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.

Unidentified Analyst: That’s helpful. And then on a follow-up. So the top line guide implies a bit of a step down. What got materially worse? And is that kind of split between PCH and Biologics? And that also implies a 4Q step-up outside of historical norms, is that just from COVID? Any color around that would be helpful.

Tom Castellano: Sure. So we did highlight in our prepared remarks that where we do see a change in outlook is primarily driven on the PCH side of the business. And I would say the consumer health part of that business, really the area where we have derisked. I would say, from a COVID standpoint, there certainly is a step up here in our fourth quarter. As we mentioned, we have orders and visibility to a booster season in the fall with demand ramping up across multiple formats for a major strategic customer in that fourth quarter. So given the fact that we do expect to see minimum COVID revenue in our third quarter, based on what we have visibility to, but significant demand in our fourth quarter, we wanted to ensure that, that point was communicated to you all. So again, I would say, PCH continues to be the area where we have seen the most pullback and again, on the consumer health side of that business.

Operator: Our next question comes from Dave Windley with Jefferies. Please go ahead, Dave.

Dave Windley: So Tom, I wanted to try to focus a little bit on gene therapy and some of your commentary around the contract asset and the conversion of that. So if we presume that Sarepta gets good news and gets approved and you continue there, you say like you’ll move the contract asset into build receivable. And then I guess from a commercial product standpoint, it would then become a batch delivery revenue recognition model. I guess I’m trying to understand at the point at which that gets approved and you’ve been recognizing revenue in the contract asset, do you then have a period where there’s not revenue recognition until you get the next batch done and deliver that because it’s now an approved product? Can you walk us through that a little bit?

Tom Castellano: Yes, Dave, it’s a great question and one that we continue to wrestle with and work through internally here. I would say there’s various different ways that we can address in the event that we do see the Sarepta product essentially moving to commercial, though the scenario that you laid out, which would be a movement from percent completion as it’s done on the development cycle to batch release upon commercialization is certainly one of those alternatives. There are other alternatives as well that would align to U.S. GAAP and ASC 606 guidance around revenue recognition. And we are pursuing those and looking at those with our auditor — in conjunction with our auditor EY to ensure that we have the best possible scenario as outlined.

In the situation in which you highlighted, if we were to move to batch release being driving the recognition and the cycle time remains as long as it is from that production cycle, it wouldn’t relate — it would create a period of an air pocket, as you mentioned, from a revenue standpoint. And I think that’s the piece that we essentially need to continue to look at. So as we know more around this and come to determination, one, whether or not that commercial approval is granted in that late May time period, again, being outside of our control, obviously, we’ll communicate more to The Street around this. I would say, regardless of what happens on May 29, the impact to us in fiscal ’23 is minimal, if at all, right? Because what we will have at that point in time is the majority of revenue that we would be recognizing in that June time period being batches that are essentially already in flight that have essentially kicked off while the product was still considered a development product.

So, many moving pieces around this, Dave, I think you’re asking the right questions. These are the types of things we’re looking at internally. And when we come to a determination on exactly what that revenue recognition profile is going to look like for this particular product, given the binary event associated with the approval where we will ensure that that’s properly communicated so that you all understand how to model it.

Dave Windley: I appreciate that. My follow-up question, Alessandro is for you. You mentioned in your prepared remarks some recent successful regulatory reviews. I was going to ask or give you the opportunity to maybe elaborate on that. Going back a little bit further, you’ve obviously had some fairly high-profile 483s that probably caused some angst with management and trying to address those and energy and so forth. And so in the context of those things, I guess, I wanted to understand what — you emphasize Catalent’s quality, I wanted to understand are your aspirations to eliminate these 483s or deal with them best you can when they happen? I’m just wanting to understand where the aspirations are on the track record relative to regulatory review?

Alessandro Maselli: Sure. Look, this is a great question, and thanks for asking it. So look, first of all, I would say, as you said, 483s are not uncommon in our industry, especially in some type of manufacturing operations, surely sterile operations are the one that the CDs to happen more frequently. Just to be clear, we don’t plan for 483s. So we work very hard across our quality management system, with our leadership, with our people, with our operational excellence expectations to avoid this 483 to the extent as possible. However, it’s — these are public information. You see that there is a share of those inspections, which will result in 483s. This is true for all the players into the industry. And it’s as important as try to prevent them, but even more important, how you respond to those observations in a thorough, extensive and holistic way committing to corrective actions.

And some of those corrective actions, actually, most of them yields to an improved operation on the other end of them. So that’s one part of the answer. The other part of the answer, which I want to stress, is that as we signaled many times, Catalent receives regular inspections all the time. Now in this couple of cases happen to be, as you said, more visible, but there are inspections all the time. And we are pretty pleased with our track record of inspections, both from share and ratio of the ones resulting in 483s, but also looking at the number of observations that are normal in those 483s. So look, I know it’s been an element of noise in the last few months, but given that the outcome of those inspections you’re referring to, plus the ongoing track record on the further inspections we received, we feel pretty confident about our quality management system and our operational excellence.

Operator: The next question comes from Max Smock of William Blair. Please go ahead, Max.

Max Smock: I just wanted to touch on funding dynamics. I know last quarter, you pointed to some cash conscious decision- making from customers on the biologics side. Just curious if your conversations really have changed here at all given some of the positive developments in the market, and what are customers telling you about their conviction and their ability to go out and raise funds? And how does that compare to when we spoke this time — or at the end of last year?

Alessandro Maselli: Yes. Sure. Look, thanks for the question. I believe, look, we need to separate it out in our consideration — relative considerations and absolute consideration. I will tell you that in absolute terms, our market could continue to be a very exciting market. Our share in this market continues to be one of the leading shares into the market. We continue to see very nice wins across the board of our offerings. So some of the considerations sometimes are in relative terms in terms of what was and what could have been. But in general terms, we are very, very happy about the market that we’re operating in. The funding has been surely reducing. But when you look at the growth in our core business, our non-COVID business, you’re still seeing the business growing above market and to be honest, in the mid-teens.

And when you look at Biologics specifically even more exciting than that. So I would tell you, the market that did correct a little bit, but still supporting a very exciting growth perspective for the future.

Max Smock: That’s good to hear. And then just a quick follow-up for me around the Brussels facility. I know last — in fiscal year 2022, it was closed down obviously for six months. Just wondering if there’s any way or any detail you can provide that helps us think about the margin tailwind in fiscal 2022 from that factory being online for the full year?

Alessandro Maselli: Yes. This is — Brussels is a relatively small facility for us overall, but it’s certainly, as I mentioned in my prepared remarks, Matt — Max, provides a little bit of a tailwind for us here, both from a revenue and a margin standpoint, as you mentioned, the site was taken offline in the second half of the fiscal year. So it is up against a relatively easy comp. But again, Brussels not a significant site in terms of size from a revenue and profitability contribution for the Company.

Operator: Our next question comes from Paul Knight with KeyBanc. Please go ahead, Paul.

Paul Knight: On the inventory discussion earlier, are you finding that you can effectively destock now because of better supply chain conditions as well as normalized customer demand?

Tom Castellano: So, I would say, Paul, we’re seeing pockets of improvement. And again, we order many different components and inputs for the various different types of products that we manufacture across our Biologics and PCH segments. I would say there are areas of improvement, but there are certainly areas especially on the PCH side of the business, where we do continue to see some challenges from a supply chain standpoint that factored into our decision to continue to remain, I would say, slightly elevated or elevated from an inventory standpoint. We were very specific to say that in the short term, this is going to be a tailwind opportunity for us when we have the comfort in being able to pull back on some of those higher levels of inventory are more likely to be a meaningful contributor to free cash flow in ’24 than I would say it is in ’23; although, as we get into the back half of the year, we should see some modest improvement.

Alessandro Maselli: Yes. Look, cutting short the answer, I believe that our level of comfort in destocking is higher in biomanufacturing than it is in small molecule. Given the geographical source of these components, there is a little bit of a difference there.

Paul Knight: And then last question would be, you had mentioned at the beginning, Alessandro, the fill/finish market, very good. And what are the dynamics creating these positive trends in fill/finish and I believe you’re at top one, two, three in the world?

Alessandro Maselli: Yes, sure. Look, number one, we are very, very excited about our position in that market being one of the top players. And surely one of the players that before others moved into the state-of-the-art technology, which is fill and finish under isolator. So that is really creating a competitive advantage for Catalent and surely continued to increase our share of the most attractive molecules from a CDMO standpoint. I believe that the positive trends are twofolds: number one, the pipeline itself is lending naturally towards fill and finish because you’re looking at assets in the pipeline, which are — you cannot put in oral solid, so they are lending themselves more to fill and finish. And because there is a tendency to self administration, they lend themselves more towards prefill syringes and auto-injectors.

So that’s one dynamic. So, the pipeline — when you analyze the pipeline, that’s one dynamic. The other one is related to the increased movement of critical products to under isolator technology. Clearly, the regulatory environment is an evolving environment. And so the expectations when it comes to steady assurance I’m really suggesting that going forward, the preferred — by far, the preferred way of doing this is going to be under isolator. And for that, we are very well, well positioned with great assets already online and many more coming online in the next 18 months.

Operator: Our next question comes from Tejas Savant with Morgan Stanley. Please go ahead.

Tejas Savant: Tom, just a quick cleanup on the margin trajectory here into the back half of the year, it sounds like based on your comments, you are expecting a pretty significant sequential step up in EBITDA dollars into the fourth quarter here. Is the right way to think about it, essentially just the fact that you’ll get over $150 million essentially in COVID revenue in the fourth quarter and very little in the third quarter? And ex-COVID, can you just point us to sort of how you see that margin line fourth quarter here?

Tom Castellano: Sure. Tejas, I think your point is spot on. Certainly, we will see COVID in that range, as you mentioned, the $150 million-plus after a minimal contribution in Q3 that will certainly drive part of the margin story. But I was also very specific in discussing the ramp-up of the major gene therapy program, as we’ve talked about being late in the third quarter here and having a full quarter of ramped contribution to us from a fourth quarter standpoint, and given the operating leverage, you can see from the utilization of assets there as well as the just novel attractive margins that you see related to the gene therapy side of your business, and Biologics overall you can see that step-up. I would say from a non-COVID standpoint, if you were to strip out COVID out of all of our quarters, you would see a seasonality profile that very closely mirrors what our historical seasonality has been pre-COVID, which is that step up in — with the second quarter versus Q1 levels, then a step up to Q3.

But then ultimately a significant ramp in Q4 ahead of the summer months and some of the, I would say, downtime that we see across our customers and across our customers’ networks as well as our own network related to normal maintenance-related activities that you see in the summer months there and taking up sites off-line. So, that’s certainly all contributing to that significant step-up we see in the fourth quarter.

Tejas Savant: Got it. That’s super helpful. And then one on the — a two-parter the top line actually perhaps for Alessandro here. So first on Bettera, how confident are you that the asset can return to those sort of 20% growth levels that you talked about at the time of the acquisition? Or do you think that perhaps is being partially driven by uptake during the pandemic and perhaps now normalizes to a slightly lower level? And then the second part of my question here is on the Biologics front. As you think about potentially a $400 million to $450 million step down into fiscal ’24 from COVID, you’ll also be lapping some of these pre-approval sort of like inventory build for Sarepta, et cetera, how do you think about framing the growth for the Biologics segment as it sort of anniversaries those dynamics?

Alessandro Maselli: So, look, for the Bettera one, this is a market we are looking at very, very closely. The overall BMS market has decreased in fact, in 2022. So, we are really trying to get together with our customers, with our biggest customers to try and to understand a little more. The fundamental dynamics about this market have not changed, meaning that there is a tendency of people to go to self or preventative medicine, so to speak. However, you want to call it, and surely gummies is our preferred dosage form. So the fundamentals are there. Clearly, the market is going through a correction both because of the end market demand, which has contracted in 2022 and because of destocking for cash considerations. So, we have seen surely be clearly a disappointing trend in the last few quarters.

We expect this to continue through our fiscal year. But at the moment, there are signals that at some point in the later part of this calendar year, the correction of inventory could go out, we will be back serving the end market demand. With regards of the 2024, it’s a little bit too early to have any consideration about it. So, as we’re going to continue to walk through the fiscal year, we’re going to keep you updated about this. But I would say that we continue to be excited about the partnerships we have with the key customers going into the future.

Operator: Our next question comes from Sean Dodge of RBC Capital Markets. Please go ahead.

Sean Dodge: Yes. Tom, you mentioned the $75 million to $85 million of headcount-related savings. But then said there could be some additional beyond that, that could be in the tens of millions of dollars from other efficiency and I think you said procurement initiatives. Is there any more kind of detail you can share on the timelines for the latter? When do you expect the benefits from the other efficiency and procurement initiatives begin to accrue?

Tom Castellano: Yes. I think it’s the same timing of what we’re seeing from a headcount standpoint. The headcount initiatives said we were actioning by the end of the calendar year to be able to see the full benefit in the second half of fiscal year and the full annualized savings over the calendar 2023. I would say it’s been the same for some of the non-employee-related initiatives and procurement initiatives that we’ve had underway. We did highlight the tens of millions, but I would say there will be a partial contribution in fiscal ’23 assumed and then the carryover of that being into the first half of fiscal ’24. So again looking at that from the same lens on a calendar year basis.

Sean Dodge: Okay. And just to clarify, you said about half of that annual run rate you expect to capture in the second half of your fiscal ’23. It looks like some of these headcount reductions took place after the beginning of Q2, was there any amount of these savings reflected in this most recent — your fiscal second quarter?

Tom Castellano: No, there was no material impact from these initiatives in the second quarter. They were actioned, I would say, late in the second quarter. Some of the cash costs associated with those exits were contemplated in the second quarter. Some of that may perhaps carry into Q3 as well. You’ll see that as an add back to our adjusted EBITDA through the restructuring line item. But the real impact from a savings standpoint will be realized in the second half of the fiscal year and then again carry into first half of ’24.

Operator: The next question comes from Justin Bowers of Deutsche Bank. Please go ahead.

Justin Bowers: So just based on the comments on PCH us coming in a little lighter, it would imply that Biologics is coming in stronger. Can you just help us bridge the non-COVID growth in the second half of the year and some of the key drivers there?

Tom Castellano: Yes, Justin, we really didn’t highlight any material change to the non-COVID Biologics growth. I would say it’s very similar to what was assumed and what we saw as part of our last guidance. The real change that offsets the call, the pullback on the PCH side is the over performance of the COVID portfolio. As we mentioned, COVID was originally assumed to be approximately $550 million of revenue for us in our prior guidance. And based on the orders that we have now related to our fourth quarter as our customer ramps up for the fall booster season, we now expect COVID revenue to be more than $600 million in the year. So, it’s really the COVID revenue that’s offsetting the pullback on PCH.

Justin Bowers: Okay. Got it. And then just you talked about tech transfers over the last couple of quarters. Have those started or are they contributing yet? And then just with the commentary on the additional suites at Harmans, are they — when are those coming online? Is that a fiscal year event or is that a calendar year event? Just a little more clarity there would be helpful.

Alessandro Maselli: Yes. Look, let me ask this from the latter part of your question. So yes, additional suites are coming online as we speak in the — as we have already shared. The level of utilization is ramping — will be ramping up in the next few quarters, right? So I believe that in Q3, you’re going to see a little bit of a balanced impact because, yes, you’re ramping up, but you also — the utilization, but you’re also ramping up the cost associated with adding and training the people that are required for these new suites. As we said, we remain very optimistic around the gene therapy demand and viral vector manufacturing going forward, not only with Sarepta, but across the spectrum of our clients, it’s a pretty good space for us.

With regards to the tech transfers, these tech transfers continue to progress. Of course, there are several programs at the same time progressing. And I would say that they — we are pleased with the kind of program we’re transferring in. And surely, these programs will continue to contribute to our drug product growth into the future.

Operator: Our next question comes from Derik De Bruin of Bank of America. Please go ahead.

Derik De Bruin: Can we talk a little bit about the Sarepta contract? I’m just sort of curious, is that contemplated and sort of like the ramp-up contemplated in your original fiscal ’23 guide or is what you’re seeing now more incremental to what you had originally expected?

Tom Castellano: So related to Sarepta, Derik, this is playing out as we had anticipated for the fiscal year here. As I mentioned, the PDUFA date in late May, we’re depending on where that lands, that doesn’t have a material change for us regardless of whether that’s an approval or not in the current fiscal year and the outcome of that will have more of an impact for us on fiscal ’24. But I would say nothing materially different from what we had assumed based on the — this has always been a program that obviously our customer that we have been bullish on as well. So, no real change in outlook there in terms of what the ’23 impact is related to the announcement here.

Alessandro Maselli: Yes. I just want to say that the partnership with Sarepta goes — is a little bit wider than these only programs. So, they have some capacity that we dedicate to them into our Harmans facility, and they can allocate different programs, both clinical and preparation for commercial as they see their internal plants developing. So that is more than just DMD here.

Derik De Bruin: Got it. And I want to follow up on Tejas’ question on the PCH business. I mean it does look like that the — when I look at third-party research on the gummies market, it looks like that’s more like a 12%, 13% sort of like growth market from what I’ve been able to dig up. I mean when you look at that 6% to 10% guide you put out for the long term in the PCH, how critical is the gummy segment going back to the 20% range to sort of like get to that number?

Alessandro Maselli: So look, number one, I would tell you that we never assume a business going forward to grow at the top end of any range. So we didn’t assume in our story there, the 20% assumption for sure, right? So we tend to be pretty conservative on these forecast because, as you know, things may change in these markets. So that’s the first consideration. The second consideration I would say in terms of the PCH story, there is much more to PCH just regarding the gummies. When you look at the demand we are seeing that was in my remarks around Zydis dosage form is just exceptional demand. And I used the word exceptional, not by chance or mistake, we are seeing the demand that is far exceeding capacity. So we are building capacity as fast as we can.

We’re going to be opening soon in North America, not very soon, but sometimes in the next few quarters a North America facility for Zydis because we need an additional facility. We have installed recently — last year, we have installed an additional line in Zydis, we are working on a number of operational excellence programs to debottleneck capacity there. But there are some very, very visible products, which are growing very fast in the Zydis format. So that is one area that is surely contributing to the growth story of PCH. And let me remind you that’s one of the most profitable business of the current network should be over and above some other businesses, even considering Biologics. And with regards of the other parts of PCH, look, clearly, PCH, especially in the pharmaceutical supply is very much dependent on the timing of some approvals and the timing of some of — and the launch of some of these approvals.

So, it tends to be a little bit lumpy at times. But when you look at in the three to five years’ horizon, that is a business that is a very exciting pipeline to support growth.

Operator: Our next question comes from John Sourbeer of UBS. Please go ahead, John.

John Sourbeer: Just with the increase in the COVID guidance in that greater than $600 million in strength in 4Q, any one you could provide some color on what the endemic COVID runway looks here even beyond fiscal ’23? And what should we — how should we think about this long term?

Tom Castellano: Well, I think it’s a difficult question to answer, John. So, we’re going to hold back from giving any more specifics around what fiscal ’24 could look like here. But I think the relationship and the continued relationship and strategic partnership that’s been extended as well as expanded with Moderna, I think, speaks to the future that we believe exists for COVID- and vaccine-related revenue in the future for us. But again, we’re going to fall short of giving any specific run rate as we exit this year in terms of what that could look like for us in ’24.

Alessandro Maselli: I’m going to add one comment to this one. Look, the fact that we are bringing online more assets into the network surely will contribute to the ability of running an endemic business with better productivity and profitability.

John Sourbeer: If I could ask sneaking a follow-up, the Company has previously said, I think, working on greater than 150 supported gene therapy products. Any update just on the number of programs here? And just how we think about with the additional capacity coming online in that non-Sarepta opportunity with some of these programs?

Tom Castellano: Yes. I wouldn’t say there’s any change to that. We continue to work on about 150 development programs across that part of the business. That’s what has justified further capacity expansions within that space. And I would say not only we’re pleased with the number of programs we work on, on the gene therapy side of the business but also the progression and maturity of those that continue to move from earlier phase to a later phase. And obviously, the Sarepta relationship and program or programs is just one example of that. So again, feel very good about the growth prospects and opportunities in this business.

Operator: Our next question comes from Evan Stover with Baird. Please go ahead, Evan.

Evan Stover: Just one for me because as John asked one of mine, but this is a cleanup. Last quarter, you said you had some efficiency initiatives that were in flight and in your last updated guidance, so I just wanted to be perfectly clear that 75 to 85 of efficiency actions that you kind of noted today. Is that, that prior program or is that incremental addition — an additional cost savings to your guide today?

Tom Castellano: No. Evan, these were all originally contemplated. We felt the need to be able to provide some additional disclosure and meat on the bone, if you will, related to the cost savings initiatives. The 700 headcounts we’ve talked about were difficult for us to talk through at the time of our last guidance because we weren’t able — we didn’t execute on those, but now we’ve since executed on that through the end of the calendar year, so we’ll see half of that run rate savings in the current fiscal year with the remaining half to be carried into the first half. So, you should look at that annualized number across calendar ’23 versus our fiscal year. And I would say the further commentary around the tens of millions of dollars related to other cost savings initiatives, efficiencies and procurement programs were also contemplated as part of the original guide.

Operator: Our final question comes from Jack Meehan of Nephron Research. Please go ahead, Jack.

Jack Meehan: So, I want to talk about core organic growth. It was over 20% last quarter, it was 4% this quarter. Can you frame for us the math on some of the moving parts that led to the quarterly slowdown? And then for 3Q, is the reacceleration over 20% happening right now? Just talk about your visibility at the end of that.

Tom Castellano: Sure. So Jack, I think we’ve said in Alessandro’s comments that one of the things we needed to do was prioritize a COVID-related program related to the emergency use authorization of the pediatric COVID vaccine over non-COVID-related revenue out of our Bloomington facility. I’m not going to be in a position to tell you what our non-COVID growth would have been in the second quarter. If we weren’t prioritizing that program, but that certainly had a significant impact and why we were only able to achieve 4% non-COVID growth in Q2 and 12% non-COVID growth in Q2 for the Biologics business. But it’s not necessarily the same assets and lines that are being utilized, but it’s certainly the same operations and quality folks that we have in terms of putting in the time and efforts around releasing of batches.

So, that certainly played into why we had a depressed non-COVID-related growth in the second quarter. So, I think returning in the third quarter back to non-COVID levels that we have seen through the first quarter of the year is what I would consider to be normal course or a low bar based on what we’ve been able to show. And again, the uptick in COVID-related revenue that we expect to see in the fourth quarter is really offsetting the pullback on the PCH side of the business, where we continue to experience headwinds, particularly in consumer health.

Jack Meehan: Got it. And I wanted to try on the margin one more time. Just looking at the fourth quarter, your guidance in the commentary, I think it implies 4Q EBITDA is about 40% of the full year. I look over the last five years, it’s about 33% — so just help us with the math again. I know there are some things that are really stepping up in the fourth quarter. It’s just much more pronounced than I think we’ve seen previously?

Tom Castellano: Yes. I think your numbers are probably close. Maybe I’d say it’s a little bit on the high side in terms of the Q4 contribution, but again, not materially different, I would say, three things like point to one, the COVID-related revenue here is going to be sizable. As we’ve already talked, as we’ve already talked about, the ramp-up on the gene therapy side of the business related to a major customer program that we’ve talked about here, new capacity that’s going to be coming online in the third quarter. It’s going to be utilized. This is going to be by far the strongest gene therapy contribution we’ve ever seen in the fourth quarter. So very difficult to compare that to historical years where we weren’t seeing gene therapy contributions to the levels that we’ll see here around the business.

But third area that I would say I would factor in and then just a normal level of seasonality that we see around the PCH side of the business around Q4, heading into the summer shutdown period is another item to take into consideration here. Lastly, I would say the Brussels dynamic for us in the prior year, if you’re looking at this and certainly, I would say, a headwind that we had in the prior year. So the natural lift up that we’ll see here for the fourth quarter that was a business that was shut down or a facility that was shut down for us, that will be up and running here as well. So, I think all of those things factor into the margin profile we expect to see in the fourth quarter. And lastly, I would say I’d just reiterate that this was — that the demand is there, right?

The level of visibility that we have to volume or demand for the second half of the year and even the fourth quarter is high and it comes down to the levels of execution that we’re able to deliver upon across our network of sites.

Operator: Those are all the questions we have for today. So, I’ll turn the call back to Alessandro for concluding remarks.

Alessandro Maselli: Thank you, everyone, for taking the time to join our call and your continued support of Catalent.

Tom Castellano: Thank you.

Operator: Thank you, everyone, for joining us today. This concludes our call, and you may now disconnect your lines.