Catalent Inc

NYSE:CTLT

Earnings Call Transcript 2019-Q2

[Operator]

Good day, ladies and gentlemen, and welcome to the Second Quarter Fiscal Year 2019 Catalent Incorporated Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call may be recorded.

I would now like to introduce your host for today’s conference, Tom Castellano, Vice President, Investor Relations, Treasurer. Please go ahead.

[Thomas Castellano]

Thank you, Crystal. Good morning, everyone, and thank you for joining us today to review Catalent's second quarter fiscal year 2019 financial results. Please see our agenda in slide two 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 three for more detail.

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

Catalent's Form 10-Q 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.

[John Chiminski, Chair and Chief Executive Officer]

Thanks, Tom. And welcome everyone to our earnings call. We’re pleased with our second quarter financial results which were ahead of our internal expectations and position us well heading into the second half of the fiscal year.

We continue to be confident in delivering our fiscal year 2019 full year financial guidance, which we are reaffirming.

As you can see on slide six, our revenue for the second quarter increased 3% as reported and increased 5% in constant currency to $623 million, driven by our Biologics and Specialty Drug Delivery segment, as well as the acquisition of Juniper Pharmaceuticals.

These increases were partially offset by the ASC 606 revenue recognition change related to the treatment of comparator sourcing activity within our clinical supply services segment, which is now recorded on a net basis as compared to a gross basis under the prior financial guidance.

Excluding the impact of this revenue recognition change, revenue would've increased 10% in constant currency compared to the prior year. Organic revenue grew 4% year-over-year during the quarter, led by our Biologics and Specialty Drug Delivery and Clinical Supply Services segments.

Our adjusted EBITDA of $146 million was above the second quarter of fiscal year 2018 on a constant currency basis by 6%. Our adjusted net income for the second quarter was $65.4 million or $0.45 per diluted share, which is in line with the adjusted earnings per diluted share figure from the prior fiscal year.

The strong financial results were led by our Biologics and Specialty Drug segment, which continues to be the fastest growing segment in the Catalent portfolio and recorded revenue growth of 25% and EBITDA growth of 28% during the second quarter, most of which was organic.

Now, moving to our operational update, first, we continue to make great strides on our Biologics strategy. The integration of the Bloomington business acquired in October of last year is essentially complete.

The business continues to deliver. And as I stated on the last earnings call, the Bloomington site recently received approval for its 20th 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 of fiscal year 2018. Our growing robust funnel of late-stage clinical opportunities will help increase the utilization of the new capacity in fiscal year 2019 to more than 50%.

We also received approval from our Board of Directors for, and recently commenced, a $200 million investment spanning both Bloomington and Madison that will add more drug substance manufacturing and drug product fill-finish capacity due to projected growth among existing and future customers.

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

As a reminder, Catalan 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 of Biologics in a variety of 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.

Second, you will recall that we closed the acquisition of Juniper Pharmaceuticals during the first quarter, adding to our network of our European early development center of excellence with dose form development and early manufacturing capabilities.

Juniper's proven solutions and capabilities in formulation, development, bioavailability solutions and clinical scale, oral dose manufacturing, including spray dry dispersion, are already advancing 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 patient faster.

The integration of the Nottingham UK site and its nearly 150 employees into the Catalent network is well underway and tracking according to our expectations, while contributing strong financial results to our Oral Drug Delivery segment.

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

Although the supply shortage is improving, the situation remains a challenge. During the second quarter, the ibuprofen shortage reduced segment EBITDA by approximately $8 million and we currently expect some impact in the third quarter, although we see the basis for greater supply stability by the fourth quarter, in part because we've taken the steps to secure alternative sources of supply that should be alleviating some of the bottleneck by then.

Lastly, I’d like to discuss several factors that give us confidence in delivering our fiscal year 2019 financial guidance. First, we have a very strong pipeline of new products that are expected to launch in the fiscal year and we already have visibility to more than $70 million of expected revenue from the 92 products that launched in the first half of the fiscal year, a higher rate than the first quarter when we launched 38 products.

Next, our Biologics business continues to experience robust demand and we’re confident in our ability to execute on the demand, including the 20 commercial products in Bloomington.

In addition, we've built a backlog of orders in many of our sites across the network and once again we’re confident in our ability to execute on that demand throughout the second half of the fiscal year just as we did in the second quarter.

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

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

[Wetteny Joseph]

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

The reported results for the three and six months ended December 31, 2018 reflect the application of the new standard, while the reported results for the three and six months ended December 31, 2017 were prepared under the guidance of the prior standard, ASC 605.

It 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 reported on a net basis compared to a growth basis in the prior-year now.

Now, please turn 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 $213.7 million declined 3% during the quarter, with segment EBITDA declining 9% due to lower consumer health volume as a result of the worldwide ibuprofen shortage, which negatively impacted segment EBITDA by approximately $8 million.

Given the latest information we have available, we expect the ibuprofen shortage to continue for the next quarter until the worldwide supply stabilizes, as John noted earlier.

This headwind was partially offset by strength in Europe where we experienced higher demand for prescription and consumer health products.

Asia-Pacific divestitures negatively affected the segment revenue by 2 percentage points, but did not materially impact the segment’s bottom line.

Another important item to note regarding Softgel segment performance is that, normalized for the Q2 impact of the Asia-Pacific divestitures and ibuprofen shortage, the segment would have reported revenue growth of approximately 3%, which is in line with the segment’s historical average.

Slide 8 shows that our Biologics and Specialty Drug Delivery segment reported revenue $184.3 million in the quarter, which was up 25% versus the comparable prior-year period, with segment EBITDA growing 28% during the quarter.

A portion of the segment’s revenue and EBITDA growth was driven by the Bloomington Biologics acquisition, which closed in October of 2017, and contributed 10 percentage points of the revenue growth and 10 percentage points to the EBITDA growth.

The Bloomington site has performed above our expectations continuously from the time of acquisition announcement and we feel good about the immediate and long-term growth prospects of this critical high-growth business.

On an organic basis, we saw strong growth, with revenue in Biologics and Specialty Drug Delivery segment of 15% and segment EBITDA up 18% during the quarter.

Recent organic investments in our legacy Biologics business continued to translate into growth during the second quarter and remains the fastest growing business within Catalent.

We reported strong growth in drug substance, driven by the completion of project milestones and larger clinical programs, but this was partially offset by modest declines in our European drug product business.

We continue to believe that our Biologics business is positioned well to deliver future growth.

As John mentioned, the third suite of Madison is complete and online and its utilization level continues to ramp.

In addition to the strong performance in Biologics, we saw a nice recovery within our respiratory and ophthalmic business, which saw higher volumes in the second quarter and experienced a combination of favorable product mix and increased capacity utilization levels. Fundamentals continue to remain attractive for these key sterile fill technology platforms.

Slide 9 shows that our Oral Drug Delivery segment reported revenue of $154 million in the quarter, which is up 14% versus the comparable prior-year period, with segment EBITDA increasing 11% during the quarter, driven by the Juniper Pharmaceuticals acquisition, which contributed 17 percentage points of the segment’s revenue growth and 26 percentage points of the segment EBITDA growth during the quarter.

The organic revenue decline of 3% and EBITDA decline of 15% was primarily driven by volume declines for a few high-margin products within our US oral solids business, in which one customer has moved volumes in-house to leverage unused internal capacity as discussed during our first-quarter earnings call.

That being said, we have one of our strongest development pipeline, including several late-stage spay dry development programs within this high-margin segment and expect to see accelerating growth in the near to midterm.

Partially offsetting the oral solids decline was the recovery within our Analytical Development Services business, which experienced increasing volumes during the second quarter.

In order to provide additional insight into our long-cycle businesses, which included Softgel Technology, Biologics and Specialty Drug Delivery and Oral Drug Delivery, we are disclosing our long-cycle development revenue and a number of new product introductions, NPI, 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 first six months ended December 31, 2018, we reported development revenue across both small and large molecule of $310 million, which is 24% above the development revenue reported in the first six months of the prior fiscal year.

Additional disclosure on our development revenue, which is now calculated in accordance with ASC 606, is included in our Form 10-Q filed today with the SEC. In addition, we introduced 92 new products which are expected to contribute $75 million of revenue in the fiscal year, which is more than double the revenue contribution of NPIs launched in the first six months of the prior fiscal year.

This is especially important as it gives us additional confidence in our ability to deliver on our fiscal 2019 financial guidance as John previously highlighted.

Now, as shown on slide 10, our Clinical Supply Services segment posted revenue of $80.8 million, which was down 25% compared to the second quarter of the prior-year, driven by ASC 606 revenue treatment of comparator sourcing activity on a net basis compared to growth basis in the prior fiscal year.

Excluding the impact of ASC 606, segment revenue increased 2% due to increased volume related to cold storage and distribution services. Segment EBITDA increased 13% compared to the second quarter of the prior-year, primarily driven by the revenue growth in our cold storage and distribution services business, favorable product mix and improved capacity utilization across the network. All of the revenue and segment EBITDA growth recorded within CSS was organic.

As of December 31st, 2018, our backlog for the CSS segment was $319 million, a 6% sequential increase. The segment reported net new business wins of $106 million during the quarter, which is an increase of 59% compared to the net new business wins recorded in the second quarter of the prior-year.

The segment’s trailing 12-month book-to-bill ratio is 1.2 times. 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 and revenue accounting and now include comparator revenue on a net basis.

The next slide contains reference information. We have already discussed the segment results shown on the consolidated income statement by reporting segment on slide 11.

Slide 12 shows in precisely the same presentation format as slide 11 the six month, year-to-date performance of our operating segments both as reported and in constant currency. I won’t cover the various drivers in detail since they closely parallel our second quarter results.

The key growth drivers are the acquisition of Bloomington and Juniper Pharmaceuticals, strong growth within our Biologics business and increased storage and distribution revenue within Clinical Supply Services, which are partially offset by the Softgel impact of the worldwide ibuprofen shortage and oral solids revenue declines due to certain high-margin products.

Slide 13 provides a reconciliation for the last 12 months of EBITDA from operations for the most proximate GAAP measure, which is net earnings or loss. This bridge grace 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 14, second quarter adjusted EBITDA increased 5% to $146 million. On a constant currency basis, our second quarter adjusted EBITDA increased 6%. Most of the growth was driven by the Bloomington Biologics and the Juniper Pharmaceuticals acquisition.

On slide 15, you can see that second quarter adjusted net income was $65.4 million or $0.45 per diluted share compared to adjusted net income of $60.7 million or $0.45 per diluted share in the second quarter a year ago. This slide also includes a reconciliation of net earnings or loss to non-GAAP adjusted net income in a summarize 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 back as seen on the adjusted EBITDA reconciliation slide.

Slide 16 shows our capital vision table and capital allocation priorities. Our full net leverage ratio as of December 31 was 3.4 times, which is modestly down from the 3.5 times 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 US dollar-denominated term loan in July, with the proceeds from the equity offering, and closed the Juniper acquisition on August 14. And impacts on both transactions is reflected in our leverage issue.

Additionally, given the strong free cash flow generation of the company and its growing adjusted EBITDA, the company naturally delivers a ratio decrease of between one half and three quarters of a turn per year.

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 on slide 17, we are reaffirming our previously issued guidance. We continue to 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.

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, which we expect to be between 25% and 27% in the fiscal year.

We also expect interest expense in fiscal year 2019 to be approximately $112 million to $114 million, which is reflective of both the July debt pay down as well as an updated LIBOR curve for our floating-rate debt.

Additionally, 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 being our strongest by far.

This will continue to be the case in fiscal year 2019 where we expect to realize between 40% and 45% of our adjusted EBITDA in the first half of the year and 55% to 60% of our adjusted EBITDA in the second half of the fiscal year.

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

[Operator]

Thank you. [Operator Instructions]. And our first question comes from Tycho Peterson from J.P. Morgan. Your line is open.

[Tycho Peterson, J.P. Morgan]

Hey, thanks. Couple of questions. I guess, looking forward on Oral Drug Delivery, you talked a little bit about the 3% decline. Can you maybe just talk through your confidence level in that coming back in the back half of the year? I know you had telegraphed some of the softness last quarter, but just [indiscernible] on the recovery.

[Wetteny Joseph]

Sure, Tycho. As you know, we issue guidance on a consolidated basis for the company and not by segment. But the color I would provide for you is our oral drug business has, as we've said in the prepared commentary, one of the most robust pipelines that we have. Among the thousand development programs we have across the company, the Oral Drug Delivery segment has a great pipeline that should contribute to interesting growth in the business, I would say, in the near to midterm, including, as we talked about, spray dry dispersion, which is one of the areas of future growth for the business and for the segment where we have a number of late-stage development programs that we will look to capitalize on as those progress through late phases up to commercial approval.

So, if you look at the business, we’re very excited about its future, given the pipeline that it has. Currently, in the near-term, as we discussed last quarter as well as this one, we have a few high margin products that have seen declining volumes, including one that was taken in-house by a customer, and that has had the near-term or short-term impact for the business, but we look forward to the mid to long-term returning to growth that is at the Catalent average, if you will, for the segment.

[Tycho Peterson, J.P. Morgan]

Okay. And then on Softgel, a number kind of moving pieces here. You mentioned an alternative supplier. BASF, their plan, I think, is also going offline again in April and May. So, can you maybe just talk on those two dynamics and what's baked into the guide for the ibuprofen impact in the back half of the year?

[John Chiminski, Chair and Chief Executive Officer]

Sure. Our guidance fully reflects what we expect to receive at this stage from the perspective of ibuprofen. Our supplier is bring their facility back up and running, but that facility is expected to be taken back down. So, we have taken steps to secure supply from alternative providers, again, reflecting what we have here in the – for the balance of the year. But we do expect to continue to see some headwind associated with this, which continues to be a worldwide shortage for ibuprofen given the size of the supplier that’s involved here.

[Tycho Peterson, J.P. Morgan]

Okay, thank you.

Operator\

Thank you. Our next question comes from John Kreger from William Blair. Your line is open.

[John Kreger, William Blair & Co. LLC]

Hi. Thanks very much. John, given the high-profile ibuprofen shortage, have you guys thought at all about API production perhaps being a little bit more strategically attractive to you on the oral solid side? Thank you.

[John Chiminski, Chair and Chief Executive Officer]

Yeah. Thanks, John. So, we continue to look at all adjacencies, I would say, as potential inorganic growth opportunities for the company and we’ve continued to have, what we call, our bull’s eye chart where we look at where we’d like to strategically add adjacent businesses, and API continues to be something that we look at certainly in our oral drug – broadly speaking, our oral technologies, which includes Softgel and Oral Drug Delivery, there could be some interesting synergies there in terms of bringing in more molecules into the company. So, certainly, it’s an area of interest, but it always goes with understanding if you have something that really fits the profile of Catalent, is that commodity-based and would be somewhat specialized. Nothing currently on the table, but certainly, again, of interest to us, as are other adjacencies that we continue to look at.

[John Kreger, William Blair & Co. LLC]

Great, thank you. And then, one quick follow-up. You mentioned the board approval of the $200 million CapEx plan around Biologics. Can you expand upon on that a little bit? And as a result, should we think about any sort of kind of elevated CapEx requirements for the company broadly over the next few year? Thanks.

[John Chiminski, Chair and Chief Executive Officer]

Sure. So, we do not expect to go beyond our current 7% to 8% of revenue spend on CapEx, even with this large CapEx announcement. The way we do CapEx within the company is on a project by project basis that's approved for its returns and strategic nature.

With regards to those two particular projects, those are really being feathered in when we see the capacity needs for both Madison and Bloomington. As we’ve stated, our third train, which just went live last April, in this fiscal year will probably exceed 50% of capacity utilization in its first year, so that fourth and fifth train, one will be necessary to make sure that we have the capacity for the pipeline for both our current and future customers; second, it’s really going to go put us in a position to have some commercial products at our Madison facility. We’re putting two 2 x 2000 single-use bioreactors in the fourth and fifth train. And, clearly, that's going to give us the capability for going commercial with some of these molecules that will require sub-5000 meter bioreactors.

With regards to Bloomington, again, we've got a very robust pipeline there. I would say that we achieved a level of commercial products there that we really didn't fully anticipated at the time of the acquisition, going from 12 to 20. And we’re probably operating somewhere between 50% and 60% capacity utilization. And what we’re going to be doing is more or less doubling the capacity of Bloomington in the 2021, 2022 timeframe by putting in both syringe and high-speed vial line in some cartridge assembly. So, again, very robust pipeline there. A lot of approved commercial products and we just want to make sure that we continue to stay ahead of the capacity curve for the growth that we have both in Bloomington and Madison.

[John Kreger, William Blair & Co. LLC]

Very helpful. Thanks.

[Operator]

Thank you. Our next question comes from Ricky Goldwasser from Morgan Stanley. Your line is open.

[Ricky Goldwasser, Morgan Stanley]

Yeah. Good morning. Can you talk a little bit more about the SG&A savings efforts and how should we think about the margin for Softgel? I know that, in the past, you talked about some of the cost-cutting opportunities offsetting the revenue decline. Where are you at in that process and where should we think about margins bottoming?

[Wetteny Joseph]

Ricky, we've communicated and are committed to delivering an additional 200 basis point to 300 basis point expansion to our EBITDA margins for the company in the next two to three years in addition to the 160 basis points that we have in our guidance for fiscal year 2019. As we look across the company, certainly, the Softgel business will be a contributor to that as we look to execute from a productivity and throughput perspective. Across the company, we've established the center of excellence to carry through and capitalize on best practices across the operating sites that we have within the Softgel business. So, we see that contributing to that overall margin expansion that we talked about for Catalent as a whole, in addition to the mix of Biologics in Catalent contributing to that as well as, lastly, the change in the revenue recognition or ASC 606 contributing to this year's 160 basis points expansion, about half of that coming from the comparator change. So, again, 160 basis points this year, another 200 basis points to 300 basis points beyond this year in the next two to three years coming from mix, Softgel contributing to that as well as other products of the company.

[John Chiminski, Chair and Chief Executive Officer]

Yeah. Ricky, I’ll dial in a little closer to your question with regards to Softgel. As we've talked about, Softgel’s historical growth rate has been about 2% to 4%. And quite frankly, outside of the ibuprofen shortage and dispositions of some assets in Asia, it would be performing in line with that historical growth rate. But in addition to that, you can see that we've really been – I would say, the business has performed despite those headwinds, in part due to, I would say, the aggressive productivity efforts that we have within the Softgel business and we have, in a strategic plan, an acceleration of productivity in the Softgel business over the next four years, already with contributions starting this year that will actually have Softgel as one of the contributors to this margin expansion that Wetteny just detailed.

[Ricky Goldwasser, Morgan Stanley]

Okay. And when you about your guidance range, you talked about kind of like some of the expectations. As we think about Softgel, what are your expectations for Softgel at the low end of the range versus the high end of the range?

And for the Biologics business, kind of the same question, but should we assume Biologics growth second half kind of like normalizing and maintain organic level?

[Wetteny Joseph]

Sure. From a Softgel perspective, again, our guidance is on a companywide basis and not by segment, Ricky. But what I would say is when we look at the Softgel business, we see it in the 0 to 2% growth for fiscal year 2019. You can see some of the short-term impacts from ibuprofen as well as the divestitures we anniversary in the third quarter. So, for the first two quarters, the divestitures were each 2 percentage points off the top line for Softgel for each of the first and second quarter. That will become about a 1% for the full year for Softgel. So, we see that in the 0% to 2% range for the year.

And then, from a Biologics perspective, we see the core Biologics business growing in the teens, with remainder of the segment, which Biologics is about 60% of the Biologics and Specialty segment, the specialty delivery elements about 40% of the business, which we see growing in the Catalent average of 4% to 6%. So, you can net that out to about 10% or so for the segment. That is what we would expect.

[Ricky Goldwasser, Morgan Stanley]

Thank you. Our next question comes from Donald Hooker from KeyBanc. Your line is open.

[Donald Hooker, KeyBanc Capital Markets, Inc.]

Great. Good morning. Hey, just kind of broad, higher-level question here in terms of just looking at kind of the pull back in biotech equity valuations across all your various businesses, thinking about net product introductions and whatnot, a lot of noise around the FDA shutdown and all that, can you talk a little bit about kind of your thoughts around recent sort of equity gyrations in biotech?

[John Chiminski, Chair and Chief Executive Officer]

Really no commentary with regards to equity valuations, but I would just say is that the VC funding continues to be very strong and we continue to see, I would just say, robust demand. Most of the business that we do out of our Madison facility – actually all of this stuff we do out of our Madison facility is preclinical and clinical work for Biologics. And then, within Bloomington, we really have 20 commercial products, so those are ready off and running, but they also have a very large slate of, again, preclinical and clinical products there. So, I can’t really comment on equity valuations, but I can say the R&D spending continues to be strong and, again, it was in part the support for the $200 million in CapEx spend that we have across Madison and Bloomington.

[Donald Hooker, KeyBanc Capital Markets, Inc.]

So, you don't see any changes in your conversations around pipeline or anything like that? So, that's what I mean by my question. And then maybe kind of – you gave a lot of guidance and we all appreciate that. In terms of free cash flow, it seems like in prior years, you were turning ahead of your long-term expectations. How are you thinking about this year? I know it moves around quarter to quarter. But we watched that metric closely as you're paying down debt and whatnot, can you give us a little commentary on maybe kind of your near-term outlook for free cash flow?

[Wetteny Joseph]

Sure. Our outlook for the year is between 65% and 75% of free cash flow as a percentage of our adjusted net income. You would have seen us deliver slightly north of that in the prior three years. The first half of the year, particularly the first quarter, tends to be a slower start as our EBITDA tends to be lighter in the first quarter and strongest in the fourth quarter. So, free cash flow generation tends to be a bit more back half sort of weighted, which is what we’re seeing this year. So we continue to guide to 65% to 75% of our adjusted net income for the year.

[Donald Hooker, KeyBanc Capital Markets, Inc.]

Great, thank you. That's all for me. Thanks. Bye.

[Operator]

Thank you. Our next question comes from Juan Avendano from Bank of America. Your line is open.

[Juan Avendano, Bank of America Merrill Lynch]

Hi. Congrats on the quarter. Can you give us an update on the level of capacity utilization at Cook or at Catalent Indiana? And then, also if I heard correctly, there is still about 20 products, commercial products, launched out of Catalent Indiana, which is the same number as of the last quarter. So, were there no additional commercial products launched over the last quarter?

[John Chiminski, Chair and Chief Executive Officer]

So, first of all, I’d say, I think I stated to an earlier question that we’re running somewhere between 50% and 60% of capacity utilization in Bloomington and currently the CapEx that we plan on spending there, about $112 million, will really dovetail into when they'll be approaching somewhere near full capacity utilization in the 2021, 2022 timeframe. We had no additional products that went commercial since the last quarter, which is not unusual given the relative lumpy nature of when commercial approvals happen. We expect, with the pipeline that we have, about another half dozen potential commercial approvals over the next 2 to 3 years. So, we don't expect the rate of approvals that we had for the time that we acquired them from 12 to 20 to continue at the same pace, but we do have another, I would say, half a dozen or so that we expect in the near term over the next couple of years.

[Juan Avendano, Bank of America Merrill Lynch]

Thank you. And on the Oral Drug Delivery segment, you had a notable sequential improvement, but Juniper was well ahead of expectations. And so, how should we think about Juniper revenue growth run rate going forward? Has there been a recent higher?

[Wetteny Joseph]

So, Juan, what I would say is we factored in the acquisition in the guidance that we prepared. If you recall, we closed on the acquisition prior to issuing guidance. Well, I would say, we’re pleased with the performance of the business. Certainly, the strategic intent here is to add to our Oral Drug Delivery, bringing more molecules into Catalent and having a center of excellence in Europe, which is effectively a theater of molecules that we work on in the development stages, in some cases preclinical, that would feed into the long-term growth of the Oral Drug business. So, so far, we’re very pleased with what the business is performing, contributing and the strategic intent here is to drive more molecules through Catalent. We haven't broken down any specifics in the end of guidance by segment. It is factored into the overall guidance that we issued.

[Juan Avendano, Bank of America Merrill Lynch]

Okay. Lastly, and very quickly, on the CSS, the Clinical Supply Services, even excluding the impact of the adoption of ASC 606, that segment is growing low single-digits, and that’s been usually higher than the company average. And so, can you give us an update on the landscaping there, the competitive dynamics and also the end market, how that's working out?

[John Chiminski, Chair and Chief Executive Officer]

We’re very pleased certainly with the EBITDA performance in the segment, double digits, 13% in the quarter. And I think you see several quarters in a row that the business has delivered double digit EBITDA growth.

The other thing I would say, if you look at the net new business wins as well as the book to bill ratio, those have been trending up over the last two quarters, which is an early signal of topline growth for the business. So, we look forward to sort of an increasing growth rate in the business as we look out in the near term for the segment. But, certainly, we’re pleased with what the business has been delivering from an EBITDA perspective.

[Juan Avendano, Bank of America Merrill Lynch]

Thank you.

[Operator]

Thank you. Our next question comes from David Windley from Jefferies. Your line is open.

[David Windley, Jefferies LLC]

Hi. Good morning. Thanks for taking my questions. John, I was hoping to start in Biologics and to try to get a better feel for how the kind of bevy of commercial product approvals that you see in that business are ramping. I guess, my intuition is that you would usually have a client requesting launch quantities in and around the time of the commercial approval. And so, I'm wondering if you have enough of a diverse portfolio there now for that to be a relatively smooth progression in and after the launch or is it still kind of fits and starts until those commercial products find their footing in the end market?

[John Chiminski, Chair and Chief Executive Officer]

I would say that we’re not really seeing lumpiness in the performance of the business. I would say that it’s been much more of a normal smooth progression. They already had 12 products that were commercial when we purchased them. So, we've got another 8. And I would just say that, across those eight, it's just kind of working out to be not very lumpy and somewhat of a smooth ramp in terms of what we would expect. So, you do have launch quantities feeding into that. But then, you kind of have the normal progression of product growth over a multiyear period. So, I would say that the way the business is performing with the products, we’re very pleased with it. And our challenge is just to make sure that we continue to have the capacity to supply those commercial products. So, so far, so good, David.

[David Windley, Jefferies LLC]

Okay, great. That sounds good. In terms of then breaking down between your drug substance activities and your drug product activities, you had these nice approvals. You also – I think in the prepared remarks, there was a comment that drug substance actually hit some milestones and did pretty well in the quarter. Can you give us a sense for how much of the overall Biologics activity is substance versus product?

[John Chiminski, Chair and Chief Executive Officer]

Again, we don't breakout the actual numbers for that. But I would just say that our Madison facility, which we've talked about in the past, is primarily – it really all drug substance. And then, our Bloomington facility is probably about 80/20 in terms of drug substance, drug product, maybe two-thirds/one-third. So, that's the mix across those two facilities. And then, within Madison, we do not yet have a product that has gone commercial, but over the next couple of years certainly as we look to bring on the additional fourth and fifth train, we do expect to either bring in-house or have one of the current late stage clinical products there go commercial. So, should be a continuing nice ramp in the drug substance area, complementing what we already have for commercial and drug product.

Q - David Windley\

Okay. And then, from a go-to-market strategy standpoint, are you in the market offering a combined substance and product kind of soup to nuts offering to the client or is it still being sourced by the client pretty independently, such that that doesn't make sense?

[John Chiminski, Chair and Chief Executive Officer]

So, first of all, I would say that, currently, the trend is for a lot of this sourcing independently. And with the acquisition of Bloomington, we’re actually at work creating an end-to-end offering that will be going to market, so we have some pilots with that. In advance of that, I would just say that the dialogues that we were having in Madison have crossed over to Bloomington and vice versa, meaning that each site now has a broader view of opportunities across the continuum from cell line development through drug substance and drug product. So, we’re already seeing some of those benefits. And I can tell you that we've captured customers we would not have otherwise and we’re currently in the process, as I said, of creating an end-to-end offering as a real offering, not just we have the capability, that we’ll be piloting. So, I think it will be a huge differentiator. And again, this is one of the strategic rationales for having that drug product is creating that end-to-end across Biologics, which I'll tell you, in general, end-to-end solutions are much more of a talk tracking, a marketing ploy than it is in real – in how it works in real life, not so on the Biologics front. It really will be a differentiator having that end-to-end capability. So, that'll be making some progress over the next 12 to 18 months.

[David Windley, Jefferies LLC]

Okay, great. And last question for me. On the 1,000 projects in development currently, how does the mix of Softgel in that base look relative to history? Is Softgel still kind of holding its share of your development pipeline?

[John Chiminski, Chair and Chief Executive Officer]

Softgel’s pipeline actually looks terrific. The challenge is that it’s for smaller disease populations, orphan drugs and so forth. So, the challenge is just more from a volume standpoint, not from a natural new product introduction. We've had some terrific new product introductions in the pipeline for Softgel and they're well north of 100, 120 or so of active, I would say, RX projects, which is the real value-add drivers in Softgel. And, certainly, a large number of OTC and VMS projects. So, very healthy pipelines. And again, this has been a historical 2% to 4% grower, given the niche dose form. But when you're the leader and four times bigger than the next, it’s really a terrific business. So, we’re really running it in that zip code for growth, but trying to get more marginal out with our productivity.

[David Windley, Jefferies LLC]

Got it. Thank you very much.

Operator\

Thank you. Our next question comes from Evan Stover from Robert W. Baird. Your line is open.

[Evan Stover, Robert W. Baird]

Yeah. Thank you for taking my question. Just one for me. In BSDD, you talked about increased volumes from your respiratory and ophthalmic platforms. I know that was an area of some softness last quarter. Now, we’re seeing some recovery. I'm wondering if you can tell me the kind of – some more color, the drivers of that. Are we talking normal ebb and flow here or is this more the result of operational and executional improvements that maybe are little bit more durable there?

[John Chiminski, Chair and Chief Executive Officer]

It’s purely operational and executional improvement. As you know, we had some operational challenges in our blow-fill-seal facility dating all the way back almost a year-and-a-half ago that we've been working through. And through that period, a backlog had been developing. And really, what we’re seeing now is the relief of that backlog through improved operations. And we expect that healing to continue, if you will, across that respiratory and ophthalmic business.

[Evan Stover, Robert W. Baird]

All right. Thank you very much.

[Operator]

Thank you. Our next question comes from Daniel Brennan from UBS. Your line is open.

[Daniel Brennan, UBS]

Great. Thanks for taking the question. First, I just wanted to go back to the Juniper acquisition. Can you just give us a little more color on some of the strength you're seeing right now with that business? I know – I think it was doing around $15 million per quarter when you closed the deal and it looks like this quarter substantially higher than that. So, just kind of talk through how we should think about the opportunity for Juniper going forward?

[Wetteny Joseph]

So, the business, as I mentioned, is doing well, I would say, across both fronts. There is the development activity as far as working with our customers as their products are making it through the clinic. So, from preclinical through clinic and that continues to execute well for us. We’re very pleased with what the business is doing on that front. And slightly above, I would say, internal expectation.

And then, there is a product that we partner with that we’re supplying for the market as well commercially that is also performing well for us. I wouldn't say anything fundamentally is changing with the business, but it is performing slightly above the internal expectations that we have.

[Daniel Brennan, UBS]

Okay, great. Thanks. And then, on the Biologics side, so I know you just mentioned to Dave’s question previously that the eight commercial products that you've kind of gained since closing the deal, you wouldn't expect that pace to continue. Certainly, that's a very robust pace. But could you just speak a little bit to kind of why you've been so successful out of the gate and possibly why that pace might not be able to continue? I think you certainly talked about the capabilities, cross-selling, but just a little more color on what you've seen to date since the acquisition and how you think about that opportunity to capture new commercial products going forward?

[John Chiminski, Chair and Chief Executive Officer]

Yes. So, look, what I would say is that, Cook built this business up over a 15-year period. And, specifically, in the drug products front, I would say, over the last 8 to 10 years, they had a high focus on two things – one is, late stage biologics products that they believed would go commercial and then focused on customers that would stay with them for commercial. So, they had a very specific strategy that, quite frankly, Catalent has been the beneficiary of that we literally acquired them on the upswing of this terrific pipeline. So, they had 12. We thought maybe another three or four, we’re going to go commercial, and then, again, it just worked out that they had a stronger slate of approvals than we had expected. And they went up to 20. We certainly do not expect to see that same rate of approvals. We do have about another half a dozen over the next 2 to 3 years that are, again, in the shoot for potential approval. But that doesn't mean that the growth rate is slowing down because we also continue to win and bring in clinical stage business, which is again the front-end engine of that business. So, we continue to see, I would say, the growth rate of that business continue with no fall off. And then, the bonus is when you do get some of those commercial products.

Most of the products in Catalent that we do in our development pipeline do not get approved. So, our business model is to bring in molecules, do development work on them and then if and when they get approved, do the long-term commercial manufacturing. So, I’d say Bloomington is fitting right into our Catalent’s follow-the-molecule strategy and is performing, I would say, better than we had forecasted, but continue to see that growth rate going forward.

[Daniel Brennan, UBS]

Thanks. And maybe just quick final – just on ibuprofen and Softgel, can you just remind us, basically what’s implied in guidance right now is you have the second source coming on in the fourth quarter and that the divestiture impact that you saw in the first two quarters is done now?

[John Chiminski, Chair and Chief Executive Officer]

All factors related to Softgel are baked into our guidance, whether they be the ibuprofen where the product participation that had rollen off, as well as the divestitures as well as the second source that we brought online. So, I would say, that's all contemplated in our reaffirmed guidance.

[Daniel Brennan, UBS]

Okay, thank you.

[Operator]

Thank you. And I'm showing no further questions from our phone line. I would now like to turn the conference back over to John Chiminski for any closing remarks.

[John Chiminski, Chair and Chief Executive Officer]

Thanks, operator. And thanks, everyone, 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, our strong Q2 performance positions us well in the second half of the fiscal year and we’re confident in, and committed to, delivering fiscal year 2019 results consistent with our financial guidance and are focused on continuing to drive organic growth across our overall business.

Second, we’re committed to continuing to grow our world class Biologics business, as demonstrated by recent announcement of $200 million of CapEx being deployed to further build our 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, 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 at our recent inorganic investments. The Juniper business continues to perform above expectations.

Fourth, expanding the adjusted EBITDA margin of our business is a key focus area for this management team as we drive towards 200 basis points 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.

[Operator]

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.