Earnings Call Transcript - SDGR Q2 2023

Operator, Operator

Thank you for standing by. Welcome to Schrödinger's Conference Call to review Second Quarter 2023 Financial Results. My name is Chris, and I will be your operator for today's call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, 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, Ms. Jaren Madden, Senior Vice President Investor Relations and Corporate Affairs. Please go ahead.

Jaren Madden, Senior Vice President Investor Relations and Corporate Affairs

Thank you, and good afternoon, everyone. Welcome to today's call during which we will provide an update on the company and review our second quarter 2023 financial results. Earlier today, we issued a press release summarizing our financial results and progress across the company, which is available on our website. Here with me on our call today are Ramy Farid, Chief Executive Officer; Geoff Porges, Chief Financial Officer; and Karen Akinsanya, President of R&D Therapeutics. Following our prepared remarks, we'll open the call for Q&A. During today's call, management will make statements that are forward-looking and made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, including, without limitation, statements related to our outlook for the full-year 2023, our quarter ending September 30, 2023, our plans to accelerate the growth of our software business and advance our collaborative and proprietary drug discovery programs, the timing of initiation of and readouts from our clinical trials, the clinical potential and properties of our compounds, the use of our cash resources as well as our future 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 due to a number of important factors, including the considerations described in the Risk Factors section and elsewhere in the filings we make with the SEC, including our Form 10-Q for the quarter ended June 30, 2023. These forward-looking statements represent our views only as of today, and we caution you that except as required by law we may not update them in the future, whether as a result of new information, future events, or otherwise. Also included in today's call are certain non-GAAP financial measures. These non-GAAP financial measures are not prepared in accordance with Generally Accepted Accounting Principles and should be considered only in addition to and not a substitute for or superior to GAAP measures. Please refer to the tables at the end of our press release, which is available on our website for reconciliations of these non-GAAP measures to the most directly comparable GAAP measures. With that, I'd like to turn the call over to Ramy.

Ramy Farid, CEO

Thanks, Jaren, and thank you, everyone, for joining us today. This is an incredibly exciting and pivotal time for computationally driven drug discovery. The heightened interest in this field is undoubtedly driven by the promise that computers and in particular artificial intelligence can increase efficiency across the R&D continuum and deliver more drugs to patients faster. At Schrödinger, we have developed powerful physics-based methods and integrated them with the most advanced machine learning methods of artificial intelligence to accelerate discovery of higher quality molecules for both therapeutics and materials. Our leading platform is used by thousands of companies and research institutes worldwide. We extensively publish our underlying scientific advances and we now have numerous success stories that have convincingly validated our approach. Eleven of the molecules we have discovered with our collaborators or independently are currently in the clinic, which includes two wholly-owned molecules. We continue to heavily invest in advancing our computational platform to solve grand challenge problems in drug discovery and materials design. We have made excellent progress during the first half of the year. For the second quarter, we reported total revenue of $35.2 million, which was in line with our expectations. With respect to software revenue, we are in active discussions with more than a dozen global biopharma software customers about multi-year, multi-million dollar contracts. We are confident about our software revenue outlook for the year given the stage of these discussions, the number of them, and the enthusiasm we are seeing from our customers to deploy our platform on their discovery programs at scale. In fact, our confidence in these opportunities has led us to increase our software revenue growth guidance for the year to 15% to 18%. As Geoff will describe shortly, we are reducing our 2023 outlook for drug discovery revenue. This adjustment primarily reflects expectations that some milestones previously anticipated in 2023 have shifted to 2024. As you will hear from Karen, we continue to make significant progress on our proprietary pipeline. Our two Phase 1 studies for our MALT1 inhibitor SGR-1505 are ongoing, and today we announced FDA clearance of our IND for our CDC7 inhibitor SGR-2921. With our proprietary pipeline advancing, we have expanded our leadership team with the addition of Margaret Dugan as Chief Medical Officer. Margaret brings more than 25 years of pharma experience and will be responsible for clinical development and regulatory strategy for our pipeline of wholly-owned programs, and we look forward to her contributions. We've made considerable progress in the first half of the year and we are very excited about the opportunities that lie ahead in the second half of the year. I greatly appreciate the dedication and hard work of all our employees who are critical to achieving our mission. I'll now turn the call over to Geoff.

Geoff Porges, CFO

Thank you, Ramy. Good afternoon, everyone. Schrödinger had a solid quarter in Q2 that met our expectations. Our pipeline advanced significantly and we continued building the breadth and capabilities of our organization. We managed our expenses and capital carefully and are very well-positioned to invest in the active development of our computational platform and the exploration of the full potential of our proprietary pipeline. Our company is at the center of a revolution in the capabilities of computation to discover novel medicines, and we're engaged with our largest customers, partners, technology companies, and new entrepreneurs to capitalize on the opportunities presented by that revolution. Our Q2 software revenue was in line with our expectations, and our results reflect the relatively limited renewal opportunities among our largest customer accounts in the period coupled with stable trends in other markets and segments. Our drug discovery efforts continue to evolve from mainly collaborations to a balance between collaboration projects and our proprietary portfolio. We have increased our software revenue guidance based on the prospects for new or increased large-scale technology deployments we expect to contribute meaningfully to revenue in the second half of the year. We have lowered our drug discovery revenue guidance for the year, reflecting our new expectations for the timing of milestones and for the contribution of new business development activity. We are not including any revenue contributions from partnering any of our most advanced programs in that guidance. We continue to advance discussions about new collaborations with some of the largest and most innovative companies in the industry, and those collaborations could contribute significant near and long-term value if successful. Let me turn to the financial results for the quarter. Software revenue for the quarter was $29.4 million, which was 2% below Q2 2022. There were several services contracts that contributed revenue to Q2 2022, including our Gates battery research project that had lower contributions in Q2 2023. We expect the Gates Ventures contract to be renewed at an increased level in Q3. Hosted software grew faster than on-prem during the quarter, driven by new contracts with hosted licenses implemented in prior periods, and providing continuing revenue this quarter. Drug discovery revenue for the quarter was $5.8 million compared to $8.5 million in the same period in Q2 2022. The drug discovery revenue result was affected by the expected timing for achievement of development milestones in collaborations. The timelines and costs for the achievement of certain milestones in our collaborations are exceeding our prior estimates, which resulted in a reduction in the amount of deferred revenue we recognized this quarter for those programs. Total revenue was $35.2 million compared to $38.5 million in the same period a year ago, mainly due to lower drug discovery revenue in the quarter. Cost of revenue was $21.4 million for the quarter and was similar to the cost of revenue from the same period in 2022. Our software gross margin was 77% and is consistent with our expectations. The cost of our drug discovery activities was similar to the prior year and increased compared to the prior quarter, driven by royalty payments and higher CRO expenses for partner programs. Gross profit decreased from $17.1 million in Q2 2022 to $13.8 million in Q2 2023, based on lower drug discovery revenue, and our gross margin declined from 45% to 39% for the quarter. Total operating expenses were $75 million compared to $61 million in the same quarter a year ago and $76 million in Q1 2023. R&D was $42.7 million and increased by 37% from $31 million in Q2 2022, and was 5% higher than the $41 million we reported in Q1 2023. The increase was driven by increased headcount to support the development of our platform, the redeployment of our discovery organization towards proprietary programs, and building the capabilities and scale of our drug development organization. CRO expenses increased significantly year-over-year driven by the progress of our existing programs and the addition of new programs to our portfolio. Technology spending also increased as our discovery portfolio broadened and advanced. We expect our R&D expenses to increase through the year as we progress the most advanced programs in our portfolio into clinical development and increase our investment into our earlier stage molecules and programs. We intend to outline the progress and potential of the most advanced programs and also discuss the earlier programs at our first Schrödinger pipeline later this year. During the quarter, our sales and marketing expense was $9 million and increased by 21% compared to prior year Q2 and was flat compared to Q1 this year. The year-on-year increase was mainly due to increased staffing to support our geographic expansion to commercialize into new industry verticals and to support our growing number of global accounts. We foresee our sales and marketing expenses offering significant operating leverage from these levels. Our G&A expense was $23 million in Q2, which is an increase of 5% compared to Q2 2022. This increase was due to high headcount and lease expenses offset by savings in certain external services. G&A was lower in Q2 compared to Q1 due to lower one-time costs associated with the Nimbus distribution in Q2. We expect quarterly G&A to be relatively stable through the balance of 2023. Overall, our loss from operations was $61.1 million in Q2 compared to $43.5 million in Q2 2022, and $30.5 million in Q1 2023. Other income items were significant during the quarter, reflecting changes in the value of our equity investments in structure therapeutics Morphic, adjustments to estimated tax liabilities from prior periods, and interest income. Change in fair value of equity investments was $40.7 million. Other income including interest was $4.3 million and we reported tax benefit of $20.4 million as an adjustment to the full-year tax estimate that was applied in Q1. Overall, total other income was $45 million and compared to a loss of $4.2 million in the same period in 2022. As a result of these items, we reported GAAP net income of $4.3 million for Q2 compared to a net loss of $47.7 million in the same period a year ago. This translated into net earnings of $0.06 per basic and diluted share compared to a loss of $0.67 in Q2 2022. Our non-GAAP net loss for the quarter was $56.8 million and cash used in operating activities during the quarter was $18.4 million, compared to cash used in operations in Q2 last year of $24.7 million. Year-to-date, our cash used in operating activities was $49.5 million. As of June 30, 2023, we reported cash and marketable securities of $554 million, compared to $532 million at the end of March 2023. Our accounts receivable declined significantly as we collected on milestone payments, software contracts, and other receivables during the quarter. As I mentioned earlier, we are updating our revenue guidance for the year. We are raising our software revenue guidance for the year from 13% to 17% growth to 15% to 18% growth. This increase is based on the number and value of the large renewals we expect in the second half of the year, particularly in Q4. For Q3, our software revenue guidance is $27 million to $31 million. Based on the timing of milestones and anticipated business development activity, we are lowering our drug discovery revenue guidance from $70 million to $90 million to $50 million to $70 million. While there are scenarios in which our realized discovery revenue is higher than the new range, we now believe that the probability of those higher scenarios being realized is low. We anticipate that most of the milestones associated with this change in guidance will now be achieved in 2024. We continue to expect operating expense growth this year to be significantly lower than operating expense growth last year and anticipate that our operating cash burn this year will also be lower than last year. We continue to expect our cash position at year-end to be above our cash position at the start of the year. I'll now turn the call over to Karen.

Karen Akinsanya, President of R&D Therapeutics

Thank you, Geoff, and good afternoon, everyone. In line with our strategy to build a growing pipeline of discovery and development assets, we have made important progress during the first half of this year. In addition to the nine molecules designed using our computational platform that have transitioned to the clinic through collaborations, our clinical stage wholly-owned programs now include MALT1 and CDC7 and our WEE1 inhibitor program is on track for an IND submission next year. Our immunology programs are also advancing and we expect to select our first development candidate in this therapeutic area in 2024. The increasing number of potentially first-in-class or best-in-class investigational medicines speaks to the power of the platform and provides us with an opportunity to advance molecules through proof of concept to create additional value. With a growing clinical stage portfolio, this was the right time to hire a Chief Medical Officer. This week, we welcomed Margaret Dugan to our team. And as CMO, Margaret will oversee clinical development and regulatory strategy for our wholly-owned programs. Margaret is a Board-certified Medical Oncologist and Hematologist with more than 30 years of clinical medical research and drug development experience, including serving as the Global Program Head for Novartis Oncology. We are very pleased to welcome her to the team and look forward to the insight she will bring. Turning now to our wholly-owned programs. We are pursuing a global development strategy to build our safety pharmacokinetics, pharmacodynamics, and preliminary anti-tumor data activity package for SGR-1505 our MALT1 inhibitor. In addition to adding clinical sites in the U.S. to our ongoing Phase 1 study in patients with advanced B-cell malignancies, we also expect to open sites in Europe this year to support our recruitment objectives. We are conducting a Phase 1 healthy volunteer study designed to generate additional data on the profile of SGR-1505. We plan to leverage the data from these pharmacology assessments to inform our ongoing and planned trials in B-cell malignancies and potentially other indications. We designed and optimized SGR-1505 to improve on the properties of previously described MALT1 inhibitors. Emerging preliminary data from the healthy volunteer study informs our assessment of the pharmaceutical properties of SGR-1505 and points to once-daily dosing, well-behaved pharmacokinetics and evidence of pharmacodynamic activity that support further development. We are really pleased with the progress we are making and look forward to sharing additional results at medical meetings and investor events. Moving to our CDC7 program. Today, we announced IND clearance for SGR-2921. Our preclinical data package demonstrates that SGR-2921 exhibits strong monotherapy and combination anti-tumor activity in multiple preclinical patient-derived AML models independent of genetic drivers and resensitizes AML models to standard of care agents such as FLT3 inhibitors. Activities are already underway to open clinical study sites globally this year. The Phase 1 study is designed to evaluate the safety pharmacodynamics and establish a recommended dose of SGR-2921 in patients with acute myeloid leukemia or myelodysplastic syndrome. Once the recommended dose is determined, we intend to evaluate SGR-2921 in combination with approved AML and MDS treatments. Earlier this year, we selected our WEE1 development candidate SGR-3515, which has shown durable anti-tumor activity in preclinical models used to study more advanced WEE1 inhibitors. Clinical data from another WEE1 program presented at a medical meeting earlier this year continues to validate WEE1 inhibition as a therapeutic strategy in several forms of cancer with high unmet need, including uterine and ovarian cancers. We are excited about the profile of SGR-3515 and believe it may offer advantages over prior inhibitors including lower risk of drug-drug interactions and off-target activity. Furthermore, our collaboration with MD Anderson has resulted in the identification of potential synthetically fatal relationships and sensitive tumor types, which help inform our Phase 1 trial design. We are continuing to characterize SGR-3515 as we move through IND enabling studies to support an IND submission to the FDA next year. Beyond these three programs, we are working on a number of undisclosed programs in oncology, immunology, and neurology at various stages of discovery. We're continuing to initiate new programs that we may elect to partner or advance independently to key value inflection points. We also announced today that for strategic reasons Zai Lab has elected not to advance their discovery collaboration with us to the next stage of development. In the two years of the collaboration, the joint team has made substantial progress towards the technical goals for this complex target. The program is now wholly-owned by Schrödinger. In summary, we are very pleased with the progress we have made this quarter and expect continued advancements across our pipeline in 2023. Our Pipeline Day is now scheduled to take place in December given the timing of data availability, abstract submission and embargo periods associated with medical meetings, and we look forward to providing a more detailed update on our pipeline at that time. I will now turn it back over to Ramy.

Ramy Farid, CEO

Thank you, Karen. As you heard, we've made excellent progress across the business this quarter, and we look forward to updating you on the opportunities that lie ahead in the second half of the year. At this time, we'd be happy to take your questions.

Operator, Operator

Thank you. Our first question is from Michael Yee with Jefferies. Your line is open.

Michael Yee, Analyst

Hey guys, thank you for the opportunity to ask some questions. We have two. On the revenue side, can you just reemphasize or clarify what you are seeing on the software part? I think I heard you say multiple big companies talking multi-year deals, and so that's the positive on the software part, but on the drug discovery part, I heard a lot of comments around timing of milestones. I would say $20 million guidance change is not small. So what exactly was going on there? And then, my question for Karen is on the MALT1, it sounded like you were making quite good progress on the Phase 1 including on the healthy. Can you just remind us how much progress you have there? And if you've been dosing patients and you're not seeing anything, so you feel quite good about safety so far? Thank you.

Ramy Farid, CEO

Thanks, Mike. This is Ramy. I'll answer the first couple of questions; ask Geoff if he wants to add anything, then I'll hand over to Karen. So with regard, that's correct. With regard to the software guidance and the increase, that is the result of real confidence we have in the quality and the number of multi-million dollar and multi-year contracts with quite a number of large companies. Given the stage of these discussions relative to what it was like in previous years, we're about how those are going and that's given us the confidence that's required to increase the guidance. We think this is coming from just the overwhelming validation of the platform coming from success in the structure and BMS and Morphic and even our own programs. I think that must be contributing to the quality of the discussions and the clear desire by quite a number of companies to use the different platform. With respect to the drug discovery revenue, I'll hand it over to Geoff.

Geoff Porges, CFO

Yes. There are several factors influencing the change in the drug discovery guidance. We need to concentrate on collaborations that involve programs beyond our control, and it can be challenging to obtain updates on their progress. We have taken a careful approach with this revision, aiming to estimate when certain milestones will be achieved. Another factor is the ongoing collaborations where our project teams are engaged. In some instances, we need to modify timelines based on program costs; changes in milestone results can affect the anticipated revenue for future quarters. Additionally, we are trying to project new business development activities, including their potential revenue contributions. As you may know, revenue recognition rules can impact when we can account for contributions, even from deals that we may finalize, and there is always uncertainty regarding the timing of closing those transactions. Therefore, we felt it was wise to adjust the guidance at this time.

Karen Akinsanya, President of R&D Therapeutics

And then on SGR-1505, hi Mike, we are pleased with the progress we're making on this program. We have an open, healthy volunteer study, and we are beginning to see data from that study. And it's suggesting to us that we have an attractive profile. We have gathered some PK/PD data, and so far the data is suggesting that we have a well-behaved compound with well-behaved PK and evidence of pharmacodynamic activity on the patients that are being dosed both here in the U.S. and globally. We're pleased with the progress we're making; so far so good on SGR-1505.

Operator, Operator

The next question is from David Lebowitz with Citi. Your line is open.

David Lebowitz, Analyst

Thank you very much for taking my question. With respect to the change in guidance on the partnership and drug discovery businesses, would you view it as appropriate for us to take the incremental shift we do and just move it to next year and place it on top of what our prior expectations were for next year? Or would there be a more nuanced way to adjust?

Geoff Porges, CFO

Yes. Dave, I think I don't want to model, but I would say that we're pretty clear that most of the milestones that we have taken out of this year's guidance we expect now to occur next year. Clearly, that's a milestone that we don't anticipate growing in the future, but that's only a relatively small component.

David Lebowitz, Analyst

Got it. And on achieving enrollment objectives in the Phase 1 MALT1 trial. Has the pace shifted from earlier this year to this point, or do you really need the European sites to come on board for the pace to catch up to where you expect your expectations?

Karen Akinsanya, President of R&D Therapeutics

Yes. Hi, yes indeed, we are opening more sites because we believe that's going to help us with our enrollment objective. We're seeing and have spent time with investigators actually globally now, and there's a lot of interest in the trial. And so we do think that additional sites in Europe will help with enrollment goals that we have.

David Lebowitz, Analyst

Any thoughts on when we might see data from the patients, the DLBCL patients?

Karen Akinsanya, President of R&D Therapeutics

We're not guiding anything specific right now. I think 2024 we're ready to share any data from the patient study.

Operator, Operator

The next question is from Evan Seigerman with BMO Capital Markets. Your line is open.

Evan Seigerman, Analyst

Hi guys, thank you so much for taking my questions. One on kind of the Zai Lab partnership. Any color as to why they pulled out of the collaboration? Was there something on the data or is it just the refocusing of their pipeline priorities? And just the bigger picture question for me, with all the interest in AI these days, how are you working to keep your narrative focused that you are a software company, but also a drug development company to not get ahead of yourself? I know that's a common question that comes up, but would love to hear if you have any updated thoughts there. Thank you.

Karen Akinsanya, President of R&D Therapeutics

So first along the Zai collaboration. So Zai did elect not to advance the discovery to the next stage of development. We understand that's for strategic reasons. Obviously, the collaboration was going well; the team was making great progress, but Zai elected for strategic reasons to discontinue the program.

Ramy Farid, CEO

Oh, I'm sorry. I didn't catch the other part. Could you please repeat that?

Geoff Porges, CFO

Could you repeat the question Evan about AI?

Evan Seigerman, Analyst

Yes, for sure. So the question was kind of taking a step back with all the hype in AI, how are you controlling the narrative so that investors and folks interested in Schrödinger are not getting ahead of themselves when it comes to what you're working on and kind of how you manage the business in terms of your software platform, but also your drug development platform?

Ramy Farid, CEO

Yes. I think there's a really clear answer to that, which is what we've been doing for the last 33 years, which is just avoiding hype and just talking about the platform and the technology and what it can and cannot do in a completely rigorous and accurate way. And I think we've gained that reputation of doing that, publishing all the advances we make, we review journals, we have people using the software and validating it with their own publications. I think as long as we avoid just using words that think people hear, which is the definition of hype, and we talk about the science in a rigorous way. We're able to differentiate ourselves; I think from a number of other companies in this space.

Operator, Operator

The next question is from Vikram Purohit with Morgan Stanley. Your line is open.

Vikram Purohit, Analyst

Hi, good afternoon. Thank you for taking our questions. I have two questions. First, can you clarify the drug discovery revenue guidance for this year, which is between $50 million and $70 million? Does this figure include any future considerations or is it purely dependent on partnerships? Secondly, regarding MALT1, as you approach the initial data set from healthy volunteers and progress through the patient study, how do you view potential partnership opportunities for this program as well as your other lead proprietary programs? When do you believe would be the right time in the development phase to seek partnerships? Thank you.

Geoff Porges, CFO

So let me answer the question on the drug discovery guidance. There is a very small amount of potential DD part to that forecast of that guidance. The reason it is now small is because of the likely revenue that we could report in the second half of the year even if we close the transaction. So there isn't a huge amount riding on closing additional deals. That being said, we are engaged in very active discussions as we are at any at all times about both collaborations and about proprietary assets. It's not suggesting anything should be viewed as imminent, but we are with everybody in the industry. Of course, those discussions were ongoing. Karen, do you want to chime in about strategy on MALT1?

Karen Akinsanya, President of R&D Therapeutics

Yes, certainly. Regarding the healthy volunteer study, we are compiling data that will provide more insight into the compound's profile. We are pleased with the pharmaceutical properties we've observed, including pharmacokinetics and pharmacodynamics, which will inform our strategy moving forward. We are exploring opportunities in oncology and believe this mechanism may also have potential in other areas. The healthy volunteer trial positions us to pursue various directions with this asset. As for your second question about partnering, we are exploring possibilities with our mature and early programs, particularly with SGR-1505. Earlier this year, there was a monotherapy published at EHA and ICML for another molecule, which we believe supports MALT1's potential. We think there are opportunities for MALT1 in combination with BTK inhibitors and other standard or emerging treatments for B-cell malignancies. We are actively pursuing partnerships with companies that have these assets available. Additionally, to advance those combination studies, access to the necessary drugs will be essential, and we are focused on exploring those opportunities.

Operator, Operator

The next question is from Matt Hewitt with Craig-Hallum. Your line is open.

Matt Hewitt, Analyst

Good afternoon. Thank you for the questions. First, could you clarify regarding the software? Ramy, in your prepared remarks, you mentioned that you are in discussions with over a dozen multinational pharmaceutical companies for multi-year, potentially multi-million dollar contracts. Are these new customers or expansions with existing ones?

Ramy Farid, CEO

Yes, that's a good question. It primarily involves existing customers, as we are already working with nearly everyone in the industry, as Geoff mentioned. In fact, all of these discussions are with current customers who have already gone through several steps of increasing their usage. They are very familiar with the technology and are already experiencing its benefits, which is leading them to scale up even further. This is certainly very encouraging.

Geoff Porges, CFO

We are considering large scale-ups, and it's encouraging to see that established biotech companies are relying on our software for their drug discovery efforts. They are recognizing the real benefits and are in discussions with us about increasing their utilization. I want to emphasize that it's not just global pharma companies benefiting from the technology in accelerating drug discovery; biotech companies are finding it helpful as well.

Ramy Farid, CEO

Yes. That's a great point. Yes.

Matt Hewitt, Analyst

That’s really helpful. And then go ahead.

Geoff Porges, CFO

We are considering some large scale opportunities and it's encouraging to see that established biotech companies are using our software for drug discovery and experiencing significant benefits. They are also in discussions with us about increasing their usage. I want to clarify that it's not only global pharma companies finding our technology valuable in accelerating drug discovery; biotech companies are benefiting as well.

Matt Hewitt, Analyst

Can you hear me?

Ramy Farid, CEO

Oh, no, no. Just a second. Can you say that again?

Matt Hewitt, Analyst

Can you guys hear me okay?

Ramy Farid, CEO

Yes, we can hear you. We may have encountered a technical issue on our side. I apologize if you were speaking.

Matt Hewitt, Analyst

No, that's okay. I guess the follow-up here is, we've already heard from a number of companies so far this earning season that, given the weak funding environment, which was originally impacting small pharma and small biotech, has now expanded to larger pharma and larger biotech companies that are slow to move through their contracting phases. What I'm hearing from you is that not only is this not happening, but you’re actually experiencing growth. So my question is, what do you think is the reason for this difference? Is it the AI and machine learning component that is generating excitement and leading to those new contracts? Or is there something else? Thank you.

Ramy Farid, CEO

Yes, we believe it's more than just that. They're experiencing tangible effects. They are now recognizing that they are producing fewer compounds while also increasing the probability of success. They are witnessing the benefits of utilizing the technology. As we've discussed previously, the combination of physics-based methods with machine learning is influencing real projects they are engaged in. If they're noticing an improvement in efficiency in drug discovery, that will naturally drive motivation; it's not merely hype. It's not just because the platform is linked to AI that it would be a temporary trend. This is something much more substantial.

Operator, Operator

The next question is from Gaurav Goparaju with Berenberg Capital Markets. Your line is open.

Gaurav Goparaju, Analyst

Hey guys, thanks for taking my questions. First one, assuming CDC7 and WEE1 reached the clinic while MALT1 is still in your hands, do you think you have the bandwidth and resources to support internal clinical development for three programs in addition to launching and advancing new proprietary discovery stage programs?

Karen Akinsanya, President of R&D Therapeutics

Yes. Thanks for the question. So yes, we have now an, as you know, ongoing SGR-1505 trials in Phase 1. We have our IND accepted for CDC7, and we have been preparing to bring that molecule to the clinic over the last six to nine months. So we are on track with regard to planning for those programs. And WEE1, as you know, is going to transition. We expect it to transition next year. Everything's going as according to plan. So we have been planning for this obviously over the last few years, the fact that our molecules will transition into the clinic. So as you heard today, we've just brought on Margaret Dugan who will be working closely with our teams not just on the execution of the existing programs, but also building up this capability at Schrödinger to manage these clinical stage programs. And as far as discovery is concerned, you're aware that we have a significant number of programs in motion these last for a couple of years, three years, and then we replace those. So we think that the bandwidth in discovery is good and we are preparing right now and in the future to bring our programs to the clinic. So we feel well prepared.

Gaurav Goparaju, Analyst

Awesome. Thanks. And then just a quick follow-up also related to the same topic. So as you increase the number of internal programs into the clinic, do you expect to pull back any tech platform investment or do you feel you have the bandwidth to support both efforts? Just looking to see where your capital allocation priorities will stand as internal clinical development activities escalate. Thanks.

Geoff Porges, CFO

Yes. Good question, Gaurav. You're correct. We are making a significant investment in our platform. We're focusing heavily on discovering proprietary medicines, as well as advancing the most advanced of those medicines. At this point, we have no plans to reduce our investment in technology. One reason we are well-positioned with our customers is our commitment to innovation. We are actively investing in our physics-based methods, machine learning, and enterprise informatics platform. We continue to introduce new features every quarter through updates that enhance our software's utility and set us apart from competitors. We are not pulling back on our investment in discovering new medicines, and we are excited about the potential to advance our existing programs. However, looking ahead, our growth will likely stem from advancing our proprietary medicines rather than the other areas, where we plan to maintain investment.

Gaurav Goparaju, Analyst

Nice. Got it. Thanks for the color, Geoff. I appreciate it, guys.

Ramy Farid, CEO

Thanks.

Operator, Operator

The next question is from Michael Ryskin with Bank of America. Your line is open.

Michael Ryskin, Analyst

Thank you for taking my question. I have a couple of inquiries. First, I want to follow up on what you just mentioned, Geoff, regarding your investment focus going forward. You mentioned the internal pipeline. Regarding drug discovery and collaborations, considering the update today and your comments about some collaborations taking longer to generate revenue, is there a desire to initiate new collaborations to expand that area? If your current collaborations are progressing slowly, are you interested in pursuing more to balance that out, or is your priority mainly on the internal pipeline?

Geoff Porges, CFO

Just with respect to the collaborations, you are right. And we've signaled this the last couple of quarters, Mike, there is a transition going on in where we're allocating capital between the collaborations and the proprietary programs. And we are lucky that we have such a good balance sheet that we have an opportunity to put more skill in the game with our own programs. That being said, we are not walking away from collaborations. We're completely committed to those that we have. But as you can see with the news, for example, from Zai that leaves us a little bit more dependent upon the internal decision making and changes that might occur in the collaboration partners. So we do think that there are opportunities for additional collaborations. We do believe that we have bandwidth to take on a very small number of additional collaborations. I've alluded to some of the business development discussions that we're having. Those remain very active, but of course, we're going to be very selective about them. We're going to go after targets that we think our technology is going to be effective at enabling and where we think that we have attractive economic terms. And of course, with the validation of our technology, there are opportunities for those terms to continue to improve.

Michael Ryskin, Analyst

Thank you for the information. I appreciate your insights. It seems you're not just pursuing a number for the sake of it. My second question relates to software revenues and your software guidance, along with your comments about ongoing negotiations with customers. I want to ensure I understand this correctly. If most of these customers are existing ones, many of whom are already under multi-year contracts, if a majority or all renew later this year, it appears that you're suggesting this will primarily occur in the fourth quarter since you're guiding to flat sequential revenues. Your fiscal year guidance indicates approximately $29 million in software revenue for the third quarter and $67 million for the fourth quarter, which represents a significant increase to reach the midpoint of your forecast. If that renewal happens in the fourth quarter, could that potentially leave a gap next year? If customers scale up now instead of next year under a multi-year contract, they wouldn’t need to renew in the fourth quarter of 2024. Am I understanding this correctly?

Geoff Porges, CFO

You are thinking about it correctly, Mike. First, there are some multi-year contracts from previous periods that will be renewed in the fourth quarter. We've shared that information in the past, and our software has a very high retention rate, so we expect those contracts to be renewed. We are very optimistic about the discussions we are having with customers and the potential to increase the deployment of our technology beyond what we had in the previous contracts, which is contributing to our expectations for the fourth quarter. As for whether this creates a gap for next year, we can address that later. I'm not providing guidance for next year, but we are aware of the potential volatility from this situation, and it's on our minds. While I don't want to offer further guidance for next year, we do see additional opportunities to expand the deployment of our technology next year, as well as this year.

Ramy Farid, CEO

Yes, we have more than 12 customers.

Michael Ryskin, Analyst

Yes, yes, yes. I'm exaggerating of course. I totally get that but…

Ramy Farid, CEO

No, no, no. And I didn't mean to be surprised, but that's exactly right.

Michael Ryskin, Analyst

No, you're absolutely right. Okay. All right. Appreciate it. Thanks, guys.

Ramy Farid, CEO

Thanks.

Operator, Operator

The next question is from Joseph Catanzaro with Piper Sandler. Your line is open.

Joseph Catanzaro, Analyst

Hey everybody, thanks for taking my questions here. Maybe two for me on the clinical side of things. I know you've said a couple of things on the MALT1 healthy volunteer experience, but I was wondering if you could say how long you're dosing the healthy volunteers for and whether you think that's long enough to give you a sense of whether you're avoiding some of the safety liabilities that we've seen with other MALT1 inhibitors. And then second question on the immunology side of things for your first candidate in 2024, should we think of that as a target with clinical proof of concept where you think there's opportunity for best-in-class or rather one where there's opportunity to be first-in-class? Thanks.

Karen Akinsanya, President of R&D Therapeutics

Okay. So first of all, on SGR-1505, we are not sharing today the expansive information we have on the molecule, of course, but we can say that we've obviously dosed in single dosing and multiple dosing, and so far the profile is looking good. There is further work to do on that first-in-human trial, and so we expect to be sharing more about that later on this year. But so far, we're very happy with the profile we've seen for that molecule, especially from a pharmaceutical properties point of view and safety so far. But look, there's more data that we need to collect. As far as the immunology program is concerned, we are not yet sharing information about the target, and we'll hope to look to present some of that towards the end of this year. I will say this target that I alluded to is one that has strong genetic validation and we believe that constitutes strong human evidence. There are other programs that have been in the clinic on this program, and as you know, from our track record, we believe there's always an opportunity to design really fantastic molecules including in the immunology space. So we'll be sharing more about this later on this year.

Operator, Operator

The next question is from Chris Shibutani with Goldman Sachs. Your line is open.

Chris Shibutani, Analyst

Yes. Thanks very much. In terms of the software business, I think a lot of us are trying to assess what is driving the growth, and there's this sense that you have such depth of penetration in the industry, particularly in the biopharma side. Can you help us understand a little bit, what are the variable factors that would influence the decision? I think when we think about the smaller companies, we think about their budgetary constraints, there's always going to be an appetite to do things better, cheaper, but maybe they're kind of constrained by financing. But with the larger companies, what are the factors that drive this variable spend? And when it reflects in your revenues, are you able to do anything with pricing? What is the dynamic there? Just in terms of thinking actually the software revenue print, these large customers seem to be so meaningful and this decision that's going to come in the Q4 period, what are the factors that will define that? And then a second question that I have, as we think about the way artificial intelligence and machine learning is being inculcated throughout the kind of like drug discovery and development process, obviously your expertise primarily centers on the discovery side, but with your pipeline, you're moving more into the development side. I'm kind of provocatively curious to know whether we should think about the clinical development path as being kind of an approach you're taking and equipping yourself that's pretty much on par with everybody else in the industry. Or do you feel that you are going to invoke something that is maybe smarter somehow with artificial intelligence-guided ways of better patient selection, managing clinical trials, etc., that also would enable you to sort of say, see, we have this better, smarter path to discovery. And we're going to continue to walk that walk on the clinical development side. Thanks.

Ramy Farid, CEO

Thanks, Chris. I'll address the first question and then pass it to Karen for the second one. We've discussed this a bit before. The key variable here may be the potential barriers to increased spending from larger companies. It's important to remember that utilizing this technology requires significant internal expertise and a fundamental shift in the drug discovery process. Factors such as how many compounds to create, the number of chemists assigned to a program, the involvement of computational chemists, and the commitment of computing resources all come into play. We're actively involved in training medicinal chemists to effectively use this advanced technology. We're seeing remarkable trends in the online courses we offer, with a notable rise in participation from companies, not just academic institutions, in learning how to implement this technology at scale. This transition takes time, but we are very encouraged by the progress, as reflected in our discussions. As for pricing, let me clarify the situation regarding price increases. Our customers are still not fully utilizing the technology, which refers to the number of calculations they are actually running. The increase in spending comes from licensing more instances of calculations and running more calculations simultaneously. Hence, there's no need to raise the price per license, as they are still far from reaching the maximum number of licenses needed to fully support their programs. We have insight into this, as we utilize the software at a much larger scale than even our biggest customers. Karen, would you like to discuss AI and development matters?

Karen Akinsanya, President of R&D Therapeutics

Yes. So I think as a company that has a kind of a phenotype of looking for ways to run programs more efficiently. We are certainly eyes wide open on the validation that's required to really make a difference, obviously in discovery with our methodologies. And we're taking the same view of clinical opportunities for technology to improve the efficiency and speed with which trials are done. But I do want to be clear that this is a highly regulated space in the clinic. Our first programs are following a very typical approach, but as we advance, we do want to keep our eyes wide open for opportunities that are well validated as having an impact on clinical trial progress, patient selection, understanding tumor types, etc. So we are keeping a very close eye on that, but really focused on validation, which we think is important in all spaces for technology-enabled drug discovery and development.

Chris Shibutani, Analyst

And is the state-of-the-art now, are there well-validated choices that you'd be willing to go with or is that still a work in progress?

Karen Akinsanya, President of R&D Therapeutics

I believe it's still a work in progress. We're seeing some really nice opportunities to identify patient populations because of computation. That's more industry broad, I'd say, but also actually using imaging to look at tumor responses and understanding the opportunity to segment patients that is emerging. And I think that within years, not decades, that's obviously going to be something that we and others will be able to benefit from.

Operator, Operator

Thank you. We have no further questions at this time, and we'll conclude today's call. You may now disconnect.