Company Overview

Schrödinger, Inc. is a leading provider of computational software solutions that accelerate drug discovery and materials design. The company has developed a differentiated, physics-based computational platform that enables the discovery of high-quality, novel molecules more rapidly and at a lower cost compared to traditional methods. Schrödinger's software solutions are licensed by biopharmaceutical and industrial companies, academic institutions, and government laboratories around the world.

Historical Background and Challenges

Established in 1990, Schrödinger has a rich history of innovation and technological advancements. The company was founded with the goal of transforming the way therapeutics and materials are discovered. In its early years, Schrödinger focused on developing its computational platform and introducing new capabilities to refine the software. This required substantial resources and significant investments, which posed challenges for the company. Over the last decade, Schrödinger has entered into numerous collaborations with leading biopharmaceutical companies, providing significant revenue and the potential for milestone payments, option fees, and future royalties.

Expansion into Drug Development

In 2018, Schrödinger began to develop its own pipeline of proprietary drug discovery programs, aiming to use its platform to produce a portfolio of novel, high-value therapeutics. This expansion into drug development has presented new challenges, as the company has had to navigate the complex and lengthy process of clinical drug development, including conducting necessary preclinical studies, submitting Investigational New Drug (IND) applications, and initiating and progressing clinical trials. Schrödinger's first IND application for its MALT1 inhibitor, SGR-1505, was cleared by the FDA in June 2022, allowing the company to initiate a Phase 1 clinical trial. Subsequently, Schrödinger received FDA clearance for INDs for its CDC7 inhibitor, SGR-2921, in July 2023 and its WEE1/MYT1 co-inhibitor, SGR-3515, in April 2024. The company has had to carefully balance its investments in software development and commercialization with its investments in proprietary drug discovery programs.

Financials

Schrödinger's software products and services generate the majority of the company's revenues, which totaled $216.7 million in the fiscal year ended December 31, 2023, representing an 11% increase from the previous year. The company's software business is highly profitable, with a gross margin of 77% in 2023. Schrödinger's software solutions are used by its customers to streamline various stages of the drug discovery and materials science processes, from initial target identification to lead optimization and candidate selection.

In addition to its software business, Schrödinger has also established a robust drug discovery collaboration model, working with leading biopharmaceutical companies to leverage its computational platform for the identification and development of new therapeutic candidates. These collaborations have resulted in a pipeline of promising drug candidates, some of which have advanced into clinical trials. In 2023, Schrödinger recognized $52.1 million in drug discovery revenue, although this represented a decrease from the prior year due to the timing and number of milestones achieved.

For the most recent quarter (Q3 2024), Schrödinger reported total revenue of $35.29 million, down 17% from the prior year period. This decrease was primarily driven by lower drug discovery revenue, which decreased 75% year-over-year due to the timing and amount of collaboration milestones achieved, including a $25 million milestone recognized from Bristol-Myers Squibb in Q3 2023 that did not recur in Q3 2024. However, software revenue increased 10% year-over-year, driven by growth in hosted software subscriptions.

The company's net income for Q3 2024 was -$38.14 million, with operating cash flow of -$33.26 million and free cash flow of -$34.60 million. For the full year 2023, Schrödinger reported net income of $40.72 million, operating cash flow of -$136.73 million, and free cash flow of -$150.14 million.

Liquidity

The company's financial position remains strong, with $398.4 million in cash, cash equivalents, restricted cash, and marketable securities as of September 30, 2024. Schrödinger has historically maintained a healthy balance sheet, which has enabled the company to invest in research and development, expand its software capabilities, and pursue strategic collaborations and acquisitions.

As of September 30, 2024, Schrödinger's debt-to-equity ratio was 0.27, indicating a relatively low level of debt. The company's current ratio and quick ratio were both 4.11, suggesting strong short-term liquidity. Schrödinger has a $60 million 5-year cloud computing agreement and a $21.8 million 5-year office lease agreement with minimum payment obligations.

Growth Strategy

Schrödinger's growth strategy is centered around three key pillars: 1) Accelerating the adoption of its software solutions by existing and new customers, 2) Expanding its drug discovery collaborations and advancing its proprietary pipeline, and 3) Leveraging its computational platform to address opportunities in adjacent industries, such as materials science.

In the software business, Schrödinger continues to focus on enhancing the capabilities of its platform, developing new product features, and expanding its customer base. The company has made significant investments in areas like machine learning and cloud computing to improve the speed and accuracy of its computational models. Schrödinger has also been successful in cross-selling its software solutions to existing customers, as well as attracting new customers, particularly in the life sciences and materials science industries.

On the drug discovery front, Schrödinger has established collaborations with several major pharmaceutical companies, including Bristol-Myers Squibb, Novartis, and Morphic Therapeutic. These collaborations have provided the company with a steady stream of milestone payments and potential future royalties, while also allowing Schrödinger to advance its proprietary drug discovery programs. In 2023, Schrödinger's collaboration with Morphic Therapeutic, a company that Schrödinger co-founded, resulted in a $48 million cash inflow when Morphic was acquired by Eli Lilly.

Future Outlook

Looking ahead, Schrödinger remains focused on executing its growth strategy and capitalizing on the significant opportunities in both its software and drug discovery businesses. The company's recently announced collaboration with Novartis, which includes a $150 million upfront payment and the potential for up to $2.3 billion in milestone payments, underscores the value that pharmaceutical companies place on Schrödinger's computational platform and drug discovery capabilities.

Schrödinger has narrowed and increased the lower end of its software revenue growth guidance for 2024, from 6-13% to 8-13%. This updated guidance reflects the company's confidence in closing necessary renewals and the contribution from the new multi-year software agreement with Novartis. However, Schrödinger has lowered its drug discovery revenue guidance for 2024 to $20-$30 million, down from the previous guidance of $30-$35 million, due to uncertainty around the timing of collaboration milestones.

The company expects its operating expense growth in 2024 to be significantly lower than in 2025. Schrödinger's operating cash use guidance for 2024 remains unchanged but will be influenced by the timing of the $150 million upfront payment from the Novartis collaboration around year-end.

Despite the challenges posed by the COVID-19 pandemic, Schrödinger has demonstrated its resilience and adaptability. The company quickly implemented measures to protect the health and safety of its employees, while also ensuring the continuity of its operations and customer support. Schrödinger's ability to navigate through this period has further strengthened its reputation as a trusted partner in the life sciences and materials science industries.

Product Segments

Schrödinger's revenue is primarily derived from two main segments: Software Products and Services, and Drug Discovery.

Software Products and Services segment generates revenue from five main sources: 1) On-premise software license fees: Customers are granted the right to use Schrödinger's software on their own servers or cloud instances for a specified term, typically one year. Revenue is recognized upfront upon transfer of control or the effective date of the agreement, whichever is later.

2) Hosted software subscription fees: Customers access Schrödinger's cloud-based software solution on their own hardware without taking control of the licenses. Revenue is recognized ratably over the term of the arrangement, typically one year.

3) Software maintenance fees: This includes technical support, updates, and upgrades related to on-premise software licenses. Revenue is recognized ratably over the term of the arrangement.

4) Professional services fees: These include training, technical setup, installation, or assisting customers with modeling services. Revenue is recognized when resources are consumed.

5) Software contribution revenue: This consists of funds received under non-reciprocal agreements with Gates Ventures, LLC and the Bill & Melinda Gates Foundation. Revenue is recognized when invoiced.

For the three months ended September 30, 2024, software products and services revenue was $31.88 million, up 10% from the prior year period. For the nine months ended September 30, 2024, it was $100.70 million, up 11% from the prior year period.

The Drug Discovery segment generates revenue from collaborations, including upfront payments, research and development activities, and achievement of discovery and development milestones. For the three months ended September 30, 2024, drug discovery services revenue was $2.81 million, down 78% from the prior year period. For the nine months ended September 30, 2024, it was $17.01 million, down 66% from the prior year period. The decreases were primarily due to Bristol-Myers Squibb electing not to proceed with further development of two programs during 2023.

Drug discovery contribution revenue, consisting of funds received under agreements with the Bill & Melinda Gates Foundation, was $593,000 for the three months ended September 30, 2024 and $1.51 million for the nine months ended September 30, 2024, down 37% and 35% respectively from the prior year periods.

Conclusion

In conclusion, Schrödinger is well-positioned to capitalize on the growing demand for computational solutions in drug discovery and materials design. The company's innovative technology, strong financial position, and strategic collaborations position it for continued success and long-term growth. As Schrödinger continues to push the boundaries of what's possible in molecular discovery, it remains a compelling investment opportunity for investors seeking exposure to the rapidly evolving world of computational biology and materials science.