NeuroPace, Inc. Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2021. NeuroPace is a commercial-stage medical device company focused on the RNS System, a brain-responsive neuromodulation system for adults with drug-resistant focal epilepsy. The company had more than 3,000 implanted patients as of September 30, 2021 and generated revenue solely in the United States.
Financial Performance and Position
| Metric | Q3 2021 | Q3 2020 | 9M 2021 | 9M 2020 |
|---|---|---|---|---|
| Revenue | $10.3 million | $12.8 million | $34.2 million | $30.4 million |
| Gross profit | $7.5 million | $9.6 million | $25.4 million | $22.1 million |
| Gross margin | 72.6% | 75.0% | 74.2% | 72.6% |
| Loss from operations | $(6.2) million | $(1.2) million | $(14.7) million | $(10.1) million |
| Net loss | $(8.1) million | $(4.1) million | $(25.4) million | $(19.7) million |
| Net loss per share | $(0.34) | $(19.26) | $(1.81) | $(96.02) |
| Cash used in operating activities | Not separately provided | Not separately provided | $(16.4) million | $(15.2) million |
- Revenue mix: Q3 initial implant revenue was $7.8 million, down 15%; replacement implant revenue was $2.5 million, down 31%. Replacement procedures represented approximately 26% of nine-month revenue versus approximately 33% in the prior-year period.
- Operating expenses: Nine-month research and development expense increased 9% to $12.9 million, while selling, general and administrative expense increased 34% to $27.2 million. SG&A growth reflected public-company costs, compensation, sales support and marketing investments.
- Liquidity: Cash, cash equivalents and short-term investments totaled $123.3 million at September 30, 2021, compared with $38.1 million at December 31, 2020. Cash and cash equivalents alone were $26.6 million.
- Debt: Long-term term-loan debt was $49.6 million, net of debt discount and issuance costs. The loan bears a stated interest rate of 12.5%, is secured by substantially all company assets, and has a 10% repayment fee. Principal is due in a lump sum on September 30, 2025 after the interest-only period.
- Equity financing: The April 2021 IPO generated approximately $105.5 million of net proceeds. Preferred stock automatically converted into common stock, leaving 24.3 million common shares outstanding at September 30, 2021.
- Cash flow allocation: Investing cash outflows of $85.2 million primarily reflected purchases of short-term investments. Financing cash inflows of $101.6 million primarily reflected IPO proceeds.
- Accumulated deficit: $413.1 million at September 30, 2021. The company has incurred operating losses and negative operating cash flow since inception.
Material Changes Versus the Prior Comparable Period
- Q3 revenue declined 19% year over year, primarily because COVID-19 Delta variant effects, hospital staffing shortages and vacations reduced procedure volume. Revenue for the first nine months nevertheless increased 13%, reflecting higher initial implant volume.
- Q3 gross margin declined to 72.6% from 75.0% as manufacturing costs returned toward pre-COVID levels. Nine-month gross margin improved to 74.2% from 72.6% due to higher production volume and lower fixed costs per unit.
- Q3 operating loss increased substantially as revenue declined while R&D and SG&A increased. Nine-month operating loss increased 46% to $14.7 million.
- Interest expense decreased 42% for the nine months, primarily because of lower average convertible-note and term-loan balances. This benefit was more than offset by a $5.2 million unfavorable change in the fair value of preferred-stock warrant liability recorded in other expense in connection with the IPO.
- The company completed its IPO, repaid the $4.0 million PPP loan, converted all preferred stock to common stock and eliminated the preferred-stock warrant liability.
Guidance, Outlook, Risks and Unusual Items
- Management expects continued net losses and negative cash flows for the next several years while it invests in commercialization, clinical studies, R&D, indication expansion and public-company infrastructure.
- Management believes existing cash, cash equivalents and short-term investments will fund planned operations for at least 12 months from the issuance of the interim financial statements. This assessment depends on assumptions that may prove incorrect.
- The term loan requires minimum annual GAAP revenue of $43.0 million beginning in 2021 and minimum cash and cash equivalents of $5.0 million. Failure to satisfy these covenants could permit the lender to accelerate the debt and terminate remaining borrowing commitments. The additional $10.0 million of borrowing capacity is available only if a 2021 revenue milestone is achieved.
- COVID-19 continues to affect elective procedures, epilepsy evaluations, hospital capacity, clinician access, clinical studies and supply chains. Management identified unusual Q3 seasonality related to COVID-19 restrictions, hospital staffing shortages and vacations.
- The company is pursuing potential FDA label expansion for adolescents and generalized drug-resistant epilepsy. It also submitted a labeling change related to the RNS System’s expected longer battery life; approval is not assured.
- In May 2021, the company received an NIH award with a total budget exceeding $9.3 million over five years; first-year approved reimbursement was $0.8 million, subject to qualifying expenses and milestones.
- A material weakness in internal control over financial reporting remains unremediated. The weakness relates to insufficient segregation of duties over account reconciliations and manual journal entries.
- On October 18, 2021, stockholders filed a lawsuit concerning the company’s reverse stock splits. The company believes the claims lack merit; no loss estimate or range can be made.
- The company 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 with the inquiry.
- Key ongoing risks include dependence on a single product and concentrated Level 4 comprehensive epilepsy centers, competition from surgery and other neuromodulation systems, reimbursement changes, FDA compliance, clinical-study execution, single-source suppliers, cybersecurity and data privacy, intellectual property, and the need for additional capital.
Most Important Facts to Verify
- Whether procedure volumes and revenue recover after COVID-19-related disruptions and whether the company satisfies the $43.0 million annual revenue covenant.
- The pace of initial implant adoption versus the expected decline in replacement procedures caused by longer device battery life.
- Whether operating losses and cash burn moderate sufficiently to preserve liquidity beyond the stated 12-month period.
- The maturity, repayment terms and covenant compliance of the secured term loan, including the 2025 balloon payment.
- Progress toward remediation of the material weakness in internal controls.
- Status and potential exposure from the reverse-stock-split lawsuit and CFIUS inquiry.
- FDA decisions on battery-life labeling and planned indication expansions, as well as the effect of clinical and regulatory outcomes on future growth.