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

Hi, everyone. Thanks for making it to the end. We saved the best for last. I'm Joe Vruwink, the vertical software analyst at Baird, and our next presentation is from Certara. Certara is a company that is really changing and transforming the way drugs are developed, and they do that through leadership in biosimulation software [indiscernible] related set of service offerings. Joining us from the company today is William Feehery, he's CEO; John Gallagher, CFO. This is going to be a fireside chat format. If anyone in the audience has questions, you can raise your hand or e-mail session2@rwbaird, then I'll get them on the tablet.

But maybe just to begin, we can get a brief overview of Certara and kind of your -- how you think about the investment case.

Yes. Thanks a lot, Joe. So for our standard disclaimer, and they asked me to just use one chart to introduce the company for anybody who may not know us. Certara is a biosimulation company. We have an unusual history. We have been around in some form or another for over 20 years, and we've grown to over 1,200 employees. Our employee base is given our product base is very heavily scientific. So we have lots and lots of PhDs in the company. And it's been growing over the years with -- by putting together a lot of acquisitions. The core of the company, as I said, is biosimulation. And the idea is that we develop mathematical models of biological processes used to simulate how drugs work in the human body and how they work across populations of humans like you'd find in the clinical trial or like you'd find when a drug reaches the market. We have multiple products. We have multiple services. But generally, the idea is we want to enable biosimulation for the simple reason that about half of drug spending is in human clinical trials. By using biosimulation, you can reduce the amount of spending on human clinical trials, either by reducing the trials, by ending earlier because you know the drug won't work or by redesigning the trials. Since there's so much money that goes into human clinical trials, it's not hard to understand how the small changes can justify pretty big spending on software and services to make use of scientific information. So we have basically software that works in biosimulation. We also help our clients with regulatory and compliance and to some extent, with market access. And then we report our segments in both, software and services, but we have an integrated company where we have fairly complex software. Some companies like to buy our software, but also like us to extend it or would like to talk to the experts. Other companies, particularly on the smaller side don't have the internal groups of experts to use the software, and so we do, and we can provide biosimulation on a project basis. So the net result of this is we have overall a $13 billion TAM. A lot of that TAM is in the regulatory side. So maybe a more accurate version would be that we have about a $3.3 billion TAM in biosimulation. We have a very extensive customer base. There's about 2,300 customers across 70 countries. Our 1,400 or 1,300, whatever it is, employees are in 30 of those countries. So we're a global company. It's quite an interesting place to be. Because we've been around for a while, we have a pretty long tenure with our large customers, about 10 years for our top 30 customers. Most companies in pharma do some business of some kind with us. And then our largest customers have obviously grown. So every year, we report statistics. So there's about 370 right now with an ACV of over $100,000 and then 57 of at least $1 million. Some of them quite a bit larger than $1 million, and that -- those numbers have been growing every year since we've been public. So just kind of give you a little bit of a quick view of financials. I'll just turn it over to our CFO, can maybe just give a quick introduction on that. John?

Yes. Thank you, Bill. Yes. So the financial profile of Certara, you can see the revenue that we did at Q2 on here was $90 million, representing 10% constant currency growth. We -- on our last call, we guided the full year at $345 million to $360 million of revenue. You can see that we are generating income and cash. In fact, our EBITDA margins are in the mid-30s, and we've consistently put up EBITDA margins in that neighborhood. From a capital and cash perspective, we have cash on the balance sheet. Net leverage is less than half a turn. And capital allocation-wise, we've been an acquisitive company during our history and continue to look for opportunities in that space, particularly in the software area.

Great. Maybe, Bill, unpacking a few other things you said. So one on just the history of Certara form because you joined an informatics company and a modeling company. And I think shortly thereafter, Simcyp was acquired. Can you just maybe explain the logic of your different software offerings? Are they all complementary with one another? Do customers tend to use everything, can they use everything? Just kind of how you think about it strategically.

Yes. Thanks for the question. We have, in the company, something like depends on how you can say, 12 software products, but 3 of them will constitute 80% of the software revenue. So I'll just talk about that. So the 3 products or one of them is -- well, -- 2 of them are focused on biosimulation. There's 2 flavors of biosimulation, so one is predictive and one is analytic. So predictive is we're developing a drug. We know very little about the drug. So we're developing -- we're using information from the scientific literature and whatever we can glean about similar drugs to predict what's going to happen in the next stage of drug development. That product is our Simcyp kind of flagship product, and it has kind of been the -- it's been kind of the basis of the company. It's a very unique product. It has a very loyal following among both, big companies and small. And it's -- how do I put it? It's a product that it's fostered by the -- I would say, generally, it's become part of the infrastructure of pharma development, because the FDA likes biosimulation has become the premier product. We have another product that's much more widespread. The idea there instead of predicting pharmacokinetics, we analyze clinical trial data and fit the kinetic model to that. Everybody needs to do this in pharma at some point during drug development, usually multiple times. That product has tens of thousands of seats that cross everything from large pharma to small pharma academics to CROs. That one's called Phoenix. And then the third one we have we acquired in 2021, our product called Pinnacle 21, it's a very different sort of flavor, the idea there is -- we're worried about how you submit clinical trial data to the FDA. It's basically a product for using data validation. The idea is we want to have all the data that pharma is handling to a certain -- meet a certain standard. By doing that, cuts a lot of cost out, but also enables the use of biosimulation. Most companies probably almost all the companies that are developing drugs today are going to buy those products at some point. I would say almost -- probably everybody has to use Pinnacle 21 because at some point, you submit your data to the FDA, and they pretty much are required to use that. Our Phoenix product is pretty widespread. It's been out a long time. It's kind of an industry standard. Probably the smallest one in terms of potential share we could -- smaller share and maybe opportunities to gain is in Simcyp, and that has to do with just the sophistication of the product. The products were all acquired separately. And over time, we've been integrating them more and more. They do use common data that gets passed from product A to product B. And so there's been opportunities to do that. And then a number of our acquisitions of the smaller software products have been designed to kind of over time, unite this into a wider platform that we can basically do bigger deals with.

Okay. Great. When you call out your 7-figure-type ACV accounts, are those distinguished by just number of users? Or are they much more progressive in how they're using Certara, working with Certara in that distinguishes that?

Yes. Almost all of the largest companies like that are -- they got there by purchasing multiple products from us. Some of them are large companies -- large customers simply because they are very large companies, but it's not 100% overlap. So there are surprising names in there of companies that are spending a lot of money with us that are not necessarily the largest companies around. And that happens also because they'll have a large late-stage trials going on. They're spending a lot of money. So generally, we're looking at people buying several software products. And then with them, they're typically becoming services customers for one or more of our areas. So that's kind of -- that kind of integrated offering is the overall strategy, and those are the companies where we're seeing that really pay off.

Okay. You've -- as you noted, these updates have been moving in the right direction. Same can be said for your software net retention disclosures. I think last quarter, it was up to 112%. And so what you just described is typically the evolution of a customer relationship, is it more modules and then more users of said modules?

Yes. So the formula on software is that it's a pretty sticky software. So in any given year, usually between 90% and 95% of all of the seats that we sold last year will come back and renew this year. So let's say we're going to get 95% renewal rate. On top of that, we have, let's say, mid-single digits typically price increases, then you have the ability to sell additional seats to our customers. And then we have increasingly, over the last couple of years, we started launching new products, and that's kind of ticking that rate up to 112%. So over the last -- we've always had a pretty good net renewal rate, but it's been ticking up over the last couple of years as we get those new products out there.

Okay. So once you have a valid biosimulation results, then kind of the work begins to incorporate as part of a regulatory process, and that's where a big part of your services business can step in and be helpful. How would you maybe -- in the similar vein of just how your software is distinguished, how would you maybe define differentiation for your regulatory services?

So the reason why we have the regulatory services originally was because it's important in biosimulation to be knowledgeable and credible in the regulatory area, because we're advising our customers to make decisions in their drug development, which are going to have regulatory implications. At some point, maybe even a couple of years later, you will have to explain to the regulator why you did this. And pharma is notably and logically conservative area. So we had to be knowledgeable in what the latest regulatory trends are and experience with the FDA. What we found is that there's also been a segment of our customers that have been quite interested in the fact that we have kind of a boutique onshore, high-end regulatory services component where in most cases, we know a lot about your drug, because we've been working with you for a long time. That segment tends to be in the smaller size like in the biotech area. So the last couple of years, we've done really well with biotechs. It's growing a little bit less aggressively right now, just basically due to funding pullback in that one particular segment. But we have a good profitable offering there. It's also, as you can sell from our chart, we have regulatory software as well as kind of underlies this, which also gives us attractive cost position as we're delivering this.

One question that has been coming up more recently is just how customers kind of think of Certara, because it seems like on one hand, the biosimulation performance has been better than expected. And I think about how our estimates have changed over the past year, it's a lot better. And yet that seems to be separate than what regulatory has been going through. I guess why aren't they more connected? So if one is doing well, the other one is doing well.

I think what it is, is we have a very broad customer base. So you can see, 2,300 customers. And so when you have a segment of the market, at some point that either does outstandingly well or lags, that -- we do see that. In the case of our regulatory business, it's very highly concentrated on that smaller size segment. So that's what's kind of making it go a different way. Right now, you can tell that our software business, it's quite healthy. A lot of our software revenues are coming from either late-stage drugs or large companies. And so that segment is doing quite well and still growing. And a couple of years ago, when biotech funding was really strong, we were seeing a whole lot coming on the other side. So I think it's, to some extent, just the cycles of the industry that are happening there.

There was brief comment made on the second quarter call where, I don't want to say it's green shoots, but you're starting to see maybe a month-over-month improvement in services activity. Now the forecast was adjusted in one way, I think, to better encompass some of the things you just mentioned, but I wanted to hone in on that month-over-month comment and maybe see if there's any more recent updates you can say in that side of the business.

Maybe you want to take that, John?

Yes, yes, I'll take that. So I think -- so what we're seeing is the business is performing in line with the expectations that we laid out on the August call. The bookings cadence in Q3 is lining up to be similar to what we saw in Q2 from a sequential dollar perspective, and that's consistent with our internal plan. So that's a little bit about performance. The management team is very focused at this point on converting the pipeline. So we have good visibility on the pipeline and converting that to bookings and then ultimately to revenue, both in software and in services. A couple of other comments around the steps that we've taken from a go-to-market perspective related to aligning services in regulatory with services and Biosim have -- we've got good initial feedback from customers on that and also positive feedback on the integration of the sales force that we've done. On top of that, we're continuing to invest in software. In fact, we've recently launched another Simcyp product. And we're also very excited about the efforts that we've made in AI, where already for a couple of product lines, we have the Vyasa acquisition, AI integrated into those products, but there's really a lot more to come there, both in the regulatory space and in biosimulation.

Maybe since you brought up AI, we can have an AI discussion and I think a few different things are needed from kind of an underlying infrastructure standpoint. And Certara was already moving in this direction. Anyways, one is just having data in the cloud. So having more of your applications cloud-based, and you're starting to see cloud native. Now where does that stand as a portfolio? And then we can talk about AI specifically, just cloud readiness in your offerings.

Sorry, the cloud readiness of AI offerings or...

Of Certara's kind of established software portfolio because -- and correct me if I'm wrong, but I think that's kind of a central building block that AI will then need to utilize.

Yeah, good point. So we've been increased -- so like a lot of software companies, we've been making this transition from term based on presence licenses to SaaS. Right now, I think 57% of our software is SaaS-based. And that's been increasing sort of like 3% to 4% a year for the last couple of years. Several of our products we provided both, SaaS-based and on-premise, just because there are clients that want both. But overall, like -- just like a lot of other clients and for reasons like you're talking about, we're expecting and investing an increased shift to SaaS. There are some accounting changes when you switch to SaaS, because your revenue recognition changes. At the same time, you typically charge a higher price for the license because now, you're managing things that previously the customer's IT department was. For us, that's balanced off nicely. So we're not seeing what has happened in some companies to make that shift as you see a temporary dip in revenue, we've managed to grow through that. It does provide the basis for what you're talking about for AI. One of the interesting things about SaaS is that we don't have the rights to our customers' data, but it is flowing through the system that once you know where it is, you can start to sell -- you expect to do things with that, you can start to sell them additional products and do some more creative things like add AI engines on top of something.

So how do you see your product sets evolving specifically around AI? And I think you already have some unique assets. You have the integral products. So you have stores of information that are probably helpful to your customers as they think about wanting to actually tap into their data and use their data for ultimately an AI application, but then you could also be building the AI applications themselves. I guess, what could we maybe expect out of Certara from an AI product standpoint?

So I think the -- we did make a very well-timed AI investment. It wasn't because we saw ChatGPT coming along, but we did see a trend for what we could do in biosimulation with AI. There's a couple of interesting aspects to it. So one is, there's a tremendous amount of unstructured data in healthcare and in pharmaceutical development. That is kind of difficult to take advantage of in biosimulation or really as people are making decisions in drug development. So a lot of our customers are very excited about opportunities like that. ChatGPT is sort of like one example. I mean its ability to generate text, which is kind of unstructured data. But if it goes the other way, too, you can cause it to analyze lots of scientific papers or clinical data reports, things like that. The company that we bought, I think, was -- they had a vision about the fact that there were going to be AI engines, but to make it useful in healthcare, we're going to need to take -- we're going to need to tap into specific databases that exist in healthcare. So some of the databases might be, for example, all of the papers that are written on a particular therapeutic area. But all of our customers have -- actually maybe not all, but a lot of our customers have large internal databases that they also want to make available to the AI. So the product that we bought makes it very easy to basically integrate many different databases to the AI engine. So one way to think about it is rather than just using ChatGPT and asking a question, you are asking the question, it will give us an answer for within the data that we've specified as opposed to just like, I don't know how it made up an answer and even if it was correct. It will give us references. It will summarize things. So that turns AI from a general purpose tool to, in our case, a healthcare-focused tool that I think can solve a lot of problems that our customers have. It also gives us a lot of interesting opportunities to just sort of integrate in value-added features in our software for which we can charge an additional amount, because we're delivering extra value.

That's great. Any questions from the audience? Okay. John, to your point about uniting kind of the sales teams, I think it's somewhat surprising. It's just an indication that there's still things Certara is doing to kind of optimize the organization. It's surprising from a standpoint that you have mid-30% EBITDA margin. So it's already a very kind of well-run operation, but I think there's more to do. When you look at the implication of all your functions now under one leader, what can that kind of unlock going forward? And what's kind of the milestones you're hoping to achieve going forward?

Yes. So we think the opportunity there -- and you're right, we think the margins that we have are certainly best-in-class and show a lot of discipline down our P&L. We think this step with the integration of sales provides an opportunity for us to really have sort of one view of Certara as we approach our customers with the mindset that we're able to sell them the whole portfolio of products as well as over time, increase the call point within these customers that we're interacting with, so that we can pitch the total value proposition of saving time, creating efficiencies and saving money by using biosimulation on clinical trials. So that's what we're seeing over time, and the early feedback has been very positive.

To go back to Simcyp new products, a lot of these more recent efforts have actually been moving Certara earlier in drug development and actually moving into the discovery phase, which I think when you break apart the $13 billion TAM, a lot of that is actually in discovery. And to those points, Certara has been more, I think, kind of Phase II, Phase III exposed. Why do you think -- or I guess the question is that opportunity, how was Certara thinking about tackling it because there's a different competitive landscape? There's kind of established providers in some aspects. What's kind of your path to market there?

Yes. So probably 70% of Certara's revenues right now is coming from the clinical phase, and that was not accidental. I mean there's a lot of money in clinical budgets, and so it was a good place to grow the company. But the thing is that what happens with most of biosimulation now is it starts after our customers have chosen their drug candidate. So they've chosen the drug candidate and then we start biosimulation. There's -- one of our visions has always been to integrate this, when I call end-to-end like from the very beginning of drug discovery through approval. And if you could do that, you could start to ask questions very early on as you're selecting your drug candidate about not just, hey, is this a molecule that's likely to match a specific target, but is it likely to make it through clinical trials, which is really where -- which would add a lot of value. So said a different way, this looks like the catch -- we'd like to catch the customers a lot earlier than we do. And to do that, that's kind of led to an interesting discovery. We have one product in discovery called D360, it's growing nicely, and it's a valuable product, but right now, it's probably single digits portion of our revenue. And so we see an opportunity to expand there. Having said that, we're not a venture capital company. We're not out looking at acquiring technologies that are unproven. So we've been cautious about how we think about that market.

Okay. Just maybe in the time remaining, talking a bit about kind of your financial profile, I think 2022, as I do a 3-year look back revenues ended up growing pretty close to 20%. There's M&A in there, but close to 20%. And then in your proxy, you kind of align your incentives with 15% to 20% growth in both, revenue and free cash flow. Maybe think about if we could see kind of the ground level and up kind of build-out of how you get to a mid-teens plus type of growth rate, what do you think some of the biggest drivers are for the business?

Yes. So we talked about some of the customer metrics earlier. That's a big part of how you get to that growth profile. We said the renewal rate has consistently been in the mid-90s. As you noted, Joe, the net retention rate for the software business has been increasing and has increased even from Q1 into Q2 sequentially, and at Q2, stood at 112%. Those are in addition to launching the new products that Bill is describing those are keys to continuing that momentum into the future. And when you combine that with an outlook on the services business that where we believe some of the weakness that we've seen recently will drive some recovery into the future is how over time, we'll be at that mid-teens growth.

When you think about the outlook for regulatory services in the past, it has been framed as actually being one of your fastest sources of growth from just a TAM standpoint. Obviously, quite a few things have changed about the nature of the TAM. So it's a bit different today, but any kind of way of -- when you think of Biosim, it's been mid-teens plus, what about that regulatory piece in terms of kind of an enduring growth profile?

Yes. The -- we mentioned that the regulatory business is where some of the recent weakness that we've seen in, and the growth has slowed there. We think we can return to growth in regulatory. And the regulatory business for us has a margin profile that's consistent with the overall Certara margin. And so it's throwing off considerable cash that ultimately is being invested in the overall focus of the company, which is on biosimulation.

There's always a question on how your bookings inform kind of next 12-month revenues. And I'll frame the question specifically on services. When you think about bookings trends to this point, does it preclude a return to growth next year as next year to tighter timeframe? Or is that in the realm of possibility?

Without providing guidance, we do -- we expect to grow the company. That is what -- that's our -- the management team's expectation as we finish out this year and move into next year. The formula around bookings is -- has historically been an important indicator for what revenue will be, but I think it's also important to recognize that some of the delays or elongation of the bookings and ultimately, bookings to revenue cycle also leaves the opportunity for us to continue to take the considerable bookings that we've had over the last 6 to 12 months and continue to convert those to revenue over the coming quarters. So we're at a position where we feel we'll be growing the company moving into next year.

Great. We're out of time, but please join me in thanking Certara.