Inspire Medical Systems Inc

Notes to Consolidated Financial Statements (Unaudited)

1. Organization

Description of Business

Inspire Medical Systems, Inc. is a medical technology company focused on the development and commercialization of innovative, minimally invasive solutions for patients with obstructive sleep apnea ("OSA"). Our proprietary Inspire system is the first and only United States ("U.S.") Food and Drug Administration ("FDA"), European Union ("EU"), Medical Devices Regulation ("MDR"), and Japan Pharmaceuticals and Medical Devices Agency ("PDMA")-approved neurostimulation technology of its kind that provides a safe and effective treatment for moderate to severe OSA. Inspire therapy received premarket approval ("PMA") from the FDA in 2014 and has been commercially available in certain European markets since 2011 and certain Asia Pacific markets since 2021.

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the U.S. (“GAAP”) for interim financial reporting and as required by the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (including those which are normal and recurring) considered necessary for a fair presentation of the interim financial information have been included. When preparing financial statements in conformity with GAAP, we must make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosures at the date of the financial statements. Actual results could differ from those estimates. Additionally, the results of operations for the interim periods are not necessarily indicative of the operating results for the full fiscal year or any future periods. All intercompany accounts and transactions have been eliminated in consolidation.

For a complete discussion of our significant accounting policies and other information, the unaudited consolidated financial statements and notes thereto should be read in conjunction with the audited financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2023.

Cash and Cash Equivalents

We consider all highly liquid securities, readily convertible to cash, that have original maturities of 90 days or less from the date of purchase to be cash equivalents. Cash is carried at cost, which approximates fair value, and cash equivalents, which consist of money market funds, are stated at fair value.

Foreign Currency

Our functional and reporting currency is the U.S. dollar. Our subsidiaries have functional currency in Euro and Yen. The consolidated financial statements are translated to U.S. dollars. Non-monetary assets and liabilities denominated in foreign currencies are translated at rates of exchange in effect at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are translated using the exchange rate prevailing at the balance sheet date. Sales and expenses denominated in foreign currencies are translated at exchange rates in effect on the date of the transaction. Foreign currency transaction gains and losses and the impacts of foreign currency remeasurement are recognized in other (income) expense, net in the consolidated statements of operations and comprehensive income (loss). For the three-month periods ended September 30, 2024 and 2023, we recognized $0.1 million of gain and $0.2 million of loss, net, respectively. For the nine-month periods ended September 30, 2024 and 2023 we recognized $0.1 million of loss and $0.3 of loss, net, respectively. Any unrealized gains and losses due to translation adjustments are included in accumulated other comprehensive income within stockholders' equity in the consolidated balance sheets. We had $0.3 million and $0.2 million of unrecognized gain in our accumulated other comprehensive income balance as of September 30, 2024 and December 31, 2023, respectively.

Investments

Our investments are classified as available-for-sale and consisted of the following:

Investments are classified as available-for-sale and are reported at their estimated fair market values which are based on quoted, active or inactive market prices when available. Any unrealized gains and losses due to interest rate fluctuations and other external factors are reported as a separate component of accumulated other comprehensive income (loss) within stockholders' equity. We had $1.4 million and $0.6 million of unrecognized gain in our accumulated other comprehensive income balance at September 30, 2024 and December 31, 2023, respectively. Any realized gains and losses are calculated on the specific identification method and reported net in other (income) expense, net in the consolidated statements of operations and comprehensive income (loss). For the three and nine months ended September 30, 2024 and 2023, we recognized $0 of realized gains, net.

As of September 30, 2024 and December 31, 2023, we hadno investments with a contractual maturity of greater than two years. Currently, we do not intend to sell the investments, and it is not more likely than not that we will be required to sell the investments before recovery of their amortized cost bases, which may be maturity. We do not consider those investments to be other-than-temporarily impaired as of September 30, 2024. Each reporting period, we evaluate whether declines in fair value below carrying value are due to expected credit losses, as well as our ability and intent to hold the investment until a forecasted recovery occurs. Expected credit losses, not to exceed the amount of the unrealized loss, are recorded as an allowance through other expense in the consolidated statements of operations and comprehensive income (loss). The total allowance for credit losses was $0 at both September 30, 2024 and December 31, 2023.

Fair Value of Financial Instruments

We measure certain financial assets and liabilities at fair value on a recurring basis, including cash equivalents and investments. 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: Observable inputs, such as quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2: Inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and inputs (other than quoted prices) that are observable for the asset or liability, either directly or indirectly.

Level 3: Unobservable inputs that are supported by little or no market activities, which would require us to develop our own assumptions.

We classify instruments within Level 1 if quoted prices are available in active markets for identical assets, which include our money market funds and U.S. treasury securities. We classify instruments in Level 2 if the instruments are valued using observable inputs to quoted market prices, benchmark yields, reported trades, broker/dealer quotes or an income approach, such as a discounted cash flow pricing model that calculates values from observable inputs such as quoted interest rates, yield curves and other observable market information. These instruments include our commercial paper, certificates of deposit, corporate debt securities and asset-backed securities. The available-for-sale securities are held by a custodian who obtains investment prices from a third-party pricing provider that uses standard inputs (observable in the market) to models which vary by asset class.

The following tables set forth by level within the fair value hierarchy our assets that are measured on a recurring basis and reported at fair value as of September 30, 2024 and December 31, 2023. Assets are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

There were no transfers between levels during the periods ended September 30, 2024 and December 31, 2023.

Concentration of Credit Risk

Financial instruments, which potentially subject us to concentrations of credit risk, consist principally of cash equivalents, investments, and accounts receivable. We maintain the majority of our cash and cash equivalents in accounts with major U.S. and multi-national financial institutions, and our deposits at certain of these institutions exceed insured limits. Market conditions can impact the viability of these institutions. In the event of failure of any of the financial institutions where we maintain our cash and cash equivalents, there can be no assurance that we will be able to access uninsured funds in a timely manner or at all.

Our investment policy limits investments to certain types of debt securities issued by the U.S. government and its agencies, corporations with investment-grade credit ratings, or commercial paper and money market funds issued by the highest quality financial and non-financial companies. We place restrictions on maturities and concentration by type and issuer. We are exposed to credit risk in the event of a default by the issuers of these securities to the extent recorded on the consolidated balance sheets. However, as of September 30, 2024 and December 31, 2023, we limited our credit risk associated with cash equivalents by placing investments with banks we believe are highly creditworthy.

We believe that the credit risk in our accounts receivable is mitigated by our credit evaluation process, relatively short collection terms, and dispersion of our customer base. We generally do not require collateral, and losses on accounts receivable have historically not been significant.

Accounts Receivable and Allowance for Expected Credit Losses

Trade accounts receivable are recorded at the invoiced amount and do not bear interest. Customer credit terms are established prior to shipment with the general standard being net 30 days. Collateral or any other security to support payment of these receivables generally is not required.

Each reporting period, we estimate the credit loss related to accounts receivable based on a migration analysis of accounts grouped by individual receivables delinquency status and apply our historic loss rate adjusted for management's assumption of future market conditions. Any change in the allowance from new receivables acquired or changes due to credit deterioration on previously existing receivables is recorded in selling, general and administrative expenses. Write-offs of receivables considered uncollectible are deducted from the allowance. Specific accounts receivable are written off once a determination is made that the amount is uncollectible. The write-off is recorded in the period in which the account receivable is deemed uncollectible. Recoveries are recognized when received and as a direct credit to earnings or as a reduction to the allowance for credit losses (which would indirectly reduce the loss by decreasing bad debt expense).

The following table presents the changes in the allowance for credit losses related to accounts receivable:

The increase in accounts written off, net of recoveries during the nine months ended September 30, 2024 related primarily to accounts receivable with three healthcare systems.

Inventories

Inventories are valued at the lower of cost or net realizable value, computed on a first-in, first-out basis and consisted of the following:

We expense prelaunch inventory as research and development expense in the period incurred unless objective and persuasive evidence exists that regulatory approval and subsequent commercialization of a product candidate is probable and where we also expect the future economic benefit from the sales of the product candidate to be realized. In August 2024, we received approval from the FDA for our next generation Inspire system, which we expect to fully launch in 2025. The balance of inventory related to our next generation Inspire system was $10.0 million and $0.9 million as of September 30, 2024 and December 31, 2023, respectively.

We regularly review inventory quantities on-hand for excess and obsolete inventory and, when circumstances indicate, incur charges to write down inventories to their net realizable value. The determination of a reserve for excess and obsolete inventory involves management exercising judgment to determine the required reserve, considering future demand, product life cycles, introduction of new products, and current market conditions. The reserve for excess and obsolete inventory was $0.9 million and $2.4 million as of September 30, 2024 and December 31, 2023, respectively.

Property and Equipment

Property and equipment are stated at cost, less accumulated depreciation and amortization and consisted of the following:

Construction in process is comprised primarily of production equipment. Depreciation is determined using the straight-line method over the estimated useful lives of the respective assets, generally three toten years. Leasehold improvements are amortized on a straight-line basis over the shorter of their estimated useful lives or the term of the lease. Depreciation and amortization expense was $1.9 million and $0.8 million for the three months ended September 30, 2024 and 2023, respectively, and $4.1 million and $2.0 million for the nine months ended September 30, 2024 and 2023, respectively.

Strategic Investments

For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. These securities are presented within other non-current assets on the consolidated balance sheets. The balance of equity securities without readily determinable fair values was $10.4 million as of both September 30, 2024 and December 31, 2023, respectively. There were no adjustments to the carrying amount during either of the nine months ended September 30, 2024 or 2023.

Impairment of Long-lived Assets

Long-lived assets consist primarily of property and equipment, operating lease right-of-use assets, and strategic investments are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances require that an asset be tested for possible impairment, we compare the undiscounted cash flows expected to be generated by the asset to the carrying amount of the asset. If the carrying amount of the asset is not recoverable on an undiscounted cash flow basis, we determine the fair value of the asset and recognize an impairment loss to the extent the carrying amount of the asset exceeds its fair value. We determine fair value using the income approach based on the present value of expected future cash flows or other appropriate measures of estimated fair value. Our cash flow assumptions consider historical and forecasted revenue and operating costs and other relevant factors. We didnot record any impairment charges on long-lived assets during either of the nine months ended September 30, 2024 or 2023.

Accrued Expenses

Accrued expenses consisted of the following:

The following table shows the changes in our estimated product warranty liability accrual, included in accrued liabilities:

Revenue Recognition

We derive our revenue from sales of our products in the U.S. and internationally. Customers are primarily comprised of hospitals and ambulatory surgery centers, with distributors being used in certain international locations where we do not have a direct commercial presence.

Revenues from product sales are recognized when the customer obtains control of the product, which occurs at a point in time, either upon shipment of the product or receipt of the product, depending on shipment terms. Our standard shipping terms are free on board shipping point, unless the customer requests that control and title to the inventory transfer upon delivery. In those cases where shipping and handling costs are billed to customers, we classify the amounts billed as a component of cost of goods sold.

Revenue is measured as the amount of consideration we expect to receive, adjusted for any applicable estimates of variable consideration and other factors affecting the transaction price, which is based on the invoiced price, in exchange for transferring products. All revenue is recognized when we satisfy our performance obligations under the contract. The majority of our contracts have a single performance obligation and are short term in nature.

Sales taxes and value added taxes in foreign jurisdictions that are collected from customers and remitted to governmental authorities are accounted for on a net basis and therefore are excluded from net sales. Shipping and handling costs associated with outbound freight after control over a product has transferred to a customer are accounted for as a fulfillment cost and are included in cost of goods sold.

Variable consideration related to certain customer sales incentives is estimated based on the amounts expected to be paid based on the agreement with the customer using probability assessments.

We offer customers a limited right of return for our product in case of non-conformity or performance issues. We estimate the amount of our product sales that may be returned by our customers based on historical sales and returns. As our historical product returns to date have been immaterial, we have not recorded a reduction in revenue related to variable consideration for product returns.

See Note 7 for disaggregated revenue by geographic area.

Cost of Goods Sold

Cost of goods sold consists primarily of acquisition costs for the components of the Inspire system, overhead costs, scrap and inventory obsolescence, warranty replacement costs, as well as distribution-related expenses such as logistics and shipping costs, net of shipping costs charged to customers. The overhead costs include the cost of material procurement, depreciation expense for production equipment, and operations supervision and management personnel, including employee compensation, stock-based compensation, supplies, and travel.

Research and Development

Research and development expenses consist primarily of product development, clinical and regulatory affairs, quality assurance, consulting services, and other costs associated with products and technologies in development. These expenses include employee compensation, including stock-based compensation, supplies, materials, prelaunch inventory, consulting, and travel expenses related to research and development programs. Clinical expenses include clinical study design, clinical site reimbursement, data management, travel expenses, and the cost of manufacturing products for clinical studies.

We expense prelaunch inventory as research and development expense in the period incurred unless objective and persuasive evidence exists that regulatory approval and subsequent commercialization of a product candidate is probable and where we also expect the future economic benefit from the sales of the product candidate to be realized.

Stock-Based Compensation

We maintain an equity incentive plan to provide long-term incentives for eligible employees, consultants, and members of the board of directors. The plan allows for the issuance of restricted stock units ("RSUs"), performance stock units ("PSUs"), and non-statutory and incentive stock options to employees, and RSUs, PSUs, and non-statutory stock options to consultants and directors. We also offer an employee stock purchase plan ("ESPP") which allows participating employees to purchase shares of our common stock at a discount through payroll deductions.

We recognize equity-based compensation expense for awards of equity instruments based on the grant date fair value of those awards as expense in the consolidated statements of operations and comprehensive income (loss). We estimate the fair value of stock options using the Black-Scholes option pricing model and the fair value of RSUs and PSUs is equal to the closing price of our common stock on the grant date. The fair value of each purchase under the employee stock purchase plan is estimated at the beginning of the offering period using the Black-Scholes option pricing model.

Stock-based compensation expense is recognized on a straight-line basis over the vesting term for stock options and RSUs, and over the vesting and performance period based on the probability of achieving the performance objectives for PSUs. We account for award forfeitures as they occur.

Advertising Expenses

We expense the costs of advertising, including promotional expenses, as incurred. Advertising expenses were $23.3 million and $25.5 million during the three months ended September 30, 2024 and 2023, respectively, and $72.1 million and $74.3 million during the nine months ended September 30, 2024 and 2023, respectively.

Leases

Operating leases are included in operating lease right-of-use ("ROU") assets, accrued expenses, and operating lease liabilities – non-current portion in our consolidated balance sheets. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at the lease commencement date based on the present value of lease payments over the lease term. In determining the present value of lease payments, we use our incremental borrowing rate based on the information available at the lease commencement date as the rate implicit in the lease is not readily determinable. The determination of our incremental borrowing rate requires management judgment based on information available at lease commencement. The operating lease ROU assets also include adjustments for prepayments, accrued lease payments, and exclude lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise such options. Operating lease cost is recognized on a straight-line basis over the expected lease term. Lease agreements that include lease and non-lease components are accounted for as a single lease component. Lease agreements with a noncancelable term of less than 12 months are not recorded on our consolidated balance sheets.

We account for income taxes using the liability method. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates that will be in effect when the differences are expected to reverse. Valuation allowances against deferred tax assets are established, when necessary, to reduce deferred tax assets to the amounts expected to be realized. As we have historically incurred operating losses, we have recorded a full valuation allowance against our net deferred tax assets. We will continue to maintain a full valuation allowance until the point at which we are more certain than not that the deferred tax assets will be realized. Therefore there is no provision for federal income taxes, but we do record provision for current state and foreign taxes, which includes a foreign tax reserve relating to uncertain tax positions. Our policy is to record interest and penalty expense related to uncertain tax positions as other expense in the consolidated statements of operations and comprehensive income (loss).

Comprehensive Income (Loss)

Comprehensive income (loss) consists of net income (loss) and changes in unrealized gains and losses due to interest rate fluctuations and other external factors on investments classified as available-for-sale, and foreign currency translation adjustments. Accumulated other comprehensive income (loss) is presented in the accompanying consolidated balance sheets as a component of stockholders' equity.

Income (Loss) Per Share

Basic net income (loss) per share is computed by dividing the net income (loss) by the weighted average number of shares of common stock outstanding during the period. Diluted net income (loss) per share is computed by dividing the net income (loss) by the weighted average number of shares of common stock and dilutive potential shares of common stock outstanding during the period. For the periods presented with a net loss, diluted net loss per share is the same as basic net loss per share as all potentially dilutive shares consisting of outstanding stock options, unvested RSUs and PSUs, and shares issuable under our employee stock purchase plan were antidilutive in those periods.

Recent Accounting Pronouncements

In November 2023, the FASB issued ASU No. 2023-07, Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures (“ASU 2023-07”). The standard requires disclosure of significant segment expenses that are regularly provided to the chief operating decision maker (“CODM”) and included within each reported measure of segment profit or loss, an amount and description of its composition for other segment items to reconcile to segment profit or loss, and the title and position of the entity’s CODM. The amendments in this update also expand the interim segment disclosure requirements. This authoritative guidance will be effective for us in fiscal 2024 for annual periods and in the first quarter of fiscal 2025 for interim periods, with early adoption permitted. We are currently evaluating the effect of this new guidance on our consolidated financial statements and disclosures.

In December 2023, the FASB issued ASU No. 2023-09, Improvements to Income Tax Disclosures (“ASU 2023-09”). The guidance is intended to improve income tax disclosure requirements by requiring (i) consistent categories and greater disaggregation of information in the rate reconciliation and (ii) the disaggregation of income taxes paid by jurisdiction. The guidance makes several other changes to the income tax disclosure requirements. The amendments in ASU 2023-09 are effective for us in fiscal 2025, with early adoption permitted, and is required to be applied prospectively with the option of retrospective application. We are evaluating the impact of the standard on our income tax disclosures.

In March 2024, the SEC issued climate-related disclosure rules, which the SEC has subsequently stayed pending ongoing legal challenges. If they survive litigation, the rules will require disclosure of material climate-related risks and material direct greenhouse gas emissions from operations owned or controlled (Scope 1) and/or material indirect greenhouse gas emissions from purchased energy consumed in owned or controlled operations (Scope 2). Additionally, the rules will require disclosure in the notes to the financial statements of the effects of severe weather events and other natural conditions, subject to certain materiality thresholds. We are in the process of analyzing the impact of the rules on our related disclosures.

We have reviewed and considered all other recent accounting pronouncements that have not yet been adopted and believe there are none that could potentially have a material impact on our business practices, financial condition, results of operations, or disclosures.

3. Leases

We lease office space for our corporate headquarters under a noncancelable operating lease. The prior corporate office leases were amended in May 2023 to increase the total space leased to approximately 106,000 square feet and to extend the noncancelable lease term through May 31, 2035. We entered into an additional warehouse and office space lease for our corporate headquarters under a noncancelable operating lease in August 2023. This space includes approximately 22,000 square feet and a noncancelable lease term through May 31, 2035. Each lease includes options to renew for up totwo additional periods offive years each at the then-prevailing market rates. The exercises of the lease renewal options are at our sole discretion and were not included in the lease term for the calculation of the ROU assets and lease liabilities as of the lease modification date as they were not reasonably certain of exercise.

In March 2024, we entered into an amendment on our additional warehouse and office space lease which is expected to commence in January 2025. This amendment provides for approximately 18,000 square feet of additional space and follows the lease term and renewal options in the original lease described above.

In October 2024, we entered into an amendment on our corporate headquarters office space lease which is expected to commence in January 2025. This amendment provides for approximately 10,000 square feet of additional space and follows the lease term and renewal options in the original lease described above.

In addition to base rent in these leases, we also pay our proportionate share of the operating expenses, as defined in the leases. These payments are made monthly and adjusted annually to reflect actual charges incurred for operating expenses, such as common area maintenance, taxes, and insurance.

The following table presents the lease balances within the consolidated balance sheets:

As of September 30, 2024, the remaining lease terms were 10.7 years and the weighted average discount rate was 4.9%. The operating cash flows from our operating leases were $0.5 million of cash inflow and $0.6 million of cash outflow for the three-month periods ended September 30, 2024 and 2023, respectively, and $0.9 million and $1.5 million of cash outflows for the nine-month periods ended September 30, 2024 and 2023, respectively.

4. Employee Retirement Plan

We sponsor a defined contribution employee retirement plan covering all of our full-time employees. The plan allows eligible employees to defer a portion of their eligible compensation up to the maximum allowed by IRS Regulations. We make voluntary matching contributions of 50% of the first 6% of each participating employee's contribution, up to 3% of eligible earnings. Our match contributions are made to funds designated by the participant, none of which are based on Inspire common stock. Our matching contributions to the plan totaled $1.1 million and $0.8 million for the three months ended September 30, 2024 and 2023, respectively, and $3.7 million and $3.0 million for the nine months ended September 30, 2024 and 2023, respectively.

5. Stock-Based Compensation

As of September 30, 2024, there were 4,603,343 shares reserved for issuance under our equity incentive plan, of which 1,386,572 shares were available for issuance.

Stock-based compensation expense is recognized on a straight-line basis over the vesting term for stock options and RSUs, and over the performance period based on the probability of achieving the performance objectives for PSUs, and is reduced by actual forfeitures as they occur. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase, or cancel any remaining unearned stock compensation expense. Future stock-based compensation expense and unearned stock-based compensation will increase to the extent that we grant additional stock-based awards.

Stock Options

Options are granted with an exercise price, which is equal to the closing price of our stock on the date of grant. Stock options include afour-year service period and 25% vest after the first year of service and the remainder vest in equal installments over the next 36 months of service. The stock options granted to the board of directors vest inone orthree equal annual installments, in each case subject to the director's continuous service through the applicable vesting date. The stock options have a contractual life often years.

The fair value per share of options is estimated on the date of grant using the Black-Scholes option pricing model.

Option Value and Assumptions

Expected Term— Due to our limited amount of historical exercise, forfeiture, and expiration activity, we have opted to use the "simplified method" for estimating the expected term of options, whereby the expected term equals the arithmetic average of the vesting terms and the original contractual term of the option. We will continue to analyze our expected term assumption as more historical data becomes available.

Expected Volatility— During the nine months ended September 30, 2024, we based expected volatility on the historic volatility of our common stock. Prior to 2024, due to our limited company specific historical and implied volatility data, we incorporated our historical stock trading volatility with those of a group of similar companies that are publicly traded for the calculation of volatility. When selecting this peer group, we generally selected companies with comparable characteristics, including enterprise value, stages of clinical development, risk profiles, position within the industry, and those with historical share price information sufficient to meet the expected life of the stock-based awards.

Risk-Free Interest Rate — The risk-free rate assumption is based on the U.S. government Treasury instruments with maturities similar to the expected term of our stock options.

Expected Dividend Yield— The expected dividend assumption is based on our history of not paying dividends and our expectation that we will not declare dividends for the foreseeable future.

Stock Option Activity

The aggregate intrinsic value of options exercised is the difference between the estimated fair market value of our common stock at the date of exercise and the exercise price for those options. The aggregate intrinsic value of outstanding options is the difference between the closing price as of the date outstanding and the exercise price of the underlying stock options. As of September 30, 2024, the amount of unearned stock-based compensation to be expensed from now through the year 2028 related to unvested stock options is $79.4 million, which we expect to recognize over a weighted average period of 2.3 years.

Restricted Stock Units

RSUs are share awards that entitle the holder to receive freely tradable shares of our common stock upon vesting. The RSUs cannot be transferred and the awards are subject to forfeiture if the holder’s service terminates prior to the release of the vesting restrictions. The RSUs granted to employees include three- orfour-year service periods and vest in equal installments on each anniversary of the date of grant. The RSUs granted to the board of directors includeone- orthree-year service periods and vest in equal installments on each anniversary of the date of grant. The fair value of the RSUs is equal to the closing price of our common stock on the grant date. A summary of RSUs and related information is as follows:

The aggregate intrinsic value of unvested RSUs was based on our closing stock price on the last trading day of the period. The aggregate intrinsic value of vested RSUs was based on our closing stock price on the date of award vesting. As of September 30, 2024, the amount of unearned stock-based compensation currently estimated to be expensed from now through the year 2027 related to unvested RSUs was $103.5 million which we expect to recognize over a weighted average period of 2.3 years.

Performance Stock Units

During 2022, 2023, and 2024, we granted PSUs to officers and key employees. The number of PSUs that will ultimately be earned is based on our performance relative to pre-established goals for thethree-year periods ending December 31, 2024, 2025, and 2026, respectively. The expense is recorded on a straight-line basis over the requisite service periods based on an estimate of the number of PSUs expected to vest. Management expectations related to the achievement of the performance goals associated with PSU grants are assessed each reporting period. The number of shares earned at the end of each of thethree-year periods will vary based on actual performance, from 0% to 200% of the number of PSUs granted. If the performance conditions are not met or not expected to be met, any compensation expense recognized associated with the grant will be reversed.

A summary of PSUs and related information is as follows:

The fair value of the PSUs is equal to the closing price of our common stock on the grant date. The aggregate intrinsic value of unvested PSUs was based on our closing stock price on the last trading day of the period. As of September 30, 2024, there was $36.8 million of unrecognized stock-based compensation expense related to outstanding PSUs that is expected to be recognized over a weighted-average period of approximately 1.7 years.

Employee Stock Purchase Plan

Employees may participate in our ESPP provided they meet certain eligibility requirements. The purchase price for our common stock under the terms of the ESPP is defined as 85% of the lower of the closing market price per share of our common stock on the first or last trading day of each stock purchase period. There were 1,217,973 shares available for future issuance under the ESPP as of September 30, 2024. The current purchase period under the ESPP began on July 1, 2024 and ends December 31, 2024.

Share Repurchase Program

In August 2024, our Board of Directors authorized the repurchase of up to $150.0 million of our outstanding shares of common stock from time to time through open market transactions, privately negotiated transactions, tender offers, or other means. We are not obligated to repurchase any specific number of shares and the program may be modified, suspended, or discontinued at any time. The share repurchase program will expire in August 2026, subject to the earlier termination or extension by the Board, in its sole discretion and without prior notice. As of September 30, 2024, no shares have been repurchased under this program.

6. Income Taxes

At both September 30, 2024 and December 31, 2023, a valuation allowance was recorded against all deferred tax assets due to our cumulative net loss position. We recorded income tax expense of $1.8 million and $0.3 million for the three months ended September 30, 2024 and 2023, respectively, and $3.5 million and $0.8 million for the nine months ended September 30, 2024 and 2023, respectively. The income tax expense reflects state and foreign income tax expense in both of the nine months ended September 30, 2024 and September 30, 2023.

We filed our 2023 U.S. federal income tax return during the third quarter of 2024. Considering the provision to return true-ups, our gross federal net operating loss carryforward as of December 31, 2023 was $206.6 million, which a portion created prior to 2018 will expire at various dates beginning in 2036. In addition, net operating loss carryforwards for state income tax purposes of $173.5 million that include net operating losses will begin to expire in 2024. We also have gross research and development credit carryforwards of $15.7 million as of December 31, 2023, which will expire at various dates beginning in 2033.

Utilization of the net operating loss carryforwards and research and development ("R&D") credit carryforwards may be subject to an annual limitation due to the ownership change limitations provided by Section 382 and Section 383 of the Code and similar state provisions. During 2023, we finalized a detailed analysis to determine whether an ownership change has occurred through December 31, 2022, and if a limitation exists. It was determined that December 11, 2018 was the only date that we experienced an ownership change. The study concluded that none of the $126.5 million of federal net operating losses nor the $1.7 million of federal R&D credits that were accumulated on December 11, 2018 will expire unused solely due to the limitations under Sections 382 and 383 of the Code. We are in the process of updating the analysis through December 31, 2023. Although unexpected, if we experienced an ownership change during 2023 or 2024, the timing of our ability to utilize the tax attributes may be affected.

Realization of the deferred tax assets is dependent upon the generation of future taxable income, if any, the amount and timing of which are uncertain. Based on available objective evidence and cumulative losses, we believe it is more likely than not that the deferred tax assets are not recognizable and will not be recognizable until we have sufficient book income. Accordingly, the net deferred tax assets have been fully offset by a valuation allowance.

We had $0.1 million of tax payable on unrecognized tax positions as of both September 30, 2024 and December 31, 2023.

We file income tax returns in the applicable jurisdictions. The 2020 to 2023 tax years remain open to examination by the major taxing authorities to which we are subject. We donot expect a significant change to our unrecognized tax positions over the next 12 months.

7. Segment Reporting and Revenue Disaggregation

We operate our business asone operating segment. An operating segment is defined as a component of an enterprise for which separate discrete financial information is available and evaluated regularly by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. Segment information is consistent with how management reviews the business, makes investing and resource allocation decisions and assesses operating performance.

We sell our Inspire system to hospitals and ambulatory surgery centers in the U.S. and in select countries in Europe and Japan through a direct sales organization, and in Singapore and Hong Kong through distributors. Revenue by geographic region is as follows:

Long-lived tangible assets by geographic location were as follows:

8. Income (Loss) Per Share

Basic net income (loss) per share is computed by dividing the net income (loss) by the weighted average number of shares of common stock outstanding during the period. Diluted net income (loss) per share is computed by dividing the net income (loss) by the weighted average number of shares of common stock and dilutive potential shares of common stock outstanding during the period. For the periods presented with a net loss, diluted net loss per share is the same as basic net loss per share as all of the following potentially dilutive shares were antidilutive in those periods.

The following common stock-based awards were excluded from the computation of diluted net income (loss) per common share for the periods presented because including them would have been antidilutive:

INSPIRE MEDICAL SYSTEMS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS (Unaudited)

9. Related Party Transaction

In December 2023, we entered into an agreement with an entity controlled by our Chief Executive Officer (the "Entity"), pursuant to which we agreed to share the costs of a corporate suite at a sports and entertainment venue (the "Venue") (the “Suite”) (the “Cost Sharing Agreement”). In August 2023, the Entity entered into an agreement with the Venue, pursuant to which the Entity acquired certain rights to use the Suite for specified sporting and other events at the Venue through August 2026. Pursuant to this agreement, the Entity agreed to pay $0.2 million per year, with each year beginning September 1 and ending August 31, and the fee increasing by 5% for each succeeding year. Under the Cost Sharing Agreement, we will reimburse the Entity 50% of the cost of the Suite in exchange for the right to use the Suite for 50% of the specified events at the Venue through August 2026.

10. Commitments and Contingencies

We are involved in claims and litigation in the ordinary course of business, some of which seek monetary damages, including claims for punitive damages, which may not be covered by insurance. We evaluate all matters and record liabilities for losses from legal proceedings when we determine that it is probable that the outcome will be unfavorable and the amount, or potential range, of loss can be reasonably estimated. An adverse determination in one or more of these pending matters could have an adverse effect on our consolidated financial position, results of operations or cash flows.

As previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2023, Inspire and two of its executive officers were named as defendants in a purported federal securities law class action filed in the United States District Court for the District of Minnesota, captioned City of Hollywood Firefighters’ Pension Fund v. Inspire Medical Systems, Inc., et. al., Court File No. 0:23-cv-03884 (the "City of Hollywood Lawsuit"). The plaintiff filed an amended complaint on April 19, 2024, which alleges violations of Sections 10(b) and 20(a) of the Exchange Act, and Rule 10b-5, which alleged violations relate to certain prior disclosures of Inspire about the effectiveness of a program intended to help certain customers establish independence in seeking prior authorization from payors for our Inspire therapy. The plaintiff seeks to represent a class of shareholders who purchased or otherwise acquired Inspire common stock between May 3, 2023 and November 7, 2023. The plaintiff seeks damages and other relief, including attorneys' fees and costs. The defendants are vigorously defending this lawsuit. On June 28, 2024, the defendants moved to dismiss the amended complaint in its entirety. The motion is now fully briefed and will be argued in November 2024.

On July 16, 2024, a stockholder derivative lawsuit was filed in the United States District Court for the District of Minnesota, purportedly on behalf of Inspire against certain of our present and former officers and directors and Inspire (as a nominal defendant), captioned Lawrence Hollin v. Herbert, et al., Court File No. 0:24-cv-02716 (the “Hollin Lawsuit”). The Hollin Lawsuit arose out of the same subject matter as the City of Hollywood Lawsuit and alleged the following claims under common law and the Exchange Act: (1) breach of fiduciary duty; (2) unjust enrichment; (3) waste of corporate assets; and (4) as against the officer defendants, contribution under Sections 10(b) and 21D of the Exchange Act. The lawsuit sought unspecified damages. On September 5, 2024, counsel for Mr. Hollin filed a motion for voluntary dismissal of the Hollin Lawsuit, which motion remains pending.