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

Please go ahead..

Thank you, operator and thank you all for listening in on our second 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 those 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..

Thank you everyone for joining Schrödinger call to review our most recent financial results. We had a very strong second quarter building on the momentum of our first quarter.

As you'll hear from Karen, we are making excellent progress on our five internal wholly-owned drug discovery programs and have achieved important milestones with several of our biotech and pharma collaborators.

Also, as Joel will describe later on the call, we saw very strong revenue growth in our software business and we continue to make significant progress on the science that underlies our differentiated computational platform.

As further validation of our technology and business model, we saw two important developments since our last call, Petro Pharma was acquired, a testament to the strength of the assets discovered by leveraging our computational platform and Relay Therapeutics had a very successful IPO in July.

These milestones build on the success we've seen at Nimbus Therapeutics and Morphic Therapeutic, and demonstrate our continued ability to derive value from our portfolio of biotech equity stakes.

In a moment, Joe will expand on the financials in greater detail, but topline which you've total revenue of $23.1 million in the second quarter, which represents 21% growth over the second quarter of 2019. Underpinning this topline growth was software revenue of $20.9 million, an increase of 44% compared to the second quarter last year.

This growth is a clear sign our customers are engaging more deeply with our platform. Importantly, we're also adding new material science customers, an the area we think will become increasingly meaningful in the coming years as the industry continues to recognize the potential of computational methods.

As part of our ongoing efforts to deepen our software solutions for material science applications, we entered into a three-year agreement in June with Gates Ventures to develop and apply novel accurate atomistic simulation methods to improve battery performance.

We remain strongly committed to advancing the science that underlies our computational platform.

To that end, in the second quarter, we published several noteworthy scientific papers describing our work in such areas as integration of molecule genitive machine learning, with mixed physics-based and machine learning scoring for ultra large scale multi-parameter optimization, improved methods for determination of Cryo-EM structures of protein ligand complexes, improvements to the accuracy of binding affinity predictions from FEP+, through enhanced modeling of water molecules, and improved methods for calculation of protein thermal stability using FEP+.

In addition to these publications, we released to our software customers method for calculating absolute binding affinities using Free Energy Perturbation. We have shown that this technology can improve hit rates in virtual screening. We look forward to continuing to make important scientific advances in drug discovery and materials design.

We are also excited that we've expanded the reach of our platform by forming partnerships with leading structural biology companies, Viva Biotech, a leader in X-ray crystallography, and Thermo Fisher, the leader in cryogenic electron microscopy Cryo-EM.

These joint efforts will allow us to explore targets that were previously not structurally enabled for physics-based methods, thereby broadening the domain of applicability of our platform.

I'd like to give you an update on the progress we were making on our COVID-19 Multi-Company Philanthropic Alliance, which was created to discover and develop small molecule antiviral therapeutics to address COVID-19 and possible future SARS-CoV-2 outbreaks.

In June, we announced that Google Cloud had joined the Alliance with a significant donation of high-power parallel computing resources to help accelerate our discovery work.

We are also excited because the Alliance is using live design, our enterprise solution that enables full project management and interactive collaboration among discovery teams at numerous sites, and across many traditionally siloed areas of research.

If ever, there was a more critical time to apply live design, it is now and the Alliance is finding it instrumental for sharing computational and experimental data across all the organizations at multiple sites.

And finally, I'm very happy to report that despite the obvious challenges we're all facing with COVID-19, our teams have been collaborating to successfully engage both existing customers and potential new customers, while advancing our drug discovery programs and those of our collaborators.

We're also executing on the hiring plan we established at the beginning of the year and we're pleased to be adding more talent to our already impressive ranks. Summing up, we're excited by the many advances we've made as we continue to transform the way therapeutics and materials are discovered.

Our leading physics-based computational platform is enabling us, our customers, and our collaborators to accelerate the discovery of higher quality novel molecules compared to traditional methods. I'll now turn the call over to Karen for an update on our drug discovery programs..

Thank you, Rami. Good morning everyone. I'm pleased to share an update on the continued progress across our portfolio of drug discovery collaborations, and our pipeline of internal wholly-owned program.

The hard work and dedication of our teams and global partners has enabled us to continue to navigate the challenges of the COVID-19 pandemic with minimal disruptions.

We continue to see the profound impact of our physics-based methods, including FEP+, deep learning, and ultra large scale compound enumeration on the efficiency and speed of our programs, as well as our ability to address difficult design challenges.

We have leveraged these methods extensively in the development of our internal pipeline, which is rapidly advanced since we launched our first program in mid-2018. In our first quarter call, we reported that our third wholly-owned program advanced into late discovery in just under 18 months.

Since then, three additional programs have moved into the optimization across our collaborative portfolio. This brings the total number of partners and internal programs at this later stage of discovery to 12, the largest group we've seen at this stage to-date. We are often asked how large our library have compound is and that's an important point.

We don't really rely on physical libraries, which are necessarily limited to compounds that have been previously synthesized, and are therefore much smaller than computationally enumerated virtual libraries. We're able to explore vast amounts of chemical space virtually once we have a validated computational assay.

During the first half of 2020 alone, we have explored 237 billion compounds virtually across our collaborative and internal program. Furthermore, by combining physics-based methods with deep learning approaches, we've been able to rapidly move several programs into lead optimization in just months instead of potentially years.

It is quite clear that fully exploring chemical space within and between chemical theories during all stages of the program allows us to prioritize design and synthesis strategies almost in real-time, and achieve multi-parameter optimized compound. Details of this approach were just published in the Journal of Chemical Information and Modeling.

Focusing on our wholly owned pipeline, we have 5 active programs targeting solid tumors and hematological malignancies. Based on the mechanistic validation and characteristics of our molecules, we believe these assets could have monotherapy activity in specific populations, as well as utility in combination with other therapies.

We made considerable progress across our programs during Q2, most notably, in our Mot1 program.

We are developing novel allosteric Mot1 inhibitors to treat relapsed or resistant lymphomas, which represent an area of high-unmet medical need Molecules from our first Mot1 chemical series demonstrates similar tumor growth inhibition in vivo, when compared to data from activated B-cell, defused large B-cell lymphoma or ABC DLBCL xenograft models just reported by Ensign at AACR for their clinical compound.

We have continued to advance our Mot1 program inhibitor optimization, and now our most advanced molecule has been shown to be an order of magnitude more potent than other known competitor molecules.

Additionally, published Mot1/2 molecule data has shown that these inhibitors have activity against both naive and abridgement resistant CLL [ph] and mantle cell lymphoma. We are now testing our most potently to assess that potential both as monotherapy and in combination regimens in resistant and relapsed patient sample.

We are delighted with the rapid pace with which our Mot1 molecules are progressing. Just over a year into the program and a quarter ahead of schedule, our leads are on track to begin non-GLP tox in the coming months, followed by GLP tox studies early in 2021.

Our two programs focused on DNA damage repair mechanisms, CDC-7 and WE-1 are also in vivo testing phase. Across both programs, we have achieved differentiated kind of selectivity profiles, while maintaining potency and desirable drug like properties.

Our plan for 2021 initiation of GLP tox studies in support of regulatory interactions, including pre-IND meetings with the FDA, and Ind-filings are on track.

Our picomolar CDC7 inhibitors show excellent potency in our biochemical assays and deeper growth inhibitor responses in preclinical acute myeloid leukemia models when compared to other known CDC-7 inhibitors.

Additionally, our inhibitors show synergistic effects on AML when combined with VENCLEXTA, which received accelerated approval in 2018 for the treatment of newly diagnosed AML in adults. We have now gone on to show that CDC-7 inhibition is effective and AML model with a right range of sensitivity to VENCLEXTA.

To date, CDC-7 inhibitors have only been studied clinically in solid tumors. So we believe our data provides compelling rationale to investigate them in hematological malignancies such as AML. Moving on to our WE-1 program.

The potential for this class of drug was confirmed by recently reported deep prolonged responses to AstraZeneca AZD1775 in uterine serous carcinoma, especially in the setting of SPXW7 loss.

From a precision oncology perspective, identifying the hallmarks of super responders is a key component of our molecular stratification plans to achieve improved therapeutic windows in patients. Our next generation we-1 inhibitors are highly selective, and we believe have the potential to be used in optimized dosing regimens.

I'll round out the discussion of our internal programs with two more updates. First, next generation inhibitors that address resistance have seen significant clinical success and approvals over the last few years.

We believe that our next generation HIF-2 alpha program for use in renal cell carcinoma patients who have become resistant to first generation agents is an important opportunity to capture more patients with VHL disease associated renal cell carcinoma.

Finally, our early stage cells one inhibitor program for use in combination with KRAS inhibitors also continues to advance. Using drug combinations to target proteins that indirectly interact with KRAS is an emerging and promising strategy.

We believe that multi targeted approaches will likely be necessary to achieve a durable therapeutic response in most cancers harboring mutant KRAS. From capabilities and execution standpoint, we continue to strategically expand our rights as we prepare to enter the next stages of discovery and development in liquid and solid tumors.

We are adding industry veterans with decades of experience in order to expedite the development of potential new therapies for patients in need. We continually evaluate our drug discovery programs in order to focus on those with the best chance for success.

We are accelerating promising new targets with validation or genetic support in human cohorts and emerging pharmacology data that we believe are valuable candidates for future development. Some of these emerging and potentially high value drug targets do not have protein structures, which limits our ability to apply our physics based technology.

We recently entered into strategic collaborations with Thermo Fisher and Viva Biotech that will provide our teams with greater access to Cryo-EM and X-Ray structures to broaden the reach of our technology.

We are quite pleased with the substantial progress in our diversified portfolio of collaborative and wholly-owned programs and the continued positive impact of existing and new technology. We are genuinely excited by the opportunities for our future preclinical and clinical pipeline. Now, I'll turn it over to Joel.

Thank you, Karen. Hello, everyone. Thank you for joining us today to review our second quarter results. As you heard from Ramy and Karen, we are executing on our strategy across our business. In the second quarter, we continue to see strong momentum, recording $23.1 million in total revenue, an increase of 21% compared to the second quarter of 2019.

Our software business powered the results delivering $20.9 million in revenue, which represents 44% growth versus the second quarter of 2019. The underlying trends of new customer additions and increase the adoption of our solutions continue to drive the business and we experienced growth in all regions and in both life sciences and material science.

We also continue to see increasing adoption of live design, our project management enterprise solution for drug discovery Live design plays an essential role in our integrated platform offerings, and this solution can be especially powerful in fully remote work environments that many of our customers are still experiencing.

With regard to the COVID-19 crisis, while we did not experience any material impact to our software business in the first half, certain risks have been identified that if materialized could affect the growth of our software business in the second half of the year.

Customers, particularly those in hard hit industries could come under budgetary pressures, which could impact our software sales growth. Software sales could also be affected by the limited ability to engage with customers in person as the crisis continues.

That being said, through the first half of 2020, we have been pleased with the execution of our strategy to grow our customer base and increase adoption of our solutions, which resulted in 35% software revenue growth versus the first half of 2019.

On the discovery side of our business, we achieved revenue of $2.2 million in the second quarter compared to $4.5 million in the same quarter last year. As we've discussed previously, these revenues depend upon the timing of program milestones and are expected to vary significantly from period-to-period.

This quarter, we continue to see broad advancement of our collaborative programs, many of which we expect will lead to milestones and associated revenues in future periods.

In some cases, we are experiencing variability in certain collaboration program timelines impacted by COVID-19 that could result in delays and reaching certain milestones and impact the timing of revenue in the second half of 2020.

Turning to our internal programs, we are moving rapidly through late-stage discovery as you heard from Karen, and we are on track to begin our first IND enabling studies early next year. Accordingly, we are continuing to add to our capabilities as we prepare for the advancement of our programs toward the clinic.

In the quarter, we also saw significant returns from our collaborations that are reflected in other income in the P&L. One of our collaborators Petra Pharma Corp was acquired in June, which resulted in a $4.2 million gain in the quarter.

As part of the acquisition, we received 4.6 million in cash from our share of an upfront payment related to our equity stake in Petra.

We are also eligible to receive potential earn-outs tied to the achievement of specified development, regulatory and commercial milestones, in addition to being eligible to continue to earn revenue under the terms of our original collaboration agreement.

Also, our equity holdings in Morphic Therapeutic resulted in a $10.3 million gain in the quarter, reflecting Morphic’s stock price appreciation. In a subsequent event to the second quarter Relay Therapeutics successfully completed an IPO in July.

We anticipate that we will record a gain in the third quarter commensurate with the approximately 422,000 shares owned by Schrödinger and these will be mark-to-market each quarter. So we continue to derive value from our biotech equity stakes.

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 $25.1 million, an increase of 12% compared to the end of the second quarter of 2019, reflecting underlying growth in our business.

Moving on, gross profit reached $13.6 million in the quarter, up 38% compared to the second quarter of 2019. The growth was driven by the significant increase in software revenue and slower growth in cost of revenues. Software gross margin was 82% compared to 75% in the second quarter of last year.

Operating expenses were $30.7 million for the quarter, up 29% versus the same period 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, several of which are in late stage discovery.

The growth relative to 2019 also reflects the increased costs associated with operating as a public company. Looking at sequential total expense growth in 2020, including both cost of revenues and operating expenses taken together, we experienced a 6% increase versus the first quarter of this year.

As I pointed out last quarter, we expect total expenses to continue to rise steadily quarter-to-quarter on a sequential basis as we progress through the rest of this year and continue to invest in key capabilities and our drug discovery programs.

Loss from operations was $17.1 million in the quarter versus $14 million in the second quarter of 2019, driven primarily by the increased investment in research and development.

As I mentioned earlier, our results this quarter reflects the positive contributions from our equity stakes in two collaborators, Morphic and Petra resulting in $13.1 million in other income. Net loss in the second quarter after adjusting for non-controlling interest was $3.4 million versus $0.5 million in the second quarter of 2019.

Our total cash and marketable securities balances were $284.5 million at the end of June, a decline of $4.2 million from the end of the first quarter of this year as our increased operating expenses were partially offset by strong software revenue performance and the cash distribution from our equity stake in Petra.

We are excited about the continued execution of our strategy to further develop our platform science, drive growth in our software business and rapidly advanced our discovery programs. During the second quarter, we made significant progress in these areas, despite an uncertain global environment.

We believe that we are well positioned to deliver on our long-term strategy and that the current crisis only underscores the critical need for transforming drug discovery and material design. With that, we would like to open the call to your questions.

Operator?.

Thank you. [Operator Instructions] Our first question comes from the line of David Lebowitz with Morgan Stanley. Your line is now open..

Thank you very much for taking my question.

When you talk to your customers, do you hear any commentary from them on how they might be evolving their approach to spending on discovery and clinical stage development these days, given what has happened in the pandemic?.

Hi, David. This is Ramy. Yes, thanks. Thanks for the question. Not really actually.

We certainly are hearing on the discovery side that because of reduced -- chemistry resources as wet chemistry resources that they are relying more heavily on computation and pleased to see that the platform is resulting in fewer compounds being synthesized, but that's the extent of it on, we're not hearing anything about changes in plans on the development side, but maybe Karen knows of -- has a different thought.

.

Nothing direct but I think everyone's aware that certain trials have been delayed. It's been talked about publicly in the media, but we don't have any specific information about the impact on customers, particular trials now..

Actually, I might add that, the momentum in the quarter really was largely underpinned by continued increasing adoption of our solutions by some of our largest customers. So to the extent that that's an indicator that they're still investing in methods to drive early discovery that might be the case..

And to make it more efficient, yes. Right..

Exactly..

Thank you for that. And also, given that you said you had three compounds entering, I guess, GLP talks in preparation for entering the clinic in 2021.

From that point, how long does it actually take do you expect until an IND would be filed and you do enter humans?.

Karen?.

So, yes, the -- one can think about a span of nine months to 12 months, we've been in regular contact with the vendors who will be working with us on those studies. We're not hearing anything about delays or extended timelines for GLP studies.

So again, you can think about nine months to 12 months between the start of those IND-enabling studies and the opening of our IND studies or dosing..

Thank you for taking my questions..

Thanks..

Thank you. Our next question comes from the line of Michael Yee with Jefferies. Your line is now open..

Hi. This is our [indiscernible] on for Michael Yee. Thanks for taking my question. So it feels like -- two questions right, it feels the consensus for Q4 it is modeling a potential deal.

Would you be able to commentary -- comment on that, it seems like there's a bit of a spike in Q4? And the second question is, is there any progress or any development on a potential partnership for any of the two to three key assets that are wholly-owned? Thanks..

Sure.

Karen, do you want to…?.

Yes, so as we've discussed in the past, we are pursuing discussions both around internal programs, but also just in terms of how one can apply the platform to early stage drug discovery. So we continue to have actually very good conversations with potential partners, very active space for us.

So I think one is looking forward to the opportunity to partner these, I think, can -- we remain optimistic that in some cases it may make actually sense for us to pursue some of these assets ourselves into the clinic, as the landscape for these programs and these mechanisms continues to evolve.

We think it might make sense actually for us to pursue some of these further into development before partnering them. And on the other side, I would say that we're seeing a lot of excitement around particular targets or disease areas, we're partnering around discovery and development of assets is actually a key theme of our conversation.

So I think there's a lot of optionality there in terms of deal making for us..

Thanks. And -- okay. Thanks..

Thank you. Our next question comes from the line of Do Kim with BMO Capital Markets. Your line is now open..

Thanks. Good morning, and thanks for taking my questions. Congrats on a great quarter. Just a follow-up question for Karen on that prior question.

When you're thinking about how the lead internal programs of three drugs fit into the cancer treatment landscape, are they more valuable as a combination therapy so a former partner that would have a synergistic program already in place or a partner just looking to get competitive in cancer?.

So if I understood your question correctly, there are a couple of different opportunities. One is, to part of these with companies that already have existing assets in the pathway. The other is potentially to take these orders. So I think that's what you're asking.

So on the partnering these assets with folks who already have these mechanisms in place, I would say that, if one takes for example, the Mot1program, obviously, Mot1 shipped to pathway is generating quite a lot of excitement out there these days. And there are many players in the space. Some of them are big pharmas, some of them are biotechs.

And as such, I think what we're seeing is excitement about the opportunity to combine. The first one which came around Mot1program, shipped two and other mechanisms in that space with each other. So yes, I would say there is the opportunity to partner these assets with companies that already have existing mechanisms.

I'd also point to one similarly, as you probably are aware, in the relapsed and resistant setting, combination therapies are expected to be become more and more important in terms of managing the late stage patient, these patients who are not responding to existing therapies.

So I think for many of our assets, that is going to be the opportunity to partner either early or later on with companies who have existing assets.

In terms of monotherapy for each of these mechanisms, we know the plan would be to study these as monotherapy and I think that opens up opportunities for either initial work in the clinic for us or partners who take this on internally after partnering. So I hope, I'm answering your question, if not, feel free to follow-up..

No. That was very helpful. Thank you, Karen.

And a question on the on the software business, when you look at the proportion of on-premise versus hosted software, what do you what do you see that distribution going? And is that a potential driver of revenues?.

Joel, did you want to take that?.

Sure. I can take that. Thanks Do. So, actually, in the quarter, we saw healthy growth from both on-premise and hosted software 29% and 21% respectively, and on-premise still represents a majority of our revenue base so 53% this quarter, hosted was 11%.

And I just remind everybody that we -- under our hosted solutions really provide, we host only access to our license, we don't actually host the computation all the heavy computational work that is done actually, by our customers own computers or their own instances on the cloud.

And so economically over the life of the contracts, we're fairly indifferent between whether our customers choose to enter into contracts through an on-premise arrangement or a hosted arrangement.

And I think we're really just focused on the fact that although there are some differences in revenue recognition timing between the two, we're really just focused on the fact of on a strategy to drive increased uptake, which we saw strong evidence of in the second quarter..

Great. Thank you.

And last question on the relay equity, is there is there an ongoing relationship with that company? Are you involved with a platform or drug discovery? And are there any economics in that pipeline?.

There are economics, Do, this is Ramy. And -- but with regard to the ongoing relationship, that's actually not something that we can comment on. Given confidentiality between, the companies..

Okay. Understood. Congrats again. Thank you my question..

Thanks so much, Do..

Thank you. Our next question comes from the line of Mike Ryskin with Bank of America. Your line is open..

Hey, guys. Thanks for taking the question. Congrats on the quarter. I want to ask sort of the bigger picture question first on the software utilization and some of your conversations with customers you know flag, potentially some budgetary constraints for a couple quarters now as a result of COVID.

But I'm wondering, longer term, do you think you've seen any indication of a longer term change in how your customers think about software versus how they think about web chemistry and internal design? And I mean, beyond the next couple quarters once it sort of shakes out and people come back to the lab? Are the conversations indicating that you could, this entire outbreak could lead to potentially wider adoption, or just sort of different workflows in terms of people how go around, go around doing early stage drug discovery?.

Yes.

So I think the trends that we're seeing now of broader and broader adoption and this idea that you really can, by deploying the technology on a large scale, really reduce the number of compounds that are made which significantly, of course reduces the cost associated with getting to a development candidate, of course, reduces the time and really does result in higher quality compounds.

We see that trend continuing. And I seriously doubt that when this current crisis is over that somehow there'll be a shift in that, it doesn't make any sense, right. This is, what I think happened is COVID-19 crisis sort of catalyzed the faster adoption, right? Because necessity.

And then of course, once you recognize the positive impact it has, it's hard to imagine it going back. So hopefully I'm answering your question..

Yes. Yep. And then I want to follow-up on the material science side of the business. Nice update there with the agreement with Gates ventures.

I'm just wondering, was there any upfront revenue or milestone with that? And also on the back end, do you have so flexibility to monetize whatever comes out of that idea of potential collaboration partners lined up? And just in general, if you could add some comments on material sciences of how that's progressed over the last -- the last couple months? That'd be great..

Sure. Yes.

So that collaboration that we announced the three year collaboration with Gate’s centers to improve battery, to develop software to improve battery performance is really meant to fund basic research effort, as probably most people know, batteries are incredibly complex interface between the electrolyte and cathode anode are very complex, the cathode and anode themselves are highly complex, and there is a real need to develop software to more accurately simulate these complex interfaces.

So that's what the collaboration is about is to is to fund basic research and I think we have a pretty good track record of working on really hard problems and solving them. And so and then to answer your other question, yes, we -- that the agreement allows for us to take that to, a technology that we hopefully sell us again, it's basic research.

So, you know, there is uncertainty in it, but that's how we solve hard problems, right, working on basic research problems and take that technology that and productize it and monitor you know, put it into software and actually, sell it With regard to -- work on with this, there are no, we haven't announced anything along those lines, but you know, that's certainly something we'll be looking at..

Sorry. And one -- Just to add, I think Mike you asked if there was an upfront, so we did receive a million dollars from Gates ventures in the second quarter, and it's part of a three year deal, $3 million deal. So we expect to receive that annually and the million dollars and it's under contribution revenue in our software business segment..

Great. Thanks so much..

Thank you. Ladies and gentlemen, this concludes today's question-and-answer session and earnings call. Thank you for your participation. You may now disconnect. Everyone have a great day..