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

Good morning, everybody. Luke Sergott. I cover life sciences tools and diagnostics at Barclays. With me, I have Bill Feehery. Feehery?

Feehery, right.

And Andrew Schemick.

Hello.

So I guess we could start off here. The businesses you own is not as well known as some of the other ones. You guys haven't been public for very long, but you've been in the business for 15-plus years. So talk about the high-level dynamics that you've seen over the past year and how you ended the year and then really the underlying growth drivers within the industry that supports your 15-plus growth?

Yes. Thanks. So -- yes, the company has been around in one form or another for quite a while. It's benefited since we've had -- the benefit of years of building our models and having them accepted by the FDA and by the industry. We've been public for just over 2 years now. And before that, we had a series of private owners over the years. The underlying driver of our industry really is -- of our company really is the number of drugs that actually get approved. So we make about 70% of our revenues from -- in the late stage and in the clinical phase. So we're kind of dependent on the FDA continuing to approve, say, 40 to 50 new drugs a year. The bulk of the benefit of what Certara does has to do with the reduction of the use of human clinical trials, which is the largest portion of the spend. And so that tends to grow quite rapidly as the drug gets towards the end. Having said that, we have a pretty widespread customer base. We have round about 2,000 customers, so the top 50 are -- say, 50% of our business. The other 50% is in the other part. And so the way we think about this is everywhere a drug is being developed, Certara is -- we'll say we want to be there, we can be quite relevant. We try to catch companies when they're small or when drugs are early stage, so we can stay with it over time. And that part of the business hasn't really changed. So I'd say the one thing that's probably changed as we went public is we've gotten a little bit more experience around how to deal with public markets and how to talk about our forecast and that type of thing. So Andy, you want to contribute there?

No. I think I will cover this elsewhere.

Awesome. Yes. So when you think about having the 2 businesses that you reported on -- the software and the services, but really what you're offering is just the overall software and then you're using the service, you're essentially renting out somebody that can run it for you, correct?

So we have -- that's true. So we have -- about 35% of our business is straight software sales, could be either term or subscription license. And then we have the other part of our business is the services business. The bulk of that is our biosimulation services, which we're doing what you talk about, which is largely were hired by companies that do want to buy our software to basically use our software to deliver the project. Those companies could be small companies that don't have the internal groups or maybe they only have a couple of drugs, so it's not like they could buy the software. Or they could be large companies that want customization. So they want to talk about the expert who are at the model, those types of things. The other portion of our services are in regulatory, a little bit more traditional services there. We'll do everything either from a regulatory basis, regulatory strategy, we'll do the regulatory writing, publishing. And that part of the business, we have it for strategic reasons. It's important for us to know what we're talking about from a regulatory standpoint for our biosimulation clients. And we have it because it's a highly profitable part of our business where we get a lot of our customers because we started working with them earlier -- quite early, and we know a lot about that drug.

Okay. That's been there. Over the last couple of quarters, the regulatory [indiscernible]. Talk about what's going on there. And then we can talk into the overall demand environment?

Yes. So the regulatory part of our business is about 20% of our business. Over the last year -- it [indiscernible] actually slightly shrunk last year in that part of the business. What I'll say about it is it still is quite profitable, but it's not dilutive to the margins of the business. So we like it from that standpoint. And it gives us a lot of credibility from what we're doing in price simulation. I mean, that said, the bulk of our capital allocation goes into investment in our biosimulation business, so it's probably not surprising that the growth rates are different from those types of things. If you look at the dynamics specifically in regulatory, I think there were a lot of things that happened during COVID and after COVID, as basically trials either got delayed in starting or delayed in finishing. They've kind of affected the length of time between our -- when we book projects and actually do them in regulatory. The other dynamic in that particular part of the business is that there are fewer larger projects there. And so it tends to be a little more lumpy than our biosimulation business, where we have literally thousands of projects. So it tends to grow much more smoothly.

Right. On the biosimulation side, [indiscernible] you have the Phoenix software, there's all these different markets that you bring to the table. The -- talk about the overall portfolio construction here and where you guys play across that whole preclinical to Phase 1 workflow.

Okay. That's a good point. So we have several different projects -- products that we work on software side, but the one that's -- probably we're the most known for is called Simcyp. That is our core biosimulation software and it tends to start in -- being used during preclinical phases. We charge less for it in that phase, and there tends to be a fairly small number of trials in preclinical. But as a drug becomes successful and moves into human trials and into late-stage clinical trial, the use of Simcyp grows and the amount of revenues that we can acquire also expands there. If you look at our product called Phoenix, which is a little bit different, it's used for analyzing pharmacokinetic data, the bulk of that is used either in preclinical or in -- after the clinical, so you're analyzing data that comes out of the trial threshold and gets used a couple of different places. And then the third big product we have is Pinnacle 21, a little bit different product. The idea behind Pinnacle 21 is it's a data validation product. So when you go to submit your clinical trial data to the FDA, it needs to be the [ CDx ] format. The FDA uses Pinnacle 21 whether or not you're -- you've met the standard and whether they'll accept the data. So everybody uses it -- that portion what you submit to the FDA, and then it gets used earlier in the cycle as companies try to ensure that their data basically meets the standard they're going to experience through the FDA.

Okay. So the Pinnacle was just a recent acquisition for you guys. And like you said, it's always good to buy the software that the FDA uses because that's pretty much [indiscernible].

Well, it's also strategic for us. So, Pinnacle 21 fundamentally, it's kind of a benchmark for data. So clinical trial data is going to flow through Pinnacle 21 as companies validate that it meets the standard. So that happens really in a couple of different places. One is when you go to the FDA. But increasingly, it's being used as pharma companies interact with their data providers, their labs or their clinical trial providers. They can also use Pinnacle 21 to say, "Hey, I have a contract with you. In order to determine whether you've met the terms of the contract, I want you to show that you meet Pinnacle 21 standards." And so it's used that way. The -- but if you kind of think about it -- if you have a piece of software that everybody flows their clinical trial data through, then we can build other interesting things like data repositories, data analysis. It kind of opens up the whole market of -- the armies of biostatisticians that pharmas have to manage all that they do there.

Okay. That's helpful. And so we were talking about -- I mean, it's a software business, but it's mostly consumption driven. And one of the drivers that you guys talked about for maintaining your growth rate is increasing the amount of subscription volume. So talk about the dynamics here. And why would the pharma customer move to the subscription model if they only have 3 or 4 projects in the pipeline. I mean, what's the dynamics there?

Primarily, just to clarify that point is the subscription model is more a reflection of the GAAP revenue recognition model. The impact when you're comparing us to historical periods. Historically, you can go back 2 years, we were about -- our software product sold 50% in term licenses, 50% on subscription. As we introduced new products for that acquisition, we've seen that increase where we ended last year with about a mix of 60% in subscription and we see that going to 65%. So the point being that whether it was a term license or a subscription license, we have high stickiness of our customer and our customer [indiscernible] rate over 100,000. There's not been one that's left the company. It's more a reflection of a comparison year-over-year, there seems greater percentage of our revenue that's occurred because of the licensing model.

Got it. And so with that sticky customer base, where would they go? I mean, there's not a lot of other options out there. And if there are too, what would be the rationale for not using it?

In terms of our model [indiscernible] store members to the extent that we see churn in customers, it's moving with a start-up company that's not successful or if it was one of our larger or more significant customers, we're really only impacted by drug failures or adverse regulatory events we call them. And that's baked into our profile [indiscernible]. What happens there is there's a period of time where the company is deciding what their strategy is for that program or for other programs we're allocating the resources and need to stay embedded with that customer which is the revenue recognition GAAP that's baked into our...

Then to answer your question, look, all good ideas have competition. There's always options, right? But the way we think about things is twofold. So one is we have the most experience with drugs actually getting approved with the FDA. So there is a good reason to use our solutions versus others. And the second is it is fairly sticky in terms of once you have a model that's working for your drug, it's hard to switch that. You have to have a big push to want -- if you want to switch that out. And as long as we're delivering [Technical Difficulty] expand the uses and capabilities of our software, we think that we can keep that under control.

Yes. Okay. And kind of talking about -- speaking about the guide here and your growth [indiscernible], so you guided for low double digits to mid-teens, which is slightly below your sort of target. So talk about what you guys are seeing here. Any type of comment that you'll give on recovery and how the quarter is progressing?

All of our KPIs [indiscernible] logos, book-to-bill, et cetera, we're seeing upsize those or helping business fundamentals. Look at our book to bill at the end of the year, around 1.22, that's historically translated to mid-teen revenue growth. In terms of the guidance, we tend to overweigh the most recent historical performance as future expectations by putting out guidance. That's been our methodology [indiscernible] bookings and 10% to 15% is consistent with our growth rate in 2022. [indiscernible] '21, we did have some benefit from M&A. I will say that specifically what's factored into that is the right group delivering low single digit growth which historically, that group has grown in line with the overall company metrics is, but because of some of the volatility coming out of COVID and the regulatory point of view in some of our China-related business there. Just expecting that to cover this year but at a slower pace of recovery than maybe the potential businesses long term. And there's also an impact on the revenue recognition, what we discussed earlier from software subscription revenue versus license revenue.

Okay. That's helpful. And then from a margin perspective, [indiscernible] talk about regulatory being really accretive margins and that's how -- what you guys are targeting for the year...

Yes. We're targeting mid-30s. We're still in -- we still see the company in a point in time where there is significant growth investment opportunities. In terms of continuing to build out the company but where we are in terms of kind of industry and regulatory guidance is still relatively early to [indiscernible] of the overall market size. And we're comfortable that at the mid-30s EBITDA margin, that gives us enough organic capital to reinvest in sales and marketing and growth initiatives. Some being, we just acquired a company, [indiscernible], earlier in the year. It came with a team of developers, but not a full commercial footprint or marketing strategy or a product guys, some integrations going on there. We will be making any divestments on the sales and marketing and the R&D side on an organic basis, and that's going to hold us at that mid-30s margin as opposed to no expansion.

Okay. On the -- let's talk about [indiscernible]. I've never heard of the company, never came across it. So give us the one-on-one on what it brings to the business. Is it the opportunity here and just really just begin on that.

Yes. Well, so ever since we went public, everybody has asked us about AI, and our answer has always been that Certara has build up their models from mechanistic side. So we've been modeling the known parts. That's been the foundation of the company. But we've always said that at some point, marrying the 2 of these will make sense, right, modeling the known part and then using AI to think about all the unknown parts, which are significant. And so -- we've been looking for different solutions, and we started working with [indiscernible] over a year ago. So what we saw with these guys is they have built a very solid deep learning tool. So it's using a lot of the technology that you -- it's kind of interesting that we bought that and all the stuff about ChatGPT going on, but it was coincidental. We've been working on it for a while really. And they also have -- they have also built it so that you can plug into lots of different data sources, very easily. So that's really what you want as you bring in deep learning, which is you want to bring in lots of different database to ask questions as much as possible as with normal ones. So the immediate interest for us was that this can plug into a lot of our existing software. So it becomes an additional feature for a lot of the software that we sell. Obviously, we will have -- if we add it in, we'll have an upcharge for that. And we're delivering something that our clients have been asking about and the technology direction has led to for a while. They -- the reason you haven't heard about them is it was a small company. They developed a really interesting tool. But the thing about AI is it's not very useful by itself. You need to marry it with certain things. So we brought -- I think we bring a big platform to them that they didn't otherwise have. And obviously, they can plug into a lot of our software. So I think this is going to be a good partnership for us as we go forward. We don't have a material prediction in our -- or a comment here, but we don't have anything material for this year, partly because we've got some engineering work to do to plug into all of our software. Maybe we'll exceed that. We'll see how it goes. But we're all quite excited about it. And like I said, it's quite a hot topic lately, partly because there's a really -- there's a lot of really interesting things that you can do with this that are unable to be achieved before.

So it's not ChatGPT for regulatory submission?

No, it's not ChatGPT for regulatory submission, absolutely not. Well, so one of the things we had a recent press release and one of our software products we haven't talked a lot about was D360. It's a software product that's used in discovery to sort of act like a search engine across all of the chemical -- chemicals that a pharma company might have made over the years, right? And so by plugging that in, now you can do cool things like say, "Hey, I'm interested in these 3 targets, use the AI to tell me what targets that are very similar to that, but maybe I also ought to go look at" right? So that's very interesting to pharma. And it's -- we're getting a lot of interest in terms of like things -- applications like that can otherwise provide.

Yes, anything to accelerate the development curve. Okay. That's helpful. So when you think about like having that upcharge and you're plugging that in. But when you're selling the total portfolio to pharma -- say it's a big pharma, and they have all these build programs in the past, where they maintain all that data. Do you have to get to convert that data so that the software can read it?

No. It actually is capable of -- I'm not going to give all the technology here, but it's basically capable of plugging into structured or unstructured database and basically creating its own hierarchy of what's in there. So it can be searched without doing that kind of creation. So it's not like the -- technology people talked about in the past, used to talk about converting everything and creating a database. That's not what this is. Now we leave all the databases where they are and you plug into it and it kind of pulls from all of them. So [indiscernible].

Somebody just hit me up. I didn't ask you guys early on at the top of SVB exposure. Do you guys done any analysis on that for your clients?

We have done analysis on SVB. We don't have a direct banking relationship with SVB in terms of SVB and other impacted banks that we've seen out there. We've looked at the incoming wire transfers over the course of 2022 from all of these -- group of 5 or 6 banks, and it's less than 1% of revenues. Similar in terms of our -- similar immaterial in terms of our current AR balance. We don't expect any impact from that.

So you guys are like -- you're net cash positive from those guys?

Yes.

Okay. That's good. And from the -- I guess, as you're having those conversations, I guess, the indirect knock-on as you're talking to a lot of these customers, talk about their R&D budget and their -- has their philosophy started to change and starting to tighten up?

I would say our bookings remain quite strong. The reality on Certara is that the percentage of the revenue that we get from the emerging biotech sector, which is the one that everybody questions around the funding sources is a couple of percent of our revenue, so not a really significant part. It's not necessarily because we don't have them as customers, is it just because we don't charge -- we don't have significant revenue products for that. It's more like we just do a project here or there to keep our name in their heads, right? In terms of the larger pharma, a lot of our clients have significant dollars, particularly to invest, particularly coming out of the pandemic. And so at least I think we're as aware as everybody about all the macroeconomic things and risks that are going on, but we haven't really seen that at the company.

Yes. It's also probably such a small part of their spend in [indiscernible] so core to getting the drug through the pipeline.

Yes. And I would also agree that -- I'd also argue that if push really came to shove that I don't think you [indiscernible] things we're just not -- to your point, just not the big dollar figure to go after.

No, it's not where you're going to cut the [indiscernible] or something. Okay. That's helpful. And then so lastly, here as we think about continue to do M&A. Talk about pools or areas of portfolio that you'd like to build out on, especially as you look out in the next year or 2?

Well, we've talked in general in a couple of areas. One is that we get most of our revenues from clinical, but a lot of decisions get failed in pharma. So we thought about generally just expanding our footprint in preclinical on the discovery. M&A is not our only opportunity. We've launched a few more products in preclinical, for example, and we're investing in D360 in discovery. So -- the way I think about M&A is we're in an interesting space. We want to have flexibility to do something once it's available. But if it's not, we've got plenty of interesting internal opportunities to fund and those are quite attractive. We've also -- now we're getting into the AI space, it opens up interesting opportunities around data that we might want to collect that's relevant to biosimulation. And over time, we have done lots of little tuck-ins in services. Most of these, I kind of think about it is almost like acquihires where we get 50 or 100 people, [indiscernible], we do those whenever we find them at a reasonable price, and you can expect that we'll do them because they're good for shareholders and they're a good way to grow the company with some good talent out there. So makes sense.

Awesome. That's all the time. Thank you.

Thanks.