NeuroPace Inc Q4 FY2021 Earnings Call

Good afternoon and welcome to NeuroPace's Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards 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 Matt Bacso from the Gilmartin Group for a few introductory comments.

Thank you, operator. Good afternoon 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 fourth quarter and full year ended December 31, 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 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 during this call that relates 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, FDA approvals, 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, product performance 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 more detailed description 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 report on Form 10-Q filed with the SEC on November 10, 2021, the Annual Report on Form 10-K for the year ended December 31, 2021 to be filed with the SEC, 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 March 10, 2022. 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'll turn the call over to Mike.

Thanks, Matt. Good afternoon, everyone, and thank you for joining us. For today's call, I'll provide opening comments and a business update, followed by Rebecca who will provide additional detail regarding our quarterly results and 2022 guidance before opening the call to Q&A. Moving to our quarterly revenue results. Consistent with our pre-announcement on January 11, total revenue for the fourth quarter of 2021 was $11 million. Initial implant revenue in the fourth quarter of 2021 was $8.5 million, representing 9% growth over the third quarter of 2021 and 10% growth over the fourth quarter of 2020. For the full year 2021, we generated revenue of $45.2 million, representing growth of 10% compared to full year 2020. Despite the continued COVID-19 impact, we navigated quite well through the pandemic in 2021. I’m proud to report that initial system implants represented 75% of our revenue in 2021 and grew at 20% over 2020. Before providing a business update, I want to speak to trends we experienced in the fourth quarter of 2021 that extended into the first quarter of 2022. While pleased with our initial implant growth in the fourth quarter, it is important to point out that we did see business impact due to the Delta variant at the beginning of the quarter and Omicron variant cases started to impact our business in late December. As we entered the first quarter of 2022, headwinds associated with the surge in Omicron variant cases were severe in January, causing revenue to sequentially decline from December. The decrease in January procedure volumes was driven by temporary limits on elective procedures, staffing shortages, and patient COVID infections. As a result, January was one of our most COVID-impacted months of the pandemic. However, the operating environment has improved. In the month of February, we saw a marked improvement off of January levels with improving trends continuing into March. Throughout the pandemic, we have seen the volume of patients going through the epilepsy monitoring units or EMUs reduced compared to pre-pandemic levels. As a result, we believe there is an increasing backlog of patients at the EMUs. As we have discussed previously, it takes about six months from initial EMU admission to RNS System Implant. We expect that EMU volumes will eventually return to pre-pandemic levels and grow from there, creating significant opportunity for our business. The progress we have made and the investments we are making to increase the number of implanting centers and to increase utilization positions us well for when EMU volume increases. Now let me provide you an update on our key initiatives, as we look to extend our leadership position and drive long-term growth, starting with our commercial organization and our focus on increasing awareness and demand generation. As we have communicated throughout the pandemic, COVID has presented a number of unique challenges, which have impacted our patients and our commercial efforts. Given this reality, we believe it is more critical than ever to make investments in the commercial channel. We will continue to increase the number of implanting centers and increase the utilization rate of our RNS System within the implanting centers. One area we are increasingly focused on is targeting epilepsy specialists who practice outside of level 4 centers. Over the last few years, the number of epilepsy specialists has grown significantly. It is our understanding that there are now more epileptologists practicing outside of level 4 comprehensive epilepsy centers than within level 4 CECs. We plan to educate these epilepsy specialists about the RNS System and to help them collaborate with CECs to have their patients treated with the RNS System. Through these relationships, we can make RNS therapy available to a larger number of patients with ongoing device programming and patient management provided by epilepsy specialists practicing outside level 4 CECs. In order to do this, we are accelerating hiring within our field organization. We ended 2020 with 42 field representatives, and the size of our field organization did not materially change in 2021. Given the investments we are making, we expect to end 2022 with approximately 56 field representatives, with most of those additions coming in the first half of the year. This would get us to the size of the field organization we initially anticipated having at the end of 2023 a year earlier. It takes time for a new hire to be fully productive. We want to ensure that our team is in place and productive as we anticipate the increase in patient volumes in the coming quarters. We are also driving demand generation by identifying and educating drug-resistant epilepsy patients earlier in their treatment journey as they consider treatments beyond medication. We intend to expand our multi-channel marketing programs, including an increase in digital and social advertising, lead generation efforts, and patient ambassador connections. As we connect with more RNS candidates earlier in their care journey, our patient education team will provide information about NeuroPace's RNS System and guide appropriate patients through the process. Moving to recent clinical updates and future indication expansion opportunities. As communicated on our last earnings call, we received IDE approval from the FDA for our NAUTILUS pivotal trial to support a PMA supplement to expand our indication to include primary generalized epilepsy. We remain on track to enroll our first patient around the middle of 2022. In addition to the large market opportunity for generalized epilepsy, there are important differences from our current focal epilepsy patient population that make this an excellent opportunity for our RNS therapy. First, diagnosis of generalized epilepsy can often be established with an outpatient EEG and does not require intracranial monitoring. In contrast, seizure onset localization for patients with focal epilepsy requires a one to two-week hospital stay in the EMU for non-invasive monitoring. Approximately 70% of our patients are admitted for a second one to two-week stay in the EMU with temporary electrodes implanted in the brain to identify the seizure onset location. Consequently, on average, it takes focal epilepsy patients approximately six months from the initial EMU admission until the implantation of the NeuroPace RNS device. For generalized epilepsy, we expect the path from diagnosis to RNS treatment to be shorter and simpler. Another difference with generalized epilepsy is that there are no surgical alternatives to treat generalized epilepsy since there is no focus that can be resected or ablated. Upon FDA approval, we expect a relatively fast commercial rollout because we anticipate selling to the same physicians who are already treating focal epilepsy patients using the same NeuroPace device. We are excited to start enrollment in the NAUTILUS study and look forward to an indication expansion into this large and underserved patient population. While progress on the RESPONSE study for patients aged 12 to 17 with focal epilepsy has been slower than expected, the first patient enrolled in the study was recently implanted with the RNS System. We expect to continue to support the RESPONSE trial in 2022 and look forward to seeing the impact of our RNS System on patients going through the study. Next, I want to provide an update on the estimated battery life of the neurostimulator we have been selling since 2018. I am pleased to announce that we received approval from the FDA to update our labeling to claim an estimated battery life of nearly 11 years under typical use conditions. This represents more than a two-year increase from our previously approved labeling. We believe that a longer battery life removes an important barrier for initial implant adoption and gives us a distinct competitive advantage over other neuromodulation devices for epilepsy, which have much shorter expected battery life. Given the relatively young age of our patients and a replacement rate of over 90%, this change brings significant benefit by reducing the number of required replacement procedures over a patient's lifetime. We believe that providing an estimated service life of nearly 11 years with no recharging burden will enhance the patient experience, especially as we continue our pivotal trial to support expanding our indication to adolescent patients. While the longer battery life is of significant benefit to our patients, it will reduce replacement implant revenue in the coming years as was communicated previously. To provide increased transparency, as of the end of 2021, there were 282 patients being actively treated with first-generation devices. We expect approximately two-thirds of those devices to reach the end of their battery life in 2022. As I look back on 2021, I can proudly say we have been able to make significant progress on key company milestones. On the clinical side, we enrolled our first patient in the adolescent study and received breakthrough device designation and IDE approval for the primary generalized epilepsy indication study, important steps to expand our indication and market opportunity. On the commercial side, we were able to make significant progress by expanding into 150 implanting centers, driving increased utilization and expanding the number of physicians prescribing and programming our RNS System. Lastly, we completed a successful IPO in April, raising net proceeds of $105.5 million in growth capital to facilitate investments to make RNS therapy the future standard of care for epilepsy patients globally. With that, I will turn the call over to Rebecca, NeuroPace's Chief Financial Officer.

Thanks, Mike. NeuroPace's revenue for the fourth quarter of 2021 was $11 million, compared to $10.8 million for the fourth quarter of 2020, an increase of 2%. 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 fourth quarter, revenue from initial implants was $8.5 million, an increase of 10% over the fourth quarter of 2020. Fourth quarter 2021 initial implant revenue was driven primarily by an increase in the number of implanting accounts compared to the prior year period. As Mike mentioned previously, we ended 2021 with 150 active implanting accounts, up from 132 in 2020. Growth in the quarter was impacted by headwinds from the Delta variant at the beginning of the quarter and by Omicron in the back half of December. Revenue from replacement implants was $2.5 million, a decrease of 19% compared to the fourth quarter of 2020. We continue to expect replacement implant revenue generally to decrease for the next several years due to the transition to the current model of our device which has a longer-lasting battery. Gross margin for the fourth quarter of 2021 was 73% compared to 76% in the fourth quarter of 2020. The decline in gross margin relative to the prior year period was primarily due to an increase in certain costs, as our manufacturing operations returned to normal levels following COVID-19-related disruptions in 2020. Total operating expenses in the fourth quarter of 2021 were $17.1 million, compared with $11.2 million in the same period of the prior year. R&D expense in the fourth quarter of 2021 was $5.3 million compared with $3.9 million in the same period of 2020. The increase in R&D expense was primarily driven by an increase in product development and clinical study expenses. SG&A expense in the fourth quarter of 2021 was $11.7 million compared with $7.3 million in the prior year period. The increase in SG&A was primarily driven by increased costs associated with operating as a public company and increased sales and marketing expenses. Loss from operations was $9 million in the fourth quarter of 2021 compared to $3 million in the prior year period. We recorded $1.9 million in interest expense in the fourth quarter, which was flat compared to the prior year period. Net loss was $10.7 million for the fourth quarter of 2021 compared with $4.6 million in the fourth quarter of 2020. Our cash and short-term investments balance as of December 31, 2021, was $115.6 million while our long-term borrowings totaled $49.8 million. Now, turning to our outlook for 2022. Given the impact the Omicron variant had on procedure volumes in January, we remain cautious given near-term uncertainty surrounding the severity and duration of COVID-19 and the potential impact on hospital, physician, and patient behavior. Our 2022 outlook is highly sensitive to assumptions around a steady global recovery which anticipates case scheduling and elective procedure levels normalizing throughout the year. For 2022, we expect annual revenue to range between $45 million to $48 million. This guidance assumes initial implant revenue to be in the range of $39 million to $42 million. Consistent with the last several quarters and given uncertainty around clinical trial revenue, our initial implant guidance assumes minimal revenue from clinical trials in 2022. Lastly, given the replacement revenue dynamics Mike mentioned previously, we anticipate replacement revenue to be approximately $6 million. Following one of the lowest initial implant revenue months of the pandemic in January, February bounced back strong. As of today, March booking trends suggest a sequential initial implant revenue increase compared to February. Given this positive momentum, we expect first quarter 2022 total revenue to be in the range of $10 million to $11 million, which includes an initial implant revenue range of $8 million to $8.5 million and a replacement implant revenue range of $2 million to $2.5 million. Moving down the income statement, we expect gross margin to be in the mid-70s percentage and operating expenses to be in the range of $74 million to $76 million, of which approximately $8 million to $9 million is non-cash stock-based compensation expense. This concludes our prepared remarks. I would like to turn the call back over to the operator who will open the call for questions.

Thank you. Our first question comes from Robbie Marcus from JPMorgan. Please go ahead.

Great. Thanks for taking the questions. Maybe to start, it's great to hear that trends are improving throughout first quarter. Maybe just to start there, do you think the Street is in a good place, where we sit now on first quarter? And does guidance assume that COVID trends materially improve from here, or does it assume they very modestly get better?

Thanks for the question, Robbie. So for Q1, we provided guidance of revenue in the range of $10 million to $11 million, which is really based on what we've seen in the quarter so far and where we see trends going in the quarter to be able to close out here in the last few weeks of the quarter. So I think what we provided in guidance is really our best thoughts about where things stand overall for Q1. As we think about the rest of the year, the guidance for the rest of the year, we continue to believe that the initial implant revenue portion of our business is a growth in the low to mid-20s percent over year-over-year, growing at that pace in a normalized COVID environment. Primarily, that's driven by assumptions about the number of patients coming through the EMU being similarly impacted to the way that they were in 2021. Our guidance, specifically the lower end of the guidance range that we provided for 2022 revenue incorporates the slow start to the year with Omicron having a higher degree of disruption early in the quarter than we saw in other recent waves of COVID. And so taking that into account and being thoughtful about the guidance, we incorporated that into the first – into the lower end of the guidance range that we're providing for initial implant revenue. The replacement revenue really being driven by the number of those devices of the old generation that are remaining and provided numbers for where that's – for specifically, where that's coming from. We're encouraged by the progress that we've been continuing to make in Q1 of this year. We finished Q4, as you know, better than where we thought that we would when we were in November. So we're very pleased with how we were able to finish the year. Things have been continuing to trend in a positive direction after the significant impact in January and really incorporating that as we go forward. Just as a reminder, we did increase our business in 2021 by about 20% year-over-year for the initial implant revenue portion of our business. That was really driven by a combination of new centers, additional centers prescribing the device as well as more utilization in each of those centers. We expect to be able to continue to do that, and the foundation that we built for the business in 2021 is a strong one that we'll be able to build off of. Over the longer run, when we do anticipate the number of EMU visits going back up to pre-pandemic levels and growing from there, it puts us in a strong position to be able to grow from that. But really anticipating that that will be a longer-term impact, meaning not so much of an impact in 2022 but really more impact beyond 2022.

I apologize. Shame on me for not hearing the first quarter guidance. Maybe just as a quick follow-up here. It sounds like you're building out the sales force faster than expected, feels like awareness is still a major limiting factor here. How do you think the increased feet on the street can help grow sales? And where are they really going to be spending their time? Is it driving interest within existing accounts or trying to bring on new accounts? Thanks.

Thanks, Robbie. So the focus of the field organization, primarily, is on driving increased utilization or pushing increased utilization within the epilepsy centers and bringing on new centers. We grew our business last year from a combination of those two. We expect to continue to do that. As we have communicated previously with more implanting centers, it creates more feet on the street to be able to support those as well as to bring on more centers beyond that. The one additional reason that we're accelerating the timing of hiring in the field organization is to allow our team to call on epilepsy specialists, epileptologists that are practicing outside of Level 4 centers and establishing relationships for those patients being managed by these epilepsy specialists to be implanted with the NeuroPace device at a Level 4 center and then go back to the community settings with these epilepsy specialists for ongoing care. We want to be able to have that combination of bringing on new implanting centers, increasing utilization, but also recognizing that a large portion, approximately 80% of patients with drug-resistant epilepsy are not currently being seen in a Level 4 center. The recent trends show that there are more and more epilepsy specialists, not general neurologists, but epilepsy specialists that are establishing practice outside of those centers, creating a great opportunity for us to be able to identify those patients, increasing patient opportunity, and tie them in with the level 4 centers for implantation to be able to over time accelerate the growth of the business.

Thank you. I show our next question comes from the line of Larry Biegelsen from Wells Fargo. Please go ahead.

Hey, good afternoon. This is Vik in for Larry. Thanks so much for taking the question. Maybe a couple from us. You mentioned the fact that patient volumes are not yet back to pre-COVID levels. Help us understand when you expect those EMU patient volumes to return to 2019 levels? That's the first question. And then the second question I had was perhaps on your margin guidance. Help us understand how we should think about the cadence for 2022? Thanks so much.

Thanks. To clarify our forecast for EMU volumes, patients who are candidates for the NeuroPace system typically undergo a diagnostic process in epilepsy monitoring units, which often involves one or two stays. The number of patients visiting these units has decreased compared to pre-pandemic levels due to hospital constraints and staffing issues. For our 2022 guidance, we are assuming that the rise in EMU visits will not significantly affect our revenue this year. We expect these volumes to return to pre-pandemic levels later this year, but the time between admission to the EMU and NeuroPace device implantation will not substantially impact our business in 2022. Rebecca, would you like to discuss the margin?

Sure. Absolutely. Our guidance is that our gross margin will be in the mid-70s range. We don't anticipate significant differences throughout the year. Of course, the gross margin will fluctuate with volume. But in general throughout the year, we expect that it will stay within a fairly narrow range within that general guidance of mid-70s. And over time, we expect that it will improve, but throughout the year generally within that range of mid-70s.

Thank you. I show our next question comes from the line of Danielle Antalffy from SVB Leerink. Please go ahead.

Hi guys. This is Priya on for Danielle. Congrats on a solid quarter despite all of the COVID challenges. I guess the first one for me here is, I appreciate that you guys expect an increase in the number of implanting centers. But when we look at utilization per center, what are some of the barriers to adoption aside from COVID that you've seen in the past few quarters? And now that you've got an expanded sales force, how is the team anticipating to combat these barriers as you enter these new centers? Thanks.

Thank you. The growth we are experiencing in the business is due to the addition of more implanting centers and increased utilization within those centers. Our efforts and the challenges we are overcoming at comprehensive epilepsy centers that are now utilizing our services are leading to greater usage as more doctors at these centers are prescribing the NeuroPace device for their patients. These institutions usually have multiple epilepsy specialists. We are transitioning from having one or two specialists, where we typically begin adoption, to a larger group of these specialists prescribing the NeuroPace device. This involves identifying patients and incorporating neuromodulation, specifically NeuroPace neuromodulation, into the practice of additional physicians. We are providing education to these doctors about the clinical advantages and excellent results of our product, the improvements we've made for ease of use, and the overall benefits it offers in terms of treatment options for patients who previously had limited choices. As for our field team, we have not increased its size yet, but we plan to expand significantly in the first half of this year. We expect this larger field organization to facilitate entry into more centers, allowing new representatives to support this effort. They will also reach out to more physicians within the centers to boost the number of prescribing doctors. Importantly, we will also engage with epilepsy specialists outside the Level 4 centers, who can refer their patients to a Level 4 center for implantation and then manage their ongoing care. Up to this point, we have not focused much on this area. Trends in the medical industry indicate that more epilepsy specialists are entering the field, many outside Level 4 centers, presenting us with a great opportunity to identify those patients and provide access to the NeuroPace device.

Super helpful. Thanks. And if I could squeeze one more in. I was wondering if you could speak to some of the early feedback you've received on the remote capabilities of the RNS System, especially in an operating environment where staffing shortages have played a large role? And how do you think this could benefit NeuroPace over the long term? Thanks for the question, guys.

One of the interesting and really unique aspects of the NeuroPace device is that we do have a system that records information that's happening inside of the patient's brain, including the electrical signals associated with abnormal events that our device detects. We also provide trending information about how often those events are being detected and when they're being detected. All of that information is uploaded into a database that can be viewed by the physician anywhere, with or without the patient present. That's been really helpful through the pandemic, as there have been fewer patient in-person visits. It enables physicians to get objective information about what's happening with their patient, without requiring the patient to physically come into the hospital to obtain that information. The diagnostic review of those ECoGs or intracranial EEG signals is also reimbursed. It serves as a mechanism in a remote setting for the epilepsy specialists to get reimbursed for that work that they’re doing reviewing the diagnostic information stored by the device. As we move forward, with the focus on patients to be implanted in Level 4 centers, but potentially managed by epilepsy specialists outside of those centers, we expect that this unique data component and visibility of the diagnostic information becomes even more important, as multiple physicians, some within Level 4 centers and others in the community will all be able to access that data for those patients to optimize treatment, again with reimbursement established for those physicians when they do that diagnostic review.

Thank you. Our next question comes from the line of Drew Ranieri from Morgan Stanley. Please go ahead.

Hi. Thank you for taking my questions. Regarding the previous inquiry about utilization, I understand that you're working on adding more centers and increasing the number of prescribers. Could you discuss the underlying trends you're observing in the business? Specifically, how many implanters are currently prescribing RNS compared to the levels in 2019? This would provide us with a clearer view of the total clinicians using or prescribing RNS at this time. Additionally, what are your expectations for this in 2022?

We haven't provided specific numbers at this point of prescribing physicians. The level of detail we provided, as you know, is at the account level. What I can tell you is that the growth we're seeing in utilization, so the number of patients treated per center, per year, is driven significantly by more physicians within those centers prescribing for their patients. We're seeing trends similar to the more centers implanting for more physicians prescribing within those centers and then over time also pushing to have more utilization per physician. Without getting into specific numbers to answer your question, Drew, the utilization increases we're seeing in large part are being driven by more physicians within those centers prescribing for their patients.

Okay. Helpful. Thank you. And with the clinical trial revenue, I heard the word minimal. But can you just help us think through that? It only takes a few implants to drive a percentage point of growth for the business. Should we be thinking 10, 20 implants as kind of what you're thinking in terms of clinical trial-based implants for the year?

There are a couple of things I wanted to clarify around clinical studies and then get into the specific answer to your question. We have the two clinical studies we are pursuing in 2022. The primary focus for our organization is on the NAUTILUS study for expansion into generalized epilepsy. We have a significant opportunity there. In the prepared remarks, I made a number of comments about why we think that opportunity is especially interesting for our business and what it means for us over time. We're very much focused on executing that study. Timing-wise, we're expecting to start enrolling in that trial around the middle of this year. There is a delay required due to baseline data collection between when a patient is enrolled and when a patient is implanted. The other comment I'll make is that while we are seeking reimbursement for patients in the NAUTILUS study, we don't know how effective we will be at getting insurance companies to reimburse those patients in that trial. We have taken a much more conservative view around our ability to get reimbursed for the patients in the trial, resulting in minimal revenue, which we've incorporated within the guidance for initial implant revenue overall.

Got it, and my last question is for Mike. You mentioned that you're expanding the sales team from 42 to 56 in 2021, but it seems you haven't made any new hires for the sales force this year. It appears there's competition for talent in the medtech sector, as several companies have highlighted increased challenges in attracting new talent. How critical is the addition of these potential salespeople for your revenue in 2022? Thank you.

Thanks. To clarify, we have just started that process. The results of that are still largely ahead of us. But we've been in the process of hiring and expanding the field organization, with hiring primarily in the first half of the year. Following that, there is a period of time before a new representative really becomes productive in the field. It takes about three months on average for a new representative to be qualified to treat or to be in the hospital by themselves to manage the implantation procedures or really support the clinicians. I would say it takes about 12 to 18 months to be fully productive. Given the assumptions we've discussed for most of these hires happening in the first half of the year and the time to be productive, there's really not significant impact that we're building into our guidance for 2022 for that expansion. The expansion and investments we're making are really to position us for increased patients coming through epilepsy monitoring units, as those come back and to support the growth we expect over the longer run, so not significantly built into our numbers for 2022 but important investments for us.

Thank you. I'm showing no further questions in the queue. This concludes the Q&A portion. At this time, I would like to turn the call back over to Mike Favet, CEO for closing remarks.

Thank you again for your time today. We look forward to meeting with many of you at upcoming investor conferences as well as individual meetings. Have a great evening.

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.