Catalent Inc (CTLT) 2015 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Q2 2015 Catalent Pharma Solutions Inc earnings conference call. My name is Alex, and I will be operator for today.

(Operator Instructions)

As a reminder, this call is being recorded for replay purposes. I will now turn the conference over to your host for today, Mr Thomas Castellano, Vice President Finance, Investor Relations, and Treasurer. Please proceed.

Thank you, Alex. Good afternoon, everyone, and thank you for joining us today to review Catalent's FY15 second-quarter financial results.

Please see our agenda on slide 2. Joining me today representing Catalent are John Chiminski, President and Chief Executive Officer; Matt Walsh, Executive Vice President and Chief Financial Officer; and Cornell Stamoran, Vice President of Strategy. John will start the call with a review of the key financial and operating achievements for the second quarter. Then, Matt will discuss the Company's fiscal second-quarter and year-to-date financial performance, as well as update the Company's outlook for FY15. Finally, we will open the call up for your questions.

During our call today Management will make forward-looking statements, including its beliefs and expectations about the Company's future results. It is possible that actual results could differ from Management's expectations. We refer you to slide 3 for more details. Please be aware that the forward-looking statements are based on the best available information to management and assumptions that management believes are reasonable. Such statements are not intended to be a representation of future results and are subject to risks and uncertainties. We refer you to Catalent's Form 10-K, filed with the SEC on September 8, 2014 for more detailed information on the risks and uncertainties that have a direct bearing on the Company's operating results, performance, and financial conditions.

As discussed on slide 4 and 5, on the call today, we'll also disclose certain non-GAAP financial measures, which we use as supplemental measures of performance. We believe these measures provide useful information to investors in evaluating Catalent's operations period over period. For each non-GAAP financial measure that we use on this call, we have included our earnings press release -- issued just a few moments ago -- a reconciliation of the non-GAAP financial measure to the most directly comparable GAAP financial measure. Please note that the non-GAAP financial measures have limitations as analytical tools, and they should not be considered in isolation or as a substitute for our financial results, prepared in accordance with GAAP.

Now, I would like to turn the call over to John Chiminski, President and Chief Executive Officer.

Thanks, Tom, and welcome, everyone, to our FY15 second-quarter earnings call. I'm joining today's call from one our facilities in Brazil, where I've spent the last few days meeting with my [local] management team. Given my robust schedule while here in Brazil, I will only be providing some opening comments and will then turn the call over to Matt. Additionally, Matt, Cornell, and Tom will handle the Q&A portion of today's call.

We're pleased with our second-quarter results, highlighted by revenue growth across all our business segments with strong levels of profitability. Additionally, during the quarter, we continued to invest in strategic initiatives, which position Catalent for further organic and inorganic growth and offer the potential for market share expansion.

I'd like to start my presentation on slide 6, which highlights our key financial and operating accomplishments. Our second-quarter 2015 revenue grew 3%, as reported, and 8% in constant currency, to $455.8 million. For the first six months of FY15, our revenue was $874.1 million, an increase of 2%, as reported, and 5% at constant currency.

Revenue growth, for both at quarter and year-to-date, was driven by strong performance from our Medication Delivery Solution segment and the Modified Release Technology business, as well as increase demand for Analytical Services. As a result of generally capable product mix and a continuous focus on leveraging existing fixed manufacturing costs, our second-quarter gross margin expanded 300 basis points to 34%. However, it's important to note that market expansion of this magnitude year-over-year is atypically high.

During the second quarter, our EBITDA from continuing operations totals $101.7 million, an increase of 22% year-over-year. This strong performance was driven by double-digit EBITDA improvements in our Development and Clinical Services and Medication Delivery Solutions segments, due to both mix shift and more profitable products and services as well as operating efficiencies. Our adjusted EBITDA increased 21% year-over-year, to $112.9 million, or 25% of revenue. Additionally, our adjusted net income nearly doubled versus the prior year, to $55.9 million.

Now let me briefly discuss our key operating accomplishments. As we already discussed with you on the previous earnings call, during the quarter, we completed two strategic acquisitions, including the remaining stake in Redwood Bioscience and its SMARTag antibody-drug conjugate, or ADC, technology platform and Micron Technologies, the leading international provider of particle-sized engineering technologies.

Just recently, we entered into a collaboration with Sanofi-Aventis to implement our proprietary SMARTag technology in the development of next-generation ADCs. Under the agreement, we will develop site-specific modified antibody constants, using Sanofi's proprietary antibodies. Our precision protein chemical engineering approach will enable Sanofi to evaluate [site-selective payload] conjugation in order to enhance ADC pharmacokinetic efficacy and safety.

The acquisition of Redwood Bioscience, along with our collaboration agreement with Sanofi-Aventis and other customers we're working with, strengthens our position in the fast-growing Biologics market. The Micron acquisition enables us to provide an unprecedented set of the integrated development solutions and superior drug delivery technologies to the industry, partnering with our customers' R&D teams earlier in the development cycle and helping them deliver better treatments to clinic and get to market faster and more efficiently.

Finally, we'll be adding new coating and blister packaging equipment at our 360,000 square-foot Eberbach, Germany softgel manufacturing facility, expanding the integrated softgel solutions available to our customers. Coating services are now operational, with commercial revenue expected to be recorded in our fiscal fourth quarter, while the packaging equipment is expected to be online for the start of our FY16. The new coating equipment, designed to coat softgels for controlled, enteric, and targeted release, will be capable of processing more than 300 million capsules per year, in complement to the existing softgel coating capability at our facility in France.

Now, I'd like to turn the call over to our Executive Vice President and Chief Financial Officer, Matt Walsh.

Thanks, John.

First, I'll briefly review our second-quarter operating accomplishments by business segment, starting with Oral Technologies on slide 7. Our softgel business, which accounted for approximately 67% of the Oral Technologies segment's revenue for the second quarter, performed essentially in-line with prior year levels, both at the top and bottom line. Strong softgel growth in North America and Latin America was offset by declines in Europe and Asia-Pacific. As we highlighted during our first-quarter call, we are expecting a mix shift from prescription softgels to consumer health softgels to continue in the near term.

Our modified release business, which accounted for roughly 33% of the Oral Technologies segment's revenue, continued to generate strong profit share revenues from product participation related activities. As a result of favorable product mix shift within controlled release and increase product participation revenue, EBITDA margin across the business segment expanded 400 basis points.

The Development and Clinical Services segment, shown on slide 8, also performed well during the quarter. While Clinical Services revenue was in-line with the prior year, the business posted double-digit EBITDA growth, which was driven by favorable product mix. Strong revenue and EBITDA growth in Analytical Services was driven by higher project that volumes in the US and growth from our integrated oral solids development and supply business. As of December 31, 2014, our backlog for the Development and Clinical Services segment was $381 million, a 1% decrease compared to the first quarter of FY15.

The segment also recorded net new business wins of $95.5 million during the second quarter, which decreased significantly compared to the second quarter of FY14, mainly due to above baseline new business wins in the prior year, led by several large signings, which we alluded to on our first quarter call. The segment's trailing 12-month book-to-bill ratio was 1.0.

As John discussed earlier, the acquisition of Micron Technologies will augment our current capabilities in highly potent and cytotoxic drug handling, integrated inhalation solutions, and analytical laboratory services. The Micron integration is underway and in-line with our plans.

Now, on slide 9, we have the business update for our Medication Delivery Solutions segment. Blow-Fill-Seal performed extremely well compared to the prior year, as increased demand and timing of customer contractual obligations resulted in double-digit revenue and EBITDA growth. Market fundamentals for Blow-Fill-Seal remain attractive, with a robust new product pipeline. Continue the trend from prior quarters, we're seeing our product mix shift to higher-margin products.

Sterile Injectables experienced a recovery after slow start to the fiscal year, which was partially related to timing of customer order patterns. We maintain a positive long-term outlook for this business, as we continue to capitalize on the business development activities of the last two fiscal years, as well as our entry into the Animal Health Market.

Finally, during second quarter, our Biologics business also achieved solid revenue growth, which was attributable to the timing of customer order patterns related to our innovative GPEx gene expression technology. As evidenced by the completion of the acquisition of Redwood Biosciences and its SMARTag ADT technology during the quarter, we continued to invest in our Biologics business. This transaction broadened Biologics services we can offer to our customers, and we look forward to growing this business in the future.

As an indicator of our long-cycle business, which includes both Oral Technologies and Medication Delivery Solutions, we are disclosing the number of new product introductions, or NPI, and our long-cycle development revenues, as directional indicators of future commercial revenue growth. Due to the inherent quarterly variability of these metrics, we will provide the numbers on a year-to-date basis.

For the 6 months ended December 31, 2014, we introduced 88 new products, which is essentially in-line with the number of new products introduced in the same period of the prior fiscal year. We reported development revenue of $62 million, an increase of 32% versus the same period of the prior fiscal year. These metrics are only directional indicators of our business, as we don't control the sales or marketing of these products, nor can we predict the ultimate commercial success of them. However, we expect both of these metrics to provide insight into what the long-term potential organic growth of our long-cycle business might be.

Before I get into more details on our financial results, let me remind you that all the segment revenue and EBITDA results I will discuss in the next two slides are on a constant currency basis. So now, turing to slide 10. For the second quarter, revenue from the Oral Technologies segment increased 3% to $277.2 million over the second quarter a year ago. This growth was attributable to increased demand within the modified release technologies business and higher revenue from product participation-related activities, partially offset by lower end-market demand for certain customer products using our softgel technology platform.

Oral Technologies segment EBITDA in the second quarter increased 7% to $74.7 million. The increase was primarily driven by increased profit from our product participation-related activities and higher revenues from products utilizing modified release technologies.

Revenue from the Development and Clinical Services segment increased 7% to $107.8 million, versus the second quarter a year ago. This growth was attributable to increased revenue in the Analytical Services business, driven by the growth of our integrated oral health development and manufacturing capabilities as well as higher project volumes in the US. Development and Clinical Services segment EBITDA in the second quarter grew 21% to $21.9 million. This EBITDA improvement was primarily attributable to increased demand for Analytical Services and favorable product mix within Clinical Services.

Revenue from the Medication Delivery Solutions segment was up 38% to $73.7 million, over the second quarter a year ago. This strong performance was attributable to timing of customer order patterns, contractual settlements, increased demand for certain products utilizing our Blow-Fill-Seal technology platform, as well as increased demand for Injectable products and increased revenue from Biologics, mainly related to GPEx. Medication Delivery Solutions segment EBITDA in the second quarter of 2015 more than doubled, to $18.1 million. This improvement was driven by increased demand, timing of customer contractual obligations, and a favorable product mix shift within Blow-Fill-Seal.

Turning to slide 11 of the presentation, we see, in precisely the same presentation format as on slide 10, the 6-month year-to-date performance of our operating segments, both as reported and at constant currency. I won't cover every variance item in detail, but I will say that our year-to-date results parallel our second-quarter results, which show constant currency revenue and EBITDA growth across all three operating segments.

Slide 12 shows the reconciliation to the last 12 months EBITDA from continuing operations from the most proximate GAAP measure, which is earnings or loss on continuing operations. This was a mechanical computation, which doesn't require much supporting commentary. It's really there for your benefit, to assist in tying out the reported figures to our computations of adjusted EBITDA, which is detailed on the next slide.

Now, moving to adjusted EBITDA on slide 13, second-quarter 2015 adjusted EBITDA increased 21% to $112.9 million, compared to $93.4 million in the second quarter a year ago. The double-digit EBITDA growth is essentially driven entirely by the strong performance within our operating segment, as we've just discussed. This drives our last 12 months EBITDA figure to $453 million, an increase of 4% compared to the last 12 months EBITDA as of September 30, 2014.

Now, moving to slide 14. Our track record of adjusted EBITDA growth remains very strong. What we're looking at, here, is the last 12 months adjusted EBITDA for each and every quarter since June 2009. It clearly depicts our observation that Catalent's business has grown steadily over a longer analysis period, while we have experienced black quarters -- or even down quarters -- from time to time. The diversity and global scale of our business are key features of Catalent that have helped us deliver consistent growth historically. And we are investing in managing our businesses to continue this trend well into the future.

On slide 15, you can see that second-quarter adjusted net income was $55.9 million, or $0.44 per diluted share, compared to adjusted net income of $27.9 million, or $0.37 per diluted share, for the second quarter of the prior fiscal year. This slide also includes the GAAP to non-GAAP reconciliation to adjusted net income in a summarized format for your reference. A more detailed version of this reconciliation can be found in our supplemental information section of the slide deck, where you'll find essentially the same [add-back access] theme as seen on the adjusted EBITDA reconciliation slide.

Now, turning to slide 16. As we discussed on our previous call, during the first half of FY15, Catalent raised over $1 billion in gross proceeds through our initial public offering, with the net proceeds used to pay down our highest cost debt. Additionally, during the second quarter, we added $191 million to our senior secured term loan, with the proceeds primarily used to fund the Micron and Redwood Bioscience acquisitions and most of the remainder used to pay down our remaining highest-cost debt. Due to the strength of our second-quarter results, we were able to assume this additional debt with minimal impact to our leverage ratio. As a result, our December 31, 2014 leverage ratio was 4.1 times, compared to 4 times, as of September 30, 2014, and 6.1 times, as of June 30, 2014.

Now moving to slide 17. As we've already mentioned in today's [earnings press] release, due to the impact of the continued strengthening US dollar and its effect on foreign exchange translation, we are revising our previously issued financial guidance, despite that we are trending ahead of our previously issued guidance on a constant currency basis. For FY15, we now expect revenue to be in the range of $1.82 billion to $1.86 billion, compared to our previous guidance of $1.89 billion to $1.92 billion. To be clear, the change to our revenue guidance is due to foreign currency translation headwinds.

We now expect adjusted EBITDA to be in the range of $434 million to $444 million, compared to our previous guidance of $450 million to $460 million. Adjusted net income is now expected to be in the range of $204 million to $214 million, compared to our previous guidance of $215 million to $225 million. Again, to be clear, the change to our revenue, adjusted EBITDA, and adjusted net income guidance is due to foreign currency translation headwinds.

As a reminder, more than 65% of Catalent's revenue is recorded in currencies other than the US dollar, with the majority of the exposure being from the euro and the British pound. Since we last reaffirmed our FY15 financial guidance in November, we've seen the euro weaken by approximately 14%, and British pound weakened by approximately 10% versus the US dollar. The translational impact of these movements, in addition to further weakening of the other currencies in which Catalent does business, outpaces the strong base business performance and the anticipated impact of the acquisitions closed during the second quarter.

In addition, based on our updated operational outlook and the fact that we are moving more quickly through our slate of capital projects, we now expect our capital expenditures to be in the range of $120 million to $130 million, compared to our previous guidance of $115 million to $125 million. Finally, starting this quarter, we are now providing guidance for fully diluted share count on a weighted average basis for the fiscal year ending June 30, 2015, which is expected to be in the range of 122 million shares to 124 million shares.

Slide 18 has been added for your reference and walks through some of the moving pieces that we considered when determining our revised guidance. As I mentioned earlier, the change to revenue, adjusted EBITDA, and adjusted net income guidance is due to FX translation as a result of the strengthening US dollar.

The first set of bars brackets the FX impact to revenue, in the $90 million to $100 million range, and the FX impact to EBITDA, in the $20 million to $30 million range. The second set of bars brackets the recent strength that we've seen in our base business performance, primarily as it relates to our modified release technology business and our Blow-Fill-Seal offerings. The last set of bars shows the minimal impact related to the two acquisitions we closed the second quarter. As a reminder, both acquisitions are small contributors to Catalent's financial results but are really quite strategic and position the Company for further, long-term organic growth. However, as you can see, the upside in the base business and the impact of FY15 acquisitions is not enough to combat the strong FX translation headwinds we're currently facing.

Additionally, let me remind everyone of the seasonality in our business and highlight our expected quarterly progression throughout the year. Due to the timing of our customers' annual facility maintenance periods, as well as due to the seasonality associated with budgetary spending decisions in the pharmaceutical and biotechnology industries, the first quarter of any fiscal year is seasonally our lightest quarter of the year by far, with the fourth quarter of any fiscal year being our strongest by far.

While our fiscal third quarter is typically seasonally stronger that our fiscal second quarter, the timing of certain customer orders in the second quarter means that this seasonal trend will not be as apparent this year. However, there's no change to the fundamental long-cycle [mix] for the year, and when we expect our historical seasonality in fiscal fourth-quarter to be consistent with prior years.

In conclusion, I'd like to summarize that Catalent had a strong quarter, as our first-half financial results show revenue growth of 5% on a constant currency basis and adjusted EBITDA growth of 12%, which positions us quite well to achieve our full-year financial outlook. We're pairing organic growth with the Micron and Redwood Biosciences acquisitions that will enhance our market leadership and commitment to building value for our shareholders.

Alex, we'd now like to open the calls for questions.

(Operator Instructions)

Your first question comes from the line of Tycho Peterson with JPMorgan. Please proceed.

(Technical difficulties) quarter. I guess, first on the standard PTL, obviously, you're getting some progress with SMARTag. Can you just talk about what the pipeline beyond the initial deal looks like and how you're thinking about that overall market opportunity in biologics?

Thanks, Tycho.

We are building the pipeline in ADC business. The deal with Sanofi is similar to ongoing projects that we have with other customers. These are all early-stage development type agreements.

Revenue would be in the hundreds of thousands kind of range. And it will become more significant, we believe, over a three- to five-year timeframe.

So I think the agreement with Sanofi is more significant because we're able to discuss it than it is different than any of the other relationships that we have with the customers that our trialing the technology. Generally, these customers like to select to operate at a relatively low level publicity when they're trialing new technology.

Sanofi is an exception to it, but it does enable us to provide our -- not just to our investors, but other customers and the healthcare community, at large -- of what our activities are. So we were excited to put the release out there for that reason.

And then, on the CapEx revision, can you maybe give us a little bit more guidance as to where that's being directed? Does any of that guide to medicine? I know you built out some additional capacity there and (inaudible). So is any of that linked up to some of the CapEx increases?

No, Tycho. The capital related to our biologics business was spent, primarily, last fiscal year. The capital that we're seeing deployed this year is in our modified release business and our development clinical services business, as regards our integrated oral supply activities, which have been growing nicely, as well as our inhalation franchise. So these can all be a terrific long-term growers for us, and we've been able to deploy capital faster than our initial plans.

I would say there's no budget overruns on any of the key projects -- that's not what's driving it. It's just, when we start the year, there's always an ambitious slate of projects that were more rate limited, just for engineering resources, than we are anything else. But we've just been more successful in achieving this slate of projects that we have a little bit faster.

So that's how I would characterize the modest uptick in the guidance, which I think, net-net, is going to be a positive force because we're going to be deploying earnings assets faster.

Okay. Thank you very much.

Thank you.

The next question comes from the line of the Ricky Goldwasser with Morgan Stanley. Please proceed.

Yes. Hi. Good afternoon, and congratulations on a very good quarter.

You talked about stuff like the seasonal trends being mispronounced between third quarter and fourth quarter. If you can just narrow down for us a little bit more -- should we think about third-quarter being flat, quarter-to-quarter, and then back to seasonality in the fourth quarter?

Well, Ricky, I would prefer that we talk about full years. Catalent is a long-cycle business. We are able to predict our revenue and profits over longer time horizons.

I mentioned that we're going to see shifting quarter-to-quarter. And so that's what we've seen in the second quarter, and that we had seen more growth earlier in the year than we had anticipated. If you recall last year, we saw more of the growth weighted later in the year. And this will happen from time to time.

So our thoughts about the full year are consistent. In fact, they're up a little. But the timing of quarter-to-quarter movements is just something that's going to be inconsistent with the way that we manage Catalent, the way we think about it. And that's where I'd like to leave that question.

Okay.

And just maybe, that will help us. When you think about what was pulled forward, was it pulled forward from third quarter or from the fourth quarter -- versus your expectations?

Sometimes, that's hard to tell. What I can tell you is, we've seen it pulled forward into the second quarter from the second half.

Okay.

And that -- on the margin expansion, I think, John mentioned in his prepared remarks that the margin expansion is not typical. Can you talk about the sustainability of those margins?

When we talk about margin expansion in the business, it has been related to execution of operating leverage, principally. While we may talk about products and product mix shift within any business, over the graph of Catalent, they tend to normalize.

And so we talked about margin expansion of 300 basis points in the Company, generally speaking, being available over a five-year timeframe. Our thinking along those lines hasn't changed. We happen to have a spike in the quarter, but that doesn't change our longer-term outlook on margin expansion, due to operating leverage.

Okay.

And then, I mean, obviously, you reiterated your M&A strategy. But when you think about your leverage ratio, which is shy of four now, and in taking into account internal capacity constraints, what is your appetite for executing in M&A in the second half of the year?

Well, I wouldn't think of that -- in answering that question, I wouldn't think about internal capacity constraints. We are taking a very broad look, with respect to acquisitions in our space. Performance services base is consolidating, Catalent, as well as other players in it are active. We believe that there's advantages and shareholder value creation at Catalent is among the more active in the sector.

So what I can tell you, Ricky, is that we have expanded our internal capabilities to execute on to M&A, and we have an internal corporate development group that is as large as it is ever been. And we are very actively looking to grow through acquisition in our space, and we don't see significant limits on that, except for those that we might self-impose on ourselves related to the criteria for deals that we will do.

We're very disciplined. We understand quite well that return on invested capital is the metric that we should be paying attention to and all deals should be measured against. That's a higher hurdle than [increasing] dilution. And that would probably be more of a limiter than our balance sheet or available capital or any other considerations that you might think about.

The management team here at Catalent has been place for most of the transformation. John, six years; myself, seven years. When you look at the ELT, we've got the same sort of tenure.

So we certainly know our business well. We know the industry well, and we know where we can play and win. And we will be, as I said earlier, we'll be actively and are actively looking at acquisition opportunities to grow the Company.

Okay. Thank you.

The next question comes from the line of Derik de Bruin with Bank of America Merrill Lynch. Please proceed.

Hi. Good afternoon.

Hey, Derik.

Hey. So can you give me -- can you give us a specific M&A contribution to the quarter -- revenues?

It would be very low, Eric. We would remind you that Redwood Biosciences is in the development-stage Company, and so it's revenue base is small.

We talked about, in the last call, Micron being about 1% of Catalent's consolidated revenues on a run-rate basis, and we acquired that halfway through the quarter. So we're talking about minimal contributions from acquisitions for the quarter.

Great. That's what I thought.

So can you talk a little bit about the implied organic revenue growth guidance? Is it still in the mid-single-digits to high-single-digit range, or is the strength of the corner driving it up a little bit? (multiple speakers)

Yes. So I would say that we continue to have confidence in our full-year look at the business, which implies that mid-single-digit organic revenue growth. I think it's great that we had a relatively stronger second quarter. And as we discussed in some of the prepared comments, some of that is timing. And so it's not enough to move us off of what our full-year thinking is, on a constant currency basis.

I think the numbers are coming in a little bit stronger, but we still believe that we're quite good at forecasting the business on an annual basis. And this quarter, while good, doesn't motivate us to change that thinking.

Great.

And could you talk a little bit more about the medication delivery solutions and the strength in that business? Just -- and particularly -- I'm curious on the sterile injectables business. And is it that strength [of the products]? And just a little bit more color on what's driving demand.

Sure. I think, really, the strengthening in the MDS business is really it's more related to Blow-Fill-Seal. We certainly saw strength, really, pretty broadly, across the segment. But the driver in the second quarter was more Blow-Fill-Seal than it was injectables.

And what we're seeing in Blow-Fill-Seal is good performance, in terms of volume, out of the product slate they we have. The products that are doing well tend to be our higher-margin products. And so, not only do you get good asset utilization in an environment like that, but you do get favorable margins, just because of the mix. We saw that in Blow-Fill-Seal for the quarter.

The other thing that we saw, we alluded to it in the prepared comments, was some contractual activity, which resulted in accelerated income for us. So one of the features of our business, which we talk about on a regular basis, is the contractual strength that we have because of our proprietary technology platforms.

So in the second quarter, we had a contract termination that resulted in accelerated recognition of revenue and cash in the quarter, which drives the timing comment that I made. Now, as had that contract not terminated, we have would have seen revenue and profits, just due to the manufacturing of the product in the fourth quarter. So we had some acceleration.

It was not a significant driver. It wasn't the only thing, by any stretch, that drove the good performance we saw in MDS, but it was a contributor. And it's one of the factors that leading us to say that we still like where we are thinking about the business on a full-year basis.

Great. That's very helpful. Thank you very much.

The next question comes from the line of George Hill with Deutsche Bank. Please proceed.

Hey. Good afternoon, guys, and congrats on a good quarter.

Matt, I just have two quick questions. Number one is, can you quantify the contract settlement component on the contribution in med delivery in the quarter?

And then the other one is, the Sanofi deal -- is the Sanofi deal net expense from your perspective, or is it net revenue generating? Will they be paying you guys for the development? Thanks.

Thanks, George.

For the first one, we're not in a position to quantify the contract settlement issue, precisely. But because it would -- net-net -- it would be a difference between what the settlement was and what our forecasted production would have otherwise been, which ends up being a low- to mid-single-digit number, in terms of revenue and EBITDA in the millions.

Okay.

And so, when you look at the performance year-over-year, it's a contributor but, once again, not a driver.

Fair enough.

And the second question, related to Sanofi -- I would say, the entire business, right now, is a development-stage business. And so it has a staff of 14, and it incurs annual operating costs in the mid-single-digit millions.

And so we don't look at contract performance on a variable basis. We look at what are we working on that moves the technology forward and the milestones that we set for ourselves.

So this is one where we staked out a commitment to this technology. And we're looking at opportunities to develop the technology. And the more opportunities we have with customers like Sanofi, that will be the key determinant to whether this will be a long-term, viable business for Catalent.

So the notion that we would look at the profitability of a contract is short-term thinking, in my view. And we're taking a very long-term perspective with where the SMARTag business can grow.

That's good color. I appreciate it. Thank you.

You next question is from the line of [Gary McMahon] with Goldman Sachs. Please proceed.

Hi. Good afternoon. Nice quarter, Matt.

I've appreciated the explanation of the guidance revision and FX impact really driving it. I just want to better understand why you're taking down guidance that much with such a strong quarter, where you absorbed the FX headwind pretty comfortably in 2Q. You said it's just currency, but maybe the year is turning out to be more front-end loaded -- and you realize, I just want to confirm there's nothing else in there.

And is there a way, maybe, to better hedge FX?

So thanks, Gary.

The notion that we're front-loading growth this year versus, for example, how we performed last year, where it was more back-end weighted, I think is, indeed, the case. So I wouldn't dissuade you from thinking that your approach to thinking is incorrect.

So we are seeing growth that is front-end loaded this quarter. But once again, we started the year with a certain view of what the full year would look like, and it hasn't changed. We're just seeing the growth a little bit earlier.

And I'm sorry. The second part of your question was?

Well, I mean, it has to do with just the guidance revision and FX and -- because it seemed like you absorbed it pretty well in the second quarter. So I guess, I'm a little surprised that you had to take down the full-year that much.

And also, just about hedging. I guess, there's a better way to, maybe, do that?

Yes. So the -- our earlier guidance -- in our earlier guidance, we were able to absorb the translation impact with the superior performance of the business. But in the back half, especially given the 14% and 10% decline that we mentioned over a six month period, covering about $900 million of revenue, that's the way the math works, Gary.

And it is translational only. We are very well-balanced, on a cash basis. We don't need to move or translate vast amounts of foreign currency from one to another. That's where we would see actual realized issues within FX, and we, historically, don't see that.

So for example, in our second quarter, which saw pretty significant weakening of currencies against the dollar, just the way that our cash management work -- we actually saw small FX gains on a real live basis. And that tends to be very random, because that's generated by timing differences between when invoices are issued and when cash is collected from customers, or when we receive invoices from suppliers and when we play suppliers.

So it really is an FX translation issue. And from where I'm sitting, I have a hard time justifying hedging the translation issue with actual cash resources that the Company would deploy. And I'd rather sit here and try and explain to you what the translation issues are and that it doesn't impact us economically. And hope that I can do that, versus, then, having to hedge the balance sheet and the P&L so that we can have reported earnings that look more buffered but would cost the Company $5 million, $10 million in cash to produce.

Okay. No, that's fair.

And one other question on softgel. It seems like, based on your comments, that you actually saw some growth in North America. And the declines were in Europe and Asia-Pac. So maybe just comment more broadly on when you think we're going to see more of a turnaround there, in terms of the benefit from the conversion to OTC. Thanks.

Thanks, Gary.

I would say that our business development activities in the consumer health space will be seen on a shorter time horizon than what we would experience in the Rx or generic space. But business development activities typically start in the consumer space with a development project, tech transfer.

So we -- I would tend to be thinking about next fiscal year, seeing the impact to commercial revenues, as we're just voluntary pursuing more consumer health business. It's not a current fiscal year impact that we would see.

And the only other thing I would point out is, we are generally known as a softgel Company. But when you look at the growth that we produced in the quarter and on a year-to-date basis, it's mainly in all of our other technology platforms, which I think speaks to the diversity of the business and all the things that we were talking about when we were introducing the Company to our new shareholders.

Okay. Great. Thanks.

Your next question comes from the line of John Ransom with Raymond James. Please proceed.

Hi. Are there any generic cliffs coming up that would impact your particular book of business or, conversely, give you an opening? I'm thinking, for example, Nexium.

The way that we see the generic versus Rx landscape, John, it's pretty balanced. We had mentioned that, for any Rx products -- brand of products that we have, we're not precluded from working on the generic, and we often do. And we'll do more of it.

And that will help buffer us from any volume downsides that we might see in our branded portfolio. But in our current view of the landscape, there's nothing that's a needle mover in the Rx to generic activity that we might see. We see a balance between pluses and minuses.

Great.

And has consolidation and increasing regulation of the generic industry -- thinking, if we ever see the [DMD] manufacturers, how does that -- as you look at the chessboard, how do you factor that in, if at all?

We think, on a long-term basis, this plays well for Catalent. The US has only been a very high-compliance environment.

We're routinely affected by the FDA, and when they come into our sites, it's not a one-day inspection. It's a week and sometimes more. And it's a thorough, soup to nuts examination that we receive.

Other countries are getting more and more stringent, so the global regulatory and compliance environment gets -- is getting tougher. It's getting more expensive. That will accrue benefits to the folks with the bigger platforms, if you've got the resources to be able to comply. So we do believe that, as tough as it is for all Companies to make the increasingly stringent guidelines, we believe we're better positioned than smaller, less-well-capitalized companies to be successful.

Okay.

And I think, what gets overlooked sometimes is your OTC business. Are there any -- and I'm mentally fishing -- are there any trends going on in the OTC business that we need to be mindful of, that are thinking that are -- again, that you had put on your chessboard? How do you think about going to market?

There hasn't been any significant changes, John, since the pre-IPO marketing period and the kind of descriptive information that we have out there, whether it's in the [S1] or any of our Ks -- nothing significant. The observation we would have is that the OTC business and the vitamin mineral supplement side of the business tends to be faster to market for us. And as we pursue -- we're pursuing all of the prescription and generic business we can.

Right.

And so we fill out our marketing activities with now increasing amount of concentration on the OTC and EMS space. That business can be faster onboarded.

That said, I would go back to the earlier answer I gave, noting that it's probably not an FY15 impact that we would see, because they're still tech transfer work and commercialization work that precedes the actual introduction and filling of supply chains, which results in commercial revenue for us. So this is more of a FY16 phenomenon versus 2015.

Is just finally, there's some people who might think that this dollar-euro is not just a blip, but maybe more of a secular trend. At what point would the pain threshold get sufficient to where you might think about making some strategic changes? Or is that not really something you guys are thinking about?

Well, the way we think about it, there's large volume of customer demand to be had in the regions that are, right now, not doing so well versus the dollar. But we have productive capacity sales and marketing infrastructure in the countries.

And as long as these economies are not hyperinflationary and we have enough inventory of cash -- which is an inventoriable commodity, just like anything else, in my view -- we can operate economically at a point where we can still generate returns on capital that can be commensurate with the prior performance and what we would deem as attractive. So I don't see that changing in the near term.

And I know what you're talking about, John. You've got some people out there predicting that parity between the euro and the dollar, at some point, whether it's in the 2015 calendar year, or 2016.

Right.

That wouldn't cause us to change much because what we're making in the euro region, we're selling in the euro region.

Right.

Generally speaking, we're not moving that much material across what, for us, would be currency borders, if you will.

Right. So I guess, I could think about you making more there and selling more here. Is that a possibility, if we get to that -- moving some production over there? Or is that not as easy as it sounds?

I would say that kind of arbitrage, if that's the word, could potentially happen at the margin. But it wouldn't be something that drives the business because there are compliance documents in place that dictate that we're going to make product A in facility X, and those become very costly to change.

Got you. Okay. Thank you.

Thanks, John.

Your next question comes from the line of Dave Windley with Jefferies. Please proceed.

Good evening. Thanks for taking my question.

I did have to join late, so I apologize if you touched on this, but last quarter, we talked quite a bit about Micron and the opportunity for downstream selling there -- the 400 and some compounds that they see being somewhat similar to the total number projects that you have. So on that front, I'm wondering if, in this short period of time, if you have had some traction or if you could give some color on the traction that you would anticipate getting in the relative near term.

So we are, as we speak, actively triaging their portfolio. And we are portioning it, according to the technology platforms that are most applicable for each molecule.

We're deploying business development resources as we speak. We didn't really have any revenue contribution specifically for the quarter, David. And I think it's just about timing of this.

We'll start to see development revenues first from the cross-selling opportunity. And those will occur, probably, towards the end of the second half and will be stronger in FY16.

And just to reaffirm what I think I heard you say -- that those would be opportunities that would show up in DCS first? Or would they not be in that segment?

It would be a combination. We would see some analytical and formulation and development revenue in analytical. But we would also see it within our long-cycle businesses who had their own and very specific formulation and development resources, which are specifically geared towards generating commercial revenues and having long-term contracts and products that would be in the portfolio for many years.

So we'll actually pursue it both ways. And so it's sort of two ways to win, when you think about cross-selling in Micron.

Got it.

And the development activities that are embedded within the long-cycle businesses -- are those revenue-generating activities? Or do you do that work on the [come], based on an expectation of getting the commercial manufacturing business down the road?

Yes. Those are revenue-generating activities for us. Those scientists are doing scientific work on a fee-for-service basis, and that is a number that we actually disclose. I disclosed it in my prepared comments, and we'll be doing it on a year-to-date basis.

And so for example -- I'll just review with you -- we had $62 million of formulation and development revenue in the long-cycle businesses. And it's actually up 32% over prior year. None of that is even Micron yet.

But I will tell you that in, our rack and stack across the industry and the formulation and development revenue that we get between our dev clin segment and what's embedded in our long-cycle segment -- Catalent's number one in the industry, in terms of formulation and development revenue and solving those customer challenges, which can be very difficult with our proprietary platform. And I'm sorry for the sales pitch, but I have to let you know that.

Okay. I wanted to, just quickly on DCS and the backlog -- and I know we don't want to get overly focused on book-to-bill different for your business than others. But what -- just thinking about growth there and what you need to be able to produce growth.

I saw on the slide that you talked about 1.0 trailing book-to-bill. Is that adequate, or are you expecting that to accelerate, perhaps, for some of the reasons you mentioned?

We would expect it to accelerate. Our second-quarter performance was on the low side of what we expected. And I think it -- we expect it to accelerate in the second half of the year.

And it would need to be in excess of 1.0 for us to be able to achieve the kind of growth that we want to achieve in the business. And so this quarter was just on the low side, but this will happen from time to time, especially because there are certain core -- and you know this very well, David, from your coverage of the CROs -- sometimes, things that get put into your portfolio in prior quarters and may be large signs, the customer just cancels the contract and then, the project goes nowhere, and it draws down your net new business wins. And we've had a little bit more of that than we expected to see.

Okay.

And my last questions, just coming back to it -- I think Gary might have asked this question earlier. But in terms of your front- and back-end load -- last quarter on the call, you were fairly clear about the business typically having back-end revenue load and back-end revenue growth load.

And I guess, I'm thinking that was fairly low into the 2Q. And I know you're saying that you can forecast the year better than the quarters, but I guess, I just want to get a little bit better understanding of why the pull forward into 2Q wasn't more visible three months ago?

We've got a broad and diverse business, David. And the combination of customer order patterns and how the products are doing in the market sometimes clouds my crystal ball, if you will, and can result in short-term changes that, generally, level out, over time. That's really the best explanation I can provide.

Okay. Thank you for that.

Thanks.

Your next question comes from the line of Sean Wieland with Piper Jaffray. Please proceed.

Thanks.

So I don't want -- I want to continue on that. Can you point to any macro drivers or externalities that would cause this year to be more front-end loaded than last year? Or is it just, pretty much, luck?

(multiple speakers) You go first. Sorry.

Okay. Thank you.

Our performance in any fiscal year is always much more tied to what our product slate is doing, versus what the industry is doing. And that is just the nature of the proprietary platforms that we have and the specialized nature of the products that are on them. So I can't point to a macro trend -- for example, Obamacare or some exogenous industry, sort of a macroeconomic factor -- that would be impacting the phasing of our business for this year. (multiple speakers)

Yes. So the second part, then, is what's to say that -- what would preclude first half of 2016 business slipping it up, getting pushed up into the second half of 2015?

There's a possibility of that happening. There can always be shifts of business, either into our out of a quarter, depending on, as I said, the end market demand for these products or supply chain considerations our customers.

So in the long run, Catalent sells medicines to patients, right? And there's people in the middle. In the short run, we sell to our customer supply chains. And the dynamic, there, can differ.

All right. Thanks for the thoughts.

Thank you.

And you last question comes from the line of John Kreger with William Blair. Please proceed.

Thanks very much.

And, Matt, actually just a follow-up on that last point. So at least, in the US, if you look at the IMS script trends, they've had of pretty nice uptick in the last several months. When, if at all, would you see that filter into higher-volume orders from your clients, at least from your domestic production?

That would depend on how many days of inventory our customers have in their supply chains for the products that we're selling. And that's different for every product. And even for a consistent product, our customers may change that, quarter-to-quarter, depending upon their view of -- their reading of IMS and other data.

So it's a difficult question for me to answer. Even if I were to try and take a broad average -- let's say, for example, at time zero, there's an uptick in IMS script trends that's material. When does that -- when can we see that running through Catalent's numbers?

It's a function of all of the 7,000 products that we have and the supply chain strategy for each of them. And it's difficult for me, sitting here, to be able to come up, really, with an answer you would find useful, John. I don't know if Cornell has anything to add.

The only other thing I would say is, thinking back over time, script and our [TRX] trends don't necessarily translate the same in volume of actual [tab caps], necessarily. When we talked about both brand and generics, which increased access to coverage versus what those more limited Medicaid or Medicaid-like plans are covering. So the script trends, by themselves, may not be representative of what's happening to the overall -- every product in the marketplace. So it really is about the specific products we touch -- [mobile day sales.]

Great. Thank you.

And another thing to clarify -- the new business metric that you gave -- $95 million for dev clin. On a book-to-bill basis, long-term, would it be reasonable to expect, maybe, a 1.1 book-to-bill? I know you said it needs to be north of 1.0, but could I get you to just be a little bit more specific on the type of number that you'd need to see, longer-term?

I would say, John, that, if we're at 1.1, 1.2 -- in that range -- this is something that will result in the kind of growth that we believe the business is capable of, which is mid- to high-single-digits. We believe that correlation exists.

Great. Thanks.

And just one last one -- your medication delivery performance was quite a bit higher than what we would have thought. In your view, it is that just seasonal variation? Or is your longer-term thinking on the underlying growth of that business, perhaps, inching up?

Our long-term perspective on the business hasn't changed. We happened to have a great quarter. We're happy that we did. But it doesn't cause us to move our long-term thinking about the business.

Great. Thank you.

Thanks.

If there's no further questions, we'd just like to thank everyone for joining us today. And we look forward to updating you again on our next conference call. Thanks for your time.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.