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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2021
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For transition period from         to
Commission File Number 001-40337
NEUROPACE, INC.
(Exact name of registrant as specified in its charter)
Delaware22-3550230
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
455 N. Bernardo Avenue
Mountain View, CA 94043
(650) 237-2700
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)
Securities registered pursuant to Section 12(b) of the Act:
Title of each classTrading SymbolName of each exchange on which registered
Common Stock, $0.001 par value per shareNPCENasdaq Global Market
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☐ No ☒
Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filerAccelerated filer
Non-accelerated filerSmaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes ☐ No
As of June 3, 2021, there were approximately 24,291,134 shares of the registrant's common stock outstanding.



TABLE OF CONTENTS
Page



SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements about us and our industry that involve substantial risks and uncertainties. All statements regarding results or events that may occur in the future contained in this Quarterly Report on Form 10-Q, including statements regarding our future results of operations and financial condition, as well as expectations of management for future operations, are forward-looking statements. In some cases, you can identify forward-looking statements because they contain words such as “anticipate,” “believe,” “contemplate,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “should,” “target,” “will,” or “would,” or the negative of these words or other similar terms or expressions.
We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements are subject to a number of risks, uncertainties, factors and assumptions described in “Risk Factors.” These risks are not exhaustive. Other sections of this Quarterly Report on Form 10-Q include additional factors that could harm our business and financial performance. Moreover, we operate in a very competitive and rapidly changing environment. New risk factors emerge from time to time, and it is not possible for our management to predict all risk factors nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ from those contained in, or implied by, any forward-looking statements.
You should not rely on these forward-looking statements as predictions of future events. We cannot assure you that the events and circumstances reflected in the forward-looking statements will be achieved or occur. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. Except as required by law, we undertake no obligation to update publicly any forward-looking statements for any reason after the date of this Quarterly Report on Form 10-Q or to conform these statements to actual results or to changes in our expectations, whether as a result of any new information, future events, changed circumstances or otherwise. Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about:
our expected future growth;
the size and growth potential of the markets for our products, and our ability to serve those markets;
our ability to accurately forecast demand for our products;
our expectations regarding the impact of the COVID-19 pandemic on our sales, business, financial condition and results of operations;
the rate and degree of market acceptance of our products;
coverage and reimbursement for procedures performed using our products, including pre-implant evaluations, implant procedures, and follow-up care;
the performance of third parties in connection with the manufacturing and development of our products, including single-source suppliers;
regulatory developments in the United States and in any foreign countries in which we make seek to do business;
our ability to retain regulatory approval for our products or obtain regulatory approval for updates to our products, or new products or indications in the United States and in any foreign countries in which we make seek to do business;
our research and development for existing products and new products;
our reliance on third-party suppliers for product components, some of which are single source suppliers;



our ability to manufacture our products in conformity with FDA requirements and with regulatory requirements of any foreign countries in which we make seek to do business;
our ability to retain or scale our organizational culture;
the development, regulatory approval, efficacy and commercialization of competing products;
our ability to retain and hire our board of directors, senior management, or operational personnel;
our expectations regarding the period during which we will qualify as an emerging growth company under the JOBS Act and as a smaller reporting company under the federal securities laws;
our ability to develop and maintain our corporate infrastructure, including our ability to remediate our existing material weakness and to design and maintain an effective system of internal controls;
our financial performance and capital requirements; and
our expectations regarding our ability to obtain, maintain and enforce intellectual property protection for our products and technology, as well as our ability to operate our business without infringing, misappropriating or otherwise violating the intellectual property rights of others.
You should read this Quarterly Report on Form 10-Q and the documents that we reference in this Quarterly Report on Form 10-Q and have filed as exhibits to this report with the understanding that our actual future results, levels of activity, performance and achievements may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements.



PART I. FINANCIAL INFORMATION
Item 1. Unaudited Financial Statements
NeuroPace, Inc.
Condensed Balance Sheets
(unaudited)
March 31,December 31,
(in thousands, except share and per share amounts)20212020
Assets
Current assets
Cash and cash equivalents$13,841 $26,390 
Short-term investments16,689 11,689 
Accounts receivable8,202 8,395 
Inventory7,042 6,909 
Prepaid expenses and other current assets1,314 1,179 
Total current assets47,088 54,562 
Property and equipment, net476 515 
Restricted cash366 366 
Deferred offering costs2,371 484 
Other assets23 23 
Total assets$50,324 $55,950 
Liabilities and Stockholders’ Deficit
Current liabilities
Accounts payable$1,484 $949 
Accrued liabilities5,734 6,603 
Short-term debt3,590 2,043 
Total current liabilities10,808 9,595 
Deferred rent, noncurrent1,204 1,301 
Long-term debt49,561 50,821 
Redeemable convertible preferred stock warrant liability3,491 369 
Other liabilities274 274 
Total liabilities65,338 62,360 
Commitments and contingencies (Note 5)
Redeemable convertible preferred stock, $0.001 par value - 60,757,386 shares authorized as of March 31, 2021 and December 31, 2020; 16,614,178 shares issued and outstanding as of March 31, 2021 and December 31, 2020 (Liquidation value $227,755 as of March 31, 2021 and December 31, 2020)
141,422 141,422 
Stockholders’ deficit
Common stock, $0.001 par value - 74,636,348 shares authorized as of March 31, 2021 and December 31, 2020; 470,634 and 314,096 shares issued and outstanding as of March 31, 2021 and December 31, 2020, respectively
  
Additional paid-in capital240,032 239,826 
Accumulated other comprehensive income33 33 
Accumulated deficit(396,501)(387,691)
Total stockholders’ deficit(156,436)(147,832)
Total liabilities, redeemable convertible preferred stock and stockholders’ deficit$50,324 $55,950 
The accompanying notes are an integral part of these unaudited interim condensed financial statements.
1

NeuroPace, Inc.
Condensed Statements of Operations and Comprehensive Loss
(unaudited)
Three Months Ended March 31,
(in thousands, except share and per share amounts)20212020
Revenue$11,217 $9,975 
Cost of goods sold2,7242,918
Gross profit8,4937,057
Operating expenses
Research and development4,1004,833
Selling, general and administrative8,2677,682
Total operating expenses12,36712,515
Loss from operations(3,874)(5,458)
Interest expense (includes $0 and $461 to related parties in the three months ended March 31, 2021 and 2020, respectively)
(1,849)(2,998)
Other income (expense), net(3,087)1,715
Net loss$(8,810)$(6,741)
Unrealized loss on available-for-sale debt securities(41)
Comprehensive loss$(8,810)$(6,782)
Net loss per share attributable to common stockholders, basic and diluted$(32.73)$(33.32)
Weighted-average shares used in computing net loss per share attributable to common stockholders, basic and diluted269,178 202,341 
The accompanying notes are an integral part of these unaudited interim condensed financial statements.
2

NeuroPace, Inc.
Condensed Statements of Redeemable Convertible Preferred Stock and Stockholders’ Deficit
(unaudited)
Redeemable Convertible Preferred StockCommon StockAdditional Paid-In CapitalAccumulated Other Comprehensive IncomeAccumulated DeficitTotal Stockholders’ Deficit
(in thousands, except share amounts)SharesAmountSharesAmount
Balances as of January 1, 202116,614,178$141,422 314,096 $ $239,826 $33 $(387,691)$(147,832)
Net loss— — — — — — (8,810)(8,810)
Issuance of common stock pursuant to stock option exercises— — 156,538 — 4 — — 4 
Stock-based compensation— — — — 202 — — 202 
Balances as of March 31, 2021
16,614,178 $141,422 470,634 $ $240,032 $33 $(396,501)$(156,436)

Redeemable Convertible Preferred StockCommon StockAdditional Paid-In CapitalAccumulated Other Comprehensive Income (Loss)Accumulated DeficitTotal Stockholders’ Deficit
(in thousands, except share amounts)SharesAmountSharesAmount
Balances as of January 1, 2020635,048$73,568 202,121 $ $234,290 $1 $(363,641)$(129,350)
Net loss— — — — — — (6,741)(6,741)
Unrealized loss on available-for-sale debt securities— — — — — (41)— (41)
Issuance of common stock pursuant to stock option exercises— — 131 — 6 — — 6 
Stock-based compensation— — — — 301 — — 301 
Balances as of March 31, 2020
635,048 $73,568 202,252 $ $234,597 $(40)$(370,382)$(135,825)
The accompanying notes are an integral part of these unaudited interim condensed financial statements.
3

NeuroPace, Inc.
Condensed Statements of Cash Flows
(unaudited)
Three Months Ended March 31,
(in thousands)20212020
Cash flows from operating activities
Net loss$(8,810)$(6,741)
Adjustments to reconcile net loss to net cash used in operating activities
Stock-based compensation expense202 301 
Depreciation74 82 
Amortization of debt discount and issuance costs69 72 
Non-cash interest expense217 1,560 
PIK interest incurred but not paid on term loan1,350
Inventory write-downs24 97 
Realized loss from sale of short-term investments 15 
Change in fair value of redeemable convertible preferred stock warrant liability3,122  
Change in fair value of derivative instrument (1,705)
Changes in operating assets and liabilities
Accounts receivable194 (197)
Inventory(157)349 
Prepaid expenses and other assets(135)144 
Accounts payable536 (109)
Accrued liabilities(1,094)(1,692)
Deferred rent(178)(74)
Net cash (used in) operating activities(5,936)(6,548)
Cash flows from investing activities
Acquisition of property and equipment(35)(16)
Proceeds from sale of short-term investments 6,300 
Purchase of short-term investments(5,000)(6,755)
Net cash (used in) investing activities(5,035)(471)
Cash flows from financing activities
Issuance of common stock pursuant to stock option exercises4 6 
Payment of deferred offering costs(1,582) 
Issuance of convertible notes, net of issuance costs (includes $0 and $11,867 from related parties in the three months ended March 31, 2021 and 2020, respectively)
 12,514 
Net cash (used in) provided by financing activities(1,578)12,520 
Net (decrease) increase in cash and cash equivalents(12,549)5,501 
Cash, cash equivalents and restricted cash
Beginning of the period26,756 4,123 
End of the period$14,207 $9,624 
Reconciliation of cash, cash equivalents and restricted cash to balance sheets:
Cash and cash equivalents$13,841 $9,624 
Restricted cash366  
Cash, cash equivalents and restricted cash in balance sheets$14,207 $9,624 
Supplemental disclosure of cash flow information:
Cash paid for interest$1,563 $ 
The accompanying notes are an integral part of these unaudited interim condensed financial statements.
4

NeuroPace, Inc.
Condensed Statements of Cash Flows
(unaudited)
Supplemental disclosures of non-cash investing and financing information:
Unpaid deferred offering costs included in accounts payable and accrued liabilities$578 $ 
The accompanying notes are an integral part of these unaudited interim condensed financial statements.
5


NeuroPace, Inc.
Notes to Unaudited Interim Condensed Financial Statements
1.The Company
NeuroPace, Inc., or the Company, was incorporated in the state of Delaware on November 19, 1997. The Company is a commercial-stage medical device company that has developed the RNS System, a brain-responsive neuromodulation system designed for treating medically refractory focal epilepsy by delivering personalized, real-time treatment at the seizure source. The Company began commercializing its products in the United States in 2014.
Initial Public Offering
On April 21, 2021, the Company’s registration statement on Form S-1 (File No. 333-254663) relating to its initial public offering, or IPO, of common stock became effective. The IPO closed on April 26, 2021, at which time the Company issued 6,900,000 shares of its common stock at a price of $17.00 per share, which included the issuance of shares in connection with the exercise by the underwriters of their option to purchase up to 900,000 additional shares (see Note 14). The Company received an aggregate of $117.3 million gross proceeds, before underwriting discounts and commissions and offering costs, and approximately $105.2 million in net proceeds after deducting underwriting discounts and commissions and estimated offering costs.
Upon the closing of the IPO, all outstanding shares of the Company’s redeemable convertible preferred stock converted into 16,614,178 shares of common stock, warrants to purchase 346,823 shares of Series B’ convertible preferred stock net exercised to 213,941 shares of Series B’ convertible preferred stock and subsequently converted into common stock on a one-to-one basis, and warrants to purchase 219 shares of common stock net exercised to 185 shares of common stock. In connection with the completion of its IPO, on April 26, 2021, the Company’s certificate of incorporation was amended and restated to provide for 200,000,000 authorized shares of common stock with a par value of $0.001 per share and 10,000,000 authorized shares of preferred stock with a par value of $0.001 per share. The unaudited interim condensed financial statements as of March 31, 2021, including share and per share amounts, do not give effect to the IPO, as it closed subsequent to March 31, 2021.
Liquidity and Capital Resources
The Company has incurred operating losses and negative cash flows from operations since its inception. For the three months ended March 31, 2021 and 2020, net loss was $8.8 million and $6.7 million and cash used in operations was $5.9 million and $6.5 million, respectively. As of March 31, 2021, accumulated deficit was $396.5 million and cash, cash equivalents and short-term investments was $30.5 million. Through March 31, 2021, the Company has funded its operations principally through the sales of its products, issuance of redeemable convertible preferred stock and debt financing. On April 26, 2021, the Company completed an IPO in which the Company issued and sold 6,900,000 shares of its common stock, which includes 900,000 shares issued and sold pursuant to the exercise of the underwriters’ option to purchase additional shares, at a public offering price of $17.00 per share, for aggregate gross proceeds of $117.3 million. The Company received approximately $105.2 million in net proceeds after deducting underwriting discounts and commissions and estimated offering costs.
The Company’s condensed financial statements have been prepared on the basis of the Company continuing as a going concern for the next 12 months. Management believes that the Company’s cash, cash equivalents and short-term investments as of March 31, 2021, together with the net proceeds from the IPO, will allow the Company to continue its planned operations for at least the next 12 months from the date of the issuance of these unaudited interim condensed financial statements.
In connection with the New Term Loan described in Note 6, the Company will need to be in compliance with a minimum annual net revenue covenant determined in accordance with generally accepted accounting principles beginning in the year ended December 31, 2021 of $43.0 million and maintain a minimum cash and cash equivalents balance of $5.0 million after the completion of the IPO. If the Company cannot generate sufficient revenue in the future, the Company may not be in compliance with the annual net revenue covenant and the lender may call the debt resulting in the Company immediately needing additional funds.
The COVID-19 pandemic and the resulting economic downturn are affecting business conditions in the industry in which the Company operates. Beginning in March 2020, the Company’s net sales were negatively impacted by the COVID-19 pandemic as hospitals delayed or canceled elective procedures. In response to the pandemic, many
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state and local governments in the U.S. issued orders that temporarily precluded elective procedures in order to conserve scarce health system resources. The decrease in hospital admission rates and elective surgeries reduced both the number of patients being evaluated for treatment with and demand for elective procedures using the Company's RNS System. The Company has taken necessary precautions to safeguard its employees, patients, customers, and other stakeholders from the COVID-19 pandemic, while maintaining business continuity to support its patients, customers and employees. The timing, extent and continuation of any increase in procedures, and any corresponding increase in sales of the Company’s products, and whether there could be a future decrease in the current level of procedures as a result of the COVID-19 pandemic or otherwise, remain uncertain and are subject to a variety of factors.
2.Summary of Significant Accounting Policies
Basis of Presentation
The unaudited interim condensed financial statements have been prepared in conformity with generally accepted accounting principles in the United States, or GAAP, as defined by the Financial Accounting Standards Board, or the FASB.
Reverse Stock Split
On August 18, 2020, the Company effected a 1-for-100 reverse stock split of its common stock and redeemable convertible preferred stock. Upon the effectiveness of the reverse stock split, all issued and outstanding shares of common stock and redeemable convertible preferred stock and related per share amounts contained in the accompanying financial statements were retroactively revised to reflect this reverse stock split for all periods presented. The par value of the authorized stock was not adjusted as a result of the reverse stock split.
On April 9, 2021, the Company effected a 1-for-2.6 reverse stock split of its common stock and redeemable convertible preferred stock. All issued and outstanding shares of common stock and redeemable convertible preferred stock and related per share amounts contained in the accompanying financial statements have been retroactively revised to reflect this reverse stock split for all periods presented. The par value of the authorized stock was not adjusted as a result of the reverse stock split.
Unaudited Interim Financial Information
The condensed balance sheet as of December 31, 2020 was derived from the Company’s audited financial statements, but does not include all disclosures required by GAAP. The accompanying unaudited condensed financial statements as of March 31, 2021 and for the three months ended March 31, 2021 and 2020, have been prepared by the Company, pursuant to the rules and regulations of the Securities and Exchange Commission, or the SEC, for interim financial statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to make the information presented not misleading. Accordingly, these financial statements should be read in conjunction with the audited financial statements as of and for the year ended December 31, 2020 and notes thereto, included in the Company’s final prospectus for the IPO filed with the SEC pursuant to Rule 424(b)(4) on April 23, 2021, or the final prospectus. In the opinion of management, all adjustments, consisting only of normal recurring adjustments necessary for a fair statement of the Company’s condensed financial position as of March 31, 2021 and condensed results of operations and cash flows for the three months ended March 31, 2021 and 2020 have been made. The results of operations for the three months ended March 31, 2021 are not necessarily indicative of the results of operations that may be expected for the year ending December 31, 2021.
Use of Estimates
The preparation of unaudited interim condensed financial statements in conformity with GAAP requires the Company to make estimates and assumptions that affect the amounts and disclosures reported in the financial statements. The Company uses significant judgment when making estimates related to the valuation of its common stock and related stock-based compensation, the valuation of deferred tax assets and related valuation allowances,
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provision for excess and obsolete inventories, the valuation of derivative financial instruments and redeemable convertible preferred stock warrant liability. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Although these estimates are based on the Company’s knowledge of current events and actions it may undertake in the future, actual results may ultimately materially differ from these estimates and assumptions.
Fair Value of Financial Instruments
Carrying amounts of certain of the Company’s financial instruments, including cash equivalents, accounts receivable, accounts payable and accrued liabilities, approximate fair value because of the short-term nature of these instruments. Short-term investments comprise available-for-sale debt securities, which are carried at fair value. The Company believes that its borrowings bear interest at the prevailing market rates for instruments with similar characteristics; accordingly, the carrying value of this instrument approximates its fair value. Derivative instruments and the redeemable convertible preferred stock warrant liability are carried at fair value based on unobservable market inputs. The Company determines the fair value of financial and non-financial assets and liabilities using the fair value hierarchy which establishes three levels of inputs that may be used to measure fair value (see Note 3).
Concentration of Credit Risk, and Other Risks and Uncertainties
Financial instruments that potentially subject the Company to credit risk consist of cash and cash equivalents, short-term investments and accounts receivable to the extent of the amounts recorded on the balance sheet. The Company’s cash is invested in one major financial institution in the United States. Deposits in this financial institution may exceed federally insured limits. The Company’s cash equivalents are invested in money market funds.
The Company’s accounts receivable are due from a variety of health care organizations in the United States. For the three months ended March 31, 2021 and 2020, there were no customers that represented 10% or more of revenue. As of March 31, 2021 and December 31, 2020, no customer represented 10% or more of the Company’s accounts receivable.
The Company is subject to certain risks, including that its devices may not be approved or cleared for marketing by governmental authorities or be successfully marketed for expanded indications. There can be no assurance that the Company’s products will achieve widespread adoption in the marketplace, nor can there be any assurance that existing devices or any future devices can be developed or manufactured at an acceptable cost and with appropriate performance characteristics. The Company is also subject to risks common to companies in the medical device industry, including, but not limited to, new technological innovations, dependence upon third-party payors to provide adequate coverage and reimbursement, dependence on key personnel, single-source suppliers and vendors in connection with the manufacture of its products, concentration of Level 4 CECs, obtaining, maintaining, protecting, enforcing, and defending intellectual property rights and proprietary technology, product liability claims, and compliance with government regulations.
The Company’s medical devices require approvals or clearances from the U.S. Food and Drug Administration, or the FDA, or international regulatory agencies. In addition, in order to continue the Company’s operations, compliance with various federal and state laws is required. If approvals or clearances were withdrawn by the FDA for the Company’s current products or if such approvals or clearances were denied or delayed for future products, product updates, or expanded indications for use, it would have a material adverse impact on the Company.
Deferred Offering Costs
The Company capitalizes, within other assets, certain legal, accounting and other third-party fees that are directly related to the Company’s in-process equity financings, including its initial public offering, until such financings are consummated. After consummation of the equity financing, these costs are recorded as a reduction of the proceeds received as a result of the offering. Should a planned equity financing be abandoned, terminated or significantly delayed, the deferred offering costs are immediately written off to operating expenses. As of March 31, 2021 and December 31, 2020, $2.4 million and $0.5 million of deferred offering costs were recorded on the
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condensed balance sheets, respectively. Upon closing the IPO, all deferred offering costs were charged against the proceeds from the IPO and recorded in stockholders equity (deficit) as a reduction of additional paid-in capital.
Net Loss per Share Attributable to Common Stockholders
Basic net loss per common share is calculated by dividing the net loss attributable to common stockholders by the weighted-average number of shares of common stock outstanding during the period, without consideration of potentially dilutive securities. Diluted net loss per share is computed by dividing the net loss attributable to common stockholders by the weighted-average number of shares of common stock and potentially dilutive securities outstanding for the period. For purposes of the diluted net loss per share calculation, redeemable convertible preferred stock, stock options, common stock subject to repurchase related to early exercise of stock options, and convertible notes are considered to be potentially dilutive securities. Basic and diluted net loss attributable to common stockholders per share is presented in conformity with the two-class method required for participating securities, as the redeemable convertible preferred stock is considered a participating security because it participates in dividends with common stock. The Company also considers the shares issued upon the early exercise of stock options subject to repurchase to be participating securities, because holders of such shares have non-forfeitable dividend rights in the event a dividend is paid on common stock. The holders of redeemable convertible preferred stock and the holders of the shares issued upon early exercise of stock options subject to repurchase do not have a contractual obligation to share in the Company’s losses. As such, the net loss was attributed entirely to common stockholders. Because the Company has reported a net loss for all periods presented, diluted net loss per common share is the same as basic net loss per common share for those periods.
Recent Accounting Pronouncements
Recent Accounting Pronouncements Not Yet Adopted
In February 2016, the FASB issued ASU No. 2016-02 (Topic 842), Leases. ASU 2016-02 requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease, respectively. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. This ASU provides a lessee with an option to not account for leases with a term of 12 month or less as leases in the scope of this ASU. This ASU will also require new qualitative and quantitative disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. This ASU should be applied through a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. In July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements, which allows entities to elect an optional transition method where entities may continue to apply the existing lease guidance during the comparative periods and apply the new lease requirements through a cumulative effect adjustment in the period of adoption rather than in the earliest period presented. In June 2020, the FASB issued ASU 2020-05, Revenue from Contracts with Customers (Topic 606) and Leases (Topic 842): Effective Dates for Certain Entities, which delays the adoption dates for ASU 2016-02 for non-public entities to fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. Early adoption is allowed. The Company expects to recognize a right-of-use asset and corresponding lease liability for its real estate operating leases upon adoption, expecting to use the modified retrospective approach for the adoption of this ASU.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments- Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which amends existing guidance on the impairment of financial assets and adds an impairment model that is based on expected losses rather than incurred losses and requires an entity to recognize as an allowance its estimate of expected credit losses for its financial assets. An entity will apply this guidance through a cumulative-effect adjustment to retained earnings upon adoption (a modified-retrospective approach) while a prospective transition approach is required for debt securities for which an other-than-temporary impairment had been recognized before the effective date. For public business entities that meet the definition of an SEC filer, excluding entities eligible to be smaller reporting companies as defined by the SEC, adoption is effective
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for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. For SEC filers that are eligible to be smaller reporting companies and for all other entities, this ASU is effective for fiscal years beginning after December 15, 2022, and interim periods within those fiscal years. Early adoption is permitted. The Company is in the process of evaluating the impact of the adoption on its financial statements and related disclosures.
In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The amendments in ASU 2020-04 provide optional expedients and exceptions for applying generally accepted accounting principles to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments in this ASU are effective for all entities as of March 12, 2020 through December 31, 2022. An entity may elect to apply the amendments for contract modifications by Topic or Industry Subtopic as of any date from the beginning of an interim period that includes or is subsequent to March 12, 2020, or prospectively from the date that the financial statements are available to be issued. Once elected for a Topic or an Industry Subtopic, the amendments must be applied prospectively for all eligible contract modifications for that Topic or Industry Subtopic. The Company is currently evaluating the impact of the adoption of this ASU on the Company’s financial statements and related disclosures.
In August 2020, the FASB issued ASU 2020-06, Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging-Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. This ASU simplifies the accounting for certain financial instruments with characteristics of liabilities and equity, including convertible instruments and contracts on an entity’s own equity. Specifically the ASU removes: i) major separation models required under GAAP and ii) certain settlement conditions that are required for equity contracts to qualify for the derivative scope exception, which will permit more equity contracts to qualify for the exception. For public business entities that meet the definition of an SEC filer, excluding entities eligible to be smaller reporting companies as defined by the SEC, this ASU is effective for interim and annual reporting periods beginning after December 15, 2021. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted, but no earlier than fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. The Company is currently evaluating the impact of the adoption of this ASU on the Company’s financial statements and related disclosures.
3.Fair Value Measurements
The Company measures certain financial assets and liabilities at fair value on a recurring basis. Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. A three-tier fair value hierarchy is established as a basis for considering such assumptions and for inputs used in the valuation methodologies in measuring fair value:
Level 1Quoted prices in active markets for identical assets or liabilities.
Level 2Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
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The Company utilizes the market approach to measure fair value for its financial assets and liabilities. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.
The following table summarizes the Company’s financial assets (cash equivalents, marketable securities and liabilities) at fair value as of March 31, 2021 (in thousands):
Fair Value as of March 31, 2021
Basis for Fair Value Measurements
(Level 1)(Level 2) (Level 3)
Assets:
Money market funds, included in cash and cash equivalents$5,088 $5,088 $ $ 
Fixed income mutual funds, included in short-term investments16,689 16,689   
Total$21,777 $21,777 $ $ 
Liabilities:
Redeemable convertible preferred stock warrant liability3,491   3,491 
Total$3,491 $ $ $3,491 
The following table summarizes the Company’s financial assets (cash equivalents, marketable securities and liabilities) at fair value as of December 31, 2020 (in thousands):
Fair Value as of December 31, 2020
Basis for Fair Value Measurements
(Level 1)(Level 2) (Level 3)
Assets:
Money market funds, included in cash and cash equivalents$5,062 $5,062 $ $ 
Fixed income mutual funds, included in short-term investments11,689 11,689   
Total$16,751 $16,751 $ $ 
Liabilities:
Redeemable convertible preferred stock warrant liability369   369 
Total$369 $ $ $369 
The money market funds are highly liquid and primarily invest in short-term fixed income securities issued by the U.S. government and U.S. government agencies. The Company’s available-for-sale investments comprise short-
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term investments in fixed income mutual funds, which primarily consist of debt securities issued by the U.S. government and U.S. government agencies and corporate bonds and notes.
The following is a summary of the Company’s available-for-sale debt securities (in thousands):
March 31,December 31,
20212020
Cost basis$16,656 $11,656 
Unrealized gain33 33 
Fair value$16,689 $11,689 
The following table sets forth a summary of the changes in the fair value of the Company’s Level 3 financial instruments (in thousands):
Redeemable Convertible Preferred Stock Warrant Liability
Fair value as of January 1, 2021$369 
Change in fair value included in other income (expense), net3,122 
Fair value as of March 31, 2021
$3,491 

Derivative Instrument
Fair value as of January 1, 2020$4,719 
Recognition of derivative instrument related to 2020 Convertible Notes1,669
Change in fair value included in other income (expense), net(1,705)
Fair value as of March 31, 2020
$4,683 
The fair value of the derivative instrument has been estimated at the date of inception and at the subsequent balance sheet date using a two-step approach to valuation, employing a probability-weighted scenario valuation method and then comparing the instrument’s value with-and-without the derivative features in order to estimate their combined fair value, using unobservable inputs, which are classified as Level 3 within the fair value hierarchy.
In August 2020, the derivative instrument was extinguished in connection with the issuance of Series B’ redeemable convertible preferred stock and conversion of all outstanding convertible notes and accrued unpaid interest into shares of Series B’ redeemable convertible preferred stock.
In determining the fair value of the redeemable convertible preferred stock warrant liability, the Company used the Black-Scholes option pricing model to estimate the fair value using unobservable inputs including the expected term, expected volatility, risk-free interest rate and dividend yield (see Note 8).
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4.Balance Sheet Components
Inventory
Inventories consist of the following (in thousands):
March 31,December 31,
20212020
Raw materials$1,823 $1,721 
Work-in-process1,532 1,487 
Finished goods3,687 3,701 
Total$7,042 $6,909 
Property and Equipment, net
Property and equipment, net consists of the following (in thousands):
March 31,December 31,
20212020
Machinery, equipment, furniture and fixtures$3,544 $3,544 
Computer equipment and software2,765 2,730 
Leasehold improvements2,402 2,402 
8,711 8,676 
Less: Accumulated depreciation(8,235)(8,161)
Property and equipment, net $476 $515 
Depreciation expense for the three months ended March 31, 2021 and 2020 was $0.1 million and $0.1 million, respectively.
Accrued Liabilities
Accrued liabilities consist of the following (in thousands):
March 31,December 31,
20212020
Payroll and related expenses $3,708 $4,565 
Inventory-raw materials471 636 
Professional fees641 279 
Deferred rent, current585 666 
Clinical trials36 107 
Other293 350 
$5,734 $6,603 
5.Commitments and Contingencies
Facility Lease
In August 2011, the Company entered into a non-cancelable operating lease for combined office and manufacturing facilities in Mountain View, California. The lease was scheduled to expire in April 2019 and was amended in May 2018 to extend it through June 2024. The terms of the facility lease provide for rental payments on a graduated scale; however, rent expense is recognized on a straight-line basis over the lease term. The Company has an option to extend the lease for a period of five years, commencing on July 1, 2024 and expiring on June 30, 2029. In conjunction with the original lease agreement, the Company obtained a letter of credit for $0.9 million in lieu of a security deposit. In May 2019, the letter of credit was amended and reduced to $0.7 million.
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Rental payments range from $2.9 million to $3.3 million per year over the extended term of the lease. In April 2020, the Company amended the lease agreement to defer 50.0% of the rental payment for May and June 2020 of $0.3 million. The deferred rental payments accrue interest at an annual rate of 8.0% starting from October 1, 2020 and will be payable in three equal monthly installments commencing on April 1, 2021.
Rent expense for the three months ended March 31, 2021 and 2020 was $0.7 million and $0.7 million, respectively. As of March 31, 2021 and December 31, 2020, $1.8 million and $2.0 million was recorded as deferred rent expense, respectively.
The Company’s future payments under the non-cancellable operating lease (in thousands) are as follows:
March 31,
2021
2021 (remaining nine months)$2,632 
20223,172 
20233,267 
20241,666 
Total$10,737 
Indemnifications
In the normal course of business, the Company enters into contracts and agreements that contain a variety of representations and warranties and may provide for indemnification of the counterparty. The Company’s exposure under these agreements is unknown because it involves claims that may be made against it in the future but have not yet been made. To date, the Company has not been subject to any claims or been required to defend any action related to its indemnification obligations.
The Company indemnifies each of its directors and officers for certain events or occurrences, subject to certain limits, while the director or officer is or was serving at the Company’s request in such capacity, as permitted under Delaware law and in accordance with its certificate of incorporation and bylaws. The term of the indemnification period lasts as long as the director or officer may be subject to any proceeding arising out of acts or omissions of such individual in such capacity. The maximum amount of potential future indemnification is unlimited. The Company believes that the fair value of these indemnification obligations is minimal. Accordingly, the Company has not recognized any liabilities relating to these obligations as of March 31, 2021 and December 31, 2020.
Contingencies
From time to time, the Company may have certain contingent liabilities that arise in the ordinary course of business activities. The Company accrues a liability for such matters when it is probable that future expenditures will be made and such expenditures can be reasonably estimated. The Company determined that no accrual was required as of March 31, 2021 and December 31, 2020.
Legal Proceedings
From time to time, the Company may become involved in legal proceedings arising from the ordinary course of its business. The Company may also pursue litigation to assert its legal rights and such litigation may be costly and divert the efforts and attention of its management and technical personnel which could adversely affect its business. The Company is currently not aware of any matters that could have a material adverse effect on its financial position, results of operations or cash flows.
6.Debt
2014 Term Loan
In November 2014, the Company entered into a Term Loan Agreement, as amended, for total borrowings of up to $40.0 million with Capital Royalty Partners II L.P. and its affiliates Capital Royalty Partners II – Parallel Fund “A” L.P. and Parallel Investment Opportunities Partners II L.P., or collectively, CRG. As of December 31, 2019,
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$40.0 million had been funded under this Term Loan Agreement, or the Term Loan. The Term Loan bore interest at a rate of 12.5% per annum based on a 360-day year and actual days elapsed. Payments under the Term Loan were to be made quarterly with payment dates fixed at the end of each calendar quarter, or the Payment Dates. Through September 30, 2017, the Company had the option to pay interest as follows: 8.0% per annum paid in cash and 4.5% per annum paid-in-kind, or PIK, by increasing the principal of the Term Loan. On each Payment Date through September 30, 2016, the Company elected the PIK option, issuing PIK notes totaling $2.7 million. On each Payment Date from December 31, 2016 through December 31, 2019, the Company paid all interest due in cash.
The Term Loan was interest-only through September 30, 2019. Following the interest-only period, principal payments were to be made in equal installments at the end of the next four calendar quarters, with the final payment due on September 30, 2020. The Term Loan included a fee upon repayment of the loan equal to 5% of the aggregate principal amount being prepaid or repaid. The Company ratably accreted the fee over the life of the loan.
In connection with the Term Loan, the Company paid total closing fees of $0.8 million and issued warrants to purchase 219 shares of its Series I redeemable convertible preferred stock at $1,866.80 per share. The initial fair value of the warrants was $0.3 million and resulted in a discount to the Term Loan, which was amortized to interest expense over the life of the loan using the effective interest method. Prior to 2019, these warrants were modified to be exercisable for 219 shares of common stock at $2.60 per share, all of which remain outstanding as of March 31, 2021. Upon the closing of the IPO, warrants to purchase 219 shares of common stock net exercised to 185 shares of common stock.
In October 2019, the Term Loan Agreement was amended to extend the interest-only period through December 31, 2019. This amendment was accounted as a debt modification and the impact on the Term Loan’s effective interest rate was a decrease from 15.0% to 14.7%.
In February through June 2020, the Term Loan Agreement was amended to extend the interest-only period through June 30, 2020 and to allow the Company to pay such interest entirely in kind by adding it to the aggregate principal of the loan. The Company paid $1.4 million in interest due on March 31, 2020 in kind and paid $1.4 million interest due on June 30, 2020 in cash. The amendments were accounted as a debt modification and the Term Loan’s effective interest rate was changed within 14.7% to 14.2% with each amendment.
The Term Loan was collateralized by substantially all of the Company’s assets. The Term Loan Agreement contained customary representations and warranties, covenants, events of default and termination provisions. The affirmative covenants included, among other things, that the Company achieve minimum annual revenue thresholds and maintain a minimum balance of cash and cash equivalents.
In September 2020, the Company repaid its entire obligation under the Term Loan amounting to $47.6 million, including principal of $44.1 million, interest of $1.3 million and fees of $2.2 million, using the proceeds from New Term Loan (as defined below). The repayment of the Term Loan was accounted for as a debt extinguishment, which resulted in an immaterial extinguishment loss.
2020 Term Loan
In September 2020, the Company entered into a new Term Loan Agreement with CRG Partners IV L.P. and its affiliates for total borrowings of up to $60 million, or the New Term Loan, and borrowed $50 million. The remaining $10.0 million of the New Term Loan will be available to the Company for borrowing until March 31, 2022 if the Company achieves a revenue-based milestone in 2021.
The New Term Loan bears interest at a rate of 12.5% per year. Payments under the New Term Loan are made quarterly with payment dates fixed at the end of each calendar quarter. The New Term Loan was interest-only through September 30, 2023, which could be extended through September 30, 2025 at Company’s option if the Company completed its IPO on or prior September 30, 2023. In connection with closing the IPO, the Company extended the interest-only period to September 30, 2025. Following the interest-only period, principal payment is due in one installment on September 30, 2025. The New Term Loan includes a fee upon repayment of the loan equal to 10% of the aggregate principal amount being prepaid or repaid. As of March 31, 2021, the New Term Loan had an annual effective interest rate of 16.08% per year.
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The New Term Loan is collateralized by substantially all of the Company’s assets. The New Term Loan Agreement contains customary representations and warranties, covenants, events of default and termination provisions. The financial covenants require that the Company achieve minimum annual revenue thresholds commencing in 2021 and maintain a minimum balance of cash and cash equivalents (see Note 1).
The Company paid $1.0 million in fees to the lender and third parties which is reflected as a discount on the loan and is being accreted over the life of the loan using the effective interest method. Also, the Company issued warrants to the lender for a total of 346,823 shares of Series B’ redeemable convertible preferred stock. The warrants had a fair value of $0.6 million as of the issuance date, which was accounted as debt issuance costs (see Note 8).
During the three months ended March 31, 2021, the Company recorded interest expense related to deferred financing and debt issuance costs of the New Term Loan of $0.1 million.
Interest expense on the New Term Loan was $1.8 million during the three months ended March 31, 2021.
Paycheck Protection Program
In April 2020, the Company received $4.0 million from a federal Small Business Administration loan under the Paycheck Protection Program, or the PPP Loan. The note bears interest at 1.0% per year on the outstanding principal amount and matures 24 months from the date of the note. No payments were due for the six-month period beginning on the date of the note. Payments of principal and interest were due over the following 18 months. The Small Business Administration modified the PPP Loan such that monthly payments of principal and interest are due from September 2021 through April 2022. As of March 31, 2021, the Company did not make any repayments of the PPP Loan.
In April 2021, the Company repaid its entire obligation under the PPP Loan amounting to $4.1 million, including principal of $4.0 million and interest of less than $0.1 million, using the proceeds from its IPO.
As of March 31, 2021, future minimum payments for the New Term Loan and PPP Loan are as follows (in thousands):
New Term LoanPPP Loan
2021 (remaining nine months)$4,774 $2,060 
20226,337 2,060 
202312,587  
202429,364  
202524,931  
Total77,993 4,120 
Less: Unamortized debt discount and issuance cost(1,360) 
Less: Unaccreted backend fee(4,577) 
Less: Interest(22,993)(32)
Total future minimum payments$49,063 $4,088 
2019 and 2020 Convertible Notes
In March and September 2019, Company issued convertible notes to certain investors for aggregate proceeds of $21.3 million, or the 2019 Convertible Notes. In January and March 2020, the Company raised $7.1 million and $5.4 million, respectively, through the sale and issuance of additional convertible notes, or the 2020 Convertible Notes. The 2019 and 2020 Convertible Notes were subordinated to the Term Loan, bore interest on the outstanding principal amount at the rate of 8.0% per annum, and had a maturity date of December 31, 2020.
Upon the consummation of an equity financing with aggregate proceeds to the Company of not less than $18 million, or the Qualified Financing, the outstanding principal balance of the 2019 and 2020 Convertible Notes and accrued but unpaid interest would convert into shares of capital stock issued in such Qualified Financing at a
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NeuroPace, Inc.
Notes to Unaudited Interim Condensed Financial Statements
conversion price equal to 85% of the issuance price per share of such capital stock in such Qualified Financing. In the event the Company consummated, while the 2019 and 2020 Convertible Notes remained outstanding, an equity financing that did not constitute a Qualified Financing, then the majority holders had the option to treat such equity financing as a Qualified Financing. If the Company did not complete a Qualified Financing prior to the maturity date while the 2019 and 2020 Convertible Notes remained outstanding, the holders of the notes could elect to convert the outstanding principal and unpaid accrued interest into the Company’s Series A’ redeemable convertible preferred stock at a conversion price of $116.35 per share.
Upon the occurrence of a change of control, the 2019 and 2020 Convertible Notes would upon the election of the majority holders either (i) become due and payable upon the closing of such change of control in cash in an amount equal to (a) the outstanding principal amount plus any unpaid accrued interest, plus (b) a repayment premium equal to 100% of the outstanding principal amount, or (ii) be converted such that the outstanding principal balance of the notes and any unpaid accrued interest would convert into shares of the Company’s Series A’ redeemable convertible preferred stock at a conversion price equal to $116.35 per share.
The 2019 and 2020 Convertible Notes contained embedded derivative instruments, including automatic conversion into equity securities upon completion of a Qualified Financing, that were required to be bifurcated and accounted for separately as a single derivative instrument initially and subsequently measured at fair value with the change in fair value recorded in other income (expense), net in the statements of operations and comprehensive loss. The issuance date estimated fair values of the derivative instruments issued with the March and September 2019 notes were $4.1 million and $1.9 million, respectively, which were recorded as debt discounts. The issuance date estimated fair values of the derivative instruments issued with the January and March 2020 notes were $1.0 million and $0.7 million, respectively, which were recorded as debt discounts. In August 2020, the derivative instrument was extinguished in connection with the issuance of Series B’ redeemable convertible preferred stock.
The discount on the 2019 and 2020 Convertible Notes was amortized over the contractual term ending on December 31, 2020, using the effective interest method. The annual effective interest rate was estimated from 10.8% to 12.2% per year. The interest expense for the three months ended March 31, 2020 was $1.4 million, consisting of $0.9 million of contractual interest expense and $0.5 million amortization of debt discount arising from separation of the embedded derivative instrument.
For the three months ended March 31, 2020, $10.3 million of convertible notes were issued to related parties, resulting in interest expense of $0.5 million.
In connection with the sale and issuance of Series B’ redeemable convertible preferred stock all outstanding convertible notes were modified to remove the 15% discount on conversion. All outstanding convertible notes of $33.9 million and accrued unpaid interest of $2.5 million were converted into 8,379,410 shares of Series B’ redeemable convertible preferred stock at 100% of the preferred stock issuance price of $4.3423 per share.
The conversion of the 2019 Convertible Notes and 2020 Convertible Notes into shares of Series B' redeemable convertible preferred stock was accounted for as a debt extinguishment with $4.1 million extinguishment gain recognized as a deemed capital contribution to additional paid-in capital in the quarter ended September 30, 2020, as the holders of the notes were existing stockholders of the Company.
7.Redeemable Convertible Preferred Stock
In August 2020, the Company amended its Certificate of Incorporation, pursuant to which the Company has two series of redeemable convertible preferred stock, designated as Series A’ and Series B’. In August 2020, the Company issued 7,599,720 shares of Series B’ redeemable convertible preferred stock at $4.3423 per share for gross proceeds of $33.0 million. In connection with the issuance of Series B’ redeemable convertible preferred stock, all outstanding convertible notes of $33.9 million and accrued unpaid interest of $2.5 million were converted into 8,379,410 shares of Series B’ redeemable convertible preferred stock at such price.
17


NeuroPace, Inc.
Notes to Unaudited Interim Condensed Financial Statements
As of March 31, 2021 and December 31, 2020, the redeemable convertible preferred stock comprises (in thousands, except per share and share amounts):
Number of Shares AuthorizedNumber of Shares Issued and OutstandingCarrying AmountLiquidation ValueOriginal Issue Price
Series A’1,651,154 635,048 $73,340 $36,945 $58.1750 
Series B’59,106,232 15,979,130 $68,082 $190,810 $4.3423 
60,757,386 16,614,178 $141,422 $227,755 

On April 26, 2021, upon the closing of the Company’s IPO, all outstanding redeemable convertible preferred stock automatically converted into 16,614,178 shares of common stock. Prior to the closing of the Company’s IPO, the holders of redeemable convertible preferred stock had the following various rights and preferences:
Dividends
The holders of redeemable convertible preferred stock were entitled to receive dividends, out of any assets legally available therefore, prior and in preference to any declaration or payment of any dividend to the common stockholders, at the rate of $4.6540 per share per annum on each outstanding share of Series A’ redeemable convertible preferred stock and $0.3474 per share per annum on each outstanding share of Series B’ redeemable convertible preferred stock, payable when, as and if declared by the Board of Directors. Such dividends shall not be cumulative and if less than the full amount of dividends payable on the redeemable convertible preferred stock is declared and paid, any such payments would have been made ratably among the holders of the redeemable convertible preferred stock in proportion to the total amount each holder would be entitled to receive if the full amount of dividends payable on the redeemable convertible preferred stock had been declared. As of March 31, 2021 and December 31, 2020, no dividends had been declared.
Liquidation
In the event of any liquidation, dissolution or winding up of the Company, the holders of the Company’s Series B’ redeemable convertible preferred stock would have been entitled to receive, prior to any distribution of the Company’s assets to the holders of Series A’ redeemable convertible preferred stock and common stock, an amount per share equal to (i) as of and following August 19, 2020 (the “Initial Closing” of Series B’ redeemable convertible preferred stock), and prior to, at the Company’s election, the earlier of (a) the date the Company’s cash balance falls below $4.0 million and (b) March 31, 2022 (the “Deferred Closing”), 2.75 times $4.3423 per share for each share of Series B’ redeemable convertible preferred stock, and (ii) as of and following the date of the Deferred Closing, either (x) 2.75 times $4.3423 per share if the Company’s actual cash-burn between the Initial Closing and December 31, 2021 is 110% or less of the Company’s business plan cash-burn for such time period as approved by the Board of Directors, or (y) otherwise 3 times $4.3423, for each share of Series B’ redeemable convertible preferred stock, plus declared but unpaid dividends.
If, upon the occurrence of such event, the assets and funds thus distributed among the holders of redeemable convertible preferred stock would have been insufficient to permit the payment to such holders of the full amounts, then the entire assets and funds of the Company legally available for distribution would have been distributed ratably among the holders of redeemable convertible preferred stock in proportion to the preferential amount each such holder is otherwise entitled to receive.
After full payment to the holders of Series B’ redeemable convertible preferred stock, the holders of Series A’ redeemable convertible preferred stock would have been entitled to receive, prior to any distribution of the Company’s assets to the holders of common stock, an amount per share equal to $58.1750 per share for each share of redeemable convertible preferred stock plus declared but unpaid dividends. If, upon the occurrence of such event, the assets and funds thus distributed among the holders of redeemable convertible preferred stock would have been insufficient to permit the payment to such holders of the full amounts, then the entire assets and funds of the
18


NeuroPace, Inc.
Notes to Unaudited Interim Condensed Financial Statements
Company legally available for distribution would have been distributed ratably among the holders of redeemable convertible preferred stock in proportion to the preferential amount each such holder is otherwise entitled to receive.
After the payment to the holders of redeemable convertible preferred stock of the full preferential amounts specified above, all of the remaining assets of the Company available for distribution to stockholders would have been distributed among the holders of Series B’ redeemable convertible preferred stock, Series A’ redeemable convertible preferred stock and common stock pro rata based on the number of shares of common stock held by each such holder, treating for this purpose all shares of redeemable convertible preferred stock as if converted to common stock prior to such liquidation, dissolution or winding up of the Company.
Conversion
The Company’s redeemable convertible preferred stock is convertible into shares of common stock at the option of a holder on a one-for-one basis with the conversion ratio subject to standard antidilutive adjustments, such as stock splits, stock dividends, combinations, subdivisions, recapitalizations or the like. The initial conversion price was $4.3423 and $58.1750 per share of Series B’ and Series A’ redeemable convertible preferred stock, respectively. Each share of Series A’ redeemable convertible preferred stock is convertible into shares of common stock immediately upon the date specified by written consent or written agreement of the holders of a majority of the outstanding shares of Series A’ redeemable convertible preferred stock. Each share of Series B’ redeemable convertible preferred stock is convertible into shares of common stock immediately upon (A) the date specified by written consent or written agreement of the holders of a majority of the outstanding shares of Series B’ redeemable convertible preferred stock and the Requisite Significant New Holders (as defined below) and (B) any firm commitment underwritten public offering approved by two new investors that have committed to the investment of an aggregate of $7,499,900 or more (each, a “Significant Investor”) in the Initial Closing and the Deferred Closing combined (such two Significant Investors, together, the “Requisite Significant New Holders”).
Voting Rights
The holders of redeemable convertible preferred stock shall have the right to one vote for each share of common stock into which such redeemable convertible preferred stock could then be converted. With respect to such vote, the holder shall have full voting rights and powers equal to the voting rights and powers of the holders of common stock, would have been entitled to notice of any stockholders’ meeting in accordance with the bylaws of the Company, and would have been entitled to vote, together with holders of common stock, with respect to any question upon which holders of common stock have the right to vote.
Redemption and Balance Sheet Classification
The redeemable convertible preferred stock is recorded within mezzanine equity because, while it is not mandatorily redeemable, it will become redeemable at the option of the holders upon the occurrence of certain deemed liquidation events that are considered not solely within the Company’s control.
8.Redeemable Convertible Preferred Stock Warrant Liability
On September 24, 2020, in connection with entering into the New Term Loan Agreement, the Company issued CRG Partners IV L.P. and its affiliates warrants to purchase 346,823 shares of Series B’ redeemable convertible preferred stock at an exercise price of $6.51339 per share, or the Series B’ Warrants, which was accounted as debt issuance costs.
The Series B’ Warrants will terminate at the earlier of the ten year anniversary from the issuance date, the closing of the Company’s IPO or Liquidation of the Company. These warrants have a net exercise provision under which their holders may, in lieu of payment of the exercise price in cash, surrender the warrant and receive a net amount of shares based on the fair market value of the Company’s stock at the time of exercise of the warrants after deduction of the aggregate exercise price. The Series B’ Warrants contain provisions for adjustment of the exercise price and number of shares issuable upon the exercise of warrants in the event of certain stock dividends, stock splits, reorganizations, reclassifications, and consolidations.
19


NeuroPace, Inc.
Notes to Unaudited Interim Condensed Financial Statements
The fair value of the Series B’ Warrants on the date of issuance of $0.6 million was recorded as a debt discount. The Series B’ Warrants had a fair value of $3.5 million and $0.4 million as of March 31, 2021 and December 31, 2020, respectively. The change in fair value of $(3.1) million during the three months ended March 31, 2021 was recorded as a component of other income (expense), net in the statements of operations and comprehensive loss.
The redeemable convertible preferred stock warrant liability was valued using the following assumptions under the Black-Scholes option pricing model:
March 31,December 31,
20212020
Stock price$14.50$3.43
Expected term (in years)9.59.7
Expected volatility38.4%39.0%
Weighted average risk-free interest rate1.68%0.91%
Dividend yield%%
As of March 31, 2021, all Series B’ Warrants remained outstanding. Upon the closing of the IPO, the Series B’ Warrants net exercised to 213,941 shares of Series B’ convertible preferred stock and subsequently converted into common stock on a one-to-one basis.
9.Common Stock
The Company’s Certificate of Incorporation, as amended in August 2020, authorized the Company to issue 74,636,348 shares of $0.001 par value common stock.
The holders of common stock are entitled to receive dividends whenever funds and assets are legally available and when declared by the Board of Directors, subject to the prior rights of holders of redeemable convertible preferred stock outstanding. As of March 31, 2021 and December 31, 2020, no dividends had been declared.
As of March 31, 2021 and December 31, 2020, the Company had reserved common stock for future issuance as follows:
March 31,December 31,
20212020
Conversion of Series A’ redeemable convertible preferred stock635,048 635,048 
Conversion of Series B’ redeemable convertible preferred stock15,979,130 15,979,130 
Outstanding options under the 2009 Plan6 6 
Outstanding options under the 2020 Plan2,829,317 2,835,265 
Options available for future grant under the 2020 Plan668,299 818,889 
Redeemable convertible preferred stock warrants issued and outstanding346,823 346,823 
Common stock warrants issued and outstanding219 219 
Total20,458,842 20,615,380 
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NeuroPace, Inc.
Notes to Unaudited Interim Condensed Financial Statements
10.Stock Option Plans
A summary of stock option activity for the three months ended March 31, 2021 is set forth below:
Options Outstanding
Shares Available for GrantNumber of SharesWeighted-Average Exercise PriceWeighted Average Remaining Contractual Term (in Years)
Balances as of January 1, 2021818,889 2,835,265 $0.03 9.57
Options granted(188,361)188,361 $1.04 
Options exercised(156,538)$0.03 
Options cancelled37,771 (37,771)$0.03 
Balances at March 31, 2021
668,299 2,829,317 $0.09 9.49
Vested and exercisable at March 31, 2021
450,358 $0.03 9.05
Vested and expected to vest at March 31, 2021
2,829,317 $0.03 9.49
Early Exercise of Stock Options
The terms of the Company’s 2020 Stock Plan, or the 2020 Plan, permit the exercise of options granted under the 2020 Plan prior to vesting, subject to required approvals. The shares of common stock issued from the early exercise of unvested stock options are restricted and continue to vest over the original implied service period. The Company has the option to repurchase any unvested shares at the original purchase price upon any voluntary or involuntary termination. The shares purchased by the employees and non-employees pursuant to the early exercise of stock options are not deemed, for accounting purposes, to be outstanding until those shares vest. The cash received in exchange for exercised and unvested shares related to stock options granted is recorded as a liability for the early exercise of stock options in accrued liabilities on the accompanying balance sheet and will be transferred into common stock and additional paid-in capital as the shares vest. As of March 31, 2021 and December 31, 2020, there were 182,316 and 30,802 early exercised options subject to repurchase, respectively.
The Company recognized stock-based compensation as follows:
Three Months Ended March 31,
20212020
Cost of goods sold$10 $5 
Research and development37 100 
Selling, general and administrative155 196 
Total stock-based compensation$202 $301 
As of March 31, 2021, the total unrecognized stock-based compensation expense related to unvested stock options was $2.0 million, which will be amortized on a straight-line basis over a weighted average remaining period of 3.4 years.
11.Income Taxes
The Company did not record a federal or state income tax provision or benefit for the three months ended March 31, 2021 and 2020 as it has incurred net losses since inception. In addition, the net deferred tax assets generated from net operating losses are fully offset by a valuation allowance as the Company believes it is not more likely than not that the benefit will be realized.
The Company accounts for the uncertainty in income taxes by utilizing a comprehensive model for the recognition, measurement, presentation and disclosure in financial statements of any uncertain tax positions that
21


NeuroPace, Inc.
Notes to Unaudited Interim Condensed Financial Statements
have been taken or are expected to be taken on an income tax return. There had been no changes in the estimated uncertain tax benefits recorded as of December 31, 2020.
12.Net Loss per Share Attributable to Common Stockholders
The following table sets forth the computation of basic and diluted net loss per share attributable to common stockholders (in thousands, except for share and per share amounts):
Three Months Ended March 31,
20212020
Numerator:
Net loss attributable to common stockholders$(8,810)$(6,741)
Denominator:
Weighted-average common stock outstanding used to compute basic and diluted net loss per share269,178 202,341 
Net loss per share attributable to common stockholders, basic and diluted$(32.73)$(33.32)
The following potentially dilutive securities outstanding have been excluded from the computation of diluted weighted average shares outstanding because such securities have an antidilutive impact due to the Company’s net loss, in common stock equivalent shares:
As of March 31,
20212020
Redeemable convertible preferred shares16,614,178 635,048 
Options to purchase common stock2,829,317 176,361 
Unvested early exercised common stock options182,316 83 
Redeemable convertible preferred stock warrants346,823  
2019 and 2020 Convertible Notes*
  
Total Shares19,972,634 811,492 
______________
*As of March 31, 2020, the conversion of the 2019 and 2020 Convertible Notes into redeemable convertible preferred stock was dependent on the outstanding loan balance including accrued interest and the per share conversion price (see Note 6). Due to these factors, the number of shares of convertible preferred stock issuable upon conversion of the convertible notes was not determinable.
13.    Related Parties
Covidien Group S.a.r.l., an indirect wholly-owned subsidiary of Medtronic, plc, became a holder of more than five percent of the Company’s capital stock in August 2020. Pursuant to the terms of a cross-license with Medtronic, the Company made royalty payments of approximately $0.1 million during both the three months ended March 31, 2021 and 2020.
Also see Note 6 for additional related party transactions related to the 2019 and 2020 Convertible Notes.
14.    Subsequent Events
In April 2021, the Board of Directors authorized the grant of options to purchase a total of 53,067 shares of common stock to employees at a weighted average exercise price of $16.00 per share.
In April 2021, the Board of Directors authorized the grant of options to purchase a total of 130,188 shares of common stock to the non-employee directors at a weighted average exercise price of $17.00 per share.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis of our financial condition and results of operations together with our condensed financial statements and the related notes and other financial information included elsewhere in this Quarterly Report on Form 10-Q. This discussion and other parts of this report contain forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions, which are based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section of this report entitled “Risk Factors,” under Part II, Item 1A and those discussed in our final prospectus for our initial public offering dated April 23, 2021, and filed with the SEC, pursuant to Rule 424(b)(4) of the Securities Act of 1933, as amended.
Overview
We are a commercial-stage medical device company focused on transforming the lives of people suffering from epilepsy by reducing or eliminating the occurrence of debilitating seizures. Our novel and differentiated RNS System is the first and only commercially available, brain-responsive neuromodulation system that delivers personalized, real-time treatment at the seizure source. By continuously monitoring the brain’s electrical activity, recognizing patient-specific abnormal electrical patterns, and responding in real time with imperceptible electrical pulses to prevent seizures, our RNS System delivers the precise amount of therapy when and where it is needed and provides exceptional clinical outcomes with approximately three minutes of stimulation on average per day. Our RNS System is also the only commercially available device that records continuous brain activity data and allows clinicians to monitor patients not only in person, but also remotely, in order to make more informed treatment decisions, thus optimizing patient care. We believe the therapeutic advantages of our RNS System, combined with the insights obtained from our extensive brain data set, offer a significant leap forward in epilepsy treatment.
Our RNS System is currently indicated in the United States for use in adult epilepsy patients, or patients who are 18 years of age or older, with drug-resistant focal epilepsy. As of March 31, 2021, over 3,000 epilepsy patients have received our RNS System. We believe our compelling body of long-term clinical data, demonstrating continuous improvement in outcomes over time, will support the continued adoption of our RNS System among the approximately 575,000 adults in the United States with drug-resistant focal epilepsy. Over time, we plan to seek indication expansion more broadly for use across the entire approximately 1.2 million drug-resistant epilepsy patients in the United States and may additionally seek to expand our operations to reach the approximately 16.5 million drug-resistant epilepsy patients globally.
Our commercial efforts are focused on the comprehensive epilepsy centers, or Level 4 CECs, that facilitate appropriate care for drug-resistant epilepsy patients, including procedures for implantation of epilepsy neuromodulation devices such as our RNS System. While most drug-resistant epilepsy patients begin their care at physician offices or community hospitals, we estimate that approximately 24,000 adult drug-resistant focal epilepsy patients are treated in Level 4 CECs in the United States each year. We estimate that this patient pool represents an annual core market opportunity of approximately $1.1 billion for initial RNS System implants, and we expect that it will continue to grow as both the number of Level 4 CECs and the number of epilepsy specialists increase, and as more patients are referred to these CECs. In addition, our RNS System currently has an average battery life of approximately eight years, which, through the sale of replacement neuromodulation devices, provides a recurring revenue stream that is additive to our current $1.1 billion annual market opportunity for initial implants.
We received Pre-Market Approval, or PMA, from the FDA for our RNS System in late 2013 and began the commercial rollout of our RNS System in early 2014. We market our RNS System in the United States through a direct sales organization primarily to the epileptologists and neurosurgeons who respectively prescribe and implant neuromodulation devices in the approximately 200 Level 4 CECs in the United States. As of March 31, 2021, our commercial organization of 21 Therapy Consultants and 22 Field Clinical Engineers has established a significant account base at these Level 4 CECs. Given the concentrated and underpenetrated nature of our target market, we believe there is a significant opportunity to efficiently grow our account base, drive higher utilization within these
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centers, and increase the number of drug-resistant patients referred to Level 4 CECs without significant salesforce expansion.
The implant procedure for our RNS System and the ongoing patient treatment provided by clinicians, including monitoring and programming, are reimbursed under well-established physician and hospital codes. In addition, we believe that our RNS System is currently the only neuromodulation system for epilepsy with reimbursement available for periodic in-person or remote review of brain activity data. Given the relatively young average age of our patient population, our payor mix has historically been more heavily weighted towards commercial payors. As of March 31, 2021, commercial payors have written positive coverage policies that address approximately 200 million covered lives in the United States. Medicare and Medicaid also routinely provide coverage for implantation of our RNS System and follow-up care. Based on our experience, less than 1% of potential RNS System patients have been unable to undergo an implant procedure with our RNS System due to lack of payor coverage. We believe the established, differentiated, and favorable reimbursement paradigm for our RNS System will continue to support its broad commercial adoption.
We currently manufacture our RNS System at and distribute all of our products from our approximately 53,000 square foot facility in Mountain View, California. This facility provides approximately 20,000 square feet of space for our production and distribution operations, including manufacturing, quality control and storage. We believe our existing facility will be sufficient to meet our current and near-term manufacturing needs.
Since our inception, we have generated significant losses. To date, we have financed our operations primarily through private placements of equity securities, debt financing arrangements and sales of our products. We generated revenue of $11.2 million, with a gross margin of 75.7% and a net loss of $8.8 million, for the three months ended March 31, 2021, compared to revenue of $10.0 million, with a gross margin of 70.7% and a net loss of $6.7 million, for the three months ended March 31, 2020. As of March 31, 2021, we had an accumulated deficit of $396.5 million, cash, cash equivalents and short-term marketable debt securities of $30.5 million, and $53.2 million of outstanding term loans, net of debt discount and issuance costs. In January and March 2020, we raised $7.1 million and $5.4 million, respectively, through the sale and issuance of additional convertible notes, or the 2020 Convertible Notes. In August 2020, we received $33.0 million in gross proceeds by issuing and selling 7,599,720 shares of our Series B’ convertible preferred stock at a price of $4.3423 per share. In addition, in connection with the Series B’ offering, all of our outstanding convertible notes were converted into 8,379,410 shares of Series B’ convertible preferred stock.
In September 2020, we entered into a new Term Loan Agreement, or the New Term Loan, with CRG Partners IV L.P. and its affiliates for total borrowings of up to $60 million and borrowed $50 million. We used the proceeds from the New Term Loan to repay the principal, interest, and fees due under the previously existing term loan. The remaining $10.0 million will be available to us for borrowing until March 31, 2022, if we achieve a revenue-based milestone in 2021.
On April 21, 2021, we completed our initial public offering of our common stock, or IPO, in which we issued and sold an aggregate of 6,900,000 shares of common stock (inclusive of 900,000 shares pursuant to the exercise by the underwriters of their option) at a price of $17.00 per share for aggregate cash proceeds of approximately $105.2 million, net of underwriting discounts and commissions and estimated offering costs. The sale and issuance of 6,900,000 shares in the IPO closed on April 26, 2021. Upon the closing of the IPO on April 26, 2021, all outstanding shares of redeemable convertible preferred stock automatically converted into 16,614,178 shares of common stock. Subsequent to the closing of the IPO, there were no shares of redeemable convertible preferred stock outstanding.
We have invested heavily and expect to continue to invest in research and development and commercial activities. These research and development expenses include clinical studies to demonstrate the safety and efficacy of our RNS System and to obtain, as well as retain, FDA approval. We intend to continue making significant investments in research and development, clinical studies and regulatory affairs to support future regulatory submissions for retaining and expanding indications of our RNS System, including to adolescent patients, ages 12-17, and drug-resistant generalized epilepsy patients, support continuous improvements to our RNS System, and develop future products that address neurological disorders. We have also made significant investments in building our field commercial team and intend to make significant investments in sales and marketing efforts in the future,
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including initiatives to drive awareness and increase the number of drug-resistant epilepsy patients referred to Level 4 CECs. Moreover, we expect to continue to incur additional expenses associated with operating as a public company. We may in the future seek to acquire or invest in additional businesses, products, or technologies that we believe could complement or enhance our products, enhance our technical capabilities or otherwise offer growth opportunities, although we currently have no agreements or understandings with respect to any such acquisitions or investments. Because of these and other factors, we expect to continue to incur net losses and negative cash flows for the next several years. We may require additional funding to support operations and pay our obligations or may opportunistically seek to raise additional capital, which may include future equity or debt financings.
We believe our existing cash, cash equivalents and short-term investments, together with the net proceeds from our IPO, will allow us to continue our operations for at least the next 12 months.
Recent Developments
Impact of the COVID-19 Pandemic
Since it was reported to have surfaced in December 2019, a novel strain of coronavirus (COVID-19) has spread across the world and has been declared a pandemic by the World Health Organization. Efforts to contain the spread of COVID-19 have been significant and governments around the world, including in the United States, have implemented severe travel restrictions, social distancing requirements, quarantines, stay-at-home orders and other significant restrictions. As a result, the current COVID-19 pandemic has presented a substantial public health and economic challenge and is affecting hospitals, physicians, patients, communities and business operations, as well as contributing to significant volatility and negative pressure on the U.S. and world economy and in financial markets.
The COVID-19 pandemic has negatively impacted our business, financial condition and results of operations by decreasing and delaying procedures performed to implant our RNS System, and we expect the pandemic will continue to negatively impact our business, financial condition and results of operations. Beginning in March 2020, our net sales were negatively impacted by the COVID-19 pandemic as hospitals delayed or canceled elective procedures, including because patients feared potential exposure. Many state and local governments in the U.S. issued orders that temporarily precluded elective procedures in order to conserve scarce health system resources in view of the pandemic and to protect patient health. The decrease in hospital admission rates and elective surgeries reduced the demand for elective procedures, including implantation of our RNS System. In addition, hospitals delayed or cancelled admissions for epilepsy diagnostic procedures which we believe has reduced and will continue to temporarily reduce our patient pipeline.
In response to the COVID-19 pandemic, we have implemented a variety of measures intended to help us manage its impact while maintaining business continuity to support our customers and patients. These measures include:
Establishing safety protocols, facility enhancements, and work-from-home strategies to protect our employees;
Ensuring that our manufacturing and supply chain operations remain intact and operational;
Keeping our workforce intact, including our experienced and specialized U.S. sales and clinical support team;
Developing new methods of supporting physicians remotely in their use of our RNS System;
Implementing virtual physician training programs to support opening new accounts with minimal in person interaction;
Continuing our physician education programs and direct-to-patient marketing efforts through social media and other virtual forums; and
Increasing our capital resources through the issuance of our Series B’ convertible preferred stock for gross proceeds of $33.0 million in August 2020 and through the completion of our IPO in April 2021.
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While our hospital customers began to gradually perform elective epilepsy procedures again during the second half of 2020, we saw another reduction in these procedures in late 2020 and early 2021. Although the growth of our business has slowed during the pandemic and we cannot give any assurance that the growth of our business will stabilize, we believe the recovery of our business beginning in the second half of 2020 is an encouraging sign. We believe the following key indicators are contributing to the stabilization of our business:
Strong physician participation in our virtual educational events;
Expansion into new accounts;
A significant patient pipeline;
Hospitals accepting patients for elective procedures at closer to normal levels.
Despite the encouraging signs of recovery of our business, we believe the challenges resulting from COVID-19 will likely continue for the duration of the pandemic, which is uncertain, and will continue to impact our revenue and negatively impact our business, financial condition and results of operations while the pandemic continues. While there was an increase in sales of our RNS System beginning in the second half of 2020 compared to the first half of 2020 while the COVID-19 pandemic was at its peak, and continuing in the first quarter of 2021, we saw another reduction in RNS procedures in late 2020 and early 2021 with another spike in COVID-19 cases. As a result, we cannot provide assurance that any recent increase in sales of our RNS System is indicative of future results or that we will not experience additional negative impacts associated with COVID-19, which could be significant. We believe that we may see fluctuations in RNS System procedures as the impact of COVID-19 continues. In addition, due to the pandemic, our patient pipeline may be reduced temporarily due to a delay in the diagnostic procedures that are used to identify appropriate patients for our RNS System. Further, once the pandemic subsides, there may be a substantial backlog of patients seeking appointments with physicians and procedures to be performed at hospitals for a variety of medical conditions and, as a result, patients seeking treatment with our RNS System may have to navigate limited provider capacity. We believe this limited provider and hospital capacity could have a significant adverse effect on our business, financial condition and results of operations throughout the remainder of and following the end of the pandemic. The extent to which the COVID-19 pandemic impacts our business will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity and spread of COVID-19 and the actions to contain the spread of COVID-19 or treat its impact, among others.
Our financial statements reflect judgments and estimates that could change in the future as a result of the COVID-19 pandemic.
Factors Affecting our Performance
We believe there are several important factors that have impacted and that we expect will continue to impact our business and results of operations. These factors include:
Clinician, Hospital and Patient Awareness and Acceptance of Our RNS System
Our goal is to establish our RNS System as a standard of care for drug-resistant epilepsy. We intend to continue to promote awareness of our RNS System through training and educating clinicians and epilepsy centers on the clinical benefits of our RNS System. In addition, we intend to publish additional clinical data in scientific journals and to continue presenting at medical conferences. We plan to continue building patient awareness through increasing direct-to-patient marketing initiatives, which include advertising, social media and online education. We also intend to continue supporting patient and referring clinician outreach efforts to help increase the number of patients with drug-resistant epilepsy being treated at Level 4 CECs. These efforts require significant investment by our marketing and sales organization. In order to grow our business within existing and new accounts, we will need to continue to make significant investments in educating clinicians, hospitals, and patients on the advantages of our RNS System for the treatment of drug-resistant epilepsy.
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Our Ability to Retain Our Experienced Commercial Team and Increase its Productivity
We have made significant investments in, and will continue to invest in, recruiting, training and retaining our experienced and specialized direct sales team, which includes Therapy Consultants and Field Clinical Engineers. Significant education and training is required for our team to achieve the level of technical competency with our products that is expected by clinicians and to gain experience building demand for our RNS System. Upon completion of initial training, our personnel typically require time in the field to grow their network of accounts, build relationships with clinicians and increase their productivity to the levels we expect. We believe successfully training, developing and retaining our Therapy Consultants and Field Clinical Engineers will be required to achieve growth. In addition, the loss of any productive sales personnel would have a negative impact on our ability to grow our business.
Competition
Our industry is highly competitive and subject to rapid change from the introduction of new products and technologies and the marketing activities of industry participants. There are two primary treatment alternatives for adults with drug-resistant epilepsy: (i) an ablative or resective surgery; and (ii) implantation of a neuromodulation device. Within neuromodulation, we currently compete with two manufacturers of neuromodulation devices. These companies have longer operating histories, significantly greater resources and name recognition, and established relationships with physicians and hospitals that treat patients with epilepsy. In addition to competing for market share, we also compete against these companies for personnel, including qualified sales and other personnel that are necessary to grow our business.
Leveraging Our Manufacturing Capacity to Further Improve Our Gross Margin
With our current operating model and infrastructure, we believe that we have the capacity to significantly increase our manufacturing production. If we grow our revenue and sell more RNS Systems, our fixed manufacturing costs will be spread over more units, which we believe will reduce our manufacturing costs on a per-unit basis and in turn improve our gross margin. In addition, we intend to continue investing in manufacturing efficiencies in order to reduce our overall manufacturing costs. However, other factors will continue to impact our gross margin such as the cost of materials, components and subassemblies, pricing, procedure mix, and geographic sales mix to the extent that we commercialize our RNS System outside of the United States.
Investing in Research and Development, Including Clinical Studies, to Expand Our Addressable Market
We intend to continue investing in clinical studies and existing and next generation technologies to further improve our RNS System and clinical outcomes, enhance the patient and provider experience and broaden the patient population that can be treated with our RNS System. In addition, we are continuing to leverage our extensive database of intracranial electroencephalogram, or iEEG, data and our advanced data analysis capabilities to equip clinicians with the data they need to establish optimal program settings for each patient.
While research and development and clinical studies are time consuming and costly, we believe that a pipeline of product enhancements and new products that improve efficacy, safety and ease of use is important for supporting increased adoption of our RNS System.
Change in Procedure Mix Due to Longer Device Replacement Cycle
We derive revenue from sales of our RNS System to hospital facilities both for initial RNS System implant procedures and for replacement procedures when our implanted devices reach end of service. We launched our current neurostimulator model in 2018. This device has an average battery life of approximately eight years, twice as long as the battery life of our prior neurostimulator model. The longer battery life results in fewer replacement procedures over a patient’s life time, providing a significant benefit to the patient. Revenue from our replacement procedures represented approximately 28% of our total revenue for the three months ended March 31, 2021 and approximately 32% of our total revenue for the year ended December 31, 2020. We expect that our revenue from replacement procedures will decrease over the next few years as a result of the extended replacement cycle of the
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newer device. In addition, a change in procedure mix between initial and replacement procedures may have a negative impact on our gross margin.
Components of Our Results of Operations
Revenue
We derive substantially all our revenue from sales of our RNS System to hospitals facilities (typically Level 4 CECs) that implant our RNS System. We currently deliver our RNS System to a hospital on the date of the scheduled procedure. There is no commitment to purchase our RNS System until the delivery of the product; the procedure may be canceled at any time.
Our revenue fluctuates primarily based on the volume of procedures performed and the procedure mix between initial and replacement implants. Our revenue also fluctuates and in the future will continue to fluctuate from quarter-to-quarter due to a variety of factors, including the success of our sales force in expanding adoption of our RNS System in new accounts and the number of physicians who are aware of and prescribe our RNS System.
Cost of Goods Sold and Gross Margin
Cost of goods sold consists primarily of costs related to materials, components and subassemblies, payroll and personnel-related expenses for our manufacturing and quality assurance employees, including expenses related to stock-based compensation, manufacturing overhead, charges for excess, obsolete and non-sellable inventories, and royalties. Overhead costs include the cost of quality assurance, testing, material procurement, inventory control, operations supervision and management personnel, an allocation of facilities and information technology expenses, including rent and utilities, and equipment depreciation. Cost of goods sold also includes certain direct costs such as those incurred for shipping our RNS System. We record adjustments to our inventory valuation for estimated excess, obsolete and non-sellable inventories based on assumptions about future demand, past usage, changes to manufacturing processes and overall market conditions. We expect cost of goods sold to increase in absolute dollars as more of our RNS Systems are sold.
We calculate gross margin as gross profit divided by revenue. Our gross margin has been and will continue to be affected by a variety of factors, primarily by our manufacturing costs and pricing. Our gross margin may increase over the long term to the extent our production volume increases as our fixed manufacturing costs would be spread over a larger number of units, thereby reducing our per-unit manufacturing costs. We expect our gross margin to fluctuate from period to period, however, based upon the factors described above.
Operating Expenses
Our operating expenses consist of research and development costs and selling, general and administrative costs.
Research and Development Expenses
Our research and development activities primarily consist of engineering and research programs associated with our products under development and clinical studies. Research and development expenses include payroll and personnel-related costs for our research and development employees, including expenses related to stock-based compensation, consulting services, clinical trial expenses, regulatory expenses, prototyping, testing, materials and supplies, and allocated overhead including facilities and information technology expenses. Our clinical trial expenses include costs associated with clinical trial design, clinical trial site development and study costs, data management costs, related travel expenses, the cost of products used for clinical activities, and costs associated with our regulatory compliance. We expense research and development costs as they are incurred. We expect our research and development expenses to increase in absolute dollars as we hire additional personnel to develop new product offerings and product enhancements and conduct studies for expanded indications for use.
Selling, General and Administrative Expenses
Our selling, general and administrative expenses consist primarily of payroll and personnel-related costs for our sales and marketing personnel, including stock-based compensation and sales-based variable compensation, travel
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expenses, consulting, public relations costs, direct marketing, customer training, trade show and promotional expenses and allocated facility and information technology expenses, and for administrative personnel that support our general operations such as executive management, information technology, finance, accounting, customer services, human resources and legal personnel. We expense sales variable compensation when revenue related to the underlying sale is recognized. Selling, general and administrative expenses also include costs attributable to professional fees for legal, accounting and tax services, insurance and recruiting fees.
We intend to continue to increase our marketing spending to support increased adoption of our RNS System. We expect our sales and marketing expenses to increase in absolute dollars as we add programs in order to more fully penetrate the market opportunity. We expect our administrative expenses, including stock-based compensation expense, to increase as we increase our headcount and expand our systems to support our operations as a public company. Additionally, we anticipate increased expenses related to audit, legal, regulatory and tax-related services associated with being a public company, compliance with exchange listing and Securities and Exchange Commission, or SEC, requirements, director and officer insurance premiums and investor relations costs. Our selling, general and administrative expenses may fluctuate from period to period as we continue to grow.
Interest Expense
Interest expense consists primarily of interest expense related to our term loan facilities and convertible notes, including amortization of debt discount and issuance costs.
Other Income (Expense), Net
Other income (expense), net primarily consists of changes in the fair value of our derivative instrument and redeemable convertible preferred stock warrant liability.
Results of Operations
Comparison of the Three Months Ended March 31, 2021 and 2020
The following table summarizes our results of operations for the periods indicated (in thousands):
Three Months Ended March 31,
20212020Change% Change
Revenue$11,217 $9,975 $1,242 12 %
Cost of goods sold2,7242,918(194)(7)%
Gross profit8,4937,0571,43620 %
Operating expenses
Research and development4,1004,833(733)(15)%
Selling, general and administrative8,2677,682585%
Total operating expenses12,36712,515(148)(1)%
Loss from operations(3,874)(5,458)1,584(29)%
Interest expense(1,849)(2,998)1,149(38)%
Other income (expense), net(3,087)1,715(4,802)NM
Net loss$(8,810)$(6,741)$(2,069)31 %
NM = Not meaningful
Revenue
Revenue increased by $1.2 million, or 12%, to $11.2 million during the three months ended March 31, 2021, compared to $10.0 million during the three months ended March 31, 2020. The increase in revenue was due to an increase in the number of units sold for initial implant procedures in the three months ended March 31, 2021 as
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compared to the three months ended March 31, 2020. All of our revenue was generated from sales in the United States.
Cost of Goods Sold and Gross Margin
Cost of goods sold decreased by $0.2 million, or 7%, to $2.7 million during the three months ended March 31, 2021, compared to $2.9 million during the three months ended March 31, 2020. The decrease primarily resulted from lower fixed costs per unit associated with increased volume in the three months ended March 31, 2021 compared to the prior period, as well as ongoing efforts to lower our manufacturing costs. Cost of goods sold in the three months ended March 31, 2020 was impacted by unfavorable manufacturing variances from lower production in March 2020 as a result of the COVID-19 pandemic. Our gross margin increased from 70.7% for the three months ended March 31, 2020 to 75.7% for the three months ended March 31, 2021.
Research and Development Expenses
Research and development expenses decreased by $0.7 million, or 15%, to $4.1 million during the three months ended March 31, 2021, compared to $4.8 million during the three months ended March 31, 2020. The decrease in research and development expenses was primarily due to a decrease of $0.5 million in payroll and personnel-related expenses primarily due to COVID-19 expense reduction efforts, and a decrease of $0.3 million in allocated facilities related expenses, including rent, depreciation, information technology costs and utilities. The decreases were offset in part by an increase of $0.1 million in costs associated with our clinical studies.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased by $0.6 million, or 8%, to $8.3 million during the three months ended March 31, 2021, compared to $7.7 million during the three months ended March 31, 2020. The increase in selling, general and administrative expenses was primarily due to an increase of $0.7 million in general and administrative costs including outside services, legal expenses, and recruiting related expenses, and an increase of $0.7 million in in payroll and personnel-related expenses primarily due to the adoption of new and updated incentive programs. The increases were offset in part by a decrease of $0.5 million in sales and field support costs including travel related expenses, and a decrease of $0.2 million in marketing costs including contractors, advertising, marketing collateral and travel related costs, in each case due to COVID-19 restrictions being in place for the full first quarter of 2021.
Interest Expense
Interest expense decreased by $1.1 million, or 38%, to $1.8 million during the three months ended March 31, 2021, compared to $3.0 million during the three months ended March 31, 2020 primarily due to lower average balances of our convertible notes and term loans during the three months ended March 31, 2021 compared to the three months ended March 31, 2020.
Other Income (Expense), net
Other income (expense), net decreased by $4.8 million to ($3.1) million during the three months ended March 31, 2021, compared to $1.7 million during the three months ended March 31, 2020, which was primarily due to an increase in the fair value of redeemable convertible preferred stock warrant liability of $3.1 million in the three months ended March 31, 2021, and a decrease in the fair value of derivative instrument of $1.7 million in the three months ended March 31, 2020.

Liquidity and Capital Resources
Prior to our IPO, we financed our operations primarily through private placements of equity securities, debt financing arrangements and sales of our RNS System. As of March 31, 2021, we had cash, cash equivalents and short-term marketable debt securities of $30.5 million, an accumulated deficit of $396.5 million, and $53.2 million outstanding under the New Term Loan and PPP Loan, net of debt discount and issuance costs. In January and March
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2020, we received $7.1 million and $5.4 million, respectively, in gross proceeds through the sale and issuance of the 2020 Convertible Notes. In August 2020, we received $33.0 million in gross proceeds from the sale and issuance of our Series B’ convertible preferred stock. In September 2020, we entered into the New Term Loan for total borrowings of up to $60 million and borrowed $50 million. We used the proceeds from the New Term Loan to repay principal of $44.1 million, interest of $1.3 million and fees of $2.2 million due under the outstanding Term Loan. In April 2021, we completed our IPO and received $105.2 million in net proceeds after deducting underwriting discounts and commissions and offering costs, of which $4.1 million was used to repay the PPP loan.
2014 Term Loan
In November 2014, we entered into a Term Loan Agreement, as amended, for total borrowings of up to $40.0 million with Capital Royalty Partners II L.P. and its affiliates. As of December 31, 2019, $40.0 million had been funded under this Term Loan Agreement, or the Term Loan. The Term Loan bore interest at a rate of 12.5% per annum based on a 360-day year and actual days elapsed. Payments under the Term Loan were to be made quarterly with payment dates fixed at the end of each calendar quarter, or the Payment Dates. Through September 30, 2017, we had the option to pay interest as follows: 8.0% per annum paid in cash and 4.5% per annum paid-in-kind, or PIK, by increasing the principal of the loan. On each Payment Date through September 30, 2016, we elected the PIK option, issuing PIK notes totaling $2.7 million. On each Payment Date from December 31, 2016 through December 31, 2019, we paid all interest due in cash.
The Term Loan was interest-only through September 30, 2019. Following the interest-only period, principal payments were to be made in equal installments at the end of the next four calendar quarters, with the final payment due on September 30, 2020. The Term Loan included a fee upon repayment of the loan equal to 5% of the aggregate principal amount being prepaid or repaid. We ratably accreted the fee over the life of the loan.
In connection with the Term Loan, we paid total closing fees of $0.8 million and issued warrants to purchase 219 shares of our Series I convertible preferred stock at $1,866.80 per share. The initial fair value of the warrants was $0.3 million and resulted in a discount to the Term Loan, which was amortized to interest expense over the life of the loan using the effective interest method. Prior to 2019, these warrants were modified to be exercisable for 219 shares of common stock at $2.60 per share, all of which were outstanding as of March 31, 2021.
In October 2019, the Term Loan was amended to extend the interest-only period through December 31, 2019. Further, through June 2020, the Term Loan was amended to extend the interest-only period through June 30, 2020 and to allow us to pay such interest entirely in kind by adding it to the aggregate principal of the loan. We paid $1.4 million interest due on March 31, 2020 in kind and paid $1.4 million interest due on June 30, 2020 in cash. In September 2020, we repaid the entire obligation under the Term Loan using the proceeds received from the New Term Loan.
2019 and 2020 Convertible Notes
In March and September 2019, we issued convertible notes, or the 2019 Convertible Notes, to certain investors for aggregate proceeds of $21.3 million. In January and March 2020, we raised $7.1 million and $5.4 million, respectively, through the sale and issuance of the 2020 Convertible Notes. Proceeds received from the issuance of 2020 Convertible Notes were used to fund operating expenses and other liquidity needs. The 2019 and 2020 Convertible Notes were subordinated to the Term Loan, bore a simple interest on the outstanding principal amount at the rate of 8.0% per annum and had a maturity date of December 31, 2020. In connection with the sale and issuance of our Series B’ convertible preferred stock, our 2019 and 2020 Convertible Notes converted into shares of our Series B’ convertible preferred stock.
The 2019 and 2020 Convertible Notes contained embedded derivative instruments, including automatic conversion into equity securities upon completion of a Qualified Financing, that were required to be bifurcated and accounted for separately as a single derivative instrument initially and were subsequently measured at fair value with the change in fair value recorded in other income (expense), net in the statements of operations and comprehensive loss. The issuance date estimated fair values of the derivative instruments related to the March and September 2019 Convertible Notes were $4.1 million and $1.9 million, respectively, which were recorded as debt discounts. The issuance date estimated fair values of the derivative instruments related to the January and March 2020 notes were
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$1.0 million and $0.7 million, respectively, which were recorded as debt discounts. In August 2020, the derivative instrument was extinguished in connection with the issuance of Series B’ redeemable convertible preferred stock.
The discount on the 2019 and 2020 Convertible Notes was amortized over the contractual term ending on December 31, 2020, using the effective interest method. The annual effective interest rate was estimated from 10.8% to 12.2% per year. Interest expense for the three months ended March 31, 2020 was $1.4 million, consisting of $0.9 million of contractual interest expense and $0.5 million amortization of debt discount arising from separation of the embedded derivative instrument.
Series B’ Convertible Preferred Stock
In August 2020, we received gross proceeds of $33.0 million by issuing and selling 7,599,720 shares of our Series B’ convertible preferred stock at a price of $4.3423 per share. All outstanding convertible notes and accrued unpaid interest were converted into 8,379,410 shares of Series B’ convertible preferred stock at such price. The conversion of the 2019 and 2020 Convertible Notes into shares of Series B’ convertible preferred stock was accounted for as a debt extinguishment with $4.1 million extinguishment gain recognized as a deemed capital contribution to additional paid-in capital in the quarter ended September 30, 2020, as the holders of the notes were existing stockholders of the Company. Upon the closing of our IPO, all outstanding shares of redeemable convertible preferred stock automatically converted into 16,614,178 shares of common stock.
2020 Term Loan
In September 2020, we entered into the New Term Loan with CRG Partners IV L.P. and its affiliates for total borrowings of up to $60 million and borrowed $50 million. We used the proceeds from the New Term Loan to repay principal of $44.1 million, interest of $1.3 million and fees of $2.2 million due under our previous Term Loan. The remaining $10.0 million will be available to us for borrowing until March 31, 2022 if we achieve a revenue-based milestone in 2021. The borrowings under the New Term Loan are secured by substantially all of our properties, rights and assets, including intellectual property.
The loan bears interest at a rate of 12.5% per year. Payments under the loan are made quarterly with payment dates fixed at the end of each calendar quarter. The loan was interest-only through September 30, 2023, which could be extended through September 30, 2025 at our option if we completed our IPO on or prior September 30, 2023. In connection with closing the IPO, we extended the interest-only period to September 30, 2025. Following the interest-only period, principal payment is due in one installment on September 30, 2025. The New Term Loan includes a fee upon repayment of the loan equal to 10% of the aggregate principal amount being prepaid or repaid.
We paid $1.0 million in fees to the lender and third parties which is reflected as a discount on the loan and is being accreted over the life of the loan using the effective interest method.
Paycheck Protection Program
In April 2020, we received $4.0 million from a federal Small Business Administration loan under the Paycheck Protection Program. The note bears interest at 1.0% per year on the outstanding principal amount and matures 24 months from the date of the note. Payments of principal and interest are due from September 2021 through April 2022. In April 2021, we repaid our entire obligation under the PPP Loan amounting to $4.1 million, including principal of $4.0 million and interest of less than $0.1 million, using the proceeds from our IPO.
Future Funding Requirements
We expect to incur continued expenditures in the future in support of our commercialization efforts in the United States. In addition, we intend to continue to make investments in clinical studies, development of new products, and other ongoing research and development programs. We also expect to incur additional costs associated with operating as a public company. We may incur additional expenses to expand our commercial organization and efforts, further enhance our research and development efforts and pursue commercial opportunities outside of the United States.
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As of March 31, 2021, we had cash, cash equivalents and short-term marketable debt securities of $30.5 million. Based on our current planned operations, we expect that our cash, cash equivalents and short-term marketable debt securities, together with the net proceeds of approximately $105.2 million from our IPO, which closed in April 2021, will enable us to fund our operating expenses for at least 12 months from the issuance of our condensed financial statements as of and for the three months ended March 31, 2021. We have based these estimates on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we expect.
Because of the numerous risks and uncertainties associated with research, development and commercialization of medical devices, we are unable to estimate the exact amount of our working capital requirements. Our future funding requirements will depend on many factors, including:
the costs of activities related to commercializing and marketing our RNS System in the United States and elsewhere, and manufacturing and distribution costs;
the research and development activities we intend to undertake, including product enhancements and clinical studies for indication expansions that we intend to pursue;
the impact of the COVID-19 pandemic on our business;
the cost of obtaining, maintaining, defending, enforcing, and protecting any patents and other intellectual property rights;
whether or not we pursue acquisitions or investments in businesses, products or technologies that are complementary to our current business;
the degree and rate of increased market acceptance of our RNS System in the United States and market acceptance elsewhere;
our need to implement additional infrastructure and internal systems;
our ability to hire additional personnel to support our operations as a public company; and
the emergence of competing technologies or other adverse market developments.
If we do raise additional capital through public or private equity or convertible debt offerings, the ownership interest of our existing stockholders will be diluted, and the terms of these securities may adversely affect our stockholders’ rights. If we raise additional capital through debt financing, we may be subject to covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. If we are unable to raise capital when needed, we will need to delay, limit, reduce or terminate planned commercialization or product development activities in order to reduce costs. In addition, COVID-19 has negatively impacted our business by decreasing and delaying procedures performed to implant our RNS System, and we expect the pandemic will continue to negatively impact our business, which may negatively impact our future liquidity.
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Summary Statements of Cash Flows
The following table sets forth the primary sources and uses of cash and cash equivalents for the periods presented below (in thousands):
Three Months Ended March 31,
20212020
Net cash provided by (used in):
Operating activities$(5,936)$(6,548)
Investing activities(5,035)(471)
Financing activities(1,578)12,520 
Net decrease in cash and cash equivalents$(12,549)$5,501 
Cash Flows (Used in) Operating Activities
Net cash used in operating activities was $5.9 million for the three months ended March 31, 2021. Cash used in operating activities was primarily a result of the net loss of $8.8 million, adjusted for non-cash charges of $3.7 million and change in operating assets and liabilities of $0.8 million. The non-cash charges primarily consisted of $3.1 million in change in the fair value of redeemable convertible preferred stock warrant liability. The change in operating assets and liabilities was due to a decrease in accrued liabilities of $1.0 million largely due to the payout of annual bonuses offset in part by an increase in accounts payable of $0.5 million primarily due to the timing of payments to our vendors.
Net cash used in operating activities was $6.5 million for the three months ended March 31, 2020. Cash used in operating activities was primarily a result of the net loss of $6.7 million, adjusted for non-cash charges of $1.8 million and change in operating assets and liabilities of $1.6 million. The non-cash charges primarily consisted of $1.6 million of non-cash interest expense related to our term loans and convertible notes, $1.4 million in PIK interest incurred but not paid on term loan offset in part by $1.7 million in change in the fair value of derivative instrument. The change in operating assets and liabilities was due to a decrease in accrued liabilities of $1.7 million, offset by a decrease in inventories of $0.3 million. The decrease in accrued liabilities was primarily the result of the timing of payments to our vendors.
Cash Flows (Used in) Investing Activities
Net cash used in investing activities was $5.0 million for the three months ended March 31, 2021, which primarily consisted of purchases of marketable debt securities of $5.0 million.
Net cash used in investing activities was $0.5 million for the three months ended March 31, 2020, which consisted of purchases of marketable debt securities of $6.8 million, which amounts were partially offset by proceeds from sale of marketable debt securities of $6.3 million.
Cash Flows (Used in) Provided by Financing Activities
Net cash used in financing activities was $1.6 million for the three months ended March 31, 2021, which primarily relates to payment of deferred offering costs of $1.6 million.
Net cash provided by financing activities was $12.5 million for the three months ended March 31, 2020, which primarily relates to proceeds of $12.5 million from the issuance of convertible notes.
Contractual Obligations and Commitments
There have been no material changes to our contractual obligations as of March 31, 2021, as compared to those disclosed in the final prospectus for the IPO filed with the SEC pursuant to Rule 424(b)(4) on April 23, 2021.
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Off-Balance Sheet Arrangements
Since our inception, we have not engaged in any off-balance sheet