NeuroPace Inc Q4 FY2022 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 the 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 Trip Taylor, from the Gilmartin Group, for a few introductory remarks.

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, 2022. 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 the 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 relate to expectations or predictions of future events, results, or performance are forward-looking statements. All forward-looking statements, including those around NeuroPace's business opportunities, market conditions, 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, market opportunity, revenue outlook, and commercial expansion are based upon current estimates and various assumptions. These statements involve material risks and uncertainties that could cause actual results or events to differ materially 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 SEC, including our quarterly report on Form 10-Q for the quarter ended September 30, 2022, and our annual report on Form 10-K for the year ended December 31, 2022, 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 this live broadcast on March 2, 2023. 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, Trip. Good afternoon, everyone, and thank you for joining us. Today, I will highlight our fourth quarter performance and update you on the priorities we intend to focus on in 2023, before turning the call over to Rebecca to detail the financial results and open the call to questions. Before we begin, I want to highlight our key accomplishments from a productive 2022. In our first full year as a public company, we drove meaningful adoption of our RNS System, increasing utilization within the comprehensive epilepsy centers, or CECs, and adding more implanting centers. We also became the exclusive U.S. distributor of the stereo EEG products produced by DIXI Medical. This provides us with not only an additional revenue stream through our established sales channel, but also visibility into patients being worked through the diagnostic process who are potential candidates for RNS Therapy. We made meaningful progress toward expanding the RNS indication, specifically through our NAUTILUS pivotal study for primary generalized epilepsy. We accomplished all of this while reducing cash burn in the second half of 2022 to approximately $15 million compared to approximately $23 million in the first half of 2022. I will provide more color on these accomplishments and how they position us well for 2023 and beyond. Starting with our fourth quarter performance, total revenue for the fourth quarter was $12.8 million, representing growth of 16% compared to the prior year period and 15% compared to the third quarter of 2022. This was primarily driven by increased adoption of our RNS System, evidenced by strong initial implant revenue of $9.8 million, representing growth of 15% compared to the prior year period and 7% sequentially. This was coupled with revenue contribution from the distribution of DIXI Medical products, which was slightly ahead of expectations at $1.6 million in our first quarter selling this product line. We believe epilepsy monitoring unit, or EMU, patient volumes remained stable throughout the fourth quarter with no significant disruption since the first quarter of 2022. As a reminder, diagnostic evaluation in the EMU is the initial step in evaluating treatment options, including the potential use of RNS. Stability in the EMU supports the pipeline of interventional therapy candidates, including candidates for RNS Therapy. We continue to execute commercially in the normalizing operating environment, one that we do not believe has yet returned to pre-pandemic levels, and have been successful in driving physician and patient awareness of the clinical benefit and differentiated features of our RNS System. As a result, we are seeing a trend of increasing utilization, meaning that more patients are getting the benefit of RNS Therapy. Considering this momentum, we expect total 2023 revenue of $50 million to $52 million compared to $45.5 million in 2022. Our growth will be driven primarily by increasing RNS utilization within CEC and a full year of selling the DIXI Medical products. Growth in these areas will be offset by declining replacement implant revenue as the remaining first-generation devices reach end of service and are replaced by our second-generation device with a nearly 11-year battery life. Commercially, our priority is to increase utilization of the RNS System. Our strategy concentrates on three objectives: one, expanding patient selection; two, managing the patient pipeline; and three, driving adoption of the RNS system by additional prescribers and additional implanting centers. To expand patient selection, our team is focused on physician education. Our goal is to increase physician awareness of the benefits of the RNS System for all indicated focal epilepsy patient subgroups. The RNS System is highly versatile, with the ability to position leads throughout the brain and customize detection and stimulation in a way that allows treatment of a full range of focal epilepsy onset locations. We have compiled compelling clinical evidence showing the differentiated benefits of RNS Therapy across these patient subgroups, and we are working to ensure these data are understood by more physicians. We believe this will help inform deeper integration of RNS system into their treatment algorithms for a broader set of patients. We are also working to close the treatment gap by guiding epileptologists and neurosurgeons to evaluate more drug-resistant epilepsy patients for interventional therapy so that more of their patients can realize the life-changing benefits provided by RNS Therapy. Our next objective is to actively manage every level of the patient funnel. We believe that identifying and educating potential RNS patients earlier in their treatment journey is critical for increasing RNS utilization. At the top of the patient funnel, we are adding leads using direct-to-consumer efforts, and through our field team working within the CECs, including through our work in the EMUs with the DIXI Medical stereo EEG products. We utilize nurse navigators who help guide these patients through the diagnostic process. We also provide patient education on the RNS System through our commercial team and a network of patient ambassadors. We believe that our efforts to manage the patient pipeline from end to end will be a key factor in increasing RNS therapy utilization. As a reminder, we are the exclusive distributor of DIXI Medical stereo EEG leads, which is the diagnostic device used to determine where epileptic seizures originate. Most RNS patients and most surgical resection and ablation patients in the United States are being localized with stereo EEG before intervention. Distribution of these products is not only an incremental revenue stream, but is providing the opportunity for earlier patient engagement, where we believe we can have a greater impact and a stronger voice explaining the benefits of the RNS system. Q4 was our first quarter distributing the DIXI Medical products, and we are encouraged by our early progress. We are confident this partnership will have a positive impact on the RNS patient pipeline. Third, we believe that driving adoption by additional prescribers and bringing on new implanting centers will also contribute to our overall growth. The sales force expansion completed in 2022 has enabled, and will continue to enable, this team to cover a greater portion of the market, and we intend to leverage that to introduce our RNS system more broadly. These three commercial objectives are designed to increase utilization of the RNS System and CECs and support our initial implant revenue growth in 2023. I will now provide an update on replacement revenue. As expected, in the fourth quarter, replacement revenue was $1.4 million, which represents a decline of 44% compared to the prior year period. As of December 31, 2022, there were 56 patients being actively treated with first-generation RNS devices. We do not plan to provide this metric going forward as we do not expect it to represent a material part of our business in 2023. We continue to expect quarterly replacement revenue to sequentially decline through the year as the remaining first-generation devices are replaced with the second-generation device with a longer-lasting battery. We believe that we will have completed the transition process by the end of 2023. Moving to our clinical trial updates, generalized epilepsy continues to be our top clinical priority. In 2022, we initiated enrollment in our NAUTILUS study. The NAUTILUS study is designed to evaluate the safety and efficacy of the RNS System for the treatment of primary generalized epilepsy. I am pleased to report that all 25 participating sites are now active and are seeking to enroll patients in the study. We also continue to make good progress on the NIH-funded feasibility study for patients with Lennox-Gastaut syndrome, a type of symptomatic generalized epilepsy. Generalized epilepsy represents a meaningful market expansion opportunity. 40% of drug-resistant epilepsy patients have generalized epilepsy, and diagnosis of these patients is simpler and faster than for focal epilepsy. We believe that RNS Therapy represents the optimal intervention for these patients as resection and ablation are not applicable for generalized epilepsy, and there is no FDA-approved neuromodulation therapy for this indication. To wrap up, as I look back on 2022, I can proudly say that we have been able to make significant progress across our business. We drove increased RNS system utilization. We expanded our field team and optimized our commercial process. We successfully initiated distribution of DIXI Medical Products for stereo EEG. We made important progress towards expanding our indication into generalized epilepsy by beginning enrollment in the NAUTILUS study and the LGS study. We did all of this while reducing our cash burn to approximately $15 million in the second half of 2022. With over $77 million of cash available at the end of 2022, at this burn rate, we would have more than two years of available capital. Collectively, these accomplishments have positioned NeuroPace well for 2023 and beyond. With that, I will now turn the call over to Rebecca to detail the fourth quarter and full year financial results.

Thanks, Mike. NeuroPace's revenue for the fourth quarter of 2022 was $12.8 million, representing growth of 16% compared to $11 million for the fourth quarter of 2021 and 15% sequentially compared to $11.2 million in the third quarter of 2022. In the fourth quarter, revenue from initial implants grew 15% to $9.8 million compared to $8.5 million for the fourth quarter of 2021. Sequentially, initial implant revenue in the fourth quarter grew 7% compared to the third quarter. The increase in revenue was largely due to an increase in initial implant procedures. Revenue from replacement implants was $1.4 million compared to $2.5 million in the fourth quarter of 2021. We continue to expect replacement implant revenue generally to decrease through the end of 2023 until we have completed the transition to the second-generation device. This means that we expect revenue only from replacements of our second-generation devices after this year. We expect this will be a growth driver for our business when more of the second-generation devices reach the end of their battery life and are ready for replacement. Gross margin for the fourth quarter of 2022 was 69% compared to 73% in the fourth quarter of 2021. The decline in gross margin relative to the prior year period was primarily due to distributing DIXI Medical products, which have a lower gross margin than our core RNS business. The fourth quarter of 2022 was our first quarter distributing DIXI Medical products, and we expect gross margins to generally increase from that level. Total operating expenses in the fourth quarter of 2022 were $18.7 million compared with $17.1 million in the same period of the prior year. Operating expenses in the fourth quarter, including one-time costs associated with the DIXI Medical partnership launch, increased by 3% compared to the third quarter. As expected, operating expenses for our core RNS business decreased slightly in the fourth quarter compared to the third quarter. We plan to continue to focus on initiatives to optimize operating expenses through 2023. R&D expenses in the fourth quarter of 2022 were $5.1 million compared with $5.3 million in the same period of 2021. The decrease in R&D expenses was primarily driven by a decrease in personnel-related expenses. SG&A expenses in the fourth quarter of 2022 were $13.6 million compared with $11.7 million in the prior year period. The increase in SG&A was primarily driven by DIXI Medical partnership launch expenses and personnel-related expenses. Loss from operations was $9.9 million in the fourth quarter of 2022 compared with $9 million in the prior year period. We recorded $1.9 million in interest expense in the fourth quarter compared to $1.9 million in the prior year period. Net loss was $11.1 million for the fourth quarter of 2022 compared to $10.7 million in the fourth quarter of 2021. Our cash and short-term investments balance as of December 31, 2022, was $77.4 million and our burn rate in the second half of the year was approximately $15 million compared to approximately $23 million in the first half of the year. Our long-term borrowings totaled $52.9 million as of December 31, 2022, with the full principal due on September 30, 2025. Now turning to our outlook for 2023, for 2023, we expect revenue to range between $50 million and $52 million. Growth will be supported mainly by increases in initial implants and revenue from the sale of DIXI Medical products. As discussed, replacement revenue is expected to decline this year. Gross margin for 2023 is expected to be between 69% and 71%, potentially a slight improvement from the 69% generated in the fourth quarter, which was our first full quarter with DIXI Medical revenue contribution. As a result of the distribution agreement for the DIXI Medical partnership, that revenue produces a lower gross margin than our core business. Fluctuations in the proportion of DIXI Medical revenue to overall revenue will create small variability in our quarterly gross margins. Operating expenses for 2023 are expected to range between $75 million and $77 million, including $11 million to $12 million in non-cash expenses. Lastly, it is important to highlight that our cash burn rate for the second half of 2022 was approximately $15 million. We were able to reduce our cash burn in the second half of the year compared to the first half of the year because of the spending discipline and cost controls we implemented starting in the middle of the year. We intend to maintain that level of discipline in 2023. Given our cash balance at year-end of 2022 and our ongoing efforts to reduce our burn rate, we do not believe we will have a need to raise capital in the next 12 months. 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.

And our first question comes from Michael Polark from Wolfe Research. Your line is now open.

Maybe to start, Mike, I’m interested in your thoughts on the top of the funnel. It seems that the last nine months of 2022 were stable regarding EMU admissions, which is a positive sign for new patient implants. What do you think is driving this? How sustainable and consistent do you believe it can be moving forward? Additionally, do you think there was any catch-up effect in the last nine months of 2022 due to extended COVID disruptions that may have prevented patients from engaging with the system? Is that contributing unusually to what you observed in the latter half of the year, or do you believe we are at a stable state with a level of new admissions that can be maintained in 2023?

Great. Thanks for the question, Mike. So jumping into the stability that we've seen in the market over the last three quarters or so. Largely, I attribute that to having not had any significant COVID-related disruptions since Q1 of last year. The market has been relatively stable from that perspective, and that's allowed centers to be able to get back to a new normal for patients coming through the epilepsy centers. We don't believe that the epilepsy centers are all the way back to pre-pandemic levels yet, primarily because of staffing limitations that some of the hospitals have had. So we're not getting COVID disruptions, but there are staffing challenges that some of these centers have had. I haven't seen what I'll call a surge of makeup that's coming through the centers. It's really allowing them to get back to a flow of patients that are coming through the centers. And given that we're not back to pre-pandemic levels yet, at least we believe that we're not, and the hospitals are working to bring in the staffing. I do expect, over time, there's an opportunity for that volume to increase. And then historically, prior to the pandemic, most of the growth, the volume of patients coming through the epilepsy centers was driven by more epilepsy centers being created. I'm starting to hear out in the community that there's more activity around that again, where centers are hiring an epileptologist looking to bring in surgeons to be able to create new epilepsy centers, which provides another opportunity for the market to grow overall. So, I think stability, no significant COVID disruptions, and that's put us in a position to be able to show the share gains that we've been able to make within the EMU, with more of the patients coming through the EMU being treated, not being offset by declines in the number of patients coming through these centers.

Helpful. And maybe for the follow-up part of the hook with DIXI was more upstream visibility into this funnel. And I guess, I know it's early days with this distribution agreement. But kind of what are you learning with DIXI? And then is that helping you manage the flow and funnel and identify patients better?

Yes, as you mentioned, it's still early. We're about a quarter and a half into the U.S. distribution of the DIXI product, and it has largely met our expectations. The collaboration with our field organization is quite strong, and I feel optimistic about our ability to support and market this product to our commercial team. The initial reports, which are more anecdotal than broadly substantiated, align with our assumptions. We're gaining better insights into patient flow through the epilepsy centers, including how many patients are entering the Phase 2 studies leading to treatments like the RNS system implant. This information enables us to create more sales opportunities, allowing a greater percentage of those patients to transition to the RNS system. While it's still early and mostly anecdotal, I am very encouraged by the sales synergy and the potential positive impact on our pipeline.

And thank you and one moment for our next. And our next question comes from Frank Takkinen from Lake Street Capital Markets. Your line is now open.

Congratulations on the progress. I wanted to start by discussing the guidance. I’ve heard the comments about the growth drivers, specifically your initial implants and DIXI being offset by replacements. Could you explain how you view the low end versus the top end? What needs to happen to reach the top end? What circumstances might lead to hitting the bottom end? Lastly, what would be required to exceed the top end of the guidance?

Thanks, Frank. I'm looking forward to executing our plans for 2023. As you mentioned, the growth drivers include initial system implants of the RNS system and DIXI revenue. For the DIXI component, growth will rely on a mixture of market growth and our ability to capture market share. I am optimistic about the distribution efforts we began in the fourth quarter of last year, which gives us a solid foundation. Regarding NeuroPace RNS revenue, which constitutes the majority of our earnings, our outlook depends on the speed of the market's recovery. We're anticipating that the normalization we observed over the past three quarters will continue into 2023. If the market recovers more quickly, returning to and growing beyond 2019 levels, that could provide additional opportunities. Another crucial factor will be how quickly we can boost utilization rates within these centers. The primary driver for initial implants is accelerating the growth of initial implant utilization, which depends on the effectiveness of our commercial strategies and efforts to manage the patient pipeline. Additionally, expanding access to the RNS system by bringing on new centers will also support our revenue range.

Okay. That's helpful. And then maybe for my second one on the generalized population. Can you provide any update around the enrollment and if unable to give specific patient numbers, maybe if you can share some goalposts around timing for enrollment completion expectations?

Thank you for the question. I’m really excited that we have now included all of the centers in the study. Moving through 2023, our focus will be on driving enrollment through these centers. We expect that it will take approximately a year from now to enroll the remaining patients in the NAUTILUS study. We are making every effort to expedite this process, but we anticipate it will take about a year. As a reminder, there is a one-year follow-up for the primary endpoint of the study. We are pleased with the progress in getting the sites operational and there's a lot of enthusiasm in the medical community, so we are very happy with the number and quality of sites participating in the trial.

And thank you and one moment for our next question. And our next question comes from Robbie Marcus from JPMorgan. Your line is now open.

This is Allen on for Robbie. I had a quick one just on the trends you're seeing in the first quarter. It sounds like you're seeing some good stability, but just curious to see what you're seeing so far in the first quarter? And also just what that implies for seasonality going from 4Q to 1Q, and then through the balance of the year?

Yes. What we've seen in the start of the first quarter has been consistent with what we've been seeing in the last three quarters, meaning that the epilepsy monitoring units have been normalizing over that period of time. No significant COVID-related disruptions in the epilepsy centers through the first couple of months of 2023, which extends what we saw again in the last three quarters of 2022. That puts us in a nice position to be able to focus on the share gains within the epilepsy center to be able to have those come through. Overall, I think, it's a continuation of where we exited 2022 as we started into the first couple of months of this year.

Got it. And then when we think about DIXI, it came in a little bit stronger in the fourth quarter. We were thinking for 2023 roughly around a $6 million contribution. Is that still the right way to think about it? And any kind of color on cadence you think about that as being more back-end loaded?

Yes. The way that I think about the DIXI revenue, the fourth quarter was, I think, a good baseline for where we expect revenue for that business going forward. There's, I would say, some growth potential. But I would think about it as being able to build off of the $1.6 million of revenue that we had in the fourth quarter. There wasn't anything that was abnormal about the fourth quarter, meaning it wasn't a stocking quarter; it was a continuation of the work that DIXI was doing when they were distributing directly in the U.S. themselves. Prior to the fourth quarter, we were able to pick that up and continue that. So think about 1.6 as kind of the baseline and then being able to run off of that as we go through 2023.

And thank you and one moment for our next question. And our next question comes from Larry Biegelsen from Wells Fargo. Your line is now open.

I'm not sure what happened. This is Vik in for Larry. So a couple of questions for me. About your comments on the gross margins for 2023, but just help us understand how we should think about the cadence for 2023, given the DIXI Medical agreement? And I have a follow-up.

Rebecca, do you want to cover that?

We expect gross margin to be between 69% and 71% in 2023, with potential for upside based on our fourth-quarter results. DIXI has a lower gross margin compared to our core RNS business, and our overall gross margin will be influenced by the revenue mix between DIXI and our core business. We don't anticipate any unusual changes in that mix as the year advances, so there should be no significant fluctuations.

Okay. And then my follow-up, Mike, I got your comments. But could you help us understand at what pace you expect to add new centers going forward in 2023?

Thank you for the question. We ended 2022 with 156 implanting centers, an increase from 150 the previous year. Most of our revenue growth from last year was driven by higher utilization within these centers. As we move into 2023, we are taking steps to expand access to the RNS system in the United States and expect to continue adding centers throughout the year, building from the existing 156. I anticipate providing more details on this as we progress, as it will be a key growth driver for us. However, we primarily expect an increase in adoption of the RNS system to stem from greater utilization within these centers. We have a foundation of 156 centers with more patients being treated through them, and we are working on making the RNS system more widely available across the U.S.

And thank you and one moment for our next. And our next question comes from Drew Ranieri from Morgan Stanley. Your line is now open.

Maybe just to put some math around 2023, but if I kind of take your comments on replacement revenue, I think you have 56 patients remaining. Your DIXI commentary, it looks like new patient implant growth for the year might be in the high teens kind of given your initial guide here. So just kind of curious you've talked about getting back to low to mid-20s in a normalized environment. Is that still the case? Do you think that you can do that in 2023? Is it more about just stability? Or do you need to see EMU visits get back to 2019 levels to truly kind of grow new patient implants at that growth rate?

Thank you for the question, Drew. We have significant opportunities to treat more patients coming through the epilepsy centers with the RNS system, and we've been discussing taking a greater share of those patients. Additionally, market growth will likely have a positive impact over time. If we see an increase in epilepsy monitoring unit admissions, it could accelerate the growth of those numbers. However, we aren't factoring in substantial changes in EMU admissions into the guidance we've provided, which does leave room for upside if those admissions improve throughout the year. We remain cautious about the overall market situation, but we expect to effectively take more shares of the patients coming through the EMU, regardless of the admission volume.

Got it. And maybe just two high-level questions, but you're talking about a lot of excitement on the NAUTILUS study and the potential there and generalized epilepsy. So maybe as you're having centers come online, having patients even interested, is it driving at all any halo effect maybe on the focal side as more interest in epilepsy or treating epilepsy through RNS is growing? And then second, just with DIXI, how it's giving you another revenue stream? Do you foresee any additional partnership opportunities in '23 to augment revenue?

Yes. Thanks, Drew. I think it's too early to comment on any specifics about halo effect. But I will comment that some of the centers that are participating in the NAUTILUS studies are centers that are not doing a lot of RNS, not doing very much RNS with the focal epilepsy indication. And so that's providing an opportunity for us to have more touch time with them, talking about the RNS system and the benefit that's there. I do think there is some halo effect back to the already approved indication within those centers. It's all a good thing for us to have more talk points and more touch points with a broader set of clinicians talking about and patients talking about the benefit of response neuromodulation. As we think about the impact of the DIXI Medical revenue and where there could be other opportunities, I'm not going to comment on that specifically. We do have a top-end sales organization selling now DIXI product as well as the RNS system in the U.S., and we'll be always creatively looking for how can we be able to make the most of it, but nothing specific that I would comment on for 2023.

And I am showing no further questions. I would now like to turn the call back over to Mike for closing remarks.

Great. Thank you all for your participation today. I look forward to talking to you again on our Q1 earnings or at upcoming investor conferences. Have a good evening.

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