Schrodinger Inc

NASDAQ:SDGR

Earnings Call Transcript 2020-Q3

[Operator]

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.

[Unidentified Company Representative]

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.

[Ramy Farid, President and CEO]

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. And 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 also 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 in 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.

[Karen Akinsanya]

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 [ph] 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 of 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.

[Joel Lebowitz, EVP and CFO]

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 delay 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?

[Operator]

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

[Do Kim, 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?

[Ramy Farid, President and CEO]

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 that is of using computers to calculate our predictive properties of molecules. And for looking back on it for much of that period, essentially, we were doing no better – 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 very significant way. And we can now at a very, very large scale and something that was not imaginable just even a few years ago, we could imagine a few years ago, we can compute the properties of a massive number of molecules. And at the same time, we can actually, because we're using that software, we're producing 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, very clear understanding and, again, validation of the technology. And 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 all 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's kind of 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.

[Do Kim, BMO Capital Markets]

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?

[Karen Akinsanya]

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 don't support the notion of taking these into initial clinical study. And 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, preclinical development, of course. As you heard from Joel, we’ll be taking these programs forward and that means initiating GLP-tox working with the FDA. So all of this is in motion and we're very pleased with the progress so far in that build.

[Do Kim, BMO Capital Markets]

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

[Ramy Farid, President and CEO]

Thank you.

[Operator]

Our next question comes from Michael Yee with Jefferies.

[Michael Yee, 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.

[Ramy Farid, President and CEO]

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

[Joel Lebowitz, EVP and CFO]

Sure. Thanks, Michael. So yes, with regard to metrics around what's driving the growth, so what we look at internally – obviously, on an annual basis, we've provided some metrics around the number of large customers and how much spend, in particular, buckets we're seeing. What we look at – but we don't do that quarterly. What we look at internally though, we do look at the number of customers and we do 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, the adoption of live design, as Ramy said. So we look at all those things. And 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.

[Ramy Farid, President and CEO]

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

[Michael Yee, Jefferies]

Okay, great. Thank you.

[Ramy Farid, President and CEO]

Thanks, Michael.

[Operator]

[Operator Instructions]. Our next question comes from Michael Ryskin with Bank of America.

[Michael Ryskin, Bank of America Merrill Lynch]

Hi. How are you guys doing? Thanks for taking my question. I'd like to ask a little bit on the material science business. That always gets a little bit of color on the prepared remarks. But then we haven't really seen as much of that just given that’s in an earlier stage. So I was hoping you'd give us an update on some of the programs you've working on there. If there's anything in particular we should be looking at. And how that's trended over the past quarter? Is it still sort of growing in line or above overall software, sort of how do we think about the material science possibilities in the next couple of years?

[Ramy Farid, President and CEO]

Yes, absolutely. I appreciate the question. So as you know, we aren't reporting separate revenue from the materials business versus the life science business, but we can report that it continues to grow very rapidly and actually at a higher percentage wise software part of the business compared to the life science business. So we also are definitely adding new customers and new verticals as we extend into new verticals from where we started, which was really just focused on OLEDs. So we're getting more into customers that are focused on polymers and other types of displays and then, as you know, beginning to have, as the technology matures, more discussions with companies that are focused on energy storage and batteries. So we're also investing more heavily. We talked a lot about this at the beginning. At the beginning of this project or this initiative and the formation of this division in our company, we were focused on leveraging the existing technology. And now, and this is really important, we're finding applications where we can continue to leverage the existing technology, but build on it and make new advances in the science. And so that's a new area that we're investing in that we're obviously very excited about. And as you know and we talked about this the last call, it relates to what I just mentioned earlier, which is the initiative to develop software for designing batteries and you know about our public collaboration with the Gates Foundation. So, we continue to be really pleased with the progress that we're making on materials as the fraction of our software business attributed to materials grows.

[Michael Ryskin, Bank of America Merrill Lynch]

Great. Thanks. And if I could ask a follow-up actually just continuing on that exact point on investing in the business. Following the equity raise, I think as you said, you're sitting at right around 600 million in cash on the balance sheet. How should we think about the investment priorities going forward, balancing between existing programs, in drug discovery? You talked about some new programs. You've got some programs potentially moving to the clinics that requires a ramp up. Then you also do have the material science business between. Between all those moving pieces, how should we think about priorities over the next 6 to 12 months? And then also, are there any additional opportunities in terms of M&A to bring additional technologies or capabilities in-house?

[Ramy Farid, President and CEO]

Yes. So, as you heard from Karen, the rapid progress of our internal programs and our requirement to really ramp up our capabilities to be able to run IND-enabling studies and take some of these programs into the clinic is certainly a high priority. And obviously, that's something we're going to focus on. The fact that we have this extraordinary platform that is having this profound impact on drug discovery projects, allowing us to get to development candidates so much more rapidly and, as Karen said, with higher quality molecules and with a much higher success probability, that's obviously an area that we're really focused on. As you can imagine, in a situation like this, it's attracting a lot of attention. And that means it's, of course, going to also inspire people to try and replicate it. And in order to maintain the significant lead that we currently enjoy, that's going to require, really in a very serious way, investing in it, maintaining that lead, and we absolutely intend to do that. And as I’ve said, that's not only going to be in the underlying science for the life science business, for the drug discovery business, but absolutely in the materials business. With regard to M&A, that's something we're always exploring. As you can imagine, we get a lot of inbound interest to work with us now as the leader in this space and we explore all of those opportunities, and we're open to the possibility of M&A, but there's nothing right now that we can report.

[Michael Ryskin, Bank of America Merrill Lynch]

Great. Thanks.

[Ramy Farid, President and CEO]

Sure.

[Operator]

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.

[Ramy Farid, President and CEO]

Thanks very much.