The Operator of the Catalent, Inc. Third Quarter Fiscal Year 2023 Earnings Conference Call welcomed participants and introduced Paul Surdez, Vice President of Investor Relations, who discussed the risks and uncertainties that could affect the company's performance. He then turned the call over to Alessandro Maselli, President and Chief Executive Officer, to provide additional detail on the process of reviewing the company's financial situation and its progress towards returning to its historical levels of performance and margins.

On the May 19 call, the company provided a revised outlook for the fiscal year 2023 after a deep dive analysis of the Biologics segment. The company has continued to address issues with forecasting rigor and discipline and is progressing towards the transition of late stage gene therapy products to commercial supply. Additionally, an independent third-party balance sheet review was conducted at the two largest sites in the Biologics segment, which resulted in a few accounting adjustments, including raw material write-offs and an increase to the inventory reserve, as well as a $26 million revenue recognition error.

The company delayed completing their third quarter Form 10-Q and amended their annual report on Form 10-K due to a $26 million revenue recognition error related to a contract modification with a Bloomington customer. This error led to a goodwill impairment of $210 million and led to the company identifying a material weakness in their internal control framework. Ernst & Young has restated their opinion on the company's internal control framework, but their opinion on the financial statements remain unchanged.

The company has been taking steps to strengthen internal control processes and personnel changes to ensure similar issues do not happen again. Three sites with operational challenges, Bloomington, Brussels, and BWI, have seen productivity improvements since the last update. At Bloomington, organizational changes have been implemented to regain efficiencies. BWI has been ramping up production levels and is now at the desired operational level. However, gene therapy revenues are expected to be lower in Q4 than Q3 due to lower utilization rate. Also, there have been margin issues in the Biologics segment due to investments in new modalities.

The company's expectations for higher revenues in fiscal 2023 have not been met, resulting in low absorption and utilization of their service offerings and a significant impact on the EBITDA margin. This is due to a combination of factors, including optimistic forecasting and macro related items, and the company is actively addressing these issues. The PCA segment is also expected to have lower revenue and EBITDA increases than previously expected due to delays in fulfilling demand and logistical issues. The company is also working on a new cost reduction plan to double their previous commitment of $75 million in annualized run rate savings.

In the third quarter of fiscal 2022, Catalent reported a net revenue of $1.04 billion, a 19% decrease compared to the same quarter of the previous year. This decrease was mainly due to the impact of acquisitions and divestitures, as well as an organic revenue decline of 19% measured in constant currency. The company expects to eliminate costs through remediation activities and limit new CapEx to achieve sustainable, profitable growth. They have also taken corrective and preventive actions to address FDA observations. Finally, they are committed to remaining their customers' number 1 CDMO partner.

In the third quarter of 2023, adjusted EBITDA decreased 69% to $105 million, while adjusted net income was negative $17 million. The decrease is mainly due to significantly lower year-on-year COVID demand, with COVID revenue declining 68% to $120 million. This included a one-time settlement for COVID-related raw materials totaling $35 million. The company originally expected COVID revenues to be more than $600 million in fiscal 2023, but the quarterly phasing of this revenue is different than expected.

In Q3 of fiscal 2023, Catalent recorded higher than expected COVID revenue due to the resolution of take or pay and component sourcing arrangements. However, the Q4 COVID expectation is now substantially reduced and long-term COVID take or pay agreements are concluded. The core gene therapy business was the strongest source of growth but still grew below expectations. The drop in development revenue was due to the conclusion of certain COVID revenue and a change in product classification from development to commercial. The segment's EBITDA margin was 1.1%, compared to the 31.1% recorded in the third quarter of fiscal 2022.

The Pharma and Consumer Health segment generated net revenue of $563 million, an increase of 1%, compared to the third quarter of fiscal 2022 with segment EBITDA down 10% over the same period. The growth was due to the recently acquired Metrics business, while commercial revenues were affected by softened consumer demand and supply chain issues. Adverse impacts to net revenue and segment EBITDA included productivity issues, higher than expected costs, accounting adjustments, ERP implementation, unforeseen operational challenges, and low absorption and utilization. The accounting adjustments totaled $55 million and impacted margin by more than 1,100 basis points.

Segment 9's EBITDA margin of 22.3% was lower than the 25.2% recorded in the third quarter of the previous year, due to an unfavorable product mix and cost inflation. The company has a well-structured debt load and intends to reduce it more aggressively, with the nearest maturity not until 2027. The net leverage ratio as of March 31, 2023 was 4.9x, an increase from December 31, 2022, due to lower year-on-year adjusted EBITDA in Q3. Cash, cash equivalents, and marketable securities decreased by $218 million, primarily due to negative free cash flow in the quarter and a $50 million revolver repayment.

The paragraph discusses the company's contract assets, which increased primarily due to gene therapy programs with long cash conversion cycles. It also mentions a change in classification from development to commercial of a large gene therapy program, and the resulting change in accounting under GAAP guidance. This change has no effect on the company's guidance nor is expected to have a material impact on future results.

Interim CFO Alessandro has adjusted the company's guidance for fiscal 2023, expecting net revenue in a range of $4.225 billion to $4.325 billion, adjusted EBITDA in a range of $700 million to $750 million, and adjusted net income in a range of $169 million to $210 million. This is due to the lower sequential growth assumptions in the Pharma and Consumer Health segment, and the challenges in the Biologics segment. At March 31, the company had one strategic customer that represented 23% of their aggregate net trade receivables, and two customers in the Biologics segment that each represented 11% of consolidated net revenue. For fiscal 2024, the company expects to reduce their CapEx to only the most critical projects.

Ricky Hopson responds to a question from Jacob Johnson about the Biologics segment's performance in the fourth quarter. He explains that the revenue may be down sequentially due to the lighter COVID demand, but the margin should improve. Hopson also explains that it will take time to return the Biologics segment to its historical profitability levels, but that the process can be accomplished through cost savings and increased margin on both COVID and non-COVID related work.

In Q4, the operational productivity challenges that were seen in Q3 will continue to cause depressed margins. Revenue is also expected to decrease from Q3 to Q4 due to the decrease in COVID-19 related revenue from $120 million to $40 million. To regain productivity, interventions are being made in three areas: regaining productivity at certain locations, aligning headcount to the new mix, and ensuring uptime on production lines. These activities are being done responsibly and thoughtfully to ensure that the business remains in control.

Catalent is taking steps to improve their margin recovery, including investing in new sites and assets to pursue new modalities, such as cell therapies and plasmid. They are also adjusting their cost structure and investments to align with their new outlook of revenues. They are confident that they can bring the segment back to its original margin, as the pricing and margin of the business remains the same as before the pandemic. GLP-1 drugs represent an exciting opportunity for the industry, with a large patient population.

Ricky and Alessandro Maselli both discussed the working capital efficiency initiatives that Catalent has been working on with customers, such as shortening testing time lines and improving cash flow generation. Alessandro also commented on the potential implications of an age restricted label for Sarepta's drug.

Alessandro Maselli commented that regular inspections are part of their business model and that there are times when there is a concentration of inspections at one location. He mentioned that in January, February, and March, there were three inspections at their gene therapy facility and they were satisfied with the outcome. They have addressed the issues as they always do.

Ricky Hopson confirms that the previously announced $100 million cost takeouts for the next fiscal year includes remediation costs that have already been confirmed. He states that they have already made progress on achieving this goal, with an announcement of a headcount reduction at their Bloomington facility and additional actions being implemented before the end of the month.

Alessandro Maselli states that operational events often have a delayed impact on financials due to the long lead time. He goes on to say that operational challenges in Q3 may have an impact on Q4, and that the ERP implementation in BWI impacted the end of Q3 and the beginning of Q4. As a result, margins in Q4 will be lower than in Q3.

Ricky Hopson clarified that the $26 million error which was reflected in the revised financial statements for fiscal 2022 would not have any impact on the fiscal 2023 financial statements. Luke Sergott asked if the range of 700 to 900 for the jump-off or EBITDA target for the next year was a better estimate of what to expect.

Ricky Hopson and Alessandro Maselli discussed how the company is attempting to tighten up their range for fiscal 2024. They expect to face a headwind due to COVID, but there are also tailwinds in the form of cost actions, one-timers, and growth in the business. Maselli assigned Hopson the task of revealing the forecasting engine of the company, which had not been working as well as it had in the past. Hopson had to prioritize the Biologics division and by the end of 2019 he had completed the work necessary for that division.

Ricky Hopson and the finance team have conducted a deep dive into the PCH segment and found that the risk profile wasn't where they expected it to be. As a result, they have decided to reduce revenue and EBITDA by 25 million. Sean Dodge then asked if there was more detail regarding the ERP delay at the Harmans campus, to which Ricky replied that they expect to recover all of the revenue related to the delay in fiscal 2024.

Ricky Hopson and Alessandro Maselli discuss the guidance revisions for fiscal 2023, with Hopson noting that operational challenges have been resolved and that financial performance will be seen in the first quarter of 2024. Maselli adds that there are signs of improvement in biotech funding, as seen in the number of leads, contacts, quotations, and signed business in the past three months.

Alessandro Maselli is satisfied with the work that Ricky, the temporary CFO, has done in bringing the company's finances into a relatively good order. He is also pleased with Ricky's knowledge of the company and the balance of risk profile he has established. The search for a permanent CFO is ongoing and Catalent is taking its time to ensure the right decision is made.

Alessandro Maselli, CEO of Catalent, discussed the company's debt load reduction and the possibility of divestitures to achieve their target leverage. He emphasized that the company has the optionality to decide when and who the best owner of an asset is. He also noted that the company is in a productive and constructive discussion with their board and they hope to soon discuss their plans in more detail.

Alessandro Maselli explains that the company's current capacity is capable of delivering the projected $6.5 billion in revenue, though the ramp-up for certain modalities is lower than expected. The company is behind in terms of capacity for fill/finish for syringes and Zydis offerings, and needs to accelerate to meet the high demand for these assets.

The company is investing in areas of the business to bring capacity online and mitigate costs, with a goal of reaching $6.5 billion. However, they have suffered from hyper growth in the past two years and are now looking for a more sustainable plan. In the upcoming fiscal year, the priority is on free cash flow and cash generation, with CapEx as a percentage of revenue expected to be in the high single digits. For COVID-related costs, there was an impact of $120 million in the 3rd quarter, and the company expects a clean number of $40 million in the 4th quarter.

Ricky Hopson and Mike Ryskin discussed the supply chain product issues in PCH and how they are close to resolution and expecting to be fully resolved in the first quarter of their fiscal 2024. Max Smock then asked for more details on the operational COVID cliff at the facility, to which Alessandro Maselli responded that the product mix does matter and the COVID vaccine is a simple product mix.

The pharmaceutical industry is much more complex than one product with one presentation in billions of doses. It is normal to transition from one product to another and training can take 6-9 months. The disruption caused by COVID-19 is much greater in certain areas due to the concentration of revenue. This has caused a high level of complexity and many challenges that were not well understood. Technical work is required to get new products online and this is a unique situation that has never been done before.

Alessandro Maselli and Ricky Hopson of Max Smock spoke on the expected ramp-up of new programs coming online in the second half of the calendar year. They both confirmed that the program is still on-track and that PCH is expected to return to growth in fiscal 2024.

Alessandro Maselli discussed the company's gene therapy customers and pipeline, and mentioned that they are conservative in disclosing customer numbers due to contractual terms. He also discussed the large capacity of their site and the ability to expand for key programs. John Sourbeer added one more question at the end.

Alessandro Maselli and John Sourbeer responded to a question about the 6.5 billion capacity number and the assumption of utilization. Maselli stated that 75% utilization is a fair assumption, as it is the sweet spot of the industry. He also mentioned that this would be an average of different points in time. Sourbeer concluded the call with thanks for everyone's questions and support.

This summary was generated with AI and may contain some inaccuracies.