Nanosonics Limited (NAN) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Nanosonics Limited 2024 Half Year Results Call. [Operator Instructions] I would now like to hand the conference over to Mr. Michael Kavanagh, Managing Director and CEO. Please go ahead.

Thank you very much, and a very good morning, everybody, and thank you all for joining the call this morning. I am joined here today with Jason Burriss, our CFO, who, as you know, joined the organization a number of months ago in October. And you'll hear from Jason shortly as we go through the financial outcomes for the half year. As you will have seen, the results released this morning confirm the numbers in the trading update we provided on the 23rd of January. And it's clear from the results that the market challenges that we faced in the first half resulted in lower-than-expected capital sales, in particular, upgrades, which consequently impacted our revenue. And these challenges, as explained before, were primarily due to the hospital capital budget constraints, which resulted in an increase in the time frame for our units in the sales pipeline, which is growing to convert into sales. And this impact was particularly felt in December, which is usually the largest sales month of the half. Several significant upgrade opportunities in North America, which were forecast to close in December, consequently have now moved into the second half forecast. But pleasingly, the purchase orders for a number of those that did move, including a large single order for over 170 upgrade units have now been received, and the revenue from which we'll recognize that over the next few months as we work with the customers on the installation schedule. But importantly, with our pipeline going into the second half, we do expect growth both in units and revenue in the second half over the first half. Now as per usual, we have provided a lot of granular detail, especially in the investor presentation, all of which is posted online. There are, however, a couple of broader messages that I believe are important. And the first and most important, I believe, is that we still believe that the growth opportunity for trophon remains very significant. The requirement for high-level disinfection of ultrasound transducers has not changed. That's important to understand. This is not a reshaping of the infection prevention requirements in hospitals. The requirement for the high-level disinfection of semi-critical devices, including ultrasound transducers, has not changed. And indeed, for ultrasound, we believe these requirements will only strengthen over time. And as such, the opportunity for growth remains with our trophon business in all regions, and indeed, our sales pipeline continues to grow signifying the underlying need and demand. The second message, I guess, is we recognize and understand the requirement to adapt our sales models as the market challenges emerge such as the macroeconomic impacts on hospital budgets. And these models should be designed to provide our customers with greater, I guess, financial flexibility to access the best available technology, which, in turn, enables them to deliver the best standard of care. Now fortunately, our consumables and service annuity revenue business model, it provides us with the potential to flexibly adapt the sales offerings of our trophon capital units with minimum impact, if any, on the lifetime value of a unit placed. And as you know, also, we have a strong balance sheet and with no debt, that enables us to do this as well as continue to invest in our long-term growth. And finally, we remain confident in our opportunity for further growth through product expansion. So it's not just trophon. We're excited by the opportunity for CORIS. We believe this technology can set new standards of care and address one of the most significant clinical issues in infection prevention today with flexible endoscopes. And we're getting very close to regulatory submission. So we remain very confident with that opportunity as well. So just as we've demonstrated in the past, we certainly believe that Nanosonics continues to be a growth company with strong growth drivers for the future, and we're committed to executing on the long-term strategic growth agenda that we have established whilst, of course, trying to navigate as best as possible the market challenges as we face them. So moving on to some of the details in the first half results. First of all, the installed base. Well, the global installed base, it increased by 1,100 units to 33,550 units in operations today. So that's an increase of 3% in the last 6 months or 8% in the last 12 months. In North America, the total installed base grew by 970 units or just 3%. So over there now, there's over 29,000 units. So 29,360 units, I believe. And that represents about 49% of the estimated total addressable market, that 60,000 units that we've quoted before. This growth is obviously below our normal run rates and certainly has been impacted by the delays in capital budget availability. There does remain, however, a significant opportunity to continue to grow the installed base in North America. And I'll spend a minute or 2 on that because if you look at the United States, there are approximately 5,700 hospitals that use ultrasound. And trophon is operating today in at least 1 department in about 70% of these hospitals. Now being in at least 1 department is a very important point because ultrasound is used in many departments, including radiology, obstetrics and gynecology, urology, emergency care operating theaters, intensive care, cardiology, et cetera, covering over 150 different types of ultrasound procedures. So when you take that into consideration where we believe the opportunity for ongoing growth in North America comes from, it includes, for existing hospitals, the ongoing adoption of trophon into additional departments that use ultrasound, as these hospitals standardize their high-level disinfection practice for ultrasound throughout their whole facility. And indeed, a significant percentage of our new installed base sales today are into hospitals that have actually adopted trophon into at least one department. Then, of course, there's the hospitals that don't have trophon yet. So it's expansion into those hospitals that have not yet adopted. And that represents over 1,000 hospitals. And then there's another important segment of the market, and that is the private physician office markets, especially in radiology and obstetric gynecology. And we have partnered now with a number of channel partners who are dedicated to this segment. And we believe that, that will be -- can be a growing aspect of our installed base moving forward as well. So we're very confident in the direct infrastructure that we have established not just across sales and marketing and clinical and service but also across our strategic account management in North America, where we now have enterprise agreements established with the majority of the IDNs as well as the ability now to transact with government hospitals as well. And as I mentioned, we have also partnered with a number of channel partners who specialize in the private physician market, who coincidentally what the channel partners that GE has in the past as well. So all of that has been established. In the Europe, Middle East region, EMEA, the total installed base grew 4% in the last 6 months. So that's up to now 2,090 units and 10% in the last 12 months. 80 units were installed in the first half. And as Jason will cover, total revenue in EMEA grew 19% versus prior corresponding period with consumables and service actually up 30%. So that's what Jason will cover that off shortly. And just as in North America, the markets environment in Europe, it does continue to be challenging both on cost and staffing pressures in hospitals. But we did see our sales pipeline grow strongly in the first half and expect good growth now in new IB in H2 over H1, which is included in our guidance. Trophon in the U.K. was also established on the NHS framework in the half, and that should facilitate the easier procurement processes with customers moving forward. And over in Europe, the company is also now direct in Ireland. Also where trophon has become the standard of care, and it does continue to grow the Irish market for us. And in Germany, there actually new guidelines from the commission for a hospital hygiene and infection prevention in Germany, also known as KRINKO at the Robert Koch Institute. And there, we believe, are due for publication in mid-2024. And expectations is that the recommendations from these guidelines are truly for not just automated but validated disinfection processes for ultrasound probes, of which trophon obviously delivers an automated solution, but we have all our validation protocols in place as well. So we fit there and the build there. And so these guidelines should certainly support growth in Germany moving forward. In Asia Pacific, the total installed base grew 2% in the half or 6% in the last 12 months. Australia and New Zealand as you know, represent the majority of the current installed base where trophon is the standard of care and while the market is highly penetrated, there still is opportunity for ongoing growth in ANZ and we expect growth in units in the second half over the first again. In Japan, the -- our market development activities, they continue to progress, and there are now just over 100 units actually installed in the Japan market. And in this last half, we also completed a new multi-center study in Japan, examining the degree of contamination of ultrasound probes in emergency departments and across a number of major teaching hospitals. And over 75% of the probes used in this setting were found to be contaminated. So that study, together with the study that we had conducted previously in OB/GYN, which demonstrated over 90% of the probes are contaminated, that further supports the company's work towards the development of national-based guidelines, which we continue to work towards. In China, the regulatory submission has also progressed. And the expectation is that we will get approvals and full registration, not just for the capital but consumables within the next 9 months, there are backlogs on approvals and that we are experiencing up in China. But within the next 9 months, we expect that and commercial realization plans to follow thereafter. And moving on to upgrades. I think we all know that there is a significant upgrade opportunity exists. And particularly in North America, where there are approximately 9,000 units of the original trophon model, the trophon EPR, today over the age of 7 years in use. So when thinking of the upgrade opportunity, it's important to understand that the opportunity is not just related to increased capital revenue, but actually incremental annuity revenue in the form of service contracts. And why this is the case is the majority of these aged units were originally sold by GE Healthcare when they were the exclusive and then nonexclusive distributor partner for trophon. And so when they actually sold those original units, they also sold the service contracts. But of course, now that we're direct in managing the total installed base, we now sell the upgrades and then also the associated service contracts. So -- and currently, about 65% of upgrade units out of warranty take out of service contract. So it's not an insignificant opportunity moving forward. And over time, we certainly see service becoming a significant component of our revenue. Over the last 4 halves, the upgrades you saw in the past have grown strongly, and our sales pipeline remains very strong. It was, however, the capital components that was most impacted due to hospital budget constraints where customers in our upgrade sales pipeline extended the use all their current machine. And as I mentioned earlier, this particularly impacted in December, which is normally the biggest sales month in the half. But pleasingly, a number of those have already started to come in. So consequently, our upgrade volumes were actually down 23% on the prior corresponding period. So there was 620 units sold in the first half. And as mentioned, impact felt most in North America, where there was 480 upgrades were installed in the first half, down from 600 in the prior corresponding period. As you would know that the size of the upgrade opportunity in EMEA and Asia Pac, it's not as significant as North America, given the size and age profile of the installed base in those regions. And across both those regions together, there was about 140 upgrade units were sold in the half. So pleasingly, as I did mention a number of those upgrade sales, our forecast in December have come in now and in particular, that large 170-unit order. And as I mentioned, we are now working with the customer on the installation schedule, so the revenue from these will be recognized over the next few months. So I'll hand over to Jason now to just to give a brief overview of some of the key financials, and then I'll come back. So Jason?

Thanks, Michael, and good morning, everybody. Firstly, to revenue. Consistent with the trading update on January, the 23rd, global revenue for the half was $79.6 million, down 2% versus the prior corresponding period. As Michael explained, this reduction was due to lower-than-anticipated capital sales, where capital revenue was down 15% or $4 million, with the biggest impact being in North America, which was $3 million of the $4 million. Consumables and service revenue was up 4% or $2 million in the half. When thinking about consumables across the different regions, there are a number of things that need to be considered. In North America, we are fortunate enough to have access to good ultrasound procedures volumes data, which I'll touch on in a minute. Also since going direct, we have appointed several channel partners that specialize in going to the private physician offices. Now there are 2 dimensions to think about here: one, being pricing, where we do reduce our pricing by around 5% versus our direct pricing. Second, because they are stocking distributors, the timing of the purchases can be a little volatile from month to month. In Europe, Middle East and Africa, we have the MES model. Their higher pricing is in place to offset the cost of capital. And as Michael said earlier on, the results for consumables was very pleasing, which was up 30% in the first half. versus the prior corresponding period. APAC, which has always been a distributor market, can also see variations with stocking orders. This we see for both capital as well as consumables during the first half of '24. But getting back to North America, the main market where our primary volumes are. What we saw in the first half on ultrasound procedure volumes was a lot of volatility. Now we have the first half data in. On average, U.S. procedural volumes were down 4% and versus the prior corresponding period. Encouragingly, however, December data just in indicates a turnaround in volumes, which correlates with our experience in December shipments and volumes for the second half to date. January and February volumes are also up approximately 10% on prior corresponding months. This is positive to consumables for the second half. We're also seeing growth in volumes through channel partners in North America, which is encouraging. While still early days, it does give us a positive indication of the success of these partnerships, accessing the private physician offices. Now switching to revenue by region. Total revenue in North America was $72.3 million, down 2%, with capital revenue down 13% and consumable service revenue up 2%. In Europe, total revenue was $4.3 million, up 19%, with capital revenue down 22% and consumables and service revenue up 30%. As you know, the U.K. is our largest market in the EMEA region, and the majority of the units placed in the U.K. are under our managed equipment service model, where no capital revenue is recognized for placements but this is offset with higher consumables pricing, which you see come through with the consumable service revenue, up 30% versus the prior corresponding period. In Asia Pacific, total revenue for the half was $3.1 million. It was down 18% compared to prior corresponding period, primarily due to a drop in capital revenue, reflecting larger upgrade purchases in prior periods, and the timing of distributed purchases of units at the end of fiscal year '23. Consumables and service revenue was $2.2 million, consistent with the prior corresponding period and up 10% compared to the last half. Our gross profit margin for the half was 79.7%. This is a strong gross profit margin driven by revenue mix and the positive impact of foreign exchange rates. On to operating expenses. Our operating expenses for the half totaled $60.8 million, up 12% on the prior corresponding period and 2% on the prior half. Now one of the focus areas I've had since joining in October was to look at opportunities for productivity enhancements. As a result of this, we will see operating expenses for the year reducing from the 17% to 22% growth outlook to between 9% to 11% growth for the full year. These operating expenses include investments being made in the preparation to the commercialization of CORIS as well as costs associated with the new ERP, which commenced in fiscal year '24. It's worth noting when we break our operating expenses down, 43% goes towards sales growth, both the investments we make to drive growth in more established markets like the U.S., as well as investments we are making in geographical expansion into emerging markets in EMEA and Asia Pacific. 27% of our OpEx goes into R&D. And in the first half, we invested $16.2 million into R&D, which was 19% higher versus the prior corresponding period but only 2% higher than the prior half. The majority of these expenses are associated with CORIS and include many activities not just engineering. They include product introduction to manufacturing and all of their medical affairs, clinical studies and patent costs. The organization will continue to invest in R&D. However, we expect R&D as a percentage of revenue to start coming down. Operating profit before tax was $4.9 million for the half, and total free cash flow for the half was $7.9 million. Total cash at the end of December -- on 31st of December was $118.3 million, and the company doesn't have any debt. Now just speaking a little bit about the trophon-only business. A significant proportion of the company's operating expenses are associated with future earnings opportunities from new product development and expansion, it is useful to look at the profitability of the underlying trophon business which we started to do in our fiscal year '23 full year results. Excluding operating expenses of approximately $13.3 million associated with the development and commercialization preparation of the CORIS technology, the unaudited pro forma profit before tax of the current trophon business in half 1 '24 was approximately $18.2 million. This includes all operating and investment costs associated with developing emerging trophon markets that do not currently contribute significantly to revenue as well as R&D associated with the trophon technology road map. Now looking forward, we expect that revenue will grow faster than OpEx in the trophon-only business in H2 over H1 '24. With that, I'll hand back to you, Michael.

Thanks, Jason. A couple of comments on CORIS and then the outlook. So preparations for the FDA, the de novo regulatory submission, they continue to progress. The company, we're currently conducting the clinical "in use" study here in Australia and also Phase II of the human factor study in the U.S.A. And once the data from these studies are available, we expect to be in a position to lodge the FDA submission. And we continue to target that submission date by the end of this quarter that we're in now. We have also presented the -- once all that's happening is the market is hearing a lot more -- in the clinical scientific market hearing about CORIS and its efficacy. And we've now presented the efficacy data at a number of conferences internationally and more scheduled for this half. The first publication, which will be on biofilm removal is also being submitted shortly in collaboration with 2 of the global leading experts on biofilm in endoscopy. And on top of that, there's a number of further studies outside of that particular one that we believe definitely continue to demonstrate the superiority of the CORIS device compared to current standard practice. And so we expect whilst the de novo the regulatory authorities are reviewing, we expect more and more information, especially in the clinical and scientific community coming out about the technology. And finally, our updated outlook for the year. And as I said at the very beginning, the underlying fundamentals for the ongoing growth of the trophon ultrasound business, it remains strong. The opportunity is there. High-level disinfection of ultrasound probes has not gone away the requirements, and the sales pipeline for both new installed base and upgrade certainly continues to grow. We do obviously have to acknowledge the macroeconomic conditions. They've not materially changed from those experienced in the first half. And we do expect that those challenges with hospital capital budgets are likely to continue throughout the second half. We are, however, as I've mentioned, adapting as best we possibly can to those market conditions with the introduction of customer offerings designed, so as mentioned, to provide customers with greater financial flexibility. And that may manifest itself as seeing a growth in rental versus up-front capital budgets or volume-type discounts or we may look at payment terms for some of our customers, et cetera. But as I mentioned earlier on is that the -- when you think of the lifetime value, of trophon unit, we don't expect any of these programs that we will have on offer from customers to materially change in any way, if any, the value of a trophon unit. So in that context, the targets for FY '24 have been adjusted. For total revenue, we expect total revenue in H2 to grow between 6% and 15% over the first half. So this results in a full year revenue between $164 million to $171 million. Naturally, the company is aiming for the higher side of the targets and above, if possible. However, we do need to be prudent about and cognizant of the hospital budget challenges that exist. But we do expect that the increase in revenue includes growth in both new installed base and upgrade units over H1 as well as ongoing growth in consumables. Our gross profit margin. Our expectations for the gross profit margin for the full year now between 76% and 78%. So obviously, that means that the gross profit in the second half will be lower than what we've had in the first half. And -- but that is primarily driven, as you would expect, by the increased proportion of capital sales that we expect to achieve in the second half over the first half, but also allows for the potential short term impact associated with the introduction of a number of the customer offerings that I outlined like rentals, for example, where you wouldn't have all the capital revenue coming in, you'd have it coming in over the life of the rental. And then operating expenses for the year. As Jason has mentioned, they've been moderated from the previous outlook. So operating expenses are now expected to grow by 9% to 11%, and that is down from the previous outlook of 17% to 22%. So with that, I will hand over for any questions.

[Operator Instructions] Your first question comes from Lyanne Harrison at Bank of America.

I might start with those hospital capital budgets. You mentioned that some of those constraints will continue into the second half of financial '25. Do you have any thoughts as to whether that might be more prolonged and might impact your first half of '25?

Look, a good question, Lyanne. My expectation is that the it could go into FY '25. We'll have to wait and see. But the -- what's really important is introducing some of these new models or sales models or offerings, I should say, rather than sales models that will enable the customer to adopt were what we would like to think is that will enable the customer to adopt the technology earlier, where it doesn't have as big a capital outlay for them upfront. So I would like to think -- well I imagine that those sort of offerings would continue into FY '25.

Okay. And that adoption of the -- or giving the customers different payment model options. At what point in first half of '24 was that introduced, were you able to see any meaningful change in customer patterns at that point?

No, it was really as a result of the first half results and particularly, the December results that we have -- so it's really is H2 introduction, Lyanne.

Okay. Great. And just to understand, in your view, is this really a delay and a timing issue? Do you see any hospitals falling out of that pipeline?

No. I mean the pipeline continues to grow. So that's why it gives us confidence is that the pipeline is there, which means that the underlying requirement is there. We just now need to deal administratively with the speed by which they can get the budgets through the capital budgeting process. So we've seen a couple, as I mentioned, the 170 units coming through from December into -- and there obviously such a large deal like that would have been volume discounts. So I think the next couple of months will give us a good indication as to, if any, of the offerings that we're putting out there, are gaining traction.

Okay. And based on that, so that longer-time frame of converting that pipeline to sales, how much longer are we looking at now versus the average before COVID?

It could -- in some cases, it could have extended it by 60, 90 days, depends on the size of the order. And so we'd like to, that's one of the things that we'll be tracking during the half now is time to close. Are we seeing a contraction in time to close.

Okay. And one last question for me. Is this capital budget constraints or is that still limited to only the United States? Or are you starting to see that outside of the United States as well?

I think it's -- I mean, it's universal. I think it's well known. The hospital sector are under stress, not just financially from a margin perspective. But in some markets, we still see it with the NHS in the U.K. just staffing issues. And that compounds the cost because when there are staffing issues, there's a reliance on using agency staff then that can -- it's an order of magnitude cost increase in agency staff versus full-time people. So it's not unique to the U.S. Obviously, for us, it's more pronounced in the U.S. because of the size of the market.

Your next question comes from Josh Kannourakis at Barrenjoey.

Can you hear me?

Yes.

A couple of quick questions. First, just on guidance, just around some of the underlying assumptions around sort of new installed base growth. Can you give us a little bit more context around how you guys are thinking about the second half maybe in terms of upgrades versus new installed base?

Look, we haven't come out and said specifically the percentage increase by new installed base and by upgrades. But we certainly expect the both to increase. And some of it will be determined by, as I mentioned earlier, that the a lot of our units are going into hospitals that already have trophons and whether how they deploy that capital moving forward, will they deploy it to upgrades or will they deploy it to new installed base. But we'd like to see both of them actually grow strongly.

Got it. Okay. And maybe the second part to that question, just in terms of the new models and offerings, customer offerings. How are you thinking about in terms of putting that towards upgrades versus installed base? And I guess, obviously, optimizing that for your consumables as well? Just how are you sort of thinking about that decision process of what you'll offer to people across with upgrades or installed base.

Look, we'd offer the -- principles would apply to both. And what's important is, for example, rental or even if there was volume price discounts or if there was deferral in payment for the capital. If it's an upgrade, well, obviously, if that brings the adoption of the upgrade forward, well, then what that means is you're getting to consumables earlier. So anything that you're giving up is probably regained because of the earlier consumables usage, but also if it's to upgrades, it just means that the warranty period goes faster or for the time goes faster to the end of the warranty period where you start getting service revenue coming through. We don't necessarily get upgrade -- sorry, you don't necessarily get increased consumables associated with an upgrade. So I think the sort of models that we're looking at are applicable to both, Josh.

Yes. perfect. And just a quick final one, just on CORIS Obviously, you gave some good granularity around breaking up some of the base trophon versus those costs. If all goes to plan, how should we be thinking about the phasing of, I guess, the cost base for CORIS as you move from this phase into commercialization over the next 12 to 18 months?

Yes. I think obviously, when we launched the product, there will be a cost increase associated. And that's why I think one of the things we expect in the -- with the trophon business. For example, with the work that Jason has done on some productivity measures across the business and a lot of that will be in the whole trophon area. Whilst the guidance that we have for sales in the second half, that 6% to 15%, the growth in OpEx in the trophon-only business in H2 will be lower than the lower end of that guidance. So we keep pulling out the -- so people understand the profitability in that trophon business, but there will be initial, as you can imagine, CapEx as we build up inventory or working capital as we build up inventory in all of those and launch costs that we'll see in FY '25 and then hopefully we start seeing a return on some of the investments in that launch -- those launch costs in FY '26.

Your next question comes from Shane Storey at Wilsons Advisory.

I'm going to go back to the business models, please, Michael. In the U.S. market, should we be thinking about that market as one where the up-front capital model remains 90% or more of the business but with some short-term concessions here, just conscious of the environment? Or is it a targeted shift, do you think, where capital model ultimately gives way more permanently for some rent to buy or even MES approaches, one seems easier to unwind than the other? So it's important to know which.

Yes. I think it's more going to be intermediate than long-term chain. The -- because traditionally, the U.S. market has been very much up-front capital purchase. And I think when, hopefully, things return to better flows of revenue in the hospitals and availability of the capital that's -- they would return to that as a preferred model. So I think it's intermediary. And -- but time will tell us, but our internal assumptions would be it's not a long-term shift.

And that leads into my second question. So when I back solve this in the second half, gross margin, just in view of the revised guidance there. So we shouldn't be thinking of that second half gross margin as being the new level that we take forward?

No. The gross margin, obviously, the mix is the biggest deal with increased capital. And as you know, the -- in one sense, it's a lower gross margin driven by a lot of new capital, and particularly new IB capital is a good thing to have because it just feeds the higher gross margin in the outer years. But you're probably correct in that the lower gross margin that we get in the second half, we wouldn't -- we'd like to think that, that probably moving into '25, '26 would start creeping back up.

Last question for me, just one for Jason, please. Jason, you mentioned in your comments around the uptick in ultrasound volumes that you've seen through December and into the second half. I missed the explanatory factors that you think might have been at play there. Firstly, in the, I guess, the relatively sort of slugging rates you saw early in the half and then why that seems to have improved?

Thanks for the question, Shane. Yes, this is data that we get from the national patient procedure volumes, so we get this independent data, which takes a sample of over 500 hospitals in North America, which is around 10% of the total hospitals in North America, and they provide us with this monthly ultrasound procedure volumes. So we've taken that data for the first 6 months of the year. And what that showed was that the procedural volume was down 4% versus the first half in '23 so that's where it's based on.

Your next question comes from Mathieu Chevrier from Citi.

Just on the hospital CapEx budget constraints. I mean I've never really heard of a hospital system that's not CapEx constrained. And I was just curious to understand your thinking around the change in business model based on 1 month of sales. It seems to be quite a departure from existing sales practices. And then I just wanted to check that you're basically saying you'll be using your balance sheet to finance these much larger health care systems.

Thanks for the question. I guess you're right, there's always CapEx processes that have to go through budget approvals in the hospitals, but we certainly saw and heard directly from customers that they just have budgets, either budget freezes on CapEx or how the allocation of their capital budgets changes to a more emergency equipment or whatever. Hence, why we're seeing when they had a trophon EPR extending the life of that rather than outlaying the CapEx when they have those constraints. On the -- yes, you're right that we've got a very strong balance sheet. And these sort of models that we're introducing, we don't necessarily believe that there is much funding that's required. We're going to be funding the hospitals with leases and things like that. It's just the models may be that the timing where we will recognize revenue, especially in things like rentals will come across the life of the machine or they may rent it for a year or 2 years and then buy it out rights and things like that. So it's more associated with the revenue recognition versus there's significant funding that we will have to use our working capital to support the customers with. There may be some that we might see depending on the type of account and that we may extend some payment terms for some, but I don't see that being a major one. I think it will be more if rentals increase or volume units that we might give away a bit of margin on the capital to get the units in there earlier and then start burning the consumables because they're in there earlier.

Okay. And then what do you think that means then for price increases going forward? And I guess, the value the way your value proposition is perceived by customers outside of North America where agents tend to be -- budgets tend to be a bit tighter than in the U.S., especially.

Yes. We already have a number of different models outside of the U.S. So for example, in the U.K., what Jason mentioned, the Managed Equipment Service model where there is no up-front capital. And those, we certainly hold on our balance sheet and depreciate over 5 years or so. And -- but to compensate from that, the consumables price is higher -- a lot higher than had you bought the capital. So -- and the NPV on that over 5 years is actually quite positive, very nice. And you're seeing that in the first half, we saw our consumables service in Europe growth 30%. So that's a -- really, we've got to look at it market by market and what the conditions are and try to adopt the sort of models that we have in each of these markets. Of course, the most important thing, and this is primarily related with capital. Remember the most important driver then is the consumables -- the value of the consumables, and we have had price increases on consumables. I think we're not looking going out there now to try and gauge customers when it's difficult to try and keep putting further price increases on consumables, certainly not in the short term. And as you all know, that the consumables deliver very high margin.

Yes. Yes. Got it. And then maybe 1 just final one on CORIS. Have you had feedback from endoscope manufacturers and how they're thinking about having another device interacting with their own device in terms of liability and warranty, that sort of thing?

I mean that's our bread and butter. We do that for ultrasound and work with all the OEMs. You can anticipate similarly with endoscopes. And remember, the endoscope manufacturers, they do this as well is with -- because those devices are all going into washer disinfectors. So to us, we don't see that being an impediment.

[Operator Instructions] Your next question comes from David Low with JPM.

Perhaps if I could just start with the question on the OpEx. I mean that's quite a significant change. It's effectively sort of half the growth. Is there, Jason, are you seeing a lot more potential on this front? I mean could we see OpEx continue to wind back quite rapidly?

I think we're prioritizing our operating expenses. So I think the main important one is obviously CORIS and getting that one to market as soon as possible. So we're making sure that we spend the right investment there. But in the rest of the business, we're looking through all of the processes and really just questioning if we can simplify or find another way to get the same result. And what this does is it frees up time for people to focus on other things and in some cases, there might not be a need for additional resources. You've heard with comments and Michael as well that going forward in the second half, we expect in the trophon business that the revenue will grow faster than operating expenses.

Yes. And I guess I'm just trying to understand whether that's a trend which will play out over a couple of years or we'll see the bulk of it in this period.

We'd like to think, David, that we will -- question is both from business as we continue to grow, that will ultimately start demonstrating operating leverage -- further operating leverage over time in the trophon business. Obviously, as Jason mentioned, when we go to launch CORIS, it will be -- on a consolidated view, you'll see operating expenses go up but just on the trophon alone business, we expect over time to get further operating leverage out of that business.

Okay. Great. Just changing topics. That private physician market was raised in the prepared remarks. I was just wondering where is that? How big an opportunity is it? Is it a segment that GE did very well and that Nanosonics is a great opportunity? Just trying to [indiscernible]

I mean it's a decent sized market. And GE didn't put a lot of focus on it but we're now putting a fair amount of effort into it with 3 channel partners, in particular, that focus on those areas. And actually, we have our own manager just looking at those channel partners. So the 2 segments within private physician is the private OB/GYN and private radiology. Obviously, it's not necessarily targeting initially the wound person type operation. It will be more the larger operations. And -- but we're seeing at the moment that we're seeing a bit of growth in that segment. Too early, but we think it's a component of why we feel comfortable that there's still ample opportunity to continue to grow new installed base in North America.

Okay. So that I take it from that, that you see it as a much underpenetrated part of the market versus hospitals.

Yes, yes, very much so.

Okay. Last question for me. Just the FX impact in the half and what you're expecting going forward? I mean I see the basis of the guidance. That's a fairly decent move in the U.S. Just how much benefit of that has flowed through the P&L, please?

So in the first half, you would have saw the benefit is around $1.6 million on the revenue line between the 2 years. So the first half of 2023, the FX rate was around $0.67; in the first half of '24, it was $0.66.

And what's the flow-through the profit line improvement? I'm trying to get a sense to understand how much that is offset by hedging programs and whether we should see a bigger benefit in the second half?

In the second half, we expect the FX rate to be around $0.67. So it's relatively close to the first half. And while we do recommend $0.67 in the outlook is because of our hedging program with the majority of hedging already in place, it indicates that that's [indiscernible] best rate for us in the second half.

But we should use the first half as a reasonable guide there.

Yes.

Your next question comes from Craig Wong-Pan at Royal Bank of Canada.

Just wanted to understand about R&D. I mean there was the comment made that, that should start to reduce the trophon business. I was wondering if you have any targets like a percentage of sales or target level of dollars that we should think about for R&D expenditure?

Yes. That's a good question. I think the comment I made is as revenue continues to grow, R&D as a percentage of revenue would come down. Now traditionally, for more mature companies in medical device sector, your are looking at R&D as a percentage of revenue, somewhere in the order of anywhere from 10% to 12.5%. Obviously, we're a lot higher than that, but that's a function of our revenue. I don't think -- it's not yet a good measure. Obviously, when we're a lot more mature and we've got a critical mass of revenue on the top line to enable funding of the R&D., we would like to think that in the future, we'll be looking at R&D as a percentage of revenue coming down to those 11%, 12%. But that's not going to happen overnight.

Okay. And then just on China, you mentioned potential approval process in the next 9 months or so. Just wanted to understand how we should think about the potential growth there? Is that going to be -- I mean what's your growth plans for when you get that approval process? Are you going to be having like a workforce there? Or are you going to be using channel partners?

Yes. It's China. We have set up our own WOFE in China or wholly owned foreign entity just to ensure that we continue to own the registration. We do have a general manager and a clinical person up there at the moment. That market will be a distributor market. But as per other markets in the past, I think we will have a number of people up there at the time of when we do sign distributors up there to support the distributors. So it's not really a large FY '25 play, but I think coming into FY '26, it could certainly contribute.

Okay. And then last question, just to clarify, these new kind of rental agreements, that's just for the capital equipment. So they still pay, is at a similar rate for the consumables depending on the volumes?

Correct. And I think we've always had -- just we always have had rentals. It's more now increasing the prominence of rentals in our offerings. And so we'll see what comes through in the second half as to whether -- back to Shane Storey's question earlier, the United States normally is a capital purchasing. We fundamentally believe it will maintain being a capital purchasing for a -- for the long term. But just as an interim, it maybe that rentals increase in prominence. But we'll see where the trends of that come through over the coming months.

That concludes our question-and-answer session for today. I'd now like to hand back for closing remarks.

Well, thank you all again for attending. It's been an hour. And I know everybody is busy with during the results season. So I appreciate everybody's attendance, and I'm sure we'll be seeing many of you over the coming days. Thanks a lot. Bye-bye.

Thank you. Bye-bye.

Thank you. That concludes our presentation. You may now disconnect your lines.