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

We'll get started. Hi, everyone. I'm Joe Vruwink. I cover Vertical Software at Baird. Our next presentation comes from Certara, a company that's helping transform drug discovery and development through leadership and biosimulation software, technology and services. With us from the company today, William Feehery, CEO; John Gallagher, CFO. This is going to be a fireside chat format. If there's questions in the audience, you can raise your hand or e-mail session2@rwbaird, and I'll get them on the iPad. But maybe to begin, I'll turn it over and we can get an intro to the company and investment case.

Great. Thanks, Joe. So for anyone who doesn't know us, we are a company that focuses on what we call biosimulation. Our software is used by about 1,700 pharma companies and biotech companies around the world. And what it does is we are simulating what happens when drugs are introduced into the body and introduced into populations of people that you would encounter in a clinical trial or population of people that takes the drug. The aim of doing this is to get insight into what will happen in the drug in development before you go into very expensive trials. So we're interested in things like what dose should you introduce, what population should you exclude or exclude, how should you design the trials. And if you use our software and our technology the way it's intended, you can save a lot of money in drug development by either changing the probability or failing earlier or possibly getting a drug through that might not have otherwise. The company overall is operates in 2 different ways. One is we have a core software business, which has a number of products targeted at doing biosimulation in different phases of development. And then we have a services group, which is largely there because we have some pretty technical software. A lot of our clients need help in either using it at all if they're smaller companies, or in scaling it up as big products come through the pipeline. And so it's a big piece of the way we address the market and that we can bring to bear people who have lots of drug development expertise and know how to use this to help our clients with their needs.

Great. I was going to ask why you need to be in the business of both software and services. I think you just covered that. Maybe I'll ask it differently. Why do you need to be in the business of biosimulation paired with regulatory expertise?

Good question. Yes. So we have a number of different services. Most of it, call it, 80% or so, is in biosimulation services, what I talked about. We also have the other 20%, is in regulatory and market access type of work. That is, I guess, less -- sort of the less sexy business than some of the other parts because what we do is we have a lot of people who are basically writing the scientific reports, writing the regulatory documents, NDA and IND for the FDA. We have the business because nobody does anything in the pharmaceutical industry without thinking about what the regulators will think about it. And it's useful for us when we've done a lot of work on the drug to be able to basically write the report and take the client all the way to the FDA. It's also useful from us from a credibility standpoint to have a group that's regularly in front of the FDA, making cases and arguing. That business has not grown with the same degree as our biosimulation business over the last couple of years. So there's been a number of comments about it. And I guess what we say is we're not seeking to create the world's largest regulatory writing business. We won a nice business, which is, in fact, quite profitable that we can use to augment our core biosimulation business. And it does -- if it was a stand-alone business, it would be generating margins that are kind of close to the average of the company. So it's still a profitable business for us. It's just not really intended to grow at the same rate as our core biosimulation offerings.

Okay. When you look at -- maybe I should ask of your customer base, how frequent is the overlap where they typically are buying both biosim and regulatory as part of kind of a package?

Do you want to?

Yes. Yes. I mean our -- to build on what Bill was saying, our right to win in that space is really predicated on the biosim services that we're offering. And there's a natural cross-sell opportunity from customers that we're working with for biosim services, then carrying over and using our regulatory services. And we have the business positioned that way. And so I'd say it's pretty common. In the instances where we're doing regulatory business, it's pretty common that we're also doing biosim services for them as well.

And if I could just inject. We spent a lot of time talking about this regulatory business, even though it's less than -- it's probably, what, 16% or 17% of the company. But there are some interesting things going on. So we've just launched a software product in regulatory. It's an AI product that actually writes these documents. It will write the first draft. We have data we've done comparisons with different teams showing that we can get a 30% cost savings in terms of the time to write some of these huge documents. Now keep in mind that NDA can be 3 million pages, so these are big projects. So we've taken it -- one of the strategies of this business, since we're on the topic, has been to take advantage of the deep expertise we had to go and create a software product here that we think can attack the much bigger regulatory writing market. We launched that product this summer. We've already got paying customers. So it's like a lot of software, you cover software. I mean this is version 1. We're taking feedback from customers. We're going to launch new versions quite regularly since it's a SaaS product. But I think we're going to turn this into something that's even more interesting for the company.

I was going to ask about AI and Gen AI later. But while we're on the topic, we can go there. So medical writing seems like an area where there's a lot of promise and opportunity as the technology is refined. You're also doing some creative things, and Certara was kind enough to be on an AI panel we hosted yesterday where the actual model creation, so these are not easy models to put together in the first place. AI is helpful here. I guess how do you view the AI opportunity in terms of new products you will be able to build? What you spoke of one, versus making your existing product sets better, so it's maybe not a new monetizing, but it's something that improves penetration. It makes it more obvious that customers should be adopting your products versus maybe customers having an easier time building things themselves. And so do you have to compete against what your biggest customers are maybe working on internally now?

So I think that one of the things that they said yesterday is that AI is kind of in this phase now where people are -- we don't really have, the world is building the core applications. So the way I see it for us, AI enables a couple of different things. So one, which is a big deal, as it enables us to process unstructured data in ways -- to be honest, the only way to process large amounts of unstructured data, like, for example, scientific literature in the past was to hire PhDs to go read it all, and that took a long time. So one is, there will be an efficiency gain in our core work. The second piece, though, is it enables us to basic -- particularly the AI software architecture that we've designed, enables us to tie into multiple different databases and index them to train sort of custom AIs, and I think that will lead to new products that we can't otherwise create right now. And I think the third piece of it is it's speed, right? So one of the problems we have in modeling and everybody has a modeling, is that drug development proceeds on its own path and sometimes modeling is slower. So a customer will come to us. If we've never seen that problem before, it might take us 6, 9, 12 months to come up with something that's useful. Well, in 6, 9, 12 months, they might just go into a clinical trial and you're not relevant anymore. If we can speed that up using AI, the market that we can attack expands a lot actually. There's many, many places where one could use modeling, it's just practically do you have one ready when the customer has one, and the ability to kind of speed that up with the process changes we can get out of AI, I think, is a big deal. There will be other things as we go forward. We have plenty of things on the table. We've looked at things like predictive toxicology and things like that, that you can't otherwise do. So I think the issue on AI has been -- when you sit in a room with people for 10 minutes, you get 100 ideas, but we can't do 100 ideas. So we've been narrowing this down to a couple of really good things that we can execute on, and one of them has already come out.

And the way you're going to market with this right now is Certara.AI, that's a technology platform that's -- part of it's designed, correct me if I'm wrong, but it's designed to be taken inside the private clouds of your customers.

Yes. The core technology that we acquired, I guess, it's 2 years now, was what I talked about was we called it data fabrics. So the idea was what I talked about earlier. So you want to tie a bunch of different databases together, some of them might be public, some of them might be internal to the clients. Some of them might be so secret that they don't want to let us see them, right? And we want to train an AI across them without -- ideally without sucking all the data out of 5 or 10 or 15 databases and putting it in a central one. And so the core -- our core architecture allows us to do that and everything we're building on, all of our products allow us to do that because really, at the end of the day, that's what you're trying to do with AI. You need to index, let's say, an LLM not just on the worldwide web, but you want to -- we want to have very specific models that might be trained on, let's say, all of the drugs that have been in this area ever since the beginning of time, for example, right? So the ability to create those kind of custom things is kind of how we're thinking about the products as we go forward. And that's what we call Certara.AI.

Okay. Maybe moving away from this topic, perhaps it's -- there's a tie-in, but you've seen some tech vendors to pharma actually call out. Well, our big customers are realizing they need to invest in AI and that focus on this particular topic has actually hurt us in the near-term because the spending we expected for ourselves has been postponed or delayed. And Certara has called out recently that with some of your big customers, there has been a bit of a change in the trend line in terms of the demand you've seen. Would you pinpoint any of that change to AI considerations? Or in your view, are customers grappling with different things?

No, I think it's a good question. I think there's different things going on in the market. Everybody is -- all of the customers are either experimenting with AI or certainly open to hearing new ideas. They're all being [indiscernible] used with resilient ideas. A lot of them are not fully implemented. And also they have -- it's possible, obviously, for a lot of internal IT departments, depending on how big they are, to do some things as well. So that's expected and things will sort out over time. I think what we cited was more around the dynamics of the pharmaceutical industry. So the 2 things that have been going on for the last 2 years has been one is, up until recently, there was a significant downturn in biotech funding. And at the same time, a lot of big pharma companies are pruning or reevaluating their portfolios because I would say a lot of it has to do with the IRA, which has taken out a lot of profits. So you've got sort of the same cost to create a drug and probably a lower expected lifetime return from some of them. So there's sort of a rationalization going on in a lot of the pharma companies. Those 2 things kind of hit over time, but they really got quite acute sort of end of last year and the beginning of this year. We've seen a little bit of a turnaround. So biotech funding this year, particularly in the first quarter, turned around, but it's the highest it's been since -- if you look year-to-date, it's the highest it's been since '21, and it's probably double where it was last year. That cycle of funding has started to come through. So we're starting to see clinical trials starts tick up, and we're seeing some of that come through in our pipeline. And at the same time, some of the rationalization from the big pharma companies has started to -- they've started to figure out what they want to do. That hit us a bit because we have people stopping certain drugs and starting others, and there's turmoil and there's periods of time in between that kind of hit us at the beginning of the year. I would say, we're sort of cautiously optimistic as we go forward as we look at the last couple of months of our bookings and what we're hearing from customers, I'd say it's not like -- the pharma industry is really going gangbusters sort of the 2020, '21 time. We're not back to that, but it's sort of stabilizing and coming out of those 2 trends right now.

As I think back to the last reporting season, the early reporters, a lot of the big CROs had pretty good updates. And then Certara reported, and you were presenting some information, which was a bit different than maybe what we have been hearing. And then towards the end of reporting, other service providers came out and seemed to kind of echo what you have been seeing. And so I'll ask 2 questions. Do you view the later reporters as basically just confirming some of the things you saw, you maybe just saw them earlier? Or how do you internally, maybe audit what is purely macro related or tried to particular clinical activity versus some sort of share loss or the customer deciding to do this internally versus using a vendor? Can you kind of suss all that out when you try to reconcile the changes in your business activity?

Yes, good question. So there have been -- I think the industry is doing what it's doing, and we were the only ones talking about it, it would be surprising. There aren't a lot of companies really like Certara. So CROs are talking about some of the similar things, but their business is actually different than ours in a lot of ways. And I would say, from our standpoint, as we went public in 2020, and the company has gotten -- has had the ability to invest particularly in our -- we invested a lot in R&D, but we've invested a lot in our sales organization and infrastructure. So we've been -- we've gotten a lot better and it's still probably not as good as I think we're going to be in a year or so, but we've gotten a lot better about tracking our pipeline and understanding when we win or lose, why is that? So I would say we -- there isn't any evidence of any share loss. There has been evidence of drugs, either that were underway that were canceled sort of earlier than we would have expected or -- and particularly, in the biotech, if we looked at sort of new business creation, there's always hundreds of new biotechs that can create around the world. If we looked at that, that dropped for a while, and it started to -- with that funding cycle, it's come back a little bit. So I'd say most of this has been probably a couple of cycles going on in the pharma industry and we're not a huge player here compared with some of the CROs that are reporting. So navigating that as a new company is always a little bit tricky.

Yes. I think recently, you had your inaugural customer conference. And I gather one of the themes, just kind of reading some of the announcements and the aftermath of the conference was really making the case to customers that Certara shouldn't be thought of as being great in these individual product areas. So don't think of just Simcyp and separately Phoenix, but think of Certara as truly a development platform where all of these things can work together. How far along is that message in terms of customers actually using Certara in that way? And is that going to be a bigger opportunity, really, we'd be talking about more cross-sell and probably better net retention going forward? How big of an opportunity is that?

Yes. So the company was formed over a long period of time by -- as a private company by acquiring a lot of interesting software and services companies. It wasn't until recently that we got to the size and the scale to try to figure out how to integrate them. So a lot of -- a couple 5 or 6 years ago, people knew our products more than the company. And we set out to change that. So where we've gotten so far is, I would say, the vision here is we'd like to have one software platform. Now you can only create that so fast. It takes a lot of investment over time. Where we've gotten so far is, I would say, we have 3. So one is all built around Simcyp. Our Simcyp platform is kind of the core biosimulation platform. We've added sort of the high-end modeling called, quantitative systems pharmacology. We've added a toxicology. We've added immune models, things like that to that whole side. And that's got a whole infrastructure that's all tied together, and people are buying into it. The second one is around our Phoenix platform. That's tied to pharmacometrics, so that's people who are working on PK in general, but there's -- I don't want to get into all the different analyses people do, but pretty typically, when drugs are going through development, you have to do PK analysis, you'll bring in pharmacometricians to do population PK, you'll do trial design and things like that. That's all based around that platform. Third one is our Pinnacle 21 platform, which is all around the data validation, standardization submission platform, which is turning into a big thing. We've added Formedix, we've added data exchange, and that's building out. And now you haven't asked me this question, but I'm sure we're going to get into it, but we're buying a company recently where we're going to take one of our smaller products, D360 which is in discovery and create a biosimulation platform around that. So those are the kind of what's been going on recently. And then we've got those 3 platforms growing and the vision over time is to kind of create one platform. That's what you see if you look at some of our announcements about Certara Cloud and Certara AI, which is going to be kind of overlying that. And to come back to your point about the customer conference, that was kind of the message, which is biosimulation applies through all of drug development. It's not just one group, one stage. We're interested in how that drug moves under development. You need to bring different tools. You need the data needs to move seamlessly from one group to another so you can do these different type of analysis. And we've got an excellent start on that. And certainly, I think the farther ahead than anybody else does on that kind of a thing.

I kind of think your bread and butter is Phase II, Phase III clinical when you get into preclinical discovery, not traditionally an area of focus, becoming now an area of focus with the Chemaxon acquisition that you just mentioned. Why now in terms of moving earlier were customers telling you that they wanted you to be there?

Yes. It's really simple. So one of the strategic problems we saw is that customers often come to us after they've chosen the drug molecule they intend to go forward. And so you've kind of lost the ability to help them in basically the choice of drug molecule and the lead optimization phase. And in some cases, it really cost us because particularly if it's a small company, we don't find them early enough. They might go quite a long time before almost everybody comes across some of our software as the drug moves and develop, but earlier is much better for us. And earlier it's better for our clients, too, because if you can make a better choice on which drug to take forward or you could say, "Hey, these will have tox problems. Stay away from them." It's better for everybody. So yes, we have heard that a lot. We have this one product, D360, which is used pretty widely, but it isn't a huge product for us. And it's used in an ecosystem with a bunch of other companies. So one of the things we did was we bought one of those other companies to create a bigger product there. But the vision here is we want to go a full cycle. So we'd like to be able to start out with the molecule selection process. And we'd like to screen -- we'd like to be able to tell you early on what's likely to happen when you're in full-blown clinical trials for that molecule even as you're selecting and use that as one of the selection criteria. No one can really do that right now, and it's worth a lot. So that's kind of the vision we had as we bought that. Chemaxon is also a good -- it's a good software company, we're always interested in adding software revenue to Certara. We worked with them for years as partners, so we know them well. And it's based in Eastern Europe. So it's a good kind of software low cost -- relatively low-cost base for us as we expand.

When you try to benchmark biosimulation companies and see how everyone is growing and make a determination how this company is doing better than others, it's an imperfect exercise just because the public ones that are out there, there's maybe tiny overlaps, but by and large, you're all kind of doing different things. Nevertheless, when you run that analysis, Certara's software growth being closer to the mid-teens, that certainly stands out relative to kind of the universe we analyze. My question is, if you were to do that with Chemaxon and think about just the broader market for discovery-related software, would they be growing faster than the addressable market if you ran that analysis?

Well, the way we look at it is it's taking biosim -- it's taking our market leadership in biosimulation and porting that over with Chemaxon. So we think -- and we had said that Chemaxon is basically about $20 million of software revenue that's going to grow in line with what Certara's software has been growing. So to your point, Joe, we've been growing our biosimulation software even through some of these turbulent end market times over the last 18 months, consistently in the mid-teens. And so to bring on Chemaxon, that is going to creep our biosimulation software exposure and also add on to D360 at that same growth rate, we think is a pretty exciting value proposition. And we think that biosimulation, the market for biosimulation, should continue to grow in the mid-teens, which is consistent with what you've seen in our software performance.

Okay. Bill, you mentioned briefly earlier, Certara Cloud. So when I think of some of the other technical application companies I cover, they're all great use cases, but sometimes the catalyst for faster adoption is just making it easier to consume in provision. And I think that's the vision behind the Cloud platform is in part to make it easier for customers to access everything. Where does Cloud stand in terms of just adoption, customer interest? How important is that part of the story?

Yes. So it's a good point, Joe. So the first part of Certara Cloud is simply to make it easier. It's going to -- we've solved the -- to basically get access to any of Certara's software products, you need a cloud log on. All of that stuff will be handled centrally, so we don't have multiple software teams working on authentication and all that kind of thing. It's a marketing aspect, and for -- as customers log on, they can see all the products in Certara that they have, they can see all the products that they don't have. We can have a conversation with them about, "Hey, you want to think about these types of things." And they can easily turn it on and provision potentially hundreds of scientists with it. In the long run, though, our vision on Certara Cloud is it's a framework for us to share data among customers, among our products and for the workflows to be tied between our products. We can't afford to just rewrite all of our products in a single platform. So the idea around Certara Cloud is that glue where one product can talk to another. So there's going to be a data storage and workflow aspect to it as we go forward. So it's got a huge amount of utility right now just for us and for selling and for cutting some of the annoying costs that our customers have from having to buy 12 or 15 products from us. But in the long run, it's the foundation of a bigger platform.

How does that change the financial model? Typically moving from on-prem to cloud, the economics, top line economics get better, I mean you're taking on more responsibilities so customers have to pay you for that. You typically run your field teams a bit differently. There's probably duplicative costs that get to go away. So is this a proposition where your ARR becomes better and you're more efficient at the same time?

Yes. It does. It does. Yes, the quick answer to that is yes, it does. To your point, one of the key value propositions around it is our ability to price. So us, taking our software into the cloud, we're able to price at about 2x. So using Phoenix Cloud as an example, we're able to price at about 2x the amount. So that's obviously going to help the revenue proposition. Over time, as we continue to find efficiencies with onboarding our software platforms across the portfolio, then certainly, there's opportunity on the bottom line moving into the future.

And then one last question on bottom line. So the EBITDA profile has always been very good. You're doing some things here at year-end, kind of rightsizing your services capacity. Maybe we can talk about that briefly, but just how you think about the EBITDA margin profile of Certara going forward?

Right. Yes. We did take some actions, as you noted, at the end of Q2 to ensure that we would be within the guidance range that we had on the EBITDA margin, which was 31% to 33%. So given where we are at for the first half of the year, then we were looking at utilization, and we found it to be prudent to take certain measures to make sure that we were going to accelerate that margin into the back half of the year. So we're in -- those actions have taken place, it's flowing through the P&L through July, August, September. So that's going to show up in our results for the back half of the year. As far as our margin, so we plan to be on our guidance for the margin expectation this year. We'll see how the remainder of the year plays out and then look forward.

Great. With that, we are out of time, but please join me in thanking Certara.