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Edited Transcript of NAN.AX earnings conference call or presentation 26-Feb-20 12:30am GMT

Half Year 2020 Nanosonics Ltd Earnings Call

Mar 20, 2020 (Thomson StreetEvents) -- Edited Transcript of Nanosonics Ltd earnings conference call or presentation Wednesday, February 26, 2020 at 12:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* McGregor Grant

Nanosonics Limited - CFO & Company Secretary

* Michael C. Kavanagh

Nanosonics Limited - CEO, President, MD & Executive Director

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Conference Call Participants

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* Davinthra Thillainathan

Evans & Partners Pty. Ltd., Research Division - Research Analyst

* John Hester

Bell Potter Securities Limited, Research Division - Senior Healthcare Equities Analyst

* Josh Charles Kannourakis

UBS Investment Bank, Research Division - Research Analyst

* Shane A. Storey

Wilsons Advisory and Stockbroking Limited, Research Division - Senior Analyst

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Presentation

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Operator [1]

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Thank you for standing by. And welcome to the Nanosonics H1 FY '20 Half Year Results Call. (Operator Instructions)

I would now like to hand the conference over to Mr. Michael Kavanagh, CEO. Please go ahead.

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Michael C. Kavanagh, Nanosonics Limited - CEO, President, MD & Executive Director [2]

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Thank you very much. And a very good morning, everybody, and thank you all for dialing in. I'm joined here in Sydney by McGregor Grant, our CFO.

Well, this morning, you would have seen we released our FY '20 half year results, which outlined a significant level of ongoing achievements and progress by the business over the last 6 months. And record sales were delivered, along with positive growth in our installed base across the regions. But importantly significant, we've made significant investments, ongoing investments to support our longer-term growth strategy.

The key highlights, as outlined in the release, were sales of $48.5 million, and that was up 19% on prior corresponding period and 11% on prior half. We've got continued strong global installed base growth, which was up 17% in the last 12 months and 8% in the last 6 months, and that's now running at 22,500 units.

Sales of $34.1 million associated with consumables and service, and that was up 40% on the prior corresponding period and 25% on the prior half. And this strong growth in the consumables and service sales really reflects the growing installed base, but there was also impacts of increased price to GE Healthcare in North America for the consumables, which did come into effect during the half but also the timing of shipments of one of GE's orders, which was a January order that was shipped in December to make the January delivery date that was required.

Our capital sales for the period, they were $14.4 million. This was actually down 12% on prior corresponding period. However, when you break that down a bit, the capital sales to end-user customers were actually up 13% on the prior corresponding period, and that increase of 13%, that's a reflection of the increasing installed base, but also importantly, the transition from trophon EPR to trophon2, which is at a higher average selling price. And there certainly is a skew now to adoption of trophon2 over the EPR. The capital sales to the company's main North American distributor, that's GE Healthcare, they were down 24% on prior corresponding period, but that was primarily due to timing of purchases in prior periods and the distributors' ongoing inventory management.

We continued to invest, and that's a core part of our strategy, in our overall growth strategy with the first half operating expenses of $30.7 million. That was up 11% on prior half and 43% on pcp. Our operating profit before tax was $6.7 million, and that was compared with $11 million in the -- on pcp and $5.8 million on the prior half, but that , as you all know, reflects the increased investments we're making in the business.

We had very good positive free cash flow for the half. That was $10 million compared with $1.6 million in the prior corresponding period. And that resulted from increased receipts from customers, but also lower internal inventory. And cash and cash equivalents for the business were up $9.8 million in the half to $82 million at the end of December.

Geographical expansion, that progressed in the business with market development activities ongoing, and particularly in Asia Pacific, specifically in Japan. During the 6 months, we appointed 5 distributors for that region, and the first units were actually installed in Japan. Our China market entry strategy, that does continue to develop, with a major focus at the moment on regulatory and distribution strategies continuing to be explored.

And our investments in R&D in those activities did continue to grow. The R&D in the half, we invested $6.8 million, that was up 24% on pcp and 15% on the prior half. And the R&D investment does span a range of programs that we are working on, but the investment -- current investment is certainly weighted towards the next new infection prevention innovation we're planning to bring to market.

So expanding on these highlights a little bit. First, the installed base. As I mentioned, the overall installed base grew 17% in the last 12 months, where there's now 22,500 units, or at the end of December, there was 22,500 units in place. And for us, certainly internally, it's important that we don't lose sight of the fact that what an installed base like that means is that every day, approximately 75,000 patients are protected from the risk of cross-contamination because the ultrasound transducer used in the medical procedure was decontaminated using trophon. And that's equivalent to approximately 19 million patients per annum, and that number continues to grow on a daily basis.

Breaking it down by region. In the U.S., the trophon is certainly becoming standard of care. The total IB was up 17% in the last 12 months, and at the end of December stood at 19,930. So that's almost 50% market penetration. And that new IB comes from not only expanding into new hospitals, but importantly, expanding into more and more departments within hospitals that had already adopted the trophon technology, as awareness continues to grow on the importance and requirements for decontamination of all semi-critical probes. And what that means, we're getting into more and more departments within these hospitals.

In Europe, the IB grew 19% in the last 12 months to just over 1,000 units. And here, there remains a great opportunity for growth as the European market is highly underpenetrated at this stage, but the fundamentals for adoption have now strengthened to support our plans for ongoing growth.

In Asia Pacific, the total IB was up 8% in the last 12 months to just over 1,500 units. And that was primarily in Australia and New Zealand which, as you know, is highly penetrated and growth there was -- that's really explained by the 8% growth. But of course, Asia Pacific as a whole remains highly underpenetrated like Europe. So a large opportunity for us to grow in this region, and in -- particularly in Japan where we had a lot of activities underway, but also now activities underway in China and broader Southeast Asia.

So expanding a little bit more on the financials. As I mentioned, the total sales for the half were $48.5 million, up 19% on pcp. In constant currency, sales were $45.8 million. And if we deconstruct that revenue, the total revenue, as I said, the sales for consumables and service was $34.1 million, so that was up 40% on pcp. And that first half strong sales in the consumables really reflects the ongoing growing installed base, but also the impact of the price increase to GE for consumables. And that came into effect late in the actual half.

And in addition, as I mentioned, the January order for GE for consumables was shipped in late December so we could meet the early January date delivery. Otherwise, GE would have gotten close to an out of stock situation and that order was at the higher price.

And as I mentioned, the capital equipment sales of $14.4 million were down 12%. And -- but again, if you break it out into what's probably most important message, is the capital equipment sales to end users were actually up 13% on the prior corresponding period. And a lot of that attributable to the higher price associated with -- that we're getting for trophon2 and the skew now towards adoption of trophon2 over the EPR.

That 13% obviously was offset by the lower sales going into the channel, particularly in North America to GE, and that was down 24% actually on pcp. But that really is attributable to the timing of prior capital purchases that they had made and then the consequent inventory management. And by no means should that be interpreted as a slowdown in sales by GE to end users as they do continue to deliver excellent new installed base growth numbers.

So breaking that down regionally. The first half revenue in North America was up 18% to $43.8 million. And really, the explanation I've given on the consumables and the capital, that really is primarily associated with that North American.

For Europe and Middle East, here, it's important to remember the different sales models that are deployed in Europe, in particular, the MES model in the U.K., where Nanosonics provides a fully maintained machine to the customer, and then charges an all-inclusive price for the consumables. Therefore, there's no upfront capital revenue with MES. And the skew in sales in Europe at the moment is towards the U.K., so -- and that's reflected in the result, where revenue for the consumables was up 38% on pcp to $2.4 million, whereas the capital revenue was just slightly down on the -- similar to the last period.

And a key focus for us in the first half -- as I said at the beginning of the year, a major focus for us in Europe was now to build the infrastructure. We appointed a new regional president who came on board around the September time frame. And in that time frame, he has done quite a lot of work in our infrastructure in Europe. We now have new sales force being added in the U.K. and Germany. We've got a European clinical head appointed -- or European regulatory head appointed. And we just appointed a dedicated resource to manage our growing number of distributor partners. And we plan further expansion in Europe in our infrastructure in the second half. And indeed, with this infrastructure investment, we are actually getting a very good sense of momentum in the first 6 weeks of sales in the half in Europe.

For Asia Pacific, the total revenue was up 27% on pcp to $22.4 million. Capital revenue was up 35%, albeit off a low base, and consumables were up 25% to $1.9 million. And as you know, Australia and New Zealand market is highly penetrated. However, the installed base does continue to grow here.

In Japan, our market development activities, they continue, and preliminary sales have begun. They are preliminary. We have -- now have appointed 5 distribution partners in Japan. We've appointed a president for the local Japanese entity that we've established as well as a vice president for sales and are currently hiring for 2 more roles out there to support our distributor partners. And the plan also is that around the April, May time frame this year, we will launch trophon2 in Japan.

We also progressed our market assessment on China and believe there is definitely an opportunity in this market. Indeed, just this week alone, we are seeing guidelines emerging, supporting the high levels of infection of ultrasound transducers. And our focus now is on establishing a Chinese entity, appointing distribution partners, and we've met with a number, as well as our regulatory strategy for trophon2.

And as mentioned in the release, the current situation with the coronavirus will likely slow down our market development activities in the second half. However, we will continue to progress all the work that will have to be done centrally here anyway in Sydney, with our regulatory department to put together the regulatory submission documentation.

On an OpEx side of things, as previously explained, Nanosonics, we are making significant investments across all aspects of the business to support our strategic growth agenda. For the first half, our OpEx was $30.7 million. That was up 43% on prior corresponding period and 11% on the prior half. And this includes increased investments in the likes of -- what I mentioned, in our regional operations, in particular in Europe.

But we did add extra head counts for Asia Pacific as well as the United States. Actually, our overall headcount had a growth of about 10%, where we now have over 300 people in the organization. And of course, increased investments in R&D, which was up 15% in the half to $6.8 million. And our intention is to continue to invest strongly in the ongoing growth.

With that in mind, our previous guidance of $67 million OpEx for the full year, that stands. And we expect it to be in the region of $67 million to $68 million potentially, and that means that an OpEx for the second half will be in the range of $36 million to $37 million.

And then from an operating profit perspective, well, as a result of the increased investments we're making in the business, the operating profit before tax was $6.7 million, which was down on the prior corresponding period. But that was to be expected.

Our free cash flow for the half, that was $10 million, and that's compared with $1.6 million in pcp. And this is a result of an increase in customer receipts, primarily due to alignment of payment terms for GE North America with our standard payment terms as -- and that has been explained previously. In addition to our new Chief Operating Officer, we are introducing many operational and manufacturing efficiencies, which resulted in a decrease in our internal inventory. That has provided an impact there as well.

The cash and cash equivalents at the end of December, they were up $9.8 million on the prior half to $82 million at the end of December. And as I previously said, it is worth noting that our capital management strategy, it does continue to be regularly reviewed. And -- but at this stage, ongoing growth in the investments in our long-term growth strategy is considered the best use of our free cash flow and capital reserves, especially when you consider the degree of underpenetration and opportunity in the Asia Pacific and European region, but also the opportunities from a research and development perspective. But of course, we will continue to review this on an ongoing basis.

From a foreign exchange perspective, the company generally benefited from a stronger U.S. dollar. And the results include a net gain in foreign currency of approximately $650,000.

Moving very quickly on to R&D and then I'll quickly open for questions. But in the last half, we have invested $6.8 million in our research and development, and that was 24% increase on prior corresponding period and 15% on the last half. And I did outline at our AGM in November the areas of interests in our R&D. And they span 5 core areas, including instrument cleaning, instrument disinfection, storage solutions, environmental decontamination as well as digital solutions for traceability and compliance. And we do have active programs in place covering a number of these areas.

But the majority of our R&D investment in the first half was towards our next new innovative platform technology. And this new technology is being designed to address the major unmet need, as I've previously noted, and also, as previously explained, would involve both capital and consumables and is targeting a large addressable market. And subject -- again consistent with what I've said in the past, subject to achieving a number of technical milestones as well as timing of individual markets, regulatory approvals, we are targeting the commercial introduction of this new platform technology in FY '21. And I realize that everybody would like to know specific and more details about this new product, and they'll be forthcoming in the fullness of time, which is not today.

So from an outlook perspective for the remainder of FY '20, while we continue to target continued growth in the installed base in North America with the FY '20 adoption similar to FY '19, adoption of trophon in Europe to grow from the expanded geographical reach, the stronger fundamentals for adoption and growing awareness, but also very importantly, the investments that we are making in the Nanosonics European infrastructure, we will continue our investments in Asia Pacific growth strategy, focusing on Japan, but also the -- continuing where we can the developments across the broader region, including China. We will continue our investments. And our operating expenses in H2 are expected to be between, as I mentioned, $36 million and $37 million, thus resulting in a full year operating expenses of approximately $67 million to $68 million, and that does include almost $15 million in R&D.

And the FY '20 profit phasing is now more balanced between H1 and H2 as a result of timing of consumables in H1, the sales of consumables, and -- but also the phasing of operating expenses between each half. At the beginning of the year, I had indicated that we believe that the profit would be far greater phased into H2, but now we believe it will be more balanced between both.

I guess all companies are mentioning the potential impact of the coronavirus situation. And we are certainly actively considering and monitoring the potential risks of this to the business. With the exception of potentially slowing down some of our activities in China as part of our market development efforts over there, today, there are no material impacts to the business operations. However, we do continue to monitor the situation very, very closely in the -- especially, for things like the supply chain, et cetera. But at this stage, there are no material impact.

So with that overview, I'll now open to any questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Josh Kannourakis with UBS.

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Josh Charles Kannourakis, UBS Investment Bank, Research Division - Research Analyst [2]

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Can you hear me okay?

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Michael C. Kavanagh, Nanosonics Limited - CEO, President, MD & Executive Director [3]

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Josh, how are you?

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Josh Charles Kannourakis, UBS Investment Bank, Research Division - Research Analyst [4]

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Yes, very well. First question, just on the consumables order of GE, are you able to give any context just around either the magnitude of that January order that dropped in December? Or perhaps just in terms of the total revenue of consumables, just how much was at that higher revenue rate?

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Michael C. Kavanagh, Nanosonics Limited - CEO, President, MD & Executive Director [5]

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Look, I think the way to think of the consumables is that the primary increase in the revenue associated with consumables was associated with the increase in price of GE. And that came into effect for more than just that January order. It came into effect around the November time frame. So that's the primary reason. We don't see that it will necessarily impact greatly consumables in the second half or volumes in the second half. And indeed, remember that second half consumables will -- all of it, 100% at GE will be at the higher price.

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Josh Charles Kannourakis, UBS Investment Bank, Research Division - Research Analyst [6]

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Got it. Understand. Just in terms of upgrades, are you able to give us any context about how many trophon2 units are within the total installed base at the moment? And just maybe some commentary on the outlook for the upgrade cycle over the next 1 to 2 years.

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Michael C. Kavanagh, Nanosonics Limited - CEO, President, MD & Executive Director [7]

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Yes. The majority of sales in the first half were actually trophon2, probably close to about 80% of sales were trophon2 for the new installed space. For overall capital sales, still a very minor number associated with upgrades. As I mentioned previously, the upgrades are not really a focus at all for the Nanosonics direct team as the majority of units -- or all the units over 5, 6 years old are GE installed base. They have sold some upgrades, but -- I don't have the exact figure, but not a material number that would have impacted the overall results. We expect over the next 6 to 12 months to start seeing greater penetration of upgrades, however.

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Josh Charles Kannourakis, UBS Investment Bank, Research Division - Research Analyst [8]

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Understand. And how are you in terms of strategy, I guess, providing an environment where it's favorable to push those, I guess, or for some of those upgrades to eventuate over the next couple of years as they reach the sort of 6 years of life?

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Michael C. Kavanagh, Nanosonics Limited - CEO, President, MD & Executive Director [9]

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Yes. Look, I mean as I say, a lot of that is based on GE and how they want to sell it. And any particular trade -- it can be a case of trade-ins, it can be a case of explaining the -- not only the benefits that comes from the superior feature set that comes with trophon2. But economically as well, the older the machines are, will then be requirement for service. And if somebody is taking out service contracts, well, the price of an annual service contract immediately is a discount on the price of the trophon2 because it comes with a 12-month warranty. So I'm sure they're leveraging all of those aspects to convey it to their customers.

There's one thing to take -- that we have to consider though in terms of the upgrades and the timing is, as I mentioned, there's a lot of units that are now going into existing hospitals. So in the past, I talked about our go wide, our go deep strategy, go wide, getting into new virgin hospitals, so to speak; go deep, getting into more and more departments within hospitals that have already adopted trophon. And for some departments, they may need more in the department that already has trophon. And it sort of in one sense can be difficult for them to mix the 2 models because it requires a standard operating procedure. So in some cases, some of them who wanted more, whilst they saw the benefits of trophon2, they actually bought some more EPR.

Now the thing about the EPRs is they now have a finite life. And so probably, within the next 6 months or so, the EPRs will be obsolete. Obviously, all the EPRs that are in the market will continue to be maintained in service. But in terms of sales of EPRs, that will probably cease in -- within -- certainly within the next 12 months, but probably within the next 6.

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Operator [10]

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Your next question comes from Shane Storey with Wilsons.

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Shane A. Storey, Wilsons Advisory and Stockbroking Limited, Research Division - Senior Analyst [11]

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Michael, I'm going to return to the price increase, please. You gave us the timing of its introduction. But look, are we right in applying that elevated price across all of the U.S. installed base from now? Or do you think that will be phased over the period?

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Michael C. Kavanagh, Nanosonics Limited - CEO, President, MD & Executive Director [12]

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No. I think from now, the ASP of the sonics is now across the whole of the U.S.

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Shane A. Storey, Wilsons Advisory and Stockbroking Limited, Research Division - Senior Analyst [13]

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Okay. Second question, maybe it's for McGregor. I was just wondering if you could comment, and just quantitatively, on how you're seeing the gross margin evolve in EMEA, where the MES contracts have been an important part of that business for a number of years now. And if you did a compare and contrast so with the U.S. segment, I'd give you a bonus point to that.

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McGregor Grant, Nanosonics Limited - CFO & Company Secretary [14]

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Well, the profitability of the MES business is, in a sense, over the life of the arrangements, is similar to the sale. But you do get this sort of different timing of margin so that you don't get that upfront capital sale with the margin on that, you do get -- but you do get the higher sales of consumables over the life of the contract. I think the answer is that the MES business is bearing out according to the model that we had anticipated and delivering the profitability according to the shape of that model.

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Operator [15]

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(Operator Instructions) Your next question comes from Davin Thillainathan with Evans & Partners.

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Davinthra Thillainathan, Evans & Partners Pty. Ltd., Research Division - Research Analyst [16]

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Just a question on your capital sales from North America in the second half with regard to the purchasing patterns of GE. Could you perhaps give us a bit of direction on what we should be expecting in the second half? Are we directionally expecting it to grow?

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Michael C. Kavanagh, Nanosonics Limited - CEO, President, MD & Executive Director [17]

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Look, I think we'll see capital sales grow by virtue of the -- especially to installed base -- with the installed base continuing to grow. I would imagine GE, from an inventory management perspective, is now getting close to inventory holdings. So it should start reverting back to a more normal purchasing pattern. I wouldn't imagine a similar sort of decrease, rather a more stable number of units going into the GE channel in the second half.

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Davinthra Thillainathan, Evans & Partners Pty. Ltd., Research Division - Research Analyst [18]

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Yes. And in Europe, just with reference, particularly in the U.K., we've seen one of your competitors, Tristel, raised prices on their product in the U.K. Has that provided a catalyst -- a better catalyst for the adoption of trophon given the pricing dynamic there?

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Michael C. Kavanagh, Nanosonics Limited - CEO, President, MD & Executive Director [19]

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Well, it should be. We've -- to be honest, I saw that mentioned and -- but in many of the accounts. Remember, Tristel is not just about ultrasound. The Tristel technology, I'm not exactly sure what percentage, but it'd certainly be less than 50%, I believe, that we see for ultrasound. It's involved in wipes from many other applications in the hospital as well.

So where the price increase has been applied, I'm really not sure. We're just focused on getting into all the new accounts, some of those are replacing Tristel. Some are just on high-level disinfecting at the moment and are commencing. But certainly, if they increase their price, that helps our economic argument as well.

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Davinthra Thillainathan, Evans & Partners Pty. Ltd., Research Division - Research Analyst [20]

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And just finally for me. On your new product, I know you're not going into specifics today. But with regard to the time frame of commercialization, I think the last reference point we had was your AGM commentary of getting released by first half '21 subject to regulatory clearance. And today, I guess the disclosure is FY '21. Should we be reading too much into that? Or has that timing slightly drifted?

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Michael C. Kavanagh, Nanosonics Limited - CEO, President, MD & Executive Director [21]

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Look, it's not so much that it's drifted. We're still targeting FY '21. And if it's in the first half or the second half, there's a lot of determinants to that. As everybody on the call would understand, that all product development programs, there are inherent risks that can impact commercializations. There's still a few things we have to do, but we're confident in that FY '21 timing, subject to us achieving the technical hurdles, which are at a very high level, that we're setting for the technology as well as those regulatory time frames.

But we're continuing to invest in the R&D team, it's the primary and major focus. It's a subset of the group working on other things as well. So we're sticking to that FY '21 timing at this stage, yes.

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Operator [22]

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Your next question comes from John Hester with Bell Potter.

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John Hester, Bell Potter Securities Limited, Research Division - Senior Healthcare Equities Analyst [23]

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Just a quick one for me. Your consumables revenue went from $21.5 million up to $30 million odd. And yet, we've seen no movement in your gross profit margin. You said already that in -- from November onward, you were at the higher pricing for the consumable sales with GE. Can you help us understand why there was no movement in the margin, please?

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McGregor Grant, Nanosonics Limited - CFO & Company Secretary [24]

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Sure, John. One of the contributing factors to the gross margin results in this half has been actually a result of lower recoveries resulting from lower production volumes. You see the inventories come down quite a bit. We've been managing our inventory quite tightly for a variety of reasons. And as a result, we've had lower than -- lower recoveries of overheads. So that's actually been a bit of a headwind for us.

But you take that away and the underlying gross standard margin, gross margin, if you like, has improved. As a result of that, we expect in the second half that production volumes will be higher than the first half. So to some extent, we should see some improvement around that.

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John Hester, Bell Potter Securities Limited, Research Division - Senior Healthcare Equities Analyst [25]

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Right. How many [sensors] were produced in the first half relative to the prior period? Probably...

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McGregor Grant, Nanosonics Limited - CFO & Company Secretary [26]

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Look, I'm not going to go to specifics of that.

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Operator [27]

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(Operator Instructions)

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Michael C. Kavanagh, Nanosonics Limited - CEO, President, MD & Executive Director [28]

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Okay. I think if there are no further questions, we'll finish it there and get back to the work that we're doing. Thank you all very much.