Schrodinger, Inc. Q1 FY2021 Earnings Call

Thank you for standing by. Welcome to Schrödinger Conference Call to review the company’s First Quarter Financial Results. My name is Kevin, and I’ll be your operator for today’s call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that this call is being recorded at the company’s request. Now, I would like to introduce your host for today’s conference call, Jaren Madden, Senior Vice President of Investor Relations and Corporate Communications. Please go ahead.

Thank you, and hello, everyone. Welcome to today’s call during which we will provide an update on the company and review our financial results for the first quarter of 2021. Earlier this morning, we issued a press release summarizing our financial results and progress across the company, which is available on our website at www.schrodinger.com. Here with me on our call today are Ramy Farid, President and Chief Executive Officer; Karen Akinsanya, Executive Vice President, Chief Biomedical Scientist and Head of Discovery R&D; and Joel Lebowitz, Executive Vice President and Chief Financial Officer. Following our prepared remarks, we’ll open up the call for Q&A. I would like to remind you that during today’s call, 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 our future financial performance, including our outlook for the year 2021, 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 relating to the COVID-19 pandemic, our expectations related to the use of our cash, cash equivalents and marketable securities, as well as our other 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. And with that, I’d like to turn the call over to Ramy.

Thanks, Jaren, and thank you everyone for joining us today. At Schrödinger, we have developed a computational platform that is transforming the way therapeutics and materials are discovered. The platform is enabling our customers and our internal drug discovery team to discover high-quality molecules for drug development and materials applications faster at a lower cost, and with, we believe, a higher probability of success compared to traditional methods. We license our platform to pharmaceutical, biotech and materials companies, and universities and government labs worldwide. We are also leveraging our platform in a number of drug discovery programs in collaboration with pharmaceutical and biotech companies. And we are advancing an internal drug discovery pipeline, which Karen will review shortly. As we look out at the next decade, we believe the increasing speed of computing, expanding access to high resolution three-dimensional protein structures, coupled with our platform’s ability to predict molecular properties with a high degree of accuracy, will allow us to broadly explore even greater chemical space, and ultimately, enable us to identify novel high-quality development candidates for a broad range of targets within as little as one year from program launch. Beyond the progress we are making across our internal drug discovery pipeline, we’re continuing to see exciting examples of the power of our platform and the potential for continued scale-up by the industry. In March, our collaborator Morphic Therapeutic reported promising clinical results from one of their integrin programs for the treatment of inflammatory bowel disease. We also recently expanded our collaboration with AstraZeneca to fully deploy our platform across all their structurally enabled discovery programs. We are making continued investments in the science underlying our platform to maintain our leadership position in physics-based computation and machine learning, focusing on increasing the accuracy of the predictions and expanding the domain of applicability to a wider range of therapeutic targets and industrial applications. We also continue to look for opportunities to make supercomputing even more accessible for our customers. Last month, we established a strategic collaboration with NVIDIA to further optimize our platform for one of NVIDIA’s key enterprise systems designed to enable companies to reach supercomputing power. As you’ll hear shortly from Joel, we are in a strong financial position, ending the quarter with cash resources of $649 million. This allows us to continue to invest in our science, invest in growing our software business, advance our internal pipeline and add new talent to support our strategic initiatives. We’re excited by the progress we’ve made so far this year across all aspects of our business. We are continuing to navigate the challenges of COVID-19 and are planning for a return to several of our offices in the fourth quarter. We appreciate the dedication of all our employees and we are optimistic about the ability to return to working together in person again. I’ll now turn the call over to Karen for an update on our drug discovery programs.

Thank you, Ramy, and good morning, everyone. We are continuing to make important advances on many fronts across our internal pipeline and portfolio of collaborative programs. We have collaborations with both small biotech and large pharmaceutical companies spanning a broad range of target classes and in these collaborations, we are leveraging our platform at the same scale we do internally. We believe this level of large scale deployment enables us to more rapidly identify high quality development candidates. We expect several collaborative programs to continue to advance in the clinic and new programs to enter the clinic this year. We have also made significant progress in our own internal oncology programs targeting solid tumors and hematological malignancies. Today, I will highlight three of our most advanced programs, MALT1, CDC7 and Wee1. Based on the strong data we have generated to date, we plan to move forward with IND enabling studies for these programs. Subject to completion of the preclinical data packages, we expect to submit up to three IND applications in 2022, with our first submission expected in the first half of next year. Starting with our MALT1 inhibitor program, today we announced we have selected a development candidate. To give you a sense of how we explored chemical space to identify a novel potent selected MALT1 inhibitor with favorable drug-like properties, our team triaged over 8 billion compounds, scored approximately 12,000 compounds using our most advanced multi-parameter optimization methods and synthesized just 78 molecules to identify those suitable for development candidate nomination within 10 months of program initiation. MALT1 has emerged as an interesting target because it is downstream of BTK in the NF KappaB signaling pathway. Constant activation of NF KappaB is a hallmark of several subtypes of lymphoma. We believe that inhibiting MALT1 could be an effective therapeutic strategy to treat certain relapsed or resistant B-cell lymphomas and chronic lymphocytic leukemia. In December, we presented preclinical data from our MALT1 inhibitor program at the American Society of Hematology annual meeting. We reported potent in vitro inhibition of MALT1 enzymatic activity and in vivo anti-tumor activity in mouse xenograft models of diffuse large B-cell lymphoma. Additionally, in in vivo mouse models, our MALT1 inhibitors demonstrated dose-dependent anti-proliferative effects in combination with ibrutinib and venetoclax, which are approved BTK and BCL-2 inhibitors, respectively. We are excited about evaluating the potential of combining our MALT1 development candidate with BTK or BCL-2 inhibitors in the clinic. Our GLP-tox studies are expected to begin shortly and we are beginning to make plans for Phase 1 studies in patients with hematological malignancies. We expect to share more details about the clinical study after the Phase 1 protocol is finalized. Now I’ll turn to CDC7 and Wee1, two programs that target cancer through replication stress and DNA repair mechanisms. CDC7 is a protein kinase that has been shown to be required in DNA replication initiation. CDC7 is thought to be linked to cancer cells' proliferative capacity and ability to bypass normal DNA damage responses. Targeting proteins that play important roles in DNA replication and replication stress is gaining momentum as a new therapeutic approach for cancer. Last month, we presented preclinical data from our CDC7 inhibitor program at the AACR annual meeting. Our compounds demonstrated dose dependent picomolar potency and were highly selective. They also showed synergy with several approved and investigational cancer therapies that modulate apoptosis, DNA repair mechanisms and DNA checkpoints. These compounds significantly inhibited tumor growth in mouse models of both acute myeloid leukemia and colorectal cancer. The data we have generated to date suggests that we have an opportunity to develop a best-in-class inhibitor with a very favorable pharmacokinetic profile. Our other DNA damage repair program targets Wee1, a tyrosine kinase regulator of the G2/M cell cycle checkpoint. The therapeutic objective of targeting Wee1 is to reduce cell viability by inducing G2/M phase arrest and apoptosis of cancer cells. Others have shown clinically meaningful tumor regression in uterine serous carcinoma, ovarian and other solid tumors through WEE1 inhibition. However, existing inhibitors have profiles that may make dosing and combination therapy more difficult. The design challenge in our program was to develop highly selective molecules in an effort to minimize off-target effects, limit drug-drug interactions and maximize the potential for combinations. We have identified multiple potent molecules that are highly selective for Wee1 and show strong pharmacodynamic responses and anti-tumor activity in vivo. Our molecules also have optimized drug-like properties, including no observable inactivation of CYP3A4, a key liver enzyme. We believe this profile limits the potential for accumulation and the need for dose adjustment of combination products. As these programs advance and transition into development, we expect to initiate new programs. We have prioritized several new program opportunities with human genetic support and emerging pharmacology data in oncology and immunology. We expect to launch these programs during the year. In summary, we have multiple programs advancing into GLP toxicology studies to enable IND submissions and the initiation of Phase 1 clinical studies next year. Activities to support the expansion of our pipeline into additional disease areas are well underway. We look forward to updating you on our R&D activities throughout the year. I will now turn the call over to Joel to review our financial results.

Thank you, Karen, and hello, everyone. This morning I’m pleased to discuss our financial results for the first quarter of 2021, and I’ll also review our outlook for the year. We reported total revenue of $32.1 million for the first quarter, up 23% compared to the first quarter of 2020. Software revenue was $26.3 million, representing 11% growth compared to the first quarter of 2020. The growth in software revenue was driven by increased deployment of our solutions, including FEP+ and live design, as well as growth in new customers. Drug discovery revenue was $5.8 million for the first quarter, compared to $2.4 million in the first quarter of 2020. Of note, drug discovery revenue this quarter included recognition of $2.2 million from a collaboration milestone related to the advancement of a preclinical program. We recognized this revenue one quarter earlier than anticipated. First quarter drug discovery revenue also included $2.4 million recognized from our collaboration with Bristol Myers Squibb. As a reminder, the BMS agreement, which we signed in November 2020, included a $55 million upfront cash payment, which we expect to recognize over a four-year period as we progress the BMS programs to development candidates. Gross profit was $16.2 million in the first quarter of 2021, up 3% over the first quarter of 2020. Software gross margin was 78% in the first quarter of 2021, compared to 83% for the same period in the prior year, reflecting our investment to support the rollout of large scale deployments of our platform. Operating expenses were $40.1 million, compared to $27.4 million in the first quarter of 2020, reflecting our investment in R&D to advance our technology and our pipeline, the addition of staff to drive long-term software sales growth and expenses required to support a public company infrastructure. Other income was $23.5 million versus a loss of $2.4 million in Q1 2020. During the quarter, we recorded $24.8 million of income from the mark-to-market of our shares in Morphic Therapeutic. As we mark-to-market our shares each quarter, we can experience significant fluctuations in the value of our holdings depending on stock price movements. We recorded a net loss after adjusting for non-controlling interests of approximately $29,000, compared to a loss of $13.8 million for the same period in the prior year. We ended the first quarter with cash, equivalents, marketable securities and restricted cash balances of $649 million, up from $643.2 million at the end of the fourth quarter of 2020. In March, we provided our financial outlook for the full year and today we are reaffirming that guidance. We expect total annual revenue in 2021 to be in the range of $124 million to $142 million, which includes software revenue of $102 million to $110 million and discovery revenue of $22 million to $32 million. We continue to expect software revenue growth to be higher in the second half of the year, with the majority of second half growth in the fourth quarter. Drug discovery revenue is expected to be highly variable based on the timing of potential milestones related to collaboration agreements. As we said before, we anticipate that operating expense growth will be higher than the 42% annual growth rate we saw in 2020, primarily driven by our commitment to fund R&D to advance our technology and our internal drug discovery pipeline. We also anticipate that software gross margin will be lower than the 81% reported in 2020, reflecting investment to drive and support large scale adoption by our customers. We are pleased with the progress we have made so far this year, particularly the advances we have seen across our collaborative programs and internal pipeline. We are also excited about the potential for large scale utilization of our software and drug discovery and material science applications. And finally, we have the resources to invest in our growth strategy across our business. I’ll now turn the call back over to Ramy.

Thanks, Joel. We’re excited about the significant impact our technology is having on our internal and collaborative drug discovery programs. It is exciting to see the power our platform has to advance the discovery of new therapeutics with the potential to improve treatment paradigms across a broad range of disease areas. We are also excited about the potential of our platform to impact sustainability initiatives across multiple industries. We have an exceptional team committed to advancing our vision and we look forward to providing updates on our progress throughout the year. At this time, we’d be happy to take your questions. Operator?

Operator Instructions. Our first question comes from Michael Yee with Jefferies.

Hey, guys. Good morning and thanks for the update. Maybe two questions for us. First, I guess, on software, I noticed that you maintain the guidance. We’re sort of into May now, you gave an updated think March 23rd and also in January. Do you get the sense that things are picking up? You feel more confident about the range of the guidance or the higher end, as it relates to either people getting back to work, COVID, the adoption, just all of those things, do you have any sense of how things are going, whether better or not here we are at the midpoint of the year. That’s question one on software as it relates to the guidance? And then question two, maybe for Karen or the team. You have a candidate now from MALT1, that’s fantastic. Do you feel you’d like to get these things in IND before you consider partnering? Is that kind of, okay, a line in the sand but kind of a good place to think about where is most optimal IND and greater, maybe just talked to that for MALT1 or something else? Thank you.

Joel, do you want to take Mike’s first question or…

Sure. Thanks, Ramy. Thanks, Mike. Good morning. We have maintained our guidance for the full year. In the last quarter, our performance was slightly above what we anticipated in March, achieving 11% growth compared to high single-digit expectations. Looking ahead, we reaffirm our outlook, which is important to consider. We expect higher growth in the second half of the year, particularly in the fourth quarter. Our assessment is based on customer interactions, renewal timings, and whether those renewals are on-premise or hosted, as this impacts when revenue is recognized. We also evaluate upsizing opportunities and the potential for new customers. At this point, we feel confident in the full-year guidance we provided and are maintaining it.

Karen?

Yes. Good morning, Mike. So, on our MALT1 program and others, as we’ve discussed in the past, we do plan to move these programs forward ourselves. And at this moment, we are looking towards IND opening studies next year, as we discussed in the call. However, we do stay very cognizant of the landscape. Each of these mechanisms, as you’re aware, for AACR and ACS, a lot of information coming out and we stayed in contact with potential partners. As you know, each of these mechanisms has the potential to combine with existing marketed agents and so we expect to see combination trials be a part of the clinical development program. And so we remain interested in the potential to benefit from those combination compounds. There are a number of ways to accomplish that, and so at this point, we are planning to open those IND studies ourselves and stay in touch with potential partners.

Great. Thank you guys. Appreciate that.

Thanks, Michael.

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

Hey, guys. Thanks for taking my question. I want to follow up on the last one on just real quick on the software pacing through the year. I want to make sure I think about this correctly, because I know this was a big point of debate last quarter and that was sort of as we started the year. Typically there is a little bit of seasonality or 1Q tends to be a little bit stronger than 2Q as far as software revenues go. Is that a fair way to think about that, just because I know that some of the comps last year with COVID could have been or would have been messed up? So I sort of confirm that a mild step down 1Q to 2Q software is appropriate and I’ve got a follow-up for Karen.

Sure, Mike. Good morning. So you’re right, we have seen that kind of seasonality in the past. And I think the thing is that we have guided to back half being higher growth during the first half and fourth quarter being the majority of that growth. So I think as you think about the pacing of the year, I think, it’s important to keep that in mind. Also, if you look at the performance in the first quarter, as I mentioned, it’s just slightly above what we had guided to in the first quarter in terms of high single-digit. So I think that, hopefully, that’s helpful in thinking about the pacing throughout the year.

Thanks, Karen. It seems you’re highlighting that, in addition to the three-week compounds in the internal pipeline, there are more potential candidates being developed, and you've started to see some promising results. I'm curious about the scope of that early pipeline. How many assets do you currently have the capacity to manage simultaneously, and how should we approach this as we look ahead?

Yeah. Thanks, Mike. So as we’ve described in the past, our capacity to run discovery programs, we can run around 20, 25 of these programs. Those are both in collaboration and a holding in pipeline. This year we’ve been really ramping up the team that’s looking at the earlier stage program, where we’re able to initiate a hit ID and hit to lead. And I would say that, right now, we have the capacity for around five steady state programs that are wholly owned and we intend to maintain that steady state over the next couple of years. And as the team grows, that gives us the ability to further expand our internal pipeline. Obviously, as these candidates move forward and into development, clinical development, our plan is to replace them. So, the team is very busy right now working on additional programs that you’ll be hearing more about in the future.

Okay. And one the last quick one for Joel, if I can squeeze it in, you had some comments in the prepared remarks on sort of going back to the office post-COVID, returning to normal operations. Should we be assuming any significant impact to the operating expense line, as we go into for cue from those activities or is it going to be a more gradual transition?

Thanks, Mike. We are planning to return to the office in the fourth quarter. We had this plan in place without knowing the exact timing at the start of the year, but as we mapped out our expenditures for the whole year. It will be a gradual transition as we return to the office. Other than being in the office, we are operating at full strength, so there shouldn't be much change in how we support our operations. Collaborating together again will be a welcome change. More significantly, variability in expenses will be driven by our R&D side, particularly the pacing and timing of our programs as they move towards clinical stages and the hiring throughout the year to enhance our capabilities for early clinical operations. Additionally, the timing of our CRO expenses will affect how we advance our internal programs. I believe these core operating metrics will have more impact than our return to the office at the end of the year.

Great. Thank you.

Operator Instructions. Our next question comes from Do Kim with BMO Capital Markets.

Hi. Good morning, everyone. I just wanted to ask about the expanded AstraZeneca collaboration. Could you provide a little more detail on that? How much of a step up in usage would AstraZeneca be involved in the platform? And what does the extension mean in terms of economics for Schrödinger?

Thank you for the question. This was a very successful pilot program, and it was encouraging to see its success and the subsequent rollout across the entire company. While we won't disclose the specifics of the agreement, it indicates both the short-term benefits of the expansion and its long-term potential. We have discussed the use of our software by pharmaceutical companies in relation to our internal collaboration, and this transition to a larger-scale deployment is a strong sign of our progress towards achieving the total addressable market for the software. We are excited about moving from a pilot stage to a broad deployment across all their programs.

Great. And you’ve talked previously about how Schrödinger has the ability to use their own software platform in an unlimited fashion. Could you quantify for us, how much it would cost an external company to construct the internal program that you have currently, just like terms of dollar figures, number of licenses that Schrödinger theoretically used?

Absolutely. That’s a good question. Currently, we're running around 20 to 25 programs, and this number is expected to increase as time progresses. Right now, the cost of the software to support these programs is approximately $30 million to $40 million, excluding compute costs, just focusing on software licenses. It's important to note that while we're discussing 20 to 25 programs, pharmaceutical companies usually have a greater number of programs, especially the larger ones. The remarkable aspect is that this number continues to grow rapidly. The performance and availability of computers, along with the availability of protein structures, a critical input for these methods, are increasing exponentially and have been for a considerable time. Currently, we are exploring hundreds of billions of molecules, up from a single-digit billion number a year ago. As computer performance and the number of programs continue to rise, that $30 million to $40 million figure will also increase. This reflects the current value.

Great. That’s very helpful. Karen, you previously mentioned that you expect some collaborations currently in lead optimization to progress into GLP-tox studies. Is that still your expectation for the next few quarters? Regarding the milestones you anticipate, will they result in cash payments or simply recognition of previous payments?

So I’ll say that, first of all, we don’t have full visibility into everything going on in all of our collaboration. However, we have seen and I think you’ve also seen the progress that’s being made in the programs that are described publicly, you’ve seen progress, for example, with Morphic, and we know that these programs that we’re working on with a variety of different partners are meeting their scientific milestones moving forward with regard to the data packages. So we continue to be very confident that these programs are going to move forward through the various stages of GLP-tox and including a number that are in IND enabling studies actually moving into the clinic with the data packages supporting that. So I would say that we remain confident about a number of these programs not just moving into the lead time, but to further milestones and dates. I would though turn over the question on the financial to Joel, if that’s okay.

Sure. If I misunderstood your question, please clarify. Regarding our discovery revenue, we have indicated this year that we expect growth in our full year guidance compared to last year. We also mentioned that as we advance collaboration programs, milestones typically increase in size, particularly with BMS, where we could potentially earn over $2 billion in milestones, approximately two-thirds of which are pre-commercial. We are excited about investing in and advancing these programs toward significant future milestones. As Karen noted, we are seeing progress in the pipeline. In the first quarter, we recognized $2.2 million from an early preclinical milestone one quarter earlier than expected, which is a positive indicator of the continued advancement of that specific program. Overall, we are witnessing broad advancements and are eager to continue growing this aspect of the business.

Great. Thanks for taking my question.

Thanks, Do.

Our next question comes from David Lebowitz with Morgan Stanley.

Thank you for taking my question. Can you explain the purchasing dynamics for a pharmaceutical company? What is the typical decision-making cycle? They typically make decisions on an annual basis, but do they also make incremental decisions throughout the year, or is it mostly a one-time annual decision followed by upgrades at the end of the cycle?

Most of our contracts are typically one-year agreements, so decisions generally occur annually. However, there are instances when companies realize mid-year that they are running out of licenses, which can lead to contract negotiations at that point. Typically, though, renewals happen once a year. Notably, in 2020, we experienced a significant increase largely due to external validation of our technology, fueled by the successes of Nimbus and Morphic alongside our internal programs. This led to broad adoption of our platform by many companies. Although renewal decisions are made annually, scaling up significantly can take longer than a year because the focus shifts to internal validation. This means that companies need to deploy the technology at a larger scale than before, which involves running calculations on the cloud. They must also conduct design tests and make iterations to gauge the technology's impact, which can extend the timeline beyond a year. This reflects how growth in the business occurs; it may not be entirely linear. While we have a clear trajectory, the path can be somewhat irregular.

Yes. It does.

Yeah. Great.

On the occasion, when a customer does add on incrementally during the year, would that add-on be a year-long contract or would it be to, I guess, to fit into the current contract and then conclude that in the fourth quarter? So if that’s when the contracts currently in and…

It really varies. Sometimes the contract starts and coincides with the earlier contract. Just as often, it’s a new contract where there are two duals in the year that are later merged. There are many different ways this can happen. Sometimes it’s six months, sometimes three months, nine months, or even a little over a year. There’s quite a bit of variability.

Thank you very much for taking my questions.

Sure.

Thank you. There are no further questions. Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect.