Oxford Nanopore Technologies PLC

LSE:ONT

Earnings Call Analysis

Significant Growth and Margin Improvement

In the first half of 2023, the company saw a robust momentum with 46% revenue growth at £86 million, excluding Emirati Genome Project (EGP) and COVID sequencing activities. The increase was fuelled by new customer acquisitions and higher utilization of consumables. Margins improved by 280 basis points, reaching 57.6% due mainly to automation and manufacturing process enhancement. Though the firm faced higher costs for processors and components, the strong financial position, with £485 million in cash or equivalents, underpins ongoing innovation and commercial expansion. Notably, 75% of the revenue stemmed from consumable kits and flow cells -- critical to future growth. The earnings report acknowledged an adjusted EBITDA loss of £39.4 million, a slight increase from the previous year, and an impact from reduced COVID sequencing and EGP revenues.

Revenue Momentum and Diversified Growth

In the first half of 2023, the company boasted a 46% increase in underlying revenue on a constant currency basis, excluding COVID sequencing and other specific projects, achieving £86 million for the period. This surge was primarily driven by new customer acquisitions and greater utilization across consumable products. The Americas region, led by a strong year-on-year growth of 72%, showcases particular potential as a major driver of future growth, mainly due to increased research into human diseases such as cancer and neurological conditions.

Robust Gross Margin Improvement

Gross margin improved significantly by 280 basis points to 57.6%, propelled by advancements in supply chain optimization and manufacturing efficiency of flow cell production. This enhancement was achieved without a negative impact on pricing for customers, as over 85% of gross profit stemmed from consumable sales. However, the cost increases for compute and other generic components have pressured the gross margin on devices and services.

Investment in Innovation and Global Expansion

The company continued to bolster its commercial infrastructure worldwide, doubling its commercial headcount since their IPO to fulfill growth and commercial objectives. These investments are cultivating new customer groups and expanding market opportunities, which resulted in strong growth across all customer segments.

PromethION Platform Enhancements

The PromethION platform has undergone significant upgrades, improving compute capabilities and expanding its applications, thus supporting customer growth across all segments. These upgrades, however, have contributed to an increased spending which affected margins in the short-term.

Fiscal and Operational Health

The financial health of the company is supported by a solid balance sheet, with available cash and cash equivalents totaling £485 million. Although Adjusted EBITDA reflected a loss of £39.3 million, up from a £34.6 million loss in the previous year, this is offset by the company's preparedness for future investments to fuel growth and innovation.

Guidance for 2023

For the entire year of 2023, the company has outlined a LSRT revenue growth forecast of between 18% and 25% on a constant currency basis, which is consistent with earlier projections―reflecting a recognized future headwind from a reduction in Covid sequencing revenues. Meanwhile, gross margin is anticipated to surpass 57% for the year, with a longer-term goal to exceed 65% by 2026, aligning with IPO targets.

Earnings Call Transcript 2023-Q2

[Gordon Sanghera, Chief Executive Officer]

Good afternoon and welcome to our 2023 Interim Results Presentation. I'll provide a short summary of our financial and key business highlights for the first half of 2023. Tim will then walk you through our financials in more detail. We are seeing strong momentum across the business. We are delivering on revenue and margin. We continue to innovate on our platform. We continue to simplify end-to-end workflows, as well as launch new applications. We've doubled our commercial headcount since the IPO to meet the growth and commercial targets that we set out at IPO. We've continued to make progress in applied market opportunities and partnerships.

So, moving on and getting into a little more detail on the numbers. We saw continued momentum in our business in the first half of 2023. Our revenue for the period was £86 million, which is 46% underlying growth on a constant currency basis. And this is excluding EGP and COVID sequencing. The growth was driven by new customer acquisitions and increased utilization across all of our consumables in existing accounts.

Our margin increased by 280 base points to 57.6%. This was driven by automation and our continued improvement programs in our consumable manufacturing processes. We have a strong balance sheet with cash or cash equivalents of £485 million, supporting our investment in innovation and commercial expansion. So just to remind you all, 75% of our revenues come from our consumable kits and flow cells. Our flow cells have the electronic sensing circuit embedded in the consumable. This enables infield, regular hardware, software, and chemistry upgrades. These innovation upgrades are central to driving our commercial growth.

As I've said, in the first half of 2023, we saw strong growth across all of our customer groups. From the S1 genomic explorers, primarily MinION and Flongle users up 36% to the S2 public health, primarily GridION and P24 users up 61%, and to our S3 genomic enterprise customers with large-scale programs and or all service labs up 53%. In direct sales, we're also up through local distributors 61%.

Our key drivers for customer growth are innovation, customer experience, and operations. In innovation, the PromethION fleet has been significantly upgraded with hardware, software, and NVIDIA Series-A Compute upgrades. There is broad adoption of our Q 20 plus chemistries. On the customer front, we have doubled the commercial groups in the last 18 months. We are seeing strong starter pack growth and the P2 solo rollout and developer launch of P2 I have commenced. In operations, scale-up and automation of manufacturing are developing at a pace. We have improved logistics with new partners in the USA, Singapore, and Australia.

I want to focus a little bit today on transforming the PromethION platform. The PromethION fleet upgrade to the A-Series delivers four and a half fold increase in base calling speed. This includes Dorado, our methylation base caller, which is integrated into our MinION operating system. This enables scalable human genomes from $345 upwards with a technology roadmap to further reduce the cost to $200. 1 P24 can deliver up to two and a half thousand genomes per annum.

The PromethION fleet upgrade and particular the A100 compute upgrade has meant higher spend, and Tim will provide more details on the impact of these upgrades. It is interesting to note that the initial demand for our P2 solo is across all of our customer groups. S1, S2, and S3. We have a very strong order book for P2 solo, as well as placing hundreds of P2s infield in over 45 countries already. We've also released P2I, the P2 with integrate, compute for developers.

In parallel, we are transforming performance with our Q20+ chemistry. We continue to roll out the Q20+ chemistry, which has the following key features, high precision variant detection, duplex accuracy of Q30, and a capability with this release of chemistry to complete T-to-T assemblies fully assembled genomes. Over 90% of new flow cell orders from PromethION are for our Q20+ chemistry, and over 50% of our MinION customers have switched to Q20 chemistry with the remainder switching in the next six months.

Scaling our manufacturing operations, our automation program is driving both product consistency and margin improvements. We have established a new facility in Harwell next to our MinION factory to meet increasing demand for our library prep kits. Our continuous improvement programs are targeting 20% to 50% increase in flow cell outputs across all of our platforms, and last, not least, accelerating our commercial execution.

In 2022, we restructured our commercial teams to three regional hubs. Each region has now doubled the sales, technical services, and field application support teams. We have transitioned to UPS as our global partner and established distribution hubs in each region, AMR, AsiaPAC, and in Australia. We have established customer excellence centers in Houston, Dubai, and Singapore, and we are investing in both commercial headcount and the underlying digital platforms to match growth and enhance our customer experience.

With that, I'm going to hand it back over to Tim and we will take a deeper dive into the first half year 2023 numbers.

[Tim Cowper, Chief Financial Officer]

Thank you, Gordon. Good afternoon, everyone. During the first half of 2023, we have continued to deliver a strong financial performance whilst investing in driving future growth and profitability. Firstly, we delivered strong revenue and margin growth in our core life science research tools business, I shall refer to this as LSRT. LSRT revenue for the first half was £86 million, up 22% on a reported basis and 46% on an underlying basis at constant currency. All underlying growth rates referred to in this presentation exclude COVID sequencing and the Emirati Genome Project or EGP. LSRT gross margin increased by approximately 280 basis points to 57.6%. This was despite a challenging environment, particularly in relation to the increased cost of computer processors and other core components, due to supply chain constraints.

Total revenue was £86 million, which was entirely LSRT revenue. As a reminder, Legacy Covid Testing revenue ended in 2022. Adjusted EBITDA and alternative performance measure was a loss of £39.4 million compared to a loss of £34.6 million in the first half of ‘22. As Gordon has explained, we have continued to strengthen our core commercial teams around the world whilst also investing in innovation to provide the foundation for future growth and profitability.

Finally, we finished the period with cash, cash equivalences, and liquid investments of ₤485 million. Let's look more closely at LSRT revenue. There are a number of figures on this slide, but the key message I'd like to leave you with is the underlying revenue growth in the first half of the year was 46% on a constant currency basis. This growth is driven primarily by new customer acquisition through direct sales and our expanding distributor network, as well as growth within existing customer accounts.

Including the EGP and COVID sequencing, LSRT revenue growth was 22% on a reported basis and 16% on a constant currency basis. This includes a significant headwind from COVID sequencing down ₤9.9 million compared to the first half of 2022, as well as a small reduction in revenue from the EGP of ₤0.9 million compared to the first half of the previous year. As the company's revenue grows, we are pleased with the increasing diversity of our overall revenues, with less contribution from one single program.

Let's look at LSRT revenue by category. In previous years, we have broken down our revenue into starter pack consumables, and other revenue, to better communicate the components of our revenues. From now on, we are providing more traditional breakdown split into consumable sales and devices and services. Consumables revenues shown on this graph now include the consumable portion of starter pack revenue, and we have grouped the remaining device portion within devices and services. Total revenue for the six months ended 30th of June, 2023 consists of ₤64.3 million of consumable sales and ₤21.7 million of devices and services.

Importantly, 75% of our revenue is made up of consumable revenue. This proportion is largely consistent with prior years. Growth in consumable spend of 18% was strong considering the ₤9.9 million COVID sequencing headwind, which was predominantly consumable spend, and the slight decline in EGP consumables year-on-year. The next slide explains the breakdown of underlying year-on-year growth across the customer groups. A full breakdown of S1, S2, and S3 sales, as well as the average revenues per group and customer numbers, is shown in the appendix for you to refer to.

As previously discussed, revenues for the first half of 2023 were affected by the expected slowdown in COVID sales of ₤9.9 million, and revenues from the EGP showed a small decline. But once this impact is stripped out, we showed strong underlying growth across all customer groups as shown on this graph. S1 revenues excluding COVID sequencing was up 36% year-on-year, driven by new customer acquisition.

Sales in the S1 group are predominantly driven by digital marketing and through our unique e-commerce platform. To better communicate our distributor revenues, the Avantor indirect sales channel, which had been included previously in S1, has been moved into the indirect group with the other distributors. This has been reflected in both the 2022 and ‘23 numbers on this graph.

S2 revenues, excluding COVID sequencing, have seen the highest level of growth at 61% year-on-year. We continue to grow the number of customers in this group, which we believe is uniquely open. Oxford Nanopore. We have added an additional 130 customers in this group on a rolling 12-month basis, whilst maintaining average spend per customer. We now have almost 1,100 customers spending on average, $66,000 per annum.

S3 revenues is excluding both COVID sequencing and EGP have grown by £6.8 million or 53%. This is the group most affected by the Covid headwind. However, when you exclude COVID sequencing and EGP, underlying growth was driven by new customer acquisition and increases in spend per customer. These customers are mainly focused on human genetics and cancer research, which are developing our future growth opportunities and driving profitability.

Finally, we are increasingly investing in improving the level of service for our customers. We rely on an expanding network of regionalized distributors to help us. Revenue for these indirect customers increased by 61% year on year, which was largely due to strong performance from Avantor and post COVID sequencing in China.

Moving to regional results for LSRT revenue. We delivered strong year-on-year growth across all regions led by the Americas. Revenue across the Americas was up 72% on an underlying basis. This reflects increased investment in commercial resources and growing demand for our unique technology platform. Revenue growth in this region is principally driven by research in human disease in the U.S. and Canada, including projects looking at cancer and neurological diseases. We see the commercial opportunities in the North America region as one of the key drivers of future growth.

Revenue in APAC was up 23% on an underlying basis. Revenue in APAC is weighted to China, which is now beginning to pick up after COVID, although conditions remain challenging. In addition, we are seeing a growing contribution from Southeast Asia on the back of our investments in Singapore.

EMEAI revenue was up 57% on an underlying basis. Growth in this region was driven by a pickup in sales across Europe, again, reflecting the increased demand for long reads and our increased commercial presence in the region.

Now let's move to gross margin. We have invested in our supply chain and making operational improvements, particularly in the optimization of flow cell production. As a result, we have continued improving margins. Overall, LSRT gross margin has increased 280 basis points year-on-year. Almost all of the growth in gross margin came from flow cell improvements. Improvements to manufacturing efficiency continue to drive our reduction in costs per flow cell.

At the same time, increased output and improved accuracy is reducing the effective cost of Nanopore sequencing to customers without impacting our margin. Over 85% of our gross profit is generated by consumable sales. Devices and services generate much smaller margins. The increased cost of compute and the additional costs of generic components has reduced gross margin on devices and services. And so, despite a 36% increase in device and services revenue, gross profit has remained largely unchanged in the year.

As Gordon has mentioned, we are investing in transforming the PromethION platform, which has impacted our margins year on year. But we believe this will drive future growth in revenues and profitability through consumable sales. We have increased investment in innovation and expanded our commercial infrastructure to drive future growth. Adjusted R&D expenses of £49 million reflect the increased headcount and related material costs of increased innovation.

This currently represents 57% of revenues and the proportion is expected to decline over the next few years. Adjusted SG&A cost was £61.9 million compared to £46.5 million in the first half of 2022. This increase is principally due to a 47% increase in the commercial team. As Gordon has explained, we have continued to strengthen our core commercial teams around the world in line with the opportunities that we see. Adjusted SG&A is currently 72% of revenue and is expected to decline as the proportion of revenue going forward. You can find a reconciliation of adjusted R&D and SG&A expenses in the appendix.

Adjusted EBITDA was a loss of £39.3 million compared to £34.6 million in the first half of 2022. This includes adjustments for the settlement of the DHSC contract last year and share-based payments related costs as you can see on the slide. Now, turning to our balance sheet, we ended the first half with £484.6 million in cash, cash equivalents and liquid investments compared with £558 million at the end of 2022. Cash burn was higher than normal due to two short term factors. Firstly, inventory levels were up £15.2 million in the first half, which reflects the shortening of lead times on core components leading to early deliveries of these items. And secondly, capital expenditure increased particularly on the A-Series PromethION compute boxes held at customer sites. Both of these are expected to return to normal levels in 2024.

Moving now to 2023 guidance, as you will have seen in the press release, we have narrowed our guidance range. We expect full-year 2023 LSRT revenue growth of between 18% and 25% on a constant currency basis. This is within the range we previously guided to and in line with consensus. This range includes an anticipated headwind of approximately £18 million from Covid sequencing slightly lower than previously expected. Based on the first half, we now expect EGP revenue for the financial year ‘23 to be lower than last year. As a reminder, in 2022, EGP revenue was £13.2 million. Underlying LSRT revenue growth is expected to be more than 40% on a constant currency basis for the financial year ’23.

We now expect the gross margin to be more than 57% for the full-year 2023, which reflects the one-off impact of upgrading the computer towers on our PromethION devices. As Gordon mentioned, this is an important investment to drive higher utilization and customer acquisition over the longer term. Our progress in gross margins continues and we continue to target gross margin of more than 65% for the full-year 2026 consistent with our IPO guidance, all medium-term guidance is unchanged.

Before I turn back to Gordon, I would like to quickly summarize the four key takeaways. First, we delivered strong underlying growth across our diversified customer base, driven by consumable sales. Second, we delivered a very strong gross margin progress despite supply chain challenges and significant inflationary pressures. The operational improvements we have made will continue to drive margin expansion towards our 65% medium-term target.

Third, we have a strong balance sheet with ₤485 million of cash, cash equivalents, and liquid investments, despite significant increases in inventory levels. And finally, we are very excited by the progress we are making in new market applications. This will be a key driver of long-term growth. Over to you, Gor.

[Gordon Sanghera, Chief Executive Officer]

Thanks, Tim. Over the last three years, we have delivered a compound annual growth rate of 41%. We are expanding our commercial and tech support teams and upgrading our customer technology portal to meet the continued growth we anticipate into 2024 and beyond. Our continuous improvements in manufacturing and automation will deliver short-term and medium-term improvements in both product performance and margin. Our long-term innovation pipeline will drive growth and longer-term opportunities will come through partnerships.

Before I wrap up here, I would like to just highlight a few of our national genomics programs that we're working on. I've talked previously about the U.S. NIH card study looking at structural variation in Alzheimer's patients. Our initial data shows accurate structural variations at lower cost and higher throughput compared to traditional sequencing methods. In the UK, we have multiple programs integrating Nanopore sequencing into the NIHs. In Germany, we have set up a collaboration to look at advanced rare disease research using long reads. There's growing momentum in using Nanopore sequencing in national genomic programs and translation towards clinical care.

These research and translational programs and our partnerships in these programs catalyze longer-term applied market opportunities. And on the applied market front, we will be talking in more detail at our Capital Market Day on October the 19th about the market opportunities. I have spoken previously about our four-basis collaboration on distributed breast cancer screening, and about Asuragen and our collaboration on carrier screening, our collaboration with bioMerieux on infectious disease. We will also be talking more about pharma, biotech, and emerging customer segment, which we are uniquely positioned to take advantage of.

With that, I will now hand over to the operators for questions. Thank you very much.

[Operator]

[Operator Instructions] Our first question comes from Odysseas Manesiotis from Berenberg. Please go ahead.

[Odysseas Manesiotis, Berenberg Capital Markets]

Hi, good morning. Thanks for taking my question. On U.S. sales firstly, impressive underlying growth there. Could you give us a sense of how much of your additional underlying sales here came from new customers? And where have you seen the most success with new customer acquisition and market share gains in the region?

[Gordon Sanghera, Chief Executive Officer]

I'll do the customer types first. If that's okay. So, we've seen -- well, we've seen strong growth across all our customers. In terms of real needle-moving customers, Avantor, our distributor is really doing well in the Americas. On the certified service provider sides, there is continued strong growth. We talked full-year results in March about plasmid sequencing. We can completely close out plasmids and give whole complete plasmid sequences. And that continues to grow with two or three major certified service providers doing plasmid sequencing. And we are continually strong with human sequencing. And again, that's derived from the Q20+ chemistry, the upgrade to the 4.5x base calling, and the overall promethium fleet upgrade, which is driving those. Do you want to do…?

[Tim Cowper, Chief Financial Officer]

Yeah, so, just a reminder, if you look at our S2 customer group, we've added a significant number of customers now got 1,100 S2 customers. This is globally who are spending on average over $60,000 per annum. That growth is, we are acquiring a lot of customers in that range. But also, within North America, there is an emphasis on human genetics and cancer in particular. And we've acquired a number, they may not be completely new customers, but they're new to the larger customers to the S3 customer base.

[Odysseas Manesiotis, Berenberg Capital Markets]

And one on the H1 to H2 dynamics around the cost lines below gross profit. Looking at R&D and SG&A percentage of sales perspective, does it make sense to expect both R&D and SG&A had touched higher in H2, given the increase in headcount throughout the quarter?

[Gordon Sanghera, Chief Executive Officer]

To some extent, there will be an annualizing of the recent headcounts that we have added. So, yes, there will be a controlled increase in both adjusted SG&A and adjusted R&D. I believe these are still in line with what is expected for the full year. So, we are still expecting that to remain in line.

Over time, both we have invested, as we said, we would at the IPO in doubling our commercial teams in increasing our innovation and that, and getting ourselves set up to be a PLC. This will continue in a targeted and controlled way into the future, but as a percentage of sales, a percentage of adjusted SG&A and the percentage of R&D will decrease as a proportion of revenues.

[Odysseas Manesiotis, Berenberg Capital Markets]

Helpful. Thank you.

[Operator]

And we move on to -- with our next question to Charles Weston off RBC. Please go ahead.

[Charles Weston, RBC Capital Markets]

My first is on the competitive landscape, appreciating you have a differentiated proposition with the -- and the other launches by competitors. Has this changed the dynamic in terms of labs budget allocations and minds share with those labs? And perhaps if you can split the answer between S2 and S3 customers.

[Gordon Sanghera, Chief Executive Officer]

So, what's the question, Charles? You're asking about Mindshare.

[Charles Weston, RBC Capital Markets]

Yeah. It's the competitive landscape. There's a lot of noise by all these other competitors, big product launches. And labs have certain budgets and there, and obviously the all competitors are going to be making a big push, so I appreciate your technology differentiated, but they're just not some budgetary constraints in the near term.

[Gordon Sanghera, Chief Executive Officer]

Understood. So, I mean, firstly, the OpEx model is actually significant. And I think there's no better stat than we grew 20% last year while the competition was static or zero, zero or negative growth. The S3 customer base, those large centralized core facilities, and high throughput service providers I think that's where there is a limited amount of cash primarily dominated by Illumina. We still are seeing good growth, particularly with core service providers with plasmid sequencing.

So, there are application-specific drivers that have enabled us to grow significantly in the S3 category. With regard to, do people purchase platforms A, B, or C? These large central core facilities and service providers tend to have all platforms. So, I don't think we're seeing it as holding us back. If anything, the Q20+ chemistry, the recent upgrades on the compute, and the much faster base calling and methylation are driving customers to purchase in that S3 group. And remember, we've got S2 and S1, which are open space for us, where the other players do not operate.

[Tim Cowper, Chief Financial Officer]

I just, I would like to add to that, just to remind you of our diversified customer base. So, we have a, we have a small number of large customers. We highlight the EGP as one of them. But actually, we have a huge range of customers and we have a good mix between academic customers, commercial customers, pharma, biotech customers, government, and the core service providers. So, we are in many, many different places. So that is why we believe we are the only sequencing platform that has consistently delivered strong revenue growth and margin growth over the last few years.

[Charles Weston, RBC Capital Markets]

Thank you. My second question is on the applied market partnerships. Appreciate, you're going to be talking about this in more detail, the capital market day, but just thinking about the full basis and the Sure and VM area, what's the application that's nearest to market?

[Gordon Sanghera, Chief Executive Officer]

I think, they're all, it's not a foot race here. I think it will be driven by two gating items definitely. We are developing our regulated platform and that's on target for the next six to nine months. On the other side of that it will be a confluence of multiple factors. For example, Asuragen are still developing assays. On the other hand, four bases. BRCA 1, BRCA 2 breast cancer screening for distributed clinical use is already developed, and then bioMerieux sits somewhere in the middle of that, so there'll be a range of technical hurdles and then regulatory hurdles to go over.

And they're all roughly in the same place for now as the next couple of years unfold. One or two of them will go more quickly, and one or two of them will go to RUO. Others may go directly to full CE-IVD, which puts them two or three years behind the others. So, it'll become clear, right now, they're all valid runners and riders and about the same sort of place at the start of the race.

[Charles Weston, RBC Capital Markets]

Thanks. Just a clarification, please. On the point of the regulated platform, is that platform necessary before commercial rollout of these programs, or can they start rolling out earlier on a RUO basis?

[Gordon Sanghera, Chief Executive Officer]

RUO, LSRT customers can use current platforms that with the clinical customers, the strategic partners, they will be moving to queue line. And that's important for the long-term because ultimately some or all will move from LDT RUO to CEIVD fully regulated. So, we want to have that foundation in place.

[Operator]

And up next, we have Paul Cuddon from Numis. Please go ahead.

[Paul Cuddon, Numis Securities]

I've got two questions, please. I mean, firstly, you've stripped out COVID-19 sequencing from sort of underlying kind of sales growth, but I'm just wondering to what extent you've been able to retain those customers doing kind of alternative applications and to what extent they may be able to ramp up COVID-19 sequencing game with the new variant getting everybody excited.

[Gordon Sanghera, Chief Executive Officer]

So, I think first of all, the S2 growth which is where the bulk of COVID sequencing was up 61%. So, we're very pleased with that. There isn't a direct map that people stop doing COVID and start doing flu. Some do, but it varies. When we look at the type of kits they buy, and the public health laboratories that we interact with more heavily than others, they may be looking at TB or HIV or other public health challenges. I think the good news for us is even with that COVID headwind, we have still managed to make good progress in the S2 category.

We don't think there is a large surge, even though there is a new variant of concern. And I'm sure you've noticed I have -- my cleaners didn't turn out yesterday, because they've all got COVID. So, there are more people with COVID, but it seems to be a variant of not big concern because it doesn't seem to be super spreading and it doesn't seem to be a super killer. So, I think that is reflected in the demand for sequencing as well. Everybody said it would always end up being a bit like flu or a common cold, and it seems to be the market dynamics seem to be heading in that direction.

[Paul Cuddon, Numis Securities]

Excellent. Thank you. And my second question is just around sort of the S1 customer numbers. It does seem to have changed quite a bit from the end of last year. And I'm just wondering whether it's the change of how you are recording those customers or has there actually been a slowdown in kind of S1 customer additions in H1 ‘23 and perhaps what does that mean for the kind of likely funding out outlook for the rest of 2023?

[Gordon Sanghera, Chief Executive Officer]

Yeah. Mainly it's a reclassification of how we're recording the numbers. So, six months ago, we recorded the event or customers within the S1 group because that is the area that they're targeting. We've now split those out into indirect sales. So that's why the customer number has apparently gone down, but it hasn't gone down on a year-on-year basis.

So, we continue to be an area of strong underlying growth. And we expect it to continue. It is uniquely open to our platforms and we expect that to continue. Avantor have had a very strong performance between last year and this year, and they're really picking up now and we see that as a key part of our future growth.

[Paul Cuddon, Numis Securities]

Okay. And just to clarify there, so, I mean, if you were adding 800 customers per half in prior years and you've added 400 in the S1 category, we would probably think that Avantor have added a similar number, but it's now in the distributor category.

[Tim Cowper, Chief Financial Officer]

Avantor growth has been -- was the main contributor to the indirect revenue growth that you see within in indirect, which was over 60%. And that comes about from them adding customers. And it would be, it would be reasonable to assume that those customers are spending similar amounts to $5,500 each if you wanted to work back a number. But I can't. That's how I would think about it.

[Operator]

And now moving on to a question from Veronika Dubajova from Citi. Please go ahead.

[Veronika Dubajova, Citigroup]

Hi, guys, and thank you for taking my questions. I have three, please. One, just curious, Gordon and Tim, what you're seeing in China. Obviously, given some of the more cautious commentary from Illumina. I think, Tim, you made some statements in your opening remarks, but maybe you can elaborate a little bit on what you're seeing, especially in the second half of the year, and is the scenario of concern for you as you think, through the back half? And is that reflected to guide in the guidance?

Then my second question, Gordon would just love to hear on the P2 solo traction, it sounds like it's going pretty well, but maybe anything that you know, is surprising either to the upside or the downside there in terms of customer types and the degree of interest that you're seeing.

And then my final question is around the EBITDA loss expected for the full year. Tim, earlier, I think on the full-year call you had talked about a broadly comparable EBITDA loss year on year. Obviously given the change in the gross margin guidance, I wonder if you can help us about how much of that drop through to EBITDA versus what you can compensate by better OpEx control and leverage and higher sales. Thanks guys.

[Tim Cowper, Chief Financial Officer]

I'll do the P2 one first, shall I? Okay.

[Gordon Sanghera, Chief Executive Officer]

Yeah, please.

[Tim Cowper, Chief Financial Officer]

So, I said several hundred, it is -- it's trending up towards 400 or 500, and of that 20% are new customers. And also, we are seeing strong interest across the S1, S2, and S3 customer base. So, it is really interesting to see how it develops and where, I mean, we expect it to sort of be in the S2 category. But it was interesting when we did the pre-marketing for P2, there was a lot of interest from S1 customers. So, it is hard to predict where it will land. But if you look at the computer industry, give people a supercomputer and they find lots of interesting things to do with it, and this is a low-cost supercomputer, you can do phenomenally challenging genomic experiments with two PromethION flow cells. So, it'll be interesting to see how it evolves. 20% new customers also very interesting stuff as well.

[Gordon Sanghera, Chief Executive Officer]

Okay. Looking at China, China's revenues half year and a half year were pretty much unchanged. So, there was no change overall, but, there was a lot of Covid sequencing in the first, in the first half of 2022, and a much smaller amount for reasons we've already discussed in the first half of ‘22. So, we see a sort of, we've seen a growth rate in China of, you know, approaching 20%. But we remain pretty cautious about China in that the environment is undoubtedly a challenging one and we're not, we're not placing too much reliance on that market, but we can continue to look at it. And sorry, can you just remind me of your other question, Veronika?

[Veronika Dubajova, Citigroup]

Just on, the expected EBITDA loss for the year, what you had said at full year versus where we are tracking to now, given the revenue and also the lower gross margin.

[Gordon Sanghera, Chief Executive Officer]

Yeah, we have made a, so just to talk this through again, we've made a strategic decision to up upgrade our compute on PromethION. We strongly believe this will drive consumable revenues and consumable revenues are generating 85% of our gross profit at the moment. So, there will be a -- there will be a one-off hit from that. We are indicating up to 300 basis points from where we were expecting. So that hit I think is reasonable to add to the EBITDA compared to what your models showed before.

[Veronika Dubajova, Citigroup]

That's helpful. Thanks guys.

[Operator]

Thank you. And we're now taking a question from James Gordon of JP Morgan. Please go ahead.

[James Gordon, JP Morgan]

Hello, James Gordon, JP Morgan. Thanks for taking the questions. A couple, please. One on top-line guidelines, which has two parts. So, you narrowed the range today and slightly lower at the midpoint, but the range is still quite wide, seven percentage points wide, with two-thirds of the year already in the back. So, what is the big remaining flex for 2023? Where is the main uncertainty? Could it be a bit like last year where there's a few big orders that could slip from one year to the next? Or is competition the key uncertainty?

And the other part of the question, was just if I think if we take out COVID and EGP, the midpoint of the guidance is about 50% growth. Is that somewhat exceptional, cause it's benefiting from orders that could have made it into ‘22 but actually spilled into ‘23 and that's why you would then expect to return into the low thirties or into the thirties growth next year? Or is this 50% a bit of a step up because actually, your product offering has strengthened, your promotional intensity's gone up, particularly in the U.S. and we could really extrapolate this 50% growth forward?

So that's the first question, please. The second one was just a clarification on gross margin. So how many bits or percentage points is the gross margin headwind this year? That's one-off. So, from the combination of COVID right down. and the compute upgrades, what would be your underlying growth margin guidance for this year? And that we should then build on going forward, and how quickly should we build on that going forward? How quickly do you get to the over 65%? Are you also as well as those one-off factors, seeing some inflationary headwinds and things like higher chip prices are other factors? So, it's a sort of slow and steady build, or is it actually that the underlying gross margin is still at least 60% this year, and you think you're going to quite quickly go up from that next year?

[Gordon Sanghera, Chief Executive Officer]

Okay. So just on -- let me deal with margins first. So, on the margins, we have taken a one-off hit the end of COVID meant we took a write-off on COVID sequencing. The decision to upgrade the compute is going to hit us by up to 200 basis points. And that's why we're indicating our margin will be greater than 50% -- 57% that is still ahead of last year's margins. And it's still showing the consistent margin growth that we have shown over the last few years since IPO.

In terms of where we will be, we've said greater than 57%. So, I can't say where we would've been, because we haven't completed the year yet, but we continue to add -- for instance, in this period we've added 280 basis points since the same period last year. That is what we've consistently done and that's what we expect to consistently do going forward. So that's 800 basis points to add between now and 2026 approximately up to 800 basis. And we expect to -- we expect to achieve that. It will not be linear. These things do not come out in a linear fashion. I'd like you to focus on the 65%, greater than 65% that we will get to, and we will get to that as soon as we can.

In terms of -- sorry I just need to you to remind me exactly what your first question was on revenues.

[James Gordon, JP Morgan]

Sure. It was two parts. It was -- first it was about the ‘23 guidance. So firstly, it was about that we're two-thirds through the year, but it's still quite a wide range. And just, so what are the key uncertainties? Is it like big order timing or competition or is it other -- what's the big flex? And then the other tip was extrapolating the 50% or not.

[Gordon Sanghera, Chief Executive Officer]

Okay. So, there are a number of factors there. We've highlighted the EGP as something we can -- we are assuming we'll come in lower than last year. Last year was 13.2 million. So, we've highlighted that, that the performance in the first half was 4.9. So that is a difficult number to predict. And when samples come in and the customer requires more flow cells, we will deliver more flow cells there, and they're capable of -- with their capacity of huge ramp-ups in how many flow cells they are using. So that is an unpredictable number.

I think, when we looked at last year, it was a disappointing December. There is usually in the other years that I have been at this company, a much bigger push in December and that can add or subtract from the December numbers. And we've seen some very big movements between December and January that do make an effect on annual results that are really, are exactly the same thing. Whether we deliver on December 14th or January, 14th is the same underlying business growth that we are looking at. So those the exact cutoff can sometimes be a surprise.

[James Gordon, JP Morgan]

And the other part of that was just whether 50% is actually like a new normal for your growth, particularly is the progress you've made with your devices and also the strength and promotional intensity, whether we need to be a bit cautious extrapolating that.

[Tim Cowper, Chief Financial Officer]

Yeah, we've achieved 46% underlying growth in the first half. I think moving forward in at that sort of rate is our intention has always been to do greater than 30%. But that doesn't mean we're aiming for 31%. That means we're aiming for the highest level of growth that we can achieve. And the improvements that we've made in our platform over the last 12 months are really driving that growth. So, we will continue to work on increasing that. Medium-term guidance is greater than 30%. It remains at greater than 30%, but we will be aiming for the highest level of growth that we can achieve.

[James Gordon, JP Morgan]

Thank you.

[Operator]

I'm now moving on to Blanka Porkolab from Barclays with our next question. Please go ahead.

[Blanka Porkolab, Barclays]

Good afternoon. Thank you for taking my questions. I have two, please. I guess, one of them is a clarification just around one of the previous questions. So, could you walk us through the rationale for the narrowing of the guidance range on the top line, given the COVID headwind is now expected to be lower?

My other question is also clarification around the narrowing of the gross margin guidance. So, am I correct in thinking that a hundred bits of that relates to the COVID write-off and 200 bits on the decision to upgrade compute on pre? Thank you.

[Gordon Sanghera, Chief Executive Officer]

Yeah. So, the biggest factor in -- we have narrowed the guidance with within our range and within the consensus. The biggest factor in there is the EGP, which we had previously guided to being £15 million to £20 million. That is the largest impact, but there are -- within the range, there are not really any other significant factors in there -- that is just how the numbers look like they're going to come out and that is a wide range, but we can see us coming out anywhere within that range.

Sorry. And then in terms of margins. To just to clarify, yes, it will be getting on towards 1% on the COVID sequencing kits. And it will be approaching 2% on or 200 basis points on the write-off of the towers as in relation to the upgrade of compute.

[Operator]

And up next we have David Westenberg of Piper Sandler. Please go ahead.

[David Westenberg, Piper Sandler]

So, can you talk about the relationship with bioMerieux, how should we think about the contribution to revenue growth both near and longer term, and how should we think about infectious disease, clinical sequencing generally? Thank you.

[Gordon Sanghera, Chief Executive Officer]

So bioMerieux, the relationship, they have been a bioscience research tools customer for the last couple of years and they've been looking at using GridION in their workflows in a variety of infectious disease clinical applications. And we've picked a couple of project areas to collaborate with them on. So, we've moved from, for them to prove out the real time streaming and ability to look at drug resistance and infectious disease to wanting to now insert the GridION in some of their existing clinical workflows.

So, the partnership is a collaboration to develop that integrated end-to-end workflow with bioMerieux. The infectious disease area generally we also have an ongoing proof of concept clinical trial going on with Guy’s and St. Thomas' who are looking at antimicrobial resistance in ICU patients. So, you're returning results in three to four hours rather than three to four days.

And of the 350 patients we've done so far, half of them were on the wrong antibiotic for respiratory metagenomic scanning. So, we're very excited about that. And the bioMerieux group are also interested in reducing the time to result and getting a broader picture of the antimicrobial resistance and the bacterial pathogens, which you can get with NGS versus traditional PCR. So, it's a very hot area for us and we're very excited about partnering with, what is one of the global leaders in infectious disease monitoring and clinical settings.

[David Westenberg, Piper Sandler]

Got it. Thank you. And now that we're further into the launch, are the P2 customers jumping into S2 or are they starting in S1 like we've seen with the MinION customers?

[Gordon Sanghera, Chief Executive Officer]

It's a bit of everything. We have some height utilization and some, occasional and, sort of some with a good beat rate. So, we have sprinters, marathon and middle-distance runners all in the same PTC and it, and it's not surprising to us because I think there's just some interesting things you can do with a hundred gig flow style occasionally, often, and very often at a low-cost entry point.

A lot of these customers are already customers in, and, but we have seen about 20% of new customers come in as far as we can see. They're new customers that have taken the P2. So, they will probably be working their way towards the S2 range over the year. But they haven't had the P2s, they've only had the P2s for a, they haven't had them for a whole year yet, but the other customers would be in the category they were already in. So, it'll be across the whole range.

[David Westenberg, Piper Sandler]

Got it. Thank you.

[Operator]

Thank you. I'm going to now take a question from Shubhangi Gupta of HSBC, please go ahead.

[Shubhangi Gupta, HSBC]

Hi, thanks for taking my question. I have two, please. So, you mentioned 75% of your revenues are from Continuable and flow cells. So, could you please indicate how much time after a device is bought these revenues start coming in? And second, following up on the question on China. So, China is pretty much unchanged. So, could you get some color on what are your customer base in China? Is it predominantly diagnostic labs or you have some pharma biotech customers as well, and also your market share in China? Thank you.

[Gordon Sanghera, Chief Executive Officer]

Okay. So, I mean, Tim's talked about, and he can elaborate further if needed, the COVID headwind in China, underlying there was still growth in China…

[Tim Cowper, Chief Financial Officer]

20%.

[Gordon Sanghera, Chief Executive Officer]

20%, and China is interesting in that there is the distributor model works really well. So, we have a series of distributors, and some of them sell directly into life science research tools, but China also has a large concentration of service providers as well. So, they are doing a whole host of service provision. And then the third category, these distributors were interested in the diagnostic markets going from RUO to LDT and ultimately CEIVD. And so, all of those categories exist in China. And even with that COVID headwind at the underlying growth of 20%.

Now we are cautious -- cautiously optimistic because there is traction in China, at beyond COVID, the last couple of years, everything's been shrouded by sort of COVID sequencing, but as that fog players we're clearly seeing growth in service providers and distributors in pushing towards diagnostics. So -- but at the same time, there is an economic slowdown. There are the macro-economic geopolitical considerations. So, we are cautiously optimistic about China.

[Tim Cowper, Chief Financial Officer]

Your other question, which is interesting is, how quickly do people start using consumables after they've received the device? So, we've obviously got a large range of devices, but if you think about the MinION customer, we consider the MinION to almost be a consumable. It's not counted in consumables, but basically it will arrive, you set it up, and you can be sequencing the same day. And that's the same with most of our products. It's very, very quick to get there with the -- we take a bit more time over the PromethION installations, but basically, you're ready to go. Once you've got the device installed, they sit on a bench top.

[Gordon Sanghera, Chief Executive Officer]

The determining step with the S2, S3 customers who are doing large programs tends to be the setting up of the program, the accumulation of samples, the limbs, the integration of the platform into already existing workflows. But in principle, you can plug and play same day.

[Operator]

Thank you. And our last question for today comes from Miles Dixon of Peel Hunt. Please go ahead.

[Miles Dixon, Peel Hunt]

If I could ask more generally on the evolution of the platform and technology. I mean, the speed at which you are improving both the quality of those. I was wondering if particularly with reference to S1 customers, is there a risk that you are potentially moving that technology forward too fast, and might risk making some of the S1 customers and their products legacy before you've recouped costs? Thank you.

[Gordon Sanghera, Chief Executive Officer]

So, people do sometimes think we move too quickly. We launch too often, but there is a segment of the market that want the latest and the greatest, and we will continue to innovate and launch very regularly. Remember, an S1 customer, I mean iron user will get that upgrade in the flow cell, so they don't -- people who are using a min iron from 2015 because it's just got a fan and the data processing pathway through what is called an FPGA workflow will be able to get today's Q20+ chemistry from their kit and software and close sale upgrades. With regard to certain customers that we now have who are starting to develop screening tests or particular assays, they need stability and our move towards Q Line will give them a platform that still changes, but not very often.

It changes less often and therefore, and in a controlled manner I should say. So those customers, we are now starting to, and the whole premise behind Q line is not just a step for diagnostics, it's for those customers who need stability and they will get less regular updates. So, we are seeing the market, the customer base broadening and therefore we will do that.

But I want to add, this innovation piece tends to make the platform more accurate and cheaper without any downside because it's an invisible upgrade. That's why I really wanted to highlight in the presentation today that some of the sequencing is in the consumable and that really allows us to do these upgrades seamlessly. You don't have to buy a new box on a CapEx cycle every three or four years. And that's why we are really excited about the PromethION upgrades that we're pushing through and we think that will be significant in driving growth going forward.

[Unidentified Analyst]

And could I just ask one follow-on then, particularly in relation to the pro -- compute upgrade given that these are seamless from the customer perspective, where do you sit on the kind of development of a platform more generally? Particularly, and might we expect more one-offs, such as the pro capture in the future to get you to where you want to be for the broader platform tech?

[Gordon Sanghera, Chief Executive Officer]

Sure. I think, we've in the main, we've baked in upgrades like the motherboard and other things. This NVIDIA GPU heat in the market and the 20% increase in prices was only announced in July I think. And also, minimum orders have been jacked up. All these things we believe are a one-off, if this continues and there is -- I mean, NVIDIA are responding. They're a big company and they are manufacturing at a fast speed. We are one of their preferred vendors, but we did have to buy a minimum amount in order to secure the stock. So, we very much believe it's a one-off. If it continues and the compute prices going to a different point, then we will consider how we absorb that to ensure that we are on track to hit EBITDA profitability in 2026.

[Operator]

There are no further questions in the queue, so I'd like to hand the call back over to you Gordon, for any additional or closing remarks.

[Gordon Sanghera, Chief Executive Officer]

I’d just like to say, thank you for your time today, and we are in London for the rest of the week and then New York so I’m looking forward to meeting some of you face to face, and thanks very much, everybody.