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NeuroPace, Inc. (NASDAQ:NPCE)
Q3 2021 Earnings Call
Nov 10, 2021, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Good afternoon and welcome to NeuroPace's third quarter earnings conference call. [Operator instructions] I would now like to turn the call over to Matt Bacso from the Gilmartin Group for a few introductory comments.

Matt Bacso -- Investor Relations

Thank you, operator. Good afternoon and thank you for participating in today's call. Joining from NeuroPace are Mike Favet, CEO; and Rebecca Kuhn, CFO. Earlier today, NeuroPace released financial results for the quarter ended September 30, 2021.

Copy of the press release is available on the company's website. Before I begin, I'd like to remind you that management will make statements during this call that include forward-looking statements within the meaning of federal securities laws, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Any statements made during this call that relate to expectations or predictions of future events, results or performance are forward-looking statements. All forward-looking statements include those around NeuroPace's clinical trials and those relating to our operating trends and future financial performance, FDA approvals, the impact of COVID-19 on the business and prospects for recovery, expense management, expectations for hiring, growth in our organization, market opportunity, revenue guidance, commercial expansion, product performance and product pipeline development are based upon our current estimates and various assumptions.

These statements involve material risks and uncertainties that could cause actual results or events to materially differ from those implied by these forward-looking statements. Accordingly, you should not place undue reliance on these statements. For 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 quarterly reports on Form 10-Q filed with the SEC pursuant to Rule 424B4 on August 12, 2021, as well as any reports that may be filed with the SEC in the future. This conference call contains time sensitive information, which we believe is accurate only as of the live broadcast on November 10, 2021.

NeuroPace disclaims any intention or obligation, except as required by law, to update or revise any financial projections or forward-looking statements, whether because of new information, future events or otherwise. And with that, I'll turn the call over to Mike.

Mike Favet -- Chief Executive Officer

Thanks, Matt. Good afternoon and thank you for joining us. Following a very strong second quarter, where we reported record initial implant revenue and continued momentum following our initial public offering, we experienced COVID-19 related headwinds in the third quarter. Early in the quarter, we saw unusual seasonality associated with increased patient and provider vacation demand.

Later in the quarter, we were negatively impacted when procedures, including initial RNS System implants and EMU diagnostic procedures were postponed or delayed. This was primarily a result of hospital restrictions on inpatient elective procedures due to the Delta variant, hospital staffing shortages and patient reluctance to be in the hospital. While initial implant revenues declined sequentially in the third quarter, I am extremely proud of the NeuroPace team's resiliency during this challenging and dynamic period. Despite the recent COVID-19 headwinds, we did increase the number of active accounts and physicians in the third quarter.

As of November 1, 140 centers have completed an initial implant this year with additional sites scheduled to complete a procedure by the end of 2021. We have also continued to improve product performance in ways that we believe are important for patient adoption and to make progress toward expanding indications and increasing the market opportunity. It is important to point out that a year-over-year comparison may not be particularly helpful given the third quarter of 2020 was an entirely different environment. Specifically, in the third quarter of 2020, we experienced strong growth from cases that were rescheduled from the start of pandemic, whereas in the third quarter of 2021, inpatient elective procedure volumes were significantly disrupted due to COVID-19, leading to implant procedures for our device being delayed beyond the third quarter.

While we believe that Delta variant infection rates and hospitalizations have declined since the recent peak, based on our estimates, EMU patient volumes continue to remain below 2019 levels, as they have throughout the pandemic. We are confident in our ability to recapture postponed cases. But frequent and unpredictable surges in COVID infection rates, in addition to staffing shortages, risk-averse patient behavior and hospital restrictions on elective procedures continue to impact the number of patients moving through the diagnostic process at CECs. Since our business is largely dependent on EMU diagnostic evaluations, we believe our organic initial implant growth will be impacted and now expect growth to be in the low to mid-20% range annually until we emerge from these macro headwinds.

We continue to have a high degree of confidence in our ability to activate new centers and drive utilization within those centers, but our previous initial implant growth assumptions were predicated on COVID-19 headwind subsiding, resulting in a stable and growing EMU diagnostic patient funnel. Next, I would like to provide an update on the estimated battery life of the neurostimulator we have been selling since 2018. We recently submitted a premarket approval application supplement to the FDA that, if approved, will allow us to claim an increase in the estimated battery life of this device under typical operating conditions to nearly 11 years. This represents more than a two-year increase from our currently approved labeling.

We believe that a longer battery life removes an important barrier for initial implant adoption and gives us a distinct competitive advantage over other neuromodulation devices for epilepsy. Given the relatively young average age of our patients and a replacement rate of over 90%, this change brings significant benefit by reducing the number of required replacement procedures over a patient's lifetime. We believe that providing an estimated service life of nearly 11 years with no recharging burden will enhance the patient experience, especially as we look to expand our indication into younger patients. We believe that it will make us a more attractive treatment option compared to other neuromodulation devices with five to seven years of longevity, potentially fueling future initial implant growth.

While the longer battery life is of significant benefit to our patients, it will reduce replacement implant revenue in the coming years, including by approximately $2 million to $2.5 million in 2022. Moving on to clinical updates. Today, we announced that we received IDE approval for a pivotal study to expand our indication for drug-resistant idiopathic generalized epilepsy, otherwise known as primary generalized epilepsy. Given the timing of this approval, we believe that we are in a favorable position to begin enrollment in 2022.

As a reminder, we received breakthrough device designation from the FDA for this indication earlier this year. Additionally, we continue to make progress toward beginning enrollment in the IDE clinical study to expand our indication for drug-resistant focal epilepsy to younger patients aged 12 to 17. Lastly, our RNS System was recently highlighted in a Nature Medicine journal article on October 4, titled, closed-loop neuromodulation in an individual with treatment-resistant depression. The article features a woman who became the first patient to be implanted with our RNS System in an investigational study being conducted at UCSF to treat severe treatment-resistant depression.

Similar to the therapeutic approach used for epilepsy patients treated with our RNS System, surgeons were able to calibrate and detect neural activity patterns that occur when a patient is becoming depressed. Once detected, our RNS System was used to deliver pulses of electrical stimulation to stave off depression. This is the first known study of our device in this patient population. While patient stories like this are encouraging, it's important to note that any potential indication for depression is many years away.

That said, we continue to believe the RNS System is a truly innovative neuromodulation platform that has the potential to be used to address a variety of diseases. Before we move on to financial results, I would also like to update you on a change in our board makeup. As of November 1, we added Lisa Andrade to the board, replacing Evan Norton. Lisa joins NeuroPace with over 25 years of experience in both large and early stage med tech, software and technology companies.

Currently, Lisa is CEO of M33, an executive coaching and leadership development firm, which she founded in 2018. Prior to founding M33, she served as Chief Marketing Officer at St. Jude Medical, which was acquired by Abbott in 2017. We are excited to welcome Lisa to our board of directors, as she brings a wide range of strategy, product development and marketing leadership expertise.

Lisa's breadth of experience in growing medical device businesses will be a valuable asset to NeuroPace as we continue to execute our commercial strategy. I would also like to thank Evan for his service as a board Member of NeuroPace. Evan was and continues to be a big supporter of and advisor to the company, which was especially beneficial during the execution of our IPO earlier this year. In conclusion, our primary focus is to continue to grow revenue from initial system implants in our current indication.

We intend to do this by expanding into all CECs in the United States, driving increased utilization at these centers, enhancing referral pathways and investing in innovations to improve patient outcomes and ease of use. We are also investing to expand our indications to younger patients with focal epilepsy, patients with generalized epilepsy and exploring potential opportunities outside the United States. Finally, we are supporting the early feasibility work, such as the UCSF study on treatment-resistant depression that could bring the benefits of responsive neuromodulation therapy to patients with other brain disorders. With that, I will turn the call over to Rebecca, NeuroPace's chief financial officer.

Rebecca Kuhn -- Chief Financial Officer

Thanks, Mike. As we compare our operating results in 2021 to 2020, it's important to note that 2020 was a very different environment due to the initial impact of COVID-19 on our revenues and the changes in our operations and cost-cutting measures we implemented as a result. NeuroPace's revenue for the third quarter of 2021 was $10.3 million compared to $12.8 million for the third quarter of 2020, a decrease of 19%. The decrease was primarily driven by a decrease in unit sales of our RNS System to comprehensive epilepsy centers for initial implant procedures.

In the third quarter, revenue from initial implants was $7.8 million, a decrease of 15% over the third quarter of 2020. Third quarter initial implant revenue was significantly impacted by reduced procedure volumes due to COVID-19 Delta variant headwinds and increased patient and provider vacation. Revenue from replacement implants was $2.5 million, a decrease of 31% compared to the third quarter of 2020. As Mike stated, we continue to expect replacement implant revenue generally to decrease for the next several years due to the transition to our device with a longer-lasting battery.

Gross margin for the third quarter of 2021 was 72.6% compared to 75% in the third quarter of 2020. The decline in gross margin relative to the prior year was primarily due to an increase in certain costs as our manufacturing operations returned to pre-COVID levels following COVID-19 related disruptions in 2020. Total operating expenses in the third quarter of 2021 was $13.8 million compared with $10.7 million in the same period of the prior year. R&D expense in the third quarter of 2021 was $4.3 million compared with $3.7 million in the same period of 2020.

The increase in R&D expense was primarily driven by an increase in product development and clinical study expenses. SG&A expense in the third quarter of 2021 was $9.4 million compared with $7.1 million in the prior-year period. The increase in SG&A was primarily driven by increased costs associated with operating as a public company and increased sales and marketing expenses. Loss from operations was $6.2 million in the third quarter of 2021 compared to $1.2 million in the prior-year period.

We recorded $1.8 million in interest expense in the third quarter compared to $2.8 million in the prior-year period. The reduction in interest expense is due to lower average debt balances in 2021 compared to 2020. Net loss was $8.1 million for the third quarter of 2021 compared to $4.1 million in the third quarter of 2020. Our cash and short-term investment balance as of September 30, 2021, was $123.3 million, while our long-term borrowings totaled $49.6 million.

Now, I'd like to provide an update to our 2021 outlook. While we are pleased to see elective procedure volumes beginning to recover in the fourth quarter, following a challenging third quarter, we remain cautious given near-term uncertainty surrounding the severity and duration of COVID-19 and the potential impact on hospitals, physician and patient behavior. Based on this, we are lowering our full year revenue guidance to be in the range of $44 million to $44.5 million, representing growth of 7% to 8% compared to full year 2020. We now expect initial implant revenue to be in the range of $33 million to $33.5 million, representing growth of 18% to 20% compared to full year 2020.

Lastly, given the replacement revenue dynamics Mike mentioned previously, we anticipate replacement revenue to be approximately $11 million, representing a decline of 16% compared to full year 2020. This concludes our prepared remarks. I would like to turn the call back over to the operator, who will open the call for questions.

Questions & Answers:


Operator

Your first question comes from Robbie Marcus with J.P. Morgan.

Robbie Marcus -- J.P. Morgan -- Analyst

Great. Thanks for taking questions. Maybe to start, Mike, it's I don't think a surprise after some of the commentary we heard from you in the quarter and what we've seen from peers in the market in general, that trends are a bit slower due to Delta. But I was wondering if you had any sort of qualitative or quantitative comments on what the adoption and feedback has been like in areas in the country where we've seen less of a Delta impact and try and take that and overlay it for future trends?

Thanks, Robbie. We haven't done, I would say, specific analysis of putting hotspots of Delta variants against the -- meaning where there's higher infection rates against what we're seeing. Part of that is because the dynamics that we saw in Q3 related to COVID had a number of different causes associated with them. Some of them were related to vacation schedules earlier in the quarter, which was independent of hot spots or not hot spots.

And then there's the staffing, hospital staffing, which again was generally independent of the hotspots. That said, we have seen things generally trending more positively as we've come out of the third quarter, so third quarter being impacted more significantly by the Delta variant. We've seen things moving in a positive direction, but still impacted to the stage, to some degree, more in certain pockets. And then also the limitations on the patients coming through the electors, which has really been consistent throughout the pandemic, but it got worse during Q3.

Got it. Also really good news on the IDE start here for the breakthrough designation device in generalized epilepsy. How do we think about the time lines here and maybe your competitive advantage and what you're hoping to prove versus other devices for epilepsy? We've seen great results in focalized, but just trying to maybe set baseline expectations for what we might see in a generalized population the benefits? Thanks a lot.

Mike Favet -- Chief Executive Officer

Yeah. Thanks, Robbie. We were very pleased to get the positive response back from the FDA on the IDE submission and really looking forward to gearing up that study to start enrollment next year. A couple of comments that I would make about it.

One, I had made previous comments about not having definitive answers to the length of follow-up for that study. We know at this point that it's a one-year follow-up for the primary endpoint, which is an important driver of the amount of time it will take to get through that process. The primary endpoint is less than 100 patients that we need to enroll in the trial to be able to get to the primary endpoint. And so those parameters now are defined and agreed to by the FDA.

The amount of time that it takes to enroll is going to be to a large degree a function of when we get started. And so now with this recent news that we have the IDE approval, the team is gearing up efforts to go through site selection and then list it and look forward to getting the first patients enrolled next year and then doing everything we can to drive enrollment in the study. And I'll tell you that the interest from physicians is high about this. There are no devices today that are indicated for treatment of generalized epilepsy.

And so with that, there's a lot of interest and participation and sites that are anxious to be able to get going and collect that information. What we're really excited about from a device standpoint is the technology with responsive neurostimulation, being able to bring the ability to detect patient-specific brain activity in patients with generalized epilepsy, record the diagnostic information about when those events are happening, how they're trending over time, I mean doing that in a patient population that we haven't otherwise been able to treat by using network stimulation. Now by using network stimulation, that unique aspect of the patient-specific therapy, the recording is to go along with that, the trending and the diagnostic information, it was really new and unique to this patient population and differentiated from anything else that's available. For us, it opens up a whole new part of the market that doesn't have treatment options with our device today.

And again, like I said, a lot of interest from investigators to get going with this because it's an underserved patient population.

Robbie Marcus -- J.P. Morgan -- Analyst

Great color. Appreciate it. Thanks a lot.

Operator

Your next question comes from Drew Ranieri with Morgan Stanley.

Drew Ranieri -- Morgan Stanley -- Analyst

Hi, Mike and Rebecca. Thanks for taking the questions. Just through your prepared remarks, I think you were mentioning or talked about some color for 2022. I thought I heard you say new patient implant growth of 20% next year and we should think about replacements being down about $2.5 million, which makes sense.

But as you kind of look at the environment today, there's still clear uncertainty. It sounds like there's some dynamics that are getting better, but you continue to kind of call out the EMU diagnostic headwinds. But just kind of what gives you confidence today that you are capable or the implant volume could achieve 20% growth in 2022, just given the backdrop of uncertainty today?

Mike Favet -- Chief Executive Officer

Yeah. Thanks for the question, Drew. So when we think about the market today, the growth that we've been able to experience over the last 18 months, that was all in the backdrop of EMU volumes down. So since the beginning of the pandemic, EMU volumes have been decreased and continue to be decreased.

And in spite of that, we've been able to increase the number of centers and planting the device and increase the utilization at those centers. I mean, we're confident that that will continue as we move forward. We've made some commentary about the number of centers year-to-date that have implanted the center, which is already more than implanted in all of last year. So with that dynamic, we've been able to grow the business.

We're confident in our ability to be able to do that. There are some things that we're doing on the commercial side to increase patient awareness and on activities around driving referral development through all of this. But the commentary about 2022 is to put into context that we do see that throughout 2021, we've had these reduced number of patients coming through the epilepsy monitoring unit. That does have an impact on our business over time.

Because as we've discussed before, it takes time for a patient coming into the EMU to work through all of the procedures to get to a definitive scheduling of an RNS device, a NeuroPace device implant. And so with those numbers down, we know that that's going to continue and there's uncertainty around how long that is going to last, as we all know. And so I would say we're being cautious about what that looks like for 2022 as we evaluate that. But again, very confident in our ability to grow the business in the low to mid-20s as I provided, based on the patients that are -- the centers that are coming online, the additional physicians that are programming and prescribing the device.

I mean, some important news that's coming out about increased longevity and so forth that we know will have positive dynamics in adoption.

Drew Ranieri -- Morgan Stanley -- Analyst

Got it. Thank you. And just as we think near-term in the fourth quarter, clearly, the fourth quarter implied guidance is a step-up from the third quarter. But are you thinking that these are recaptured deferred procedures? Are these kind of de novo implants? Just any more color there? Thank you.

Mike Favet -- Chief Executive Officer

Yes. They're mostly -- we believe that they're mostly de novo implants. So the dynamic that we saw in Q3 was more, I would say, hesitancy or cases that were not being scheduled as opposed to large numbers of cases that were on the calendar and pulled off of the calendar. We saw more of that in Q3 than we had seen in previous quarters, but most of the impact was cases not being scheduled.

I mean, so when we look into Q4, the number of those patients, we anticipate to be larger than in Q4 -- or than in Q3. So incrementally stronger performance overall in Q4 versus Q3. But again, most of that coming from de novo patients coming through as opposed to large numbers of patients that were stopped and then rescheduled, which was the dynamic we saw back in 2020 at the beginning of the pandemic. We really -- this is more about new patients coming through.

Drew Ranieri -- Morgan Stanley -- Analyst

Got it. Thanks for taking the questions.

Operator

Your next question comes from Danielle Antalffy with SVB Leerink.

Danielle Antalffy -- SVB Leerink -- Analyst

Hey, good afternoon, everyone. Thanks so much for taking the question. Congrats on growing, congrats on the quarter despite the issues. Just a question on the recent COVID dynamics and the impact from staffing shortages.

And I'm just curious what you guys are seeing there at the epilepsy centers, the CECs and how you're seeing that play out? And I'd be curious, this is probably a tough question to answer, but just given the remote capabilities of the device, is that something that in an environment where staffing is even more critical and you need greater efficiency, you actually think could ultimately be a tailwind for the business longer term? Just curious if you have any thoughts there.

Mike Favet -- Chief Executive Officer

Thanks, Danielle. The staffing challenges that we hear from our customers, from the centers, is really in two areas. One is the technicians and the staff they have to support the epilepsy monitoring unit. So part of the driver for number -- the reduced number of patients coming through the epilepsy monitoring unit relative to pre-pandemic levels is related to staffing of the people in those epilepsy monitoring units, the staff of the hospital and those epilepsy monitoring units.

We also occasionally see it around OR staffing. So the support staff for the operating room, creating some challenges there. But I would say mostly, for us, it's around the number of patients that can be seen through the epilepsy monitoring unit because of staffing there. You bring up an important point that we have made important progress with getting codes added a couple of years ago for remote review of the diagnostic information stored by our device.

And that is really helpful on the follow-up side. And so as hospitals look at staffing for support of clinics and the ability to be able to manage those, the ability of our system to have diagnostic review that can be done remotely, helps with that piece, but it doesn't directly address the staffing within the EMU, which is a different dynamic.

Danielle Antalffy -- SVB Leerink -- Analyst

OK. That's helpful. And then just on the generalized epilepsy. Just curious if you can talk about how we should think about time lines here if -- I didn't see -- I might have missed it, but anything about trial design and numbers? So I'm not sure if that's available yet.

But just curious what you can tell us for how we should think about feed of enrollment and when this could come to market? Thanks so much.

Mike Favet -- Chief Executive Officer

Thanks, Danielle. So we haven't provided specific timelines yet associated with the study. It's just recent news that we just announced today that we got the IDE approval. And so with that moves us into the next step of getting centers signed up and going through all of that process to be able to start screening patients in order to start enrolling.

We'll have better information on that as we get through that administrative part of the process to be able to actually begin screening patients. I didn't in the prepared remarks, provide any comments about the makeup of the study or the parameters of the study. But in the Q&A, I did mention that we did get the IDE approval for a study that has a one-year follow-up for the primary endpoint. That's what we proposed to the FDA and they agreed with that.

And the number of patients that would be required or that is required to be able to meet that primary endpoint is less than 100. So we haven't provided specific numbers there, but that's in line with what we had expected prior to this. And again, very pleased that we were able to get that IDE approved through the FDA and now gearing up internally to be able to support the kickoff of that study.

Danielle Antalffy -- SVB Leerink -- Analyst

Thank you.

Operator

[Operator instructions] Your next question comes from Michael Polark with Baird.

Michael Polark -- Robert W. Baird and Company -- Analyst

Hi, good afternoon. Thanks for taking the question. I'll follow the questioning there on generalized and ask specifically, is this going to be sham-controlled, or is this single arm? I'd be curious how it's structured.

Mike Favet -- Chief Executive Officer

Thanks, Mike. Without getting into all of the details of the study, it is a randomized study, randomized controlled study. It has somewhat of a different design that allows for less impact for the patients that are randomized to a sham therapy. So I'll follow-up maybe at a later time, we can go into more specifics.

I'm not prepared to go into the details of the study design, but it is a randomized sham-controlled trial, but a different approach to doing that than what has been done for most device studies in the past.

Michael Polark -- Robert W. Baird and Company -- Analyst

If I can sneak in two more hopefully quick ones. If you said it, I missed it on the adolescent study. Has enrollment started there? Or do you still expect to start or enroll your first patient by the end of this year? What is the update on timing for the adolescent project?

Mike Favet -- Chief Executive Officer

Yeah, thanks for the question. I didn't specifically address that. For the adolescent study, we're now at a point where we have our first center of our centers through all of the contracting and IRB approvals. And so we have the first patients that are being screened and look to be identified through that process.

There's more centers that are still going through the setup process. And so the number of centers will be going up over time. I didn't provide a specific guidance around when we expect that first patient to be enrolled by -- we're getting close to that point. So the process, the administrative process, which slowed down here through the third quarter is now picking up speed again.

Michael Polark -- Robert W. Baird and Company -- Analyst

And the last one, I'm curious on the extended -- or the submission for the extended battery life claim from eight to 11 years. It sounds like the product is the same. You just have more information to support an average use that's longer than prior climate? I'm curious how that -- what happened there? What do you find? Is it as simple as that? The initial claim was more conservative and you're more confident in 11 or is something else? Any color would be great. Thanks for taking the questions.

Mike Favet -- Chief Executive Officer

Yeah, thanks for the questions. So the battery life estimations, when the device was initially approved, were based on models that we did, assumptions and models that we did from the -- from the design of the product. Now we have more data on actual performance of the product being produced. And so, we recently were able to complete that analysis that showed that the performance of the devices is better than the models that were used to create the initial approvals.

And so that is the information that we provided back to the FDA and the submission is the data on what the actual device performance is. And then we're using that to be able to support an increased claim for the labeling. So should the FDA agree with that, that would allow us to market the longer longevity.

Michael Polark -- Robert W. Baird and Company -- Analyst

Thank you.

Operator

There are no further questions at this time. I'll now turn it over to Mike Favet for the closing remarks.

Mike Favet -- Chief Executive Officer

Thank you all for your time today. We hope we have provided you with an overview, not only of our results, but also our priorities on how we continue to go about achieving them. We look forward to meeting many of you in the future at investor and industry conferences as well as with individual meetings. Have a great day.

Operator

[Operator signoff]

Duration: 36 minutes

Call participants:

Matt Bacso -- Investor Relations

Mike Favet -- Chief Executive Officer

Rebecca Kuhn -- Chief Financial Officer

Robbie Marcus -- J.P. Morgan -- Analyst

Drew Ranieri -- Morgan Stanley -- Analyst

Danielle Antalffy -- SVB Leerink -- Analyst

Michael Polark -- Robert W. Baird and Company -- Analyst

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