Catalent Inc (CTLT) 2019 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Catalent Third Quarter Fiscal Year 2019 Earnings Conference Call.

(Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the conference over to Tom Castellano, Vice President of Investor Relations and Treasurer.

Sir, you may begin.

Thank you, Shannon.

Good morning, everyone, and thank you for joining us today to review Catalent's third quarter fiscal year 2019 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 is possible that actual results could differ from management's expectations.

We refer you to Slide 3 for more detail.

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

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

Now I would like to turn the call over to John Chiminski.

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

We recorded strong adjusted EBITDA growth across 3 of our 4 reporting segments.

We continue to be confident in delivering our fiscal year 2019 full year financial guidance, and we are announcing today a tightening of the ranges that are part of that guidance.

As you can see on Slide 6, our revenue for the third quarter decreased 2% as reported but increased 2% in constant currency to $618 million.

The substantial growth in revenue from our Biologics and Specialty Drug Delivery and Oral Drug Delivery segments was partially offset by the ASC 606 revenue recognition change which affected how we report comparator sourcing activity within our Clinical Supply Services segment.

Excluding the impact of this revenue recognition change, revenue would have increased 6% in constant currency compared to the prior year.

Organic revenue grew 3% year-over-year during the quarter in constant currency led by our Biologics and Specialty Drug Delivery and Oral Drug Delivery segments.

Our adjusted EBITDA of $154.3 million was above the third quarter of fiscal year 2018 on a constant currency basis by 14% with 10 percentage points of the growth being organic.

As a result of this strong bottom line growth in the quarter, we continue to make progress towards our adjusted EBITDA margin expansion goals.

Our adjusted EBITDA margin increased nearly 300 basis points in the third quarter compared to the prior year.

Our adjusted net income for the third quarter was $71.2 million or $0.49 per diluted share, which is $0.08 above the same figure from the prior fiscal year.

The strong results of the profitability line were led by our Biologics and Specialty Drug segment which continues to be the fastest-growing segment in the Catalent portfolio as well as by contributions from our Oral Drug Delivery and Clinical Supply Services segments.

Now moving on to our operational update, first, we continue to make great strides on our Biologics strategy.

The business continues to deliver strong financial results.

And as previously stated, the Bloomington site now has 20 approved commercial products which is up from the 12 it was producing at the time of the acquisition.

Additionally, our robust funnel of late-stage clinical opportunities will help increase to more than 50% the utilization in fiscal year 2019 of the third manufacturing train in our Madison facility which we completed in the fourth quarter of fiscal 2018.

Also during the quarter, we received approval from our Board of Directors for, and announced in January, the commencement of a $200 million investment spanning both Bloomington and Madison that will add more drug substance manufacturing and drug products fill/finish capacity due to projected growth among existing and future customers.

The combination of organic and inorganic investments we are making in Biologics continues to create significant value for the company, our customers and our shareholders.

As a reminder Catalent Biologics, including both Bloomington and our pre-existing businesses, can provide integrated solutions from drug substance manufacturing and analytical services through clinical and commercial supply and fill/finish in a variety of finished dosage forms including vials, cartridges and syringes.

As we're seeing in the numbers, the Bloomington site continues to accelerate the already strong growth of our pre-existing Biologics business.

Biologics comprised approximately 14% of Catalent's consolidated revenue in fiscal year 2017 and represents more than 26% of the company's revenue today.

Further adding to our Biologics portfolio, on April 15, we announced our agreement to acquire Paragon Bioservices, a leading viral vector development and manufacturing partner for gene therapies.

Paragon will provide its new expertise and capabilities in one of the fastest-growing therapeutic areas in health care, reinforcing Catalent's leadership position across biologics and positioning us for accelerated long-term growth.

Paragon brings deep expertise in adeno-associated viral vectors, the most commonly used delivery system for gene therapy as well as a platform for development of an expanded offering of vectors enabling entry into other adjacent technology categories to support the development and manufacturing of gene and cell therapies.

This expertise, combined with Paragon's manufacturing capabilities and world-class facilities, will position us to capitalize on substantial industry tailwinds in gene therapy.

Paragon's leading position in vector manufacturing, its blue-chip customer base and its expanding commercial footprint make it an ideal strategic fit for our business.

Additionally, the expected positive impact of Paragon on our revenue and EBITDA profile will deliver highly compelling value to shareholders as evidenced by the increased long-term revenue growth outlook from 4% to 6% to 6% to 8%.

The transaction which will be financed with a combination of new term loan debt and the preferred stock investment from Leonard Green & Partners is expected to close later this quarter.

Second, the European early-development Center of Excellence we acquired as part of the Juniper Pharmaceuticals transaction in the first quarter of fiscal 2019 continues to advance our strategic goal to be the most comprehensive partner for pharmaceutical innovators, helping our customers to unlock the full potential of their molecules and provide better treatments to patients faster.

The integration of the Nottingham U.K. site and its nearly 150 employees into the Catalent network is tracking according to our expectations, and the acquisition continues to contribute strong financial results to our Oral Drug Delivery segment.

Third, I want to provide a further update on our Softgel Technologies business which is generally performing in line with our expectations but was once again negatively affected by the worldwide ibuprofen API shortage.

As expected, during the third quarter, the segment EBITDA impact related to the supply shortage was approximately $2 million, which brings the cumulative fiscal year 2019 year-to-date EBITDA impact to approximately $14 million.

However, we see the basis for supply stability in the fourth quarter in part because we have secured alternative sources of supply and already have the ibuprofen needed to deliver on our customer commitments.

Finally, we remain positioned increasingly well in an attractive, robust growing market and have the strongest development pipeline since Catalent's inception with nearly 1,000 active projects.

Now I'll turn over the call to Wetteny Joseph, our Chief Financial Officer, who will take you through our third quarter financial results.

Thanks, John.

As John previously mentioned earlier, the company adopted ASC 606, the new accounting standard concerning revenue from contracts with customers as of July 1, 2018, using the modified retrospective method.

The reported results for the 3 and 9 months ended March 31, 2019, reflect the application of the new standard while the reported results for the 3 and 9 months ended March 31, 2018, were prepared under the guidance of the prior standard, ASC 605.

This is especially important as I discuss the results related to our Clinical Supply Services segment where adoption of the new standard changed the treatment of our comparator sourcing activities which are now recorded on a net basis compared to a gross basis in the prior year.

Now turning to Slide 7 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 $214.5 million declined 1% during the quarter with segment EBITDA declining 2% due to lower prescription volumes in North America.

However, given the strong pipeline of potential product launches we have on the horizon, we believe this headwind will abate in the fourth quarter.

Additionally, as expected, we were impacted by the ibuprofen shortage in the third quarter which negatively impacted segment EBITDA by approximately $2 million.

As John stated earlier, we do not expect the ibuprofen shortage to impact our results in the fourth quarter given the secondary sources of supply and look forward to being able to grow our ibuprofen franchise beginning in the fourth quarter.

The softness in North America was partially offset by strength in Europe where we experienced higher demand for prescription and consumer health products.

Another important item to note regarding Softgel segment performance is that normalized for the ibuprofen shortage, the segment would have reported revenue growth of approximately 1%.

Furthermore, we expect Softgel year-over-year revenue and EBITDA growth in the fourth quarter could be above its historical average as a result of a strong slate of product launches and the recovery of ibuprofen.

Slide 8 shows that our Biologics and Specialty Drug Delivery segment recorded revenue of $172.1 million in the quarter, which is up 5% versus the comparable prior year period with segment EBITDA growing 12% during the quarter.

All of the segment's revenue and EBITDA growth during the quarter was organic as we have had no new acquisition in the most recent 12-month period.

Recent investments in our Biologics business continue to translate into growth during the third quarter and remains the fastest-growing business within Catalent.

We recorded strong growth in drug products across the U.S. and Europe but experienced a modest timing-related decline within drug substance driven by the completion of project milestones and larger clinical programs that were recorded in the prior year.

We believe that our Biologics business is positioned well to drive future growth as the utilization levels of Madison's third suite continue to ramp.

Additionally, we experienced volume declines within our respiratory and ophthalmic business which impacted revenue, but the platform benefited from favorable product mix which limited the impact to the bottom line.

Fundamentals continue to remain attractive for these key sterile fill technology platforms.

Slide 9 shows that our Oral Drug Delivery segment recorded revenue of $161.7 million in the quarter which was up 12% versus the comparable prior year period with segment EBITDA increasing 21% during the quarter primarily driven by the Juniper Pharmaceuticals acquisition which contributed 11 percentage points to the segment's revenue growth and 13 percentage points to the segment's EBITDA growth during the quarter.

The organic revenue growth of 1% and EBITDA growth of 8% was driven by increased revenue from favorable product mix related to product participation activities, partially offset by volume declines for a few high-margin products within our U.S. oral solids business in which 1 customer has moved volumes in-house to leverage unused internal capacity as discussed during our last 2 earnings calls.

That being said, the segment is one of our strongest development pipelines including several late-stage spray-dry development programs.

And we expect to see accelerating growth in the near- to mid-term.

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

As a reminder, these metrics are only directional indicators of our businesses since we do not control the sales or marketing of these products nor can we predict the ultimate commercial success of them.

For the first 9 months ended March 31, 2019, we reported development revenue across both small and large molecule of $452 million, which is 19% above the development revenue recorded in the first 9 months of the prior fiscal year.

Additional disclosure on our development revenue, which is now calculated in accordance with the ASC 606, is included in our Form 10-Q filed today with the SEC.

In addition, we introduced 141 new products which are expected to contribute $96 million of revenue in the fiscal year which is more than double the revenue contribution of NPIs launched in the first 9 months of the prior fiscal year.

Now as shown on Slide 10, our Clinical Supply Services segment reported revenue of $77.8 million, which was down 23% compared to the third quarter of the prior year, driven by the ASC 606 revenue treatment of comparator sourcing activity.

Excluding the impact of ASC 606, segment revenue grew 2% compared to the prior year period while segment EBITDA increased 14% compared to the third quarter of the prior year primarily driven by the revenue growth in our core manufacturing and packaging services business, favorable product mix and improved capacity utilization across the network.

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

As of March 31, 2019, our backlog for the CSS segment was $346 million, an 8% sequential increase.

The segment reported net new business wins of $113 million during the third quarter which is an increase of 40% compared to the net new business wins recorded in the third quarter of the prior year.

The segment's trailing 12 month book-to-bill ratio is 1.2x.

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 not on some comparator revenue on a net basis.

The next slide contains reference information.

We have already discussed the segment results shown on the consolidated income segment by reporting segment on Slide 11.

Slide 12 shows, in precisely the same presentation format as Slide 11, the 9-month year-to-date performance of our operating segments both as reported and in constant currency.

I won't cover the variance drivers in detail since they closely parallel our third quarter results.

The key growth drivers are: the acquisition of Juniper Pharmaceuticals, strong growth within our Biologics business, favorable product mix within Oral Drug Delivery related to product participation activities and increased storage and distribution and manufacturing and packaging revenue within Clinical Supply Services, which are partially offset by the impact of the worldwide ibuprofen shortage on our Softgel segment which, as John previously stated, negatively impacted segment EBITDA by approximately $14 million.

And oral solids revenue declined due to certain high-margin products.

Slide 13 provides a reconciliation for the last 12 months EBITDA from operations to the most approximate GAAP measure which is net earnings or loss.

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

Moving to adjusted EBITDA on Slide 14.

Third quarter adjusted EBITDA increased 11% to $154 million.

On a constant currency basis, our third quarter adjusted EBITDA increased 14% of which 10% was organic and driven by our BSDD, ODD and CSS segments.

The remaining 4% of the growth was driven by the Juniper Pharmaceuticals acquisition.

On Slide 15, you can see that third quarter adjusted net income was $71.2 million or $0.49 per diluted share compared to adjusted net income of $55.2 million or $0.41 per diluted share in the third quarter a year ago.

This slide also includes a reconciliation of net earnings or loss 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 which shows essentially the same add-backs as seen on the adjusted EBITDA reconciliation slide.

Slide 16 shows our capitalization table and capital allocation priorities.

Our total net leverage ratio as of March 31 was 3.3x, which is modesty down from the 3.4x we reported during the prior quarter and is the lowest level in Catalent's history.

As a reminder, we proactively paid down $450 million of our U.S. dollar-denominated term loan in July with the proceeds from the equity offering and closed the Juniper acquisition on August 14; and the impact from both transactions is reflected in our leverage ratio.

Additionally given the free cash flow generation of the company and its growing adjusted EBITDA, the company naturally delevers between 1/2 and 3/4 of a turn per year.

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

Turning to our financial outlook for fiscal year 2019 on Slide 17, we are tightening the range of our previously issued guidance to reflect our increased visibility to our year-end results.

We now expect full year revenue in the range of $2.5 billion to $2.52 billion.

We expect full year adjusted EBITDA in the range of $605 million to $615 million.

And full year adjusted net income in the range of $268 million to $278 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.

In addition to the guidance we just provided on revenue, adjusted EBITDA and adjusted net income, we also wanted to provide our expectations related to our consolidated effective tax rate which we now expect to be between 25% and 26% in the fiscal year.

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

(Operator Instructions) Our first question comes from Tycho Peterson with JPMorgan.

John, maybe I'll start with Softgel, obviously a number of moving pieces here.

Can you maybe just talk whether the headwinds in the near term came in worse than your own forecast?

And have you shifted all of your business over to the alternative supplier at this point?

I'm just curious how we think about the BASF facility risks going forward.

Yes.

So I would say that we continue to be disappointed by the supply from API.

And I think we're really starting to finally come out of it.

Obviously, we still had some additional impacts in the quarter of about $2 million in EBITDA and the cumulative impact has been $14 million throughout the year.

So it's really been, I would say, a difficult situation, but we have qualified additional suppliers.

The 1 large supplier that had been on and off down for almost a year now has started to provide us some supplies.

So we certainly see this situation abating in the final quarter.

So I think our Softgel business, honestly, had performed amazingly well in the face of this API shortage of ibuprofen.

And I think as we go into the fourth quarter here, I think we're again hopeful that we should be returning back to some normalcy, although we don't expect a big snapback, if you will, from refilling the shelves.

But we certainly don't expect to be surprised again by IP -- by API shortages from -- on ibuprofen.

Can you talk about 4Q '19 launches expecting to offset maybe going forward?

How robust is the funnel for new formulations using Softgel?

Well, so in Softgel, I would say we have a very robust slate of products and we've recently had a couple of products approved and launching here within actually this prior quarter and now in this quarter.

So I would say in general we feel pretty good about the prospects for Softgel here in the fourth quarter with the API shortage abating and having some of those NPI products actually being approved.

So I think we'll be pleased with the way Softgel ends up exiting the quarter for this fiscal year.

Okay, last one on BSDD, now that you've lapped Cook, you did only grow I think 5% organic in the quarter.

I know there are some timing elements there on some of the drug volumes.

Can you maybe just talk to that dynamic and how should we think about this business going forward?

Yes.

No, I think -- I mean the biggest impact here is first of all the business continues to be incredibly robust and strong.

I think the biggest issue for us was really on the drug substance side in Bloomington where we had some -- I would just -- drug substance at Bloomington and then drug substance from Madison had some milestones and large clinical programs.

So from a comparison standpoint, I would just say it was a little bit tough but the business continues to be long term robust.

So I don't get too worked up on kind of year-over-year comparisons for this business given its ability to continue to grow extremely strong.

Tycho, I would just add that when you look at our core Biologics offerings, of course we have substance and drug product which we spent a lot of time talking about.

In the quarter, the core Biologics still grew in the low to mid-double digits as it has in recent quarters as well.

Our next question comes from Rivka Goldwasser with Morgan Stanley.

So when you think about your long-term outlook that you updated, you have both revenue growth and adjusted EBITDA.

Can you talk a little bit about the drivers?

Is it just Paragon or are you seeing also improved trends in other area?

And obviously, you have one more quarter for the year, but as we think about 2020, should the long term -- should we be thinking about growth in 2020 kind of in line with that new long-term range that you provided?

Yes.

So first of all, as you know, Ricky, we'll provide guidance when we release our fourth quarter earnings and full year earnings, we'll provide guidance for fiscal year '20.

But with regards to the updated long-term growth rates going from 4% to 6% to 6% to 8% and then going from 6% to 8% to 8% to 11%, it's a multitude of factors.

Certainly, Paragon is being factored into that but I have to step back and say first of all on the Biologics front, when we take a look at the increase of our business going from about 26% of our revenues being Biologics to with Paragon, we now have 31%.

The overall mix of the business that's being exposed to Biologics and its growth rate and its margin rates, certainly, are creating an overall pull towards that new guidance of 6% to 8%.

But in addition to that, as we've done our -- looked at our strategic plans, we certainly have seen a very robust slate of pipeline products in our Oral Drug Delivery business, along with Softgel as we've stated that we expect to continue to see some near-term pressure based upon ibuprofen and the dispositions of businesses.

Next year, we'll also have a disposition of a Softgel business that's in Braeside that'll impact its numbers

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Softgel will return back to its normal growth rate of 2% to 4%.

So the culmination of where Softgel will be in a couple of years, the increasing exposure of the business to a fast-growing biologics business going to 31%.

And in fact, across our strat plan, we actually show Biologics approaching near 50% of the overall revenues of the company over a 5-year strat plan plus an increasingly strong Oral Drug Delivery pipeline combined with, I would say, our CSS business getting back to high single-digit growth rates and possibly beyond as we continue to build -- or have a strong book-to-bill ratio.

In fact right now, I mean, we've been recording the strongest book-to-bill ratios in several years over the last 6 to 9 months.

And then there's a little bit of a lag between when you see that book-to-bill ratio and the sales wins to when it shows up.

So it's really the culmination of all of those things gave us very strong confidence in taking our long-term growth rates to that 6% to 8%.

And just to confirm when we think about Softgel for the fourth quarter, I think that in the prepared remarks you said that you already have product that's ready to ship.

So should we think of that to mean you have strong visibility?

Softgel -- yes, what I'm saying about Softgel is we have the materials we need to basically deliver on Softgel.

So it's been a challenge throughout the year as we talked about this cumulative $14 million EBITDA impact.

Obviously you can take a look at the revenue of that, it would probably be about twice.

So that's really been a drag on Softgel and to some extent, on a modest extent on the overall business.

But now as we go into the fourth quarter, we do have the materials we need combined with some recent approvals that give us confidence in Softgel's performance here in the fourth quarter.

Our next question comes from Juan Avendano with Bank of America.

On the Biologics and Specialty Drug Delivery segment, you noted that there were some soft timing-related issues with drug substance volumes.

But when I look at your overall consolidated revenue guidance, it did come down by $35 million at the midpoint.

So if those were timing-related volumes that didn't come back, why did the revenue guide decrease at the midpoint?

And related to this question, I guess on the other part of the BSDD segment, excluding Biologics which you just said grew low to mid-teens, that means that the Specialty Drug Delivery part of it perhaps had a mid-single-digit decline organically.

And so can you give us an update on what's happening with the ophthalmic, respiratory and the blow-fill-seal business that is part of the BSDD but excluding Biologics?

Yes, Juan, this is Wetteny here.

So let me just provide some color here.

First of all with respect to Biologics in our overall guidance which we've tightened the range here, obviously we don't provide guidance by segment.

But if you look at the overall Catalent guidance that we just again tightened, it really is a factor of a number of things.

First, if you look at ibuprofen, which we just spent some time talking about, it's really been a lingered issue well into our third quarter.

Obviously coming into Q4, we've discussed our visibility into and our ability to have already received supply to manufacture in the quarter, which gives us confidence as it relates to Softgel in particular, but the lingered effects of ibuprofen throughout the year, the first 3 quarters of the year is certainly an impact in terms of where we now are within that existing guidance range.

So that's the first thing I would say.

The second item I would point to is while we're very pleased with the book-to-bill rations and net new business wins in our clinical business, there's a little bit of a lagging effect in terms of when we're seeing those come through in our revenues here.

It's probably trailing about 1, maybe 2 quarters slower than what we've typically seen, but it certainly gives us confidence as we move forward here.

We would've expected a little bit more revenue contribution in terms of top line growth from CSS given about 9 months of positive book-to-bill there.

The last item I would point to is if you recall earlier in the year, we have with the change in revenue recognition with ASC 606 because of the timing of a contract end solution which we've had from time to time in the business, we have income and cash flows coming into the company which will not ever show up in our revenues.

And so it's effectively lost revenue to the tune of $50 million plus that we added back the EBITDA given the cash flows and the income is reflective of what is ordinary course for us, but don't have the revenue in that.

So if you take those 3 elements combined, certainly, they're all considered in terms of where we are within the range.

I would say positively clearly given that we are at the midpoint of our EBITDA, adjusted EBITDA guidance, clearly we've had positive product mix across the businesses.

The growth within our core Biologics business continues to be in the low to mid-single digits.

And all of those given the higher EBITDA contribution from those businesses are certainly helping us to remain within the midpoint.

That takes me to the second part of your question which is within Biologics and Specialty Drug Delivery, if Biologics is growing in the double digits, then where are we within the Specialty Drug Delivery?

The ophthalmic and respiratory which we described on the prepared comments was a bit of a headwind for us in the quarter albeit a positive mix from an EBITDA perspective and therefore did not have an impact at the EBITDA line.

But as you know, volumes or demand across a slate of products is not something we necessarily control.

We do have high diversity across Catalent with 7,000 products which allow us to be able to continue to deliver on growth and EBITDA growth as well.

But certainly, there are volumes across products that have an impact in the current quarter.

Therefore, the lower contribution in terms of revenue offsetting that core Biologics growth.

Got it.

And then also on Biologics can you give us an update on the capacity utilization at Catalent Indiana, the number of products that have been commercialized out of there relative to the last quarter?

And then given your pending acquisition of Paragon, does that change at any point the capital, the CapEx plans that you announced at the beginning of the year regarding further expanding drug substance capacity?

Yes, with regards to the products approved.

As we've stated, we've got 20 products currently approved out of our Bloomington facility.

And we definitely expect going into this next fiscal year that we're going to have additional products approved.

We don't know what the exact number is but we're working off a fairly large list of products, of which we've got a lot of potential PAIs that are scheduled.

So I think the continued growth track of Bloomington is going to be very strong.

With regards to capacity, the best way for me to discuss this is that with the way that we are running the factory and with the equipment that we have, we see our way towards meeting our robust demand through the facility through 2021 right when we're going to be dovetailing in the capacity expansion that will essentially double our drug product filling capacity.

So we just recently had our board there for a review -- our strategic review and had a review of the site.

And again, without giving you a pinpoint on the capacity, I would say that our capacity situation really does allow for our continued strong growth through Bloomington up through 2021 where we're going to be dovetailing in the new capacity expansions.

Our next question comes from Donald Hooker with KeyBanc.

Just wanted to check in on the -- hear maybe a little bit more about the Follow the Molecule strategy at that order acquisition of Pharmatek and maybe kind of looking at the funnel coming out of Juniper.

I know these things take time to play out but just curious if there's been any product that's been commercialized out of those prior acquisitions?

Sure.

So with regards to -- actually, we now have 3 preclinical development sites.

So we have our Pharmatek acquisition, we have the Juniper acquisition which is now our Nottingham site and we've recently repositioned our Somerset sites.

We actually have 3 preclinical sites, all total will have the capacity to bring in 100 or so molecules per year into the company in terms of preclinical development.

I will tell you that already, we have a strategy -- internally, we call it the super highway.

And what we're talking about is taking the molecules from these preclinical development sites, and moving them along to our commercial sites.

And then I can tell you we've had somewhere between 5 and 10 molecules already exit out of those, out of our Pharmatek facility that have been now gone into our larger commercial facilities for scaleup in advance of a potential approval.

And I can also tell you in our Somerset sites here, we already have a slate of products that, again, can be moved along for exit into a commercial facility.

So the strategies are working extremely well.

As you know, starting from preclinical all the way to commercial approval, you've got somewhere between a 1% and 10% chance of those molecules ultimately being commercialized.

But again, as you know, we earn money all the way through the potential failure or launch of that molecule.

So the strategy is working extremely well, and we've -- again, I think we've accelerated this Follow the Molecule strategy with those 2 acquisitions in the last 2 to 3 years combined with the repositioning here of our Somerset facility.

So that's what leads to us growing those number of development programs and ultimately getting products launched.

And as I said, we've already had exits out of those facilities.

With regards to Nottingham and Pharmatek, it also brought us spray-drying capability that we didn't previously have.

And we're now looking to do scaleup of spray-drying to I guess let those molecules grow up into larger producing molecules for the company.

So overall, I would say the strategy is performing extremely well, very healthy and quite frankly gaining momentum with those 3 sites.

Okay, great.

Then maybe just one follow-up and then I'll jump back in queue.

What is the right growth rate kind of looking out for the Oral Drug Delivery segment at this point?

I mean I guess it's been kind of lumpy.

I just want to refresh that.

And is there any -- in that one in-sourcing situation, is that sort of still an anomaly or is there any kind of trend to worry about there?

So certainly, this year we've been impacted by that significant product.

And those happen aperiodically.

They don't happen on a consistent basis.

And we've just been caught with a fairly large product that went away and then modestly came back.

So certainly, we're not forecasting a string of those.

They do happen aperiodically and we got caught up in it.

What we've talked about with regards to Oral Drug Delivery in the past is that in our previous long-term guidance of 4% to 6% that we believe the pipeline of Oral Drug Delivery will deliver at the high end of that 4% to 6% growth rate, so certainly, will not be a drag on our 6% to 8% per se.

So (inaudible) incredibly strong strategy of which I was just talking about what we're doing from a Follow the Molecule strategy with the 3 preclinical sites.

It has one of the strongest product pipelines that we have within the company.

And we're just -- as we heal from one of the large products and as we start to get some of the new product approvals, again, we're confident that this will be a product that will -- in our old guidance, will grow at the high-end of that growth rate and certainly be a contributor to the new 6% to 8% guidance.

Yes, and I guess if there was another in-sourcing situation that came, you'd have fairly good visibility to that.

I guess the customer will be talking to you...

Yes, we do.

We do.

And as a matter of fact, we had one large product we knew it would be coming but they pulled the plug, I would say, earlier and faster than we had anticipated.

And as it turned out, they actually did pull it a little bit prematurely because it ended up coming back to us a little bit.

So again, we have that visibility.

And as we've always talked about, we have a very small slate of products that are large within the company.

No single product is more than 4% of revenues.

But if one of those does go away, it does have a significant impact.

We happen to have one that was in the Softgel business and one that was in the Oral Drug Delivery business.

Again, both have visibility to those.

Our next question comes from John Kreger with William Blair.

John, if you look across the portfolio, where do you see the biggest opportunities to drive further margin enhancements given how much margin improvements you've seen in the last year?

Yes.

So first of all, we still have our Softgel business at somewhere a little south of 35% of the overall business.

I think it might be 33% or 34% post-Paragon acquisition.

But as we take a look at our strat plans, all of our efforts -- a lot of our efforts, I would say in Softgel are towards margin expansion.

So we've been culling some of the sites as you know.

We dispositioned a couple of sites in the Softgel network.

We've got a third one slated here with Braeside . That's obviously having a small -- having impact on the revenue but it also will help on the margin accretion.

Plus we have productivity programs there.

So as we kind of take a look at the Softgel business again at somewhere around 33%, 34% of the overall business, we see somewhere between 200 and 400 -- 400 basis points of expansion there.

So that's pretty significant.

Obviously, as the mix of our business continues much more towards Biologics approaching 31% given the high margins in that business, the mixup from that business is also a driver.

And then I would also say that Oral Drug Delivery as it kind of moves back into the expected growth rates and a strong slate, it actually has the highest margins in the overall business in aggregate as a stand-alone business unit.

So it's the mixup of BSDD and ODD combined with the margin enhancement progress that we have within Softgel that give us significant confidence in our ability to continue to drive those -- to drive margin enhancements within the company.

And you can only imagine when we're 50% of the company has revenues coming out of Biologics, which will be our gene therapy and our drug substance, drug product, analytical business, where those margins are at, it just pulls the entire company up.

So again, I think it's a very strong and very real story from a margin standpoint with the company.

And just 1 follow-up, can you just -- given the $200 million CapEx plan for Madison and Bloomington, what's the broader CapEx outlook particularly when you layer in a Paragon over the next few years?

Look, we've said our CapEx is somewhere between 7% and 8% especially given the ASC 606 netting of comparator that was about nearly 50 basis points increase in the percentage there.

And so we'll give individual annual guidance but clearly given the expansions within the broader Biologics, $200 million there, and what we can anticipate with respect to Paragon once we close that transaction, we would expect to have a bit of an uptick for probably a couple of years as we execute on those capital expansions and then returning to sort of a more normalized rate is what I would say at this point.

Our next question comes from Evan Stover with Robert W. Baird.

The $14 million year-to-date ibuprofen EBITDA shortfall, I just kind of wanted you to pull out your crystal ball a little bit.

And with the supply situation normalizing in that market, is that EBITDA something that Catalent would expect to recapture over the next 12 to 18 months?

I would assume a lot of your customers have eaten into some safety stocks and would need to build that back up.

But I just wanted to make sure I'm not missing something in the market that maybe you're kind of at this lower level for the foreseeable future of ibuprofen contribution?

Yes, sure.

So I mean there are a couple of things that are happening here.

So first of all I would say that the EBITDA impact is a little bit stronger than the actual API issue given the fact that you have a situation where you have underabsorption within your factories and base costs, and we just can't continue to lay off some of those base costs and lay off people during the situation.

So I think it's a little bit more pronounced at the EBITDA line than it normally would be.

We're certainly seeing good demand coming back.

But these things have a way of taking some time to get back to normalization, because given the large number of choices that people have in the pain relief category and the [NSAIDS] that it's not clear how quickly you get some of that market share back and whether or not they'll fully completely fill the inventory.

So I think we're not at a "new low" but I wouldn't expect to see all that EBITDA all of a sudden snap back into the company.

What we're just happy about is that we've been able to get back to I would say more normal levels of supply that give us confidence here in our fourth quarter.

But I certainly wouldn't be -- and we're not baking in any upside of that cumulative $14 million as we go into our fiscal year '20.

All right.

And within Oral Drug Delivery, there was a call-out in the prepared remarks about some favorable product participation, the high-margin type of revenue.

My sense over the last couple of years is that the product participation part of the equation has been coming down in importance for Catalent.

And I just want to confirm if this is kind of a one-off event, onetime favorable item or does Catalent overall continue to kind of deemphasize product participation?

And perhaps you can just tell us how much of a percentage of your EBITDA those arrangements would consist today?

So this is Wetteny here.

Look, throughout the prior fiscal year '18 and even into the first quarter of this year with respect to Softgel, we discussed product participation being a headwind for us.

And what we said was that we'll get to a low enough level -- and you're right, it's not necessarily an area of particular focus for us, that if we talk about product participation, it would be as a tailwind as opposed to headwind given the lower levels that we are.

I would say that it can be somewhat lumpy in this area.

So I wouldn't necessarily consider this to be a new normalized run rate for us with respect to product participation.

But there are occasions where we would see opportunities across product participation on a go-forward basis if that's helpful.

Our next question comes from David Windley with Jefferies.

First one is fairly simple, I think.

Does the updated guidance still exclude Paragon until you close that deal or have you now included anything for Paragon in the updated guidance for that stub?

Yes.

So with respect to Paragon, obviously we have not closed on the transaction yet and so we have not factored it into the tightened ranges that we have articulated here today.

What I would say is that we expect the transaction to close sometime in this quarter.

And given the trajectory that the business is growing, going from roughly $13 million of EBITDA in calendar year '18 to $56 million in calendar year '19, we clearly are in an up-ramp where it's going to be a bit more back-end loaded as we ramp up that trajectory.

So I wouldn't expect this to be materially significant with only a few weeks by the time we actually close the transaction.

Right.

Okay.

John, I think you mentioned in the BSDD segment some tougher comps related to milestones in the prior year.

And I gather that would have been both revenue and pretty substantially, I guess, EBITDA headwinds year-over-year in the comp.

What's more normal?

Would you expect to see milestone payments like that fairly regularly or are quarters when you do see them more the oddity?

Yes.

No, they're aperiodic.

They're not normal.

We've got several situations with regards to -- we've talked about our Redwood Biosciences and so forth.

And specifically within our drug substance business I would say we had some very large short -- or short-term clinical programs that we're delivering in the year that basically we've got comps against that right now.

So we're not concerned at all about the growth rates that we have from drug substance.

We know that as you kind of look at it, on a quarter basis, it looks like you've got a little bit of a [tool] back.

We just know what was in it last time and I would just say that you shouldn't expect to see these milestone payments on a regular basis.

And again, there were some large clinical -- short-term clinical programs that we're delivering last year that have -- that were only intended to be very short term for the business that have moved away.

So that's kind of where that impact is from.

Okay, if -- maybe a last question, if I could zoom out a little bit.

The BSDD that you just touched on had some -- maybe some specific issues.

As I look at each of the 4 segments in the quarter, relative to consensus, were light.

And I hear management talking about 19% growth in development.

Juniper is outperforming BSDD, while maybe not as strong in the quarter, certainly on a solid trend line.

I guess 1, did we mismodel it?

Was consensus too far ahead of you?

And if not, we hear the part -- I guess I'm not hearing and able to reconcile what part of the business is so soft that it drags the consolidated revenue number under expectations by close to $30 million when several of the metrics, the development work, the Juniper, the BSDD all seem to be performing at or better than your expectations.

Can you help me to kind of complete the picture?

Yes.

This is Wetteny here.

As you know, we don't provide guidance by segment nor by quarter.

It really comes back to our annual guidance, and where do we fall within that guidance.

And what I will just reiterate here is as we now have just 1 quarter left in the year, we see an ibuprofen issue that has really lingered longer than we would have anticipated all the way through and including Q3, with the trough of that having been in the second quarter.

But certainly, it's contributed to where we fall within the guidance that we issued for the year as we tighten it here.

So that's 1 element.

What I would say is also I think our clinical business, we're very pleased that the business is really booking higher levels of wins, net new business wins above what we are currently having reflected as current period revenues.

So that trailing 12 book-to-bill ratio is going to contribute to an uptick in terms of growth in that business.

We would have expected that to already start here with our third quarter with normal burn rates coming from wins but it sort of extended a little bit, I would say about 1 to 2 quarters.

So there's a couple items that I already mentioned, the lost revenue element within the year as well.

And so taking all those into account, we've tightened the range from a revenue perspective, still within the guidance that we gave.

What I would say is sitting here, as we look at Q4 and of course, we'll give guidance for the next year on the next call.

But as I look at the ibuprofen challenge which again has lingered going back to the prior fiscal year and well into this one, very pleased with the fact that we have the supply that we need for the fourth quarter and we have secured alternate suppliers so that we can be a bit more assured in terms of the future as it comes to ibuprofen.

Recent approvals within Softgel also gives us confidence in terms of Softgels.

And I would say the core Biologics business

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perform for us again in the low double-digit range that we've seen from the business over the last several quarters.

So those are the things that certainly are in front of us as we look across the segments and a bit of color in terms of where we've landed within that range from a revenue guidance perspective.

But certainly, from an EBITDA standpoint, we like the mix, the product mix across the business, the Biologics contribution.

CSS, despite lower top line growth rates, has been really recording double-digit EBITDA growth for several quarters.

All of those factors are contributing towards an adjusted EBITDA guidance that is at the mid -- slightly above the midpoint of our guidance that we started the year with.

So that's how we've positioned both revenue and then adjusted EBITDA.

Our next question comes from Dan Brennan with UBS.

I just wanted to start with Softgel.

I know it's been discussed a couple of times so far in Q&A.

But I think in the prepared remarks you talked about fourth quarter.

You expected to be above historical averages given product launches.

And I missed the second part, maybe just some of this supply shortage coming back.

So can you just clarify a little bit what you imply by being above historical averages?

Yes, Softgel, as we've said, has been really a 2% to 4% top line grower for us.

It's a business that's in a niche dosage form, et cetera, certainly generates significant cash flow contribution to the overall company.

But that's where the business has performed from a top line perspective and in that context is what we're seeing -- we would see above those historical levels as we are going to Q4, combination of the ibuprofen supply being in hand for the quarter as well as recent product approvals within Softgel that have given us some tailwind here for the fourth quarter.

Okay.

And then, John, I think you talked about in your strat plan you were kind of pointing to Biologics getting to 50% of total revenues.

So just to the paradigm.

But can you just remind us like how you're thinking about kind of a 5-year trajectory within Biologics to kind of reach that level?

Well, I mean, first of all, the combined Biologics business, we're early days obviously with Paragon.

But when we take a look at the investments that we're making in Bloomington and Madison that are essentially going to double their capacity, and then you layer on top of that the aggressive growth and capacity expansions that we're going to have from Paragon, I mean Paragon is growing from $100 million to $200 million just between '18 and '19.

And I don't expect it to continue to have that doubling every year.

But the growth rates that we expect from Paragon and Biologics, they're going to be married up with the capacity buildouts in Paragon.

And the expansions that we have in Madison and Bloomington really point to a revenue number.

When we take that into account of the growth rates of the rest of the business that could approach 50% in our 5-year strat plan.

So we're talking about our '20 to '24 strat plan.

So you've got to think out in 2024, but that's where it could be.

It certainly will be north of 40% given the fact that we're already sitting at 31%.

And by the way, that's not at the expense of the other business units.

It's just it's growing at a much faster clip than the core business.

So that's how we get there.

Great.

And then maybe one final one.

I think this was asked earlier, but [I'd be interested] -- maybe I missed kind of the answer or maybe you can flesh it out a little bit.

But in terms of that specialty delivery business, I understand that business was weak in the quarter.

But can you just remind us within that overall division, kind of how did that business perform in the third quarter and kind of how do we think about that business as kind of a normalized growth rate?

Yes, so specialty delivery was down on the quarter partially offsetting the low double digit growth we saw across the core Biologics business, netting Biologics segments to about a 5% growth rate.

And that business should deliver what type of growth do you think, Wetteny, in terms of just like the way you guys think of that?

Yes, so I...

Yes, sorry about that.

So I would say that the rest of the specialty delivery within BSDD, I would probably put some more in the middle of our former 4% to 6% growth rate that we've now taken up to 6% to 8%.

So I would say right in the middle of that 4% to 6% is what I would expect the rest of the specialty delivery to grow long term.

Again, we don't provide guidance by segment and here we're talking about a subsegment here in any given year and so on.

Got it.

Okay.

And then I'm going to sneak one final one in.

I think you cited that $35 million, I think you said that the 606 transition issue, which you got the contribution of EBITDA but not the revenue, so I know that came up on, I believe, the fiscal first quarter.

So did something change this quarter that led to a revenue drag versus prior guidance?

Or was that always implicit when this issue first popped up and you kind of noted it in the fiscal first quarter?

Look, I would say this is more of a cumulative effect on the year where we've tightened -- still within the guidance we started with, but certainly tightened here.

The other 2 elements I described, both the lingering effects of ibuprofen and not seeing the top line growth coming through our clinical business a bit earlier in terms of -- relative to the uptick that we've seen in net new business wins, it's a little bit more delayed.

And so those are sort of the more recent elements within again we're now just a quarter left in the year, we're able to tighten given where our visibility is where we would land for the total year.

Thank you.

And I'm showing no further questions at this time.

I'd like to turn the call back over to John Chiminski for closing remarks.

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

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

First, we remain confident in 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 including Softgel, which is expected to recover nicely in the fourth quarter.

Second, we're committed to continuing to grow our world-class Biologics business as demonstrated by our January announcement of $200 million of CapEx being deployed to further build out capacity and capability in our Madison and Bloomington sites and look forward to continued strong double-digit revenue and high-margin EBITDA growth from our Biologics offering.

Third, we're excited to close the acquisition of Paragon Bioservices in the coming weeks and look forward to welcoming the talented management and workforce into our company.

The transaction will fundamentally enhance our Biologics offering while accelerating long-term growth and increasing shareholder return.

Fourth, the continued successful and efficient integration of the Juniper Pharmaceuticals business into the Catalent family is a top priority as we look to swiftly capitalize on our recent inorganic investments.

The Juniper business continues to perform above expectations.

Fifth, expanding the adjusted EBITDA margin of our business is a key focus area for this 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, this concludes today's conference.

Thank you for your participation.

Have a wonderful day.