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. [Operator Instructions].

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..

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 at shordinger.com.

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..

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. 11 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 of 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..

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 with partners and 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 the 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 head count 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..

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 plan 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 resensitize 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 treatment. 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 fatality 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..

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..

Thank you. [Operator Instructions]. Our first question is from Michael Yee with Jefferies. Your line is open..

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 multiple 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 healthiest.

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..

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 again with quite a number of -- excuse me, with 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 that must be -- we think that's 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..

Yes. Hey, Mike. There are a number of contributing factors to the change in the drug discovery guide. We have to focus, what I collaborate is to doing with programs that are out of our control. And as you can imagine, it's sometimes difficult to get information about the progress those programs are making.

We've taken a cautious approach with this update and try to estimate when those milestones will occur. The second component is the ongoing collaborations where our project teams are working.

And in some of those cases, we have to adjust the timelines for if the cost of the program -- milestone results in us changing the revenue that we can expect out of subsequent quarters that's a contributing factor here.

And then lastly, of course, we're trying to forecast new business development activity, particularly the revenue contribution from that be, and as you probably understand, revenue recognition rules.

When was the contribution that you can take for active even a deal that we might close and of course there's uncertainty about timing for closing those deals. So it's -- change in the guidance that we thought was prudent to put out at this point..

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 and obviously in that healthy volunteer trial.

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 -- sites both here in the U.S. and globally and we're pleased with the progress we're making, so far so good on SGR-1505..

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

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?.

Yes. Dave, I think I don't want to -- model, but I would say that we're pretty clear that, 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 with the [Technical Difficulty]..

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 does it away? Do you really need the European sites to come on Board for the pace to kind of catch-up to where you expect your expectations?.

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 spend 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..

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

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

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

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 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 on that you are a software company, but also 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..

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 the strategic reasons to discontinue the program..

Oh, I'm sorry. Well, I didn't hear the other.

I'm sorry --?.

Could you repeat the question Evan about AI?.

Yes..

Yes, for sure.

So the question was kind of taking a step back with all the hype in AI, how do you -- 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?.

Yes. I think and there's a really clear answer to that, which is what we've been doing for the last 33 years, which is just avoiding always 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 gain that reputation of doing that publish all the advances we make, we reviewed journals, we have people using the software and validating it with their own publications. And I think as long as we avoid just using words that think people here, 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 and don't see that that you are making alluding to.

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

Hi, good afternoon. Thanks for taking our questions. Two from our side. One clarification question, so just to make sure we understood this correctly.

So for drug discovery revenue guidance for this year of $50 million to $70 million, is there any future or is there any -- sorry ED contemplated in these numbers or is this purely economics from or partnerships? And then secondly on MALT1 as you move towards an initial healthy volunteer data set and as you're moving towards moving through study in patients, how are you thinking about potential partnership opportunities for this program and also for your other lead proprietary programs? And when do you think might be a good time in phase of development here to seek partnerships? Thanks..

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 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 deal. We just don't think it's prudent to be sort of putting us in this situation. 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 is, should be viewed as imminent, but where -- because we are with everybody in the industry, of course, those discussions were ongoing.

Karen, do you want to chime in about strategy on MALT1?.

Yes, certainly. So on the healthy volunteer study, as you point out, we are approaching or having a package of data health volunteers that will tell us more about the profile of the compound, as we said on the call, really happy so far with the pharmaceutical properties that we've observed and including PK and PD of the strategy moving forward.

As you're well aware, we are pursuing opportunities in oncology. We believe this mechanism has the potential for indications outside of oncology as well. And healthy volunteer trial sets us up well to take a number of different directions with this asset potentially.

So with respect to the second part of your question, you asked about partnering and as Geoff just alluded to, we can -- about our mature programs and our obviously early programs with a number of partners; specifically with SGR-1505 we see a number of opportunities.

First of all, I think we all saw earlier this year that there is monotherapy that was published at EHA and ICML for another molecule. We think that sets up MALT1 well, but we do believe that combinations with BTK inhibitors and other standard of care or even emerging are opportunities for MALT1.

And as such the potential to partner with companies who have those assets either approved and on the market or emerging for B-cell malignancies we think is very interesting. And we continue to have those conversations.

So there's the potential to partner around combinations and I think that in order to pursue those combinations, obviously there's going to have to be access to drugs for those combination studies and we continue to pursue those types of opportunities..

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

Good afternoon. Thank you for taking the questions. Maybe a first a clarification on the software, I think Ramy, in your prepared remarks, you mentioned over a dozen multi-national global pharmaceutical companies are your discussions with them for multi-year, possibly multi-million dollar contracts.

Just the clarification, are those new -- would those represent new customers or would those represent expansions with existing customers?.

Yes. That's a good question. It's very, very much existing customers to the extent that we of course, already are working with pretty much everybody in the industry as Geoff just said.

This is in -- I'd say in all cases actually discussions with existing customers who have already actually even gone through a few of those steps of increasing their usage and are very familiar with the technology already seeing an impact of the technology and they're scaling up even more. So it's -- that's very encouraging, of course,.

Absolutely. And then -- go ahead --.

Some of these -- these large scale up that we are contemplating and not specifically with pharma companies what's quite encouraging is that we are seeing established biotech companies who are relying on the software for their drug discovery efforts, and they're seeing the real benefit and also in discussions with us about stepping up the utilization to higher levels.

So I don't want to leave the impression that it's just global pharma companies who are finding the technology very, very helpful of accelerating drug discovery it's biotech companies as well..

Yes. That's great point. Yes..

That’s really helpful. And I guess it ties into my -- the next question, which is we've heard from a number of companies already that --.

Geoff, do you have anything else..

Can you hear me?.

No, no, maybe he's on mute. We're not sure what's --.

Can you guys hear me okay?.

Oh, no, no. Don't -- yes, we're -- no, no. Just a second.

Could -- can you say that again?.

Can you guys hear me okay?.

Yes, we can hear, we might have had a technical problem on our end. Sorry, if you were saying --.

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 what given the weak funding environment, which was originally impacting small pharma, small biotech, now that's expanded where even larger pharma, larger biotech companies are just kind of slow rolling their contracting phases.

And what I guess I'm hearing from you is that not only is that not occurring, but you're actually seeing an expansion. So I guess the question is, what do you think is differentiating? Is this the AI and the machine learning component that's really driving a lot of excitement and leading to those new contracts? Or is there something else? Thank you..

Yes. No, no, it's -- we don't think that's what it is. We think it's much better than that. It's actually because they're seeing impact. They're now starting to see that they're making fewer compounds. They've increased the success probability. They're seeing the positive impact of using the technology.

It doesn't -- as we talked about many times of using what we -- the combination of physics-based methods with machine learning that's impacting real projects that they're working on. And so if they're seeing improvement in efficiency in drug discovery, of course that's going to be the motivating driver it's not hype.

It's not just because it somebody might associate the platform with AI that, that would be a sort of artificial and short-lived phenomena. This is a real, something much, much more real than that..

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

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?.

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 months 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..

Awesome. Thanks. And then just a quick follow-up also related on 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..

Yes. Good question, Gaurav. You're right. The -- we're making a significant investment in the platform now. We're making a significant investment in discovery of proprietary medicines. And of course, we're making an investment in advancing the most advanced of those proprietary medicines. So it's all free.

At this stage, we certainly don't have any plans to scale back our investment in the technology. I think part of the reason that we are as well-positioned as we are with our customers is because we are continuing to innovate.

We are continuing to invest not just in our physics-based methods, but our machine learning, our enterprise informatics platform. We're just adding new features literally every quarter with a quarterly update that I think enhances the utility of our software and differentiates us more and more from our competitors.

So we're not backing off in that investment. We're not backing off in our investment in discovering new medicines. And we're certainly excited about the opportunities to enhance, to advance the ones that we have.

That being said, I think the area of growth in the future is in our investment, our capital allocation is likely to be in the progress of the proprietary medicines rather than the first two areas that I described where we're going to maintain the investment, but I think obviously the growth's going to be in the proprietary programs progressing..

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

Thanks..

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

Great. Thanks for taking the question, guys. I've got a couple. First, I want to pick up exactly where you just left off Geoff on the relative areas of investment and sort of focus going forward, you talked about internal pipeline.

For the drug discovery and the collaboration side of things, I mean, is there an appetite given the update today and some of your language around some of these collaborations just taking longer to come to fruition in terms of revenues? Is there an opportunity or an appetite to sign new collaborations to continue to expand that to sort of -- if your current ones are just moving through a little bit slower, is there interest to do more to offset or is that just not as priority for you because you're focusing more on the internal pipeline?.

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..

Okay. That's really helpful. I appreciate that color it sounds like so you're not just going to be chasing a number for the sake of chasing it. And then my second question is, I got to go back to the software revenues and the software guide and your comment on all those customers and the negotiations and the conversations you're having.

I just want to make sure I'm thinking through this correctly.

So if most, if not all of these all are existing customers, and they would normally, and a lot of them already are on sort of multi-year contracts, if they all re-up or if a lot of them re-up later this year and just based on your guide, it looks like it implies that it's going to be a 4Q re-up because you're essentially guiding to flat sequential revenues then the fiscal year guide calls for something like roughly $29 million software in the third quarter, $67 million in the fourth quarter so huge step up just to hit the mid-point of the guide.

So if that happens in the fourth quarter, does that create an air pocket in the sense for next year, because customers that may have renewed and scale it up next year, if they all scale up this year, then there's -- if it's a multi-year contract and you're doing it in 4Q 2023, then you're not going to be renewing anything in 4Q 2024.

Am I thinking about that correctly?.

Look, you are thinking about it correctly, Mike. I would say first, there are some multi-year contracts from prior periods that are going to be renewed in the fourth quarter anyway. And we've disclosed those in the past and we've also disclosed that that our software very high degree of retention. So we expect those contracts to renew.

Now, as we've indicated, we're very positive about the discussions that we're having with those customers and the opportunities to scale up the deployment of our technology to even higher levels than we have in the pre-existing contracts so that that's contributing to the output that we have for the fourth quarter of the year.

Now the question of whether that creates an air pocket for next year, maybe we'll come to that next year. And I'm certainly not trying to give guidance for next year, but the -- that volatility that comes from that is certainly not lost on us and it's something that we're thinking about.

I don't want to get into giving more guidance about next year, but we do see further opportunities to scale up the deployment of our technology next year as well as the opportunities we see this year..

Yes, we have more than 12 customers..

Yes..

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

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

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

Thanks..

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

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 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..

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

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 expect -- 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, et cetera, 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..

Thanks, Chris. I'll take the first question and I'll hand it over to Karen to for the second one. So we've talked a little bit about this before. We think the variable, if you will, and maybe what you're really asking is sort of what might be barriers to continued increases in spend from these larger companies.

And one thing you have to remember is that so there's -- it really require a fair amount of expertise, internal expertise to utilize this type of technology. And there needs to be a real shift in the whole drug discovery process.

For example, how many compounds you're committed to making, how many chemists you put on a program, how many computational chemists, how many computers you're or how many computer nodes that you'll dedicate to a program? And that's one of the things that we're playing a really big role in this in helping to train medicinal chemists, for example, to use this kind of sophisticated technology.

We're seeing something really extraordinary happening in, for example, the online courses that we provide. We're seeing huge increase in the number of people in companies, not just in academic institutions, but in companies taking these courses and learning about how to deploy this technology at scale. And that's taking time.

But we're obviously very encouraged, as you can hear by the nature of those discussions. But it takes time because of that. You mentioned something else about price as well. Let me explain that really quickly about increasing the price.

So to the extent that our customers are now still limited and the -- or they're not fully utilizing the technology, and by utilization what we mean is the number of calculations that they're actually running.

So the way that we're getting these increases and the way that the spend goes up is by simply licensing more instances of the calculations, more number of -- more calculations that they're running simultaneously.

And so that's where the increase comes from, getting more licenses not just by and so it's unnecessary to increase the price per license, sense they're still far, far away from maxing out on the number of licenses that are really required to fully support a program.

And we know that number because it's the way we use the software and as we've said many times, we're still utilizing the software orders of magnitude higher scale than even our largest customers.

Karen, do you want to talk about AI and development stuff?.

Yes. So I think as a company that has a sort 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 that 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, et cetera.

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..

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?.

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 of 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'll and others will be able to benefit from..

Thank you. Appreciate the insightful comments..

Thanks, Chris..

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