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

Hi, everybody. My name is Luke Sergott. I cover life sciences tools and diagnostics here at Barclays. With me, I have John Gallagher from Certara, who [indiscernible] CFO, I guess, relatively speaking.

Thanks for having me, Luke.

Yes. Thank you again for coming.

I was just thinking we kind of just kick it off with kind of the headline key results from the quarter and kind of dig in from there as we get into the bookings and demand environment?

Yes, sure. So to start off, Q4, we had solid results as we look at the bookings. We were aided by the acquisitions that we've done, not only of Chemaxon in October of '24, but also some of the acquisitions that we had done in the tail end of 2023, which we haven't lapped quite yet. So the strong bookings results you see on a headline number on an organic basis, kind of fell in line with what you saw organic revenues at. And then we ended the year with a 32% adjusted EBITDA margin, which was right in line with our expectations on the year. And of course, you probably recall that we had about halfway through last year, we had taken some actions to drive that -- the utilization in our services group and to take out some excess capacity and that increased the margin in the back half to end up in the range where we had intended.

All right. And just a little bit on that because we -- before we get into the demand environment stuff, but talk about -- because this is largely a services business or largely software business, but even that your services piece has a large software component. But so where were you able to drive that productivity improvement among your services component? And you talked about taking capacity out. What was that?

Well, a lot of that was due to the regulatory business. So the regulatory business in Q3, we had indicated that we were doing a strategic review of that business. And that's mainly because the core focus of the company at this point is on biosimulation. And as we were looking at the performance of services over the last -- not just in the middle of last year, but really over the last year plus, then we were seeing a sustained overcapacity, and that made sense at that point for us to take some of that capacity out, which drove a higher gross margin into the second half of the year.

And on the strategic view on some of the regulatory piece, how much of an incremental margin driver would that be once that's totally gone?

We didn't quantify what the margin -- the potential for margin accretion would be if we do decide to move forward with divesting R. But what we did say is that the RE business is -- has a profitability profile that is attractive. It's -- it's a $50 million business in revenue. We said that the margin profile is 20% to 30%. And so that's certainly an attractive business from a profitability standpoint.

Got you. And then from -- going back to you had a nice step-up there in bookings across the board. Talk about the demand here from large pharma versus biotech, just the overall 30,000-foot view that everybody wants to try to figure out.

Yes. Yes, we saw -- so as we're exiting the year, we saw -- some of what you've heard everybody say, I'm sure, is the -- we've seen some slowness in Tier 1. So Tier 1 is the big pharma companies that are our customers and almost all of them are our customers, and we're seeing some slowness in decision-making, which is driving some slowness to bookings. We're seeing -- we believe a lot of that is a result of the portfolio prioritization activities that they've been going through, some of which have resulted in headcount reductions that select big biopharmas. And for us, that translated -- we made some commentary on the call that translated to an impact on our Phoenix product line, where we saw some slower renewals and some reduced seat licenses.

That makes sense. I mean it's your software, you're placing seats and it's a restructuring.

Exactly.

Are you seeing [indiscernible]...

Now the flip side to that is we've seen continued and sustained strength in Simcyp. So we've been very pleased with the continued strong growth from Simcyp. On top of that, too, Chemaxon had a very strong Q4. That was one of the key drivers of the high growth rate in bookings in Q4. So -- and some of that is due to seasonality in Chemaxon, but some of it's overperformance, too. So they're coming out of the gate together with Certara very strong. So we're happy about that. You asked me, too, about the biotechs. And so we define them as sort of Tier 3 customers would be biotechs, and they have performed well during 2024. We definitely saw, thanks to the funding environment improving during 2024, some pull-through into our Tier 3 business, both in software and in services. But as we approach this year and looking forward and seeing what's happened so far this year, too, we just want to be cautious that there's -- what we haven't seen is a full recovery in Tier 3, and we're watching closely what the funding environment looks like in '25.

And as you think about the different kind of debundled a couple of years ago, all your software so that you could broadly attack the biotech customer individually according to what their needs are. Talk about where -- when you're seeing this recovery, slow recovery that you're talking about and the demand coming back, is there a particular software or service that they're more focused on and this is like, all right, we're going to buy this first, and then we'll go and think about these other offerings later or just pretty broad-based?

Yes. We -- I mean the -- we now have 4 key pillars in software. So it's Simcyp, which we talked a bit about. We talked about Phoenix, which although impact from Tier 1 customers still obviously growing this year. And then Pinnacle, which has been a strong contributor. And now we're adding Chemaxon to that. Those are the 4 key pillars of the software business. And I wouldn't say there's any one of them that's really the start. Our commercial team is attacking each of them and each customer's needs are different. And now that we've added Chemaxon to the portfolio, we now have a presence across drug development, including in discovery, where our footprint had been smaller previously.

Right. And on that discovery piece, that's been relatively -- that's been the really most soft part of -- for the last couple of years as the restructures have come through. Maxon really exceeded expectations there in 4Q. So how much of that is just being under your umbrella and having a larger commercial or pushing it versus actually you start to see like that drug discovery market start to bottom and come back?

Yes, yes. To be clear, we haven't seen and nor does our 2025 guidance contemplate an inflection point during this year. So we are assuming that end markets, whether it be Tier 1 customers or Tier 3 customers are -- that the spending patterns and what we've seen from some of the dynamics in those end markets would be the same in '25 as what we saw in '24. Specifically to your question on Chemaxon, so Chemaxon, what we're seeing is also a seasonally -- has a seasonally strong Q4, much like the remainder of Certara, which usually has a strong Q4 also. So we actually think that, that's the key driver around the strong bookings that we saw in Q4. Not so much a recovery in the end markets as it is just some seasonality that we're getting to know in that business.

Okay. And then as you talked about the 4 pillars and kind of coming out with the unified cloud and being able to deliver that, that's kind of a longer-term growth driver over the medium and longer term, obviously. Talk about the integration into the Unified Cloud and how this is some early wins and early feedback and demand there.

Yes. Yes, yes, that's a good question because we -- in our guidance, we talked about the investment in R&D that we're making. And so there's 3 key areas of R&D investment that we're making during 2025 and beyond. And one of which, of course, is unifying the technology architecture behind our various platforms and shifting to cloud. And so that's one area of the R&D investment that we've been discussing. We think that's going to aid the customers. It gives us some -- gives us some pricing power as we shift to the cloud. And that process has already begun with the hosted version of Phoenix, which which we've been beginning to ramp the conversion of Phoenix hosted into the cloud. So we're excited about that as a prospect, but then unifying the entire architecture of our software offerings is a key part of it of the investment this year. The other 2 parts of the investment is in AI. So we want to continue from the acquisition we did of Vyasa back in 2022, we've been investing in that technology. Last year, we rolled out the co-author product, which is AI for regulatory writing. That's a good opportunity. We're already seeing bookings and revenue come in there. but we're investing further in AI. And then the third area of investment that we're making in R&D is on new products and features within our existing platforms. And so we think it's very important as you think about Phoenix, Simcyp and Pinnacle that we're putting new functionality, new features that are attractive to our customers, and we're doing that inside of this year and next year.

And following up there on the AI, I mean, technology adoption within pharma and the drug development space has always been very slow. And you're already offering simulation software and providing some of these leading-edge tools and now you're going to roll on AI. So where do you think like the low-hanging fruit or the opportunities for AI within your business or within the pharma development chain are most realistic versus, hey, we're going to have AI develop a drug and we don't even need to use humans anymore, right? I mean that's like what -- you have the 2 ends of the spectrum there.

Right, right. Yes. That end of the spectrum is not where Certara plays, as you know. But what we see -- so I mentioned co-author, obviously, we're excited about that. That was certainly some of the lowest hanging fruit was using generative AI to -- and apply that to a regulatory writing practice, which creates a ton of efficiency and creating drafts and revising drafts in preparation for submitting to the FDA or other regulatory bodies. So that's the first piece of it already on the market, already selling. So we're pleased about that. As you look forward and how does AI further get rolled out under the context of what Certara does, then you can start thinking about clinical applications as it relates to, say, for example, Simcyp. So Simcyp is a product that -- it's highly complex software and with a lot of data, and it's been in place for a long time. So the aggregated accumulated data and learnings from Simcyp over time and automating and gaining speed to understanding and gaining speed around modeling capabilities for Simcyp is one of the next phases that we're focused on for AI.

And then from the regulatory writing, this is an area that was under pressure for, I guess, 2 years ago. It was pretty soft all through, I think, most of '24, start seeing that start to come back. On that writing piece, you guys have the services side. And as you're rolling out the co-author, how much cannibalization is going on there? Or is this more of -- it's just giving your regulatory services piece another tool for them to use instead of actually being more manual. I mean just how is the pricing work there?

Yes. Yes. So we're approaching AI from both angles, actually. It's a good question because we're selling co-author, as I mentioned, paying customers for it. In tandem with that, we're also using the AI technology on our own staff are utilizing that when you think about biosimulation services or certainly for regulatory writing services to be able to find efficiencies in the existing processes that allow us -- put us in a position to be able to take on more volume while spending less time on it. So that is another key use case as we think about co-author.

Okay. And then continuing on the pricing dynamic, just you guys have been able to get decent pricing each year. How is -- with the tighter budgetary environment among large pharma, especially among biotechs, is there strap for cash as well. How have the conversations been going from a pricing perspective? And is this kind of the new normal that we should be rebasing on. Just thinking long term.

Right. Yes. I mean we -- because we're the market leader in biosimulation and because of our strong presence, we do have good pricing power. We're also, I think, reasonable and consistent with annual price increases. So -- and we've continued to carry that practice even in times where the end markets have been more challenging. I'd say on the software side, we've been able to maintain our pricing on an annual basis. On services, we've had to adjust price in some instances not reducing price, but just raising price a little bit less on the services side as we've seen the demand profile in that business change more during the last 2 years.

Okay. And then from a margin perspective, your margin guide for the year contemplates about that 70 basis points of contraction. You talked about some of the investments you're making. You have Chemaxon running -- coming on board. You're bringing things on to unified. So talk about the different buckets there organically, what's going on? You're not able to get as much pricing. You might have a little bit more wage inflation. So talk about what you're seeing there from a margin perspective. And this is where we -- the jump-off point, we should expect things to improve from here or kind of flattish over the next year or 2?

Right. Well, certainly, for 2025, it is a year of investment, as you said, Luke. We are focusing the investment in '25 on R&D, and I explained the 3 buckets or 3 key areas that we're focused on. When you look back to 2024, we invested in 2024 that was mainly in the sales and marketing team, where we've fully built out a commercial and marketing team. And we think that, that piece of the investment is behind us now. We've built that out. Those expenses will continue to grow, but grow more in line with organic sales growth. And so as we focus on R&D, then that's an area that is impacting the margin. As you saw, our guidance for the adjusted EBITDA margin was 30% to 32%, which is down, I guess, as you said, 70 basis points from the prior year. Some of that is the investment, sort of continued investment, if you would. And then about 50 basis points of it is from Chemaxon. As we've said, a big piece of the -- a big piece of the integration activity with Chemaxon is getting their profitability profile up to Certara's adjusted EBITDA margin. And we're committed to getting to that spot as we exit 2025. we're on good pace so far.

Okay. And then so after that, it should be back to how things were consistently kind of...

Yes. Well, the investments that we're making, I mean, clearly, we're making those investments because we think they're going to catalyze growth, one with our commercial team; two, with the software investments and development that we're making. And as that growth -- and hopefully, there's some cooperation from end markets, perhaps we don't have it in the guidance this year, but as we move into '26. And as we -- as that happens, then obviously, our revenue growth would increase and it better positions us for margin expansion into the future.

Yes, at that level. From your guide this year, given all the various headwinds that we've seen across the end market, your longer-term guide has always been that mid-teens growth and then you'll add some more M&A on top. But as you're thinking past '25 and your kind of your exit rate, it still implies you're going to need to step up there to get to that mid-teens. Like how do you think about the momentum that you're going to build? And then from a bookings visibility perspective, how that kind of paces out through '26?

Yes. Yes. So the path back to a mid-teens growth rate for the company is really predicated on a couple of different things. One is our investment in the company, which we've talked about, sales and marketing, R&D, and that's going to catalyze growth. And the other is the end market. So we have seen now on a prolonged basis, pretty difficult end markets, whether it be big biopharmas, whether it be biotechs. And so as that dynamic resolves and presumably goes back to where we've seen historic levels. And if you take both of those together, we see -- we don't see any reason why Certara wouldn't be growing in the mid-teens in that kind of an environment.

And I guess just from a philosophical or however you want to approach it, but right now, it just feels like that this has become the new normal among biopharma. And yes, we will eventually get back to that era of continued and strong investment. So when you're thinking about that LRP, like over the next 3 years, should we be thinking about your base business growing in this like high singles, low doubles as just kind of, all right, well, if things don't get that much better and we don't hit that inflection in the biotech side and biopharma stays tighter for longer, like is that a more appropriate way to think about your business growth in the out years as well? Or -- because right now, everybody is kind of modeling, okay, you have high singles this year, maybe low doubles and then next year, you're getting back to that mid-teens. Like instead of having that cycle of, well, things aren't playing out and having to pull some numbers down, is it more prudent for us to think about this as kind of like a high single, low double digit over the next couple of years and we'll get back to that mid-teens when things unlock.

Yes. I mean we're certainly doing our part to drive the growth in the meantime. And Q4 is a good example of that, difficult end markets in Q4 for sure, yet we posted a solid quarter in the face of that, and that's the execution from the commercial team that we've been growing and investing and putting in place. So I don't disagree with your point. I think we can drive some level of growth despite the end markets. But to get all the way there, which I think is what you were saying, to get all the way there back to the mid-teens, we would need the end markets to aid us as well.

Yes. All right. That's fair. And then lastly, just kind of wrapping things up these last couple of minutes, going back to that quarter, we talked about Tier 1, you said was strong and then Tier 3 was from a bookings perspective, you saw strength with the Tier 2 customer. walk through what's going on there and the conversations you're having, like what kind of customer that Tier 2 ultimately fits? And then from an outlook perspective, with the recovery or trough?

Es, yes. Yes. So the way we define the -- so Tier 1 customers are customers whose annual revenue is $5 billion or more. That's the big pharma. Tier 3 is less than $100 million of revenue. And then so the Tier 2s are in between that. And so they're obviously deep into commercialization and the larger ones are nearing the edge of being a big biopharma company. And you're right, that was on the services side for Q4, that was the one area where we saw a decline -- and in bookings, at least on that quarter. And that was mainly driven by the regulatory business. So the -- our biosim services business during the quarter grew well, but it was more than offset by weakness in the regulatory business in the Tier 2 category. Now one thing that -- but to add on to that point, Tier 1 alternatively for regulatory -- actually returned the regulatory business to growth in Q4. So it was the first time during 2024 that we posted year-on-year growth in bookings. So as you think about the regulatory business, it impacted the company's Tier 2 performance, as you pointed out. But when you think about regulatory and the performance on the quarter, it was actually quite good because the first quarter that returned to growth, not only in bookings, but also in revenue. but that was centered mainly in Tier 1 customers.

And do you typically see it kind of the Tier 1 started and then it kind of flows down like Tier 2 and then Tier 3? So as you think about pharma spend and going down to the small biotech.

Not necessarily. But what we have seen is that Tier 1 -- as it relates specifically to regulatory, Tier 1, we tend to have our heaviest quarter of bookings in Tier 1 in Q4. And so I think that rather than it necessarily trickling down, I think we're seeing better performance in the Tier 1 category in regulatory. And that's due to execution and focus, but it's also due to just typical seasonality we see in that business and getting some of the bigger customers and bigger deals at the end of the year.

Got you. All right. And then lastly here, M&A always a big part of the story. You seem to have been -- you've been adding a bunch of businesses. The integration seems to be going on track, if not a little bit better. Talk about areas where you would like to play you have 4 legs to the stool. And is it just more about bolt-ons around those? Or do you see maybe a fifth leg to -- I don't even know if that's a stooling whether that might be on the table or...

The table then, right? We think that -- so we've been happy with the investments that we've made and the choices that we made with M&A. And you're right, it's really built out our footprint across drug development at this point. We certainly have the balance sheet capacity and the cash to be able to execute on additional deals. We're very focused on the integration with Chemaxon. But at the same time, we wouldn't want to exclude an opportunistic software deal that would be a near adjacency to the pillars that already exist at the company now.

Perfect. Thank you. I appreciate it.

Thanks for having me.

Yes, you got it.