NeuroPace, Inc. (NPCE) Earnings Call Transcript & Summary

Thank you everyone for joining us this afternoon for another session at the Morgan Stanley Healthcare Conference. I'm Drew Ranieri, one of the medical device analysts here. From NeuroPace, it's my pleasure to have CEO, Mike Favet and CFO, Rebecca Kuhn with us here today for a fireside chat. Before we jump into that, just a brief disclaimer. For important disclosures, please see morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. And with that, Mike and Rebecca, thank you so much for taking the time here today. Looking forward to the discussion.

Thanks Drew, appreciate the opportunity.

And maybe first, just given that you are a newer company from a public perspective, just give us a brief overview of the company, of the technology. And maybe importantly, just how the patient, how the epileptic patient progresses through the funnel and maybe what have been kind of the traditional historic barriers to treatment for these patients.

So NeuroPace, just starting at the top, NeuroPace mission is to transform lives of patients, people living with drug-resistant epilepsy. The company is built around a unique technology, a brain responsive neurostimulation device that is cleared and approved in the United States and is helping thousands of patients with drug-resistant epilepsy control their seizures. The device and the way that it works is a patient-specific approach. We have a device that is programmed or can be programmed to recognize patient-specific patterns, abnormal patterns that are indicative of an upcoming clinical seizure. The device recognizes those, very quickly responds with automatic therapy, a neuromodulation stimulation therapy that's provided at an imperceptible level to the patient. I mean the delivery of that therapy results in a prevention or a reduction in the number of seizure events that happen for a patient. Importantly, because we are recognizing patient-specific abnormal patterns, the device also is able to record important brain diagnostic information brain signals associated with those events. That includes information around when those abnormal events are detected, we can trend those and see cycles or patterns, see whether the number of events are increasing or decreasing and we also store the brain signals associated with those abnormal detections. So that includes the signals in the brain prior to the detected event and also shows what the brain signals are like after our therapy is delivered. All of that brand diagnostic information is provided back to the doctor in a way that makes them -- allows them to optimize the programming of the device, all of that leading to improved outcomes over time as we optimize the therapy. You asked the question, Drew, about the patient market opportunity and the patient flow, the patients that we're treating with us are really focused on patients that are being seen at a comprehensive epilepsy center. Comprehensive epilepsy centers are specialty centers, multidisciplinary approach to treating people with drug-resistant epilepsy. They're identified as different types of epilepsy. Our product today is indicated for adults aged 18 and above that have what's called focal epilepsy. It's a epilepsy where their seizures originated in a specific location or a location in the brain. There are about 1.2 million people in United States that have drug-resistant epilepsy. About half of them, 60% of them actually have focal epilepsy, about 48% are adults with focal epilepsy. That's our concentration today. And every year, about 50,000 patients with drug-resistant epilepsy get referred into a comprehensive epilepsy center, one of these specialty centers. I mean that is our -- commercial focus is on treating those patients that are coming into the comprehensive epilepsy center, providing them with a treatment alternative to the drug therapy that's -- unfortunately, for those people who have been ineffective in controlling their seizures.

Got it. Thank you for that perspective. And I guess just kind of one other broader theme or maybe a couple here, but just kind of on the competitive landscape, look, when we launched the company, I think we were kind of coming out of a view of competition is really the status quo, which is keeping these patients on drugs that have been shown that they don't work. The next drug doesn't work. So maybe just help us think through that. Is that kind of your view, too? And there are other competitive neuromod devices out there. So maybe just where does RNS fit between BNS and DBS and maybe some of the other more invasive potential surgical options?

Yes, Drew, you're absolutely correct. The majority of our business growth has come from patients being treated with the NeuroPace RNS device that otherwise just were not going to be treated. So the status quo is really the primary alternative for treatment. And that's the focus of our commercial team and our marketing efforts is on changing the status quo, getting patients that are resistant to drugs, the opportunity to move on to another therapy that's been proven to be safe and effective at treating epilepsy. For those patients that have focal epilepsy, our indication today, historically, the treatment of choice was for those patients that were candidates was to move on to a receptive procedure or an ablated procedure. Those are procedures where they identify -- the physicians identify where the seizures are coming from and then they go in and surgically remove that portion of the brain with a receptive procedure or going with a laser probe and burn and destroy the brain tissue in the area where the seizures are coming from. For those patients, 80% of patients, that's not an option for them because the seizure onset location is coming from a place that would be too damaging to remove or to destroy the brain tissue in that area. But for some patients, that's a treatment option. Over time, we're providing an option that's a non-destructive, the nerve based solutions and non-destructive option for treating those patients that have a focal onset. The other neuromodulation therapies, there's 2 other neuromodulation therapies that are approved, a VNS device, our Vegas Nerve Stimulator and a DBS device or a Deep Brain Stimulator. Those approaches to treatment are fundamentally different than the approach that I described for the NeuroPace system. Both VNS and DBS use a duty cycle stimulator, meaning that the device is programmed to stimulate in a continuous pattern of on/off, on/off, on/off throughout the day, throughout the night, those devices are not responding to brain activity. So they're not looking for the abnormal events that the NeuroPace device is detecting and responding to, they're just in this duty cycle mode and all of that important brain information that's important -- that's available on the NeuroPace device that guides the improvement in therapy over time is not available from the VNS device for the DBS device. So NeuroPace really fits into a segment of the market. But going back to the original comment, unfortunately, for these patients with drug-resistant epilepsy, most of them are just on what I call the hamster wheel of drug therapy where you try 1 and fail one and try one and fail one. And studies have shown that once a patient tries and fails 2 or more antiepileptic drugs, the probability that they're going to control their seizures with antiepileptic medication is very, very small. I mean so it's really important for us to break that cycle and to bring in this few treatment option for those patients with drug-resistant epilepsy.

Great. I appreciate that. Maybe just to touch on COVID for a moment, we saw the 8-K last week, I know you talked about it recently at another conference. But just can you remind us or just maybe in brief detail share the impact that you're seeing on the commercial side, I think there's a few different buckets that I just kind of want to better appreciate. There's the new implant side, but then also the EMU side as well. But just help us kind of better understand those dynamics.

So let me start with an overarching comment. So we -- a little over a month ago, we announced our Q2 results. And so throughout COVID, we've had a lot of success as an organization, being able to continue to grow the business, increase the number of centers that are implanting the NeuroPace device, increasing the utilization. Q2 is a really strong quarter for us and very, very pleased with the success of the organization through the first part of the year. That said, historically, for the last 18 or so months of COVID, we recognize that the NeuroPace device and the implantation procedure for it are very susceptible or sensitive to COVID. Reasons for that is we do have a device that's considered -- the implementation is considered to be an elective procedure. It is a hospital-based surgical procedure that requires an in-hospital stay, typically 1 or 2 nights in the hospital, ICU availability that goes with that. And the centers that we're targeting are the large centers, typically urban centers that have been, in many cases, more impacted by COVID throughout the 18 or more than 18 months now that the COVID has been around. With all of that coming into Q3, there's 2 different factors that we've seen playing out for our business in Q3. One, at the beginning of the quarter, we saw a seasonality impact that we haven't seen in our business historically. I mean that was coming from surgeons and operating staff and to some degree, patients that took a much needed opportunity to go on vacation at the beginning of the quarter. They haven't had an opportunity to do that for a long time, especially the hospital staff. And so we saw a near-term effect of that short-term effect in that at the beginning of Q3. And then as we started getting into the latter part of the quarter, we've seen an increasing amount of impact due to the delta variant and restrictions in hospitals have put in place on doing elected procedures. That started really about a month ago with a few centers and hotspots that started to defer those procedures and we've seen that spread with more and more of these centers deferring elective procedures over the course of the last weeks. It's something that we're very mindful of in our business. I do want to point back to last year and maybe and talk about the other aspect -- positive aspect of our business, that while our business is sensitive to COVID, in terms of limitations on elective procedures, we do have a very sticky business and that the patients that have been identified leading up to this time that are candidates and are being scheduled for the RNS device, when the electric procedures are paused, then those cases get delayed but once elected procedures resume, those cases come back again. We saw that in a much bigger way last year with the beginning of COVID and the cases were postponed. And those cases, by and large, those cases were rescheduled. And within a few months of resumption of elective surgical procedures, those cases were put back on to the calendar. And we expect to see a similar pattern this time where there are more and more of these that are being delayed. But again, those patients are not lost. They're coming back again on the other side of this. We went through a similar cycle in Q4 of last year, beginning of Q1 of last year, and saw a similar pattern. And then as things get better, then those cases get rescheduled and they happen again. For us, there's a timing effect associated with that. We don't sell devices to the hospitals in anticipation of a procedure. We're only selling devices, not the time of implant. And so as we think about what that means for our business, this quarter, as those cases get delayed from potentially Q3 into subsequent quarters, then there's a timing impact there. And as we think about through the rest of the year, not knowing exactly when those cases are going to start coming back and whether they get scheduled in Q4 or whether some of those push out into 2022. With all of that said, they were confident those cases will come back, it's just a matter of when.

So just in terms of the impact that you're seeing in terms of the third quarter, it sounds like maybe the fourth quarter of last year, when we saw some types of resurgences might be a decent proxy to kind of think about the impact on new patient implants, at least for this quarter.

Yes, that's an accurate statement, Drew. I think as we look at the comparison, the best comparison was when we had the surge at the end of last year going into the beginning of Q1. Similar kind of impact that we're seeing on the number of centers that are deferring elective procedures. And again, we don't know how long it's going to last, but I would say Q4 of last year is probably the best proxy for the delta related impact. Obviously, the vacation schedule that I talked about for the beginning of the quarter is unique to Q3.

And kind of how does replacement revenue or replacement devices kind of fit into this landscape? These are patients that have had the implant. We know it works. They're getting a replacement. So should we expect a similar impact to this business or would you expect this to be a little bit more stable? And I know there's some underlying dynamics there and replacement that maybe we should highlight here.

Yes. So talking about replacement business, so as you stated, our device is a battery-operated device at the end of the battery life of the neurostimulator, the neurostimulator needs to be replaced with a new neurostimulator. That generates a replacement revenue for us. That's a smaller portion of the revenue, most of our revenues from initial implants. Historically, again, over the course of COVID, the replacement revenue or replacement procedures have really not been very much affected by COVID. Those procedures in contrast to the initial implants are outpatient procedures. They don't require typically ICU stay, patient goes home very, very shortly afterward. And they're generally considered to be non-elective procedures by the hospital. The patient has therapy that if they don't replace the neurostimulator, that's going to stop. They're not going to get that therapy. And so those procedures even during the height of the pandemic shutdowns last March, April, May, really were not very much affected from overall gain contrast to the initial implants. With that said, we did see a stronger number -- more number of -- higher number of replacements in Q2 of this year. Some of that could have been in reaction to planned vacation schedules that they knew that the replacement is coming up. And so pulling in the timing of those replacements into Q2 to be able to get out ahead of known sometimes where the surgeon wasn't going to be operating. But just as it relates to the delta variant, really very, very negligible impact of replacements on the delta variant. There is an overarching dynamic that's happening for replacement that we were selling a device up until 2018 that had a shorter battery length, on average a 4-year battery life for that neurostimulator. In 2018, we had a very important product introduction. They brought in a new user interface for the device and brought in a battery longevity that was much, much longer, 2 plus times of the longevity of the original device. The result of that transition back in 2018 is that as the devices are -- the older devices with the shore battery life are replaced with the newer devices with a much longer battery light, we're going through a transition where revenue from replacement starting in 2021 and for the next several years will be declining as we replace those older short lasting devices with the newer long-lasting devices. That dynamic has been going on starting this year and really will continue, as I mentioned, through the next several years and relatively unimpacted by the delta variant or any other COVID.

Okay. And I'm not sure if you want to provide this level of detail, but how many potential replacement devices are there in the field at this point? Kind of what's the finite amount that we should be kind of considering gets replaced over the next 2 to 3 years?

So we haven't provided at this point specific number of devices. In total, we have more than 3,000 patients that have been implanted with neuro based devices. But in terms of the number with the old shorter lasting battery, we haven't provided those specific numbers. We did provide guidance that we're expecting around $11 million of revenue from replacements in 2021. That represents a decrease from revenue last year. As we provide guidance for 2022 and the future in 2023, Ray will continue to break out replacement revenue contribution versus the initial implant revenue. But as I mentioned, over the next several years, that's going to be meaningfully declining revenue in replacements over the next few years until we start hitting the replacement cycle for the newer devices, the newer longer-lasting devices.

Right. I mean really, new patient implants is really what's going to be driving growth here. That's the most important factor to really be paying attention to than we're closing?

Yes. Absolutely, right Drew. The initial implants is the majority of our business today and will become an even larger part of the business. That's the fast-growing segment of the market, and it's where all of our commercial efforts are focused on growing that initial implant.

So just with the environment and delta impact in the south and the Midwest. You have 148 accounts, I can't imagine all of them are in those 2 geographic areas. So just as you look at the past couple of months, for accounts that are in non-affected areas, the utilization trends that maybe you're seeing there, I mean, are you seeing a kind of more proactive adoption or onboarding new epileptologist or neurologists to use RNS technology.

So just I want to clarify something. I know that when you look at the news and it talks about Florida and Texas being most impacted in terms of number of cases, that's absolutely true. But in terms of impact on hospitals and ICUs being filled and hospitals that are putting in place limitations around electric procedures, it's across a much larger portions of the public country. So Pacific Northwest, in California, in Georgia and even parts of the Northeast and the Midwest, Utah, I mean there's a number of places across the country where there's institutions that have -- hospital is at capacity and are putting in place those procedures. Just sort over the weekend Intermountain Health in Utah announced that they're putting a hold on elective procedure. So it's not just Texas and Florida. It's more than that. But that said, that's a temporary impact, right? So it's going to come -- it's going to go, those patients are going to come back. The focus that we have for our commercial business really is about driving increased utilization, both by getting to more centers that are going to implant the device over time. We had 132 centers last year that implanted the NeuroPace device. That's increasing this year. We're expecting about 148 centers to implant the NeuroPace device in 2021. And then within the centers that are implanting the device, most of our growth actually is coming from increased utilization within those centers. And we've seen those trends being very positive through the first half of this year with more of the physicians within those centers, prescribing the NeuroPace device for their patients and moving physicians from their initial evaluation and sporadic use of the device to a more routine utilization. And so when we look going forward, there's a lot of opportunity both for more centers to implant the device but even more importantly, to increase that utilization within the centers. And again, very positive trends that we're seeing in all of those through the first half of the year, some bumps associated, temporary bumps associated with COVID and then confidence around being able to continue those trends as we move into 2022.

I think when we were doing diligence, I think one of the more interesting aspects of R&S was kind of this data aspect. You're collecting so much data from a patient. But when you're going into a new account or you're already there and you're expanding to other clinicians, how important is this data aspect in their minds and maybe what new technologies or new software programs are you doing to kind of further the data analytic capabilities?

The data component, the visibility and insights into what is happening inside of a person with epilepsy, what's happening inside of their brain, that's really key to this technology. So the therapy is what's providing the efficacy, but the data is what's informing the physician -- that's allowing them to make the updates to the device programming to manage their patients overall. Since the beginning, NeuroPace is really founded on this idea of a patient specific, customized approach and the data that goes along with that is instrumental. Historically, we had a lot of data. We always had a lot of brain data that was available. We've been working to make that data really accessible to the physician in a way that highlights what's most important. We've recently, through the course of 2021, have been introducing, what we call our Insight platform. It's a gateway of information that's available to the physician that highlights what's most important, the information that we collect, synthesizing that down to a simple view that highlights the information that's most actionable for the physician to make the decisions about programming changes to the device, to make decisions about patient management, on really bringing visibility into a condition where before the neuro based device, it was entirely based on patient self-reporting. When we know that the patients self-reporting in epilepsy is inaccurate in many cases. So we're bringing that objective data. That has been and will continue to be, I would say, a big emphasis for NeuroPace and our unique approach to treating these patients. I think you may be on mute again, Drew.

Thank you. Sorry about that. So just and thinking about the opportunity and you're in adult focal, which is a very sizable market opportunity and very exciting, but you also have potential other opportunities down the road for indication expansion. So where are you there with those potential opportunities? And then just also maybe on the new product side, I know you launched another generation system in 2018, the 8-year battery device. But is there anything that we should be paying attention to from a new development or a new product development perspective?

So let me start with the things that we're doing to increase the size of the market opportunity, your first part of your question. So before we get to indication expansion studies, I do want to highlight that most of the patients that are -- that have drug-resistant epilepsy today are being managed outside of specialty centers. They're being managed in the community, often by general neurologists. We've started some work really just in the first part of 2021 to have more of a referral development effort as well as more of a direct-to-patient and patient education, patient awareness effort to help those people that are outside of the specialties via aware of treatment alternatives like the NeuroPace device that are available to them at these comprehensive centers. Through those efforts over time, that provides an opportunity to bring more and more of these patients that are in the community in for treatment and increase the size of the market opportunity. In addition to that, we are making the investments to increase the indication for our product. So that includes moving to younger patients with focal epilepsy. We're expecting to start enrollment in a clinical study that's already been approved. The IDE study has been approved by the FDA. We'll begin enrolling in that study later this year to expand now to age 12 with focal epilepsy. And then we're working with the FDA and will be later this year submitting an IDE study for a generalized epilepsy indication. Generalized epilepsy is a type of epilepsy where the seizures originate broadly across the brain at once, not from a focal location, but broadly, we're using our same device, the same technology, applying responsive neurostimulation to those patients in a network stimulation mode. And so we're very excited about that. We were able to get a breakthrough device designation from the FDA earlier this year. It's been very helpful with us for us working with the FDA to get to that IDE submission, and we anticipate enrolling in that study starting next year.

Got it, thank you. I know we're getting close to the top of the session here, but wanted to ask Rebecca a question on gross margins. So you have a very healthy gross margin profile today. Is there any reason structurally when you're -- when the business is at scale that margins can't move closer to 80% over time?

You're right, Drew. We do have a very healthy gross margin today. We expect that our gross margin will grow primarily due to volume and scale as our business grows, it will fluctuate likely quarter-to-quarter due to a variety of factors. It's fairly sensitive to small changes in costs. It may fluctuate with volume and product mix. But over time, the general trend will be up, we believe. And there's really nothing that prevents us from reaching that 80% number you mentioned over the next several years, given growth in the business.

So not next quarter, over the next couple of years or next few years.

Not next quarter. Thanks for your patience. It will be over a few years.

Okay. And just with people able to travel again just in the last minute that we have, but you have the American Epilepsy Society meeting coming up in December in Chicago. But I mean, is there anything that you would point us towards to pay attention to? Anything on the data side for RMS or anything supportive of the technology?

As you mentioned, Drew, the American Epilepsy Society Meeting is the big epilepsy meeting, it's in December. Hopefully, it stays in person this year, and we were able to get together with our customers there. I did it at the beginning talk about the clinical data and the emphasis that NeuroPace has put on that. We have an extensive data set, 9-year follow-up data from our original FDA study. Last year, in 2020, we had publication of a real-world outcome study that showed the learnings from that initial FDA trial applied back to new patients being treated after FDA approval, resulted in much better outcomes, even faster than we saw in the original FDA trial, 67% median seizure reduction at 1 year of follow-up, up to 82% median seizure reduction at 3 years of follow-up. We've continued at the AEs meeting and other meetings to really be leading in science. And so there's a number of publications that we're expecting and abstracts that will be presented on various different subpopulations of epilepsy. The unique approaches to using the data from the NeuroPace device to do things like inform subsequent surgeries. And so there's a lot of pieces coming out. There's no landmark data that's going to be coming out at the AEs meeting. But every year, we've had more and more publication and a larger and larger share of the scientific mindset going to the NeuroPace technology responsive neurostimulation and expect that, that trend will continue this year.

Got it. And with that, we hit the top of our session, but Mike and Rebecca, very happy that we had the opportunity to talk to you today about the technology and your progress. And thanks again for being able to participate.

Thanks, Drew.

Thanks so much Drew.