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

All right. Let's go ahead and get started. Thanks for joining everyone. This is the fireside chat with Certara. My name is Vikram Purohit. I'm one of the biotech analysts with Morgan Stanley Research. Happy to have with me CEO, Bill Feehery; and CFO, Andy Schemick. Bill, Andy, thanks for joining us. Before we get started, I need to read a brief disclosure. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley sales representative. With that, Bill, Andy, why don't we start with some opening remarks. Maybe you could just talk a bit about what biosimulation is and how Certara is involved with the space for those in the audience that may not be fully familiar with the story.

Great. Thanks, Vik. We appreciate it. Appreciate the opportunity to be here. So for anyone who's not familiar with us, Certara is known for biosimulation. We have our flagship software called Simcyp, is a model of the human body, which is used to model how drugs interact with the body, how they're transported, eliminated and how they interact with the ultimately with the drug target. It's been used. It's been developed over a 20-year period. So it's taken a long time to develop biosimulation to a part where it's accepted as it is. But we have been working with the FDA since 2008. They've been a big supporter of the concept and effectively a big user of our software. And we've helped over 250 drugs where you can actually see the use of our software on the label claim when they were approved. Certara has other software as well that's used in other aspects of biosimulation and the drug development as it's our goal to basically start working with companies early in their drug development and stay with that as it moves through preclinical and then clinical and then even into post approval. We tend to make about 70% of our revenues in the clinical phase. And we generally have 2 methods of doing business. One is we're a traditional software company. We have several big flagship products that are extensively used in pharma. And then the other is we have a services group, which largely uses our software for clients that either don't want to or just don't have the internal capabilities to do that kind of work.

Great. Maybe we could talk a bit about how the business is set up in a little bit more detail. So how much of your business is software versus services? And how much of your business, looking at it from like a business segment perspective, how much is biosimulation versus market access versus regulatory science?

I can start with that. So the company provides both software and services. Our current mix with software is 35% software, 65% services. That mix has increased from previous years. We're about 30-70, primarily due to the acquisition of Pinnacle 21, but also good growth on the biosimulation software. Out of the 65% services, 40% is biosimulation services and the remainder is regulatory and market access.

Okay. Understood. And a common question that comes up is what are the TAMs for each of those 3 business segments: biosimulation, market access, regulatory science. What's your current estimate of that?

We focused mainly on the biosimulation TAM, which is $2.8 billion. The regulatory and market access TAMs can aggregate to be $13 billion, but we have a niche product in that space. So within the biosimulation TAM of $2.8 billion, it's about 50% software, 50% services. And on the software side, 45% in discovery, 55% in clinical, roughly. Our software plays mostly in the clinical space. TAM has been growing mid- to high teens consistently for the last several years.

Got it. Got it. And from a qualitative standpoint, could you walk us through an example of what a typical Certara, our customers' experience with Certara's platform is? How do they start using certain pieces of software? And how does their use of different software and different kinds of services to grow as their pipeline grows?

Sure. So we have 3 software products that comprise maybe 80% of the software revenue of Certara. In terms of the core biosimulation, which is Simcyp and another product we call Phoenix, we'll see customers -- ideally, they'll start early on in preclinical. And they'll be asking questions like dosing questions, right? So how do we translate data that come from, let's say, an animal model or from lab data to first-in-human dosing. As this moves on, they'll ask questions more around trial design. How do we design the most effective clinical trials? What can we use -- and in a lot of cases, you can use biosimulation to eliminate certain types of clinical trials. When we get into late-stage clinical trials, often use Simcyp for drug-drug interaction studies in which it's a fairly common nowadays that the FDA will allow the replacement of certain clinical trials with biosimulation. And you'll also see customers throughout this entire process using our Phoenix product, which is used for PK modeling. So there's really 2 ways you can go at biosimulation. One is what Simcyp does, which is it's called mechanistic, you start with the basic science, you model what's known about it. The other option, which is also provided by Certara and is very common in the industry is you start with some data that you might get from preclinical or clinical, fitted to a model and then start predicting what's going to happen at the next stage. So people will start using Phoenix and some of our services for that. So there's a bunch of different places. Sometimes we get people onboarding in that whole thing, but that's kind of the ideal that people are going to use the whole services, and we catch them early when we'd like to.

Got it. Okay. And are there particular therapeutic areas or indications where the Certara platform is more applicable versus than others? Or is it been pretty broad into your experience?

Yes, it's pretty broad. The history of this is it started out in small molecule drugs. I think it was around 2014, and we started, started modifying it and launching additional products in the biologics area, and that's continued up until now. So from the standpoint, if you just want to look at our small molecules and biologics, we're in both and, I guess, biologics has generally been growing a bit faster as you see the industry. In terms of therapeutic areas, I think we're a fairly close natural with the pharma industry is probably collectively working on. So effectively maybe half or so of our work is in oncology, which is where a lot of the money has been gone. We also do a lot of rare diseases and lots of other things. And then if you look at kind of like therapeutic modalities, the big push has been to extend some of the new things that are out there, cell and gene therapies. We've done things like in antisense technology, things like that. We've recently announced a new collaboration with Memorial Sloan Kettering to get into a model for CAR T. So part of our goal is basically to keep up with the technology that pharmas intending to launch and then always have a model ready that's useful as they take drugs into approval.

Got it. And from a competitive standpoint, do you think you're more actively competing with other providers of similar software and services? Or are you more actively competing with in-house groups at your client firms? Or is it more just a general need to educate customers more about how to grow the use case for Certara's offering within what they're currently doing?

Yes. So the biggest issue for us over the years has just been the lack of knowledge as to what biosimulation can do. And certainly, the company -- as I've mentioned earlier, the company has been around a long time. So we've had a long time to kind of work at that, and we've gotten to a point where this is accepted in the pharmaceutical industry. There's still pockets where we're still trying to penetrate. And it's not that people don't know what biosimulation is, but it can do a lot of things. It's a pretty complicated piece of software. And so the education component has been a big factor of that. It helped as we've had people leave Certara and go into pharma and vice versa, that kind of helped there quite a bit. In terms of our clients, I mean, I wouldn't say there are our competitors, they're our clients. They are big users of our software. But I think what you're referring to is what we see a lot of our bigger clients are doing is they're using our software as the basin and they're building on top of that. And then we're always expanding the envelope so we add more features. So what they would consider the base is expanding, right, so they can direct their efforts to other things and hopefully buy more of our software. So that's another valid opportunity for us to expand it.

Got it. So then what does it take to really aggressively drive kind of more uptake, both from a micro perspective, considering where your clients are at any given point where their pipelines and also from like a macro perspective and from a regulatory perspective, what needs to happen to kind of keep growing the use case for what you have to offer?

Yes. So really, there's 2 thrusts that we have on this. So one of this is we have not modeled everything that can be modeled in the pharmaceutical industry. And as we develop new models, it sort of opens up a new segment of the market that we can attack. So one of the -- and that's been one of the primary uses of capital as we -- particularly after we went public, is to direct more R&D into those areas so we can create more products. And in fact, we have been launching products at a faster rate over the last couple of years as a result. The other areas have been around the, I guess, you could call it the cross-selling, right? But what we want to do is we want to catch it. We want to work with the drug early on, even if maybe we're only capturing $10,000 or $20,000. We're doing an early study because some fraction of them will get to a clinical phase where we can actually capture a lot of value. In order to do that, that has to do with kind of having an end-to-end suite of software and services where we've got something that's relevant that we can stay with that drug at all periods of time. And that's been part of our use of capital as well. As we've acquired new capabilities, we require some services that will bring us some capabilities that we didn't have. And then, for example, in Pinnacle 21 that brought us into the biostatistics space and in the data validation space, which we know a lot of our customers are struggling with, and so we can tie that into biosimulation.

Got it. Got it. I do want to talk about Pinnacle 21, but before we get there, your comment on launching new products, how do you prioritize what to work on? And what are some of the common themes of customer feedback that you're getting about unmet need? And where they think you should be focusing your efforts on kind of next-generation products?

Right. So the history of our company has been -- we were owned by private equity for several generations of private equity. And so we've been very careful with our cash and what we've spent money on. And so generally, what that's meant is what we invest in is generally, we've got a pretty good lead that somebody will buy it pretty quickly. And so that's great because we've got a lot of market feedback. We've got customers pulling in and also, we've got customers who are giving us data and helping us. That continues to this day, but we've been a little bit more aggressive in terms of spending to try and accelerate the growth rate as we went public. And that's, I think, turning into some positive outcomes there. The other thing that happens is, particularly in Simcyp, we have what's called -- we call the consortium model. So these are the big companies that basically almost stood the company up originally. They've been long-term customers. We get together every year with them, and there's effectively they get input into what the features will be for next year. There's a big boat among all of them. And you can imagine with all these competitors around, that's a really interesting situation, but it's been going on a long time. And so they'll pick 3, 4, 5 significant features that we're going to add for next year's version. And so that's also kind of an important point of customer feedback that we got. So we have really not done anything where we've just decided to kind of go off and just invest on our own and kind of hope the market there is more of a market-driven approach that we use.

Okay. Understood. With Pinnacle 21, it's been roughly a year since you announced that acquisition now?

Almost, yes. Yes.

I guess at this point, how are the cross-selling opportunities panning out? And what's been interesting areas of overlap there between Certara, Pinnacle 21 and now with Pinnacle 21?

Yes. So with Pinnacle 21, we had said when we bought it, was that it was accretive to Certara's growth and margins. And however you want to look at it, it was going to be attractive. And we're -- we closed on October 1 last year. So after a year, I can say, yes, we're right on track with what we said it would be. And so -- and in addition to that, they've also launched some new products that were in the pipeline, which we hadn't fully described when we bought the company. So we're very happy with how that went. They had about 150 customers when we bought them. We have about 2,000, something like that, depending on account if you want to take out some of the little ones, maybe we have 1,700. But let's say, we have 10x at least the number of customers. So it's been a pretty active opportunity and a successful one to introduce Pinnacle 21 to more of our customers. Part of what we've been doing with them though is they really made a lot of money. What Pinnacle 21 does is it validates the clinical data submission to the FDA. And so you really need it right when you go to the FDA. But the new products have to do with basically data validation and transfer between a big pharma company and its suppliers, it's CROs or it's labs. And then -- so that basically expands the TAM that Pinnacle 21 can get into. And also brings us much more into the area where we're seeing our biosimulation customers have trouble. But working with the clinical data and the biosimulation data has to get analyzed. So I think we've got a lot -- I think what I would say is we've done -- it's been a very successful acquisition in terms of -- we've done everything we said we would do, but there's still a lot more to come with that strategy there.

Okay. Understood. That's helpful. Maybe we can shift gears a little bit and talk a bit about the typical terms for your software contracts, for your services contracts, and how much visibility do you have into those contracts on kind of a quarter-to-quarter basis?

Happy to take that. So on the software contracts, we have software licenses, which is where Phoenix sits and those are term licenses, so they're annual or multiyear term licenses. Prior to the accounting change to 606, they were recognized ratably. So it's essentially a SaaS model, it's cash upfront, term licenses, very high customer renewal rate. On the subscription side, we have -- which is primarily Simcyp and Pinnacle 21, it's upfront ratable subscription revenue. On the services side, we typically, just to clear things up, we put out a metric called bookings from our perspective, bookings. We only report out the annual expected bookings, so it's a signed contract or purchase order and it's only the next 12 months expected revenue from that. So to the extent it's a multiyear services arrangement, we're only booking the next 12 months' worth, and then we'll book it again the following year. So our services contracts are typically -- it's a mixture of retainers or fixed fee or time materials, depending on the engagement with the client. And it's 12 months or less conversion to revenue.

Okay. Got it. Got it. And from the...

So from a visibility perspective, if I take the bookings trend, the trailing 12-month bookings that give me high visibility into the next 12 months revenue. So the software, we count 90% of the previous period software revenues because we have a gross retention rate of 90%. There's a tail. And then with the level of services bookings that we have on a trailing 12-month basis, those 2 amounts give us about 10 months' worth of visibility going forward. And that's kind of our baseline for 80% visibility going forward. But we have some visibility beyond that given that using the gross retention rate for software, and we have pretty reliable trends on a net retention basis as well.

Got it. Got it. So building on that, from the world of metrics that you do provide to The Street on a quarterly and annual basis, what are some of the key metrics that you look at? That kind of just gauge the health of the business. What are some of the core metrics in your mind?

Yes. So the bookings is a key metric, and that's specifically by definition, including only 12 months' worth of revenue, there's a high correlation to where the business is going. We also look at the software renewal rates on a gross and a net basis. So it's about 90% gross retention and 105 to 108 depending on the period on a net retention basis, excluding Pinnacle 21. And on the services side, we look at the repeat rate. We don't lose significant customers year in, year out. We typically have about a 10% expansion, so 110 repeat rate or same-store sales with our existing services customers.

Okay. Got it. Got it. Maybe we can now touch on your most recent earnings update and your guidance update that you provided through that earnings release. So you lowered your 2022 guidance. So first question there, could you just unpack for us what were some of the puts and takes with that move?

We lowered our guidance based on 2 primary factors. So the -- we're seeing the software business -- Pinnacle 21 is on track. Software business is performing well. On the biosimulation services, we're seeing an acceleration to some extent. The trailing 12-month bookings in the biosim services are up 33%. They were up over 40% in the quarter. We didn't -- we took a conservative view in terms of conversion on that end. So what we really did was take some first and foremost, adjusted for foreign currency. So Simcyp we have a fairly large operation in the U.K. but also in Europe and Japan. That comprised [ $50 ] million. And then we made an adjustment for the regulatory services business, essentially based on our ability to have forward visibility. So looking at what's in the pipeline and what we've recognized in revenue to date. And then in light of some challenges that we've had in that business that we've discussed regarding clinical trial disruption and some impact from China -- import China business that we saw some good traction on last year, kind of essentially going away this year. Those 2 factors combined with the bookings trends gave us the kind of the logic for bringing down the regulatory for the rest of the year.

Got it. And thinking beyond 2022, do you think that any of these factors impacting the regulatory science part of the business should present a headwind from 2023 onwards? Do you think some of these are longer-term issues?

No, I think that we expect the business to return to the historical rates of growth. It's been a reliable business since 2014 when we brought it into the company. It's been growing in the low teens range. We do think that given the business has grown significantly and in light of more concentrated than our biosim business where we could have thousands of projects ongoing that setting a goal closer to the high single digits, low teens as opposed to mid-teens growth is probably more of an expectation for next year.

Okay. All right. Understood.

Caveat, I'd say, we're in the midst of our budgeting process.

Okay. Understood. Let's touch on margin profile. So first, recap for us kind of what is your current gross margin -- EBITDA margin profile? And what do you think is going to be the trend there for the next 1 to 2 years?

We tend to focus on EBITDA margin at this company, and that's due primarily to the interchange between the software and the services. So you can't really discretely carve out a gross margin. On an EBITDA margin basis, we're in the mid-30s percent. We've seen pretty reasonable margin expansion over the years to get to where we are in the mid-30s. That's been our financial goal, and we expect to maintain that goal for the next 1 to 2 years, given that there are significant opportunities to continue to invest in the business as opposed to running the business over the next 24 months to maximize the margin. We're still focused on investing, which is this MSK CAR T, the Simcyp Discovery product that came out just some of the software opportunities that we have and modeling opportunities.

Okay. Got it. How is that effort going with the CAR T program? And more broadly, what other kinds of similar efforts do you have underway for kind of more personalized medicine type biosimulation programs?

Well, the CAR T program was just announced, I think, last month, so it is just getting off the ground to program. And I would expect -- I mean, what it's doing is it's giving us access to data that was very valuable in other words, it would be hard to get and as well as access to experts at MSK. We're very interested in this. It will give us a lot of credibility as we work with other companies in CAR T as well. But products takes time and 2 years is 2 -- I would say 2 for this one, but 2 to 3 years has been kind of our typical as we've embarked on this kind of thing because you have to go through the -- not just the creation of the model, but validation, sometimes discussion with regulators before anybody is really going to buy it. Our -- we have our group called QSP, we probably need a better name, but Quantitative Systems Pharmacology, which is doing a lot of what you're talking about. It's been -- there's been quite a number of projects in cell therapy, which is, I guess, when you talk -- where you're talking about personalized medicine. Most of those are still -- there's still drugs under approval as opposed to there's still not a ton of them that have been approved, but there's a lot of activity, and we both benefited and also been investing pretty significantly in that area.

Got it. Got it. Okay. Take a pause here and see if there's any questions from the audience. We got 3 minutes left. Yes.

Just ask a clarification question. I think you said low or high single digits, low double digits. Was that specific to the business in total or just the regulatory?

Just the regulatory. So I'll have a better view as we approach the end of the year because we base our forecast based on what we've booked given, I described it as the 12-month value. But this year, we're coming in with flat growth in that area. So just being more conservative about the outlook going forward.

Biosimulation growth?

Yes, biosimulation growth has been approaching 20% on the services side, 19% on a constant currency basis in the second quarter. And that's kind of above our mid-teens target range that we've seen historically.

Great. Anyone else? Okay. So let me ask you one final question before we close out then. What's the company's current thinking around business development? And are there any capabilities that you think you would be useful or helpful to tap resources for externally?

I'm assuming you're asking kind of questions around capital allocation.

Yes. What capabilities do you look to build that could make sense to bring in from an outside source versus building ground-up?

Yes, it's a good question. There's a -- we have -- we've been acquisitive over the years, and so we've always got our eyes on different things and timing and frankly, the valuations matter as to what we do. But in general, the strategy has been end-to-end services and software, aiding in the big decisions that get made during drug development. We've -- with Pinnacle 21, we've been pulled into a whole interesting new area around data management, standardization and validation, which can grow a lot and they're not Pinnacle 21, certainly not the only ones in that area. One of the obvious places that were not particularly -- we have some software in discovery, but given what I said around we'd like to capture projects early. We've always been looking at some of the technologies that are available there. We're not really an AI company right now. And my view is the AI companies that are out there are not competitors, but at some point, technologically, there will be some synergies between them as we go forward, too.

Okay. Great. Let's close out there. Bill, Andy, thanks so much for your time. Really appreciate it. Thanks, everyone, for joining.

Thank you.

Thank you.