NeuroPace, Inc. 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 system for adults with drug-resistant focal epilepsy. The company also became the exclusive U.S. distributor of DIXI Medical stereo-electroencephalography products beginning in October 2022. This unaudited Form 10-Q covers the three months ended March 31, 2023, compared with the three months ended March 31, 2022.
As of March 31, 2023, more than 4,000 patients had received the RNS System. All reported revenue was generated in the United States.
Financial performance and position
| Metric | Q1 2023 | Q1 2022 | Change |
|---|---|---|---|
| Revenue | $14.5 million | $11.4 million | Up 27% |
| Gross profit | $10.4 million | $8.3 million | Up 26% |
| Gross margin | 71.7% | 72.6% | Down 0.9 percentage points |
| Research and development | $5.3 million | $5.6 million | Down 6% |
| Selling, general and administrative | $13.4 million | $12.4 million | Up 8% |
| Loss from operations | $(8.3) million | $(9.8) million | Improved $1.4 million |
| Net loss | $(10.4) million | $(11.5) million | Improved $1.1 million |
| Net loss per share | $(0.41) | $(0.47) | Improved $0.06 |
| Cash used in operating activities | $(9.7) million | $(11.4) million | Improved $1.7 million |
Revenue growth was driven primarily by higher initial implant unit volume, increased pricing and the addition of DIXI Medical product sales. These benefits were partly offset by lower replacement implant volume; replacement procedures represented less than 10% of revenue in Q1 2023 versus approximately 23% in Q1 2022.
Gross margin declined because DIXI Medical products carry lower margins than the RNS System. SG&A increased primarily from higher sales-based compensation, stock-based compensation and $0.5 million of DIXI-related commercial support costs. Interest expense increased to $2.0 million, while interest income increased to $0.7 million. Other expense of $0.8 million primarily reflected investment losses and a $1.1 million reclassification of an accumulated unrealized loss.
At March 31, 2023, the company had cash and cash equivalents of $6.7 million, short-term investments of $60.9 million and total cash, cash equivalents and short-term investments of $67.6 million, compared with $77.4 million at December 31, 2022. Current liabilities were $9.9 million, and total liabilities were $78.8 million. The accumulated deficit was $481.2 million.
Operating cash use was partially offset by $10.2 million of proceeds from selling short-term investments, resulting in a $0.1 million increase in cash and cash equivalents during the quarter. Inventory increased to $10.8 million from $9.7 million at year-end, and accounts receivable increased to $9.2 million from $7.5 million.
Material changes versus the prior comparable period
- Revenue increased 27%, primarily from initial implants, higher pricing and DIXI Medical sales.
- Replacement-procedure revenue declined materially as a percentage of total revenue.
- Gross margin decreased from 72.6% to 71.7% due mainly to the lower-margin DIXI product mix.
- Operating loss and net loss improved despite higher SG&A and interest expense.
- R&D spending declined 6%, while SG&A increased 8%.
- Stock-based compensation increased to $2.1 million from $1.5 million.
- The company sold $10.2 million of short-term investments to support liquidity; cash, cash equivalents and short-term investments declined $9.8 million from year-end.
- In February 2023, the term loan amendment increased the annual interest rate from 12.5% to 13.5%, effective March 1, 2023, and reduced the 2023 minimum annual net revenue covenant to $45.0 million.
Debt, liquidity, outlook and risks
Term loan debt was $53.9 million net of debt discount and issuance costs at March 31, 2023, compared with $52.9 million at December 31, 2022. The loan bears a 13.5% stated interest rate, has an effective interest rate of 16.8%, is secured by substantially all company assets including intellectual property, and includes a 10% backend repayment fee. The company has elected the paid-in-kind interest option for applicable payment dates, increasing principal by $2.6 million from April 2022 through March 2023. Principal is scheduled to be repaid in a single installment on September 30, 2025.
The company was in compliance with its debt covenants as of March 31, 2023. The covenants require at least $45.0 million of 2023 net revenue and a minimum cash and cash equivalents balance of $5.0 million. Failure to meet the revenue covenant could permit the lender to call the debt, potentially requiring immediate additional capital and creating substantial going-concern risk.
Management believes existing cash, cash equivalents and short-term investments will fund planned operations for at least 12 months from issuance of the interim financial statements. However, management expects continued net losses and negative operating cash flows for the next several years and may need additional equity or debt financing. The company has not used its $50.0 million at-the-market equity program.
Key risks include dependence on the RNS System and a concentrated network of comprehensive epilepsy centers; competition from larger neuromodulation companies and alternative treatments; reimbursement and market-adoption uncertainty; FDA and other regulatory requirements; clinical-study delays; single-source suppliers; product liability and recall exposure; cybersecurity and patient-data privacy risks; and the possibility that additional financing will be unavailable or dilutive.
The DIXI agreement requires minimum product purchases of $2.4 million for the initial 12-month period beginning October 2022, with purchase minimums increasing by 10% in each of the following two years. NeuroPace also owes DIXI Medical $1.25 million in each of the fourth quarters of 2023 and 2024 for ongoing commercial support.
The Mountain View facility lease extends through June 2030, with undiscounted remaining payments of $22.3 million at March 31, 2023. The company reported no material pending legal proceedings or accrued contingent liabilities. Disclosure controls were considered effective, and no material changes in internal control over financial reporting were reported.
Most important facts for investors to verify
- Whether revenue growth remains sufficient to satisfy the $45.0 million 2023 minimum revenue covenant.
- Whether operating cash burn and the scheduled 2025 term-loan repayment will require additional financing.
- The sustainability of initial implant growth and the effect of declining replacement procedures.
- The revenue contribution, gross margin and purchase commitments associated with DIXI Medical products.
- Whether gross margin can recover despite product-mix pressure and manufacturing costs.
- Progress toward FDA label expansion for generalized epilepsy and patients ages 12 to 17.
- Exposure to single-source suppliers, reimbursement changes, competing devices, regulatory actions and product recalls.
- The impact of stock-based compensation and potential dilution from outstanding equity awards.