Catalent, Inc. (NYSE:CTLT) Q2 2023 Earnings Call Transcript

Catalent, Inc. (NYSE:CTLT) Q2 2023 Earnings Call Transcript February 7, 2023

Operator: Hello, everyone, and welcome to the Catalent, Inc. Second Quarter Fiscal Year 2023 Earnings Conference Call. My name is Emily, and I’ll be moderating your call today. I will now turn the call over to our host, Paul Surdez, Vice President of Investor Relations. Please go ahead, Paul.

Paul Surdez: Good morning, everyone, and thank you all for joining us today to review Catalent’s second quarter 2023 financial results. Joining me on the call today are Alessandro Maselli, President and Chief Executive Officer; and Tom Castellano, 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.catalent.com. During our call today, management will make forward-looking statements and refer to GAAP and 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 on forward-looking statements.

Slides 4 and 5 discuss Catalent’s use of non-GAAP financial measures and our just issued press release provides reconciliations to the most directly comparable GAAP measures. Please also refer to Catalent’s Form 10-Q that will be filed with the SEC today for 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 Alessandro Maselli, whose opening remarks will begin on Slide 6 of the presentation.

A – Alessandro Maselli: Thank you, Paul, and welcome, everyone to the call. Before turning to our results for the quarter, I want to address the Bloomberg news report that appeared over the weekend, but only to say that as a matter of policy, we do not comment on market rumors. With that topic out of the way. Our second quarter results met our expectations and have strengthened our forward momentum for our strategic plans, highlighted by expanded collaborations with strategic partners, significant new business wins in our drug product and gene therapy offerings, renewed business development in and exceptional demand for our world-leading Zydis fast-dissolve technology. As we pass the midway point in fiscal ’23, I would like to first look back at the past six months.

Our non-COVID business continued to shower strength, as we grew organic constant currency net revenue above market at approximately 12% despite softness in nutritional supplement demand. We brought online new capacity to support areas of market with anticipated high demand, particularly of prefilled syringes, viral vector manufacturing and Zydis. We executed our plans to meet the increasing demand for fit-for-scale, high potent drug manufacturing through the acquisition of Metrics. We are very pleased with its overall performance out of the gate, including the recent FDA approval of two new high-potent drugs that Metrics is manufacturing. Broadening our lens. Since the beginning of 2022, Catalent has been a manufacturing partner for a total of seven new approvals across our — FDA approvals across our network.

In addition, we touched approximately 50% of all FDA approvals through that time through our critical — clinical supply, analytical support and early development service offerings. We have agreed and announced an extended partnership with the two of our largest customers. All of these validates our strategy of providing to our partners a comprehensive portfolio of services underpinned by our operational excellence track record, which together position Catalent to be the partner of choice to maximize the potential of their pipelines and allows us to continue to increase our share of the most valuable molecules in the CDMO market. Looking forward, I’m very excited to be leading Catalent in the next chapter of our journey. We have a clear mission to help people live better, healthier lives.

At an investor conference last month, I discussed several aspects of Catalent that should excite everyone about our premier place in the market and the growing opportunities in front of us. Among other things, I noted the continuing growth of our total addressable market, which you can see on Slide 6. Our strategic investments have materially expanded our total addressable market and will provide us with greater future growth opportunities. Since fiscal ’17, we have invested over $7 billion to enable accelerated growth in exciting segments of the CDMO market, and those moves have expanded our opportunities. In fiscal ’19, we addressed a $35 billion market. After our thoughtful diversification, including investment in technology, capacity and new capabilities, today, we address a $70 billion market as an active and scaled player in many of the largest, fastest-growing segments in our space.

Looking ahead to fiscal ’26, we anticipate our addressable market growing another 40% to $100 billion across the markets in which we operate, and we are incredibly well positioned to continue to increase our share in these markets over time. Now moving on to the highlights of the second quarter. As expected, our second quarter results compared to the prior year period were negatively impacted by the lower year-on-year demand for COVID-related products. However, notably, revenue from COVID products grew sequentially as we were the primary U.S. fill and finish site for a pediatric booster vaccine that received emergency use authorization during our Q2. Net revenue of $1.15 billion was down 6% on a reported basis or a 2% decrease on a constant currency basis compared to the second quarter of fiscal ’22.

When we exclude the impact of acquisition and divestitures, our organic revenue declined 4% measured in constant currency. I would like to call out that our organic non-COVID revenue grew approximately 4% in the quarter in constant currency, including double-digits growth in our Biologics segment. This is a slower growth they realized in the first quarter because we prioritized the launch of the pediatric booster and COVID-related work at our Bloomington facility. We expect consolidated non-COVID revenue growth for the remainder of the fiscal year to be more in line with the Q1 levels, which was more than 20% on a constant currency organic basis, as we address our large backlog of non-COVID work, particularly in our gene therapy and drug product offerings, and our PCH business returns to growth.

Our second quarter adjusted EBITDA of $283 million declined 9% as reported or 6% on a constant currency basis compared to the same quarter of fiscal ’22. When excluding M&A, the organic adjusted EBITDA decline was 7% when measured in constant currency. Moving to Slide 8, I would like to cover some data regarding our COVID-related revenue that we addressed during the recent public webcast. Our revenue guidance assumed an approximate $750 million decline in COVID- related revenues from approximately $1.3 billion in COVID revenue we recorded in fiscal ’22. We’re actually tracking slightly better than previously reported with approximately $450 million in COVID revenue recorded in the first half of the fiscal year and expected additional demand in the fourth quarter to prepare for a seasonal COVID vaccine in the fall, which is expected to result in fiscal ’23 COVID revenues that is more than $600 million.

Having said that, given the expected new seasonality of the product, we expect a minimal revenue contribution from COVID products in Q3, resulting in a decline of COVID-related revenue of nearly $350 million when compared to the third quarter of fiscal ’22, which was our peak COVID quarter. Moving on, we continue to position ourselves as the industry partner of choice across the pharma, biotech and consumer health sectors. Our position has been further validated by two significant strategic partnership expansions. First, we will be extending and expanding our manufacturing partnership with Moderna, which will see Catalent support the manufacture of multiple Moderna products in multiple formats across our North American and European biologics drug product network.

Catalent will continue to provide the drug products fill and finish services and production capacity for Moderna’s COVID-19 programs. In addition, there are plans to extend the non-COVID-19 programs such as, two non-COVID-19 programs such as flu and RSV vaccines from our manufacturing site in Bloomington, Indiana, as well extending the partnership to support Moderna from our state-of-the-art European facility in Anagni, Italy. We look forward to our strengthened long-term relationship in helping Moderna advance its robust mRNA pipeline. Second, we recently expanded our existing manufacturing partnership with Sarepta. Catalent will be the Sarepta’s primary commercial manufacturing partner for its leading gene therapy candidate for the treatment of Duchenne muscular dystrophy, which has May 29 PDUFA date.

The agreement was also created mechanisms for Catalent to support multiple gene therapy candidates in the Sarepta pipeline for limb-girdle muscular dystrophy. To meet increasing demand for maturing gene therapy pipelines from Sarepta and other customers, we are ramping up additional suites at our BWI campus later this year. Critical to our business in building strong partnership with our customers is our quality and regulatory track record. Quality and compliance are central to everything we do and our strong quality management system continues to be a differentiator for Catalent with several strong recent regulatory inspection results. In addition to enhancing our strong quality performance, our management team and I have a renewed focus on improving efficiency across the organization and free cash flow generation, as demonstrated by our recently executed restructuring activities.

Tom will share additional details on these activities in a moment. I will also walk you through our fiscal ’23 guidance ranges, which are unchanged from our November call. On Slide 9, we cover our recent progress in ESG areas. We have a strong commitment to ESG and corporate responsibility at Catalent. And we will soon publish our fiscal 2022 corporate responsibility report which shows our continued progress in this area. We have developed our CR strategy to align to our patient-first culture, enhancing our inclusive culture, which drives our commitment to operational and quality excellence. Our CR strategy is focused on three main pillars: people, environment and communities, each of which is informed by our employees, communities, customers, investors and other key stakeholders.

We put patients and people first, invest in and show respect for our employees and promote responsible supply chain. Recent progress includes completion of a third-party human rights assessment as part of our responsible supply chain initiative, A sizable increase in diversity in our global leadership teams and extensive adoption of our employee resource group at our sites. For the environment, we are heavily focused on reducing our greenhouse gas emissions, waste and water used, as you can see by the targets and initiatives on the slide. Finally, we give back to our communities by investing our time, talent and resources in serving patients. I’m proud of the increasing contribution that Catalent and employees have made to communities we serve and where we live and work.

To close, we are uniquely positioned to leverage our cutting-edge technologies to advance health care innovation on behalf of our customers and their patients, while powering the next generation of medicine. We’ve also created many opportunities for our business through our investment so that we may achieve long- term attractive growth. With the assets we have in place, we are focused on executing our strategy to optimize our best-in-class CDMO ecosystem. We are maximizing asset utilization and free cash flow generation to enhance value for our customers, patients and shareholders. With that, I will turn the call over to Tom.

Tom Castellano: Thanks, Alessandro. Before commenting on our segment performance, let me provide you with some additional details related to our recent restructuring activities and other cost savings measures. Our restructuring effort, which was in part driven by our desire to align our organization to our business following the peak surge in COVID-related activity, reduced our cost structure in both operations and at the corporate level and consolidated facilities within our Biologics segment to optimize our infrastructure. Under the restructuring plan, we reduced our head count by approximately 700 employees and expect to incur cumulative employee charges between $14 million and $20 million. As a result of our restructuring plans, we expect to deliver annualized run rate savings in the range of $75 million to $85 million over calendar 2023, with approximately half of the savings to be realized in the second half of our fiscal ’23.

In addition, we expect to generate savings from other cost efficiency and procurement programs above and beyond the reduction of approximately 700 staff that are expected to generate additional annualized savings of tens of millions of dollars. Now let’s discuss our segment performance where commentary around segment growth will be in constant currency. As shown on Slide 10, Q2 net revenue in our Biologics segment of $580 million decreased 7% compared to the second quarter of 2022. The decline is primarily driven by lower year-on-year COVID-related demand. Q2 results included $54 million from the vaccine take-or-pay settlement disclosed last quarter. The decline in COVID revenue was partially offset by growth across our non-COVID programs, with gene therapy being the strongest growth contributor.

Total non-COVID revenue growth for the Biologics segment was more than 10%, down from Q1. The non-COVID revenue growth rate in Biologics is expected to return to the higher levels of growth we saw in the first quarter driven by increased demand in our gene therapy offering, easier comparisons in Brussels and uptake in demand for several drug product programs. The segment’s EBITDA margin of 31.3% was slightly higher than the 31.1% reported in the second quarter of fiscal 2022. Year-over-year margin expansion is mainly attributable to the vaccine take-or-pay settlement that we discussed during our Q1 call. As shown on Slide 11, our Pharma and Consumer Health segment generated net revenue of $570 million, an increase of 3% compared to the second quarter of fiscal 2022 with segment EBITDA down 3% over the same period last fiscal year.

Photo by Myriam Zilles on Unsplash

The segment’s revenue growth was primarily driven by the recently acquired Metrics business, which contributed three percentage points to the segment’s top line and four percentage points to the bottom line. There were a number of moving pieces that drove organic PCH results in the quarter. First, as you can see on the revenue stream chart, our Development Services and Clinical Supply Services showed strong growth, but that was offset by a decline in our manufacturing and commercial supply revenue. Within the commercial stream, growth in over-the-counter cold and cough products were offset by a decline in prescription products and lower consumer spend for nutritional supplements such as gummies and other premium formats. The segment’s EBITDA margin of 23.7% was lower by roughly 170 basis points year-over-year from the 25.4% recorded in the second quarter of fiscal 2022.

Year-over-year margin decline was a result of cost inflation and unfavorable product mix across the network. We expect the PCH segment organic growth rate to modestly increase in the back half of the year, particularly in the fourth quarter, due to continued demand for clinical supply services and increased volume for prescription products, most notably in our Zydis delivery platform. Moving to consolidated adjusted EBITDA on Slide 12. Our second quarter adjusted EBITDA decreased 9% to $283 million or 24.6% of net revenue. On a constant currency basis, our second quarter adjusted EBITDA declined 6% compared to the second quarter of the prior year. As shown on Slide 13, second quarter adjusted net income was $122 million or $0.67 per diluted share compared to adjusted net income of $163 million or $0.90 per diluted share in the second quarter a year ago.

Slide 14 shows our debt-related ratios and other capital allocation priorities. Catalent’s net leverage ratio as of December 31, 2022, was 3.7x, up from the 3.2x as of September 30, 2022, due to draw-downs on our revolving credit facility to fund the Metrics acquisition, which closed October 3, 2022. Net leverage as of December 31, 2021, was 2.8x, and our long-term net leverage target ratio remains at 3.0x. Our combined balance of cash, cash equivalents and marketable securities as of December 31, 2022, was $470 million, an increase of $125 million from September 30, 2022. Although our free cash flow generation is improving, there’s still work to do and this remains a significant focus of the management team. For the second quarter, we were pleased to generate free cash flow of approximately $45 million, making the first time in several quarters that we generated positive free cash flow.

This was a result of more disciplined CapEx spending, as previously discussed; a strong quarter of AR collections; and a rise in contract liabilities due to upfront payments from several customers. We continue to expect our fiscal ’23 CapEx as a percentage of revenue to be between 10% and 11%. Free cash flow was again negatively impacted by our strategic decision to maintain increased inventory levels, which we do not expect to change in the short term due to our concerns about the stabilization of the global supply chain and our commitments to our customers to deliver reliable supply. Note that approximately 15% of our inventory includes work in process with the remainder being raw materials and supplies. As a reminder, we do not include our customers’ finished goods in our inventory balance.

As noted in the past, contract assets are generated as revenue is recorded based on percentage of completion versus entirely on batch release as it is for typical commercial programs. As of December 31, 2022, our contract asset balance was $513 million, a sequential increase of $52 million. This increase was primarily driven by gene therapy programs in the development stage, for which the cash conversion cycle is longer given the duration of the manufacturing and release testing process, which can take multiple quarters from start to finish. We have a number of internal initiatives in place to optimize the manufacturing cycle time. In addition, improvement of our contract terms is a potential lever that could reduce our cash conversion cycle and contract asset balance.

Once the batch subject to contract asset treatment is released to the customer and the invoices sent to the customer and the related balance moves from contract assets to accounts receivable. As you will read in our 10-Q filed today, we have two strategic customers that collectively represent approximately 35% of our aggregate net trade receivables and current contract asset values in the second quarter. Separately, and unrelated to our balance sheet, during the second quarter, we had two customers that each accounted for more than 10% of net revenue. The majority of revenue from these customers were derived from COVID programs. Now we turn to our financial outlook for fiscal 2023, as outlined on Slide 15. We are reiterating our guidance ranges for the full year.

However, I would like to highlight some of the changes in the assumptions that underpin our projected full year results. First, as mentioned earlier on the call, our COVID business is tracking ahead of our expectations, with full year revenue now expected to be above $600 million compared to our previous estimate of approximately $550 million. Based on current visibility, we expect Q3 to have a minimal COVID contribution and be our lightest COVID quarter by far in fiscal ’23. However, looking to Q4, we expect revenue to sequentially increase based on customer demand related to the fall booster season. Second, as consumer discretionary spend challenges continue, our projections for consumer health products, including gummies, have been negatively impacted that are now anticipated to be down when compared to prior year levels.

Third, we continue to see increased strength in gene therapy with a significant program further ramping late in our third quarter, which we expect to lead to a notable step-up in Q4 revenue and earnings. Fourth, our non-COVID business outlook remains strong with the second half of the year expected to be in line with the growth we saw in the first quarter, which was more than 20% on an organic constant currency basis. For the full year, non-COVID growth is expected to be in the high teens. Fifth, from a quarterly perspective, we expect Q3 revenue to be roughly in line with the reported Q2 results. However, as Q2 included the $54 million take-or-pay agreement, we project margins to be sequentially down from Q2 to Q3, then expanding as we get into the fourth quarter.

Finally, the U.S. dollar has weakened since our last report, resulting in a modest FX tailwind when compared to our November assumptions. Operator, I would now like to open the call to questions.

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Q&A Session

Operator: Our first question today comes from Jacob Johnson with Stephens. Please go ahead, Jacob.

Jacob Johnson: Maybe for Tom, following up on those last comments around the guidance. The updated guidance assumes kind of less of an FX headwind, slightly higher COVID revenue. That would seem to imply maybe you’re tempering slightly your organic ex-COVID growth versus prior expectations. Maybe some of that’s related to the 2Q actual. But any areas where you built in some conservatism there? And then still a fairly wide range for the guidance for this year. Just any kind of puts and takes you’d call out as we think about the high and low end of guidance?

Tom Castellano: Sure. Jacob, thanks for the question. Look, I would say we did see, as we mentioned on the call, non-COVID organic growth in the first half of the fiscal year at about 12%. It was down in the second quarter in comparison to where we saw in first quarter levels. However, as we get into the second half of the year, we have line of sight, which is very typical at this point in time to have strong visibility to adjust the remaining five or six months that we have in the fiscal year from those volumes, so expecting to see non-COVID growth in the second half more in line with what we saw in the first half, again, in that 20% range, and that will bring our full year non-COVID-related growth to be in the mid-teens as I mentioned on the call.

I think we continue to be very bullish on the demand profile we see around gene therapy programs as well as on the drug product side of the business. Those would be the main contributors that we would see to the change in organic non-COVID-related growth in the second half of the year, and we were able to still hold our guidance range and pull back around the assumptions on the PCH side of the business, where, as we mentioned, we continue to see some pressures, particularly when it comes to discretionary spend on the gummies and, I would say, just Nutraceutical products across both Softgel and gummies in the second half of the year. You did mention FX that is, I would say, a modest tailwind for us here. But given where we are in the year and only the modest weakening of the dollar we saw in comparison to the euro and GBP, not a significant uplift there.

I would say, as you think about the range that we have out there for the full year guide, I think it really comes down to execution in terms of where we land fits in the range. As I said, at this point in time, we typically do have very strong visibility to the demand profile across the business and it comes down to execution across our network. And we’ve certainly, I would say, built in some natural hedge just based on the normal execution-related hiccups you can see in this business when you operate 55 sites across the globe.

Jacob Johnson: Got it. That’s helpful. And then just my follow-up maybe for Alessandro. Just on the agreement with Moderna. First, congratulations, and it’s good to see. Can you just talk about this relationship kind of beyond FY ’23, as we and investors think about kind of the endemic COVID revenue opportunity, but also the non-COVID work you could do with them perhaps with RSV and flu and COVID, all of these things are kind of blurring together, but just kind of any thoughts about that relationship, kind of COVID, ex-COVID dynamics?

Alessandro Maselli: Sure. Look, first of all, I would say that our relationship with Moderna, it goes back many, many years. So we started to work with them when they were at the very beginning of the journey in 2015-2016. So, we are very, very pleased how this relationship has grown and continuous to grow into the future. I believe that with regards to the vaccine, we are keeping that network to be in the best position to serve what is going to be a seasonal product going forward. So that, on one hand, we can search capacity across our network in multiple sites. And at the same time, maintain a level of efficiency and productivity, which is important to us, right? And this is the best way to do it when it comes to seasonal demand.

On the other hand, very, very excited about participating to these promising new platforms, we continue to support them, both on the clinical side, but also preparing across different formats for what the market might require. So, we are very excited about this relationship. We’ve always been in partnership with them, and we are very pleased that this relationship will continue to grow as in the next few years.

Operator: Our next question comes from Luke Sergott of Barclays. Please go ahead, Luke.

Unidentified Analyst: This is on for Luke. Just a couple of questions here. With a couple of quarters left in the fiscal year, what gets you guys to the low to high end of the EBITDA guidance range? Does Sarepta factor in there with their approval? We can just start off there.

Tom Castellano: Sure. So obviously, we did mention the Sarepta relationship and the PDUFA date being in late May, I would say, very little downside risk associated with Sarepta outside of just normal execution here just given the fact that at this point in time, we really do have very strong visibility, as I mentioned earlier, to the volume related to that program and quite frankly, related to many of the larger development and commercial programs that we have across the network. As I said, we continue to manage the business to a higher set of financial targets internally, as we commit to — that we commit to externally, which is very standard. And as I think about the range of our guidance for next year, I think execution really drives where in that range do we land versus any material changes in demand, just based again on where we are in the fiscal year and the amount of visibility we have around the demand profile across both — especially across our Biologics business, but I would say even across our Clinical Supply and Pharma side of our PPD or PCH segment.

The one area where I would say we have a little more variability, but again, have a relatively reduced outlook related to the consumer health side of our PCH business is certainly already factored into the guidance as well.