Schrodinger, Inc. Q3 FY2020 Earnings Call

Ladies and gentlemen, good morning, and welcome to the Schrödinger Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference call is being recorded. It is now my pleasure to turn the call over to the Schrödinger's team. Please go ahead.

Thank you, operator, and thank you all for listening in on our third quarter financial results call. Today, you will hear from Ramy Farid, President and Chief Executive Officer; Karen Akinsanya, Chief Biomedical Scientist and Head of Discovery R&D; and Joel Lebowitz, our Chief Financial Officer. Before we begin, I’d like to remind you that management will make statements related to our business that are forward-looking and are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, including without limitation, statements related to the potential advantages of our platform, our strategic plans to accelerate the growth of our software business, and advance our collaborative and internal drug discovery programs, risks related to the COVID-19 pandemic, our expectations related to the use of our cash, cash equivalents, and marketable securities, as well as our future operating expenses. These forward-looking statements reflect our current views about our plans, intentions, expectations, strategies, and prospects, which are based on the information currently available to us, and on assumptions we have made. Actual results may differ materially from those described in the forward-looking statements and are subject to a variety of assumptions, uncertainties, risks, and factors that are beyond our control, including the demand for our software solutions, our ability to further develop our computational platform, our reliance upon our drug discovery collaborators and other risks detailed under the caption, Risk Factors and Elsewhere in our most recent Securities and Exchange Commission filings and reports. Except as required by law, we undertake no duty or obligation to update any forward-looking statements discussed on this call, as a result of new information, future events, changes in expectations or otherwise. These forward-looking statements should not be relied upon as representing our views as of any date subsequent to today. With that, I'd like to turn the call over to Ramy.

Thanks, and thank you everyone for joining Schrödinger call to review our most recent financial results. We had a very strong third quarter building our momentum of the first half of this year. As you’ll hear from Karen shortly, we’re making excellent progress on our pipeline as we prepare to initiate IND-enabling studies for our most advanced programs. We also achieved important milestones in several of our collaborative programs. Also, as Joel will describe later on the call, we saw very strong revenue growth in our software business. We continue to make excellent progress on the science that underlies our computational platform, which fuels both our drug discovery and software business. In the third quarter, we successfully raised 347 million in gross proceeds in a follow-on equity offering. Combined with a capital raise from our IPO in the first quarter, we raised a total of 579 million gross proceeds this year, providing us with balance sheet strength and strategic optionality. We achieved total revenue of 25.8 million in the third quarter, which represents 29% growth over the third quarter of 2019. Underpinning this top line growth was software revenue of 22.9 million, an increase of 42% compared to the third quarter last year. We continue to see deeper engagement with our platform by our customers, leading to the strong year-over-year growth in our software revenue. Our talented team of scientists and software developers continues to make significant progress in advancing the science that underlies our computational platform. We've recently published several papers describing advances in FEP+ including improved methods for accurately modeling binding affinities in metalloenzyme inhibitors, improved support of macrocycle design and optimization, and improved approaches to optimizing binding selectivity, which is a major way of reducing potential toxicity of drug molecules. We also released our active learning workflow for structure-based hit discovery, which can screen massive libraries of compounds with greatly improved computational efficiency. And finally, I'm pleased to report that despite the challenges of COVID-19, we are successfully engaging both existing customers and potential new customers, and advancing our drug discovery programs and those of our collaborators. We're also executing on our hiring plan and continue to add highly talented scientists and software developers to our already impressive ranks. We're excited by the many advances we've made as we continue to transform the way therapeutics and materials are discovered. And I'll turn the call over to Karen for an update on our drug discovery programs.

Thank you, Ramy, and good morning, everyone. During the third quarter, we continue to make important advances on many fronts across our internal pipeline and portfolio of collaborative programs. The rapid pace at which the programs are advancing is a direct result of the hard work of our research teams, combined with the power of our platform. We have seen new drug candidates discovered in our collaborative programs progress into IND-enabling and first-in-human studies. We believe these advancing programs represent examples of the impact of our physics-based methods, not just in achieving broad exploration of chemical space, but more importantly on the optimization of high-quality development candidates with balanced properties for clinical testing. As an example, Morphic’s MORF-057 for inflammatory bowel disease, which initiated a clinical trial in the third quarter, is one of several examples where Schrödinger technology enabled solutions to our partner’s preclinical design challenges. In this case, the design of selective compounds for the integrin alpha 4 beta 7 was enabled by an important advance in our force field to properly treat the receptor’s metal centers. In our second quarter call, we reported a significant increase in the number of collaborative programs that had reached the latest stages of drug discovery. We expect to see many of the collaboration programs and lead optimization into preclinical development over the next year. Turning now to our internal pipeline. As a reminder, starting in the second half of 2018, we launched five oncology programs targeting solid tumors and hematological malignancies. The preclinical data packages we have assembled to date include mechanistic validation and anti-tumor activity data. We believe based on the data generated to date that each of these assets could have monotherapy activity in specific populations, as well as utility in combination with other approved and late-stage oncology products. As the field of KRAS inhibition continues to make major advances in the clinic, our advancing SOS1 inhibitor program for potential use in combination with KRAS inhibitors also continues to advance preclinically. We believe that combining these two mechanisms has the potential to provide meaningful improvements in durable responses in patients with tumors harboring mutant KRAS. Our MALT 1 program is focused on developing novel allosteric MALT 1 inhibitors to treat relapsed or resistant lymphomas. We have observed similar tumor growth inhibition in in-vivo preclinical studies when compared to data from activated B-cell diffuse large B-cell lymphoma, or ABC DLBCL, xenograft models reported by Janssen at AACR for their clinical stage MALT 1 inhibitor compound. We have confirmed plasma IO-10 and tumor BCL10 as robust PD markers in PK/PD studies in both OCI-LY3 and OCI-LY10 tumor bearing mice. Dose dependent tumor growth inhibition was observed in an OCI-LY3 xenograft model with improved anti-tumor activity also observed in combination with venetoclax and ibrutinib, which are approved BCL2 and BTK inhibitors, respectively. Our physics-based software platform helped to accelerate compound optimization in our MALT 1 program, enabling candidate selection in under two years. Data from our MALT 1 program will be presented at the upcoming American Society of Hematology meeting on December 5. In addition, targeting proteins that play important roles in DNA replication and replication stress is gaining momentum as a new class of anti-cancer therapeutics. Recent monotherapy data for third party clinical stage WEE1 inhibitors reported at ASCO and mechanistic studies for CDC7 published in Science Advances provide important validation for these targets. Preclinical in vivo PK/PD performance of our next-generation PLK1 sparing WEE1 compounds and CDC7 inhibitors relative to benchmark compounds lead us to believe that we are well positioned to achieve differentiated profiles and dosing regimens in the clinic. Target engagement data obtained during the last quarter with multiple of our CDC7 inhibitor chemical series triggered solid tumor and hematological xenograft studies that we expect will position us for future clinical combinations in both indication types. In the case of WEE1, we have observed robust PK/PD relationships including the PD biomarkers, phosphorylated CDC2, gamma-H2AX and phospho-Histone H3. Superior target engagement has been observed relative to clinical benchmark compounds in both OVCAR-3, a cyclin E amplified high grade serous ovarian cancer model and in A427 KRAS mutant non-small cell lung cancer-derived CDX model. From a pipeline perspective, we believe that novel and selective inhibitors identified across our programs over the last two years have significant potential as future monotherapy agents, and as part of combination regimens that include important mechanisms such as PARP inhibitors, BTK, BCL2 and KRAS inhibitors. We are on track to initiate GLP-tox studies and regulatory interactions, including pre-IND meetings with the FDA for at least one of our programs in the first half of 2021. As these programs advance and transition to the next stage of development, we also expect to initiate new programs. We have prioritized several new program opportunities with genetic support in human cohorts and emerging pharmacology data in oncology and immunology. In addition to strategic hires in preclinical and early clinical development, we have also expanded our drug discovery team, adding key seasoned immunology expertise. In summary, our diverse portfolio of collaborative and internal programs is rapidly advancing towards the clinic. Activities to support expansion of our pipeline into additional disease areas are well underway. We are extremely pleased with the overall progress and believe we have multiple value-creating opportunities ahead of us. I will now turn the call over to Joel.

Thank you, Karen. Hello, everyone. I'm pleased to be speaking with you today about our third quarter results. As Ramy mentioned, total revenue was 25.8 million in the third quarter, up 29% versus the third quarter of 2019. This performance was driven by software revenue of 22.9 million, an increase of 42% over the third quarter of 2019. The growth in software revenue reflects the continuing trend of increased adoption of our solutions by large customers as well as the addition of new customers. As was the case in the first half of the year, we experienced growth in both life sciences and material science. We continue to see strong uptake in live design, our enterprise solution for drug discovery. Live design integrates discovery workflows and can be especially powerful in fully remote work environments that many of us are still experiencing. In our drug discovery segment, we recorded revenue of 2.9 million in the quarter, down 24% versus the third quarter of 2019. As I've mentioned before, revenues in this segment will vary period-to-period, as they primarily depend upon the timing of achieving specific program milestones. As you heard from Karen, our collaborative programs are continuing to progress, Morphic’s alpha 4 beta 7 program entering Phase 1 being a great example. In addition to revenue from this segment, we recorded a non-cash equity gain of 18 million in the third quarter related to the successful IPO of one of our biotech equity holdings Relay Therapeutics, demonstrating how we continue to drive value from our collaborations and partnerships. Before shifting to the rest of the P&L, I'd like to point out that our deferred revenue balance at the end of the quarter was 21.7 million, an increase of 13% compared to the end of the third quarter of 2019. As a result of the strong revenue performance in the quarter, total gross profit was 15.3 million, an increase of 43% versus the third quarter of 2019. Software gross margin was 81% this quarter, unchanged from the third quarter of 2019. Operating expenses were 30.7 million for the quarter, up 40% versus the third quarter of 2019, primarily reflecting the continued investment in research and development for the advancement of our technology platform and support of our internal drug discovery programs, particularly our three most advanced programs that are approaching preclinical development. We're planning to take at least one of these programs into IND-enabling studies in the first half of 2021. G&A expense also contributed to operating expense growth relative to 2019 from increased costs associated with operating as a public company. Loss from operations was 15.4 million in the quarter versus 11.3 million in the third quarter of 2019, primarily as a result of the increased investment in research and development. As I mentioned earlier, our results this quarter include an $18 million non-cash gain from our equity stake in Relay Therapeutics reflected in the 18.7 million of other income. In the quarter, we recorded net income adjusted for non-controlling interests of 3.9 million versus a net loss of 11.5 million in the third quarter of 2019. Another important event in the third quarter was our follow-on public offering. We issued 5.25 million new shares for gross proceeds of 347 million, 326 million in net proceeds for the company, which resulted in third quarter ending cash and equivalents balances of 599 million, up 315 million from the second quarter of 2020. With regard to the business impact of COVID, we continue to experience no material impact to our business both in the quarter and year-to-date. Looking ahead, the same risks we've referenced previously with respect to our software sales remain, particularly if our existing or potential new customers come under extended budgetary pressures. On the drug discovery side, the pandemic could cause temporary delays in some programs. In any case, we do not envision a long-term impact from COVID on our ability to execute on our strategy. As we consider our performance in the third quarter and the year-to-date, we are very pleased with the execution across our business resulting in strong revenue growth, increasing collaboration equity value, progress in our internal and collaboration programs, continued scientific advancement of our technology and the successful IPO and follow-on financings that strengthen our balance sheet and provide strategic optionality. We believe we are better positioned than ever to deliver on our mission to transform drug discovery and materials design. With that, we would like to open the call to your questions.

[Operator Instructions]. Our first question comes from Do Kim with BMO Capital Markets.

Good morning. Thanks for taking my questions and congrats on the quarter. I was hoping if you could talk more about how you've been able to capitalize on the deeper engagement of the platform and converted to larger license agreements or new customers? And have you seen some of that conversion lately?

Yes. Hi. Thanks for the question. This is Ramy. So what's happened is really pretty extraordinary because, as you know, this is a field that's over 35 years old and for a large portion of that time, the field of using computers to calculate our predictive properties of molecules. And looking back, for much of that period, we were doing not much better than a random number generator. And as you know, in recent years, we've been able to really change that in a significant way. Now at a very large scale, something that was not imaginable just even a few years ago, we can compute the properties of a massive number of molecules. At the same time, we can actually, because we're using that software, produce the sort of validation that is getting out there and being recognized by these pharma companies. So, now what's happening is that there's very clear understanding and, again, validation of the technology. Now it's just a matter of scaling it up. And that's exactly – and this is now to your question, that's what's happening at these larger companies. They're scaling up the use of the advanced technologies and they have to scale up the use of the software that we've developed to be able to manage this huge amount of data. And that's live design, as you know. So how have we done it? It's kind of straightforward, right. It doesn't take a lot of marketing or a lot of convincing. You just look at the progress of the huge number of collaborative programs that continue to enter the clinic. As Karen mentioned, at least one of them. There are others. And as we continue to see the progress of our internal programs, it becomes very clear. That's a nice way of – that's a nicer way or a more convincing way of validating the technology than just sort of trying to convince people that some black box really works.

That's great. And then a question on the internal pipeline for Karen. When would you make a decision to move internal drug into clinical studies yourself? And what's your current capacity to take on that development in clinical programs? And would you need to start ramping up those capabilities?

Yes. Thanks for the question. Yes, indeed, as we've described, we are very excited about our programs. We think the profile of the preclinical packages supports the notion of taking these into initial clinical studies. In preparation for that, we have already begun to build the infrastructure and hire the people required to take these programs into the clinic. So we've hired a number of translational folks as well as starting to work on things like clinical operations and preclinical development. As you heard from Joel, we’ll be taking these programs forward and that means initiating GLP-tox and working with the FDA. So all of this is in motion and we're very pleased with the progress so far in that build.

Great. Congrats, again. Thanks for taking my questions.

Thank you.

Our next question comes from Michael Yee with Jefferies.

Hi, guys. Thanks for the question and congrats on a very solid quarter. Two questions. One was sort of following on the idea of the acceleration you're seeing. Are there any metrics or any data points to support the idea that customers are accelerating their use per license or more licenses per company, same-store sales types of metrics or average value of each license, maybe the idea that it's not just new customers but actually just a lot more utilization? That’s question one. And then question two is, you have talked about a potential partnership and I definitely get the sense that you really want to bring your stuff forward into the clinic yourself. A year ago, you looked back and there was sort of a guidance for a potential partnership this year. And I think consensus has a lot of an upfront maybe in this year as well in the fourth quarter. So can you just maybe talk to the idea that it definitely sounds like you want to move forward yourself and that we shouldn't be having milestone stuff or anything in the fourth quarter? Thank you so much.

Thanks, Michael. Joel, can you take the first question, the metrics question, and then I'll answer the second question.

Sure. Thanks, Michael. So yes, with regard to metrics around what's driving the growth, we look at the number of customers and we look at the amount of spend of our large customers and whether or not we're seeing increasing contract size driven by the number of licenses. What we can confidently say is that we are seeing a significant contribution coming from the increased adoption from large customers of the solutions. And so we are getting to some larger contract sizes and additional licenses. We'll report more on that at the end of the year.

Right. And then, Michael, regarding your second question, thank you for that. As you know, as Karen said it, we really are extremely excited about the progress that our internal programs are making. We are, as you heard, preparing to begin our first IND-enabling studies next year. Our decision to partner will be made on a program-by-program basis. We are considering opportunities to partner some of our programs preclinically, and of course, we plan to also take some of our programs into the clinic ourselves. So that's what we can say at this point.

Okay, great. Thank you.

Thanks, Michael.

And since there are no further questions at this time, this does conclude today's presentation. We thank you for your participation. You may all disconnect and have a wonderful day.

Thanks very much.