Oxford Nanopore Technologies plc (ONT) Earnings Call Transcript & Summary

It feels like if you have the innovative products out there, customers are willing to find the budget for them because they don't want to themselves fall behind.

So that's exactly right. So like where does research dollars get pointed to? Is it to do the same experiment again? Or is it to try and unlock new biology? It's to unlock new biology, and that's where we believe we offer a considerable advantage here because of the long-read nature of the platform and the fact that we look at DNA and RNA directly, which means we see all modifications.

Yes. And then as we look out to the 2030 revenue ambition, what are the key assumptions there around customer mix, utilization and account expansion, just given, again, the volatility we've seen in some of these end markets, how are you thinking about that for the next few years?

Yes. So on -- we've been pretty prudent here. Well, you expect us to say that, but we have been in terms of what we're expecting on utilization actually because -- we know we can do better here. And historically, if you look at all of the numbers we printed, we've actually talked to quite considerable utilization growth year-on-year. We're not assuming that continues. We're really just looking at further adoption of the platform and those specific things within biopharma as well. So -- and in terms of pricing, we've been pretty prudent here as well. Like on the PromethION flow cell, we're assuming that actually price declines because our cost per genome will come down over time. It just continues to go in that same trend. The difference is, we can see specific end markets, target applications, which are quite high value actually that we have a real right to win, and we're just going to focus on those areas and not play in the same spaces where the other players are.

Yes. And Francis, one of the clearer messages from the strategy update was the need to translate differentiated technology into a more market-led product road map. What changes in practice in terms of how you allocate R&D, decide what gets built? And just as importantly, what are you now prepared to stop or perhaps deprioritize?

Sure. So one of the things we did as we characterized these end markets and prioritize them, we did a gap analysis of the customer needs and requirements in each of those target applications and where we are now and what product enhancements, software workflow enhancements we would need to do in order to win and claim our fair share of that market. And so that's going to inform our product road map, our priorities in R&D, our go-to-market structure, and we expect refinements in all of these. There -- in terms of the current activities in R&D, it is a long tail of activities that are currently happening. Our strategy historically has been driven by what's scientifically possible versus what -- where we can create customer value. And so there's an opportunity to truly reset and create more operational discipline, create a clear link between how we invest in R&D, how we align our resources versus the business and the customers we're serving.

And when you speak with those customers today, what do you think the biggest product constraint is? Is it reliability, workflow simplicity, bioinformatics? Just where do you see the biggest adoption unlock being in the years to come?

Yes. Look, the dependability and the robustness of our technology is not a theme anymore. It's not what I'm hearing from customers. It's enhancements around the workflow. It is some -- in specific segments, some gaps around bioinformatics. It is also about generating the evidence and the data to substantiate our claims to be clearer in our value proposition, to be clear in terms of showing the data that supports the claims we're making in terms of how long read is valuable, stressing the so what of what methylation can bring in terms of biological insights, structural variants, what information that actually -- what questions it helps answer, et cetera. And so it's a multitude of things, but there are tweaks, they're enhancements. They are not huge showstoppers. And clearly, the good news is we don't need to develop any new platforms or anything. The technology is there.

I thought the bioinformatics angle is interesting and I guess, software more broadly. Do you see that as just a way of removing friction and driving consumable usage? Or is that bioinformatics itself perhaps a revenue driver in isolation?

It could be. It depends on target segments and markets in some target segments, in biopharma in particular. And the expectation is really to start from sample to answer and to report, and that includes more than just the sequencing. So it includes the sample preparation. It includes the library preparation and the bioinformatics workflow all in one. And so that's not necessarily the case in clinical applications. So it depends really in terms of what use case you talk about, but software as a revenue generator is certainly an opportunity for us going forward.

And it's somewhat linked to that, but I've been spending a lot of time with investors working out who are the AI winners and losers are in the life science tool space. It feels like there is consensus that the data generators are the ones that have the advantage and you have the instruments to generate that data. So how are you thinking about that AI work stream in the future? And how important could that be as a potential tailwind for the business?

Yes, it's a really interesting question. And we believe in the sequencing industry, we generate the richest data, including long reads, but also methylation, structural variants, et cetera. And so you have to believe that if you use agentic AI, you've got to base it on the richest data. And so we're really excited about the potential of what that could bring for us. As a first step, we look forward to the results of the U.K. Biobank who are now currently processing 50,000 samples based on our data. And those data will come out at the end of this year and will be a great use case to see what biological insights can be generated from that data. And hopefully, that will be a sign of more to come and perhaps an opportunity to look at the other 450,000 samples in the database and to see that as a use case for further database building and then ultimately exploiting that with the agentic AI models.

Exciting. And outside of just like the new demand vector, what are you doing internally with AI to make Oxford Nanopore smarter?

Well, AI and machine learning has been a big component for us in terms of base calling, and that's a key capability in our technology. So that's a core capability, I would say. We are looking also at what else we can do in terms of improving the data of our -- the quality of our data and how we let that inform our decision-making in a richer manner. We have hired a new Chief Information Officer, who started with us 3 months ago. So really in the process of exploiting that potential.

Amazing. And Nick, just on the gross margin, I think H1, 62.2%. There's quite a few moving pieces, it seems within that. Just perhaps for those newer to the story, do you mind unpacking that gross margin? And then is approximately 62% the right base? Or is there already kind of a higher underlying exit rate you think more broadly within the business?

Yes, of course. Gross margin is up around 400 bps from the prior year in the same period. This has been driven by -- last year, we took a 330 bps write-off related to inventory essentially, which essentially exited that. And we pointed people to it at the time and said the kind of see-through margin was more like 61%. We have seen product mix impact here. And that's to that earlier point about more device sales versus consumables. So you've seen that mix impact come through on the gross margin. As we kind of look forward, we expect that to normalize. We've historically seen currency headwinds as well, but now the dollar has kind of stabilized. We're starting to see that stabilize as well. But we are seeing underlying improvements. Now over the last few years, we've seen quite considerable improvements to the gross margin from changing the pricing model. And so selling devices rather than kind of looking at place them with customers. As we look further forward and to answer your question, I think it's fair to say that 62% is -- we are aiming to do better than it. So when we kind of exit the year and the kind of where we should be thinking about this going in the future is further increases. And this is going to be driven by recycling of the PromethION flow cell, where we're already making inroads and actually have the process working in certain instances. So for anybody who's new to the story, on our consumable item, the flow cell itself, one of the most expensive pieces is the wafer, the chip that's on it. We -- as part of the ESG push, we do get the chips back from all the vast majority of the customers, particularly on the PromethION. And we are recycling them to essentially strip it all down, clean the wafer and then use it again. Now on the MinION, we are successful with this process, and it's already driven our margins on the MinION to quite high levels. PromethION, we're just starting that process, and we've got some percentage, like low percentage of all flow cells have now been recycled going out. And we're working through the process for how it works from different suppliers of that wafer to make sure the customers can't even notice the difference. We think we've got a path here for this. And when we do, we could see a circa 10 percentage points increase in the margin for the PromethION range alone, and that's our biggest revenue line overall. And so yes, I think the 62% we're at today, but actually the trajectory that we're seeing for it is positive. And as we continue to increase the number of recycled chips for PromethION, you can think about expansion of our gross margin overall. To round it off, we put in the slides from the recent results, we're around 75% on our consumables gross margin today. We were around 63% when we kind of -- like a few years ago. So we've delivered quite a meaningful increase. As we look out over the next couple of years, getting over 80% is absolutely possible.

Great. One point I'm just trying to understand and reconcile is that the clinical and biopharma is the mix shift that you want. I think customer mix, there was 160 bps gross margin headwind in H1. So why strategically is that better mix initially dilutive? And then when can we start to see that ramp more meaningfully take?

So it was customer and product. So essentially, it's that product piece essentially that you got to focus on rather than the customer. To answer to this square as well, for the biopharma piece, absolutely, that mix shift is going to be beneficial to our gross margin, particularly the majority of the customers in the QC pipeline are on the MinION product using the GridION Q. So the margins are substantially higher. We will see that be a benefit to margin over time. On the clinical piece, this is an area where we see greater competition in certain segments. So against the other long-read player out there, we do see some price competition at times, and that means that the margin isn't as high as we'd like today. But we have advancements coming through from a product perspective, which will mean that we can do more -- and so more samples per flow cell. Our pricing is all per sample. So essentially, we can see the benefit coming through, and that will drive margins over time. But in the here and now, we want that adoption into those areas as well.

And the consumables, I think, 75% gross margin today, you have that potentially above 80%, I think, longer term. Devices and services roughly 34% with potential around 40% -- 34% with potential around 40%, which of those 2 margin journeys do you think is harder from here? And like what specifically has to change operationally to reach those levels?

I think it's harder on the devices and services piece because as we kind of flagged as well, we're living in a world where compute costs and memory costs are kind of going quite a bit. And now we're doing -- we are completing development on the products to essentially take out cost, and we're going to see those benefits offset by headwinds in the next year. So we expect device margins to stay broadly flat actually for next year. The difference will be on services where we're scaling. And so for awareness in the room, this isn't where we are sequencing for customers. This is actually where we have fixed contracts for support -- enhanced support plans and things like that for customers, where we are seeing -- we could do better in terms of the number of customers, percentage of customers that are signed up. And as that scales, we'll see the margin improve significantly.

And just given the tighter product and market focus, how should we be thinking about the shape of R&D investment from here? I think innovation has obviously fueled the success you've had to date. So how are you thinking about that trade-off between those 2 factors?

Yes. I mean we feel that R&D at the current level is where it needs to be sustained for the foreseeable future, 2, 3 years or so. We have opportunity to reprioritize to make a clearer link between what we have in terms of target product profiles and how our R&D resources line up behind that. Going forward, '28 and beyond, there's an opportunity to -- as we scale the business further to probably increase that spend a little again. But then we probably would need to do that on -- just on a basis of where we have installed more operational discipline and clear prioritization, and that's now Phase 1. And we feel pretty comfortable that what we need to achieve in order to win in those target applications, we can do that within the current levels of spend.

And then just on the path to adjusted EBITDA breakeven in 2027, a big inflection point for any company there. How much of that plan is within your control through gross margin and cost actions? And how much depends on sustaining that revenue growth in perhaps the mid-teens?

We absolutely do need to kind of continue to grow as the numbers suggest. So at the top line, we've guided the market already for next year the mid-teens. If we deliver the mid-teens growth that we believe it's absolutely possible. Gross margin expansion above the 62% we've guided to this year, a few hundred bps and costs remaining disciplined on costs. So in the first half of this year, everybody has seen adjusted OpEx costs were down 7% overall. We've guided the market to negative 2% to 0 for this year, which we feel very comfortable with. And as we look into next year, if we can -- as Francis said, we've got opportunities to take out non-headcount-related expenditure, particularly around logistics and IT costs, and we've got focused programs of work that we're going on there. That will allow us to kind of invest in other areas. We'll reprioritize internally about what we're doing, costs remaining broadly flat. And essentially, we'll do one of those magic things that the company does turn profitable.

Good stuff. And maybe in the last 1.5 minutes, a question for you both. What do you think is most underappreciated about the Oxford Nanopore story when you spend time with us, when you spend time with investors?

Yes. I think -- I mean, the story for a long time has been around long read versus short reads, has been around accuracy, it's been around maturity of the technology. I think all of that is behind us now. And we see at least our customers telling us they want us to succeed. They want us to be successful. They don't want us to give them a reason not to validate our technology. And I feel really excited about that.

Great. Nick, anything to add?

Yes, I completely agree. And I think -- the fact that this is a sensing platform, I think we often get put next to other sequencing companies far too often actually when -- the ability for this to be a true sensing platform to see other things that those platforms can't see and those technologies can't see. We're seeing it ourselves now with like the mRNA opportunities. I think we're playing in a different park than those guys actually. And I'm not sure the investment community necessarily appreciates that yet.

Amazing. Francis and Nick. Thank you so much.

Okay. Thank you.

Thank you.