Schrodinger, Inc.

Thank you for standing by. Welcome to Schrodinger's conference call to review fourth quarter and full year 2023 financial results. My name is Mon Diep and I'll be your operator for today's call. There will be a question and answer session following management's prepared remarks. At this time, you can ask a question by pressing star one on your telephone keypad. Please be advised that this call is being recorded at the company's request. Now I'd like to welcome your host for today's conference, Mr. Matthew Lucchini, Director of Investor Relations and Corporate Affairs.

Please go ahead. Thank you and good afternoon, everyone.

Welcome to today's call during which we will provide an update on the company and review our 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 Rami Fareed, Chief Executive Officer, Jeff Porges, Chief Financial Officer, and Karen Unkinson, 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 reconciliation of these non-GAAP measures to the most directly comparable GAAP measures. With that, I'd like to turn the call over to Rami.

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 TIC2 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 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 established and emerging biotechs. 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 in 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 biologic 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 at a scale that 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, SGR1505, our Malt1 inhibitor, and SGR2921, our CDC7 inhibitor. In December, we reported positive data from our phase one study of SGR1505 in healthy subjects and are encouraged by the progress in our ongoing patient study in advanced B-cell malignancies. We expect to report data from the patient studies of both SGR1505 and SGR2921 in late 2024 or 2025. We are also on track to submit an investigational new drug application for SGR 3515, our We1-MIT1 inhibitor, in the first half of this year and are advancing an existing portfolio of discovery programs to position us for our fourth IMD 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 have 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 its 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 Jeff.

Thank you, Rami, and good afternoon, everyone. Schrödinger had an excellent Q4, which capped 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 reflects 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 rateably 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 live 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 contribute 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 the 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 five 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 results 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 Q4-22 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. and 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 expense. 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 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. GNA expense for Q4 was $26 million compared to $23 million in Q4 2022. The increase in money due to high headcount and one-time royalty obligations, partially offset by lower professional services. For the full year, GNA 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 law 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 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 and that income was $40.7 million or $0.54 per diluted share. As we explained previously, we did not expect our profitability in 2023 associated with an in-bus distribution to persist in 2024. For GAP 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 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 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 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 8-12% 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 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 Schrodinger in 2023. with progress in our software business collaborations and proprietary programs. We realize 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 Schrodinger. Now I'll turn the call over to Karen to provide you with an update about our therapeutics R&D activities.

Thank you, Jeff, and good afternoon, everyone. Our therapeutics team continues to advance the maturing pipeline of collaborative and proprietary programs. As Rami and Jeff reported, companies we have co-founded are successfully advancing programs into clinical trials, including phase two and three, 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 1 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 SGR 1505, 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 SGR 1505 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 indigent 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 I study of SGR 1505 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, relaxed refractory patients, and models incorporating P53 and Flip3 mutations that confirm broad sensitivity to SGR2921. These preclinical data and key opinion-leader feedback confirm high interest in mechanisms that have mutation-agnostic anti-parasitic potential, providing compelling rationale for our ongoing Phase I study in patients with acute myeloid leukemia or myelodysplastic syndrome. The primary objectives of this study are to evaluate the safety pharmacogenetics and pharmacodynamics and establish the recommended Phase II dose. The study is progressing well with multiple dose escalation steps completed, and we expect to report initial data in late 24 or 25. Turning to SGR 3515, we continue to be excited about the differentiated pharmacological profile of our molecule. SGR3515 inhibits both WE1 and MIT1, 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, SGR3515 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 one dose escalation study by the end of this year. In addition, we are progressing several discovery programs, including inhibitors of EGFR C797S, PRMT5MTA, 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 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 INZ-enabling studies for SGR 3515. We also progressed several discovery programs to enable a steady flow of programs for internal or partner development. I'll now turn the call back to Rami.

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.

The floor is now open for your questions. To ask a question at this time, simply press star followed by the number one on your telephone keypad. We'll now take a moment to compile our roster. Our first question comes from the line of Michael Yee with Jeffries. Your line is open.

Hi, this is Chajing Wen on the line for Michael E. Thank you for taking my question. I guess my first question is, how should we think about the software guidance of 6% to 13% year-over-year growth, which seems actually lower than the typical 15% growth guided in the past years, especially given the recent industry-wide AI momentum? And secondly, maybe comment on how the recent AI evolution changes your view on the competitive landscape, and what are your efforts that will keep you ahead of competition? Thank you.

Jeff, do you want to take the first thing at all?

Sure. Thanks. Yes. Regarding the guidance for software business, we have a fairly high degree of confidence in the long-term growth potential of the software business. We have multiple opportunities to increase the adoption of the software, in our largest customers, but also to move up what we sort of refer to as the next tier of customers that we highlighted today that are greater than one million, but still not at that five million per year. So there's a lot of opportunity. That being said, as I highlighted in my prepared remarks, there were significant renewals of multi-year contracts in the fourth quarter that deliver that very strong fourth quarter revenue number. And those renewals effectively pose a headwind for us to overcome in 2024. So we do believe that we can grow the business. We believe that we can continue with that growth trajectory that you mentioned from the previous years. But we have to overcome the effect of those deals in the fourth quarter. But the underlying dynamics of the business are still growing significantly. I will also highlight that in 2023, we did see some of the effects of the biotech capital markets in our smaller customers. And you can see that in some of the information about the KPIs where the renewal rate across the board customer group went down slightly from 96% to 92%. But it remained very high in the larger customers. And to those smaller customers that we are seeing some of the turmoil associated with companies running out of capital, shutting down R&D, getting merged, etc. We think that that's being a drag on our growth in 2023. We think we're planning on that consisting in 2024. But if there's some relief in that, and some of those companies do go ahead and get funded, then that will also provide us with opportunities. Bobby, do you want to talk about AI?

Yeah, absolutely. So, let me just also emphasize what Jeff just said. I mean, there's no question that we view this, our software business, as a growth business, there's still, as Jeff said, many opportunities. Now, one of those, as you mentioned, is actually some nice progress in AI on structural biology and biology fronts. And the structure biology front, this is something we've actually published on recently. This is resulting in a bigger supply of protein structures, which is the input, of course, to our physics based methods. As we've shown, these structures still need refinement with physics based methods, which, of course, we've developed. But this is providing a larger pool of targets. Similarly, A lot of the work in AI on sort of elucidation of biology is also resulting in a larger number of targets that are of interest. And, of course, that helps fuel growth in our business. Now, with regard to your comment about staying competitive, I think we talked a lot about this. We have a very large effort in the area of developing state-of-the-art, using state-of-the-art machine learning methods, but as we've shown over and over again and discussed many, many times, these methods have no value without a training set. And of course, that's the definition of machine learning. And we've shown that our physics-based platform is in a unique position to be able to develop the sorts of training sets that are required to actually make machine learning, you know, to fully realize the utility of machine learning. And to date, We see no efforts in the space that are competitive with our physics-based approaches. So we're feeling very good about our sort of leadership position in this area.

Great. Thank you. Thanks.

Our next question comes from a line of David Lebowitz with Citigroup. Your line is open.

Thank you very much for taking my question. When you look at the drug discovery guidance for next year, you had spoken earlier in the. In this quarter in January about a shift in the methodology and guidance, and I was wondering if you could clarify the extent that. The guidance for next year. Reflects a shift from your. expectations that you would have given under your prior methodology with guidance, just to understand the extent that the shift is an organic shift in expectations versus a systematic change relative to your approach.

Yeah, thanks. Thanks for your question, David. I totally understand it. Yes, we found it challenging to provide guidance that incorporates the uncertainty associated with partners advancing programs that would trigger milestones to our benefit. And we just are in a position to have information about, for example, where a phase two trial might stop or a phase three trial might read out. And so we have elected to take those milestones out of that guidance because we just can't determine what the probability of those programs advancing is or when they will advance. So that is a change that we have made. The second change we've made is that we aren't including any allowances or estimates for new business development transactions, i.e. new collaborations with new partners or partnering proprietary programs. Now, of course, we're in active discussions with many participants in the industry, both large companies and emerging companies, about lots of different opportunities. But again, we just didn't think that we could reasonably estimate the probability, timing, value, et cetera, of what might emerge from those discussions. So we've also kept that out of the guidance for drug discovery. And we're guiding to what we believe today, be the most likely range of outcomes at the beginning of the year. But you can imagine that we're going to be very busy throughout the year looking for all these opportunities that I mentioned. But that's the most likely range of outcomes at this stage of the year.

Thank you for taking my question.

Your next question comes from the line of Vikram for Whole Heat with Morgan Stanley. Your line is open.

Hi, thanks for taking our questions. We had two, one on the software guidance and then one on the pipeline. So for the revenue growth guidance of 6 to 13%, could you provide a bit more color on which situations would drive each of those bookends? And then for the one data set expected later this year or next year, how are you framing what a strong outcome here could be and any details available at this point on how much data, how much follow-up may be available through that initial patient data set. Thank you.

Okay, do you want to do the second question first?

Yeah. So, as you know, we're in a patient trial right now. We're recruiting into B-cell malignancy. In terms of the data, obviously, we're still gathering PK, PD, and FACI. It's a phase one dose escalation trial. But we obviously will also be looking at activity in that trial, and in terms of what good looks like, I think, you know, that that's still to be determined. We know that Janssen, for example, saw ORR and CRs and PRs in their trial, but that's something that obviously we're still looking at, you know, what we believe a great outcome will be for this mechanism as monotherapy and then ultimately a combination where, as you know, again, there was very interesting data presented previously by Yanton. And what was the second part of your question?

Well, the first question was about the software. Yeah, so we'll answer that. There were two parts, I think. Did we answer your question, Vikram, about Malt1?

Yeah, the second part of the Malt1 question was just any color you might have at this point on, how much data we could see, how much follow-up we could see. tumor types, et cetera.

Yeah, I mean, it's a little bit too early to say. I think, as I said, you know, we're monitoring for PKPD and clinical activity. So I just think it's too early to say what we'll be able to share this year versus next year. But yeah, the study's going well, enrollment's going well, and we look forward to giving you an update as you go. Yeah.

Take a first stab at your first question and hand it over to Jeff if there's anything else to add. Here's how we see it. There's a remarkable heightened interest in computation among pharma companies and merging companies. I mean, it's a really exciting time. It seems, as we said, this sort of decade-long debate of whether to use computation and how to use it. And, you know, does it really work is, I mean, this is such an exciting thing to be saying given how long we've been in this field, you know, is over. So there's really significant demand. What's going to dictate sort of where we end up in the range is whether companies can get to the point of scaling up their software to the level that we see our largest customers at. And that's going to depend on things like And we talked about this, you know, this sort of worldwide shortage of mothers. How long is it going to take to train mothers and to and to bring them on board. And how long is it going to take to get the IT system set up to be able to access the kinds of compute resources that are required to run our calculations. So the interest is there. It really is there. It's just a matter of sort of how how quickly and how large the scale up. And the scale up has started to happen in the industry. And that's the exciting thing. It's just, has it happened across the board evenly with all top companies and the hundreds of emerging companies? No, not yet. The other thing that's important to keep in mind, and Jeff has talked about this, and again, Jeff can add more color is, remember, we have very different revenue recognition rules associated with on-prem versus hosted. And the sort of mix of hosted and on-prem has a big impact on this range. It doesn't impact, you know, the underlying growth is there, but how it gets recognized and what year and so on is obviously variable. So, Jeff, do you want to add anything to that?

Yeah. I would just say the timing and type of the renewals that we see during the year has a large impact on how those renewals translate to revenue. So first, if we renew with multi-years versus single years, that has an impact. And secondly, if we renew on a hosted basis versus off-rash. And I did highlight a little bit in my prepared remarks that there is a slow trend towards more hosted that of course slows down our reported revenue growth as we make that transition, but ultimately, we think that it's beneficial because it produces a more steady and predictable revenue outlook. So we're not going to advance that transition on a sudden basis rapidly, but it is underway. So the type of contract, the timing of the contract during the year, and of course, the degree of scale up, whether a customer is going from a one million a year contract to a two million or three million year contract. That's the fundamental driver. And we see lots of opportunity, as Rami alluded to, for that scale up. But of course, it does get down to every single contract and how it gets recognized.

Got it. Thank you. Thanks, Mikko.

Our next question comes from a line of Evan Siegerman with BMO Capital Markets. Your line is open.

Hi guys, thank you so much for taking the questions. Take a step back as you think about kind of your dual business model where you have your software licensing and then your own internal development. I guess a question for Rami, just how, say two, three years from now, how do you expect your internal pipeline to kind of drive your business? Are you going to be bringing these to phase two, three and then out licensing them? You can bring them all the way to phase three and outlicense them. I'm just trying to understand how this evolved, you know, understanding that your business is a bit in flux with some of the nuances between hosted software and outlicense software. Love the commentary on that. Thank you so much.

Yeah. Yeah, thanks, Evan. I think, you know, we talked a little bit about this before. You can see we have a, you know, rather a larger pipeline than we had a few years ago. We have these three more advanced programs, two in the clinic, one more that's going to be in the clinic. We just said we're going to be expecting to file an IND for one of the now next cohort of programs next year. There are quite a number of those. And so we have a lot of options. That's a number of programs. We expect, as we said, some of those programs, it'll make sense to partner them. And after phase one, in some cases, it may make sense to take them further. And we're making sure that we allow ourselves to have the opportunity to have that sort of flexibility. So, I think you'll see a mix of all the things that you said over the next several years. Do you want to add anything?

Sorry. I was going to say my colleagues. What's the hurdle that you need to get over to bring something really forward into a mid-phase trial and use your capital to advance that versus outlicense it at phase one? I'm just trying to think about how this becomes part of your business in a way that's efficient when it's in the hands of Schrodinger versus in the hands of someone else.

Yeah, I mean, I think to some extent, I'll start and maybe Jeff can add. I mean, I think to some extent, it depends on the target. We believe that there are targets where when they're first in the industry, first in the world, and there's a lot of interest and demand in the target, you know, we don't necessarily even need to take it to the clinic. However, we, you know, will assess that on a case by case basis. But from a clinical development standpoint, We are very comfortable doing phase one dose escalation. We've got two of those ongoing and a third about to start. But I think for some programs, when it's a multiple tumor type, you've got lots of different potential indications. You've got combinations to pursue. We do see that having a partner for that development could be very, very helpful. So I think it really depends on the target, whether we feel comfortable taking it into the facility in the first place, but then expanding the program later on. So, I don't know, Jeff, if you want to add to that.

Yeah. Ellen, I think from an economic standpoint, clearly, we're going to consider cost. We're also going to consider value. What's required to really create a lot of value from the program. And then lastly, we're also going to consider what the industry requires. Now, in some cases, what the industry requires is 10 subjects with showing that you have a differentiated decay profile or a safety profile. In other cases, what the industry might require is a very large randomized phase 2B study, which we might not be inclined to do. So I think on a case-by-case basis, we're going to consider all of those components to make a decision. I don't think that we were inclined to make a blanket decision one way or another.

Great. Thank you, guys. Appreciate it. Thanks, Evan. Our next question comes from a line of Scott Shownhow with KeyBank.

Your line is open.

Hi, team. Thanks for taking my question. So I just wanted to follow up on Vikram's question on the software. So it seems like the wide guidance range has to do with whether or not you can or how much of the book you can shift from on-prem to hosted. Is that correct? And would you be able to, is it easier to shift these sort of contracts from on-prem to hosted with larger clients, mid-size clients or smaller clients? Just trying to get a sense of the scale here on this shift from on-prem to hosted.

I just want to clarify something. If the hosted on-prem shift is a small component, Of the trends in our business, I mean, it's what I call without deliberately, but the biggest factor is whether we our business materializes in the form of multi year contracts or single year contract. Because if we do an on-prem annual renewal, then all of the revenue is recognized or almost all of the revenue in the year in which that. And most of it in that corner. But if we do a multi-year on-prem, it's even more of the revenue, especially in that quarter. So the biggest variable is the mix of duration of contracts. The second biggest, most important variable is the size of contracts, whether we're scaling up big contracts or small contracts. And then probably the least influential variable is the hosted versus on-prem shift. But to the extent that there is a shift to hosted, in the year in which that occurs, it reduces the reported revenue growth rather than increases it. So that does have some effect, but I don't want to convey that that's most of the effect.

Yeah. And then just to answer the other, that's absolutely right. And just to touch on the last part of your question, there's really no barrier to companies shifting for us to shift companies from on-prem to hosted because it's not actually the software itself or the the compute engine that's being hosted, it's just a license server, which is a trivial piece of code that just controls the licensing. So this is, it doesn't matter large, small, and it's completely under control, and there doesn't seem to be much resistance. In fact, a lot of companies like it when that's being managed because we can serve them better. But just to be clear, 99.999% of the computation that's being run is still on print. It's just that tiny little bit of code. And when that little bit of code is hosted, then the whole entire contract is considered hosted. That's not our rule. That's, you know, the rule. Okay, I hope that helps.

That's, yeah, that's all very helpful. Can I just sneak in one follow up? Jeff, you mentioned about the opportunities in smaller biofarm or biotech potentially developing. Is any of that baked into that growth range on the software side for this year?

We have taken a cautious approach to the outlook in the emerging companies. We haven't accounted for any recovery in capital availability or new companies showing up. Let me give you a little bit more color. What we saw in 2020 and 2021 was a lot of new customers who were newly, relatively recently capitalized companies showing up and saying, we need to discover molecules against our proprietary targets quickly and sort of setting up software contracts with us. That slowed down in 2022 and the natural flux amongst that population of smaller companies, more companies dropped out than came in. So we are assuming that that reverses itself and we go back to 2020 or 2021. Great, thank you so much.

Our next question comes from a line of Chad Wietrowski with TD Cowan. Your line is open.

Hey, everyone. This is Chad Wietrowski on for Stephen Ma. I guess on the software revenues, how does a validating expansion of an agreement like with Lilly, for example, in the fourth quarter, how does that translate when you're looking into that tier two customer expansions and what does that specifically validate about the platform itself?

Yeah, that's a great question. We really see that as highly validating and the beginning of an important trend of adoption of our computational platform at scale by the pharma industry overall. It's extremely unlikely that, and it's not just Lilly, there are a number of customers that are, you know, you see what our KPI is for, for example, customers spending over 5 million. There are, we believe a critical number of pharma companies that have scaled up their usage of the software and using it at a scale that's approaching what we're doing internally as, again, as a beginning of a trend. And it's extremely unlikely that it'll just be those a handful of customers that will do that. And the reason we're saying that is, you know, sort of the obvious thing, but also the level of engagement from the other companies that are working their way up to that is really quite positive. And we're sure that it's going to happen. It's a matter of, as Jeff is saying, we're saying just sort of, you know, when exactly is it going to happen? Is it going to be in multiple stages where they go from one tier then to the next, you know, over a couple of years? That's where the uncertainty comes from. But it seems pretty clear that that trend that we're seeing, and we're obviously very encouraged by those handful of customers spending at that level, that that trend will continue.

I should mention one other thing that's actually pretty... Oh, sorry. Go ahead, please.

No, I was just going to kind of pivot. You can continue on that question.

Yeah, I was just going to say one other really important thing, but I'll be very brief and let you ask the other question. It's important to point out that we continue to advance the platform. We have a very significant effort. We continue to make breakthroughs in the science, and we expect that to continue as well. So that's another thing that over the next several years and really beyond, we will continue to see more and more breakthroughs in the science that we think will continue to increase the value and the impact that the software will have, and I think that's something else that the industry will continue to react to.

And so you have partnerships with NVIDIA and Google Cloud, and like for example, NVIDIA's BioNemo platform is an emerging marketplace for fine-tuned AI tools for drug discovery. Is there any type of incentive structure for you to launch software on these marketplaces? Is that a way that you could further monetize this growing capabilities?

Yeah, we're not prepared to discuss that now, but I'm glad you brought up those collaborations. They're extremely important and long-standing, by the way. These aren't recent. They've been in place for a long time. And I'm sure we will continue to be able to leverage those collaborations to benefit not just us, but really benefit the whole industry.

Thanks for the questions.

Our next question comes from a line of Matt Hewitt with Craig Hallam Capital Group. Your line is open.

Hi, guys. This is Jack on from Matt. Thanks for taking my questions. Firstly, with the former Bristol Myers and Zio Labs program now being solely Schrodinger assets, Will that alter the timing of trials and how should we think about those assets? And then my second question, when you previously mentioned that Eli Lilly renewed and expand their software agreement, are there any other large customer renewals this year we should be monitoring? Thanks.

So with respect to the first question about the BMS and ZY program, obviously we've described in the past that some of these are for commercially targeting, commercially validated targets. whereas others were more novel targets. And we have been looking at how we will incorporate these into our portfolio. Right now, there is no impact of those programs on our disease of clinical programs. The three programs or the two programs in the clinics and the one that's about to enter were all wholly owned, are all wholly owned proprietary programs that came from our own efforts. We continue to look at some of the programs that have been returned as potential opportunities in the future, but we have not made a decision on that yet.

And then with regard to your other question, we're, as I said, really engaged in a number of discussions with large companies and, as Jeff said, emerging companies. That's very important to keep in mind. It's not just the top 10, 20 pharma companies. that have the potential to scale up their usage of the software. So the conversations are encouraging. We're certainly having them. But at this point in the year, we're certainly not prepared to name the next company that's going to be, if you want to call it the next Lilly. But yeah, we're certainly having those conversations.

Understood. Thank you.

Again, the floor is now open for your questions. To ask a question at this time, simply press the star, followed by the number one on your telephone keypad. Our next question comes from the line of Michael Riskin with Bank of America Securities. Your line is open.

Hi, thanks. This is both on for Mike. I appreciate taking questions. So the multi-year renewal dynamic that you have going on in software is pretty well understood, but also software only came in modestly above your guide in 3Q, even with these big renewal benefits, and your 4Q outlook is fairly well below. So kind of backing out these timing and comp-related dynamics, have you seen some change in the underlying markets, or what's it going to take for software to get back to that 20% plus multi-year growth profile that I follow?

Yeah, okay. No, I understand the question. So we highlighted some of the flux in the smaller customers that have been affected by financing, consolidation in the industry, et cetera. And there is no doubt that that was a significant, if I want to phrase it the right way, a drag on what we reported in 2023. We think that there is a path to more than offsetting that. And the growth opportunity in what I referred to as the sort of mid-cap companies, let's just say greater than 500,000 to 50 are there, more than offset the effect of that drag, if you like, in the smallest accounts. And we're not counting on those small accounts coming back, although, Theoretically, that's a possibility. Now, we deliberately called out the multi-year contribution in Q4 and specifically highlighted the Lilly deal because of the size of that and the impact that it had. That was something that we were working towards throughout the year. And there are a number of other multi-year agreements that we worked towards through the year, some of which Um, you know, became closed contracts and generate revenue, but others that we're still working on. So, there is plenty of wood to chop and plenty of opportunity. To drive things this year, but we're being pretty careful. Not to suggest that that there's another really out there right now, because probably that was a major opportunity for us that we pulled out in the 4th quarter. Yeah, no, I think that's perfect. Yep.

Okay, thank you. Then on the other side of the business and drug discovery, I think the change in guidance methodology is pretty clear there. I'm not going to ask you to guide the 25 or the out years, but given that there was kind of this inflection expected for drug discovery previously, should we now be thinking of more of a kind of steady ramp there barring any clear indications of milestones or just how should we think about the trajectory for that segment?

I hope that we conveyed the challenges we find in forecasting this segment in my answers to questions and prepared remarks. It is difficult because of the nature of this business and of our business there and the programs to estimate when programs will go ahead, particularly if they become more advanced. So of course, as they become more advanced, the milestones become larger and so the outside effect becomes even greater. We continue to be very confident that if we keep initiating those programs and advancing them and they continue to progress, that there are opportunities for that revenue to grow. But the other way we are thinking about this, of course, is that we are shifting our capital allocations towards our proprietary programs. And as we advance our proprietary programs into the clinic or even to advance preclinical development, Um, we believe consistent with industry standards that they going to be worth more in partnering transactions. So, we are planning that a number of our programs will be partnered in the next in the foreseeable future, because obviously we couldn't take everything in our very rich portfolio already forward and. Our therapeutics group is continuing to come up with promising new development opportunities. So we do think that there's a very significant revenue opportunity there, but given the methodology and the approach we're taking, we think it's prudent to be not guiding to the timing or value of those transactions.

Got it. Thanks for your time. I'm showing no further questions at this time. That concludes today's call.

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