Edited Transcript of VEC.L earnings conference call or presentation 17-Mar-20 9:30am GMT

So if we move to page — slide then, let me start by giving you a few headlines for the performance for 2019. I would start by saying we’re very pleased with our performance in 2019 where we delivered a solid set of results for the company. We saw double-digit growth for both revenue and EBITDA. Revenue was 11% up from the previous year to GBP 178.3 million and our adjusted EBITDA was also up just more than 11% on the previous year’s to $43.4 million.

In 2019, we also announced a capital returns program of GBP 60 million in cash for shareholders. GBP 40 million of that was a special dividend, which was paid in October of last year. And we have a GBP 20 million share buyback program, which is currently underway. And as of last night, we have completed GBP 9.8 million by the end of business yesterday, and the remaining balance will be completed throughout the course of 2020.

From a news-ful perspective, I would draw your attention to 2 events in the main. The first is our resubmission of our data package to the FDA with our partner, Hikma, for the generic Advair program, or as we call VR315, and we would expect to get feedback from the FDA in the second half of 2020. And as you know, the U.S. court case against GSK was judged in our favor. This is subject to appeal, which is ongoing at the moment, and we would expect to hear the final outcome in quarter 1 of 2021.

So since I joined the company back in November, really my main priority has been all around starting to execute on the plan to transform the company to become a leading player in the inhalation CDMO space and really to get our entire organization aligned around a very clear and a simple strategy for growth. And I’m going to come on to that strategy and, more importantly, the execution plan a little later. But what I’d like to do is just give you a few quick updates on what I’ve been focused on in the main.

Firstly, I’ve really been focused on building out our leadership team and making sure that we have more expertise in the company from a CDMO perspective. And for those of you who may have read the press, I’ve quickly brought in 2 outstanding executive leaders from outside the company who will very nicely complement the deep, rich domain expertise we have within Vectura today.

Secondly, we’ve really been investing in our business development and marketing team. So building out the front end of the business, that means more people, more resource. And just yesterday, actually, we launched a new very distinctive brand for the company, which the organizations will become very proud of in time to come.

And then thirdly, all of our activity is focused on driving the size of our funnel so that we can convert those business opportunities into deals, which will then feed the future growth of the company.

So as I said, I intend to come back to give you many more details later on in the presentation. I’ll walk you through the strategy. I’ll take you through the execution plan that we’ve already started with. But right now, I’m going to hand you over to Paul Fry, our CFO, and he’s going to walk you through our performance for 2019 and also give you an update on some of the highlights for this year.

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Paul Andrew Fry, Vectura Group plc – CFO & Executive Director [3]

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Thanks, Will, and good morning.

If we can move straight to Slide 7. As Will has already said, we delivered a very strong — or a solid set of financial results in 2019 with both revenue and adjusted EBITDA up 11%. And at a high level, on the revenue side, we saw the loss of high-margin revenues from EXPAREL patent expiry, and obviously, a nonrepeat to the large license upfront payment from Hikma, which arose from the generic Ellipta agreement we signed in 2018. The growth, therefore, has come from a very strong flutiform performance last year as well as us continuing to resize and reshape our R&D base, which fell nearly 10% last year. And the combination of these effects enabled us to maintain EBITDA margin at around 24%. Working capital headwinds impacted our cash conversion in 2019, which I’ll come back to later in the presentation. But despite this and the significant capital return, as Will mentioned, we closed the year with a strong cash balance of GBP 74.1 million.

Moving to Slide 8 and taking a quick look at the full income statement. You can see here the revenue mix effect on gross profit as those high-margin revenues were replaced with flutiform and EBITDA margin being supported by the reductions in R&D. I’d also draw your attention to the significant improvement in operating loss as amortization continues to fall, even despite the VR647 impairment, which we took in the second half of 2019, which was approximately GBP 8 million.

Moving on to Slide 9. I’ll step you through now the 3 main revenue sources briefly, and I’m going to start on this slide with product supply. So you can see here that overall product supply revenues grew 34%, with flutiform being the key driver, of course, growing 37%. And I think as we mentioned back at the interims last year, the growth is helped by a low comparator in early 2018. But even accounting for this, shipments were very strong in 2019, particularly in the second half. I think what’s also very pleasing to see here is the continued strong growth in in-market sales of the brand. And that’s obviously sales by our partners to wholesalers and pharmacies in their local markets. And in the table here, you can see that these volumes increased by 12%.

Europe continues to outperform what is a competitive market, gaining value market share and growing volumes over 5%. And growth in Japan continues to be strong, nearly — growing nearly 14% in volume terms. And Rest of the World, albeit only — still only around 11% of total flutiform sales, continues to grow rapidly. And these in-market volume growth numbers are obviously indicators of underlying demand for the brand, which feed through to orders placed on ourselves. And the other determining factor is clearly partner stock management policies. And in 2019, we did see our partners move to the more conservative end of their stockholding policies as well as a shift in Japan from air to sea shipments, also leading to an increase in stock levels in the supply chain.

We’ll get to guidance later, but these stocking levels are why we’re looking at the first half of 2019 as a better indicator of run rate in 2020 rather than the second.

If we move on to Slide 10. Here, we lay out how the flutiform gross margin has evolved. And as you can see, after removing the one-offs in 2018, the margin is steady at around 36%, slightly above our guidance of 35%. And in understanding that margin performance, I think it’s important to note here that there was a positive geographical mix effect in 2019 arising from an unusually high proportion of shipments being made to higher-margin territories. And this has benefited the 2019 margin by around 1%. So you could think about underlying margin being around 34.8% last year. And then looking ahead, as you can see, we’re guiding here a 2020 margin of between 30% and 32%, which we’re saying is probably also a prudent indicator for the medium term. And the step down from 2019 is partly a function of the unwinding of that positive geographical mix effect I mentioned as well as full year effects of price reductions in Japan and then on some Rest of World contracts.

But on top of this, we are being cautious about how Brexit is likely to affect margins going forward, in particular now that the need for additional release testing for Europe is looking more likely than not. And this brings with it, of course, not only the additional costs of testing, which we’d need to start in the second half, but also we’re being prudent here over the possible impacts on batch yield, which particularly for our inhaled products can be a bit of an issue when you introduce new variables into the mix. I’d stress here that we hope to improve on this performance, and we have a number of initiatives underway to do that. But in the current context, we’re being cautious on our guidance here.

If I move on to Slide 11, I’m going to quickly move you through the royalties here where the major impact, as we mentioned earlier, has been the loss of EXPAREL revenues, which, of course, we guided back on at the beginning of 2019. And if you exclude this, royalties are down around 2.5%. Important to remind you that despite EXPAREL patent expiry, we are still entitled to a $32 million sales milestone once sales of the product passed $500 million. And just for — just to note that Pacira reported just over $400 million of sales last year.

Our Novartis royalties from Ultibro and Seebri were down a little over 1% on a constant exchange basis — exchange rate basis, reflecting the trends that Novartis is reporting in their in-market performance, but positive currency effects gave us a small growth in our numbers.

And perhaps 2 other quick points to note would be the strong performance of RAYOS as part of the oral portfolio, which helped markedly slow the orals decline we saw last year and also to note that we expect the GSK Ellipta royalties not to repeat in 2020, but we are expecting launch milestones and royalties from both VR315 and QVM149 approvals.

Moving then on to Slide 12. Here, we see the third revenue stream, which are development revenues, which are the key focus for the company right now, as Will will describe later. The fall of 31% in 2019 is a function of the higher 2018 comparator as we booked part of the upfront from the Hikma Generic Ellipta agreement last year as well as a couple of projects around flutiform k-haler and VR315 support coming to an end as both of these have reached the commercial phase. For 2020, we expect that for existing development contracts that we have, we will book similar levels of revenue into 2019, and that any new CDMO development business will be on top of this.

Moving to Slide 13. Here, we see the drop in overall R&D spend I referred to earlier of around 10%. You can also see the proportion attributed to partner programs grew from 37% last year to around 50% this year. And clearly, that trend is now going to accelerate into 2020 as our own pipeline investment reduces down. Overall, we expect R&D to continue to fall in 2020 to between GBP 40 million and GBP 45 million and within that, the majority to be focused on partner programs, with the rest being invested in our proprietary technology device and formulation platforms.

Briefly then on Slide 14. We sum up here the main adjusted EBITDA movements, which again show the loss of some royalty and licensing revenue being more than offset by growth in flutiform gross profit and reductions in R&D and other costs. Together, these delivered an adjusted EBITDA growth of just over 11% and maintained our EBITDA margin versus last year.

Moving to Slide 15. Here, we’re showing the key movements in our cash balance from 2018 to 2019. And as you can see, the largest influence by far on this equation has been the capital return, approximately GBP 40 million by way of special dividend and a share buyback of GBP 3.5 million after the first tranche of GBP 10 million. You can also see here that our cash from operations was around GBP 19 million, which is a decline in our EBITDA-to-cash conversion ratio compared to last year. And this was mainly due to some unusually large working capital headwinds arising from trade payables balances, which we owed at the end of last year but didn’t pay out until 2019. These included legal costs associated with the U.S. litigation and VR475 closedown costs, which together accounted for about GBP 9 million. We expect the 2020 conversion ratio to improve substantially versus 2019.

On 16 — Slide 16 then. Just looking ahead now, we set out some guidance here for 2020. I think I’ve covered most of these points already. On royalties, we said that we’ve assumed second half approvals for both VR315 and QVM149 and also assuming GSK Ellipta royalties don’t repeat this year. And assuming all that, we can expect this revenue bucket to grow in the mid-single-digit percentage terms this year. For R&D, as I’ve said, we expect overall spend to fall in the range of GBP 40 million to GBP 45 million this year. And we also expect some modest exceptional costs as we transition the business to a more services-based model. I think more broadly, as the gross margin mix begins to move back in our favor over the medium term, and R&D is not only reduced but more focused on generating in-year development services revenue, we do expect improvements in operational leverage, which I think is a good platform for future growth.

And then lastly, on Slide 17, we wanted to address the COVID-19 issues head on today and to underline what we believe — that we believe Vectura is a very resilient business in the face, obviously, of the risks that COVID-19 may throw up. This is a very fast-moving picture, obviously, and we’ll be agile in identifying and managing the risks associated here, which we’re doing. At a high level, we see the risks — we see risk that could potentially affect demand for our products and services. And of course, flutiform is the most material of these revenue streams. As of today, we’ve yet to see a reduction in demand signal. And orders are locked in now until August currently. And speaking to our partners yesterday, they continue to be very confident in flutiform performance for this year. And even in Italy, for example, they’ve not seen any drop in demand so far.

Of course, there could also be disruption in our own operations, and we have taken assertive steps, like many, to protect our employees. And whilst this obviously does affect our ways of working, we don’t expect to see any immediate major losses on productivity, but of course, we’ll be continuing reviewing that position as events unfold. It’s also very evident we need to approach business development interactions in a different way over these coming months, relying much more on digital channels. And this will mean adding some uncertainty into predicting new deal flow in the very short term. But I think it’s also important to note from our guidance that we expect to deliver at least the same development services revenue in 2019 and 2020 even without these new deals.

And on the supply side, of course, we’re working hard to stay close to key suppliers and again, have not identified any immediate risks. I would also say here that we do have higher-than-normal stocks available to us in our third-party warehouses. And those conservative stockholding policies also mean our partners are well prepared in case of any temporary supply chain disruption.

I suppose lastly, I wanted to remind everyone that we remain financially very resilient even after the recent capital return. We have resilient revenue streams, the vast majority of which are already contracted. And we also have a very strong balance sheet with GBP 74 million in cash at the end of last year and a further GBP 50 million RCF, which remained undrawn. And we think together, this puts us in a better position than many perhaps to weather the current events.

And so on that note, I’ll now hand you back to Will to take you through our strategic focus.

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William Downie, Vectura Group plc – CEO & Executive Director [4]

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Thank you, Paul. So let’s come on to the strategy and execution part of this presentation.

And if we can move to Page 19, let me start by giving you a very simple ambition we have for Vectura. We’re really focused on, I would say, 3 things in the main. The first is to transform the business to create a true leader in the inhalation CDMO market. Secondly, to really focus on furthering our innovation and technology for the future and, in turn, making sure that we deliver a performance culture for the company that will deliver strong results for many years to come. And finally, if we do all of that, we’ll look to provide long-term predictable growth and very strong returns for our shareholders.

And in reality, this is our true north for the company, and this is everything we’re doing right now. Everything is aligned around the strategic ambition. And every activity we have within the company right now is focused on making sure that we can deliver on this.

If I move to the next slide then, Slide 20. This is really just a fairly quick reminder of what we do as a business because I think we actually have a pretty unique offering for our customers. We’re able to combine expertise in both product formulation and development for our customers as well as being experts in device development across a range of technology platforms, DPIs, MDIs, and smart nebulizers. And there are very few companies that are able to do both drug and device formulation and very few have the capability to combine both, which is a very important advantage for our customers. It means that they only have to go to 1 partner when they’re thinking about developing either a drug or a device together.

And if you look about how we go about doing that, we start all the way in early clinical development, all the way back to just after discovery, we work with our clients all the way from preclinical formulation. This tends to start with formulation feasibility studies. Then we would move through to thinking about what’s the optimal device at that very, very early stage of development. So that right from the very beginning, we’re thinking about patient compatibility and patient compliance and building that into the early product design. And then, we’ll work with our customers all the way through from early development all the way through to late-stage development and tech transfer for commercial manufacturing. So there are very few people who can do this, who can go all the way from drug development all the way through to putting the right product in the right device and then going all the way through to commercial scale-up.

I have to say, since I joined the company back in November, I’ve spent a lot of time out at our sites, at the shop floor, on the bench, and I’m incredibly impressed by the deep scientific know-how we have in the company and the world-class capability we have as an inhalation innovator. And when you think about out of our 400 staff, more than 200 are very, very talented scientists, which is a disproportionately high number, actually, for a company of our size. So that ability to combine drug development and device development is a very rare combination, and there are very few companies actually, if any, that can do just that, which is going to help us in a major way as we open aperture of the business for prospective clients.

If you go into Page 21 then, just a few words on the heritage of the company. And I think that heritage will actually help us in the future as we think about building our business with a new set of clients. In the past, our business model has really been twofold. Firstly, to develop and codevelop products with our clients, household names like Bayer, GSK, Novartis, Sandoz, Mundipharma, Kyorin. And in return for working with them, in terms of development and codevelopment, we make money through a series of milestones and royalties and in the case of flutiform, of course, product supply revenues.

And up until our recent strategic review of the business, we were also developing our own products. And I should make it very clear that we will not be continuing the development of our own products. We’ve now pivoted to a much simpler strategy focused on making sure that we can deliver excellence and expertise on driving the CDMO revenue part of our business and opening up the aperture of our business so that we can work with a much more diverse customer base, helping them, of course, to bring products to market across their pipeline.

If you look at some of the stats on this page, they are really, really quite impressive. We’ve helped our partners to bring 11 products to market to date. And if you look at the end-user sales of those products, only since 2012, they’ve delivered end-user market sales of $10 billion, which we have certainly helped them to deliver on that success. We wouldn’t claim all of that success, clearly, but we’ve been an important partner for their end-user market sales.

And I think the important thing here is that, that track record of successfully developing products is actually going to play very nicely into the new strategy because ultimately, what clients will do is they will be looking for people who’ve got a real pedigree and having done this before. In effect, they are handing us their babies. And they’re not going to do that with their products or their babies, unless they are very, very convinced that they’ve got someone they trust and someone that can help to bring those products through childhood, through its adolescence and then hopefully, one day, through to full adulthood. So I think our rich heritage is going to play very nicely into the future growth of the company.

If I move to Page 22 then, I now describe the strategy of the company going forward. The company strategy is really based on 5 strategic pillars. The first is targeting a much broader inhalation market and moving away from the previous very historical narrow focus that we had. We’re now going to be working with clients across a much, much broader inhalation continuum. And by that, I mean small molecules and large molecules, respiratory products and nonrespiratory products, new molecular entities and also repurposing products that are in the market today. And I think by providing that differentiated offering and investing in that next-generation technology by making sure we’ve got a very clear technology road map, we can stay ahead of the curve.

And as we move towards CDMO focus, we’ll see development revenue across a much more diversified customer base. And that means that our revenue profile will be smoother, we’ll be less dependent on one-off milestones. And in effect, we’ll take the risk out of the business and provide much more predictability of earnings. From an operational perspective, we’ll be delivering operational and quality rigor all day, every day. And in addition to that, we’ll be simplifying the operating model. And then last, but certainly not least, of course, we’ll be making sure that we deliver financial discipline in everything that we do, making sure that we continue to reduce our R&D spend that Paul talked about earlier and redirecting some of that capital towards growth projects.

So if we move to Page 23, I’ve already talked quite a bit about the fact that we’re doubling down on our efforts to really access the inhalation segment of the CDMO market. And there are a number of reasons why we like this space so much. Firstly, if you look at a macro level, the underlying market dynamics of this market are very, very strong. Today’s growth is somewhere in the region of about 7%, and we expect to see that continue for the next 5 years.

If you look at the rate of outsourcing within the CDMO market, it averages out at a blend of about 40% to 50%. If anything, that increases the smaller the company becomes, which makes sense in many ways because the smaller companies and biotechs are not going to invest in their own infrastructure, and they’re certainly not going to be spending their own money on manufacturing. That virtual model means that the outsourcing rates are that much higher with smaller players. There’s also a real need for innovation. Companies are constantly looking to differentiate their products to meet payer demands and also to meet the stringent demands of regulatory bodies across the world.

And if you distill it, all of that, down into the inhalation space, we think there’s a very attractive market here. As we speak today on this call, there are 300 molecules out there in current development. 70% of them are in early phase development, Phase I, Phase II and all the way back to preclinical. And this is a real sweet spot for the company. And the other thing is that inhalation development is very difficult. The barriers to entry are high. The number of competitors are relatively low. And I think for a company like Vectura, that’s a good thing.

So when you put all of those factors together, you can see why we’re so attracted to the CDMO space. We’re really going to be putting our focus and attention in penetrating the market. We’re already today one of the most respected product developers in the inhalation space and that we’re going to drive our investments and our activity across a much broader spectrum of customers in the CDMO space.

So if I now then move to execution on Page 24. In my first few months in the company, I’ve really focused on a few things in particular. The first is sales and marketing. Already, we’ve created a new distinctive brand for the company, and we’re investing in the commercial engine by making sure that we increase the size of our team across both Europe and North America. And that is already driving the size of the funnel of business opportunities.

From a product development perspective, we carried out recently a strategic review of our drug development and device technologies, and we’ve put in place a very clear technology road map with prioritized investments so that we can stay ahead of the curve. And as Paul said earlier, we’re no longer investing in our own product pipeline, which means that we’ll be able to redirect some of those monies towards technology platforms, which will help us to continue to innovate for the future.

And then finally, from an operational perspective, we’re simplifying our processes. An example of that is that we’ve made a recent announcement that we’ll be closing our Munich site at the end of 2020. And of course, in addition to all of that, we’re approaching everything with lean management tools and making sure that we drive operational excellence and supply chain robustness at all times.

If we move to Page 25. In my mind, performance and long-term growth ultimately always starts with leadership. And so what I’ve done in the first few months of being here with Vectura is make 2 immediate changes to our executive team, so that we’re set up for success with the new strategy. And I’ve brought in 2 industry veterans from the CDMO market. Sharon Johnson is the first one. She is our new EVP of Delivery Management. She’s a tremendous operator and previously worked in the last 8 years with Catalent. Mark Bridgewater is our new Chief Commercial Officer. Mark actually starts with us on Monday of next week. He is an outstanding growth leader, and he comes to Vectura with a very, very impressive track record of performance. He’s actually spent 20 years in the CDMO market and, most recently, with Flex and then previous to that with Catalent and Patheon.

And their industry experience is going to be perfectly balanced with 2 of our other key functional leaders. Our Head of Product Development, Geraldine Venthoye, is clearly regarded as one of the best scientists and probably one of the world’s most renowned thought leaders in the inhalation market. And she spent 30 years in inhalation and before that had a PhD in pharmaceutic — pharmaceutics. And then Tony Fitzpatrick came to Vectura a couple of years ago and prior to that had a very illustrious 18-year career at Baxter Healthcare.

So this is a very strong team we’ve got in place here. And they will make sure that we drive excellence in everything that we do, making sure that we have a pervasive performance culture across the company. They’ll make sure that we execute with speed, agility and customer focus. And of course, we’ll deliver on time, every day of every week for our customers.

If we move to Page 26. So one of the things I know from my experience, having spent 10 years in the CDMO market, is you have to have an excellent approach to B2B sales and marketing. And this is one of the first areas that I prioritized as I came into the company. We need to make sure that we’re very prominent in the minds of our potential customers, and that we’re the first company they think about when they’re thinking about developing a product in the inhalation space. So we’ve been driving our activity on a few fronts, firstly, increasing the size of our BD team in both the U.S. and Europe. So as well as bringing in Mark Bridgewater as our new Chief Commercial Officer, we’ve been hiring to add people on the street on both sides of the Atlantic. And what we want to do is clearly make sure that our excellent BD specialists are close to where the customers are, close to where the action is and close to where the molecules are. And their job, of course, is to drive that funnel of business opportunities and as time progresses, diversify their customer base.

From a marketing perspective, we’ve appointed an excellent VP of Marketing, a gentleman called Richard Harper, and he, working together with the rest of the team, will drive true brand leadership for Vectura. In particular, he’s already started the development of a very distinctive brand that we launched for the company just yesterday, and we’ll also be taking more money to make sure that we drive excellence across advertising, PR and content marketing, with the overall intention, of course, being that we need surround sound communication in the CDMO market so that people know about the company and know what we stand for.

If we move to Page 27. So going hand-in-hand with strong sales and marketing, we really need to make sure that we’ve got a strong focus on innovation and technology. Ultimately, at the end of the day, science is what makes us different from our competition, and it’s the thing that’s most important for customers. It helps us to differentiate but will also help us to bring more products to market and more molecules to market in the future for our clients. So we’ve been focused in a few areas. Firstly, in product development, we’ve been investing in, and we’ll continue to invest, in liquid formulation for nebulizers. That means that we can work across both small and large molecules. We’re expanding our analytical services, which means that we’ll have a full suite of solutions within our labs. And we’re upgrading our biologics capability as the opportunity for large molecule biologics is only increasing in the CDMO space today.

For DPI manufacturing then, we’re investing in an assembly line, which is going to allow us to industrialize the manufacturing of all of our DPI devices internally ourselves. Today, we develop the devices and then we outsource the assembly of those components to other companies. We’re now planning to do that ourselves, which is going to help us to manufacture all of our devices up to commercial scale and, in turn, will allow us to capture more value.

Our nebulizer platform is really, really important. There’s already 1 product on the market today, a commercial product, but we intend to invest in our nebulizers so that we can help our clients to get into the clinic faster. There is a very, very strong demand for nebulizer technology right now in the market, and we need to make sure that we’re satisfying that demand and continuing to invest in the best technology both for today and for tomorrow.

And then finally, I would say that connected health is a major trend. We see it on the high streets every day around us today. And from the perspective of being a CDMO, we need to make sure that we’ve got real-time data, which will allow our clients to guide patient care. So our plan is to make sure that all of our devices in the future will be digitally enabled with Bluetooth. And this is a way in which we’ll provide a true end-to-end approach across drug development, device development and then enabling all of our devices with connected apps.

You add all of that together, there are a few companies, if any, that have got this breadth of offering in inhalation, all the way from formulation through product development, a very strong suite of device platforms and making sure that all of those are connected. And what we’re trying to do here is meeting the needs of our customers today but also tomorrow.

So if I move to Page 28. Over the course of the next few years, you’ll start to see a reshaping of the business. You’ll continue to see strong value being created by our base business, in particular from flutiform and the royalties that we have on other products, which will continue for many years to come. We hope to see significant value being created from our existing partner pipeline, in particular, from generic Advair with Hikma, which is under FDA review as we speak; from our basket of Ellipta generic products, again, which are being developed with our partner, Hikma; and of course, we have the pending approval of the Novartis first triple combination product, QVM149; as well as working, in addition to that, with our client Sandoz. And on top of all of this, we’ll be building a successful CDMO business, and that will drive a stream of development revenue.

So if you add all of that together and our strategy of making sure that we can deliver in the CDMO space, you’ll see a number of things happening — happen. There will be not the requirement to invest as much money in high-risk R&D because clearly, we’re not developing our own products. There will be a much more predictable, diversified, lower risk development revenue profile for the company. And in addition to that, we’ll diversify our client base and deliver a smoother earnings profile.

So if I move to the last slide today and come to the end of the presentation, I’d really make the following concluding remarks. Firstly, we’re very pleased with our financial performance in 2019, delivering double-digit growth for the business, and we look forward to building on that momentum as we go through this year. In 2020, we look forward to continuing a solid financial performance, and we look forward to the potential approval of both VR315 and QVM149 with our partners, Hikma and Novartis, during the year. We will continue to reduce our R&D spend so that we can redirect some of that effort towards customer growth, and we’re going to be working with our strategic partners to open up the aperture of the business and become a true leader in the CDMO market.

So I would say in 2020, we’re well and truly into full execution mode here as we transform the company to become a true leader in the inhalation segment of the CDMO space. And I would say that you can expect to see the following throughout the rest of this year. Firstly, our enhanced leadership team will drive performance with rigor and discipline. Secondly, you will see us diversify our customer base and continue to build the funnel of opportunities. And then finally, we’re going to invest in technology and innovation and a very clear road map that will create a market-leading position for our customers in the future.

So with that, I thank you for your time today. And I’ll now hand back to the operator for the Q&A session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from James Gordon from JPMorgan.

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James Daniel Gordon, JP Morgan Chase & Co, Research Division – Senior Analyst [2]

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Hope you can hear me okay. This is James Gordon from JPMorgan. I have 3 questions, please. One was about strategy in the CDMO market. So the numbers about CDMO growth are really helpful. But can you talk at all about what the actual growth rate is for inhalation or respiratory growth? I know you got the 300 molecules, but any sense of how that compares to last year or a couple of years ago? The second question was on flutiform. And I know investors are getting increasingly focused on CO2 emissions and I believe it’s a product that’s pMDI and so used as a propellant. Could that be an issue? And is there a way that you could maybe reformulate that would get around that CO2 issue? And then third and final question, just on capital allocation. So GBP 74 million of cash is what you finished with. What sort of cash buffer do you need to maintain? And so beyond what level could you look to either returning with more cash or potentially acquire some assets?

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William Downie, Vectura Group plc – CEO & Executive Director [3]

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Thanks, James. So why don’t I start firstly by talking about the market. So as you saw earlier, the CDMO market at a very macro level is growing about 7% year-on-year. We expect that, as I said before, to continue for the next 5 years. Within that, it’s often difficult to get the exact data when you drill down into inhalation. But I would say that the 300 molecules that we see today is certainly very buoyant. There’s nothing that would suggest that, that will reduce in any way. In many ways, you can probably expect that to increase. And our approach is actually going to be not just focused on respiratory but also nonrespiratory, and I think that’s going to give us an opportunity. It’s going to be pretty sizable, actually. So there are no specifics when you look at global data when you drill down into the actual segment itself. But I can already see from the funnel of opportunities that we have, from the discussions that we’ve had, and there’s ample opportunity there in the market. So that’s the first point.

I would say secondly, on flutiform, of course, you’re absolutely right. Everyone is focused on making sure that we can reduce our carbon footprint. And of course, we’re looking at future technology in that regard. But we’re not in a position to go into any specifics today around that. But clearly, as an organization in this field, it’s something that we’ll keep a close eye on. And I think on the capital allocation, why don’t I pass it on to you Paul who can take you through that.

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Paul Andrew Fry, Vectura Group plc – CFO & Executive Director [4]

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James, thanks for the question. So I’m going to obviously remind people that we are — we have made the biggest capital return in the company’s history, and we’re not finished on that. We announced GBP 60 million last year, and we’re just about finished GBP 50 million of that. So there’s still a little to go. I think what we have said is if we do see and do receive some cash [bolus to use] in the future, and as you know, there’s some possibilities of that, we’re very open to the idea of further special returns, obviously, in the absence of any other inorganic opportunities. But clearly, we’re keeping all of that under review. I suppose, particularly in the current context, it’s important to just continue to relook at that. But we’re not ruling out special returns in the future. I think our statements have underlined that.

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Operator [5]

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And your next question comes from Max Herrmann from Stifel.

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Max Stephen Herrmann, Stifel, Nicolaus & Company, Incorporated, Research Division – Head of European Healthcare Equity Research & MD [6]

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I have 3, if I may. Firstly, just in terms of the R&D you’re guiding GBP 40 million, GBP 45 million. I wondered how much of that will be self-invested R&D and perhaps sort of expecting — secondly, just interested, obviously, you’ve had this strategy in place now for several months. Will, I appreciate you’ve joined subsequent to that strategy and so a part of that. But I wondered if you could give us an update on where you see your discussions going at the moment? I mean, obviously, pre 2019, I assume will — at that level. And then…

(technical difficulty)

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William Downie, Vectura Group plc – CEO & Executive Director [7]

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Max, can I just interrupt you for a second, if you don’t mind. It’s very difficult to hear you. I don’t know if you’re on a mobile line, but it’s very, very crackly. We can make out just about every second word.

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Mary-Jane Elliott, Consilium Strategic Communications Limited – Managing Partner [8]

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I think we should move to the next question. And Max, do you think you’d be able to dial back in and ask your question at the end, please, on a different line? Sorry. Thank you very much. Can we take the next question, please, operator?

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Operator [9]

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It comes from Nick Nieland from Citigroup.

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Nick Peter Russell Nieland, Citigroup Inc, Research Division – VP and Analyst [10]

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I hope you can hear me. So the first one was just on the CDMO and when might we see a meaningful impact on your top line from CDMO. Second one was just on your cost base. So with R&D, you’ve talked about, post-2020, a reduction in your R&D costs. What’s the shape of that moving forward? Plus you’ve talked about the new hiring and new — for the new model, how much cost ex R&D should be — how should we see that evolve over the next few years? And then thirdly, just on flutiform gross margin. You’ve mentioned 3 factors which have influenced that in 2020 or which will in influence that in 2020. What’s the longer-term outlook for flutiform gross margin, bearing in mind those 3 factors?

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William Downie, Vectura Group plc – CEO & Executive Director [11]

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Thanks, Nick. So why don’t I take questions 1 and 3, and then Paul can take you through the second and your fourth question there on flutiform. So on the CDMO side, I would say that we’re building the funnel as we speak. We’re seeing some very healthy discussions and activity within that. But we’re not guiding at the moment on the shape of revenue and the timing of that in this year and over the course of the next few years. It’s too early to say, quite frankly. But I would say the funnel is building nicely. The opportunities within it are very, very interesting, and we’ll start to see the fruits of our labor over time.

On the third question then of hiring and cost of all of that, we’re not going to go into the specifics of that other than to say that, like any good business, we will bring in additional talent that will complement the already excellent team that we have internally, and we’ll be able to do all of that in the context of being able to drive a P&L that is the right shape for the future. So the specifics of that, I’m not going to go into, and I don’t think you need to go into yourself. Paul, do you want to take the second and the fourth one?

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Paul Andrew Fry, Vectura Group plc – CFO & Executive Director [12]

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Sure. So just on the cost base, obviously, we’ve not provided today, and I’m not going to provide some specific numbers on that. But you say broadly in terms of shape, we expect R&D to continue to reduce down. But really, the rate of that will depend on how — as we would deploy that R&D to obviously profit-generating new CDMO business, and the extent of that new business at some point, you would expect R&D to go in the other direction but not immediately.

And then in terms of the other costs, clearly, there is additional investment into the sales and marketing front end, and Will described some of those earlier, but — and — but that’s not going to negate the margin benefit you’re going to see on R&D, at least in the next year or 2. And just back to flutiform gross margin, I think as we said in the statement, certainly for the medium term, and we’re not really going beyond that, you should expect margin to stay within that corridor of 30% to 32%. As I said earlier in the presentation, we’re working hard to try and improve that, but that’s probably a prudent place to be for the next few years.

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Operator [13]

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And your next question comes from Max Herrmann from Stifel again.

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Max Stephen Herrmann, Stifel, Nicolaus & Company, Incorporated, Research Division – Head of European Healthcare Equity Research & MD [14]

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Hopefully, the line is better now.

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William Downie, Vectura Group plc – CEO & Executive Director [15]

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Much better.

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Mary-Jane Elliott, Consilium Strategic Communications Limited – Managing Partner [16]

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It’s perfect, Max. Thank you.

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Max Stephen Herrmann, Stifel, Nicolaus & Company, Incorporated, Research Division – Head of European Healthcare Equity Research & MD [17]

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Okay. Firstly, just on the R&D, the self-investment, just trying to understand, obviously, you’ve guided to lowering the overall R&D spend. Wondered how much this year you anticipate to be so for R&D investment and what sort of aspects — what areas are you currently investing in. And then secondly, just regarding the Ellipta agreement or the royalties that you’ve been receiving, I believe this is related to the Skyepharma IP. And there was a prospect of potentially that lasting until 2021. I know, obviously, it’s difficult to guide. Are you sure if you had confirmation from GSK that there is no possibility of an extension there? Those are my questions.

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William Downie, Vectura Group plc – CEO & Executive Director [18]

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Thanks, Max, and we can hear you loud and clear this time. So thanks for that. I would say on R&D, so we’ve guided for this year to expect our spend to be anywhere between GBP 40 million to GBP 45 million for the year. The shape within that, we’re not getting into the specifics of what self-investment looks like. But I kind of go back to what I was talking about earlier around that technology road map. And that’s where we will spend the appropriate amount of money to make sure that we’re driving innovation, making sure that our technology platforms are fit-for-purpose for the future and will drive demand for clients over the course of the next few years. But we’re not going to the specifics there, but you can kind of get the shape there of technology platforms are really, really important for this business. Innovation is incredibly important for this business, and we need to make sure that we continue to invest so that we’re ahead of the curve for the future. I think on Ellipta, I’ll pass you over to Paul, if you don’t mind.

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Paul Andrew Fry, Vectura Group plc – CFO & Executive Director [19]

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Yes, Max, just to say that’s not a discussion we’ve had with GSK. That’s our assessment of the situation and our expectations, so you should assume it doesn’t come — obviously, if we think there are grounds to pursue that in a different way and that expectation changes, obviously, we’ll let you know. But right now, you should assume that it doesn’t arrive in 2020.

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Max Stephen Herrmann, Stifel, Nicolaus & Company, Incorporated, Research Division – Head of European Healthcare Equity Research & MD [20]

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Just one follow-up. You obviously mentioned, I think, your German Munich facility, closing it sometime before the end of this year. Does that materially impact your R&D investment out into 2021?

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Paul Andrew Fry, Vectura Group plc – CFO & Executive Director [21]

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Not in a huge way. It does make some difference but not in a huge way. We’ve been sort of running down that site anyway over the last year or 2, and there will be just some very small exceptions associated with that.

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Operator [22]

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And your next question comes from Julie Simmonds from Panmure Gordon.

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Julie Simmonds, Panmure Gordon (UK) Limited, Research Division – Equity Research Analyst of Healthcare [23]

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Three questions, sort of slightly less specific, I guess. Firstly, sort of in terms of the new technologies you’re looking at bringing in, I’m just wondering about how much of that is going to be internally developed and how much of that needs to be sort of bought in and where those particular areas are that you say you need to strengthen what you’ve already got. Then sort of how fast through the business development recruitment are you? Is that all in place already? Or are we still looking for that to happen over the next period? And then finally, just picking up on what you said about needing to be well-known within the field, I was wondering, well, from sort of coming in externally, how well you see Vectura as being known in the respiratory services segment at the moment.

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William Downie, Vectura Group plc – CEO & Executive Director [24]

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Thanks a lot, really good questions. I think in terms of new technology, a lot of what we will do, we’ll do ourselves. I mean we’re excellent as an innovator when it comes to device technology. There will be some partnerships around that. When you look at some of the specifics around components and some of the architecture around IT, but most of that will be focused on the platforms that we have today and making sure that — for DPI, I’ve talked about the fact that we’ll do all of that ourselves in terms of the assembly of those devices. Today, we outsource that. We’ll do it ourselves. Nebulizers, this is — we see this as a really, really potentially strong avenue of growth for the future. We’ve got 1 product on the market today, which is commercialized. And there’s a demand within the funnel as we speak today. And so it’s making sure that we’re working — because every molecule is different, and you have to be able to adapt the device, the nebulizer, to the molecule itself. And so that will be a real focus for us.

And then I would say on the digital front, it’s very important from a patient compliance and adherence perspective that patients have got excellent information so that they know they’re taking their medicine at the right time, and so making sure that we’re in a position where we can have all of our devices across all of our platforms. I’m talking here about DPIs, MDIs and nebulizers are going to be digitally enabled. That’s going to be, I think, a major driver going forward. On the second front, I would say we’re doing really well on the BD, business development, front. We don’t need a huge team, quite honestly, but we need a small and perfectly formed team.

And so we’ve started that recruitment. We already have a new individual in the East Coast of the U.S. We’ve got another individual based here in the U.K. We have another one starting in the U.K. as well. And then we’ll be adding to the West Coast of the U.S., that recruitment is taking place as we speak, and then into Continental Europe as well. And then we’ve got our Chief Commercial Officer who is a real heavyweight from the industry. So I think we’re in good shape, and we’ll just keep moving. We’ve been moving really quickly and expect we’ll have the full complement of staff here sometime very soon.

In terms of coming in from the outside then. So I knew Vectura very well. They were always known as a real expert in the inhalation space. And I’ll give you a real example of that. I went to the DDL conference, Drug Delivery to the Lungs conference, in December before Christmas. And I have to say that everybody knew Vectura. They knew all of our staff, they knew all of our excellent scientists and so I knew the company from the outside. When I saw it from the inside, it was clear to me that we’re very, very well known. But because we have been developing our own products and because of the previous strategy, we weren’t in a position where we were trying to drive awareness, diversify our customer base and work on many, many more molecules.

And so I think that pivot in strategy is one that makes perfect sense, quite honestly. When I was looking at the company from the outside, it seemed self-evident to me that, that should be the strategy. And we’ll just continue to drive that through really good marketing, a lot of marketing this — these days in the B2B field is all about digital. And it’s actually even more importantly about content, making sure that you’ve got real science and that you can communicate that and help scientists with really complex challenges that they have for the molecule. So I knew the company very well. Now we will absolutely be shouting from the rooftops and making sure that everyone knows us not just as a product developer of inhalation products but the leading company inhalation field for CDMO.

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Operator [25]

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And your next question comes from Paul Cuddon from Numis.

(technical difficulty)

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Mary-Jane Elliott, Consilium Strategic Communications Limited – Managing Partner [26]

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Paul, it’s MJ. Paul, your line is really, really crackly as well. Would you mind dialing back in straightaway? And yours is the last question, and we’ll just hang on until you’re back in, please? Thanks very much.

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Operator [27]

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We have one more question from the line of [Alex Alexander].

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Unidentified Analyst, [28]

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Is the line okay?

(technical difficulty)

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Mary-Jane Elliott, Consilium Strategic Communications Limited – Managing Partner [29]

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Actually, [Alex], it’s not, I’m afraid. Would you mind dialing back in as well, and we’ll wait for you? Thanks.

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Operator [30]

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You’ve had one more question coming through from Andrew Whitney.

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Andrew Mark Whitney, Investec Bank plc, Research Division – Analyst [31]

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I thought I’d use the time. In the start of the presentation, you talked about the strength and breadth of Vectura’s existing capabilities across formulation and device. And then I noted on your second sort of strategic bullet, your sort of ambition, you talked about enhancing competencies. And I know later on, you’ve talked a lot about technologies, but you’ve also mentioned sort of large molecules and nonrespiratory as well. I was wondering, is there one particular area that you see particularly ripe for investing into to drive future revenue? Or is this more generally you can upscale in a number of places to drive the sort of portfolio of competence?

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William Downie, Vectura Group plc – CEO & Executive Director [32]

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Yes, it’s a very good question, Andrew. I would say I’d answer it differently, which is, in any ways, we want to be as agnostic as possible. And in some ways, you’ll let the molecule decide whether that’s large molecule, small molecule, and working across a breadth of disease states outside of respiratory in the main as well. And I think you can think about in the future, you won’t have to venture too far to think about compounds for endocrinology, products for even oncology, pulmonary arterial hypertension and disease around that where the inhalation route could be very, very advantageous because often, the route of administration can help in terms of lower systemic side effects. So I think we will be taking a very broad view of the market. And I think as time goes on, it will become quite clear where some of the real pools of advantages, quite frankly, are going to be for patients. I would say we’re going to open the aperture, and we’re going to be very, very agnostic.

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Andrew Mark Whitney, Investec Bank plc, Research Division – Analyst [33]

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Okay. Are there — the nonrespiratory path, is that a bigger leap from where you are now relative to maybe some of the investments you can make in technology that will be easier for you to achieve? Is that the right way to think?

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William Downie, Vectura Group plc – CEO & Executive Director [34]

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I’m not sure. I think — honestly, I think respiratory and nonrespiratory, and you can think of nonrespiratory as being a myriad of different conditions and diseases, I think that the approach in many ways is exactly the same. It’s all about working with molecules, many of them which are very complex, have been able to help customers to formulate and develop successfully. And I think challenges exist in any disease state. And often, products in terms of their solubility profile and the ability to get to the bodies is very difficult, and that’s not necessarily disease specific. It’s more about the actual molecule itself. So when we think about it, it’s more around working with the molecule rather than being specifically targeted the disease because we’ve seen lots of molecules in medicine for decades that actually worked for many different disease states.

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Operator [35]

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And we have no further questions at the moment.

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William Downie, Vectura Group plc – CEO & Executive Director [36]

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Very good. Well, thank you very much indeed, everyone, for your time today. We’re very pleased with our 2019 results, and we look forward to building the momentum as we go through this year. And finally, of course, I wish everyone’s safety. We live in unprecedented times right now, and we hope that everyone is safe and looking after yourselves. So thank you very much, indeed.

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Operator [37]

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Thank you. That does conclude our conference. Thank you all for attending. You may now disconnect.