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Good afternoon, and welcome to Sonendo's Second Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. I would now like to turn the call over to Louisa Smith from the Gilmartin Group for a few introductory comments. Please go ahead.
Thanks, operator. Good afternoon, and thank you for participating in today's call. Joining me from Sonendo are Bjarne Bergheim, President and CEO; and Michael Watts, CFO.Earlier today, Sonendo released financial results for the quarter ended June 30, 2023. A copy of the press release is available on the company's website.Before we begin, I'd like to remind you that management will make statements during this call to include forward-looking statements within the meaning of federal securities laws, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Any statements made on this call that relate to expectations or predictions of future events, results or performance are forward-looking statements. All forward-looking statements, including those relating to our operating trends and future financial performance, the impact of COVID-19 on our business, expense management, expectations for hiring, growth in our organization, market opportunity, revenue guidance, commercial expansion and product pipeline development are based upon our current estimates and various assumptions.These statements involve material risks and uncertainties that could cause actual results or events to materially differ from those implied by these forward-looking statements. Accordingly, you should not place undue reliance on these statements. For a list and description of the risks and uncertainties associated with our business, please refer to the Risk Factors section of our most recent annual report on Form 10-K filed March 8, 2023, with the Securities and Exchange Commission and available on EDGAR and in other public reports filed periodically with the SEC.This conference call contains time-sensitive information and is accurate only as of the live broadcast on August 9, 2023. Sonendo disclaims any intention or obligation, except as required by law, to update or revise any financial projections or forward-looking statements, whether because of new information, future events or otherwise.And with that, I will now turn the call over to Bjarne.
Thanks, Louisa. Good afternoon, everyone, and thank you for joining us today.For this call, I will start with some commentary about second quarter performance, business highlights and forward-looking strategy before turning the call over to Mike to provide additional detail regarding financial results. We will finish with Q&A.During the second quarter, we continued to see increased adoption of our technology while also navigating a challenging market environment. Total revenue for the quarter was $11 million, in the range from our expectations. While we acknowledge that revenue was to the low end of quarterly guidance, we remain confident in the strong foundation of the business, the uniqueness of the technology and that we will ultimately capture long-term value.I'd like to spend some time discussing the second quarter results and specifically highlight some of the challenges we have experienced at the top and bottom lines. I'll then provide some detail regarding specific initiatives that we have already begun implementing for the remainder of the year, including top line growth drivers, margin profile improvements and balance sheet preservation.In the second quarter, the team delivered 5% year-over-year revenue growth. PI sales for the second quarter totaled $5.6 million, representing a 16% year-over-year increase. We're very pleased with the year-to-date performance of procedure instruments and the positive benefits of our new pricing program. CleanFlow adoption also improved, reaching over 60% penetration, and we are now projecting to be significantly ahead of our 2024 targeted time line for full conversion.Turning to console placements. We experienced a decline in placements year-over-year and moderate sequential growth over Q1. There are several reasons as to why this was the case, many of which are dynamics we have communicated over the past year in prior calls and at investor conferences. But today, I'd like to address the headwinds in capital sales and what we're doing to drive console placements going forward. During the second quarter, we had several late-stage opportunities where potential buyers chose to delay making a purchasing decision. They are not falling out of the sales pipeline, and we believe they will adopt GentleWave later in the year. We attribute much of this delay to macroeconomic uncertainty and related to increasing interest rates.As we have noted in previous calls, our pipeline and interest in GentleWave remains strong. We are generating more new leads than in prior quarters and have more opportunities that we continue to nurture within our pipeline than at the same point last year. We're seeing constraints primarily on timing of capital expenditures at dentist offices and other financial considerations. The implication of these dynamics is an elongation of our sales cycle. When we look at the first half of the year, the vast majority of deals that we have signed continue to be with endodontists with only a limited number of console sales attributed to dentists within the GP channel. There is significant runway of untapped customers in the GP segment, particularly in higher-volume dental practices. We've noted previously that the GP rollout would be a measured strategy to ensure the high level of service Sonendo has become known for and provide us with the opportunity to address this new channel.An analysis of the funnel entering the second half shows a more equally weighted pipeline between GPs and endodontists. The majority of GPs do not know about the GentleWave procedure and the value proposition it brings to their practice. But as we educate them through our sales team, we're encouraged by their enthusiasm. An example of this is our recent attendance at the Florida Dental convention, where there was a lot of interest and discussion around how the technology works and how to integrate it into their practice. This gave us great exposure and is similar in experience to other GP-focused trade events. Therefore, we believe the demand generation we have cultivated in the initial stages of our GP strategy will produce a higher proportion of sales within that segment in the future.Associated with the earliest GP accounts, we've gained some important learnings for our long-term strategy. The sales team is seeing 3 distinct segments where GentleWave delivers a significant value proposition to their practices. The first segment consists of GPs that were already keeping procedures in-house. As a result of GentleWave, they're now able to offer not only a better patient experience, but reduced chair time but also increase practice productivity and potential referrals from satisfied dental patients. The second segment are those GPs that see the potential for leveraging GentleWave to offer same-day endodontic workflows that include both the endodontic and restorative procedure and therefore, increased revenue per chair.The third segment represents those GPs that had previously been referring out root canals and who are now able to keep them in-house to produce an additional revenue stream for the practice. In all these segments, our system allows these doctors to confidently treat their patients. One GP who recently adopted GentleWave shared with our sales team that, and I quote, "This machine gives the confidence to perform high-quality RCTs on most molars, which we previously didn't do. The disinfection of the root canal system is now perfect every single time." We're still in the early stages of what we believe to be a significant growth opportunities for GPs, and we remain confident that investing in the GP channel is the right strategy for the business at this stage.Consequently, we reallocated resources to increase awareness and demand from new doctors specifically within the GP segment, while also moving investments into educational events and activities that have historically been important closing initiatives. We have several programs that allow doctors to get in-office access to GentleWave that allows them to evaluate how the system works for their business model and how it fits into their practice workflow. Additionally, we're focusing investments to drive professional media, specifically for this segment. Building out this GP channel strategy should prove valuable as we move through Q3 into Q4, which has historically been our largest quarter due to the increased purchasing trends that a company doctors benefiting from tax incentives.In conjunction with our GP channel initiatives is our approach to the DSO or dental service organization market. This includes both specialist DSOs and other GP DSOs. We're pleased to announce that we have recently hired a corporate account leader that has direct responsibility for the development and implementation of our DSO strategy and who comes with substantial experience within the DSO market. There are thousands of DSOs in the United States and Canada and the new corporate account role is a reflection of our commitment to put more attention and focus on a critical market opportunity. While we're bullish about the opportunity to expand the GP channel and gain traction within the DSO market, we have not relented on the focus on endodontists. Endos remain an underpenetrated market with less than 20% of the over 5,000 endodontists in the United States and Canada, utilizing the GentleWave system. It remains an important strategy for Sonendo moving forward and one that we will continue to commit resources to.Moving to the bottom line, I'd like to focus some of our time to discuss margin expansion. The second quarter gross margins were negatively impacted by the result of specific accounting adjustments. Mike will discuss the details of those charges during his remarks, but I'd like to address our action plan to return higher margins as we exit 2023 and prepare for accelerating improvements in 2024. Regarding an improvement to margins on our procedure instruments, first, one of the charges we took in Q2 will accelerate our adoption of CleanFlow by exiting its supplier relationship and canceling a future order relating to the Molar PI.Second, and this also relates to gross margins, on August 1, we announced that the CleanFlow PI is now indicated for use on interior teeth. Until now, interior teeth required the use of a separate PI, the APM to be used for the GentleWave system, requiring multiple manufacturing line and sourcing of alternative materials. These steps mark important milestones within our planned margin expansion and goal of one PI for all teeth at the start of 2024. Having one PI will greatly improve our ability to achieve economies of scale, simplify the product portfolio, achieve supply chain consolidation and ultimately results in higher contribution margins.Turning to consoles. As we discussed in our first quarter call, we have made the decision to bring G4 console assembly in-house. The assembly line is fully operational, and we have already placed a number of internally assembled units with customers. In-house assembly not only allows us to focus on optimizing the manufacturing process, it also ensures closer supervision of the entire supply chain and oversight for quality control for units in the field. We anticipate that we will be able to accelerate cost reduction, leverage internal resources and therefore, margin improvements by making this change.And finally, I'd like to touch on our ongoing strategies for balance sheet preservation and expense management. In June and July, we implemented an approximate 10% reduction in force and cut future expenditures to reduce our cash burn. We are continually reassessing our spending requirements, and we are prioritizing a tighter expense program in the near and longer term.In summary, we're allocating resources to accelerate GentleWave adoption and have multiple initiatives to improve gross margin and reduce cash burn.I will now turn the call over to Michael Watts, Sonendo's Chief Financial Officer, and then return for some closing comments ahead of the questions-and-answer session. Mike?
Thanks, Bjarne.As previously stated, Sonendo total revenue for the second quarter of 2023 was $11 million compared to $10.5 million for the second quarter of 2022, an increase of 5%. Q2 Products segment growth was 4% versus the prior year, with an increase in PI revenue, partially offset by a decline in console revenue. PI revenue was $5.6 million compared to $4.8 million in the second quarter of 2022, an increase of approximately 16%. PI revenue growth was driven by new PI pricing program, which resulted in an approximate 17% increase to average selling prices compared to the prior year period. Procedure instruments sold in the quarter totaled over 73,000. As we had mentioned during our Q1 2023 earnings call, PI sales out were higher in Q1 due to customers buying ahead of the 2023 price increase. We believe this negatively impacted Q2 volumes by approximately 5%. Note that year-to-date PI revenue is up 24% over the same period for 2022, reflecting positive results in our pricing program and utilization.In the second quarter, GentleWave console revenue was $2.2 million compared to $2.7 million in the second quarter of 2022, with reasons for the decline addressed in Bjarne's commentary. The average selling price for the GentleWave console was roughly $60,000, sequentially lower with an unfavorable ASP mix attributed to special pricing on the legacy GentleWave Gen 3 console. Total other product-related revenue was $1 million in the quarter. Total software revenue for the second quarter was $2.3 million compared to $2.1 million in the second quarter of 2022, an increase of 8%. TDO continues to perform well and gained favorable traction in group practices.Gross margin for the second quarter of 2023 was 10%. This represents a decline versus Q2 2022 and Q1 2023. As Bjarne previously mentioned, within the quarter, we recorded 2 charges relating to inventory. The first charge of $1.7 million relates to an excess quantity of our legacy Gen 3 consoles and reflects lower-than-anticipated demand of Gen 3 driven by customers choosing the newer G4 console. We are committed to supporting our Gen 3 installed base and plan to continue to offer Gen 3 as an option for customers, albeit at lower quantities than planned. The second charge of $1.2 million relates to the retirement of legacy procedure instruments, the Molar and APM and termination of a supplier relationship for those products. Our plan to accelerate the transition to one PI with CleanFlow will lead to sustained margin improvements in the second half of 2023 into 2024. Excluding these adjustments, gross margin for the second quarter would have shown positive improvement year-over-year and sequentially from Q1 of this year.Total operating expenses in the second quarter of 2023 were $18 million compared to $16.8 million in the same period of the prior year. Increases were driven primarily by higher general and administrative costs relating to stock-based compensation, recruiting and legal expenses and higher sales and marketing expenses related to increased revenues, offset partially by lower R&D spending.Loss from operations was $17 million in the second quarter of 2023 compared to $14.3 million in the second quarter of 2022. Net loss was $17.7 million for the second quarter of 2023 compared to $15.1 million in the second quarter of 2022. Our cash and cash equivalents and short-term investments as of June 30, 2023, were approximately $65.9 million, while long-term borrowings remained at approximately $40 million. As noted in our earnings release, Q2 cash and cash equivalents includes the receipt during Q2 of the entire $4.4 million employee retention credit recognized in other income in 2022.As for our 2023 financial guidance, we now expect net revenue to be in the range of USD44 million to USD46 million. This guidance reflects the dynamic that we have seen over the first half of the year with respect to lower-than-expected console pipeline closure rates and an elongation of the sales cycle of GentleWave consoles. We are expecting third quarter revenue to range between USD10.2 million and USD10.6 million.Now back to Bjarne for closing comments.
Thank you, Mike.I'd like to end by saying that we remain steadfast in our commitment to driving sustainable success of the GentleWave procedure and are encouraged by the growth opportunities that lie ahead. I'm proud of the progress Sonendo has made in revolutionizing endodontic care, we strongly believe in the business fundamentals and sound infrastructure and anticipate that the back half of 2023 will bring more predictability to the sales cycle. We're committed to value creation not only for our shareholders, but also for this industry as a whole and intend to continue prioritizing drivers for long-term growth.At this point, I'd like to open the call up for questions.
Thank you. [Operator Instructions] Our first question today comes from the line of Jason Bednar from Piper Sandler.
I actually want to pick up maybe where we just left off there in the prepared remarks, maybe on the purchase delays and the slowed adoption here in the current macro environment. I think you've been referencing these now for the past year or so, at least with respect to your business. But I'm curious if you could elaborate on what the root cause of the elongation of the purchase decisions in 2Q were and maybe what you expect here over the next couple of quarters. Just any extra color is behavior deteriorating versus where we sat 2 or 3 quarters ago, are the effects of rising interest rates just having a larger effect on your business, really just trying to reconcile kind of what you're seeing out there versus what seems like maybe more stable or even in some cases, improving tone from some other parts of the equipment market.
Well, thank you, Jason. Let me just start off by saying that we are not happy with our performance in Q2. We're making some changes to change our trajectory. It's going to be critical for us to have a clear pathway to cash flow breakeven. So you're going to see us being acutely focused on top line growth, margins and cash preservation. I think you're asking a very, very good question. We have talked about the purchase lates, if you will. So let me try to give a little bit more color specifically around this. I think what we're seeing, like we have said before, is that macroeconomic conditions are making console sales slower to prospective customers. And I think for us, I don't think we realize to its fullest extent how significant the macro economy is to the decision-making process of these small business owners. No, I think the other thing that we've looked at is how we're now penetrating into this market. Specifically, as we move deeper into the endodontic segment or the endodontist segment, if you will. I think we're approaching endodontists that are point one, they're comfortable with patient care they're providing. And two, they're happy with the way their business is currently being run. As a result, we're approaching many doctors that don't necessarily see the need to change. So we're not seeing customers that say no. They're just delaying their decision to later in the year.Now the other thing I would say is that these customers have invested a lot of time with us. They're deep into our sales funnel. They've spent a lot of time going through our sales process. So they're actively engaged, and that's also one of the things that we've looked at to really get a sense of exactly what's going on. We also surveyed our customers to understand their thinking, just to make sure that our understanding of the mechanics, if you will, in the market is correct. And it just confirms effectively our thinking here. So we have put together some specific actions that we have put in place to really go after this, and that's something that we can allude and talk more about.But I also just want to hit the last portion, I think, of your question, whether or not this is deteriorating or not. What we're seeing in Q2, what we saw in Q2 is similar to what we saw in Q1. So we're not seeing a deterioration. We're just seeing that the macro is stable, if you will, on impacting our customer in a similar way to what we have seen in the past.
Okay. All right. Very helpful. Maybe looking at the gross margin or maybe the adjusted gross margin is probably a better reflection. I mean it definitely took a nice step forward here. So this is, I think, now the third consecutive quarter of gross margin improvement. After you've taken these actions, it sounds like they probably accelerate the path to improvement. I guess with some of these other actions that you have now on the PI side. Where do you think we are maybe we're sitting a year from now with gross margins? I mean are we talking about still some step function improvements in gross margins? Or just any other thoughts on the trajectory we're on here because it seems like that is an improving part of the story here, not just for the rest of this year, but going forward in '24 too.
Jason, it's Mike. I'll take the first part of that and then let Bjarne add color. But as you indicate, if you [ plot ] the adjustments that we took in the quarter, our performance was a step up sequentially and year-over-year. And what we're expecting for the rest of the year is that we would see gross margins in the mid-30s. So definitely an improvement over Q1 last year, mid-30% for the remainder of the year. And that is really due in large part to having our progression and our strategy to have one PI around CleanFlow. And then also, as we bring G4 in-house and leveraging and benefiting from scale of our production capacity here. I would also add that the adjustment that we took for PIs will help us to accelerate our movement to CleanFlow into 2024. So we're expecting CleanFlow to be earlier than what we had previously communicated. We previously communicated middle of 2024 for conversion, and now we're seeing that much earlier in the year potentially at the beginning of the year with January.
Maybe just let me add just a few comments there. Mike is spot on here talking about CleanFlow because that is ultimately our key margin driver, and that's something that we're acutely focused on. For point one, we're launching CleanFlow for interior teeth. Obviously, that will help transition customers over to CleanFlow. Point two, as Mike was alluding to, we took this extra charge extricating ourselves from a supplier agreement, which means that we will effectively be converted to CleanFlow at the beginning of 2024. And the other thing is that we also released an enhanced CleanFlow that will further simplify the CleanFlow technology just to make sure that customers have an incredible experience with CleanFlow. And that ultimately just simplifies the entire operations for us. We have one PI, it simplifies the supplier side, the manufacturing side, the training side, sales side and just really will be a key element as we continue to drive margins.
Okay. Great. And then maybe one more from my side. Just curious, Mike or Bjarne, just if you're comfortable offering up a view now on cash burn expectations as we move forward, again, over the next, say, 6 to 12 months, you are taking some actions here to protect the balance sheet. That was very clear in the prepared remarks. But again, sorry if I missed it, but where do you think cash burn goes here moving forward?
So as Bjarne indicated, we're committed to reducing our cash burn. We're expecting a sequential reduction in cash burn when you exclude the benefit that we received from the ERC. So the ERC in Q2 gave us a benefit of $4.4 million. So if you exclude that, we'll see a sequential improvement in cash flow for Q3 and Q4. And the reduction in positions that we've taken and other expense reduction efforts will contribute to that. And then also an added benefit of moving to one PI, we're able to get more leverage out of our balance sheet and the inventory position.
I would just add that we're going to continue to look at expenses as we go forward here. And we're going to be just stay very, very acutely focused to ensure that we continue to have a strong balance sheet, looking at any no different opportunities here to preserve the balance sheet as we go forward.
The next question today comes from the line of Sarah Conrad from Goldman Sachs.
I guess I wanted to start first on the procedure instrument volumes. Looking at the 17% price increase and even including the 5% pull forward into the first quarter, it still seems like we might have seen a sequential step down. What is driving that? Is that pull back because of the pricing? Or are we seeing lower volumes per console would just love a little bit of color.
Sarah, it's Mike. I'll take the question and then again ask Bjarne if he has anything to add. But when you look on a year-to-date basis, we see a year-over-year increase, double-digit increase in procedure and instrument sales out and utilization. I think what you may be alluding to is when you look at a per console basis in utilization per console, we did see a dip on that basis, roughly around 4% to 5%. Now that was within the range of our expectations when we had done the pricing increase, the analysis surrounding that. We anticipated that some customers may make the choice to not use GentleWave on certain procedures. But we're still very pleased with the overall utilization increase that we've had on a year-to-date basis when you look to 2 quarters combined. And then also just how the price increase is playing out.
Sarah, if I may just add, we're obviously looking at utilization closely, but we're also looking at revenue per device. And we've done a very, very significant number of different pricing increases, so if you go back in a year or back 2 years, you will see a very, very significant pricing increase. So I think it is natural to have a slight reduction in utilization. But like Mike is alluding to, we had an increase in revenue overall on the procedural instrument side and also an increase in revenue on the per box.
Okay. Really helpful. And then I guess I just wanted to touch on the GP channel expansion. You said there's now a more equally weighted pipeline. I just wanted to know how is the conversion of console sales for those GPs compared to endos? Just any color around that decision?
Yes. So Sarah, it's Mike. When we look at the pipeline right now, as we look at the phases of our pipeline has a beginning and an end. And right now, the GPs are weighted more at the beginning and the endodontists that had been with us for some time are weighted towards the end. So they're closer to the closure rate. So that's how we see more endodontists filling our existing installed base. And conversations around the GPs now are just continuing to educate them on the benefits GentleWave can have to their practice, engaging DSOs to move them through. And that's a very big part of where we're focused in the second half, and we're allocating additional resources into that capacity. Hopefully that helps.
[Operator Instructions] The next question today comes from the line of Jon Block from Stifel.
This is Joe Federico on for Jon. I just wanted to start with the guidance revision. It looks like with the new guidance, the implied second half sales came down by about $5 million. Just looking at our model, we had previously modeled around maybe a little bit above $6 million in second half console sales. So I just wanted to see if we could get some more color on what else is being taken into account with the new guidance.
So Joe, so when you look at the guidance, what we built into there is around the low end is just what we've experienced in the first half of the year for console sales out and then also PIs. So consoles, of course, as we add console to our installed base, it drives additional PI revenues. So when we pull consoles down, you're also going to see PIs come down with that. But when we look at just continuing the trends with limited GP conversions in the second half of the year, that's where we hit the low end. When we look at the high end, we start to come back up to where we had placements in 2022, and the GPs in our pipeline start to convert. But the base still will remain in [ odonto ] specialists. So it's all the adjustment is relating to consoles, but of course, it has a tail with the PIs. Hopefully, that helps.
Okay. Yes, that makes sense. And then just on the cost actions that you mentioned earlier, can you give us any more color on like where those cost actions are being taken or what we can look for there?
Yes. So the reductions were largely centered around the general administrative and research and development and some management positions as well with limited impact to the field sales team and our commercial efforts. So on the P&L, you would see that in SG&A for admin and then R&D. The split would be more weighted towards the G&A aspect of it at this point.
Just maybe let me add some additional commentary. For us, it's very important to drive console sales and top line growth. And hence, that's why we've been very careful, obviously, cutting too many expenses on the commercial side.
[Operator Instructions] There are currently no additional questions waiting at this time. So I'd like to pass it back to the management team for any closing remarks.
Thank you, operator. I just want to reiterate again. We appreciate everyone's time today. Thank you for your interest in Sonendo. Have a great day.
This concludes today's conference call. Thank you all for your participation. You may now disconnect your lines.