Evotec SE

XETRA:EVT

Earnings Call Transcript 2018-Q1

[Operator]

Dear ladies and gentlemen, welcome to the First Quarter Report 2018 of Evotec AG. At our customer's request, this conference will be recorded. [Operator Instructions] May I now hand you over to Dr. Werner Lanthaler, CEO of Evotec AG, who will lead you through this conference? Please go ahead, sir.

[Werner Lanthaler, CEO & Member of Management Board]

Thank you very much, and good morning to everyone on the telephone lines. We have uploaded a presentation which should guide you through our information about the first quarter 2018 of Evotec's business. We will go together through this presentation, and let me start by saying that it has been a good start for our external innovation business with a new business mix that we are bringing together to ultimately accelerate our e-productivity and innovation in the sector. I'm here together, as you can see on Page #2 of this presentation, with my colleague Enno Spillner, our CFO; with my colleague Mario Polywka, our COO; and our CSO, Cord Dohrmann, who together with me are managing this business. When you are following me to Page #4 of this presentation, you should appreciate that our growth does not come from mere chance. Our growth comes from many different forces that are working together. And if you look at the interplay of Evotec Execute, Evotec Innovate and our corporate activities, you can see that all these things are very well coming together and has produced a very good start into 2018, which allows us to confirm our very good guidance for 2018 already now. Mario will guide you through the significant progress that we have made in Evotec Execute. Cord will inform you about ongoing negotiations with Sanofi and also about the expected new sellout of our platform in Evotec Innovate. And on the corporate side, you should see that we are very happy with our ongoing integration of Aptuit, which is the result of our new business mix, and we have implemented preparations not only to make the company a more European-style company by converting into an SE corporate format. We also have implemented a long-term strategic plan which we call Action Plan 2022. All of this in the short term will lead to a top line guidance of 30% plus, an EBITDA guidance of 30% plus and a very strong spending on the high innovation in our Evotec Innovate project. Enno will bring you through the detailed results of our Q1, but what you should see is that the business is strong. Actually, it's fair to say that business is very strong. Why? Because we can see in all business lines that the feedback of our partners and customers is really appreciating that we are bringing now a value chain together that is better than ever before. So I think it's really the start of something where these numbers will grow also going forward very nicely. Coming to growth on Page #6 of this presentation. Let me remind you that we have put together over the last 10 years a very consistent strategy where our strength and growth comes from continuous efforts into the same direction. And only if you go the same direction and continue these efforts, you're going somewhere. And the somewhere for us is very clearly defined that we will lead as the #1 the field of external innovation. So our Action Plan 2022 is highlighting that we are not only going to be a profitable biotech company going forward, an increasingly profitable biotech company going forward, what we will be is a company that is creating the largest co-owned portfolio out of our Evotec Innovate and other initiatives in this company going forward. And this constitutes our business model rounded up with BRIDGEs and other corporate initiatives which ultimately always use the power of our platforms. And when it comes to platforms, it's really what we have brought together with our currently more than 2,300 scientists, all the platforms where we then apply a business model, which is called either Evotec Execute, when we operate on the IT of our partners, or Evotec Innovate, when we generate our new IT. On that note, let me hand over to the first segment of our business, Evotec Execute, which is led by Mario. I hand over to Mario on Page #8.

[Mario Polywka, COO & Member of Management Board]

Thank you very much, Werner. And welcome, everybody, to the first quarter results presentation. And as Werner said, I'll focus on the Execute segment where we're focused on driving our partners' projects from our fully integrated discovery and development platform. If we move to Slide 9, we see a tremendously strong organic and inorganic growth in the EBITDA -- Evotec Execute segment. The growth in revenues of around EUR 30 million over the corresponding period last year was at EUR 48.5 million was obviously driven by a full quarter addition of Aptuit revenues as well as, excluding milestones, a nearly double-digit growth of the core business. Maintaining an EBITDA margin above 20% of revenues despite lower milestone achievements in the first quarter, which is just the natural volatility of such payments, and also the contribution of what is a fundamentally slightly different lower margin business of Aptuit, this really represents an excellent performance and one that we believe will only improve as the year and as the years progress. Moving to Slide 10, which gives a snapshot of our customer base and type and where the customers actually sit and live. With 30% of our revenues being contributed from the Aptuit acquisition, it's no surprise to us that the strong dependence of the revenue makeup of our top 10 clients have decreased significantly in both relative and absolute terms. This spread of customer risk is, of course, most welcome. Our customer type remains fairly similar but has swung somewhat to the biotech and midsize pharma companies, and this is driven by clients that required the full integration of our drug discovery and now drug development solutions. Geographically, we've seen a swing towards the Japanese market. This is assisted primarily by the strong Aptuit contribution as well as some growth from the core Evotec business. Our strong presence in Europe in the integrated CMC area results in some of the change in the U.S. euro split, although it's clear that this may also just be a simple timing situation with respective clients. What is clear is that our now fully integrated drug discovery and development offering is especially appreciated by the increasing virtual biotech companies and the more innovative midsized and even large pharma companies. Moving over to Slide 11. This slide sums it up really nicely. We continue to progress our current partnerships. Many are expanding and extending. New projects have been signed. We still look to bring in technologies that help us in identifying novel chemical starting points for integrated drug discovery and development. We're pleased to have signed the new CRISPR license with ERS Genomics for -- who have, of course, the European patent for the genetic screening and technologies using CRISPR. And moving to Slide 12. In speaking about innovative partners, this is an opportunity to show you this excellent white paper where we published, along with benefit, of how true cooperation between companies with the same mindset in terms of driving innovation towards achieving new medicines to the market. We presented this white paper. It's on our multitarget endometriosis collaboration with Bayer, and this is a collaboration that continues to meet and, indeed, really exceed all of its initial objectives in this most debilitating female disease. The objectives here, as it is with the majority of our partners, is to realize resources and capabilities and ideas and innovation from both parties to drive products forward. In this case, our aim was to drive 3 candidates into Phase I within a 5-year period. And as you know, to date, we have 6 preclinical candidates who've been nominated. And actually just a week or so ago, we nominated the third Phase I candidate in this the fifth year of the cooperation. So as well as having received multiple milestones and research funding over the last few years, this project will continue to feed into our pharmaceutical pipeline, which, of course, Cord will talk about later. And we anticipate further clinical milestones in the years ahead. Slide 13 is a graphical representation that we are now truly the one-stop ideal partner for external innovation, going from target identification, validation, all the way through to first entry into the clinic and then supporting beyond. And as Werner said at the outset here, the acquisition of Aptuit is -- has been key to our extension of our already industry-leading discovery platform. So we are able to deliver clinical-ready compounds now to our partners and, if required, also support drug product and API supply through our integrated CMC capabilities and capacities. How is it going with Aptuit, in Slide 14? Well, the initial integration steps are effectively complete. The most important, of course, has been the coupling of technical competence, the use of preclinical activities, bringing that into the late derisking phase of lead optimization and then formally being able to seamlessly move from existing discovery programs also to stand-alone programs into the fully integrated preclinical package known as INDiGO. So technically and commercially, we have that offering together. INDiGO, as you know, affords the most time-efficient way to proceed through the preclinic through an ID or an equivalent submission. And managing and coordinating all the activities within 1 organization under 1 roof by industry-leading experts is the only and most efficient way in the market to bring our partners' products to the clinic. We launched INDiGO from a marketing perspective in Q1. And although this process was already active in Aptuit, through a more formal marketing approach and through our broader and deeper reach into our commercial partners, we've seen a significant response such as the recent additions of Petra Pharma and now Carna, Japanese biotech, for our INDiGO services. We've seen the read-through from our discovery projects. We also see the selling of discovery projects through the ability to be able to support our partners, and we feel we can really develop this into a truly value-generating proposition. So finally to Slide 15 and in summary. We're starting to realize and see the potential of the integration of the Aptuit acquisition. We continue to sign new deals, both integrated and stand-alone. We progressed existing ones successfully and some, of course, as you see, into the milestone-bearing rewards. So our outlook for the rest of the year remains unchanged. And with that, I'll thank you for your attention, and I'll now pass you over to Cord Dohrmann.

[Cord Dohrmann]

Thank you, Mario. And good afternoon to everybody on the call. Last year has been a spectacular year for Evotec Innovate, and the first quarter of 2018 has been a very solid start of what we believe will be another great year for Evotec Innovate. Just as a reminder, the Evotec Innovate business segment is focused on long-term value generation through high-value pharma partnerships, which not only deliver significant R&D payments but also very significant upside value through potential milestones and royalties. Milestones usually range in a few -- in the range of a few hundred millions whereas royalties are tiered usually and can reach, in many cases, double-digit percentages. Based on the performance in the first quarter and the first on the current outlook for the remainder of the year, we expect that Evotec Innovate will deliver very significant growth in 2018. On my first slide, Slide 17, Evotec Innovate's financial performance is summarized. Revenues from Evotec Innovate are very solid and in line with expectations, although slightly lower than in the first quarter of last year due to lower milestone contribution. We do expect that milestone contributions will increase in line with our growing portfolio of co-owned product opportunities. However, we cannot predict when exactly milestones will be reached in individual projects, and thus the milestone contribution can vary very significantly from quarter-to-quarter. Due to the lower milestone contribution in the first quarter of 2018, EBITDA is also a bit lower than in previous years. And R&D expenses, as you can see, are currently in line with prior year. So in conclusion, Evotec Innovate had a very solid start into 2018, laying a very good foundation for significant further growth in 2018. On the following page, Slide 18, I want to give a brief update on our co-owned product pipeline. We continue to make progress in our early stage and development stage partnerships, and in the first quarter of 2018, we have already had significant progress to report from our Bayer endometriosis alliance. In this alliance, we recently introduced a program into Phase I of clinical development. This is now the third clinical stage program coming out of this alliance which was only started at the end of 2012. We have good reasons to believe that we will be able to report further advancement of this pipeline during the remainder of the year and are very much looking forward to this. At the next slide, Slide 19, we would like to emphasize that within Evotec Innovate we continue to invest into paradigm-shifting platforms and transformative projects. As the pharma industry as a whole struggles with declining productivity, the rate of return on drug development investments has been decreasing very steadily over the past 3 years. According to some estimates, the return of -- rate of return could actually be approaching 0% in 2020 if productivity continues to decline at the current rates. This declining rate of return is largely due to 2 factors. Success rates for clinical trials continue to hover around the mid-single-digit range, while R&D costs to develop a new drug is steadily increasing and now estimated to be greater than EUR 2.5 billion per drug introduced into the market. At Evotec, we firmly believe that new approaches and platforms, but also business models, have the potential to reverse this trend. New technological developments in fields such as artificial intelligence, stem cell technology and organic cultures as well as panomics and molecular phenotyping are on the verge of being integrated into the drug discovery value chain. Our Innovate R&D investments are geared to drive and accelerate these developments and make them available to our partners in the context of Innovate's business models. One example of Innovate's technology platform is shown on the next slide, Slide 20. Patient-centric approaches, and here in particular iPS cell technology, can address the problem of relatively low clinical success rates, which is the state of development where actually the costs are highest. We continue to make great progress in the development of Evotec's unique iPSC platform, adding more and more unique patient-derived disease models and cell types. And in our iPS cell-driven partnerships, we reported the achievement of important milestones in the past and are confident that there are more to come in the future. We continue to invest also into next-generation projects, which will hopefully drive future partnership in this area. Beyond investments into paradigm-shifting platforms, we also continue to invest in the acceleration of a pipeline of drug candidates, as you can see on Slide 21. A field that we feel offers challenges but also lots of opportunity is the field of infectious diseases. This field certainly deserves more attention and is in dire need of new approaches. At Evotec, we first ventured into infectious diseases with the acquisition of Euprotec in 2014, a business unit that has grown very significantly since then. We built partnerships with Harvard and Oxford University and other academic institutions but also invested into exciting start-ups such as Forge. Most recently, we announced that we are planning to enter into a strategic partnership with Sanofi in infectious diseases, which is expected to close in Q2 of this year. This partnership will be a very significant step forward to become a global leader in the field of infectious disease drug discovery. And with the closing of this [ drugs ] planned action, Evotec will have one of the largest infectious disease drug discovery platforms and pipelines, with over 150 highly experienced scientists in over 20 projects in the field of antimicrobials, antivirals but also in the global health field. With this, I would like to move to the next slide, Slide 22, and update you on our academic BRIDGE strategy. Over the past 6 or 7 years, we have built collaborations with over 50 academic laboratories. These academic collaborations with leading academic institutions and researchers are a basically sheer, endless source of innovation that feeds our Evotec Innovate strategy. Today, I would like to point out that our academic BRIDGE strategy has evolved significantly. We have made these -- this more strategic and more efficient and more productive than ever before by combining strategic disease funding with highly innovative projects and highest quality drug discovery platforms into the framework agreements that vastly reduce research costs but also contract negotiation time lines and time and costs of key data points. Our LAB282 with Oxford University and similarly our LAB150 in Toronto are 2 key examples of this. Both of these academic BRIDGEs were only formed fairly recently. LAB282 with Oxford was formed at the end of 2016 and LAB150 in Toronto at the end of 2017. For LAB282 alone, we have selected and established 17 projects in a period of less than 18 months. Obviously, not all of these projects will make it to market, but we are convinced that we will be the fastest and most efficient way to key data points that will allow for the assessment and improved decision-making regarding the best possible development of these projects. We are convinced that Evotec's academic BRIDGE model will become a blueprint for many pharma companies going forward and that academic institutions and -- as well and are hopeful to participate in quite a number of these going forward as well. So looking forward for Evotec Innovate in 2018, our expectations are summarized on Slide 23. We do expect to progress our portfolio of co-owned product opportunities, and this is also our clinical stage pipeline. We also want to further expand our academic BRIDGE network in Europe as well as in the U.S., and we expect significant progress in our R&D portfolio. And based on these projects, we expect to structure new Innovate partnerships. And finally, we will continue to invest into paradigm-shifting platforms to make drug discovery more translatable, more efficient and ultimately productive and a key area will continue be going forward the iPS cell platform here. With this, I'd like to thank you for your attention and hand over to Enno.

[Enno Spillner, CFO & Member of Management Board]

Yes, thank you, Cord. Thank you very much. And welcome from my side as well to everyone on the call, introducing the Q1 2018 numbers to you right now. Let me just make a brief upfront statement with regards to a former topic. As from January 1, 2018, onwards Evotec will now apply IFS 15 in our financial year 2018, which is mandatory. And for comparison reasons, we have also adjusted the 2017 numbers accordingly. That said, overall, you can find additional information already in our annual report for 2017 on this topic on Page 92 in the English version, and this has no significant impact so far on our financial numbers in general. On Slide #25, let me now introduce our strong financial numbers for Q1 2018. A significant step up of the revenues has been achieved and compared to Q1 2017 increasing by 55%, which is mainly due to a positive contribution by Aptuit and growth of the Evotec base business, which means also without Aptuit and without Cyprotex we would have seen an upswing in our revenues. So also the core business of Evotec keeps growing strongly. That said, please bear in mind that we have not yet seen significant more volume and milestones in 2018, as indicated by Cord and by Mario, which is hopefully yet to come. This was different in Q1 2017, where we had received several milestones at the beginning of the year already, obviously with the beneficial impact on revenue, gross margin and also EBITDA at that time. Looking at the gross margin, which reduced from 37.3% to 23.4%, there's 2 mainly -- or mainly 4 effects, which I will describe on a separate slide. But as a summary upfront, this is about amortization. This is a different revenue mix. This is a smaller model of milestones year-to-date, and this is a challenging foreign exchange environment. R&D expenses remained stable while SG&A increased, as expected and as already forecasted in our last conference call. Main reasons are, obviously, now Aptuit for the first month with their SG&A and first month -- first 3 months in 2018; growth of the SG&A team overall, including BD. We have some M&A activities coming from the Sanofi transaction that Cord just described and, obviously, from the Aptuit integration. And we have other topics ongoing like implementation of new systems, infrastructure, additional billings and so on. On the other operating income, we see quite an uptick on the increase in R&D tax credits, which was mainly coming from France and from U.K. And now since end of '17 already, but getting more traction in each of these from our Verona site as the Aptuit branch. And we hope to further develop this area as a contribution to our overall financials. Looking at the adjusted group EBITDA, which increased by 4% and reflects the growth and the base business and, obviously, the contribution from our strategic acquisitions like Aptuit and Cyprotex. Maybe to mention, which is not on the slide here, but our cash position just -- is currently is the cash, cash equivalents and investments amounts to EUR 78.5 million compared to EUR 91.2 million at the end of the year. Consequently, right now we feel operationally and financially in a quite strong position here with this amount of money, with no immediate need for further financing at this point in time. Looking at the next slide and diving a little bit into the segments, starting with the Execute segment. Regarding Execute, basically all the effects I just described on the previous slide also apply for this segment, in particular the impact obviously of the Aptuit acquisition on the P&L, which mainly affects the Execute segment as Aptuit is obviously part of the segment delivering business services. Revenues in the segment significantly expanded, driven by good performance in the base business and adding, as mentioned, EUR 25.3 million by Aptuit. Reasons for the reduced gross margin mainly are the same reasons as described on the previous -- or indicated on the previous page. We'll come back to that in a second. And also, with regards to the SG&A development as well as the increased other operating income, they are mainly the same arguments as shown on the previous page, for example, the increase in our tax credits achievements. On the Innovate segment, we do have a reduction in revenues by approximately EUR 2.1 million, as already mentioned just a minute ago by Cord. However, just looking at the base revenue, we do have an increase by approximately 20%, thus making good progress on the base revenue level compared to the previous third quarter of 2017. The reduction in gross margin is largely the consequence of the milestone timing. And the R&D expenses are stable in Q1 2018. They have been with a focus of CNS metabolic diseases, oncology and the academic BRIDGE activities or initiatives that were just described. Overall, I would like to reiterate what Cord already mentioned. This is a confirmation of my statement also from the last call in March that it is better from a milestone perspective to look at the full year instead of the individual quarter since we have a certain volatility in these developments and in achieving the milestones. On Slide 27, looking a little bit closer into the analytics of the group revenues and the gross margin. We have a significant step up of revenues compared to Q1 2017, as mentioned before, Aptuit contributing EUR 25 million, and the rest of the step up is growth within the base business of Evotec. And if you take out milestones, upfront payments and licenses and then also take out the Aptuit contribution, you would look at the base revenue increase of about 14%. And that really shows you that we still have a strong growth rate also in our core business. One can also see that the milestones and upfront licenses are significantly lower than last year, which then also has a strong influence, obviously, on gross margin and EBITDA. As in most cases, there are no costs accounted against the milestone revenue recognition. The other part if we had been at constant foreign exchange rates we would have seen roughly EUR 3.3 million more in revenues compared to last year or an improvement of 1.8 percentage points in our gross margin. Coming to the gross margin, as I mentioned, there are 4 major effects. And the amortization of our strategic measures, Aptuit and Cyprotex in particular, were EUR 3.1 million is probably the biggest position here. And also here, the gross margin without the amortization would improve by roughly 3.8 percentage points, so this is something that we clearly have to keep in mind. We have first contribution of the first 3 months now including Aptuit with a different revenue mix. And we have also, as already indicated, the impact of the foreign exchanges, which on the gross margin level would change the amount by roughly EUR 2.2 million if we would apply the foreign exchange rate from last year, just for your comparison. With that, coming to the next slide to the guidance, which Werner already indicated at the very beginning, that we can confirm our guidance; this will remain unchanged. And the numbers Werner just described at the very beginning. So we want to achieve 3 times 30, 30% increase in group revenue; about 30% step up in the group EBITDA; and investing in the range of EUR 20 million to EUR 30 million into R&D and into new innovation. And with this, I conclude my part of the presentation and hand back to Werner. Thank you very much.

[Werner Lanthaler, CEO & Member of Management Board]

Thank you very much. Thanks to all of you for following our webcast. And with this, we open for questions.

[Operator]

[Operator Instructions] The first question is from Falko Friedrichs, Deutsche Bank.

[Falko Friedrichs, Research Analyst]

I would have 3 please. Firstly on the gross margin, can you give us a rough idea of what we can expect here on a full year basis? Is it a fair assumption that it will likely be below last year's level? And then also can you provide some insight on how the gross margin at Aptuit could be brought up to the Evotec levels? And then secondly, could you tell us how much of the other operating income line is actually coming from these R&D tax credits and whether we can use that as a quarterly run rate for the year? And then my third question is you mentioned a continuous focus on the expansion of the iPSC platform. It would be great if you could provide some additional color on the recent developments here.

[Werner Lanthaler, CEO & Member of Management Board]

Thank you so much. The first take on the gross margin question, which I will then hand over to Mario, you should see that it's not about bringing up one part of the company to other part of the company. It's really about bringing all of our projects and all of the processes together to ultimately run the best possible integrated projects for our partners. And of course, further down the line, you become more "commoditized." That's why a lot of the businesses that we have in Aptuit have a different gross margin in the markets than what Evotec does in high innovation discovery. Having said that, you will see that the gross margin of Aptuit will improve significantly because of the fact that there will be more integrated deals coming. But what you should also appreciate, we have only acquired Aptuit and taken it over in the fourth quarter of 2017. So you cannot change an ongoing business which is very healthy and the contracts there because these are long-term contracts that are running. So the effects that you will see will take a while, but they will come. And with this, to give you a bit more color, I hand over to Mario.

[Mario Polywka, COO & Member of Management Board]

Well, I'm not sure how much more color I can put to that, Werner. Very clear exposition there. I think there is a fundamental lower margin with some of Aptuit's work because it involves a significant more material aspect. If you're making API and then from then drug product, the raw material, which has to be taken as revenue because it's part of the product you're making, will, of course, dilute against the other costs of the project. But putting that aside, as Werner said, we're in the early days of the acquisition. We absolutely see the strategic rationale, and now our client sees the strategic rationale for this. And the way to access better margin is to pull that together within drug discovery. The key thing here is, of course, the INDiGO. We're finding a tremendous takeup effect going forward. It'll improve to what it used to be, and, of course, the more capacity we use on INDiGO then that will, of course, drive up margin. And then, of course, we're accessing clients from the discovery base that are tied into us. It's a captive audience, and we need to drive that strategically through beyond INDiGO and in a lot of cases into integrated CMC where the margins are considerably higher.

[Werner Lanthaler, CEO & Member of Management Board]

The second question I would hand over to Enno, which was on the visibility of tax credit going forward.

[Enno Spillner, CFO & Member of Management Board]

Yes. So tax credits in this quarter were in the range of EUR 5 million to EUR 6 million. But that said, we should be a little careful taking this as a given for the next quarters to come because this depends on the projects which are eligible for R&D tax credits applications and also on the partner on the other side who is working on these projects. Because if they have an R&D tax credit accreditation, then sometimes you cannot fully or not at all claim for it on the Evotec side. But obviously, you can see that there's an increase compared to the previous years, and we will work on this to further step this up. And obviously, as now Aptuit came on board, we have a third country which is allowing us to claim for tax credits, which we have, for instance, in Germany and the U.K. -- in Germany and Switzerland are not allowed to do in such a way.

[Werner Lanthaler, CEO & Member of Management Board]

And I think the iPS question has only 1 natural owner. Cord?

[Operator]

Are your questions answered?

[Cord Dohrmann]

So iPS -- sorry, I was on mute. So in the iPS field, we have already built very significant partnerships in the area of neurodegeneration and diabetes. And, of course, there are many additional areas that -- where iPS cell technology can have a very significant impact. And here, we currently have on our short list of areas in particular early developmental disorders, which lend itself extremely well to the technology, but also kidney diseases and certain eye diseases, muscle-wasting diseases, including MS, and quite a number of additional areas that we feel are highly exciting in this context. In each of these areas, the goal is really to reflect as large a patient population as possible, which means to continuously expand disease model of individual patients that reflects certain portions of such a patient population. And increasingly as iPS cell technology is taking hold here, iPS cell technology is not only used to reflect individual cell types, which are manifold essentially for the different diseases, but also to build organic and organ-like structure based on iPS cell technology. So going forward, it's really a very -- this is only really just the beginning. I would say we are still at the very beginning of how to systematically implement iPS cell technology in the drug discovery process. And here, building really large libraries of patient-derived disease models and ultimately come -- becoming closer to the vision of creating the potential to conduct clinical trials in a dish and thereby then actually stratify patient populations for subsequent clinical trials and thus, hopefully, improve clinical outcomes over the clinical success rates.

[Operator]

The next question is from Julius Hedden (sic) [ Joseph Hedden ], Rx Securities.

[Joseph Hedden, Healthcare Analyst]

Two if I may. Firstly, the first quarter contribution from Aptuit of EUR 25.3 million was below the Q4 number of EUR 30.9 million. Can you just allude to if there's anything significant driving that? And then secondly, be interested if you could tell us the amount of the amortization charge for Aptuit and Cyprotex that's going through the cost of goods line.

[Werner Lanthaler, CEO & Member of Management Board]

Thanks very much. The amortization question will go to Enno, and maybe, Mario, I think you can give a bit of the business mix and top line mix color at the beginning, that would be great.

[Mario Polywka, COO & Member of Management Board]

Yes, thank you, Julius (sic) [ Joseph ]. Yes, there's nothing really behind the slightly higher Q4 2017 versus Q1 2018. But Q4 is always, and this is across all of the Evotec business line, a heavy quarter as you would have seen in previous years. And of course, a lot of the Aptuit business is large fee-for-service business versus the Evotec classical discovery business which is long-running FTE business. So you can get timing issues where you get multiple projects finished within a particular quarter and then projects straddle other quarters. Nothing really fundamental there at all. The classical, strong Q4. And then as we go into Q -- 2018, we'll build up through the quarters as business comes through.

[Werner Lanthaler, CEO & Member of Management Board]

Thank you so much. The amortization goes to Enno.

[Enno Spillner, CFO & Member of Management Board]

Yes. So out of the total amortization that we have in right now, which is about EUR 3.1 million, EUR 2.8 million, and thus the major portion, go to Aptuit and Cyprotex in total. And that will obviously decrease over the years slightly, but on average, this should be the numbers in 2018.

[Joseph Hedden, Healthcare Analyst]

Enno, is that going all through the cost of goods line?

[Enno Spillner, CFO & Member of Management Board]

Yes.

[Operator]

The next question is from Igor Kim, ODDO BHF.

[Igor Kim, Research Analyst]

This is Igor Kim from ODDO BHF. I've got a couple of questions. First on INDiGO programs. Now with 2 [indiscernible], with the Petra and Carna, how many projects do you expect by the end of 2018? I mean INDiGO projects. And how many INDiGO projects you could expect in the midterm, let's say in 5 years? And one question on iPSC cells. Are there any other similar iPSC technologies apart of yours? And if there is any, could you give a bit of color how you're different from them? That would be helpful.

[Werner Lanthaler, CEO & Member of Management Board]

Thank you so much. The second question is either an answer of 2 hours or an answer of 20 seconds. I don't know how Cord will do it, but it goes to Cord. And the first question goes to Mario, where I think the short message is we cannot give too much guidance. But overall, we see a very, very great offering that we are putting together here with the INDiGOs. But on the quantities, Mario, it would be good if you can give a bit of color.

[Mario Polywka, COO & Member of Management Board]

Yes, well, thank you. And thank you for the questions. So first of all, don't be mistaken that the release of 2 press releases with Petra and Carna, I mean, they're the only 2 INDiGOs, because at the moment I think we have approximately 10 to 12 INDiGOs ongoing, so [ that's back up ] to the year. At any one time, we can probably do between 20 annualized completed INDiGOs. It's our view, and we've already started some investment, to be able to increase that by at least 30%, 40% over the next few years and then perhaps going out further into the 2021, '22s being able to double that. Of course, it's -- the capacity is -- tox capacity -- 28-day tox is, one of the key ones. There's only so many months in a year, of course, but the number of rooms to do that is very important. But also very importantly, it's about API. Because one of the key areas here is being able to generate the API to make the drug product to go forward and run the GLP tox and the safety pharmacology, and that can depend on the type of process. So we get some horrific API processes, 20-plus steps, which of course takes a while to make a few kilograms for GMP, or we can get very simple ones. So the answer is ongoing, probably around 20 or so within the year. We hope to double that within the next 3 to 4 years.

[Werner Lanthaler, CEO & Member of Management Board]

Thank you so much. And the FTS technology question to Cord.

[Cord Dohrmann]

Could you please briefly restate the question? I had some noise in the line. I couldn't...

[Igor Kim, Research Analyst]

Is there other technologies out there that are comparable to our iPS technology and if so which?

[Cord Dohrmann]

IPS cell technology is fairly unique in this regard that you -- that it is possible to really devise very much patient -- individual patient-derived disease models. So there is nothing like it on that level. When it comes to what makes Evotec special in the iPS cell disease model space, it is really the adaptation of a process that has been originally established, of course, in academia. But we have industrialized the process to a point that we have been able to adapt the generation of specific cell types, be it neuronal cell types, endocrine cell types or others, into a high-throughput format that allows us to make these cell types in an 83 -- 384-well format that is high-throughput screenable. And that's really the key differentiator where we have achieved an industrialization and robustness of the process that is currently unparalleled in the industry and where we feel we have a step up and leg up on everybody else at this point in time.

[Operator]

The next question is from Victoria English, Evernow Publishing Limited.

[Victoria English]

Yes. Werner, I have essentially 2 questions. One concerns the comments that were made about rate of return on R&D. I'm wondering whether the prognosis that you've given, which is really quite pessimistic, is for the industry as a whole or for a certain segment of the industry? And the reason why I'm asking is that it wasn't very long ago that Andrew Witty was -- of GlaxoSmithKline was talking about achieving a 14% rate of return on R&D at GSK. The second question concerns the infectives project that you have underway with Sanofi. When I first read the press release, it wasn't clear to me whether any of Sanofi Pasteur's assets would be transferred to that. So that's a simple question. And secondly, I can see that Novo Nordisk is a shareholder, and they -- excuse me, Novo Holdings has recently set up a fund to finance antibiotics. And I'm wondering to what extent Novo is involved in this anti-infective initiative?

[Werner Lanthaler, CEO & Member of Management Board]

So first of all welcome, Victoria. Good to hear your voice. Secondly, the 3 questions, let me start with the last one. Novo Holdings has set up the repair fund, which is exactly focusing on projects that are not in the typical sweet spot of the venture capital growth in longer time need for development in the preclinic. And the repair fund with about $150 million of funding is a fund where many academic projects now can go to and have an additional source of funding, which I think is illustrating the picture that the co-development part and the supporting partners for anti-infectious projects is not only pharma companies, because they are increasingly getting out of the segment, it's really other institutions and organizations that can provide the funding for these projects. So I think here is a great synergy that can be seen and that we will, of course, try to capitalize on going forward. On the other assets from Sanofi in our contemplated transactions with them, there are all portfolio assets that are in this infectious disease unit in there coming with the transaction. So we take more than 10 ongoing projects, most of them in discovery or in preclinical stage, as the basis for this portfolio work that we bring forward. And that's also the [ substance ] that we want to bring forward into this portfolio-building effort. And on your general question of rate of return in R&D, actually, we, first of all, have to differentiate that we -- that Evotec are going into first-in-class, best-in-class innovations where currently you either have suboptimal treatment or no treatments. That's, of course, where it takes a lot of scientific breakthrough potential, first, and, secondly, long development times to get there. The second dimension that we all have to face is to increase personalization. In general, the targeted markets will not get larger but will get smaller, which also has the potential to get potentially clinical time lines and clinical costs down. But I think what we all are experiencing only if you have a very, very well-defined, early discovery or preclinical candidate that you can translate into a clinical, then you can achieve substantially positive rate of returns in discovery. I think this old style let's go with many project interface [ tool ] and then see what works best, that's just over because that's not going to work anymore. And here the idea of creating early stage portfolios with our partners, benchmark early targets very early in the discovery phase on the best platforms is just absolutely superior to how the world has done this in the past. Why? Because the low returns within pharma companies essentially comes from the low utilization of the fixed costs that are behind these platforms because they always have only one customer to drive projects forward. With Evotec, you many customers utilize our platforms, which brings the R&D productivity up. So I think, yes, R&D projects is a challenge. But if there's a place where it would be higher than anywhere else, then it's us.

[Operator]

The next question is from Alex Cogut, Kempen.

[Alexandru Cogut, Analyst]

I have a couple questions on milestones. Could you provide a bit more color into the split of milestone revenue between Execute and Innovate? And just to get a feel for timing of milestone revenue for 2018, would you expect that some in Q3? Or is it more rather towards H2? And just 2 more questions. On INDiGO, is it fair to say the new projects you announced this year are more at the gross margin level of the Evotec base business? And a more fun question, more interesting, what is the next major inflection point for the development or the iPSC platform?

[Werner Lanthaler, CEO & Member of Management Board]

So to -- the first things is milestones are not driven by quarterly events, which is a time function. Milestones are driven by biology. And that's why a milestone for us is not only a cash event. A milestone for us, more than anything else, is a value event, where science is progressing into a different value phase. Please always keep this in mind because sometimes we get really a bit confused by just looking at quarter-by-quarter is there now a [ million ] or not. That's really not what is happening here. A milestone represents a massive value event because, one, as it is going forward in its biological development, finding these biological developments is not that easy. In fact the nice thing for us is that we have at this stage more than 80 projects that are linked to milestones and that are fully invested. So there is a lot going on, more than ever before, and that's also what will be reflected going forward. And if you look at the milestone curve over the last years, it has been growing steadily, which is just a reflection of the higher value that this portfolio is generating over time. And as you have not seen many milestones in Q1, I think you should prepare for more milestones to come because there are more experiments that are reading out in the next quarters. And the nice thing about our business is that even if worst case scenario would happen that no milestone would come, you would still have a very nicely profitable, not in need of any funding running biotech company, which then has even more projects going forward because they're generating all the new milestone-bearing projects. So very long answer to the question. Second, in Execute you typically don't have milestone-bearing projects. There's 1 or 2 examples of -- that are there from a mix of targets that have come together by the IP of our partners and from our IP, which again for historic reasons, are at this stage, reporting under the Execute segment. The most prominent of that is in the endometriosis collaboration. So going forward, you will see milestone in Execute coming out of this collaboration. But I would say 80% of the milestone-bearing projects going forward will be Innovate projects that are there. And on the iPS, the next major inflection point is really many, many biologic events. But I think there are 2 critical readouts that will come in the next 12 months from the existing alliances already. One is our beta cell projects together with Sanofi where we will see a very quick experiment on beta cells and how they behave in living organs or living systems. And the second experiment is what is ongoing in our collaboration with Celgene in CNS, where we hope to see a lot of the targets that are screenable under our platforms which then allows really novel targets through these platforms to go forward. So that's really as exciting as it gets to anticipate. But more importantly, that's creating true long-term value. And the other thing is we are currently working on more than 5 unpartnered iPS projects that we are compensating to partner in the next years. But the nice thing here is also that it's all happening on our platforms, so there is no need for partnering, and the projects are, nevertheless, focusing at good speed.

[Alexandru Cogut, Analyst]

And on the INDiGO question?

[Werner Lanthaler, CEO & Member of Management Board]

Oh, sorry. INDiGO gross margin. INDiGO gross margin, as Mario was illustrating, INDiGO is a package which has [ 6, 7 ] components behind it. And you will see higher gross margin packages and lower gross margin packages. But I think the target is here to come to our Evotec Execute margin as a minimum going forward, if not higher. And that's exactly what Mario and the team is driving every day to bring gross margins here up significantly above 25%.

[Operator]

The last question is from Mike Cooper, Trinity Delta.

[Michael Thomas Dudley Cooper, Research Analyst]

A question about the BRIDGE study. I'm imagining you're having lots of universities knocking your door asking to form these BRIDGE collaborations with you. How do you decide which university to go with? And on a related theme, Cord I think mentioned that there was -- you're working currently with 60 universities or departments. How many networks -- how big a network can you realistically manage? And what is the golden number there?

[Enno Spillner, CFO & Member of Management Board]

I mean it's all about quality is the first thing to answer. The second thing to answer on this one is never forget that Evotec is razor-sharp focused on drug discovery and early development only. So for us, we can very quickly assess if a scientific project is fitting to a disease area and not fitting to a disease area, [indiscernible] if innovation is high or not so high. So I think here, you really have a fantastic filter, and the platform with 2,400 scientists and [ 7 ] disease area is so well trained in understanding what's the latest science, what's the progress scientifically, that there is an enormous throughput that this organization can manage. So I would not be afraid of any limitation in scale here, which brings me to the number of academic places that we want to sign up with which funds. As you've seen, we have LAB150 in Toronto; we have LAB282 in Oxford, which are clearly 2 geographies of outstanding quality that we have signed up. We have ongoing relationship with Harvard, Yale and other institutions that are in the top league. So I would say our target list are the top 50 academic places generally, and that's what we will roll up over time. And it's not needed to be all done in 1 quarter. That's an ongoing process over the next years, which brings me back to our strategy is long. And therefore, you will see with these BRIDGEs, 10 years ago no academic institution had a career center. Now, everyone has a career center. And in 10 years from now, everyone will have a BRIDGE, and that's how we approach that.

[Operator]

As there are no further questions, I would like to hand back to you, speakers.

[Werner Lanthaler, CEO & Member of Management Board]

Thank you so much for all your questions. Thank you so much for following Evotec, and especially thank you so much to all our coworkers that are producing what we are able to discuss with you on the fantastic progress of the company. And with this, I wish you all a great day. Thank you so much.

[Operator]

Ladies and gentlemen, thank you for your attendance. This conference has been concluded. You may disconnect.