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

[Audio Gap] session. Thanks for joining us, everyone. My name is Mike Ryskin. I'm on the BofA life science tools and diagnostics teams, and I'm excited to be joined by John Gallagher, Chief Financial Officer of Certara. John, thank you for coming.

Hi, Mike. Thanks. Yes. Thanks for having me, Mike.

We'll do a fireside chat as usual, but maybe just to kick things off, you recently reported 1Q results. Anything you want to recap or just give us an update on how things played out relative to your expectations?

Yes. I mean, look, the Q1 played out in line with our expectations. And as far as how we had looked at the plan, then things came in line. Software performed really well, which is a continuation of what we saw last year. Software put up 19% revenue growth on the quarter, and that's on the heels of a mid-teens last year. So very pleased with what we've seen on the software side of the business. And then in services, although services was flat, we did see a continuation of this notion of stability. So coming out of the back half of last year, we were looking for stability in our bookings, stability in the performance of the services business and looking at Q3 of last year, Q4 of last year. And now Q1 of this year, we are seeing that stability. So that's kind of what we're seeing for the quarter.

Okay. And then from there, I'll just take a step back a little bit and talk about some of the bigger picture items. I think to start, Certara is a very unique business. Not a lot of direct comps, very unique technology and sort of unique market you play in. So maybe you could just walk us through sort of your view of biosimulation and what the value add is to the pharma company.

Yes. Yes, sure. So Certara is a software and services company that's focused on model-informed drug development or biosimulation. And what that means is we're developing computer-aided models of biological processes, and then we're using those to help our customers with their -- mainly in the clinical phase of drug development is where most of our business is, and we're helping enable that clinical phase through our software and our services. Our customers, we have over 2,000 customers from the biggest biopharma customers to biotechs, and we're helping enable them by selling both the software. And of that software, we have a few different programs that really comprise the -- or platforms that comprise the majority of our software. That's Simcyp, it's Phoenix and it's Pinnacle 21. And then our services offerings are centered around biosimulation services, which help support either those software platforms or can help -- we work on projects with biotechs to help them even in the earlier phases of their development.

Okay. So a lot there that I want to sort of follow up on. Maybe just to start, some of the ones you called out, Simcyp, Phoenix, Pinnacle 21. You've talked about those platforms for years. Could you give us a little bit of further detail on each of them, sort of like what the value add is, what do they enable your customers to do that they wouldn't be able to do otherwise?

Yes. So the 3 largest software platforms comprise about 80% of our software revenue, and it is the ones you just said, Simcyp, it's Phoenix, and it's Pinnacle. Simcyp is sort of core biosimulation tool. It's a consortium model with some of the largest drug companies in the world, come together in this consortium to help drive model-informed drug development, which started a long time ago with a model of a liver, and has since moved on to having over a dozen different organs modeled. So that's sort of core biosimulation, if you will. Phoenix is also biosimulation related. It has a larger customer base and very strong renewals and expansions. In fact, one thing that I should have mentioned before, too, is our software -- on the quarter, our software net retention ratio was 114%. And that -- what that's indicative of is it's indicative of our existing customers and -- not only renewing, but then also expanding, driving that ratio to a high point that we've seen historically. And when it comes to Phoenix, that's indicative of strong renewal rates, and then expansions of additional products. And then the third one is Pinnacle 21, which is in the space of data formatting, data standardization for regulatory submissions. It's a ratable software business with high penetration across biopharmas.

Okay. And then -- so that covers the software side of things. On the services side, as you said, a lot of it is really tied to biosimulation services. So how do those 2 parts of the business go hand-in-hand? And sort of what's the relationship between them?

Yes. So probably the best way to think about that is if you break it down into customer tiering, we think about our customers in 3 tiers, a Tier 1, a Tier 2 and a Tier 3. We define that as Tier 1 customers are customers whose annual revenue is $5 billion or more, so think big pharma companies. And then Tier 3s are customers whose annual revenue is $100 million or less. So there, you can think more biotechs. And the way to think about how the services offerings port into and correlate to the software business is the software business, as you would expect, naturally skews more toward Tier 1, because those big customers have more of a propensity to be buying the software products that we have, and they've got more experience in the drug development space that's allowing them to make use of that software. And oftentimes, they use services associated with it. But when you skew over to the services side, then you see that the higher proportion of our revenue on the services side is in Tier 3s. And so that sort of fits together. So our services offerings are complementary from a customer tiering perspective, because we're hitting these customers with different value propositions at different points in their life cycles.

That's helpful. And then within services, you also have regulatory services, regulatory players. What's been sort of the key factors there? That business has been a little bit more choppy over the last couple of quarters, last couple of years.

Yes, it has. And the recovery in regulatory services is slower than we anticipated. That business -- or that market, rather, is growing more slowly than the biosimulation side of the market. And we are -- but one thing that we've been doing to address that is last year, we did consolidate leadership of our services business to have biosimulation services and regulatory services under one leader. It allows for more cross-sell opportunity. And we really saw some fruits of that combination in the late part of last year as we were getting some of the larger regulatory services bookings in Q4, which has typically been the case. And last year, earlier in the year, we weren't seeing that. They came in, in Q4, and that was a good sign toward the recovery. But it continues to be a challenging spot for us.

Okay. All right. So we kind of ran through the background of sort of the setup. I want to dive into a little bit more of the forward outlook, your '24 guide and sort of the story beyond that. So as you said, on 1Q, you [ related to ] your '24 guidance. It calls for about 11% revenue growth, a little bit of a year-over-year step down in margins. In 1Q, you put up 7%. So you're implying some acceleration as you go through the year. What are the factors underpinning that? What's driving that pickup as you go through the year?

Yes. That's a good question, Mike. So one of the things there, at the time that we did the guidance we had laid out, that the services business is typically, and we expect to be this year too, more weighted to the back half. So there's a first half, second half story around what we're seeing or expecting for revenue achievement in the services business. So there's a natural lift associated with that. Additionally, the performance of the acquired businesses, we expect to accelerate during -- as the quarters progress, with Q1 being one of the lower quarters for this year. So what our guidance contemplates is it contemplates the stable end market environment kind of persists for the year. And for us to be at the lower end of that guidance, we would need to see a deterioration in the end markets. We're not seeing that. So the good news is that's not something we're seeing. It's not something we're anticipating. To be at the higher end of the guidance range, that's really focused on some of the efforts that I mentioned earlier. So it's really centered in this stable end market environment, our execution against some of the initiatives that we've had in place. So we said we were investing in sales and marketing. We made some changes to the commercial organization. I just mentioned that we combined the services businesses' leadership during the course of last year. We think that, that can help drive execution and growth during the course of this year, and if that plays out a little better than we had anticipated, then that would push us more to the higher end.

Okay. And then thinking about underlying customer demand, underlying customer budgets, things like that. There's been a lot of talk about biotech funding. First quarter was obviously a really good start. You talked about Tier 1 versus Tier 3 in terms of your customer segments. Obviously, Tier 3 is where we're talking about emerging biotech and [ have ] that funding environment. So early signs there. Are you incorporating any of that improvement in end market into your outlook? Or would that just be upside at this point?

That would be upside. So the guidance that we contemplated did not rely upon a recovery in the end markets there. What we've seen is that in the Tier 2 and particularly the Tier 3s, as you said, Mike, then we have not seen a recovery back to -- at least as it relates to our bookings and sales back to historic levels of spend. And so that's something we're keeping our eye on. Obviously, it's a really great sign that the capital markets have been conducive and biotechs are getting funding, and make no mistake, we are sending our commercial team squarely at the organizations that are receiving funding. But it takes time. And we thought that would be the case. We didn't see it in the Q1 numbers. We wouldn't expect to see it in the Q2 numbers, because from the time a company gains funding to sorting out capital allocation priorities to then ultimately creating a booking with Certara, we expect that to take time and have not baked that into the guidance for the year.

Okay. And you touched on earlier, when you were discussing the business, you talked about 114% net retention in 1Q in software. I don't think you gave a number for services. But in general, as you look back over the last year or so and some of the choppy market environment we've been, has the retention rate dropped? Is it not upselling new accounts, not bringing in new accounts? Sort of where does the choppiness materialize in the business?

Yes. That 114% is more of a software metric that we look at. But to your point, though, where -- the choppiness has been centered really in both sides of the services business. So we talk about biosim services, and then as we talked about regulatory services offerings that we have. We've seen the choppiness in both of those, particularly with Tier 3 customers, and there's been some churn there as some of those customers have gone away, and then other customers have come in. And what we haven't seen is we haven't seen the spending patterns or the bookings engagement return to historical levels. So that's -- that inflection -- I think we said on the call that although the funding environment is much better, and that's a great sign, it's not yet an inflection point for Certara's bookings. And that wasn't totally unexpected, but perhaps something that we see later in the year.

Okay. And since you touched on bookings, I kind of want to follow up on that. Historically, from a model perspective, we've always kind of relied on trailing 12-month bookings both in software and services to guide the forward model. Your outlook for revenue growth in 2024 is a little bit better than trailing 12-month bookings would indicate from last year. Is there anything -- part of that obviously is the M&A you completed. That's a factor of it. But is there anything else driving that? Do you think that relationship continues to hold longer term? Or is there some reason you're able to outperform your bookings?

There's 2 points that really go beyond, as you said, just the fact that the book-to-bill ratio is more like a 1:1. There's 2 factors that would drive us to be able to achieve higher than what would historically been indicated by that 1:1. One of those factors would be the backlog. So we had stronger services bookings in Q3, and especially Q4 of last year, that -- and the engagement with our customers to initiate, progress and complete projects was slower than we've seen historically, which created a bit more backlog than we've seen historically to solve for and convert to revenues during the course of this year. And you saw that play out even in Q1, where our revenue achievement remained strong and in line with our expectations, even though the bookings on the services side was softer. The other thing on -- as far as why would we achieve a bit higher than what you might have seen historically on a book-to-bill, the other reason is associated with new software products. So we've seen really strong uptake on new software product offerings, more so than we'd seen in recent years. And obviously, that was reflected in the results that we had on Q1. And that is the other key driver why we would be able to achieve higher, at least contemplated higher, in our guidance on the year. So -- and all of that, as you said, is in addition to the accretion associated with the M&A transactions that we did in Q4, which are adding to our overall growth number on the year.