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

All right. Welcome, everyone. Let's go ahead and get started. This is the fireside chat with Certara. My name is Vikram Purohit. I'm one of the biotech analysts with the Morgan Stanley Research team. I need to read a brief disclosure statement. 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, I'm very happy to have with me the team from Certara. Thank you both for joining us. Really appreciate it. So we have roughly 25 minutes and a good amount of material to cover, but Bill, maybe I'll turn it to you first, just for some opening remarks just to kind of level set us on some of the key milestones you feel like Certara has hit throughout the year, some of the key inflection points for the business overall, both on the software side and on the services side, and then we'll dig in deeper from there.

Yes. That's great. It's great to see you, and thanks for the question.

Of course.

So, Certara is a -- fundamentally, we're a biosimulation company. We're devoted to creating mathematical models of biological processes that will let drug companies develop their drugs more efficiently, and primarily, we're interested in helping them reduce the use in human clinical trials, which are very expensive and a good place to focus efficiency on. As a company, we're focused -- we do that in a couple of ways. So we are fundamentally a software company with a very big services arm. We need to do that in order to help our clients be successful in biosimulation. So if you look at us on a -- as a software side, we've launched a couple of new products this year. Recently, we launched a new Simcyp product targeted at more preclinical areas. We've launched a new AI-based product called CODEx, which uses artificial intelligence to search databases of existing clinical trial data, it can give you some idea how your drug will do going forward based on existing data that's been tested on similar drugs. We launched new features like a predictive -- basically, the ability to use AI to predict interesting molecules for discovery scientists to pursue based on, say, a couple of things they're interested in right now. So that's been an exciting opportunity. We acquired a company called Vyasa earlier this year, which was a very well-timed acquisition in AI. I think we bought them a couple of years before everybody figured out what ChatGPT was. And so we've been investing a lot in making that reality and showing some pretty significant success. We've also been building up our services side as we went through the year. We've combined our biosimulation and our regulatory services into one big group so that we can offer a more integrated opportunity to our clients. We're seeing some very good uptick from that. And we're continuing to invest in both that and in creating new software as we move forward.

Great. Great. I want to dig in a little deeper on 2023 performance trends and both sides of the business overall. But before we do that, just to kind of orient us, could you both mention, just some of the key metrics that people should keep in mind when they're evaluating Certara's business. On a kind of a full year basis and also on a quarterly basis, like, what are the key parameters to look at to get a sense of how the underlying health of the business is progressing?

Yes. Yes, Vikram, thanks for the question. So some of the key metrics to look at, of course, would be our bookings, would be the start. So that's where we're taking visibility from the pipeline, converting that to bookings. And then our conversion of those bookings to revenue is obviously the first place that you'd want to start. A couple of other metrics that would be important would be our net retention rate in the software business, on the quarter, it was 112%, which is actually up sequentially from Q1. So we've been pleased with the results there, and that's indicative of existing customers that are expanding their footprint and taking on more business from us. A couple of other metrics that are interesting, too, is around customers and the size of customers. So we do track customers that are greater than $100,000 of annual business. And we also track customers that are -- accounts that are greater than $1 million of annual business, both of which have been growing on a year-over-year basis. But maybe a good time, too, to just give a little bit of an update on how the business is actually doing too, which -- so as we look, the business is performing in line with the expectations that we laid out on the August call. The cadence of the bookings that we're seeing in Q3 are consistent with -- and are very similar with what we saw during Q2, and that's consistent with our internal plan. The management team is, of course, very focused on taking what -- the visibility that we have in the pipeline and converting that to bookings and ultimately, revenue across the product portfolio of software and services. Bill was touching on some of the org changes, too. So we've seen really good uptake as far as the combination of the reg business, combined with biosimulation, we're seeing and getting good feedback on that from the customers as well as positive feedback on the integrated sales force. So, those are all good touch points. We're continuing to invest in software. So Bill mentioned before, we're investing in software, and we've launched a new Simcyp product. And we're very excited about the efforts that we have in AI. We've already rolled that out in a couple of products. And in addition to that, there's much more to come on the AI front, both in regulatory and in biosimulation. So that's a bit of an update on just how the business is doing and how we're seeing it during the quarter.

Understood. And I was actually going to ask you how the org change that you mentioned during the 2Q call had been playing out? It seems like you're saying that they've been well-organized internally, well received by customers. I guess, what exactly did that org change achieve that has been beneficial to clients and customers. Is it just an easier point of sale? Is it just kind of interacting with one person who can talk to you about 2 different offerings and therefore, it's just easier to complete the sales cycle? Or is it something else?

Well, our -- I can start. And then -- our biosim business is complementary then to the regulatory business in the sense that we're already working with customers for biosimulation and it's a natural cross-sell point for us to also sell them the regulatory services that we offer.

So I think the -- it's worth pointing out, the bigger point of Certara is around being a biosimulation company, not being a collection of individual businesses that we bought that are providing different services or software. So I look at this as the natural evolution for us, right? We were formed from a lot of acquisitions. We've gotten to the point where having -- particularly on the services side, internally, we've had 2 services groups, 1 focused on regulatory and access, 1 focused on biosimulation. They have different back offices, different processes, there's a significant internal opportunity for efficiency, which we can better serve customers with. But the bigger point is we bought these because there's an integrated offering that we can provide to clients to help them with their drug development, and this enables us to be 1 point of contact, to be -- of course, we've always had cross-selling incentives for our sales force. But it's one thing to have an incentive to go sell the other thing and another thing to have everybody in one group selling basically all the products in an integrated fashion to a customer. I think it enables us to move up at a higher level to talk to a higher level of management in our customers, do bigger deals. It's a bit early for us to tell you -- show you lots of statistics on it, but I can tell you anecdotally, we've closed a couple of quite interesting deals already. So people are excited about it internally, and I think there's more to come.

Got it. Got it. Okay. That's helpful. Post your 2Q call, there was also a good amount of focus, obviously, on the guidance update. The one question I have for you there just to clarify for everyone is the bookends of guidance, what scenarios and what outcomes throughout the year do those bookends contemplate? And is there any color you can provide at this point on kind of which bookend you feel like you're tracking more towards at this point?

Yes. So the way to think about that guidance is at the low end, in order to be at that low end, we would need to see further weakness on top of what we've discussed already in both the regulatory business and biosimulation services. So that is what gets you to the low end. At the high end, we need to see recovery, both in the Tier 3 customers, where we've seen the biotech funding environment impact the services business there, but also in the Tier 1s, where we've said there is a little bit of delay as far as signing new bookings, delay in starting projects in the Tier 1s. And to the extent that we see that begin to unlock and the biotech funding environment start to improve, that would push us more towards the high end. And as I commented, as far as looking at the business during the quarter, we're sort of tracking to our expectations for now.

Okay. Understood. Topic of biotech funding has obviously been -- it's been talked about quite a bit. But when you think about the funding cycle that everyone went through, is going through now, the impact that you've seen and reported on, on your business, are there ways to try to help insulate from these kinds of funding cycle volatilities going forward? Is that something that you think about as a business going forward? Or is this not possible given how tied you are to this kind of clinical spend in the business that you're in?

Well, it's kind of a positive and a negative, right? So we have a very broad customer base of about 2,000 customers. We cover everything from big pharma to biotechs. And so if you do that, the good news is you're covering a lot of the market, but if some part of the market has issues that we're certainly going to see it. So from that standpoint, I don't really -- I don't know that I really want to change that. On the other hand, we're not a really huge company, and we're serving a massive industry. And so I think some of what happened was a little bit who we targeted and there's some opportunities there for us to change that. There's still plenty of activity going on in the pharma industry, it's not like it all dried up. Big companies are very, very active. And even biotechs, there's a lot of well-funded ones out there that are moving. And so I think -- if some of this will take on us, it's a little bit of who we targeted and what we're -- maybe concentrate a little bit on the wrong side of the market, and we're adjusting, as you would expect as we go forward.

Got it. Got it. Okay. And you've often talked about -- kind of on the tangential topic, you've often talked about just the size of the TAM that's out there for biosimulation and for your entire umbrella of products. Looking into 2024 and beyond, what do you think needs to happen to work from where your current revenue base is, to kind of work more aggressively towards that TAM? And what needs to happen or what can -- what levers can you pull, with your products, with your teams, with your company? And what do you think needs to happen, if anything, from like a macro standpoint to enable working towards that TAM?

Yes. So the TAM expands in a couple of different ways for us. So one is just the sort of the overall utility of biosimulation. So what -- there's general biosimulation and specifically, is it good in this use case for this therapy? And over the last 20 years, we've been gradually expanding that, right? We've added cell and gene therapy. We've added immuno-oncology. We've added vaccines. We've added neural models for working on Alzheimer's. And there's a lot of white space that we still have to work on. When I say work on it, some of it is developing the models, some of it is getting to the point where our regulators feel comfortable in letting a customer bring it through. And there's this endless cycle of doing this that we've been working through for years and we're continuing to do that. And we -- and I think this is the bigger point, and we're accelerating it, particularly after we went public because we're able to put more sustained R&D in that. So I think as we go forward, we could see that growth rate pick up. The second piece of it is just generally the regulatory environment. There are some things that are positive for us. I get asked questions about nonhuman primates, the shortages that are of them, and that's tied into the FDA Modernization Act, where -- which is generally pushing against using animal models. Well, one really good way to do that is to do more biosimulation, and we have models of animals that you can use for translational studies and things like that. So that's maybe not an immediate light switch kind of a turnover, but another tailwind that's happening for us. Third thing is just generally that we've been expanding the number of seats that can be bought of our software. So give an example, Simcyp is a -- it's an expensive, very versatile product. It does a lot of things. In the hands of a very skilled user, it can do a lot of things. And that's our core hard-core users, that market. But there's a lot of people out there in pharma that just want to solve 1 specific problem. Don't want to -- maybe don't want -- don't need or don't want to pay for the whole thing, but we can target them with other versions of that. And that's what we've seen as we've launched some of our newer versions of Simcyp that are targeting sort of like these specific spaces, the idea of let's get -- let's just expand the sort of the democratization of biosimulation. So there's a lot of things that are basically tailwinds for us that we can continue to invest in. And I think as we go forward, you'll sort of see, we've got a pretty good growth rate in adoption now and we can kind of tick that up as we go forward.

Got it. I mean, on the topic of use cases, are there maybe 1 or 2 use cases where you feel like Certara's software services would just be a great fit, but where biopharma companies just aren't seeing the value in those use cases yet or just slow to act? Kind of low-hanging fruit use cases where you feel like that could be a near-term revenue opportunity if the decision-makers at those organizations were just to speed up their decision process?

Yes, thanks for the question. I think one of the areas that we have invested in recently and I think is exciting is moving into toxicology. So the toxicology market is underserved in biosimulation. There's very few products available. There's a ton of data to analyze, and there's a lot of really interesting models that we can use in it. To some extent, it's like an alternative use of biosimulation. So talking about how a drug interacts with the target it's supposed to hit, we're trying to simulate how it interacts with all the targets that you don't want it to hit. I think there's a tremendous opportunity there. We've launched a product in that area called Secondary Intelligence. We've gone through a couple of iterations, it keeps getting better and better. And I think we're starting to get some interest on that, but I think there's an opportunity to make that bigger as well.

Got it. And in terms -- kind of building on the topic of areas of investment, 2 acquisitions that you've talked about, Vyasa, Pinnacle 21, a couple of years ago, would just love to hear from you on how those integrations are doing? Obviously, they're at very different time points, right, you acquired them, but how are those -- assimilations of those businesses going? And are there some interesting use cases coming out of the synergies across platforms from those integrations?

Yes, thanks for the question. So those are 2 very different acquisitions, and maybe they kind of show the breadth of how we think about our business. Pinnacle 21 was the largest acquisition we did, it's over $300 million acquisition. We acquired a profitable company that basically was growing faster than Certara and was, on an EBITDA basis, even more profitable than Certara. And since they came into the company, it's done even better than that. So it's continued to grow really quickly. They have launched a new version -- expanded version of the product that wasn't really even on the road map before we acquired them. And I think what's more important for us is we kept the whole team. And really, strategically, what that enabled us to do is we took in a very accomplished software team and use it to restructure all of our software around that. The founder of Pinnacle 21 is now the CTO. He reports directly to me. And so I would regard that as, we've got an even healthier business than what we acquired, and we kept a whole team of really great people, has been a really big success. And I think we're going to see more as we go forward. Vyasa is a little bit of a different story. It was the only -- this is maybe not what they want me to say, it was the only company we've ever acquired that wasn't profitable when we bought them. But look, we knew -- we worked with this company for over a year before we bought them. We had them actually implement Vyasa in one of our products, D360, so we could see it. So we knew what they could do. And then when the acquisition happened, it happened to be about a month before everybody learned what ChatGPT was. So it looked very well timed. We're not in the business of being a venture funding, but to acquire that capability and integrate that in our products was just really, really compelling. Since they've come in, the first thing we did was we sort of did the low-hanging fruits. So we implemented features across several of our products, which sort of extended the existing product in a way that added AI, and so we can have an upcharge for that. The second thing we're doing is we're kind of looking at the original prospect of AI -- of Vyasa, which was to create a health care-oriented large language model. So we can search unstructured data in health care. It's not -- so unlike using what you might get online from ChatGPT, ours is focused on health care data. It will give you answers within it from -- it will give you answers and references from within publicly available documents or potentially, even internal databases, and that's drawing a lot of attention. And it's providing a lot of opportunities for us to expand in ways that really, we -- this time last year, we weren't even thinking about.

Sure. Okay. That's helpful. Staying on the topic of business development then. What areas of investment seem interesting looking forward? Are there specific capabilities or technologies that you think would be quicker, more efficient to bring in-house through an acquisition versus building internally and how are you thinking about the capital allocation in general?

Yes. So I'll start and then I'll turn it over to John. But we think about acquisitions in a couple of ways. One is, we have a tremendous amount of internal ideas, so we don't need to do any acquisitions, right? Where there's a lot of things we can invest in internally, and this company will continue to grow. We're also in a really interesting area that is changing a lot. There's a lot of really interesting smaller companies out there that can benefit from the fact that Certara has a really wide footprint of customers. And so the way we thought about this is, we'd like to expand the percentage of revenue that we get from software. So to the extent that we can do anything significant would likely be in the software side. We also benefit a lot by having a very unique recognized set of experts in biosimulation, and sometimes we find some small services companies where we can do an acquihire or bolt-on certain things, but those tend to be smaller. As we look forward, there's a lot of areas where we can go. I've talked before about we're always interested in discovery. Right now, we tend to start working with the molecule after it's been selected, and then people want to simulate what happens in trials. But we've always been looking at how do we get more in the discovery area so we can capture customers early -- earlier. We've been expanding a lot -- because of Pinnacle 21, we've been expanding a lot in the whole biostatistics area into things like the metadata for clinical trial data and things like that. And I think there's probably some other technologies out there. So I would say we keep our eye on a lot of things. We don't feel like we ever have to do an acquisition. But when the strategy is right and the team looks right and the price looks right, we have the ability to move, and that's been successful for us. So...

Yes. Yes. And for capital allocation, I mean, look, we have the balance sheet to get deals done. So to Bill's point, we don't have to do one, but we've certainly positioned ourselves to be able to capitalize on one. We have cash. We have net leverage of less than half a turn, and we have a mindset towards software acquisitions should they make sense for us. Meanwhile, there's plenty of great ideas organically to invest in, in the organization, many of which we've talked about. But that's kind of how we're thinking about it.

Got it. Got it. Switching gears a little bit, Bill, I know we've spoken before about the ex U.S. business and some of the dynamics that play out in different geographies. They're trying to drive a biosimulation business ex U.S., but I'd just love to hear your latest take and perspective on what your ambitions are for Certara outside of the United States? And what are some of the efforts you might have in Europe and Asia to bolster those businesses?

So look, the strategy of Certara is to be able to go wherever the drug development industry goes. And a lot of times we sit here in the U.S., we think it's a U.S. game, but that is not the case, right? It's -- we have people, I think, 35 countries or something like that. And we're finding expansion of trials of really good companies in a lot of the world. So we've got a heavy presence in the U.S. and also in Europe. We've been expanding in Asia as well. We have a large set of customers in Japan. They've been long-standing customers. We're starting to see a little bit in India. I would say the one place that I've been disappointed about has been in China. A couple of years ago, I said that was my strategy to grow. And I guess with all that's happened in China, it's been harder than we thought. We do have a group in China, and we do sell some software there. So we have a presence, and I still have hopes that, that will be an opportunity. I mean, at the end of the day, if you're going to develop a drug, you want to sell it worldwide. And so we want to be able to help customers both develop the drug and get it approved throughout the world. So...

Got it. And do you think maybe slower-than-expected uptake ex U.S. in certain countries, has that been more related to just kind of inertia from biopharma customers there in terms of their awareness and use of biosimulation? Or is it more localized competition or in-house solutions or...

Well, I mean, I'm not -- I don't know that it's necessarily slower. So Simcyp is purchased by 17 global regulatory agencies, it's not just the FDA. So there's -- the EMA and the PMDA in Japan have been notable users of it and talk about it. So I think I'm not necessarily sure that you see a huge difference between, say, Europe and North America. I mean, most of the companies are pretty global nowadays. And there are differences in how the FDA and EMA treat certain things that we have to be aware of and help our customers with, but they're harmonizing over time. In China, I think there's a lot of -- despite all the geopolitical issues, there's a lot of good R&D going on there, and it really doesn't make sense for anybody in the world to develop a drug and only keep it in one place. So we expect -- I want to keep a footprint there because at some point, we are certainly going to see a greater opportunity of things that are -- want to spread around the world. And so we'll hopefully be able to serve that as well.

Got it. Great. And I think with that, we're actually at time -- a little past time. So let's close it out there. Thank you both for your time. Really appreciate it. Good discussion. And I hope you all found it informative. We'll go ahead and close out.

Thanks, Vikram.

Thanks.