Certara, Inc. (CERT) Earnings Call Transcript & Summary

Hello, everyone, and welcome again to the Piper Sandler Healthcare Conference. We're really pleased today to have the executive team from Certara joining us. Specifically, we have William Feehery, the CEO; and Andrew Schemick, the CFO. So thank you again, guys, for joining us and making the time.

And I'll just jump right into the questions. Maybe we'll start with a big picture view of the market opportunity. I would say from a macro level, there seems to be a lot of momentum to make drug discovery and development more efficient and effective. So I'd ask what major macro factors would you call out that are creating tailwinds specific to the adoption of biosimulation?

Yes. Thanks, Jeff. It's a great question. The #1 for us over the years has been the increased adoption by the -- of biosimulation, not only by the industry, but very specifically by the FDA. So we have had over 80 drugs approved, where our biosimulation was specifically cited on the drug labels. And the number of situations and cases in which the regulators will permit or even encourage the use of biosimulation has been growing over the years, and we expect it to continue to grow in the future. So that's probably the #1 biggest tailwind for us. On top of that, we have, in general, we think the pharma industry is very healthy today. There's a tremendous amount of investment dollars going into biotech sector. Right now, it's continuing, Pharma budgets are going up. And generally, I think coming out of the amazing inventions around COVID epidemic, we're seeing kind of just an increased optimism and continue to invest in pharma. So that's definitely helping us. And then lastly, trials are expensive. They're not getting cheaper. The message that we have around, use biosimulation and use data and modeling in order to be more efficient in your drug development expenditures, I think, is certainly that resonates across the industry all over the globe.

Excellent. Very helpful. And I think we'll dive more into the regulatory aspect because that's an interesting way of getting your offerings validated and kind of spurring adoption from customers. But just to stay on the market opportunity for a second and maybe try to put a number around some of the trends, you guys have pegged your TAM at $12 billion and growing 12% to 15% annually. So what's baked into that $12 billion TAM number on a per biopharma product basis? And then how should we break up -- break that up between biosimulation, regulatory and other components of your current portfolio?

You want me to take that, Bill?

Yes, why don't you take that, Andrew?

Okay. So to start with how we develop our TAM, we base our TAM off of our current core markets, biosimulation, regulatory science, real-world evidence market access. The biosimulation market is approximately $2.4 billion of the TAM. It's growing mid-teens 15% growth rate; our regulatory sites, $8 billion, growing at 12% growth rate; and real-world evidence market access, $1.3 billion, it's also growing around 12%. If you could help clarify what you mean by per biopharma product basis?

Yes. So thinking per product, per project, maybe per trial is another way to put it, but I know there's some variance there. Just thinking about ballpark average spend or potential kind of top spend per product or project. And then on biosimulation and related services, not on the -- just the overall cost.

Did you start with that?

One way that I look at this is that if I look at the dollars spent per phase of clinical trial and the total number of active clinical trials by phase, and I take the most basic offering that we make per phase, so for example, early on, a noncompartmental analysis in later stages, PBPK drug-drug interaction. I estimate that it's approximately 2% to 3% of the total trial cost if it was fully adopted. It's another way to extrapolate out and get approximately $2 billion of the total market size. So in terms of penetration, you can see what our company's revenue level is at, is about some portion of that is done in-house to estimate maybe 50%, with the remainder being cases where biosimulation is not being leveraged as a part of the clinical trial.

No. That helps frame the current penetration and the potential to expand that, I think, many multiples higher. And from there, I'll dive into the differentiation of Certara versus some of your peers versus some of your clients' internal efforts. And you kind of alluded to it a little bit. But I'm guessing you don't get much pushback on why biosimulation can deliver significant time and cost savings in drug discovery and development. But maybe just start at the highest level, key topics of how you're differentiated and how you deliver super results versus your peers and your clients' own internal efforts.

Yes, it's a good question. So the thing about this particular market is that the -- it's not just the existence of the model that sells it. It's the fact that the models have been validated against existing clinical trial data. And so therefore, our clients have confidence in their accuracy and knowledge about how accurate they are. So there's a reason to make big decisions, you need to know how good these models are and that's important. And then the second piece is that nobody in pharma wants to do anything unless the regulators will accept it. And so that also takes time. So our biosimulation models are quite expensive. At this point, they're covering many systems of the body, many modalities, many therapeutic areas. And every year, we've pushed the boundaries a little bit farther in terms of the sophistication of the model and also in validating those additions to the models. So that's -- that trust that customers have built up over 2 decades is really the key here. It's a significant barrier to entry. And our customers are really depending on us here. The -- we talked a little bit about it before, but you can't underestimate the value or the need for regulatory acceptance. So the FDA is -- it's not just that they accept it, but generally, they've taken the lead in talking about why this is a good idea for the industry, right? The FDA is not the -- they are cutting edge scientists. They are not interested in fostering more clinical trials than strictly need to be done. If good science can be done through modeling, they've been pushing it both for their own use and for the industry's use. And so that's a big piece of this. Over the years, the issue with biosimulation is a lot less now, but these biosimulation is, hey, you tell me does this work, is it accurate? and can I go to a regulator with it or not? And I think we've started to -- I think we've made pretty good headway on answering them, and that's why we see the adoption levels that we've got right now.

Excellent. That helps. I think another unique thing about Certara is the end-to-end platform, and Andy alluded to this, that you help a client with an initial phase of the study, and then they move on to the next phase and you have additional capabilities to help them. So how does spanning the entire biopharma product life cycle from discovery to clinical to post-approval, ultimately drive better results for both you and your clients?

Yes. Why -- yes, absolutely. So in our view, the process of developing a drug is really one of integrating data from many different sources, right? Lab data, clinical data, molecular data and using that to ask the right questions about whether that drug should move forward to ask questions about what's the most efficient way to get to the next stage. And then to make a case to the regulators that the drug should be approved. So those are the things that our clients really care about. What we see is that by working end-to-end, we can help our clients a lot more than if we just come in at individual points along the process. A lot of decisions get made pretty early on that had -- when a program is pretty small, that can have quite large ramifications as you go into Phase III and you're doing huge trials and you're going to regulatory and you're spending a lot of money. So what we find is that our clients benefit as we get in early, we can bring in our expertise across all the phases of drug discovery, we have different products and services that are applicable. And a lot of times, we can help them make a better decision or help them cut a lot of cost out of the overall process. I think the other thing is the industry as a whole, I think, recognizes that you'd like to start to think not just in the individual phase you're in. So for example -- I'll give you one example. We added a small market access business to Certara. And our idea there was even early stage, our clients are starting to recognize the idea that you'd like to incorporate what's known about the health economics and what's known about the price of the existing standard of care, even early on as you're trying to make that molecule decision. So there's this element of it's not a linear process, there's an integrated hole where there's a lot of loops in here that we can also -- in terms of looping knowledge and experience from other phases as you're making your decision that we believe we can help a customer with. So we've got a great end-to-end story. It works. We've got lots of clients that are purchasing multiple products from us simultaneously. And then it's very, very common that our clients that start working with us early, tend to stay with us as that drug moves forward hopefully to the approval.

Got it. That helps. So the offering, it's end-to-end in nature, and it's also increasingly comprehensive. So I want to ask what the positive feedback cycle is between the portfolio of biosimulation and regulatory submission offerings. And I guess now with the Pinnacle 21 acquisition, I should add data management into that mix.

Yes, great point. So we added regulatory offerings to our product portfolio a number of years ago, for the simple reason that it's really difficult to be a player of biosimulation if you can't provide good advice about what the regulators are going to accept, right? People are making big decisions using biosimulation, well before they're going to go see a regulator and they need understanding about is this decision going to be accepted or am I going to get to the end and get rejected, and have to go redo some of this. So we need to be expert at it. We need to be seen to be expert at it. And so we added that to our services. But what we also find is that for our business, if we've worked on a successful project, where we're helping a client with biosimulation, we know a lot about that project. And so it's pretty natural to continue with us and for us to help them through the regulatory process. Regulatory projects can get pretty big. So in a way, it kind of magnifies the benefit we can get to the company from having done that great earlier-stage biosimulation work. And then you mentioned Pinnacle 21, which I think is a great thing to bring up. So Pinnacle 21 is taking us kind of in an exciting direction. So what we see in biosimulation is that we've got clients that are getting data from many CROs and different labs and even within CROs from different sites. It's coming in, in lots of different formats. And we spend a lot of time helping our clients kind of sort that out so that we can get the data in the right shape. So we've used biosimulation, helped them and of course, the out pushing biosimulation are going to go as part of the regulatory submission to the FDA. So the FDA is using Pinnacle 21 because they want their data to come in, in an understandable format so they can process it. And what we think is that our clients all have the same problem the FDA does. So we believe there's a big issue here that Pinnacle 21 can help us to solve as we help them through the regulatory process and even earlier or as we are helping design the drug development program, and ideally helping them think about what's their data acquisition strategy. And as they're starting a project rather than later as you're just trying to get into the FDA and maybe repair some of the earlier mistakes.

All right. That all makes a lot of sense, and it's great to see that all coming together. And that expertise component, certainly combining that with data and intellectual property that you have, it seems like it creates a pretty durable, sustainable competitive advantage. So maybe we'll turn from there to how you take that set of offerings to your competitive advantage and you've land and expand from here. Seems to be a pretty clear formula for you guys, add new customers and grow with them over time, grow across modalities, grow across therapeutic areas. So -- and maybe we'll start on the new customer front. And on the most recent quarterly call, you called out record contributions from new customers. Any common threads between the most recent new customer adds?

Yes. Thanks for the question. So maybe, Andrew, you want to take that one?

Sure. Happy to. So we saw, as we mentioned on the call, a record number of new logos in the third quarter. The metric has been strong each quarter this year. In terms of common threads, the majority of the new logos have been in biopharma, specifically in biotech. The customers have been in North America, where the majority of the R&D is spent. We've also seen an uptick in some of the larger markets in Europe as well as in China. Typical sales, these new logos are biosimulation services first, second entry point is biosimulation software. But we've also seen regulatory as a driver of new logos, particularly in China.

Understood. That helps. And maybe follow up a little bit because you've also talked about having a strong pipeline going into Q4. So if we try to slice that pipeline up by customer type, different geographic regions, particular products, any areas you would call out as having more momentum than the other? Anything that's differentiated from what you just called out on the new customer add front?

So the pipeline is generally reflective of our revenue mix. So to that point, we're about 50-50 between top 50 R&D spend and all other in terms of the biopharmaceutical market. So generally speaking, the pipeline is diversified. Looking at third quarter, the growth was strong in all regions. Revenue grew in the 20% range in the 3 regions that we track. So it's also been and remains a diversified pipeline globally. Given the pipeline and the recent revenue performance, the momentum is strong in all areas, but it's notably strong in the biosimulation and software services.

Got it. And maybe we'll go a little bit further, just thinking about the expand component of land and expand. Your customers have diverse projects, especially the larger pharmaceutical companies have diverse projects across therapeutic areas, across the mechanism of action. And some of those operations can be siloed just by their nature, by geographies, et cetera. So is it necessary to get top leadership to buy into biosimulation and Certara? Or can you more naturally or organically expand from department to department from project to project?

Yes, it really varies depending on segment. Historically, in the large pharma, we have gone from department to department. And in biotechs, we might only have one or a handful of drugs, you'll see us interacting more frequently with the top leadership. I think as we further integrate our offerings and expand sort of further establish our end-to-end solution, we'll see an increased reason to interact at the top level. But it's also good to kind of be embedded in kind of the underlying R&D process that's going on in individual departments.

I know you have a really strong roster of expert scientists leaders in their field and anything, I think, their ability to connect with their peers is probably a big part of your success in the past and going forward as well. And kind of continuing on the expansion of human capital and leadership, you brought on your first Chief Commercial Officer recently. How do you envision he's going to take your go-to-market operations to the next level?

Yes. I think we brought him on because we've gotten to the size and the scale where we've got quite a number of large accounts, where we're bringing not only just multiple products -- multiple Certara products and services to that account, but we're even serving multiple drugs in them across multiple departments. So it's time to bring in a little bit of sort of global account management to this. We think that by going in and presenting Certara a little bit more as an integrated whole, we can kind of raise our profile a bit and maybe provide some more understanding to our clients about all of the method that we can bring there. We've been expanding our sales and marketing investment considerably after the IPO. And so there's also a bigger group there to manage. And so I think it was just the right time to bring in that kind of talent.

Makes sense. So let's turn to the revenue model from there and more specifically on visibility. But you want to ask how do software renewals and the backlog of services bookings give you a line of sight into the next 12 months of forward revenue? And then also following the Pinnacle acquisition, do you think you have more or less revenue visibility than you did 12 months ago?

Thanks, Jeff. I'll take that, Bill. So to start, in terms of the visibility, the first metric we look to is our bookings. Our bookings are -- the majority of our bookings convert to revenues in 12 months or less. And based on a 15% to 20% TTM bookings trajectory, we have a rolling 10 months of services work to deliver, which gives us high visibility from that perspective. When that's combined with deferred revenue, deferred software revenue that we have on the balance sheet and our consistent 90% gross retention rate, that gives us an 80% to 85% visibility looking forward. That's what we use for planning purposes. The addition of Pinnacle 21 will further improve the visibility. Given the high renewal rates in the business, they're going to be accretive to our overall company aggregate renewal rates as well as from the deferred revenue resulting from the SaaS business model.

Excellent. I appreciate that. I'll turn to profitability. I'll sneak in one on that front. Gross margin trends have been favorable each quarter this year despite the revenue mix shifting towards services. So how much of that gross margin sequential improvement is attributable to the technology component of your tech-enabled services? And how much is from efficiently deploying your experts?

It's a great question. We have, throughout the year, seen some efficiency gains in the deployment of the experts. But the majority of the margin trends have been driven by the technology component, and that's in both our biosimulation and our regulatory services.

Great. I appreciate that. Lots of tech-enabled services out there, but I think your offering is maybe differentiated from those, that you have experts using your own biosimulation software. And I think that's underappreciated when we reflect on the gross margins. So I'll try to close out the conversation by setting the stage a little bit for your December 15 Analyst Day. I know the plans to dive deeper on proprietary technology with presentations from business leaders. But I want to ask if there's any particular areas that have you guys excited, that you're just looking forward to sharing in more depth with investors?

Yes. We've gotten a lot of questions about how biosimulation works and how the software works. So one of the things we're going to do as a result of that request is show how the software works, right? We're going to take people through an example of what we've gone through and show -- we'll actually show the software what biosimulation does. And I think that will go a long way towards understanding, a lot of people have been following us. We've got other products that maybe we haven't as much in some of our discussions, so we're going to show off some of those as well. There's a whole -- my management team, I think, is pretty impressive. And I think giving them -- giving the investors some exposure to them is a great idea. Andy's going to update our guidance for 2022. And I think we're kind of set up for a good year next year.

Great. Looking forward to -- yes, I think the demo will be great to take it a little bit from the clinical research lab to the actual label. And to show how that happens, I think will be excellent. And I won't try to get ahead of Andy's financial commentary, but I will ask from a high level, what are the key headwinds and tailwinds for investors to consider as they think about extrapolating your year-to-date performance in 2021 forward?

Yes. I mean I think we've got a healthy backlog of business going into 2022. We've got increased -- an increasing adoption rate. We've got a great product pipeline. We've been investing, I think, well organically for the last couple of years, and some of those are starting to come to fruition. Pinnacle 21 is a great company. We'll be far along our integration as we start 2022 and start to see some of the great synergies we expect from that. And I think -- it will be great. One of the interesting things here since we went public over the last year, and we haven't actually met very many of the investors face-to-face, I think it would be great to just kind of get together and see -- get to meet some of these people face-to-face and give them a chance to interact a little bit. We're really looking forward to it.

Excellent. I appreciate that. I put myself in that camp. And I think that sum things up pretty nicely. I do want to give you one last opportunity to give any takeaways from our conversation here that you want to make sure that investors leave with.

No. I think I'll leave you with two points. I think one is I think the management -- the scheme from our management team, we laid out a plan when we went public almost exactly 1 year ago. And we have pretty much delivered what we said we were going to do. Wasn't easy all the time, but it was a good plan. And I think, hopefully, we're showing the investor base that this is a good, solid foundation behind our company. We've got a lot of opportunity ahead. From -- specifically where we sit, I mean, biosimulation has really started to take off in pharma. It's a great idea and why you would choose to spend more money in clinical trials, if you can use some modeling and some software to make better decisions ahead of time. Not many people would say that would be a great idea. So there's still plenty of places we can take this. There's lots of great organic investment opportunities in the company. We still have plenty of therapies and modalities and pharma is always moving into the cutting edge where we can follow them with our software. So I think speaking for Andy and myself, we're very excited about the prospects of the company as we go into next year.

Excellent. Thank you for that, and thank you again for your time, and look forward to speaking with you guys soon. Take care.

Yes. Thanks, Jeff.

Thank you, Jeff.