Somerset Feb 3, 2020 (Thomson StreetEvents) -- Edited Transcript of Catalent Inc earnings conference call or presentation Monday, February 3, 2020 at 1:15:00pm GMT

* John R. Chiminski

Catalent, Inc. - Chairman & CEO

* Wetteny N. Joseph

Catalent, Inc. - Senior VP & CFO

UBS Investment Bank, Research Division - Senior Equity Research Analyst of Healthcare Life Sciences

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Associate

* Jacob K. Johnson

William Blair & Company L.L.C., Research Division - Partner & Healthcare Services Analyst

* Tycho W. Peterson

Ladies and gentlemen, thank you for standing by, and welcome to the Catalent Second Quarter Fiscal Year 2020 Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions)

I would now like to hand the conference over to your speaker today, Paul Surdez, Vice President, Investor Relations. Thank you. Please go ahead, sir.

Good morning, everyone, and thank you for joining us today to review Catalent's Second Quarter Fiscal Year 2020 Financial Results. With me today are John Chiminski, Chair and Chief Executive Officer; and Wetteny Joseph, Senior Vice President and Chief Financial Officer.

In addition to reviewing our second quarter earnings release issued earlier this morning, we will also refer you to our other press release issued today regarding our agreement to acquire cell therapy leader, MaSTherCell. Please see our agenda for this call on Slide 2 of our supplemental presentation, which is available on our Investor Relations website at http://www.catalent.com.

During our call today, management will make forward-looking statements and refer to non-GAAP financial measures. It is possible that actual results could differ from management's expectations. We refer you to Slide 3 for more detail. Slides 3, 4 and 5 discuss the non-GAAP measures, and our just-issued earnings release provides reconciliations to the nearest GAAP measures. Catalent's Form 10-Q, to be filed with the SEC later today, has additional information on the risks and uncertainties that may bear on our operating results, performance and financial condition.

Now I would like to turn the call over to John Chiminski.

John R. Chiminski, Catalent, Inc. - Chairman & CEO [3]

Thanks, Paul, and welcome, everyone, to the call. In addition to reporting strong Q2 results, we're excited to announce this morning our plan to further expand our biologics footprint by acquiring MaSTherCell, a leader in cell therapy development and manufacturing.

Before reviewing the strategy behind adding MaSTherCell to the Catalent family, let me summarize our financial highlights from the second quarter. As you can see on Slide 6, our revenue for the second quarter increased 16% as reported or 17% in constant currency to $721 million, with 7% of the constant currency growth being organic, which is above our expectations for the long-term organic growth of our base business.

Our adjusted EBITDA of $171 million for the quarter was above the second quarter of fiscal year 2019 on a constant currency basis by 16%, with 5% being organic. Our adjusted net income for the second quarter was $72 million or $0.45 per diluted share, unchanged from the per share adjusted net income in the prior fiscal year.

Three of our 4 reporting segments had strong performances as Biologics, Softgel and Oral Technologies and Clinical Supply Services each contributed to the organic revenue and adjusted EBITDA growth, partly offset by headwinds in our Oral and Specialty Delivery segment. Wetteny will detail these results later in the call.

Now moving on to the operational update. First, we announced 2 important executive appointments in January that provide additional depth and breadth to our leadership team. We recruited Karen Flynn to return to Catalent after 10 years of leading operations and commercial activity for a well-respected biopharma services company to be President of our Biologics segment and our Chief Commercial Officer. Karen, who is replacing the retiring Barry Littlejohns, will execute our biologics strategy and further expand our Biologics drug substance, drug product and gene therapy businesses. We also recruited another former Catalent executive with decades of experience in the biopharmaceutical industry, Ricci Whitlow, as our President of Clinical Supply Services in place of the retiring Paul Hegwood. In addition to growing our CSS business with our traditional customer base, she will be focused on growing its footprint through cross-selling opportunities with our Biologics and other long-cycle businesses. Karen and Ricci, like Barry and Paul before them, report to our COO, Alessandro Maselli. They replace distinguished leaders who are celebrated here at Catalent for growing their businesses and for their tireless efforts to help establish our patient-first culture.

Next, last week, the Catalent Board of Directors approved the deployment of additional capital for further expansion of our gene therapy commercial facilities at BWI, which expansion will support operations on the BWI campus as well as our other gene therapy facilities in BioPark, Rockville and Gaithersburg. This investment is above and beyond the CapEx previously approved for the build-out of the 10 suites in our BWI facility, all of which are on track to be operational at the end of this calendar year. The additional CapEx approved last week will allow us to achieve higher revenue potential from the Paragon acquisition than anticipated at the time of the original acquisition last May once all the projects are completed.

Additionally, early last month, we took ownership of Bristol-Myers Squibb's oral solid biologics and sterile product manufacturing and packaging facility in Anagni, Italy, which we had agreed to acquire in June. This multipurpose site enhances our global network and provides us drug product sterile fill/finish capacity and oral solid-dose manufacturing in Europe and comes with an agreement to continue to manufacture BMS's current product portfolio at the site. The Anagni facility expands our European capabilities in biologics drug product, solid oral dose manufacturing and packaging to accelerate development programs and provides greater commercial supply capacity.

The acquisition of Anagni is another example of our progress in realizing our global biologics strategy, which continues to develop and strengthen across our network. As an additional example, I'm pleased to announce that the Bloomington site received yet another commercial product approval in January, bringing its total to 22 versus the 12 it was producing at the time of the acquisition, with several additional launches on the horizon. The previously announced $200 million investment in Bloomington and Madison are progressing according to plan and will help us serve the existing pipeline of late-stage clinical work and other opportunities for these high-margin sites.

Another important element of our biologics strategy is our entrance into the gene therapy space last year. The acquisitions of Paragon Bioservices and related gene therapy assets provided Catalent with new expertise and capabilities in one of the fastest-growing techniques for therapeutic intervention today and position us for accelerated long-term growth. The integration of these gene therapy assets into the Catalent portfolio is progressing ahead of our expectation and has been a key contributor to our strong year-to-date financial results. The CapEx approval I previously highlighted was supported by this early outperformance as well as by research remission from an independent third-party consultant, which indicates the gene therapy pipeline will continue to increase much more rapidly than the manufacturing assets needed to service the demand.

Paragon provided us with a platform for development of an expanded offering in biologics, enabling entry into technology categories adjacent to the development and production of viral vectors for gene therapies. The success we've experienced thus far with Paragon provides us with the confidence and blueprint to further expand our biologics offering into cell therapy, which we are announcing this morning.

Please turn to Slide 7 for an overview of our agreement to acquire MaSTherCell, a technology-focused cell therapy development and manufacturing partner to cell therapy innovators. MaSTherCell's service offerings include the development and manufacture of both autologous and allogeneic cell therapies as well as a variety of related analytical services. It has worked with a range of therapies, including those based on the so-called CAR-T cells, tumor-infiltrating lymphocytes as well as T cell receptors and other cell types.

MaSTherCell, which was founded in 2011, has sites in Belgium and Texas. Its current operating facility near Brussels provides preclinical and clinical stage services, and MaSTherCell is in the process of building a commercial-scale production and fill/finish facility nearby, which is expected to open in late 2021. MaSTherCell is also in the final stages of completing the build-out of a preclinical and clinical stage facility near Houston, Texas and has future plans to expand into commercial there as well.

Cell therapy, like gene therapy, is attracting enormous funding as both the number of active programs and the level of funding have rapidly expanded over the last 5 years. There are now more than 500 public and private companies with cell therapy programs and hundreds of active cell therapy-based investigational new drug applications. Much of the focus today is in oncology, but we're seeing applications expand in other therapeutic areas, such as autoimmune diseases, cardiology and neurology. Our research indicates that the cell therapy pipeline is growing in the mid-teens range with over 800 cell therapy assets in the pipeline today and also estimate cell therapy manufacturing to be approximately 65% outsourced, which is comparable to viral vectors.

Also, similar to viral vector manufacturing, cell therapy capacity is scarce, and the trend of demand outstripping supply is projected to become more acute despite investments in additional capacity being made across the industry. We see MaSTherCell as a complementary addition to our gene therapy capabilities and the rest of our Biologics portfolio.

We also believe that MaSTherCell will be a strong, strategic fit for Catalent as we're well positioned to combine MaSTherCell's team of experts and differentiated capabilities with our extensive resources and our significant experience in scaling new platforms to help MaSTherCell build out its development and commercial manufacturing capabilities. Furthermore, we believe MaSTherCell rounds out our program to be the leader in gene and cell therapy, creating deeper and broader relationships with customers, and like we've seen with Paragon, open up cross-selling opportunities across Catalent's other technology platforms.

From a structural perspective, this is an all-cash transaction with a total purchasing price of $315 million subject to customary purchase adjustments. Catalent expects to finance this transaction with either a partial drawdown of its revolving credit facility with proceeds from a possible future incremental capital raise. Any such raise may also include funds for capital expenditures in support of our gene therapy programs and other strategic initiatives.

Slide 8 illustrates how our actions continue to fundamentally transform our business and increase our share of the R&D pipeline by significantly increasing our exposure to the faster-growing area of the industry that is biologics. We've done this through significant organic and inorganic investments, putting to work nearly $3 billion over the last 5 years.

In the 12-month period ended December 31, our Biologics segment represented 27% of our portfolio. In the quarter we're reporting today, it's now just over 30%. And when factoring in our long-term organic revenue growth guidance of 6% to 8%, combined with strategic acquisitions like MaSTherCell and Anagni, we believe we're on pace for 50% of our revenues to be driven from Biologics segment by the end of fiscal 2024 with total company revenues projected to be approximately $4.5 billion. Given the greater margin contributions from our Biologics segment, we believe adjusted EBITDA margins in 2024 will expand to at least 28%, up approximately 300 basis points from our expected levels in 2020.

We're proud that the combination of organic and inorganic investments we're making in biologics is already delivering substantial benefits to patients. We believe our strategy that drove us to uniquely combine capabilities to support the fastest-growing areas of drug development with Catalent's historical leadership and deep expertise in global contract drug manufacturing will continue to create significant value for our company, our customers and our shareholders.

Now I'll turn over the call over to Wetteny, who will take you through our second quarter financial results and the details related to our updated financial guidance.

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Wetteny N. Joseph, Catalent, Inc. - Senior VP & CFO [4]

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Thanks, John. I will begin this morning with a discussion on segment performance, where both the fiscal 2019 and fiscal 2020 second quarter results are presented on the basis of the revised reporting segments we introduced last quarter. Please turn to Slide 9, which presents our Softgel and Oral Technologies business. As in past earnings calls, my commentary around segment growth will be in constant currency.

Softgel and Oral Technologies revenue of $267.9 million increased 3% during the quarter, with segment EBITDA increasing 19%. After excluding the impact of the October 2019 divestiture of the segment's manufacturing site in Braeside, Australia, segment revenue and EBITDA grew 9% and 24%, respectively. The growth primarily relates to volume increases across the consumer health portfolio within Europe as well as increased demand in the prescription product business in North America, which is partially attributable to recently launched products.

Revenue in the consumer health business also increased in North America and Latin America due to the prior year shortage in ibuprofen API supply. Additionally, the strong segment EBITDA performance was driven by improved capacity utilization and favorable product mix across the network.

Slide 10 shows that our Biologics segment recorded revenue of $225.2 million in the quarter, which is up 66% versus the comparable prior year period, with segment EBITDA growing 61% quarter-over-quarter. Note that a large portion of both the revenue and the segment EBITDA growth was inorganic and driven by the gene therapy acquisitions, which contributed 56 percentage points to revenue and 49 percentage points to EBITDA growth. Excluding acquisitions, the segment recorded organic revenue growth of 10% in the second quarter and segment EBITDA growth of 12%.

Recent investments in our Biologics business continued to translate into growth during the second quarter as we recorded strong growth in drug product volumes in the U.S. As a reminder, drug substance revenue continues to be impacted by the completion of a limited-duration customer contract, which had a particularly high drop-through of EBITDA, following the completion of the client build-out of its own capacity. The customer's strategy to move its production in-house was fully contemplated when we entered into the contract, and the precise timing was less defined given typical production complexities. We continue to expect this to be a comparison headwind for our drug substance business for another quarter as we work to onboard new customers to increase our utilization levels. Drug acceptance, after excluding the completion of this noncell line clinical manufacturing contract, also grew year-on-year.

As I mentioned, we just closed on the Anagni acquisition on the 1st of January. As we did not know the timing of the close when we gave initial guidance in August, the site was not included in our original estimate, but is now reflected in our current guidance updated today. As the site is multipurpose, its future financial reporting is likely to be split between Biologics and OSD segments, and we will provide you more details when we report our third quarter.

To close out the commentary on Biologics, I'd like to echo John's excitement about bringing MaSTherCell's cell therapy expertise to Catalent, which enables us to establish a position in this exciting new therapeutic platform and stay at the forefront of bringing new, advanced therapies to scale. Catalent provides MaSTherCell access to growth capital, leverages its functional and system expertise and provides access to additional customers. However, given the company's early stage, MaSTherCell is not expected to provide meaningful EBITDA in the next 2 years as profit generated in its current clinical services will be consumed by its commercial build-out. We expect to provide additional color next quarter following the expected closing of the transaction.

Slide 11 shows that our Oral and Specialty Delivery segment recorded revenue of $143.2 million in the quarter, which is down 7% versus the comparable prior year period, with segment EBITDA declining 28% quarter-over-quarter. While we experienced growth in our orally delivered commercial products, this was more than offset by decreased volumes in the segment's respiratory and ophthalmic specialty delivery platform. This business experienced very strong demand a year ago as it generated revenues in anticipation of new product introductions. However, these NPIs have not yet materialized, creating a headwind for the segment this quarter, which despite expected sequential improvement will result in a year-on-year headwind for the remainder of the year and is factored in our new guidance. Despite the softness we are experiencing this quarter, we believe the OSD segment continues to have a very strong development pipeline, including several late-stage quasi-development programs that will drive future long-term growth.

In order to provide additional insight into our long-cycle businesses, which include Softgel and Oral Technologies, Biologics and Oral and Specialty Delivery, we are disclosing our long-cycle development revenue and the number of new product introductions as well as revenue from these NPIs. As a reminder, these metrics are only directional indicators of our business since we do not control the sales or marketing of these products nor can we predict the ultimate commercial success of them.

For the first 6 months of fiscal year 2020, we recorded development revenue across both small and large molecule of $422.5 million, which is more than 36% above the development revenue recorded in the first half of the prior fiscal year. Additional disclosure on our development revenue is included on our Form 10-Q to be filed today with the SEC. In addition, we introduced 87 new products in the first 6 months of fiscal year 2020, which are expected to contribute approximately $27 million revenue in the fiscal year.

Now as shown on Slide 12, our Clinical Supply Services segment posted revenue of $87.9 million or 9% growth over the second quarter of the prior year, segment EBITDA of $24 million or 15% growth. The strong growth in both revenue and segment EBITDA was driven by strong demand in the segment's storage and distribution and manufacturing and packaging businesses. All the segment revenue and EBITDA growth recorded within CSS was organic.

As of December 31, 2019, our backlog for the CSS segment was $390 million, a 4.5% sequential increase. The segment recorded net new business wins of $104 million during the second quarter, which is a decrease of 2.3% compared to the very high level of net new business wins recorded in the second quarter of the prior year. The segment's trailing 12-month book-to-bill ratio remains at 1.2x.

Slide 13 and 14 contain reference information for our second quarter and year-to-date segment results, both as reported and in constant currency.

Slide 15 provides a reconciliation of EBITDA from operations from the most approximate GAAP measure, which is net earnings. This bridge would assist in tying out our reported figures to our computation of adjusted EBITDA, which is detailed on the next slide.

Moving to adjusted EBITDA on Slide 16. Second quarter adjusted EBITDA increased 17% to $171 million or 23.7% of revenue compared to 23.4% of revenue reported in the second quarter of prior year. On a constant currency basis, our second quarter adjusted EBITDA increased 18%, including 5% organic growth.

On Slide 17, you can see that second quarter adjusted net income was $72 million or $0.45 per diluted share compared to adjusted net income of $65.4 million, also representing $0.45 per diluted share in the second quarter a year ago.

Slide 18 shows our debt-related ratios and our capital allocation priorities. Our total net leverage ratio as of December 31 was 4.2x, which has modestly reduced from the ratio as of the end of the prior quarter. Pro forma for completed acquisitions, our total net leverage ratio was 4.0x, which is an improvement of approximately 1/2 of a turn compared to the ratio at the time we announced the Paragon transaction. Given the free cash flow generation of the company and its growing adjusted EBITDA, the company naturally delevers between 0.5 and 0.75 of a turn per year. Additionally, continued investments in Biologics, including the new CapEx approved by our Board last week for our gene therapy business, led us to increase our fiscal year 2020 projections for CapEx spending. Taking into account customer funding, capital expenditures are now expected to be approximately 13% to 14% of net revenue compared to our initial assumption of 11% to 12% of net revenue. Our capital allocation priorities remain unchanged and focus first and foremost on organic growth followed by strategic M&A.

Now we'll turn to our financial outlook for fiscal year 2020 on Slide '19. As John reviewed in his opening comments, we are raising our financial guidance to reflect the acquisition of Anagni and for the continued growth of the gene therapy business and are also slightly tightening these ranges to reflect the passage of time. No contribution from MaSTherCell is assumed in this revised guidance, which regardless of when it closes will be immaterial to our full year 2020 results.

We now expect full year revenue in the range of $2.87 billion to $2.95 billion compared to our previous guidance of $2.78 billion to $2.88 billion. Note, this new guidance continues to assume organic revenue growth of 4% to 7%. Full year adjusted EBITDA -- for full year adjusted EBITDA, we now expect a range of $711 million to $735 million compared to our previous expectation of $700 million to $730 million. This new range continues to assume our original organic adjusted EBITDA growth assumption of 9% to 12%. Note the greater increase in our revenue guidance relative to our adjusted EBITDA guidance will result in a somewhat lower adjusted EBITDA margin level for 2020 than our original guidance. We now expect adjusted EBITDA margin to increase over fiscal year 2019 results of 23.8% by approximately 100 basis points at the midpoint of the new range versus the previous expectation of an approximate 150 basis point increase. This is largely due to the addition of Anagni, which, as expected, currently has lower utilization levels until it adds more customers.

We're also updating our full year adjusted income guidance to a range of $307 million to $331 million compared to the previous guidance of $300 million to $330 million. We now expect that our fully diluted share count on a weighted average basis for the fiscal year ending June 30 will be in the range of 160 million to 161 million shares, which continues to account the preferred shares we issued in May to fund part of the Paragon acquisition as if they all were converted to common shares in accordance with their terms. We continue to expect our consolidated effective tax rate to be between 24% and 26% for the fiscal year.

Finally, Tom Castellano is also in the room with us today, and I'd like to personally thank him for the outstanding job he has done leading the Investor Relations function for Catalent since our IPO. Tom will continue to add great value to the company in his new leadership role as Global Vice President of Operational Finance and as the finance leader for our Biologics segment. Tom has transitioned his IR responsibilities to Paul Surdez, who joined us last month and many of you know from his time leading Investor Relations at other public health care companies.

Operator, we'd now like to open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Tycho Peterson with JPMorgan.

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Tycho W. Peterson, JP Morgan Chase & Co, Research Division - Senior Analyst [2]

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I'll start with MaSTherCell. I know it's a smaller deal than Paragon, but I'm just wondering if you could compare and contrast the 2. How you think about kind of the cellular market versus the gene therapy market? How should we think about CapEx needs? Any customer concentration risks? And then as we think about kind of the longer-term guidance of 10% to 15% for Biologics, what do you think the cellular therapy market opportunity could do to that growth rate?

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John R. Chiminski, Catalent, Inc. - Chairman & CEO [3]

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Sure. A lot there, Tycho. So let me just step back and look at the big picture here. First of all, I think on our acquisition of Paragon in the gene therapy space really gave us the confidence to enter into another very fast-expanding space in cell therapy. When we take a look at the number of cell therapy trials that are ongoing, it actually significantly exceeds those in the gene therapy area, and it's growing kind of in the mid-teens growth rate.

I would say that from an acquisition standpoint, I would say that we have acquired MaSTherCell a little bit earlier in the cycle than we have from a Paragon standpoint. So obviously, a smaller acquisition compared to Paragon, but I would say we're probably catching it 2 to 3 years earlier in the cycle. So they're still early on. They've got a very strong position. I would say they're really the leading stand-alone cell therapy CDMO player, and they've got some tremendous capability. I would say from a customer standpoint, I think it's very similar to our acquisition of Paragon where you've got a couple of marquee base customers there, but then have behind that, a broad slate of overall customers, both in the autologous as well as the allogeneic area.

From a CapEx standpoint, I would say that on a comparative basis to Paragon, they're smaller numbers based upon the overall technology, but it is going to require some additional CapEx for us to build out the commercial facilities that they already have started in the Belgian area as well as the preclinical and clinical facility they have in Houston and an anticipated additional commercial facility there. So we've anticipated that in terms of looking at our CapEx going forward, which Wetteny can further detail out.

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Wetteny N. Joseph, Catalent, Inc. - Senior VP & CFO [4]

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Yes. Tycho, the one thing I would add is, as John mentioned in his prepared commentary, MaSTherCell is in the midst of expanding clinical operations with a new facility in the U.S. in addition to a commercial facility that they're in the middle of in Europe. So as those come on and ramp up, we would expect to attract even more customers into the business as we continue to scale it from a customer standpoint.

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Tycho W. Peterson, JP Morgan Chase & Co, Research Division - Senior Analyst [5]

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Okay. And then just one follow-up on oral and specialty. You talked about the delays in product approvals and maybe some pressure there for the next couple of quarters. I guess should we be modeling that business down then the next couple of quarters? And is -- when does Zydis Ultra start to kind of contribute as well? Is that going to be beneficial at all?

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Wetteny N. Joseph, Catalent, Inc. - Senior VP & CFO [6]

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Yes. So in terms of the remainder of the year, I would say, given my prepared commentary here, I would expect some continued headwind for the OSD segment for the balance of the fiscal year. That's all factored into the guidance that we just gave as well for the year, just giving you some additional color there. Although I would expect the business to show sequential improvement quarter-on-quarter. From a growth rate standpoint, it would still be a headwind for the balance of the year.

In terms of Zydis Ultra , as we've talked about, this is an exciting area for us to expand the base of our Zydis offering to be able to bring on molecules with bigger drug loading than we did before. We have gone through pilot stages, proving that the technology can work. We are in the midst of a capital expansion to scale that to commercial levels and have already signed a number of programs with customers to leverage that technology. But this is factored into our long-term confidence in this business segment as well in terms of its ability to grow at the 5% to 7% in the long term. But those are -- in terms of Zydis Ultra, we're talking further out before we'd start to see meaningful revenue from Zydis Ultra.

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Operator [7]

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Our next question comes from Dan Brennan with UBS.

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Daniel Gregory Brennan, UBS Investment Bank, Research Division - Senior Equity Research Analyst of Healthcare Life Sciences [8]

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Congrats on the quarter and the deal. First, just on Paragon, just -- can you give us a little flavor? It came in other than we expected this quarter, I guess, not surprising given the commentary intra-quarter and the overall market. But can you give us a little flavor for kind of what you're seeing there? And then secondarily, can you kind of clarify a little bit on the increased CapEx plans, kind of any clarification on kind of what the future revenue contribution as you build-out the capacity in Paragon? Because I know, John, you've alluded to that in your prepared remarks.

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