NeuroPace, Inc. — Q1 2021 Form 10-Q Summary
Business context and reporting period
NeuroPace is a commercial-stage medical device company that develops and sells the RNS System, a brain-responsive neuromodulation device for adults with drug-resistant focal epilepsy. The report covers the three months ended March 31, 2021, with comparisons to the three months ended March 31, 2020. Revenue was generated entirely in the United States.
Financial results and liquidity
| Metric | Q1 2021 | Q1 2020 | Change |
|---|---|---|---|
| Revenue | $11.2 million | $10.0 million | Up 12% |
| Gross profit | $8.5 million | $7.1 million | Up 20% |
| Gross margin | 75.7% | 70.7% | Up 5.0 percentage points |
| Research and development | $4.1 million | $4.8 million | Down 15% |
| Selling, general and administrative | $8.3 million | $7.7 million | Up 8% |
| Loss from operations | $(3.9) million | $(5.5) million | Improved $1.6 million |
| Interest expense | $1.8 million | $3.0 million | Down 38% |
| Net loss | $(8.8) million | $(6.7) million | Loss increased $2.1 million |
| Net cash used in operating activities | $(5.9) million | $(6.5) million | Improved $0.6 million |
Revenue growth reflected higher initial-implant unit volume. Gross margin benefited from lower fixed manufacturing costs per unit and manufacturing-cost reductions; the prior-year quarter was affected by unfavorable manufacturing variances related to COVID-19. The net loss widened primarily because other expense was $3.1 million in Q1 2021, compared with $1.7 million of other income in Q1 2020. The 2021 expense principally reflected a $3.1 million increase in the fair value of the preferred-stock warrant liability.
At March 31, 2021, cash and cash equivalents were $13.8 million, short-term investments were $16.7 million, and cash, cash equivalents and short-term investments totaled $30.5 million. Current liabilities were $10.8 million, total debt was approximately $53.2 million net of debt discount and issuance costs, and accumulated deficit was $396.5 million. Stockholders’ deficit was $156.4 million.
Cash used in investing activities was $5.0 million, primarily for purchases of short-term investments. Cash used in financing activities was $1.6 million, primarily for deferred IPO offering costs. Cash, cash equivalents and restricted cash declined by $12.5 million during the quarter to $14.2 million.
Material changes versus the prior comparable period
- Revenue increased 12%, driven by more initial implant procedures.
- Gross margin expanded from 70.7% to 75.7%.
- Research and development spending decreased 15%, partly due to COVID-19 cost-reduction efforts.
- SG&A increased 8%, including higher general and administrative and personnel-related costs.
- Operating loss improved, but net loss increased because of the unfavorable change in warrant valuation and the absence of the prior-year derivative-related gain.
- Interest expense declined as a result of lower average convertible-note and term-loan balances.
Guidance, outlook, risks, contingencies, and unusual items
Management expects continued net losses and negative operating cash flow for the next several years while investing in commercialization, clinical studies, research and development, regulatory activities, and public-company infrastructure. The filing does not provide formal revenue or earnings guidance.
COVID-19 continued to delay or reduce elective epilepsy diagnostic and implant procedures, restrict hospital access, affect the patient pipeline, and create potential supply-chain and clinical-study disruptions. Management cited signs of recovery, including new-account expansion, physician participation in virtual education, a significant patient pipeline, and hospitals operating closer to normal elective-procedure levels, but cautioned that procedure volumes may fluctuate and recent improvements may not continue.
The New Term Loan is secured by substantially all company assets, including intellectual property. It carries a 12.5% stated interest rate, a 10% repayment fee, and financial covenants requiring minimum annual GAAP revenue of $43.0 million beginning in 2021 and minimum cash and cash equivalents of $5.0 million after the IPO. Failure to meet the covenants could result in accelerated repayment. The remaining $10.0 million commitment is available through March 31, 2022 only if a 2021 revenue milestone is achieved.
After quarter-end, NeuroPace completed its IPO on April 26, 2021, issuing 6.9 million shares at $17.00 per share for $117.3 million of gross proceeds and approximately $105.2 million of net proceeds. The IPO proceeds were used in part to repay approximately $4.1 million of PPP debt. All outstanding preferred stock converted into common stock, and the preferred-stock warrants net exercised and converted into common stock.
Management reported that disclosure controls were not effective because of an unresolved material weakness involving segregation of duties over account reconciliations and manual journal entries. Management is implementing additional accounting personnel, procedures, and controls. The company reported no material pending legal proceedings, but disclosed an April 2021 inquiry from the U.S. Treasury regarding a matter that may fall under CFIUS jurisdiction and stated that it is cooperating.
Most important facts for investors to verify
- Whether post-IPO cash resources and the $105.2 million of net proceeds provide sufficient funding as operating losses and cash needs continue.
- Compliance with the New Term Loan’s $43.0 million annual revenue covenant and $5.0 million minimum cash covenant.
- The pace and durability of recovery in elective epilepsy procedures following COVID-19 disruptions.
- Progress toward remediating the material weakness in internal control over financial reporting.
- The effect of the longer RNS device battery life on future replacement-procedure revenue, which represented approximately 28% of Q1 2021 revenue.
- Supply continuity and pricing exposure from reliance on single-source suppliers and one Mountain View manufacturing facility.
- Regulatory and clinical progress for planned indication expansions to adolescents and patients with generalized epilepsy.
- The status and potential impact of the disclosed CFIUS inquiry, which the filing does not quantify.