Certara, Inc. (CERT) FY 2021 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

For purposes of this Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") section, we use the terms "Certara Inc.", "the Company","we", "us", and "our" to refer to Certara, Inc.

You should read the following discussion of our financial condition and results of operations in conjunction with our audited consolidated financial statements and the related notes and other financial information included elsewhere in this Form 10K and our audited consolidated financial statements and notes thereto.

As discussed in the section titled “Special Note Regarding Forward Looking Statements,” the following discussion and analysis, in addition to historical financial information, contains forward-looking statements that involve risks and

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uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth in the section titled “Risk Factors” under Part I, Item 1A above.

We intend the discussion of our financial condition and results of operations that follows to provide information that will assist the reader in understanding our Consolidated Financial Statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles, policies and estimates affect our Consolidated Financial Statements.

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Executive Overview

We accelerate medicines to patients using biosimulation software, technolog, and services to transform traditional drug discovery and development. Biosimulation is a powerful technology used to conduct virtual trials using virtual patients to predict how drugs behave in different individuals. Biopharmaceutical companies use our proprietary biosimulation software throughout drug discovery and development to inform critical decisions that not only save significant time and money but also advance drug safety and efficacy, improving millions of lives each year.

As a global leader in biosimulation based on 2021 revenue, we provide an integrated, end-to-end platform used by more than 2,000 clients including biopharmaceutical companies, regulatory agencies and academic institutions across 62 countries, including 38 of the top 40 biopharmaceutical companies by R&D spend in 2020. Since 2014, customers who use our biosimulation software and technology-driven services have received 90% of all new drug approvals by the FDA. Moreover, 17 global regulatory authorities license our biosimulation software to independently analyze, verify, and review regulatory submissions, including the FDA, Health Canada, Japan’s PMDA, and China’s NMPA. Demand for our offerings continues to expand rapidly.

We build our biosimulation technology on first principles of biology, chemistry, and pharmacology with proprietary mathematical algorithms that model how medicines and diseases behave in the body. For over two decades, we have honed and validated our biosimulation technology with an abundance of data from scientific literature, lab research, and preclinical and clinical studies. In turn, our customers use biosimulation to conduct virtual trials to answer critical questions, such as: What will be the human response to a drug based on preclinical data? How will other drugs interfere with this new drug? What is a safe and efficacious dose for children, the elderly, or patients with pre-existing conditions? Virtual trials may be used to optimize dosing on populations that are otherwise difficult to study for ethical or logistical reasons, such as infants, pregnant women, the elderly, and cancer patients.

Biosimulation results need to be incorporated into regulatory documents for compelling submissions. Accordingly, we provide regulatory science solutions and integrate them with biosimulation so that our customers can navigate the complex and evolving regulatory landscape and maximize their chances of approval. Our differentiated regulatory services are powered by submissions management software and natural language processing for scalability and speed, allowing us to deliver more than 250 regulatory submissions over the past four years. Our team of regulatory professionals has extensive experience applying industry guidelines and global regulatory requirements.

The final hurdle to delivering medicines to patients is market access, defined as strategies, processes, and activities to ensure that therapies are available to patients at the right price. We believe that biosimulation and market access will continue to be increasingly intertwined as health systems and countries move toward outcomes-based pricing. We have recently expanded into technology-driven market access solutions, which help our customers understand the real-world impact of therapies and dosing regimens earlier in the process and effectively communicate this to payors and health authorities. Our solutions are underpinned by technologies such as Bayesian statistical software and SaaS-based value communication tools.

With continued innovation in and adoption of our biosimulation software, technology, and services, we believe more biopharmaceutical companies worldwide will leverage more of our end-to-end platform to reduce cost, accelerate speed to market, and ensure safety and efficacy of medicines for all patients.

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Public Offerings

On December 15, 2020, we completed our IPO, pursuant to which we issued and sold 14,630,000 shares of our common stock and certain selling stockholders sold 18,783,250 shares of our common stock (representing the full exercise of the underwriters’ option to purchase additional shares), at a public offering price of $23.00 per share. We received net proceeds of $316.3 million, after deducting underwriters’ discounts and commissions, but before offering costs. We incurred offering costs of $4.4 million, net of the tax effect of $0.3 million, which we recognized as a charge to additional paid-in capital.

In connection with the closing of our IPO, we repaid in full the $80.0 million outstanding principal amount and $3.0 million accrued interest on our Loan Agreement.

On March 29, 2021, we completed an underwritten secondary public offering in which certain selling stockholders, including EQT, sold 11,500,000 shares of the Company’s common stock, including 1,500,000 shares of common stock pursuant to the full exercise of the underwriters’ option to purchase additional shares. We did not offer any common stock in this transaction and did not receive any proceeds from the sale of the shares of common stock by the selling stockholders. We incurred costs of $1.1 million, recorded in general and administrative expenses, in relation to the secondary public offering.

On September 13, 2021, we completed another public offering, at a public offering price of $31.00 per share, pursuant to which the Company sold 4,500,000 shares of its common stock, and certain selling stockholders sold 18,500,000 shares of our common stock, including 3,000,000 shares of common stock pursuant to the full exercise of the underwriters’ option to purchase additional shares. We received net proceeds of $134.1 million after deducting underwriters' discounts and commissions. In addition, $0.7 million of legal, accounting and other offering costs incurred in connection with the sale of the Company's common stock in the public offering were capitalized and offset against the proceeds received.

On November 22, 2021, we completed another secondary public offering in which certain selling stockholders, including EQT, sold 10,000,000 shares of the Company’s common stock.  We did not offer any common stock in this transaction and did not receive any proceeds from the sale of the shares of common stock by the selling stockholders. We incurred costs of $0.6 million, recorded in general and administrative expenses, in relation to the secondary public offering.

Key Factors Affecting Our Performance

We believe that the growth of and future success of our business depends on many factors. While each of these factors presents significant opportunities for our business, they also pose important challenges that we must successfully address to sustain our growth and improve results of operations.

Customer Retention and Expansion

Our future operating results depend, in part, on our ability to successfully enter new markets, increase our customer base, and retain and expand our relationships with existing customers. We monitor two key performance indicators to evaluate retention and expansion: new bookings and renewal rates.

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The table below summarizes our quarterly bookings and renewal rate trends:

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Investments in Growth

We have invested and intend to continue to invest in expanding the breadth and depth of our solutions, including through acquisitions and international expansion. We expect to continue to invest (i) in scientific talent to expand our ability to deliver solutions across the drug development spectrum; (ii) in sales and marketing to promote our solutions to new and existing customers and in existing and expanded geographies; (iii) in research and development to support existing solutions and innovate new technology; and (iv) in other operational and administrative functions to support our expected growth. We expect that our headcount will increase over time and also expect our total operating expenses will continue to increase over time, albeit, at a rate lower than revenue growth.

Our Operating Environment

The acceptance of model-informed biopharmaceutical discovery and development by regulatory authorities affects the demand for our products and services. Support for the use of biosimulation in discovery and development from regulatory bodies, such as the FDA and EMA, has been critical to its rapid adoption by the biopharmaceutical industry. There has been a steady increase in the recognition by regulatory and academic institutions of the role that modeling and simulation can play in the biopharmaceutical development and approval process, as demonstrated by new regulations and guidance documents describing and encouraging the use of modeling and simulation in the biopharmaceutical discovery, development, testing, and approval process, which has directly led to an increase in the demand for our services. Changes in government or regulatory policy, or a reversal in the trend toward increasing the acceptance of and reliance upon in silico data in the drug approval process, could decrease the demand for our products and services or lead regulatory authorities to cease use of, or to recommend against the use of, our products and services.

Governmental agencies throughout the world, but particularly in the United States where the majority of our customers are based, strictly regulate the biopharmaceutical development process. Our business involves helping biopharmaceutical companies strategically and tactically navigate the regulatory approval process. New or amended regulations are expected to result in higher regulatory standards and often additional revenues for companies that service these industries. However, some changes in regulations, such as a relaxation in regulatory requirements or the introduction of streamlined or expedited approval procedures, or an increase in regulatory requirements that we have difficulty satisfying or that make our regulatory strategy services less competitive, could eliminate or substantially reduce the demand for our regulatory services.

Competition

The market for our biosimulation products and related services for the biopharmaceutical industry is competitive and highly fragmented. In biosimulation software, we compete with other scientific software providers, technology companies, in-house development by biopharmaceutical companies, and certain open source solutions. In the technology-driven services market, we compete with specialized companies, in-house teams at biopharmaceutical companies, and academic and government institutions. In some standard biosimulation services, and in regulatory and market access, we also compete with contract research organizations. Some of our competitors and potential competitors have longer operating histories in certain segments of our industry than we do and could have greater financial, technical, marketing, R&D, and other resources. Some of our competitors offer products and services directed at more specific markets than those we

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target, enabling these competitors to focus a greater proportion of their efforts and resources on those specific markets. Some competing products are developed and made available at lower cost by government organizations and academic institutions, and these entities may be able to devote substantial resources to product development. Some clinical research organizations or technology companies may decide to enter into or expand their offerings in the biosimulation area, whether through acquisition or internal development. We also face competition from open source software initiatives, in which developers provide software and intellectual property free of charge, such as R and PK-Sim software. In addition, some of our customers spend significant internal resources in order to develop their own solutions.

Impact of COVID-19

As of December 31, 2021, we believe there have been and will be short-term impacts on our business due to the Omicron variant.  With the COVID-19-related slowdown in closing out clinical trials, there have been delays in regulatory services projects.  Furthermore, the increase in COVID-19 cases with the Omicron variant reduced the capacity of our employees and clients.  We believe that these are transitory factors that we are well-equipped to manage going forward.

non-GAAP measures

Management uses various financial metrics, including total revenues, income from operations, net income, and certain metrics that are not required by, or presented in accordance with, GAAP, such as Adjusted EBITDA, Adjusted Net Income, and Adjusted Diluted Earnings Per Share, to measure and assess the performance of our business, to evaluate the effectiveness of our business strategies, to make budgeting decisions, to make certain compensation decisions, and to compare our performance against that of other peer companies using similar measures. We believe that presentation of the GAAP and the non-GAAP metrics in this filing will aid investors in understanding our business.

Management measures operating performance based on Adjusted EBITDA defined for a particular period as net income (loss) excluding interest expense, provision (benefit) for income taxes, depreciation and amortization expense, intangible asset amortization, equity-based compensation expense, acquisition and integration expense, and other items not indicative of our ongoing operating performance.  Management also measures operating performance based on Adjusted Net Income defined for a particular period as net income (loss) excluding, equity-based compensation expense, acquisition and integration expense, and other items not indicative of our ongoing operating performance. Further, management measures operating performance based on Adjusted Diluted Earnings Per Share defined for a particular period as Adjusted Net Income divided by the weighted-average diluted common shares outstanding.

We believe Adjusted EBITDA, Adjusted Net Income, and Adjusted Diluted Earnings Per Share are helpful to investors, analysts, and other interested parties because they can assist in providing a more consistent and comparable overview of our operations across our historical periods. In addition, these measures are frequently used by analysts, investors, and other interested parties to evaluate and assess performance.

Adjusted EBITDA, Adjusted Net Income, and Adjusted Diluted Earnings Per Share are non-GAAP measures and are presented for supplemental purposes only and should not be considered as an alternative or substitute to financial information presented in accordance with GAAP. Adjusted EBITDA, Adjusted Net Income and Adjusted Diluted Earnings Per Share have certain limitations in that they do not include the impact of certain expenses that are reflected in our consolidated statements of operations that are necessary to run our business. Other companies, including other companies in our industry, may not use these measures and may calculate both differently than as presented, limiting the usefulness as a comparative measure.

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The following table reconciles Net loss to Adjusted EBITDA :

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The following table reconciles Net loss to Adjusted Net Income(Loss):

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The following table reconciles diluted earnings per share to Adjusted Diluted Earnings Per Share:

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Components of Results of Operations

Revenues

Our business generates revenue from the sales of software products and delivery of consulting services.

Cost of Revenues

Cost of revenues consists primarily of employee related expenses, equity-based compensation, the costs of third-party subcontractors, travel costs, distributor fees, amortization of capitalized software and allocated overhead. We may add or expand computing infrastructure service providers, make additional investments in the availability and security of our solutions, or add resources to support our growth.

Operating Expenses

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We expect to increase the size of our general and administrative staff to support the anticipated growth of our business. As a public company, we expect to incur significant expenses on an ongoing basis that we did not incur as a private company. Those costs include additional director and officer liability insurance expenses, as well as third-party and internal resources related to accounting, auditing, SOX compliance, legal, and investor and public relations expenses. As a result, we expect the dollar amount of our general and administrative expense to increase for the foreseeable future. Excluding public company expenses, we expect general and administrative expense to grow at a rate lower than revenues.

Other Expenses

Acquisitions

On March 2, 2021, we completed a transaction which qualified as a business combination for a total consideration of $2.7 million. The business combination was not material to our consolidated financial statements. Based on the Company’s preliminary purchase price allocation, approximately $1.2 million, $0.1 million and $1.2 million of the purchase price was assigned to customer relationships, non-compete agreements and goodwill, respectively.

On June 7, 2021, we completed a transaction which qualified as a business combination for a total consideration of $15.2 million. The business combination was not material to our consolidated financial statements. Based on the Company’s preliminary purchase price allocation, approximately $7.4 million and $4.7 million of the purchase price was assigned to customer relationships and goodwill, respectively.

On October 1, 2021, we completed the acquisition of 100% of the equity of Pinnacle for a total consideration of $339.1 million, consisting of cash $266.3 million ($246.9 million net with cash acquired from the acquisition) and 2,239,717 shares of restricted common stock of the Company. Based on the Company’s preliminary purchase price allocation, approximately $15.8 million, $103.0 million, $24.6 million and $183.9 million of the purchase price was assigned to trademark, acquired software, customer relationships, and goodwill, respectively. Pinnacle  has been included in our consolidated results of operations since the date of acquisition.

Also, after year end 2021, on January 3, 2022, we completed the acquisition of Integrated Nonclinical Development Solutions, Inc. (INDS), a company that provides the SEND Explorer® software and drug development consulting, for total

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consideration of $7.1 million. We will complete the initial accounting for the acquisition of INDS, including the allocation of purchase consideration, in the first quarter of 2022.

For more information about our acquisitions, see NOTE 5. “Business Combinations” in the notes to the Consolidated Financial Statements.

Results of Operations

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Comparison of the Years Ended December 31, 2021 and 2020

Revenues

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Revenues increased by $42.6 million, or 17%, to $286.1 million for the year ended December 31, 2021, as compared to the same period in 2020. Excluding $6.1 million revenue from Pinnacle 21, which was acquired in the fourth quarter of 2021, the revenues increased $36.4 million, or 15% for the year ended December 31, 2021 as compared to the same period in 2020. The overall increase in revenues was primarily a result of growth in our technology enabled services and software product offerings from strong renewal rates, client expansions and new customers.

Software revenue increased by $13.4 million, or 18%, to $86.8 million for the year ended December 31, 2021 as compared to the same period in 2020, driven primarily by growth in sales of our software subscriptions of 29%, or $9.6 million and sales of our software licenses of 10%, or $3.7 million.  Excluding $5.7 million revenue from Pinnacle 21, the revenue from software subscription increased $3.9 million, or 12%. The overall growth is primarily attributable to maintaining high net revenue retention rates and renewal rates for our core software products, growth from acquisitions and new customers.

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Services revenue increased by $29.2 million, or 17%, to $199.3 million for the year ended December 31, 2021, as compared to the same period in 2020, primarily driven by growth in our technology-driven services product lines, which increased by 18%, or $29.5 million. The growth in overall services revenue is primarily attributable to strong growth in biosimulation and regulatory services from client expansions with ACV greater than $0.1 million and new customers.

Cost of Revenues

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Cost of revenues increased by $10.9 million, or 11%, to $111.6 million for the year ended December 31, 2021, as compared to 2020. The increase was primarily due to a $10.0 million increase in employee-related costs resulting from billable head count growth, a $2.8 million increase in consulting costs, and $1.4 million increase in intangible assets amortization, partially offset by a $3.6 million decrease in stock-based compensation cost. Excluding $0.8 million expense from Pinnacle, the cost of revenue increased $10.1 million.

Sales and Marketing Expense

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Sales and marketing increased by $0.9 million, or 5%, to $20.1 million for the year ended December 31, 2021, as compared to 2020. Sales and marketing expenses increased primarily due to a $5.4 million increase in employee-related costs resulting from head count growth and a $0.5 million increase in professional and consulting costs as well as $0.1 million increase in equipment and software expenses, partially offset by a $5.2 million decrease in stock-based compensation cost.

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Research and Development Expense

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Research and development expenses increased by $0.7 million, or 4%, to $20.4 million for the year ended December 31, 2021 as compared to 2020. The increase in R&D expenses was primarily due to a $5.1 million increases in employee-related costs resulting from head count growth, partially offset by a $4.3 million decrease in stock-based compensation cost. Excluding $1.3 million expense in research and development from Pinnacle, the research and development expense decreased $0.6 million.

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General and Administrative Expense

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General and administrative expenses decreased by $8.9 million, or 10 %, to $79.5 million for the year ended December 31, 2021 as compared to 2020. The decrease was primarily due to a $24.4 million decrease in employee-related costs resulting from a $22.0 million decrease in stock-based compensation cost and a $2.4 million decrease in other-employee related costs. The decreases were partially offset by increase of $10.7 million in acquisition costs, $2.7 million in insurance expenses, $1.0 million increase in public company expense, and $0.8 million increase in stock offering transaction cost.

Intangible Asset Amortization Expense

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Intangible asset amortization expense increased by $1.3 million, or 3%, to $38.7 million for the year ended December 31, 2021 as compared to 2020. The increase in intangible asset amortization was primarily the result of increased amortization in acquired intangible assets. Excluding $2.4 million expense in intangible asset amortization from Pinnacle, the intangible asset amortization expense decreased $1.1 million.

Depreciation and Amortization Expense

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Depreciation and amortization expense decreased by $0.3 million, or (13) %, to $2.1 million for the year ended December 31, 2021 as compared to 2020.  The decrease in depreciation and amortization expense was primarily due to the decrease in average carrying balances of fixed assets in 2021 compared to 2020.

Interest Expense

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Interest expense decreased by $8.5 million, or 33%, to $16.8 million for the year ended December 31, 2021 as compared to 2020. The decrease in interest expense was primarily due to lower average outstanding principal balances on our credit facilities in 2021 compared to the same period in 2020. The decrease in interest expense was partially offset by interest expense reclassified as interest from other comprehensive income due to hedge ineffectiveness.

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Miscellaneous, net

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Miscellaneous expenses decreased by $0.3 million, or 75%, to $0.1 million for the year ended December 31, 2021 as compared to 2020. The decrease in miscellaneous expenses was primarily due to increase in currency gain, partially offset by increase in loss from  fixed asset disposals.

(Benefit from) Provision for Income Taxes

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Our income tax expense was $9.9 million, resulting in an effective income tax rate of (293.1)%, for the year ended December 31, 2021, as compared to an income tax benefit of $0.8 million, or an effective income tax rate of 1.6%, in 2020. Our income tax expense for the year ended December 31, 2021 was primarily due to the impact of rate changes in certain jurisdictions, the impact of non-deductible items, and the relative mix of domestic and international earnings.

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Net Loss

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Net loss decreased by $36.1 million, or 73%, to $13.3 million for the year ended December 31, 2021, as compared to the same period in 2020. The decrease was primarily due to increase in revenues and decrease in stock-based compensation expense and interest costs in 2021 compared to 2020, partially offset by increase in cost of revenue, employee-related costs, acquisition costs, and taxes.

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Comparison of the Year Ended December 31, 2020 and 2019

Revenues

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Revenues increased by $35.0 million, or 17%, to $243.5 million for the year ended December 31, 2020 as compared to the same period in 2019. The increase in revenues was the result of growth in our technology enabled services and software product offerings from strong renewal rates and client expansions.

Software revenue increased by $5.1 million, or 7%, to $73.5 million for the year ended December 31, 2020 as compared to the same period in 2019, driven primarily by growth in sales of our software licenses of 10%, or $3.3 million and subscriptions revenue of 8%, or $2.3 million, partially offset by a decline in software maintenance revenue of $0.5 million. The growth is attributable to maintaining high net revenue retention rates and renewal rates for our core software products.

Services revenue increased by $29.9 million, or 21%, to $170.1 million for the year ended December 31, 2020 as compared to the same period in 2019, primarily driven by organic growth in our technology-driven services product lines of 23%, or $30.6 million, partially offset by a $0.7 million decrease in professional services offerings. The growth is primarily attributable to strong growth in biosimulation and regulatory services from client expansions and new customer acquisition.

Cost of Revenues

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Cost of revenues increased by $21.0 million, or 26%, to $100.8 million for the year ended December 31, 2020 as compared to 2019. The increase was primarily due to a $8.6 million increase in stock-based compensation driven by the exchange of performance vesting Class B Units in connection with the December 2020 offering and an increase to employee-related costs of $8.6 million related to increased headcount. The remaining increase is due to consulting costs and bonus expense, partially offset by decreases in travel related costs, retention, and software expenses.

Sales and Marketing Expense

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Sales and marketing increased by $8.5 million, or 79%, to $19.2 million for the year ended December 31, 2020 as compared to 2019. The increase was primarily due to a $7.3 million increase in stock-based compensation driven by the exchange of performance vesting Class B Units in connection with the December 2020 offering.  The remainder of the increase is due to sales commissions, employee-related costs, and other marketing costs, offset by decreases in advertising and tradeshow, travel and entertainment, bonus, and consulting expenses.

Research and Development Expense

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Research and development expenses increased by $8.0 million, or 69%, to $19.6 million for the year ended December 31, 2020 as compared to 2019. The increase was primarily due to a $7.0 million increase in stock-based compensation driven by the exchange of performance vesting Class B Units in connection with the December 2020 offering.  The remaining increase was due to employee-related costs, consulting expenses, and bonus expense, partially offset by lower capitalization of software development costs, tax credits, and travel and entertainment spend.

General and Administrative Expense

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General and administrative expenses increased by $40.6 million, or 85%, to $88.5 million for the year ended December 31, 2020 as compared to 2019. The increase was primarily due to a $39.8 million increase in stock-based compensation driven by the exchange of performance vesting Class B Units in connection with the December 2020 offering. The remaining increase is due to increases in professional fees, IPO transaction costs, employee-related costs, bonus expense, IT-related costs, and D&O insurance coverage, partially offset by decreases in travel and entertainment spend, severance expenses, restructuring costs, acquisitions and integration costs, and office supply expense.

Intangible Asset Amortization Expense

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Intangible asset amortization expense increased by $1.2 million, or 3%, to $37.4 million for the year ended December 31, 2020 as compared to 2019. The increase in intangible asset amortization was a direct result of increases in capitalized software development costs and increases in acquired intangible assets.

Depreciation and Amortization Expense

Depreciation and amortization expense of $2.4 million was relatively flat for the year ended December 31, 2020 as compared to 2019.

Interest Expense

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Interest expense decreased by $2.7 million, or 10%, to $25.3 million for the year ended December 31, 2020 as compared to 2019. The decrease in interest expense was primarily due to lower outstanding debt resulting from the payoff of our higher interest term loans and lower interest rates on the outstanding debt.

Miscellaneous, net

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Miscellaneous expenses decreased by $0.3 million, or 39%, to $0.5 million for the year ended December 31, 2020 as compared to 2019. The decrease in miscellaneous expenses was primarily due to a $0.2 million decrease in asset disposals and sublease losses and $0.2 million of Australian stimulus income provided by the Australian government, partially offset by $0.3 million of unfavorable foreign currency exchange rate fluctuations compared to the U.S. dollar, particularly with the pound sterling.

(Benefit from) Provision for Income Taxes

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Our income tax benefit was $0.8 million, resulting in an effective income tax rate of 1.6%, for the year ended December 31, 2020, as compared to an income tax benefit of $0.2 million, or an effective income tax rate of 2.5%, in 2019. Our income tax benefit for the year ended December 31, 2020 was primarily due to the tax effects of the U.S. pre-tax loss and the impact of tax rate changes in certain jurisdictions.

Net Loss

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Net loss increased by $40.5 million, or 453%, to $49.4 million for the year ended December 31, 2020 as compared to the same period in 2019. The increase was primarily due to an increase in operating expenses, namely general and administrative expenses, sales and marketing, and research and development expenses.

Liquidity and Capital Resources

We have consistently generated positive cash flow from operations, providing $60.4 million, $44.8 million, and $38.0 million as a source of funds each year for the years ended December 31, 2021, 2020, and 2019. Our additional liquidity comes from several sources: maintaining adequate balances of cash and cash equivalents, issuing common stock, and

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accessing credit facilities and revolving line of credit. The following table provides a summary of the major sources of liquidity as of and for the years ended December 31, 2019, through 2021.

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Our material cash requirements from known contractual obligations as of December 31, 2021 is as follows:

We believe our existing sources of liquidity will be sufficient to meet our working capital, capital expenditures, and contractual obligations for the foreseeable future. We believe we will meet longer-term expected future cash requirements and obligations through a combination of cash flows from operating activities, available cash balances, and potential future equity or debt transactions.

Our future capital requirements, however, will depend on many factors, including funding for potential acquisitions, investments, and other growth and strategic opportunities, which could increase our cash requirements. While we believe we have, and will be able to generate, sufficient liquidity to fund our operations for the foreseeable future, our sources of liquidity could be affected by factors described under “Risk Factors” elsewhere in this filing.

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Cash Flows

The following table presents a summary of our cash flows for the periods shown:

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Operating Activities

During the year ended December 31, 2021, operating activities provided approximately $60.4 million. The $15.6 million increase in cash from operating activities compared to 2020 was primarily due to a decrease in cash paid in interest and taxes, partially offset by cash paid for accounts payable and accrued expense.

During the year ended December 31, 2020, operating activities provided approximately $44.8 million of cash and cash equivalents, primarily resulting from a net loss of $49.4 million, offset by $100.9 million of non-cash operating expenses inclusive of depreciation and amortization, amortization of debt issuance costs, equity-based compensation costs, and deferred income taxes. Changes in our operating assets and liabilities used cash and cash equivalents of approximately $6.7 million.

During the year ended December 31, 2019, operating activities provided approximately $38.0 million of cash and cash equivalents, primarily resulting from a net loss of $8.9 million, offset by $38.2 million of non-cash operating expenses inclusive of depreciation and amortization, amortization of debt issuance costs, equity-based compensation costs, and deferred income taxes. Changes in our operating assets and liabilities provided cash and cash equivalents of approximately $8.7 million.

Investing Activities

During the year ended December 31, 2021, investing activities used approximately $269.9 million of cash, an increase of $261.3 million, compared to $8.6 million in 2020. Cash used in investing activities was primarily for investing in business acquisitions and capitalized software development to support our growth.

During the year ended December 31, 2020, investing activities used approximately $8.6 million of cash, primarily for investing in capital expenditures and capitalized software development to support our growth.

During the year ended December 31, 2019, investing activities used approximately $9.5 million of cash, primarily for investing in capital expenditures and capitalized software development to support our growth.

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Financing Activities

During the year ended December 31, 2021, financing activities provided approximately $123.4 million, compared to $208.2 million in the same period of 2020. The $84.8 million decrease in cash from financing activities was primarily due to $183.0 million less proceeds from stock offerings in 2021 compared to 2020. The decrease was partially offset by $100.4 million decrease in debt payment in 2021.

During the year ended December 31, 2020, financing activities provided approximately $208.2 million of cash, primarily attributable to proceeds from issuance of common stock in connection with our IPO, partially offset by payments on long-term debt.

During the year ended December 31, 2019, financing activities used approximately $8.5 million of cash, primarily attributable to payments on long-term debt, capital lease obligations, our revolving credit facility, and unit repurchases, partially offset by proceeds from capital contributions.

Indebtedness

Credit Facilities

We are a party to a Credit Agreement that originally provided for a $250.0 million senior secured term loan and commitments under a revolving credit facility in an aggregate principal amount of $20.0 million, with a sub-commitment for issuance of letters of credit of $10.0 million. The loans were originally scheduled to mature on August 14, 2024, with respect to the term loan thereunder, and August 14, 2022, with respect to the revolving credit facility thereunder.

In January 2018, we and the lenders amended the Credit Agreement to add incremental term loans in the amount of $25.0 million to be used for our general corporate purposes. Additionally, in April 2018, we and the lenders amended the Credit Agreement to (i) add incremental term loans in the amount of $40.0 million to be used for our general corporate purposes and (ii) provide a reduction of 50 basis points in the margin under the term loan. The terms of such incremental term loans were the same as the terms of our existing term loans, including in respect of maturity, and are considered an increase in the aggregate principal amount of the existing term loans outstanding under the Credit Agreement and are part of the existing term loan.

We entered into a third restated and amended loan agreement on June 17, 2021 (“Third Amendment”), which provides for, among other things, (i) the extension of the termination date applicable to the revolving credit commitments under the Credit Agreement to August 2025, (ii) the extension of the maturity date applicable to the term loans under the Credit Agreement to August 2026, and (iii) an increase of approximately $80.0 million in commitments available under the revolving line of credit (resulting in an aggregate amount of commitments of $100.0 million).  The term loan under the Third Amendment has substantially the same terms as the existing term loans and revolving credit commitments. The Credit Agreement is collateralized by substantially all U.S. assets and stock pledges for the non-U.S. subsidiaries and contain various financial and nonfinancial covenants.

Borrowings under the Credit Agreement currently bear interest at a rate per annum equal to either (i) the Eurocurrency rate, with a floor of 0.00%, as adjusted for the reserve percentage required under regulations issued by the Federal Reserve Board for determining maximum reserve requirements with respect to Eurocurrency funding, plus an applicable margin rate of 3.50% for the term loan and between 4.00% and 3.50% for revolving credit loans, depending on the applicable first lien leverage ratio, or (ii) an alternative base rate (“ABR”), with a floor of 1.00%, plus an applicable margin rate of 2.50% for the term loan or between 3.00% and 2.50% for revolving credit loans, depending on the applicable first lien leverage ratio (with the ABR determined as the greatest of (a) the prime rate, (b) the federal funds effective rate, plus 0.50%), and (c) the Eurocurrency rate plus 1.00%.

Additionally, we are obligated to pay under the revolving credit facility (i) a commitment fee of between 0.50% and 0.25% per annum of the unused amount of the revolving credit facility, depending on the applicable first lien leverage ratio, (ii) customary letter of credit issuance and participation fees, and (iii) other customary fees and expenses of the letter of credit issuers.

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All obligations under the Credit Agreement are unconditionally guaranteed by our wholly owned direct and indirect subsidiaries, subject to certain exceptions. All obligations under the Credit Agreement, and the guarantees of those obligations, are secured on a first lien basis, subject to certain exceptions, by substantially all of our assets and the assets of the other guarantors.

As of December 31, 2021, we had $300.5 million of outstanding borrowings on the term loan, and $100.0 million of availability under the revolving credit facility under the Credit Agreement, and outstanding letters of credit of $0.2 million under the Credit Agreement. As of December 31, 2021, we were in compliance with the covenants of the Credit Agreement.

Income Taxes

We recorded income tax expense of $9.9 million for the year ended December 31, 2021 and income tax benefit of $0.8 million for the year ended December 31, 2020.

As of December 31, 2021, we had federal and state NOLs of approximately $2.4 million and $2.6 million, respectively, which are available to reduce future taxable income and expire between 2024 and 2040 and 2029 and 2039, respectively. We had federal and state R&D tax credit carryforwards of approximately $1.5 million and $0.4 million, respectively, to offset future income taxes, which expire between 2038 and 2041. We also had foreign tax credits of approximately $15.1 million, which will start to expire in 2025. These carryforwards that may be utilized in a future period may be subject to limitations based upon changes in the ownership of our stock in a future period. Additionally, we carried forward foreign NOLs of approximately $24.5 million which will start to expire in 2022, foreign research and development credits of $0.4 million which expire in 2029, and Canadian investment tax credits of approximately $3.8 million which expire between 2030 and 2039. Our carryforwards are subject to review and possible adjustment by the appropriate taxing authorities.

As required by Accounting Standards Codification (‘‘ASC’’) Topic 740, Income Taxes, our management has evaluated the positive and negative evidence bearing upon the realizability of our deferred tax assets, which are composed principally of NOL carryforwards, R&D credit carryforwards, investment tax credit carryforward, and foreign tax credit carryforwards. Management has determined that it is more likely than not that we will not realize the benefits of foreign tax credit carryforwards. At the foreign subsidiaries, management has determined that it is more likely than not that we will not realize the benefits of certain NOL carryforwards. As a result, a valuation allowance of $18.2 million is recorded at December 31, 2021.

Off-Balance Sheet Arrangements

During the periods presented, we did not have, and currently we do not have, any significant off-balance sheet arrangements, as defined under the rules and regulations of the SEC.

Critical Accounting Policies and Estimates

Our management’s discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make judgments and estimates that affect the reported amounts of assets, liabilities, revenues, and expenses and the disclosure of contingent assets and liabilities in our consolidated financial statements. We base our estimates on historical experience, known trends and events, and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. On an ongoing basis, we evaluate our judgments and estimates in light of changes in circumstances, facts, and experience. The effects of material revisions in estimates, if any, are reflected in the consolidated financial statements prospectively from the date of change in estimates.

While our significant accounting policies are described in more detail in the notes to our consolidated financial statements appearing elsewhere in this filing, we believe the following accounting policies used in the preparation of our consolidated financial statements require the most significant judgments and estimates.

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Revenue Recognition

Application of GAAP related to the measurement and recognition of revenue requires us to make judgments and estimates. Specifically, complex arrangements with nonstandard terms and conditions may require significant contract interpretation to determine the appropriate accounting, including whether promised goods and services specified in an arrangement are distinct performance obligations. Revenue recognition is also impacted by our ability to determine when a contract is probable of collection and to estimate variable consideration. We consider various factors when making these judgments.

Our revenue is primarily derived from the sale of software products and delivery of consulting services. We recognize revenue when control of the promised good or service is transferred to the customer in an amount that reflects the consideration for which we are expected to be entitled in exchange for those services.

Software Licenses and Support

License revenue includes perpetual license fees and term license fees, which provide customers with the same functionality and differ mainly in the duration over which the customer benefits from the use of software. Both revenues from perpetual license and term license performance obligations are generally recognized up front at the point in time when the software license has been delivered. A source of software license revenue is from term and bundled licenses that are time-based arrangements for one or multiple software products sold together with maintenance and support for the term of the license arrangement. We have determined that post-customer support and the right to unspecified enhancements and upgrades on a “when-and-if-available” basis included with term licenses is an immaterial component of the transaction price and, therefore, recognize these performance obligation components up front with the license when delivered.

Software Services

For contracts that include multiple performance obligations, such as a software license plus software training, implementation, and/or maintenance/support, or in contracts where there are multiple software licenses, the transaction price is allocated to each of the performance obligations on a pro-rata basis based on the relative standalone selling price of each performance obligation. Maintenance services agreements consist of fees for providing software updates and for providing technical support for software products for a specified term. Revenues allocated to maintenance services are recognized ratably over the contract term beginning on the delivery date of each offering. Maintenance contracts generally have a term of one year. Expenses related to maintenance and subscription are recognized as incurred. While transfer of control of the software training and implementation performance obligations are performed over time, the services are typically started and completed within a few days. Due to the quick nature of the performance obligation from start to finish and the immaterial amounts, we recognize any software training or implementation revenue at the completion of the service. Any unrecognized portion of amounts paid in advance for licenses and services is recorded as deferred revenue.

License revenue and post-contract services are combined and reported as software revenue on the consolidated statements of operations and comprehensive loss.

Subscription Revenues

Subscription revenue consists of subscription fees for access to, and related support for, our cloud-based solutions. We typically invoice subscription fees in advance in annual installments and recognize subscription revenue ratably over the term of the applicable agreement, usually one to three years, which is initially deferred and recognized ratably over the life of the contract. Unearned maintenance and subscription revenues are recorded as deferred revenue. Our subscription services arrangements are generally non-cancelable and do not contain refund-type provisions. In rare instances that subscription services arrangements are deemed cancelable, we will adjust the transaction price and period for revenue recognition accordingly to be reflective of the contract term.

Services and Other Revenues

Services primarily represent advisory services, which may be either strategic consulting services, reporting and analysis services, regulatory writing services, or any combination of the three. Strategic consulting services consists of consulting,

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training, and process redesign that enables customers to identify which uncertainties are greatest and matter most and then to design development programs, trial sequences, and individual trials in such a way that those trials systematically reduce the identified uncertainties, in the most rapid and cost-effective manner possible. Our professional services contracts are time and materials, fixed fee, or prepaid. Services revenues are generally recognized over time as the services are performed. Revenues for fixed price services and prepaid are generally recognized over time applying input methods to estimate progress to completion. Training revenues are recognized as the services are performed over time.

Consortium revenues consist of contractual agreements with customers where the customer receives multiple benefits as part of their contract with the Company, as follows: access to the latest version simulator software, which has at least one new release per year, free access to a preset number of training workshops, a block of consulting hours to be used at the customer’s discretion, as well as voting rights at the annual consortium meeting where development priorities for the upcoming year are set. The Company’s consortium contracts are generally for three years with an annual termination clause and annual upfront billings. Consortium revenues are recognized over time as the benefits of the consortium arrangement are realized over the course of the contract. Both the training and consulting services performance obligations will utilize an output method to measure the progress at the end of each reporting period. As the simulation license was determined to be a functional license with the right to access, the license revenue is recognized evenly over the contract period.

Equity-Based Compensation

Equity-based compensation expense is calculated based on the fair value on the grant date. Upon consummation of the IPO, vested class B units were exchanged for shares of restricted common stock issued by the Company.  Although the class B units are not longer outstanding, the grant date fair value of the time based vested class B units will continue to be recognized over the remaining service period of the restricted common stock, and therefore our methods for estimating fair value of our class B units remains relevant.

We estimated the fair value of the class B units using the Monte Carlo option pricing model in 2019 and the Black-Scholes option-pricing model in 2018. In order to derive an estimate of each security class of EQT, we first determined the enterprise value of EQT. To do this we used the enterprise value of the Company as a proxy because the primary asset of EQT is its investment in the Company and therefore the total enterprise value was assumed to be the same.

The three valuation methodologies used to determine the enterprise value, each of which was given equal weighting, include the following:

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Application of these approaches involves the use of estimates, judgments and assumptions that are highly complex and subjective, including those regarding our future expected revenue, expenses, cash flows, discount rates, market multiples, the selection of comparable public companies and the probability of future events.

We then subtracted the interest-bearing debt from the enterprise value to determine the operating equity value. The operating equity value is then adjusted for cash and cash equivalents to determine the total equity value.

We then allocated the total equity value of EQT to the Class A Units and the various Class B Units, by utilizing the appropriate option pricing framework. We concluded on the fair value of the Class A Units and the various Class B Units by taking into consideration the relative rights and privileges of the various security classes as well as the following assumptions of the option pricing framework:

Expected Exercise Term.  We estimate the expected life of equity awards based upon the timing of a potential liquidity event.

Expected Equity Volatility.   Prior to filing the IPO, we were a private entity and therefore, the selected equity volatility was based on the historical and implied volatility of comparable publicly traded companies over a similar expected term. This is representative of the expected future equity volatility of the Company and of the equity volatility of EQT since its equity is similar.

Risk-Free Interest Rates.   We based the risk-free interest rate on the rate for a U.S. Treasury zero-coupon issue with a term that closely approximates the expected life of the option grant at the date nearest the option grant date.

The assumptions underlying these valuations represent management’s best estimates, which involve inherent uncertainties and the application of management’s judgment. As a result, if factors or expected outcomes change and we use significantly different assumptions or estimates, our equity-based compensation expense could be materially different.

Goodwill and Other Intangible Assets

We assess goodwill for impairment at least annually, during the fourth quarter based on balances as of October 1st, and more frequently on an interim basis if we believe indicators of impairment exist. Goodwill is tested for impairment at the reporting unit level, which is one level below or the same as an operating segment. The application of an interim or the annual goodwill impairment test begins with the identification of reporting units, which requires judgment. We determined that we have four reporting units: the software reporting unit (“Software”), the SimCyp reporting unit (“SimCyp”), the Integrated Drug Development reporting unit (“IDD”), and the regulatory writing reporting unit (“Regulatory Writing”), which are within a single operating segment of the Company. The process of evaluating the potential impairment of goodwill is highly subjective and requires significant judgment. Our review of impairment starts with performing a qualitative assessment to determine whether events or circumstances lead to a determination that it is more-likely-than-not that the fair value of the reporting units are less than their carrying amounts.

Our qualitative assessment of the recoverability of goodwill considers various macroeconomic, industry-specific and company-specific factors. These factors include: (1) the nature of the business and the history of the Company and its reporting units from their inception; (2) the economic outlook in general and the condition and outlook of the industry in which the Company and its reporting units operate; (3) the financial condition of the Company and its reporting units; (4) the earnings capacity of the Company and its reporting units; (5) the dividend-paying capacity of the Company and its reporting units; (6) whether goodwill or other intangible value exists within the Company and/or its reporting units; (7) previous sales of the Company’s and/or reporting units’ stock and the size of the block of stock to be valued; and (8) the market prices of stocks of corporations engaged in the same or a similar line of business having their stocks actively traded in a free and open market, either on an exchange or over-the-counter. After assessing the totality of events and circumstances, if we determine that it is not more-likely-than-not that the fair values of our reporting units are less than their net book values, no further assessment is performed. If we determine that it is more-likely-than-not that the fair values of our reporting units are less than carrying value or if we elect to bypass the qualitative assessment, we proceed to a quantitative assessment or test of goodwill.

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If a quantitative assessment of goodwill is required, the determination of the fair value of a reporting unit will involve the use of significant estimates and assumptions. Our quantitative goodwill impairment test uses both the income approach and the market approach to estimate fair value. The income approach is based on the discounted cash flow method that discounts forecasted future cash flows expected to be generated which are based on the Company's estimates of financial performance including revenues, adjusted EBITDA, taxes, and working capital and capital asset requirements. When performing our market approach, we rely specifically on the guideline public company method. Our guideline public company method incorporates revenues and EBITDA multiples from publicly traded companies with operations and other characteristics similar to our entity. If the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit.

We performed the annual goodwill impairment analysis during the fourth quarter. The quantitative assessments resulted in no impairment as the estimated fair value of each reporting unit significantly exceeded its carrying value.

Our other intangible assets primarily consist of customer relationship assets, software products acquired in acquisitions, tradenames, software development costs, and non-compete agreements. Other identifiable intangible assets with finite lives, such as software products acquired in acquisitions, non-compete agreements, tradenames, and customer relationship assets, are amortized over their estimated lives using either a straight-line method or a method based on pattern of expected economic benefit of the asset as follows: acquired software — three to ten years; non-compete agreements — two to five years; tradenames — 20 years; customer relationships — 11 to 16 years; and trademarks — 10 to 17 years. The Company evaluates finite intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset might not be recoverable. An impairment loss is recognized when estimated undiscounted future cash flows expected to result from the use of the asset are less than its carrying amount.

Software Development Costs

Software development costs are accounted for in accordance with ASC Subtopic 985-20 if the software is to be sold, leased or otherwise marketed, or by ASC Subtopic 350-40 if the software is for internal use. After the technological feasibility of the software has been established (for software to be marketed), or at the beginning of application development (for internal-use software), software development costs, which include primarily salaries and related payroll costs and costs of independent contractors incurred during development, are capitalized. Research and development costs incurred prior to the establishment of technological feasibility (for software to be marketed), or prior to application development (for internal-use software), are expensed as incurred. Software development costs are amortized on a product-by-product basis commencing on the date of general release of the products (for software to be marketed) or the date placed in service (for internal-use software).

Recently Adopted and Issued Accounting Standards

We have reviewed all recently issued standards and have determined that, other than as disclosed in Note 2 to our consolidated financial statements appearing elsewhere in this filing, such standards will not have a material impact on our consolidated financial statements or do not otherwise apply to our operations.

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