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

I'm on the Bank of America Life Science Tools and Diagnostics team working with Derik De Bruin and covering the tech-enabled drug discovery space. And for our next session, we're excited to bring you Certara. We're joined by William Feehery, Chief Executive Officer; and Andrew Schemick, Chief Financial Officer. Gentlemen, thank you for coming out here.

Thank you.

Nice to be here, Ryskin.

And format is going to be fireside chat, open and then we'll open up for Q&A towards the end of the presentation. So if you got any questions, feel free to jump in or just raise your hand throughout.

So I think just to start for those of us that are less familiar with the story given it's still a relatively recent IPO and slightly unique business model and market. Maybe you could please provide a high-level overview of Certara's biosimulation offerings, the markets you play in, sort of how you're positioned?

Yes. Thanks, Michael. Certara has been around for -- in one form or another for a while. We focus on the biosimulation market. What biosimulation is a growing trend in drug development to do computer modeling of how drugs interact with the human body. The primary reason to do this is to reduce or eliminate human clinical trials, which are the most expensive part of drug development. Certara is a fairly unique company in that we started doing this about 20 years ago. We've been building it up slowly year-over-year. We have significant adoption by the regulators as well, which is important in the market we stand. And our core product Simcyp is quite unique, has a significant moat around it. It's used to model the known biology on how drugs interact not just with 1 person, but across populations of people that might differ based on genetic or other conditions like comorbidities, such as you would encounter in a human clinical trial. So any time you can use software general principle is anytime you can use software, it's going to be the lowest cost option compared with actually trying in a lab or in an animal or in a human. And we've been building up a nice business there, and we believe, even though we've been around for a while that we're really still at the beginning of the overall adoption in pharma.

Great. Great. And just following up on one of the points you brought up. I mean, given the business has been around for 20 years, could you talk about the evolution of the platform? You touched on Simcyp. So maybe I don't know if you want to go software specific or across sort of the breadth of offerings you have, you could compare Certara 20 years ago, 10 years ago, 5 years ago now, sort of how has the business evolved?

Yes. So Certara, originally, there are 2 core software platforms were Simcyp, which I just referenced for biosimulation and a software that's called WinNonlin or Phoenix, which is used for PK/PD analysis by -- very widespread in the pharma industry. To that, we added a component -- a significant component in regulatory because well, really for 2 reasons. One is because it's important for Certara to be confident and seem to be confident in regulatory matters because our clients are making significant decisions early on in their drug development process using our software and need to understand how the regulators will view it. And then we also added a -- particularly since I arrived a couple of years ago, we've really pushed to add a services component to our software. And the reason we do that is because in our market, we have a group of large pharma companies that are quite sophisticated and like to look at us as a software company. They buy the software. We have other pharma companies that don't have or don't want to have some of the internal experts needed to use our software to its fullest potential. And so we maintain a pretty good staff of them so that we can -- if you don't want to buy our software, we will do the project for you. So the way I think about it is I'm delivering the technology in the manner to which I have different market segments as they would like to consume it. We've added some other things over as well. Our most recent acquisition was Pinnacle 21, which is compliance software in the regulatory space that basically determines if you've met compliance with the CDISC standard, which is needed to submit your regulatory data to the FDA and is increasingly used by pharma as an internal standard as they are getting their data from, say, external partners like CROs. So generally, the theme here has been we're building a software company but there's some unique twists on this that we have that's made us a lot more formidable, I think, in the market as we continue to grow, we can leverage our projects, and we can also deliver some of the key things that our clients are requiring.

Okay. That's a great overview. I want to dive into a lot of that a little bit later on. But to start, let's focus on the biosimulation market. I think one of the biggest questions we've had since the IPO is, okay, that sounds great. We can see the value add. Why isn't that further along? What's holding customers back from adopting it even further? And if you could just comment on sort of where you think the market is in terms of biosimulation penetration, how widely it's used, where it's been more successful, less successful and sort of how you see that evolving over time, that would be really helpful.

Well, the external research has sized the biosimulation market at over $2 billion. Now we're obviously not $2 billion. So a lot of people say, where is the rest of it? The biggest chunk of it is internal. And some of the big pharma companies, they have been building out significant internal groups to do this. And it's a little bit of a complicated situation. Those companies are our customers, but that's also addressable market because as we add features, then they don't make internal investments to do the same thing. We also have a number of smaller companies that are out there. But I think one of the characteristics of the market we're in is that it has a very high barrier to entry. So in order to make this work, you need the confidence of both the industry and the regulators that the models we have are accurate and can be depended on to make significant regulatory decisions. And that doesn't come overnight. So we've been kind of -- we started a long, long time ago. Every year, we have a new version that extends the size of the model and the capabilities of the model that all has to be validated against existing clinical trial data. Regulators have to get comfortable with it, the industry has to be comfortable with it. And we've been building that flywheel. So the flywheel started turning slowly in the beginning, but gradually, it's been speeding up. And what we've seen is kind of over time a bending upward in that curve. So there's still ways to go, but adoption has been growing and we've been the beneficiary of that as we went into the IPO.

And longer term, how big could the market get, I mean if it's $2 billion today? If we sort of look at the broader clinical research trial market, both CROs and pharma, and if we think about comparing that to $2 billion, how much penetration could you -- or how much conversion could you get from traditional clinical trials to something more along the lines of biosimulation 5, 10, 20 years down the road?

Well, we see it growing at north of 15% a year, the overall market. But the way I kind of think about this is, is what I said before. The most expensive thing that a pharma company does when it develops a drug is human clinical trials. More than half of their spend on a drug that gets approved is going to go there. That's -- okay, we're never going to get rid of all human clinical trials, but it doesn't take a whole -- it doesn't take a huge shift in that to drive a ton of interest and revenue over the biosimulation. The main issue has been over the years in the beginning people said, show me, are these models actually -- are they accurate? And are they usable in the format the industry is in? And the answer is they are, but you need to understand the extent of it. So where can they be used appropriately? What's the extent of the current model? And obviously, we're expanding the capability every year. And that expansion just kind of keeps expanding our -- when you kind of think of as our target market. So adding -- as we add, say, more organs of the body, we can attack more therapeutic areas. As the models get more accurate and as people get more comfortable with them, they rely on them earlier on to basically direct their clinical trials, which basically expands for us. That's kind of the long-term trend we're doing. We're not in a market where everybody -- look, it's pharma, right? Nobody wakes up tomorrow and suddenly shifts where the whole industry works. It's kind of a gradual change. But like I said, it's a gradual change after 20 years of being at this, right? So we've got some good tailwinds behind us.

And what are the key levers you have to drive that adoption? You talked about mid-teens CAGR in terms of market growth. You also touched on adoption by the regulatory agency. Sort of like what are the main levers you have to potentially drive that higher over time?

Well, I mean, I think the way we think of the company is we're a software company. So over time, we want all of this technology to be embedded in software. That software that gives us, obviously, from a financial standpoint, you have high gross margins on software. But it also kind of encodes the known knowledge of the industry in a way that particularly the regulators can understand what's in there and they can be comfortable. And when company A and company B and company C all come in, they kind of -- they see it and they recognize it and they approve it. So that helps us a lot. But then the other thing we found out is the services component is important for us. It's not just that we have companies that don't want to buy software for a bunch of reasons. But the -- a lot of times, the service projects we do are the really cutting-edge things and they are the next wave of what we're going to encode in the software. So I think one of the -- to answer your question, that's a big lever to us. We run the company. It's a profitable growing company. We could be more profitable than we are. What we're doing is we've kind of chosen to where we wanted to be around an EBITDA margin. And then as we're growing, we're reinvesting that and producing more and more software. So again, as we've launched more products, which we've been doing, and I think as we go forward this year, we'll see an increased pipeline of products launching. That extends our reach and our utility to our pharma customers. So we have a very extensive customer base, and we have about 1,700 customers. A lot of the industry is working with us. The key for us is to kind of expand that penetration. So find more and more places where either we can be used or our customers feel comfortable at using us and then we kind of move up in the percentage of the budget we can acquire.

Okay. Again, there's a lot there to dive into. That was really helpful. But before we go into some of that, I want to touch on the regulatory side of the business. You commented on that earlier. Could you sort of walk us through what the interplay is between the biosimulation, which is sort of the core foundation of the business and then the regulatory offerings, how do your regulatory offers differ from a lot of the more traditional CROs that we see out there?

So it's a good question. Some of our regulatory offerings are quite similar to what the CROs offer, but we offer them for -- I would say, we offer them for a different reason. The reason we got pulled into regulatory is because we tend to work in the preclinical or even more in the clinical phases, making fairly big decisions on the strategy of drug development. We needed to be credible, that's 1 issue. And then the second piece of it is, once you know the drug in that degree -- with that degree of intimacy, what we found is a lot of customers were either expected or very willing to give us the regulatory work. So it's kind of a way to magnify all the good work we had done early in the development. Regulatory is -- it's a growing business and CROs are probably the biggest piece of it. We don't really compete with them. I mean it tends to be we get the project because we did the biosimulation not because we're out doing an RFP against one of the big CROs. And so what we found is it's been a nice way to kind of magnify the impact we have with some of our customers.

Is there -- could you just comment on the extent of cross-selling opportunities between the biosimulation and the ...

Yes. I mean that's kind of the strategy, right? So we're -- our primary customers are customers that have been working with us in biosimulation and we basically cross-sell in terms of regulatory. I'm not seeking to be the world's biggest regulatory customer. I'm seeking to have a very competent offering that goes with the biosimulation that we offer because customers benefit from that.

And then talking about the customer profile and how that's evolved over time, one of the more common pressures in the market in the space that we've seen has been concerned about biotech funding, especially some of the earlier nonprofitable or nonrevenue-generating biotechs. In this market environment, if they can't do additional raises, given you're more clinical exposed, could you sort of talk about your customer profile mix between the large pharma, the mids, the early stage sort of what's at risk? And if you've seen anything like that show up in the numbers where any increased level of cancellations or anything like that?

Yes. And I think everybody is getting the question about the biotech funding. We've looked back over the last couple of quarters, and we've actually seen quite healthy growth in biotech. And I think what it is, is a little bit of what you're kind of referencing, which is most of our revenue is in the clinical phase. We're making most of our money from when drugs get fairly far down the line. And so those companies are still funded, and they're certainly not going to pull back their funding if they have a drug that's moving forward. The way we think about it is it's not whether it's biotech or it's pharma, we're interested in making sure that we can capture a drug as it gets into a fairly significant stage. And so if biotech goes down a bit and pharma goes up a bit, we should be -- we're accessing both sides of the market, and we have seen some good growth in the last quarter in big pharma. And then the last thing I'd say, and I can't prove this because I haven't gone through a significant downturn, but my belief is that if the industry was really pushed, you would do more biosimulation and not less, given the fact that if you wanted to be really judicious with your R&D dollars, I think we're a pretty good place to put it.

Yes. I mean what is the value proposition from that perspective, sort of like how do you quantify the value add or the cost savings, whichever way you want to go? I know it's going to vary tremendously trial by trial or case by case, but sort of how do you make that pitch to a potential customer?

Well, I mean, the way we make the pitch is that there are certain types of trials where the FDA has accepted using biosimulation in lieu of doing some of the trial or all of the trial. So that's kind of known in the industry and so we can point to that. And then you get into the more complicated things and say, well, if we can get involved early, you would use biosimulation to direct the trial strategy. And so basically, the argument is if you don't use me, you're going to do this many human clinical trials. But if we're a little bit smarter about this, we can shrink that down. And there's enough positive examples of that happening. I think we've got some credibility.

Okay. And then I mean as far as other questions or sort of debates we have with clients on the name is you talked about the visibility into the business and sort of just the financial profile. You provide a lot of clarity on backlog, on the order book, on renewal rates, things like that and relatively or very stable over time, but there are still quarterly fluctuations. So how do you explain that seasonality? How do we know that this is just seasonality or timing versus a longer-term trend and sort of how do you analyze those KPIs?

You want to talk about that?

That's why we stuck with annual guidance. So we're going to have quarterly fluctuations from quarter-to-quarter. The -- it's a function of the revenue recognition. So software revenue recognition is going to be ratable over time or at that point in time. On the services side, it's based on milestones or delivery. And given that 70% -- 65% of our revenues are services, there's some dependency on the client time lines. So we can see delays. Essentially anything that could cause a delay in the clinical trial could cause a delay on a project that we're working on. When we take a step back, we have confidence in our mid-teens organic revenue growth target. One of the aspects that gives me confidence is that we're embedded in multiyear drug development programs. So once our models are in that project, it's going to continue as long as the company is continuing to develop the drug. So the quarterly movements are less -- from my perspective, are not great indicator of a change in the visibility. So what we look at is our trailing 12 months bookings are highly correlated to the next 12 months revenues. We monitor our renewal rates and our retention rates. And going back in time, we have normalized, meaning we lowered it to take out anomalies net retention rate on our services of 110%. So essentially, what's happening is each year, our existing clients are coming back and they're expanding by 10%, and that's been a pretty steady trend for us.

Any questions from the audience? All right. I'll keep going. I mean another point of -- another frequent point of discussion is sort of the relationship between the software business and the service business, both sort of how they fit together. And I think you touched on that a little bit earlier, William, but also the relative margin profile of the two. And it goes to your point of you're building a software company, but 30%, 35% of your revenues are software and the rest of the services. So how do you reconcile that argument?

Well, I think you're right. I mean, in software, marginal cost of an extra copy is obviously going to be nearly 0. But when you get down to the EBITDA margin, software tends to have higher R&D in different sales cost profile. So I'd say based on -- I'm not sure how much we've said publicly, but the EBITDA margins of the 2 businesses are not very different. So we have a lot of demand for services, a lot and a lot of pricing power as well, given the value that we deliver. So I think as we went public, that was one of the things that we spent a lot of time talking to people back as I think some of the investment community thought service is bad, software good. But really, it's a lot more nuanced than that. These 2 businesses are fairly intertwined and they're not very different in terms of final EBITDA margin once we look at it.

I'd say a good data to look at would be the -- comparing 2020 to 2021 where we saw 2020 services outgrew software growth, and we had a negative mix shift EBITDA margin expansion. 2021, we added Pinnacle 21. So we had a shift back towards software. We saw a similar performance on the EBITDA line. So they're both contributing to incremental EBITDA margins. We have a high level of tech enablement in our services. Essentially, they're using our software. We have charged for that, tech charge for that.

Yes. I mean I think a lot of -- again, a lot of our conversations come down to it's a labels game. Is it a CRO? Is it a tech-enabled company? Is it a software company? And then you see that in the sell-side coverage you see that engaging the buy-side coverage. And I think each of those -- because the problem is there's not a lot of companies quite like Certara. One public comp that's more or less a direct comp and then not much beyond that. So it's -- the comp set kind of becomes cobbled together from a bunch of different areas and people always try to label what is the business because that's going to impact valuation, obviously, but it is a very unique story.

Yes. I mean I don't know that's necessarily a bad thing. Certainly, when I go talk in the marketplace, there's not a lot of biosimulation alternatives to us. And the reason is because it's really, really hard to build up a business with this level of competitive moats around it. I will say though, we are definitely not a CRO. We don't do clinical operations. And frankly, we don't intend to even take the company in that direction. So as I look forward in the future, basically, what we're investing is, is to expand the software side. We want to expand the capabilities in the therapeutic areas that we can touch with software and all of it, pretty much all of our R&D dollars are headed that way.

So on that point then, how do we think about the platform evolving in the future, both organically and organically? And you touched on Pinnacle 21 earlier, but you've also done a series of acquisitions historically to complement the portfolio. So again, when you think about 3 years, 5 years from now, what's Certara going to look like? How is it going to be different? Are there modalities you're targeting? Are there certain disease areas or therapeutic areas where you're underindexed, where you want to build our capabilities and sort of -- and what are the targets?

Right. So look, the core idea behind Certara has been to use modeling to improve the efficiency of pharma development. Now we have gotten a little bit into after development when we get into like health economics, and that's been an interesting addition. But generally, it's been how do we -- and we don't cover the whole -- we go from discovery through approval, but there are some places in there that we would like to fill in. I think the larger vision is around, okay, how do we link all of these things together so you can start to make earlier and earlier good decisions about what molecules to bring forward and what's the best development path from a probability or cost or time set. So as we've added things, that's how we thought about it. Some of the things we're investing in. I mean one of the -- a lot of the cutting-edge stuff that everybody in pharma is talking about is called quantitative systems pharmacology. So we're modeling the -- basically, the mechanisms of action. That's when you get into a lot of the gene therapy work that we're doing and as well as increasingly a lot of the work we're doing in biologics. That's been a growing area over the last, I don't know, 3 or 4 years. And if you just look at pharma, that's increasing. I mean, it's not just us. That's been an increasing investment in terms of lots of pharma companies. So that's 1 area. And I think that's still playing out. And we've got a great -- we've got a nice -- a very nicely growing business, but we're not even close to where we're going to be. I think there's a lot of -- some of the cutting-edge technologies, I mean, I think what happened with COVID really has jump-started a lot of the work in vaccines and mRNA, which -- it's not like we ignored them in the past, but they weren't quite as -- we weren't really investing. It really changed the game a lot there. And now we'll move outside of COVID, I mean most of those -- a lot of the companies are looking at other diseases and looking at moving into cancer and that's been an area of increased interest. We're also looking at just generally -- pharma companies are -- in our view, they're big data companies, right? They have to go out and get data from labs. They have got to get different trials. Massive amounts of data comes in. You have to get it in some kind of format where you can put it in the models and make intelligent decisions. Our investment in Pinnacle 21 was a movement towards that because that's one of the key linchpins in getting that to work but there's more expenses that we can do in that.

Good. Yes. No, Simcyp, Phoenix, D360, PK/PD modeling, all of that, I understand. Quantitative systems pharmacology is new me. I got a brush up on that. I have no idea what that is, but good to know that's where things are going. Any questions from the audience? We have a couple of minutes left. I mean, I guess other topic that's just a very prominent and sort of came up in the last couple of months for you guys, specifically is given your investments in internal OpEx and given where the market is with labor pressure inflation, shortages of talent for a lot of these highly technical roles, sort of how has that impacted your 2022 modeling assumptions? How has that impacted your view going forward on where you're prioritizing internal spend?

So I think every company is dealing with those challenges right now, relatively quickly developing. We had essentially developed our plans in terms of pricing. We've increased the frequency of pricing reviews. And the expectation built into our forecast was an environment similar to the one we're in. I would say 1 thing to consider is the cost of our scientists has always been high, and it's always been a competitive market. It's not really a new dynamic from our perspective. And the evidence to look at is if you take a look at the first quarter, we've done extensive hiring in the fourth quarter. And in the first quarter, our cost of revenues has come down relative to overall revenues. So it's been factored into our plan for prices as well as costs.

And is your ability and frequency with which you can take price impacted by the fact that sometimes these are longer-term contracts or long-term projects?

There's -- we have about 10 months forward services revenues on the books at any given point in time when you look at our bookings, the way that we present the bookings are the 12-month booking. So we don't show the multiyear factor in that, so you can draw some correlations between bookings and revenue visibility. And given the fact that we've got 10 months in advance, there could be a lag there, but it's an opportunity for us to evaluate the next price increase.

Okay. All right. And in the last minute or so we have left, I'm going to default to Derik's standard question, which is sort of what's underappreciated? What's misunderstood? What's been the biggest sort of debate that you've had with clients over the last couple of months?

I think the main thing is -- well, the main thing, the company is run, I think, I would view it as fairly conservatively. So we've targeted to have a mid-30s EBITDA margin. And as we grow our profitability to reinvest that, we have a healthy balance sheet. So we're -- we have positive EBITDA, positive cash flow. We're actually profitable. So that puts us in a really good position. Now sometimes we get questions about, well, why don't you invest faster, take your EBITDA margin down and grow faster? And we've had those discussions with people. I think they're healthy. But I think we're pretty comfortable with this kind of a very sustainable business model. I think maybe we put ourselves out as maybe being slightly more predictable than people thought. I mean we have -- we've put out 1 year bookings. We had a little bit of hiccup at the end of last year around COVID, which people wanted to see if that went away, and it has. But overall, it's a very healthy business model, and I think it's going to -- we're still growing the market, growing very nicely and it's going to continue for quite a while in the future.

Okay. All right. Thanks so much.

Thank you.

Thank you.