Neuropace, Inc.

Good day and thank you for standing by. Welcome to the Q3 2022 NeuroPace Earnings Conference Call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during this session, you'll need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Tripp Taylor, Investor Relations. Please go ahead.

Thank you, operator. Good afternoon, and thank you for participating in today's call. Joining me from NeuroPace are Mike Favit, CEO, and Rebecca Kuhn, CFO. Earlier today, NeuroPace released its financial results for the third quarter ended September 30th, 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 federal securities laws, which are made pursuant to the safe harbor provisions of the Private Security 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 narrow-paces business development opportunities or projections, 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 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 those forward-looking statements. Accordingly, you should not place undue reliance on these statements. For more detailed descriptions of the risks and uncertainties associated with our business, please refer to the risk factors section of our public filings with the Securities and Exchange Commission, or SEC, including our annual report on Form 10-K for the year ended December 31st, 2021, filed with the SEC on March 10, 2022, and our quarterly report on Form 10Q to be filed with the SEC on November 8, 2022, 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 8, 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 will now turn the call over to Mike.

Thanks, Tripp. Good afternoon, everyone, and thank you for joining us. I will start today's call with updates on our commercial progress and advancements with our clinical initiatives before turning the call over to Rebecca to provide details regarding our quarterly results and full year 2022 financial outlook. We will then open the call to questions. Our third quarter results represent increased adoption of RNS therapy. Total revenue was $11.2 million, representing growth of 8% compared to the prior year period and 9% compared to the second quarter of 2022. We drove strong initial implant revenue of $9.2 million, representing growth of 18% compared to the prior year period and 15% sequentially. Previously noted second quarter improvements in the epilepsy monitoring unit or EMU operating environment contributed to an increased patient pipeline and strong RNS system implants in the third quarter. Along with improved market conditions, awareness of the clinical benefits and differentiated features of RNS therapy is growing and resonating with physicians. Commercial and operational execution drove increased utilization of our technology within comprehensive epilepsy centers which we believe demonstrates a higher percentage of overall EMU patients being treated with the RNS system. In the third quarter, we observed stable EMU patient volumes, sustaining the improvements we observed in the second quarter operating environment. From our discussion with epilepsy centers, we anticipate continued gradual increases in the capacity for diagnostic monitoring of patients, and thus an increase in the pipeline of potential interventional therapy candidates as market dynamics normalize. Now I'd like to talk about three strategic growth objectives designed to drive increased utilization of RNS therapy and comprehensive epilepsy centers. By leveraging the expansion of our field team and distribution agreement with Dixie Medical, we are better positioned to, one, take share in EMUs, two, increase the patient flow into EMUs through expanding referral networks and DTC marketing, And three, drive adoption of the RNS system at additional comprehensive epilepsy centers or CECs. I'd like to further discuss our top focus of taking share in the EMU by treating an increased percentage of patients admitted for monitoring. We believe consistent, positive, real-world patient outcomes further proves the benefits of RNS therapy to clinicians and is an imperative factor to support increased utilization of the technology. Our team will continue to reiterate and emphasize the benefits of RNS therapy for patients. We are working to ensure clinicians include RNS as an option in their epilepsy treatment algorithms and educating them on expanded patient selection criteria for prescribing RNS. We are also prioritizing education of non-prescribing clinicians at active CECs in order to increase the overall number of prescribers. Another important initiative is identifying potential RNS patients earlier in the diagnostic process and providing patient education and awareness of the benefits of RNS therapy. Our recent agreement with Dixie Medical to distribute their stereo EEG product portfolio meaningfully improves the potential reach of these efforts by providing greater visibility and earlier touch points with providers and patients in the diagnostic and therapy selection process. We believe through earlier engagement, we can have greater influence and a stronger voice explaining the benefits of the RNS system. We expect this will have a positive impact on the RNS patient pipeline. We are off to a strong start distributing the Dixie Stereo EEG products and are pleased that the initial experience in the field has aligned with the intended strategic rationale of the agreement. As planned, our team began selling Dixie products on October 1st. Stereo EEG electrodes are used in comprehensive epilepsy centers to determine where epileptic seizures originate. The stereo EEG approach to intracranial monitoring has become the predominant approach used in the United States, with most RNS patients and most surgical resection and ablation patients being localized with stereo EEG prior to therapeutic intervention. As a reminder, the intracranial monitoring market of the United States is estimated to be between $25 to $40 million. We believe the intracranial monitoring market is growing, driven by the benefits of stereo EEG compared to the previous monitoring approaches and the adoption of newer interventional therapies, including RNS. Stereo EEG electrodes are sold to CECs, the same call point our team is focused on for the RNS system. Most RNS implanting centers are not currently using Dixie electrodes, representing an opportunity for us to take share in this market. Approximately two-thirds of patients implanted with our RNS system are admitted to the EMU for intracranial monitoring as part of the process to identify where seizures originate. Results from intracranial monitoring helps clinicians determine if the RNS system is a fit for the patient. As such, we see this as a highly synergistic opportunity for our sales force to both generate additional revenue and strengthen our RNS patient pipeline. This opportunity builds upon our prior efforts to provide earlier patient education on the benefits of RNS therapy. At the highest level commercially, the entire team will remain focused on creating a more interventional mindset for treating drug-resistant epilepsy patients in CECs. In the third quarter, we were successful integrating and training the new members of our field team who joined in the first half of the year. We expect their ramping productivity aligned to high-value opportunities, including access to patients earlier in the treatment continuum, to be a growth driver. I will now turn to provide an update on replacement implant revenue. Revenue from replacement implants was $1.9 million in the third quarter of 2022, which was ahead of our expectations. As we have discussed in the past, we continue to expect quarterly replacement revenue to sequentially decline as the remaining first-generation devices are replaced with the longer-lasting second-generation devices. To provide continued transparency, as of September 30, 2022, there were 96 patients being actively treated with first-generation devices. We do not plan to provide this metric in 2023 as it becomes less and less material. Given our historic approximately 90% replacement rate, we believe most of the remaining first-generation devices will be replaced by the end of next year. Moving to recent clinical updates. In our Q2 earnings call, we announced the start of enrollment in the Nautilus study, and we recently announced the first patient in the study was implanted with our RNS system following collection of baseline seizure information. The Nautilus study is designed to evaluate the safety and efficacy of the RNS system for the treatment of primary generalized epilepsy. We intend for the results of this study to support a PMA supplement to expand the label for the RNS system. Approximately 40% of drug-resistant epilepsy patients have generalized epilepsy. So, our work on the Nautilus study, as well as the work on the NIH-funded Lennox-Gastaut study, represent a meaningful market expansion opportunity. In addition to representing a large market opportunity, generalized epilepsy is also of specific interest because surgical resection and ablation are not appropriate for these patients, and there are no approved neuromodulation therapies. Additionally, the process to diagnose and identify patients is easier and faster than for focal epilepsy. We are focused on bringing additional Nautilus study sites online and will continue to do so through the remainder of the year to support increased enrollment throughout 2023. We are excited about the opportunity to offer the benefits of RNS therapy to more people living with epilepsy. In summary, we are pleased with the demonstrated increase in RNS therapy utilization in the third quarter. We continue to increase the pipeline of patients considering RNS and are converting patients to implants at higher rates. Our expanded sales force is ramping productivity in current accounts, working to add new prescribers, and creating patient referral networks. Additionally, the team is beginning to leverage sales of Dixie Medical Stereo EEG electrodes to engage patients earlier in the therapy selection process to educate them on the benefits of RNS therapy. Lastly, we remain committed to expanding the market opportunity for our RNS system into generalized epilepsy through execution of our Nautilus study. While the EMU operating environment remains constrained relative to past levels, we are encouraged by the stability over the past six months and encouraged by the positive commentary from clinicians regarding intentions to increase patient capacity. Looking forward, we are well-positioned to execute commercially and operationally to both expand and further penetrate the drug-resistant epilepsy treatment market. With that, I will now turn the call over to Rebecca to detail the third quarter financial results.

Thanks, Mike. NeuroPACE's revenue for the third quarter of 2022 was $11.2 million, representing growth of 8% compared to $10.3 million for the third quarter of 2021 and 9% sequentially compared to $10.2 million in the second quarter of 2022. In the third quarter, revenue from initial implants grew 18% to $9.2 million compared to $7.8 million for the third quarter of 2021. Sequentially, initial implant revenue in the third quarter grew 15% compared to the second quarter. Revenue from replacement implants was $1.9 million compared to $2.5 million in the third quarter of 2021. We continue to expect replacement implant revenue generally to decrease for the next couple years due to the transition to the current model of our device, which has a lasting battery. Growth margin for the third quarter of 2022 was 71% compared to 73% in the third quarter of 2021. The decline in growth margin relative to the prior year was primarily due to a short-term supply chain disruption, which was resolved in the third quarter. Total operating expenses in the third quarter of 2022 were $18.2 million. compared with $13.8 million in the same period of the prior year. As expected, operating expenses in the third quarter, including costs associated with Dixie, were flat to slightly down compared to the second quarter. R&D expense in the third quarter of 2022 was $5.6 million, compared with $4.3 million in the same period of 2021. The increase in R&D expense was primarily driven by an increase in personnel, product development, and clinical study expenses. SG&A expense in the third quarter of 2022 was $12.6 million compared with $9.4 million in the prior year period. The increase in SG&A was primarily driven by personnel-related expenses and increased sales and marketing costs to support commercial expansion initiatives. Loss from operations was $10.2 million in the third quarter of 2022 compared to $6.2 million in the prior year period. We have recorded $1.9 million in interest expense in the third quarter compared to $1.8 million in the prior year. Net loss was $11.8 million for the third quarter of 2022 compared to $8.1 million in the third quarter of 2021. Our cash and short-term investments balance as of September 30, 2022 was $85.4 million, while our long-term borrowings totaled $52 million. Today, we are also announcing the filing of a shelf registration statement that includes an agreement that establishes the potential for at-the-market or ATM sales of the company's common stock. We consider it to be prudent and consistent with good corporate practices to file the registration statement at this time to provide flexibility for expeditiously raising capital in the future when we determine it would be best for the company. Given our current position of cash and short-term investments of approximately $85 million as of September 30th, 2022, we do not have an immediate need to issue securities under the registration statement. Now, turning to our outlook for 2022. We now expect total revenue between $44.5 and $45.5 million, up from our previous guidance of $43 to $45 million. This assumes initial implant revenue between $35 and $36 million and replacement revenue of nearly $8 million for the full year. we continue to expect to generate approximately $1.5 million of revenue in the fourth quarter from our new partnership with Dixie Medical. Moving down the income statement, we continue to expect gross margins will be in the low 70% range. This gross margin guidance includes revenue contribution from Dixie Medical, which has a lower gross margin than our core R&S business. We continue to expect 2022 total operating expenses will be in the range of $74 to $75 million, of which approximately $1 million will be Dixie launch-related expenses in the fourth quarter, and approximately $8 to $9 million is non-cash, stock-based compensation expense. We expect operating expenses for the core R&S business will be roughly flat sequentially in the fourth quarter given the steps we have taken to focus our business priorities and manage expenses in the second half of 2022. This concludes our prepared remarks. I would now like to turn the call back over to the operator who will open the call for questions.

Thank you. At this time, we will conduct a question and answer session. As a reminder, to ask a question, you'll need to press star 1 1 on your telephone and wait for your name to be announced. Please stand by while we compile the Q&A roster. Our first question comes from the line of Robbie Marcus of J.P. Morgan. Your line is now open.

Hi, team. This is actually Allen. I'm for Robbie. Congrats on the quarter. I just want to start off by asking about how trends have really gone so far through October and into November, whether or not you're really seeing that continued improvement in EMU operating volumes that we saw through second quarter and third quarter, and how we should frame that with the guidance that you've given.

Great. Thanks for the question. As I stated earlier, we've seen really stable EMU situation for the last six months through the third quarter and through the first month of the fourth quarter. That's really encouraging for us because that provides the pipeline. That's the pipeline of patients, prospective patients with the RNS system. I mean, we've really seen that for the first time in a long time be stable for a relatively extended period of time. That's allowed us to execute against our commercial strategies the efforts to be able to increase utilization and try to increase patient awareness earlier in the process and continue to feel like that is setting us up for what we expect to be sequential growth and initial implants from Q2 to Q3, which we delivered, and then from Q3 as we head into Q4. Got it.

And then, you know, when we think about how that should set you up for 2023, so you highlighted that it's been stable, but it sounds like it is still constrained to below path levels. What's really the timeline for getting back the EMU and the pipeline back up to the levels that you saw pre-COVID? And how does that really set you up to grow in 2023 relative to, you know, current street expectations for give or take 20% growth next year, understanding that you haven't formally guided yet?

What we're hearing from our customers, from the comprehensive epilepsy centers and the EMUs there, is that their general expectation is that EMU volumes are going to continue to gradually increase over time. That is driven by a number of factors, including continuing to increase staffing and driving efficiencies within those centers. So that's the assumption that we're working off of, and that's been the case here really for the last couple of quarters, as I've stated, barring some other interruption, that just generally it's going to be a gradual increase in capacity as they work through the new normal. I think we're past at this point. I'm past at this point talking about COVID impact. Hopefully we don't have to do that anymore. We're in a new normal for the last couple of quarters and expect, based on what we're hearing, that EMU volumes will be able to have stabilized and will be able to have increasing capacity as the centers are allowed to bring more patients in or have the capacity to bring more patients in.

Okay, thank you. Please stand by for our next question.

Our next question comes from the line of Larry Bigelson of Wells Fargo. Your line is now open.

Good afternoon. Thanks for taking the question and congrats on a nice quarter here. Mike, just a quick one on initial implant and then I wanted to ask about replacement. Do you think there was any catch up here? Just wanted to make sure you beat by a significant amount here. Anything one time in Q3?

We didn't really see anything that I would call one time. We did see, as you know, an impact in Q2 from the delay of procedures back, the delay of EMU admissions back at the beginning of the year. We saw that be stable, that number of EMU patients be stable through the second quarter into the third quarter. We had recovered what we believed were those catch-up patients prior in the year. And so really what we saw in Q3 we believed to be organic growth of the business, increased utilization and success of the commercial team executing against the strategy.

That's helpful. Rebecca or Mike, you know, I apologize for the math here, but I'm trying to understand how to think about replacements going forward. You gave us the 96 patients left on the prior generation. 90% of those get replaced, 86 left. Q4 implied about 37, if I'm doing the math right, on the guidance. So you've got only like 50 or so left, if I'm thinking about this right, which is a little less than $2 million. So how do we think about replacement revenue going forward? And when does the current generation of replacement start to, when do you start to see that And when can replacements start to grow? So hopefully, I'm sure you understand kind of what I'm trying to get at. Thanks for taking the question.

Yeah, thanks for the question, Larry. So in the guidance, we talked about nearly $9 million, I'm sorry, nearly $8 million of revenue. So just kind of taking that, we're talking small numbers in granularity, but You know, nearly $8 million of revenue for the year in 2022. Your math is generally right about the amount of replacement revenue that's left following 2022. We're expecting most of that to be coming in 2023 as we're kind of well past the expected life of the prior generation devices as we head into 2023. We do expect that we'll start getting some of the early replacements of the next generation device as we move into subsequent years. We haven't provided guidance, as you know, for revenue for 2023, but we expect that we're reaching the end of the replacement cycle for the old generation device by the end of next year, and that there'll be small numbers, keeping in mind very small numbers of early replacements of the next generation device that start kicking in, and then we'll be growing from that in subsequent years. Thanks so much.

As a reminder, To ask a question, please press star 1-1 on your telephone. Our next question comes from the line of Drew Ranieri of Morgan Stanley. Your line is now open.

Hi, this is Anna on for Drew. Thank you so much for taking the questions. Maybe to start on the commercial organization, how should we be thinking about your sales force splitting time between the initiatives you outlined expanding into new centers, direct utilization, An existing center is driving a referral network as well as selling Dixie products. And then maybe to layer onto that, is 52 reps the right number or could there be another push in FY23? Great.

Thank you for the question. So the focus of our field team is predominantly on increasing utilization within the comprehensive epilepsy centers. The team that we put together that included an expansion of the team in the first half of the year is spending most of their time on that increasing utilization. So that's focusing on centers that have been implanting the RNS device, getting more of the prescribers to prescribe and expanding the way the physicians in those centers think about RNS for their patients. And then a push on the patient pipeline. So awareness of the patients that are working their way through the diagnostic process at those centers. so that we can influence more of those patients to move on to RNS therapy. Dixie plays right into that. So the customers we're selling the Dixie product to are the same ones that we're selling the RNS device to. The patients that are going through the diagnostic process using the Dixie electrodes are potential candidates for the RNS device. And so leveraging that with the same team selling to the same customers, both the increased utilization as well as selling the Dixie product and looking at opportunities to be able to convert competitive accounts over to using the Dixie product. We also have, with the field team, effort that they're putting into referral development, expanding patient centers, but just again emphasizing that the majority of the focus of the field team is on increasing utilization within the comprehensive epilepsy centers, and Dixie fits right in with that. So it's very much hand-in-hand. with the core R&S business as we approach that new product. We haven't provided guidance yet for 2023, but we did communicate previously that the expansion that we did to 52 people in the sales organization at the first half of the year, that our focus for the second half of the year was getting those people trained and productive in the field. And so that hasn't changed. We're expecting to be staying at a stable sales force through the end of the year. And then we'll be evaluating what opportunities are beyond that, but expect that we'll be continuing to grow revenue at a faster pace than we're growing spending. So we're at a point in our evolution where we believe that there's commercial leverage, and so we're not looking to spend out ahead of, but being able to use the growth of the business to be able to support moving towards profitability and then spending within the organization consistent with that.

Thank you and then maybe just I wanted to make sure I understood your response to Larry's question correctly. Should we be thinking about the backlog of patients who had previously deferred treatment as completely worked through or could there be potential upside from the backlog to 4Q or to 2023? Thanks for taking the questions.

The backlog of patients, as we think about the backlog of patients, it's primarily patients that are working their way through the epilepsy monitoring units. The feedback we get from our customers is that in most cases, they still have waiting lists of patients working to come through. And as they're able to increase their capacity, that's part of the commentary I gave about generally expecting a gradual increase in the number of patients working through the EMUs. So I don't think about it as backlog specifically for patients that have been worked up and identified for RNS implant. It's more globally a backlog of patients that are working their way through the diagnostic process at the epilepsy centers. And then, again, that growing gradually over time as the centers are able to increase capacity.

At this time, I'm showing no further questions, so I'd now like to turn it back to Mike for closing remarks.

Thank you all for joining us today. Have a great evening.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.