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

All right, everyone. We can go ahead and get started. So welcome to another session at the Morgan Stanley Healthcare Conference. I'm Andrew Ranieri, one of the medical device analysts here. I'm delighted to have Michael Favet, CEO; and Rebecca Kuhn, CFO of NeuroPace. And before we just jump into it, I'd have to read our quick disclaimer. But for important disclosures, please see Morgan Stanley's research disclosure website morganstanley.com/researchdisclosures -- and if you have any questions, just reach out to your sales rep.

So with that, let's kind of kick it off. And Mike, maybe let's start on kind of the EMU volumes here. I mean, this has kind of been one of the ongoing debates and we've seen a lot of kind of fits and starts over Covid and maybe more recently in 2022 as we kind of moved into an endemic phase. So maybe just kind of give us an update on EMU volumes and if you can, kind of what you're seeing maybe here in June, July, August and even into September, that gives you the confidence to hit new patient implant growth for the year?

Great. Thanks, Drew. Thanks for the opportunity to be able to talk today as well. For those of you who are maybe less familiar with our business, the patients that get treated with the NeuroPace device moved through a diagnostic workup process that includes going through the Epilepsy Monitoring Units, or EMUs. We've seen throughout the pandemic that the number of patients coming through those diagnostic procedures at the comprehensive epilepsy centers was impacted by for a variety of reasons by COVID. We talked about earlier this year that, that was especially true in the first quarter at the end of December last year and in the first quarter of this year with the Omicron wave causing fewer patients to come through the comprehensive epilepsy centers. We've seen that recover here in the second quarter of this year into the third quarter of this year. What we're hearing from our customers is that the epilepsy monitoring unit volumes now are back to the 2021 levels, which is still not all the way back to pre-pandemic levels, but they're back to the levels that we saw throughout the year in 2021. What that means for us is a larger number of patients that are being moved forward for consideration of interventional therapies, including the RNS device. That's translated in our business to patients that are getting scheduled for the RNS device implant -- that EMU volume is a leading indicator of the size of the opportunity for our business as we need those patients to move through. On average, it takes about 6 months for a patient to go from EMU admission to the implant of the NeuroPace device. So the increases in patient volume or recovery in patient volume that we saw in the second quarter into the third quarter is translating now into patients that are being scheduled for the procedure for our procedure in the second half of the year.

And maybe just on the volumes getting back to '21, still not back to 2019 levels. But kind of what's the gating factor for getting back there? And I know that it's difficult to have a crystal ball here, but how do you kind of think about that maybe playing out in '23 and beyond?

There's a variety of different reasons that we hear from our customers. But one of the themes is the staffing challenges at the institution that through the pandemic, -- they lost a number of nurses, in particular, nurses and techs that are required to staff these epilepsy monitoring units. They're relatively resource intensive. There's a high amount of monitoring as implied by the name of the epilepsy monitoring unit. And so with that, the centers haven't been able to operate as many beds, epilepsy monitoring unit beds as they did prior to the pandemic. When I talk to our customers, there is a high level of interest in getting those EMU volumes back, staffing up the hospitals, bringing more patients into the epilepsy monitoring units, at a number of these centers, there's backlogs to patients, so patients that they've identified to be able to get them into the epilepsy monitoring unit at other centers, there's work that they're starting to do to bring back more staff or to staff up those centers and then also to do their referral development for patients coming in from the community. So I hear a strong commitment from our customers and actions that they're taking to get those epilepsy monitoring unit volumes back to pre-pandemic levels. And as a reminder, prior to the pandemic, the number of patients coming through the EMU have been increasing every year. There's a large number of patients that are drug-resistant epilepsy patients that are currently not being referred into those centers that historically have not been referred into those centers. So the growth in EMU volumes is not just new patients being diagnosed for the first time, but it's working through the approximately 800,000 patients that are drug-resistant epilepsy patients that are being managed in the community, having more of those patients being sent into the epilepsy centers. So specifically to your question, we're hearing from our customers steps that they're taking to get back those volumes and to be able to recover from that, primarily through staffing, but through a variety of other things as well.

So they're actively engaged in getting EMU volumes up themselves. So it's not necessarily like a structural issue. It's just maybe there's a capacity constraint still on the staffing side.

Correct. Yes. When I talked to -- I talked to our customers regularly, as you can imagine, and they're all motivated to have more patients coming through to be filling up those beds and having more patients coming through the process.

Got it. And you touched on this a little bit about just the size of the population that's being treated in this community and not getting to the EMU, that is kind of like the key central debate, I think, for the company and specifically really achieving long-term growth. But maybe talk about what you're doing in terms of getting that patient population in the door here and you're still against a capacity constraint, but are you seeing any early signs of that actually you're actually achieving that goal?

With the number of patients that we talked about coming through the epilepsy monitoring units, we've taken actions. We are taking actions. And as we go forward, doing more to bring high-quality RNS leads into the comprehensive epilepsy centers. So the EMU beds can be more filled with patients that are good candidates for the NeuroPace device implant. There's a couple of ways that we're doing that, in particular, these are 2022 initiatives that we've set out for our organization. One of them is about calling on epilepsy specialists that are practicing in the community. I talked about most of these patients that have drug-resistant epilepsy are being managed in the community. Historically, that management was done by a general neurologist, a neurologist that's treating a wide range of conditions, epilepsy being a very small part. Is that -- over the last 5 to 10 years, there's been a big change in the treatment of epilepsy with the introduction of an epileptology fellowship and specialty. More and more epileptologists are being trained. It's very much a growing specialty. And now we estimate that there are more epilepsy specialists outside of comprehensive epilepsy centers than in comprehensive epilepsy centers. One of the -- we haven't talked about it here this morning, but we made an expansion of our field team, accelerated hiring of our field team in the first half of 2022. And a large part of the rationale for that is to be able to call on more of these epilepsy specialists that are in the community to identify good RNS candidates to send in, so that with the limited capacity today for the EMUs, that more of those high-quality RNS leads are filling those beds. And the other effort that we're doing in 2022 is more on the direct-to-patient education awareness. So efforts to get our team to provide information about the benefits of RNS therapy to these prospective patients so that they're able to help advocate for themselves to get into the comprehensive epilepsy centers and to move through that process. So referral activities with epilepsy specialists in the community supported by expanded field organization and then direct-to-patient education and awareness to help the patients be able to advocate and then supporting them through that journey.

So maybe with the Salesforce piece, you increased in the first half. I mean, I'm sure that there's some training process that has to be involved. But where are those reps actually spending their time? I mean, there's 200 epilepsy or comprehensive epilepsy centers roughly in the U.S. right now. Just how are they kind of going to be, I guess, is the question going to be splitting your time between comprehensive epilepsy centers and the community hospital to really kind of get that patient funnel going?

Yes. So we did complete the expansion in the first half of the year. As you alluded to, there is an onboarding process and getting those reps to be productive, that takes some time. So we typically see it's about 3 to 6 months before a rep is starting to be productive. And then I would say full productivity is a 12 to 18 months kind of process. So there's a number of people that we brought in. They're getting through that training process where they're able to be active in their centers and then really building up effectiveness as we go forward. Where they're going to be spending their time is mostly within the comprehensive epilepsy centers. There's still a large opportunity for us to have more utilization within the comprehensive epilepsy centers. But as we have centers in particular, that are starting to more regularly use the RNS device, that's where the referral development comes in so that we're able to identify patients that are in the community at these, with these epilepsy specialists in the community to send those into centers that are able to process them through and have an RNS device implanted. I don't have an exact percentage, but the majority of the time of these representatives will still be on the comprehensive epilepsy centers, but with some capacity now to be able to call on these epilepsy specialists in the community.

Got it. So maybe to kind of go back to the market a bit and you're kind of thinking about moving community or patients in the community into the Level 4 centers. But I mean there's kind of been this ongoing debate about the epilepsy market in general being a very prescription heavy type of market. So as you're kind of doing sales force engagement, DTC campaigns, what barriers are you kind of running into and really kind of what gives you the confidence that the plan, the commercial strategy is working right now?

So the -- you're right, a lot of the doctors that are in this space are still pharmaceutically oriented medically oriented. That changing that mindset of those physicians is a key part... The phone is buzzing. Changing the mindset of these positions is a key part of our commercial efforts. So it's making them familiar with the outstanding efficacy that we've been able to demonstrate with our product. The benefit of having patients be treated. So not letting these patients stay unmanaged or undermanaged on medical therapy for year after year, but moving them through that process. Ease of use is an important part of that. So it's making the NeuroPace device or system easy to fit into the way that patients are managed in these comprehensive epilepsy centers. So it's overcoming those barriers getting more and more of the epilepsy specialists to be able to comfortably prescribe the NeuroPace device for their patients. There is some competitive conversion as well. So we do think about share of patients coming through the epilepsy monitoring units, and we've been able to grow that share. So the number of patients coming into the epilepsy monitoring units, higher percentage of those patients being treated with the RNS device. Some of that is coming from patients that otherwise would not have been treated, but it's also increasing the efficacy and performance of our products so that we are able to move ahead of resection or ablation in certain instances, move ahead of some other therapies -- other therapy options that are being considered for some of these patients. But most of it is getting the physicians to -- and the patients to recognize the benefit of early intervention and moving on to effective treatment options and not just waiting another year to try another drug.

And like I know that you were just kind of talking about the competition in the Level 4 centers for different procedure types. But I mean when you're looking at kind of a community hospital, again, they may not be spending all their time on epilepsy, maybe 10%, 15% of the, of their patients. So there's kind of been a 20-year history of neuromodulation in epilepsy. I mean is -- are there competitive factors here that's a bottleneck for some of these general neurologists or specialists to get more engaged with RNS as you're kind of thinking about building this channel?

I wouldn't say that there's competitive factors that are involved. There's a lot of education and setting the expectations for the clinicians and the community about what needs to be done. I want to point to an article that just or a publication that came out just a few weeks ago from the International League against epilepsy, which is the surgical or the medical society that's overarching for treatment of epilepsy. They came out with a publication that's really reiterating and emphasizing the importance of moving patients that have failed 2 or more antiepileptic drugs onto consideration of interventional therapy to be seen by the epilepsy specialists. We're seeing more society efforts, medical practice efforts to be able to move patients on to educating neurologists to be able to move those patients on. The epilepsy center is taking more active roles and pushing their -- or advocating for their options that they're able to provide, getting more of those patients to come in. So it's not something that NeuroPace is doing all by itself. We're part of that. But the physician society is being involved with that, the patient advocacy groups getting more involved to create that awareness of what options are available for patients at the comprehensive epilepsy centers. The treatment of epilepsy has changed dramatically in the last 10 years. It wasn't that long ago, and the only option available was a resective procedure where you're removing a part of somebody's brain and ideally controlling or eliminating their seizures, but there's risk that's associated with that. There are so many more options that are available today, less invasive diagnostic processes that are available today. We'll talk about that with the DIXI and stereo EG in a minute. And we will -- and there's also neuromodulation therapies that are available, laser ablation therapies that are available. The space has really changed a lot. And so it's getting that information out to the physicians and the communities so that they can move those patients on, especially as we have more epilepsy trained physicians that are in the community, there's more comfort in doing that.

Yes. So yes, DIXI was going to be kind of the next topic. It was actually after the EMU volumes, so we kind of digressed a bit. But when you're kind of looking at DIXI, maybe just remind us or really emphasize what kind of the strategic rationale was for the partnership. And really, how does that potentially, I don't know, give you more visibility on the patient funnel beyond kind of the immediate like revenue benefits of having the partnership?

Yes. So we were very excited to announce our earnings a few weeks ago, a month ago, that we find an exclusive distribution agreement for the DIXI Medical stereo EEG electrodes to be selling those into the United States. That is important to us for a couple of key reasons. One, it's an opportunity for us to leverage our commercial organization in the epilepsy space, the stereo EG electrodes or intracranial monitoring is a procedure that's done by the same centers that are using the RNS device. So comprehensive epilepsy centers, the same neurosurgeons that are implanting those electrodes, same epileptologists that are advocating for prescribing their patients to have that treatment. And so it's a very effective use of our field organization to sell another product into that group. But as important is the visibility that, that provides for us of patients that are earlier in the diagnostic process. We talked about -- I've been talking this morning about efforts to have more patient education awareness to influence therapy decisions earlier in that diagnostic process to move those patients through. And the DIXI product provides a great opportunity for us to have an engagement in that diagnostic upstream in that diagnostic process. So we see what patients are being considered for interventional therapy. We can, with that advocate for the RNS device implant on the other side of that. And so it's highly synergistic with our current sales, same customers -- it's the same patients. Most of the patients that are going through -- that are getting an RNS device implant have gone through a Phase II study or an intracranial EEG study. Up until here, this is a great opportunity for us to convert a higher percentage of those patients to RNS with the sales organization that we have in the field.

And on the sales force side, that component. I think the guidance was for fourth quarter revenue, nothing in the third, but has the sales force kind of been fully trained and they're ready to go...

We are beginning -- we're beginning distribution at the beginning of the fourth quarter, anytime of October. So we're in that process now of training our field team, getting all of the system set up to be able to launch as NeuroPace in the fourth quarter. And that's all going according to plan. So I'm very pleased with the progress that we've been able to make and everything is on track to be able to begin that distribution at the beginning of the fourth quarter.

All right. And maybe as you're kind of thinking about other opportunities here for partnerships or distributing a distribution agreement, I mean, what else kind of intrigues you what else can you maybe push through the -- push through your sales force channel when you're working with comprehensive at epilepsy centers?

So I'm not going to speculate on where there's other opportunities. But we are, as an organization, very focused on more education, better and earlier education of the patient. So partnerships like DIXI that give us that opportunity to leverage our field organization, the spending that we have there, but also to have a call point into the patients that are moving through that diagnostic process that makes a lot of sense for us. But I'm not going to speculate on where there may be other opportunities.

That's right. Maybe to go on to initial implants for a moment since this is really the key driver growth driver for the company. I think our model has like maybe 160 centers by the end of this year, which I think is kind of roughly in line with your thinking. But how do you kind of see utilization developing? And maybe for centers that haven't been as impacted from some of these headwinds, maybe what utilization have you seen that kind of gives you the confidence that this is really applicable really across all the centers?

We are -- as we grow as an organization, most of that growth is coming from -- needs to come from increased utilization within the center. So we are, over time, an opportunity for us to expand into additional centers. But most of the opportunity we have is to have more volume of patients being treated at the centers that we're treating today or that we're acting at today. The growth of that volume within the center is increasing utilization, comes from more of the epilepsy doctors within those centers prescribing for our product. The centers -- the comprehensive epilepsy centers are large institutions, typically, on average, they have that 6 epilepsy specialists per center. And we still, today, are not getting prescriptions, regular prescriptions from most of those epilepsy specialists. So there's a lot of opportunity for us to grow our business through increased utilization, grow our initial implant business through increased utilization within those centers. Some of that then over time comes from more patients that are high-quality RNS patients coming into those centers. So step one is getting more patients that are treated at the centers as they're already coming through and then augmenting that with patient volumes from referring doctors sending in patients that are already identified as RNS leads and over time, being able to benefit from the increase in volume of patients coming through the epilepsy centers as those -- as the centers make those efforts to increase EMU volumes, then we're able to benefit from that over time. We have seen that we've been able to gain share within the centers that we're operating in. So as the epilepsy center volumes had declined over the pandemic. We believe that our share of patients coming through the EMUs has increased, and there's more opportunity for us to be able to do that as we move forward. And then again, as volumes increase and opportunity to grow as the market grows.

Do you have a sense of like where you're taking share, like what procedure category you're taking share again?

Mostly it's from patients that otherwise would not have been treated. So it's not -- there is occasionally around the edges conversion of a resective or an ablative patient to move to an RNS device. Generally, the other neuromodulation devices, the VNS device and the DBS device, are used for a different type of patient within the comprehensive epilepsy centers. So most of the growth that we're seeing is more patients being treated within those centers and moving patients to be treated interventionally that otherwise wouldn't have been.

Got it. Maybe to move on to a different topic, but the generalized indication that could be essentially game-changing for the company. So maybe just kind of walk us through what that really opens up for the market for NeuroPace from a competitive standpoint. Just -- and why generalize is maybe the right opportunity to focus on kind of focused on?

Yes, thanks for that. So we are very excited. Our customers are very excited about the opportunity to treat patients with generalized epilepsy. So just a little bit of background relevance, a relevant background. About 60% of patients that have drug-resistant epilepsy have what's called focal epilepsy or partial onset epilepsy. That's a type of epilepsy where seizures originated a specific location or locations in the brain. The other 40% of patients have what's called generalized epilepsy, which is where seizures originate broadly across the brain all at once. Our device today is indicated for focal epilepsy for that group of patients that have a discrete focus or foci where seizures originate. There is a large opportunity for us as we move into generalized epilepsy. So market -- 40% of the market is there. The diagnostic process associated with generalized epilepsy is a much simpler diagnostic process. For focal epilepsy, you need to get diagnosed with epilepsy, but then you need to identify where the seizures are coming from to be able to provide therapy for that individual location. -- generalized epilepsy is using a network approach, the same device that we're using for the focal onset, but it's applying the stimulation into a network location. So a much faster and simpler workout process. So it bypasses a lot of these issues that we talked about with EMU capacity and the number of beds, we don't need to go through that process for generalized epilepsy. Some of the competitive technologies are, in particular, resective procedures and ablative procedures, which is the predominant therapy used at the comprehensive epilepsy centers are not applicable for generalized epilepsy. So there's no consideration for resective procedure or an ablative procedure. So it's a more straightforward process to be able to treat these patients. And when I talk to our customers, they're especially excited about this because we're bringing forward if the trial is successful as we think that it will be bringing forward a treatment option for patients that they didn't really have an option for historically. And so we're prioritizing that because of the size of the market opportunity because of the simplified pathway to get those patients through to treatment with the RNS device, that's where we're putting the majority of our focuses and organizations on that indication expansion. We are continuing to pursue the indication expansion into the adolescent -- that's an important expansion for us. But the clear message for our organization, for investors is that our primary objective is to expand and to generalize -- to expand into generalized epilepsy and that's where we're putting the majority of our resources towards making that happen.

Right. And I have to ask, but any goalposts on trial timelines or enrollment that you can kind of share just generally just help us kind of frame the pathway to approval eventually...

Yes. We announced in the earnings call in August that we had begun enrollment in the Nautilus study, which is our indication expansion study for primary generalized epilepsy, which is a large category of generalized epilepsy. That's an important milestone for us that we've gotten through a lot of the steps to be able to have our first patients enrolled in that trial. The majority of the centers are still coming online. So when we think about priorities for 2022, the rest of this year, it's about getting the rest of the centers online so that we're able to really hit our stride for enrollment as we head into 2023. We have to enroll about a 100 patients in that study to be able to meet the primary endpoint. It's a 1-year follow-up for the primary endpoint and then a PMA submission. To your point, we haven't provided specific guidance on when we will complete enrollment in that trial as we get sites online and get a better indication of what the enrollment per center per month is, we'll provide better clarity for that. But the basic guideposts are we need to enroll 100 patients, we need to follow those patients for a year.

Okay. Got it. Got it. Maybe to go over to Rebecca for a moment. But help us with gross margins for a moment. And as we're kind of looking at our model, there's kind of a step down with the DIXI Medical sales. But I'd like to just get a better understanding of maybe kind of your underlying RNS gross margin capabilities over time. As we've kind of thought about it as maybe eventually getting to the 80s. But I would just like to hear your views on gross margin expansion at the company.

Sure. Our gross margin has been about 73% for the last few quarters. We believe it will grow over time. We're not going to be highly specific about that, but I believe that it will grow largely with volume. Our team, our manufacturing team is doing a really good job working on continuous efficiency improvements that helps. We also see some inflation in material costs for certain components. So those 2 kind of offset each other. So we believe it will grow over time. And as you said, with the -- we're starting to distribute the DIXI products, DIXI will have a lower margin, obviously, as a distributed product. So that will have some downward pressure, but not a whole lot.

Okay. Is there opportunity to get the DIXI component higher over time? Or is that on a fixed basis, if you can?

It will be within a fairly narrow range.

Okay. Maybe just in the last minute that we have here, just anything on ‘23 that you can help us have to ask, but you kind of talked about long-term growth being in that low to mid-20s. Just are you still confident in all the drivers that you have at the company, the tailwinds from patient funnel commercial expansion, anything there?

Yes. As you would expect, we're not providing guidance for 2023 at this point, but I will highlight a couple of the things that we talked about through the discussion today. We've made investments and completed the expansion of our field team in the first half of the year. That's really important for us as we build out that capability to call on more of the epilepsy specialists, both within the Level 4 centers and outside the Level 4 centers. We have started enrollment in the Nautilus trial, so setting the foundation for an expansion into the generalized epilepsy population it’s really important for us. And that doesn't have so much of effect on 2023, but over the long run, it's an important driver for growth for us. We have made investments in the direct-to-patient awareness and moving upstream to provide better education for patients on the treatment options that are available and in particular, steering them towards the NeuroPace device that has impacted for us over time. We are expecting that the recovery that we've seen in the second quarter into the third quarter in EMU volumes is a leading indicator of that being able to continue to grow and fuel the growth in the business over time to growing the size of the market opportunity. And then the introduction of the DIXI products, which provides a revenue source for us, leveraging our field team, but also provides an opportunity for us to call on those epilepsy special -- the epilepsy patients that are moving through the diagnostic process to provide that earlier education and move a higher percentage of those on to treatment with the RNS device. So we feel very good about what we've been able to accomplish in the first half of 2022 as we head into the third quarter. And the work that we're doing there puts us in a position to be able to continue to grow the business as we head into 2023. But it's not answering your question.

Got it. I appreciate that. And with that, we're kind of out of time. But thank you, Mike, Rebecca for joining us today.

Great. Thank you, Drew. Appreciate it.