Earnings Call Transcript - NPCE Q3 2023

Operator, Operator

Ladies and gentlemen, greetings and welcome to the NeuroPace, Inc. Third Quarter 2023 Earnings Conference Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Irina Ridley, Chief Legal Officer. Please go ahead.

Irina Ridley, Chief Legal Officer

Good afternoon. Thank you for joining us for NeuroPace's third quarter 2023 financial and operating results conference call. On today's call we will hear from Joel Becker, Chief Executive Officer; and Rebecca Kuhn, Chief Financial Officer. Earlier today NeuroPace released financial results for the third quarter ended September 30, 2023. A copy of the press release is available on the company's website at neuropace.com. Before we begin, I would like to remind you that throughout this call, we will make statements 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 relate to expectations or predictions of future events, results or performance are forward-looking statements. All forward-looking statements including those around NeuroPace's projections, business opportunities, commercial expansion, 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, estimates of market opportunity and forecasts of market and revenue growth are based on 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 SEC, including our annual report on Form 10-K for the year ended December 31, 2022 filed with the SEC on March 2, 2023 and our quarterly report on Form 10-Q for the period ended September 30, 2023 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 November 6, 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 NeuroPace's Chief Executive Officer, Joel Becker. Joel?

Joel Becker, Chief Executive Officer

Thank you, Irina, and good afternoon, everyone. As you saw in the press release we issued earlier today, we had a strong third quarter, marked by strong year-over-year revenue growth and operating execution. The fundamentals of our business are well established. And I look forward to updating you on several meaningful milestones which we believe will drive future growth. On today's call, I will provide highlights from the third quarter of 2023, and review our key business priorities for the remainder of 2023 and into 2024. I will then turn the call over to our CFO, Rebecca Kuhn, to present the details of financial performance for the quarter before opening the call to Q&A. Total revenue for the third quarter was $16.4 million, representing growth of 47% compared to the prior year, and as anticipated, down 1% compared to the second quarter of 2023 as we experienced flight seasonality and a reduction in the number of replacement procedures. As we complete our transition to the newer, longer lasting battery device, strong year-over-year performance was again primarily driven by initial implant growth within comprehensive epilepsy centers, or CECs, both through increased utilization and adoption by prescribers and by implants over our RNS system and our NAUTILUS study. We also continued to see increasingly higher transduction from our partnership with DEXI Medical. As expected, replacement RNS implant revenue continues to decline, now at approximately 3% of total revenue. We believe that replacement revenue will become a tailwind once more of the newer devices with the longer lasting battery life begin to reach end of service. In light of our Q3 results, we are raising full year 2023 revenue guidance to a range of $62.5 million to $63.5 million, up from $59 million to $61 million said last quarter, and up from the $50 million to $52 million range we communicated at the start of the year. We were also pleased with our gross margin performance improvement to 74.5% in Q3, up from 71.4% in the prior year period, and 72.5% in Q2 2023. As volumes increase, and the costs are allocated across more units, we expect gross margin for 2023 to be between 71% and 73%, up from 70% to 72% as previously communicated. We remain committed to disciplined expense management. And this, in combination with revenue growth and gross margin performance, along with the impact of the timing of collections from our customers, has resulted in cash burn of $2.2 million in the third quarter of 2023 compared to $4 million in the second quarter of 2023. Again, without compromising revenue growth, and with the continued focus on our key priorities. While we believe Q3 cash burn was the result of several factors, we're pleased with the result and we'll continue our efforts to manage expenses as we focus on profitability. Based on our current cash burn rate, we now believe that we have sufficient capital to fund our planned operations into 2026. I would now like to turn your attention to our operating achievements, which we expect will have a meaningful impact on our near and longer term growth prospects. There were a number of significant operating achievements in the quarter, which reinforce our continued focus on demonstrating strong execution in the business. We saw our first implants of the RNS System in the community setting as part of the initiation of our pilot activities for our Project CARE program. We also took significant steps in streamlining patient care, particularly important as we expand into the community through FDA approval of our Tablet Remote Monitor, and the launch of the nSight platform. And we remain on track to complete enrollment in our NAUTILUS trial in Q1 2024, to expand our indication into generalized epilepsy. We have been focused on refining our strategy for launching our commercial efforts into the community and are expecting a full launch of our pilot program with a group of community customers in the first half of 2024. We have seen significant interest in these efforts, and some of these pilot customers have been eager to advance quicker through the process. As a result, we're happy to announce our first implants of the RNS System in the community setting with this initial group of pilot customers. The patients implanted are doing well, and we're pleased that we're now able to bring RNS Therapy not only to the additional 1,800 epileptologists and an expanded group of functional neurosurgeons, but most importantly, to the indicated patients who would or could not have been referred to a Level 4 Center for Treatment. We will continue to be thoughtful and targeted in these expansion efforts. It is also important to note alongside our initial work with these community centers, we have remained focused on ensuring appropriate patients are referred to Level 4 CECs for further diagnosis and treatment. We believe that as a result of the work we've started to do in the community, additional patients have already been identified for referral into Level 4 centers. Our expansion into the community demonstrates the benefits both locally and more broadly with expanding access to RNS Therapy. We're excited by the opportunity to close the treatment gap and plan to provide additional updates as our efforts continue. Next, we are pleased with our continued progress in enrolling patients into our NAUTILUS trial. As we look to grow and scale our business, we are focused on delivering a product that is not only clinically superior, but also user friendly, both as it relates to our patient and clinician user groups. With that in mind, as you may have seen, we recently introduced two new product enhancements designed to streamline the RNS experience. We launched our enhanced nSight Data Management system in Q3, with overwhelmingly positive clinician feedback. We also recently launched our new tablet remote monitor ahead of schedule. The TRM and nSight launches enable important advancements in the efficiency and ease of use of the RNS System. We believe that delivering a quality product that is easy to use across a variety of stakeholders and is supported by world class data will enable us to further grow and scale. We are committed to continuing to deliver product improvements that streamline care, making it easier for physicians to deliver optimal care to their patients. As our financial results for the quarter suggest, we saw continued momentum around our efforts to make our RNS System available to more patients living with drug-resistant epilepsy. We believe this is a critical time to focus on transforming the ways in which epilepsy care is delivered to patients. We are focused on the International League Against Epilepsy or ILAE guidelines, which state that once a patient has tried and failed medications, they should be referred for additional treatment, even if surgical intervention is not appropriate. We believe RNS fits exactly in that category. This has and will continue to help drive our strategy, which involves expanding utilization of our RNS System among existing clinicians and CECs, increasing adoption of our RNS System by additional clinicians at CECs and in the community, and expanding patient indications for our RNS System. With that, I will now turn the call over to Rebecca to review our strong third quarter financial results. Rebecca?

Rebecca Kuhn, Chief Financial Officer

Thank you, Joel. NeuroPace's revenue for the third quarter of 2023 was $16.4 million, representing growth of 47% compared to $11.2 million for the third quarter of 2022 and down 1% compared to $16.5 million in the second quarter of 2023 as seasonality and a decline in replacement revenue played a role in our sequential performance. Our strong Q3 results were primarily driven by increased adoption and utilization of our RNS System by physicians treating new patients. We also continue to generate meaningful revenue from DIXI Medical Products. The placement implant revenue continued to decline again this quarter, as anticipated, and represented approximately 3% of total revenue. Gross margins for the third quarter of 2023 were 74.5% compared to 71.4% in the third quarter of 2022, and 72.5% in the second quarter of 2023. Our gross margin increased primarily due to the increase in RNS products produced and sold. As our fixed manufacturing overhead costs were spread over more units. The increase in RNS gross margin was partially offset by the lower gross margin for distribution of DIXI Medical Products. Total operating expenses in the third quarter of 2023 were $18.2 million, compared with $18.2 million in the same period of the prior year. Consistent with prior quarters this year, operating expenses as a percentage of revenue were lower for both R&D and SG&A. We maintained our focus on appropriate resource allocation and cash management and remain committed to effectively managing our operating expenses without compromising revenue growth. R&D expense in the third quarter of 2023 was $4.8 million, compared with $5.6 million in the same period of 2022. This decrease was primarily due to a decrease in expenses for clinical studies, and an increase in grant funding, which reduces our research and development expenses. SG&A expense in the third quarter of 2023 was $13.4 million, compared with $12.6 million in the prior year period. This increase was primarily due to an increase in personnel-related expenses, driven by an increase in sales-based variable compensation as a result of the increase in revenue compared to the prior year period. We also had an increase in sales, sales support, and marketing expenses, including expenses associated with distributing DIXI Medical Products. These increases were partially offset by reduced general and administrative expenses, primarily outside services and insurance. Loss from operations was $6 million in the third quarter of 2023, compared with $10.2 million in the prior year period. We recorded $2.2 million in interest expense in the third quarter, compared to $1.9 million in the prior year period. Net loss was $7.3 million for the third quarter of 2023, compared with $11.8 million in the third quarter of 2022. Our cash and short-term investments balance as of September 30, 2023, was $61.3 million. Our long-term borrowings totaled $55.9 million as of September 30, 2023, with the full principle due on September 30, 2025. As Joel mentioned, we are raising full year 2023 revenue guidance to a range of $62.5 million to $63.5 million, up from a range of $59 million to $61 million that we set on our Q2 earnings call. We expect that revenue growth will be supported mainly by increases in initial implants and revenue from the sale of DIXI Medical Products. Replacement of substantially all of the prior generation iOS devices is still anticipated to be completed by the end of 2023. As previously indicated, the decline we have experienced in replacement revenue is anticipated to revert once the newer, longer-lasting devices introduced in 2018 again reach the end of their battery life. We are increasing our gross margin guidance to 71% to 73%, up from 70% to 72%. We may see variability in our gross margin due to fluctuations in the proportion of DIXI Medical revenue to overall revenue and other factors. We are updating our guidance for operating expenses to $75 million to $76 million, reducing the upper end of the range. Operating expenses are expected to include $9 million to $10 million in noncash expenses. Our cash burn in the third quarter of 2023 was $2.2 million, a continued improvement over $4 million in the second quarter of 2023. Based on our current cash burn rate, we now believe that we have sufficient capital to fund our planned operations into 2026. I would now like to turn the call back over to Joel for closing remarks.

Joel Becker, Chief Executive Officer

Thank you, Rebecca. Overall, we enter the final quarter of 2023 well-positioned to build on this positive momentum. We are encouraged by the higher utilization we've seen among our CEC customers, excited about the initial implants, and are focused on beginning to drive adoption among community centers, pleased with our progress in enrolling patients into our NAUTILUS trial and are happy with the important product development advancements we have brought to market to streamline patient care. In short, by continuing to extend our reach to an expanding number of CECs, epileptologists, and neurosurgeon, streamlining utility and enriching data value, we continue to establish an ever-stronger foothold at the forefront of drug-resistant epilepsy treatment. Additionally, and importantly, we remain focused on and are executing with operating discipline, as demonstrated by ongoing strong cash management through revenue growth, gross margin performance, and operating expense execution. Our balance sheet remains strong, providing us ample runway to execute on our commercial, clinical, and operating strategy. To reiterate, based on our current cash burn rate, we are comfortable extending our cash guidance to fund our planned operations into 2026. Positioning us for continued strong momentum into 2026, positioning us for continued strong momentum for the rest of the year 2024 and beyond. Lastly, I would like to address the questions we and other members of the Medtech community have fielded relative to GLP-1 exposure. Let me be clear that epilepsy does not have any correlation to obesity or body mass index. And we do not believe that either our target patient populations or our RNS System, as a technology platform, are impacted in any way as a result of the GLP-1 class of drugs. This concludes our prepared remarks. I would now like to turn the call over to the operator who will open the call for questions.

Operator, Operator

Our first question is from Vik Chopra with Wells Fargo. Please go ahead.

Vik Chopra, Analyst

Hey, good afternoon, and thanks for taking the questions. Congrats on a great quarter. Maybe just two for me here. So just in the performance, I think you talked about initial implant in the quarter, maybe just some additional color or what growth in initial implants. Was it primarily driven by utilization within existing centers? Or there's something else you call out, and then I had a follow-up, please.

Joel Becker, Chief Executive Officer

Hi, Vik. Thank you for the question and for joining us today. The short answer is that the growth has primarily been in initial implant utilization, which is where we saw the most significant growth for RNS during the quarter.

Vik Chopra, Analyst

Great. And then maybe one for Rebecca, given where we are in the year, just maybe highlight some potential headwinds and tailwinds to keep an eye out for 2024 as it pertains to the top line. Thanks for taking my questions.

Rebecca Kuhn, Chief Financial Officer

Vik, we are not guiding to 2024 and really can't comment on what to expect in 2024 just yet. So I think we'll just have to ask you to hold that question until we get a little further down the road.

Operator, Operator

Hi, Vik, this is the operator. Do you have any more questions?

Vik Chopra, Analyst

No, I'm okay. Thank you.

Operator, Operator

Thank you. Our next question is from the line of Michael Polark with Wolfe Research. Please go ahead.

Michael Polark, Analyst

Good afternoon. Thank you for your question. My first inquiry is regarding the expansion into the community. Joel, I noted your comment about ensuring the selection is appropriate. Patient selection is crucial, and suitable patients will be referred to Level 4 centers. I'm interested in understanding what factors influence that decision at the patient level. Which patients are deemed suitable for treatment in the community versus those that should be referred to higher-level centers? This is the first part of my question. For the second part, I'm curious about your CARE program. Specifically, I want to know how the level of support you're providing to community practitioners differs from what is already being offered at the Level 4 centers.

Joel Becker, Chief Executive Officer

Thank you for the question, Mike, on both topics. Regarding patient populations as we expand into the community, there are several types of patients who can be effectively treated there. Specifically, those who only require Phase I monitoring and do not need to be referred back for Phase II monitoring are ideal candidates. Patients with drug-resistant conditions who only need Phase I surveillance fit well into this model. We have already observed that as healthcare providers assess the populations they manage in the community, they are identifying suitable Phase I candidates. In contrast, more complex patients who require additional monitoring and support can be referred back to higher-level centers. Previously, these patients might not have been recognized as suitable for RNS therapy due to a lack of referral pathways from local centers to Level 4 facilities. We are working on establishing connections to ensure that patients receive appropriate therapy and have a solid management plan. Our efforts focus on both the types of patients and their underlying conditions to ensure they are suitable for community treatment through Phase I monitoring, as well as identifying more complex cases and establishing referral relationships. We are at the early stages of this initiative, so I won't go into detail just yet, Mike, as we're still starting the program. Some centers are progressing faster than others, and we anticipate discussing the CARE program in more detail as we prepare to launch the full pilot in the first half of 2024. These are just some early insights we've gathered.

Michael Polark, Analyst

For the follow-up, I'm curious, I mean, I appreciate the comments and discipline around operating spending. I imagine you still have to invest to drive growth here and penetration within your centers. So as you look out into '24 and '25, I'm not asking for guidance per se, but do you envision still creating more sales territories to kind of grow the business or maintaining the number of territories you have and putting more field support within those territories to promote the depths? I'm just curious how you're thinking about the field organization over the next couple of years and balancing the breadth versus depth dynamics. Thank you so much.

Joel Becker, Chief Executive Officer

Thank you, Mike. That's a great question. We will provide more details as we progress with the CARE program, but I can share a few points. First, we previously mentioned investing in the breadth of our organization, which included expanding our sales force from a territorial standpoint and adding resources earlier last year. Those new team members have been undergoing training and are now starting to contribute in the field more effectively. Initially, we plan to leverage a lot of that capacity. As I stated earlier, we are focused and targeted in these initial efforts. Part of what we will learn during the pilot program is the type of support needed—whether it's more about prospecting and identifying the right target centers and patient populations or focusing on clinical support. This will help determine whether we need to broaden our approach, dive deeper, or optimize a combination of both with our current organization. We are examining how to appropriately expand our reach to those targeted centers using existing resources while also considering what the resource model should look like and the level of clinical support required in the community. We are particularly excited about the program and are looking forward to launching the pilot in the first half of '24. We've received great feedback from many early centers and a lot of enthusiasm for RNS therapy and access to patients. More updates will follow, but that's our current status.

Michael Polark, Analyst

Thank you.

Operator, Operator

Thank you. Our next question is from the line of Frank Takkinen with Lake Street Capital Markets. Please go ahead.

Frank Takkinen, Analyst

Thanks for taking the questions. Hey, Joel. Hey, thanks for taking the questions. Congrats on the quarter. I was hoping we could go a little bit deeper into initial implants. I heard your comment that, that was a driver of growth. But maybe if you could speak about the market? Are you gaining market share? Is the market returning to growth? There may be some DIXI in forming the funnel that's driving better initial implants, pockets of power users emerging? Or just anything you can really share with us to get a little better feel for what is the underlying growth driver of initial implants.

Joel Becker, Chief Executive Officer

Absolutely. Thank you, Frank. As I mentioned, we really observed strong performance among our initial implant patients and product segment, primarily due to increased utilization within our core centers. We're seeing significant usage and growing adoption within these centers. The rising rates of both usage and adoption among this key group has been a major driver of our growth. This aligns with our focus on expanding how the RNS system is perceived for use among patient populations. We're encouraging broader thinking about RNS beyond its traditional application in a narrow segment of focal refractory patients to include a wider array of patient populations through targeted STEM, network stimulation, or combination therapy. This expansion in utilization and adoption has proven beneficial for growth. Additionally, we've seen positive outcomes from DIXI, with some centers gaining better integration and visibility into their patient pipelines, which helps shape their approach to RNS therapy. Overall, the key factors are the increased usage and adoption within these core centers, as well as the vertical integration into the patient pipeline in select locations.

Frank Takkinen, Analyst

Got it. That's good color. And then maybe to speak about seasonality a little bit. I heard the comments around Q3 is typically a little seasonally slower. So maybe talk a little bit about regular seasonality patterns into Q4 and how you incorporated that into the implied guidance for the fourth quarter?

Joel Becker, Chief Executive Officer

Yes. We did see some seasonality in so far as that we do see clinicians and institutions take some vacation over the summer. We did see that in some centers. We also see where Q4 does have some seasonality as it relates to, obviously, Thanksgiving and the Christmas holidays. AES, the biggest conference of the year, is also in Q4. So those are some of the dynamics, along with then the declining minimum contribution we expect from replacement revenue here in Q4 given calendarization of replacement revenue as well. So those would be some factors that we point to as we think about the way Q4 is shaping up.

Frank Takkinen, Analyst

Got it. And then maybe one last quick one, just to clarify. I think I heard replacements is down to 3% of revenue. I didn't hear the distinction of whether or not it was 3% of Q3 or 3% of year-to-date or if it's a trailing 12 months. What is that 3% based off of?

Joel Becker, Chief Executive Officer

Rebecca, you maybe want to …

Rebecca Kuhn, Chief Financial Officer

Sure. Frank, that 3% of revenue was a Q3 number. So replacement revenue accounted for about 3% of our total revenue in the third quarter.

Frank Takkinen, Analyst

Perfect. That’s great. Thanks for taking the questions and congrats again.

Joel Becker, Chief Executive Officer

Thanks, Frank.

Operator, Operator

Thank you. Our next question is from Robert Marcus with J.P. Morgan. Please go ahead.

Unidentified Analyst, Analyst

Hi. This is actually Lily on for Robbie. Thanks for taking the question. Could you talk through the trends that you're seeing at the top of the funnel in terms of EMU volumes and how that's translating to RNS implants? It seems like most end markets are basically at or above pre-pandemic levels, and you had a good quarter. So do you think that same kind of growth is occurring? And how are you thinking about the operating environment into fourth quarter and 2024?

Joel Becker, Chief Executive Officer

Thank you for the question, Lily. We see the pipeline as solid, consistent, and strong. We had an excellent quarter, following a record high for the company. Regarding the pipeline, its strength and consistency are important indicators, especially with the strong top-line performance we experienced. We have seen continued strength in the pipeline in Q3, although we previously mentioned and will reiterate that we are unsure if pipeline volumes have fully returned to levels where we saw both throughput through the EMUs and EMU expansion. We are observing strong throughput and a robust pipeline in the EMUs, yet we're still uncertain about the level of EMU expansion. However, the market dynamics from an RNS perspective are favorable, and we feel optimistic about it. When we examine initial implant growth and its distribution alongside the DIXI growth we have been experiencing, combined with the pilot starting in CARE and recent product launches with nSight and the tablet, we believe we are well-positioned for the remainder of 2023 and into 2024. Additionally, we've made significant internal progress, including enhancements in sales leadership, structure, and execution visibility. We are also evaluating our sales compensation structure to ensure we are well-prepared for consistent business growth. Overall, we feel confident about the pipeline and our execution positioning in the markets and products within our organization.

Unidentified Analyst, Analyst

Great. Thank you. Another follow-up. It sounds like growth is coming primarily from growing utilization in existing accounts. So if that's the case, how should we be thinking about the trajectory of new center adds? And where do you think penetration stands within the total center opportunity? Thanks so much.

Joel Becker, Chief Executive Officer

Yes, it's a great question. And we, of course, continue to look to add additional centers, but we've got strong penetration across the Level 4 centers in most cases today. So our focus has really been expanding adoption within the centers and expanding utilization within current customers. So that's where our focus has been, and where we are seeing most of the growth come from is expanding adoption and utilization within that core group of centers versus necessarily needing to add a lot of additional Level 4 centers given the penetration that we have within those groups.

Unidentified Analyst, Analyst

Great. Thank you.

Joel Becker, Chief Executive Officer

Thank you.

Operator, Operator

Thank you. As there are no further questions, I would now hand the conference over to Joel Becker, CEO, for closing comments.

Joel Becker, Chief Executive Officer

Thank you, everyone, for joining the call today and for your questions. I want to conclude by highlighting another extremely strong quarter, with year-on-year revenue growth of 47%. We are raising our guidance to a range of $62.5 million to $63.5 million, up from the previous $59 million to $61 million. This reflects consistent revenue performance off an all-time high for the company, alongside effective OpEx control and cash management, as well as strong operational execution across several core initiatives. Our near-term initiatives, such as our efforts within the Level 4 centers, expansion opportunities with DIXI, and recent product launches are all contributing positively. The CARE expansion is moving forward with initial implants underway and a pilot program in the first half of the year. We are maintaining a sense of urgency and focus on execution throughout the business. Additionally, we are on track to complete our NAUTILUS enrollment in Q1 and are making strides into the generalized epilepsy population. We believe we are well-positioned for the rest of 2023 and into 2024 to leverage increased access to RNS for the 1.2 million drug-resistant patients in the United States. Our target market consists of 30,000 patients, with a possibility of reaching 50,000 a year in Level 4 centers within the focal population. With the strategic actions we are taking and our rapid progress, we aim to expand from the 30,000 target to include the entire 1.2 million drug-resistant patient population in the U.S. We are strongly focused on demonstrating consistent execution aligned with our strategy. Thank you all for being part of the call today, and I appreciate your time.

Operator, Operator

Thank you. The conference of NeuroPace, Inc. has now concluded. Thank you for your participation. You may now disconnect your lines.