Certara, Inc.

Good day and thank you for standing by. Welcome to the CETERA first quarter 2022 earnings conference call. At this time, all participants are on a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during this session, you'll need to press star 1 on your telephone. Please be advised that today's conference may be recorded. If you require any further assistance, please press star then 0. I would now like to hand the conference over to your host today, David Diekler. Please go ahead.

Good afternoon, everyone. Thank you all for participating in today's conference call. On the call from Surtara, we have William Ferry, Chief Executive Officer, and Andrew Chemek, Chief Financial Officer. Earlier today, Surtara released financial results for the quarter ended March 31st, 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 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 risks and uncertainties associated with Sertara's business, please refer to the Risk Factors section of our Form 10-K filed with the Securities and Exchange Commission on March 1, 2022. 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 their remarks or responses to questions, management may mention some non-GAAP financial measures. Reconciliations of adjusted EBITDA, adjusted net income, and adjusted EPS to the 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. May 5, 2022. Sartara 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 Sartara's first quarter earnings call. Andrew and I will start with prepared remarks, and then we will take questions. I am pleased with how the Sitara business performed in the first quarter of 2022 as we executed on our strategic and financial goals. We continue to grow our position as a global leader in biosimulation. We reported strong first quarter revenue of $81.6 million, growing 22% year over year, including Pinnacle 21. Software revenue was $29.2 million, growing 33% year over year, with a 92% renewal rate, driven by double-digit growth in our core CIMSIF and PHENIC licenses and the impact from Pinnacle 21. Pinnacle 21 continues to meet our expectations. Technology-driven services revenue was $52.4 million, representing 17% growth compared with the first quarter of last year. We are pleased with the sequential improvement in our technology-driven services business. As expected and discussed on our fourth quarter call, we saw some impact from the Omicron variant in January, and several regulatory services projects continue to be delayed. We remain focused on navigating through the delays in our clients' clinical trials to better manage the conversion of our bookings to revenue and regulatory services. We effectively managed through issues related to COVID, and the business exited the first quarter at more normalized levels of employee and client availability as well as project activity. Looking forward to the remainder of the year, we expect the positive momentum in the business to continue. Booking's trends in both software and technology-driven services remain very strong, and we continue to add new customers. We continue to experience healthy double-digit growth in new customers over last year. As such, we remain well positioned to achieve our 2022 financial guidance. Now, moving on to other recent highlights. Our sensitive COVID-19 vaccine model continues to get recognized for its contributions to combating the pandemic and improving patient outcomes. A few weeks ago, we were honored to receive a Thomas Edison Award in the therapeutic impact category. Winning an Edison Award is one of the highest accolades a company can receive for the successful launch of a game-changing new product or service. Results from our COVID-19 vaccine model have been submitted to global regulatory agencies, including the FDA, to support clinical trial designs. Our clients and we are currently using the COVID-19 vaccine model to optimize dosing for special populations, such as the elderly and children. The FDA continues to support expanded use cases of biosimulation to help advance the safety and efficacy of medicines. On our last earnings call, we highlighted our first quarter announcement that the FDA recently licensed our immunogenicity simulator to be used in evaluation of biologics. Immunity reactions can be a major problem in biologics and can lead to reduced effectiveness and or adverse events. Our simulator helps guide improved study design to drive better clinical outcomes. In February, the FDA released draft guidance providing recommendations for incorporating clinically relevant information into the labeling of products having immunogenicity assessments. We think that this is a growth area within the R&D pipelines at customers. Additionally, as I've mentioned, The FDA's Project Optimist is an initiative to reform the dose optimization and selection paradigm in oncology drug development. There was a dosing workshop just this week held by the FDA that we contributed to. This is a positive development for the use of biosimulation regarding dose finding and optimizing clinical study design. We continue to invest in capabilities that are strategically aligned with regulatory guidance. Innovation and growth are driven by the people at Sitara. We remain committed to growing, retaining, and developing talent at Sitara, and we have invested in additional professional development programs to support these goals. Our culture, people, and commitment to innovation and customer partnerships continue to make Sitara an employer of choice. We continue to invest in our global team of experts across the organization and we're well positioned to capitalize on the opportunities ahead. We started the year with a higher level of investment, particularly in software R&D and sales. Specifically, we're investing to expand the use cases of our SimSip simulator and also advancing R&D initiatives to support Pinnacle 21 enterprise software development. This elevated level of investment did pressure our reported adjusted EBITDA margins in the quarter, as Andy will discuss in a minute. but I remain confident in our ability to deliver on our EBITDA guidance for the year. A few weeks ago, Sitara issued its inaugural ESG report, which can be found on our investor relations website. This report relays our commitment to understanding, managing, and monitoring our ESG impact to support sustainable growth, and we are pleased to share it with our stakeholders. In summary, I'm pleased with the performance of the company in the first quarter and our continued dedication to advance global adoption of our software and technology-driven services. We remain on track to achieve our revenue and adjusted EBITDA goals for the remainder of the year. I will now turn it over to our CFO, Andrew Chemek, to discuss first quarter financial results in more detail.

Thank you, William. Hello, everyone. Total revenue for the three months ended March 31, 2022, was $81.6 million, representing year-over-year growth of 22%, which included approximately 100 basis points of negative FX impact. Excluding Pinnacle 21, reported first quarter revenue growth was 13%, which included approximately 200 basis points of negative FX impact. As a reminder, the largest non-U.S. dollar currency exposures are the British pound, euro, and yen. We remain well-positioned with trailing 12-month bookings coming in at $368.3 million, up 19% year-over-year on a reported basis, and up approximately 14% excluding Pinnacle 21. I continue to look at trailing 12-month bookings as a basis for forward 12-month revenue. Software revenue was $29.2 million in the first quarter, which increased 33% over the prior year period. Excluding $5.6 million in Pinnacle 21 software revenue contribution, year-over-year growth was 8%. The growth in the quarter, excluding Pinnacle 21, was driven by our biosimulation software, SimSip and Phoenix, which grew 13%. Reported software growth was affected by a reallocation of software revenues to services under select contracts. Additionally, the software business was disproportionately impacted by the move in FX rates. Software bookings were $29.4 million in the first quarter, which increased 34% from the prior year period. Pinnacle 21 contributed $6.4 million to software bookings in the first quarter, So first quarter year-over-year software bookings growth excluding Pinnacle 21 was 5%. Trailing 12-month software bookings were $101.9 million, up 32% year-over-year, and up 13% excluding Pinnacle 21. Software aggregate renewal rate was 92% in the first quarter, and net retention rate was 130%. Services revenue was 52.4 million in the first quarter, which increased 17% over the prior year period. As expected, weakness in technology-driven services during December and January was transitory, and we saw improvement in each month during the quarter. Technology-driven services bookings in the first quarter were 79.1 million, which increased 32% from the prior year period. TTM services bookings were $266.4 million, which increased 15% as compared to the prior year. The strengthened bookings provide support for the confidence we have in our 2022 outlook. Moving further down the P&L for first quarter results, total cost of revenue for the first quarter of 2022 was $32.8 million, an increase from $26 million in the first quarter of 2021. primarily due to a $4.5 million increase in employee-related costs resulting from billable headcount growth and a $1.7 million increase in intangible asset amortization from acquired software. Total operating expenses for the first quarter of 2022 were $42.6 million, an increase from $35.1 million in the first quarter of 2021. The components of operating expenses are as follows. Sales and marketing expenses were 6.1 million compared to 3.8 million for the first quarter of 2021. This increase is primarily due to the aggressive hiring that we successfully executed during the last two quarters in our commercial organization. R&D expenses were 7.5 million compared to 4.7 million for the first quarter of 2021. The increase in R&D expenses was primarily due to people and investments made to support software development. G&A expenses were $18.3 million compared to $16.6 million for the first quarter of 2021. The increase was primarily due to operational headcount, medical, and other benefit expenses. Additionally, the company incurred $0.9 million increase in professional and consulting costs associated with the financial audits and SOX implementation. The increases were partially offset by a reduction of $1 million in acquisition-related costs. Intangible asset amortization was 10.1 million compared to 9.5 million in the first quarter of 2021, increasing due to amortization costs from acquired assets. Depreciation expense was 0.5 million compared to 0.6 million last year. And continuing down the P&L, other expenses include interest expense and miscellaneous income. Interest expense was 3.2 million compared to $3.9 million for the first quarter of 2021 due to lower interest rates on the term loan and interest swap. Miscellaneous income was $0.8 million due to foreign currency gains from remeasurement accounting at one of our foreign subsidiaries that maintains a U.S. dollar bank account. Income tax expense was $1.5 million compared to $0.5 million in the prior year due to a 41% effective tax rate compared to 33% last year. Net income for the first quarter of 2022 was $2.2 million compared to a net income of $1.1 million in the first quarter of 2021. Diluted earnings per share for the first quarter of 2022 was $0.01 as compared to $0.01 in the first quarter of 2021. Adjusted EBITDA for the first quarter of 2022 was $27.7 million compared to $23.9 million for the first quarter of 2021 representing 16% growth. As William mentioned, we accelerated operating investments in the first quarter, resulting in adjusted EBITDA margin of 34%. Despite this performance in the quarter, we remain on track to deliver our adjusted EBITDA margin target of 36% for the full year. Adjusted net income for the first quarter of 2022 was $16.9 million compared to $14.4 million for the first quarter of 2021. Adjusted diluted earnings per share for the first quarter of 2022 was $0.11 compared to $0.09 for the first quarter of 2021. Now moving to the balance sheet. We ended the quarter with $184.3 million of cash and cash equivalents. As of March 31, 2022, we had $294.3 million of net outstanding borrowings on our term loan and full availability under our revolving credit facility. We are reiterating our full-year guidance issued during the fourth quarter call with the exception of an update to our year-end fully diluted chairs. Revenues in the range of $350 to $360 million, adjusted EBITDA in the range of $127 to $131 million, adjusted EPS in the range of $0.48 to $0.53 per share, fully diluted chairs in the range of $159 to $161 million, a gap tax rate in the range of 40% to 45%, and a cash tax rate in the range of 20% to 25%. Thank you. Now we will open up the line for questions. Operator, please open the line for questions.

Thank you. If you have a question at this time, please press star, then the number 1 on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. And our first question comes from the line of Dave Windley with Jefferies. Your line is open. Please go ahead.

Hi. Thanks for taking my questions. Good afternoon. I was thinking, looking back to this time last year, when your customer count was about 1,650 and now over 2,000. So you've added about 350 customers in the last year. And then the last two quarters I've seen your bookings really step up. So I wondered if perhaps those threads were interwoven and you could talk about the progress you're making with that new customer base, where they are engaging, and how quickly they are expanding.

Yes. Hi, David. It's Andrew. We've seen in the metrics, particularly coming out of Q1 with the higher customer count, strong growth rates in the clients with greater than 100K customers. And we've seen growth in the number of clients and also a growth in the dollar amount with those clients. So that's kind of driving the growth. We've also seen strength with our largest accounts, accounts greater than 1 million. So I think the newer clients are coming on board and they're progressing into that greater than 100K nicely. But we're also seeing strong growth with the larger clients greater than 1 million.

And in terms of the products that they're starting with or with which they are engaging in contract, are there any themes there? Is it kind of same old, same old in BioSim? Or are you seeing other avenues of customer engagement?

At this point, it's primarily driven by BioSim. particularly Phoenix and BioSim services. We're also getting introduced to new customers through Pinnacle 21.

Okay. And then maybe just on the guidance, the margin point that you made and so comfortable with EBITDA margin guidance for the year, how should we think about the higher investment in 1Q tapering off, or is it level through the year and your revenue grows into that? Just help us with cadence that gets you to the 36 by the end of the year.

Yes. The way that, just to clarify that, so the first quarter margin, you know, the bridge from, you know, 34% to the target, about half of that was accounting costs. primarily associated with higher than expected costs for the integrated audit and completing the SOX implementation. The other half was growing headcount, particularly in light of the strong performance in bookings, Q4, Q1, and what we could see in the pipeline. In terms of the margin progression for the year, Essentially what I'm seeing right now is a, you know, we'll take the one-time half of those costs, the one-time costs out of the first quarter and the second quarter. We'll see some improvement quarter over quarter, Q1 to Q2, and then kind of in excess of target in the back half of the year to get back to the 36%. Okay, great.

Thank you.

Thank you. And our next question comes from the line of Michael Ryskin with Bank of America. Your line is open. Please go ahead.

Hi, great. Thanks. This is Wolf Chan off on from Mike. Thanks for taking the questions. I know you've spoken to this a little bit, but I was wondering if you'd give us some more color on how successful you've been in capturing, recapturing the service revenue shortfall from 4Q and how we should be thinking of kind of modeling that dynamic as it plays out through the rest of the year. Thanks.

Thank you, Michael. This is William Fury here. As you know, at the end of last year, we saw a lengthening in time to start certain services projects, particularly in regulatory. We saw that continue in the months of December and January, but then as we went through the quarter, we saw a month-to-month improvement each month through the quarter. So what I'd say is we haven't quite gotten back to the point where all the delays have been removed. There are still some projects that are delayed, largely waiting on clinical data to be completed. But basically we're marching in the right direction, and we've made up a lot of the ground in the first quarter.

Great. Thank you very much. And then just to kind of higher level one, can you give us some color on the early cross-selling opportunities you've been able to realize with the Pinnacle deal? Maybe some particular products or just, yeah, anything you can speak to in that area. Thanks.

Yeah, thanks. So Pinnacle 21 has opened up a lot of opportunities for us. There's a, I think immediately we found a lot of cross-selling opportunities between Pinnacle 21 and our integral data repository product. So, you know, a data repository that ties into a data validation product, they kind of go nicely together. So we think there's some opportunities as we go forward there. We've also seen tie-ins between Pinnacle 21 and some of our services business partners. You know, we've been able to add on to some of our services projects by basically offering data validation using Pinnacle to projects. We've managed to make some larger. We've managed to open up some new customers as well for Pinnacle 21. So, you know, I think there will be more to come as we go forward, but I think we're off to a pretty good start with Pinnacle 21 on this.

Great. Thank you.

Thank you. And our next question comes from the line of Zikram Purehit with Morgan Stanley. Your line is open. Please go ahead.

Great. Thanks for taking my question. So I had a broad one on your biosimulation TAM. I noticed that in your current corporate presentation, you broke out the TAM by software versus services, and then within each of these segments, you have a further breakout between drug discovery and drug development. So the two questions I had here are, first, if you could just walk us through a bit of what's feeding this high-level, build for the biosimulation TAM? And then secondly, which of the specific areas of the opportunities you laid out here do you think Sertara has the most opportunity to grow in moving forward over the next couple of years, especially now that Pinnacle 21 is fully within the Sertara umbrella?

Sure. Thanks, Vikram. The information we put on the corporate, you know, we're just always trying to update the research we've done on the size of the market. A lot of people have been, you know, in the last few years, the biosimulation market has been growing and maybe got defined in a lot of investors' minds, so we wanted to provide the latest thinking we had on the different sizes and break it down. In terms of, you know, where Sotara is playing, you know, the bulk of our – Biosimulation expertise and revenue has been on the development side. Typically, particularly with SIMSIP, companies get involved during clinical or during the design of clinical trials. And so our services kind of mirror that as well. But we've also moved some of our software to earlier stage. So we have Pinnacle 21, which largely comes in at the end of clinical when you submit to the FDA, but is increasingly being used during the clinical phase and during the preclinical phase as companies are collecting data and want to hold that data to a certain standard. And then we have other software. which we either have or have been developing, which have pushed our reach, you know, earlier stage into preclinical and even a little bit into discovery. You know, for example, we have – we acquired a piece of software a while ago called Send Explorer, which is kind of like a – data visualization product during the preclinical phase. We have D360, which is primarily used during the discovery phase. So, you know, I think over the time and as we go forward, you know, over time, the company is interested in extending the reach of biosimulation earlier stage into discovery, but The reality today is probably 60%, 70% of our business is really tied to the development phase. Hopefully that helps.

Very helpful. Thank you.

Thank you. And our next question comes from the line of Justin Lin with William Blair. Your line is open. Please go ahead.

Hi. Good afternoon. Congrats on the quarter. First of all, I think you said your software bookings was up 34%, but excluding Pinnacle 21, it was up 5%. First of all, I want to clarify I heard that right. And second, I guess, how did that compare to your expectation?

You did hear that right. Typically, we look at bookings over a trailing 12-month period, and software bookings ex-Pinnacle 21 Trailing 12 months is 13%. The factors that drive us to look at it over a longer time horizon is that we have client renewals that tend to shift from quarter to quarter, sometimes early, sometimes late. They don't have an impact on revenue recognition. We also saw some disproportionate impact on FX in terms of the software bookings, given the nature of where our products are developed around the world. So that impacted that bookings line. We didn't adjust for that for a constant currency basis. And then we had a sale last year that was essentially delivered this year through a services arrangement. So when I normalized for those, the quarter was, I think, about 10% in terms of kind of software bookings and looking at the quarter and looking at the TTMs. I would call that things were healthy and is what we were expecting.

Got it. That's helpful. Can you remind us what your capital deployment priorities are? Has the rising rate environment affected your thinking on M&A or investments in general at all?

From my perspective, we're still you know, evaluate M&A opportunities. We're open to that, you know, given, you know, the current environment could be, you know, it's a good time to be, have a strong balance sheet, take advantage of opportunities. So I would say, you know, this has been a relatively fast-moving event. We haven't changed our capital deployment strategies.

Okay, and just last one from me. Can you talk about the opportunities you see in cell and gene therapy specifically? Are you happy with your expertise in this area at the moment, or are there additional investments needed, whether towards expanding your software capability or hiring the right people?

Yeah, thanks. A lot of our cell and gene therapy work is done by our quantitative assistance pharmacology group which has been one of our faster growing areas a lot of the work in cell and gene therapy is for just for you know orphan drugs that just tends to be what's in the pipeline and that tends to lend itself to the type of modeling and dosing work that Sertar is known for to deliver so I've I guess to answer your question, I feel very good about the group we have and the offering we have, but our ambitions are much larger. So we think that QSP in general will be a growth. We know for a fact it will be a growing part of the pharma market going forward. There's a lot of pharma companies adding to their groups in that area, and there's a lot of need for it. So we are planning to continue to invest in growing that group as we go forward. And we're also, you know, thinking about how best to tie that to our software offerings. We already tie it a lot to our SIMSIP offering. But, you know, there's other opportunities to kind of create specialized software offerings and QSP that we're also, you know, thinking about or pursuing.

Got it. That's very helpful. Thank you very much.

Thank you. And our next question comes from the line of Jacob Putman with Barclays. Your line is open. Please go ahead.

Hey, guys. Thanks for the question. Can you talk about your ability to pass on pricing and how many of your contracts allow pricing scalers given that they're long-term for the life of the program?

Yeah, I can start, and then Andrew can chime in here. Most of our contracts are for one year or less. We do occasionally, because customers ask for it, enter into longer-term contracts, and particularly in the current environment, we're very sensitive to making sure that there's appropriate price increases in any contract that goes out. You know, we're aware that we're in an inflationary environment, Um, right now it's just as every other company is. Um, and you know, we have the ability to, uh, we believe we have the ability to, you know, uh, basically offset inflation with pricing and maintain our margins.

Great. That's helpful. And how about any other offsets to rising costs?

Well, there's, there's always, uh, efficiencies to be gained in any company. In particular, in Sotara, we're growing quite rapidly, and that's enabling us to make investments in basically company infrastructure that leads to efficiencies that offset some of that. We've been investing heavily, for example, in our sales and marketing group. Basically, since we went public, we said we would do that. You know, what that lets us do, for example, is free up our, you know, our scientists from having to sell, and they can, you know, write more software or go do more project work, which, you know, for example, leads to one sort of efficiency.

Great. Thank you so much. That's helpful. Thanks.

Thank you. And, again, if you have a question at this time, please press star, then 1. And our next question comes from the line of Vikram Kassabhotla with Baird, your line is open. Please go ahead.

Yeah, thank you for taking the question. I think on the last call you talked about the fact that you saw some increased attrition in the workforce towards the end of the year. It sounded like that had started to normalize towards the start of the year. I'm wondering if you can just give us an update there and talk about what turnover has looked like in the organization so far this year and what your expectations are for managing headcount through the balance this year.

Yes, Victor. Thanks for the question. You're right. We did see an uptick in in attrition at the end of last year. Fortunately, we saw that drop down to a more normalized level in the first quarter. I think we're making sure we keep up with market in terms of wages and we're maintaining our margins. But the uptick I guess we saw I think there were a lot of disruptions at the end of last year due to COVID or people's perception of COVID and things like that that have kind of worked their way through people's perception of their careers. I think Sartar has got a tremendous backlog of really interesting work right now. which helps to attract people. And we've been investing in training, and we've been bringing in some really great colleagues here. So I think all that's been reflected in the fact we've seen much more normalized attrition as we went through the first quarter.

Okay, thanks. And then I guess from a higher level, can you just remind us of the visibility that you have into the revenue guidance range at this point in the year? I think historically you've talked about the approach that you've taken to building guidance based on your bookings performance. Just wondering if there's been any updates to that approach, and I guess at this point of the year, where do you think some of the key areas of variability could come from in the revenue performance?

Yeah, so we've used the same methodology in terms of forward visibility. I think... You know, we have high confidence in the guidance for this year in light of the Q1 performance, the bookings for the last two quarters, the TTM bookings, as well as the pipeline looking forward for bookings. The variability – from the perspective of predicting the revenues at the end of the year today versus the actuals primarily rely around opportunities that we don't have visibility into right now. So we do that kind of bottoms-up build to get to the revenue forecast. And I think the offset to that is just variability in client timelines and client drug development program successes.

All right, thank you.

Thank you, and I'm showing no further questions at this time, and I would like to turn the conference back over to William Fury for any further remarks.

Thank you all for joining us. I think the overall message I would say is that after where we were in the fourth quarter, we saw significant improvement in Q1. We're very happy to see very strong bookings. We saw month-over-month improvements. you know, throughout all three months in the quarter. And we're, you know, feeling quite confident as we look forward to the rest of the year. So we'll look forward to updating everybody in future quarters. Thank you very much.

This concludes today's conference call. Thank you for participating. You may now disconnect. Everyone have a great day.