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 and related financing, includes forward-looking statements that involve risks and uncertainties. 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.
Overview
We are transforming the way therapeutics and materials are discovered. Our differentiated, physics-based software platform enables discovery of high-quality, novel molecules for drug development and materials applications more rapidly, at lower cost, and with, we believe, a higher likelihood of success compared to traditional methods. Our software platform is used by biopharmaceutical and industrial companies, academic institutions, and government laboratories around the world. Our multidisciplinary drug discovery team also leverages our software platform to advance collaborative drug discovery and development programs and our own pipeline of novel therapeutics to address unmet medical needs. 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 internally. 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.
We are using our computational platform for both collaborative and internal drug discovery programs. Over the last decade, we have entered into a number of collaborations with biopharmaceutical companies that have provided us with significant income and have the potential to produce additional milestone payments, option fees, and future royalties. Furthermore, in mid-2018, we launched a pipeline of internal, wholly-owned programs.
We generate revenues from sales of our software solutions and from upfront payments, research funding and milestone payments from our drug discovery collaborations, and have received distributions on account of, or proceeds from the sale of, our equity stakes in our collaborators, all of which we have used to support our research and development and other operating expenses. Furthermore, we have also financed our operations from sales of our equity securities. OnFebruary 10, 2020 , we closed our initial public offering of our common stock, in which we sold 13,664,704 shares of common stock at a public offering price of$17.00 per share, resulting in net proceeds to us of$209.6 million , after deducting underwriting discounts and commissions and offering expenses borne by us. In addition, onAugust 17, 2020 , we closed a follow-on public offering, in which we sold 5,250,000 shares of common stock at a public offering price of$66.00 per share, resulting in net proceeds to us of$325.6 million , after deducting underwriting discounts and commissions and offering expenses borne by us. 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 payments and discovery and development milestones. In the future, we may also derive drug discovery revenue from our collaborations from option fees, the achievement of 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 internal drug discovery programs when we believe it will help maximize the commercial potential of the program. InNovember 2020 , we entered into an exclusive, worldwide collaboration and license agreement with Bristol-Myers Squibb Company, or BMS, pursuant to which we and 81
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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. The collaboration includes HIF-2 alpha and SOS1/KRAS, which are two of our internal pipeline programs. Under the terms of the agreement, we received an upfront payment of$55.0 million , and we are eligible to receive up to$2.7 billion in total milestone payments across all potential targets, 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 "Business-Collaboration Agreement with Bristol-Myers Squibb Company" for additional information relating to this agreement. We generated revenue of$108.1 million ,$85.5 million , and$66.6 million in 2020, 2019, and 2018, respectively, representing year-over-year growth of 26% and 28%, respectively. Our net loss was$26.6 million ,$25.7 million , and$28.4 million for the years endedDecember 31, 2020 , 2019, and 2018, respectively.
Business Impact of COVID-19 Pandemic
InDecember 2019 , a novel coronavirus, or COVID-19, emerged and has since spread to many countries worldwide, includingthe United States . OnMarch 11, 2020 , theWorld Health Organization declared the outbreak of COVID-19 a pandemic, and onMarch 13, 2020 ,the United States declared a national emergency with respect to COVID-19. In response to the COVID-19 pandemic, state, local, federal, and foreign governments have put in place, and others in the future may put in place, quarantines, executive orders, shelter-in-place orders, and similar government orders and restrictions in order to control the spread of the disease. In order to safeguard the health of our employees, in earlyMarch 2020 we implemented a company-wide work-from-home policy. Beginning inJune 2020 , we began limited re-openings of certain of our offices inthe United States and abroad. Our re-openings are being conducted on a limited basis and are voluntary for all of our employees. We intend to continue to phase-in the re-opening of our offices as our management and federal, state, or local authorities advise, and we may take further actions that alter our operations as may be required by federal, state, or local authorities, or which we determine are in our best interests. During 2020, we did not see material impacts to our business from the COVID-19 pandemic. While we do not expect material impacts in 2021 from the COVID-19 pandemic, the full extent of the future impact will depend on many factors outside of our control, including, without limitation, the timing, extent, trajectory and duration of the COVID-19 pandemic, the development and availability of effective treatments and vaccines, the imposition of protective public safety measures, and the impact of the COVID-19 pandemic on the global economy. For instance, with respect to our software business, some of our customers may experience increasing budgetary pressures as a result of downturns or uncertainty in their respective businesses, which may cause them to delay or reduce purchases. In addition, due to the restrictions related to COVID-19, our sales force has limited in-person interactions, and their ability to attend events that promote and expand knowledge of our company and platform, including industry conferences and events, has been hampered. Relative to our drug discovery programs, the COVID-19 pandemic could delay the progress of certain programs, particularly ones that are in clinical studies or preparing to enter clinical studies. Delays in these programs could result in delays in achieving milestones and related revenue. While there remains uncertainty about the extent of the effect of the COVID-19 pandemic, we do not envision a long-term impact from the COVID-19 pandemic on our ability to execute on our strategy. Management is actively monitoring the COVID-19 pandemic and its possible effects on our financial condition, liquidity, operations, customers, contractors, and workforce. For additional information on risks posed by the COVID-19 pandemic, please see "Risk Factors - Risks Related to Our Operations - A widespread outbreak of an illness or other health issue, such as the COVID-19 pandemic, could negatively affect various aspects of our business and make it more difficult to meet our obligations to our customers, and could result in reduced demand from our customers as well as delays in our drug discovery and development programs," included elsewhere in this Annual Report. In response to the COVID-19 pandemic, we have joined a multi-company philanthropic effort to discover and develop novel small-molecule antiviral therapeutics to address COVID-19. The intent of the alliance, which to date also includes Takeda Pharmaceutical Company Limited, Novartis AG, Alphabet, Inc., Gilead Sciences, andWuXi AppTec, Inc. , is to make any discoveries from this alliance available to the public. There is no expectation that this effort will generate revenue for any of the companies involved in the alliance, including us.
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. 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 82
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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 annual contract value, or ACV, of over$100,000 . We had 153, 131, and 122 of these customers for the years endedDecember 31, 2020 , 2019, and 2018, respectively. This subset of customers represented approximately 79%, 78%, and 77% of our total ACV for the years endedDecember 31, 2020 , 2019, and 2018, respectively. In addition, we had 16, 10, and 11 customers with an ACV of over$1.0 million for the years endedDecember 31, 2020 , 2019, and 2018, 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 inthe United States , orU.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$92.1 million ,$75.6 million , and$64.0 million for the years endedDecember 31, 2020 , 2019, and 2018, respectively. Another important driver of our ability to expand our customer relationships is the retention of our customers with an ACV over$100,000 . For the year endedDecember 31, 2020 , our year-over-year customer retention rate for such customers was 99% and was 96% or higher for each of the previous seven fiscal years. We calculate year-over-year customer retention for our customers with an ACV over$100,000 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 customers in the current fiscal year. We then divide this number by the number of customers with an ACV over$100,000 we had in the previous fiscal year to arrive at the year-over-year customer retention rate for such customers. We intend to leverage our existing relationships with our customers to drive larger-scale adoption of our software solutions. If we are unable to continue to increase revenue from existing customers, our financial performance will be adversely impacted.
Ability to increase our customer base for our software solutions
We believe that we have significant opportunity to continue to increase the number of customers who use our solutions. We had 1,463, 1,266, and 1,150 active customers for the years endedDecember 31, 2020 , 2019, and 2018, respectively. We define the number of active customers as the number of customers who had an 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. While we have significantly penetrated the pharmaceutical industry, with all of the top 20 pharmaceutical companies, measured by 2019 revenue, licensing our software in 2020, our strategy is to grow our customer base. We believe there remains a large opportunity for growth as there are thousands of biopharmaceutical companies that could benefit from our solutions. Additionally, since the physics underlying the properties of drug molecules and materials is the same, we have been able to extend our computational platform to materials science applications in fields such as aerospace, energy, semiconductors, and electronic displays. We sell our software solutions to a growing number of materials science customers, and we believe materials science industries are only beginning to recognize the potential of computational methods. We continue to promote the education and recognition of our computational platform across industries. As part of our strategy, we have driven the adoption of our software by researchers, and we had more than 1,690 academic institutions across the world using our software in 2020. We believe that by introducing the benefits of our computational software at the academic stage, we will drive brand awareness and expand the use of our platform to industries that have historically relied on traditional methods for discovery of molecules. Our ability to continue to grow our customer base is dependent upon our ability to educate the market and support the business through investment in our sales and marketing efforts and the ongoing enhancement of our software solutions.
Advancement of our collaborations
We have entered into a number of collaborations with various biopharmaceutical companies, some of which we have co-founded, 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 often rely on decisions of the management of such companies with respect to clinical development and commercialization. Our ability to continue to derive value from our 83
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collaborations will be driven by both our capability to make progress in these programs as well as whether our collaborators successfully advance such programs beyond the discovery stage.
Ability to develop and expand our internal proprietary drug discovery pipeline
We are advancing our pipeline of internal drug discovery programs through extensive application of our software platform. Our initial programs are 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 in the areas of immunology and neurology. As we progress these programs, we will strategically evaluate on a program-by-program basis entering into clinical development ourselves, entering into collaborations, or out-licensing programs to maximize commercial opportunities. As part of this strategy, inNovember 2020 , we entered into an exclusive, worldwide collaboration and license agreement with 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. We will need to continue to devote substantial resources to develop and expand our internal pipeline. Our ability to advance and build value in our internal drug discovery programs will impact our financial performance, especially as we increasingly shift our focus to these programs.
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. We recognize revenue for on-premise software license fees upfront, either upon delivery of the license or the effective date of the agreement, whichever is later. 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. 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, such as training, technical setup or installation or modeling services, where we use our software to perform tasks such as virtual screening and homology modeling on behalf of our customers, generally are not related to the 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. Contribution. Contribution revenue consists of funds received under a non-reciprocal agreement withGates Ventures, LLC . The agreement is an unconditional non-exchange contribution without restrictions and the initial contribution was invoiced upon execution of the agreement. Revenue was recognized upon execution of the agreement 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
We currently generate drug discovery revenue from discovery collaboration arrangements, including research funding payments and discovery and development milestones. We expect our drug discovery revenue to trend higher over time as collaboration arrangements advance and we receive additional revenue from research funding payments, the achievement of discovery, development, and commercial milestones, option fees, and royalties on commercial drug sales. The majority of our current collaborations are in the discovery stage. Milestone payments typically increase in magnitude as a program advances. In addition to revenue from our collaborations, we may also derive drug discovery revenue from entering into collaborations or out-licensing our internal drug discovery programs when we believe it will help maximize the commercial potential of the program. For example, inNovember 2020 , we entered into an exclusive, worldwide collaboration and license agreement with BMS, pursuant to which we received an upfront payment of$55.0 million from BMS, of which approximately$1.0 million is included in our drug discovery 84
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revenue for the year endedDecember 31, 2020 . However, 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.
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 6.3% and 6.7% of software revenues in the years endedDecember 31, 2020 and 2019, 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, and allocated compute capacity and overhead costs. While we have incurred costs associated with discovery efforts for this collaboration since late 2017, we have recognized and expect to continue to recognize revenues in the future if and when milestones are achieved. Generally, drug discovery costs of revenue for collaborations are incurred in advance of the revenue milestone achievement. Royalty payments to third-parties represented 11.2% and 6.7% of drug discovery revenues in the years endedDecember 31, 2020 and 2019, respectively. We expect our drug discovery costs of revenue to trend higher over time as our discovery collaborations advance. 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. For example, the cost of royalties due for sales of our hosted software arrangements are recognized upfront, whereas the associated revenue is recognized over the term of the underlying agreement. Currently, gross margin is not meaningful for measuring the operating results of our drug discovery business.
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 internal drug discovery 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 internal discovery programs; and
• allocated compute capacity on our internal discovery programs and overhead
(facilities and information technology support) costs.
We expect our research and development expense to increase substantially in absolute dollars for the foreseeable future as we continue to invest in activities related to discovery and development of our internal drug discovery programs, in advancing our platform, and as we incur expenses associated with hiring additional personnel directly involved in such efforts. 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 internal drug discovery programs. Since our internal drug discovery efforts are at a very early stage, currently we do not track research and development expense on a program-by-program basis.
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 inthe United States andEurope , advertising, and allocated overhead costs. Most 85
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operating costs of our sales offices inEurope andJapan are included in sales and marketing expense. 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, 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 increase the size of our general and administrative staff to support the anticipated growth of our business. 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 aU.S. securities exchange and costs related to compliance and reporting obligations pursuant to the rules and regulations of theSecurities and Exchange Commission , orSEC . 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 received from our equity investments.
Change in Fair Value
Fair value gains and losses consist of adjustments to the fair value of our equity investments, including Nimbus, Morphic Holding, Inc., or Morphic, and Relay Therapeutics, Inc., or Relay. Morphic and Relay became publicly traded companies inJune 2019 andJuly 2020 , respectively. As such, fair value is determined as the current market value of the respective common stock as of the reporting date. We remeasure our investments at each period end. Prior to Morphic's initial public offering, fair value changes for our Morphic investment were determined under the hypothetical liquidation book value, or HLBV, method. For further information regarding the HLBV method, see "-Critical Accounting Policies and Significant Judgments and Estimates-Valuation of Equity Investments" in this Annual Report.
Prior to Relay's initial public offering, fair value changes for our Relay
investment were determined under the cost method. In
We expect that fair value gains and losses may fluctuate significantly in future periods.
Interest Income
Interest income consists of interest earned on our cash equivalents and marketable securities.
Income Tax Expense (Benefit)
Income tax expense (benefit) consists ofU.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. 86
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Table of Contents Results of Operations
Comparison of the years ended
The following table summarizes our results of operations data for the years
ended
Year Ended December 31, Change 2020 2019 $ % (in thousands) Revenues: Software products and services$ 92,530 $ 66,735 $ 25,795 39% Drug discovery 15,565 18,808 (3,243 ) -17% Total revenues 108,095 85,543 22,552 26% Cost of revenues: Software products and services 18,003 13,646 4,357 32% Drug discovery 26,620 22,804 3,816 17% Total cost of revenues 44,623 36,450 8,173 22% Gross profit 63,472 49,093 14,379 29% Operating expenses: Research and development 64,695 39,404 25,291 64% Sales and marketing 17,795 21,364 (3,569 ) -17% General and administrative 41,898 27,040 14,858 55% Total operating expenses 124,388 87,808 36,580 42% Loss from operations (60,916 ) (38,715 ) (22,201 ) 57% Other income: Gain on equity investments 4,108 943 3,165 Change in fair value 28,263 9,922 18,341 Interest income 2,253 1,878 375 Total other income 34,624 12,743 21,881 Loss before income taxes (26,292 ) (25,972 ) (320 ) Income tax expense (benefit) 345 (291 ) 636 Net loss (26,637 ) (25,681 ) (956 ) Net loss attributable to noncontrolling interest (2,174 ) (1,110 ) (1,064 ) Net loss attributable to Schrödinger stockholders$ (24,463 ) $ (24,571 ) $ 108 Revenues Year Ended December 31, Change 2020 2019 $ % (in thousands) Revenues: On-premise software$ 58,311 $ 42,647 $ 15,664 37% Hosted software 9,192 7,418 1,774 24% Software maintenance 14,465 11,643 2,822 24% Professional services 9,562 5,027 4,535 90% Contribution 1,000 - 1,000 - Total software products and services 92,530 66,735 25,795 39% Drug discovery 15,565 18,808 (3,243 ) -17% Total revenues$ 108,095 $ 85,543 $ 22,552 26% 87
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On-premise software. The increase in revenues for on-premise software was primarily attributable to existing and new customer growth, and an increase in multi-year arrangements during 2020 as compared to 2019.
Hosted software. The increase in revenues for hosted software was primarily due to increased spend from existing hosted customers, as well as new customers purchasing hosted software subscriptions, for which revenue is recognized ratably over time.
Software maintenance. The increase in revenues for software maintenance was primarily due to the increase in on-premise software sales in previous years, offset by an overall reduction in the cost to provide such services. Software maintenance revenue is recognized over time. Professional services. The increase in revenues from professional services was primarily due to revenue from significant technology service projects that began in late 2019, as well as an increased number of modeling service contracts.
Contributions. Contribution revenue during 2020 was due to an agreement with
Drug discovery. The decrease in revenues for drug discovery was primarily due to the timing and amount of collaboration milestones achieved during 2020 as compared to 2019. Cost of Revenues Year Ended December 31, Change 2020 2019 $ % (in thousands) Cost of revenues: Software products and services$ 18,003 $ 13,646 $ 4,357 32% Gross margin 81 % 80 % Drug discovery 26,620 22,804 3,816 17% Software products and services. The increase in cost of revenues for software products and services was attributable to increases of approximately$2.6 million in personnel-related expense, approximately$1.5 million in royalty expense due to higher sales levels, and approximately$0.4 million in other costs, offset by a decrease of approximately$0.2 million in travel and entertainment expense due to COVID-19. The increase in gross margin was primarily attributable to sales mix. Drug discovery. The increase in cost of revenues for drug discovery was attributable to increases of approximately$3.3 million in personnel-related expense, approximately$0.7 million in compute capacity costs, and approximately$0.4 million in royalty expense, offset by a decrease of approximately$0.6 million in third-party CRO costs to support collaborations.
Research and Development Expense
Year Ended December 31, Change 2020 2019 $ % (in thousands)
Research and development
The increase in research and development expense was attributable to increases of approximately$11.7 million in personnel-related expense, approximately$10.1 million in CRO costs associated with the expansion and progression of internal drug discovery programs, approximately$2.3 million in compute capacity costs, and approximately$1.1 million in other expenses. Sales and Marketing Expense Year Ended December 31, Change 2020 2019 $ % (in thousands) Sales and marketing$ 17,795 $ 21,364 $ (3,569 ) -17% 88
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Table of Contents The decrease in sales and marketing expense was attributable to a decrease of approximately$2.7 million in personnel-related expense, a decrease of approximately$1.2 million in travel and entertainment expenses due to COVD-19, partially offset by an increase of$0.3 million in other expenses.
General and Administrative Expense
Year Ended December 31, Change 2020 2019 $ % (in thousands)
General and administrative
The increase in general and administrative expense was attributable to an increase of approximately$10.5 million of personnel-related expense, and an increase of approximately$7.5 million in other expenses, primarily reflecting costs necessary to build a public company infrastructure, partially offset by a$3.3 million reduction for non-comparable items recognized during 2019. Gain onEquity Investment Year Ended December 31, 2020 2019 Change (in thousands)
Gain on equity investments
The gain on equity investments during 2020 represents realized gains in the form of a cash distribution received from thePetra Pharma Corporation , or Petra, merger inMay 2020 on account of our equity stake in Petra. The gain on equity investments during 2019 represents realized gains in the form of a cash distribution received from our Nimbus investment. Change in Fair Value Year Ended December 31, 2020 2019 Change (in thousands) Change in fair value$ 28,263 $ 9,922 $ 18,341 The change in fair value during 2020 was due to a gain on our investment in Relay of$17.6 million and a gain on our investment in Morphic of$13.7 million , offset by a loss on our investment in Nimbus of$3.0 million . The change in fair value during 2019 was due to a$14.1 million gain on our investment in Morphic, offset by a$4.2 million loss on our investment in Nimbus. Interest Income Year Ended December 31, 2020 2019 Change (in thousands) Interest income$ 2,253 $ 1,878 $ 375 The increase in interest income was attributable to increased earnings on our investment portfolio balance, which increased significantly year-over-year due to the investment of proceeds from our initial public offering inFebruary 2020 and our follow-on public offering inAugust 2020 , partially offset by a significant reduction in interest rates year-over-year. Income Tax Expense (Benefit) Year Ended December 31, 2020 2019 Change (in thousands) Income tax expense (benefit)$ 345 $ (291 ) $ 636 89
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Due to the full valuation allowance on ourU.S. federal and state deferred tax assets, income tax expense (benefit) represents our income tax obligations in certain foreign jurisdictions in which we conduct business. The income tax benefit during the year endedDecember 31, 2019 is due to alternative minimum tax credits previously utilized that are refundable under the Tax Cuts and Jobs Act of 2017.
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 endedDecember 31, 2020 . 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. Three Months Ended December 31, September 30, June 30, March 31, December 31, September 30, June 30, March 31, 2020 2020 2020 2020 2019 2019 2019 2019 (in thousands) Revenues: Software products and services$ 24,957 $ 22,861 $ 20,900 $ 23,812 $ 17,530 $ 16,118 $ 14,482 $ 18,605 Drug discovery 8,075 2,936 2,192 2,362 8,302 3,842 4,528 2,136 Total revenues 33,032 25,797 23,092 26,174 25,832 19,960 19,010 20,741 Cost of revenues: Software products and services(1) 5,806 4,334 3,862 4,001 3,745 3,097 3,671 3,133 Drug discovery(1) 8,234 6,191 5,647 6,548 6,560 6,152 5,488 4,604 Total cost of revenues 14,040 10,525 9,509 10,549 10,305 9,249 9,159 7,737 Gross profit 18,992 15,272 13,583 15,625 15,527 10,711 9,851 13,004 Operating expenses: Research and development(1) 17,319 17,019 16,657 13,700 11,082 10,353 9,531 8,438 Sales and marketing(1) 4,675 3,969 4,362 4,789 5,743 5,185 5,343 5,093 General and administrative(1) 13,582 9,729 9,651 8,936 6,549 6,465 8,940 5,086 Total operating expenses 35,576 30,717 30,670 27,425 23,374 22,003 23,814 18,617 Loss from operations (16,584 ) (15,445 ) (17,087 ) (11,800 ) (7,847 ) (11,292 ) (13,963 ) (5,613 ) Other (expense) income: Gain on equity investment (48 ) - 4,156 - 943 - - - Change in fair value 4,750 18,233 8,359 (3,079 ) (685 ) (1,427 ) 12,661 (627 ) Interest income 521 463 570 699 415 501 524 438 Total other (expense) income 5,223 18,696 13,085 (2,380 ) 673 (926 ) 13,185 (189 ) (Loss) income before income taxes (11,361 ) 3,251 (4,002 ) (14,180 ) (7,174 ) (12,218 ) (778 ) (5,802 ) Income tax expense (benefit) 225 (35 ) 64 91 (29 ) (257 ) (51 ) 46 Net (loss) income (11,586 ) 3,286 (4,066 ) (14,271 ) (7,145 ) (11,961 ) (727 ) (5,848 ) Net loss attributable to noncontrolling interest (447 ) (566 ) (716 ) (445 ) (375 ) (454 ) (227 ) (54 ) Net (loss) income attributable to Schrodinger stockholders$ (11,139 ) $ 3,852$ (3,350 ) $ (13,826 ) $ (6,770 ) $ (11,507 ) $ (500 ) $ (5,794 ) (1) Includes stock-based compensation as indicated in the table located further below. Revenues: Three Months Ended December 31, September 30, June 30, March 31, December 31, September 30, June 30, March 31, 2020 2020 2020 2020 2019 2019 2019 2019 (in thousands) Revenues: On-premise software$ 16,542 $ 15,064 $ 11,105 $ 15,600 $ 10,723 $ 10,300 $ 8,601 $ 13,023 Hosted software 2,373 2,374 2,312 2,133 1,934 1,862 1,911 1,711 Software maintenance 3,841 3,536 3,551 3,537 3,181 3,025 2,848 2,589 Professional services 2,201 1,887 2,932 2,542 1,692 931 1,122 1,282 Revenue from contracts with customers 24,957 22,861 19,900 23,812 17,530 16,118 14,482 18,605 Contribution - - 1,000 - - - - - Total software products and services revenue 24,957 22,861 20,900 23,812 17,530 16,118 14,482 18,605 Drug discovery 8,075 2,936 2,192 2,362 8,302 3,842 4,528 2,136 Total revenues$ 33,032 $ 25,797 $ 23,092 $ 26,174 $ 25,832 $ 19,960 $ 19,010 $ 20,741 90
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Table of Contents Deferred Revenue: As of December 31, September 30, June 30, March 31, December 31, September 30, June 30, March 31, 2020 2020 2020 2020 2019 2019 2019 2019 (in thousands) Deferred revenue$ 86,567 $ 21,659 $ 25,117 $ 23,835 $ 27,259 $ 19,129 $ 22,417 $ 17,970 Gross Margin: Three Months Ended December 31, September 30, June 30, March 31, December 31, September 30, June 30, March 31, 2020 2020 2020 2020 2019 2019 2019 2019 Software products and services gross margin 77 % 81 % 82 % 83 % 79 % 81 % 75 % 83 % Stock-Based Compensation: Three Months Ended December 31, September 30, June 30, March 31, December 31, September 30, June 30, March 31, 2020 2020 2020 2020 2019 2019 2019 2019 (in thousands) Stock-based compensation: Cost of revenues: Software products and services $ 152 $ 169$ 124 $ 85 $ 42 $ 41$ 33 $ 36 Drug discovery 276 230 181 168 62 60 48 53 Research and development 863 857 822 508 122 114 113 111 Sales and marketing 141 165 116 93 86 79 75 71 General and administrative 1,571 1,617 1,486 921 269 267 262 249 Total stock-based compensation expense$ 3,003 $ 3,038$ 2,729 $ 1,775 $ 581 $ 561$ 531 $ 520 Depreciation: Three Months Ended December 31, September 30, June 30, March 31, December 31, September 30, June 30, March 31, 2020 2020 2020 2020 2019 2019 2019 2019 (in thousands) Depreciation: Cost of revenues: Software products and services $ 67 $ 62$ 48 $ 43 $ - $ - $ - $ - Drug discovery 226 213 205 193 229 234 227 219 Research and development 222 212 200 176 157 159 155 147 Sales and marketing 39 30 39 34 43 44 37 30 General and administrative 457 372 388 432 479 502 497 481 Total depreciation expense$ 1,011 $ 889$ 880 $ 878 $ 908 $ 939$ 916 $ 877 Quarterly Revenue Trends On-premise software revenue is subject to seasonality that favors the first quarter of each year, although for 2020 the trend is shifting toward the fourth quarter, primarily due to the calendar year 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 in the periods presented, as existing customers and new customers increased their spend on hosted solutions, for which revenue is recognized over time. As a result, a substantial 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. The majority of our current collaborations are in the discovery stage. 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 91
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of actual achievement. Deferred revenue balances have generally increased over the periods presented, but have fluctuated based on the timing of sales, shifts in product mix, fluctuations to the number and size of milestones that were deemed probable in advance of actual achievement, and the measurement of progress toward completion for service projects.
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 not 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 internal 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 launch and expansion of our internal drug discovery programs.
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 Nimbus, Morphic and Relay, our realized gain from thePetra Corporation merger, and, to a lesser degree, interest income. Segment Information
The following tables summarize segment information for the years ended
Segment gross profit is derived by deducting operational expenditures, with the exception of research and development, sales and marketing, and general and administrative activities, fromU.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. 92
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Certain cost items are not allocated to our reportable segments. These cost items primarily consist of 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. Year Ended December 31, 2020 2019 (in thousands) Segment revenues: Software$ 92,530 $ 66,735 Drug discovery 15,565 18,808 Total segment revenues$ 108,095 $ 85,543 Segment gross profit: Software$ 74,527 $ 53,089 Drug discovery (11,055 ) (3,996 ) Total segment gross profit 63,472 49,093 Unallocated (expense) income: Research and development (64,695 ) (39,404 ) Sales and marketing (17,795 ) (21,364 ) General and administrative (41,898 ) (27,040 ) Gain on equity investment 4,108 943 Change in fair value 28,263 9,922 Interest 2,253 1,878 Income taxes (345 ) 291 Consolidated net loss$ (26,637 ) $ (25,681 )
Liquidity and Capital Resources
Historically we have incurred substantial operating losses and expect to continue to incur significant operating losses for the foreseeable future, we have not maintained profitability and may never become profitable in the future. As ofDecember 31, 2020 , we had an accumulated deficit of$129.6 million . 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. Our primary use of cash is to fund operating expenses, which consist of research and development, sales and marketing, and general and administrative expenditures. Cash used to fund operating expenses is impacted by the timing of when we pay operating expenses to vendors and collect amounts due from customers and collaborators, which is reflected in changes in our operating assets and liabilities, including accounts payable, accrued expenses, prepaid expenses, deferred revenue, and accounts receivable. We generate revenues from sales of our software solutions and from upfront payments, research funding and milestone payments from our drug discovery collaborations, and have received distributions on account of, or proceeds from the sale of, our equity stakes in our collaborators, all of which we have used to support our research and development and other operating expenses. Furthermore, we have financed our operations from sales of our equity securities. OnFebruary 10, 2020 , we closed our initial public offering of our common stock, in which we sold 13,664,704 shares of common stock at a public offering price of$17.00 per share, resulting in net proceeds to us of$209.6 million , after deducting underwriting discounts and commissions and offering expenses borne by us. In addition, onAugust 17, 2020 , we closed a follow-on public offering, in which we sold 5,250,000 shares of common stock at a public offering price of$66.00 per share, resulting in net proceeds to us of$325.6 million , after deducting underwriting discounts and commissions and offering expenses borne by us. As ofDecember 31, 2020 , we had cash, cash equivalents, restricted cash, and marketable securities of$643.2 million . Cash in excess of immediate requirements is invested in accordance with our investment policy, primarily with a view towards capital preservation and liquidity. 93
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Table of Contents Cash Flows The following table presents a summary of our cash flows for the periods shown: Year EndedDecember 31, 2020 2019 (in thousands)
Net cash provided by (used in) operating activities
(381,721 ) (53,855 ) Net cash provided by financing activities 541,274
28,684
Net increase (decrease) in cash and cash equivalents and restricted cash$ 176,310 $ (51,230 ) Operating activities During the year endedDecember 31, 2020 , operating activities provided approximately$16.8 million of cash. Cash provided by operating activities increased primarily from changes in our operating assets and liabilities, which provided cash of approximately$59.2 million primarily due to an increase of$59.7 million in deferred revenue, of which approximately$54.0 million is related to our agreement with BMS, and$12.5 million of non-cash operating expenses included in net loss, including depreciation and stock-based compensation costs. These increases are partially offset by our net loss of$26.6 million and$28.3 million non-cash gain from changes in fair value. During the year endedDecember 31, 2019 , operating activities used approximately$26.1 million of cash, primarily resulting from net loss of$25.7 million , which included a$9.9 million non-cash gain from changes in fair value and a$0.9 million gain on equity investment that is classified as an investing activity, partially offset by$6.2 million of non-cash operating expenses included in net loss, including depreciation and stock-based compensation costs. Changes in our operating assets and liabilities provided cash of approximately$4.2 million .
Investing activities
During the year ended
During the year ended
Financing activities
During the year ended
During the year ended
Funding Requirements
We believe that our existing cash, cash equivalents, and marketable securities will be sufficient to fund our operations and capital expenditure requirements for at least the next 12 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 internal 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 co-founded companies and other drug discovery collaborators and partners. 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. In addition, with respect to our internal programs, as part of our strategy we may choose to enter into collaborations or pursue out-licensing arrangements when we believe it will help maximize the commercial value of any such program. For example, inNovember 2020 , we entered into an exclusive, worldwide collaboration and license agreement with 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 94
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oncology, neurology and immunology therapeutic areas. Under the terms of the agreement, we received an 55.0 million upfront payment from BMS, and we are eligible to receive up to$2.7 billion in total milestone payments from BMS across all potential targets, 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. However, under this agreement and any other future arrangements, the potential amounts we may be entitled to and the likelihood and timing of such payments, including at what stage of discovery or development we may choose to pursue such arrangements, is uncertain. 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.
Contractual Obligations and Commitments
The following table summarizes our contractual obligations as ofDecember 31, 2020 : More Less than 1 to 3 3 to 5 than Total 1 Year Years Years 5 Years (in thousands)
Operating lease obligations(1)
(1) Operating lease obligations consist of our continuing rent obligations
through
2026, respectively.
InNovember 2019 , we entered into a three-year agreement with a third-party cloud provider for compute power. The agreement originally contained a minimum payment obligation, which totaled$18 million over the three years after the date we entered into the agreement. InDecember 2020 , we entered into a new five-year agreement with such party for compute power, which replaced the prior three-year agreement. The agreement contains a minimum payment obligation, which totals$60 million over the five years after the date we entered into the subsequent agreement. These amounts are not included in the table above because there is not an annual commitment. We enter into agreements in the normal course of business with CRO vendors for research and preclinical studies, professional consultants for expert advice, and other vendors for various products and services. We have not included these payments in the table of contractual obligations above since the contracts do not contain any minimum purchase commitments and are cancelable 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.
Income Taxes
AtDecember 31, 2020 , we had federal and state net operating loss carryforwards of approximately$206.3 million and$126.7 million , respectively. These carryforwards, with the exception of federal net operating losses generated post 2017, will expire between 2022 and 2040, if not used by us to reduce income taxes payable in future periods. Utilization of post 2017 federal net operating loss carryforwards is limited to 80% of taxable income generated in a given tax year and carry forward indefinitely. AtDecember 31, 2020 , we had federal and state research and development tax credit carryforwards of approximately$9.4 million and$0.5 million , respectively. These carryforwards will expire between 2021 and 2040 if not used by us to reduce income taxes payable in future periods. 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$58.2 million and$35.3 million has been established atDecember 31, 2020 and 2019, respectively. The change in the valuation allowance for the years endedDecember 31, 2020 and 2019 was$22.9 million and$7.7 million , respectively. We recorded income tax expense of$0.3 million for the year endedDecember 31, 2020 and income tax benefit of$0.3 million for the year endedDecember 31, 2019 . 95
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Table of Contents Seasonality Historically, the first quarter of each year has typically been our largest quarter for software products and services revenue, although for 2020 the fourth quarter was our largest quarter, 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.
Off-Balance Sheet Arrangements
During the periods presented, we did not have, and currently we do not have, any off-balance sheet arrangements, as defined under the rules and regulations of theSEC .
Critical Accounting Policies and Significant Judgments 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 withU.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 Note 2 - Significant Accounting Policies to our consolidated financial statements appearing in Item 8 of this Annual Report, we believe the following accounting policies used in the preparation of our consolidated financial statements require the most difficult, subjective and complex judgments and estimates.
Revenue
We recognize revenue in accordance with ASC 606, Revenue from Contracts with Customers. In accordance with ASC 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 ASC 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. Our software revenue may include upfront payments for the performance of services in the future, which have both fixed and variable consideration. At contract inception, we assess the goods or services promised within each contract that falls under the scope of ASC 606 to identify distinct performance obligations. We allocate the transaction price to each distinct performance obligation based on a relative stand-alone selling price, which requires our judgement. We then recognize as revenue the amount of the transaction price that is allocated to the respective performance obligation when or as the performance obligation is satisfied. 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.
Milestone payments: 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; • initiation of Phase 1, Phase 2, and Phase 3 clinical trials;
• filing of regulatory applications for marketing approval in the United
States,Europe orJapan ; 96
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• marketing approval in major markets, such as
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 a relative stand-alone selling price 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. Collaboration and license agreements: At the inception of each arrangement we allocate the transaction price to each performance obligation based on the relative stand-alone selling price of each performance obligation at inception, which will be determined based on each performance obligation's estimated stand-alone selling price. We determine the estimated stand-alone selling price 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 inputs used to determine the total costs to perform the research activities 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 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. Progress towards completion is remeasured at the end of each reporting period.
Stock-Based Compensation
We estimate the fair value of stock option awards granted using the Black-Scholes option-pricing model, which uses as inputs the fair value of our common stock and subjective assumptions we make as follows:
Fair Value of Common Stock. As ofFebruary 2020 , we determine the fair value of our common stock based on the closing price of our common stock as reported on the Nasdaq Global Select Market.
Expected Term. The expected term of employee stock options represents the weighted average period that the stock options are expected to remain outstanding. The expected terms were calculated using an average of historical exercises.
Expected Volatility. We base expected future volatility on the historical and implied volatility of comparable publicly traded companies over a similar expected term.
Expected Dividend Yield. We have never declared or paid any cash dividends and do not presently intend to pay cash dividends in the foreseeable future. As a result, we used an expected dividend yield of zero.
Risk-Free Interest Rates. We based the risk-free interest rate on the rate for a
If any assumptions used in the Black-Scholes option-pricing model change significantly, stock-based compensation for future awards may differ materially compared with the awards granted previously.
JOBS Act Election
We qualify as an "emerging growth company" as defined in the Jumpstart Our Business Startups Act of 2012, or JOBS Act. An emerging growth company may take advantage of reduced reporting requirements that are not otherwise applicable to public companies. These provisions include, but are not limited to:
• not being required to comply with the auditor attestation requirements on
the effectiveness of our internal control over financial reporting; 97
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• not being required to comply with any requirement that may be adopted by
the PCAOB regarding mandatory audit firm rotation or a supplement to the
auditor's report providing additional information about the audit and the
financial statements (auditor discussion and analysis); • reduced disclosure obligations regarding executive compensation arrangements; and
• exemptions from the requirements of holding a nonbinding advisory vote on
executive compensation and stockholder approval of any golden parachute
payments not previously approved.
We may use these provisions untilDecember 31, 2025 . However, if certain events occur prior to such date, including if we become a "large accelerated filer," our annual gross revenues exceed$1.07 billion , or we issue more than$1.0 billion of non-convertible debt in any three-year period, we will cease to be an emerging growth company prior to the end of such five-year period. We are also a "smaller reporting company," as defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended, or the Exchange Act, although we expect to cease to be a smaller reporting company in connection with the filing of our Quarterly Report on Form 10-Q for the first quarter of 2021. Similar to emerging growth companies, smaller reporting companies have reduced disclosure obligations, such as an ability to provide simplified executive compensation information and only two years of audited financial statements in an annual report on Form 10-K, with correspondingly reduced "Management's Discussion and Analysis of Financial Condition and Results of Operations" disclosure. The JOBS Act provides that an emerging growth company can take advantage of an extended transition period for complying with new or revised accounting standards, until those standards apply to private companies. We have elected to take advantage of the benefits of this extended transition period and, therefore, we will not be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies. Our financial statements may therefore not be comparable to those of companies that comply with such new or revised accounting standards. Until the date that we are no longer an emerging growth company or affirmatively and irrevocably opt out of the exemption provided by Section 7(a)(2)(B) of the Securities Act of 1933, as amended, upon issuance of a new or revised accounting standard that applies to our financial statements and that has a different effective date for public and private companies, we will disclose the date on which we will adopt the recently issued accounting standard.
Recent Accounting Pronouncements
See Note 2 to our consolidated financial statements appearing elsewhere in this Annual Report for a discussion of recent accounting pronouncements.
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