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

All right. Awesome. I think we'll go ahead and get started here. Thanks, everybody, for joining us at the Baird Healthcare Conference this week. For those of you who don't know me, my name is Vikram Kesavabhotla. I'm 1 of our senior research analyst here at Baird. I lead our coverage of the health care technology and services space. Very excited today to be hosting Certara at our conference. Joining us from the company is Andy Schemick, Chief Financial Officer. We're going to start off with a quick presentation for Andy, just giving an overview of the business and then we're going to dive into some Q&A from there. Just to level set, we have about 30 minutes scheduled for this conversation, and we'll try to cover as much as we can. So with that, Andy, if you want to get started, and that we'll go from there.

Yes. Thank you. Appreciate that. I'm Andy Schemick, Chief Financial Officer of Certara. I've been in that role for 8 years, and I'll do a quick company overview and we'll go to Q&A. Okay. So first slide here is just the business at a glance. At the highest level, Certara is a leader in a field called biosimulation. Our solutions address critical drug discovery and development risks and provide decision support using biosimulation, technology and services. A quick overview of the company at a glance from a business perspective. We've been in business approximately 20 years and that kind of corresponds to the earliest evidence of regulatory guidance and support around some of our products and we've been innovating the company since that time. We currently have around 1,100 employees. It's a sophisticated workforce, 350-plus have PhDs, PharmDs, MDs, and we've got a large team of software developers. Over this period of time, we've done 16 acquisitions. The most significant acquisition was in 2012 when Simcyp and Pharsight merged to put together a complete biosimulation software solution. Since that time, there's been approximately 15 acquisitions that has been a part of. The 1 point I'd like to make there is this is a little bit different than what you would expect from a private equity-owned company. It was more of a merging of an industry and coming together of like-minded people. Out of the 16 acquisitions, 15 of them were either our partner working with us side by side and client engagements or we had used the product as a part of our solution. So it was organic from that perspective. The end-to-end platform consists of -- I'm losing my screen here, folks.

The screen up here is dark.

So we've got an end-to-end platform. It goes from drug discovery to post approval. The software is -- there's really 3 core pieces of software. So when you're looking at the company, it's going to be Simcyp, Phoenix and now Pinnacle 21 that comprises over 80% of the software revenues, but we also have products in Regulatory and Compliance and Market Access. And we use these software as both stand-alone licenses and subscriptions. We also leverage the software for our technology-driven services. The technology-driven services are around three core areas. The most significant piece is our drug discovery and development with biosimulation and then we have some complementary add-ons that we've put in place over time based on customer feedback. Large TAM, $13 billion. I'll drill down that a little bit later. In terms of the customer mix, we've got 2,000 customers across 62 countries. If you look at our top 30 clients, the average tenure is greater than 10 years, staying with Certara. We have a little less than 300 customers with an ACV greater than $100,000, a little bit more than 50 customers with an ACV greater than $1 million. Those are 2 cohorts that we track to measure our land and expand strategies, the success of those if you are following the company. Revenues for the second quarter financials, $82.8 million, it was 21% growth on a constant currency basis. We did have a benefit from an acquisition comp. So it was 11% growth, excluding the Pinnacle 21 and that we have strong cash flow generation, $28 million of EBITDA, and we maintained EBITDA margin in the mid-30s, while continuing to invest in innovation. That's been our profile for a while. The biosimulation, what is it? So it is a computer-aided modeling of biological processes and systems to simulate and predict how the body affects the drug and how the drug affects the body. We talk about biosimulation software. We talk about essentially what we call Simcyp and Phoenix. And Simcyp is a field they call PBPK and QSP and Phoenix is what they call PK/PD for those, who are interested. The common applications of the software today include first-in-human dosing and translational questions, decision support for designing clinical trials with a goal to reduce the size and complexity of the clinical trials, evaluation and prediction of drug-drug interactions, dosing recommendations for different populations, as well as for statistical analysis, including noncompartmental analysis PK/PD analysis and toxicokinetics. We talk about the acceptance of the technology. It can really be seen that the software has been adopted by 17 regulatory agencies around the world. In some cases, they're the largest users of certain of our software. There has been over 300 label claims to date. So since I've been here, when I started, it was 0, so we're starting to see an increasing evidence of label claims based on biosimulation. This dose can be provided to a pediatric population based on simulation. We can trace that back in those 300 are attributable to Certara, and we can trace that 90% of drugs approved annually use some component of our software and our solutions. This here on the presentation is really a diagram of our Simcyp software. So just to clarify that, which is separate from the Phoenix win-on-win software. This software is a software that start off as a model of the liver. And over the years, has grown into 10 organs, 25 virtual populations and over 100 compound files. That's a quick overview on that. Okay. This is just a slide showing that our software and our services are relevant throughout drug development. I think the first thing to note here is the software revenues about 30% of the revenues, the tech-driven services are 70%. That does not include Pinnacle 21, including Pinnacle 21, it's 35%, 65% today. And I think 1 area that needs to be considered is that there's a significant percentage of the services revenues that are wholly dependent on the software that we provide given the limitation of scientists out there available to provide this type of service we are often engaged to run the models or prepare the simulation on behalf of a client. So this has been purpose-built and we've continually invested for a long time. So on the TAM here, the big TAM, $13 billion is large and growing. The key factors or tailwinds are probably common themes that you're hearing digital transformation and increasing adoption of biosimulation. It's been providing significant tailwinds for us. We expect it to be growing -- the market continue to grow in the teens. Our core here to focus on is the biosimulation TAM. That's $2.9 billion. That's what the company was put together to go after. This biosimulation TAM can be split about 50-50 between software and tech-enabled services. In software, 45% of that is in Discovery. So if you're looking at Certara, we have a small footprint in Discovery today, that's not a meaningful part of the market, but we see that as an opportunity for us in the future. That's our D360 and some applications of the QSP modeling. 55% is in the development phase, and this is where overall 60% to 70% of Certara's revenues come in clinical development stage Phase II, Phase III. We're heavily weighted there. For the service, the TAM here is 50%, it's $1.4 billion. It's driven off of essentially the number of our view, which reconciles with the external views. It's driven off the number of active drug programs. So that's the key metric there, the number of drug programs ongoing by phase. And then in terms of value of that market, from our perspective, about 70% of the value of the market is derived in Phase II and Phase III, which is where our solutions sit. We -- so basically, the conclusion, when we get to Q&A, our differentiated strengths enable us to win new customers and projects. Our software is industry standard. So there's lots of evidence of that. There's the label claims. There's just a sheer number of research publications that you could search on Google Scholar using our software. There's the adoption by the regulatory agencies. We have a 90% renewal rate. That's a gross retention rate. So I use that mostly for calculating visibility. So the net retention rate were 105 to 108 on the software. So I mostly use that as a metric to derive what's the baseline for next year's software growth. You can see scientific publications were used by 400 academic institutions training the next generation of scientists. In Services, again, we have a high repeat rate on our services and 90% of our top 50 customers use both biosim and Reg and Access from Certara. I'll stop there so we can get to questions, which is probably more interesting than reading a slide. Thanks.

Thanks, Andy, for giving that over you. That's super helpful. So I mean, a couple of things. I want to start on the biosimulation part, and then we can kind of talk about some of the other dynamics of the company. So I guess, first, the TAM that you cited on the biosimulation part of the business was $2.8 billion. Your company does a couple of hundred million of revenue -- a few hundred million. I guess what is the rest of that TAM right now? Is that coming from like internal spending in the end market? Or is it your competitors? What makes up the rest of the market right now?

There's 2 pieces. So there is a -- in terms of the competitive landscape, there is not -- it's a growing field. There's not a lot of significant direct competition. So when we talk about companies like Schrodinger, Simulations Plus, Certara, we're all able to operate in the market. And we focus most of our time on the white space or expanding within our clients. It's less of a -- the market is not mature -- in a mature enough environment right now where it's kind of head-to-head competition. So those pieces comprise a small part. There's other software, so there's the discovery -- a handful of discovery AI companies. There are some elements in Dassault. But essentially each solution or strategy that addresses a different need or question. So there's not a lot of kind of direct replacement competition for Certara the way I see it. And then there's a large groups and big pharmaceutical companies, and those are the companies that participate in our Simcyp consortium, and we train the employees every year, but they're hiring and they're doing a lot of work in-house as well.

Yes. And the 16% CAGR that you have on there for the biosimulation market, what do you think is driving that growth? Does that have to do with awareness of the product or something about the product that's evolving? Great to understand like what's driving incremental growth at this point? .

Yes. Ultimately -- so awareness is a big piece. So we've been forming this market position and kind of building awareness over the last several years, and that certainly helped us, but really, what drives it is regulatory acceptance. So an example of some of the strength that we've seen this year is the FDA comes out with a project called Project Optimus. That project essentially is requesting that companies who are developing a candidate in oncology would use the optimal dose in the patient, as opposed to the maximum tolerable dose, I would imagine for ethics and safety reasons. So the FDA comes out with a guidance in that regard, it creates a lot of interest for Certara, who has tools that can help you predict the correct first in-human dose or have a more safe profile to your dose. So I think industry and regulatory acceptances really is what's driving it.

Yes. And then I guess if we think about the last handful months, obviously, a lot has evolved in the macro environment, especially within the end market that you work with. I guess -- have you seen a change in terms of how your customers are approaching purchasing a solution like this? Like how they're evaluating the options that are available to them, their propensity to spend. Are you seeing anything different as you go through your sales cycles now?

We have seen -- there's 2 pieces there. So our end-to-end solution was put together based on working with clients and what they're looking for. As a component of that is our Regulatory and Access business. We've seen some extensions of budgets or slowdown in spending decisions in that space, but it's still generally speaking, healthy. Margins are good, and margins are comparable with the rest of the company. Conversely, with regards to the biosimulation side, we've seen kind of an acceleration in bookings. We're still processing that. The bookings that we report are an annual bookings metric. So it's the revenues we expect to incur in the next 12 months post the booking -- book total contract value. And on a trailing 12-month basis, the bookings on the biosim services are up 33%, and we've seen revenue growth when we adjust it for the currencies, which we do have a big footprint in the U.K. That's where Simcyp is located, 19%. So approaching 20% there, so starting to catch up with the bookings growth. So we've seen some increasing engagement on the biosim side and some lumpiness on the Regulatory and Access side, but still moving forward on the Regulatory and Access side.

And I appreciate the decisions on the regulatory side are probably different than the processes on the biosimulation side, but you called out some of the lumpiness on the regulatory side of the business. Is there any reason to think that type of kind of purchasing volatility or behavior could eventually kind of find its way into the biosimulation part of your business? Or are you seeing any of that right now?

We still have a relative -- so if there's, I don't know, 10,000 drug programs ongoing in early stages, getting down to 1,000 in Phase III, that -- the opportunity to add value with biosimulation is significant. So that's how we kind of build up the $2.8 billion TAM based on our average price in each 1 of those phases. So we still think there's a lot of room for penetration in the market, and we don't see an overall reduction in the number of drug programs. And given that biosimulation projects essentially build upon themselves, so the more data that you acquire, the more value you can get out of modeling or simulating the data in terms of decision support for -- essentially decision support. And the fact that it's 7 to 9 years to develop a drug. I think I'm not expecting a slowdown there. And there's some argument to be made that there's a significant ROI to what we do. So we'll see how that plays out over the future months, given that we could be a good alternative for companies that are trying to manage their budget.

Yes. And then on 1 of the slides you broke down the biosimulation TAM between discovery and development. You talked about -- and today, you have a small footprint on the discovery side. I guess when you think about this business going forward, how do you expect that mix to evolve within your company? And where do you expect most of the growth going forward to come from?

Yes. I'd say, obviously, in the near term, I would assume a similar mix to where we are right now with the majority of the revenue coming into clinical phase, Phase II, Phase III, which is where we can have the most impact. Discovery, we do have a small footprint in terms of revenues, but we have a pretty significant footprint in terms of user base. And over the long term, from our perspective, it would be strategic to get attached to clients even earlier because then we continue to show the end-to-end platform, we have solutions and software that could be used at critical stages across development. So to the extent, we could start earlier with the clients. We think that would be a good opportunity for Certara, but that's not something that I would anticipate having a material impact over the next 2 years, having some strategic change.

Maybe if we can kind of move on and talk about the regulatory part of your business a little more. You referenced some of the lumpiness that you've seen this year. I guess can you start off just talking about some of the factors that have impacted that business this year and driven some of that difference in performance?

Yes. So I've had some time to reflect on that. So I would like to make it clear to people that when you think about our commentary on the regulatory market, that's a massive market. So extrapolating our cohort of clients in that market might not be applicable. But what we see -- to the broader industry, what we've seen is really 2 factors. The first factor was we had -- we see -- basically, since the first quarter of last year, coming out of COVID, we started to see some extensions in our revenue conversion metrics. We saw a kind of acceleration in Q3 last year, and that was some clients needed urgent regulatory milestones. They pulled us to do that work. And then we thought we were kind of getting back to where we were before the pandemic, but it's continued. And the biggest drivers for this year are, we started getting -- we opened up a China office. Early last year, we started getting Chinese sponsor companies, who are looking for a pathway to submit to the U.S. regulatory agencies. And there's been some feedback provided by the regulators that led to kind of come back with a more robust data set there. And that's essentially a business we thought was going to be kind of a growth driver for us. And over the short term, it's gone to 0. Long term, we do expect that to be a good business given the attractiveness of the U.S. market. And then on the second factor is we're essentially -- given our client base, we're about 2 projects missing. So when you get to NDA or late-stage regulatory project, this could be in the $2 million to $4 million range. And we're just not in our client mix, having any of those events come up this year. So that's really what's going on.

And so when you think about the fiscal '22 guidance you have out there now, what does that now assume for that regulatory part of your business?

Yes. So we basically took an approach whereby we looked at the business that we had sold through June 30 and then allocated the projects that had start and complete dates between June 30 and the end of the year and put that into our guidance. That represented about 60% of the total business that we had sold in regulatory. So for opportunities, we would -- so it's essentially 100% coverage as of June 30. But for opportunities, we would have the pull-through of the 40% that we don't have start dates for, and we would also have a new business, which is incorporated there. And then for risks, it would be an adverse regulatory event for one of our clients or a client having difficulty meeting their own internal deadlines, extending the revenues. So I think it's a balanced approach to the back half of the year.

Yes. And I guess more of a higher-level question, right? I think historically, you've all been pretty clear in terms of how you go about building the guidance range based on your backlog and visibility. Given some of the experience that you've gone through this year with the market changing, has anything evolved in terms of your broader guidance philosophy or the way you go about forecasting the business given some of the changes that you've seen?

Yes, it's been a pretty reliable means for us to develop forward-looking numbers. I think we'll keep -- we'll maintain the same approach. But in light of some of the increased volatility and the delays which are new to the market, probably prudent to overlay some additional conservatism over the way we've done things in the past.

Okay. Maybe just shifting gears to a couple of other topics. I guess first on the margin side, your company now is in mid-30s EBITDA margin. What -- how should we think about the progression of margins from here going forward? It would be great to get some color on that.

Yes. So again, we don't -- for this year, for example, if we ran business as usual, we would have had about 100 basis point expansion in our EBITDA margin. We made the decision to take that and put that into software development and other investments for the company. And I would expect that -- given the significant growth opportunities that we have in front of us, we have found that maintaining that mid-30s EBITDA margin is the right mix of profitability for the company with investment for future growth opportunities. We've got a number of growth opportunities that we've been working on some products we've launched this year already.

Yes. Could you maybe just double click on that, I guess, in terms of product innovation, particularly on the biosimulation side, but really across your portfolio, what are some of the biggest areas of focus for you from a product standpoint?

Yes. So we did launch a product called Simcyp Discovery, which is a software product that's focused on preclinical and early clinical, which is a space where we're currently underpenetrated. And that was an area that was essentially modularizing the 10 organ 20 virtual population into more directing a specific question as far as an open up ended question, where we think there could be a lot of value for clients. So we'll continue to develop -- use our existing technology to develop new products or modules, if you will, to go after different market segments. We're also going to be investing in the kind of emerging technologies in the space, which at this point in time is quantitative systems pharmacology, which looks more at the pharmacodynamics. And we have several of those endeavors ongoing right now. We have an immuno-oncology product, immunogenicity product, vaccine simulator, neurodegenerative disease simulator and the toxicology simulator ongoing. And just to talk about the cycle there, the first 1 started maybe 4 years ago. We limit that to a handful of clients. So the revenues, by definition, don't grow. We keep it to a base of about 5 clients while we develop the software and the model and gather feedback. And then earlier this year, we saw the FDA take a first license of that. So it's about a 4-year process. So we were getting revenue and profitability along the way. But now that the regulators are evaluating it kind of creates additional demand. As I said, the guidance is for the regulators tend to be a big pull-through factor for us. And then don't forget, Pinnacle 21. So Pinnacle '21 is -- we launched a new product called Data Exchange. Simple put, historically, Pinnacle 21 is the data validation screen between a sponsor and the FDA, which uses Pinnacle 21 to validate all data that they receive since it was mandated that 2 years ago. And we launched -- that's also an issue earlier on as opposed to right at the end in drug development. We launched a product called Data Exchange, and we've seen pretty good uptake there, which is more about the sponsors receiving data from numerous sources and they can ensure the compliance of the data before they accept the data from their third-party vendors. We see some interest in that as well, too. And then overall, data standardization and data validation is strategic for us given that -- that's a big component of our biosimulation efforts is assessing is the data available, getting the data in the right format so that we can then do models in simulation. That's a good growth area for us.

Yes. And so I guess if you put all that together and just going back to also one of the earlier comments you made, is there a way for you to measure the ROI that you're providing to clients and measure, I guess, even -- I guess, if not a customer satisfaction. But is there a way to kind of put numbers around the value that you're providing?

Yes. It's difficult to do that. So you can -- there's an ROI from stopping a program from reducing the size of the clinical trial. There's a number of use cases. The ROI is significant. I think that's why we get the -- you can see the profitability that we maintain. The way that I look at the ROI is really around, to me, what significance the label claims. So there you can see specific, okay, this is a drug -- avoidance of drug-drug interaction trial or some clinical trial. You can calculate the cost of that, and it's versus a several hundred thousand dollar consulting engagement. So we believe the ROI is high. It's just difficult to measure because the numbers are big to get a drug to market 3 months faster.

Well, I guess, considering that, is there an opportunity for you to, I guess, be more aggressive on your pricing going forward? Is that something that you lean on typically? Or is that not one of the levers you really...

We -- obviously, in this environment and probably pricing is on everyone's mind, we do evaluate our pricing frequently just in light of the cost situation around the world. But we are a leader in the industry. We have long-term client relationships. So that's not a primary lever for us going forward.

Okay. We're down to about a minute. I want to give you a chance, anything that I didn't get a chance to touch on here or any other kind of closing remarks you want to leave our audience with.

No, just for -- hopefully, it's a lot to process when we start bringing people into the world of Certara. I'm happy to interact with you going forward. And I appreciate you coming and love to have some questions if there are any.

All right. I think it's probably a good place for us to wrap up then. Thank you, Andy, for joining us today. Thanks, everybody, in the room for joining as well. Please let us know if you have any more questions, and we'll leave it there. Thanks, everyone.

Thank you.