Sonendo, Inc. (NYSE:SONX) Q1 2024 Earnings Call Transcript May 11, 2024

Sonendo, Inc. isn't one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good afternoon, and welcome to Sonendo's First Quarter Earnings Conference Call. At this time all participants are in listen-only mode. We will be facilitating a question-and-answer session at the end of today's call. 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.

Louisa Smith: Thanks, operator. Good afternoon, and thank you for participating in today's call. Joining me from Sonendo are Bjarne Bergheim, President and CEO; and Chris Guo, Interim CFO. Earlier today, Sonendo released financial results for the quarter ended March 31, 2024. 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, 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 description of the risks and uncertainties associated with our business, please refer to the Risk Factors section of our most recent quarterly report on Form 10-Q filed today, May 8, 2024, 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 May 8, 2024. 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. With that, I will now turn the call over to Bjarne.

Bjarne Bergheim: Thanks, Louisa. Good afternoon, everyone and thank you for joining us today. Today's call will be structured slightly differently than in the past. While we will review the first quarter results, I plan to spend most of my time providing information about a strategic business reset that Sonendo's management and Board have undertaken together to drive fundamental change in the organization. Sonendo is truly revolutionizing how tooth decay, the most prevalent chronic disease in the world is treated. We have an incredible technology and recently crossed the milestone of 1.4 million patients treated. Only 20% of endodontists in the United States and Canada performed the GentleWave procedure, so the company has significant growth potential going forward.

We understand the value of what we have, but the change in strategy is needed. Following several years of outsized initial growth from 2017 to 2021, we decided to initiate a more ambitious and complex commercial plan to try to capitalize on what we believed to be valuable growth opportunities. We made significant investments in programs such as sales force bifurcation and consumer marketing. We changed the incentive structure for our sales team focusing primarily on capital sales and procedure instruments by losing focus on helping doctors with utilization and building their practices. We also shifted the attention of much of our sales team to general practitioners and lost focus on our core endodontic customers and KOLs. As these changes took effect during 2022 and 2023, we did not realize revenue growth commensurate with the level of investment made in our commercial strategy.

For example, excluding our software business, sales and marketing expenses increased 61% from 2021 to 2023, while console revenues only increased 10% over the same period. We could not support the associated cash burn with the number of programs we pursued. We needed to make a strong pivot in our approach to return the company to growth and we have subsequently reset our focus on our core strategy and opportunities. We are adjusting the organization to the current realities of the market and are moderating commercial investments in the near term to achieve financial strength in the long term. As part of the reset, we are providing more transparency around financial milestones, like operating expense management, gross margin targets and timing.

Management and the Board have set the 2024 plan with reduced commercial spending and increased focus guided by our learnings over the past two years. We decided to capitalize in areas in which we have previously been successful and the early results have supported the shift in our approach. We had a solid first quarter with revenue of $7 million, exceeding our $6 million guide, and we're encouraged by several proof points in the quarter regarding our unfolding strategy. We reduced sales and marketing expenses by 37% over the first quarter of 2023, yet still had a productive quarter. We received orders for more consoles than we shipped and built a healthy backlog of capital sales orders. GAAP gross margin for the first quarter of 2024 was 28% compared to 23% for the first quarter of 2023.

Non-GAAP gross margin increased from 23% to 30% and more than 700 basis point improvement year-over-year and non-GAAP operating loss decreased from $12.8 million to $7.5 million, a 41% reduction. As a result of these early successes and our confidence in the reset strategy, we're increasing our 2024 full year revenue guidance to $29 million to $31 million from the prior range of $28 million to $30 million. While we are happy with our first quarter results, we know there is far more to do. We see this quarter's performance as early indications of a step in the right direction. I would now like to spend time outlining the three initiatives of our plan, which are commercial execution, cash conservation and margin expansion. I'll provide some details on how and why we're focusing on each of these key targets and some commitments related to improving each going forward.

The first focus of our 2024 strategic reset is commercial execution. As I mentioned earlier, having experienced rapid growth between 2017 and 2021, we invested heavily in several commercial programs starting in the second half of 2021. While these investments did convert into sales, the effectiveness of our ability to place consoles and our ability to drive utilization in 2022 and 2023 was significantly less than we had observed earlier. Sonendo was trying to do too many things at once, scaling initiatives before we were ready and straying from the selling practices we had been very successful with in earlier years. Given what we have learned, we have analyzed every commercial program to ensure we focus efforts on those that will generate a positive return on investment.

One of the critical areas we have reevaluated is the targeting of GPs. In 2022, a herd pivot into the GP channel took focus away from our core customers, the endodontist. While GPs perform many root canal procedures, we have not found an effective way to target high-volume practitioners on a consistent basis. Additionally, a GP that is only an occasional user of GentleWave significantly dilutes our overall consumable utilization and it's less likely to build out their practices around the procedure. However, endodontists that primarily performs root canals is much more likely to be a consistent user of Sonendo's technology. We're now 20% penetrated in the end market in North America, and we believe we can meaningfully increase our presence in those practices going forward.

As a result, we are purposefully shifting away from the GP strategy in the near term, and refocusing exclusively on endodontists to reestablish touch points with both existing and potential customers. We believe this shift will help drive growth for procedure volumes and subsequent PI sales. To support our commercial efforts, we have modified our sales compensation plan. In the past, most compensation dollars were spent incentivizing console placements, which affected doctor relationships and cost utilization to decline. We've remedied this by creating an incentive structure that rewards reps for not only selling consoles but also for building partnerships with doctors and driving utilization. In addition, I have spent a lot of time working with the entire commercial team amidst this reset.

And I have a good grasp on which programs are vital to driving commercial execution and success going forward. Our senior leadership team has been working very closely with the Board to analyze and review these programs. As a result, we're focusing the organization on a few commercial programs that we think will be critical for us going forward. One example of such a program is clinical education events. These events resonate well with customers as we help them understand the benefits from incorporating GentleWave into their practice, providing a multistep plan to increase the referral base and demonstrate how they can improve workflow within their practice. These events have shown a good ROI for us and will be prioritized going forward. Driving focus in the commercial team and throughout the entire organization is a key tenet of our strategic reset.

This was part of the rationale behind divesting TDO, our software business. For one, the sale of TDO helps strengthen our balance sheet and pay down a portion of our debt. But from an organizational perspective, the sale of TDO now allows us to focus solely on growing awareness of adoption of the GentleWave procedure. Selling consoles and PIs is very different than selling practice management software. From now on, we will focus on doing a few things very well. We are flattening the organization and simplifying the way we operate and we are intent on returning to double-digit revenue growth in 2025. Make no mistake, though, I have full confidence in this commercial team and that they will be successful as we work together to build the position of leadership in the market.

The second focus area of our 2024 strategic reset is cash conversation. Company-wide, we're finding ways to do more with less by creating clarity and priorities and processes across teams. We have discontinued programs that do not show a clear return on our investments. And as a result, we reduced non-GAAP operating loss by approximately 40% in the first quarter. Most of our expense reductions are in sales and marketing. We've also eliminated expenses associated with completed projects such as the design and development of G4, design and development of CleanFlow procedure instrument and the transition to one procedure instrument in the field. We're focusing our R&D dollars on improving margins within our existing product portfolio. Additionally, we have eliminated many of the higher fixed and back office costs.

We anticipate the current level of operating expenses to become our new normal as we diligently work to find additional efficiencies in the existing business without compromising growth opportunities. As a result, we will likely experience moderated growth throughout the remainder of 2024 as we manage our cash proactively and allow sufficient time for the effects of the strategic reset to take hold. We expect our non-GAAP operating loss for 2024 to be approximately $28 million, a 40% decrease or improvement over the prior year. I want to note that we are not just cutting expenses to save cash. Instead, we have analyzed our strategic needs and reallocated resources to areas that will drive growth while trimming unnecessary spending and thereby extending our cash runway.

I also want to reiterate that management and the Board are exploring multiple viable financing options, including in combination of debt, equity and non-dilutive sources to secure our balance sheet. We will provide more details as those discussions progress. The third focus area of our 2024 strategic reset is margin expansion. As discussed earlier, we increased our non-GAAP gross margin by more than 700 basis points to about 30% this quarter, but we have more work to do. In prior years, we have always been working in the background to drive incremental margin improvement, but the primary focus of our engineering teams was to develop and manufacture a reliable console capable of being the new standard of care in root canal therapy. Our previous G3 GentleWave consoles had some reliability issues that required necessary service calls by our service team.

This created frustrations among the installed base and hindered peer-to-peer referrals. In addition, the cost of making these service calls within 24 to 48 hours of a request proved to be a significant burden on our overall gross margin profile. As a result, our team undertook a significant redesign of the console, creating the next-generation G4 GentleWave console launched at the end of 2022. Since then, the team has invested a lot of time to drive reliability through both the sign and manufacturing optimization, and I'm pleased to say that the G4 console is now exceptionally reliable. For previous generation G3 consoles, we had seen an average of two unplanned field service calls per year. In contrast, the service calls for our G4 installed base averages less than 0.5 per year.

This is an outstanding reliability profile. In addition to a significant improvement in reliability, our G4 consoles are also helping our GentleWave providers drive better workflow in their offices. Many offices report saving more than 1 hour of doctor and staff time daily with the G4 console. Given the significant improvements in reliability, we have also decided to eliminate third-party service support in the field, which will further reduce our service costs and improve margins. Instead, a dedicated Sonendo field service team allows us to better assist our customers and ensure that their needs are being met as quickly and efficiently as possible. Moving forward, our commercial team will prioritize upgrading existing customers from a G3 to a G4 so that customers can experience the significant improvements we have made.

Upgrading customers to G4 consoles will result in fewer service calls, improved customer satisfaction and help drive peer-to-peer influence as we move forward. These are all critical elements of our reset. In addition to the improvements to the console, we were also committing a lot of resources to consumable-related projects like the development and subsequent conversion of customers through a single CleanFlow procedure instrument. These projects prove to be expensive, but were necessary to position Sonendo for future margin gains while establishing the satisfaction of our customers. Now that we have ensured the performance and reliability of our product portfolio, we can focus the team on margin improvement projects. We have cost reduction road map that includes strategic sourcing, material cost reductions and value-based engineering projects that put us on a clear pathway to significant margin improvements.

These projects are fully staffed and resourced. From a commercial perspective, we are now incentivizing our sales team to drive utilization as opposed to selling procedure instruments. Coinciding with this change, we're limiting our prior discount programs in favor of building closer relationships with our doctors, helping them drive clinical efficiencies, efficacy and better practice economics with the GentleWave procedure. This decision resulted in procedure instrument ASP increasing from $71.60 in Q4 of 2023 to $75 in Q1 of 2024. Implementing these changes resulted in fewer procedure instruments sold in Q1 of this year. In the future quarters, we expect procedure instruments shipments to align with customer utilization. Current CleanFlow procedure instruments have a contribution margin in the mid-60% range.

By the end of 2025, we expect CleanFlow contribution margins to be in the low to mid-70% range. As a result of our margin focus, we expect the overall company non-GAAP gross margin to be in the high 30% range as we exit 2024. And we expect this number to move towards the mid- to upper 40% range as we exit 2025. Beyond this forecast horizon, we see clear opportunities to move company gross margins well into the 60% range. The Board shares my conviction about the opportunities ahead, and we believe the strategic reset I have outlined today is an important first step for moving Sonendo towards meaningful growth in the future. We're confident in the technology, our team's ability to execute and Sonendo's opportunity to revolutionize root canal therapy and the treatment of tooth decay.

We are just getting started. I would now like to introduce to you, Chris Guo, Sonendo's Interim CFO to review the first quarter's results in more detail. Before stepping into this role in March, Chris had been Sonendo's Vice President of Finance and Corporate Controller since July 2021. He is a certified public accountant with extensive experience in both public and corporate accounting and has brought valuable financial and governance discipline to Sonendo since before our IPO in 2021.

Chris Guo: Thanks, Bjarne, and thank you all for joining us today. Please refer to this afternoon's press release and 10-Q filing for more details on specific financial results, including reconciliations between GAAP and the non-GAAP financial results. As previously stated, total revenue of continuing operations for the first quarter of 2024 was $7 million compared to $8.7 million for the first quarter of 2023. The decrease was driven by lower PI sales volumes and partially offset by an increase in PI average selling price. Q1 PI revenue was $4.2 million compared to $5.7 million in the first quarter of 2023. In the first quarter, GentleWave console revenue was $1.8 million. The average selling price during the period was approximately $50,000.

We sold 37 consoles in Q1 2024 with 29 Gen 3 trade-ins, increasing our installed base by eight. Our installed base as of March 31, 2024, was $1,142. Total other product-related revenue was $1 million in the quarter. During Q1 2024, software revenue was $1.4 million and is reported in the discontinued operations. GAAP gross margin for the first quarter of 2024 was 28% as compared to 23% in the prior year period, primarily due to higher PI average selling price and lower unit cost. Non-GAAP gross margin for the first quarter 2024 was 30%. Total operating expenses in the first quarter of 2024 were $12.3 million compared to $17 million in the same period of the prior year. The decrease was primarily driven by a reduction in headcount and lower marketing spend.

GAAP operating loss was $10.2 million in the first quarter of 2024 compared to $15.1 million in the first quarter of 2023. Non-GAAP operating loss was $7.5 million in the first quarter of 2024 compared to $12.8 million in the first quarter of 2023. Net loss from both continuing and discontinued operations in the period was $6.8 million, including a $5.7 million gain from the sale of our software business compared to a net loss of $15.4 million in the first quarter of 2023. As of March 31, 2024, our cash, cash equivalents and short-term investments were approximately $33.6 million. I will now turn the call back to Bjarne.

Bjarne Bergheim: Thanks, Chris. Sonendo's management and the Board are optimistic about Sonendo's forward outlook and are encouraged by the early indications of success in our reset strategy. We are raising our full year 2024 net revenue guidance to $29 million to $31 million. Note that this excludes revenue from TDO software, which will be reported as discontinued operations. As we work through this reset, we will continue to focus on driving efficiency and focus throughout the organization around the pillars of commercial execution, cash conservation and margin expansion. We, therefore, have a moderate growth outlook in 2024, which is reflected in our revenue guide. We expect to return to double-digit growth in 2025. We're excited about the opportunity ahead of us and remain confident that the GentleWave procedure and the GentleWave system is well positioned to transform endodontics and therapy for tooth decay. With that, I will open the call for questions.

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