Schrödinger, Inc. (NASDAQ:SDGR) Q4 2023 Earnings Call Transcript February 28, 2024
Schrödinger, Inc. beats earnings expectations. Reported EPS is $-0.41, expectations were $-0.44. Schrödinger, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Welcome to Schrödinger’s Conference Call to review Fourth Quarter and Full Year 2023 Financial Results. My name is Mandie, and I will be your operator for today’s call. [Operator Instructions]. Please be advised that this call is being recorded at the company’s request. Now I would like to welcome your host for today’s conference, Mr. Matthew Luchini, Director of Investor Relations and Corporate Affairs. Please go ahead.
Matthew Luchini: Thank you, and good afternoon, everyone. Welcome to today’s call, during which we will provide an update on the company and review our fourth quarter and full year 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 schrodinger.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 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 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-K for the year ended December 31, 2023. These forward-looking statements represent our views only as of today and we caution you that, except as required by law, we may not update them in the future, whether as a result of new information, future events, or otherwise.
Also included in today’s call are certain non-GAAP financial measures. These non-GAAP financial measures are not prepared in accordance with generally accepted accounting principles and should be considered only in addition to and not a substitute for or superior to GAAP measures. Please refer to the tables at the end of our press release, which is available on our website, for reconciliations of these non-GAAP measures to the most directly comparable GAAP measures. With that, I’d like to turn the call over to Ramy.
Ramy Farid: Thanks, Matt, and thank you, everyone, for joining us today. We made incredible progress in 2023, and we expect to continue to make important advances across the business in 2024. In 2023, we continue to make significant advances to the science that underlies our computational platform, and it’s expected we continue to see increased adoption of our software at scales that are allowing our customers to meaningfully impact their programs. We also advanced our proprietary pipeline, including initiating a phase one study for our second proprietary program, SGR-2921. 2023 was also marked by progress at several companies we co-founded and in which we have equity stakes, including Nimbus, Morphic, and Structure. Their advancing programs also further validate our platform, and in the case of Nimbus, their TYK2 inhibitor, which we co-discovered, led to the sale of the molecule to Takeda and a substantial cash distribution to Schrödinger last year.
Total revenue for the year was $217 million, a 20% increase over the prior year. Software revenue grew by 17% year over year, marked by multi-year renewals with large biopharma companies, including an expanded three-year software agreement with Lilly. We had a very successful fourth quarter in our software business, reporting revenue of $69 million, the largest quarter for software revenue in our history. We ended the year with 27 customers with an Annual Contract Value, or ACV, of at least $1 million up from $18 million the prior year, reflecting customer demand and their increased confidence in the value that our platform can deliver. This year we will continue to focus on increasing adoption of our platform at global biopharma companies, as well as establish an emerging biotech.
The interest in computationally driven drug discovery has never been higher, and we are witnessing a sea change within the industry in how computation is regarded and applied to drug discovery. We believe that the decades-long debate about the utility of computation is finally over. While this shift may have been fueled by the recent excitement about AI, there is also a growing understanding about some of the obvious limitations of AI. We believe we are well positioned to capitalize on this heightened interest in computation. Our platform is grounded in first principles methods and leverages the accuracy of physics to generate training sets for machine learning and AI. This increased interest in computation has created a worldwide shortage of computational chemists and modelers, which, in the near term may attenuate the full potential of computation, but we have made significant investments and training the next generation of modelers, who will expect and demand validated computational technologies to advance their projects.
Our platform is built on more than 30 years of science and has become the gold standard for computational molecular discovery. We are continuing to make investments to push the boundaries of molecular design, and we expect that computational breakthroughs in small molecule and biologics discovery formulations and informatics will support future growth for many years to come. We have recently published multiple papers demonstrating how our computational methods can improve the utility of ML predicted protein structures, enabling research teams to work on even more targets through structure based discovery. We are also expanding our enterprise informatics solutions to increase efficiency and drive collaboration across teams. Even with the increased scale up of our platform by our largest customers, we are still leveraging our platform to scale is at least an order of magnitude greater than our largest customers.
This is having a big impact on our ability to rapidly progress a broad pipeline of proprietary programs. We now have two programs in the clinic, SGR-1505, our Malt1 inhibitor, and SGR-2921, our CDC7 inhibitor. In December, we reported positive data from our Phase 1 study of SGR-1505 in healthy subjects and are encouraged by the progress and our ongoing patient study in advanced B-cell malignancies. We expect to report data from the patient studies of both SGR-1505 and SGR-2921 in late 2024 or 2025. We are also on track to submit an investigational new drug application for SGR-3515, our Wee1 Myt1 inhibitor, in the first half of this year and are advancing an existing portfolio of discovery programs to position us for our fourth IND in 2025. Years ago, we set forth a bold vision to transform the way therapeutics and materials are discovered, and I’m incredibly proud of the progress we have made toward achieving this goal.
There has been turbulence in the global economy and in many tech industries in particular, but we have never been more steadfast in our confidence in our technology and it’s potential. We deeply appreciate the commitment and hard work of all our employees, and I look forward to another year of progress toward realizing our vision. I will now turn the call over to Geoff.
Geoff Porges: Thank you, Ramy, and good afternoon, everyone. Schrödinger had an excellent Q4, which kept a strong 2023. In Q4, we reported record revenue of $74 million, principally driven by software. For the full year, total revenue grew 20%, with bookends of a large contribution to drug discovery revenue from a single milestone payment in Q1, and then several large multi-year software renewals driving revenue growth in Q4. The year was marked by the considerable progress we have made with our proprietary portfolio and the continued development of our technology platform, which is enabling new capabilities for molecular discovery, even as our largest customers increase the scale of their deployment of our current platform.
2023 was also a year of great validation from our co-founded companies, with $147 million distribution from Nimbus boosting our cash flow and gap earnings, and Structure and Morphic significantly advancing their programs during the year. We see multiple avenues to grow our software revenue in 2024 and beyond, and continue to be active in collaboration and partnership discussions with existing and potential new drug discovery partners. Turning to a review of our fourth quarter results, software revenue for the quarter was $69 million, an increase of 44%. The strong Q4 software result reflected the contribution from a number of multi-year, multi-million dollar on-prem software renewals in Q4, as well as some renewals by hosted customers with ratably recognized software purchases.
The contribution of these multi-year on-prem renewals in Q4 was significantly greater than the contribution of multi-year renewals in Q4 2022 compared to Q3, software revenue more than doubled, in line with our expectations and consistent with the typical seasonality of large customer renewals. Drug discovery revenue for the quarter was $5.5 million, compared to $9 million in the same quarter of 2022 and $13.7 million in Q3. Revenue decreased in the quarter compared to the prior year based on non-recurring milestones reported in Q4 2022, as well as reduced contributions from the smaller number of active collaboration programs during the quarter. Total revenue was $74 million in the quarter, an increase of 30% compared to Q4 2022, and a 74% increase compared to Q3 2023.
The increase was driven by software revenue growth in Q4. For the full year, software revenue was $159 million, an increase of 17.4%, compared to the prior year. The growth was driven by significant increases in our existing customers, including multi-year renewals by large customers in Q4. For the full year, drug discovery revenue was $57.5 million, compared to $45 million in 2022. The increase was driven by progress in our existing collaborations, recognition of some revenue from new collaborations announced in 2022, and accelerated revenue recognition for previously disclosed programs returned to us by our collaboration partners. Total revenue for the year was $217 million, compared to $181 million in 2022. The increase in total revenue was driven by both software and drug discovery revenue growth.
I have a little more color on trends in our software business. Throughout 2023, we disclosed that we were engaged in discussions with a number of large customers about stepping up their level of investment into our technology, and we are encouraged that several of them elected to renew at significantly increased scale and value during Q4. Those agreements contributed a substantial portion of the year-on-year reported growth in on-prem software. We view these companies as bellwethers in the industry and are engaged in discussions with other large companies about substantial renewals. At this stage of the year, we do see opportunities for growth from renewals this year, but since a number of our largest customers entered into multi-year contracts in 2023, the contributions from such additional renewals in 2024 is likely to be less than in 2023.
We reported that we continue to have four customers with annual contract value of at least $5 million, and the average contract value for customers over $5 million grew significantly to $6.7 million. The number of customers with ACV of at least $1 million has increased from 18 to 27, as more and more emerging companies recognize the value of increasing their scale of adoption. We have disclosed a new key performance indicator of customer retention among customers of at least 500,000 in ACV. Among such customers, the retention was 98% in 2023 and was 100% in 2022. Our net customer retention for customers of at least 100,000 per year was 92% in 2023 compared to 96% in 2022. The decrease was associated with increased consolidation and discontinuation of R&D efforts by some biotech customers in the 100,000 to 500,000 ACV range.
This discontinuation rate has been elevated since 2021 and appears likely to remain elevated in 2024. Moving now to expenses. During Q4, the gross margin on our software revenue was 87%. The gross margin performance in Q4 was particularly high based on the strong revenue result in the quarter. The full year gross margin performance was increased by favorable operating leverage and the shift in allocation of our structural biology team from customer-facing projects to internal and collaboration projects. We believe gross margin in future years is likely to be similar to 2023 with some potential variance depending on revenue performance and mix. The cost of delivering our drug discovery revenue in Q4 was $7.9 million and declined compared to $10 million in Q4 2022.
For the full year, our cost of drug discovery revenue was $46.5 million compared to $50.4 million in 2022. The change reflects the reallocation of internal resources from collaboration projects to proprietary programs. The positive profit contribution from our drug discovery revenue for the year reflects the benefits of the one-time milestone reported in Q1. Overall gross margin in Q4 was 78% compared to 68% in Q4 2022 based on improved profitability for software and the shift in mix. For the full year, software gross margin was 81% compared to 78% for 2022. Our software gross margin for the year improved due to lower royalty obligations and favorable operating leverage on our fixed costs. Our drug discovery gross margin was 19% for 2023 compared to a loss ratio of 11% for 2022.
It reflects the favorable effects of successful progression of our collaboration programs. Our overall gross margin for 2023 was 65% compared to 56% in 2022. The increase was due to the improvement in software and drug discovery gross margin. As a result of the strong revenue and gross margin performance in Q4, our gross profit increased by 49% compared to Q4 2022. For the full year, our gross profit was $141 million compared to $101 million in 2022. R&D expenses were $52 million in Q4 2023 compared to $35 million in Q4 2022. The main drivers of the increase were increased FTE numbers, CRO expenses and technology expenses. Compared to Q3, R&D expenses were 10% higher based on increased allocation of staff and resources to proprietary programs.
Higher FTE numbers and increased CRO expenses contributed. For the full year, R&D expenses were $182 million, which was an increase of 44% compared to the $126 million reported in 2022. The increase for the year was driven by the shift in allocation from collaborations to proprietary programs, higher FTE numbers and increases in CRO expenses. As in the recent past, our R&D expenses are approximately balanced between our technology platform and our therapeutics. A significant portion of the increase in R&D investment from 2022 to 2023 has been associated with the progression of our clinical portfolio. We expect R&D expense growth to moderate in 2024. Sales and marketing expense for Q4 was $10 million compared to $9.4 million in Q4 2022. The increase was mainly due to increased staff and associated expenses.
Compared to Q3, sales and marketing expense increased by 9% based on headcount and year-end incentive compensation. For the full year, sales and marketing expense was $37 million compared to $31 million in 2022. The increase of 21% was driven by higher headcount and associated expenses, as well as increased travel. G&A expense for Q4 was $26 million compared to $23 million in Q4 2022. The increase is mainly due to high headcount and one-time royalty obligations, partially offset by lower professional services. For the full year, G&A was $99 million, an increase by 9% compared to 2022. The increase is mainly due to high headcount and FTE expenses, as well as royalty obligations partially offset by lower professional services. For Q4, total operating expense was $87 million compared to $67 million in Q4 2022.
The increase is mainly due to increases in R&D. For the year, total operating expense increased to $318 million, compared to $248 million in 2022. The increase is mainly driven by R&D. During Q4, our operating cash use was $37 million, and our cash and short-term investments declined by $34 million during the quarter. For the year, operating cash use was $137 million, compared to $120 million in Q2 2022. Our cash and marketable securities balance was $469 million at year-end, compared to $456 million at year-end 2022. During the year, our operating cash use was offset by the cash distributions from our investment in Nimbus and by favorable trends in working capital. Our operating loss for Q4 was $29.6 million, compared to $28.5 million in Q4 2022.
Other items and expenses were $1.9 million in Q4 2023, compared to an income of $1.2 million in Q4 2022. Our reported net loss was $30.7 million in Q4 2023, compared to a loss of $27 million in Q4 2022 and a loss of $62 million in Q3 2023. For the full year, other income and expense items were $220 million, driven by the $147 million distribution from our investment in Nimbus, a gain of $53 million in the fair value of our investments and $19.7 million in other income, mainly interest. Our pre-tax income for the year was $43 million, and our tax expense was $2.2 million. Our net income was $40.7 million or $0.54 per diluted share. As we explained previously, we do not expect our profitability in 2023 associated with the Nimbus distribution to persist in 2024.
For GAAP reporting purposes, our fully diluted share count at year-end was $75 million, compared to $71.2 million at the end of 2022. Our basic share count increased by 0.8% over the prior year. Looking ahead to 2024, I already highlighted specific outsized top-line contributions in 2023 that we have to grow past this year. We currently expect that software revenue growth for 2024 will be in the range of 6% to 13%. We firmly believe software is a growth business for us, but that growth remains lumpy with outsized contributions from large customers when they renew extended contracts. We have opportunities to significantly increase the adoption of our technology in our large accounts this year, but it is too early to forecast whether they can match or exceed the contribution from such renewals last year.
We expect our growth outlook to benefit from the introduction of enhancements and new capabilities to our platform. Our metrics for our accounts of at least $500,000, at least a $1 million and at least $5 million trended positively in 2023, and we expect our revenue to grow in association with further changes in these metrics. While our largest customers are now purchasing significantly more than $5 million per year in software, this level of adoption is only occurring among a relatively small proportion of the population of global biopharmaceutical companies. Emerging biopharma companies are also among our largest accounts. And their relatively high level of adoption of our technology also suggests further opportunity for our commercial efforts in 2024.
We expect software revenue in Q1 to be in the range of $33 million to $35 million and expect the distribution of revenue by quarters to be similar this year to that reported in recent years. We expect drug discovery revenue to be in the range of $30 million to $35 million for 2024. Our guidance incorporates uncertainty about the occurrence and timing of development decisions by our collaboration partners and uncertainty about the outlook for progress of programs in our ongoing collaborations. We have taken a cautious approach to including value for new business development activity this year. Although we continue to be actively engaged in discussions about such opportunities with a variety of emerging and global companies. We expect our software gross margin to be similar to our gross margin in 2023 and to vary slightly depending on customer mix and contract type.
Operating expense growth in 2024 is likely to be in the 8% range, significantly below the 28% growth in 2023. In 2024, the growth is likely to be mainly for increased investment in R&D, particularly to support our growing portfolio of proprietary programs. We anticipate that our operating cash burn in 2024 will be higher than our cash burn in 2023. Our goal is to reduce our cash burn in 2025 and later years and that reduction will depend on continued growth in our software revenue, realization of value from our proprietary portfolio and continued operating expense and headcount growth discipline. To conclude, we had an excellent fourth quarter and a very strong year at Schrödinger in 2023 with progress in our software business, collaborations and proprietary programs.
We realized considerable value from our collaborations and co-founded company investments. And we see opportunities to create even more value from these activities in 2024 and beyond. Our capital allocation is shifting towards our proprietary portfolio and we are excited that the early clinical data from those programs will emerge in the next one to two years. With the industry’s leading computational chemistry platform and a growing portfolio of proprietary medicines and investments in co-founded companies and collaborations coming to fruition, the future is very bright for Schrödinger. Now I’ll turn the call over to Karen to provide you with an update about our therapeutics R&D activities.
Karen Akinsanya: Thank you, Geoff, and good afternoon, everyone. Our therapeutics team continues to advance the maturing pipeline of collaborative and proprietary programs. As Ramy and Geoff reported, companies we have co-founded are successfully advancing programs into clinical trials, including Phase 2 and 3, providing repeated and extensive validation of the impact of our platform when deployed at scale. A growing number of our proprietary programs are successfully transitioning into IND-enabling studies and clinical development. I’ll now review recent progress on several of our proprietary programs in more detail. Starting with our MORT1 inhibitor, SGR1505. During our recent pipeline day, we reported that SGR1505 was well-tolerated in a completed Phase 1ne study of 73 healthy volunteers.
No drug-related serious adverse events or dose-limiting toxicities were observed. Steady-state SGR1505 exposures achieved greater than 90% inhibition of IL-2 secretion in activated T-cells, confirming target engagement and meeting the pharmacodynamic goals for the study. The healthy subject data provide important insights into the safety and clinical pharmacology of SGR1505, and this obviates the need to explore food effect and drug-drug interaction potential in our patient study. At ASH, we presented data demonstrating that SGR1505 achieves maximum inhibition of IL-2 in ex vivo human blood at greater than 50-fold lower concentrations than the benchmark molecule, which has shown clinical responses in indolent or aggressive lymphoma and CLL.
This builds our confidence in the profile of our compound. We are encouraged by the progress in our ongoing Phase 1 study of SGR1505 in patients with relapsed refractory B-cell lymphomas. We are continuing to expand a number of clinical trial sites globally, allowing us to increase enrollment and make good progress through dose escalation, despite the early enrollment challenges we previously discussed. We are encouraged that in patients, safety and tolerability is consistent with the profile observed in the 10-day healthy volunteer study. As of mid-February, all enrolled patients have remained on drugs. We are on-track to have initial clinical data, late in 2024 or in 2025. We are also looking forward to presenting details about the discovery of SGR-1505 in an oral presentation at the Spring ACS meeting next month.
We are also continuing to advance our CDC7 inhibitor SGR-2921. In December, we reported data from a range of translational models representing treatment naive patients, relapsed refractory patients, and models incorporating p53 and FLT3 mutations that confirm broad sensitivity to SGR-2921. These preclinical data and key opinion leader feedback confirm high interest in mechanisms that have mutation-agnostic antiperipheral potential, providing compelling rationale for our on-going Phase 1 study in patients with acute myeloid leukemia or myelodysplastic syndrome. The primary objectives of this study are to evaluate the safety pharmacokinetics and pharmacodynamics and establish the recommended Phase 2 dose. The study is progressing well with multiple dose escalation steps completed, and we expect to report initial data in late 2024 or 2025.
Turning to SGR-3515, we continue to be excited about the differentiated pharmacological profile of our molecule. SGR-3515 inhibits both Wee1 and Myt1 and concurrent loss of function of these two proteins confer selective vulnerability in cancer cells, termed synthetic lethality. In A427 non-small-cell lung cancer preclinical model, SGR-3515 has shown sustained tumor growth inhibition, while maintaining a favorable safety profile, using an intermittent dosing schedule. We are on-track to submit the IND for SGR-3515 in the first half of 2024 to enable the initiation of a Phase 1 dose escalation study by the end of this year. In addition, we are progressing several discovery programs, including inhibitors of EGFRC797S, PRMT5-MTA and NLRP3, highlighted at Pipeline Day.
We have identified potent selective inhibitors that may overcome product profile design challenges observed across other programs and are on-track to select candidates that will support an additional IND submission in 2025. In our collaborative portfolio, we are excited about the progress we have made in identifying all small-molecule inhibitors for targets previously addressed by antibodies or that require intravenous administration, and we anticipate advancing early-stage proprietary modality switch programs such as these across multiple disease areas. In 2023, we completed our SGR-1505 healthy volunteer study and opened additional sites globally in the patient study. We initiated dosing in our 2921 oncology trial and advanced IND-enabling studies for SGR-3515.
We also progressed several discovery programs to enable a steady flow of programs for internal or partnered development. I’ll now turn the call back to Ramy.
Ramy Farid: Thank you, Karen. As you heard, we had a very successful 2023 and are off to an excellent start this year. We look forward to providing further updates across our business throughout the year. At this time, we’d be happy to take your questions.
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