Earnings Call Transcript - DNA Q2 2023

Anna Marie Wagner, SVP of Corporate Development

Good evening. I am Anna Marie Wagner, SVP of Corporate Development at Ginkgo Bioworks. I’m joined by Jason Kelly, our Co-Founder and CEO; and Mark Dmytruk, our CFO. Thanks as always for joining us. We’re looking forward to updating you on our progress. As a reminder, during the presentation today, we’ll be making some forward-looking statements, which involve risks and uncertainties. Please refer to our filings with the Securities and Exchange Commission to learn more about these risks and uncertainties. Today, in addition to updating you on our strong quarter, we’re going to dive deeper into our continued progress on driving operational efficiency across our platform, some recent customer successes, and our expanding government relationships. As usual, we’ll end with a Q&A session, and I’ll take questions from analysts, investors, and the public. You can submit those questions to us in advance via Twitter, #Ginkgoresults or e-mail at investors@ginkgobioworks.com. Alright. Over to you, Jason.

Jason Kelly, Co-Founder and CEO

I’m super excited to be chatting with you all today and celebrating a strong quarter for our team at Ginkgo. I always start with a reminder that our mission here is to make biology easier to engineer. And as we dig into the strategic sections today, you’ll see the progress we’re making on that mission, particularly on our path to profitability, driving efficiency through the scaling of our platform. I’m also proud of the work the Ginkgo team has accomplished this quarter as we continue to scale our platform. We had 105 active cell engineering programs on the platform this quarter, representing 44% growth over last year. Alongside that, we are delivering more work for customers. So we saw a 72% growth in cell engineering services revenue this quarter versus the same quarter last year, and we’re driving that growth efficiently. We’ll dive into what is enabling this productivity improvement in the next section. On the customer side, remember, in Ginkgo’s business, customers are choosing to outsource some of the R&D work they might have considered doing in-house. And to state the obvious, they hire us to meet at the largest, most sophisticated companies, where Ginkgo really has to showcase our scale of automation and assets that they have to add something to the considerable resources those companies have already in-house. And so, I am super excited to see the progress at Novo Nordisk, Merck, and Sumitomo, who are among our most technically advanced customers. We’ve expanded our relationships with all of these customers in the last couple of months based on strong performance and delivery on their programs. You’ll see us sharing more with you on this customer success in the future. Our performance and balance sheet are unique in our market, and I’m really excited to capitalize on these assets in the coming months and years. We continue to have a strong multiyear runway with over $1.1 billion of cash on our balance sheet. That margin of safety gives us the runway to march towards profitability, both by improving the margin on our service fees via operational investments, and you’re going to hear about those from me later on this call, and eventually as well by reaching downstream value potential from our portfolio of programs. One more piece of exciting news before I hand it back to Mark to dive into our performance more deeply. I’m really thrilled that Shyam Sankar has agreed to be Ginkgo’s Board chair to provide his leadership. Shyam is currently the CEO of Palantir and joined our Board about eight years ago. So this gives you some perspective about a year after Ginkgo. And so Shyam has seen Ginkgo grow from about 50 people to our current scale as a company today. The intuition that he has built up over the last year is about that interface between biotechnology and what he’s learned being on the Board of Ginkgo and the tech industry that he’s immersed in at Palantir. I think is going to be particularly invaluable for Ginkgo coming up, especially now that you see new technologies like generative AI that are opening even more opportunities for biotech and tech to work together. Shyam’s experience building Palantir is going to be absolutely critical for us moving forward. So we’re super happy to have him taking over as Board Chair. I am also happy to report that our current Board Chair, Marijn Dekkers, will be staying on our Board as he hands the reins over to Shyam. I’d like to take a minute to personally thank Marijn for the effort he put into growing me and the senior management team at Ginkgo as leaders over the last four years. In his first year on the Board, Marijn would spend a day or more a week, I think meeting with our executives to help them grow as leaders, which has been absolutely critical as we took the company public. We’re going to have that institutional knowledge stay with the company on our leadership team. Marijn was coming in at the time from being the CEO of Bayer in 2016. And I’ll be honest, often large multinational company CEOs do not fit in with fast-paced growth company start-up culture. But Marijn was quite special; in his 30s, he was tapped to turn around a struggling company called Thermo Electron. Brian led the acquisition of Fisher created Thermo Fisher and designed really the dominant business model in the life sciences tools industry still to this day. Ginkgo has similar ambitions to redesign how biotechnology R&D is conducted across the industry. And I want to personally thank Marijn for his contributions, working with me directly to get our business model right here at Ginkgo. That is going to be a huge part of delivering on our mission of making biology easier to engineer. I look forward to continuing to work with both Marijn and Shyam in the years to come. Alright. Now, let me hand it over to Mark to give a little more color on our financial performance this quarter.

Mark Dmytruk, CFO

Thanks, Jason. I’ll start by discussing our cell engineering business. We added 21 new cell programs and supported a total of 105 active programs across 63 customers on the cell engineering platform in the second quarter of 2023. This represents a 44% increase in active programs year-over-year with significant growth in the biopharma, food and agriculture, and industrial sub-segments. Cell engineering revenue was $45 million in the quarter, up 2% compared to the second quarter of 2022, which had benefited from a large one-time milestone. Importantly, when excluding the impact of downstream value share, cell engineering services revenue was up 72% year-over-year. This is our largest-ever quarter for cell engineering services revenue and demonstrates the strong progress we’ve made in adding new programs and customers, driving platform efficiency and program execution. Now turning to Biosecurity. Our Biosecurity business generated $35 million of revenue in the second quarter of 2023, a solid result in line with expectations as this business transitions away from K-12 COVID testing services. We are continuing to gain traction on an international scale, now totaling 11 countries with either active programs, pilots, or MOUs including a new MOU with Panama, our first program in Latin America and an important international hub. Biosecurity gross margin was 49% in the second quarter of 2023, which benefited from a mix shift to higher-margin product sales. We have also expanded our U.S. government partnerships domestically with new programs that span both our cell engineering and Biosecurity priorities with IARPA and DARPA, which Jason will discuss in the strategic section. And now I’ll provide more commentary on the rest of the P&L. Where noted, these figures exclude stock-based compensation expense, which is shown separately. Starting with OpEx. R&D expense, excluding stock-based comp, increased from $73 million in the second quarter of 2022 to $104 million in the second quarter of 2023, representing growth and capabilities, particularly from our acquisitions in the fourth quarter of last year, including Bayer’s Ag biologicals facility and Zymergen. G&A expense, excluding stock-based comp, increased from $48 million in the second quarter of 2022 to $80 million in the second quarter of 2023. The increase in operating expenses and G&A, in particular, was impacted by several significant onetime costs in the quarter, the majority of which was non-cash. We provide additional details on this in our adjusted EBITDA reconciliation in the appendix. Excluding these onetime items, services revenue grew roughly twice as fast as operating expenses as we start driving efficiencies on our platform. Stock-based comp, you will notice a significant step down in stock-based comp again this quarter, similar to what we saw in Q1 of this year. As a reminder, this is because of the catch-up accounting adjustment related to the modification of restricted stock units when we went public is starting to roll off. While the bulk of that adjustment is done, about 60% of the total $62 million stock comp expense in the quarter is still related to RSUs issued prior to us going public. Additional details are provided in the appendix to this presentation. Net loss. It is important to note that our net loss includes a number of non-cash income and/or expenses as detailed more fully in our financial statements. Because of these non-cash and other nonrecurring items, we believe adjusted EBITDA is a more indicative measure of our profitability. We’ve also included a reconciliation of adjusted EBITDA to net loss in the appendix. Adjusted EBITDA in the quarter was negative $75 million compared to negative $24 million in the comparable prior year period. The decline in adjusted EBITDA was attributable to both the higher run rate of expenses in cell engineering and the as-expected decline in Biosecurity revenue. And finally, CapEx in the second quarter of 2023 was $14 million, which includes an expansion of our process engineering lab. In terms of our outlook for the full year, we continue to target 100 new cell programs. This represents rapid sequential growth and will require our team to launch more programs than we ever have before. This target is supported by a strong late-stage pipeline as well as operational investments we have made to improve our program launch process, which Jason will discuss in the next segment. We are, however, seeing a divergence between our program starts and our revenue due to both some market pressure in the industrial biotech segment affecting program size as well as strategic decisions we have made to structure programs with more fixed pricing and milestones, which impacts the timing of revenue recognition. While we are excited about the work we’re launching, we now expect our cell engineering services revenue to land in a range of $145 million to $160 million for the year. A quick note on some of the strategic decisions we’ve made. As we’ve structured more customer contracts with fixed pricing milestones, we recognized less revenue in the early phases of a program. For example, we have recently achieved an $11 million cash milestone from a customer as part of a larger contract. But because of the large size and relatively early stage of that program, Ginkgo will only recognize about $1 million of that as revenue in 2023 with the rest recognized over the course of a multiyear program. Similarly, we believe our success-based pricing model is a unique value proposition in the market and also a strong opportunity for Ginkgo to capture additional value on delivery. However, the nature of those programs means that revenue is only recognized at the end of the program. And so a subset of programs launching in Q2 and beyond will not have any revenue recognition in 2023. We remain confident in our pipeline and are seeing improvements in the unit economics of our programs but are updating our guidance to reflect these timing and market dynamics. As for Biosecurity, we maintain our original guidance of $100 million, as discussed in previous quarters. The end of the public health emergency represents a significant shift in the business, and the second half of the year is expected to look very different with the K-12 business largely rolling off. We restructured the business accordingly, refocusing our resources on the federal and international opportunities to build lasting Biosecurity infrastructure. I’ll also just mention that while we do not provide EBITDA or cash flow guidance, our internal forecast for cash flow has not changed for the year despite the lower revenue guide because in some cases, we receive cash ahead of revenue recognition. Additionally, we have moved to thoughtfully constrain cash expenditures as we’ve driven efficiencies across the platform. In summary, we’re pleased with our overall progress in the business while navigating a challenging macroeconomic environment. We’re continuing to scale our business with strong program additions and the largest quarter of cell engineering services revenue we’ve ever delivered, and we continue to manage our balance sheet and cash flows in a long runway while obtaining flexibility to capitalize on near-term strategic opportunities with $1.1 billion of liquidity at quarter end. And now, Jason, back to you.

Jason Kelly, Co-Founder and CEO

Thanks, Mark. Ginkgo just had its strongest quarter in core services performance. We started and signed more programs than we ever had before, and we drove higher platform output and thus higher services revenue than we ever had before. I’m going to dive into the drivers behind this in more detail coming up, but I also want to address why we’re taking guidance down despite the strength. So part of this is some market weakness. We have seen industrial biotech, particularly the venture funding in that space dry up, which is certainly having a near-term impact, largely in terms of potentially smaller sizes of programs that we’re seeing when we’re signing customers up this year in industrial biotech, although we’re still seeing growth in new programs really across all market segments. But the other factor that Mark mentioned is our deal structures, in particular, the success-based pricing model we introduced for some of our offerings that Ginkgo back in April. And I want to spend a minute on this because I think this pricing model is frankly a trade worth making, even if it means we see less revenue than we were hoping for in the second half of the year. The way I like to think about success-based pricing, so to give you an analogy. If you look back in the early 2000s, Google popularized this idea of pay-per-click ads, right? And prior to this, the dominant model was pay per impression, right? The issue with an impression is you don’t really know if it’s worth anything to you as a customer. You’re going to show it up there, and you don’t know if the person is going to click through and go to your website. Customers could have very different opinions about the odds of success of that impression, whereas pay-per-click ads offer surety to the customer of the value, and so they sold at a much higher price than impressions and ultimately replaced impressions as a model largely. I look at the R&D service business today, and it feels a lot like those banner ads. An R&D services company says to a customer, we will do a good job with the work, right? But ultimately, the technical success of that work is unpredictable. Whether we meet the spec you want, we’ll do what you asked, but will it succeed? That’s not our problem. Success-based pricing that Ginkgo is introducing is our version of pay-per-click. The customer knows they’re getting something of value. And that is a weapon for our sales team to drive better conversions and hopefully, better pricing over time, although it does mean that we won’t recognize that revenue until we complete successful programs. And so that pushes out revenue from new programs signed. Overall, I’m really excited about this pricing innovation. It is good for customers. It’s good for Ginkgo and it is built on the reality that our platform scale is moving some programs, not all, but some class of programs we’re doing at Ginkgo from really what I’d consider R&D with uncertain outcomes and pricing to reflect that and moving them into the bucket of engineering, where we can start to offer customers much more certainty of the value they’ll receive. That sort of pay-per-click approach is a big part of our mission of making biology easier to engineer here at Ginkgo. So first, I want to spend a minute about how Ginkgo is driving towards platform profitability by unlocking productivity gains in our technology. The second topic today is I’m excited to be able to talk to you about some of our most recent customer success stories and how we are penetrating large existing biotech R&D budgets. And then finally, we typically spend most of our time talking about commercial customers in cell engineering, but I did want to take a moment to talk about our government relationships more broadly as we get a lot of questions about that, and we’ve announced a few recently. We’ve been working on government contracts for about a decade now, and they’re some of our most innovative programs. Especially as Biosecurity transitions, I’m excited about the convergence between cell engineering and biosecurity that I’m seeing. So looking forward to talking about that. So, I like this flywheel slide because it shows why customers continue to bring their business to Ginkgo. When we’re offering our service platform to customers, those customers are choosing us because they want cell engineering that is less risky. I talked about that with our success-based pricing, faster, and cheaper than they could do in-house. But today, I want to look down at the bottom part of that flywheel and talk about how as we add more customers and more domain and we get to build a bigger platform and how a bigger platform drives improved economics and efficiency at Ginkgo. We’ve taken a lot of us in this journey from the history of the semiconductor industry. Electronics used to be largely manufactured by hand in the vacuum tube of electronics. With the advent of Palantir semiconductor manufacturing technology, places like Fairchild, and eventually Intel, electronics manufacturing saw enormous scale economics. In other words, you could automate semiconductor manufacturing. The cost per transistor on the chips fell dramatically. This ultimately became called Moore’s Law. We’re in that 1950s era when it comes to cell engineering today; it’s being done by hand, and that high cost and low quality ultimately limits the market for biotech today to really therapeutics and some agricultural products. We believe the potential is much bigger for biotech, and our hope is that by automating these processes, we can drive our own version of Moore’s Law and achieve scale economics that will ultimately move biotech into these new markets. Much of our focus, really, over the last eight years as we started tapping into venture capital and could invest in increasing automation infrastructure at scale, has been to broaden the platform to serve starting with different species of different markets, notably in the last four years, we added mammalian cells to our previous infrastructure in microbial and fungal. That’s been really important in pharmaceuticals. There’s been this big broadening of the platform while all running it through the common infrastructure across the more than 100 active programs we talked about earlier. About a year ago, there was an opportunity to start to drive increased scale, not just through adding more infrastructure, but through better operations and utilization of the existing infrastructure with better processes. We hired and built a world-class operations or industrial engineering team who did a deep diagnostic of the platform, literally diving in with clipboards and tracking exactly how much utilization we have of different equipment in the foundry. We tracked all that across our systems, and through that diagnostic, we saw that we could achieve a process improvement that could drive 1.7 to 5x higher throughput in how we use our equipment and nearly a 3x productivity improvement without needing major head additions. And so this year, with the cash we have today, alongside these operational improvements, we’re going to drive growth while keeping expenses in line, and we have ample cash runway and a path to profitability as a result. Successful execution is what drives real value. This brings me directly into our second strategic topic of the day: how we are delivering on projects for customers and how that drives loyalty and the thing I’m most excited about coming up, which is the penetration of large existing R&D budgets at a certain class of customers. As a reminder, Ginkgo operates across a wide breadth of major industries with both start-up customers and large customers. One of the things we pay close attention to is how we’re doing with customers, right? Are we delivering on their specs? Are they coming back for more work? Are they satisfied with the service they’re getting from Ginkgo? While it’s tough to create sort of apples-to-apples comparisons in our industry, I’m most proud that returning customers typically account for over a third of our new programs every year, even as we’ve accelerated growth and broken into new industries. This is our greatest mode of competency. Customers have to choose to use Ginkgo's platforms, so we have this great check-in reality to understand whether they’re coming back. I want to highlight a few examples today. We’ve signed our first deal with Sumitomo back in 2021 to develop more sustainable bio-based chemicals. Due to our successful progress in that program, we’ve since launched two new programs with them in broader areas of their business. One other customer worth highlighting here is Givaudan, one of our earliest customers. They have a commercial product that we helped them make in those early days, now coming out of into technology. We continue to work with them today, signing a larger platform collaboration a couple of years ago. Just on Monday, I was happy to announce a second broad collaboration with Merck. This builds on our biocatalysis deal that you saw us announce late last year. This is exciting because this is different from our first program with Merck and highlights how, as we get to know a customer, they get to see where our platform can apply across their whole R&D enterprise and help their scientists in developing and manufacturing therapeutics. I want to make sure it’s clear that just because we often talk about our private sector relationships that our government programs are some of our most innovative, and they help push the platform forward in many ways. We are planting the seeds of the Biosecurity industry. The customers for that market are ultimately governments worldwide. We’ve been privileged to work with DARPA on about a half dozen programs over the years. However, what’s unique about the government as a customer is that they not only think about products that would be useful today but also the critical infrastructure necessary to allow whole new product categories and industries to flourish in the future. As I mentioned, this is a big idea from my standpoint for the synthetic biology industry: how are we able to open new markets and applications in the future. The recent programs with DARPA and IARPA are focused on cell-free protein synthesis to enable rapid high-yield distributed production of human therapeutic proteins supporting national security objectives. The most recent program with DARPA is focused on cell-free protein synthesis – being able to make proteins without a cell producing the protein to enable rapid high-yield distributed production of human therapeutic proteins supporting national security objectives. IARPA has collaborated with us previously on programs, such as a radar for genetic engineering, where we check a sequence and ask if it was engineered. The new program is focused on biosensors that continuously record and store genetic expression data, like the flight recorder in an airplane. We want to have that same idea for what’s going on inside of cells to understand the mechanisms of action for emerging threats and be able to respond efficiently. One of the things I’m excited about as we make this transition in our Biosecurity business is that the interface between Biosecurity and cell engineering is strengthening. Across the biosecurity value chain, our cell engineering business is benefiting from the insights coming back from that monitoring business we’re building out internationally and contributing valuable tools back to that Biosecurity work. This is particularly strategic as we leverage more AI tools across our platform, where the structured and unstructured data sets are becoming increasingly strategic and valuable. In summary, I am really excited about the great work the team delivered on this quarter. They should be really proud of it, and I’m looking forward to continuing the efficiency gains from scale in our platform that are already paying dividends for the company. Alright. Now I’ll hand it back to Anna Marie for Q&A.

Anna Marie Wagner, SVP of Corporate Development

Great. Thanks, Jason. As usual, I’ll start with a question from the public. And then just reminding the analysts on the line that if you’d like to ask a question, please raise your hand on the Zoom, and I’ll call on you and open up your line. Thanks, everyone. Alright. Welcome back, everyone. As usual, we’ll start with a retail question, and then I’m just going to go down in the order folks raise their hand. So Rahul, you’ll be up first, and I’ll open your line. The first question comes from Brandon A797 on, I think it’s called X now, is it called X, Twitter? Do you envision a robotics brute force heavy future, an AI software computational future, a mix of both? Or is there another path in order to make biology easier to engineer? And why do you believe it’s the best approach?

Jason Kelly, Co-Founder and CEO

That’s a really great question. We are focusing heavily on this at Ginkgo, especially given our significant investments in laboratory automation. Essentially, we foresee the emergence of foundational models in the biology sector, which will then be enhanced with task-specific data training. This data will pertain to particular activities, like enzyme functions or antibody binding. The challenge lies in obtaining that specialized training data, which can be achieved through automation in our foundry. I believe Ginkgo is well-positioned to produce this type of task-specific data for training models on top of these foundational models in biology. Our clients are likely to approach us for this kind of training data as they increasingly recognize the importance of large biological datasets. It's also worth noting that persuading established companies with extensive R&D teams to shift to our infrastructure can be challenging, as it requires them to rethink their processes. However, the AI revolution provides an opportunity for these companies to consider the benefits of leveraging large datasets to enhance their work. I believe the answer will be affirmative in biotech, aligning well with Ginkgo’s current automated processes and our future direction with AI tools.

Anna Marie Wagner, SVP of Corporate Development

Thanks, Jason. Alright. Rahul, I’ve just opened up your line, and you should be able to ask your question.

Rahul Sarugaser, Analyst

Terrific. Can you hear me okay?

Anna Marie Wagner, SVP of Corporate Development

Yes.

Rahul Sarugaser, Analyst

Thanks so much, Henry, Jason, and Marie, for taking our questions. I just want to quickly start by saying that the project appeals to me as a Star Wars nerd. Sounds pretty awesome.

Jason Kelly, Co-Founder and CEO

I’m glad that landed.

Rahul Sarugaser, Analyst

So clearly, there will be some big changes in the deal structure that you’ve announced: the fixed base pricing, the success-based pricing. So could you give us a little more color on how you’re seeing this evolving into the Q3 pipeline? And then also now looking forward in the future years, as the backdrop changes, is there a potential for a reversion to the previous model or some sort of hybrid?

Jason Kelly, Co-Founder and CEO

Yes. I’m super excited about this. I tried to get it across in sort of my statements, but I’d love to add to it, Rahul. If you think of what we offer as fundamentally R&D services to the market, why is something coming out of a company’s R&D budget and not their cost of goods for a product? The answer is, R&D is a special thing; it’s something you spend money on and hope works. Our view is biotechnology as a whole, like genetic engineering, falls squarely in the R&D bucket today. Everyone considers it to be unpredictable. We’re finding that at a certain scale of infrastructure at Ginkgo and with a certain amount of previous learning, we can drive predictability in the work. Once we know a certain class of projects is predictable, I want to turn to basically make that obvious to the customer. I want it to be that you only pay us when you get a project that works because it’s obvious to you as a customer, and it might even be able to come out of a budget that isn’t the R&D budget, which would be particularly exciting. I’m really excited about this direction. I don’t expect us to revert back; I think this is ultimately conveying the value I’m giving to customers. What I’m hoping is to expand the aperture of the types of programs I could offer this for.

Rahul Sarugaser, Analyst

Great. Thanks so much for taking our question.

Anna Marie Wagner, SVP of Corporate Development

Thanks so much, Rahul. Matt Sykes from Goldman Sachs. I’ve just opened your line; you should be free to chat.

Matt Sykes, Analyst

Hey, good afternoon. Thanks so much for taking my question. Maybe just following up on Rahul’s question on success-based pricing. Could you talk about maybe what you expect the average duration of those success-based pricing programs to be? And sort of what you envision as a percentage of programs that are going to be success-based? What I’m really trying to get at is if the phasing of the revenue is going to change to kind of help us model a little bit better, how do we kind of size the success-based programs without actually disclosing how many that are in the pipeline?

Jason Kelly, Co-Founder and CEO

Yes, Mark, I don’t know if you want to comment on this a little bit. I can say that for the types of programs we’re going after, for success space, which again is in this area of enzyme design and protein production, these are shorter time line contracts, so think of the order 6 months, a long one would be a year, something like that.

Mark Dmytruk, CFO

Yes. The average duration, let’s say, is in that sort of 6 to 12 months range with some plus or minus around that range. So they are much faster duration programs that are also lower in program size. When you think about, Matt, like the sort of revenue per quarter from a program, it would be lower; we would expect it to be lower than what you’ve seen as an average in the past, but that is also somewhat mitigated by the lower duration, right? So, the amount of revenue that we are able to push through in a quarter would be lower. In terms of kind of the percent of programs, I guess the way I would think about it is if you think about 2023, the 100 program target. So, let’s just call it a round number. We have 70 more programs to go. We do expect the success-based payment type program to be a meaningful component of those 70 programs to go. It’s not like half, for example; it’s not the majority. It’s less than that, but it’s a meaningful component of the 70 programs to go. So, if that helps you a little bit in terms of thinking about percentage of total business.

Matt Sykes, Analyst

That’s really helpful. And then just one follow-up. As we are again sort of on the modeling side for the services business for cell engineering, as we look at sort of the growth of that revenue, should we be thinking about that as generally all organic? I know there are buyer payments and things like that to come in. But just in terms of the $26 million from Q2 to Q4 million this year. Is that generally thought of as organic? And how we should think about it, or are there kind of acquisitions in there as well?

Mark Dmytruk, CFO

Yes. Generally, yes, you should just think of it as organic. We do have a large contract with Bayer, but remember, that was a contract we acquired in effect as part of that acquisition. It wasn’t a book of business that was given to us as part of that transaction.

Matt Sykes, Analyst

Got it. Thank you very much.

Anna Marie Wagner, SVP of Corporate Development

Thanks, Matt. Alright. Edmund from Morgan Stanley, I have just opened up your line. Edmund, if you are trying to speak: you are on mute.

Matt Sykes, Analyst

Hey guys, thanks for taking my questions today. In terms of the reduced guidance in cellular engineering, I was wondering if you guys can parse out how much of the adjustment was driven more by the fixed pricing in milestone-based contracts versus success-based pricing models versus margin weakness?

Jason Kelly, Co-Founder and CEO

Yes. Mark, do you want to speak to that one?

Mark Dmytruk, CFO

Yes. I would say, if you think about the reduction from the $175 million plus, certainly, the majority of that reduction is because of the timing of revenue recognition. I would say the timing of revenue recognition is about 50-50 between the fixed price milestone component and the success-based payment component. Then the remainder would be the market impact we are seeing in terms of the industrial biotech side.

Matt Sykes, Analyst

That’s very helpful. And then in terms of your success on the payment model, I am just wanting to check if I heard correctly: it’s only available in the enzyme services offering. Is that correct?

Jason Kelly, Co-Founder and CEO

Yes, it’s in enzyme services and also in protein production. If our scientists look at that and say, 'Hey, that’s a real stretch,' we would be interested in doing it still, if you want to take the research risk on it, but we consider it a risky project, and will get paid more traditionally. If it falls in our bands, then we would price it as success-based.

Matt Sykes, Analyst

Got it. And then on your IARPA contract, that sounds very interesting. Can you tell us more about this study every quarter and share some economics behind the contract? Should you be successful with these biosensors be leveraged by new Biosecurity business, or could there also be applications in cellular engineering as well?

Jason Kelly, Co-Founder and CEO

Yes, I guess would be, I don’t know what we have released exactly on the contract economics. Yes, I mean I could generally speak to the opportunity. I would say in biosensors broadly – what I like about these programs is they are usually pushing the envelope of what you can do with the technology. You can deploy things in the field that are able to sense and ideally record what’s going on with like the sensing apparatus of biology, which is pretty powerful. That’s one application. You can use biosensors for certain types of performance of a cell. You can incorporate those into the cell itself that you’re engineering, and use that to have an in vivo check for the performance of your genetic design. When you can pull that off, you can really scale up the number of designs you can test per dollar. We have a whole group here at Ginkgo that does strain selection type activities, where there are real experts in generating biosensors and making our projects less expensive and at higher throughput for customers. So, we have been doing this for a while, but it is new to imagine some of the things you could do with it out in the field.

Anna Marie Wagner, SVP of Corporate Development

Thank you so much, Edmund. Madeline from William Blair, you’re up. I have just opened up your line.

Unidentified Analyst, Analyst

Hi. Thank you so much. This is Madeline on for Matt Larew. One question, I feel like this has covered a little bit in the deck, but you recently announced a lot of new programs with organizations that you have done previous programs with. Can you talk at all about the economics for repeat customers, or is there any sort of bulk economics deal that you do with customers that you know you will do multiple programs with?

Jason Kelly, Co-Founder and CEO

Yes. I don’t think we – other than what we would have announced publicly like project-to-project, I don’t think we have specified on a particular customer. I would say two things: Generally, doing future projects with customers puts us in a better position because the first project is like a kick in the tires pilot. People are often just trying to wrap their arms around whether Ginkgo can really hold up, and I would say as we get better deals over time. You also brought up this idea of an umbrella deal. Yes, we have set that up with a number of our longer-term customers where we can make it easy to add new programs without renegotiating a gigantic IP contract. That is great, and I’m very excited to see more of that.

Unidentified Analyst, Analyst

Great. That was super helpful. And then just one more for me. I think last quarter, you said about 20% of the Biosecurity revenue was anticipated to be recurring. Is there any way you can give color on what you would expect that for this quarter and how you see that trending long-term as some of the K-12 revenue rolls off?

Mark Dmytruk, CFO

Sure, I will take that. A similar sort of number in Q2, but more importantly, if you think about the back half of the year. That implies about $20 million of revenue in the second half of the year. You should assume that the K-12 has largely or almost completely rolled off out of that number. That gives you a bit of a sense of what the exit run rate in that business is based on the contracts we have in play today. You should assume, of course, that there is a significant pipeline of opportunities that we are looking to close.

Jason Kelly, Co-Founder and CEO

I would echo that. Our general insight on Biosecurity has been that it’s a combination of an emerging market and a pandemic, which had a lot of volatility. We try to provide guidance based on what we have in hand, and we will keep doing that, so yes.

Unidentified Analyst, Analyst

Great. Thanks so much.

Anna Marie Wagner, SVP of Corporate Development

Thanks, Madeline. Alright. Steve Mah from Cowen, I have just opened up your line.

Steve Mah, Analyst

Okay. Great. Thanks for the questions. Of the 21 new program adds, could you provide some color on what industry sectors these new program adds were in? Any color would be appreciated on any particular areas of strength, and has there been any deviations from what you have seen previously on the new program adds?

Mark Dmytruk, CFO

It’s the same story, Steve, as we have seen in the past, which is that the program adds are coming from pretty much across the sectors we play in. Biopharma was a contributor, but industrial was also a good contributor. You can sort of back into roughly what’s happening with the industries, but it’s the same. We’re happy the adds are coming across all the industry segments.

Steve Mah, Analyst

Okay. Thanks. And then if I could sneak one in. How should we think about the gross margin of the Biosecurity business now that you are getting away from K-12?

Mark Dmytruk, CFO

You should expect us to target gross margin in the 40% plus or minus range. If you go back and look at the history of Biosecurity, it fluctuated quite a bit, sometimes from quarter to quarter, but you could draw a line and say, well, that’s sort of where it normalizes. So, it’s going to take us some time to figure out what the right sort of normal gross margin is.

Jason Kelly, Co-Founder and CEO

I just want to mention regarding the program adds. We have closed a certain number of deals per quarter and also have an extensive sales pipeline. We have a really valuable sales machine that has built up nicely, and I think it feels healthier than it’s ever felt.

Anna Marie Wagner, SVP of Corporate Development

Thanks, Steve. Alright. Mark Massaro from BTIG. I have just opened up your line.

Mark Massaro, Analyst

Great. Can you hear me?

Anna Marie Wagner, SVP of Corporate Development

Yes.

Mark Massaro, Analyst

Well, thanks for the time, guys. I am curious what percentage of your work is related to enzyme design in protein production. I would love a little more insight on that as it relates to cell programs or maybe just cell engineering revenue as a whole.

Jason Kelly, Co-Founder and CEO

You want to do the first one, Mark?

Mark Dmytruk, CFO

Yes, we would have to get back to you on that. It’s just a cut that I don’t usually look at.

Mark Massaro, Analyst

Got it. And then your second question—I guess, in terms of the pathway to reintroducing part of this, do you envision there could be opportunities with great demand and supply constraints of labor?

Jason Kelly, Co-Founder and CEO

Yes, for the ordering. We haven’t quite figured out how to maximize utilization efficiently. I mean to help with the pricing model pivot around that would either mean figuring out when and how that pricing model can fit or structured.

Anna Marie Wagner, SVP of Corporate Development

Thank you very much for your question, Mark. Alright, we are time-constrained. I’ll go and open up your line for the last question.

Unidentified Analyst, Analyst

Hi. This is Annabel on for Gaurav. Thank you so much for taking the question. Going off of Mark’s last question, could you elaborate a bit on how much macro headwinds are affecting new programs, if at all?

Jason Kelly, Co-Founder and CEO

Yes, so the answer is yes in the category of industrial biotechnology. Ginkgo serves agriculture biotech, pharma biotech, and industrial biotech. Those are the three big existing biotech markets. There’s also other emerging areas that have not yet developed so much. That has really created headwinds in that space and shrunk the appetite for deal size; for example, in industrial biotech. Mark can comment on how much. You don’t see it quite as much in the therapeutic space because that industry has a little more momentum behind it, but in the industrial sector, there are certain categories that just aren’t going to get funded now.

Mark Dmytruk, CFO

Yes. I mean that covers it. To reiterate, the majority of the reduction in guidance is due to timing of revenue recognition. A part of that is the success-based payments, but part of that is just the way the fixed-price milestone contracts are structured.

Unidentified Analyst, Analyst

Okay. Great. Thank you so much.

Anna Marie Wagner, SVP of Corporate Development

Thanks, Annabel. Alright. We are out of time. Before we go, any final thoughts from you, Jason?

Jason Kelly, Co-Founder and CEO

We haven’t talked too much about it, but I did – my first category of strategic topics was around adding lots of programs without greatly increasing our company-wide spend. Those efficiency gains in the platform are a big part of our motion in the second half of the year. Delivering on being able to do all those new programs in a more efficient way is key to our continued operational improvements in the second half of this year. That’s something I think you all can watch through the numbers here. This will be an exciting efficiency push towards profitability, so yes.

Anna Marie Wagner, SVP of Corporate Development

Thanks, everyone.