Neuropace, Inc.

Good afternoon and welcome to NeuroPace's second quarter 2023 earnings conference call. As a reminder, this conference is being recorded. I would now like to turn the call over to Irena Ridley, Chief Legal Officer and Head of Investor Relations for a few introductory comments.

Good afternoon. Thank you for joining us for NeuroPace's second quarter 2023 financial and operating results conference call. On today's call, we will hear from Joel Becker, Chief Executive Officer, and Rebecca Kuhn, the Financial Officer. Earlier today, NeuroPace released financial results for the second quarter ended June 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 security 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 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 annual report on Form 10-K for the year ended December 31, 2022, filed with the SEC on March 2nd, 2023. Our quarterly report on Form 10-Q for the period ended March 31, 2023, filed with the SEC on May 4th, 2023. And our quarterly report on Form 10-Q for the quarter ended June 30th, 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 August 8, 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?

Thank you, Irina, and good afternoon, everyone. It is my pleasure to be here with you today on my first quarterly earnings call with NeuroPace. I'm excited about and committed to advancing our company's mission to transform the lives of people living with epilepsy with RNS therapy. I'm pleased with what I've seen in the solid underlying fundamentals of the business, excited by the opportunities that lie ahead, and committed to leading NeuroPace to deliver on our commitments of consistent revenue growth, operating discipline, and effective cash management. I'm also very thankful for the opportunity to lead the talented and experienced team at NeuroPace. On today's call, I will provide highlights from the second quarter of 2023 and review our key business priorities for the remainder of the year. 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. I'm pleased to report total revenue was $16.5 million, representing growth of 62% compared to the prior year period and 14% compared to the first quarter of 2023. The strong performance was primarily driven by increased utilization of the RNS system within comprehensive epilepsy centers, or CECs, revenue contribution from our partnership with Dixie Medical to distribute their SEEG electrodes in the United States, and implants of our RNS system in the Nautilus study. As we've previously communicated, replacement implant revenue continues to decline as we complete our transition to our second generation device with a longer lasting battery. It now represents approximately 5% of total revenue and is expected to decline further in the second half of 2023. Given the strong underlying fundamentals of the business, we are raising full year 2023 revenue guidance to range between $59 million and $61 million up from $52 million to $54 million and from our original expectations of $50 million to $52 million at the start of the year. I am committed to delivering consistent and repeatable operating results and I look forward to updating you on our progress. Through a disciplined and focused effort on expense management, cash burn has been significantly reduced. from $9.8 million in the first quarter of 2023 to $4 million in the second quarter of 2023 without compromising revenue growth. Cash burn improvement was primarily driven by three components, revenue growth, gross margin improvement, and expense management, all of which will be key areas of focus as we continue to grow and scale the business. We remain committed to ongoing financial discipline with a focus on appropriate resource allocation and expense management. I now want to update you on the core elements of our business that comprise of the rationale for our change in guidance before providing some initial thoughts on where I will be focused as I continue to dive deeper into the business. Our commercial strategy is focused on closing the treatment gap for drug-resistant epilepsy patients by expanding access to RNS therapy. Expanding access to RNS therapy is comprised of expanding patient access to and treatment within CECs, expanding patient indications for the RNS system, and expanding the number of clinicians and centers with access to RNS therapy. With regard to CECs and currently indicated patients, The number of new RNS system implants in the second quarter demonstrates that recognition of our RNS system's distinct features and benefits continues to grow, despite our belief that patient volumes in the epilepsy monitoring units, or EMUs, have not yet entirely returned to 2019 levels and corresponding growth rates. We believe that patient volumes will continue to improve, providing an even greater funnel of patients that could benefit from our RNS system. We have recently made changes to our sales leadership and, as previously communicated, have accelerated the growth of our commercial field organization. The new members of our field organization are now moving through their training cycle and are beginning to be able to more fully contribute to our commercial efforts. We look forward to demonstrating the impact to expanding RNS therapy access that this expanded team can make over time. Through our partnership with Dixie Medical, we are identifying and educating additional prospective RNS patients earlier in their treatment journey. Additionally, our nurse navigators and patient ambassadors are working with patients that come into our funnel either through referral, Dixie Medical, or through our direct-to-consumer campaigns to address patient questions or to testify firsthand as to the benefits of our RNS system. We believe that our clinician and patient education efforts as well as our marketing programs are contributing to the growth in initial implants and will lead to more patients being able to benefit from our RNS system. We have continued to be encouraged by the ongoing durability of our results. As we have previously communicated, not only has RNS therapy demonstrated exceptional results in our regulatory clinical studies, RNS patient real-world outcomes were even better than those seen in the pivotal trial, with patients achieving 82% median seizure frequency reductions at three years. This seizure frequency reduction rate has not been seen in any published studies from our competitors. In fact, a recently published study from a competitor's patient registry demonstrated substantially worse outcomes in real-world patient populations and routine clinical practice than had been observed in their controlled clinical trial and reinforced concerns related to side effects of non-responsive stimulation, such as memory impairment and depression. We are also working to simplify and make the delivery of RNS therapy more efficient. In line with those efforts, we are excited to launch in the third quarter our updated NSIGHT software tool designed to improve patient care by enhancing efficiency of case and patient data management. As an important part of our efforts to expand the populations of patients indicated for RNS therapy, we remain on track with our plans to expand our RNS systems indication into generalized epilepsy and expect to complete enrollment in our Nautilus trial in the first quarter of 2024. We are also pleased to announce that we have completed implanting our first cohort of patients in our groundbreaking NIH-funded feasibility study in Lennox-Gastaut syndrome, or LGS, a type of symptomatic generalized epilepsy. As a reminder, approximately 40% of drug-resistant epilepsy patients have generalized epilepsy. Given that localization is not necessary, diagnosis is typically easier and faster than for focal epilepsy. Few treatment options exist for patients with drug-resistant generalized epilepsy, as resection and ablation are not appropriate for this cohort of patients, and there are currently no neuromodulation therapies approved for this indication. We believe that expanding into generalized epilepsy will be meaningful to both our business and our mission. With regard to expanding clinician and site access to RNS therapy, in my first four weeks, I've identified what I believe to be a significant opportunity that will be an important part of our strategy and our market development efforts going forward. As a result of a PMAS approval from the FDA that has expanded RNS therapy site and clinician qualification requirements, Neuropace will now have the opportunity to target the additional approximately 1,800 epileptologists outside of level 4 CECs and the entire population of functional neurosurgeons, empowering them to provide the RNS system as a much-needed treatment option for their patients. We believe that with this program qualification expansion, we now have an opportunity to help a significant number of epilepsy patients who would not have been referred to level four CECs to access RNS therapy in the community setting, as well as enabling the potential for increased referrals to level four CECs. A fully developed strategy will take time and will be the topic of additional future commentary. but we have already begun accelerating our initial market development efforts around this opportunity and are currently working through the targeting and qualification process with a number of pilot sites. I'm excited about this opportunity to offer our RNS system through a significantly expanded group of epileptologists and functional neurosurgeons and expect this to be a core area of focus for NeuroPACE in doing our part to help close the drug resistant epilepsy patient treatment gap. I plan to keep you updated going forward on our threefold commercial expansion strategy and want to reiterate my commitment to executing on our plans of consistent revenue growth, operating discipline, and cash management. Finally, before we review our financial performance over the last quarter in detail, I would like to recognize the many contributions from Mike Favitt over the past four years. His execution with the team has brought NeuroPace to the position of solid footing on which we find ourselves today. And I, along with the rest of the management team, the board, and all of NeuroPace's employees, thank him for his efforts. With that, I will now turn the call over to Rebecca to review our strong second quarter financial results. Rebecca?

Thank you, Joel. And once again, thank you, Mike. NeuroPace's revenue for the second quarter of 2023 was $16.5 million, representing growth of 62% compared to $10.2 million for the second quarter of 2022 and 14% sequentially compared to $14.5 million in the first quarter of 2023. Our strong performance was primarily driven by increased utilization of our RNS system by physicians in treating new patients. We also had meaningful revenue from Dixie Medical Products, which was higher than we anticipated previously. Replacement implant revenue continued to decline again this quarter as anticipated and was approximately 5% of total revenue. Gross margin for the second quarter of 2023 was 72.5% compared to 73.2% in the second quarter of 2022 and 71.7% in the first quarter of 2023. The decline in gross margin relative to the prior year period was primarily due to a change in product mix with the inclusion of VIXI medical products, which have a lower gross margin than our core R&S products. Over time, we expect our gross margin will generally increase as R&S volumes increase and fixed overhead is allocated over more units. Total operating expenses in the second quarter of 2023 were $19.8 million compared with $18.4 million in the same period of the prior year. In the second quarter of 2023, operating expenses as a percentage of revenue were lower for both R&D and SG&A. This was the result of our continued focus on appropriate resource allocation and cash management. And as Joel said, we plan to continue focusing on effectively managing our operating expenses going forward. R&D expense in the second quarter of 2023 was $5.3 million compared with $5.7 million in the same period of 2022. The decrease in R&D expense included reductions in outside services for product development and clinical studies, largely resulting from our increased focus and prioritization of key projects in these areas. SG&A expense in the second quarter of 2023 was $14.5 million compared with $12.8 million in the prior year period. The increase in SG&A was primarily driven by personnel-related expenses, including an increase in sales-based compensation and expenses related to our CEO transition, as well as expenses associated with distributing Dixie Medical products. These increases were partially offset by reduced general and administrative expenses, primarily outside services and insurance. Loss from operations was $7.9 million in the second quarter of 2023, compared with $11 million in the prior year period. We recorded $2.1 million in interest expense in the second quarter compared to $1.9 million in the prior year period. Net loss was $9.1 million for the second quarter of 2023, compared with $12.7 million in the second quarter of 2022. Our cash and short-term investments balance as of June 30, 2023 was $63.6 million. Our long-term borrowings totaled $54.9 million as of June 30, 2023, with the full principal due on September 30, 2025. Now, turning to our outlook for the remainder of 2023. We are increasing our revenue guidance and now expect total revenue for 2023 to range between $59 and $61 million, up from $52 to $54 million. We expect that revenue growth will mainly be driven by increases in initial implants and revenue from the sale of Dixie Medical products. We continue to expect that we will complete the replacement of substantially all of the prior generation RNS devices by the end of 2023. With more replacement implants than anticipated in the second quarter, replacement revenue is expected to decline sequentially at a rate slightly faster than we anticipated earlier in the year. Replacement implant revenue will become a growth driver when the newer, longer-lasting devices introduced in 2018 begin to reach the end of their battery life. We are increasing our gross margin guidance and now expect our gross margin for 2023 will be between 70% and 72%, up from 69% to 71%. Our quarterly gross margins may experience small variability due to fluctuations in the proportion of Dixie medical revenue to overall revenue and other factors. We continue to expect operating expenses for 2023 to range between $75 million and $77 million, including $9 to $10 million in non-cash expenses. Our cash burn in the second quarter of 2023 was $4 million, a substantial reduction from our cash burn of $9.8 million in the first quarter of 2023. Based on our current cash burn rate, we believe that we have sufficient capital to take us to mid 2025. I would now like to turn the call back over to Joel for closing remarks. Joel?

Thank you, Rebecca. Overall, the first half of the year results have been strong. with CECs continuing to expand initial implant volume, our distribution partnership with Dixie Medical contributing nicely to those efforts, and our clinical development program with Nautilus in the generalized epilepsy population is advancing as planned with tremendous opportunity and potential on the horizon. Building on the momentum with our core CEC customer group, I'm also very excited about the prospect of expanding drug-resistant epilepsy patient access to RNS therapy, through an expanded group of epileptologists and neurosurgeons in the community setting and look forward to keeping you updated on those efforts. Cash reserves remain strong and spending well managed. We believe that we have sufficient capital to take us to mid 2025. All of these factors position NeuroPace well for the remainder of 2023 into 2024 and beyond. 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?

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press star, followed by the one on your touchtone phone. You will hear a three-tone prompt acknowledging your request, and your questions will be pulled in the order they are received. Should you wish to decline from the polling process, press star, followed by the two. If you are using a speakerphone, please lift the handset before pressing any keys. One moment, please, for your first question. Your first question comes from Frank Takinen with Lake Street Capital Markets. Please go ahead.

Great. Thanks for taking my questions and great quarter. Congratulations, Joel, on the appointment. And I'll also extend my gratitude to Mike. Was hoping we could start with one around the guide. Obviously, a great quarter you guys had here. Even after backing out the 5% contribution from replacements, it feels like The back half, you guys have done a nice job of staying conservative and prudent with the forward outlook, but maybe talk a little bit about what needs to occur to achieve the guidance that you guys have laid out for 2023 and what could be sources of upside as you start to think about second half 23.

Thank you, Frank, and thanks on behalf of the team. Thanks for the question. When we talk about guidance for the rest of the year, I think it bears mentioning that we're raising guidance by the amount of the BEAT in Q2 plus nearly that much again for the rest of the full year. And that puts us in a position of having raised by $7 million, which is, again, nearly that BEAT plus the $3 million. And that's in addition to the guide that we raised by $2 million in the first quarter. putting us up now $9 million in guidance from how we were thinking about the business at the start of the year. So as we mentioned, we do think it bears consideration as well as you mentioned that we do expect replacement implants and revenue to be down somewhat in the second half of the year. But our guidance here for the rest of the year really takes into account what we've seen in the business in terms of the growth in initial implants and the RNS, the good growth contribution that we've seen from Dixie, and the dynamics that I mentioned around the replacement implants. So it's really those factors that are driving the second half of the year guidance, and that's what we're focused on.

Okay, that's helpful. Maybe shifting over to one on initial implants, I realize you guys are intentionally not breaking that out, but can you put some goalposts around just where that number came in, trying to understand just the source of outperformance? I mean, I think it's looking at my model and making some estimates that you can say a plus 30% initial implant number is probably rather conservative for the quarter, but any further clarity you can provide to break out the performance between initial implants and Dixie?

Yeah, I think as we've talked about, we're not breaking out revenue by different product lines. But what I would say is that we had strength in revenue performance across the different product lines. The initial implant contribution primarily was driven by utilization within existing centers. And so it was primarily existing centers driving that increase in initial RNS implants. But good contributions really across the business with some accelerated strength and replacement implants, as we mentioned.

Okay, perfect. And then maybe just for my last one, I was hoping to have a follow-up on the qualification requirement, downgrade, if we can call it that, to an epileptologist, not at a level four CEC. Maybe take us a little bit deeper into just how impactful that can be and if you've already started to maybe see some impact from that change.

Great. Thanks for that question as well, Frank. We're excited about the opportunity here for site expansion, really for the role that we see it playing. in advancing Neuropace's mission. Our focus is transforming the lives of patients and people who are suffering from epilepsy, and we see the opportunity here to expand sites as an opportunity to help close the treatment gap for patients who are indicated and are drug-resistant epilepsy patients. You would know, but there are 1.2 million people in the United States living with drug-resistant epilepsy, About 50,000 of those are admitted to one of approximately 200 Level 4 centers, and we believe that the opportunity here is to expand the number of physicians and associated centers to a significant fraction of epileptologists and an additional 1,800 epileptologists from the 1,200 that are associated with level four centers, and then really expanding to the entire population of stereotactically trained functional neurosurgeons. So we see that opening up the community setting where we think an enlarged group of both clinicians as well as then as RNS therapy gets more broadly visible in the epilepsy community, patients as well. and the ability to build stronger referral pathways even back into the CECs as well. So when you think about that in the past where we've really been limited and focused on those level four CECs, this opens up our ability to take out to eligible clinicians and centers RNS therapy to patients who would not have had access to it before. And we think that's really exciting. We'll talk more about, we're right at the start of this, and so we'll talk more about modeling the opportunity and how we see all that in future calls. But again, with the expansion in clinician requirements and center requirements that we see here, We think this lines up very nicely with, you know, our overall commercial strategy is to increase therapy access in CECs for patients that are in comprehensive epilepsy centers, expand indications for patients for RNS therapy, like through the work that we're doing with the Nautilus trial, and then thirdly, expand clinician and site access. And we think this... regulatory approval and the change in qualification criteria lines up very nicely with that third prong of that overall market development strategy.

Great. I'll stop there. Thanks for taking the questions and congrats on a really strong start to the first half.

Thank you, Frank. Your next question comes from Robbie Marcus with JP Morgan. Please go ahead.

Hi, this is Alan on for Robbie. Just to check, can you hear me okay?

We can, Alan. Thank you.

Got it. Yeah, I've been having some connectivity issues. I want to make sure that's not affecting it. But congrats on the good quarter. You know, I think when we look back to some of the conservatism you had after the strong first quarter, you talked about how, you know, the EMU, the procedural environment hadn't exactly returned to pre-pandemic levels due to staffing Clearly, it looks like trends have continued to improve in the second quarter. When we spoke out to third quarter, fourth quarter, should we be thinking about it as basically being a fairly normal operating environment, or was there maybe some one-time catch-up in the quarter that really drove the strength?

Alan, thank you for the question and for the congratulations on behalf of the team. So when we look at volumes, again, we really saw strength across the different pieces of the business and really that strength coming from initial implants as well as from the contributions from Dixie. We do see that patient volumes, we believe, going through the epilepsy monitoring units have strengthened, and they've strengthened our pipeline. And while we don't know yet whether the volume in those comprehensive epilepsy centers is has consistently fully returned. We believe that we have seen strengthening. Yeah. Does that answer your question?

That's helpful. And then I guess, you know, one on the, you know, I guess the expanded criteria, if you will. When we think about, you know, what's needed to really target the opportunity, I know you said that you're kind of still going through the planning yourself. But when I think about the potential need for additional costs, especially since you're reiterating, you know, that your cash can get you out to mid 2025, do you see the potential need for additional spending to really go after that opportunity? And if so, will you be able to hold to that mid 2025 kind of target? Thank you.

Thanks again, Alan. That's a great question. As you state, we are in the early stages here to really fully understand the scope of the of the opportunity. That said, I would remind us that this remains within our currently indicated patient population. These are customers, and by that I mean epileptologists and functional neurosurgeons, that are the functional specialties that we call on today. It is our current technology and our commercial field team, while these are expanded sites, our commercial field team is trained and highly experienced in interacting with just this type of procedure and customer and patient and technology. So we see that there will be customer training and education that we needed, certainly, and we're working on evaluating the scope there. But we see it really more as expanding that training and education to the additional sites and epileptologists and neurosurgeons. We'll be focused and thoughtful on targeting potential centers and we'll be working on investing as we grow. And while we grow, we'll be thoughtful about how we invest and make sure that we're doing so responsibly. so that we maintain both the ability to expand into the opportunity and develop the market while doing so with a focus on operating discipline and expense management.

Ladies and gentlemen, as a reminder, should you have a question, please press star followed by the one. Your next question comes from Paige Chamberlain with Wolf Research. Please go ahead.

Hi, guys. Thank you for taking the questions. I have one on Dixie. We understand there's, you know, several strategic reasons behind that partnership, one being more visibility into the patient funnel. So I guess I'm just curious, now that you guys are about nine months into this agreement, what have you been learning? And, you know, is this partnership helping you identify more patients on the front end and manage the patient funnel any better?

Hi, Paige. Thank you for your question. It's a great question. As you say, we are a few months into this, but it is relatively early as we think about the sales integration process and how the collaboration is integrating with both our current customer base as well as potential new customers. I would say that we are pleased with how things have started. We have seen positive contributions to both revenue as well as our ability to get visibility further up the pipeline. And we're continuing to work closely with both Dixie as well as with our field team in further defining and executing on those both current opportunities as well as customer expansion opportunities. So We're pleased with what we've seen so far. We're pleased with the contribution that we've seen to the current business as well as how it's helping us look into the pipeline deeper, but it's also still relatively early in our overall integration efforts.

Got it. Thank you. And then one more kind of jumping off that too. You guys mentioned there were some changes to the sales force in the quarter, so I guess Just kind of on an overall level, how are you feeling about the field team? Maybe if you could share any motivations behind some of those changes and what the changes will look like in practice. And then just for completeness, how is the Dixie partnership at all changing the sales strategy? Obviously, it's helpful to have another lever to pull, but what is that looking like in the field?

Paige, this is Rebecca. I'll comment on changes in the sales team There may have been a bit of confusion about that. We had a change in our sales leadership this quarter with the new VP of Sales, which we announced about two months ago. Other than that, we have not had changes in the sales team. As you may recall, we accelerated growth in our sales team earlier in 2022, but other than the change in sales leadership, there were not changes this quarter. Our field commercial organization remains about the same size that it has been for the full year. Thank you.

There are no further questions at this time. Please proceed.

Thank you. And I'd like to say thank you to all who were on the call today and for your interest in NeuroPACE. We're pleased with the first two quarters of 2023. We're focused on execution throughout the rest of the year. And we're excited about both the recent progress on and the future opportunities with our site expansion and clinical study work to expand patient indications in the drug refractory generalized epilepsy population with the Nautilus study, all of that with a focus on furthering Neuropace's mission to transform the lives of people suffering from epilepsy. Thank you, operator. With that, we'll conclude today's call.

Ladies and gentlemen, this concludes our conference call for today. We thank you for participating and ask that you please disconnect your lines.

The conference is no longer being recorded.