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Hello, and welcome to Sonendo's Third 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 Gilmartin Group for a few introductory comments.
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 September 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 that 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 on 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 descriptions 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 our 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 November 8, 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 third 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. The third quarter saw steady capital placements and revenues in line with our initial estimates totaling $10.4 million and representing growth of 6% year-over-year. Procedure Instrument revenue grew 7% year-over-year to $5.1 million in the third quarter. Console revenue growth was in line with the prior year totaling $2.1 million for the third quarter of 2023. As we have seen in prior years, our annual sales cadence for 2023 is shaping up to be reflective of the seasonality we typically encounter. The first and third quarters are generally lighter in console placements than Q2 and Q4, attributable to buying patterns common in med tech capital equipment. The third quarter of 2023 was no different. We saw lingering macroeconomic pressures in addition to the typical effects of extended vacation schedules and summer slowdowns. However, unlike previous years, we experienced a slowing of utilization and consumable sales in the latter part of the quarter. Consumable sales often rebound from the summer seasonality, but this September proved to be lighter in terms of volumes. As we have visibility to procedures at the practice level, we believe the decline was experienced broadly across many of our endodontist customers, not just a reduction in GentleWave procedures. Many of our doctors reported a decline in patient numbers as we've seen in other areas of the dental market. As we move into Q4, we're seeing procedures stabilize from the Q3 exit, but we will continue to monitor demand. While the majority of endodontic procedures are nonelective, there remains a certain number that are asymptomatic, which may result in patients delaying treatment and ultimately a shift in patient volumes. In relation to console placement trends, we continue to see a lengthening sales cycle and therefore have implemented new programs to counter these effects that I'll expand upon later. Despite these dynamics, we were pleased with general solid sales figures and remain optimistic about continued adoption of the GentleWave procedure. Going forward, we're committed to 3 fundamental pillars to drive Sonendo's success. Simply stated, those are: one, growing top line revenue; two, improving margin profiles; and three, prioritizing cash preservation. I'd like to spend a moment to detail our initiatives as they relate to each of these 3 pillars and the internal steps we have taken to ensure we execute against our plans for the remainder of the year and into 2024. As for revenue growth, we recently announced an expansion into the DSO channel and the signing of partnership agreements with 2 specialist DSO groups. DSOs represents an important segment within the industry and these partnership agreements will greatly expand access to the GentleWave procedure in endodontic offices nationwide. For example, these 2 agreements now enable us to sell into nearly 200 new target accounts. Outside of the DSO strategy, we've begun a limited trial or evaluation program for practitioners to fully experience the GentleWave technology in your offices at no initial upfront cost. This allows doctors and their staff to realize firsthand the clinical practice and patient benefits for the GentleWave system before committing to purchase. We're still in the early stages of this initiative, we're noting significant interest and positive impact on moving customers through the funnel more rapidly. We believe the continuance of these trial periods will build upon momentum in our sales pipeline and serve as important catalysts to shorten the selling cycle on a go-forward basis. Turning to utilization and consumable revenue. With our recent announcements regarding CleanFlow clearance for interior procedures and important improvements with our Gen 2 version we believe the improved clinical workflow enhances the already significant benefits of the GentleWave procedure. With 1 procedure instrument, we have simplified our training programs to ensure customer success from the start. With regards to margin improvement, we continue to focus on 2 drivers: first, accelerating our path to full conversion to the CleanFlow procedure instrument which we anticipate being essentially complete as we enter 2024; second, we completed the transition to in-house G4 assembly that have now manufactured over 100 console in our facilities. Enabling us to leverage our existing capabilities as we scale our business. Combined, these initiatives provide us much more control in future cost reductions, including gaining economies of scale, simplifying the product portfolio and achieving supply chain consolidation, all of which ultimately results in higher contribution markets. Moving to cash preservation. Sonendo remains committed to responsible and measured spending to retain a healthy balance sheet. In the third quarter, we were able to reduce quarterly operating cash burn by nearly 30% sequentially from Q2 and 35% year-over-year. We will continue to make necessary adjustments to rightsize the business without compromising long-term growth opportunities. Earlier this week, we completed a reduction force that combined with reductions announced earlier in the year, will conserve approximately $6 million to $8 million in the next 12 months and allow the company to leverage operational efficiencies in a more meaningful way. While these decisions are never easy or taken likely, we believe they are appropriate in this environment. Our customers will not be impacted by any of these changes. Lastly, we're thrilled to announce the submission of our 510(k) application to the FDA for the use of the GentleWave system for cavity indications. A future application beyond our recurrent market of root canal therapy and one that will significantly increase our total addressable market. This is a significant step forward in solving tooth decay in millions of patients worldwide. At the same time, we don't want to get ahead of ourselves in terms of quantifying this opportunity or even the time line in which we might see the revenue pull through with respect to the application of our technology for cavity indication. Needless to say, we remain incredibly optimistic about our long-term growth opportunities and a sustainable platform we're building to capitalize on the potential that exists within the endodontic and broader dental market. I will now turn the call over to Michael Watts, Sonendo's Chief Financial Officer, and then return for some closing comments after the question-and-answer session. Mike?
Thanks, Bjarne. As previously stated, Sonendo total revenue for the third quarter of 2023 was $10.4 million compared to $9.8 million for the third quarter of 2022, an increase of 6%. Q3 Products segment growth was 5% versus the prior year, driven by PI revenue increase. PI revenue was $5.1 million, compared to $4.8 million in the third quarter of 2022, an increase of approximately 7%. PI revenue growth was driven primarily by an increase in procedure instrument pricing of approximately 11% offset by a decline in unit PI sold of approximately 4% for reasons Bjarne previously addressed. Total PI sold in the quarter was approximately $69,000. In the third quarter, GentleWave console revenue was $2.1 million, in line when compared with $2.1 million in the third quarter of 2022. The average selling price for the GentleWave console was just under $60,000 in the third quarter of 2023. We placed 37 consoles in Q3 with one Gen 3 trade in, resulting in a net change of installed base at 36. Our installed base as of September 30, 2023, was 1,076. Total other product-related revenue was $900,000 in the quarter. Total software revenue for the third quarter was $2.2 million compared to $2.1 million in the third quarter of 2022, an increase of 9%. Software growth continues to be driven by an increase in revenue relating to DSOs as well as recurring revenue increases to existing customers. Before moving to margin and operating expenses, I would like to explain an impairment charge taken in the third quarter. The recent decline in our market capitalization triggered us to perform an interim long-lived assets and goodwill impairment test. As a result, we recorded a noncash impairment charge of $1 million related to the intangible asset and $2.3 million related to fixed assets of our Products segment. Of these impairment charges, $1.3 million is recorded in cost of sales and the remainder in operating expenses. Note again, the impairment charge is a noncash item and that the impairment charge is different from the inventory charges that we reported in the second quarter of 2023. There was no inpayment charge in the software segment. Gross margin for the third quarter of 2023 was 24%. Excluding the Q3 impairment charge, gross margin for the third quarter of 2023 would have been 36%, which is a significant improvement from 24% in the same period of the prior year and reflects our commitment to improve profitability. We continue to show improvement in CleanFlow adoption at approximately 70% for the quarter and in-house assembly of the G4 console and other operating efficiencies, providing sustained margin improvement. Total operating expenses in the third quarter of 2023 were $18.5 million, compared to $16.9 million in the same period of the prior year. Increases were driven primarily by a $2.1 million impairment charge mentioned above. Higher general and administrative costs within installed based compensation and legal expenses, and higher sales and marketing expenses related to increased revenues, offset partially by lower R&D spending. Loss from operations was $16.1 million in the third quarter of 2023 compared to $14.6 million in the third quarter of 2022. Net loss was $17 million for the third quarter of 2023 compared to $15.5 million in the third quarter of 2022. Our cash and cash equivalents and short-term investments as of September 30, 2023, approximately $55.9 million, while our gross term loan remains at [ $40 million ]. As for our 2023 financial guidance, as we move to close our 2023, we are revising our expectation of a full year 2023 net revenue to be approximately $44 million. This is reflective of the lower end of our previous guidance and considers recent macro trends and expectations regarding primarily lower placements of capital equipment and related consumable revenue commensurate with the industry at large. At this point, I'd like to open up the call for questions.
[Operator Instructions] Our first question goes to Jon Block, Stifel.
This is Tom Stephan on for Jon. I'll start with where you left off, Mike, just on guidance. You reiterated the $44 million to $46 million, I think, on the pre-announcement last month, but it has come down slightly now. Mike, you gave some color. But -- maybe if you guys can just elaborate a bit more on what over the last month, changed a bit? It sounds like maybe it was more capital, but any comments there would be helpful.
Yes. Tom, so the guidance that we wanted to place out there has a level of conservatism dialed into it now, given what we know nearly halfway through the quarter. So we had good placements, solid placements in Q3. We've had some good traction on the programs that Bjarne mentioned earlier in the call. But at this point, we just feel it's appropriate to make sure that we communicate a forecast that the Street can dial in appropriately.
And at the same time, Tom, I would also just reiterate that. We're really excited about some of the new programs that we're putting in place. We recognize the macro environment that we are in and it is imperative to us and incumbent on us to find new and different programs to really drive sales in this environment. That's why we're really excited about what the opportunities for this trial can bring and also what the DSO opportunity can bring on top of the other tools that we have in our momentarium.
Got it. That makes sense. And then I wanted to ask about the gross margins continue to put up some solid numbers there. Mike, any color you can maybe give on kind of the near to intermediate term. You guys obviously have a lot of initiatives around efficiencies that I think can drive good margin expansion, but any high-level comments about 2024 and what you think that could look like?
Yes. So I think if we did start with Q4 and what we communicated before was that for the remainder of 2023 would be in the mid-30s, and that's pretty much where we came out, if you exclude the onetime charge. And when we go back to the reasons for that, it's around the CleanFlow conversion that we showed good progress on in Q3, and we continue to show good progress in Q4. And related to that, is as we move out of molar and the APM to nearly 100% CleanFlow, we start the year 2024 in that position. So CleanFlow will be now a leading driver of contribution margin for consumables, of course. And then when you look at the console production, the G4 insourcing, that was substantially completed in Q2 -- end of Q2, early Q3, and we're starting to see positive leverage and benefits from that program as well. So moving into 2024, we have a single PI around CleanFlow and a single console around G4 system. And we think those are going to be good drivers to move us north in excess of 40% for 2024 without trying to get into specific guidance there. I think we feel comfortable with those numbers.
And our next question go to Jason Bednar of Piper Sandler.
Sorry for any background noise here. But maybe if I could start building off Tom's question there on the guide -- for implied guide for fourth quarter. This is going to be a bit of a softer than normal fourth quarter on the capital side than what a lot of us are probably thinking despite this being traditionally, a seasonally stronger quarter for capital to end the year. Can you help us what that means when we think about the exit rate into '24 when capital sales tend to be lighter in the front half versus the back half, definitely in the first quarter? And then relatedly, are the lengthening sales cycles that you mentioned -- are those attributable to both Endos and GPs? Or are you seeing it more concentrated in the particular group?
Yes. So Jason, maybe I'll start off by saying that Q4 is still going to be our strongest quarter, 0.1 like Mike said, we are dialing a level of conservatism in this because of the environment changing on us. And I think everyone are appreciating that across MedTech and across the health care spectrum right now. We are still very, very much believing -- obviously, we're believing in what we're doing here. And I think the programs that we are putting in place especially around the trial and around the DSO opportunity here. Those will really help drive a lot of upside to the business. So point one, there's a level of conservatism dial-in numbers for Q4. We're going to continue to drive growth in -- as we go into 2024. And that's what we obviously aspire to be. We aspire to be a growth company, and it's incumbent on us to really drive the growth engine in this environment. As with regards to the lengthening sales cycle here. Again, that's what we -- that's one of the things that we're solving for with the trial program. We have a lot of customers very interested in our technology that are in the late-stage funnel. And in this environment, we're looking at a couple of different tools to really drive them to kind of move them into buying this technology. And this is where trials can really help us. And just maybe just commenting briefly on the trial here. This is -- what we're seeing across here is that this is really a program that can really help drive and help us sell more consoles. And we have already had a lot of examples here where this can be very successful. One anecdotal example, for example, is that we had one doctor trialed the console. And because he like it so much, it ended up being a multiunit sale where the doctor didn't just want to standardize all his offices, but he also wanted to standardize all his chairs to GentleWave. So that is an example of the tools that we're using in this environment, and I think that we can be very, very effective at really helping us drive sales rep productivity and really drive this going forward. So with all of this, we're very excited about the opportunities to grow this business. So again, so this is -- like we said, this is a level of conservatism that we're dialing into the fourth quarter.
Okay. That's helpful, Bjarne. And then maybe shifting over to the volume point. Those obviously seeming also a little bit lighter. You mentioned some deferrals that might be taking place on the patient side. Do you think the volumes that you're seeing are reflective of what's occurring in the market, do you have a sense of lower procedure volumes that you're seeing are consistent with [indiscernible] root canals or doctors getting maybe more cost sensitive and on the margin shifting away from CleanFlow PIs and over to [indiscernible] just to save some dollars?
Yes, Jason. So substantially, the simple answer is this is, I think, affecting everyone across the endodontic space. This is not just us. So some of the trends that we're seeing are reflective and that are happening across the entire endodontic space. So maybe to give you a little bit more color here. So what we're seeing is that some of our doctors are seeing less patients as patient volumes in Q3. And I was like -- we talked about in our prepared remarks, this happened probably more during the last month of the quarter. It's not universal across all practices, but we've definitely observed it in some of the practices. And we think what's happening here is that a small portion -- not a large portion, but a small portion of root canal procedures are elective in nature.
The majority of them, like we've talked about before, are nonelective. But some of them are asymptomatic. They are elective in nature, and that's what som customers are choosing to delay. And the other small element that we size that in the low-volume group, as you remember, we have a couple of different pricing tiers. So in our low volume group, we saw that -- which are the ones that saw the highest price increase in the beginning of this year, this is where we saw a slight reduction in our utilization. Except for that, the dynamics that we're seeing are effectively happening across, at least to our knowledge, is happening across the entire endodontic industry.
So just to add on to that as well. So we know who those low-volume customers are, and we have the opportunity now to go back to them and show them the full benefits of GentleWave. So that's our next step here and something that's ongoing and active with our consumable sales team.
Okay. Very helpful. Maybe one -- last one to squeeze in here. I wanted to ask on your debt covenants. I think you have some minimum revenue covenants out there that you need to clear these admittedly are looking a little difficult by the middle part of next year, just given where revenues may be expected to end this year. Can you talk about your plans to address these covenants with your lenders? Have there been any early discussions on removing or reducing these covenants?
So without getting into specifics, we are, of course, discussing and have ongoing discussions with our -- with Perceptive who holds our debt and continuing to just evaluate different scenarios as well there. But we've always had a good relationship with them, and we expect that to continue moving forward.
And our next question go to [ Erin Wright ] of Morgan Stanley.
This is Justin Wang on for Erin. Can you provide some more color regarding the reductions in force in November, specifically, to what extent does this impact the sales force? And how does this affect the ability to drive top line. Additionally, are there any other areas of cuts? And I have a follow-up.
Yes, Justin, the simple answer is that we don't believe this is not going to impact our ability to grow the top line. It's also not going to impact our customers in any way.
Let me just give you a little bit more color, though, to kind of put these cuts into perspectives. From where we are right now, there are a number of projects around the organization that are complete. They're done. An example of that is development to the G4, that's substantially all done. Development of the second-generation CleanFlow, substantially all done. We're also getting much more efficient on different areas around the organization like manufacturing, operations, et cetera. So because of that, because there are some of these areas that are complete, we can now stop. And there's something about starting a project, but it's also important to talk about stopping a project. Second, the other thing that we've done during this reduction for us, we have now an opportunity to reallocate resources around the organization. That's another thing that we've done. But ultimately, at the end of the day, with all this, this is really all about us doing more with less. That's never easy, but that's something that we need to be all over, and that's something that the team and the organization here has responded very well to this. And everyone are on board with this, and that's exactly what we're going to do from an execution perspective going forward.
But I want to emphasize this, we are still absolutely focused on commercial. We aspire to be a growth company but we're, at the same time, we're going to balance growth and cash. But we're also, at the same time, we're going to manage and we're going to fund key critical initiatives like cavities that we're really excited about that. It can really provide an inflection point for us going forward.
We've been through a pandemic. We know how to make cuts like this. We have done it before. We've learned a lot. But I think this is the right step for us at this time to allow us to be good stewards of cash. And -- but at the same time, to getting back to the core elements of your question, we're going to still continue to grow the company and growing top line and this will not impact customers in any way.
That's very helpful. Additionally, you've taken a good amount of price during the year. So I was wondering if you can help us understand what's in store for 2024 regarding price? And also on that vein, any practitioner pushback on price that we should be aware of?
So Justin, I'll take the first half. It's Mike. So for 2024 guidance, we're not at this time, ready to give specifics on 2024. We have, of course, put the pricing tiers in place in February. And for the most part, people understand our principles behind that. Customers understand the value that we bring to the procedure and overall to their practice and how we can help them achieve positive results through -- GentleWave, both clinically and financially. So with that in mind, we think price is a lever that is appropriate for us to continue to evaluate. I think the second half of your question just talked about certain customers and Bjarne mentioned it a moment ago, just about the customers at the highest tier. And we'll continue to work with them. We think that there's practices out there that are utilizing GentleWave as an adjunct to root canal therapy, and we think we can help them incorporate more fully into their practice and realize the full benefits of GentleWave, not only for the patient having lower pain, but also the practitioner having more efficiencies and better clinical workflow. So with those 2 things in mind, it just goes back to the value that we bring overall with the GentleWave to the root canal therapy.
[Operator Instructions] It appears we have no further questions. I'll now hand back to Bjarne for any closing comments.
Thank you, operator. To conclude today's call, we would just like to reiterate our commitment to Sonendo's fundamentals and the opportunity ahead of us to drive market adoption and revolutionize dental care. We are incredibly excited about the future of the company. We look forward to providing additional details at future events. We appreciate everyone's time today, and thank you for your interest in Sonendo. Have a great evening.
Thank you. This now concludes today's call. Thank you all for joining. You may now disconnect your lines.