Catalent Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
January 31, 2022

There are 12 speakers on the call.

Operator

Hello, and welcome to today's Catalent Incorporated Second Quarter Financial Year 2021 Earnings Call. My name is Bailey, and I will be your moderator for today's call. All lines will be muted during the presentation portion of the call with an opportunity for question and answers at the end. I would now like to pass the conference over to Paul Serdez, Vice President of Investor Relations. Paul, please go ahead.

Speaker 1

Good morning, everyone, and thank you for joining us today to review Catalent's Q2 fiscal 2022 financial results. Joining me on the call Today are John Chiminski, Chair and Chief Executive Officer Alessandro Maselli, President and Chief Operating Officer and Tom Castellana, Senior Vice President and Chief Financial Officer. Please see our agenda for today's call on Slide 2 of our supplemental presentation, which is available on our Investor Relations website at investor.catalog.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.

Speaker 1

We refer you to Slide 3 for more detail on forward looking statements. Slide 4 and 5 discuss Catalent's use of non GAAP financial The measures in our just issued earnings release provides reconciliation to the most directly comparable GAAP measures. Please also refer to Catalent's Form 10 Q that was filed with the SEC today for additional information on the risks and uncertainties that may bear on our operating results, performance and financial condition, including those related to the COVID-nineteen pandemic. Now, I would like to turn the call over to John Chiminski for his remarks and cover Slide 6 of 7 of the presentation.

Speaker 2

Thanks, Paul, and welcome everyone to the call. Ketamine's strong start to fiscal 2022 continued in the Q2. Our financial results were driven by continuing strong growth in our Biologics business with additional support from our other business segments as we work with our customers to deliver thousands of different products that help people live better, healthier lives. The recent addition to our offerings of consumer preferred gummy dosage forms for nutritional supplements through the acquisition of Vatera added another growth engine on top of our robust organic performance. The strong second quarter, along with continued momentum in the business, has led us to again increase our fiscal 2022 guidance, which Tom will review later in the call.

Speaker 2

Our net revenue for the Q2 was just over $1,200,000,000 increasing 34% as reported or 35% in constant currency compared to the Q2 of fiscal 2021. When excluding acquisitions and divestitures, organic growth was 32% measured in constant currency. Our adjusted EBITDA of $310,000,000 for the 2nd quarter increased 39%, both on an as reported organic growth was also 39%, measured in constant currency. Our adjusted net income for the 2nd quarter was 100 and $63,000,000 or $0.90 per diluted share, up from $0.63 per diluted share in the corresponding prior year period. The Biologics segment, driven by continued high utilization of our drug product assets, was again the top contributor to Catalent's financial performance.

Speaker 2

The segment experienced organic net revenue growth of 59%, driving an EBITDA increase of more than $60,000,000 over 2nd quarter of last year. Our legacy offerings in our Softgel and Oral Technologies segment continued to experience recovery from pandemic related headwinds that we had anticipated, and this segment results were further enhanced by the acquisition of Vatera. Organic growth was very strong as year over year demand for both prescription and consumer health products recovered nicely over the same period last fiscal year, a quarter that included pandemic lockdowns. Though net revenue is now higher than compared to the pre pandemic Q2 of fiscal 2020, there are still a few headwinds and challenges driven by the ongoing pandemic, with pockets of demand still not at historic levels. However, we're pleased that our base business, Strong growth in product development and robust prescription drug pipeline are more than overcoming some of the headwinds that still exist.

Speaker 2

In addition to our positive organic performance, we received a strong boost from the 1st quarterly contribution from Vatera, which added more than 20 percentage points of net revenue growth to this segment. The Vatera acquisition was an important factor in leading us to raise Position is off to a better than expected start, and we're seeing high interest in gummy formats from our consumer health customers. Our Oral and Specialty Delivery segment also saw continued organic net revenue growth after facing headwinds in fiscal 2021. As with Softgel and Oral Technologies segment, there are improving market dynamics across our Oral and Specialty Delivery segment. These dynamics are most notable this quarter in our early phase development offerings and rising demand for orally delivered Zydus commercial products.

Speaker 2

Finally, our Clinical Supply Services segment posted high Single digit net revenue and EBITDA growth compared to the Q2 of fiscal 2021. As highlighted last quarter, we opened new CSS facilities in San Diego, California and Shiga, Japan in the first half of this fiscal year and expect them to be long term growth drivers for the segment. On our last several calls, I detailed our expenditure projects across the company, most notably in support of our biotherapeutics and cell and gene therapy offerings. I'm very proud of our team's ability to navigate the challenges presented by the pandemic, including those presented by the global increase in cases related to the to keep these critical growth projects on track. With no change to the time line or scope of these We thought it would be helpful to give you an update on the progress of our 1 Bio service offering, which we first announced in June of 2019.

Speaker 2

1bio combines our drug substance and cell line development with our drug product and clinical supply services to help reduce development timelines, Risk and complexity for our customers to get their therapies to patients, all uniquely with 1 CDMO partner. Since we introduced this initiative, we've signed more than 20 development programs, creating an additional feeder channel for our commercial pipeline. Since originally launching as an early stage offering specifically for preclinical Phase I programs, we've now expanded the offerings to support late stage programs based on customers' needs. We now have several Phase 2 and Phase 3 programs in Progress or signed. We also recently completed the first 1bio customer cGMP batch using our new small scale filling line that we acquired in Bloomington in September of 2020.

Speaker 2

We continue to see interest from existing and potential customers who are looking for a single proven partner to help them reduce And this is, of course, not limited to our biotherapeutics customers. We have a long standing history of optimizing the successful development of small molecules as well and recently launched a new service in our oral and specialty delivery segment called Xpress Pharmaceuticals that is designed to accelerate the development of oral drugs for Phase I clinical trials. Our team will integrate formulation development and provide on demand clinical manufacturing, Regulatory support in clinical testing guided by real time clinical data to reduce the time potentially by half to complete 1st in human clinical trials. I'd now like to make a few comments regarding our CEO transition plan announced last month. Catalent is in a strong position given its growth history and trajectory, its increased profitability, and its proven successful strategic execution, including the transformation of the company over the last few years as we've grown our Biologics segment and further diversified our portfolio.

Speaker 2

Catalent's offerings are not only balanced, they closely match the industry's R

Speaker 3

and D

Speaker 2

pipeline. After my 12 years at the helm, it makes sense to refresh Catalent's leadership, particularly when the board agrees that we have a Top industry leader in Alessandro to advance Catalent seamlessly. I'm very proud of and impressed with our Board for overseeing such a thoughtful and thorough succession planning process. Alessandro is uniquely positioned to lead a complex CDMO like Catalent. He started off at the site level over a decade ago, worked its way up to larger sites, then ran multiple sites, rose up to become our Senior VP of Operations and eventually became An integral part of our leadership team, his role as our President and COO.

Speaker 2

Over the last 3 years, Alessandro has been running Catalent to a significant degree, having ownership for all of our business units, go to market strategies, in technical operations. He has worked hand in hand with me on developing and executing our strategy and has been pivotal in all our decisions regarding acquisitions and post acquisitions integrations. With that said, I'd now like to turn the call over to Alessandro, who will walk you through our recently announced long term financial targets. Alessandro? Thank you, John, and I'm very honored to be given

Speaker 3

the opportunity to lead CABREN. You and I have worked closely together for a decade and side by side over the last 3 years. I look forward to continuing to partner with you through the transition over the next several months and then again in your new role as Executive Chair, where you will be delivering the important value to the company in areas critical to our success. I'm confident that we have everything we need to continue to win as we embark on this transition. We continue to expand our global network, invest in growth, driving the capabilities, attracting new talent and accelerate our progress in operational excellence.

Speaker 3

These will all be critical drivers for the CapEx to deliver our long term car As you know, in January 2020, we provided investors for the first time with our fiscal 2020

Speaker 1

of $4,500,000,000

Speaker 3

represented more than a 50% increase from our LTM revenue at the time This net revenue target in the last 12 months and our fiscal is already $300,000,000 higher at the midpoint than our prior 2024 guidance. In addition, back in 2020, we also projected our adjusted EBITDA margin to and several 100 basis points to 28% in fiscal 'twenty four, driven by increased EBITDA margin in the faster growing biologics offering. We have a very strong balance sheet, which is a very strong balance sheet. We have a strong balance sheet, which is a very strong balance sheet, changed significantly since January 2020 when our Biologics segment accounted for just a quarter of our net revenue. Now it's already topped to 50%.

Speaker 3

This transformation of our Our business in the last few years is a result of our strategic investment in work therapeutic modalities in high demand, including viral vectors, platin DNA, iPSCs, other gene and cell therapy manufacturing technologies, messenger RNA, monoclonal antibodies and therapeutic proteins. Given these projects last month at JPMorgan Healthcare Conference, we are now we are moving past our fiscal 'twenty four targets, and we introduced instead the target for fiscal 'twenty six, which are as you can see, each of our segments has an attractive long term organic growth rate target, including our largest segment, Biologics, which has the fastest rate at 10% to 15%. Our 2nd biggest segment, Software and Oral Technology, is now up to 6% to 8% with improved margins. And our oral and specialty delivery and clinical supply service segment are also slated to grow in the mid to high single digit at attractive margin profiles. Key The key drivers to our underlying growth across the company are first, the dynamic and growing spend of R and D in both large and small molecules and second, increased utilization of our premium assets, manufacturing approved products.

Speaker 3

When we look at our various segment growth rate, we are very comfortable with our overall long term consolidated organic and anticipated and A activity, we are projecting more than 7% CAGR from our fiscal 2022 guidance as updated today. We believe margins will continue to improve over the next several years with an adjusted EBITDA margin of 30% in fiscal 'twenty six. It is important to note that our long term strategic plan does not assume that the pandemic related demand for vaccines will continue in the other years. In other words, for these Our overall revenue is forecasted to continue to grow even as we expect our revenue from COVID-nineteen impact related programs to significantly decline, both in terms of up to dollar and as a percentage of overall revenue. We believe our accelerated progress towards The second quarter target, which was strengthened by our highly successful work on COVID-nineteen and response product, exemplifies our capability to deliver for all our stakeholders.

Speaker 3

And we look forward to now delivering we address our draft of facility and related and work speedily to address all of them. While some renovation efforts are relatively quick, others, like in Brussels, will take more time and resources. We are a patient first company, And we, therefore, want to restart manufacturing operations while meeting the highest regulatory standards as soon as possible. So we have assembled a team of internal and external experts to we are proud of our focused on operational excellence and quality. And now that leads us to deliver more than 10% of our total revenue guidance for for nearly 7,000 clients across more than 50 facilities each year.

Speaker 3

The broad diversity of our product offerings and resilience of our business creates a key strategic advantage over our competitors. I would like to turn the call over to Tom, who will review our financial results for the Q2 and in the Q2.

Speaker 1

I'll begin this morning with a discussion on To highlight the company's transformation over the last few years, you'll see that the company represented 52% of our net revenue in Q2 of the fiscal year compared to 44% in Q2 of fiscal 2021 and 31% in Q2 of 2020. Biologics net revenue in Q2 of $638,000,000 increased 60% compared to the Q2 of 2021, with cell therapy acquisitions adding 1 percentage point of growth. This robust net revenue growth was driven organically by broad based demand across the segment events. The segment's EBITDA margin of

Speaker 3

30.9% was up recorded in

Speaker 1

the Q2 of fiscal 2021, which is primarily attributable to mix, most notably an increase in component sourcing with our continued investments in cell therapy business. As we discussed in the past, component sourcing is where we source materials, components and other supplies for our customers, and it comes with 2 and

Speaker 3

we expect to continue to grow

Speaker 1

our revenue, but with margins well below the company average. In Q2 of last year, as We readied the additional capacity we were building, we were not yet manufacturing at large scale and therefore had a much lower contribution from component sourcing versus today's levels. Looking to the back half of the year, as we discussed last quarter, we expect the Biologics segment revenue growth rate to decelerate in the second half of fiscal twenty twenty two as we begin to compare against the higher levels of COVID-nineteen related production that started back in the back half of fiscal twenty twenty one. Also in the back half of the year, we expect the EBITDA margin for Biologics to be impacted by costs associated with corrective and preventative actions we are taking in response to the regulatory observations out of our Russell site. These remediation efforts will include a voluntary temporary shutdown as we replace equipment and revalidate the facility have been factored into our updated from our Softgel and Oil Technologies segment.

Speaker 1

Softgel and Oil Technologies net revenue of $329,000,000 increased 36% compared to the Q2 of fiscal 2021 with segment EBITDA increasing 73% over the same period last fiscal year. The October 1, the acquisition of Deterra contributed 22 percentage points to net revenue growth and 30 percentage points to EBITDA growth in the segment during the quarter. The organic net revenue increase driven by growth in both prescription products and consumer health products, particularly in cough, cold and over the counter pain relief products. Segment EBITDA increased 50 7 basis points from the Q2 a year ago with organic volume growth and the addition of the margin accretive Patera business each contributing to the margin expansion. Slide 11 shows the results of the Oral and Specialty Delivery segment.

Speaker 1

After factoring out the net impact from divestiture of Our blowfield fuel business and the acquisition of Acordis spray drying assets, organic net revenue grew 5% and segment EBITDA was up 24% over the Q2 of last year. The top line growth is primarily driven by elevated demand for for early phase development programs. You may recall that a year ago, we called out lower demand for early phase development programs as a result of pandemic related lockdowns. So this bounce back is another strong indicator of a return to pre pandemic activity levels. Organic net revenue growth was driven by demand for early phase development programs and orally delivered Zydus commercial products.

Speaker 1

EBITDA margin improvement was driven by organic net revenue growth as well as favorable comparison to our Q2 fiscal 2021 when we booked charges related to a customer in September 2020 with voluntary recall of our respiratory products. As shown on Slide 12, our Clinical Supply Services segment posted net revenue of $99,000,000 representing 7% growth over the Q2 of fiscal 2021 and segment EBITDA growth of 9% over the same period. These increases were driven by growth in our manufacturing and packaging and storage and distribution offerings in North America. Backlog for the segment was $529,000,000 compared to $515,000,000 at the end of last quarter and up 18% from December 31, 2020. Segment recorded net new business wins of $114,000,000 during the 2nd quarter The trailing 12 month book to bill ratio is 1.2x.

Speaker 1

Moving to our consolidated adjusted EBITDA on Slide 13. Our 2nd quarter adjusted EBITDA increased 39% to $310,000,000 or 25.4 percent of net revenue compared to 24.5 percent of net revenue. On a constant currency basis, our 2nd quarter adjusted EBITDA also increased 39% compared to the Q2 of fiscal 2021. As shown on Slide 14, 1st quarter adjusted net income of $114,000,000 or $0.63 per diluted share in the Q2 a year ago. Slide 15 shows our debt related ratios and our capital allocation priorities.

Speaker 1

Catalent's net leverage ratio as of December 31, 2021 was 2.8x, below our long term target of 3.0x. This compares to 0x at September 30, which reflects both the Motera acquisition we completed on October 1 and the debt we issued on September 29 in connection with the at December 31, 2020. From here, we will naturally delever absent any further M and A activity continues to grow, providing us with significant flexibility to continue to pursue organic and inorganic growth opportunities. Our combined The first of cash, cash equivalents and marketable securities as of December 31 was 9.60 also on a pro form a basis for the Natera acquisition we reported as of September 30, 2021. Moving on to capital expenditures.

Speaker 1

We continue to expect CapEx to be approximately 15% to 16% of our fiscal 2022 net revenue expectations, driven primarily by growth investments in our Biologics segment. Now we turn to our financial outlook for 22 as outlined on Slide 16. Following the strong second quarter and solid outlook for the remainder of the fiscal year, we are raising both the low and high end of our financial guidance ranges. We are also tightening the range since there are just 5 months remaining in the fiscal year. We now expect full fiscal year net revenue in the range of $4,740,000,000 to $4,860,000,000 representing growth of 19% to 22% versus our previous estimate $4,620,000 to $4,820,000,000 we project that net revenue growth from M and A will continue to be 2 to 3 percentage points, principally driven by the acquisition of Motera.

Speaker 1

We continue to project organic net revenue growth in each of our segments for the fiscal year to be within or above the long term growth range we have previously disclosed for each segment. For full year adjusted EBITDA, we expect a range of $1,250,000,000 to 1 point $30,000,000,000 representing growth of 23% to 27% over fiscal 2021 compared to our previous estimate of $1,225,000,000 to $1,295,000,000 Note that the continued strengthening of the U. S. Dollar against both the euro and the British pound is expected to negatively impact our adjusted EBITDA by approximately $10,000,000 in the second half of the fiscal year, the effect of which has been absorbed into our new guidance. We expect full year adjusted net income of $650,000,000 to $700,000,000 representing growth of 18% to 28% over the last fiscal year compared to our previous estimate of $630,000,000 to $695,000,000 range of 181,000,000 to 183,000,000 shares.

Speaker 1

This projection counts our formerly outstanding Series A convertible preferred shares as if all were converted to common shares in accordance with their terms. Finally, we also continue to expect our consolidated effective tax rate to be between 23% and 25% for fiscal 2022. Operator, this concludes our prepared remarks, and we would now like to open the call for questions.

Speaker 3

Thank

Operator

David, please go ahead.

Speaker 2

Hi, good morning.

Speaker 4

Thanks for taking my question. I wanted 2, I was hoping to ask 2. My first one is around Biologics revenue. Tom, you called out that COVID-nineteen programs were a big driver there. In a conversation we had in December, you talked about COVID and management considers COVID to be in the base and then the base you expect to be able to grow 10% to 15% over the long term.

Speaker 4

Could you talk a little bit about could you give us a little more color about How much COVID contributed to the quarter? Anything you can tell us there? And how you kind of pace out over coming years that will allow you to continue to grow that segment 10% to 15%?

Speaker 3

Yes. So David, we're going

Speaker 1

to fall short of giving any specificity further specificity around what the contribution was for COVID related We made at the start of the fiscal year was not only this being part of our base, but that it was a to be higher than the contribution that we saw in fiscal 2021. I'll remind everyone we saw about 550,000,000 On that basis, prior year and did say that in fiscal 2022, we expect that revenue to be higher than those levels. We have said that we do expect COVID for fiscal 2023 year and public disclosures that have been made around relationships with Several key customers that extend through the fiscal 2023 timeframe. In terms of what the revenue profile of COVID looks like After 2024, we haven't sorry, after 2020, we

Speaker 3

haven't talked about that specifically, but we did I

Speaker 1

could clarify on today's call, Dave, that, it's expected to be a significantly of our long term targets, especially with regards to fiscal 2026. Rams that we have built through the role that we Even the pandemic is certainly giving us the confidence to continue to see this be part of the base as well as the additional capacity that we continue to invest in and bring online across several key facilities here within the network, Primarily within Bloomington and with our NOLI facilities in Europe. Anything else to

Speaker 2

No.

Speaker 3

Look, covering the second part of your question a little bit more in detail, Across all the overall, we'll continue to be expanded in capacity over the next In JAKKS AXA, we have all that specifically with regards of it seems to be interesting. So we feel comfortable that we have enough assets, which will come online with Very good demand profile, which will continue to help growing the business at projected rates.

Speaker 4

My follow-up question, maybe a

Speaker 1

good segue. Alessandro, Andre, you touched on the $483,000,000 on this facility to be impacted Did as you remediate the issue,

Speaker 4

in other contexts, we're to believe that maybe that's a 6% or And

Speaker 1

then more broadly, this had 483

Speaker 4

These at every FDA inspection since 2013. This particular 483 highlights some issues that were appear to be kind of neglected for several years. If you could add some context to the investments in quality and the priorities around quality in this facility, I'd appreciate it. Thank you.

Speaker 3

Yes, sure. So look, we're not Providing here any specific update about the timeline to I can only share that we have deployed a significant amount of resources, internal and external experts In my comments to these, I can confirm that we're only going to restart this facility where we are satisfied meeting with the highest standards of quality and compliance, which are ongoing. So But I will full short from providing the specific guidance. With regards to your second Question around the 40 degrees in this specific facility. We take all these observations Very, very seriously, some of them are more related to the procedures or some activities that can be corrected with ongoing production, some others, like in this case, right to a point where you need to stop production for We had a time to implement some changes, especially when it comes to facilities that have been running for a while.

Speaker 3

So I believe that the response of the company has always been very, very thorough in collaboration With all the regulatory agencies, for each of those, we've been in contact. We have responded And we have brought those observations to our conclusion with the satisfaction of regulators.

Speaker 4

Excellent.

Operator

Please go ahead.

Speaker 5

Hey, guys. Good morning. Just to follow-up on Dave's line of questioning there, Tom.

Speaker 1

Have you seen any issues in terms of your ability to participate in new RFPs

Speaker 5

or your win rates? And then, can you just walk

Speaker 1

us through your bring customer projects to elsewhere in the network from Brussels?

Speaker 3

So with the first part of We, of course, plan, work very, very hard and strive They experienced and observed The performance of Cardalent and our values, 1st and foremost, the patient first So I believe that our customers have way more information and data points to make the evaluation. And as such, we have not experienced Any slowdown in our commercial activity or any impact there? And in fact, I can confirm that the demand and the request Well, Catalent Services is as high as ever been.

Speaker 1

And in terms of your question, Page asked, related to the financial diversification of the portfolio. We operate over 50 sites across the globe, manufacturing over 7,000 products across 1,000 different customers. So the size of the Catalent's of Battleship, if you will, gives us the ability to absorb these types of Normal course challenges that come up from time to time and we operate in a highly regulated state. So to answer your question, we have been able to absorb this. We seen by the robust guidance we've put forth here for the remainder of the fiscal year.

Speaker 5

Got it. And one quick Follow-up there, Tom, you mentioned remediation costs in your prepared remarks. Would you be able to sort of quantify that for us in terms of what the EBITDA impact looked like here in terms of the revised fiscal 2022 guidance?

Speaker 3

Yes. That's a level of

Speaker 1

granularity, Tejas, that we don't disclose. We don't talk about Contribution from individual plants across the network, we did want to just highlight the fact that we will that will have an adverse impact in the margin profile of the business in the second half of the year. As I said, that's all already contemplated in the robust guidance that we

Operator

Please go ahead.

Speaker 6

Hey, good morning. On the drug product side, obviously, Actually, there's been a good amount of I think as Tom mentioned, You have contracts that run into next calendar year. But if and when those dedicated lines Free up potentially for other customers. Are you already in discussions with, let's call, non COVID customers about that capacity?

Speaker 3

Yes, sure. Absolutely. Look, I wouldn't call them Non COVID customers, I will call them non COVID. And in fact, I don't believe that's the most likely scenario where those partnerships, which again have been said in a way that creates partnership and collaboration across the spectrum of the pipeline and not Certainly on the business specific products, I believe that we're going to compete lines. I'm going to To underline and underscore that these type of assets, specifically fill and finish lines under isolated In very high demand, there is not enough capacity to be stored in the water to support the current volumes and the future pipeline, more importantly to pre filled syringes.

Speaker 3

So there is demand, there is a line of which we have developed such a strategic relationship through the COVID pandemic response. So I hope this addresses your question.

Speaker 6

That's super helpful. Thanks for that, Alessandra. And maybe Just one follow-up. In your updated investor presentation, you have this slide in the next 5 years. I think you highlighted that maybe we should consider for inorganic growth at Catalon?

Speaker 3

It's both. We have already, as I shared a few weeks ago, maybe this went a little bit under the radar, but we have You had a number of facilities from the operating arm of one of our clients in the Boston facilities which were not necessarily using for the current platforms. And we have dedicated these facilities to the development of some of Platforms that you are referring to, namely oncolytic viruses, which again is one of the fairly significant patient populations, which we see So we our move is the other one that we are really working hard on is the classic G and A. We continue to see the reality is that this is at the Constrained environment and the new platforms that have been Validated through the pandemic, primarily Messenger RMA make a large use of those Some of that are we do have the infrastructure. They are not material.

Speaker 3

Full disclosure at this point in time in the overall will become at some On material and I expect that in the years to come, we're going to talk more about the contribution of Latin DNA and some of these platforms you're referring to.

Speaker 6

Super helpful. Thanks for taking the questions, Alessandro, and congrats on the new role.

Speaker 3

Thank you.

Operator

Thank you. Our next question comes from Luke Sergo from Barclays. Luke, please go ahead.

Speaker 7

Thanks for the question. Just kind of want to dig into the margin for 2022. You guys have a ton of moving parts here To get to that 100 basis points, FX headwind, you have the mix dynamics. Can you just kind of walk us through what those puts

Speaker 2

Yes. So first, I would say

Speaker 1

the FY 10 wins are not having an impact on the margin profile of As you know, we're seeing strengthening dollar impact, both the top and the bottom line at similar levels here. So no impact related to that. We are assuming, as you mentioned, Ouka, over 100 basis points of margin expansion at the midpoint of the range. We're certainly seeing the Vatera contribution help pull up the margin profile within the SOT business. We mentioned that's a business That has EBITDA margins that are operating closer to that of biologics than that of the SOP business where it is today.

Speaker 1

But also the recovery efforts that we're seeing in terms of moving closer to pre pandemic levels Within SOT and OSD, and the corresponding increase in utilization levels we're seeing in those facilities as a result of those volume upticks are contributing to the margin expansion profile that we're seeing in that Biologics is the only segment where we saw some margin pressure and that's really primarily attributable to the mix issue and the component sourcing dynamic, which I talked about in detail through my prepared remarks that I would expect that the margin profile of Biologics continues to be a modest drag for us in the second half of the year, especially now with The remediation related costs associated with the 43 out of the Brussels that are growing faster than and the top line in that business. And I would expect that dynamic to contribute in the second half of the fiscal Full year as well. So it really comes down to the inclusion of Natera and the recovery within SOT and OSD that are going to help Drive the margin profile a higher year for us and offset some of the headwinds we're seeing within Biologics.

Speaker 7

Great. Thanks. And then secondly, as you talked about some pockets of demand being less than historic levels. Can you talk about Where particularly you're seeing those? And then just the overall order book as you guys see it stacking up and how that's really kind of meeting or exceeding your expectations?

Speaker 3

Look, Alessandro here. So I mean, some of the areas would be obvious to you. All the areas of biomanufacturing clearly is in high demand. Just let me remind you that in that area, we serve both commercial products, but also the R and D The pipeline is not only increasing that we show in our presentation, but it's also maturing More and more assets are moving to the later stage. And when it comes to CDMO services specifically, there There is more opportunity for us to generate revenues in the later stage of the pipeline as opposed to the early stage of the pipeline.

Speaker 3

So that's for sure is creating some interesting dynamic to us. I would tell you the clinical service business has been an interesting one because, yes, there were a couple of dynamics During the pandemic, where some studies were paused or slowed down because of the inability to recruit patients and patients going to clinics. But on the other hand, you had the large studies for vaccine, which affected for us the effect. And now this is a little bit going backward, but the Studies are picking up steam again. So we are seeing very, very good commercial wins in that area, which are a good proxy for the future revenues to invest in that business.

Speaker 3

There is still a little bit of lingering effect, I would say, of the pandemic around the consumer, although I have to tell you that in the last few weeks, we've seen some good movement there with Some historical products, large products and brands that we serve in consumer health, which are going back to historic, will create a temporary

Speaker 2

So with regards of

Speaker 3

our feeding more the small molecules, look, we are Very, very mindful and the Paracos fully serving the small molecules, not making the volume play, but the Technology play, looking after those diseases and being targeted by small molecules. And that is an area that not only today is giving us especially for our early stage assets a good demand, but we see that trend continuing into the next few years.

Speaker 4

Great. Thank you.

Operator

Thank you, Luke. The next question comes from Sean Dodge of RBC Capital Markets. Sean, please go ahead.

Speaker 8

Yes. Thanks. Good morning. On Vatera, that was an area you all previously talked about as being a likely continued investment focus in terms of adding new capacity at some point. John mentioned that the strong client interest in companies kind of right out of the chute here.

Speaker 8

Any updated thoughts you can share around when you might begin investing, expanding across the

Speaker 2

Yes. Thanks for the question. First of all, we couldn't be more excited about our acquisition of Vatera. It's really come out of the gate Incredibly strong. As you know, we have relationships with all the large consumer health companies.

Speaker 2

And I honestly would tell you, great technology, great case profile, great overall the products that they're developing, and you plug that now into Catalent. And we have the ability to really turbocharge That overall effort, specifically on the capacity expansion piece, I will tell you that we came out of the gate with our business plan on Vatera, Already planning to spend significant CapEx there to expand capacity. The current Demand supply imbalance says for us to quickly expand capacity, literally, if we could double our footprint right now With regards to our manufacturing capacity, we could sell it all. So we have some very aggressive plans in terms of CapEx With our new Vatera team, we're hiring a significant amount of individuals. We're taking the Catalent playbook of operations and This is already expanding where we can from an operational standpoint in terms of increasing the 20 fourseven operations where we can in Certain facilities, we have CapEx expansions already deployed.

Speaker 2

And I can share with you at our Board meeting that we had just last week, we had a Specific section around Vatera and how we are going to significantly multiply the EBITDA of that business over the next Few years. So we're very excited about the space, the strong interest in demand and really how Catalyk internal charts the effort given our Strong position in franchises that we have in the consumer health area.

Speaker 8

Great. And then on Maybe on capacity utilization more broadly, you had said before there are a number of facilities that were operating 24 hours a day, 7 days a week to meet commitments. Is this still the case? Is that happening Across a lot of your footprint, is this more prevalent in any one particular segment? And then in those situations, how does that affect margins?

Speaker 8

I guess you'd have fixed costs you're leveraging, but I'd imagine you have to do things like offer shift premium, so your variable costs are probably

Speaker 3

It's a little bit across the network. I can tell you, surely you can expect our tax product assets primarily viable to run Very high capacity utilization rates, should we at 20 fourseven rate? It's only partly because as we shared, We have significant capacity coming online during this calendar year. So as you think about it, Fine. And the capacity division, the one that you calculate is some real deep when this capacity comes online.

Speaker 2

So I would tell you that in terms of the market, we are very encouraged by

Speaker 3

the high utilization, but there is still ability for us to continue to sell more. We had a very recently footprint in Baltimore, which now will grow from 10 to 18 suites, which are going to be very flexible and very helpful to in the space. Clearly, there are some early moves that we do The other areas in inhalation where we decided because Makes sense to enter into this space in these platforms organically as opposed to Yeah, my premium on an acquisition. And those can, for a period of time, could be a little bit dilutive, but we are okay with that because in the overall scheme of things, The capital deployment is still way more efficient than just a JEDON acquisition with Amortivo. So, I Tori, this is the

Speaker 8

All right. That's helpful. Thanks again.

Operator

Thank you, Sean. The next question comes from John Kreger of William Blair. John, please go ahead.

Speaker 7

Great. Thanks very much. I had a couple of questions about the longer term growth goals that you guys I referred to again in the presentation. Tom, maybe for you, what are the planned CapEx spending levels that we should assume kind of correspond to the longer term revenue growth goals that you guys have provided?

Speaker 1

Yes. Good question, John. So we've talked about an elevated level of CapEx, obviously, in fiscal 2022. We'll be spending about 15% to 15% of sales, as we mentioned in the prepared remarks. That's closely aligned to what we spent in the prior year as well.

Speaker 1

To remind folks, I would say the more normal levels of capital spend for us is somewhere in the 8% to 10% of sales basis annually. I don't know that we get back to that level in the fiscal 2023 year, but I would expect us to start to gravitate more closely to that. So I think we remain elevated above the 8 10 levels within the next 1 to 2 years, but probably not quite at the 15% to 16% level. So we're not assuming in our The normal level of CapEx spend that we will be stopped for the next several years.

Speaker 3

Yes. And Let me just add a little bit of

Speaker 2

color here. First of all, I would say that Catalent has done an excellent job staying ahead of Capacity that's needed in the industry. So we've been very astute in understanding where we can get A really quick and excellent payback on capacity investments and certainly what we've been doing in biologics, which is across Biotherapeutics, which is a drug product, drug substance, but also in our gene and cell and gene and cell and gene, terrific ability We need to be number 1 in those spaces, specifically for cell and gene therapy as well as to have the capacity that are that are kind of really Well, during COVID with regards to vaccines and therapies because we had much coveted Capacity that our customers wanted and needed, specifically the underisolator drug product billing assets that Catalent was putting online and was able to secure Even through the pandemic, the next thing that I'll tell you is that although as Tom says, we would expect an 8% to 10% more normal run rate for the business. The cycle of the business has followed. We find Great adjacency from an inorganic standpoint or an area where maybe geographically we want to Improve our position.

Speaker 2

And then when we buy that asset, get our hands on that asset, we then deploy significant CapEx Against it, you're doing with Vatera. So assuming that we don't have any significant M and A, I would expect Obviously, get to that 8% to 10% and continue to drive CapEx platform, I would say, which is the businesses that we've acquired We'll put in place, but if we do continue to get into some other adjacencies or New assets, let's say, in Europe, specifically the drug product and drug substance, you'd expect us to then quickly follow on with Some additional CapEx. So it really depends on the M and A profile, the assets that we get that will determine how quickly we Kind of get to that, I would say, normal spend level of 8% to 10%. But hopefully, that provides you a little bit of a color. And John, having followed us for a long time, you probably see that play out in the financials.

Speaker 7

Yes. Thanks, John. That's call. And maybe just one last thing to clarify along the same lines. I think in the past, you've told us you weren't really interested in investing in large capacity biologic drug substance production.

Speaker 7

Is that still your thinking?

Speaker 2

Look, we've always David, that our strategy is really in that sub-five thousand liter category for drug substance. 70% of the molecules that are in the Those are in the require 5,000 liters or less of drug substance capacity. So we really feel that we've carved out a really nice areas here, and we'll continue to invest in the sub-five thousand single use. I will tell you that we'd like to have more assets in Europe for drug We announced that we're going to be doing $100,000,000 expansion in drug substance in our Anagni facility in Italy. So we'll continue to go after that.

Speaker 2

But we really feel that our place in the drug The substance area is really in that sub-five thousand liter. There's a tremendous amount of biotechs in the small and medium size that are going after, I would say, indications that have Smaller populations. And then we combine that with that 1bio offering that I talked about in our prepared comments. And now we can take them basically from our cell line Expression Technology, Drug Substance, all the way through Drug Producting, Clinical Supply. So I think we've really carved out a great area here where Ketone is building a terrific brand, reputation demand, but where over time the consumer

Speaker 3

demand of supply vessels demand is growing. And we do believe that in the sub-five thousand leaders, there is more opportunity that Supply versus demand profile will stay healthy for longer time for CDMOs.

Speaker 7

Sounds good. Thanks, Brent.

Operator

Thanks, Geoff. Thanks, John. The next question comes from Derik de Bruin from Bank of America. Derek, please go ahead.

Speaker 9

Hi, good morning.

Speaker 2

Hey, good morning.

Speaker 3

Good morning.

Speaker 9

So Hey. So yes, a couple of questions. So first

Speaker 10

of all, just as close

Speaker 9

the loop on the 43, is that did you is the Plant shutdown or there's still lines operating, just to get a sense of

Speaker 3

So the intervention that is mostly requiring both in production, as we said, On the air filtration system, that does The approach around the filling operation of the site, including a site like that one, there are many other That is still quite an intense level of activities, including the remediation activities. So it's not like Completely both. It's just that in order to address HEPA remediation and to the extent of doing that, That requires the filling operation to be posted for a period of time.

Speaker 8

Thank you. And can you talk a

Speaker 9

little bit about Your cell and gene therapy expansion in that market, I mean, it's where is the industry in And capacity today, number of projects. We get a lot of questions from investors trying to dig into this a little bit And it's not there. It doesn't seem to be there. And I think any sort of like general comments on profitability versus some of the other biologics. Could you just sort of Talk a little bit broader about where you are in that market, where you are in the expansion, where the overall market is.

Speaker 2

Yes. So, first of all, we remain extremely enthusiastic about the cell and gene therapy space, not just from an overall Enthusiastic about its ability to literally solve diseases or cure cancers, but the fact that there is significant demand And when you take a look at gene therapy And pipeline expansion, you can see that it's going to grow about 3.5x over the next 5 years, going from about 850 programs to about 2,900 from our data. And then if you take a look at cell therapy, which again is an area that we've gotten into much earlier than we normally do, I would say, in an innovation technology investment cycle. That's growing. It has more assets Today at about 1500 pipeline programs, we see that growing also at about 3x to 4,700.

Speaker 2

Both of these areas WEN themselves extremely well to CDMOs. If you take a look at gene therapy, a lot of the assets are coming from small and midsized companies that really do not have the firepower to deploy $150,000,000 $200,000,000 or even more It's putting in place to make lower demand and ultimately idling those assets. So from a gene therapy standpoint, right now our estimate is about 70% of that All category is outsourced, and we only see that increasing over time. We've made significant investments into this area. When we acquired At Eragon, we had 2 commercial manufacturing suites.

Speaker 2

We immediately invested, which is basically Catalent's modus operandi, which is we invested to take that up to 10 suites. And since then, we now have 10 suites up and running. We announced another 5 suites and have now appended onto that an additional 3 for a total of 18 suites that we'll have from a commercial Manufacturing once they're all up and running. And again, very robust pipelines there. On a cell therapy standpoint, I'm As enthusiastic, if not, even more enthusiastic about the cell therapy space, I think over the next 10 years, this could move from a third For a second line of treatment to a first line of treatment, especially if we have some successes in the autologous Aria and Catalent has put together quite a significant campus in Belgium, we initially started off with a master cell acquisition that had assets in had an asset in Gotselyse And also in Houston and in the Gossa Leves area, we've made multiple acquisitions, whether they be business or asset Plus significant CapEx that's going to be putting in place a facility that will be able to be used for both autologous and allogeneic.

Speaker 2

So I would say we remain very bullish both on the gene and cell therapy area. I will proffer that Catalent will be the number one CDMO type are up or not already from a gene and cell therapy standpoint, and we're going to continue to invest in that area.

Speaker 3

Yes. And one point I'm going to add is a little bit clarifying the profiles of customers, right? So while In the early stage services that we provide, we tend to have in the mix much more biotech customers, which as Jean clarified, We don't have internal capacity and rely on CDMOs to progress assets through the clinics. And the support we provide goes well beyond just the manufacturing, clean the material with analytical services and everything that is required by But when it comes to more late stage assets, we have a very good mix also of large clients, which are interested in our capacity, which are less depending, so to speak, of external funding because they have already commercial products out there. So It's we feel good about the overall dynamics, but we also feel good about the mix of the customers that we serve.

Speaker 9

Thank you very much.

Operator

Thank you. Our next question comes from Jon Salveer from UBS. John, please go ahead.

Speaker 5

Thanks for taking my question. I guess I

Speaker 10

just have a question here on the guidance and given the strong top line In the quarter, can you talk about any conservatism you have baked in in the second half of the fiscal year on the base biologics or vaccines? And anything else to highlight there outside of The Belgium facility on any changes, assumptions in the second half?

Speaker 1

No. I would just say that we were very Prescripted in our prepared remarks, John, related to expected for our Biologics business in the second half of the year. As we think about the timing over the last 6 quarters or so in terms of when COVID vaccine production really started to run up Close to peak volumes, it was in the second half of our fiscal 'twenty one. The Q3 was when we brought online one of the dedicated buyout lines in the prior year. So the fact that we saw very high levels of COVID related contributions in Q3 and Q4 fiscal 2021, Q3 and Q4, in fiscal 2022 in comparison to those prior year quarters.

Speaker 1

The Brussels remediation effort an impact given the costs related to remediation on the margin than it is on the top line. And I think that's Pretty much we can add it. And we did also note the comparative sourcing dynamic we saw in the first and And given that we have seen some of the positive trends in the second half of last year, The comparative sourcing shouldn't be a material from a growth standpoint in Q3 and Q4, given again that, that was already part of the story. That's really what I can provide here in terms of the dynamics we're seeing within biologics as we enter the second half of the fiscal year and seeing growth return to that more normalized level that we would

Speaker 10

Thanks. I guess just maybe to follow-up On Derek's question on the cell and gene therapy, I think you recently provided some color that in 2021 for 2022 And growth rates?

Speaker 1

Yes. So I don't know that we talked about the growth rate of that business in particular. We may be talking about the overall market dynamics A few perspective on the yields of John's comments here. But John, we don't provide growth rate specificity down to The individual sub segment lines like cell and gene therapy or drug substance or drug product, I will say this is a business that has been, Carol, but we've certainly not disclosed anything in terms of what that growth on a percentage or absolute dollar basis. Thanks for taking the questions.

Operator

Thank you, John. The next question comes from Evan Stover from Baird. Evan, please go ahead.

Speaker 11

Thank you. A couple of quick ones from me. On At a fair near to intermediate term kind of approximation for that business, I know you had discussed biologics like and maybe shape that margin?

Speaker 1

Your back of the envelope math That's correct. I will say longer term, we view the margins of this business as being closer to Biologics, as I mentioned. This is the Q1 in which We operated the asset that you'll close to us on October 1. There were several, I would say, integration related costs We needed to deploy into the business. This was a business that was not operated at the levels of a public company, A lot of back office related, I would say, investments we needed to make here to align it to catalysts.

Speaker 1

But as we sit here and think about the business and the potential that we see here, not only do we see very robust levels of growth in the 20 plus percent range, given our expertise in terms of running manufactured facilities to these assets that will help drive further margin Mention down the road here. So I would say that the mid-twenty, give or take a couple of 100 basis points in either direction It's probably the near term view there. But like we said, we do have line of sight to this business contributing EBITDA margins Very close to that of the Biomartic segment.

Speaker 3

Look, I would just stress what Tom said around the opportunity from an operational excellence standpoint that basically running 20 fourseven, which we are very Given the high demand, very high demand that we are experiencing and the only way to respond short term is to increase the utilization rates Of the asset, that's one element of it, but we will see also incredible opportunities from an operational excellence standpoint applying the covenant playbook to these So more to come on this point.

Speaker 11

Thank you. That's great color. On free cash flow, always dangerous to look at a quarter or even a half of a year, but you were negative for the first half of the year. Is there any change to your guidance for just broadly speaking some positive free cash flow in fiscal 2022? Has that Changed at all with Brussels and maybe some other items that you'd like to address?

Speaker 1

Yes. No, I would say we were expecting To be close to these levels through the first half of the year, I mean, we see a step up in our EBITDA contributions in the back half. We do expect, if you look at us historically seeing the bulk of our free cash flow generation coming from our 3rd and 4th fiscal quarter. I will say maybe we were perhaps a little bit behind here and it's mainly related to just inventory. If you look at working capital Inventory is an area that we've, I would say, intentionally have used to make sure We hedge against some of the supply chain related challenges that we see across the industry.

Speaker 1

I would have hoped that we would have started to see some of those Alleviate here in the second quarter, we have been able to be a little bit, I would say, More cautious around inventory, but we haven't made the improvement that we expect to see in the fiscal year yet. I will say as we enter the back half of the year, this is going to be something we continue to look at here. I will Yes, it's not expected to be continued to be something that increases for us. It's just going to come down to how quickly can we get through something inventory we have and have the comfort That we can run at lower levels of safety stock around some of our key materials. So that's really the big dynamic of the free cash flow.

Speaker 1

Evan, as you look at this, I will say, we will continue to drive the business with what we believe will be a positive free cash flow year, which will be A nice improvement from what we saw in fiscal 2021, but we're not out of the woods just yet around these inventory related challenges and it continues to be a little bit of free cash flow headwind. But I wouldn't expect any material change as a result of the Brussels remediation for $83,000,000 to have a meaningful impact on free cash flow.

Speaker 11

Thanks, Tom. That's it for me.

Operator

Thank you, Evan. The next question comes from Jack Meehan from Nephron Research. Jack, please go ahead.

Speaker 4

Thank you and good morning. I had a few questions back on COVID. Can you talk about the diversity of your sales now between the vaccines and the therapeutics. As we've seen some prioritization of some vaccines over others, Seems over others, but just curious to hear what proportion of your COVID sales are now coming from your largest customer.

Speaker 3

So look, I believe that we got The vaccines, the global demand and not only the Western world. Some of your comments on unpreferred vaccine are surely applicable to the Western world, But there is still a significant number of countries, which are probably obvious vaccine given The ability to supply enough quantities. So I would tell you, We haven't seen significant softening of demand across the board on any of the vaccines that we serve. With regards of therapeutics, We have a number of them. We continue to serve them.

Speaker 3

And those are the ones that more Depending on the variant of interest and the different mutations will continue to be updated as the times go by. We do expect that on the therapeutic front, there will continue to be ongoing demand to try to

Speaker 4

Great. And one more on the I think earlier this year you called out 2,000,000,000 doses kind of as a target for 2022. Can you talk about What trends you're seeing in terms of dose per vial? Has that started to come down at all?

Speaker 3

Yes. No, look, it's going to come down. There is no doubt about it. The settings for the vaccine are going more towards physicians And again, I need to caveat my response with the Western world, Meaning, the countries which have had higher vaccination rates during the pandemic should be now at a different settings for administration of vaccines, and we are already Doing the several projects to either go to lower count per vial, but also to previous syringes, which will be, by definition, single dose presentations. So the book is going You know, that I think that direction.

Speaker 1

I just want to add one quick point of clarification here, Jack. I know you probably know this, but The 2022 dose number that we talked about at JP Morgan is the calendar year 2022 estimate. And it really was not meant For modeling purposes here, it was to speak to the role that Catalent has played and continues to play in the pandemic, but again, not for financial modeling purposes. Sounds good.

Speaker 3

Thanks a lot.

Speaker 2

And think maybe a last comment, we've made this before. It's important to note that Catalent is not paid on a dose level. We're paid on a fill, whether it's Dupral syringe, whether it's a vial, whether it's 14 doses, 5 doses per vial, we'll pay for that vial. So in some sense, When you move down to fewer doses per vial, the economics for us can be So just something I continue to mention.

Speaker 1

Operator, I think we have our last question coming in.

Operator

Thank you. Our last question comes from Paul Knight from KeyBanc. Paul, please go ahead.

Speaker 2

Thank you very much and congrats on all the questions. I know the fill and finish is one of your more significant businesses. Can you talk Where you feel you are in that position in the market today? Was it growing faster than other parts of the Biologics business?

Speaker 1

I would just tell

Speaker 2

you that drug product remains in extremely high demand Across the board, certainly the pandemic and the use of those assets for vaccines has really 3rd utilization in a significant way. I think Catalent was really on place, our investment plans for both product And then even during the pandemic, we were able to get our hands And secured some additional drug product, overall assets. The pipeline outside of Vaccines remains very robust again for drug product, and you're going to see a lot more demand specifically In the prefilled syringe area, especially with some high profile blockbuster drugs, they're going into these prefilled syringe Sure, Matt. So it's really an area that's seeing robust growth. I think Catalent has positioned ourselves Very well.

Speaker 2

Our early acquisition of Cook's Pharmaca and the follow on investments that we've made there have been absolutely making it one of the most strategic North American assets for the COVID vaccine solution, but also for future drug product Filling and then also our acquiring the asset from DMS of the Anani facility, which we're continuing on with Yes. That we can use to serve that very, very robust pipeline.

Operator

I would now like to turn the call back over to John Chiminski for closing remarks.

Speaker 2

Thanks Thank you for taking the time to join our call. I'd like to close by highlighting a few key points. The trajectory of Catalysts is to confidently provide robust projected growth targets for fiscal 2026. We're able to do this because of the strategy we have in place, the skilled team of dedicated employees to execute this and is foundational to our long term success. We're also encouraged by the many drivers of growth for the CDMO industry, allowing Catalent to expand into new therapeutic areas and modalities and to enable new opportunities for partnerships.

Speaker 2

Our response to the pandemic has revealed the The importance of a culture that is purpose built to tackle hard problems and will continue to be flexible in how we meet the needs of our customers. Catalent is well positioned to work on and find solutions to the largest, most complex challenges in the industry, as illustrated by ability to quickly stand up production efforts to produce billions of COVID-nineteen vaccine doses. We're extremely proud of our focus on operational excellence and quality and how that has led us to deliver more than 70,000,000,000 doses of medicines for more than 7,000 products for nearly 1,000 clients The broad diversity of our products and resilience of our businesses have allowed Catalent to endure widespread issues like the pandemic and challenges more specific to our industry. Indeed, Catalent has consistently found ways to improve its performance and thrive in a variety of conditions. We have the right people, leadership, processes, technologies, and capacity to help our customers.

Speaker 2

And we're proud to see how our work helps improve the lives of millions of patients around the world. Thank you.

Operator

That concludes the Catalent Incorporated 2nd quarter fiscal year 2021 earnings call. Thank you for your participation. You may now disconnect your line.

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Earnings Conference Call
Catalent Q2 2022
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