Certara, Inc. Q3 FY2021 Earnings Call

Good day, everyone. Thank you for being here and welcome to the Third Quarter 2021 Earnings Conference Call. I will now hand it over to your speaker host, David Deuchler. Please continue.

Good afternoon, everyone. Thank you all for participating in today's conference call. On the call from Certara, we have William Feehery, Chief Executive Officer; and Andrew Schemick, Chief Financial Officer. Earlier today, Certara released financial results for the quarter ended September 30, 2021. A copy of the press release is available on the company's website. Before we begin, I'd like to remind you that management will make statements during this call that include forward-looking statements within the meaning of federal securities laws, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Any statements contained in this call that relate to expectations or predictions of future events, results or performance are forward-looking statements. Actual results may differ materially from those expressed or implied in the forward-looking statements due to a variety of factors. For a list and description of the risks and uncertainties associated with Certara’s business, please refer to the Risk Factors section of our Form 10-K filed with the Securities and Exchange Commission on March 15, 2021. We urge you to consider these factors and you should be aware that these statements should be considered estimates only and are not a guarantee of future performance. Also in the remarks or responses to questions, management may mention some non-GAAP financial measures. Reconciliations of adjusted EBITDA, adjusted net income, adjusted EPS and certain other non-GAAP financial measures to the most directly comparable GAAP measures are available in the recent earnings press release, which is available on the company's website. This conference call contains time-sensitive information and is accurate only as of the live broadcast today, November 9, 2021. Certara disclaims any intention or obligation, except as required by law, to update or revise any financial projections or forward-looking statements, whether because of new information, future events or otherwise. And with that, I will turn the call over to William.

Thank you, David. Good afternoon, everyone. Thank you for joining Certara's third quarter earnings call. Andrew and I will start with prepared remarks, and then we will take questions. I'm very pleased with how the Certara business performed in the third quarter of 2021 as we continue to successfully execute on our strategic and financial objectives. In the third quarter, we continued to grow our position as a global leader in biosimulation by delivering strong financial results. Revenue grew 23% compared with the third quarter of 2020. Adjusted EBITDA grew 28% compared with the same period a year ago. In the third quarter, we set a new record for the number of new customers. We experienced strong double-digit revenue growth across all geographic regions, including North America, Europe, and Asia Pacific. Overall, we're pleased with our year-to-date performance which has been ahead of our expectations forecasted earlier in the year. In early October, we announced the closing of the Pinnacle 21 acquisition, consistent with our previous expectations for our fourth quarter closing. The integration is going smoothly and early feedback from employees and customers has been positive. As a reminder, Pinnacle 21 is an industry-leading data standardization software platform used by the biopharmaceutical industry and regulatory agencies for managing compliance with the CDISC standards. Pinnacle 21's advanced SaaS-based solutions are used by the U.S. FDA and Japan's PMDA to validate all incoming clinical submission data. The FDA recently awarded a 5-year contract to Pinnacle 21 for software and related services for the Datafit program. The Pinnacle 21 team is now part of our biosimulation and regulatory software business. As a newly combined entity, we see opportunities for expansion within existing customers and acquiring new customers worldwide. The Pinnacle 21 enterprise software is complementary to Certara's existing software and technology-driven services, and we are optimistic about cross-selling opportunities over time. As we look to the future with Pinnacle 21, we are confident that its solid position in a growing market will lead not only to increased revenue and profitability but also to an advancement of our shared goal to innovate tools to accelerate life-saving therapies for patients. Other exciting news, we received our fourth FDA grant to verify and expand biosimulation models for assessing virtual bioequivalence for the development of generic dermal drugs. Bioequivalent studies ensure that the rate and extent of absorption of the investigational drug is not significantly different from those of the comparable reference product, which is often a branded drug. Demonstrating bioequivalence is a regulatory hurdle for generic drug approvals, and biosimulation can significantly enhance the efficiency of generic drug development by streamlining or even waiving some of the clinical studies. For example, Certara's Simcyp McDermott model was used to demonstrate virtual bioequivalents for a topical gel classified as a complex generic. We are also very pleased to share that Certara's Simcyp COVID-19 vaccine model was named a winner of an R&D 100 award. Certara's COVID-19 vaccine model uses biosimulation to optimize dosing regimens and helps inform the design of clinical studies involving COVID-19 vaccine candidates. For example, the model was used to investigate potential differences in vaccine responses associated with age and ethnicity or to optimize the time interval between doses by predicting the expected duration of antibody response. It was also named a finalist in the Pharma Intelligence 2021 Citeline awards for its contribution to COVID-19 clinical activities. Citeline winners will be announced next spring. The external recognition of our Simcyp COVID-19 vaccine model is a testament to the utility of this product in the global effort to combat the COVID epidemic. More broadly, Certara's vaccine simulator covers a range of applications and is now being used to help develop vaccines in oncology and respiratory syncytial virus. As outlined in our strategy, we continue to invest in the business and to add to our expert team worldwide. At the end of the third quarter, prior to the Pinnacle 21 closing, we had more than 1,000 employees, representing growth of nearly 14% year-to-date. Following the Pinnacle 21 closing, we have approximately 1,100 employees. We continue to extend our commercial footprint worldwide with a new Chief Commercial Officer and additional business development hires globally. Nearly half of our new hires in the third quarter were scientists and subject matter experts, and now we have approximately 350 employees with doctoral degrees. In a recent study by Elsevier and Stanford University, 7 of Certara's scientists were ranked in the top 2% based on standardized citation metrics. We are incredibly proud that these 7 scientific leaders were featured in this list in the fields of pharmacology, toxicology, pediatrics, endocrinology and metabolism, as well as microbiology and chemistry. It is the Certara culture and commitment to innovation and customer partnerships that attract top talent in a very competitive environment. We continue to prioritize making Certara a great place to work. Yesterday, we announced that James Cashman will be our new Chairman of the Board of Directors. He is succeeding Sherilyn McCoy, who has decided to step down from our Board to focus on other professional commitments. On behalf of the Board, I would like to thank Sheri for her contributions and wish her all the best in her future endeavors. I'm excited to continue working closely with Jim, who's been an independent Board member of Certara since 2018. Jim has a proven track record as the previous CEO and Executive Chairman at ANSYS, the global leader in engineering simulation software. His passion for simulation-driven product development will help continue to advance Certara's innovation and global expansion. Finally, I'm pleased that we will be hosting our inaugural Investment Day at the NASDAQ market site in New York City on December 15. Our Investment Day will feature presentations from Certara's leadership team, including our business unit presidents, with a focus on our proprietary technologies and positioning to further grow the company. We are excited to meet you in person next month. If you cannot join in person, you can view the live stream of our Investor Day online on our Investor Relations website. In summary, Certara had a strong third quarter, which demonstrated accelerated progress towards our goals and expectations. Looking forward, we are focused on delivering on our strategic and financial objectives. I will now turn it over to our CFO, Andrew, to discuss the third quarter financial results and the financial impact of Pinnacle 21.

Thank you, William. Hello, everyone. Before getting into the third quarter, I'd like to touch on the financial highlights of our acquisition of Pinnacle 21. As William stated earlier, we are excited to work with the Pinnacle 21 team, and the integration is off to a smooth start. Pinnacle 21 is a strong financial and cultural fit with Certara, and the transaction is expected to be immediately accretive to our key financial metrics. As previously discussed, we are currently forecasting Pinnacle 21 2022 revenue to be in the range of $30 million to $32 million, exclusive of purchase accounting adjustments. We are currently forecasting revenue of approximately $6 million in the fourth quarter of 2021 out of an expected full year pro forma revenue of $23 million to $24 million, exclusive of the purchase accounting adjustments. To that point, we will have a purchase accounting adjustment reported revenue related to Pinnacle's software deferred revenue in the fourth quarter and throughout 2022. The impact of the deferred revenue valuation adjustment is expected to be in the range of $4 million to $5 million in the fourth quarter. We also expect the Pinnacle 21 acquisition to have adjusted EBITDA margins modestly higher than the Certara corporate average in the fourth quarter of 2021 and look for them to expand in calendar year 2022. Now to base Certara results. Total revenue for the 3 months ended September 30, 2021, was $73.9 million, representing year-over-year growth of 23%. Year-to-date bookings were $229.2 million, up 12% year-over-year and up 15% on a trailing 12-month basis. The general business environment for bookings was slow during the first 2 months of the quarter, but the recent trends in the pipeline for the fourth quarter position us well to achieve our guidance to maintain high visibility. After October results, the trailing 12 months' bookings were up 18% versus the same period last year. As a reminder, I continue to look at trailing 12 months' bookings as a predictor of forward 12 months' bookings. And on this metric, Certara is delivering in line with our long-term forecast of mid-teens organic revenue growth. Software revenue was $19.3 million, which increased 9% over the prior year period as a result of strong third quarter bookings, new logos, and expansions on renewals. Software bookings were $20.9 million, which increased 28% from the prior year period and the aggregate renewal rate was 87%. The aggregate renewal rate was below our target, primarily due to retimed renewals. Year-to-date, software bookings grew 19% and the aggregate renewal rate was 90%. The growth in the quarter and year-to-date was driven by our biosimulation software, Simcyp and Phoenix, which are up 17% year-to-date. Services revenue was $54.7 million, which increased 28% over the prior year period. The growth in services revenue was driven by the recognition of delayed tech-driven regulatory services as well as strong growth in biosimulation offerings. Services bookings were $51.4 million, which decreased 10% from the prior year period. If you recall, Q3 of last year benefited from a bolus of bookings that were delayed from the first half of the year during the start of the COVID-19 pandemic. Year-to-date services bookings are up 10%, and we have seen services bookings pick up in September and October after a couple of slow months during the summer. Looking forward, the pipeline is strong and Q3 performance is mostly reflective of timing. Total cost of revenue for the third quarter of 2021 was $28.8 million, an increase from $23 million in the third quarter of 2020, primarily due to increases in employee-related costs resulting from billable headcount growth and stock-based compensation. Total operating expenses for the third quarter of 2021 were $45.9 million, an increase from $26.9 million in the third quarter of 2020. The components of operating expenses are as follows: Sales and marketing expenses were $5.1 million compared to $3.1 million for the third quarter of 2020, due to a $1.1 million increase in employee-related costs resulting from headcount growth and $0.6 million in stock-based compensation. R&D expenses were $4.5 million compared to $3.3 million for the third quarter of 2020. The increase in R&D expenses was primarily due to a $0.9 million increase in employee-related costs resulting from headcount growth and a 0.5% increase in stock-based compensation, both of which were partially offset by smaller reductions in other line items. G&A expenses were $26.2 million compared to $13.4 million for the third quarter of 2020. The increase was primarily due to $7.4 million of acquisition costs, $4.5 million increase in stock-based compensation costs, and $0.7 million increase in insurance expenses. Also contributing to the increase were public company costs, which year-to-date have added approximately $4 million to our cost structure. Intangible asset amortization was $9.6 million and depreciation and amortization expense was $0.5 million for the third quarter. There were no significant changes in either line item. Continuing down the P&L, interest expense during the third quarter was $3.3 million compared to $5.9 million for the third quarter of 2021. The year-over-year reduction in interest expense is due to the repayment of our holdco loan last year. Income tax benefit was $1.6 million due to the tax effects of U.S. pretax loss, nondeductible items, the effects of tax elections made on U.K. earnings and the relative mix of domestic and international earnings and discrete tax items. Net loss for the third quarter of 2021 was $1.8 million compared to net income of $1.2 million in the third quarter of 2020, due primarily to the increase in stock-based compensation expense and acquisition costs which were partially offset by higher revenue and lower interest expense. Diluted loss per share for the third quarter of 2021 was $0.01 as compared to earnings per share of $0.01 in the third quarter of 2020. Adjusted EBITDA for the third quarter of 2021 was $26.1 million compared to $20.5 million for the third quarter of 2020, representing 28% growth. We continue to perform well against our plan and have made some upward adjustments to guidance based on the year-to-date performance as well as the impact of Pinnacle 21. Adjusted net income for the third quarter of 2021 was $10.8 million compared to $3.3 million for the third quarter of 2020. Adjusted diluted earnings per share for the third quarter of 2021 was $0.07 compared to $0.02 for the third quarter of 2020. Now moving to the balance sheet. We ended the quarter with $416.8 million of cash and cash equivalents, which includes net proceeds of $133 million from our offering earlier in the quarter. $250 million of the cash balance was planned for the Pinnacle 21 acquisition. And post-closing, our cash position and balance sheet remains strong after the effect of the acquisition. As of September 30, 2021, we had $301.2 million of outstanding borrowings on the term loan and $100 million of availability under the revolving credit facility under the credit agreement. Regarding financial outlook, we are increasing our previously reported guidance for full year 2021 revenue, adjusted EBITDA, and adjusted EPS, including Pinnacle 21. GAAP revenue is expected in the range of $288 million to $291 million; adjusted revenue in the range of $292 million to $295 million, which excludes the Pinnacle 21 deferred revenue valuation adjustment of approximately $4 million to $5 million; adjusted EBITDA in the range of $106 million to $108 million, including $2 million to $3 million from Pinnacle 21; adjusted EPS in the range of $0.22 to $0.26 per share; with the fully diluted share count in the range of $155 million to $166 million, which includes the impact of the 4.5 million shares sold in our secondary offering in the third quarter and approximately 2.2 million shares relating to the Pinnacle 21 acquisition. Thank you. Now I'll turn it back to our CEO, William Feehery.

Thank you, Andrew. In summary, Certara had a strong third quarter, highlighted by our robust financial results and operational performance, and we hit the ground running in Q4 with the acquisition of Pinnacle 21. Our Certara team continues to focus on our commitments to customers and to delivering strong growth for our shareholders. We believe that our end-to-end platform is well positioned to continue benefiting from solid market trends. We expect to capture a larger share of overall biopharmaceutical R&D spend as we continue to innovate, acquire, and add new solutions to our end-to-end platform. At this point, we will open up the call for questions. Operator, can you open up the line?

Our first question comes from Dave Windley with Jefferies.

I wanted to ask on Pinnacle 21. You kind of alluded to appreciate the guidance numbers there. And taking from those, you alluded to margins above your corporate average in the fourth quarter and then expanding in '22. Could you talk a little bit about that trajectory of expansion? What investments do you believe you need to make in that platform, if any? Is that something that your existing sales force can sell? Things like that would be helpful.

Thanks, David. I appreciate the question. I'll start and then maybe Andy wants to chime in on this. So largely, it's a pretty healthy company that's growing nicely. We believe that our sales force is capable of offering this more broadly to our customers than Pinnacle 21 was doing before we bought it. So we are making some investments in sales training and expanding our sales force a little bit to accommodate for additional revenues that we're putting on their plate there. But overall, we think there's a lot of opportunities to expand the product set a bit and to tie it in a more integrated fashion to some of our biosimulation products and some of our regulatory products. I don't know, Andrew, do you have any comments you want to bring up about the growth?

No, I would just comment that the EBITDA margins this year will be modestly higher than the Certara overall average EBITDA margin. We expect those margins to expand next year. It's a function of the complementary businesses and synergies not related to additional investments. So leveraging our broader range of resources we have for sales and marketing, et cetera.

Okay. And then I'd love for you to touch on maybe provide a little bit more color about the cadence of the bookings environment in the third quarter. I'm sure other people are going to ask about that. I'll ask a little more specific. You've talked about your biologics simulator and kind of carving that out and making that available on a more stand-alone basis. Have you seen adoption on that yet? Is it still too early? Or is it still too early? And is that big enough or important enough to cause some of your clients to pause and evaluate that biologic simulator as an alternative to what they're already doing?

Yes, thank you, David. It’s still an early stage for that product since we announced it relatively recently. We do have customers for it, making it a legitimate product. However, we believe there are many more opportunities for it at the moment. We will see how it evolves and grows. I don’t think this will cause customers to stop developing their biologics, but I believe it offers valuable insights that align with Certara's overarching goal of reducing the time and cost associated with drug development, specifically in biologics development. You asked two questions about bookings, so maybe Andrew, you would like to address that?

Yes, David, regarding bookings, we observed some activity at the end of the second quarter. Coming out of the pandemic, we experienced a longer time to close on bookings, but our pipeline stayed strong. As we moved into September, we noted a considerable increase. We achieved a trailing twelve months growth rate of about 15% through the third quarter, and this positive trend continued into October, allowing us to expand our growth to 18%. Our pipeline looks promising for Q4.

Sorry. So 18% is the measure through October, is that correct?

Yes, that’s the TTM.

Our next question comes from the line of Michael Ryskin with Bank of America.

I want to follow up on Dave's question on Pinnacle. Just sort of talking through some of the synergies and the growth there. Obviously, a very strong profile if you look at '22. I wonder how much of it is sort of new customers or maybe different customers that are using that software versus what you're currently offering? Or is it sort of just better exposed to a particular part of the market, just curious. And then in terms of future investment in Pinnacle and adding more capabilities there, could you talk to any opportunities on that?

Yes. Last quarter, when we discussed the acquisition of Pinnacle 21, they had a very small sales and marketing team, consisting of just one person, which highlights the quality of their product. This offering aligns well with what Certara provides to many of our customers. Our sales and marketing team is significantly larger, presenting a substantial short-term opportunity for us, and we anticipate achieving some success as we head into next year. Additionally, we believe there are prospects for introducing more products within the Pinnacle 21 line. While I'm not ready to elaborate on that now, stay tuned for some interesting developments as we progress into next year.

And if I heard you correctly, when you're talking about software revenue in the quarter in bookings, I thought you said that aggregate renewal rate for software was 87%. I mean, you indicated retire and renewals. Could you clarify what you mean by that? Is that just renewals that were pushed into 4Q or happened earlier in 2Q? And just how often does that happen? What gives you confidence that that's not something that a software customer that went away and that's something that's still going to be there later this year?

Yes. I can take that, Bill. Specifically, we have clients who, over the years, have acquired our products at different term end dates, and from time to time, they like to consolidate their renewals into a single period. What happened was we saw that renewals that were scheduled for Q3 were combined and renewed in Q2. And this is why, if you look at the year-to-date, we're at a 90% aggregate renewal rate, and we were a little bit above the benchmark in Q2, a little bit below in Q3.

Our next question comes from the line of John Kreger with William Blair.

I wanted to come back to the staffing comment. How are you feeling about your staffing availability at this point? And are you able to sort of handle the work that you're trying to convert into revenue right now? Is there any constraint there?

We have grown our headcount by about 14% year-to-date and are actively recruiting as we continue to grow. Overall, we are quite busy right now, but we are not at a stage where we are turning away work. The environment is competitive, and many companies have mentioned this, but Certara offers a strong proposition for potential employees, which has helped us stay ahead.

And then I don't want to steal the thunder from your Investor Day, but any sort of early comments you could give us on the '22 outlook relative to some of the longer-term targets you've talked about?

Well, Andrew, would you like to share your thoughts on that?

I would prefer to address that in Investor Day. What we can see, though, and we've talked about is that we kind of look at a high visibility approach to forecasting. The way that the guidance came out, our organic growth rate, excluding Pinnacle 21, is closer to the high teens as opposed to the mid-teens. So we're optimistic for next year, and we'll talk about guidance at the Investor Day.

Great. And maybe just one last quick one. If you think about the bookings experience you had in Q3. It sounds like it was a little light overall, particularly in services. As you look across the portfolio, does anything stand out to you in terms of type of work that was awarded, type of client? And any kind of takeaway beyond just sort of lumpiness through the summer?

Go ahead, Andrew, do you want to take that?

I was going to say, from my perspective, it was lumpiness from the summer. One key highlight that Bill mentioned earlier, is in both software and on the services side, we derived a larger percentage of our revenue from new clients than we had historically. So the increasing number of new logos has been positive and was part of our plans going into the year, but we’re delivering on that plan. So slightly higher mix of revenue from new clients and both –

I think, overall, we just saw a lot of clients taking some vacation in July and August. So things slowed down and then they picked up as we approached the fall.

Our next question comes from Luke Sergott with Barclays.

On the Pinnacle 21 with the new 5-year FDA contract, can you tell us if this is the reason your estimated growth for next year is increasing from the mid-teens to the high teens? If not, could you provide some insight into how this work will progress? I'm trying to understand the sustainability and the potential scale available to you.

Well, Pinnacle 21 is a 5-year contract from the FDA. The FDA uses Pinnacle 21 to evaluate all of the submissions that come in for compliance with and they started enforcing compliance. So that's the tool that they use. It's not the majority—by not anywhere close to the majority—of Pinnacle 21's revenues. The primary source of revenues are pharmaceutical companies that are using their software well before they get to the FDA. And we believe that there's a bigger market in that area, right? So there's a lot of data that gets transmitted through the pharmaceutical development process as you move from clinical through regulatory. Rather than simply try to put that in CDISC format as the last step before we go to FDA, there's a lot of opportunities for cost and labor savings for that to happen earlier in the process, and we're seeing customers that do that. We believe there's a bigger opportunity across pharma to use the software in that way. So it's a very attractive product they have in Pinnacle 21. It solves a problem that exists across the pharmaceutical industry. It's not an easy problem to solve from a software perspective. So it's a fairly complex piece of software that requires a pretty good team to develop and manage it. But we don't believe it's fully penetrated in the industry, and that's probably the first step as we complete our integration of the product.

All right, makes sense. And then last one here on the guide, the implied 4Q. Can you give us a sense of the step-up here where it's coming from software versus services?

In the fourth quarter, the growth is coming from both software and services. I expect the software growth rate to increase, reaching the low teens as we aimed for earlier this year. Therefore, the main contributor to the fourth quarter will be software growth, along with additional growth in services.

Our next question comes from the line of Vikram Purohit with Morgan Stanley.

So first, staying on Pinnacle 21. I was wondering if you could just remind us what the mix of that business is on a stand-alone basis across software and services? Is it primarily a software business? Or is there a meaningful services component to it as well?

Yes, that’s correct.

It's 90% software and about 10% services. The services include things like training and installation.

Okay. So primarily software. Got it. And now that the transaction is closed, I was wondering if you could speak in any further detail about a couple of the more interesting areas that you're looking at for cross-selling opportunities looking into 2022?

Yes. Certara engages in significant early-stage work to help design the clinical strategy for pharmaceutical projects. By integrating the data strategy with that, we can help our clients save considerable amounts of money in the long run. This was a topic we discussed earlier today. We also handle a substantial amount of regulatory work, focusing on creating and submitting the full NDA, including the BIOSTAT data. This presents an opportunity to combine Pinnacle 21's technology with our efforts for several clients, and we anticipate discovering more opportunities as we progress. Additionally, implementing data standardization across the pharmaceutical development process through Pinnacle 21 could save a significant amount of time and money if adopted broadly. Many of our clients recognize this, and the most straightforward way to standardize is to use CDISC, as compliance will be necessary for submissions to the FDA. Therefore, we see ample opportunities for Pinnacle 21 beyond just the final submission step to the FDA.

Okay. That's helpful. And then maybe one more question from my side. So related to some of the recent product updates and product launches that you've announced. I was wondering from a business cycle standpoint, could you talk to us a little bit about how long it takes in your experience for these kinds of product releases to gain some uptake and start driving new sales growth? For example, you recently launched a new regulatory writing software and base case market access software was updated several months ago. So I was just curious to see how long it takes for releases like this to start generating kind of a sales lift?

Yes, it varies based on the type of software. For many of our products, especially with significant updates like Simcyp, we have a number of customers eagerly awaiting new features and they tend to upgrade quickly. However, not everyone will upgrade immediately since some drugs may need to stay with a specific version. There is strong demand for new features and capabilities. For other products, such as our innovative toxicology software, it may take longer because we need to educate the market and clarify how it operates. Historically, those products take about one to two years to gain traction. It really depends on the product and the market. The pharmaceutical industry is quite advanced yet highly regulated, requiring proof of FDA acceptance and alignment with existing processes. Therefore, a two-year timeframe is a typical estimate for seeing meaningful adoption.

I'm showing no further questions at this time. I would now like to turn the call back over to Mr. Feehery for any closing remarks.

Yes. Thanks for joining our third quarter conference call. As I said earlier, Certara had a very good quarter. We’re very pleased with our growth, and we’re very excited about the future opportunities that we have with Pinnacle 21 and with a lot of the technology and products that we are continuing to launch and develop. Thank you for joining, and I hope everybody has a good evening. Goodbye now.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.