Schrödinger Q2 2024 Earnings Call Transcript

There are 12 speakers on the call.

Operator

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.

Operator

Jara Madden, Senior Vice President of Investor Relations and Corporate Affairs. Please go ahead.

Speaker 1

Thank you, and good afternoon, everyone. Welcome to today's call, during which we will provide an update on the company and review our Q2 2024 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 schrodinger.com. Here with me on our call today are Rami Farid, Chief Executive Officer Jeff Porges, Chief Financial Officer and Karen Akansanya, President of R&D Therapeutics. Following our prepared remarks, we'll open the call for Q and A.

Speaker 1

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 Q3 and full year 2024, 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 properties of our compounds, the use of our cash resources and 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, 2024. 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.

Speaker 1

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 Rami.

Speaker 2

Thanks, Jaren, and thank you, everyone, for joining us today. We are very pleased with our progress during the quarter, delivering excellent revenue growth and continuing to advance our proprietary pipeline. As you will hear from Karen shortly, our first two clinical programs are progressing well in Phase 1 clinical studies. And I'm happy to report that we have initiated dosing in a Phase 1 solid tumor study for SGR 3515, our V1 MIT1 co inhibitor. Total revenue for the Q2 was $47,300,000 and software revenue was $35,400,000 We are confident about our revenue outlook for the full year and are reiterating our full year software and drug discovery revenue guidance.

Speaker 2

We continue to engage in very productive discussions with customers at large global companies about significant scale ups and expanded use of our software. These discussions are maturing in line with our expectations and have been facilitated by discussions at the highest levels of these companies about the impact of large scale deployment of computation and drug discovery. It's clear that interest in deploying advanced computational methods remains high. Collaborations are continuing to be an important element of our business and our progress across several partnered programs contributed meaningfully to drug discovery revenue in the Q2. Our co founded companies are also an important part of our overall strategy, and their success provides further validation for our platform and is an additional source of capital.

Speaker 2

We would like to extend our congratulations to our partner Morphic Therapeutic on their planned acquisition by Lilly for 3,200,000,000. We are proud to have worked side by side with Morphic scientists on several programs including Morph057. We would also like to congratulate our partners' structure on the presentation of their Phase 2 obesity data and AJAX Therapeutics on their recent Series C financing and IND clearance for their JAK2 inhibitor. These achievements at our co founded partner companies demonstrate the power of our platform to serve as a catalyst for innovation in drug discovery. We have developed and deployed powerful physics based methods amplified with advanced machine learning and AI and we will continue to advance our platform to unlock the full potential of computation to drive efficiency across the and D continuum.

Speaker 2

We recently launched an exciting new initiative to develop a computational solution designed to reduce the risk of development failure associated with binding to off target proteins which can be associated with serious side effects. We have already built accurate models for a handful of key off target proteins and have begun using this technology in our partnered and proprietary programs. In the coming years, we aim to build predictive models for many of the most well known off target proteins. We expect these predictive toxicity assays to contribute to future software growth given the demand for solutions that can help screen and optimize drug molecules to enhance the likelihood of success in clinical trials. We are delighted that this effort is being funded initially by a $10,000,000 grant from the Bill and Melinda Gates Foundation.

Speaker 2

We have made considerable progress in the first half of the year, and we are executing on our strategic priorities for the remainder of the year, including driving software scale up and adoption, advancing the science that underlies our platform and progressing our partnered and proprietary programs. I greatly appreciate the dedication of our employees whose hard work and collaboration are critical to achieving our mission. I will now turn the call over to Jeff.

Speaker 3

Thank you, Ramy, and good afternoon, everyone. Schrodinger had an excellent quarter in Q2 with software revenue growing strongly, drug discovery revenue elevated by the recognition of milestones associated with the progress of several collaboration projects, significant progress achieved in our proprietary therapeutics portfolio and validation for our technology and business strategy from the planned Morphic acquisition. Our business showed its resilience as revenue growth in our global accounts offset challenges in certain geographies and market segments. We are maintaining our previously provided revenue guidance for the full year and are increasingly confident that opportunities such as the recently announced predictive toxicology project position us for sustained growth in the coming years. Software revenue in Q2 was $35,400,000 compared to $29,400,000 in Q2 2023.

Speaker 3

The 21% increase was due to increased revenue from global accounts as well as revenue recognized from our combined software drug discovery collaboration customers. As we indicated previously, our customers are progressively converting to ratable software contracts, and this conversion is reflected in the increase in our hosted software revenue this quarter. The customers making this conversion are both global pharmaceutical companies and established biotech companies. It is noteworthy that our total software revenue grew strongly even with a significant increase in the actual percentage of hosted revenue compared to the same period in 2023. On premise software grew by 11.5% to $18,800,000 in Q2 and hosted software grew by 82 percent to $8,000,000 Maintenance revenue was flat year over year at $5,800,000 and professional services increased by 23%.

Speaker 3

As a percentage of our total software revenue, hosted revenue was 22.6% in Q2 compared to 15.4% in the same period a year ago compared to 21.5% in Q1 this year. I'd like to make a few comments on the dynamics we are seeing in our software business at the midpoint of the year. First, our strategy has been to focus on increasing the scale of adoption of our technology at our established customers, and this strategy is working. We are seeing more and more customers adopting our suite of software solutions as foundational to their drug discovery efforts and recognizing that increased scale of utilization results in better outcomes. The benefits of that strategy are reflected in this quarter's results and in our reiterated guidance for the year.

Speaker 3

2nd, we continue to see volatility around renewals and scale of purchasing among emerging and small biotech customers. In some cases, these customers are dealing with balance sheet and strategic concerns by reducing or halting drug discovery efforts and concentrating on 1 or 2 of their most advanced programs. However, we are also seeing green shoots in terms of new companies that are powering their drug discovery efforts with our software. And on balance, we are finding more customers and increasing accounts than we are encountering retrenchments. In the first half of the year, the bookings increase from growth accounts continues to outpace the booking decrease from reducing accounts and the contribution from new software customers is exceeding discontinuing customers.

Speaker 3

We are confident that the opportunities in large growth and new accounts are considerably greater than the issues in the emerging company segment. 3rd, geographically, we are also balancing risks and opportunities. A relatively small business in China has had challenges associated with reduced availability of capital for biopharma research there. And those challenges are exacerbated by geopolitical issues. Our other businesses in Asia are advancing and we are very encouraged by the growth opportunities we are seeing in Europe and North America.

Speaker 3

Our drug discovery revenue was $11,900,000 this quarter compared to $5,800,000 in the same period a year ago. The increased revenue this quarter was due to recognition of revenue for the achievement of planned milestones in ongoing drug discovery collaboration projects. Total revenue for the quarter was $47,300,000 dollars compared to $35,200,000 in the same period a year ago and compared to $36,600,000 in Q1 this year. The year over year increase was driven by contributions from software and drug discovery revenue. Turning now to gross margins.

Speaker 3

Our software gross margin was 80% in Q2 compared to 77% in the same period a year ago compared to 76% in Q1 this year. The increase in gross margin was associated with increased scale of renewals at large customers during the period and lower royalties and FTE efficiencies contributed to the sequential improvement. Our cost of drug discovery services decreased significantly to $8,800,000 compared to $14,700,000 in the same period in 2023 and also decreased compared to Q1 this year. The decrease was driven by the shifting allocation of our drug discovery employees from collaboration projects to proprietary research and also lower CRO and other project expenses associated with discontinued collaboration projects. In the absence of other collaborations or collaboration projects, these expenses are likely to be in the current range in future periods.

Speaker 3

Our overall gross margin was 66% during the quarter compared to 39% in the same period a year ago compared to 52% in Q1. The increase in overall gross margin was driven by higher revenue and lower costs. R and D expense was $51,000,000 in Q2 this year compared to $43,000,000 in the same period a year ago compared to $51,000,000 in Q1 this year. The year over year increase in R and D expense was approximately 2 thirds drug discovery and 1 third nondrug discovery. The drug discovery increase was driven by the shift in allocation of staff from collaboration projects to proprietary programs and by higher headcount and increased CRO expenses for internal programs.

Speaker 3

The increase in non drug discovery R and D expense was due to increased technology and cloud expenses and higher FTE expenses. Compared to Q1, the total R and D expense was flat as changes in allocation were offset by lower underlying FTE expenses for R and D. Sales and marketing expense was $9,700,000 for the quarter and increased by 7.5% compared to the same period a year ago, but decreased by 4.7% compared to Q1 this year. The year over year increase was mainly due to higher FTE expenses, including commissions and increased marketing investment. G and A expense of $23,500,000 increased by 1.4% compared to the same period in 2023 and declined by 8% compared to Q1 this year.

Speaker 3

The decrease compared to Q1 was due to lower FTE expenses, reduced severance and lower royalties compared to prior accruals. Total GAAP operating expenses were $84,100,000 for Q2 compared to $75,000,000 in Q2 last year and $86,300,000 for Q1. The year over year increase was mainly due to R and D, while the decline compared to Q1 was due to G and A. Our operating loss for the quarter was $52,700,000 compared to a loss $61,100,000 in the same period a year ago and to a loss from operations of $67,400,000 in Q1. During the quarter, the change in fair value of equity investments was an expense of $5,800,000 as the value of our investments in Structural and Morphic declined during the period.

Speaker 3

Lilly's offer to acquire Morphic occurred after the close of Q2 and is not reflected in these results. Our other income was $4,600,000 compared to $4,300,000 in the same period last year, mainly associated with interest on our cash reserves and total other expenses was a loss of $1,200,000 Our loss before taxes and net loss were both $54,000,000 as our tax expense was negligible and our loss per share was $0.74 This compares to net income of $4,300,000 in Q2 last year, driven by the Nimbus distribution and earnings per share of $0.06 Our average fully diluted share count in Q2 was 72,700,000 compared to 75,100,000 in Q2 last year. During the quarter, our operating cash use was $54,000,000 and our cash and marketable securities balance declined by $54,000,000 compared to the end of Q1. In Q3, we expect to receive $48,000,000 from the sale of our holding in Morphic, which is expected to largely offset the cash used in operations in the period. We remain eligible for low single digit royalties on Morphix leading clinical program and to variable royalties on other programs in their portfolio.

Speaker 3

We continue to own approximately 2.4% of the common shares outstanding at Structured Therapeutics. And during the quarter, we invested an additional $3,000,000 into AgeX Therapeutics to maintain our ownership at 5.8%. Looking ahead, we are maintaining our previously provided software guidance for the year. We expect software revenue in Q3 to be in the range of $32,000,000 to $34,000,000 We expect the recently announced funding from the Gates Foundation to contribute some software revenue in the second half of the year, aligning with our expected commitment of existing and new resources to that project. We do expect this project to have a modest negative effect on our gross margins, primarily because the profitability of the grant, which is software contribution revenue, is lower than our software revenue from contracts with customers.

Speaker 3

As a result, we now expect our full year reported software gross margin to be slightly lower than last year and in the range of 2022. The lower gross margin is likely to persist for the duration of the grant, but the profitability of our software revenue from contracts with customers is trending to the same range as last year. The expected dollar increase in our cost of goods associated with the grant is likely to be matched by a similar decrease in our expected R and D expense, which should moderate our expected overall expense growth for the year by approximately 1 percentage point. We now expect our full year operating expense growth to be in the range of 8% to 10% or at the low end of our previously provided range of 8% to 12%. At the conclusion of the grant, we expect the negative effect on our operating software gross margin to reverse.

Speaker 3

Our full year Drug Discovery revenue guidance is unchanged at $30,000,000 to $35,000,000 and we expect the balance of our realized revenue to be weighted towards Q4. Finally, we continue to forecast that our cash use this year will be greater than our cash use last year. With that, I'll turn the call over to Karen to discuss our therapeutics updates.

Speaker 4

Thank you, Jeff, and good afternoon, everyone. We are continuing to advance our pipeline of collaborative and proprietary programs. We are very pleased to see the progress of compounds and clinical programs at companies we have partnered with and co founded, including Ajax and Structure, which continues to demonstrate the power of our platform when deployed at scale. As Rami mentioned, Morphic recently announced its planned acquisition by Lilly. We worked closely with the Morphic team on the discovery of several oral integrin inhibitors, including MORF057, which is a highly selective alpha-four beta-seven inhibitor.

Speaker 4

Our proprietary pipeline is progressing well and we now have 3 programs in the clinic. Beginning with SGR-five thousand and five, our MORT1 inhibitor, our Phase 1 study in patients with relapsed refractory B cell lymphomas is advancing. We are continuing to enroll patients in cohorts evaluating SGR1505 administered once daily, And we have initiated a twice daily dosing cohort. We now expect to present initial clinical data from this study in the first half of twenty twenty five. We plan to present safety pharmacokinetic and pharmacodynamic data, as well as preliminary efficacy data in a peer reviewed setting.

Speaker 4

Turning to our CDC 7 inhibitor, SGR 2921, enrollment is ongoing in our Phase 1 study in patients with acute myeloid leukemia or myelodysplastic syndrome. As a reminder, the primary objectives of the study are to evaluate the safety, tolerability, and to determine the recommended phase 2 dose. The study is progressing well with multiple dose escalation steps completed. Based on the pace of dose escalation and the timing of abstract deadlines for medical meetings, we now expect to present initial clinical data from this study in the second half of 2025. SGR 2921 was recently granted FDA Fast Track designation in relapsedrefractory AML, which underscores the unmet need and strength of our preclinical data.

Speaker 4

Today, we also announced the initiation of dosing in our Phase 1 clinical study of SGR 3515, our Wee1Mt1 co inhibitor. The phase 1 study is designed to evaluate the safety PKPD preliminary anti tumor activity and recommended phase 2 dose. The study population will include patients with advanced solid tumors predicted to be sensitive to Wee1Mt1 inhibition, including breast, ovarian and uterine cancer, in addition to other solid tumors with elevated replication stress. SGR 3515 inhibits both V1 and implement an intermittent dosing schedule with the goal of to implement an intermittent dosing schedule with the goal of maintaining efficacy while allowing recovery from any potential hematological mechanism based side effects. Turning to our Sos1 program, we are very pleased with the preclinical package for this IND ready program.

Speaker 4

Given Sos1 inhibition is expected to be used in combination with KRAS and other MAPK pathway inhibitors, we will seek to advance this program through a partnership. Within our BMS collaboration, we successfully advanced a neurology program into the later stages of discovery. We also mutually aligned with BMS on discontinuing the immunology program on the basis of the project viability and competitive positioning of the initial target product profile. Collaborations remain an important part of our strategy and we continue to engage with existing and new partners about future collaboration opportunities. We are excited about the expansion of our Predict First approach with the launch of structure based models for binding to off target proteins.

Speaker 4

The ongoing structural biology revolution is expanding access to accurate three-dimensional structures of increasing numbers of proteins. We are leveraging this expansion to pursue broad computational off target binding models, and have already begun see the impact on our internal discovery projects. Fully realizing the power of computational toxicology solutions is expected to further transform drug discovery. In summary, we are very pleased with the progress we are making across our collaborative and proprietary pipeline. We are looking forward to Phase 1 data readouts from all three clinical programs next year, beginning in the first half of twenty twenty five.

Speaker 4

Behind these programs, we have discovery programs that represent both 1st in class and best in class opportunities that can generate value through partnerships or by advancing them independently. I will now turn the call back to Rami.

Speaker 2

Thank you, Karen. We have made a great deal of progress in the first half of the year. We witnessed continued scale up and adoption of our software, launched an exciting new computational initiative to develop a predictive toxicology solution and advanced our pipeline. We look forward to updating you on the opportunities that lie ahead in the second half of the year. At this time, we'd be happy to take your questions.

Operator

Thank And we will take our first question from Michael Yee with Jefferies.

Speaker 5

Hey, guys. Thanks for the question and congrats on a good quarter. We had two questions. One was thinking about the outlook for the rest of the year. Tell us about your thoughts around any dynamic changes in your end user customers.

Speaker 5

Obviously, you're essentially maintaining the guidance and we always know it comes down to the Q4. So maybe just tell us a little bit about the dialogue and conversations you're having as it relates to confidence towards the end of the year? And our second question is more an important financial question. I'm sure Jeff would have a good lot around this as it relates to your year end cash. We have our own estimate of about $366,000,000 or so, but the burn is a couple of $100,000,000 for next year, leaving you perhaps less than a year of cash if you didn't have additional capital.

Speaker 5

Can you tell us about your thoughts around where there would be options for capital over the course of the next year or so, a partnership, other options? Tell us about that. Thank you.

Speaker 6

Thanks, Mike. I'll take the first question and hand it over to Jeff to either add to the response to the first question and obviously answer your second question. So, with regard to the nature of our discussions with with our customers, a few things. One is, we're really pleased with the level of engagement, the clear level of interest in scaling up their usage of the software. And they're excited about the kinds of advancements that we're talking about, including this Predictive Talks project.

Speaker 6

Obviously, that won't have an impact this year, but still excitement around the science and advancement of platform is very helpful in any of these engagements. We also I'll remind you that we have we continue to expect as we have in previous years to continue to have the very high, near 100% customer retention rate. So we have a lot of visibility into these discussions. We know customers will be, renewing and it's really just a matter of what the scale up might be in the, as you pointed out mostly in Q4. Jeff, do you want

Speaker 5

to add anything to that

Speaker 6

or and then answer the

Speaker 2

cash push?

Speaker 3

Yes. Thanks, Rami. Yes, just to add to that. Q4, of course, Mike, is our largest quarter always, and that's when our big customers renew. And I think the guidance range does reflect that we don't know exactly how much those customers are going to scale up their use and the exact nature of the contract, how much service there is or maintenance we're providing, how much of the mix of the revenue is going to be ratable versus on prem, and that's what contributes to the uncertainty in the guidance.

Speaker 3

But we have a very high degree of confidence that our customers are going to renew, and all of the experience that we've had, including the experience we've had in the first half of this year, is that they are likely to renew at increased scale. With respect to the cash position, you saw us, clearly have the opportunity and we'll receive the additional cash from Morphic, presuming that that closes in the immediate future. And then I highlighted the continued position that we have in structure and of course the opportunity to realize that over time as well. And then lastly, as our programs move into the clinic, we have been pretty clear that our intention is not to continue to take all of our programs ahead independently. We may under the right circumstances advance 1 or maybe more programs.

Speaker 3

But obviously given the number of programs that Karen's team is developing, we are expecting to transact on some of them. So we believe we have a number of opportunities for partnering. And we also, as Karen alluded to, continue to be actively engaged in discussions about collaboration. So both of those are additional sources of capital to sort of more or less match what we expect to be the cash burn going forward.

Speaker 5

Okay. Thank you, guys.

Operator

Thank you. And we will take our next question from Mani Foroohar with Leerink.

Speaker 7

Hey, guys. Thanks for taking the call and congrats on the quarter. I want to drill down a little bit on growth in the software based business. You've given some clarity around continuing investments and engagement with your large customers around deepening and expanding use and that's one driver of growth. Can you give us a little bit of a clarity on what you're seeing in end market use amongst smaller biotech companies, newly founded companies, venture funding companies, etcetera?

Speaker 7

And to what extent we're seeing the state of biotech capital markets reflected in your new customer adds?

Speaker 6

Yes. Jeff, you want to ask? Yes.

Speaker 3

Sure. Thanks for the question, Marty. Look, I tried to sort of allude to that in my prepared remarks. There's no doubt it's a turbulent environment for emerging biotech companies, but there are still new companies being formed. And the new companies formed tend to be looking at the most cost effective way to come up with novel molecules against their favorite targets.

Speaker 3

And so very frequently, they're reaching out to us about becoming a software customer. And so when I look at the sort of customers that are scaling back or stopping use of our software because they've said we don't do drug discovery anymore, we're just advancing Phase 1 or Phase 2 program. When I look at that number of customers and that revenue effect compared to the opportunities that we're seeing, we're still seeing more new accounts than accounts that are not software customers, and we're seeing significantly more growth accounts than we are seeing reducing accounts. So I would say it's definitely an effect. It's a fairly modest effect.

Speaker 3

Now business is really being driven by the large customers, but it's an effect that I don't think that it's increasing. I think that we're weathering it and you're sort of seeing us absorb it in the results and the guidance that we're providing. And I think that there's some signs of optimism in the green shoots that I'm alluding to and the company is reaching out to us and saying we'd like to become customers. But it's a little hard to say that that's going to sort of result in a real recovery in the growth contribution of that customer segment, which really has not been there in a large way since sort of 2021 or early 2022.

Operator

And we will take our next question from Scott Schoonhouse with KeyBanc.

Speaker 8

Thanks guys. Jeff, I guess this is a question for you. You're following up on new initiative to expand the application of computational tools for predictive toxicology. When exactly will this launch? When can you start taking orders?

Speaker 8

When should we start seeing the incremental revenues flow through? I believe you said in your opening comments next year. And then I have a second follow-up on this one as well.

Speaker 6

Yes. Let me take that first. Scott, thank you. Yes, we're obviously extremely excited about this project. We've already gotten quite a bit of feedback from pharma companies that we've discussed it with and it's been universally positive.

Speaker 6

And we've also, as we've indicated, started to use this technology and our proprietary programs. And, and getting some very nice results with it. Now, with regard to when it will be available to customers, that's something that we're building out. Now. We obviously are very excited to have it funded by the Gates Foundation with that $10,000,000 grant.

Speaker 6

We expect to sign up additional partners to help work with us on the project. That's what we've done in the past with sort of new and novel technology. And we can't necessarily get into details about exactly when it's going to be released. We've never done that. That's not a smart thing for any software company to do.

Speaker 6

But I think you can tell from how we're talking about it that this is something that will be released in the near future. Let's put it that way. And we certainly expect it to contribute continue to contribute to software revenue growth over the coming years as we add more and more off targets to the handful that we've already done.

Speaker 8

That's really, helpful color, Rami. Thank you so much. Yes, sir. I guess just to, I just guess to put a pin on the, back half software revenue guidance since it's been picked and poked at earlier with earlier questions. I guess, is there any change to the cadence of the back half from your from last quarter even, say, based on all that color that Jeff provided on the customer, the green shoots and you're seeing more increasing scale of established customers.

Speaker 8

Has anything changed over 90 days in terms of the cadence of the back half or the contribution of the back half, in terms of software revenue guidance? Thanks.

Speaker 3

Ron, do you want to jump in?

Speaker 6

Yes. Yes. Yes. Thank you.

Speaker 3

I don't think so. All I would say is I think the middle part of the year is proceeding a little better than we anticipated. We are seeing some encouraging signs in terms of, as I mentioned, both global accounts and established biotech customers scaling up their renewals, and that's kind of helping us in the middle part of the year. But the full year result still is heavily dependent upon the Q4. I've sort of mentioned that we have a very high degree of confidence about the renewal opportunities that we have and the fact that they will renew.

Speaker 3

But of course, the range of the guidance, which you can see is really influenced by the scale of the contract and the scale up in the contract, the length of the contract, some customers will come to us and say, yes, we want to have a multiyear contract or we don't. And then, of course, the nature of the contract, as I mentioned. So there are all those different elements that contribute to that variance in the guidance, but we're very confident that those renewals will happen.

Speaker 8

Thanks so much, guys.

Operator

Thank you. And our next question comes from Evan Seigerman with BMO Capital Markets.

Speaker 7

Hi, there. This is Connor McKay on for Evan. Thanks for taking our question and congrats again on the quarter. Just one for me on the updated clinical timelines that we got today. Can you maybe just comment on how trial enrollment has been progressing for your key assets that are currently in clinic?

Speaker 7

And maybe just discuss a little bit what drove the change from the previous late 2024, 2025 guidance to the newer sort of more specific first half and second half twenty twenty five guidance. Is this just a tightening of your prior range? Thanks.

Speaker 9

Yes. Thanks very much for the question. Yes, indeed, it is tightening of the range. Enrollment is going well in both our most advanced programs. And as you heard, we just started dosing in our 3rd program.

Speaker 9

We are very happy with the way things are going. And really this is around our intention and our plan to share information at Medical Congress and understanding the timing of abstract submission dates. We've been able to narrow that focus into first half of the month one and second half for CDC7. But overall things going really well and pleased with the studies and the enrollment that we're seeing. Thanks.

Operator

Thank you. And our next question will come from Michael Ryskin with Bank of America. Please go ahead, Michael. Your line is open. And once more, Michael Ryskin, your line is open.

Operator

We will take the next question from David Lebowitz with Citi.

Speaker 5

Thank you very much for taking my question. At the beginning of the call, you referenced, your talks with the large scale global companies about significant scale ups and expanded use of the software. Is that something that's actually incorporated into the data that's something we would see in the 4th typical Q4 uptick? Or is that a more broad statement that talks about potential acceleration in the coming years?

Speaker 6

Yes, Jeff?

Speaker 3

Yes. That's actually a really good question. Dave, I think it's both. I think that we recognize, as you know, that we had a lot of contribution from a large customer renewing a multiyear contract in the Q4 of last year. And so we're very focused on growing through that in the Q4 of this year and see a number of opportunities for doing that, which is what's in the guidance.

Speaker 3

But also, I think from our comments around predictive talks and from our general comments, I think we think this is relatively early days in the cycle of the industry's adoption of this technology. And we have had an opportunity in the quarter to talk to many of the largest customers about where they are in the journey of adopting our technology at scale. And I think they're starting to realize that it's still relatively early days and they have a long way to go in terms of capturing the full benefit. Rami, do you want to talk a little bit more about the long term and the discussions we've had?

Speaker 6

The long term, that's right. The question was specifically about the, right, David, about this year in the Q4, correct? Or did I miss

Speaker 5

here? I basically meant to the extent that are we talking about substantial upticks in the use of the software that's something that's already incorporated into the numbers? Or are we talking on a broader scale of them actually increasing their overall adoption going forward and how that might affect future years?

Speaker 6

Yes. Okay. So, yeah, I think Jeff covered it very well, but you're raising something very interesting, which is that as customers scale up the usage of the software, they see an acceleration in the impact that it has and that fuels more growth. We've often talked about this sort of chicken and egg problem that you have to have you have to be using the software at some sort of critical level of usage to really see the impact. So that's what we're finding is that as customers scale up, they finally get to the point where they see the sort of profound impact on their projects, the kind of thing that we're seeing internally and that our partners are seeing it.

Speaker 6

You can see the success of our partners and the impact that's having. And like I said, that continues to fuel further growth. And also, as Jeff said, we should be very clear. And we've said this many times, we're excited about where customers are going. And, you know, we, at the moment have customers that are really using the software at a, at a nice scale, but they still have a long way to go to really use the technology, to its full, you know, to realize the full benefit of it.

Speaker 6

And as we've said many, many times to use it at the scale that we're using it in our collaborative and proprietary programs. I think that's what you're getting at. And it's a great question.

Speaker 5

Thank you for taking my question.

Speaker 6

Yeah. Thanks.

Operator

Thank you. And our next question comes from Vikram Puruhead with Morgan

Speaker 10

Stanley. Hi, this is Morgan Greig on for Vikram. I have two questions related to the MALT-one program. First, for the initial MALT-one data expected in the first half of twenty twenty five, could you provide some more color on what this data set could look like in terms of number of patients, level of follow-up and parameters of data you anticipate reporting? And then following this data readout in 1H25, are there any potential plans to establish a partnership Or do you envision maintaining proprietary ownership of the molecule until additional data readouts?

Speaker 10

Thank you.

Speaker 9

Yes. So as we've described, well, this Phase I dose escalation in patients, we are very focused on understanding the pharmacokinetics and pharmacodynamics. I think we said in our prepared remarks, we're currently comparing once daily and twice daily and collecting pharmacodynamic data. And so this first half of twenty twenty five, it will really be giving insight in to what we're seeing in that Phase 1 dose escalation study. We are obviously also in an exploratory way looking at clinical activity and we also hope to be able to present that.

Speaker 9

And so yes, looking forward to the opportunities bring together and accumulate all of that data to share in a peer reviewed setting. In terms of what our plans are for MORC-one, I think we've been really clear in the past that we think MORC-one is a mechanism that will combine well with some pretty well established drugs, BTK inhibitors, BCL2 inhibitors in a range of lymphomas. And as a result of that, we think that actually the broadest potential development of MORT1 inhibitors will be in partnership with companies that own those assets or products actually on the market. And so while we will continue to study our molecule internally, we are always talking to partners about our projects. And we think that there will be an opportunity with a more complete data set to socialize that with VARMA and potentially part of the program as we conclude the Phase 1 study.

Operator

Thank you. And we will take our next question from Matt Hewitt with Craig Hallum Capital Group.

Speaker 11

Good afternoon. Congratulations on the quarter and for taking for taking the questions. Maybe first up regarding the new predictive toxicology tools. Was this something where customers had come to you, looking for help? Or was this you seeing an opportunity in the market given your strengths and basically putting this together, I guess, is the first part of the question?

Speaker 11

The second part is, as this gets adopted, as you launch this, this gets adopted, do you see that changing the methods for the traditional tox studies? Will there be a cost benefit to utilizing your software versus the traditional methods or is this in addition to those traditional talk studies? Thank you.

Speaker 6

Thanks, Matt. Those are great questions. So first of all, with regard to your first question, absolutely both. This is widely known in the industry as a very serious problem. And customers and everybody that's doing drug discovery have been complaining about this for forever.

Speaker 6

And it's a problem that everybody encounters in their drug discovery projects. So what happened is that our technology and a number of different pieces of the technology actually got to a certain level of performance that we recognize this seemingly impossible problems that, you know, it seemed like an impossible problem a few years ago, all of a sudden seemed possible. It's very ambitious project, but we think given what we've already done with a number of targets that it's now the right time. And we're excited to not only where the science has gotten to and not only the funding that we talked about before, but our partnership with Nvidia, which is also really making, this, this possible. The performance of computers even just a few years ago, was not where where it is now.

Speaker 6

And where it is now is what's making this even possible. So it's bringing together, obviously the interest and the demand for something like this with advances in the science and advances in computer hardware. Now with regard to the traditional methods, there are basically 2 methods that are used now. 1 is obviously experimental and that's what most people are doing. And of course, you can imagine that's pretty slow, not very high throughput and obviously costly.

Speaker 6

I mean, to actually make the molecule and run it through panels of, you know, it's, of, of off targets 1 at a time, to determine the sort of profile of the molecule with regard to off target toxicity. The other approach has been one that involves using purely machine learning. So this is basically collecting as much experimental data as possible and then just building ML models. The problem with that is that has a severe limitation, which is that you can only get reasonably reliable predictions for molecules that look a lot like the molecules that have already been synthesized. What that means is that these predictive computational methods only start to work very late in projects after you've accumulated a ton of experimental data.

Speaker 6

And that obviously is missing a huge opportunity to catch these problems early in projects. With the physics based approaches that we've developed and published, that allows for any novel of any molecule. It can be completely novel. There doesn't need to be any experimental data existing yet to be able to accurately predict, whether it binds to a panel of off targets. So, so that's what the sort of breakthrough is.

Speaker 6

There is never going to be a complete replacement for experimental methods. Eventually, you have to do the experiments. But the idea behind this technology is that it will significantly reduce the need to do those and it allow for prediction of this toxicology profile very early in projects and actually be able to fix it instead of just throwing your hands up and saying, oh, well, this is another yet another series that's dead. Hope that makes sense.

Speaker 11

Absolutely. Thank you. That's very helpful.

Speaker 5

Cool.

Operator

Thank you. And our next question comes from Chris Shibutani with Goldman Sachs.

Speaker 5

Thank you very much. Two questions, if I may. In terms of how you think the gross margin is being improved and strengthened by some of the shifting of the allocation of employees that you described, can you give us a sense for where you are in terms of the rightsizing or the right distribution or shaping of that distribution, so to speak, so that we can think about where on the forward this may continue to provide some gross margin benefit? And then secondly, I'm curious to know, particularly as Karen and her team continue to advance her proprietary pipeline into the clinic, you guys in essence represent the sort of the leading edge of the master class or the ability to apply artificial intelligence type informed modalities. And we often observe and wonder whether or not in the clinical development stage, there is a smarter, better, leaner, quicker way of approaching it?

Speaker 5

And if so, what is it that you guys are doing? And is it something that you're even contemplating expanding your own portfolio with? Just kind of understand if you could be the best in class example of utilizing this to the max, taking growth from discovery all the way through the clinic, what happens in the clinical development phase, what's your mindset now? Thank you.

Speaker 6

Thanks, Chris. Jeff, would you like to take the gross margin question first?

Speaker 3

Sure. Chris, thanks for your question. The gross margin, as you kind of gathered from my prepared remarks, on the drug discovery side, there has been a reduction in the cost of services associated with the drug discovery revenue as some of the project teams that were working on collaborations have shifted over to work on proprietary programs. And so the expense associated with those employees, but also any CRO services or other services associated with their work has shifted from cost of services over to R and D. I don't think that there is a lot more to shift there.

Speaker 3

And as I mentioned in my prepared remarks, the outlook very much depends upon what we do with respect to collaboration. So in future periods, if there is another collaboration that engages a number of those employees, then that shift might move back the other way. I don't think it's going to be a seismic shift back the other way, but as it has been over the past few quarters, could it trend back the other way? Yes, somewhat. The larger question, of course, related to R and D spend.

Speaker 3

You saw R and D was flat Q2 over Q1. And I think we generally feel that we're in a really good place in terms of the investment we're making in the platform and the investment we're making in proprietary medicines. You know, depending upon what happens with the clinical programs and their progress and what we decide to advance, etcetera, there could be a step up associated with the clinical side. But I don't see that as being an imminent step up because we've given you a timeline for seeing the clinical data. And so we're continuing with those current trials to turn over those cards.

Speaker 3

So I don't think that there's a big change in either the R and D line or in the cost of services. And then lastly, I think I alluded to the puts and takes on the gross margin line on software, where hopefully I managed to explain that there will be a temporary reduction associated with the funding for the predictive tox initiative and that, that will reverse itself at the conclusion of that funding. That's just an anomaly of the different profitability between software research project and a software contract with the customer. So hopefully that's clear. And Karen, do you want to talk about AI?

Speaker 5

Thank you.

Speaker 9

Certainly, yes. So you're quite right that obviously as we move our programs into the clinic, our mindset is critics first and be as efficient as possible. We ourselves are not building those types of capabilities. As you know, our platform is very much chemistry focused. However, we are engaging with companies who have built those kinds of platforms and evaluating whether they are additive to the sort of regulated way of doing things.

Speaker 9

Can these help accelerate or improve efficiency in how we run trials, including things like patient selection and site selection. However, at this point, that's not something that we will be focused on building internally. I just want to be clear with that.

Speaker 5

Thank you.

Operator

Thank you. We will take our next question from Stephen Maugh with TD Cowen.

Speaker 7

Cohen. Congrats on the quarter and thanks for taking the questions. Just two quick follow-up questions on the predictive toxicology initiative. 1, does the Gates Foundation have any downstream rights for anything you or your partners discover? And 2, is this software applicable to both small molecules and biologics?

Speaker 6

The short answer to the first question is no. With regard to the second question, the technology at its current state is being developed for prediction of binding to off targets by small molecules. So and that's that's where the focus is. Toxicity of of of antibodies, is associated with not with this sort of mechanism of off target binding. The toxicities often associated, for example, with immunogenetic responses.

Speaker 6

So it's a different kind of problem. Yeah. That's what I'm focused on.

Speaker 7

Okay. Yeah. Thanks, Luke.

Speaker 6

Thank you. Yep.

Speaker 7

Yeah. Okay. Yeah. That's what I figured. Thanks for the clarification.

Speaker 7

And then and then maybe staying on biologics, could you give us some color on the live design for Biologics? What has the traction been since the launch in March? Thank you.

Speaker 6

Sorry. What was the yeah. But what was the

Speaker 5

Oh, no. The Yeah.

Speaker 7

Sorry. A live design for Biologics. You guys launched that in March, the enterprise software?

Speaker 6

Yeah. Okay. Yes. Yep. And how's it going?

Speaker 6

Yes. The reception has been fantastic. This is clearly a product that was, sort of had a lot of pent up demand for it. And all of the demos that we've been doing and discussions with customers, again, the reception has been really, really great. As with enterprise software, the fact that it is so sticky once it's in also results in the time to adoption being a little slower.

Speaker 6

That the this is it's not expected that the customers just sort of hear about it and the next day they're, they're using the software. The, the sort of sales cycle is a little bit longer, with enterprise software. Again, the result of that is extreme stickiness once it's developed. So what we can tell you is we have had customers using it. And again, the feedback is quite positive.

Speaker 7

Great. Thank you. Yep.

Operator

Thank you. I am showing no further questions at this time. That concludes today's call. You may now

Earnings Conference Call
Schrödinger Q2 2024
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