NeuroPace, Inc. (NPCE) Q2 2021 Earnings Report, Transcript and Summary

Good morning and welcome to NeuroPace’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 Matt Bacso from the Gilmartin Group for a few introductory comments.

Thank you, operator. Good morning and thank you for participating in today’s call. Joining me from NeuroPace are Mike Favet, CEO and Rebecca Kuhn, CFO. Earlier today, NeuroPace released financial results for the quarter ended June 30, 2021. 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 will 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 contained in this call that relate to expectations or predictions of future events, results or performance are forward-looking statements. All forward-looking statements, including those around NeuroPace’s clinical trials and those relating to our operating trends and future financial performance, the impact of COVID-19 on our business and prospects for recovery, 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 more detailed descriptions of the risks and uncertainties associated with our business, please refer to the Risk Factors section of our public filings with the Securities and Exchange Commission, or SEC, including our quarterly reports on Form 10-Q filed with the SEC pursuant to Rule 424(b)(4) on June 3, 2021 as well as any reports that we may file with the SEC in the future. This conference call contains time-sensitive information, which we believe is accurate only as of the live broadcast on August 12, 2021. NeuroPace 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 Mike.

Thanks, Matt. Good afternoon and thank you for joining us. As we discuss our second quarter operating as a public company, I hope continue to sense our dedication to focus on and growing momentum and bringing life-changing therapy to people suffering from epilepsy. Although we just recently held our first quarter earnings call in June following our IPO in April, I’ll start today’s call with a brief company overview before moving on to cover business updates and quarterly results. NeuroPace is a commercial stage medical device company focused on transforming the lives of people suffering from epilepsy by reducing or eliminating the occurrence of debilitating seizures. Roughly 3.4 million people in the United States are living with epilepsy. And while antiepileptic drugs are available as a first line treatment, approximately one-third of people with epilepsy are considered drug-resistant, because medications are unable to control their seizures. As a result, there are approximately 1.2 million people living with drug-resistant epilepsy in the United States. As a company, we strive to help epilepsy patients regain their lives and reach their full potential. Our RNS System is the first and only commercially available brain-responsive neuromodulation platform, designed to reduce or eliminate the occurrence of debilitating seizures. Our device continuously monitors brain activity and is programmed to recognize patient-specific patterns associated with seizures. The device is then able to close the loop by responding in real time to deliver personalized treatment at the source, preventing seizures before they start. Our RNS System also records ongoing brain activity as patients live their normal lives, giving physicians unprecedented visibility into patients’ unique seizure patterns while providing insights they can use to optimize therapy outcomes. While our current indication for use is to treat adults with drug-resistant focal epilepsy over time, we intend to expand our indication into a broader set of epilepsy patients. We have IDE approval for a clinical study to expand our indication to drug-resistant focal epilepsy patients ages 12 to 17 and expect to begin enrollment later this year. Additionally, and as I will shortly describe, we intend to pursue potential indication expansion into generalized epilepsy, the second most common type of epilepsy. We have developed an extensive body of clinical evidence, demonstrating that our RNS System offers significant seizure reduction in all areas of the brain, with enduring improvements in quality of life and cognition for adults living with drug-resistant focal epilepsy. In the largest and longest prospective neuromodulation study conducted in epilepsy, our RNS System demonstrated seizure reduction that improved through 9 years of follow-up The more recently published results from a real-world retrospective study conducted after FDA approval reported even better results faster, with an 82% median seizure reduction at 3 years of follow-up. The study outcomes demonstrate the utility of our unique brain recordings and driving improvements in therapy effectiveness across patient cohorts over time. We also continue to learn and innovate by leveraging our extensive brain recording data set, which includes more than 6 million intracranial EEG records. These recordings, along with our data analytics capabilities allow us to improve our products and provide clinicians with information they can use to help them monitor patient progress, optimize programming parameters and better counsel their patients. One recent example is the broad launch of our nSight platform, an online physician portal that integrates EEG data from the RNS System, with patients’ seizure diary information, giving physicians a more comprehensive view of their patient’s seizure burden. We believe the capabilities of our RNS platform provide a competitive advantage, which allows us to continue to improve therapy effectiveness for people living with drug-resistant epilepsy. Hospital and physician reimbursement is established for the RNS System implant and for the programming of the device. Reimbursement is also available for the periodic in-person or remote review of the brain activity recordings, which we believe is unique to our RNS System. We believe that less than 1% of indicated patients have been denied coverage for implantation of our RNS System. And with positive coverage policies broadly in place, obtaining approval has become routine. Now, turning to the results, I am pleased to report that throughout the second quarter of 2021, the NeuroPace team continued to successfully navigate through these unique and challenging times. We reported Q2 revenues of $12.6 million, representing a 65% growth compared to the severely COVID-impacted second quarter of 2020. On a sequential basis, total revenues increased 12.5% compared to the first quarter of 2021. This increase was primarily driven by an increase in unit sales of our RNS System for initial implant procedures. During the second quarter, we were able to increase the number of implanting centers and remain on track to have 148 comprehensive epilepsy centers and plant our RNS System in 2021. As we mentioned during our last earnings call in June, it takes roughly 6 months from the initial inpatient epilepsy monitoring unit or EMU diagnostic evaluation until implantation of our RNS System. Given this lag, COVID-19 continues to impact our business as fewer patients have the prerequisite diagnostic evaluations in the second half of 2020 and the first few months of 2021. Fewer EMU evaluations means that fewer patients have moved forward in their diagnostic journey, including being identified as candidates for the RNS System. In recent months, we saw some recovery in the number of patients coming through EMUs for the diagnostic evaluation, but we continue to take a measured approach in the forecasting patient volumes, given increased physician and patient vacations in the summer months, the time between EMU admission and RNS System implant and potential headwinds resulting from the COVID-19 Delta variant. Additionally, we reported $3.4 million of replacement implant revenue, an increase of 13% compared to the second quarter of 2020 and 10% compared to the first quarter of 2021. Given the approximately 90% replacement rates we have seen over the last several years, replacement revenue is primarily a function of battery expiration in previously implanted devices. This can result in quarters with higher or lower than planned replacement implant revenue. While we are pleased with the replacement implant revenue in the second quarter, it is important to remember that we expect replacement revenue to generally decrease over the next several years due to the transition to a longer-lasting battery, which we introduced in 2018. Next, I would like to provide an update on the clinical trials we plan to initiate in the coming quarters. As previously mentioned, we have IDE approval for a clinical study to expand our indication for drug-resistant focal epilepsy to younger patients ages 12 to 17. We remain on track to initiate enrollment for this study before the end of 2021 and continue to expect minimal revenue contribution this year, given the approximately 3-month lag between patient enrollment and RNS System implant. We also received breakthrough device designation from the FDA for our RNS System in patients with idiopathic generalized epilepsy, otherwise known as primary generalized epilepsy. We remain on track to submit an IDE study proposal to the FDA before the end of 2021, which we believe would position us to begin enrollment in 2022. Additionally, in late June, we announced that NeuroPace received an NIH grant through the Brain Research Advancing Innovative Neurotechnologies, or BRAIN initiative that will provide funding of up to $9.3 million over 5 years to evaluate the use of our RNS System to treat Lennox-Gastaut Syndrome or LGS. LGS is a devastating form of childhood onset epilepsy that causes cognitive dysfunction and frequent generalized onset seizures that often lead to injury. We plan to use these funds to initiate an IDE feasibility study, which we believe will be the first to evaluate a neuromodulation device in patients with LGS and which is projected to start enrolling patients in the second half of 2022. To summarize, our primary focus is to continue to grow revenue in our current indication. We intend to do this by expanding into all CECs in the United States, driving increased utilization at these centers, increasing referrals and investing in innovations to improve patient outcomes and ease of use. We are also investing to expand our indications to younger patients with focal epilepsy, patients with generalized epilepsy and exploring potential opportunities outside the United States. Finally, we are supporting the early feasibility work that could bring the benefits of responsive neuromodulation therapy to patients with other brain disorders. With that, I will turn the call over to Rebecca, NeuroPace’s Chief Financial Officer.

Thanks Mike. NeuroPace’s revenue for the second quarter of 2021 was $12.6 million compared to $7.6 million for the second quarter of 2020, an increase of 65%. The increase was primarily driven by an increase in unit sales of our RNS System to comprehensive epilepsy centers for initial implant procedures. In the second quarter, revenue from initial implants was $9.2 million, an increase of 100% over the second quarter of 2020. On a sequential basis, initial implant revenue increased 14% compared to the first quarter of 2021. Revenue from replacement implants was $3.4 million, an increase of 13% compared to the second quarter of 2020. As Mike stated, we continue to expect replacement implant revenue generally to decrease for the next several years due to the transition to a longer-lasting battery. Gross margin for the second quarter of 2021 was 74.1% compared to 71% in the second quarter of 2020. Our gross margin improved in the second quarter of 2021, primarily due to lower fixed cost per unit as our production volume increased. In the second quarter of 2020, our gross margin was negatively impacted by reduced production volume as manufacturing was temporarily idled due to the COVID-19 pandemic. Total operating expenses in the second quarter of 2021 were $14 million compared with $8.9 million in the same period of the prior year. In the second quarter of 2020, we implemented a number of cost-cutting measures in response to the COVID pandemic, including furloughs and temporary salary reductions, resulting in lower operating expenses. R&D expense in the second quarter of 2021 was $4.4 million compared with $3.3 million in the same period of 2020. The increase in R&D expense was primarily driven by an increase in compensation expenses. Additionally, we saw an increase in product development and clinical study expenses. SG&A expense in the second quarter of 2021 was $9.5 million compared with $5.6 million in the prior year period. The increase in SG&A was primarily driven by an increase in compensation expenses and costs associated with operating as a public company. We also saw an increase in sales, marketing and field support costs, including travel, as COVID-19 restrictions ease and we return to conducting more in-person visits with our customers. Loss from operations was $4.6 million in the second quarter of 2021 compared to $3.4 million in the prior year period. In other expenses, we recorded a final non-cash charge of $2.1 million due to an increase in fair value of the convertible preferred warrant liability resulting from our initial public offering. This expense is non-recurring as the warrants were exercised at the time of our IPO. Net loss was $8.5 million for the second quarter of 2021 compared to $8.8 million in the second quarter of 2020. Our cash and short-term investments balance as of June 30, 2021 was $127.9 million, while our long-term borrowings totaled $49.4 million. Now I’d like to provide an update to our 2021 outlook. While we were pleased with our second quarter results, we continue to take a measured approach given the uncertainties surrounding COVID-19, including the risks posed by new variants and the potential impact on hospital, physician and patient behavior. Based on this, we continue to expect full year total revenue of approximately $47 million, representing growth of 14% compared to full year 2020. We expect initial implant revenue of approximately $36 million, which includes minimal clinical trial revenue and represents growth of 29% compared to full year 2020. Lastly, given the replacement revenue dynamics Mike mentioned previously, we anticipate replacement revenue to be approximately $11 million, representing a decline of 16% compared to full year 2020. This concludes our prepared remarks. I would now like to turn the call back over to the operator, who will open the call for questions.

Thank you. [Operator Instructions] Our first question comes from the line of Robbie Marcus with JPMorgan.

Hi, guys. This is actually Alan on for Robbie. I want to say congrats on the great quarter. Just to start off with kind of the elephant in the room obviously what I think a lot of investors are thinking about right now is the impact of COVID-19, especially with some hospitals, some states moving towards deferring elective procedures. So with respect to yourselves, what are you seeing in terms of your inpatient demand versus capacity and what are you seeing like what have you seen so far in third quarter with respect to the impact of COVID and Delta on your forward-looking trends?

Great. Thanks for the question. Before I answer it directly, I wanted to take a minute to go back to some of the fundamentals of the business. So, let me start with just reiterating some of the prepared remarks that we are really pleased and I appreciate your thanks on the performance in Q2, especially the strength of that driven by the initial implant procedures, which are the fundamental long-term growth driver for our business. We saw, as we reported doubling of that initial implant revenue over Q2 of 2020 and 14% sequential growth over Q1. Additional color behind that, that growth was driven both by more centers implanting the device as well as higher utilization within those centers and really wanted to keep that grounded on the fundamentals of the business, which are long-term drivers of the growth in the business that’s enabled by the clinical data that we’ve established, the reimbursement that’s in place, the balance sheet that we have for the organization. And really, with that as long – as well as investing in future indication expansions, putting us in a really fundamentally strong position for long-term growth. And with all of that said, the elephants in the room that you mentioned, we have seen headwinds to start off Q3. That’s coming in part from vacation schedules from physicians and patients that we saw to a much greater extent than what we’ve seen historically. And then on top of that, in the last couple of weeks really within the last couple of weeks, there is increasing uncertainty associated with the Delta variants of COVID-19 and what that – what the implications of that are for our business. Really, just in these last couple of weeks, we’ve started to see the reemergence of elective – of limitations on elective procedures in certain limited regions across the country, especially for procedures like our initial implant procedure that require an ICU stay. While these factors that I talked about have the potential for an impact on our business, we do believe that they are transitory in nature. That kind of impact we saw last year, to a much greater degree. And when the hospital started to allow those elective procedures to happen again, we saw the recovery of those procedures being completed once those limitations were in place. It’s very recently emerging in fact, and so we don’t know at this point how long that’s going to last or what the magnitude of that impact. At this point, like I said, it’s very regional implications, but with more uncertainty associated with that. The guidance that we’re providing for full year assumes that any impact of the Delta variant works its way through the system before the end of the year. So while there could be and there may be timing impacts of when those procedures happen, we expect that they will work their way through the system this year. And then the other impact of COVID, which we’ve talked about in the past as well is around patients that are coming through the epilepsy monitoring unit. We have reported that during the second half of 2020, first quarter of this year that we had been seeing a reduced number of patients coming through the EMU. We’ve started to see a recovery in the number of those patients starting really at the end of March of this year. We don’t know yet. It’s too early for us to know what the impact on EMU admissions are going to be, associated with the Delta variant. Again, I expect those to be transitory in nature, but at this point, too early for us to understand how much of an impact or how long that impact is going to maintain. I’d say no difference, in many ways, than the other companies that you’re talking to.

Got it. And then just as a quick follow-up, in this kind of more challenging environment, how able are you to drive continued improvement in the referral channel and really grow awareness of this, so when hopefully, fingers crossed, Delta and COVID are much less of an issue in 4Q ‘21 and into 2022, you’re able to kind of get your feet and start running? Thank you so much.

Thanks. So to this point, the ability – our ability to do referral development, reaching out to physicians in the community, more of the physicians in the community as well as some of the things that we’re piloting around direct-to-patient awareness, education awareness hasn’t been impacted by COVID. And I don’t anticipate that those efforts will be impacted by the Delta variant specifically. A lot of that, we’re doing remotely. We’ve been able to do more and more of that in person here as the travel restrictions have come out. But even if there is additional travel restrictions put in place, we’ve got the capability of doing that through digital media as it relates to patient education awareness and through remote visits as it relates to the referring physician education and awareness.

Thank you. Our next question comes from the line of Larry Biegelsen with Wells Fargo. Your line is now open.

Thank you for taking the question. This is [indiscernible] in for Larry. I was actually wondering if you could just let us know how much of the Q2 sales benefited from backlog. And then with respect to the cadence in the second half, how should we think about Q3 versus Q4? I guess should we assume a step-up in Q3 because it reflects those who entered the EMUs in Q1 and Q2 when COVID headwinds began to ease or do you think it will be masked trends in replacement implants? And then it does sound like COVID headwinds will probably impact Q4 and likely into Q1 of next year. Is that fair?

Thanks for the question. So starting with – and if I missed any of this, let me know, but starting with your question around impact on Q2 of this year from pent-up demand. And I would say, just as our business works, the pipeline of patients coming through the – through – to be considered for implant with the RNS System is driven by patients coming through the EMU. We saw last year, in Q3 of last year, really, the recovery of the patients that were deferred in Q2 of last year. And so that surge of patients that were deferred in Q2, we really captured those patients in Q3 of last year. So the performance of the business in Q4 of last year, Q1 and Q2 of this year was driven just by fundamentals of the business, adding more centers, more utilization per center. It wasn’t a pent-up demand specifically. We’ve started to see, as I mentioned, an increase late March through the second quarter of patients coming through the EMU, those numbers getting closer to pre-pandemic levels. That is a longer-term driver for the growth in our business. We’re continuing to monitor whether COVID-19 Delta variant restrictions will have impact on that for the business, overall. And then as far as your question goes about impact on the second half of the year, as we had mentioned in the prepared remarks, as well as in the last question, we’ve started to see more – or have seen more COVID-related headwinds in the third quarter, some of that coming from pent-up vacations that had happened for both patients and physicians. And then now in the last couple of weeks, uncertainty related to patients coming through the EMU – sorry, not coming through the EMU, coming through surgery. If there is elective procedural limitations that are coming up, we’re monitoring on whether that will happen. Right now, again, it’s in limited pockets across the country, but that’s really late developing, just within – in the last couple of weeks, literally the last couple of weeks, but that started to come up. So with that, we see that there is those headwinds that are in place for Q3. But again, our expectation is that those will be transitory in nature and that they’ll work themselves through the system. And that the impact, whatever impact to COVID-19 will be relatively short-term as it relates to our assumptions and then, obviously, monitoring whether that’s a fair assumption.

Thank you.

Thank you. Our next question comes from the line of Drew Ranieri with Morgan Stanley. Your line is now open.

Hi, everyone. Thanks for taking the questions. Just specifically to the second quarter, Mike, I was hoping to just get a little bit more color on what’s driving the underlying strength in the quarter, specifically to utilization. Just curious if you’re seeing more of your existing users increase their RNS adoption or is it more a function or becoming more of a function of kind of your land and expand at a comprehensive epilepsy center?

Thanks Drew. The growth that we saw in Q2 came from both more centers implanting the device, as well as from utilization. We had provided guidance that we’re expecting to increase the number of implanting centers to 148 in 2021. We continue to be on track to that, so making increase in the number of those centers that are implanting the device. With that said, the bulk of our growth is coming from, and we expect will continue to come from greater utilization within the centers that are implanting the NeuroPace system. And that’s a combination of more physicians within those centers implanting and then also, over time, increasing the amount of utilization from each center, but overall, driving utilization growth within those centers. And that’s the trend that we saw in Q2. So we did see an increase in the number of centers, but the bulk of the growth coming from utilization within the centers. And again, that’s a trend that we expect to continue.

Got it, thank you. And just on the pipeline for a moment, with the adolescent, focal and primary generalized studies coming soon, can you maybe just give us a time line of future milestones beyond that? And maybe just how many patients you expect to enroll in both of those studies or any details that you could provide at this time would be helpful?

Yes. Let me start with the adolescent studies. The adolescent study, we have the IDE approved for that. We’re working through the process of getting enrollment started in that trial. We continue to expect that, that installment will start here in the second half of the year. As I mentioned in the prepared remarks, there is about a 3-month delta between – I shouldn’t use delta with the Delta variant, a 3-month delay between when a patient is enrolled in the study and when the patient is implanted in the study. And that’s because there is a baseline, a period of baseline seizure activity that’s collected for each patient before they get the device implanted. With that, we’re expecting really minimal revenue impacts from the adolescent study enrollment this year. So we will start enrollment in the study with the delayed implant, expecting minimal impact from revenue in the second half of this year, and then that will be expanding next year. The study that we have approved requires – for adolescent study requires a minimum of 75 patients to be followed for 1 year for our primary endpoint in that study. So we will be enrolling those patients following implanting those patients, and again, with the bulk of that enrollment expected to take place next year in 2022. Switching over to the generalized epilepsy study, the idiopathic generalized or primary generalized epilepsy study that’s the study that we received a breakthrough device designation for that trial, we are working on the design of that trial. We’re engaged with the FDA and anticipate submitting to the FDA in the second half of this year for that IDE approval. Because we don’t have IDE approval yet, there is some uncertainty about exactly how large the sample size is going to need to be and what the amount of follow-up is. But what I can tell you is that what we will be proposing to the FDA is something that’s of similar magnitude to what I just described for the adolescent study and again, looking forward to engaging with the FDA on that here as we make that submission here later this year.

Great. Thanks for taking the questions, Mike. Appreciate it.

Yes, thanks, Drew.

Thank you. Our last question comes from the line of Danielle Antalffy with SVB Leerink. Your line is now open.

Hi, good afternoon everyone. Thank you so much for taking the questions. Congrats on a very strong second quarter. Mike, just a question for you. Maybe this is like a little bit of a follow-up to Drew’s question, but more around sort of how you’re seeing new centers – how you’re opening new centers? Like what the process as to getting a center up to scale, however you would define scale, and getting multiple surgeons implanting and then the epileptologists referring? Sort of how long does it take? And what’s the process for your sales reps to get that going?

Thanks, Danielle. So the growth in the number, the increase in the number of implanting centers, for us, comes from a combination of some centers that we’ve just recently engaged with. There is a program that wants to get started that we’ve created interest in RNS as a treatment for their drug-resistant epilepsy patients. And it also includes some centers that we’ve been engaged with for a long time, but it really requires them to create that first set of patients, identify that first set of patients that they go through all of the process and, ultimately, implant those patients. And so it’s a combination of both. We had talked in the road show and leading up to the IPO that we have a pipeline of accounts that we’ve been engaged with and have the contracts in place. And so a lot of that increase is coming from those centers that we’ve been engaged with for a while, and then it’s a matter of getting those first patients identified and implanted. But sometimes we do have centers that come through and move very quickly through that contracting process and are unable to move on to that. So long way of saying is that there is a lot of variability and how long it takes to get somebody from initially expressing interest to actually doing their first implant. We’re continuing to make growth in that. And so we’re seeing the number of those centers expanding over time. We’re expecting to grow 132 centers last year implanted. We’re expecting that to go up to 148 this year. And again, those are mixed with some center that have been – have engaged with us to some level for a while and others that are relatively more recent in the process. And we continue to have a pipeline of accounts that we’ve engaged with, again, having gotten to that point that will be supporting the increase in number of centers as we go into 2022 and beyond.

Got it. Okay. And then just a follow-up question on the guidance, and I think it’s sort of tied to the question I just asked. But if you do get to 148 by the end of the year, and I know these aren’t perfect numbers because you don’t necessarily know where you were in Q1 and Q2 as it relates to implanting accounts. But basically, the guidance seems to suggest stable to even maybe a little bit dilutive back half of the year utilization for implanting accounts. And I guess my question is why wouldn’t that number go higher? And I think maybe the answer is that the new centers coming online are pretty dilutive initially, but would love to get any color from you on why utilization in the back half wouldn’t be higher than even what we saw just in Q2.

Yes. Thanks for the question, Danielle. So it’s maybe a little bit of detail around when we talk about the number of implanting centers. We look at the number of implanting centers over a longer period of time because the average number of implants per center per year is still relatively modest. We’re relatively early in the adoption phase for those centers. And so when I’m talking about the number of centers implanting in 2021, that’s the number of centers implanting in the full year 2021. And so some of those centers will have implanted in Q1 and Q2 and Q3, and others will just come on and start implanting toward the end of the year. So there is a little bit of nuance, I guess, with the way that the math works out for that. With that said, overall, we’re continuing to see an increase in utilization. If you look at it on an annual basis, 2021 is going to increase over 2020 in terms of utilization. And if you look at it on a rolling 12-month basis or a rolling four quarter basis, that increase continues in the second half of the year as well. So it’s a little bit of just looking at the way that we report the number of implanting centers based on the average utilization. I don’t know if that may be confusing, but if that makes sense.

No, that’s helpful. Thank you for the reminder on the new selected center commentary. That’s helpful. Thank you.

Thank you. There are no further questions at this time. I will now turn the call over to Mike Favet for closing remarks.

Thank you all for your time today. Rebecca and I would like to thank you for taking the time with us. We look forward to meeting you in the future, hopefully, at some in-person events or industry conferences if that’s available. Have a great evening. Thanks.

Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect.