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Item 7. Management’s Discussion and Analysis

2021-03-04 compared with 2020-03-16 · 188 added, 201 removed, 397 unchanged (49% of the section changed)

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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 “Item 1A.

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.

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.

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 is used by biopharmaceutical and industrial companies, academic institutions, and government laboratories around the world, and we are the leading provider of computational software solutions for drug discovery.

We also apply our computational platform to a broad pipeline of drug discovery programs in collaboration with biopharmaceutical companies, some of which we co-founded.

In addition, we are using our platform to advance a pipeline of internal, wholly-owned drug discovery programs.

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.

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 in both collaborative and wholly-owned drug discovery programs.

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, since mid-2018, we have launched five internal, wholly-owned programs.

We generate revenues from sales of our software solutions and from research funding and milestone payments from our drug discovery collaborations, which we have used to support our research and development and other operating expenses.

In addition, since inception we have raised gross proceeds of $192.6 million from sales of our convertible preferred stock as well as amounts received from our equity investment in Nimbus Therapeutics, LLC, or Nimbus, which we co-founded in 2009.

In late 2018 and early 2019, we issued and sold an aggregate of 73,795,777 shares of Series E convertible preferred stock at $1.4906 per share, for $110.0 million in gross proceeds.

In 2016, Nimbus sold its Acetyl-CoA carboxylase, or ACC, inhibitor, firsocostat, to Gilead Sciences, Inc., or Gilead Sciences, in a transaction valued at approximately $1.2 billion, comprised of an upfront payment and earn outs that are tied to the

achievement of specified development and regulatory milestones.

Of this amount, $601.3 million has been paid to Nimbus to date, and we received a total of $46.0 million in cash distributions in 2016 and 2017.

We are eligible to receive up to $46 million in future cash distributions on the remaining approximately $600 million of earn outs, if and when such earn outs are achieved.

However, the likelihood and timing of such payments, if any, are not possible for us to predict as the achievement of the development and regulatory milestones under the transaction agreement is uncertain and outside of our control.

In December 2019, Gilead Sciences announced topline results from its Phase 2 clinical trial which included firsocostat, both as a monotherapy and in combination with other investigational therapies, in which the primary endpoint was not met.

Gilead Sciences announced that it was continuing to analyze the data from the trial and determine next steps.

We do not know how this development will affect Nimbus’ right to receive future earnout payments from Gilead Sciences or our right to receive cash distributions from Nimbus.

However, if Gilead Sciences determined not to continue to advance the development of firsocostat, then we would not expect to receive any additional distributions from Nimbus on account of this program.

Additionally, even if Nimbus were to receive any further earnout payments from Gilead Sciences, any distribution to us as an investor in Nimbus would need to be approved by the board of directors of Nimbus.

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.

On February 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, on August 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:

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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, and professional services.

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 the cloud-based software solution for a specified term.

We currently generate drug discovery revenue from our collaborations, including research funding payments and discovery and development milestones.

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, in the future we may also derive drug discovery revenue from out-licensing our internal drug discovery programs when we believe it will help maximize the commercial potential of the program.

We generated revenue of $66.6 million and $85.5 million in 2018 and 2019, respectively, representing year-over-year growth of 28%.

Our net loss was $28.4 million and $24.6 million for the years ended December 31, 2018 and 2019, respectively.

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.

In November 2020, we entered into an exclusive, worldwide collaboration and license agreement with Bristol-Myers Squibb Company, or BMS, pursuant to which we and

BMS agreed to collaborate in the discovery, research and development of small molecule compounds for biological targets in the oncology, neurology and immunology therapeutic areas.

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 ended December 31, 2020, 2019, and 2018, respectively.

Business Impact of COVID-19 Pandemic

In December 2019, a novel coronavirus, or COVID-19, emerged and has since spread to many countries worldwide, including the United States.

On March 11, 2020, the World Health Organization declared the outbreak of COVID-19 a pandemic, and on March 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 early March 2020 we implemented a company-wide work-from-home policy.

Beginning in June 2020, we began limited re-openings of certain of our offices in the 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, and WuXi 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

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The revenue that we generate through our software solutions from each of our customers varies depending on the number of licenses for each software solution that each customer purchases from us.

Accordingly, we work with our customers to improve their experience and increase the utility of our platform in order to expand the scale at which they deploy our platform in their business.

Accordingly, we work with our customers

to improve their experience and increase the utility of our platform in order to expand the scale at which they deploy our platform in their business.

Biopharmaceutical companies are increasingly adopting our software at a larger scale, and we anticipate that this scaling-up will drive future revenue growth.

Our ability to expand within our customer base is best demonstrated by the increasing number of our customers with an annual contract value, or ACV, of over $100,000.

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 ended December 31, 2020, 2019, and 2018, respectively.

This subset of customers represented approximately 79%, 78%, and 77% of our total ACV for the years ended December 31, 2020, 2019, and 2018, respectively.

In addition, we had nine, 11, and 10 customers with an ACV of over $1.0 million for the years ended December 31, 2017, 2018, and 2019, respectively.

In addition, we had 16, 10, and 11 customers with an ACV of over $1.0 million for the years ended December 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.

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ACV is not intended to be a replacement for, or forecast of, revenue.

Furthermore, 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 ended December 31, 2019 and for each of the previous six fiscal years, our year-over-year customer retention for such customers was 96% or higher.

Our ACV was $92.1 million, $75.6 million, and $64.0 million for the years ended December 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 ended December 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.

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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 the materials science industry is only beginning to recognize the potential of computational methods.

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.

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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, pre-clinical, clinical, and commercial milestone payments, and option fees, as well as royalties on any potential future sales of products, if approved.

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 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.

Our ability to continue to derive value from our

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.

Since launching our first program in mid-2018, we have built a pipeline of five programs.

We intend to progress our wholly-owned programs through the development candidate stage and potentially into investigational new drug-enabling studies and clinical development.

As we progress these programs, we will strategically evaluate on a program-by-program basis entering into clinical development ourselves or out-licensing programs to maximize commercial opportunities.

However, we will need to devote substantial resources to develop and expand our internal pipeline.

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, in November 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.

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Software Products and Services Revenue

Our software business generates revenue from four sources:

(i) on-premise software license fees, (ii) hosted software subscription fees, (iii) software maintenance fees, and (iv) professional services fees.

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 for a specified term, typically for one year.

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 access to our hosted software platform and is recognized ratably over the term of the arrangement, which is typically one year.

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.

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Professional services.

Professional services, such as 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.

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 with Gates 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 these 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.

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, in November 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

revenue for the year ended December 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.

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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.

Currently, we have only one collaboration that involves payment of CRO 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.

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We expect our drug discovery costs of revenue to trend higher over time as our discovery collaborations advance.

Personnel-related expenses for our internal discovery programs are classified within research and development expense.

Gross Profit and Gross Margin

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Research and development expense accounts for a significant portion of our operating expenses.

We recognize research and development expenses as incurred.

Research and development expenses consist of internal drug discovery program costs and costs incurred for continuous development of the technology and science that supports our computational platform, primarily:

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;

allocated compute capacity 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 target candidates, in advancing our platform, and as we incur expenses associated with hiring additional personnel directly involved in such efforts.

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.

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Other sales and marketing costs include promotional events that promote and expand knowledge of our company and platform, including industry conferences and events and our annual user group meetings in the United States and Europe, advertising, and allocated overhead costs.

Most operating costs of our sales offices in Europe and Japan are included in sales and marketing expense.

operating costs of our sales offices in Europe and Japan 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 increase our investment 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.

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

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We expect to increase the size of our general and administrative staff to support the anticipated growth of our business.

We expect to incur additional expenses as a result of operating as a public company, including costs to comply with the rules and regulations applicable to companies listed on a U.S.

We expect to continue to incur additional expenses as a result of operating as a public company, including costs to comply with the rules and regulations applicable to companies listed on a U.S.

securities exchange and costs related to compliance and reporting obligations pursuant to the rules and regulations of the Securities and Exchange Commission, or SEC.

In addition, as a public company, we expect to incur increased expenses such as insurance and professional services.

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.

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Change in Fair Value

Fair value gains and losses consist of adjustments to the fair values of our equity investments, including Nimbus and Morphic Holding, Inc., or Morphic.

In June 2019, Morphic became a publicly traded company and, as such, fair value is determined as the current market value of Morphic common stock as of the reporting date.

We remeasure our holding in Morphic at each period end.

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 in June 2019 and July 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.” We expect that fair value gains and losses may fluctuate significantly in future periods.

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 January 2021, we disposed of our equity stake in Relay for aggregate consideration of $15.7 million.

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

Interest Income

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Comparison of the years ended December 31, 2020 and 2019

The following table summarizes our unaudited results of operations data for the years ended December 31, 2018 and 2019:

The following table summarizes our results of operations data for the years ended December 31, 2020 and 2019:

Year Ended December 31,

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Loss from operations

Other (expense) income:

Gain on equity investment

Other income:

Gain on equity investments

Change in fair value

Interest income

Total other (expense) income

Total other income

Loss before income taxes

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Net loss attributable to noncontrolling interest

Net loss attributable to Schrödinger

Net loss attributable to Schrödinger stockholders

Year Ended December 31,

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On-premise software.

The increase in revenues for on-premise software was primarily attributable to new customer and existing customer growth during 2019 as compared to 2018.

This was partially offset by a shift in sales mix from customers purchasing our software product licenses for use on their own in-house servers, which is recognized upfront at a single point in time, to accessing our software as a hosted solution, which is classified within hosted software revenue and recognized ratably over the term of the arrangement.

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 existing customers shifting from on-premise software product licenses to hosted software subscriptions, for which revenue is recognized ratably over time.

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 growing product sales in previous years.

Maintenance revenue is recognized over time.

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 decrease in revenues from professional services was primarily due to lower modeling services fees and non-renewing technology service projects.

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 Gates Ventures, LLC, which began in June 2020.

Drug discovery.

The increase in revenues for drug discovery was primarily due to an increase in the number of collaboration milestones achieved during 2019 as compared to 2018.

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

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Software products and services.

The increase in cost of revenues for software products and services was attributable to increases of $2.3 million in personnel-related expenses, $0.5 million in compute capacity costs, and $0.2 million in other costs of revenue.

The decrease in gross margin was primarily attributable to an increase in personnel-related expenses.

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 $4.5 million in third-party CRO costs to support a collaboration, $1.9 million in compute capacity costs, $1.9 million in personnel-related expenses, $0.9 million in royalties paid to third parties for use of licensed software functionality, and $0.6 million in other costs of revenue.

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

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Research and development

The increase in research and development expense was primarily due to additional CRO costs associated with the expansion and progression of internal drug discovery programs.

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

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Sales and marketing

The increase in sales and marketing expense was primarily attributable to an increase in personnel-related expenses due to additional employee headcount to support the expansion of our business.

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

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General and administrative

In the year ended December 31, 2019, we recognized a total of $3.3 million in non-comparable costs, which consisted of $1.8 million of costs related to a cash distribution we received from Nimbus and a $1.5 million unconditional gift to Columbia University intended to fund a research laboratory.

The increase in general and administrative expense was also attributable to an increase of $3.8 million in personnel-related expenses due to additional employee headcount and a $1.4 million increase in other expenses.

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 on Equity Investment

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(in thousands)

Gain on equity investment

In the year ended December 31, 2019, we received a $0.9 million cash distribution from our Nimbus investment in 2019.

There was no such distribution in 2018.

Gain on equity investments

The gain on equity investments during 2020 represents realized gains in the form of a cash distribution received from the Petra Pharma Corporation, or Petra, merger in May 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

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Change in fair value

The increase in fair value was due to a $14.1 million gain on our equity investment in Morphic, partially offset by a $4.2 million loss on our equity investment in Nimbus.

Morphic became a publicly traded company in June 2019 and, as such, we revalued our investment as of December 31, 2019 to equal the current fair market value of Morphic’s common stock.

The Nimbus fair value loss was determined under the HLBV method.

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

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Interest income

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 in February 2020 and our follow-on public offering in August 2020, partially offset by a significant reduction in interest rates year-over-year.

Income Tax Expense (Benefit)

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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 ended December 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

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(in thousands)

Software products and

Software products and services

Drug discovery

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Cost of revenues:

Software products and

Software products and services (1)

Drug discovery (1)

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Operating expenses:

development (1)

Research and development (1)

Sales and marketing (1)

administrative (1)

Total operating

General and administrative (1)

Total operating expenses

Loss from operations

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Interest income

Total other (expense)

Loss before income

Total other (expense) income

(Loss) income before income taxes

Income tax expense (benefit)

Net (loss) income

Net loss attributable to

noncontrolling interest

Net (loss) income

attributable to

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

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Professional services

Revenue from contracts

with customers

Total software products

and services revenue

Drug discovery

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Quarterly Revenue Trends

On-premise software revenue is subject to seasonality that favors the first quarter of each year, 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 steadily in the periods presented, as existing customers migrated from on-premise licenses to hosted solutions, for which revenue is recognized over time.

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.

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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, but has grown in recent periods as our collaborations have advanced.

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.

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Quarterly Deferred Revenue Trends

Deferred revenue consists of the unearned portion of customer billings, which is recognized as revenue in accordance with our revenue recognition policy, as well as the unearned portion of unbilled collaboration milestones that are deemed probable in advance of actual achievement.

Deferred revenue balances have generally increased over the periods presented, but have fluctuated based on the timing of sales, the shift of product mix as customers transitioned from on-premise software to hosted software that is recognized over time, and the increase in the number of milestones that were deemed probable in advance of actual achievement.

of actual achievement.

Deferred revenue balances have generally increased over the periods presented, but have fluctuated based on the timing of sales, shift s 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 declines over the periods presented due to increased headcount and the timing effect of a shift in software sales from on-premise to hosted solutions.

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, which created fluctuation in gross margin from quarter-to-quarter.

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 involved in research and development, sales and marketing, general and administrative activities, and CRO costs related to our internal drug discovery programs.

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.

Included in general and administrative expense for the year ended December 31, 2019 was $3.3 million of non-comparable items.

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 and Morphic and, to a lesser degree, interest income.

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 the Petra Corporation merger, and, to a lesser degree, interest income.

Segment Information

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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.

Additionally, we report assets on a consolidated basis and do not allocate assets to our reportable segments for purposes of assessing segment perf ormance or allocating resources .

Year Ended December 31,

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Liquidity and Capital Resources

Historically we have incurred substantial operating losses and expect to continue to incur significant operating losses for the foreseeable future and may never become profitable.

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 of December 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, to a lesser degree, by the magnitude and timing of our drug discovery milestone achievements and research funding fees.

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.

Since inception, we have also financed our operations from sales of our convertible preferred stock, as well as amounts received from our equity investment in Nimbus, which we co-founded in 2009, and the net proceeds of our initial public offering in February 2020.

In late 2018 and early 2019, we issued and sold an aggregate of 73,795,777 shares of Series E convertible preferred stock at $1.4906 per share, for $110.0 million in gross proceeds.

In 2016, Nimbus sold its ACC inhibitor to Gilead Sciences in a transaction valued at approximately $1.2 billion, comprised of an upfront payment and earn outs.

Of this amount, $601.3 million has been paid to Nimbus to date, and we have received a total of $46.0 million in cash distributions to date.

We are eligible to receive future cash distributions on the remaining approximately $600 million of earn outs, if and when such earn outs are achieved.

Gilead Sciences announced that it was continuing to analyze the data from the trial and determine next steps.

We do not know how this development will affect Nimbus’ right to receive future earnout payments from Gilead Sciences or our right to receive cash distributions from Nimbus.

Additionally, even if Nimbus were to receive any further payments from Gilead Sciences, any distribution to us as an investor in Nimbus would need to be approved by the board of directors of Nimbus.

Furthermore, we have financed our operations from sales of our equity securities.

As of December 31, 2020, we had cash, cash equivalents, restricted cash, and marketable securities of $643.2 million.

In addition, on February 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 of $209.9 million, after deducting underwriting discounts and commissions and offering expenses borne by us.

Cash in excess of immediate requirements is invested in accordance with our investment policy, primarily with a view towards capital preservation and liquidity.

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

Year Ended December 31,

(in thousands)

Net cash used in operating activities

Net cash provided by (used in) investing activities

Net cash provided by (used in) operating activities

Net cash used in investing activities

Net cash provided by financing activities

Net (decrease) increase in cash and cash equivalents

Net increase (decrease) in cash and cash equivalents and restricted cash

Operating activities

During the year ended December 31, 2018, operating activities used approximately $23.7 million of cash, primarily resulting from net loss of $28.4 million, partially offset by $3.6 million of non-cash operating expenses included in net loss, including depreciation and stock-based compensation costs, and a $0.8 million non-cash loss from changes in fair value.

Changes in our operating assets and liabilities provided cash of approximately $0.3 million.

During the year ended December 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 ended December 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.

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Investing activities

During the year ended December 31, 2018, investing activities provided approximately $11.2 million of cash, primarily attributable to $20.1 million of proceeds upon the maturity of marketable securities, partially reduced by $5.3 million used for purchases of property and equipment, $3.3 million for the purchase of additional shares of Nimbus, and $0.3 million for the purchase of additional shares of Morphic.

During the year ended December 31, 2020, investing activities used approximately $381.7 million of cash, primarily for purchases of marketable securities.

During the year ended December 31, 2019, investing activities used approximately $53.9 million of cash, primarily for purchases of marketable securities.

Financing activities

During the year ended December 31, 2018, financing activities provided approximately $80.3 million of cash, primarily attributable to proceeds from issuances of our Series E preferred stock.

During the year ended December 31, 2020, financing activities provided approximately $541.3 million of cash, primarily attributable to proceeds from issuances of our common stock in our initial public and follow-on offerings.

During the year ended December 31, 2019, financing activities provided approximately $28.7 million of cash, primarily attributable to proceeds from issuances of our Series E preferred stock.

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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 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.

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 wholly-owned programs, as part of our strategy we may choose to pursue licensing arrangements when we believe it will help maximize the commercial value of any such program.

If we are able to successfully enter into any licensing arrangements in the future, 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.

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, in November 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.

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.

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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

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In November 2019, we entered into a three-year agreement with a third-party cloud provider for compute power.

The agreement contains a minimum payment obligation which totals $18 million over the three years after the date we entered into the agreement.

The agreement originally contained a minimum payment obligation, which totaled $18 million over the three years after the date we entered into the agreement.

In December 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.

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At December 31, 2020, we had federal and state net operating loss carryforwards of approximately $206.3 million and $126.7 million, respectively.

These carryforwards will expire between 2020 and 2039, with the exception of 2018 and 2019 federal net operating losses, if not

used by us to reduce income taxes payable in future periods .

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.

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These carryforwards will expire between 2021 and 2040 if not used by us to reduce income taxes payable in future periods.

As required by Accounting Standards Codification, or 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 NOL carryforwards and research and development credit carryforwards.

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 at December 31, 2020 and 2019, respectively.

The change in the valuation allowance was $7.8 million for the year ended December 31, 2018 and $7.7 million for the year ended December 31, 2019.

The change in the valuation allowance for the years ended December 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 ended December 31, 2020 and income tax benefit of $0.3 million for the year ended December 31, 2019.

Historically, the first quarter of each year has been our largest quarter for software products and services revenue, primarily due to the timing of customer renewals of on-premise software arrangements, for which revenue is recognized at a single point in time.

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.

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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 with U.S.

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.

We base our estimates on historical experience, known trends and events, and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.

We base our estimates on historical experience, known trends and events, and our beliefs of what could occur in the future considering available information.

Actual results may differ from these estimates under different assumptions or conditions.

On an ongoing basis, we evaluate our judgments and estimates in light of changes in circumstances, facts, and experience.

The effects of material

revisions in estimates, if any, are reflected in the consolidated financial statements prospectively from the date of change in estimates .

While our significant accounting policies are described in more detail in the notes to our consolidated financial statements appearing elsewhere in this Annual Report, we believe the following accounting policies used in the preparation of our consolidated financial statements require the most significant judgments and estimates.

We recognize revenue in accordance with ASC 606, Revenue from Contracts with Customers, which we adopted as of January 1, 2017 on a full retrospective basis.

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.

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.

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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.

For a collaborative arrangement that falls within the scope of ASC 808, Collaborative Arrangements, we apply the revenue recognition model under ASC 606 to part or all of the arrangement, when deemed appropriate.

We have determined that we are the principal in arrangements where we act as a reseller, and therefore recognize revenue on a gross basis.

We include the unconstrained amount of estimated variable consideration in the transaction price.

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At the end of each subsequent reporting period, we re-evaluate the estimated variable consideration included in the transaction price and any related constraint and, if necessary, adjust our estimate of the overall transaction price.

Research support payments :

Payments by the licensees in exchange for research activities we performed on behalf of the licensee are recognized upon performance of such activities at rates consistent with prevailing market rates.

If the expectation at contract inception is such that the period between payment by the licensee and the completion of related performance obligations will be one year or less, we assume that the contract does not have a significant financing component.

Milestone payments :

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

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

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

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

commercial milestones and/or commercial royalties;

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

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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, adjusts 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.

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Consequently, there is a risk that we may not earn all of the milestone payments from each of our collaborators.

Royalties and commercial milestones :

For arrangements that include sales-based royalties, including commercial milestone payments based on pre-specified level of sales, we recognize revenue at the later of (i) when the related sales occur, or (ii) when the performance obligation to which some or all of the royalty has been allocated has been satisfied (or partially satisfied).

Achievement of these royalties and commercial milestones may solely depend upon performance of the licensee.

The process of successfully achieving the criteria for the commercial milestone payments and sales-based royalties under our arrangements is highly uncertain.

As a result, we cannot predict when we might achieve any commercial milestone or royalty payments or estimate the amount of such payments.

Since inception to date, we have not recognized any royalty revenue or commercial milestone payments from any of our collaborations.

We may never receive any such payments.

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

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Fair Value of Common Stock.

As our stock was not publicly traded prior to our initial public offering in February 2020, we historically estimated the fair value of common stock as discussed below.

As of February 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.

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Expected Volatility.

As we did not have a trading history for our common stock prior to our initial public offering in February 2020, the selected volatility used is representative of expected future volatility.

We based expected future volatility on the historical and implied volatility of comparable publicly traded companies over a similar expected term.

We base expected future volatility on the historical and implied volatility of comparable publicly traded companies over a similar expected term.

Expected Dividend Yield.

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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.

Prior to our initial public offering in February 2020, our board of directors, with input from management, estimated the price of our common stock based upon several factors, including third-party valuations and our operating results and financial performance.

The valuations took into consideration several factors, including, but not limited to, prices for our preferred stock that was sold to outside investors in arms-length transactions, and the rights, preferences, and privileges of our preferred stock and common stock;

the fact that the option grants involved illiquid securities in a private company;

our stage of development and revenue growth;

the state of the biopharmaceutical industry and the economy;

the marketplace and major competitors;

and the likelihood of achieving a liquidity event for shares of common stock underlying the options, such as an initial public offering or sale of our company, given prevailing market conditions.

These valuations were performed in accordance with the American Institute of Certified Public Accountants’ Audit and Accounting Practice Aid, Valuation of Privately Held Company Equity Securities Issued as Compensation.

The assumptions underlying these valuations represented management’s best estimates, which involved inherent uncertainties and the application of management judgment.

As a result, if factors or expected outcomes changed and we had used significantly different assumptions or estimates, our stock-based compensation expense could have been materially different.

Subsequent to the completion of our initial public offering in February 2020, our board of directors determines the fair value of our common stock based on the closing price of our common stock as reported on the Nasdaq Global Select Market.

Valuation of Equity Investments

We have investments in a number of early stage biotechnology companies.

If we determine that, for accounting purposes, we have significant influence over the company, we value the investment using the HLBV method.

The HLBV method is a balance sheet-oriented approach to equity method accounting.

Under the HLBV method, we determine our share of earnings or losses by comparing our claim on the book value at the beginning and end of each reporting period.

This claim is calculated as the amount that we would receive if the investee were to liquidate all of its assets at recorded amounts, determined as of the balance sheet date in accordance with generally accepted accounting principles, and distribute the resulting cash to creditors and investors in accordance with their respective priorities.

Significant unobservable inputs used under the HLBV method include annual financial statements of investment companies and our respective liquidation priority.

The assumptions underlying these valuations represent management’s best estimates, which involve inherent uncertainties and the application of management judgment.

As a result, if factors or expected outcomes change and we use significantly different assumptions or estimates, our fair value gains and losses could be materially different.

A 10% increase in the net assets of our HLBV equity investments and a 10% increase in the fair value of common stock of our other equity investment holdings would result in a $1.5 million increase in the valuation of our equity investments as of December 31, 2019.

A 10% decrease in the net assets of our HLBV investments and a 10% decrease in the fair value of common stock of our other equity investment holdings would result in a $1.4 million decrease in the valuation of our equity investments as of December 31, 2019.

JOBS Act Election

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not being required to comply with the auditor attestation requirements on the effectiveness of our internal control over financial reporting;

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;

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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 have elected to take advantage of certain of the reduced disclosure obligations in this Annual Report and may elect to take advantage of other reduced reporting requirements in future filings.

As a result, the information that we provide to our stockholders may be different than the information you receive from other public companies in which you hold stock.

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.

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See Note 2 to our consolidated financial statements appearing elsewhere in this Annual Report for a discussion of recent accounting pronouncements.

Quantitative and Qualitati ve Disclosures About Market Risk.

Our primary exposure to market risk is interest rate sensitivity, which is affected by changes in the general level of U.S.

interest rates, particularly because our investments, including cash equivalents and marketable securities, are in the form of U.S.

Treasury and corporate securities and a money market fund that is invested in U.S.

Treasury and corporate securities.

Due to the nature of these investments, an immediate 10% change in interest rates would not have a material effect on the fair market value of this investment portfolio.

We are also exposed to market risk related to changes in foreign currency exchange rates.

We maintain a bank account denominated in Japanese Yen to accommodate deposits of amounts due from certain customers.

We also contract with certain vendors that are located outside of the United States whose invoices are denominated in foreign currencies.

We are subject to fluctuations in foreign currency rates in connection with these arrangements.

We do not currently hedge our foreign currency exchange rate risk.

Our cash balances and outstanding vendor invoices denominated in foreign currencies were not material as of December 31, 2018 or 2019, and our market risk associated with foreign currency exchange rates was deemed insignificant.

An immediate 10% change in foreign exchange rates would not have a material effect on our consolidated financial statements.

Inflation generally affects us by increasing our cost of labor and target development costs.

We do not believe that inflation had a material effect on our business, financial condition, or results of operations for the years ended December 31, 2018 or 2019.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis