Schrodinger, Inc. (SDGR) FY 2023 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and related notes appearing elsewhere in this Annual Report. Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties.

The following discussion and analysis of our financial condition and results of operations covers fiscal 2023 and fiscal 2022 items and year-over-year comparisons between fiscal 2023 and fiscal 2022. Discussions of fiscal 2021 items and year-over-year comparisons between fiscal 2022 and 2021 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, that was filed with the SEC on February 28, 2023.

As a result of many factors, including those factors set forth in “Risk Factors” of this Annual Report, our actual results could differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. For further information regarding our forward-looking statements, see “Cautionary Note Regarding Forward-Looking Statements and Industry Data” in this Annual Report.

Overview

We are transforming the way therapeutics and materials are discovered. Our differentiated, physics-based computational platform enables discovery of high-quality, novel molecules for drug development and materials applications more rapidly and at a lower cost, compared to traditional methods. Our software platform is licensed by biopharmaceutical and industrial companies, academic institutions, and government laboratories around the world. We are applying our computational platform to advance a broad pipeline of drug discovery programs in collaboration with leading biopharmaceutical companies. In addition, we use our computational platform to discover novel molecules for our pipeline of proprietary drug discovery programs, which we are advancing through preclinical and clinical development.

Since our founding, we have been primarily focused on developing our computational platform, which is capable of predicting critical properties of molecules with a high degree of accuracy, as well as advancing drug discovery programs both with our collaborators and on our own. We have devoted substantially all of our resources to introducing new capabilities and refining our software, conducting research and development activities, recruiting skilled personnel, and providing general and administrative support for these operations.

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Over the last decade, we have entered into a number of collaborations with leading biopharmaceutical companies that have provided us with significant income and have the potential to produce additional milestone payments, option fees, and future royalties. In 2018, we began to develop a pipeline of proprietary drug discovery programs with the goal of using our platform to produce a portfolio of novel, high value therapeutics. In June 2022, the U.S. Food and Drug Administration, or FDA, cleared our first investigational new drug application, or IND, for our MALT1 inhibitor, which we refer to as SGR-1505. We have initiated dosing in a Phase 1 clinical trial of SGR-1505 in patients with relapsed or refractory B-cell lymphomas and we anticipate reporting initial data from the trial in late 2024 or 2025. We also completed a Phase 1 clinical trial of SGR-1505 in 73 healthy volunteers to gather additional data, including data relating to the safety, tolerability and pharmacokinetics of SGR-1505, as well as the effect of food and drug-drug interactions. In the healthy volunteer trial, SGR-1505 was well tolerated with no drug-related serious adverse events or dose limiting toxicities observed. In the trial, we observed that SGR-1505 achieved greater than 90 percent inhibition of IL-2 secretion in an activated T cell whole blood assay, confirming target engagement and meeting the pharmacodynamic goals for the trial. Inhibition of IL-2 secretion is a marker for target engagement and pathway modulation as it is tightly linked to MALT1 and the downstream NF-κB signaling. The data supported continued evaluation of SGR-1505 in the ongoing Phase 1 clinical trial in patients with relapsed or refractory B-cell lymphomas. In addition, the FDA recently granted orphan drug designation to SGR-1505 for the potential treatment of mantle cell lymphoma.

In July 2023, the FDA cleared our IND for our CDC7 inhibitor, which we refer to as SGR-2921. We have initiated dosing in a Phase 1 clinical trial of SGR-2921 in patients with relapsed or refractory acute myeloid leukemia or high-risk myelodysplastic syndrome, and we anticipate reporting initial data from the trial in late 2024 or 2025. We are also advancing SGR-3515, our novel WEE1/MYT1 inhibitor for the treatment of solid tumors. We expect to submit an IND to the FDA for SGR-3515 in the first half of 2024, subject to favorable data from ongoing IND-enabling studies, and we plan to initiate a Phase 1 clinical trial of SGR-3515 by the end of 2024, subject to receipt of regulatory clearance.

We have funded our operations to date principally from the sale of our equity securities, including our initial public offering and our follow-on public offering, and to a lesser extent, from sales of our software solutions and from upfront payments, research funding and milestone payments from our drug discovery collaborations, and from distributions on account of, or proceeds from the sale of, our equity stakes in our collaborators. On February 13, 2023, April 6, 2023, and November 9, 2023, on account of our equity stake in Nimbus Therapeutics, LLC, or Nimbus, we received cash distributions of $111.3 million, $35.8 million, and $0.1 million, respectively, from Nimbus in connection with Takeda’s acquisition of Nimbus Lakshmi, Inc., a wholly-owned subsidiary of Nimbus, and its TYK2 inhibitor NDI-034858.

We currently conduct our operations through two reportable segments: software and drug discovery. The software segment is focused on selling our software to transform drug discovery across the life sciences industry, as well as to customers in materials science industries. The drug discovery segment is focused on generating revenue from a diverse portfolio of preclinical and clinical programs, internally and through collaborations, that have advanced to various stages of discovery and development.

Our software segment generates revenue from software product licenses, hosted software subscriptions, software maintenance, professional services, and contributions. The revenue we generate through our software solutions from each of our customers varies largely depending on the number of software licenses our customers purchase from us. The licenses that our customers purchase from us provide them the ability to perform a certain number of calculations used in the design of molecules for drug discovery or materials science. We deliver our software through either (i) a product license that permits our customers to install the software solution directly on their own in-house hardware and use it for a specified term, or (ii) a subscription that allows our customers to access our cloud-based software solution on their own hardware without taking control of licenses.

We currently generate drug discovery revenue from our collaborations, including upfront payments, research funding and discovery and development milestones. In the future, we may also derive drug discovery revenue from our collaborations from option fees, the achievement of regulatory and commercial milestones, and royalties on commercial drug sales. In addition to revenue from our collaborations, we may also derive drug discovery revenue from collaborating on or out-licensing our proprietary drug discovery programs when we believe it will help maximize our clinical and commercial opportunities for the program.

In November 2020, we entered into an exclusive, worldwide collaboration and license agreement with Bristol-Myers Squibb Company, or BMS, pursuant to which we and BMS agreed to collaborate in the discovery, research and development of small molecule compounds for biological targets in the oncology, neurology and immunology therapeutic areas. After mutual agreement on the targets(s) of interest, the Schrödinger therapeutics group is responsible for the

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discovery of development candidates. Once a development candidate meeting specified criteria for a target has been identified, BMS will be solely responsible for the development, manufacturing and commercialization of such development candidate. We are eligible to receive up to $1.5 billion in total milestone payments across the potential targets currently subject to the collaboration, of which we have received $25.0 million as of December 31, 2023, as well as a tiered percentage royalty on net sales of each product commercialized by BMS ranging from mid-single digits to low-double digits, subject to certain specified reductions. See “Collaboration and License Agreement” in Note 3 to our consolidated financial statements for additional information relating to this agreement.

In September 2022, we entered into a collaboration with Eli Lilly and Company, or Lilly, under which we are responsible for the discovery and optimization of small molecule compounds addressing an immunology target. Lilly will be responsible for the completion of preclinical development, clinical development and commercialization. Under the terms of the agreement we received an upfront payment and we are eligible to receive up to $425.0 million in discovery, development and commercial milestone payments. We are also eligible to receive low single- to low double-digit royalties on net sales of any products emerging from the collaboration in all markets.

We generated revenue of $216.7 million and $181.0 million in 2023 and 2022, respectively, representing a year-over-year growth of 20%. Our net income for the year ended December 31, 2023 was $40.7 million and our net loss for the year ended December 31, 2022 was $149.2 million.

Key Factors Affecting Our Performance

Ability to drive additional revenue from our software solutions from existing customers

Our large existing base of customers represents a significant opportunity for us to expand our revenue through increased utilization of our software. We had 1,785 and 1,748 active customers for the years ended December 31, 2023 and 2022, respectively. We define the number of active customers as the number of customers who had an annual contract value, or ACV, of at least $1,000 in the fiscal year. We use $1,000 as a threshold for defining our active customers as this amount will generally exclude customers who only license our PyMOL software, which is our open-source molecular visualization system broadly available at low cost. The revenue that we generate through our software solutions from each of our customers varies depending on the number of licenses for each software solution that each customer purchases from us. Accordingly, we work with our customers to improve their experience and increase the utility of our platform in order to expand the scale at which they deploy our platform in their business. Biopharmaceutical companies are increasingly adopting our software at a larger scale, and we anticipate that this scaling-up will drive future revenue growth. Our ability to expand within our customer base is demonstrated by the increasing number of our customers with an ACV at higher thresholds, including customers with an ACV of at least $500,000 or $1.0 million. For the year ended December 31, 2023, we had 54 customers with an ACV of at least $500,000 compared to 52 for the year ended December 31, 2022. Furthermore, we had 27, 18, and 15 customers with an ACV of at least $1.0 million for the years ended December 31, 2023, 2022, and 2021, respectively. We also had four customers with an ACV of at least $5.0 million for the year ended December 31, 2023, compared to four and two such customers for the years ended December 31, 2022 and 2021, respectively.

With respect to contracts that have a duration of one year or less, or contracts of more than one year in duration that are billed annually, we define ACV as the contract value billed during the applicable period. For contracts with a duration of more than one year that are billed upfront, ACV in each period represents the total billed contract value divided by the term. ACV should be viewed independently of revenue and does not represent revenue calculated in accordance with generally accepted accounting principles in the United States, or U.S. GAAP, on an annualized basis, as it is an operating metric that can be impacted by contract execution start and end dates and renewal rates. ACV is not intended to be a replacement for, or forecast of, revenue. Our ACV was $154.2 million and $140.6 million for the years ended December 31, 2023 and 2022, respectively.

Ability to retain our customer base for our software solutions

Another important driver of our performance is our ability to retain our customer base. We had 222, 227, and 190 customers with an ACV of at least $100,000 for the years ended December 31, 2023, 2022, and 2021, respectively. For the year ended December 31, 2023, our year-over-year customer retention rate for such customers was 92% and was 96% or higher for each of the previous nine fiscal years. Our customer retention rate for our customers with an ACV of at least $500,000 was 98% for the year ended December 31, 2023 and 100% for the year ended December 31, 2022. We calculate year-over-year customer retention for our customers with an ACV of at least $100,000 or $500,000 by starting with the number of such customers we had in the previous fiscal year. We then calculate how many of these customers were active

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customers in the current fiscal year. We then divide this number by the number of customers with an ACV of at least $100,000 or $500,000, as applicable, that, we had in the previous fiscal year to arrive at the year-over-year customer retention rate for such customers.

We believe our sales and marketing approach and the quality of our software solutions result in long-term relationships and high retention with our largest customers. This is demonstrated by the length of our key relationships, with the average tenure of our 10 largest software customers in 2023 being nearly 19 years. Furthermore, we have significantly penetrated the pharmaceutical industry, with all of the top 20 pharmaceutical companies, measured by 2022 revenue, licensing our software in 2023. Our ability to continue to grow our software revenue is dependent upon our ability to retain customers through the continued support and investment in our sales and marketing efforts and the ongoing enhancement of our software solutions.

Advancement of our collaborative programs

We have entered into a number of collaborations with leading biopharmaceutical companies to advance drug discovery. We will seek to enter into additional collaboration agreements, driven by the synergies we expect to achieve between our platform and the capabilities and expertise of our potential collaborators. We believe that our collaborations will be a significant driver of value for us in the form of equity stakes, research fees, preclinical, clinical, and commercial milestone payments, and option fees, as well as royalties on any potential future sales of products, if approved. We continue to work with our current collaborators to advance existing programs through discovery research stages and initiate additional programs. However, we do not generally exercise control over the development programs of our collaborators and depend on our collaborators' decisions with respect to clinical development and commercialization. Our ability to continue to derive value from our collaborations will be driven by our capability to make progress in these programs, whether our collaborators successfully advance such programs beyond the discovery stage, and the strategic priorities of our collaboration partners. We track the aggregate number of collaborative programs for which we are eligible to receive any amount of royalties on sales and as of December 31, 2023, we had an aggregate of 12 collaborative programs for which we are eligible to receive future royalties compared to 15 collaborative programs as of December 31, 2022.

Ability to progress and expand our pipeline of proprietary drug discovery programs

We are advancing our pipeline of proprietary programs through preclinical and clinical development. Our initial programs were focused on discovering and developing inhibitors for targets in DNA damage response pathways and genetically defined cancers. Since then, we have expanded into other therapeutic areas, including immunology and neurology. We have initiated dosing in a Phase 1 clinical trial of SGR-1505 in patients with relapsed or refractory B-cell lymphomas as well as in a Phase 1 clinical trial of SGR-2921 in patients with relapsed or refractory acute myeloid leukemia or high-risk myelodysplastic syndrome, and we anticipate reporting initial data from both clinical trials in late 2024 or 2025. In addition, we expect to submit an IND application to the FDA for SGR-3515 in the first half of 2024, subject to favorable data from IND-enabling studies, and we plan to initiate a Phase 1 clinical trial of SGR-3515 by the end of 2024, subject to the receipt of regulatory clearance. We continue to advance new programs where we can leverage our computational platform to discover novel molecules, and we have recently announced new discovery-stage programs targeting PRMT5-MTA, EGFRC797S, and NLRP3. As we progress and expand our pipeline of proprietary programs, we will strategically evaluate on a program-by-program basis advancing them ourselves, entering into collaborations to co-develop them with leading industry partners, or out-licensing them to maximize their probability of clinical and commercial success.

Components of Results of Operations

Software Products and Services Revenue

Our software business generates revenue from five sources: (i) on-premise software license fees, (ii) hosted software subscription fees, (iii) software maintenance fees, (iv) professional services fees, and (v) contributions.

On-premise software. Our on-premise software license arrangements grant customers the right to use our software on their own in-house servers or their own cloud instances for a specified term, typically for one year, though in recent years, we have entered into a small number of large multi-year on-premise software license agreements. We recognize revenue for on-premise software license fees upfront, either upon transfer of control of the license or the effective date of the agreement, whichever is later.

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Hosted software. Hosted software revenue consists primarily of fees to provide our customers with hosted licenses, which allows these customers to access our cloud-based software solution on their own hardware without taking control of the licenses, and is recognized ratably over the term of the arrangement, which is typically one year, though in recent years, we have entered into a small number of large multi-year hosted software license agreements. When a customer enters into a hosted arrangement for which revenue is recognized over time, the amount paid upfront that is not recognized in the current period is included in deferred revenue in our statement of financial position until the period in which it is recognized.

Software maintenance. Software maintenance includes technical support, updates, and upgrades related to our on-premise software licenses. Software maintenance revenue is recognized ratably over the term of the arrangement. Software maintenance activities are performed in connection with the use of our on-premise software, and may fluctuate from period to period.

Professional services. Professional services include training, technical setup, installation or assisting customers with modeling services, where we use our software to perform tasks such as virtual screening on behalf of our customers. These services are generally not related to the core functionality of our software and are recognized as revenue when resources are consumed. Since each professional services agreement represents a unique, ad hoc engagement, professional services revenue may fluctuate from period to period.

Software contribution revenue. Software contribution revenue consists of funds received under a non-reciprocal agreement with Gates Ventures, LLC originally entered into in June 2020 and further extended through August 2026. The agreement is an unconditional non-exchange contribution without restrictions. Revenue was recognized annually from June 2020 through June 2022 and upon extension of the agreement in August 2023, when invoiced, in accordance with Accounting Standard Codification, or ASC, Topic 958, Not-for-Profit Entities as the agreement is not an exchange transaction.

Drug Discovery Revenue

Drug discovery services. We currently generate drug discovery revenue from discovery collaboration arrangements, including upfront payments, research and development payments, and discovery and development milestones. The majority of our current collaborations are in the discovery and preclinical development stages. Milestone payments typically increase in magnitude as a program advances. However, our focus is increasingly on investing in our proprietary drug discovery programs, which may result in a smaller number of collaborative programs over time and, as a result, fewer milestone payments on account of those collaborative programs. In addition to revenue from our collaborations, we may also derive drug discovery revenue from out-licensing our proprietary drug discovery programs when we believe it will help maximize the probability of clinical and commercial success of the program. Overall, we expect that our drug discovery revenue will fluctuate from period to period due to the inherently uncertain nature of the timing of milestone achievement and our dependence on the program decisions of our collaborators.

Drug discovery contribution revenue. Contribution revenue consists of funds received under agreements with the Bill and Melinda Gates Foundation on a cost reimbursement basis, to perform services aimed at accelerating drug discovery in women’s health. Revenue is recognized as conditions are met in accordance with ASC Topic 958, Not-for-Profit Entities.

Cost of Revenues

Software products and services. Cost of revenues for software includes personnel-related expenses (comprised of salaries, benefits, and stock-based compensation) for employees directly involved in the delivery of software solutions, maintenance and professional services, royalties paid for products sold and services performed using third-party licensed software functionality, and allocated overhead (facilities and information technology support) costs. Pursuant to various third-party arrangements, we license technology that is used in our software. These arrangements require us to pay royalties based on sales volume, and such royalty payments represented 4.1% and 4.8% of software revenues in the years ended December 31, 2023 and 2022, respectively.

Drug discovery. Costs of revenue for drug discovery includes personnel-related expenses and costs of third-party contract research organizations, or CROs, that support discovery activities in our collaborations, royalties paid for services performed using third-party licensed software functionality, allocated compute capacity and overhead costs. While we have incurred costs associated with discovery efforts since late 2017, we have recognized and expect to continue to recognize

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revenues in the future if and when milestones are deemed probable or achieved. Generally, drug discovery costs of revenue for collaborations are incurred in advance of the revenue milestone achievement.

Royalty payments to third-parties represented 3.5% and 4.8% of drug discovery revenues in the years ended December 31, 2023 and 2022, respectively. We expect our drug discovery costs of revenue to trend lower over time as we shift our focus to proprietary drug discovery programs.

Gross Profit and Gross Margin

Gross profit represents revenue less cost of revenues. Gross margin is gross profit expressed as a percentage of revenue. Our software products and services gross margin may fluctuate from period to period as our revenue fluctuates, and as a result of changes in sales mix between on-premise and hosted software solutions due to timing of recognition. For example, the cost of royalties due for sales of our hosted software arrangements are recognized upfront, whereas the associated hosted software revenue for these arrangements is recognized over the term of the underlying agreement.

While the gross margin of our drug discovery business will fluctuate significantly from period to period depending on factors such as the timing of recognition of milestones, we expect the gross margins to generally trend higher over time as more programs advance to later stages of development, the milestones increase in size and our ongoing research and development obligations to such programs decline in cost.

Research and Development Expense

Research and development expense accounts for a significant portion of our operating expenses. We recognize research and development expense as incurred. Research and development expense consists of drug discovery and development program costs and costs incurred for continuous development of the technology and science that supports our computational platform, primarily:

•personnel-related expenses, including salaries, benefits, bonuses, and stock-based compensation for employees engaged in research and development functions;

•expenses incurred under agreements with third-party CROs and consultants involved in our proprietary drug discovery programs; and

•allocated compute capacity on our proprietary drug discovery programs and overhead (facilities and information technology support) costs.

We expect our research and development expense to increase in absolute dollars as we continue to invest in activities related to discovery and development of our proprietary drug discovery programs, in advancing our computational platform, and as we incur expenses associated with hiring additional personnel directly involved in such efforts. The amount to which our research and development expense may increase in the future will also be dependent on our development plans for our proprietary drug discovery programs, including the timing of any partnering or out-licensing decisions. At this time, we do not know, nor can we reasonably estimate, the nature, timing, or costs of the efforts that will be necessary to complete the development of any of our proprietary drug discovery programs.

Sales and Marketing Expense

Sales and marketing expense consists primarily of personnel-related costs for our sales and marketing staff and application scientists supporting our sales efforts, including salaries, benefits, bonuses, and stock-based compensation. Other sales and marketing costs include promotional events that promote and expand knowledge of our company and platform, including industry conferences and events and our annual user group meetings in the United States and Europe, advertising, and allocated overhead costs. Due to the inherent scientific complexity of our software solutions, a high level of scientific expertise is needed to support our sales and marketing efforts. We plan to make focused investments in sales and marketing over the foreseeable future to foster the growth of our business as we aim to expand software sales to existing customers and increase our customer base.

General and Administrative Expense

General and administrative expense consists of personnel-related expenses associated with our executive, legal, finance, human resources, information technology, and other administrative functions, including salaries, benefits, bonuses,

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and stock-based compensation. General and administrative expense also includes professional fees for external legal, accounting and other consulting services, allocated overhead costs, and other general operating expenses.

We expect to continue to incur additional expenses as a result of operating as a public company, including costs to comply with the rules and regulations applicable to companies listed on a U.S. securities exchange and costs related to compliance and reporting obligations pursuant to the rules and regulations of the Securities and Exchange Commission, or SEC. In addition, as a public company, we expect to continue to incur increased expenses such as insurance and professional services. As a result, we expect the dollar amount of our general and administrative expense to increase for the foreseeable future.

Gain on Equity Investments

Gain on equity investments consists of realized gains in the form of cash distributions from our equity investments.

Change in Fair Value

Fair value gains and losses consist of adjustments to the fair value of our equity investments, which may include Nimbus, Structure Therapeutics Inc., or Structure Therapeutics, and Morphic Holding, Inc., or Morphic. We remeasure our investments at each period end.

We expect that fair value gains and losses will fluctuate significantly in future periods.

Other Income

Other income consists of interest earned on our cash equivalents and marketable securities, interest expense, and transactional foreign exchange gains and losses.

Income Tax Expense

Income tax expense consists of U.S. federal and state income taxes and income taxes in certain foreign jurisdictions in which we conduct business. We maintain a full valuation allowance on our federal and state deferred tax assets as we have concluded that it is not more likely than not that the deferred tax assets will be realized.

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Results of Operations

Comparison of the years ended December 31, 2023 and 2022

The following table summarizes our results of operations data for the years ended December 31, 2023 and 2022:

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Revenues

Software Products and Services Revenue

On-premise software. The increase in revenues for on-premise software during the year ended December 31, 2023 as compared to the year ended December 31, 2022 was primarily attributable to an increase in multi-year arrangements for which revenue was recognized ahead of annual billings, as well as growth from existing and new customers during the year ended December 31, 2023 as compared to the year ended December 31, 2022.

Hosted software. The increase in revenues for hosted software during the year ended December 31, 2023 as compared to the year ended December 31, 2022 was primarily due to increased spend from existing hosted customers, as well as growth in new customers purchasing hosted software subscriptions, for which revenue is recognized ratably over the period of the contract.

Software maintenance. The increase in revenues for software maintenance during the year ended December 31, 2023 as compared to the year ended December 31, 2022 was primarily due to the increase in on-premise software sales in current and previous years. Software maintenance revenue is recognized ratably over the period of the contract.

Professional services. The decrease in revenues from professional services during the year ended December 31, 2023 as compared to the year ended December 31, 2022 was primarily due to decreases of approximately $3.1 million in structural biology services and approximately $2.7 million related to progress and completion of technology and modeling service projects.

Software contribution revenue. Contribution revenue during the year ended December 31, 2023 and the year ended December 31, 2022 was due to funds received under an agreement with Gates Ventures, LLC, which began in June 2020 and was extended in August 2023.

Drug Discovery Revenue

Drug discovery services. The increase in revenues for drug discovery services during the year ended December 31, 2023 as compared to the year ended December 31, 2022 was primarily due to the timing and amount of collaboration milestones achieved, including $25.0 million received from BMS, and the progress of existing and new collaborations accomplished during 2023 as compared to 2022. We expect that our revenue will fluctuate from period to period due to the inherently uncertain nature of the timing of milestone achievement and our dependence on the program decisions of our collaborators.

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Drug discovery contribution revenue. Contribution revenue during the year ended December 31, 2023 was due to services performed under an agreement with the Bill and Melinda Gates Foundation aimed at accelerating drug discovery in women’s health, which began in November 2021.

Cost of Revenues

Software products and services. The decrease in cost of revenues for software products and services during the year ended December 31, 2023 as compared to the year ended December 31, 2022 was attributable to decreases of approximately $0.9 million in personnel-related expense and approximately $0.1 million in other expenses, offset by an increase of approximately $0.9 million in cloud computing expense.

Software products and services gross margin. The increase in software gross margin during the year ended December 31, 2023 as compared to the year ended December 31, 2022 was primarily due to an increase in software revenue and relatively flat fixed costs, which was due to the re-allocation of resources from cost of revenue to research and development activities.

Drug discovery. The decrease in cost of revenues for drug discovery during the year ended December 31, 2023 as compared to the year ended December 31, 2022 was attributable to decreases of approximately $4.6 million in personnel-related expense reflecting the redeployment of our discovery organization towards proprietary drug discovery programs, approximately $0.5 million in cloud computing expense, and approximately $0.1 million in royalty expense, offset by increases of approximately $1.1 million in third-party CRO costs associated with the expansion and progression of collaborative programs, and approximately $0.2 million in other expenses.

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Research and Development Expense

A significant portion of our research and development costs have been external preclinical and clinical CRO costs, which we track on a program-by-program basis related to a product candidate, once the candidate has been identified. Our internal research and development costs are primarily personnel-related costs, rent expense, and other indirect costs and are not tracked on a program-by-program basis. All other research and development costs are related to non-program related costs. The following table summarizes our research and development expense for the years ended December 31, 2023 and 2022:

The increase in external costs of $23.5 million during the year ended December 31, 2023 as compared to the year ended December 31, 2022 was primarily attributable to an increase in costs associated with the ongoing Phase 1 clinical trials and other development activities for SGR-1505, as well as other external research costs to support our early-stage product candidates, including SGR-2921 and SGR-3515.

The increase in internal costs for programs in clinical and preclinical development of $15.0 million during the year ended December 31, 2023 as compared to the year ended December 31, 2022 was primarily attributable to an increase in personnel-related expense and rent expense.

The increase in all other research and development expense during the year ended December 31, 2023 as compared to the year ended December 31, 2022 was attributable to increases of approximately $8.4 million in personnel-related expense, approximately $4.1 million in cloud computing expense, approximately $3.4 million related to office rent, approximately $0.6 million in travel and entertainment expenses, approximately $0.3 million related to professional services, and approximately $0.1 million in other expenses.

Sales and Marketing Expense

The increase in sales and marketing expense during the year ended December 31, 2023 as compared to the year ended December 31, 2022 was attributable to increases of approximately $4.6 million in personnel-related expense, approximately $0.9 million related to office rent, approximately $0.7 million in travel and entertainment expenses, and approximately $0.4 million in cloud computing expense.

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General and Administrative Expense

The increase in general and administrative expense during the year ended December 31, 2023 as compared to the year ended December 31, 2022 was attributable to increases of approximately $8.5 million of personnel-related expense, approximately $2.2 million in royalties related to cash distributions we received from Nimbus, approximately $0.8 million in cloud computing expense, approximately $0.8 million related to office rent, approximately $0.5 million in travel and entertainment expense, and approximately $0.5 million in amortization related to the acceleration of customer relationship intangible assets, offset by decreases of approximately $2.4 million related to professional services, approximately $1.1 million related to a one-time non-recurring state and local tax item, and approximately $1.5 million in other expenses.

Gain on Equity Investments

The gain on equity investments during the year ended December 31, 2023 was due to the realized gain on our equity investment in Nimbus following the closing of Takeda's acquisition of Nimbus Lakshmi, Inc., a wholly-owned subsidiary of Nimbus, and its tyrosine kinase 2 inhibitor, NDI-034858. The gain on equity investments during the year ended December 31, 2022 was due to cash received from a third party, who previously acquired a collaborator in which we held an equity stake, in exchange for the termination of our rights to receive potential earnouts under the acquisition agreement.

Change in Fair Value

The change in fair value during the year ended December 31, 2023 was due to an unrealized gain on our investment in Structure of $49.8 million, an unrealized gain on our investment in Nimbus of $1.9 million, and an unrealized gain on our investment in Morphic of $1.8 million. The change in fair value during the year ended December 31, 2022 was primarily due to an unrealized loss on our investment in Morphic.

Other Income

The increase in other income during the year ended December 31, 2023 as compared to the year ended December 31, 2022 was primarily attributable to an increase in interest rates on our investment portfolio.

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Income Tax Expense

Income tax expense for the year ended December 31, 2023 represents our federal and certain state income tax obligations and taxes in foreign jurisdictions for which we conduct business. Income tax expense for the year ended December 31, 2022 represents our income tax obligations in certain states and taxes in foreign jurisdictions in which we conduct business. As of December 31, 2023, we have a full valuation allowance on our U.S. federal and state deferred tax assets.

At December 31, 2023, we had federal and state net operating loss carryforwards of approximately $179.1 million and $98.6 million, respectively. The state net operating loss carryforwards will expire between 2025 and 2042, if not utilized. The federal net operating loss carryforwards are limited to 80% of taxable income generated in a given year and carry forward indefinitely. At December 31, 2023, we had federal and state research and development tax credit carryforwards of approximately $23.3 million and $1.6 million, respectively. These carryforwards will expire between 2024 and 2043, if not utilized.

As required by ASC Topic 740, Income Taxes, our management has evaluated the positive and negative evidence bearing upon the realizability of our deferred tax assets, which are composed principally of net operating loss carryforwards and research and development credit carryforwards. Management has determined that it is more likely than not that we will not realize the benefits of our federal and state deferred tax assets and, as a result, a valuation allowance of $136.0 million and $138.0 million has been established at December 31, 2023 and 2022, respectively. The change in the valuation allowance for the years ended December 31, 2023 and 2022 was $1.9 million and $42.7 million, respectively. We recorded income tax expense of $2.2 million and $0.1 million for the years ended December 31, 2023 and 2022, respectively.

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Quarterly Results of Operations

The following tables summarize our selected unaudited quarterly results of operations data for each of the eight quarters in the period ended December 31, 2023. The information for each of these quarters has been prepared on the same basis as our audited annual consolidated financial statements and reflect, in the opinion of management, all adjustments of a normal, recurring nature that are necessary for the fair statement of the results of operations for these periods. This data should be read in conjunction with our audited consolidated financial statements included elsewhere in this Annual Report. Historical results are not necessarily indicative of the results that may be expected for the full fiscal year or any other period.

(1)Includes stock-based compensation as indicated in the table located further below.

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Revenues:

Deferred Revenue:

Gross Margin:

Stock-Based Compensation:

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Depreciation and Amortization:

Quarterly Revenue Trends

On-premise software revenue is subject to seasonality that generally favors the first and fourth quarter of each year, primarily due to the timing of customer renewals for on-premise software arrangements, for which revenue is recognized at a single point in time. Hosted software revenue grew more steadily over the periods presented, as existing customers and new customers increased their spend on hosted solutions, for which revenue is recognized ratably over the term of the contract. As a result, a portion of the software products and services revenue we reported in each period was attributable to sales we made in prior periods. Software maintenance revenue is related to on-premise software sales and also is recognized ratably over the term of the underlying agreement. Therefore, increases or decreases in customer sales, customer expansion, or renewals in a period may not be immediately reflected in revenue for the period. Our professional services arrangements are typically project-based and, therefore, fluctuated based on individual customer needs and ongoing project support. Drug discovery revenue fluctuated from period to period based on the achievement of specific collaboration milestones, as well as advancements of collaborative services.

Milestone payments typically increase in magnitude as a program advances.

Quarterly Deferred Revenue Trends

Deferred revenue consists of the unearned portion of customer billings, which is recognized as revenue in accordance with our revenue recognition policy, as well as the unearned portion of unbilled collaboration milestones that are deemed probable in advance of actual achievement. Deferred revenue balances have fluctuated based on the measurement of progress toward completion for service projects, the timing of sales, shifts in product mix, and fluctuations to the number and size of milestones that were deemed probable in advance of actual achievement.

Quarterly Gross Margin Trends

Our software products and services gross margin experienced fluctuations over the periods presented due to increased headcount and the product mix for software and services, as the cost of royalties due on sales of our hosted software is recognized upfront, while the associated revenue is recognized over the term of the related agreement. Currently, gross margin is less meaningful for measuring the operating results of our drug discovery business.

Quarterly Operating Expense Trends

Operating expenses generally increased during the periods presented due to increased headcount and personnel-related expenses involved in research and development, sales and marketing, general and administrative activities, and CRO costs related to our proprietary drug discovery programs. These increases in headcount across our operations have supported the overall growth and management of our business. CRO cost increases were driven by the expansion and progression of our proprietary drug discovery programs.

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Quarterly Other (Expense) Income Trends

Other (expense) income during the periods presented consisted primarily of fair value gains and losses related to our equity investments in Morphic and Structure Therapeutics, and, to a lesser degree, interest income.

Segment Information

The following tables summarize segment information for the years ended December 31, 2023 and 2022. See Note 16 – Segment Reporting in our audited consolidated financial statements for additional information regarding our segments.

Segment gross profit is derived by deducting operational expenditures, with the exception of research and development, sales and marketing, and general and administrative activities, from U.S. GAAP revenue. Operational expenditures are expenditures made that are directly attributable to the reportable segment. In many cases, these expenditures are allocated to the segments based on headcount. The reportable segment expenditures include compensation, supplies, and services from contract research organizations.

Certain cost items are not allocated to our reportable segments. These cost items primarily consist of non-drug discovery program related compensation and general operational expenses associated with our research and development, sales and marketing, and general and administrative activities. These costs are incurred by both segments and, due to the integrated nature of our software and drug discovery segments, any allocation methodology would be arbitrary and provide no meaningful analysis. Additionally, we report assets on a consolidated basis and do not allocate assets to our reportable segments for purposes of assessing segment performance or allocating resources.

Liquidity, Capital Resources and Funding Requirements

We have a history of significant operating losses and have incurred negative cash flows from operations from inception through the year ended December 31, 2023. As of December 31, 2023, we had an accumulated deficit of $338.4 million.

We have funded our operations to date principally from the sale of our equity securities, including our initial public offering and our follow-on public offering, and to a lesser extent, from sales of our software solutions and from upfront payments, research funding and milestone payments from our drug discovery collaborations, and from distributions

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on account of, or proceeds from the sale of, our equity stakes in our collaborators. Our operating cash flows are impacted by the magnitude and timing of our software sales and by the magnitude and timing of our drug discovery milestone achievements and research funding fees.

On March 4, 2021, we filed a universal shelf registration statement on Form S-3 which allows us to offer and sell an indeterminate number of shares of common stock, preferred stock, depositary shares or warrants, or an indeterminate principal amount of debt securities, from time to time pursuant to one or more offerings at prices and terms to be determined at the time of the sale. As of December 31, 2023, no securities had been sold under the Form S-3.

In May 2023, we entered into a sales agreement with Leerink Partners LLC (formerly SVB Securities LLC), or Leerink Partners, as sales agent, with respect to an at-the-market offering program, or the ATM, under which we could offer and sell, from time to time pursuant to our Form S-3, shares of common stock, having an aggregate offering price of up to $250.0 million, through Leerink Partners. During the three months ended December 31, 2023, no shares of common stock were sold under the ATM and as of December 31, 2023, we had $250.0 million of common stock remaining available for sale under the ATM.

As of December 31, 2023, we had cash, cash equivalents, restricted cash, and marketable securities of $468.8 million.

We believe our existing cash, cash equivalents, and marketable securities as of December 31, 2023 will be sufficient to fund our operating expenses and capital expenditure requirements through at least the next 24 months. Our future capital requirements will depend on many factors, including the growth of our software revenue, the timing and extent of spending to support research and development efforts, the continued expansion of software sales and marketing activities, the timing and receipt of milestone payments from our collaborations, as well as spending to support, advance, and broaden our proprietary drug discovery programs. Furthermore, our capital requirements will also change depending on the timing and receipt of any distributions we may receive from our equity stakes in our drug discovery collaborators. The potential for these distributions, and the amounts which we may be entitled to receive, are difficult to predict due to the inherent uncertainty of the events which may trigger such distributions.

We plan to utilize the existing cash, cash equivalents, and marketable securities on hand primarily to fund our software and drug discovery activities. With respect to our proprietary drug discovery programs, as part of our strategy we may choose to advance them into preclinical and clinical development ourselves, enter into collaborations to co-develop them with leading industry partners, or out-license them to maximize their clinical and commercial opportunities.

We may be required to seek additional equity or debt financing. In the event that we require additional financing, we may not be able to raise such financing on terms acceptable to us or at all. If we are unable to raise additional capital or generate cash flows necessary to maintain or expand our operations and invest in our platform, we may not be able to compete successfully, which would harm our business, operations and financial condition. In addition, we may seek additional capital due to favorable market conditions or strategic considerations, even if we believe we have sufficient funds for our current or future operating plans.

Our contractual obligations as of December 31, 2023 include lease obligations of $195.5 million, consisting of our continuing rent obligations through December 2037, primarily for our offices located in New York, New York for $145.4 million, Cambridge, Massachusetts for $16.4 million and Framingham, Massachusetts for $11.3 million, which expire in December 2037, June 2032 and March 2033, respectively. In December 2022, we entered into an agreement with a third-party to establish an exclusive integrated drug discovery dedicated facility in Hyderabad, India. The agreement contains a minimum payment obligation, which totals $21.8 million over five years after the date of first occupancy. In addition, see Note 7 – Commitments and Contingencies to our consolidated financial statements appearing in Item 8 of this Annual Report for more information relating to our operating lease obligations.

In December 2020, we entered into a five-year agreement with a third-party cloud provider for compute power. The agreement contains a minimum payment obligation, which totals $60 million over the five years after the date we entered into the agreement. There is no annual commitment.

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We also enter into agreements in the normal course of business with CRO vendors for research, preclinical studies, and clinical trials, professional consultants for expert advice, and other vendors for various products and services. These contracts do not contain any minimum purchase commitments and are cancellable at any time by us, generally upon 30 days prior written notice, and therefore we believe that our non-cancelable obligations under these agreements are not material. We have also agreed to pay volume-based royalties to third-parties for use of software functionality under various licensing and related agreements. See Note 2 - Significant Accounting Policies to our audited consolidated financial statements appearing in Item 8 of this Annual Report for more information relating to our royalty obligations.

Cash Flows

The following table presents a summary of our cash flows for the periods shown:

Operating activities

During the year ended December 31, 2023, operating activities used approximately $136.7 million in cash, due to a $147.2 million gain from equity investments, of which the cash received is included in investing activities, $53.5 million of non-cash gain on changes in fair value, $22.4 million in changes in our operating assets and liabilities, and $2.1 million of non-cash operating expenses. These items are offset by a net income of $40.7 million, including depreciation and investment accretion costs and $47.8 million in stock-based compensation.

During the year ended December 31, 2022, operating activities used approximately $119.7 million in cash primarily resulting from net loss of $149.2 million, which included an $11.8 million gain from equity investments, partially offset by $5.0 million of non-cash operating expenses included in net loss, including depreciation and investment accretion costs, $39.6 million in stock-based compensation, and $18.1 million of non-cash loss on changes in fair value. Changes in our operating assets and liabilities used cash of approximately $21.4 million.

Investing activities

During the year ended December 31, 2023, investing activities provided approximately $193.0 million of cash, consisting of $147.2 million cash distributions received, on account of our equity investment in Nimbus, from Nimbus in connection with Takeda’s acquisition of Nimbus Lakshmi, Inc., a wholly-owned subsidiary of Nimbus, and its TYK2 inhibitor NDI-034858 and $63.3 million provided by marketable securities, net of purchases. These items are partially offset by $13.4 million in cash used for purchases of property and equipment, $4.1 million used for purchases of equity investments in Structure Therapeutics.

During the year ended December 31, 2022, investing activities provided approximately $90.0 million of cash, consisting of $93.2 million provided by marketable securities, net of purchases and $11.8 million in cash from a third party, who previously acquired a collaborator in which we held an equity stake, in exchange for the termination of our rights to receive potential earnouts under the acquisition agreement. These items are partially offset by $8.0 million in cash used for purchases of property and equipment, $0.6 million used to make equity investments in Structure Therapeutics, and $6.4 million used to acquire XTAL, net of cash acquired.

Financing activities

During the year ended December 31, 2023, financing activities provided approximately $9.0 million of cash, primarily attributable to proceeds from stock option exercises.

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During the year ended December 31, 2022, financing activities provided approximately $2.1 million of cash, primarily attributable to proceeds from stock option exercises.

Seasonality

Generally, the first and fourth quarter of each year have typically been our largest quarters for software products and services revenue, primarily due to the timing of customer renewals of on-premise software arrangements, for which revenue is recognized at a single point in time. Seasonality has been a less significant factor for our hosted software arrangements, for which revenue is recognized ratably over time. Seasonality has not been a factor for our drug discovery revenues. Historical seasonality may not be indicative of future periods.

Critical Accounting Policies and Estimates

Critical accounting policies are those that are both most important to the portrayal of a company's financial condition and results, and that require management's most difficult, subjective, and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our management’s discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires us to make judgments and estimates that affect the reported amounts of assets, liabilities, revenues, and expenses and the disclosure of contingent assets and liabilities in our consolidated financial statements and the accompanying notes. We base our estimates on historical experience, known trends and events, and our beliefs of what could occur in the future considering available information. Actual results may differ from these estimates under different assumptions or conditions. On an ongoing basis, we evaluate our judgments and estimates in light of changes in circumstances, facts, and experience. The effects of material revisions in estimates, if any, are reflected in the consolidated financial statements prospectively from the date of change in estimates.

While our significant accounting policies are described in more detail in Note 2 – Significant Accounting Policies to our consolidated financial statements appearing in Item 8 of this Annual Report, we believe the following critical accounting estimates used in the preparation of our consolidated financial statements require the most difficult, subjective and complex judgments and estimates and have had, or are reasonably likely to have a material impact on our financial condition or results of operations.

Revenue

We recognize revenue in accordance with ASC Topic 606, Revenue from Contracts with Customers, or Topic 606, except for contracts that are within the scope of other standards, such as contribution grants and certain collaboration arrangements. In accordance with Topic 606, we recognize revenue when our customer obtains control of promised goods or services, in an amount that reflects the consideration which we expect to receive in exchange for those goods or services. To determine revenue recognition for arrangements that we determine are within the scope of Topic 606, we perform the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when or as we satisfy a performance obligation.

Significant management judgment is applied to determine the allocation of the transaction price and measurement of progress, including (1) the constraint on variable consideration, (2) the allocation of the transaction price to the performance obligations using their standalone selling price, or SSP, and (3) the appropriate input or output based method to recognize collaboration revenue and the extent of progress to date.

Variable consideration: Our revenue may include upfront payments for the performance of services in the future, which have both fixed and variable consideration. We include the unconstrained amount of estimated variable consideration in the transaction price. The amount included in the transaction price is constrained to the amount for which it is probable that a significant reversal of cumulative revenue recognized will not occur. At the end of each subsequent reporting period, we re-evaluate the estimated variable consideration included in the transaction price and any related constraint and, if necessary, adjust our estimate of the overall transaction price.

Research and development, regulatory or commercial milestones in our collaboration agreements may include some, but not necessarily all, of the following types of events:

•completion of preclinical research and development work leading to selection of product candidates;

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•initiation of Phase 1, Phase 2, and Phase 3 clinical trials;

•filing of regulatory applications for marketing approval in the United States, Europe or Japan;

•marketing approval in major markets, such as the United States, Europe, or Japan;

•commercial milestones and/or commercial royalties; and

•achievement of certain other technical, scientific, or development criteria.

At the inception of each arrangement that includes research, development, or regulatory milestone payments, we evaluate whether the milestones are considered probable of being reached and estimate the amount to be included in the transaction price using the most likely amount method. If it is probable that a significant revenue reversal would not occur, the associated milestone value is included in the transaction price. Milestone payments that are not within our control or that of the licensee, such as regulatory approvals, are not considered probable of being achieved until those approvals are received. The transaction price is then allocated to each performance obligation on an SSP basis, for which we recognize revenue as or when the performance obligations under the contract are satisfied. At the end of each subsequent reporting period, we re-evaluate the probability of achievement of such development milestones and any related constraint, and if necessary, adjust our estimate of the overall transaction price. Any such adjustments are recorded on a cumulative catch-up basis, which may affect license, collaboration, and other revenues and earnings in the period of adjustment. The process of successfully achieving the criteria for the milestone payments is highly uncertain. Consequently, there is a risk that we may not earn all of the milestone payments from each of our collaborators. We recognized $27.7 million and $14.7 million from drug discovery milestones for the years ended December 31, 2023 and 2022, respectively.

Software performance obligations and transaction price allocation: At contract inception, we assess the goods or services promised within each contract that falls under the scope of Topic 606 to identify distinct performance obligations, which requires significant judgment based on the nature of each transaction. We allocate the transaction price to each distinct performance obligation on an SSP basis. We determine the SSP using information that includes historical discounting practices, market conditions, cost-plus analysis, and other observable inputs. We typically have more than one SSP for individual performance obligations due to the stratification of those items by classes of customers and circumstances. In these instances, we may use information such as the size and geographic region of the customer in determining the SSP. We may also estimate SSP based on management judgment by considering available data such as internal cost and margin objectives, pricing strategies, market/competitive conditions, historical profitability data, as well as other observable inputs. We establish SSP ranges for our products and services and reassesses them periodically. The determination of SSP required significant management judgment.

Collaboration agreement transaction price allocation and measurement of progress: At the inception of each arrangement, we utilize judgment to assess the nature of the performance obligations to determine whether they are distinct or a single combined performance obligation. We allocate the transaction price to each performance obligation based on the relative SSP of each performance obligation at inception, which will be determined based on each performance obligation’s estimated SSP. We determine the SSP at contract inception of the research activities based on internal estimates of the costs to perform the services, inclusive of a reasonable profit margin. Significant judgment is used to determine the inputs for total costs to perform the research activities, which may include the length of time required, the internal hours expected to be incurred on the services and the number and costs of various studies that will be performed by third-parties to complete the research plan. Revenue is recognized on a proportional performance basis over the period of service, using input-based measurements to estimate the performance. Changes to these assumptions may have a material effect on the amount and timing of revenue recognized. We recognized revenue of $52.2 million and $24.3 million related to collaboration agreements with proportional performance measurement for the years ended December 31, 2023 and 2022, respectively.

Recent Accounting Pronouncements

See Note 2 – Significant Accounting Policies to our consolidated financial statements appearing elsewhere in this Annual Report for a discussion of recently issued accounting pronouncements.