NeuroPace, Inc. 2022 Q3 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 unaudited filing covers the three and nine months ended September 30, 2022, compared with the corresponding 2021 periods. All reported revenue was generated in the United States.
- More than 4,000 patients had received the RNS System as of September 30, 2022.
- The company primarily markets to comprehensive epilepsy centers and continues to pursue expanded indications, including adolescents and generalized epilepsy.
Financial performance and key metrics
| Metric | Q3 2022 | Q3 2021 | 9M 2022 | 9M 2021 |
|---|---|---|---|---|
| Revenue | $11.2 million | $10.3 million | $32.7 million | $34.2 million |
| Gross profit | $8.0 million | $7.5 million | $23.7 million | $25.4 million |
| Gross margin | 71.4% | 72.6% | 72.4% | 74.2% |
| Operating loss | $(10.2) million | $(6.2) million | $(30.9) million | $(14.7) million |
| Net loss | $(11.8) million | $(8.1) million | $(35.9) million | $(25.4) million |
| Net loss per share | $(0.48) | $(0.34) | $(1.47) | $(1.81) |
| Operating cash flow | Not separately provided | Not separately provided | $(29.0) million | $(16.4) million |
- Q3 revenue increased 8%, driven by higher initial implant volume and pricing. Replacement procedures represented approximately 17% of Q3 revenue versus 24% in the prior-year quarter.
- Nine-month revenue declined 4%, primarily because of fewer replacement procedures, partly offset by higher initial implant revenue. Replacement procedures represented approximately 21% of nine-month revenue versus 26% in 2021.
- Q3 gross margin declined 120 basis points, while nine-month gross margin declined 180 basis points. Management attributed the pressure principally to supply-chain disruption and lower labor absorption in Q3, and higher indirect labor costs for the nine-month period.
- Research and development expense increased 30% in Q3 and 31% for nine months, reflecting additional personnel, product development, and clinical-study spending.
- Selling, general and administrative expense increased 33% in Q3 and 39% for nine months, driven by increased personnel and stock-based compensation, public-company costs, sales and marketing investment, and DIXI distribution preparation.
Balance sheet, cash flow, debt and liquidity
- Cash and cash equivalents were $5.7 million at September 30, 2022, compared with $19.2 million at December 31, 2021.
- Short-term investments were $79.7 million, resulting in total cash, cash equivalents and short-term investments of $85.4 million, down from $115.6 million at year-end 2021.
- Cash, cash equivalents and restricted cash decreased by $13.5 million during the first nine months of 2022. Operating cash use of $29.0 million was partly offset by $14.9 million from investing activities, primarily sales of short-term investments, and $0.6 million from financing activities.
- Long-term debt was $52.0 million, compared with $49.8 million at December 31, 2021. The increase primarily reflects $1.3 million of paid-in-kind interest added to the term-loan principal during the first nine months.
- The term loan bears interest at 12.5%, is secured by substantially all company assets including intellectual property, and requires a single principal repayment on September 30, 2025. The loan also includes a 10% repayment fee.
- The company was in compliance with its debt covenants at September 30, 2022, including the $43.0 million minimum 2022 annual net revenue covenant and $5.0 million minimum cash and cash equivalents requirement.
- Management expects existing cash, cash equivalents and short-term investments to fund planned operations for at least 12 months from the issuance of the financial statements, but notes that additional capital may be required.
Material changes and unusual items
- Operating expenses grew substantially faster than revenue, resulting in a 63% increase in the Q3 operating loss and a 110% increase in the nine-month operating loss.
- Stock-based compensation increased to $6.3 million for the first nine months of 2022 from $2.4 million in the prior-year period.
- The company adopted lease accounting under ASC 842 effective January 1, 2022, recognizing operating lease assets and liabilities. In August 2022, it extended its Mountain View facility lease through June 2030, with a rent-free period from September through December 2022. Total undiscounted lease payments were $23.0 million at September 30, 2022.
- In August 2022, NeuroPace entered into an exclusive U.S. distribution agreement with DIXI Medical beginning October 2022. It committed to minimum product purchases of $2.4 million in the first 12 months and expects to pay DIXI $2.0 million in Q4 2022 and $1.25 million in each of Q4 2023 and Q4 2024. Management expects approximately $1.0 million of incremental operating expense in Q4 2022 related primarily to the launch.
- The company received approval for $2.6 million of second-year NIH funding, including $1.6 million for subawards. Through September 30, 2022, $0.5 million of qualifying expenses had been funded.
- A stockholder lawsuit concerning prior reverse stock splits was settled confidentially and dismissed with prejudice in August 2022, with no admission of liability. The company recorded an immaterial expense.
- Management stated that a previously identified material weakness in internal control over financial reporting had been remediated as of March 31, 2022. Disclosure controls were reported effective as of September 30, 2022.
Outlook, management commentary and risks
Management expects continued investment in commercialization, sales and marketing, clinical studies, regulatory activities, product development and public-company infrastructure. The company expects continued net losses and negative operating cash flow for the next several years and did not provide a specific revenue or earnings forecast in the filing.
- COVID-19, hospital staffing shortages, delayed epilepsy-monitoring admissions and reduced elective procedures continued to affect the patient pipeline and RNS procedure volume. Future effects remain uncertain.
- Growth depends on adoption within a concentrated base of comprehensive epilepsy centers, increased physician and patient awareness, referral expansion, adequate reimbursement and successful development of expanded indications.
- The company relies on several single-source suppliers and one manufacturing facility, creating exposure to supply interruptions, quality issues, production disruptions and regulatory requirements.
- Competition includes larger, better-capitalized providers of alternative neuromodulation devices and surgical treatments.
- Failure to meet the term-loan revenue or liquidity covenants could permit the lender to accelerate the debt, potentially creating a material liquidity and going-concern risk.
- Other significant risks include regulatory approval and post-market compliance, clinical-study execution, product liability, intellectual property disputes, data privacy and cybersecurity, personnel retention, reimbursement changes and potential future dilution or financing constraints.
Most important facts for investors to verify
- Whether quarterly revenue growth can continue after the decline in nine-month revenue and the reduction in replacement-procedure revenue.
- Whether the company can reduce operating cash burn and fund operations without raising additional capital.
- Progress toward the $43.0 million 2022 net revenue covenant and the $5.0 million minimum cash covenant.
- The timing, cost and revenue contribution of the DIXI Medical distribution arrangement.
- Whether gross-margin pressure from supply-chain and labor-absorption issues reverses.
- Regulatory and clinical progress for expanded RNS System indications and the effect of COVID-19-related hospital constraints.
- The September 2025 term-loan maturity, 10% repayment fee and potential refinancing or repayment requirements.