Q2 2022 Neuropace Inc Earnings Call

August 11, 2022

Good afternoon.

Welcome to <unk> second quarter earnings Conference call.

At this time all participants are in a listen only mode. We will be facilitating question and answer session. So at the end of today's call.

As a reminder, this call is being recorded for replay purposes.

I would now like to turn the call over to Matt backfill from the Gilmartin group for a few introductory comments.

Please go ahead.

Thank you operator, good afternoon, and thank you for participating in today's call. Joining me from Europe faced are Mike <unk>, CEO and Rebecca Cohen CFO earlier today <unk> released financial results for the second quarter ended June 32022, a copy of the press release is available on the company.

Website before we begin I would like to remind you that management will make statements. During this call that include forward looking statements within the meaning of federal Securities laws, which are made pursuant to the safe Harbor provisions of the private Securities Litigation Reform Act of 1985.

Statements made during this call that relate to expectations or predictions of future events results or performance are forward looking statements. All forward looking statements, including those around aerospace's business development opportunities or projections market conditions clinical trials and those relating to our operating trends and future financial performance the impact of COVID-19.

On our business and prospects for recovery expense management market opportunity revenue outlook and commercial expansion are based upon our current estimates and various assumptions.

These statements involve material risks and uncertainties that could cause actual results or events to materially differ from those implied by these forward looking statements. Accordingly, you should not place undue reliance on these statements for more detailed description of the risks and uncertainties associated with our business. Please refer to the risk factors section of our public filings with the Securities and Exchange Commission.

Our SEC, including our annual report on Form 10-K for the year ended December 31, 2021 filed with the SEC on March 10, 2022, and our quarterly report on Form 10-Q to be filed with the SEC on August 11, 2022, as well as any reports that we may file with the SEC in the future.

This conference call contains time sensitive information, which we believe is accurate only as of the live broadcast on August 11, 2022, aerospace disclaims any intention or obligation except as required by law to update or revise any financial projections or forward looking statements, whether because of new information future events or otherwise and with that.

I will turn the call over to Mike.

Thanks, Matt Good afternoon, everyone and thank you for joining us for today's call I will provide opening comments and a business update followed by Rebecca who will provide additional detail regarding our quarterly results and full year 2022 financial outlook before opening the call to Q&A.

Before I cover our second quarter results I want to share some exciting news, we announced today that narrow base will become the exclusive U S distributor of <unk> Medical's product line.

<unk> medical is a European company that pioneered the development of stereo EG or SPG intracranial electrodes lethal.

These electrodes are used in comprehensive epilepsy centers to determine where epileptic seizures originated.

<unk> approach to intracranial monitoring was developed in Europe and in recent years has become the predominant approach used for localization in the United States.

EG because they are less invasive process compared to the prior approach that required a craniotomy took possession the diagnostic electrodes.

As EEG as faster patient recovery and increases patient willingness to go through the diagnostic process.

This synergistic partnership Leverages, the Neuropace field organization that is already calling on the same customers and supports the aerospace objective to engage earlier and the diagnostic and therapy selection process.

<unk> medical has been selling in the United States since 2019 with a small direct sales team.

With this small sales team Dixie generated approximately $5 million of revenue in 2021.

We believe that in 2019 in the United States market for intracranial monitoring electrodes was approximately $25 million to $40 million with per procedure revenue up approximately $10000.

Prior to the pandemic the number of intracranial monitoring studies was increasing as more <unk> were created and more drug resistant epilepsy patients who are being treated.

We believe that the number of <expletive> EEG procedures has been growing even faster as more of the intracranial monitoring procedures are being done using EEG.

We expect to leverage our field organization, which was much larger than <unk> and already calling on the same customers to sell these best in class as EEG electrodes.

This opens a new growing market to drive incremental revenue through our existing commercial organization.

Additionally, we believe that selling SCE G electrodes to Cec's provides a significant opportunity for improved visibility into patients moving through the epilepsy monitoring unit or <unk>, many of whom are potential Rms patients.

Approximately two thirds of patients implanted with our rns device are admitted to the MQ for intracranial monitoring.

Part of the process to identify where seizures originate prior.

Prior to this agreement we were already working to engage earlier and the diagnostic and therapy selection process in order to provide earlier patient education on the benefits of rns therapy as part of the therapy decision process. This.

This partnership improves our access and visibility into the patient pipeline in a way that we believe will increase the rate of adoption of <unk> therapy with MCU seats.

Overall, we believe this partnership is highly synergistic it not only provides an additional revenue stream, but also strengthens our existing RMS patient funnel.

Moving on to our quarterly revenue results.

Total revenue in the second quarter of 2022 was $10 $2 million initial implant revenue in the second quarter of 2022 was $8 million compared to $9 2 million in the prior year period.

We estimate that in the first half of 2022, the number of patients coming through and use was significantly below 2021 levels.

As a reminder, we estimated <unk> volumes in 2021 were approximately 75% to 80% of pre pandemic levels.

Fewer patients coming through the <unk> means that fewer patients were being evaluated for potential rns system implant.

We believe that the reason for the decrease in IMU patient volumes in 2022 is a combination of IMU staffing shortages.

And the impact of COVID-19.

During the second quarter, we believe there was a gradual improvement in the <unk> operating environment with those positive trends continuing into the third quarter.

We believe as we continue to build traction a higher percentage of patients coming through the <unk> are being treated with rns therapy and that we will benefit in future quarters from increasing you have new volumes of those patients work through the diagnostic process.

Given what we saw in the second quarter of 2022, and the gradual recovery in EMEA patient volumes, we believe an adjustment to our full year outlook as necessary.

We now expect full year 2022 initial implant revenue to be in the range of $34 million to $36 million.

In summary, we continue to believe there is a meaningful and growing backlog of epilepsy patients who have been who have deferred treatment since the start of the pandemic.

Absent another COVID-19 Spike we expect the number of patients going through the EMU diagnostic process to incrementally improve.

The operating environment continues to normalize in the second half of 2022.

Turning to our commercial expansion initiative.

Completed our goal of expanding the size of our field based sales team in the first half of the year ending the second quarter with 52 field based sales team members in total.

For the remainder of the year, we will focus on integration and training to ensure the team is operating at the highest level.

As a reminder, the larger field team will allow us to increase utilization within Ccs by adding more prescribers and implanting centers.

This will also provide the resources needed to call an epilepsy specialists to practice outside of these fees in order to increase rns referrals into implanting centers.

Through these referral development efforts, we can make rns therapy available to a larger number of patients.

Additionally, these patients can be followed by epilepsy specialists practicing outside Ccs, which provides.

An attractive option to both the patient and the care team.

The expanded field team will also support growth of <unk> medical SCE electrode sales, which we expect will provide a nice incremental revenue opportunity for our business.

Moving to the recent clinical updates and future indication expansion opportunities.

We recently began enrollment in our Nautilus pivotal trial to support a PMA supplement to expand our indication to include primary generalized epilepsy.

We expect to increase enrollment through the remainder of 2022 by bringing additional study sites online.

While still early in our pursuit of our generalized epilepsy indication expansion. We remain on track and are excited about what this could mean for our business and for patients.

Next I would like to provide an update on replacement implant revenue Rev.

Revenue from replacement implants was $2 $2 million in the second quarter of 2022, which came in above our expectations.

Because replacement implant timing is primarily determined by when the neuro stimulator battery expires, there can be variations quarter to quarter to.

To provide continued transparency as of June 32022, there were 143 patients being actively treated with first generation devices.

We continue to expect quarterly replacement revenue to sequentially decline throughout the year as the remaining first generation devices are replaced with the longer lasting second generation devices.

Given the strength of the replacement revenue in the first half of 2022, we now expect approximately $7 $5 million of replacement implant revenue for the year.

Lastly, I would like to speak to steps were taken to manage our expenses.

Having completed our commercial expansion initiative in the first half of 2022, our strategy is to leverage our sales infrastructure and drive productivity.

Deliver topline growth.

We performed a strategic assessment across the business and have focused spending on our highest priority efforts, including market penetration and the model that study to expand indications for use into generalized epilepsy.

As a result, we have reduced our forecasted spend and now expect operating expenses to be flat sequentially in Q3, and Q4 for the core Rms business.

Lastly in association with the Dixie Medical partnership, we expect to recognize incremental expenses of approximately $1 million in the fourth quarter.

In summary, while we faced headwinds from reduced patient volumes, the operating environment improved in the second quarter with positive trends continuing into the third quarter. We completed our sales force expansion initiative, which will allow us to increase adoption of our <unk> therapy in CEC and facilitate patient referrals to <unk>.

Further increase the size of the market opportunity.

We announced a strategic partnership with <unk> medical which grants narrow based access to a new adjacent market, while also providing better visibility into the diagnostic evaluation pipeline for our core rns business.

We also began enrollment in the Nautilus study, which was a key milestone on our path to expand the market opportunity for our RMS system into generalized epilepsy.

All of these position us well as we move into the second half of the year.

With that I will turn the call over to Rebecca.

<unk> Chief Financial Officer.

Thanks, Mike.

No cases revenues for the second quarter of 2020 to $10 2 million compared to $12 6 million.

For the second quarter of 2021.

In the second quarter revenue from the initial implants was $8 million compared to $9 2 million for the second quarter of 2021.

We experienced a decrease in initial implant procedures in the second quarter, primarily due to the reduced number of patients going through the IMU diagnostic process in the first half of the year.

Revenue from replacement implants was $2 2 million compared.

Compared to $3 4 million in the second quarter of 2021.

We continue to expect replacement implant revenue generally to decrease for the next couple of years due to the transition to the current model of our device, which has a longer lasting battery.

Gross margin for the second quarter of 2022 was 73% compared to 74% in the second quarter of 2021.

Decline in gross margin relative to the prior year period was primarily due to an increase in direct labor costs, including stock based compensation.

Total operating expenses in the second quarter of 2022 were $18 4 million.

Compared with $14 million in the same period of the prior year.

R&D expense in the second quarter of 2022 was $5 7 million.

Compared with $4 1 million.

Same period of 2021.

The increase in R&D expense was primarily driven by an increase in personnel product development and clinical study expenses.

SG&A expense in the second quarter of 2022 was $12 8 million compared with $9 5 million in the prior year period.

The increase in SG&A was primarily driven by personnel related expenses increased.

Increased costs associated with operating as a public company and increased sales and marketing costs to support commercial expansion initiatives.

Loss from operations was $11 million in the second quarter of 2022 compared to $4 6 million in the prior year period.

We recorded $1 $9 million in interest expense in the second quarter, which was flat compared to the prior year period.

Net loss was $12 7 million in the second quarter of 2022.

Compared to $8 5 million in the second quarter of 2021.

Our cash and short term investments balance as of June 32022 was $92 $4 million, while our long term borrowings totaled $51 million.

Now turning to our outlook for 2022.

We now expect total revenue between 43 and $45 million.

This assumes initial implant revenue between 34 and $36 million.

Given the strength in replacement revenue in the first half of the year, we now expect to generate approximately $7 5 million for the full year.

Lastly, we expect to generate approximately $1 $5 million of revenue in the fourth quarter from our new partnership with <unk> medical.

Moving down the income statement, we expect gross margin will be in the low 70% range.

Our updated gross margin guidance includes revenue contribution from <unk> medical which carries a lower gross margin relative to our core <unk> business.

We now expect 2022 total operating expenses will be in the range of $74 million to $75 million.

Which approximately $8 million to $9 million is noncash stock based compensation expense.

As Mike mentioned previously we expect operating expenses for the core rns business will be roughly flat sequentially in the third and fourth quarters given the steps we are taking to focus on our highest priority effort and reduce expenses in the second half of 2022.

With the Dixie medical partnership expected to close at the beginning of the fourth quarter, we expect to recognize an incremental $1 million of expenses in the fourth quarter.

Lastly, under the distribution agreement Novartis will pay Dixie medical a $2 million of cash payment in the fourth quarter of 2022 and two additional payments.

$1 million to $5 million each in the fourth quarter of 2023 and 2024, respectively.

We expect that each cash payment will be recognized as expense over the following 12 months.

Given the attractive revenue synergy opportunity. We expect this deal will be accretive to operating income by the first quarter of 2023 and cash flow positive by early 2024.

This concludes our prepared remarks, I would like to turn the call back over to the operator, who will open the call for questions.

Thank you, ladies and gentlemen to ask a question at this time, you will need to press star one one.

And as a reminder, please limit yourself to one question and one follow up.

Any additional questions. Please re enter the queue.

One woman Farfetched question.

And our first question coming from the line of Lawrence <unk> from Wells Fargo. Your line is open.

Good afternoon. Thanks for taking the question Mike can you hear me okay.

Yes, I can hear you good.

Congrats on the <unk> agreement a couple of questions for me.

Well first I'll, just ask about the business trends.

And then and then one on the Dixie agreement so it sounds like.

Trends are improving we're.

We're improving through the quarter any more color you can give on <unk>.

<unk> monthly trends through Q2 anything Youre seeing in July and August and how to think about the Q2 or Q3 I'm sorry in Q4 cadence for the underlying business, excluding <unk> and then I had a.

A follow up on Dixie.

Very good thanks, Thanks for the question Larry.

A little bit of additional clarity I'm going back our customers told us that in the first quarter. The number of patients that were coming through the <unk>.

<unk> dropped off significantly because of OMA crime.

As a more significant impact in Q1 than we had seen with the prior waves with the Covid pandemic.

That didn't have a large impact for us in the rns implant numbers in Q1 as most of the patients that had already been through the workout process were implanted by the end of that quarter, but the larger impact for our business is really in the second quarter and the start of Q3 as the new patient needed to be worked up through the diagnostic process before getting.

Scheduled for an implant with the rns device.

The customers are telling us more recently, either AMU operating environment has been recovering back to 2021 level. So we heard that from the customers through Q2 and continuing to improve.

Movements in the operating environment in the third quarter of this year. Those are patients that ultimately are being considered for interventional therapy, including the rns to buy some planet implantation.

Im talking specifically about our trends in our business I wanted to give you some visibility into one of the ways that we monitor future revenue and that's through case edition. So when a when a patient is scheduled for an rns device implantation, we have visibility to that typically these patients get scheduled for NR and at some point a couple of weeks to a couple of months.

In advance of when the actual implant procedure.

<unk>.

We saw that in the month of May and in the first half of June there was a significant drop off in the rns cases being added to the schedule.

The reason for this is that patients that would've been scheduled added to the schedule in May and June for the patients that would have been worked out through the diagnostic process in late December and January . So we saw that drop off as a result of <unk> impact in Q1 more recently starting at the second.

Half of June and through July and into August we have seen those case adds returned back to expected levels.

The flow of patients coming through the IMU is normalized as I had mentioned and so that gives us better visibility and confidence that the trends are improving not just to new trends, but that translating through to implant volume trends as we go through the rest of Q3 and into Q4.

So hopefully that gives us some additional clarity on the on what's happening.

Yes, I mean, I don't know if you want to comment on Q3 Q4 cadence Mike.

So generally the expectation is that there'll be incremental improvements in volumes of initial implants from Q2 to Q3 and from Q3 into Q4. So as we worked through that process. That's the general cadence that we're expecting.

Sequential increase or through the last couple of quarters of the year.

And maybe before the Dixie question, just one more.

On the outlook any any preliminary thoughts on how to think about 2023, what should we think about the growth rate where consensus was before today, but maybe just off a lower base.

Any preliminary thoughts on 2003.

Ill ask the Dixie question right now the $25 million to $40 million opt.

Opportunity you talked about upfront Mike.

Is that how we should think about the opportunity for Dixie and over what time do you think you can capture that and I am going to throw one more at the margins I heard it was below the corporate average, but any more color.

On the.

The margin sorry for all the questions here.

[laughter] alright, very very efficient so I will do my best to go through each of those and then Rebecca can jump in on the on the margin question.

So I'm talking about.

The longer term growth expectations, given the improvements that we're seeing in the offer operating environment. We feel good about the updated 2022 revenue guidance.

And while we're not providing guidance for 2023 at this time, we continue to believe in the fundamental growth prospects for the business overall I'm really that's driven for us by the changes that we've made in our business. So the expansion of our field team that we completed in the first half of this year, allowing us to <unk>.

Call. It epilepsy specialists that are practicing outside of the Tcs. In addition to work that theyre doing to increased utilization within the Tcs.

We're also making good progress toward that earlier patient education awareness earlier in the diagnostic process. The partner partnership with Dixie really helps us with that to be able to have a call point for patients that are going through the diagnostic process. In addition to creating.

Revenue opportunity of its own right.

Together, we feel very good about the fundamentals of the business and kind of where that takes us coming out of.

Q2 into the rest of this year and over the longer term.

But again not providing specific guidance at about 2023 at this time.

Going to your question around the <unk> market opportunity, the $25 million to $40 million of our estimate.

What was the actual revenue in that market in 2000, 2019, so a couple of years ago.

Number of patients that were being treated with electrodes different types of electrodes for intracranial monitoring procedures and the revenue generated from that as I mentioned in 2021, Dixie had about $5 million of revenue.

So coming out of that there is a significant market share opportunity.

<unk> with that and we're looking forward to having that product be.

And class <unk> product that we would be able to take through our larger sales organization.

To be able to incrementally.

<unk> share within that within that space.

In addition to that historically the market has been growing the number of patients being evaluated for <unk>.

Diagnostic procedures going through this period with EG procedure going through intracranial monitoring procedures to grow and as the number of patients being treated a comprehensive epilepsy centers has gone up the number of comprehensive epilepsy centers has gone up.

We believe that that 25% to $40 million isn't a static number, but it's a growing market opportunity and which we have opportunity to take additional share over time.

And then let me turn it to Rebecca who can talk about the margin impact.

Sure.

So neuro pace will become the exclusive U S distributor of <unk> products and distributor.

Margins are necessarily going to be lower since they are shared economics.

When we combine what we believe will be the Dixie gross margin with our core.

Business gross margin for 2022, we believe that the result will be in the low 70% range.

Having said that.

The <unk> partnership is new and we do need to complete a full.

Technical accounting assessment to make sure that we have.

Full alignment on how all of the accounting will be for the deal, but we believe that.

Our margins combined will end up in the low.

70% range for this year.

Okay. Thanks for answering all the questions sorry for so many.

Thank you our next question.

And our next question coming from the line.

Robert Marcus from Jpmorgan. Your line is open.

Hi, yes, thanks for taking the questions.

Mike.

Like plus or minus utilization per and planning account has been pretty steady.

For the past year year plus.

Obviously COVID-19 has had an impact on this and been very difficult, especially with overnight stays in the disruption in the timeframes et cetera, maybe.

Maybe just to think about how some of your higher volume accounts are performing.

Do you have any metrics like what your top quartile is doing versus your overall just so we can get a sense of where maybe some of these centers can go to over time as trends improve.

Yes. Thanks for the question Ravi and you are right over the course of the last year year and a half.

The number of implants per active center has been relatively stable.

The growth that we've seen was coming in significant part by adding additional by adding additional centers of I would say that the impacts of Covid in particular have impacted that utilization per center. So we've been able to successfully expand the number of centers over time, but with the number of patients.

Coming through the epilepsy monitoring units at centers its impact being down at various times because of because of Covid. That's impacted the utilization rates within those centers and we've been able to keep utilization rates, where they have been historically in spite of a smaller number of patients coming through that you have used for if you will increasing our share of new patients, but net results.

It was about flat.

<unk> volumes.

I don't have specific numbers to give for what the top quartile or top portion of customers represents in terms of volumes, but what I can tell you is that the top centers the top quarter of centers represent.

Significantly higher volume of patients per year than the median so the median accounts represent a big group of centers that still is operating at a relatively low utilization rate.

Typically with just one or two of the alcohol apologists within those centers prescribing the top performing centers are.

Multiple times more volume than the than the median sensor.

And we expect with time had more prescribers and these other centers of the median centers that we are we will be able to get those centers up to the volume seen it at the higher volume centers, but without specific numbers. The top performing centers are a multiple of times volume compared to the median center.

Great and I appreciate youre cutting opex here to help preserve cash looks like you've got about $100 million on the balance sheet.

How are you thinking about your runway for cash when.

When and if you'll need more in the future and how.

How should we think about sort of your your cadence of cash use going forward. Thanks.

Yes, I think thanks Robbie for the further question. So just a comment again about the process that we went through we did conduct a strategic assessment of our business and coming out of that are focusing our spending on specifically the key priorities that we believe are the big growth drivers for our business.

That includes specifically the expansion that we did in the first half of the year of our field team, allowing us to call on more comprehensive epilepsy centers into call on the epilepsy specialist practicing outside of the levels level for epilepsy centers.

And specifically, including as well the novelist study and enrollment in the model as to who those key drivers we continue to fund and support those for the business going forward.

While we continue to support those drivers we are reducing spending in a number of other areas across the company to be able to extend the runway of the cash runway for the business.

Preserved capital for the for the organization and so we've made a number of changes in other areas to drive down those costs that also allows us to be able to support expansion into the <unk> business.

Without having actually still with the even by adding that still decreasing the spending for.

The organization overall, we Havent provided guidance at this time about what the timing is of additional capital needs, but as you commented we have a very strong balance sheet.

As an organization today. It is the spending changes spending reductions that we're making allow us to extend the runway for the capital that we have in the business and so we don't have any need for raising capital in the near term over the next year and we'll continue to monitor spending requirements as we go forward to be able to to be prudent Phi.

<unk> stewards for the company.

Great I appreciate it thanks a lot.

Thank you and our next question coming from the line of <unk> from Morgan Stanley . Your line is open.

Hi, Mike Thanks for taking the question maybe just on guidance for new placement implants are new patient implants. It looks like the cut about 120 to 130 implants as youre kind of thinking to Larry's question earlier about the cadence for the back half of the year and the sequential improvement are you assuming that those 100.

2130 implants come back or will these be new patients going through the EMU.

Channel.

We expect that their new patients that are coming through the <unk> channel.

Patients that back to the AUM of crime wave that were worked up and we're ready for an rns and plan on when that happens those were predominantly completed in the first quarter and so what we've seen in Q2 and what we're seeing as we move into Q3, a really new patients that are coming through that process, including the.

The intracranial ECG monitoring process.

Getting worked through that process and so we are seeing in Q3 with the recovery in EMEA volumes in the second quarter that that's now starting to translate is now starting to translate into the case schedules for the rns devices, we move into the second half of Q3.

And with that I'd expect that that continues as we move into the fourth quarter and so as I stated with Larry generally expecting that the volume of patients that are being treated for initial implants will continue well sequentially improved from Q2 to Q3 and from Q to Q3 to Q4, driven by that organic volume of patients coming through the year.

No.

Got it. Thank you and then on <unk> for a moment.

I know youre not ready necessarily to provide guidance for 2023, but as we're kind of thinking about our models and adding this new layer to the business.

How should we at least maybe think about 2023 revenue is it holding kind of the fourth quarter fourth quarter study is there a kind of a one term are onetime bolus of orders in the fourth quarter, just any help would be appreciated. Thank you.

Yes. Thanks for the question drew so we don't anticipate a bolus of orders in the fourth quarter and <unk> has been selling in the United States. Since 2019, they will continue to sell our products through the third quarter and then we will take over that responsibility and so how do we enter into the fourth quarter.

So with that it's going to be I would say a continuation of business is the way that we're thinking about it for the fourth quarter revenue.

We haven't provided guidance as you've stated for Q4 I'm sorry for 2023 at this point specifically predict see part of that is that this is going to be a new agreement for us a new market for us and so we'll continue to evaluate that as we pick up responsibility for selling those products in the United States and be able to provide a lot better clarity.

As we get to the end of the year and move into 2023, but specifically to your question. The revenue guidance that we provided for Q4. It isn't based on any fall I should say, it's a continuation of what they will continue to sell through Q3, and then I was taking over that as we entered the fourth quarter.

Alright, Thanks, Mike.

Thank you and I'm showing no further questions at this time I would now like to turn the call back over to Mr. Mike <unk>.

Hosing remarks.

Yeah.

Great. Thank you for your participation today I'm looking forward to seeing many many of you at the upcoming Wells Fargo and Morgan Stanley conferences.

Good day.

Okay.

Ladies and gentlemen that does conclude conference for today. Thank you for your participation you may now disconnect.

[music].

Good afternoon.

Welcome to <unk> second quarter earnings Conference call.

At this time all participants are in a listen only mode. We will be facilitating a question and answer session. So I stand up todays call.

As a reminder, this call is being recorded for replay purposes.

I would now like to turn the call over to my backfill from the Gilmartin group for a few introductory comments.

Please go ahead.

Thank you operator, good afternoon, and thank you for participating in today's call joining me from neuro paced, our mics added CEO and Rebecca Cohen CFO earlier today <unk> released financial results for the second quarter ended June 32022, a copy of the press release is available on the Companys.

Website before we begin I'd like to remind you that management will make statements. During this call that include forward looking statements within the meaning of federal Securities laws, which are made pursuant to the safe Harbor provisions of the private Securities Litigation Reform Act of 90 95 any statements made during this call that relate to expectations or predictions of future events results or performance.

Our forward looking statements all forward looking statements, including those around aerospace's business development opportunities or projections market conditions clinical trial, and those relating to our operating trends and future financial performance the impact of COVID-19 on our business and prospects for recovery expense management market opportunity revenue outlook in commercial.

Pension are based upon our current estimates and various assumptions.

<unk> or SEC, including our annual report on Form 10-K for the year ended December 31, 2021 filed with the SEC on March 10, 2022, and our quarterly report on Form 10-Q to be filed with the SEC on August 11, 2022, as well as any reports that we may file with the SEC in the future.

<unk>. This conference call contains time sensitive information, which we believe is accurate only as of the live broadcast on August 11, 2022, aerospace disclaims any intention or obligation except as required by law to update or revise any financial projections or forward looking statements, whether because of new information future events or otherwise.

With that I will turn the call over to Mike.

Matt Good afternoon, everyone and thank you for joining us for today's call I will provide opening comments and a business update followed by Rebecca who will provide additional detail regarding our quarterly results and full year 2022 financial outlook.

Before opening the call to Q&A.

Before I cover our second quarter results I want to share some exciting news, we announced today that narrow base will become the exclusive U S distributor <unk> Medical's product line.

<unk> medical is a European company that pioneered the development of stereo EG or SPG intracranial electrodes lethal.

These electrodes are used in comprehensive epilepsy centers to determine where epileptic seizures originated.

<unk> approach to intracranial monitoring was developed in Europe and in recent years has become the predominant approach used for localization in the United States.

As EEG as a less invasive process compared to the prior approach that required a craniotomy took possession of the diagnostic electrodes.

As EEG as faster patient recovery and increases patient willingness to go through the diagnostic process.

This synergistic partnership Leverages, the neuro based field organization that is already calling on the same customers and supports the neuro based objective to engage earlier and the diagnostic and therapy selection process.

<unk> medical has been selling in the United States since 2019 with a small direct sales team.

With this small sales team Dixie generated approximately $5 million of revenue in 2021.

We believe that in 2019 in the United States market for intracranial monitoring electrodes was approximately $25 million to $40 million with per procedure revenue up approximately $10000.

Prior to the pandemic the number of intracranial monitoring studies was increasing as more <unk> were created and more drug resistant epilepsy patients who are being treated.

We believe that the number of <expletive> EEG procedures has been growing even faster as more of the intracranial monitoring procedures are being done using EEG.

We expect to leverage our field organization, which was much larger than <unk> and already calling on the same customers to sell these best in class as EEG electrodes.

This opens a new growing market to drive incremental revenue through our existing commercial organization.

Approximately two thirds of patients implanted with our rns device are admitted to the MQ for intracranial monitoring as part of the process to identify where seizures originate.

This partnership improves our access and visibility into the patient pipeline in a way that we believe will increase the rate of adoption of RMS therapy with MCC.

Overall, we believe this partnership is highly synergistic it not only provides an additional revenue stream, but also strengthens our existing RMS patient funnel.

Moving on to our quarterly revenue results.

Total revenue in the second quarter of 2022 was $10 $2 million initial implant revenue in the second quarter of 2022 was $8 million compared to $9 2 million in the prior year period.

We estimate that in the first half of 2022, the number of patients coming through and use was significantly below 2021 levels.

As a reminder, we estimated IMU volumes in 2021 were approximately 75% to 80% of pre pandemic levels.

Fewer patients coming through the <unk> means that fewer patients were being evaluated for potential rns system implant we.

We believe that the reason for the decrease in IMU patient volumes in 2022 is a combination of IMU staffing shortages and the impact of COVID-19.

During the second quarter, we believe there was a gradual improvement in the <unk> operating environment with those positive trends continuing into the third quarter.

Given what we saw in the second quarter of 2022, and the gradual recovery in EMEA patient volumes, we believe an adjustment to our full year outlook as necessary.

We now expect full year 2022 initial implant revenue to be in the range of $34 million to $36 million.

In summary, we continue to believe there is a meaningful and growing backlog of epilepsy patients who have been who have deferred treatment since the start of the pandemic.

Asking another COVID-19 Spike we expect the number of patients going through the EMU diagnostic process to incrementally improve the operating environment continues to normalize in the second half of 2022.

Turning to our commercial expansion initiative.

Our goal of expanding the size of our field based sales team in the first half of the year ending the second quarter with 52 field based sales team members in total.

For the remainder of the year, we will focus on integration and training to ensure the team is operating at the highest level.

As a reminder, the larger field team will allow us to increase utilization within Ccs.

Adding more prescribers and implanting centers.

This will also provide the resources needed to call on epilepsy specialists to practice outside of <unk> in order to increase our rns referrals into implanting centers.

Through these referral development efforts, we can make rns therapy available to a larger number of patients.

Additionally, these patients can be followed by epilepsy specialists practicing outside fees fees, which provides an attractive option to both the patient and the care team.

The expanded field team will also support growth of <unk> medical SCE <unk> electrodes sales, which we expect will provide a nice incremental revenue opportunity for our business.

Moving to the recent clinical updates and future indication expansion opportunities we.

We recently began enrollment in our Nautilus pivotal trial to support a PMA supplement to expand our indication to include primary generalized epilepsy.

We expect to increase enrollment through the remainder of 2022 by bringing additional study sites online.

While still early in our pursuit of our generalized epilepsy indication expansion. We remain on track and are excited about what this could mean for our business and for patients.

Next I would like to provide an update on replacement implant revenue revenue.

Revenue from replacement implants was $2 $2 million in the second quarter of 2022, which came in above our expectations.

Because replacement implant timing is primarily determined by when the neuro stimulator battery expires, there can be variations quarter to quarter to.

To provide continued transparency as of June 32022, there were 143 patients being actively treated with first generation devices.

Given the strength of the replacement revenue in the first half of 2022, we now expect approximately seven $5 million of replacement implant revenue for the year.

Lastly, I would like to speak to steps were taken to manage our expenses.

Having completed our commercial expansion initiative in the first half of 2022, our strategy is to leverage our sales infrastructure and drive productivity.

Deliver topline growth.

We performed a strategic assessment across the business and have focused spending on our highest priority efforts, including market penetration and the Nautilus study to expand indications for use in two generalized epilepsy.

As a result, we have reduced our forecasted spend and now expect operating expenses to be flat sequentially in Q3, and Q4 for the core Rms business.

Lastly in association with the Dixie Medical partnership, we expect to recognize incremental expenses of approximately $1 million in the fourth quarter.

In summary, while we faced headwinds from reduced patient volumes, the operating environment improved in the second quarter with positive trends continuing into the third quarter. We completed our sales force expansion initiative, which will allow us to increase adoption of rns therapy in CEC and facilitate patient referrals to <unk>.

Further increase the size of the market opportunity.

We also began enrollment in the Nautilus study, which was a key milestone on our path to expand the market opportunity for our RMS system into generalized epilepsy.

All of these position us well as we move into the second half of the year.

With that I will turn the call over to Rebecca.

<unk> Chief Financial Officer.

Thanks, Mike.

No cases revenues for the second quarter of 2020 to $10 2 million compared.

Compared to $12 6 million for.

For the second quarter of 2021.

In the second quarter revenues from the initial implants was $8 million compared to $9 2 million for the second quarter of 2021.

We experienced a decrease in initial implant procedures in the second quarter, primarily due to the reduced number of patients going through the EMEA diagnostic process in the first half of the year.

Revenue from replacement implants was $2 2 million compared.

Compared to $3 4 million in the second quarter of 2021.

We continue to expect replacement implant revenue General 80 decrease for the next couple of years due to the transition to the current model of eye device, which has a longer lasting battery.

Gross margin for the second quarter of 2020 was 73% compared to 74% in the second quarter of 2021.

Decline in gross margin relative to the prior year period, primarily due to an increase in indirect labor costs, including stock based compensation.

Total operating expenses in the second quarter of 2022 were $18 4 million.

Compared with $14 million in the same period of the prior year.

R&D expense in the second quarter of 2022 was $5 7 million.

Compared with $4 1 million.

Same period of 2021.

The increase in R&D expense was primarily driven by an increase in personnel product development and clinical study expenses.

SG&A expense in the second quarter of 2022 was $12 8 million compared with $9 5 million in the prior year period.

The increase in SG&A was primarily driven by personnel related expenses increased.

Increased costs associated with operating as a public company and increased sales and marketing cost is quite commercial expansion initiatives.

Loss from operations was $11 million in the second quarter of 2022 compared to $4 6 million in the prior year period.

We recorded $1 9 million and interest expense in the second quarter, which was flat compared to the prior year period.

Net loss was $12 7 million in the second quarter of 2022.

Compared to $8 5 million in the second quarter of 2021.

Our cash and short term investments balance as of June 32022 was $92 $4 million, while our long term borrowings totaled $51 million.

Now turning to our outlook for 2022.

We now expect total revenue between 43 and $45 million.

This is <unk> initial implant revenue between 34 and $36 million.

Given the strength in replacement rather than in the first half of the year, we now expect to generate approximately $75 million for the full year.

Lastly, we expect to generate approximately $1 $5 million of revenue in the fourth quarter from our new partnership with <unk> medical.

Moving down the income statement, we expect gross margin will be in the low 70% range.

Our updated gross margin guidance includes revenue contribution from <unk> medical which carries a lower gross margin relative to our core R&M business.

We now expect 2022 total operating expenses will be in the range of <unk> $74 million to $75 million.

Which approximately $89 million in noncash stock based compensation expense.

As Mike mentioned previously we expect operating expenses for the core business will be roughly flat sequentially in the third and fourth quarters given the steps we are taking to focus on our highest priority effort and reduce expenses in the second half of 2022.

With the Dixie medical partnership expected to close at the beginning of the fourth quarter, we expect to recognize an incremental $1 million of expenses in the fourth quarter.

Lastly, under the distribution agreement Newark, Tasteful pay Dixie medical a $2 million of cash payments in the fourth quarter of 2022, and two additional payments of $1 million to $5 million each in the fourth quarter of 2023 and 2024, respectively.

We expect that each cash payment will be recognized as expense over the following 12 months.

Given the attractive revenue synergy opportunity. We expect this deal will be accretive to operating income by the first quarter of 2023 and cash flow positive by early 2024.

This concludes our prepared remarks, I would like to turn the call back over to the operator, who will open the call for questions.

Thank you, ladies and gentlemen to ask a question at this time, you will need to press star one one.

And as a reminder, please limit yourself to one question and one follow up.

Have any additional questions. Please re enter the queue.

One woman Farfetched question.

No first question coming from the line of Lawrence <unk> from Wells Fargo. Your line is open.

Good afternoon. Thanks for taking the question Mike can you hear me okay.

Yes, I can hear you.

And congrats on the <unk> agreement a couple of questions for me.

Well first I'll, just ask about the business trends.

And then and then one on the Dixie agreement so it sounds like.

Trends are improving.

We're improving through the quarter any more color you can give on <unk>.

<unk> monthly trends through Q2 anything Youre seeing in July and August and how to think about the Q2 Q3 I'm sorry in Q4 cadence for the underlying business, excluding Dixie and then I had a.

A follow up on Dixie.

Very good thanks, Thanks for the question Larry.

A little bit of additional clarity I'm going back our customers told us that in the first quarter. The number of patients that were coming through the year.

<unk> dropped off significantly because of all micron.

As a more significant impact in Q1 than we had seen with the prior waves with the Covid pandemic.

Scheduled for kind of point out what the rns device.

The customers are telling us more recently that EMEA operating environment has been recovering back to 2021 level. So we heard that from the customers through Q2 and continuing.

Im talking specifically about our trends in our business I wanted to give you some visibility into one of the ways that we monitor future revenue and Thats through case edition. So when a when a patient is scheduled for an rns device implantation, we have visibility to that typically these patients get scheduled for an art and it's implant a couple of weeks to a couple of months.

In advance of when the actual implant procedure happens.

We saw that in the month of May and in the first half of June there was a significant drop off in the rns cases being added to the schedule.

Saw that drop off as a result of.

<unk> impact in Q1 more recently starting at the second half of June and through July and into August we have seen those case adds returned back to expected levels as the flow of patients coming through the IMU is normalized as I had mentioned and so that gives us better visibility and confidence that the trends.

Are improving not just the new trends that that translated through to implant volume trends as we go through the rest of Q3 and into Q4.

So hopefully that gives us some additional clarity on what's happening.

Yes, I mean, I don't know if you want to comment on Q3 Q4 cadence Mike.

So generally the expectation is that there'll be incremental improvements in volumes of initial implants from Q2 to Q3 and from Q3 into Q4, so as we worked through that process.

The general cadence that we're expecting.

Sequential increases through the last couple of quarters of the year.

It may be before the Dixie question, just one more on.

On the outlook any any preliminary thoughts on how to think about 2023, what should we think about the growth rate where consensus was before today, but maybe just at a off a lower base.

Any preliminary thoughts on 2003.

Ill ask the Dixie question right now the $25 million to $40 million opt.

Opportunity you talked about upfront Mike.

Is that how we should think about the opportunity predictor and over what time do you think you can capture that and I am going to throw one more at the margins I heard it was below the corporate average, but any more color.

On the.

The margin sorry for all the questions here.

[laughter] alright, very very efficient so I will do my best to go through each of those and then Rebecca can jump in on the on the margin question.

So I'm talking about.

The longer term growth expectations, given the improvements that we're seeing in the offer operating environment. We feel good about the updated 2022 revenue guidance.

Call. It epilepsy specialists that are practicing outside of the Tcs. In addition to work that theyre doing to increase utilization within the Tcs.

And so together, we feel very good about the fundamentals of the business and kind of where that takes us coming out of.

Q2 into the rest of this year and over the longer term.

But again not providing specific guidance at about 2023 at this time.

Going to your question around the <unk> market opportunity, the $25 million to $40 million of our estimate.

What was the actual revenue in that market in 2000, 2019, so a couple of years ago.

So coming out of that there is a significant market share opportunity.

<unk> with that and we're looking forward to having that product the pass.

And class.

<unk> product that we would be able to take through our larger sales organization to be able to incrementally.

<unk> share within that within that space.

In addition to that historically the market has been growing the number of patients being evaluated for <unk>.

Diagnostic procedures going through this period, when yohji procedure going through intracranial monitoring procedures grow and as the number of patients being treated a comprehensive epilepsy centers has gone up the number of comprehensive epilepsy centers has gone up.

We believe that that 25% to $40 million isn't a static number, but it's a growing market opportunity and which we have opportunity to take additional share over time.

And then let me turn it to Rebecca who can talk about the margin impact.

Sure.

So newer pace will become the exclusive U S distributor <unk> products and distributor.

Margins are necessarily going to be lower shared economics.

When we combine what we believe will be the <unk> gross margin with our core.

Business gross margin for 2022, we believe that the result will be in the low 70% range.

Having said that.

The <unk> partnership is new and we do need to complete a full.

Technical accounting assessment to make sure that we have.

Full alignment on how all of the accounting will be for the deal, but we believe that.

Our margins combined will end up in the low.

70% range for this year.

Okay. Thanks for answering all the questions sorry for so many.

Thank you our next question.

And our next question coming from the line of.

Robert Marcus from Jpmorgan. Your line is open.

Hi, yes, thanks for taking the questions.

And.

Mike.

Like plus or minus utilization per and planning account has been pretty steady.

For the past year year plus.

Obviously COVID-19 has had an impact on this and been very difficult, especially with overnight stays in the disruption timeframes et cetera.

Just to think about how some of your higher volume accounts are performing.

Do you have any metrics like what your top quartile is doing versus your overall just so we can get a sense of where maybe some of these centers can go to over time as trends improve.

Yes. Thanks for the question Ravi and you are right over the course of the last year year and a half.

The number of implants per active center has been relatively stable.

The growth that we've seen was coming in significant part by adding additional by adding additional centers of I would say that the impacts of Covid in particular have impacted that.

Utilization per center, so we've been able to successfully expand the number of centers over time, but with the number of patients coming through the epilepsy monitoring units at centers that sent back being down at various times because of because of Covid, that's impacted the utilization rates within those centers and we've been able to keep utilization rates.

They have been historically in spite of a smaller number of patients coming through that you have used so if you will increasing our share of new patients, but net results is about a flat flat volumes.

Don't have specific numbers to give for what the top.

Core tile or top portion of customers represents in terms of volumes, but what I can tell you is that the top centers the top quarter of centers represent.

Significantly higher volume of patients per year than the media. So the median accounts represent a group of centers that still is operating at a relatively low utilization rate.

Typically with just one or two of the Apple apologist within those centers prescribing the top performing centers are.

Multiple times more volume than the than the median sensor.

And we expect with time had more prescribers and these other centers of the median centers that we will be able to get those centers up to the volume seen it at the higher volume centers without specific numbers.

Top performing centers are a multiple of times volume compared to the median center.

Yes.

Great and I appreciate youre cutting opex here to help preserve cash looks like you got about $100 million on the balance sheet.

How are you thinking about your runway for cash when I.

When and if you'll need more in the future and how.

How should we think about sort of your your cadence of cash use going forward. Thanks.

Yes, I think thanks Robbie for the question. So just a comment again about the process that we went through we did conduct a strategic assessment of our business and coming out of that are focusing our spending on specifically the key priorities that we believe are the big growth drivers for our business.

And that includes specifically the expansion that we did in the first half of the year of our field team, allowing us to call on more comprehensive epilepsy centers on the call on the epilepsy specialist practicing outside of the levels level for epilepsy centers.

And specifically, including as well the Nautilus study and enrollment in the model as to who those key drivers we continue to fund and support those for the business going forward.

While we continue to support those drivers we are reducing spending in a number of other areas across the company to be able to extend the runway of the cash runway for the business.

Preserve capital for the for the organization and so we've made a number of changes in other areas to drive down those costs that also allows us to be able to support expansion into the <unk> business.

Without having actually still with the even by adding that still decreasing the spending.

For the organization overall, we Havent provided guidance at this time about what the timing is of additional capital needs.

You commented, we have a very strong balance sheet.

We will continue to monitor spending requirements as we go forward to be able to to be prudent financial stewards for the for the company.

Okay.

Great I appreciate it thanks a lot.

Thank you and our next question coming from the line of <unk> from Morgan Stanley . Your line is open.

Hi, Mike Thanks for taking the question, maybe just on guidance for new placement.

<unk>, our new patient implants, it looks like the cut about 120 to 130 implants as youre kind of thinking to Larry's question earlier about the cadence for the back half of the year and the sequential improvement are you assuming that those 102130 implants come back or will these be new patients going through the EMU.

Channel.

We expect that their new patients that are coming through the <unk> channel the patients that back to the AMA crime wave that were worked up and we're ready for an rns and plan when that happens those were predominantly completed in the first quarter and so what we've seen in Q2.

And what we're seeing as we move into Q3, a really new patients that are coming through that process, including the.

Intracranial ECG monitoring process getting.

Getting worked through that process and so we are seeing in Q3 with the recovery in EMEA volumes in the second quarter that that's now starting to translate is now starting to translate into a case scheduled for the rns devices, we move into the second half of Q3.

And with that expect that that continues as we move into the fourth quarter and so as I stated with Larry generally expecting that the volume of patients that are being treated for initial implants will continue well sequentially improved from Q2 to Q3 and from Q to Q3 to Q4, driven by that organic volume of patients coming through the year.

Yes.

Got it. Thank you and then on <unk> for a moment.

I know, you're not ready necessarily to provide guidance for 2023, but as we're kind of thinking about our models and adding this new layer to the business.

Yes. Thanks for the question drew so we don't anticipate a bolus of orders in the fourth quarter <unk> has been selling in the United States. Since 2019, they will continue to sell our products through the third quarter and then we will take over that responsibility.

We enter into the fourth quarter.

So with that it's going to be I would say a continuation of business is the way that we're thinking about it for the fourth quarter revenue.

We haven't provided guidance as you've stated for Q4 Im sorry for 2023 at this point specifically predict see part of that is that this is going to be a new agreement for us a new market for us and so we'll continue to evaluate that as we pick up responsibility for selling those products in the United States and be able to provide a lot better clarity.

That as we get to the end of the year and move into 2023, but specifically to your question. The revenue guidance that we provided for Q4. It isn't based on any ball I should say, it's a continuation of what they will continue to sell through Q3, and then I was taking over that as we entered the fourth quarter.

Alright, Thanks, Mike.

Thank you and I'm showing no further questions at this time I would now like to turn the call back over to Mr. Mike <unk>.

Hosing remarks.

Great. Thanks. Thank you for your participation today I'm looking forward to seeing many of you. Many of you at the upcoming Wells Fargo and Morgan Stanley conferences.

Good day.

Okay.

Ladies and gentlemen that does conclude conference for today. Thank you for your participation you may now disconnect.

Q2 2022 Neuropace Inc Earnings Call

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