Catalent Inc (CTLT) 2018 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Fourth Quarter Fiscal Year 2018 Catalent Inc.

Earnings Conference Call.

(Operator Instructions) As a reminder, this conference call may be recorded.

I would now like to introduce your host for today's conference, Mr. Tom Castellano, Vice President, Investor Relations and Treasurer.

Please go ahead.

Thank you, Crystal.

Good morning, everyone, and thank you for joining us today to review Catalent's Fourth Quarter and Fiscal Year 2018 Financial Results.

Please see our agenda on Slide 2 of our accompanying presentation, which is available on our Investor Relations website.

Speaking today for Catalent are myself, John Chiminski and Wetteny Joseph.

During our call today management will make forward-looking statements and refer to non-GAAP financial measures.

It's possible that actual results could differ from management's expectations.

We refer you to Slide 3 for more detail.

Slide 3, 4 and 5 discuss the non-GAAP measures, and our just-issued earnings release provides a reconciliation to the nearest GAAP measures.

Catalent's Form 10-K, to be filed with the SEC later today, has additional information on the risks and uncertainties that may bear on our operating results, performance and financial condition.

Now I'd like to turn the call over to John Chiminski.

Thanks, Tom, and welcome, everyone, to our earnings call.

We're pleased with our fourth quarter and fiscal year 2018, which were in line with our expectations and position us well as we enter our next fiscal year.

We continue to deliver strong revenue and adjusted EBITDA growth across the company led by our newly formed segment, Biologics and Specialty Drug Delivery as well as from our Clinical Supply Services segment.

As a reminder, we are now reporting on 4 segments, having split our former Drug Delivery Solutions segment into a Biologics and Specialty Drug Delivery segment and an Oral Drug Delivery segment.

Our other segments remain the same.

As you can see on Slide 6, our revenue for the fourth quarter increased 11% as reported and increased 9% in constant currency to $685.3 million, driven by the acquisition of our Bloomington Biologics business, the former Cook Pharmica.

Our adjusted EBITDA of $181.5 million was above the fourth quarter of fiscal year 2017 on a constant-currency basis by 11%.

Our adjusted net income for the fourth quarter was $90 million or $0.67 per diluted share for the fourth quarter, an increase of $0.02 per diluted share versus the prior year, reflecting in part a greater number of outstanding shares due to equity issued as part of the Bloomington acquisition.

Additionally, for fiscal year 2018, we recorded revenue growth of 19% as reported and 16% in constant currency, while recording adjusted EBITDA growth of 22% as reported and 19% in constant currency.

Now, moving to our key accomplishments.

First, on July 3, we announced the acquisition of Juniper Pharmaceuticals, a European early development center of excellence with dose-form development and early manufacturing capabilities.

The acquisition builds on our acquisition of Pharmatek completed in fiscal year 2017, and expands and strengthens our offerings in formulation, development, bioavailability solutions and clinical scale, oral dose manufacturing.

Juniper's proven solutions and capabilities will further support our strategic goal to be the most comprehensive partner for pharmaceutical innovators and help our customers unlock the full potential of their molecules with the intent to provide better treatments to patients faster.

Juniper's nearly 150 employees at their Nottingham facility have deep scientific expertise in formulation development and supply, and their breadth of technological capabilities will augment our current portfolio, including in the development of spray dry dispersions.

Next, just last month, we issued 11.4 million shares of common stock at a price to the public of $40.24, yielding net proceeds of $445 million.

The proceeds were used, along with cash on hand, to pay down $450 million of our U.S. dollar denominated term loan floating rate debt.

These strategic steps have significantly strengthened our balance sheet and give us additional capacity to continue to accelerate our strategic plans through acquisitions.

Later in the call, Wetteny will take us through the impact this transaction has on our leverage ratio in fiscal year 2019 financials.

We continue to make great strides with regards to our Biologics strategy.

First, the integration of the Bloomington business acquired in the second quarter is progressing ahead of our expectation and is very far advanced.

The business is off to a terrific start, and for the third straight quarter, the financial results have exceeded our expectations.

I'm pleased to report the Bloomington site recently received approval for its 17th commercial product, which is up from the 12 it was producing at the time of the acquisition.

Additionally, the third manufacturing train at our Madison facility is complete and began contributing revenue during the fourth quarter.

As mentioned on previous earnings calls, we already signed a number of customer contracts for the third train, while also growing a robust funnel of late-stage clinical opportunities, which together will help increase the utilization of the new capacity in fiscal year 2019 to more than 50%.

We're also in the early stages of considering the construction of 2 additional manufacturing trains at the Madison site due to the anticipated continued growth in this business.

A combination of the organic and inorganic investments we've made in biologics continue to create significant value for the company, our customers and our shareholders.

I also wanted to provide a few remarks regarding our Softgel Technologies business, which has historically, on average, grown revenue somewhere between 2% and 4% each year, with EBITDA margins that have been very steady in the 21% to 22% range.

However, due to recent headwinds related to product participation revenue, a shortage of ibuprofen API and a shift by our prescription pharmaceutical customers to lower-volume new product launches targeting smaller patient populations, we expect our Softgel Technologies business to grow closer to the lower end of its historical revenue growth rates over the next few years.

However, we continue to make improvements to optimize capacity across the network and organize around centers of excellence to support business needs and product focus, and we expect that these actions will drive margin expansion across the segment over the next several years and contribute to the 160 basis points of margin expansion we've included in our fiscal year 2019 guidance.

As a reminder, Softgel Technologies is responsible for generating a significant portion of the company's free cash flow, which we expect to continue and provide us the flexibility to invest in our faster growing, higher-margin businesses, such as biologics.

Lastly, I'll reiterate that we are positioned increasingly well in an attractive robust growing market.

We have important leadership, scale and diversification, which we further enhance with our growing participation in biologics.

With our proven Follow the Molecule strategy, our patient first focus, our operational excellence and our ongoing growth investments, we are positioned to deliver future organic revenue and earnings growth.

Now, I'll turn the call over to Wetteny Joseph, our Chief Financial Officer, who'll take you through our fourth quarter fiscal year 2018 financial results as well as provide our outlook for fiscal year 2019.

Wetteny?

Thanks, John.

I will start by providing an update on changes that we have made related to our reporting segment structure.

Slide 7 shows both the view of our former reporting structure as well as what the revised structure looks like.

In light of the Bloomington Biologics deal, we reorganized our business to better align our internal business unit structure with our biologics strategy.

Under the revised structure, which parallels and reflects how we manage our business internally, we have split our Drug Delivery Solutions operating segment into 2 segments, Biologics and Specialty Drug Delivery and Oral Drug Delivery.

Our Biologics and Specialty Drug Delivery segment encompasses manufacturing, development of biologics cell lines, blow-fill-seal unit doses, prefilled syringes, vials, cartridges and other injectable and inhaled formats; analytical development and testing services for large molecules; and development and manufacturing for inhaled products for delivery via metered dose inhalers, dry powder inhalers and intra-nasal sprays.

Our Oral Drug Delivery segment includes comprehensive formulation, manufacturing and analytical development capabilities using advanced processing technologies, such as bioavailability enhancement, controlled release, particle size engineering; and taste masking for solid oral dose forms.

There is no change to our Softgel Technologies or Clinical Supply Services segments.

Therefore, for financial reporting purposes, we present 4 segments: Softgel Technologies, Biologics and Specialty Drug Delivery, Oral Drug Delivery and Clinical Supply Services.

Next, please turn to Slide 8 for a more detailed discussion on segment performance, beginning with our Softgel business.

As in past earnings calls, my commentary around segment growth will be in constant currency.

Softgel revenue of $241 million declined 7% during the quarter, with segment EBITDA declining 8%, due to lower high-margin product participation revenue and lower consumer health and prescription volumes in North America and Europe, partly due to the shortage of ibuprofen, an active pharmaceutical ingredient, as discussed on our last few earnings calls.

Our Canadian Softgel business acquired as part of the Accucaps deal during the third quarter of the prior fiscal year continued to perform well and realized strong EBITDA growth in the quarter, driven by favorable product mix and operational efficiencies at the sites.

Additionally, we experienced higher demand for consumer health products in Latin America and a favorable product mix in Asia Pacific, post the divestiture of lower-margin businesses in Australia and China, while these growth drivers were not large enough to overcome the headwinds related to product participation and the ibuprofen shortage.

Going into fiscal year 2019, we expect the ibuprofen shortage to continue for the first half of the fiscal year and the product participation headwinds to continue through the first quarter of the fiscal year.

As a result, we expect Softgel revenue to grow at the lower-end of the segment's historical annual revenue growth rate during fiscal year 2019, as John mentioned earlier.

Slide 9 shows that our newly created Biologics and Specialty Delivery segment reported revenue of $195.5 million in the quarter, which was up 98% versus the comparable prior year period, with segment EBITDA growing 151% during the quarter.

A sizable portion of the segment's revenue and EBITDA growth was driven by the Bloomington Biologics acquisition, which closed in October of 2017, contributed 71 percentage points to the revenue growth and 116 percentage points to the EBITDA growth.

The Bloomington site continues its fast start, and we feel good about the immediate and long-term growth prospects of this business.

The addition of our Bloomington site strengthens our position as a leader in biologics development, analytical services and finished product supply.

Catalent Biologics, including both Bloomington and our preexisting businesses, can provide integrated solutions from protein expression through commercial supply of biologics in a variety of finished dose forms.

The acquisition filled a major gap we had in our biologics offering by adding fill-finish formulation, development and manufacturing capabilities, including lyophilization, vial filling, cartridges and U.S.-based sterile formulation and prefilled syringes to our already strong drug substance and sterile capabilities.

As we are seeing in the numbers, the acquisition of the Bloomington site significantly accelerates the already strong growth of our existing biologics business.

Biologics comprised approximately 14% of Catalent's consolidated revenue in fiscal year 2017 and represented 26% in fiscal year 2018.

On an organic basis, the Biologics and Specialty Drug Delivery segment revenue was up 27%, with segment EBITDA increasing 35% during the quarter.

Recent organic investments in our legacy biologics business continued to translate into growth during the fourth quarter, and it remains the fastest-growing business within Catalent.

We recorded strong growth in drug substance, driven by the completion of project milestones and larger clinical programs and higher volumes related to our European drug product business.

We continue to believe that our biologics business is positioned well to drive future growth.

As John mentioned, the third suite at Madison is complete and online, and it contributed revenue during the fourth quarter.

Additionally, our blow-fill-seal offering recorded results during the fourth quarter that were nicely above the prior year period due to increased volume and stronger levels of capacity utilization.

The steps we have taken to enhance our quality and manufacturing protocols and processes at the site where our blow-fill-seal business is based are largely complete.

Market fundamentals continue to remain attractive for this key sterile fill technology.

Slide 10 shows that our other newly created segment, Oral Drug Delivery, recorded revenue of $153.7 million in the quarter, which was down 14% versus the comparable prior year period, with segment EBITDA declining 27% during the quarter, partly related to a contractual settlement that was recorded in the prior year period.

Consistent with the first 3 quarters of the fiscal year, the segment experienced declines in high-margin product participation revenue during the fourth quarter, which was aligned with our expectations.

On the positive side, we finally lapped these headwinds during the quarter, and we don't expect any material movement related to product participation revenue in fiscal year '19.

We also experienced volume declines within our analytical development services business, but the performance did improve from the third quarter, which we anticipated due to the changes we've implemented.

The oral solid commercial business in the U.S. and Europe saw volumes that were in line with the fourth quarter of the prior year, but unfavorable product mix had a negative impact on profitability.

That being said, the end market demand for oral solids across both the U.S. and Europe remain robust.

In order to provide additional insight into our long-cycle businesses, which now include Softgel Technologies, Biologics and Specialty Drug Delivery and Oral Drug Delivery, we are disclosing our long-cycle development revenue and the number of new product introductions, or NPIs, as well as revenue from 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.

For the fiscal year ended June 30, 2018, we recorded development revenue across both small and large molecule of $268 million, which is 8% above the development revenue recorded in the prior fiscal year.

In addition, we introduced 207 new products, which contributed $61 million of revenue in the fiscal year, which is 45% more than the revenue contribution of NPIs launched in the prior fiscal year.

As a reminder, the number of NPIs and the corresponding revenue contribution in any given period depend on the type and timing of our customers' product launches, which are often driven by regulatory approvals or are at the discretion of our customers, and thus these figures will continue to vary quarter-to-quarter.

Now, as shown on Slide 11, our Clinical Supply Services segment posted revenue of $107.6 million, which was up 5% compared to the fourth quarter of the prior year, driven by increased customer product -- project activity across our core storage and distribution services, partially offset by a decline in lower margin comparator sourcing activity during the quarter.

Segment EBITDA increased 20% compared to the fourth quarter of the prior year, primarily driven by the revenue growth in our core storage and distribution services business and improved capacity utilization across the network.

Given the low margin of the comparator sourcing activity, it had a minimal impact on segment EBITDA in the fourth quarter.

All of the revenue and segment EBITDA growth recorded within CSS was organic.

As of June 30, 2018, our backlog for the CSS segment was $273 million, a 2% sequential increase.

The segment recorded net new business wins of $93 million during the fourth quarter, which is an increase of 60% compared to the net new business wins recorded in the fourth quarter of the prior year.

The segment's trailing 12-month book-to-bill ratio was 0.9.

It is important to note that the backlog and net new business wins figures, that I just disclosed, have been adjusted for the ASC 606 change in revenue accounting and now only include comparator revenue on a net basis.

The next slide contains reference information.

We have already disclosed the segment results shown on the consolidated income statement by reporting segment on Slide 12.

Slide 13 shows, in precisely the same presentation format as on Slide 12, the fiscal year performance of our reporting segments both as reported and in constant currency.

I won't cover the variance drivers across the business, but I will highlight that our full year 16% constant currency revenue growth or 5% growth on an organic basis was right in line with our long-term objective of 4% to 6% organic revenue growth per year.

Slide 14 provides reconciliations of the last 12 months of EBITDA from continuing operations from the most proximate GAAP measure, which is earnings from continuing operations.

This bridge will assist in tying out the reported figures to our computation of adjusted EBITDA, which is detailed on the next slide.

Moving to adjusted EBITDA on Slide 15.

Fourth quarter adjusted EBITDA increased 14% to $181.5 million.

On a constant-currency basis, our fourth quarter adjusted EBITDA increased 11%, all of which was inorganic and driven by the Bloomington Biologics acquisition.

On Slide 16, you can see that fourth quarter adjusted net income was $90 million or $0.67 per diluted share compared to adjusted net income of $82.6 million or $0.65 per diluted share in the fourth quarter a year ago.

This slide also includes a reconciliation of earnings from continuing operations to non-GAAP adjusted net income in a summarized format.

A more detailed version of this reconciliation is included in the supplemental information section at the end of the slide deck, and shows essentially the same add-backs as seen on the adjusted EBITDA reconciliation slide.

Additionally, during fiscal year 2018, we recorded a onetime net charge of $42.5 million within our income tax provision as an estimate of the net accounting impact of the U.S. tax reform passed in December.

We expect only approximately $3 million of this charge to be paid in cash after considering the use of certain NOLs.

Given the significant complexity of the provisional estimate we've recorded in the fiscal year, it is important to reiterate that it may require further adjustment over the next 2 quarters.

Slide 17 shows our capitalization table and capital allocation priorities.

Our total net leverage ratio on a reported basis as of June 30 was 4.2x, which was down from the 4.5x we recorded in the third fiscal quarter.

However, as John mentioned earlier, we proactively paid down $450 million of our U.S. dollar denominated term loan in July with the proceeds from the equity offering.

Therefore, if you calculate our leverage ratio on a pro forma basis, taking into account the Bloomington Biologics acquisition, the pay down of debt and the Juniper acquisition we closed on August 14, our total net leverage ratio would be 3.4x, which is the lowest level in Catalent's history.

Additionally, the pay down of $450 million of our most expensive floating rate debt will yield an annualized interest rate savings of more than $20 million.

I also want to highlight the strong free cash flow generation we realized in fiscal year 2018.

We generated approximately $200 million of free cash flow during the fiscal year, which is approximately 86% of adjusted net income.

This is nicely above our expectations going into the year and marks the second consecutive year in which we have pulled more than 85% of our adjusted net income through to free cash flow.

Finally, our capital allocation priorities remain unchanged and focus first and foremost on organic growth followed by strategic M&A.

Turning to our financial outlook for fiscal year 2019.

Slide 18 shows that we expect full year revenue in the range of $2.5 billion to $2.59 billion.

We expect full year adjusted EBITDA in the range of $597 million to $622 million; and full year adjusted net income in the range of $260 million to $285 million.

We expect in the range of $175 million to $185 million for capital expenditures.

And we expect that our fully diluted share count on a weighted average basis for the fiscal year ending June 30 will be in the range of 146 million to 147 million shares.

Slide 19 walks through some of the moving pieces that we considered when determining our fiscal year 2019 revenue and adjusted EBITDA guidance.

The first set of bars bracket the changes that we expect to see in our base business performance, which aligns with our constant currency long-term outlook of 4% to 6% revenue growth, but is slightly stronger at the EBITDA line and assumes 7% to 9% adjusted EBITDA growth.

These assumptions yield anticipated EBITDA margin expansion of 160 basis points in fiscal year 2019.

As a reminder, our long-term EBITDA growth outlook remains at 6% to 8% growth.

The second set of bars adjusts FY '19 for the full year impact of 2 acquisitions.

First, the Bloomington acquisition was completed in Q2 of fiscal year 2018.

So there is 1 quarter of incremental contribution in fiscal year 2019 before we lap the transaction.

Second, the Juniper acquisition was completed on August 14, and its expected revenue and EBITDA contribution for the 10 months of fiscal year 2019 in which we will own the asset is also included in this adjustment.

The third set of bars highlights the impact of the revenue recognition change related to ASC 606.

As a reminder, effective in the first quarter of fiscal year 2019, the revenue we generate from securing comparator drugs from third parties on behalf of our customers within our Clinical Supply Services segment will now be treated as net versus gross.

This means we have a headwind at the revenue line of approximately $110 million compared to the prior fiscal year with no impact to the EBITDA line.

For more disclosure on this change, please see our Form 10-K, which will be filed with the SEC later today.

The last set of bars bracket the negative FX translation impact to revenue and adjusted EBITDA on -- year-on-year, principally driven by the recent strengthening of the U.S. dollar in relation to the euro and pound sterling and to a smaller extent the Argentinian peso and Brazilian real.

In fiscal year 2018, the average euro rate was $1.19 and the average pound sterling was $1.35.

In light of recent activity in the foreign exchange markets, we assumed a euro rate of $1.16 and a pound sterling rate of $1.30 in our fiscal year 2019 financial guidance.

In addition to the guidance we just provided on revenue, adjusted EBITDA and adjusted net income, we also wanted to reiterate our expectations related to our consolidated effective tax rate given the tax legislation signed at the end of calendar year 2017.

As a result of the U.S. federal statutory corporate tax rate decreasing to 21%, we expect our fiscal year 2019 consolidated global effective tax rate to be between 25% and 27%.

We also expect interest expense in fiscal year '19 to be reduced as a result of our July debt pay down of $450 million and be between $106 million and $110 million during the fiscal year.

Let me remind everyone of the seasonality in our business and highlight our expected quarterly progression through the year.

As discussed for several years now, the first quarter of any fiscal year is generally our lightest quarter by far, with the fourth quarter of any fiscal year generally being our strongest by far.

This will continue to be the case in fiscal year 2019, where we expect to realize approximately 42% of our adjusted EBITDA in the first half of the year and 58% of our adjusted EBITDA in the second half of the year.

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

(Operator Instructions) And our first question comes from Tycho Peterson from JPMorgan.

It's Tejas on for Tycho.

So just to kick things off here, maybe I'll go with one on Softgel headwinds.

Just wanted to get a better understanding for what is relatively weaker than your prior expectations of things getting sort of better by the end of this year?

I know there is a bunch of moving parts here with Accucaps seems to have moderated a little bit, there is weakness now in North America and Europe versus just Asia Pac and some of the nearer-term sort of headwinds including ibuprofen and the lower-end (inaudible) contribution.

So John, maybe you could you just walk us through the moving pieces there and highlight what's sort of incrementally little bit worse than sort of your prior forecast for the segment.

So I think the biggest part of this is that we have seen a historical growth rate for this segment in the 2% to 4% range, and we can go back over a 7- to 10-year period, and there was only a short period there where we really went after VMS business in the Asia market to soak up some unutilized capacity.

And as we, I would say, retooled our strategic plans to really focus on higher growth and higher-margin businesses, we essentially took a step back, I would say, from some of that VMS business.

As you know, we've divested 2 assets in Asia that were Softgel.

We also had headwinds both in our fiscal year '18, which we didn't detail out in great -- to great extent, but we had headwinds that were from the ibuprofen shortage, and those headwinds are going to continue into our FY '19, certainly through the first half.

You already mentioned the fact that we're now lapping Accucaps, and quite frankly, the funnel that we have for new product introductions for Softgel is really for much smaller disease states, smaller disease populations.

So as we kind of netted all of these things out, we really have moved strategically into a mode where Softgel has been a great cash flow generator at very high ROIC for the company.

And what we've really done is moved into a mode where we're going to continue to lean on the cash flow generation of the Softgel business on a go-forward basis to really continue to fund our growth in the higher growth, higher-margin businesses of biologics.

We are going to be driving margin expansion much more aggressively now within this segment, so you'll -- you can see from our overall estimates that we have EBITDA coming in actually quite nicely, although the revenue is more or less flat.

So what I would say is that from a strategic standpoint, we've really moved this business into its historical growth rate and are really focusing on its cash contribution, and its margin expansion is the primary point of the asset for the business.

Got it.

That's helpful.

And then one quick follow-up for me here on Oral Drug Delivery.

The segment declined, part of it was driven by a tough comp, it looks like.

Perhaps, Wetteny, could you isolate that for us?

And sort of adjusted for that contractual settlement last year, what would that 14% decline have looked like in the quarter?

And then, once product participation revenues pick up again, or rather you lapped the decline, what should segment growth look like here?

Yes, Tejas, so first of all, with respect to Oral Drug Delivery, last part of fiscal year Q4, although I am fairly certain we didn't detail out -- break out the specific impact of the contract settlement, what I would say, was most of the driver in this year in respect to looking at the comps for fourth quarter versus the prior year, particularly from an EBITDA line perspective.

The other element, I would remind you on as well is we have -- we included in our guidance for FY '18, the product participation impacts, particularly given the higher-margin impact of those for the segment and those came in right in line with our expectations and have now lapped those with the fourth quarter and don't expect those at least for the oral delivery segment to continue into FY '19.

And our next question comes from Dana Flanders from Goldman Sachs.

My first one here -- and I appreciate the bridge that you gave on FY '19 guidance.

Can you just break out exactly how much of the contribution is coming from Juniper this year and what your expected growth rates are around that?

And maybe my second question on Softgel, appreciate the additional color.

I mean, what just gives you confidence that this is a growing top line business as you work through some of these near-term headwinds?

On the guidance question, what I would say is, we have 2 acquisitions that we've put into the bridge for clarity and transparency here.

We have not broken out separately down to the site level.

These are 2 individual sites -- acquisitions.

But you can clearly see what the contribution is in terms of the inorganic element into our fiscal year.

I'll start with respect to Softgel, and then I'll let sort of John chime in on that in terms of the business.

I think John mentioned this is a business, when we look at it historically, has grown in that 2% to 4% range for a long period of time.

And now we're seeing it's growing at the low end of that, and our confidence in terms of its ability to actually have growth is really looking at the pipeline of products that we have.

We talked about development revenues from NPIs, a number of NPIs that we launched in 2018.

We continue to see a pretty robust pipeline of products that [just adds] for a good a subset of those NPIs.

They're targeting patient populations that are smaller, in some cases orphan indications and so on.

So the business continues to really perform well in attracting its share of new products such as those products not going after larger populations.

So we still see the business well positioned competitively for growth.

Yes, the only thing I would add is we do have very strong development revenues that are coming out of the business.

We see that increasing.

We've seen an increasing number of NPIs.

And quite frankly, although we have the prescription part of the business going towards smaller more focused disease states, the consumer health part of the business continues to be very robust.

We have a very strong pipeline of both owned products as well as just products that our customers are coming to us with, and certainly, Accucaps significantly strengthen that.

So I think even as in the near term, we see the business growing at the low end of that overall historical growth rate, the long-term prospects for the business continue to be strong.

And our next question comes from John Kreger from William Blair.

John, thanks for the comments you made earlier on the call about sort of how the industry is shifting to smaller, more niche rare diseases.

Given that, what is your longer-term outlook for the new Oral Drug Delivery segment?

Do you expect some kind of volume headwinds to impact that as well?

No.

I would just tell you that, first of all, the overall space continues to be very robust.

So we continue to have a significant number of new molecules that are coming into the space.

I think the overall trend is towards more focused disease states, orphan drugs and so forth.

That being said, there continue to still be significant unmet needs in some of the larger spaces whether they be in CNS and so forth.

And I would really say that we just see an industry pipeline that continues to grow.

So it doesn't mean that there are -- there aren't blockbusters or molecules that are going to be attacking significant unmet needs.

But the net of it at this point is we are seeing a much more focus towards some of the smaller, more focused disease states.

But we've got a great pipeline in the Oral Drug Delivery segment.

They continue to win a substantial number of new programs.

And it will be a growth segment for us as the other ones with really only Softgel being the one that we are pointing out that we believe is going to continue to grow at that historical growth rates of 2% to 4% with the near term being at 2%.

Great.

And then maybe a quick follow-up.

I think on the last call, you talked about some of the early batches and the third train in Madison having kind of lower yields.

Are you through that issue?

And are you getting on yields that you're hoping for?

Yes.

We're completely through that issue.

We had to work through some early startup issues.

It was a small design error in the manifold.

Nothing that I need to detail out here, but we're well beyond that.

And then as we go into our fiscal year '19, we expect to -- based on a very strong demand, we should probably get 50% or more capacity utilization out of that third train.

And as I also mentioned in my notes, we're already contemplating the fourth and fifth train for Madison.

So it continues to be an extremely robust area for the company.

And our next question comes from Derik De Bruin from Bank of America.

This is Juan Avendano on behalf of Derik.

You gave us an update on the organic revenue growth profile for the Softgel segment.

What would be the long-term organic revenue growth ranges for the 2 new segments, both the biologics and the Oral Drug Delivery?

And also could you give us update on the long-term organic revenue growth profile for the Clinical Supply Services segment after the adoption of 606?

Yes.

So Juan, first of all, we provide guidance at the total Catalent level.

We don't break it down to the individual reporting segments within that.

Obviously, we take all those inputs into consideration in coming up with our long-term guidance, which is organic growth rate of 4% to 6%.

Obviously, inorganic acquisitions will be additive to those.

So we continue to drive it that way in terms of overall Catalent and not down to the individual business units.

Okay.

And a follow-up.

Could I -- could you give us an update on the capacity utilization at Cook Pharmica?

It was about 45% as of last quarter.

And so what was it at the end of fiscal year '18?

And what are your expectations by the end of year fiscal year '19?

We see the business operating just over 50% capacity utilization now coming out of fiscal year 2018.

I think John mentioned in his comments -- prepared comments as well that we continue to see more products being approved commercially for the site.

At the time of the acquisition, we had 12 products approved.

Now the number is 17.

So we continue to be -- to look forward to continued growth in utilization of the capacity of the site where we estimated previously around 40%, now we're seeing just over 50%.

Our next question comes from Donald Hooker from KeyBanc.

Just wanted to get a sense with the new trains coming on.

Looks like your guidance for CapEx is somewhat unsurprising versus historical trends.

But kind of going forward, with maybe a little bit weaker growth in Softgel and a greater focus on the high growth biologic spaces, how do we think about CapEx over time and free cash flow over time?

Yes, so first of all, I would say that we're going to continue to spend CapEx in about the 7% of company revenues for this year and going forward.

However, there is going to be a disproportionate amount of that CapEx that's going to be applied towards our faster-growing higher-margin businesses, certainly biologics.

And I've already talked about the fact that we're contemplating fourth and fifth train for Madison.

So that's all baked into the current estimated guidance.

What I would just add from a free cash flow perspective, you've seen the last 2 years, we've generated still over 85% of adjusted net income and free cash flow that's after CapEx.

Obviously, we continue to guide to somewhere between 65% and 75% of our ANI to free cash flow.

And as we look at our CapEx, it does lean towards the higher growth portions of our business.

Certainly, in the biologics assets, our Bloomington and our preexisting businesses, we'll see the lion's share of that, where we also have maintenance CapEx, obviously, in the highly regulated industry that we're in to continue to drive that.

So we keep pegging the number at around 7% or so of our top line, with 50% of that being growth oriented and of that growth oriented, more leaning towards the biologics assets, obviously.

I mean, got you.

And then as a follow-up, maybe somewhat related.

I think your debt ratio on a pro forma basis is below your previously stated targets, I believe.

So obviously, it begs the question are we -- how do we think about that?

Or can you give us a little bit more discussion and thoughts around M&A?

What you're looking at?

What you're thinking of with regard to that equity raise?

Should we expect to see more M&A activity in near term?

Yes.

So John here.

I would say, first of all, we've had obviously, the successful equity raise and (inaudible) basically brought our debt -- our ratios down to a point where we consider ourselves having significant dry powder, if you will, for continued bolt-on acquisitions and potentially something more meaningful in some adjacent white spaces.

In addition, in the near term, we certainly, in a rising interest rate environment, have also have eliminated about $20 million of interest payments through the term loan pay down.

So I would say, for us, this was really much more of a strategic move for us than it was, I would say, purely financial, strategic from the standpoint that we wanted to have the balance sheet flexibility to be able to continue to pursue our strategic plans, and certainly, we're an organic growth company, but we use acquisitions to really accelerate our strategic plans.

And thus with our balance sheet where it is now, it just gives us that much more flexibility and ability to act.

Our next question comes from Ricky Goldwasser from Morgan Stanley.

Just a few follow-ups here.

When we think about kind of like your guidance in the 160 basis points of margin expansion, what's the contribution of the cost cutting that's related to the Softgel business versus the mix shift towards the higher-margin biologics?

So when you look at the 160 basis points, we've included in our guidance for fiscal year '19, Ricky, I would say half relates to the following.

A mix shift towards more biologics with the addition of the Bloomington as well as our organic biologics assets growing and outpacing, the increased utilization of our capacity as well as the operational execution areas that we mentioned, particularly within the Softgel business.

So those are roughly half of the 160 basis points.

With the other half contribution coming in from removing the low-margin comparator revenue and reporting that on a net basis starting in fiscal year '19, given the change to ASC 606.

So about half and half.

Okay.

And then...

Ricky, I would also -- sorry, I would also just add that we're still looking at another 200 to 300 basis points of margin expansion opportunity over the next several years that we're managing in addition to the 160 that's been baked into our FY '19 guidance.

Okay.

So when we think about that and the incremental margin expansion opportunity, how is it -- what is kind of like your margin goals for the Softgel business under kind of like this new cost structure?

Ricky, we really haven't disclosed margin goals down to the individual segment level simply to say that our goal and our target which we've been saying was to deliver anywhere from 300 to 400 basis point expansion in the next 3 to 4 years.

Now with FY '19 guidance, we're essentially 1 year into that in delivering 160 basis points.

So as Tom just mentioned, we'll have another 200 to 300 basis points to deliver in the next few years.

So that's the context we like to look at margin expansion in.

The only other thing I would say is if you look historically, you'll see that the Softgel business has historically been very consistent in terms of its delivery of EBITDA margins.

And now we're looking at these improvements to continue to operate the business and maybe even better than it has going forward.

So is the message basically, if we think about it right, you said 300 to 400, now you're at 360 to 460 that you've identified additional opportunities to expand margin and you're raising that by about 60 basis points, is that how we should think about it?

The way I would think about it is, as we look ahead, we'll continue to see growth in our biologics and that representing a bigger share of the overall Catalent pie.

We ended FY '17 with biologics representing about 14%, now it's 26%.

We still have another quarter of the Bloomington acquisition and our organic business plus Bloomington will continue to grow.

We've talked about the third chain in Madison considering now a fourth and fifth train in Madison.

Again, that's all going towards a mix shift for overall Catalent.

It's going to continue to drive margin expansion for the overall business in addition to our operational execution, where on the business like Softgel that is growing at the lower end of its historical rate, we see an opportunity to balance that with a focus from an operational perspective, centers of excellence around the world that will drive more throughput for the business.

So those are the elements that I would say are going to drive this expansion.

If you start at where we ended sort of FY '18, and you put another 300 to 400 basis points to bracket that over a period of 3 to 4 years, FY '19 clearly is a nice step towards that is how -- is the framework I would give you.

Okay.

And then lastly, just -- so we can have some sort of metric that we can follow.

You provided us some detail on Bloomington, and I think, you're now at the 17th commercial product, up from 12 when you made the acquisition.

What's the pipeline?

What's the funnel that you are seeing for fiscal year '19?

So how many products are pending approval?

We've -- I don't know that we've disclosed specific number of products.

What I would say is the pipeline continues to be robust.

We -- this is one of the attractions in making the acquisition.

It was running with around 100 molecules sort of in development, really the track record.

If you look at the overall industry, you would say the track record coming out of this acquisition in terms of number of products that have gone commercial, they were at 12 at the time of the acquisition just in October.

And now just a few short quarters later, we're talking about 17.

So clearly, the site has a good track record and a pipeline that is advanced and continues to advance.

So we remain very optimistic in terms of the future in terms of what we'll see over the next couple of years coming out of the pipeline.

And our next question comes from Sean Wieland from Piper Jaffray.

In Madison, at what utilization rate would cause you to add those additional trains?

And is the impact on revenue and EBITDA -- I understand CapEx is in your guidance, but is the impact to revenue and EBITDA in your guidance already for that?

Yes.

So there's no -- nothing about a fourth and fifth train that's in our current guidance.

And I would just say that given the fact that we're already going to be using our third train upwards of 50% this year, that clearly -- that's already getting us to the point where we know we need to move forward to add additional capacity, so there is still work to be done.

We just have this in engineering design phase right now, but highly confident that a fourth and fifth train will be needed given the fact that the third train just completed for its first year will already be at 50%.

So I think the very strong growth momentum that we have both in Bloomington and Madison is going to continue given where the industry is going with biologics.

So could you maybe quantify on an annualized basis, maybe what the impact of an additional train is?

I think, Tom, we are talking about $70 million per additional train at the top line.

Yes, we've mentioned, Sean, that this site was running at about $75 million and we have the ability to nearly double it with a third train that's come on.

We've not given any financial disclosure on what a fourth and fifth train could mean for the future revenue of the facility.

Okay.

And then on the contractual settlement from Q4 '17, can you quantify what the impact was in the year ago period?

So Sean, this is Wetteny here.

We really haven't specifically quantified that in terms of the fourth quarter of FY '17.

But what I would say is when we look at the fourth quarter of FY '18, the majority of the comparison to the prior year is driven by that contractual settlement at the EBITDA line, for sure.

And then the other contribution which we've been talking about now all year and was well in line within our expectations was the impact of product participation, which is also high-margin opportunities that are towards the end of their life cycles.

And we have now completely lapped those for the Oral Drug Delivery segment, won't be part of the top track as we look forward for that segment.

But those 2 elements drove the vast majority of the comparable year-over-year.

Okay.

So just to dial into that a little bit more.

So I think that in your K, you called out that the contractual settlement was 2% of the Drug Delivery Solutions segment of $126 million, so maybe $2.5 million.

And was that all -- was that $2.5 million on the EBITDA line too?

If you're looking at 2%, maybe an annual number on that, I would say that we haven't put a specific number to it.

2% sounds low if you're looking at just the quarter.

And again, we didn't quantify that in terms of what the impact was in terms of dollars.

Okay.

And then how about one quick one?

What's the target leverage ratio you're pushing towards now?

So 3.5x continues to be our long-term target.

As John mentioned, we, first and foremost, look for organic growth opportunities and investing in our fast-growing parts of the business, and then we look for strategic acquisitions.

Given where we are right now, our balance sheet and our leverage ratio, we continue to have a good, a solid pipeline of potential targets.

But again, those only become actionable from time-to-time, and we're now primed to be able to execute should one of those become actionable for us.

But 3.5x remains our long-term target.

Thank you.

And I am showing no further questions from our phone lines.

I'd now like to turn the conference back over to John Chiminski for any closing remarks.

Thanks, operator, and thanks, everyone, for your questions and taking the time to join our call.

I'd like to close by reminding you of a few important points.

First, we're confident and committed to delivering fiscal year '19 results consistent with our financial guidance and are focused on continuing to drive organic growth across our overall business.

Second, we're committed to building a world-class biologics business for our customers and for patients, and look forward to continued strong revenue and EBITDA growth from our biologics offerings.

Third, the continued successful and efficient integration of Bloomington Biologics as well as the integration of the Juniper Pharmaceuticals business into the Catalent family are top priorities as we look to swiftly capitalize on our recent inorganic investments.

Next, expanding the EBITDA margin of our business is a key focus area for the management team as we drive towards 200 to 300 basis points of further expansion over the next 3 to 4 years.

Last, but not least, operations, quality and regulatory excellence are at the heart of how we run our business and remain a constant focus and priority.

We support every customer project with deep scientific expertise and a commitment to putting the patient first in all we do.

Thank you.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude the program.

You may all disconnect.

Everyone, have a wonderful day.