Earnings Call Transcript - CERT Q4 2022

David Deuchler, Investor Relations

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 year ended December 31, 2022. 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 will include forward-looking statements and actual results may differ materially from those expressed or implied in the forward-looking statements. Please refer to Slide 2 in the accompanying materials for additional information, which you can find on the company's Investor Relations site. In our remarks or responses to questions, management may mention some non-GAAP financial measures. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP measures are available in the recent earnings release available on the company's website. This conference call contains time-sensitive information and is accurate only as of the live broadcast today, March 01, 2023. Certara disclaims any 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'll turn the call over to William.

William Feehery, CEO

Thank you, David. Good afternoon, everyone. And thank you for joining Certara's fourth quarter and full year earnings call. Andrew and I will start with prepared remarks and then we will take questions. We are pleased with the strong finish to 2022 and we have made significant progress across our key initiatives throughout the year. We believe we are well positioned for 2023 and beyond as we execute Certara's mission to disrupt drug innovation with our proprietary biosimulation technology and services. At Certara, we are focused on safely accelerating the drug development process by lowering the cost and increasing the probability of success in trials to improve the health and well-being of millions of people globally. Before we get into the details of the quarter, I would like to announce the appointment of John Gallagher as Certara's new CFO effective April 1st. John is a proven finance executive with experience as a public company CFO at Cue Health and has prior experience in senior finance roles at Beckman Dickinson, GE, and Ford. After eight successful years as CFO of Certara, Andrew Schemick has decided that this is a good time for him to pursue other career goals. And I'm very pleased that he will be staying with Certara in a key operational and strategic role after helping with the transition to John. For the full year of 2022, our revenue and profitability metrics exceeded the upper end of our guidance ranges provided in August. Reported revenue of $336 million grew by 17% year-over-year and 10% year-over-year excluding Pinnacle 21's contribution. We are encouraged by the pace of adoption and expanding awareness of Certara's biosimulation platform worldwide. The strong demand for biosimulation in 2022 contrasted with the underperformance of our regulatory business, which resulted in total company growth excluding Pinnacle 21 and in the low double digits compared with our historical rates of mid-teens. I am optimistic that our regulatory business has turned the corner and we are seeing early indications that the changes we made in the second half of 2022 will translate into better performance over time. Andrew will discuss more about the company's financial outlook, but we expect improved performance in our regulatory business in 2022. Pinnacle 21 has been operating within Certara for over a year and we are pleased with the contributions from the Pinnacle 21 team. Pinnacle 21 delivered at or above all our expectations in 2022 and we are excited about what the team has been able to do with the platform headed into 2023. We continue to reach new customers with our end-to-end platform and finished 2022 with 2,376 customers. Our land and expand strategy delivered solid growth among existing customers in 2022 as well, with approximately 50% of total company revenue generated from the top 50 global therapeutics companies. As of December 31, 2022, we had 370 customers with an annual contract value of more than $100,000, representing growth of 24% year-over-year. We had 57 customers with an annual contract value of more than $1 million, up 12% from 2021. Our fourth quarter revenue was $86.6 million, representing a 15% year-over-year growth on a reported basis and 18% on a constant currency basis. Revenue growth was driven by software and biosimulation services as we continue to see strong demand across all customer categories. Fourth quarter software segment revenue of $29.2 million represented 14% year-over-year growth on a reported basis and 19% on a constant currency basis. Our core Simcyp and Phoenix biosimulation software performed well, as did Pinnacle 21, delivering at or above our financial and strategic expectations for the year. Our software updates and new products in 2022 included the annual updates on Phoenix and new versions of the Immunogenicity, Immuno-oncology, and Vaccine Simulator, which were introduced into the Simcyp platform. Also in 2022, we launched the Pinnacle 21 Data Exchange Module and the Simcyp Discovery Simulator. We are committed to finding new ways to leverage Pinnacle 21's data organization and management platform across Certara. We are also encouraged by customer traction with Simcyp Discovery, an example of our effort to expand Certara's biosimulation software into adjacent use cases. Similarly, we are excited to announce the acquisition of Vyasa in early January, an artificial intelligence company with scalable deep learning software. We are working to integrate the technology throughout the existing Certara platform to help customers answer complex questions across structured and unstructured biomedical information. Vyasa was a relatively small bolt-on transaction, and we expect the software integration process to evolve throughout the course of the year. Fourth quarter technology-driven services segment revenue was $57.5 million, which grew 15% on a reported basis and 18% on a constant currency basis compared with the fourth quarter of 2021. Biosimulation services continued to see robust demand, with 2022 growing approximately 20% for the year. We expect continued strength in biosimulation services into 2023 due to encouraging bookings trends throughout the year. This is testament to the strong demand we are seeing for biosimulations as our clients expand use cases across biologics, cell and gene therapies, and small molecules. Technology-driven services’ reported growth was impacted by the weakness in regulatory services during 2022, as we discussed on previous calls. The regulatory business finished 2022 in line with our expectations laid out in the second quarter earnings call in August. Over the long term, we believe regulatory services is a strategic business for Certara. It drives incremental value to our customers and is a solid business from a financial standpoint. Andrew will discuss the near-term outlook for this business in more detail shortly. In 2022, we continued to invest in our business and expand our team worldwide. We prioritized hiring leading scientists and subject matter experts to support our growth. At the end of 2022, we had over 1,200 employees, including more than 380 with doctoral degrees. We believe we are the employer of choice in the biosimulation industry and we offer a strong culture and commitment to innovation. In summary, we're pleased with our performance in 2022 with the rapid development and adoption of biosimulation, and the proven success of our business development strategy. We believe that our team is well-positioned to drive success in 2023 and over the long term as we support and catalyze the adoption of biosimulation for drug research and development. I'd like to close my remarks by extending my deepest appreciation to the entire organization of Certara. The hard work and dedication of our people drive our mission forward. I'll now turn it over to our CFO, Andrew Schemick, to discuss our fourth quarter and full year financial results in more detail.

Andrew Schemick, CFO

Thank you, William. Hello, everyone. Total revenue for the three months ended December 31, 2022, was $86.6 million, representing year-over-year growth of 15% on a reported basis and 18% on a constant currency basis. For the full year 2022, total revenue was $335.6 million, which represents 17% growth on a reported basis and 20% growth on a constant currency basis. Excluding Pinnacle 21, full year 2022 growth was 12% on a constant currency basis. Note that we have owned Pinnacle 21 for more than a full year as of October 2022, and we will be reporting the business as part of our consolidated financials going forward. Bookings, which provides visibility into the year ahead, came in at $408.9 million for the trailing 12-month period ended December 31, 2022, and were up 20% year-over-year. Our total company book-to-bill ratio ended the year at 1.22. Software revenue was $29.2 million in the fourth quarter, which increased 14% over the prior period on a reported basis and 19% on a constant currency basis. The growth in the quarter was driven by Pinnacle 21's new products and biosimulation software. For the full year, software revenue was $115.5 million, up 33% on a reported basis and 38% on a constant currency basis. Excluding Pinnacle 21, full year software revenue grew 14% on a constant currency basis. Ratable and subscription software revenue amounted to 60% of total software revenue for the year, up from 54% in the prior year. Subscription ratable revenue accounted for 67% of the fourth quarter revenues. Software bookings were $39.5 million in the fourth quarter, which increased 22% from the prior year period. Trailing 12 months software bookings were $124.8 million, up 32% year-over-year. The software aggregate renewal rate was 88% in the fourth quarter, down due to timing but resulting in a 91% rate for the year, which is in line with our plan. Services revenue was $57.5 million in the fourth quarter, which increased 15% over the prior year period on a reported basis and 18% on a constant currency basis. For the full year, services revenue was $220.2 million, up 10% on a reported basis and 13% on a constant currency basis. As we previously discussed, biosimulation services revenue growth remained strong in 2022 and was 20% while regulatory services was a drag on the overall growth rate. Technology-driven services bookings in the fourth quarter were $80.9 million, which increased 1% from the prior year period. Trailing 12-month services bookings were $284.1 million, which increased 15% as compared to the prior year. As expected, regulatory services bookings growth was down in the quarter while biosimulation booking trends continued to be strong. The cost of revenue for the fourth quarter of 2022 was $31.8 million, an increase from $29.3 million in the fourth quarter of 2021, primarily due to a $3.5 million increase in employee-related costs, a $1.1 million increase in other costs of revenues, such as equipment, travel, and software licenses, offset by lower stock-based compensation and outside consulting costs of $1.6 million. Total operating expenses for the fourth quarter of 2022 were $43.5 million, an increase from $42.6 million in the fourth quarter of 2021. The components of operating expenses are as follows. Sales and marketing expenses were $7.8 million compared to $6.7 million for the fourth quarter of 2021. This increase is primarily due to $0.6 million in employee expenses due to the expansion of the sales force and a $0.5 million increase in marketing and travel costs. R&D expenses were $6.6 million compared to $6.5 million for the fourth quarter of 2021. R&D expenses were up slightly due to R&D expense from acquisitions in 2021 and the timing of other related investments in research and development. G&A expenses were $18.3 million compared to $18.7 million for the fourth quarter of 2021. The decrease was primarily due to a $1.8 million decrease in transaction and M&A costs, a $1.5 million decrease in stock-based compensation, offset by $2.2 million of employee-related costs. Intangible asset amortization was up slightly at $10.3 million compared to $10.2 million in the fourth quarter of 2021. Depreciation and amortization expense was $0.4 million flat with last year. Continuing down the P&L, interest expense was $5.4 million compared to $3.3 million for the fourth quarter of 2021 due to higher interest expense relating to our term loan. Miscellaneous expense was $2.2 million compared to $0.3 million for the fourth quarter of 2021 due primarily to a $2.5 million remeasurement loss related to fluctuations in foreign currency exchange rates. The income tax benefit was $5.4 million, bringing the full-year provision to $4 million compared to $9.9 million in the prior full year as a result of a change in the mix of earnings among jurisdictions, the impact of non-recurring income tax rate changes, and the tax planning project completed in the second half of 2022 to take the benefit of previously unrecognized foreign tax credits. Net income for the fourth quarter of 2022 was $9.2 million compared to net loss of $9.7 million in the fourth quarter of 2021. Reported adjusted EBITDA for the fourth quarter of 2022 was $31.9 million compared to $28.2 million for the fourth quarter of 2021, representing a 13% growth. Adjusted EBITDA margin was 36.8% in the fourth quarter of 2022 and 35.8% for the full year of 2022. Reported adjusted net income for the fourth quarter of 2022 was $25.2 million compared to $9.8 million for the fourth quarter of 2021. Diluted earnings per share for the fourth quarter of 2022 was $0.06 as compared to a loss of $0.06 in the fourth quarter of 2021. Adjusted diluted earnings per share for the fourth quarter of 2022 was $0.16 compared to $0.06 in the fourth quarter of 2021. Now moving to the balance sheet. We ended the quarter with $236.6 million of cash and cash equivalents. As of December 31, 2022, we had $297.5 million of outstanding borrowings on our term loan and full availability under our revolving credit facility. Turning to the guidance. For the full year 2023, we expect total revenue in the range of $370 million to $385 million, representing 10% to 15% growth compared with 2022. Our revenue guidance assumes continued strength in software and biosimulation services where we have good visibility given our trailing 12-month bookings. The guidance also assumes regulatory services growth in the low single digits as compared to 2022, and software subscription revenue continues to rise to increase as a percentage of total software revenues. We expect adjusted EBITDA in the range of $131 million to $137 million, adjusted EPS in the range of $0.50 to $0.55 per share, fully diluted shares in the range of 159 million to 152 million, a tax rate in the range of 25% to 30%. And one last thing before we turn the call over to questions. With today's announcement, I want to take the opportunity to welcome John to Certara. John has an impressive background, and his experience with Cue Health and Beckman Dickinson has prepared him well for the opportunity with Certara. Over the past nine years, Certara has evolved and grown significantly. Since becoming public, we have put a long-term strategic plan in place that the team has been successfully executing against. After six years as a private company CFO and two years as a public company CFO, now is a good time to transition CFO responsibilities to someone else. Following a transition period that will ensure a smooth and orderly transition of responsibilities to John, I intend to remain with Certara and focus on operations and growth initiatives. I'll now turn the call back over to our CEO, William Feehery, for closing remarks.

William Feehery, CEO

Thank you, Andrew. I'd like to personally thank Andy for his outstanding job as CFO of Certara. During his nine years as CFO, the company transitioned through two private owners and then had an IPO in 2020. Also during that time, the company has grown over six times in people and revenues, and it remained consistently profitable. And most importantly, he helped Certara build a world-class finance organization that we will continue to benefit from for years to come. I'm very happy that we are able to retain someone with Andy's qualifications and knowledge of the company as we plan for the next phase of Certara's growth. To summarize our message today, we're pleased with our 2022 results and we believe that Certara is well positioned for growth this year and in the future as we continue as a global leader in biosimulation. We will now open up the line for questions. Operator, can you please open the line?

Operator, Operator

Our first question comes from David Windley from Jefferies.

David Windley, Analyst

I guess, in biosimulation you talked about some real strength there and particularly I guess in services, it looks like you are having nice effort with new logos over the last year or so. Could you, Bill, help with kind of the relative strength of demand between large customers and small, and just kind of help us understand what's pushing that and what their uptake is, is it software, i.e. large customers or more services in the small customers? I'm just interested in customer cohort commentary.

William Feehery, CEO

So about 50% of our business across the company is with the top 50 pharma and the other 50% is with the other roughly 1,700 customers we have. And during the fourth quarter, both segments grew fairly equally in revenue. So I think it was about 15% for both segments. But it's also true what you said the buying patterns are a little bit different; the larger customers tend to skew more towards software sales. They tend to be members of our consortium, which counts as software sales, and many of our biotech customers are services customers. Although, it's not a 100% one way or the other, we have smaller customers that purchase software and we certainly provide services to the large ones, that's just sort of a general trend. I would say, nothing particularly new in this area. It's been this kind of trend for a number of years right now, and we saw just kind of a continuation of that progress in the fourth quarter.

David Windley, Analyst

As a follow-up to that, I assume many of your new logos are emerging or relatively young companies in the biotech sector. The funding landscape for these companies has become more difficult over the past year, and Novavax made a surprising announcement recently. What kind of due diligence or assessment regarding financial stability do you conduct on this customer base, and are you noticing any potential risks?

William Feehery, CEO

The majority of the revenues that Certara generates come from drugs that advance to late-phase clinical development. Currently, there are still financing opportunities available for those who manage to develop a drug to that stage. Our work with early-stage clients typically represents a relatively small portion of our revenues; mainly, we handle smaller projects for them. We aim to present Certara's potential to these clients and strengthen our relationship as they grow, although they generally won't invest significantly with us until their drugs progress further. Regarding your second question, I can invite Andy to elaborate on that.

Andrew Schemick, CFO

In terms of diligence, we are required by accounting rules to ensure that customers have the necessary funds to recognize revenue. Therefore, we conduct credit checks upfront and review our accounts receivable monthly. We are diligent about these matters. We did observe an increase in the bad debt reserve compared to last year, which was due to some isolated incidents, but it is not indicative of a broader issue.

David Windley, Analyst

And then last question for me is just a description of the health of the regulatory services business. It sounds like you expect it to grow. I'd be interested if you put a number on what it actually delivered in 2022, was it down, flat? You said it dragged on growth, like what was the performance? And then are you seeing some of those delayed projects come back, are you seeing new bookings, what gives you confidence they can grow a little bit in ‘23?

Andrew Schemick, CFO

Yes, I can start with this one. Regarding our regulatory and access services, which we combined, there was a year-over-year decline of 3%. This includes the significant projects we’ve talked about in the last quarter and earlier, particularly those related to China and some regulatory work. However, beneath this, the business is quite robust and filled with potential. In the fourth quarter, we observed a return to growth, and we remain optimistic as we build our bookings and pipeline through the first half of the year. We factored in that slight decline into our guidance.

Operator, Operator

Our next question will come out from the line of Vikram Purohit from Morgan Stanley.

Vikram Purohit, Analyst

So two from our side. First on the revenue guidance for 2023. Could you just kind of help us unpack the scenarios that are implied by the bookends of that guidance? And then secondly, on Pinnacle 21, I know you spoke about it a little bit. But I was wondering if you could provide some more detail on how cross-selling opportunities are materializing from that acquisition? And maybe mention a sample project type or two where you've had the opportunity to bring together offerings from both Certara and Pinnacle 21 into one offering, and maybe talk a bit about how cross-selling there could continue throughout the year?

William Feehery, CEO

I'll start first with the guidance bookends. So the three factors I mentioned on the call, we went in the year with a conservative mindset given the macroeconomic environment today, but with high visibility. We have about 80% to 85% visibility into the low end of the range, and that's a conservative visibility metric, just accounting for the work that we've sold and assuming a 90% renewal rate, which doesn't factor in expansion opportunities with existing clients. So the midpoint, our base case is really bookended by conservatism around regulatory and just the general environment. And the upside is related to opportunities associated with our new software products where we don't really have a track record to extrapolate the growth forward. Is that helpful?

Andrew Schemick, CFO

And then I can address the part about Pinnacle 21. So we have seen a number of cross-selling opportunities. The simplest one was there are services opportunities tied to Pinnacle 21’s user base that we're able to tap into. We've also tied Pinnacle 21 into our integral data repository, which has provided maybe the most direct example of cross-selling opportunities in terms of additional software sales of that product tied to Pinnacle 21. So there's just a couple of things that are going on right now.

Operator, Operator

Our next question comes to line of Luke Sergott from Barclays.

Luke Sergott, Analyst

Can you just give us a sense of the pacing throughout the year with regards to your guidance, and how the margin expansion, how you guys are thinking about that kind of rolling on?

William Feehery, CEO

The 2022 pacing, if you will, on the revenue side, was more consistent with what we had historically excluding 2021, where we had a bigger back half of the year versus the first half of the year. So in laying out our plan and our forecast, we see a very similar spread of revenue throughout the year. The difference with 2022 was earlier in the year we made some accelerated investments, and the expectation is that those investments will be weighted towards the early half of the year, but less significant in terms of the impact on the EBITDA margin. So a little closer relationship between the revenue and the EBITDA margin.

Luke Sergott, Analyst

I have a question about the non-human primate supply chain. I realize it will take a considerable amount of time for the FDA to adopt a biosimulation to replace those. What steps are you taking or what discussions are you having with the FDA regarding alternative data, and are you involved in those conversations?

William Feehery, CEO

We have been an advocate of this for obvious reasons for a long time. So Simcyp contains animal models in it as well, and it's been our position that a lot of animal testing is unnecessary given the modeling capabilities. And we have had conversations over the years with the FDA. The industry has been quite conservative on moving in despite what I said; the industry that has been quite conservative on moving away from animal testing, in particular primates. If that is a step change, there is potentially an opportunity for us. But we want to be conservative and watch how this unfolds.

Operator, Operator

Our next question comes from the line of Dan Leonard from Credit Suisse.

Dan Leonard, Analyst

So two for me. First, can you speak to whether you're able to capture pricing in the current environment, what is the expectations for pricing in 2023 and how that compares to historicals?

William Feehery, CEO

I had a hard time hearing you. The pricing expectations for this year are consistent with historical trends and are generally in the 3% to 5% range across the product line.

Dan Leonard, Analyst

For my follow-up, similar to Luke's question, has the frequency or intensity of your conversations changed at all following the FDA Modernization Act 2.0? Additionally, does this specific legislation affect your business opportunities in any way, considering it allows for computer modeling as an alternative to animal testing?

William Feehery, CEO

So the language actually helps us a lot. So it fosters alternative methods like modeling, which basically falls into what we provide. So the short answer is, yes, it's a benefit to us.

Operator, Operator

Our next question comes from the line of Max Smock from William Blair.