NeuroPace Inc 10-K

Item 8. Financial Statements and Supplementary Data. 113 INDEX TO FINANCIAL STATEMENTS Page(s) Report of Independent Registered Public Accounting Firm (PCAOB ID 238 ) 115 Financial Statements: Balance Sheets 116 Statements of Operations and Comprehensive Loss 117 Statements of Stockholders’ Equity 118 Statements of Cash Flows 119 Notes to Financial Statements 121 114 Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of NeuroPace, Inc. Opinion on the Financial Statements We have audited the accompanying balance sheets of NeuroPace, Inc. (the “Company”) as of December 31, 2023 and 2022, and the related statements of operations and comprehensive loss, of stockholders’ equity and of cash flows for the years then ended, including the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2023 and 2022, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. Basis for Opinion These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits of these financial statements in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Emphasis of Matter As disclosed in Note 6 to the financial statements, the Company has a term loan maturing in September 2025. Management’s evaluation of the events and conditions related to future funding are described in Note 1. /s/ PricewaterhouseCoopers LLP San Jose, California March 5, 2024 We have served as the Company's auditor since 2003. 115 NeuroPace, Inc. Balance Sheets December 31, (in thousands, except share and per share amounts) 2023 2022 Assets Current assets Cash and cash equivalents $ 18,058 $ 6,605 Short-term investments 48,396 70,804 Accounts receivable 12,314 7,482 Inventory 11,214 9,712 Prepaid expenses and other current assets 2,737 3,111 Total current assets 92,719 97,714 Property and equipment, net 1,003 1,064 Operating lease right-of-use asset 13,405 14,838 Restricted cash 122 122 Deferred offering costs 387 347 Other assets 15 21 Total assets $ 107,651 $ 114,106 Liabilities and Stockholders’ Equity Current liabilities Accounts payable $ 2,332 $ 2,147 Accrued liabilities 11,180 7,414 Operating lease liability 1,627 1,415 Deferred revenue 1,090 — Total current liabilities 16,229 10,976 Long-term debt 56,954 52,913 Operating lease liability, net of current portion 13,814 15,440 Total liabilities 86,997 79,329 Commitments and contingencies (Note 5) Stockholders’ equity Preferred stock, $ 0.001 par value, 10,000,000 shares authorized and no shares issued and outstanding as of December 31, 2023 and December 31, 2022 — — Common stock, $ 0.001 par value, 200,000,000 shares authorized as of December 31, 2023 and December 31, 2022; 27,823,465 and 25,045,751 shares issued and outstanding as of December 31, 2023 and December 31, 2022, respectively 28 25 Additional paid-in-capital 524,435 506,713 Accumulated other comprehensive loss — ( 1,108 ) Accumulated deficit ( 503,809 ) ( 470,853 ) Total stockholders’ equity 20,654 34,777 Total liabilities and stockholders’ equity $ 107,651 $ 114,106 The accompanying notes are an integral part of these financial statements. 116 NeuroPace, Inc. Statements of Operations and Comprehensive Loss Year Ended December 31, (in thousands, except share and per share amounts) 2023 2022 Revenue $ 65,421 $ 45,520 Cost of goods sold 17,299 13,027 Gross profit 48,122 32,493 Operating expenses Research and development 20,778 21,946 Selling, general and administrative 54,518 51,341 Total operating expenses 75,296 73,287 Loss from operations ( 27,174 ) ( 40,794 ) Interest income 3,050 1,578 Interest expense ( 8,517 ) ( 7,529 ) Other income (expense), net ( 315 ) ( 337 ) Net loss $ ( 32,956 ) $ ( 47,082 ) Unrealized loss on available-for-sale debt securities — ( 836 ) Comprehensive loss $ ( 32,956 ) $ ( 47,918 ) Net loss per share attributable to common stockholders, basic and diluted $ ( 1.27 ) $ ( 1.91 ) Weighted-average shares used in computing net loss per share attributable to common stockholders, basic and diluted 25,851,813 24,594,784 The accompanying notes are an integral part of these financial statements. 117 NeuroPace, Inc. Statements of Stockholders’ Equity Common Stock Additional Paid-In Capital Accumulated Other Comprehensive Loss Accumulated Deficit Total Stockholders’ Equity (in thousands, except share amounts) Shares Amount Balances at January 1, 2022 24,452,999 $ 24 $ 497,522 $ ( 272 ) $ ( 423,771 ) $ 73,503 Net loss — — — — ( 47,082 ) ( 47,082 ) Unrealized loss on available-for-sale debt securities — — — ( 836 ) — ( 836 ) Issuance of common stock pursuant to stock option exercises 157,447 — 4 — — 4 Issuance of common stock pursuant to Employee Stock Purchase Plan 284,758 1 893 — — 894 Issuance of common stock upon vesting of restricted stock units 194,705 — — — — — Shares withheld for taxes ( 8,436 ) — ( 59 ) — — ( 59 ) Repurchase of common stock ( 35,722 ) — — — — — Change in early exercise liability — — 4 — — 4 Stock-based compensation — — 8,349 — — 8,349 Balances at December 31, 2022 25,045,751 25 506,713 ( 1,108 ) ( 470,853 ) 34,777 Net loss — — — — ( 32,956 ) ( 32,956 ) Unrealized loss adjustment for short-term investment — — — 1,108 — 1,108 Issuance of common stock pursuant to stock option exercises 889,968 1 148 — — 149 Issuance of common stock pursuant to Employee Stock Purchase Plan 280,599 — 654 — — 654 Issuance of common stock as part of At-the-Market offering, net of issuance costs of $ 509 933,500 1 7,621 — — 7,622 Issuance of common stock upon vesting of restricted stock units 728,986 1 ( 1 ) — — — Shares withheld for taxes ( 53,999 ) — ( 259 ) — — ( 259 ) Repurchase of common stock ( 1,340 ) — — — — — Change in early exercise liability — — 1 — — 1 Stock-based compensation — — 9,558 — — 9,558 Balances at December 31, 2023 27,823,465 $ 28 $ 524,435 $ — $ ( 503,809 ) $ 20,654 The accompanying notes are an integral part of these financial statements. 118 NeuroPace, Inc. Statements of Cash Flows Year Ended December 31, (in thousands) 2023 2022 Cash flows from operating activities Net loss $ ( 32,956 ) $ ( 47,082 ) Adjustments to reconcile net loss to net cash used in operating activities Stock-based compensation expense 9,558 8,349 Depreciation 172 267 Amortization of debt discount and issuance costs 283 258 Non-cash interest expense 1,075 874 PIK interest incurred but not paid on term loan 2,683 1,934 Amortization of right-of-use asset 1,433 2,720 Loss on short-term investments 315 356 Inventory write-downs 196 243 Other 24 — Changes in operating assets and liabilities Accounts receivable ( 4,850 ) ( 391 ) Inventory ( 1,698 ) ( 2,133 ) Prepaid expenses and other assets 381 ( 792 ) Accounts payable 240 647 Accrued liabilities 3,768 ( 15 ) Deferred revenue 1,090 — Operating lease liabilities ( 1,415 ) ( 2,104 ) Net cash used in operating activities ( 19,701 ) ( 36,869 ) Cash flows from investing activities Acquisition of property and equipment ( 173 ) ( 603 ) Proceeds from sale of short-term investments 23,200 24,400 Net cash provided by investing activities 23,027 23,797 Cash flows from financing activities Proceeds from issuance of common stock under employee plans 803 896 Taxes withheld and paid related to net share settlement of equity awards ( 259 ) ( 59 ) Proceeds from at-the-market offering, net of issuance costs 7,888 — Payment of deferred offering costs ( 305 ) ( 347 ) Net cash provided by financing activities 8,127 490 Net increase (decrease) in cash and cash equivalents 11,453 ( 12,582 ) Cash, cash equivalents and restricted cash Beginning of year 6,727 19,309 End of year $ 18,180 $ 6,727 Reconciliation of cash, cash equivalents and restricted cash to balance sheets: Cash and cash equivalents $ 18,058 $ 6,605 Restricted cash 122 122 Total cash, cash equivalents and restricted cash $ 18,180 $ 6,727 Supplemental disclosure of cash flow information: Cash paid for interest $ 4,476 $ 4,464 Supplemental disclosures of non-cash investing and financing information: The accompanying notes are an integral part of these financial statements. 119 NeuroPace, Inc. Statements of Cash Flows Operating lease right-of-use asset obtained in exchange for lease obligations $ — $ 10,700 Net change in accrued liabilities from early exercise of options $ ( 1 ) $ ( 4 ) Purchase of property and equipment included in accounts payable $ 69 $ 124 Deferred offering costs offset against additional paid-in capital $ 265 $ — The accompanying notes are an integral part of these financial statements. 120 NeuroPace, Inc. Notes to 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 medical device company that has developed the RNS System, the only commercially available 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. At-the-Market Equity Offering In November 2022, the Company filed a Registration Statement on Form S-3, or Shelf, with the Securities and Exchange Commission in relation to the registration of common stock, preferred stock, debt securities, warrants or any combination thereof for up to an aggregate of $ 150.0 million, of which $ 50.0 million may be issued and sold pursuant to an at-the-market, or ATM, offering program for sales of the Company’s common stock under a sales agreement, or Sales Agreement, with Leerink Partners LLC, or Leerink (formerly SVB Securities LLC). The Company agreed to pay Leerink up to 3.0 % of the gross proceeds of sales of common stock made through the Sales Agreement. The Company’s common stock would be sold at prevailing market prices at the time of the sale and, as a result, prices may vary. In November 2023, the Company issued and sold 933,500 shares of common stock under the Sales Agreement for gross proceeds of $ 8.1 million. The shares were sold at a weighted average price of $ 8.71 per share for aggregate net proceeds of approximately $ 7.6 million, after deducting sales commission and offering expenses. As of December 31, 2023, we have $ 41.9 million remaining under our ATM program. Liquidity and Capital Resources The Company has incurred operating losses and negative cash flows from operations since its inception and has an accumulated deficit of $ 503.8 million as of December 31, 2023. For the years ended December 31, 2023 and 2022, the Company used $ 19.7 million and $ 36.9 million of cash, respectively, in its operating activities. As of December 31, 2023, the Company had cash, cash equivalents and short-term investments of $ 66.5 million. Historically, the Company has funded its operations principally through the sales of its products, issuance of equity securities and debt financing. The Company’s 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 will allow the Company to continue its planned operations for at least the next 12 months from the date of the issuance of these financial statements. In connection with the 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 of $ 45.0 million and $ 70.0 million in the years ended December 31, 2023 and December 31, 2024, respectively, and maintain a minimum cash and cash equivalents balance of $ 5.0 million. 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 capital, and resulting in a going concern. The Company’s ability to raise additional capital may be adversely impacted by global economic conditions and disruptions to, and volatility in, the financial markets in the United States and worldwide. If the Company is unable to raise capital when needed, it will need to delay, limit, reduce or terminate planned commercialization or product development activities in order to reduce costs. As of December 31, 2023, the Company was in compliance with all covenants of the Term Loan. 2. Summary of Significant Accounting Policies Basis of Presentation The 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. 121 NeuroPace, Inc. Notes to Financial Statements Use of Estimates The preparation of 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 provision for excess and obsolete inventories. 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. Segment and Geographical Information The Company operates and manages its business as one reportable and operating segment. The Company’s chief executive officer, who is the chief operating decision maker, reviews financial information on an aggregate basis for purposes of allocating resources and evaluating financial performance. All of the Company’s long-lived assets, comprised of property and equipment, are based in the United States. All of the Company’s revenue, with the exception of less than $ 0.1 million, was in the United States for the year ended December 31, 2023, based on the shipping location of the external customer. All of the Company’s revenue was in the United States for the year ended December 31, 2022, based on the shipping location of the external customer. Revenue Recognition The Company derives most of its revenue from sales of RNS Systems to hospital facilities (typically comprehensive epilepsy centers, or Level 4 CECs) that implant its products. Beginning in the fourth quarter of 2022, the Company also derives revenue from sales of DIXI Medical products, primarily to its current customer base. Beginning in the fourth quarter of 2023, the Company also derives revenue from services provided to Rapport Therapeutics, or Rapport. The Company recognizes revenue in accordance with Accounting Standards Codification, or ASC, 606, “Revenue from Contracts with Customers.” Under ASC 606, revenue is recognized when a customer obtains control of promised goods or services, in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. To determine revenue recognition for arrangements that an entity determines are within the scope of ASC 606, the Company performs the following five steps: i. identify the contract(s) with a customer; ii. identify the performance obligations in the contract; iii. determine the transaction price; iv. allocate the transaction price to the performance obligations in the contract; and v. recognize revenue when (or as) the entity satisfies a performance obligation. At contract inception, the Company assesses the products or services promised within each contract and determines those that are performance obligations. The Company’s contracts with customers for the RNS System often include a promise to transfer products, as well as an implied promise to provide a service to the customer, which is access to the Company’s Patient Data Management System, or PDMS, and nSight Platform. The Company has concluded that the RNS System and its related products represent a single performance obligation, as the customer cannot benefit from the products individually, and that access to the PDMS and nSight Platform represent separate performance obligations, as the clinicians can utilize them with other components of the RNS System that are readily available. The Company determines the transaction price based on the amount it expects to be entitled to in exchange for transferring the promised product or service to the customer, which is based on the invoiced price for the products or 122 NeuroPace, Inc. Notes to Financial Statements services. All prices are at fixed amounts per the sales agreement with the customer and there are no discounts, rebates or other price concessions. When a contract contains multiple performance obligations, the Company allocates the transaction price to each performance obligation based on its relative standalone selling price. Standalone selling prices are based on observable prices at which the Company separately sells its products or services. If a standalone selling price is not directly observable, the Company estimates the standalone selling price considering market data, cost, gross margin, and other available information. The Company typically delivers its RNS System and related products to a hospital on the date of the scheduled procedure. There is no commitment or contract until the delivery of the product and the procedure may be canceled at any time. Once the device has been implanted in or otherwise provided to a patient, the customer is considered to have accepted the delivery (i.e., has approved the contract) and both parties are committed to perform their respective obligations. Assuming all other revenue recognition criteria are met, the Company recognizes revenue from the sale of its RNS System and related products at a point in time when the procedure is completed and the device is implanted in a patient. The Company also ships the RNS System and related products to customers who place orders ahead of scheduled procedures. Such orders or contracts generally include a promise to transfer products only. As such, the Company recognizes revenue from these orders or contracts at a point in time when the customer obtains control of the products. The Company recognizes service revenue related to the PDMS and the nSight Platform on a ratable basis over the period in which the Company expects to provide access to clinicians. The Company has concluded that such service revenue is immaterial. The Company’s contracts with customers for DIXI Medical products generally include a promise to transfer products only. As such, the Company recognizes revenue from the sale of DIXI Medical products at a point in time when the customer obtains control of the products. The Company recognizes revenue under its contract with Rapport to provide biomarker monitoring and data analysis services. Revenue from biomarker monitoring is recognized ratably over the two-year contractual support period, as the benefits provided by the Company’s performance are simultaneously consumed by the customer. Revenue related to data analysis is recognized upon completion of the services. The Company’s contract with Rapport commenced during the fourth quarter of 2023, and the related revenue recognized as of December 31, 2023 is immaterial. The Company recognizes revenue for arrangements where it has satisfied its performance obligations but has not issued invoices. These amounts are recorded as unbilled receivables, which are included in accounts receivable on the balance sheet, as the Company has an unconditional right to payment at the end of the applicable period. Payment terms are typically 30 days from the fulfillment of the orders and fall within the one-year guidance for the practical expedient which allows the Company to forgo adjustment of the promised amount of consideration for the effects of a significant financing component. Sales taxes that are collected from customers and remitted to governmental authorities are accounted for on a net basis and therefore are excluded from net sales, however, most of the Company’s sales are tax exempt. The Company believes that collection is probable as it has no history of uncollectible accounts and the customers are large, creditworthy institutions. As allowed under the practical expedient, the Company does not disclose the value of unsatisfied performance obligations for contracts with an original expected length of one year or less. Costs associated with product sales include commissions, where the Company applies the practical expedient and recognizes commissions as expense when incurred because the expense is incurred over a period of time of less than one year. Commissions are reported in selling, general and administrative expense in the statements of operations and comprehensive loss. The Company’s contract balances were accounts receivable of $ 12.3 million and $ 7.5 million as of December 31, 2023, and December 31, 2022, respectively. 123 NeuroPace, Inc. Notes to Financial Statements The Company’s contract liabilities consist of deferred revenue for remaining performance obligations by the Company to transfer goods or services for which the Company has received consideration. The Company’s deferred revenue balance was $ 1.1 million as of December 31, 2023, which is expected to be recognized as revenue in 2024. The Company had no deferred revenue as of December 31, 2022. 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. The Company has a short-term investment in a fixed income mutual fund, which is classified as equity security and carried at fair value based on quoted market prices. Changes in the fair value of the short-term investment are recorded in income or loss. 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. 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). Cash and Cash Equivalents The Company considers all highly liquid investments with original maturities of three months or less at the time of purchase to be cash equivalents. Cash equivalents that are available-for-sale investments are recorded at fair value, based on quoted market prices. As of December 31, 2023 and December 31, 2022, the Company’s cash equivalents are entirely comprised of investments in money market funds. Restricted Cash Restricted cash is comprised of cash that is restricted as to withdrawal or use under the terms of certain contractual agreements. Restricted cash for the years ended December 31, 2023 and December 31, 2022 consists of collateral for the letter of credit issued during the year in connection with the Company’s facility lease (see Note 5). 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 sheets. The Company’s cash is invested in major financial institutions in the United States. Deposits in these financial institutions may exceed federally insured limits, and the Company is exposed to credit risk on deposits in the event of default of the financial institutions to the extent account balances exceed the amount insured by the Federal Deposit Insurance Corporation. 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 years ended December 31, 2023 and December 31, 2022, there were no customers that represented 10% or more of revenue. As of December 31, 2023 and December 31, 2022, 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 or continue to 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 speed 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 on healthcare providers to prescribe initial implants and replacements, 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 comprehensive epilepsy centers, or CECs, and epileptologists, obtaining, maintaining, protecting, enforcing, and defending intellectual property rights and proprietary technology, product liability claims, legal proceedings, and compliance with government regulations. 124 NeuroPace, Inc. Notes to Financial Statements 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. Accounts Receivable Accounts receivable are recorded at the invoiced amount and do not bear interest. The Company makes estimates on the collectability of customer accounts based primarily on analysis of historical trends and experience, the age of the receivable and changes in customers’ financial condition. The Company uses its judgment, based on the best available facts and circumstances, and records an allowance against amounts due to reduce the receivable to the amount that is expected to be collected. The Company determined that no allowance was required as of December 31, 2023 and December 31, 2022. To date, the Company has not experienced any material credit-related losses. Inventories Inventories are valued at the lower of cost or net realizable value. Cost is determined using the first-in, first-out method for all inventories. Net realizable value is determined as the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. The Company regularly reviews inventory quantities in consideration of actual loss experiences, projected future demand, and remaining shelf life to record a provision for excess and obsolete inventory when appropriate. The Company’s policy is to write down inventory that has become obsolete, inventory that has a cost basis in excess of its expected lower of cost or net realizable value, and inventory in excess of expected requirements. The estimate of excess quantities is judgmental and primarily dependent on the Company’s estimates of future demand for a particular product. If the estimate of future demand is too high, the Company may have to increase the reserve for excess inventory for that product and record a charge to the cost of goods sold. Inventory write-downs were $ 0.2 million and $ 0.2 million for the years ended December 31, 2023 and December 31, 2022, respectively. Property and Equipment, net Property and equipment, net is stated at cost less accumulated depreciation. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets, generally three to five years . Leasehold improvements are amortized using the straight-line method over the shorter of the assets’ estimated useful lives or the remaining term of the lease. When assets are retired or otherwise disposed of, the cost and accumulated depreciation are removed from the balance sheet, and any resulting gain or loss is reflected in operations in the period realized. Maintenance and repairs are charged to operations as incurred. Impairment of Long-Lived Assets The Company reviews long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If indicators of impairment exist, an impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of the assets and their eventual disposition are less than their carrying amount. Impairment, if any, is measured as the amount by which the carrying amount of the long-lived assets exceeds their fair value. The Company did no t record any impairment of long-lived assets for the years ended December 31, 2023 and December 31, 2022. Leases Upon adoption of ASC 842, Leases , on January 1, 2022, the Company determined if an arrangement is a lease, or contains a lease, at inception. Operating leases are included in operating lease right-of-use, or ROU, assets, operating lease liability, and operating lease liability, net of current portion on the Company’s balance sheets. 125 NeuroPace, Inc. Notes to Financial Statements ROU assets and lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. Since the Company’s lease does not provide an implicit rate, the Company uses its incremental borrowing rate based on the rate of interest that the Company would have to pay to borrow on a collateralized basis over a similar term and in a similar economic environment at commencement date in determining the present value of future payments. The ROU asset also includes any lease payments made to the lessor at or before the commencement date, minus lease incentives received, and initial direct costs incurred. The Company’s lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term. The Company elected certain practical expedients under ASC 842 , including the package of practical expedients, which among other things, allowed the Company to carry forward prior conclusions about lease identification and classification, as well as elections to not record leases with an initial term of twelve months or less on the balance sheet, and to combine the lease and non-lease components in determining the lease liabilities and ROU assets. 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 ATM 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. Upon closing the IPO, all deferred offering costs were charged against the proceeds from the IPO and recorded in stockholders equity as a reduction of additional paid-in capital. Upon issuing shares under the ATM offering in November 2023, $ 0.3 million of deferred offering costs were charged against the proceeds from the ATM offering and recorded in stockholders equity as a reduction of additional paid-in capital. As of December 31, 2023 and 2022, $ 0.4 million and $ 0.3 million of deferred offering costs related to the ATM offering were recorded on the balance sheets, respectively. Government Programs In May 2021, the Company was awarded a grant by the National Institutes of Health, or NIH, to support research of thalamocortical responsive neurostimulation for the treatment of Lennox-Gastaut Syndrome, a type of epilepsy. The award was issued for a five-year period and has a total budget of over $ 9.3 million, which includes approximately $ 5.5 million in funding for subawards to third-party academic epilepsy centers that are collaborating on the study and are subinvestigators on the study funded by NIH. The subawardees are determined by NIH. The Company’s responsibility for the subawards is to submit the funding requests on behalf of the subawardees. The funding of subawards does not have any impact on the Company’s financial statements. Initially funding was approved for the first year beginning June 1, 2021 and provides for reimbursement of qualified direct and indirect expenses in the amount of $ 0.8 million, including $ 0.4 million for subawards. Approvals of funds for years two through five are subject to the completion of certain milestones. On July 30, 2022, the Company received funding approval for year two in the amount of $ 2.6 million, which includes $ 1.6 million for subawards. On May 25, 2023, the Company received funding approval for year three in the amount of $ 3.0 million, which includes $ 1.5 million for subawards. For funds received under the NIH funding agreement, the Company recognizes a reduction in research and development expenses in an amount equal to the qualifying expenses incurred in each period up to the amount awarded by the NIH. Qualifying expenses incurred by the Company in advance of funding by the NIH are recorded within prepaid expenses and other current assets on the balance sheets. Through December 31, 2023, $ 2.0 million of qualifying expenses have been incurred and funded by the NIH related to the first, second and third year of funding. As of December 31, 2023, the Company recorded prepaid expenses and other current assets of $ 0.1 million related to the third year of funding. Warranty Warranty costs are accrued based on the Company’s best estimates when management determines that it is probable a charge or liability has been incurred and the amount of loss can be reasonably estimated. While the 126 NeuroPace, Inc. Notes to Financial Statements Company believes that historical experience provides a reliable basis for estimating such warranty cost, unforeseen quality issues or component failure rates could result in future costs in excess of such estimates. The warranty liability as of December 31, 2023 and December 31, 2022 was immaterial. Cost of Goods Sold The Company manufactures its products at its facility. Cost of goods sold consists primarily of costs related to materials, components and subassemblies, manufacturing overhead, direct labor, and reserves for excess and obsolete inventories. A significant portion of the Company’s cost of goods sold currently consists of manufacturing overhead costs. These overhead costs include the cost of facilities, material procurement, inventory control, quality assurance, equipment and operating supervision and management. Cost of goods sold also includes depreciation expense for production equipment and certain direct costs such as shipping costs. Shipping and handling costs are considered a fulfillment activity and are included in cost of goods sold as incurred. Research and Development Expenditures The Company expenses research and development costs as incurred. Research and development expenses consist primarily of engineering, product development, clinical studies to develop and support the Company’s products, regulatory expenses, medical affairs and other costs associated with products and technologies that are in development, including quality assurance. Research and development expenses include employee compensation, including stock-based compensation, supplies, consulting, prototyping, testing, materials, travel expenses, depreciation and an allocation of facility overhead expenses. Additionally, research and development expenses include costs associated with clinical studies including clinical trial design, clinical site reimbursement, data management, travel expenses, the cost of products used for clinical trials and costs associated with regulatory compliance and submitting and maintaining regulatory filings. Advertising Costs The Company expenses advertising costs as incurred. Advertising costs include design and production costs, including website development, physician and patient testimonial videos, written media campaigns, and other items. Advertising costs of $ 0.7 million and $ 0.7 million were expensed during the years ended December 31, 2023 and December 31, 2022, respectively. Stock-Based Compensation The Company accounts for stock-based employee compensation in accordance with ASC 718, Stock Compensation . ASC 718 requires the measurement of compensation based on the grant date fair value of the stock option or restricted stock unit (see Note 8). The Company amortizes the fair value of each award on a straight-line basis over the requisite service period of the award. Income Taxes The Company accounts for income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. The Company assesses all material positions taken in any income tax return, including all significant uncertain positions, in all tax years that are still subject to assessment or challenge by relevant taxing authorities. Assessing an uncertain tax position begins with the initial determination of the position’s sustainability and is measured at the largest amount of benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement. As of each balance sheet date, unresolved uncertain tax positions must be reassessed, and the Company will determine whether (i) the factors underlying the sustainability assertion have changed and (ii) the amount of the recognized tax benefit is still appropriate. The recognition and measurement of tax benefits requires significant judgment. 127 NeuroPace, Inc. Notes to Financial Statements Judgments concerning the recognition and measurement of a tax benefit might change as new information becomes available. 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, stock options, common stock subject to repurchase related to early exercise of stock options, and restricted stock units 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. The Company 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 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. Comprehensive Loss Comprehensive loss combines net loss and other comprehensive loss. Other comprehensive loss represents unrealized gains or losses on short-term investments that are reported as a component of stockholders’ equity on the balance sheets. JOBS Act Accounting Election The Company is an emerging growth company, as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies. The Company has elected to use this extended transition period for complying with new or revised accounting standards that have different effective dates for public and private companies until the earlier of the date the Company (i) is no longer an emerging growth company or (ii) affirmatively and irrevocably opts out of the extended transition period provided in the JOBS Act. As a result, these financial statements may not be comparable to companies that comply with new or revised accounting pronouncements as of public company effective dates. Recent Accounting Pronouncements Recently Adopted Accounting Pronouncements 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 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. The Company adopted this ASU effective January 1, 2023. The adoption of this ASU did not have a material impact on the Company’s financial statements and related disclosures. Recent Accounting Pronouncements Not Yet Adopted 128 NeuroPace, Inc. Notes to Financial Statements In November 2023, the FASB issued ASU 2023-07, Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures . The amendments in this ASU require disclosures, on an annual and interim basis, of significant segment expenses that are regularly provided to the chief operating decision maker, or CODM, as well as the aggregate amount of other segment items included in the reported measure of segment profit or loss. This ASU requires that a public entity disclose the title and position of the CODM and an explanation of how the CODM uses the reported measure(s) of segment profit or loss in assessing segment performance and deciding how to allocate resources. Public entities will be required to provide all annual disclosures currently required by Topic 280 in interim periods, and entities with a single reportable segment are required to provide all the disclosures required by the amendments in this ASU and existing segment disclosures in Topic 280. This ASU is effective for fiscal years beginning after December 15, 2023, and interim periods within fiscal years beginning after December 15, 2024, with early adoption permitted. The amendments in this ASU should be applied retrospectively to all prior periods presented in the financial statements. The Company is currently evaluating the impact this standard will have on the disclosures within our financial statements. In December 2023, the FASB issued ASU 2023-09, Improvements to Income Tax Disclosures . The ASU requires greater disaggregation of information about a reporting entity's effective tax rate reconciliation as well as information on income taxes paid. The ASU applies to all entities subject to income taxes and is intended to help investors better understand an entity’s exposure to potential changes in jurisdictional tax legislation and assess income tax information that affects cash flow forecasts and capital allocation decisions. The ASU is effective for annual periods beginning after December 15, 2024, with early adoption permitted. The ASU should be applied on a prospective basis although retrospective application is permitted. The Company is currently evaluating the impact this standard will have on the disclosures within our financial statements. 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 1 Quoted prices in active markets for identical assets or liabilities. Level 2 Observable 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 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. 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 and marketable securities) at fair value as of December 31, 2023 (in thousands): 129 NeuroPace, Inc. Notes to Financial Statements Fair Value as of December 31, 2023 Basis for Fair Value Measurements (Level 1) (Level 2) (Level 3) Assets: Money market funds, included in cash and cash equivalents $ 16,125 $ 16,125 $ — $ — Fixed income mutual funds, included in short-term investments 48,396 48,396 — — Total $ 64,521 $ 64,521 $ — $ — The following table summarizes the Company’s financial assets (cash equivalents and marketable securities) at fair value as of December 31, 2022 (in thousands): Fair Value as of December 31, 2022 Basis for Fair Value Measurements (Level 1) (Level 2) (Level 3) Assets: Money market funds, included in cash and cash equivalents $ 6,075 $ 6,075 $ — $ — Fixed income mutual funds, included in short-term investments 70,804 70,804 — — Total $ 76,879 $ 76,879 $ — $ — There were no liabilities measured at fair value on a recurring and non-recurring basis as of December 31, 2023 and December 31, 2022. 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 investment comprises a short-term investment in a fixed income mutual fund, which primarily invests in debt securities issued by the U.S. government and U.S. government agencies and corporate bonds and notes. Interest income from short-term investment is recorded in interest income. As of December 31, 2022, the Company’s short-term investment had a fair value of $ 70.8 million, a cost basis of $ 71.9 million, and an unrealized loss of $ 1.1 million, which was recorded in accumulated other comprehensive loss. During the year ended December 31, 2023, the Company recognized $ 1.0 million in unrealized gains from its short-term investment. As of December 31, 2023, the Company’s short-term investment had a cumulative unrealized net loss of $ 0.1 million, which included an adjustment of $ 1.1 million unrealized loss recorded in other income (expense), net in the year ended December 31, 2023. The adjustment was not material to any previously issued financial statements. 4. Balance Sheet Components Inventory Inventories consist of the following (in thousands): December 31, 2023 2022 Raw materials $ 4,090 $ 2,818 Work-in-process 627 1,523 Finished goods 6,497 5,371 Total $ 11,214 $ 9,712 130 NeuroPace, Inc. Notes to Financial Statements Property and Equipment, net Property and equipment, net consists of the following (in thousands): December 31, 2023 2022 Machinery, equipment, furniture and fixtures $ 4,522 $ 4,434 Computer equipment and software 1,822 2,952 Leasehold improvements 2,426 2,402 8,770 9,788 Less: Accumulated depreciation ( 7,767 ) ( 8,724 ) Property and equipment, net $ 1,003 $ 1,064 Depreciation expense for the years ended December 31, 2023 and December 31, 2022 was $ 0.2 million and $ 0.3 million, respectively. Accrued Liabilities Accrued liabilities consist of the following (in thousands): December 31, 2023 2022 Payroll and related expenses $ 9,655 $ 5,748 Inventory purchases 588 764 Professional fees 30 227 Other 907 675 $ 11,180 $ 7,414 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. In August 2022, the Company amended the lease to extend it through June 2030. The second amendment contained a rent-free period from September 2022 through December 2022. The Company has an option to extend the lease for a period of five years , commencing on July 1, 2030 and expiring on June 30, 2035. 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. In June 2021, the letter of credit was amended and further reduced to $ 0.2 million. 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. Rental payments range from $ 2.8 million to $ 3.3 million per year over the extended term of the lease. 131 NeuroPace, Inc. Notes to Financial Statements The maturities of operating lease liabilities as of December 31, 2023 are as follows (in thousands): 2024 $ 2,857 2025 2,942 2026 3,031 2027 3,122 2028 3,215 Thereafter 5,017 Total undiscounted lease payments 20,184 Less: imputed interest 4,743 Total operating lease liability 15,441 Less: current portion 1,627 Operating lease liability, net of current portion $ 13,814 Operating lease cost was $ 2.8 million and $ 2.7 million for the years ended December 31, 2023 and 2022, respectively. As of December 31, 2023, the remaining term for the operating lease in Mountain View, California was 6.5 years, and the discount rate used to measure the lease liability for such operating lease upon recognition was 8.5 %. During the years ended December 31, 2023 and 2022, cash paid for amounts included in operating lease liabilities of $ 2.8 million and $ 2.1 million, respectively, was included in cash flows from operating activities on the condensed statements of cash flows. Distribution Agreement In August 2022, the Company entered into an exclusive distribution agreement, or the Distribution Agreement, with DIXI Medical USA Corp, or DIXI Medical, pursuant to which the Company became the exclusive U.S. distributor of DIXI Medical’s product line. To maintain the exclusive distributor rights, the Company is committed to purchase a minimum of $ 2.4 million of DIXI Medical’s products during the twelve months beginning October 2022, and increase the purchase minimum by 10 % for each of the two subsequent years. The Company met the purchase commitment for the first twelve months. 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. The Company may, from time to time, be subject to claims or be required to defend actions 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 no t recognized any liabilities relating to these obligations as of December 31, 2023 and December 31, 2022. 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 related to contingencies was required as of December 31, 2023 and December 31, 2022. 132 NeuroPace, Inc. Notes to Financial Statements Legal Proceedings The Company is not involved in any pending legal proceedings that it believes could have a material adverse effect on its business, results of operations, financial condition, or cash flows. From time to time, the Company may 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 regularly evaluates current information to determine whether any accruals should be adjusted and whether new accruals are required. Such accruals, if any, reflect the estimable and probable costs that the Company may incur from the outcomes of its legal proceedings. Legal costs are expensed as incurred. There were no contingent liabilities requiring accrual at December 31, 2023 and 2022. 6. Debt Term Loan In September 2020, the Company entered into a Term Loan Agreement with CRG Partners IV L.P. and its affiliates for total borrowings of up to $ 60.0 million, or the Term Loan, and borrowed $ 50.0 million. The remaining $ 10.0 million of the Term Loan was available to the Company for borrowing until March 31, 2022 if the Company achieved a revenue-based milestone in 2021. The revenue-based milestone was not achieved, and the remaining $ 10.0 million of the Term Loan expired without being drawn. The Term Loan bore interest at a rate of 12.5 % per year. In February 2023, the Term Loan was amended which increased the annual interest rate from 12.5 % to 13.5 % effective March 1, 2023. The amendment was accounted as a debt modification and the Term Loan’s effective interest rate increased from 15.7 % to 16.8 %. Payments under the Term Loan are made quarterly with payment dates fixed at the end of each calendar quarter. Through December 2020, the Company had the option to pay the entire interest paid-in-kind, or PIK, by increasing the principal of the Term Loan. From January 2021 through December 2022, the Company had the option to pay interest as follows: 7.5 % per annum paid in cash and 5.0 % per annum PIK by increasing the principal of the Term Loan. From January 2023 through June 2025, the Company has the option to pay interest as follows: 8.5 % per annum paid in cash and 5.0 % per annum PIK by increasing the principal of the Term Loan. For each payment date from April 2022 through December 2023, the Company elected the PIK option, increasing the principal of the Term Loan by $ 4.6 million. The Term Loan was interest-only through September 2023, which could be extended through September 2025 at the Company’s option if the Company completed its IPO on or prior to 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 Term Loan includes a fee upon repayment of the loan equal to 10 % of the aggregate principal amount being prepaid or repaid, or the backend fee. As of December 31, 2023, the Term Loan had an annual effective interest rate of 16.9 % per year. The Term Loan is collateralized by substantially all of the Company’s assets. The 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). In February 2023, the Term Loan was amended to reduce the minimum annual net revenue covenant to $ 45.0 million for the year ended December 31, 2023. 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 for as debt issuance costs. During the years ended December 31, 2023 and December 31, 2022, the Company recorded interest expense related to debt discount and debt issuance costs of the Term Loan of $ 0.3 million and $ 0.3 million, respectively. Interest expense on the Term Loan was $ 8.5 million and $ 7.5 million during the years ended December 31, 2023 and December 31, 2022, respectively. 133 NeuroPace, Inc. Notes to Financial Statements As of December 31, 2023, future minimum payments for the Term Loan are as follows (in thousands): Term Loan 2024 $ 7,496 2025 65,671 Total 73,167 Less: Unamortized debt discount and issuance cost ( 621 ) Less: Unaccreted backend fee ( 2,505 ) Less: Interest ( 13,087 ) Term Loan $ 56,954 7. Common Stock The Company’s Amended and Restated Certificate of Incorporation authorizes the Company to issue 200,000,000 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. As of December 31, 2023 and December 31, 2022, no dividends had been declared. As of December 31, 2023 and December 31, 2022, the Company had reserved common stock for future issuance as follows: Year Ended December 31, 2023 2022 Outstanding options under the 2021 Plan 2,208,341 3,446,583 Shares available for future grant under the 2021 Plan 1,314,502 1,443,946 Outstanding options under the 2023 Inducement Plan 380,424 — Outstanding restricted stock units under the 2021 Plan 2,430,803 1,756,209 Common stock available for ESPP 399,798 429,940 Total 6,733,868 7,076,678 8. Stock Plans 2020 Stock Plan In August 2020, the Company adopted the 2020 Stock Plan, or the 2020 Plan, which provides for the granting of stock options to employees, directors and consultants of the Company. Stock options granted under the 2020 Plan may be either incentive stock options, or ISOs, nonqualified stock options, or NSOs, stock appreciation rights, restricted stock awards, restricted stock unit awards or other stock awards. ISOs may only be granted to Company employees (including officers and directors who are also employees). Stock awards other than ISOs may be granted to company employees, directors and consultants. The maximum term of each stock option grant is ten years . The exercise price of ISOs and NSOs granted to a 10% stockholder shall not be less than 110 % of the estimated fair value of the shares on the date of grant as determined by the Company’s board of directors. 2021 Equity Incentive Plan In April 2021, prior to the IPO closing, the Company’s board of directors and stockholders approved the 2021 Equity Incentive Plan, or the 2021 Plan, which became effective upon the IPO closing. The Company initially reserved 2,900,000 shares of common stock for issuance of share-based compensation awards, including ISOs, 134 NeuroPace, Inc. Notes to Financial Statements NSOs, stock appreciation rights, restricted stock units and other stock-based awards. ISOs may be granted only to Company employees (including officers and directors who are also employees). Shares of common stock subject to awards granted under the 2020 Plan that are forfeited or lapse unexercised will be available for issuance under the 2021 Plan. Once the 2021 Plan became effective, no further grants were made under the 2020 Plan. Options under the 2021 Plan may be granted for periods of up to 10 years at exercise prices no less than the fair market value of the Company’s common stock on the date of grant; provided, however, that the exercise price of an ISO granted to a 10% stockholder may not be less than 110 % of the fair market value of the shares on the date of grant and such option may not be exercisable after the expiration of five years from the date of grant. Vesting conditions determined by the plan administrator may apply to stock options and may include continued service, performance and/or other conditions. Generally, options and restricted stock units vest over a three or four-year period. In January 2024, the number of shares of common stock available for issuance under the 2021 Plan was increased by 1,391,173 shares as a result of the automatic increase provision in the 2021 Plan. A summary of shares available for grant under the 2021 Plan is as follows: Shares Available for Grant Shares available for grant as of January 1, 2022 2,132,750 Authorized 1,222,649 Granted/Awarded ( 2,260,197 ) Canceled 340,308 Withheld for taxes 8,436 Shares available for grant as of December 31, 2022 1,443,946 Authorized 1,252,287 Granted/Awarded ( 2,758,399 ) Canceled 1,322,669 Withheld for taxes 53,999 Shares available for grant as of December 31, 2023 1,314,502 2023 Inducement Plan In July 2023, the Company’s Compensation Committee of the Board of Directors approved the NeuroPace, Inc. 2023 Inducement Plan, or the Inducement Plan. The terms of the Inducement Plan are similar to the terms of the 2021 Plan with the exception that incentive stock options may not be issued under the Inducement Plan and awards under the Inducement Plan may only be issued to eligible recipients under the applicable Nasdaq rules. The Inducement Plan was adopted by the Compensation Committee without stockholder approval pursuant to Rule 5635(c)(4) of the Nasdaq Listing Rules. The Company has initially reserved 380,424 shares of its common stock for issuance pursuant to awards granted under the Inducement Plan, and granted an option to purchase 380,424 shares of its common stock to its Chief Executive Officer, or CEO, as a material inducement for the CEO to join the Company. A summary of stock option activity for the years ended December 31, 2023 and 2022 is set forth below: 135 NeuroPace, Inc. Notes to Financial Statements Options Outstanding Number of Shares Weighted-Average Exercise Price Weighted Average Remaining Contractual Term (in Years) Balances as of January 1, 2022 3,038,970 $ 2.61 8.83 Granted 690,218 $ 7.83 Exercised ( 157,447 ) $ 0.03 Canceled ( 125,158 ) $ 6.99 Balances as of December 31, 2022 3,446,583 $ 3.61 8.06 Granted 695,225 $ 3.85 Exercised ( 889,968 ) $ 0.17 Canceled ( 663,075 ) $ 5.00 Balances as of December 31, 2023 2,588,765 $ 4.51 7.17 Vested and exercisable at December 31, 2023 1,623,869 $ 4.22 6.28 Vested and expected to vest at December 31, 2023 2,588,765 $ 4.51 7.17 The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying stock options and the fair value of the Company’s common stock for stock options that were in-the-money at period end. The total intrinsic value of stock options exercised was $ 5.3 million and $ 0.9 million during the years ended December 31, 2023 and December 31, 2022, respectively, determined at the date of each stock option exercise. Early Exercise of Stock Options The terms of the Company’s 2020 Plan and the 2021 Plan permit the exercise of options granted under the plans 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 December 31, 2023 and December 31, 2022 there were 30,211 and 78,389 shares of common stock, respectively, issued pursuant to early exercised options and subject to repurchase. Employee Stock Purchase Plan In April 2021, the Company adopted the 2021 Employee Stock Purchase Plan, or ESPP. The Company allows eligible employees to purchase shares of the Company's common stock through payroll deductions at a price equal to 85 % of the lesser of the fair market value of the stock as of the first date or the ending date of each offering period, which is typically six months . There were 580,000 shares of common stock initially reserved for issuance under the ESPP. In January 2024, the number of shares of common stock available for issuance under the ESPP was increased by 278,234 shares as a result of the automatic increase provision in the ESPP. The Company issued 280,599 and 284,758 shares under the ESPP for the years ended December 31, 2023 and December 31, 2022, respectively. As of December 31, 2023, 399,798 shares under the ESPP remain available for purchase. The offering period and purchase period is determined by the board of directors. A new offering period of six months has been authorized beginning December 7, 2023 through June 6, 2024. 136 NeuroPace, Inc. Notes to Financial Statements Compensation expense is calculated using the fair value of the employees' purchase rights under the Black-Scholes model, which was estimated using the following assumptions: Year Ended December 31, 2023 2022 Expected term (in years) 0.5 0.5 Expected volatility 63 % - 90 % 65 % - 67 % Weighted average risk-free interest rate 5.36 % - 5.43 % 1.75 % - 4.72 % Fair value of common stock $ 4.20 - $ 8.49 $ 1.72 - $ 6.14 Dividend yield — % — % Restricted Stock Units Activity with respect to restricted stock units, or RSUs, was as follows: Number of Shares Underlying Outstanding Restricted Stock Units Weighted Average Grant Date Fair Value Unvested, January 1, 2022 596,085 $ 22.06 Granted 1,569,979 $ 7.72 Vested ( 194,705 ) $ 22.78 Canceled ( 215,150 ) $ 13.95 Unvested, December 31, 2022 1,756,209 $ 10.15 Granted 2,063,174 $ 4.77 Vested ( 728,986 ) $ 9.76 Canceled ( 659,594 ) $ 7.14 Unvested, December 31, 2023 2,430,803 $ 6.52 The fair value of RSUs is based on the Company’s closing stock price on the date of grant. Stock-Based Compensation The Company recognized stock-based compensation as follows (in thousands): Year Ended December 31, 2023 2022 Cost of goods sold $ 606 $ 518 Research and development 2,749 2,304 Selling, general and administrative 6,203 5,527 Total stock-based compensation $ 9,558 $ 8,349 The above stock-based compensation expense related to the following equity-based awards (in thousands): Year Ended December 31, 2023 2022 Stock options and restricted stock units $ 9,271 $ 7,949 ESPP 287 400 Total stock-based compensation $ 9,558 $ 8,349 137 NeuroPace, Inc. Notes to Financial Statements As of December 31, 2023, the total unrecognized stock-based compensation expense related to unvested stock options and restricted stock units was $ 16.0 million, which will be amortized on a straight-line basis over a weighted average remaining period of 2.2 years. As of December 31, 2023, the Company had unrecognized stock-based compensation expense relating to the ESPP awards of approximately $ 0.2 million, which is expected to be recognized over a weighted-average period of 0.4 years. The total fair value of options that vested during the years ended December 31, 2023 and December 31, 2022 was $ 7.8 million and $ 1.8 million, respectively. The options granted during the years ended December 31, 2023 and December 31, 2022 had a weighted average grant date fair value of $ 3.85 per share and $ 7.83 per share, respectively. The Company estimated the fair value of stock options using the Black-Scholes option pricing model. The fair value of employee stock options is being amortized on a straight-line basis over the requisite service period of the awards. The fair value of employee stock options was estimated using the following assumptions for the years ended December 31, 2023 and December 31, 2022: Year Ended December 31, 2023 2022 Expected term (in years) 5.27 - 6.25 5.27 - 6.25 Expected volatility 60 % - 63 % 50 % - 52 % Weighted average risk-free interest rate 3.74 % - 3.94 % 1.79 % - 3.56 % Fair value of common stock $ 1.54 - $ 4.50 $ 6.30 - $ 8.15 Dividend yield — % — % The expected term of stock options represents the weighted-average period the stock options are expected to remain outstanding. The Company does not have sufficient historical exercise and post-vesting termination activity to provide accurate data for estimating the expected term of options and has opted to use the “simplified method,” whereby the expected term equals the arithmetic average of the vesting term and the original contractual term of the option. The expected stock price volatility assumption was determined by a combination of the Company’s historical stock trading volatility and the historical volatilities of industry peers, as the Company does not have sufficient trading history to solely rely on the volatility of its common stock. The Company will continue to analyze the historical stock price volatility and expected term assumptions as more historical data for the Company’s common stock becomes available. The risk-free interest rate assumption is based on the U.S. Treasury instruments whose term was consistent with the expected term of the Company’s stock options. The expected dividend assumption is based on the Company’s history and expectation of not to declare and pay dividends. The fair value of the Company’s common stock is determined based on its closing market price on the date of grant. The Company accounts for forfeitures as they occur. 9. Income Taxes The Company’s operations and income tax components are solely in the United States. From inception through 2023 , the Company has only generated pretax losses in the United States and has not generated any pretax income or loss outside of the United States. The Company did not record a provision (benefit) for income taxes for the years ended December 31, 2023 and 2022 . The Company accounts for income taxes in accordance with ASC 740, which requires that the tax benefit of net operating losses, temporary differences and credit carryforwards be recorded as an asset to the extent that management assesses that realization is "more likely than not." Realization of the future tax benefits is dependent on the Company's ability to generate sufficient taxable income within the carryforward period. Because of the Company's recent history of operating losses, management believes that recognition of the deferred 138 NeuroPace, Inc. Notes to Financial Statements tax assets arising from the above-mentioned future tax benefits is currently not likely to be realized and, accordingly, has provided a full valuation allowance. A reconciliation of the statutory U.S. federal rate to the Company’s effective tax rate is as follows: December 31, 2023 2022 Tax at federal statutory rate 21.0 % 21.0 % State taxes, net of federal benefit 4.5 % 7.2 % Research and development tax credit 1.8 % 1.4 % Stock-based compensation ( 0.8 ) % ( 1.9 ) % Nondeductible interest expense ( 0.5 ) % ( 0.5 ) % FIN 48 reserve ( 0.3 ) % ( 0.2 ) % Change in valuation allowance ( 23.3 ) % ( 26.8 ) % Other ( 2.4 ) % ( 0.2 ) % Total — % — % The tax effects of temporary differences that give rise to significant components of the deferred tax assets and liabilities are as follows (in thousands): December 31, 2023 2022 Deferred tax assets: Net operating loss carryforwards $ 41,864 $ 40,884 Research and development credits 13,069 12,088 Research and development expenditures, capitalized for tax 8,271 4,563 Fixed assets and inventory 151 159 Accruals and reserves 1,633 1,180 Interest expense carryforward 5,033 3,850 Operating lease liability 3,958 4,442 Other 1,718 1,521 Gross deferred tax assets 75,697 68,687 Deferred tax liabilities: Operating lease right-of-use asset ( 3,436 ) ( 3,910 ) Total deferred tax liabilities ( 3,436 ) ( 3,910 ) Valuation allowance ( 72,261 ) ( 64,777 ) Net deferred tax assets $ — $ — Beginning January 1, 2022, the Tax Cuts and Jobs Act, or the Tax Act, eliminated the option to deduct research and development expenditures in the current year and requires taxpayers to capitalize such expenses pursuant to Internal Revenue Code Section 174. The capitalized expenses are amortized over a 5-year period for domestic expenses and a 15-year period for foreign expenses. As a result of this provision of the Tax Act, deferred tax assets related to capitalized research expenses increased by $ 8.3 million. We recognize deferred income taxes for temporary differences between the basis of assets and liabilities for financial statement and income tax purposes, as well as for tax attribute carryforwards. We regularly evaluate the positive and negative evidence in determining the realizability of our deferred tax assets. Based upon the weight of available evidence, which includes our historical operating performance and reported cumulative net losses since inception, we maintained a full valuation allowance on the net deferred tax assets as of December 31, 2023 and 2022. We intend to maintain a full valuation allowance on our deferred tax assets until sufficient positive evidence exists to support reversal of the valuation allowance. The valuation allowance increased by $ 7.5 million and $ 12.8 million during the years ended December 31, 2023 and 2022, respectively. The current year change in the valuation 139 NeuroPace, Inc. Notes to Financial Statements allowance is primarily the result of $ 7.0 million increase in gross deferred tax assets net of a $ 0.5 million decrease in deferred tax liabilities. As of December 31, 2023, the Company had net operating loss, or NOL, carryforwards of $ 155.0 million and $ 150.3 million available to reduce future taxable income, if any, for federal and state income tax purposes, respectively. The federal and state NOL carryforwards begin expiring in 2023 and 2028, for federal and state purposes, respectively. As of December 31, 2023, the amount of federal NOL carryforwards that does not expire is $ 103.3 million (subject to certain utilization limitations). As of December 31, 2023, the Company had research and development credit carryforwards of $ 4.1 million and $ 13.2 million available to reduce future taxable income, if any, for federal and state income tax purposes, respectively. The federal credit carryforwards begin expiring in 2036 and the state credits carryforward indefinitely. Utilization of the Company’s NOL and tax credit carryforwards may be subject to a substantial annual limitation due to the ownership change provisions included in the Internal Revenue Code, or Section 382, and similar state provisions. An annual limitation may result in the expiration of NOL and credit carryforwards before utilization. The Company conducted Section 382 studies as of 2016 and 2021 and has determined that it experienced Section 382 ownership changes in 2016 and in 2021. The 2016 ownership change resulted in permanent limitations of its NOL and credit carryforwards. The 2021 ownership change did not result in permanent limitations of its NOL or credit carryforwards. It has been determined that $ 226.8 million and $ 150.7 million of federal and state NOL carryforwards, respectively, have been permanently limited and will expire unutilized. It has also been determined that $ 10.4 million of federal research and development credits have been permanently limited and will expire unutilized. The gross deferred tax assets disclosed above exclude NOL and credit carryforwards that are expected to expire due to the Section 382 limitation. The American Rescue Plan Act of 2021 was signed into law on March 11, 2021 expanding the definition of covered employees as defined under Section 162(m). The provisions under the expanded definition of covered employees did not have a material impact on the Company’s tax positions for the year ended December 31, 2022 or 2023. California Assembly Bill 85 (AB 85) was signed into law by Governor Gavin Newsom on June 29, 2020. The legislation suspends the California NOL deductions for 2020, 2021, and 2022 for certain taxpayers and imposes a limitation on certain California tax credits for 2020, 2021, and 2022. The legislation disallows the use of California NOL deductions if the taxpayer recognizes business income and its adjusted gross income is greater than $1,000,000. The carryover periods for NOL deductions disallowed by this provision will be extended. Additionally, any business credit will only offset a maximum of $5,000,000 of California tax. Given the Company’s taxable loss position, this legislation did not impact the tax provision for the years ended December 31, 2022 or 2023. California Senate Bill 113 (SB 113), was signed into law by Governor Newsom on February 9, 2022. The legislation contains important California tax law changes, including reinstatement of business tax credits and net NOL deductions limited by AB 85 mentioned above. The new tax law should be accounted for under ASC 740 in the period of enactment (2022) but is not expected to have a material impact on the Company’s tax provision due to its taxable loss position. On August 16, 2022, the President signed into law H.R. 5376 (commonly called the “Inflation Reduction Act of 2022”). The primary tax provisions in the new law include an alternative minimum tax on certain large corporations, a tax on stock buybacks and certain energy-related tax credits, each of which become effective after December 31, 2022. The provisions of the Inflation Reduction Act of 2022 does not have a material impact on the Company’s financial statements and related disclosures. As of December 31, 2023, the Company had unrecognized tax benefits of $ 1.7 million related to $ 4.1 million and $ 13.2 million of federal and state research and development tax credit carryforwards, respectively. The unrecognized tax benefits, if recognized, would not have an impact on the Company's effective tax rate, due to the valuation allowance. It is unlikely that the amount of unrecognized tax benefits will significantly change over the next twelve months. No liability related to uncertain tax positions is recorded in the financial statements. 140 NeuroPace, Inc. Notes to Financial Statements A reconciliation of the beginning and ending unrecognized tax benefit amount is as follows (in thousands): Year Ended December 31, 2023 2022 Beginning balance $ 1,601 $ 1,489 Increase in balance related to tax positions taken during the current year 136 112 Decrease in balance related to tax positions taken during prior years ( 7 ) — Ending balance $ 1,730 $ 1,601 It is the Company’s policy to include penalties and interest expense related to income taxes as a component of other expense and interest expense, respectively, as necessary. The Company determined that no accrual for interest and penalties related to unrecognized tax benefits was required as of December 31, 2023 and December 31, 2022. All of the Company’s tax years will remain open for examination by the federal and state authorities for 3 and 4 years, respectively, from the date of utilization of its tax attributes. 10. 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): Year Ended December 31, 2023 2022 Numerator: Net loss attributable to common stockholders $ ( 32,956 ) $ ( 47,082 ) Denominator: Weighted-average common stock outstanding used to compute basic and diluted net loss per share 25,851,813 24,594,784 Net loss per share attributable to common stockholders, basic and diluted $ ( 1.27 ) $ ( 1.91 ) 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: December 31, 2023 2022 Options to purchase common stock 2,588,765 3,446,583 Unvested early exercised common stock options 30,211 78,389 Unvested restricted stock units 2,430,803 1,756,209 Shares committed under ESPP 81,102 190,613 Total Shares 5,130,881 5,471,794 141 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None.