be high again as it was in 2022, but you said previously that you expect that to decrease to high teens by 2025. So how much visibility do you have on the potential growth opportunities over the next couple of years?

Is there a risk that CapEx creep higher sort of back into the 20 or low 30s over that time period? And is the high teens CapEx sufficient in order to support growth, particularly as you've mentioned that you expect growth to accelerate or previously mentioned, to accelerate from 2024 almost. So any thoughts on how CapEx could progress, it would be great.

[Pierre-Alain Ruffieux, CEO]

Yes. So James, just perhaps to remind all of us all the figures for 2023 are generated. So basically, the CapEx you see on '23 are coming for many projects we started in '21 and '22. For example, we announced last year a major CapEx of CHF500 million for drug product. Obviously, we spend a small amount of money in '22, a larger part in '23 and you've been '24, and then we finished the investment in '25. So a big part of the CapEx for '23 is already corresponding to CapEx announced before.

We continue to see very attractive opportunity to invest. And obviously, as long as the opportunity are corresponding to a financial criteria that Philippe mentioned before and that we have also anchored customer we will continue to invest. But as mentioned, currently, we see a decrease going back to high teens by end of '25, but obviously, we will adjust as we go ahead if we see more opportunity for investment.

[Operator]

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

[Matthew Weston, Credit Suisse]

My question is regarding China and the pressures that you flagged. I'd just be very interested as to what those local market pressures are. Is it COVID slowing down a plant coming online? Is it COVID slowing down trial progress? Or is it competition from local CDMOs? Any color you can give us would be very helpful.

[Pierre-Alain Ruffieux, CEO]

Yes. Thanks. Happy to do so Matthew. So basically on -- in China, we have a small -- we have a facility with small-scale disposable asset. A new customer are basic, we are targeting two type of customer some western company which want to manufacture in China. And as mentioned before, in some Chinese company, which interested to have easier access to Western market.

Obviously, following the 2-year lockdown, strict lockdown in China, it was quite difficult to convince Western company to go there. So we see less business than expected. And we see also some competition on the local market. But I would like to stress that our operation in China are relatively small.

[Matthew Weston, Credit Suisse]

And can I -- just a quick follow-on. How long do you think the pressures will last? Have you got a pipeline and increased interest as COVID eases and some of the restrictions ease? Or do you think it may be more sustained?

[Pierre-Alain Ruffieux, CEO]

I would say I don't want to speculate at that time. We were very pleased to see the end of the lockdown. We have some pipeline, but I'm not going to speculate at this stage.

[Operator]

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

[Patrick Rafaisz, UBS]

I was hoping to get some more color on the mRNA impact. It's been very clear now that this was beneficial to the margin, and that will hurt in 2023. But should we assume that this will again be a headwind in 2024, given that there's still some residual sales left from mRNA or how much revenues will actually be left that could impact 2024 in a negative way?

[Pierre-Alain Ruffieux, CEO]

So Patrick, as you know, as we have only one customer in COVID sales, we don't report the detail. But what you should assume is the peak sales were excel in '22. And the residual sales are marginal. So clearly, we don't anticipate further impact for '24. Philippe, any points to add?

[Philippe Deecke, CFO]

No, I leave it at this. I think, again, we mentioned that the 15% will clearly help probably three to four points of growth coming from that business. And yes, the margins were good and helped a little bit.

[Operator]

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

[Keyur Parekh, Goldman Sachs]

Two, if I may, please. The first one, going back to James' question on 2024. Your guidance essentially implies top line growth of 14% to 15% in 2024. You're saying COVID is not going to be a drag. So I think that is useful. I'm just wondering if you can give any more color on what takes that growth up from high single digits to 14% to 15%. So if you think about that incremental 400, 500 basis points of growth, what are the buckets that we should be thinking about?

And then secondly, perhaps a bigger picture question for you, Pierre-Alain. And we all seem to be getting very confused every half year report on various moving parts of your business. What would it take for Lonza to think about reporting with a greater amount of transparency to stakeholders?

[Pierre-Alain Ruffieux, CEO]

Thank you, Keyur for your questions. Regarding the first one, okay, today, the goal is not to discuss in detail '24. Clearly, to stress again what we mentioned before, with the long-term contract or utilization rates of the facility as well as ramp up this facility we have a clear visibility on '24 and it's why we are confirming this guidance.

Building on the comment of Philippe, if you look back in the last two years' results, you have seen significant variability between half year results because our business is bulky. So again, we anticipate to finish margin for 2023 higher than the average of the year. And therefore, we are fully confident on '24 guidance.

We understand your points regarding the moving part of the business, is definitively, I think one of the challenge reporting or results. As mentioned by Philippe and me a couple of times, our business is bulky.

So we don't sell one million items every year. We sell 4, 5 campaign parse per year. And obviously, they have different characteristics. So while the trend we are committing in terms of growth and improvement of margin is consistent, you see variability quarter after quarter, half year after half year. Philippe?

[Philippe Deecke, CFO]

No, I'll just add, Keyur, I think as you've heard from Pierre, we are going to be increasing the touch points between us and yourself over this year. And so this will allow us to probably give more explanation of granularity or qualitative explanations around some of the questions that you have. And I think this will help all of you to better understand our complex business and many moving parts.

[Keyur Parekh, Goldman Sachs]

I think that would be very appreciated for all of us.

[Operator]

The next question comes from Falko Friedrichs from Deutsche Bank. Please go ahead.

[Falko Friedrichs, Deutsche Bank]

So my question is whether you can share the level of net price increases that you plan to implement this year? And tell us what is the portion that you cannot offset these anticipated price increases?

[Pierre-Alain Ruffieux, CEO]

So Falko, for price increase, we have a couple of dynamics. So on our product business, we just increased price on a regular basis depending on the pricing power we have. And again, in capsule, there is some part of the business when we can pass all the cost and some it's more difficult.

On the CDMO part, again, we have two parts. We have the long-term contract. And here, generally, we are well protected by close. But as mentioned by Philippe, they are coming generally once a year. So we will pass the cost once a year, so some time with some delay.

For the other part of the CDMO business for development services, Phase I or Phase II, it's more a short-term pricing where we can price according to the marketplace. And here, we can pass the cost immediately. So we don't provide a fixed figure. But as we mentioned, you can probably calculate that because we are able to pass most of the inflation to the customer, sometimes with the small delay.

[Philippe Deecke, CFO]

Maybe Pierre, I could add one thing for Falko. I think, you saw that for 2022, we were able to offset most of the inflation. And the biggest lever we have is, of course, pricing. We continue to have increasing impact of inflation next year, but we're also increasing our ability or our increase in prices. And so the residual effect remains roughly the same despite the increase in inflationary pressure.

[Falko Friedrichs, Deutsche Bank]

Okay. And as a follow-up, can you maybe speak a bit about your energy hedging policy for this year? .

[Pierre-Alain Ruffieux, CEO]

Philippe?

[Philippe Deecke, CFO]

Yes, sure. Yes, Falko. So I think we are basically buying our energy for the year ahead, and we're doing this gradually over time. And so for 2023, we've been purchasing most of our energy needs for -- in 2022 for 2023. There are some markets where you cannot do that or you cannot hedge your energy prices.

So of course, this will be still spot rate. But most of our energy for '23 has been locked in. This has been locked in at higher prices than you see today on the market. And as we are now prebuying our energy for 2024, we are leveraging the lower price that we see today for next year.

[Operator]

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

[Charles Weston, RBC Europe]

My question is on the Cell & Gene product headwinds that you've highlighted and the customer product issues. Are these issues fixed? Could we expect some sort of rebound? And have they disrupted the midterm opportunity in this division? And secondly, just a point of clarification, if you could provide it on the H2 weighting for 2023. How much more H2 weighted would you expect it to be than perhaps usual for the group?

[Pierre-Alain Ruffieux, CEO]

Thank you, Charles. So again, on Cell & Gene two or three key driver. First of all, we mentioned a couple of times, the pipeline is mainly made of Phase I, Phase II compound. So basically, they have a tendency not to be successful.

And when we mentioned product issue is basically product not going through the clinical trials. And we have seen a slowdown in in funding for Phase I compound, and this is really explaining some of the headwind we have seen this year and we anticipate to see early in 2023.

But we see also positive development. If we have a look on the product on the market, we see a robust demand, and this is developing. So again, we mentioned a couple of times -- our normal CDMO business is 70% phase -- commercial and 30% clinical here, it's exactly the opposite. So we don't see long-term disruption, but clearly, we have seen some slowdown in the uptake of new projects. Philippe, you take the second part, H2 versus H1?

[Philippe Deecke, CFO]

Sure. Happy to. Hi, Charles. So I think for our next year, as Pierre-Alain was mentioning, we probably feel the headwind of the two assets we are ramping up more in H1 and H2. And so you should be expecting for H2 to have more margins that are more in line with what you would expect from Lonza and therefore, also then the incremental to 2023 to not be so high.

[Charles Weston, RBC Europe]

And from a revenue basis, would there be just a bit less of an impact, presumably than that H1 to H2?

[Philippe Deecke, CFO]

In what sense, Charles?

[Charles Weston, RBC Europe]

Well, if the H2 margin is going to be more -- as a Lonza normal margin in H2 and H1, therefore, will be weaker. Presumably, the EBITDA impact will be extreme on the H1, H2 phasing basis than revenue. Is that right?

[Philippe Deecke, CFO]

Yes. I think we commented in the presentation that both sales and margin will be weighted towards H2. .

[Operator]

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

[Paul Knight, KeyBanc Capital Markets]

Congratulations on the quarter. The divisions that you provided in terms of growth, what would be the implication for 2023, similar growth that we saw in 2022? And specifically, the Biotechnology division, should that growth continue to be in the 20%-plus area?

[Pierre-Alain Ruffieux, CEO]

Paul, we don't provide detail per division. But basically, our growth is driven by many new assets coming online and improvement on the existing asset and biologics being the largest division, you will continue to definitively see -- to continue to see growth in biologics, corrected for the first part of the year of the headwind coming from the loss of COVID sales. But definitively, biologics remains strong.

[Philippe Deecke, CFO]

I think, Paul, if I can add, we did guide for the midterm growth of our divisions back at the Capital Markets Day in '21, I think if you get back to that, this gives you a good feel of where we see the growth over the period by division.

[Operator]

The next question comes from Daniel Jelovcan [ph] from Stifel. Please go ahead.

[Unidentified Analyst]

The question is more on the manufacturing setup. So continuous flow is more and more a topic coming up and the companies involved there say that the yield is much better despite the fact that you need less bigger reactors. How is Lonza positioned there in the long term? What is your view?

[Pierre-Alain Ruffieux, CEO]

So Daniel, as a technology company, obviously, we monitor all the trend to fulfil the customer demand. We see a lot of continuous process mainly without going to be technical and minus one bioreactor. So people do that in the last bioreactor before the production on, but we are also developing in our lab, continuous manufacturing.

So it's coming even if it's not representing the majority of the product today, we see also a lot of continuous process in the small molecule world, because its allow you to do reaction, it's much better condition. So it's coming, but it's not a large part of the business today.

[Operator]

The next question comes from Max Schuck [ph] from William Blair. Please go ahead.

[Unidentified Analyst]

Hi. Thank you for taking our questions. I wanted to follow up on an earlier question about the weakness that you're seeing in the Cell and Gene Technologies division specifically? And just was hoping for some incremental detail around how much of your business there is related to gene therapy versus cell therapy?

And where exactly you're seeing the most impact in terms of delays in customer product challenges as well as pullbacks due to the slowdown in biotech funding. I assume pullback is more in cell therapy just based on the commentary that we've heard from others in the space, but would be curious if my assumption is wrong there.

And then relatedly, could you just walk us through the time line for when you started to see customer behavior change due to the funding dynamics? Is this something that has happened over the last couple of months here? Or have you seen a gradual weakening or softening over the last 6 months? And what are you anticipating in terms of softening moving forward?

[Pierre-Alain Ruffieux, CEO]

So thank you, Max. Regarding the pullback, there are independent of gene or cell therapy, I think it's probably more related to the success rate. We have seen clinical failure on both modality and success on both modality. Regarding the funding, it was probably more a gradual funding for the last 4 months to 6 months. So the latest part of last year, again, is probably a new company having difficulty to get additional fundings.

To what is happening in the next month, again, always difficult to see. We see some improvement in fundings in -- towards the end of last year. We see also good ideas still getting funding. So -- but I'm not going to speculate, but probably expect a slow recovery in the quarter to come.

[Operator]

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

[Peter Welford, Jefferies]

Just coming back to the margin again. I just wanted to focus first on, on the second half margin where obviously Capsules and Health Ingredients declined sequentially quite a lot and also cell and gene therapy in particular.

Now presumably, the latter is partly due to the one-off that you booked in the first half. But -- could you just talk us through exactly what happened in cell and health -- sorry, Capsule Health Ingredients in the second half to drive that margin?

And I guess, how we should think about that going forward. Is that going to be one of the key factors we consider going into '24 in particular? Or do you think -- are the pressures now in that business that are likely to stay given that is a business where you do have pricing power without the lag? So you would have imagined less impact, I guess, than perhaps we see on sort of short-term basis.

And then could you ask a point of clarification on your more qualitative updates with investment. Should we understand -- does that mean you're now going to be giving quarterly business updates, could have formal sort of business? Will it be more sporadic, less sort of structured and less planned? Just trying to understand whether -- how we should think about potentially the more regular communication.

[Pierre-Alain Ruffieux, CEO]

So I will take the latter part of your question, while Philippe will take the first one. So clearly, we have seen that it would be important to provide more information to the investor community. They are going to be qualitative -- and probably you should expect them as a kind of quarterly basis time, we will choose the right in an opportunity to give you an update of what is ongoing in the business. Philippe, perhaps you take the margin in CHI for 2022?

[Philippe Deecke, CFO]

Sure. So Peter, there was two questions, one on the CHI and Cell & Gene, let me take them in a row. So I think for CHI, I think, first of all, see that this is a business that is more subject to inflationary pressure, and this is more energy intensive than the rest of our business. It's also an area where you do not have pass-through clause for your raw materials.

So I think everything ends up with Lonza and we need to pass on these costs through pricing. So we did successfully increase price twice last year. Again, as Pierre-Alain was mentioning in the areas where we have pricing power, some areas are very competitive, and so we cannot always pass through price as much as we would want.

On top of some of the residual inflation, we also had operational kind of a drag towards the late part of the year, where we had supply issues where in some of our businesses, we couldn't get all the raw materials that we needed to produce for our customers. And so this created some absorption issues. So I think that's on CHI, I think going forward, we still see this as a high-margin business, and we are still feeling strongly about CHI.

On Cell & Gene, maybe to note two things, we had this one-off in H1, which, of course, did not happen in H2. We had -- in H2, however, almost a similar amount size provision that we had to take for a customer that was in financial difficulties. And so on the one hand, is slightly too high first half and probably a slightly too low second half. And so this probably balances out to a margin that is not too far away from our guidance -- our midterm guidance for the division.

[Pierre-Alain Ruffieux, CEO]

Thank you, Philippe. I think we will take now the last question.

[Operator]

The last question for today comes from Massimo Bonisoli from Equita. Please go ahead.

[Massimo Bonisoli, Equita]

My question is on the cash flow generation in 2023. For how long do you expect net working capital to sales ratio to stay at about 20%. And the underlying question is, do you expect the cash flow generation to perform better than the EBITDA growth in 2023?

[Philippe Deecke, CFO]

Thank you, Marcel. So I think in terms of cash flow, if you think through the cash flow for next year, one of the larger drag in 2022 was due to inventory, a little bit was due to receivables due to sales phasing, but most of the impact was around inventory. And so we do expect, as I said in my presentation, that we will decrease our inventories now that supply chains have recovered or are recovering. And so I think you should expect a better cash flow progression in '23.

[Pierre-Alain Ruffieux, CEO]

With that, I would like to thank you very much for attending the session today, and wish you an excellent day.

[Philippe Deecke, CFO]

Thank you.