Catalent, Inc. (NYSE:CTLT) Q1 2024 Earnings Call Transcript

Catalent, Inc. (NYSE:CTLT) Q1 2024 Earnings Call Transcript November 15, 2023

Catalent, Inc. beats earnings expectations. Reported EPS is $-0.1, expectations were $-0.13.

Operator: Hello all, and welcome to Catalent’s First Quarter Fiscal Year 2024 Earnings Call. My name is Lydia and I’ll be your operator today. [Operator Instructions]. I’ll now hand you over to your host Paul Surdez, Vice President of Investor Relations, to begin. Please go-ahead.

Paul Surdez: Good morning, everyone, and thank you all for joining us today to review Catalent’s preliminary First Quarter 2024 Financial Results. Joining me on the call are John Greisch, Executive Chair of the Board; Alessandro Maselli, President and Chief Executive Officer; and Matti Masanovich, Senior Vice President and Chief Financial Officer. During our call today, management will make forward-looking statements and refer to non-GAAP financial measures. It is possible that future results could differ from management’s expectations, including as a result of the finalization of Catalent’s fiscal 2023 and first quarter fiscal 2024 financial statements. Please refer to Slide 2 of the supplemental presentation available on our Investor Relations website at investor.catalent.com for a discussion of risks and uncertainties that could cause actual performance or results to differ from what is suggested by those forward-looking statements, and slides three and four for a discussion of Catalent’s use of non-GAAP financial measures.

Please also refer to Catalent Annual Report on Form 10-K for the year ended June 30, 2022, as amended, Catalent’s quarterly report on Form 10-Q for the three and nine months ended March 31st, 2023 and our filings with the SEC for additional information on certain of the risks and uncertainties that may bear on our operating results, performance and financial condition. Now I would like to turn the call over to John for some brief opening remarks before handing it to Alessandro. Commentary for these two presenters is covered on slide five.

John Greisch: Thank you, Paul. Good morning and thanks for joining us today. Before I turn the call over to Alessandro, I want to share a few comments on the quarter and on the progress our management team and Strategic and Operational Review Committee have made over the past two and half months toward achieving our goals. As you saw in the earnings release and we’ll hear further from Alessandro, we have delivered a solid first quarter and are confirming our full-year guidance. Given the turmoil in many of our markets, we are pleased on both fronts. In addition, Matti and his team have brought a renewed focus on cash-flow and we are encouraged by already seeing benefits from improved working capital management and greater analytical rigor around CapEx spend thus far in the year.

I want to reiterate that we expect to catch up on our fiscal 2023 and first quarter 2024 SEC filings later this month. We’ve been working tirelessly to finalize these documents over the last couple of months. Matti will go into additional detail on this topic later in today’s call. Finally, I’d like to comment on the work underway by the Board Strategic and Operational Review Committee. As you will recall, we formed a committee at the end of August to conduct a thorough review of our businesses, strategies, operations and capital allocation priorities with a view towards maximizing the long-term value of the company. Since then, the Committee has made progress identifying and evaluating a number of options to maximize long-term value creation for shareholders.

We continue to work closely with Elliott as we thoroughly evaluate the strategic options and we look forward to sharing a more detailed update with all of you at a later date. Let me wrap up by emphasizing that the entire Catalent team is working hard to execute against our strategic plans in order to improve performance and create value. As you will hear today, we are confident in the value of opportunities that lie ahead and are pleased that our first-quarter performance puts us on track to realize our 2024 plans. With that, I’d like to turn the call over to Alessandro.

Alessandro Maselli: Thank you, John. Good morning, everyone. I’m proud of the work the Catalent team has done to deliver a strong start to our fiscal year ’24. We delivered a solid financial performance in the first quarter including 5% non-COVID revenue growth while also progressing on all fronts with our operational improvements. I echo John’s confidence in our plan, and I’m pleased to reaffirm our fiscal ’24 guidance today. While the macro headwinds that we started to call out in November of last year are still present, the strength of our pipeline is bearing fruit, allowing us to continue to guide to a mid to high teens revenue growth rate this year when excluding COVID-related revenue. Key factors underpinning our confidence include continued high demand for our gene therapy services.

Expanded exposure to GLP-1 demand as we bring up more lines. And a very strong rate of new approvals that we’ve seen in the pharma and consumer health segment in this calendar year. We continue to address underutilization at some of our new facilities, bolster our commercial efforts to accelerate the new business wins, and reduce our capital deployment in affected areas all while focusing our CapEx on projects that leverage high-demand areas. We also made a measurable progress in implementing operational improvements in our Biologics segment resulting in favorable performance trends over the last few months. And a quarterly sequential 1,400 basis points improvement in EBITDA margin. We are committed to demonstrating what we believe is our unrivaled ability to run the best drug development and manufacturing facilities in the world both to our investors and our customers.

To help us achieve these goals, we recently appointed David McErlane as Group President of our Biologics segment. David previously, SVP of Lonza’s Bioscience business is a seasoned and highly successful business leader with a record of developing winning strategies that drive growth and create significant value. We are energized by the immediate, positive impact he is already making on the business. In Biologics, we are seeing the impact of operational enhancement and strong commercial demand on our financial results. In the first quarter, our drug product business in Brussels and our gene therapy business in BWI, each had a strong year-over-year and sequential growth as well as margin improvements. As you know, the BWI facility serves the multiple programs for our largest customer, Sarepta, as well as many programs for other customers.

Our pipeline for gene therapy is healthy including several programs in late-stage, one of which was recently signed. As a reminder, the late-stage programs are generally insulated from softness in the biotech funding environment. Our world-class team continues to ramp operations and work around-the-clock to meet Sarepta’s demand and manufacturing goals. Sarepta has recently confirmed their scale-up plans for calendar 2024, firming up orders and we expect revenue from these top customers to grow approximately 65% this fiscal year as we manufacture product for the US market and the rest of the world to Sarepta and its partners. Additionally, I’m very pleased with the progress we are making on our working capital initiatives, including contract assets of which Matti will provide additional details.

In Bloomington, we continue to improve operational performance and we ramp up the assets needed to satisfy demand across multiple new products, including GLP-1s. As a result of these multi-site progress, we expect to exit fiscal ’24 with more normalized pre-pandemic margins in the Biologics segment. Moving to pharma and consumer health. This segment delivered the first quarter in line with our expectations with the solid organic growth when excluding our Consumer Health business. Revenue growth in the consumer business is expected to decline in the first half of fiscal ’24 and then return to growth in the third quarter. This growth is driven in part by an impressive commercial win in the first quarter, a new strategic contract with one of the leading consumer health companies for our gummy pill offering.

This is in line with our strategy to leverage the Catalent brand to increase the penetration of the legacy Bettera business in the top global consumer health companies. Winning this contract, this important contract, while making progress on other exciting business development activities bolsters my confidence in our ability to achieve our goals for the PCH segment performance in fiscal ’24 and beyond. Before I hand the call to Matti, I would like to touch on some important and exciting updates about the Biologics business on the commercial front. Our exposure to the GLP-1 opportunity is rapidly growing. We are now forecasting that a larger majority of our current and future pre-filled syringe capacity coming online in fiscal ’24 through fiscal ’26 is expected to be booked soon in support of this exciting category of products, confirming our position as a leading CDMO in this space globally.

We have plans to accelerate our investments in this area within our existing sterile fill and finish facility in Bloomington and Anagni, including partnering with our customers. We believe we are only beginning to see the tailwinds from this category. Just for reference, in fiscal ’24, we expect revenues of less than $100 million from GLP-1 programs. Once all these lines I just referred to are completed and running at scale, we anticipate this product category to contribute well over $0.5 billion in revenue. As you all know, GLP-1s present an enormous opportunity for growth in the coming years. The major role that Catalent will play in bringing this important innovation to market, especially so soon after our contributions during the COVID pandemic, is a testament to our unique capabilities and positioning.

Catalent’s Board and management team remain confident in the future of our company as we continue to make strides towards improving our operations and bringing our margin performance back to pre-COVID level with urgency while growing the exposure of the company in the most exciting areas of the biopharmaceutical service industry. We remain focused on delivering value for all our shareholders by executing on our mission to improve the lives of patients every day. I will now turn it to Matti for a discussion of our Q1 financial results.

Matti Masanovich: Thank you, Alessandro. I’d like to begin with an update regarding the status of both our annual report on Form 10-K for the fiscal year ended June 30, 2023 and quarterly report on Form 10-Q for the fiscal quarter ended September 30, 2023. While we have implemented improvements in our accounting and finance staffing and related closing processes, as we noted in our notification of late filing on Form 12b-25 filed on Monday, we were unable to file our 10-K and 10-Q on time. We require additional time to complete procedures related to management’s assessment of the effectiveness of our internal controls over financial reporting as of June 30, 2023, and other closing procedures. This has included procedures related to the management’s assessment of the measurement and timing of a non-cash goodwill impairment of approximately $700 million, which relates primarily to acquisitions in the company’s Consumer Health and Biomodalities reporting units in its Pharma and Consumer Health and Biologics segments, respectively.

Please note that for purposes of providing our preliminary first quarter fiscal ’24 earnings, we have assumed that the non-cash goodwill impairment will be included in our first quarter results. We are also incurring substantial time to review other closing procedures supporting our 10-K and 10-Q for both reporting periods. We expect to file the Form 10-K on or before November 27, and we expect to file Form 10-Q promptly following the filing of our 10-K. Additionally, based on currently available information and subject to completion of our evaluation of the potential impairment charge, as well as the preparation of our financial statements and assessment of our internal controls, we do not expect any material change to the financial results to be included in Form 10-K compared to the financial information reported in the preliminary earnings release Catalent furnished to the SEC on Form 8-K filed on August 29, 2023.

We appreciate your patience as we work through and complete our closing procedures. Moving on to our preliminary first quarter results. Starting with the consolidated numbers on Slide 6. Net revenue in the quarter was $982 million, down 4% on a reported basis and 6% on a constant currency basis compared to the prior first quarter. This decline is primarily attributed to the significant reduction in COVID revenue of approximately $85 million in the quarter as well as a one-time $30 million licensing fee in the prior year. This was partially offset by constant currency revenue growth in the rest of Biologics of 11% and 5% in PCH. The Metrics acquisition, which is reported in the PCH segment and closed in October of 2022, accounted for 2% growth on a consolidated basis.

Our first quarter adjusted EBITDA decreased 38% to $115 million or a margin of 11.7% versus margin of 18.3% in the prior year quarter. On an organic basis, our first quarter adjusted EBITDA declined 45% compared to the first quarter of the prior year, primarily driven by a decline in COVID revenue. I will speak further to the major drivers of these results in the segment commentary. Adjusted net loss was $19 million or a loss of $0.10 per diluted share compared to adjusted net income of $61 million or $0.34 per diluted share last year. Reconciliations from GAAP net earnings to each of adjusted EBITDA and adjusted net income are in the appendix into the slide deck. Excluded from adjusted net income are the non- cash goodwill impairments totaling $700 million I just reviewed.

Now I’ll discuss our segment performance, where commentary around segment growth will be in constant currency. As shown on Slide 7, First quarter net revenue in our Biologics segment was $447 million, a 16% decrease compared to the prior year quarter. The decline is primarily driven by significantly lower year-on-year COVID demand. First quarter COVID revenue of approximately $100 million represents a decline of approximately $85 million from the prior year period. On a non-COVID basis, Biologics revenue in the first quarter was in line with the first quarter of 2023. When excluding the onetime $30 million licensing fee signed in the prior year, non-COVID year-on-year revenue growth in this segment is approximately 11%. This result was driven by double-digit revenue growth in gene therapy, non-COVID drug product and drug substance, offset by a decline in cell therapy.

The bar chart on Slide 7 illustrates the Biologics commercial and development revenue streams, where the classification of development versus commercial is driven by the contractual language, which does not always align with the regulatory status of a given product. The large drop in development revenue in the first quarter had 2 primary drivers: First, the year-on-year decline in COVID revenue that has been designated as development revenue, and second, a large gene therapy product whose revenue was treated as development revenue a year ago is now treated as commercial revenue. Moving to EBITDA. The Biologics segment’s first quarter EBITDA was down $61 million year-over-year to $52 million, but was up $64 million sequentially from a $12 million loss in the fourth quarter.

The sequential improvement from the fourth quarter to the first quarter is primarily a result of improved productivity and schedule adherence in the BWI and Brussels facilities. Margin was 11.6% compared to 21.5% recorded in the prior year and up 1,400 basis points sequentially. The year-on-year drop in EBITDA margin was primarily driven by COVID declines as well as underutilization at new modality facilities, including our cell therapy business. We reduced our cell therapy cost structure during the quarter and expect improved performance in the second half of fiscal 2024. Similarly, in Bloomington, we have formalized a transformation project that will help drive margin improvement this year and in the future. When combining these prudent actions and our projected increase in revenue growth, we expect our Biologics segment to improve margins on a year-over-year basis with a more pronounced impact as we exit the fiscal year.

Our non-COVID non-Sarepta Biologics business is expected to grow in the low- to mid-teens in fiscal ’24 as we launch GLP-1 production, and bring on incremental capacity and improve productivity. Importantly, we have high visibility over this growth given the strong demand from customers. As a result of our unique scale and capabilities in sterile fill/finish, we continue to install and qualify new prefilled syringe lines in our global network and are excited to have more prefilled lines on order as part of our committed CapEx spend coming online in fiscal ’25 and ’26. We believe this investment will drive a highly attractive return on capital for Catalent over the long term as we install and validate those lines in our existing facilities. As shown on Slide 8, our Pharma and Consumer Health segment generated net revenue of $535 million, an increase of $23 million or 5% compared to the prior year first quarter, with segment EBITDA of $101 million, down $10 million or a 9% decline over the same period.

The segment’s revenue growth was primarily driven by the prior year’s acquisition of Metrics. On an organic basis, the segment declined 1% as growth in prescription products and clinical supply services was outweighed by softness in Consumer Health. We expect Consumer Health to decline in the first half of fiscal ’24 and return to year-on-year growth in the second half of the year, in part due to the recently signed substantial contract with a premier consumer health company. Adjusted EBITDA margin of 18.9% was lower by 280 basis points year-over-year from the 21.7% recorded in the prior first quarter. The decline was primarily related to under-absorbed capacity in the gummy network and the impact of a onetime $10 million insurance benefit received in the first quarter of fiscal ’23.

PCH has strong underlying fundamentals and continues to perform at a high level. Slide 9 discusses our debt, debt maturities, related ratios and CapEx plans. Our debt load remains well structured and allows for good flexibility. Our nearest maturity is not until 2027. Our primary debt covenant is the ratio of net first lien debt over the trailing 12-months adjusted EBITDA. The covenant requires this ratio to remain below 6.5 times and the September 30 actual level was 3.4 times. Catalent’s overall net leverage ratio as of September 30, 2023, was 7.4 times, a sequential increase from the fourth quarter at 6.4 times, driven by the lower year-on-year last-12-months adjusted EBITDA. Because the EBITDA portion of the net debt leverage ratio is calculated on an LTM basis, we expect this ratio to peak at the end of the second quarter due to the significant decline in COVID revenue on a year-over-year basis and then rapidly improve in the second half of the fiscal year back to the June 30, 2023, level as our adjusted EBITDA recovers to more normalized levels.

One of our top priorities remains reducing our leverage. And as we disclosed last quarter, we are taking a number of steps to achieve this, including, reducing working capital, ensuring that CapEx spend is aligned with our strategic initiatives with shorter payback periods and maximizing EBITDA with revenue growth and cost structure alignment initiatives. With these initiatives underway, including the recent finalization of a contract amendment with one of our large customers in gene therapy, we expect to significantly improve our cash flow generation as we substantially reduce the level of contract assets. We now expect free cash flow to be in excess of $100 million in fiscal ’24 versus our initial expectation of neutral. We continue to identify opportunities to drive further free cash flow generation for the year.

Our combined balance of cash and cash equivalents as of September 30, 2023, was $209 million, a decrease of $71 million from June 30, 2023. The decrease in cash was driven primarily by an increase in contract assets in the quarter related to the ramp-up of production to meet customer demand. As of September 30, 2023, contract assets had a balance of $543 million, a sequential increase of $107 million and up $82 million year-on-year. Importantly, we expect the contract asset balance to decrease going forward. At September 30, we had one strategic customer, a majority of whose business relates to our gene therapy platform, that represented 30% of our $1.4 billion in aggregate net trade receivables and contract assets. We continue to convert the contract assets to accounts receivable and receive timely payments from the customer.

As such, we are very confident about the collectability of our contract asset balance, the reduction of which will accelerate as a result of the previously mentioned contract amendment. The same customer represented approximately 16% of consolidated revenue in the first quarter of fiscal ’24 or approximately $155 million. We expect revenue contribution from this customer to also be approximately 16% of total consolidated revenue for the full fiscal year. We have clear line of sight into this outlook given already committed orders. Finally, CapEx in the first quarter was $84 million. We continue to expect CapEx in fiscal ’24 to be in the range of 8% to 10% of revenue, representing approximately $400 million. Please now turn to our financial outlook for fiscal ’24, as outlined on Slide 10.

With a third of the fiscal year behind us, we are confident in reiterating our fiscal ’24 guidance, which includes net revenue in the range of $4.3 billion to $4.5 billion, representing growth of 3% at the midpoint. Adjusted EBITDA range from $680 million to $760 million and adjusted net income in the range of $113 million to $175 million. Our underlying assumptions are largely the same, with the exception that we now expect COVID revenue of approximately $180 million, $50 million more than our previous expectation of $130 million. Roughly offsetting the COVID revenue increase are unfavorable FX rates in the euro and British pound. As a reminder, our non-COVID business is expected to continue to deliver strong performance with full year revenue growth in the mid to high-teens for the company.

This is driven by roughly 30% growth in our non-COVID Biologics portfolio, including approximately 65% revenue growth from our largest customer, which at this point of the year, is largely contracted. Non-COVID non-Sarepta Biologics segment growth is expected to be low to mid-teens, driven by tech transfer activities. In PCH, we continue to expect mid- to high single-digit growth. As we ramp up our non-COVID business and align our cost structure, we expect margins for the company and the Biologics segment to recover towards historical annual EBITDA margins as we exit fiscal ’24. We forecast roughly two-thirds of consolidated adjusted EBITDA to be generated in the second half of the year. As shared on our last call, the overall expected revenue split is more balanced with approximately 55% expected in the second half of 2024.

In closing, our priorities for fiscal ’24 remain intact, to improve our margins by supporting productivity and cost alignment plans, to deliver incremental free cash flow by lowering the company’s working capital intensity and maximizing commercial opportunities, and finally, to strengthen our internal controls and processes over financial reporting and forecasting. With thorough, careful analysis and disciplined execution of our cost structure, we are making steady progress against these initiatives and are optimistic in our continuously improving performance throughout fiscal year 2024. Operator, this concludes our prepared remarks. We’d now like to open the call for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question today comes from Tejas Savant of Morgan Stanley. Your line is open.

Tejas Savant: Hey guys, good morning and thanks for the time here. Alessandro, one on Sarepta for you to kick things off. You’ve talked in the past of not peaking in the label expansion for ELEVIDYS into your forecast. Sarepta, I think, as you alluded to, said they want to manufacture in anticipation of the unrestricted label ahead of that FDA decision. So how should we think about the implications of that in terms of perhaps potential upside for you in your FY ’24 guide? Does the $700 million-or-so that you’re baking in for Sarepta, the midpoint, factor this in, in light of your comments that I think you said you’re starting to get orders from Sarepta now for that incremental production. And then in terms of the potential downside to fiscal ’25 if the FDA doesn’t allow for label expansion. Any sort of framework that you can help us think through that dynamic here?

Alessandro Maselli: Sure. Hi, everyone. Look, this is a good question. I would tell you, overall, the way I’ll characterize the relationship with Sarepta, there is a lot of positive momentum into the relationship. When you think about, number one, our performance. Really — our Q1 performance was really underpinned by a strong operational performance at our BWI facility, where we support Sarepta. And even the recent months have been even more reassuring that we are on the right path from an operational performance standpoint. The contract amendment that Matti mentioned, which will really allow us now to normalize more the time to cash profile of this important contracts, which in turn, will reduce contract assets, improve cash flow, really also the firm demand that we’ve seen in the recent weeks.

So going to your question, really, look, our job is to continue to leverage the capacity that we have deployed, the suites with which we are supporting the customer, continue to now sustain this very good level of performance, which is the one that will allow us to satisfy this demand. And in terms of your — last part of your question in terms of you — I will not speculate, of course, on the label expansion of FDA, it’s not my place to do so. But in terms of making your model and working through your model, I will remind that, as we disclosed, indeed 50% of the revenues are pass-through revenues coming at fairly low margin with a mid to high single-digit margin. But these are materials and testing services we buy on behalf of the customer.

So this could — I believe it can be helpful in modeling this out.

Tejas Savant: Got it, that’s actually helpful. And then I want to ask one on just ex-COVID, ex-Sarepta growth on a sequential basis, just doing some quick math here. It sounds like you guys had about $235 million in Biologics revenue last quarter. That went to about maybe $185-ish million this quarter. And so can you just walk us through the moving pieces there? I know you gave color year-over-year but just sequentially and I know, you’ve got the fill-finish capacity utilization for COVID here. Did that play a role in this or was it sort of some of the cell therapy work declining? And then on your comment on the significant GLP-1 ramp over the next couple of fiscal years for you here, any color on the slope of that increase and at the cadence at which you expect this new capacity to come online?

Alessandro Maselli: Yeah, sure, look. I’m going to cover the GLP-1 and then hand over to Matti to give you some help on reconciling Q1. But when it comes to GLP-1, I would say, for this fiscal year is fundamentally a second-half story. Right. The second half is really when the commercial production is going to start coming on the — on some of the new assets. I would also add that as I said, we expect significant new capacity coming online between fiscal ’24 and fiscal 2026. And probably the way you should be thinking about these is probably that each of these given years, you know, we are going to more than double the capacity that is going to be deployed against the GLP-1. So any given year. So there are a lot of lines that are already installed and they are being qualified.

So some of them will come up to back-end of this fiscal year, full strength the next year, there is the phasing to the next year is really going to be a full-year story not only H2. And so I believe that assuming that there will be more than doubling the capacity available for these demand and the fact that we have a very strong visibility to the demand can be helpful for you to understand the ramp. And Matti?

Matti Masanovich: So I think so Biologics non-COVID revenue and then stripping out the $30 million licensing fee from the prior year quarter, we’re up 11%. So I think I put that in the script. And I think I talked about that but maybe you didn’t pick it up. But we can reconcile the quarterly…

Tejas Savant: No, I was just talking about the sequential trends there, Matti. What happened in 4Q versus 1Q, not year-over-year.

Matti Masanovich: So fourth quarter. So clearly, our BWI business has really kind of come — has bounced back and then Brussels continued to improve. And so those were the two primary businesses, with BWI being the gene therapy business, with our ramp-up as I discussed in the script, it — obviously, our BWI gene therapy business is well up.

Tejas Savant: Got it, thank you.

Operator: Our next question today comes from Luke Sergott of Barclays. Your line is open.