Catalent Inc (CTLT) 2016 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Catalent Pharma Solutions fourth-quarter FY16 earnings conference call.

(Operator Instructions)

I'd now like to introduce for today's conference, Mr. Tom Castellano, Vice President of Finance, Investor Relations, and Treasurer. Sir, you may begin.

Thank you.

Good afternoon, everyone, and thank you for joining us today to review Catalent's fourth quarter and FY16 financial results. Please see our agenda on slide 2 of our accompanying presentation, which is available on our Investor Relations website.

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.

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 detail.

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 uncertainty. We refer you to Catalent's Form 10-K, to be filed with the SEC later today, for more detailed information on the risks and uncertainties that have a direct bearing on the Company's operating results, performance, and financial condition.

As discussed on slides 4 and 5, on the call today we will 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 in our earnings press release, issued just a short while 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 President and Chief Executive Officer John Chiminski.

Thanks, Tom, and welcome, everyone, to our earnings call. I'm joining today's call from our softgel facility in Aprilia, Italy, where I just spent the day meeting with my local management team. Therefore, I'll only be providing some opening comments. We'll then turn the call over to Matt.

I'll start by discussing our financial accomplishments for the fourth quarter, which were strong, as we returned to year-over-year growth in revenue and adjusted EBITDA. As you can see on slide 6, our revenue for the fourth quarter increased 4% as reported, and increased 6% in constant currency, to $532 million, all of which was organic, with all reporting segments contributing to the growth. On a full-year basis, we continue to be pleased with our top-line performance, and recorded year-on-year revenue growth of 6% on a constant-currency basis, despite the challenges related to the Beinheim site suspension from November to April, and the softness we experienced in FY16 within our MRT product portfolio.

Our adjusted EBITDA of $141.8 million was above the fourth quarter of FY15 on a constant-currency basis by 7%, primarily due to our newly formed Drug Delivery Solutions segment. Matt will provide some additional detail related to our segment reporting changes later in the presentation.

Our adjusted net income was $64.9 million or $0.52 per diluted share for the fourth quarter. Additionally, we had a record year from a development revenue and new product introduction perspective, both of which we view as indicators of future commercial revenue growth.

Now moving to our key operating accomplishments during the quarter -- during the quarter, OPKO Health's NDA for RAYALDEE was approved by the FDA for treatment of patients with conditions related to chronic kidney disease, and marks the first FDA-approved product using Catalent's proprietary OptiShell softgel technology, which is a non-gelatin, plant-based shell formulation, and the first ever extended-release prescription softgel approved. We're pleased that OptiShell was selected as the optimum delivery method for the product, and that we're able to help OPKO bring this important drug to approval.

We also announced the launch of our Clinical Supply FastChain service during the fourth quarter, which enables us to operate at greater speed, and with greater flexibility and efficiency, in the management and distribution of global clinical supply to our customers and their trial participants. We've seen significant interest from many of our CSS customers who are looking for more flexible and innovative solutions to get to the clinic faster, and are already working with major pharmaceutical customers using this approach.

Finally, in the fourth quarter, we began moving forward with a $34 million expansion of our Madison biologics facility, which will add a 2 by 2,000 liter single-use bioreactor system to our capacity to meet customer demand for this fast-growing business. The new suite will be capable of running either 2,000-liter or 4,000-liter batches to support late-phase clinical and commercial production for our customers using single-use bioreactor technology. This expansion is an important part of our growth strategy, and builds on previous investments in our biologics capabilities.

In conclusion, I want to reiterate the dynamics of our industry and market remain very favorable, and our customers' needs for fewer, bigger, better suppliers will continue to be drivers of long-term growth.

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

Thanks, John.

I'll start my presentation by providing an update on changes we've made related to our reporting segment structure. Slide 7 shows both a view of our former reporting structure, as well as what the revised structure looks like. We recently engaged in a business reorganization to better align our internal business unit structure with our Follow the Molecule strategy.

Under the revised structure, which parallels and reflects how we manage our Business internally, we have created a Drug Delivery Solutions, or DDS, operating segment, which encompasses all of our non-softgel, long-cycle manufacturing platforms, and their associated short-cycle development services under one umbrella. DDS includes modified release technologies, pre-filled syringes and other injectable formats, blow-fill-seal unit dose development and manufacturing, biologic cell line development and biomanufacturing, analytical services, micronization technologies, and other conventional oral dose forms under a single DDS management team.

Additionally, as part of the realignment we have created a stand-alone Clinical Supply Services, or CSS, operating segment and management team, with sole focus on providing global clinical supply chain management services that aim to speed our customers' drugs to market. Further, as a result of the business unit realignment, our Softgel Technologies operating segment is now reported separately.

For financial reporting purposes, we present three financial reporting segments based on criteria established by US GAAP: Softgel Technologies, Drug Delivery Solutions, and Clinical Supply Services. And this is how we will manage and report our businesses going forward.

Moving to slide 8, in the business unit update, and starting with softgel, our softgel business turned in a strong quarter, and returned to growth of revenue and EBITDA at constant currency. Our softgel consumer health initiative, which is now in its latter stages in terms of its above-baseline impact on year-over-year sales growth, continued to gain traction within Latin America, Asia Pacific, and Europe. As a result of this initiative, we on-boarded a significant amount of new consumer health business in FY16, and have taken advantage of the available capacity within our network of 11 softgel facilities.

Our North American softgel business also had a strong quarter, posting double-digit revenue and EBITDA growth versus the prior year, driven by increasing levels of development revenue, and solid performance from our Rx portfolio. As a reminder, our Beinheim softgel facility is fully operational, and the ramp-up of activity at the facility continues to progress.

We're encouraged by the positive trends in the softgel business. We expect to see the trend continue into FY17.

The update for our newly created Drug Delivery Solutions segment is shown on slide 9. Recent investments in our biologics business continued to translate into growth during the fourth quarter, and it remains the fastest growing business within Catalent. We recorded strong revenue and EBITDA growth at our Madison facility, driven by the completion of project milestones and larger commercial programs.

The SMARTag technology continues to meet proof-of-concept milestones, and customer interest remains strong, as evidenced by our announcement of the research collaboration with Roche that we made earlier this year. We continue to believe that our biologics business is well positioned to drive future growth, and comprise an increasing percentage of our overall business. At the time of the IPO, our dedicated biologics business was approximately 1% of sales, and that has since grown to approximately 3% of sales in FY16, so more than doubling the business over approximately a two-year time frame.

The development and analytical services business within our DDS segment, which we abbreviate as DAS, recorded increased revenue and EBITDA, driven by higher levels of customer project activity. We continue to see strong revenue and EBITDA growth within our blow-fill-seal offering across the core business during the fourth quarter. Markets fundamentals for blow-fill-seal continue to remain attractive.

The modified release business, which is the largest business within this segment, delivered revenue in line with prior year levels, but EBITDA that was modestly below prior year, driven by unfavorable product mix. We believe that the challenges we've seen in this business during the fiscal year are behind us, and fundamentals remain strong. We expect this technology to return to growth as we enter FY17.

Within the sterile injectables business, revenue was modestly ahead of the prior year, but EBITDA declined modestly due to unfavorable product mix. Sterile injectables continues to be well positioned for near-term growth, with the entry to animal health pre-filled syringes, for which we anticipate commercial sales beginning in the middle part of next fiscal year.

In order to provide additional insight into our long-cycle business, which includes both Softgel Technologies and Drug Delivery Solutions, we're disclosing our long-cycle development revenue and the number of new product introductions, or NPIs. As a reminder, these metrics are only directional indicators of our Business, since we do not control the sales or marketing of these products, nor can we predict the ultimate commercial success of them. We do, however, expect these metrics to offer insight into the long-term organic growth potential of our long-cycle business. Due to the inherent quarterly variability of these metrics, we continue to provide the numbers on a year-to-date basis.

For the fiscal year ended June 30, 2016, we recorded development revenue of $156 million, an increase of 10% versus the same period of the prior fiscal year. Also in FY16, we introduced 184 new products, which is an increase of 12% compared to the number of NPIs launched in the prior fiscal year. As a reminder, the number of NPIs in any given period depends on the timing of our customers' product launches, which are often driven by regulatory body approvals, or at the discretion of our customers, and thus this figure will vary quarter to quarter.

Now on slide 10, our Clinical Supply Services segment posted strong organic revenue growth in the fourth quarter, driven by increased customer project activity. EBITDA was negatively impacted by the timing-related mix shift to lower-margin storage and distribution revenue from manufacturing and packaging revenue. Additionally, upfront costs related to operational efficiency initiatives also contributed to the EBITDA decline during this quarter. However, we're extremely pleased with the full-year revenue performance of this segment, which was up 10% versus prior year.

As of June 30, 2016, our backlog for the Clinical Supply Services segment was $292 million, a 9% sequential increase. The segment also recorded net new business wins of $106 million during the fourth quarter, representing a 10% increase year over year. The segment's trailing 12 month book-to-bill ratio was 1.2.

I'll now provide more details on our financial results for the fourth quarter. And as a reminder, all the segment revenue and EBITDA year-over-year variances I will discuss are in constant currency.

Turning to slide 11, revenue from the Softgel Technologies segment was $224.8 million for the fourth quarter of FY16, an increase of 4% compared to the fourth quarter a year ago. This performance was driven by higher end market volume demand for consumer health and prescription products, primarily in North America, Latin America, and Asia Pacific.

Softgel Technologies segment EBITDA for the fourth quarter of FY16 was $59 million, an increase of 5% versus the fourth quarter a year ago. The increase was primarily attributable to the higher end market volume demand for consumer health and prescription softgel products across North America, Latin America, and Asia Pacific, as well as from effective absorption of fixed costs through higher capacity utilization across the network.

Revenue from the Drug Delivery Solutions segment was $238.2 million for the fourth quarter, an increase of 10% over the fourth quarter a year ago. This strong performance was primarily driven by increased volumes related to fee-for-service development work and analytical testing in the US, and increased volumes related to our biologics and blow-fill-seal offering. Drug Delivery Solutions segment EBITDA for the fourth quarter was $75.7 million, an increase of 15% year over year. The increase was primarily driven by increased volumes related to fee-for-service development work and analytical testing in the US, increased biologics volumes, and higher demand for products utilizing our blow-fill-seal technology platform.

Revenue from the Clinical Supply Services segment was $81.5 million for the fourth quarter, an increase of 4% versus the year ago period. This growth was primarily due to increased volume related to core manufacturing, packaging, and storage and distribution activities.

Clinical Supply Services segment EBITDA was $13.7 million, a decrease of 7% year on year. The decrease was primarily due to upfront costs related to the network site consolidation to enhance operational efficiency, as well as further investments in infrastructure, project management, and business development efforts.

Turning to slide 12, we see in precisely the same format as on slide 11, the full-year performance of our operating segments, both as reported and in constant currency. We won't cover this slide in detail, but I would point out that we're quite pleased to report constant-currency revenue growth across all three of our reporting segments, and 6% growth for Catalent overall, with 5% of the 6% being organic growth. This is consistent with our constant-currency long-term objective of 4% to 6% revenue growth per year, which we managed to deliver despite the temporary suspension of operations at our Beinheim facility for nearly half of this fiscal year.

On slide 13, we provide for your benefit a reconciliation to the last 12 months EBITDA from continuing operations, from the most proximate GAAP measure, which is earnings from continuing operations.

Moving to adjusted EBITDA on slide 14, fourth-quarter adjusted EBITDA increased 4% to $141.8 million, compared to $136.3 million for the fourth quarter a year ago. Excluding the impact of FX translation, our fourth-quarter adjusted EBITDA increased 7% to $145.9 million, driven by strong EBITDA performance across our Drug Delivery Solutions and Softgel Technologies segments.

On slide 15, you can see that fourth-quarter adjusted net income was $64.9 million or $0.52 per diluted share, compared to adjusted net income of $33 million or $0.26 per diluted share in the fourth quarter a year ago. This slide also includes the reconciliation of earnings or loss from continuing operations to non-GAAP 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-backs as seen on the adjusted EBITDA reconciliation slide.

As a reminder, during our third-quarter earnings call, we noted that, in response to a regulatory focus on non-GAAP performance metrics, we have revised the calculation for adjusted net income. We made one change to the calculation, pertaining to the treatment of income taxes. We moved away from our prior convention, which included cash income taxes, and replaced it with book income tax expense as adjusted for discrete items.

But please note that our GAAP reported net income, GAAP EBITDA, and non-GAAP adjusted EBITDA were not impacted by this, and did not change. Our fourth-quarter and full-year 2016 adjusted net income results are presented in this format, as will the guidance for FY17 that we'll provide later in the presentation.

Now turning to slide 16, as of June 30, 2016, our net leverage ratio sequentially improved to 4.3, and our capital structure was essentially unchanged during the fourth quarter.

I'll now provide our financial outlook for FY17. As you can see on slide 17, we expect full-year revenue in the range of $1.92 billion to $1.995 billion. We expect full-year adjusted EBITDA in the range of $430 million to $455 million, and full-year adjusted net income in the range of $165 million to $190 million.

We expect in the range of $125 million to $135 million for capital expenditures. We expect that our fully diluted share count on a weighted average basis for the fiscal year ending June 30, 2017, will be in the range of 126 million to 128 million shares. It's important to note that the revenue and adjusted EBITDA ranges to which we are guiding are consistent with our constant-currency long-term outlook of 4% to 6% revenue growth and 6% to 8% adjusted EBITDA growth, adjusted upward for the anticipated recovery of Beinheim.

Slide 18 walks through some of the moving pieces that we considered when determining our FY17 revenue and adjusted EBITDA guidance. The first set of bars brackets the changes that we expect to see in our base business performance, which, as I mentioned earlier, aligns with our constant-currency long-term outlook of 4% to 6% revenue growth and 6% to 8% adjusted EBITDA growth.

The second set of bars shows the anticipated incremental growth related to Beinheim being back online for the full fiscal year. As we alluded to on last quarter's call, the Beinheim facility will not be operating at pre-suspension levels for the entire FY17, and this has already been incorporated into the guidance figures we just discussed.

The third set of bars brackets the negative FX translation impact to revenue and adjusted EBITDA year on year, principally driven by the decline in the pound sterling as a result of the Brexit decision. As a reminder, approximately 12% of our revenues are generated in pound sterling. However, we do have a natural hedge in place which will ensure that this FX impact is translational rather than economic. We expect the FX impact related to currencies other than the pound sterling to be generally neutral during FY17 compared to FY16.

Lastly, 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 the seasonality associated with budgetary spending decisions in the pharma and biotech industries, the first quarter of any fiscal year is generally our lightest quarter of the year by far, with the fourth quarter of any fiscal year generally being our strongest by far. This will continue to be the case in FY17, where we expect to generate approximately 40% of our annual EBITDA in the first half of the fiscal year, with approximately 60% in the second half.

It's also worth noting that in FY17, our first fiscal quarter is expected to be below the prior year period, given that our Beinheim facility was operating at pre-suspension levels of production during the first quarter of FY16, which is expected to impact Q1 EBITDA by approximately $6 million.

Operator, we'd now like to open the call for questions.

Thank you.

(Operator Instructions)

Our first question comes from the line of Tycho Peterson with JPMorgan.

Hey, guys, it's Tejas Savant on for Tycho. Just had a quick question on segment level growth rate embedded into your top line guidance. I know you said, Matt, there's some reorganization going on, and you've decided to realign the business. So we just wanted to get some color on how we should think about those segment level growth rates, and how they tie into your top line guidance?

Sure. So let's start with our softgel business, which would be on the lower end of the 4% to 6% long-term outlook. And the answers, I'm giving you, Tejas, are more long-term oriented versus anything specific related to FY17, specifically. So this is really just generally over the course of let's say, a strategic planning time period, we would expect our softgel business to grow towards the lower end of the 4% to 6%. We would expect our new DDS segment to grow towards the middle to higher end of that 4% to 6%. And our CSS business would also grow towards the higher end of that, or even potentially a little above the higher end of the 4% to 6%.

Got it. That's helpful. And then, in terms of margins, I mean, obviously in FY17, you had some issues with higher comparator sales, also some mix issues in blow-fill-seal. How should we think of the puts and takes there, and how that translates into your margin expectations for 2017?

So I think if you look at the midpoint of our guidance ranges, you would see that our adjusted EBITDA margin expectation for FY17 are a little bit above where they were full year FY16. So we do expect margin appreciation, FY17 versus FY16.

Got it. And then, one final one here for me, in terms of how we should think about capital deployment? I mean, obviously one of the questions we've been getting of late is Catalent has been relatively quiet, and less than, I guess, less acquisitive compared to a lot of people's expectations at the time of the IPO. Should we expect that to materially change in 2017? Could we see you enter areas like commercial scale manufacturing and APIs, particularly within biologics? So any color on that would be helpful.

Sure. I will tell you that our level of interest, and our level of effort expended on pursuing M&A activities has not changed. The deal flow that results from that is, as you stated less than people's expectations. I would say it's probably less than management's expectations. But we continue to look for viable acquisition candidates that will improve our overall results and returns on capital, and we will continue to do that in FY17.

Just as a reminder, we completed three acquisitions in our first year out, as a public company, and then none during FY16. But we have been just as active analyzing targets over that entire time period, and that continues. So it's hard for me to predict when deals will cross the finish line, and we're able to have -- announce completed deals.

But I can tell you in terms of capital deployment, our overall strategy remains the same. We will continue to aggressively reinvest organically in the business. That's our first priority to generate attractive returns on capital. Second priority would be growth through M&A to expand areas of our business, where we can accelerate growth versus what we can do organically.

You cited biologics, as an example. I would say that is certainly an area of the Company that we're aggressively growing organically. John alluded to the $34 million capital expansion that we'll be doing organically. We're also looking at external growth targets in that area as well.

Awesome. Thank you so much, Matt.

Thank you.

Thank you. Our next question comes from the line of Ricky Goldwasser with Morgan Stanley.

Hi, this is Mark Rosenblum on for Ricky. So can you guys just give us, going back to the margin point, when we look at margins in FY14 and FY15, they were around 24%. I know last year was impacted by currency in Beinheim. What -- where do you see the margins going longer term, and what kind of expansion do you think you can achieve, I guess, beyond FY17?

Sure. I think the margin picture this year, and you gave part of the answer yourself, Mark, was Beinheim. The other piece of the equation for us, as impacting margins in 2016 was the performance of the MRT product portfolio, where we experienced volume declines in some of our higher margin products. Obviously, both of those situations are turning around in FY17, versus FY16, so we do see a recovery in margins coming. And over a longer term horizon for the business, and we would continue to see EBITDA margin expansion opportunities in the 200 to 300 basis point range, as driven by principally asset utilization across our network, as well as our higher margin businesses growing preferentially faster than our lower margin businesses.

Okay, thanks. That's helpful. And then, on the revenue side, the 4% to 8% growth looks really good. Can you give a sense of what type of visibility you have into it, and what portion of that revenue growth is covered by orders?

Sure. So in a long-cycle business, we have -- which comprises our softgel reporting segment, as well as the vast majority of our DDS reporting segment, we go into every fiscal year, but with approximately 75% of that volume under contract. And while our firm order window is approximately 60 to 90 days, we are getting rolling annual forecasts from our customers, so we have a good idea of what volumes are coming to us.

So we start every fiscal year with good visibility into what's the long-cycle businesses will be doing. Where we see variability inevitably ends up being in new products launches, and we try as best as we can to forecast the timing of those. That's certainly challenging to do, as products generally launch later than our customers say that they will. But that's where we tend to experience the most variability, in terms of the otherwise quite stable outlook that we see for the bulk of the 7,000 products that we manufacture.

Okay. All right. Thank you. I appreciate the answers.

Thank you.

Thank you. Our next question comes from the line of Dave Windley with Jefferies.

Hi, thanks. Good afternoon, Matt, and the group, Tom, et cetera. I wanted to clarify, on the clinical services business update if I could, Matt. I didn't catch if you did say, how much costs you incurred related to that? And if we should view that -- is that essentially a restructuring that you are not calling out as a restructuring charge? I just wanted to understand the nature of that a little bit more specifically?

So we are consolidating one of our sites David. It was announced, it was November of 2015. We're consolidating our Deeside, Wales site into our other UK operating sites, and that's occurring this year, and a little bit into next year. And it comprises a large portion of the Q4 GAAP restructuring add back in our adjusted EBITDA table.

Okay. So -- all right, so maybe I missed it. I guess, I thought that that was -- that you attributed EBITDA margin, I thought you attributed adjusted EBITDA margin declines to that. But is that -- was that actually just GAAP EBITDA margin decline?

So that was part of the explanation, as not all the costs qualified for GAAP restructuring. And if they don't, we generally leave them in our reported adjusted EBITDA. So yes, it was part of the margin explanation, but it is -- but some of those costs also show up in the adjusted EBITDA calculation. The other parts of the margin bridge are related to the sales mix during the quarter. So we had relatively more comparator sales year-on-year.

And we also had more mix for storage and distribution within the core part of the CSS offering, which is comprised of manufacturing and packaging, and then storage and distribution. Of those two core activities, we did relatively more storage and distribution revenue during the quarter, which carries modestly lower margins than manufacturing and packaging.

Got you. So to come back to the restructuring, is it possible to quantify the amounts of the restructuring that actually stayed in the adjusted P&L?

It's approximately $1.5 million. I'd say $1 million to $2 million, and then target, [part at] the midpoint.

Okay. And then, maybe on the margin question more broadly, just doing the quick math, it looked like if I added back the mid points of the Beinheim numbers that you include in your bridge, that an adjusted 2016 would have been about 22.3% adjusted EBITDA margin, and your guidance suggests about 22.6%. So up slightly, which I think is consistent with what -- one of your earlier answers.

Right.

Is there -- I suppose I'm grasping for capacity utilization that might normally push that up more in a year? Or other factors that maybe would be offsetting that, like you're maybe anticipated some negative shift in mix that would be offsetting capacity absorption?

No, I think it's -- I think that it's more just the Company's desire to put out a very responsible set of guidance figures that the Company will be, that has a very high level of confidence in meeting.

Okay, understood. And then, my last question and I'll yield, is just a navigation item. So you give us the long-cycle development work number. And I know that that revenue has been embedded in long-cycle segments I think, but maybe not all. And so, I just wanted to understand under the new segments, where is that development work that -- the predecessor to your long-cycle opportunities, that development work, where does that reside?

That resides in the softgel technologies segment and the DDS segment. There is no development revenue within the CSS segment.

Okay. All right. Thank you.

Thanks.

Thank you. Our next question comes from the line of Tim Evans with Wells Fargo Securities.

Thank you. Matt, would you be willing to call out how much Beinheim revenue and EBITDA you got back in Q4?

So we don't disclose plant by plant economics, Tim.

Okay, I guess, what I'm trying to get at is, the range for Beinheim in your guidance bridge seems fairly wide to me. And you called out that, that you weren't expecting to get everything back. And so, my two questions I'm kind of driving at are, how much of this point do you think you won't get back? And I guess, is that range in your guidance bridge reflective of some uncertainty around how much you will get back?

So it's less uncertainty as regards customers and products. What we're trying to be responsible about is the timing of when, not just production of certain products will resume, but how the ramp will be. And what sort of productivity, labor and equipment productivity progression we will see. So that's more the driver of the range.

Okay. And just thinking longer term, putting aside the timing issue, do you feel like 90% of that revenue will come back? Is it lower than that? Just some sort of estimate of how much you'll ultimately feel comfortable that you will get back?

So that's a difficult question to answer at this point. What I can say is, the estimates that we've put into our FY17 guidance are imminently achievable. We have a high level of confidence in the Beinheim projections that are a part of that guidance.

Got you. Thank you for your help.

Thank you. Our next question comes from the line of Derik de Bruin with Bank of America.

Hi, good afternoon.

Hi, Derik.

Hey, can you give us a little bit more specific guidance on net interest expense and the tax rate? I mean, I'm following with the same sort of issue, it's like you were spot on, in terms of your EBITDA forecast for 2016 in terms of the center of your guidance. But I'm sort of falling below on the net income line. So can you just give us a little bit more guidance on the specifics on how to look about those two items, net interest expense and tax?

Yes, yes. So for net interest expense, we think we'll see something in the range of $90 million to $93 million this year, FY17, and our effective tax rate will be in the range of 30% to 32%.

Got it. Okay. So the net interest expense is quite a bit higher than what I had modeled. Are you not paying down debt as fast, or I'm just curious why the increase above 2016?

It's possible that any changes in net interest expense are not as much driven by our actual bank debt, as they are by the imputed interest expense related to capital leases, Derik. That's the only thing I'm thinking of.

Okay. Yes, that's the biggest, okay. Yes, so that's the biggest -- all right --that's the biggest delta in my model on that. Okay, that's helpful, thanks. So and can you just talk a little bit about the -- you called out in the drug development segment, you had a milestone payment this quarter. Can you sort of call that out, and should we assume it doesn't repeat for next year, what we're doing for modeling purposes?

We didn't have any one-time milestone payments on the order that we typically discuss, which would be things like contract amendments, or contract termination fees that would be sporadic in nature, and would be the kind of thing you'd want to take into account as regards to modeling. The milestone payments that I referred to in the prepared comments are absolutely normal course, and we're looking to grow those just as part of our normal operations. And where I think I referenced that in the prepared comments was in relation to our biologics business, which that's how they are recognized, the revenue in the SMARTag business, and a portion of our biologics manufacturing business. So that will absolutely continue.

Got it. And then, just one final question. You're talking about -- how's the mix going, I mean, with things like the new consumer products, and you're talking about going into the animal pre-filled syringe market? I mean, are those, are you seeing increased mix pressure on the overall business?

We're not -- so I guess, I would start by saying, that we're not seeing any margin pressure within individual verticals. We may see mix moving quarter to quarter. I think in our softgel business, our overall consumer health presence is growing. That can come at lower margins. If -- or excluding the impact of Beinheim on the numbers this year, what you would have seen was, the margin impact of more consumer health business being offset by asset utilization.

That ended up being what we saw for 2016. For 2017, we are seeing that sort of stabilize 2017 versus 2016 within the softgel business, but the Beinheim recovery is going to be overall margin accretive for the softgel business. The only other place where we see mix issues meaningfully impacting the numbers quarter to quarter would be in the clinical supply business, where we may have lumpy performance on comparator sales, which is very low margin business versus the rest of the core offerings. But we factored that all into our guidance for FY17. So we think we've got it covered, based on the way that we see our markets progressing now.

Great. And then, just one final question, and I'll jump out. Once again, looking at the net income calculation, there's a lot of variability in the other income expense net item there. And that once again, seems to be a little bit of a delta, to look at where my numbers are. Is there any sort of general guide on that for the year?

Well, so what tends to move that other expense adjustment line item is non-cash foreign currency movement gains or losses on what is often intercompany debt. And so, it ends up being pretty unpredictable, Derik, even for us.

Okay, great. Thank you.

Thank you.

Thank you. Our next question comes from the line of John Kreger with William Blair.

Hi, thanks very much. Matt, can you just talk a little bit about cash flow? It looked like your free cash flow in the year ended up at about $18 million. Can you give us a sense of what that number might have been on a normalized basis without Beinheim? Or put another way, what sort of free cash flow level would be a reasonable expectation for 2017?

So when we think about that, John, we would generally target approximately 70% to 80% of our adjusted net income figure resulting in free cash flow.

Okay, great. And then, 2017 would be -- no reason to think 2017 would be outside of that typical range?

No, it should be consistent.

Great, thanks. And then, can you talk -- maybe just expand a little bit more on the segment realignment that you walked us through? What drove the timing, and was that purely just a change in your recording structure, or is there an underlying reorganization that took place as well?

Well, it's the underlying reorganization of how we manage the business internally that prompted it. And so, during the course of the year, the businesses that now report in the DDS segment are under one business leader within Catalent -- that's Barry Littlejohns is the President of the DDS division. And during the course of the year, he has been afforded more responsibility for those units. So it just makes complete sense, that we would then reorganize the reporting structure that way.

I actually think this is a very nice improvement -- not just because it's the way we manage the business, but because now we have more evenly sized segments. You'll recall the prior structure had one relatively large segment and two pretty small ones. Now we've got two segments that are approximately the same size, and the clinical services segment being a service-oriented short-cycle segment on its own, that's now easy to see. So I think that it's a good development, not just because it's how we manage the business, but I think it provides better insight for people that are following the Company, or trying to follow the Company.

Great, thanks. And one last one. Can you talk a bit about your facility capacity utilization across the portfolio? Are there particular areas where you're underutilized, so we could expect some margin gains? And are there areas, where we should be thinking about a step up in CapEx to add more market capacity? Thanks.

Sure, John. So we talked about the capital expenditure project to expand our capacity in biologics. We put, just under $30 million into the Madison facility just a couple of years ago. That capacity is more or less already called for. And the investment that we'll make, will enable us to continue to accommodate the strong organic growth that we see within the biologic business, so that's good.

I expect to see increasing asset utilization in the DDS segment, specifically within the MRT business. The Winchester expansion which we made over the last couple of years, we will be able to grow into that over the next -- probably the next three to five years. So we should see good margin expansion opportunity because of that. And then, I think the rest of the network is pretty, pretty balanced.

Excellent. Thank you.

Thanks, John.

Thank you.

(Operator Instructions)

Our next question comes from the line of Shawn Wieland with Piper Jaffrey.

Hi, thank you. So in the modified release business, you cited last quarter some lower customer demand. I want to know, how did that play out in the fourth quarter, and can you give us what the growth rate was for the year in the modified release business?

So I'll start with the first part, Sean. So for the first three quarters of the year, you're quite correct, that we saw volume declines in some of our higher margin product in the controlled release segment. That started to turn around in the fourth quarter, and more normal order patterns returned for those products during the quarter, that gave us confidence when we were putting together the FY17 guidance, that we would see order patterns FY17, that more paralleled FY15 and years prior, and patient consumption for those medications.

Because part of -- a significant part of the reasons why we were seeing lower volume in the first three quarters of FY16 were supply chain issues, and our customers had sufficient inventory of the products we were making. Those inventory stores have been worked down, and we expect in FY17, that our manufactured volumes will more closely parallel patient consumption of the product. And we started to see -- and the confidence that we have that will be the case, is the actual volumes that we manufactured in Q4.

And in terms of the growth rate year-on-year, across the entire MRT portfolio was down about 5% to 7% year-on-year, and we expect in 2017, that growth will rebound in the MRT business. It will look more like our long-term expectation of 4% to 6%. What's good about that is, once again, these are relatively higher margin products in the controlled release segment, so the bottom line impact should be good.

Okay. And then, the other piece that you moved around in the reorganization is the development and analytical services out of -- I guess, went into DDS now, is that right?

That's correct.

What's the growth profile of that segment?

That should be towards the higher end of our 4% to 6% expectation, maybe even a little bit beyond the high end.

Okay. That's helpful. Thanks so much.

Thanks, Sean.

Thank you. And I'm showing no further questions at this time. I'd like to turn the conference back over to Mr. John Chiminski for any final remarks.

Thank you, operator. In conclusion, we're pleased with the favorable trends in our base business, and a return to year-over-year growth in revenue and EBITDA in the fourth quarter. We look forward to carrying this momentum into FY17, as we turn the page on Beinheim, and remain well-positioned to capitalize on our industry-leading partnerships. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day.