iRhythm Technologies, Inc. (NASDAQ:IRTC) Q3 2019 Earnings Conference Call November 5, 2019 4:30 PM ET

Company Participants

Lynn Lewis – Investor Relations-Gilmartin Group
Kevin King – President and Chief Executive Officer
Matthew Garrett – Chief Financial Officer

Conference Call Participants

Allen Gong – JPMorgan
Jason Mills – Canaccord Genuity

Lynn Lewis

Thank you, this is Lynn Lewis from Gilmartin Group. Thank you all for participating in today's call to iRhythm’s Q3 2019 conference call.

Joining me are Kevin King, CEO, Matthew Garrett, CFO and Dan Wilson, EVP-Strategy and Corporate Development and Investor Relations. Earlier today, iRhythm released financial results for the third quarter ended September 30, 2019. A copy of the press release is available on the company's website.

Before we begin, I'd like to remind you that management will make statements during this call that include forward-looking statements within the meaning of federal securities laws, which are made pursuant to the safe harbor provisions for the Private Securities Litigation Reform Act of 1995. Any statements contained in this call that are not statements of historical fact should be deemed to be forward-looking statements.

All forward-looking statements, including without limitation, our examination of operating trends and our future financial expectations, which include expectations for hiring, growth in our organization and reimbursement and guidance for revenue, gross margins and operating expenses in 2019 are based upon current estimates and various assumptions.

These statements involve material risks and uncertainties that could cause actual results or events to materially differ from those anticipated or implied by these forward-looking statements. Accordingly, you should not place undue reliance on these statements. For a list and description of the risks and uncertainties associated with our business, please refer to the Risk Factors section of our most recent quarterly report on Form 10-K with the Securities and Exchange Commission.

This conference call contains time-sensitive information and is accurate only as of the live broadcast today, November 5, 2019. iRhythm disclaims any intention or obligation, except as required by law, to update or revise any financial [indiscernible] whether because of new information, future events or otherwise.

And with that, I'll now turn the call over to Kevin.

Kevin King

Thank you, Lynn. Good afternoon and thanks for joining us. Third quarter results continue to demonstrate strong execution and increased market penetration. We achieved third quarter year-over-year revenue growth of 47%, reaching $56 million, where our third quarter gross margins increasing by 1.5 points to 75.4%. Our initial guidance range of 37% to 40% growth has been increased throughout the year, driven by the increased confidence in our business outlook. Going into the last quarter of the year, we are raising our revenue guidance again. Now, we now expect full year revenues to be in the range of $215 million to $217 million, up from $212 million to $216 million which corresponds to 46% to 47% year-over-year growth.

Our business continues to strengthen on many fronts, driven by the proven superiority and completeness of our Zio platform, comparative customer data confirms that adoption of our highly differentiated Zio platform enables customers to measurably diagnose more patients in less time with fewer unnecessary repeat tests and at lower costs.

Zio platform also requires significantly reduced resources compared to other approaches. Our proven and complete platform consists of a technology stack with four layers that works seamlessly with one and other to create a source of competitive differentiation. So four technologies layers include a proprietary Zio data repository layer, that contains more than 600 million hours of annotated ECG based heart rate, heart rhythm and patient level information.

In a data curation layer, that deploys proprietary artificial intelligence algorithms to reliably reproducibly and accurately share a massive amounts of collected heart rate, heart rhythm and activity information into actionable reports for medical management by prescribing physicians. And the information system layer that streamlines workflow processes by order entry, results reporting, capture, all relevant patient demographic and health plan information, physician notes and other medical record information.

And finally, our patented single use patient worn biosensors, Zio XT and Zio AT that enable continuous, uninterrupted long-term cardiac monitoring. Our clinical and R&D investments continue to build upon this innovation stack and we remain focused on enhancing this integration platform.

Before we review the key components of our growth strategy, I wanted to provide a status update on the CPT code renewal process. At the end of September, the AMA hosted a CPT Editorial Panel meeting, where the long-term continuous ambulatory monitoring CPT code change application was reviewed. The ACC and HRS submission proposed replacing the existing temporary codes with permanent codes with confirmation of approval made by the AMA on October 25, two new code sets with four codes each are set to replace the temporary codes in January of 2021.

Each new code set will cover an extended period of wear time and recognize the increased clinical value that longer-term monitoring provides as well as the utilization of resources required to deliver those services. The existing Holter, Event and MCT monitoring codes remain unchanged. We're very pleased to see the process unfold in a manner consistent with our previously stated expectations and this of course gives us increased confidence as we move into the final stages of the process.

In the next stage, we’ve planned to collaborate and provide inputs to the model to be used by ACC, HRS at the AMA RUC Meetings scheduled for January, 2020. It's expected that minutes from this meeting will be available toward the end of February. The final stages for CMS review, approve or modify the recommendation of the AMA RUC with communication in July of next year.

As I noted on our last call, the AMA is very strict in appropriate rules that prohibit any lobbying or public statements meant to influence the process. As such, we're limited in the information we can share with you. We will be as transparent as we can be while honoring the process that the AMA has established and look forward to providing updates.

Turning to the components of our growth strategy which includes the following, three items, sales expansion and continued productivity improvements; increased market penetration with our single Zio platform and expanding our addressable market into new indications.

For the first item, sales force expansion continues to contribute to our sustained growth rates. Over the past several years, we have successfully increased the size of our sales channel by 20 to 30 high quality reps per year while increasing the productivity of our most tenured reps. As previously reported, we completed the majority of our 2019 hiring plan in the first half of the year.

In the third quarter we completed additional new hires and conducted extensive sales training and development. We will provide an update on our 2020 hiring goals on our next earnings call. As we've always done, we'll structure the commercial team to meet the cost effective size required to capture the full and untapped market potential for iRhythm.

Encouraged by the success within early customers' sites, in October, we initiated the full commercial launch Zio AT. We are seeing increased growth in prescribing volumes and number of accounts. Feedback remains extremely positive with customers noting the accuracy of our analysis as well as the consistency and reliability of the platform. It's important to highlight here that we believe Zio AT is an exceptional and service.

We remain steadfast in our view, however, that Zio XT is the most appropriate solution for the vast majority of patients. Faced with patient and information overload and constantly pressed for time, customers place significant value on using a single platform to improve the effectiveness of their monitoring operations, enabled by our highly integrated technology stack that includes identical, wearable form factors, application processes, reporting platforms and workflow tools, our single platform-based approach to the market is unique.

Turning to sales expansion opportunities. The silent atrial market is a major part of our expansion strategy. The one year published mSToPS results, which provides an early look at the health economics and utilization data, gives us increased confidence into what it is that's going to be needed to open up the market. We will continue to explore opportunities with this market, with our Zio XT solution, and we'll compliment those efforts by pursuing a more complete solution with even higher yield, which may result in even better economics.

Accordingly, in September, we announced that iRhythm and Verily will be working to develop next generation atrial fibrillation products that combine both company’s technologies to improve the screening, diagnosis and management of patients with asymptomatic atrial fibrillation. This collaboration brings together our experience in AI-based algorithm, diagnosis, Verily’s advanced health data analytics technologies to address the millions of patients living with undiagnosed AFib.

Our teams are now working together to combine the strengths of our collective capabilities to develop a complete solution over the next 24 months and we will provide updates as we move forward on this initiative. And as a final update on the quarter, we raised net proceeds of approximately $107 million from a follow-on offering in September. The proceeds of this offering will be used to fund important growth initiatives including additional salesforce expansion, the Verily collaboration and related silent AF market development efforts and international expansion. We're very pleased that our strengthened balance sheet enables us to pursue these important initiatives and we look forward to updating you on the progress in the future.

In closing, our strategic approach to driving market penetration and expansion is rooted in our ability to demonstrate clinical superiority with our proven service-based platform. Our confidence remains high with our fundamentals and business outlook as strong as ever. We are combining our expertise and cardiology monitoring data analytics and commercial execution to make a tremendous impact in people's lives and we are deeply committed to this endeavor and remain steadfast in our efforts.

And with that, I'd like to turn it over to Matt Garrett, our CFO for a review of the third quarter financial results and guidance for 2019.

Matthew Garrett

Thanks Kevin. Despite the challenges in our business that come in summer, the company continued to perform well as we head into the fall. Highlights for the third quarter 2019 were, revenue growth of $56 million or growth of 47% year-over-year and 5% sequentially. Gross margins of 75.4%, an increase of 1.5% year-over-year. Continued success moving away from non-contracted claims and improved claims adjudication efforts.

Further reducing reserve requirements while improving overall ASPs. And finally a number of onboarding Zio XT account successes, which in turn accelerates adoption of Zio XT in those counts where we've launched AT. Demonstrating our capability of being the full service solution offering.

Taking a more detailed look at the third quarter results. Revenue for the three months ended September 30th, 2019 was $56 million, an increase of 47% year-over-year and 5% sequentially. We were pleased with this outcome, given the headwinds associated with summer seasonality trends and lumpiness of launching large integrated systems during this period. We continue to view the pipeline is very robust, which is now enhanced with the full launch of our AT service offering here in October.

Some of the trends we continue to monitor and communicate to investors include same store/new store revenue growth as expected rose during the quarter to just under 70% to 30%, given the challenges of launching new accounts during the summer months. We do anticipate a return to the more recent trend of 60% to 40% split as we move into Q4 and on into 2020. As a related item and a sign of continued strengthen existing accounts, our top 25 and top 100 accounts grew in excess of 40% year-over-year.

A new trend we are communicating this quarter relates to our success with EHR implementations. In 2019, accounts that have implemented our service increased XT volume by nearly 20% over the preceding six months run rate, and EHR accounts in total now contribute to nearly 10% of all registrations. And finally, we have added a new, a number of AT accounts during the summer in preparation for the full launch here in October. As we have seen in our piloted account, we witnessed considerable XT pull-through in both new and existing accounts. Since AT usage is so highly concentrated in large systems, we believe this plays extremely well with our large integrated systems strategy moving forward.

Turning our attention to the rest of the P&L. Gross margins for the third quarter 2019 were 75.4%, compared to 73.9%, a 1.5 percentage point improvement over the same period in 2018. Sequential gross margin dipped slightly, due to the combination of one-time ride offs for obsolete inventory, the continued impact of the commercial launch of AT. And finally, short-term impact of tech productivity levels, given summer seasonality and vacation schedules.

Operating expenses for the third quarter 2019 were $60.7 million, inclusive of the development costs associated with Verily, compared to $37.9 million, an increase of $22.8 million year-over-year. Net of non-reoccurring Verily costs expenses were $55.3 million or growth of 46% over the same period in the prior year. For the quarter, the year-over-year spending increases continued to be driven by the full run rate impact of first half investment in salesforce expansion, organizational support for our network sales strategy, expansion of R&D activities, the move to our new corporate offices here in San Francisco and the impact of increasing stock compensation expense.

We also experienced an increase in bad debt expenses arising from environmental factors, specifically rising deductibles and increases to patient copays. Net loss for the third quarter of 2019 including Verily development costs were $18.6 million or a loss of $0.74 per share, compared with a net loss of $10.2 million or a loss of $0.43 per share for the same period of the prior year.

Turning to our guidance for the remainder of 2019. We are raising guidance for the full year 2019 to $215 million to $217 million from $212 million to $216 million. This represents annual growth of 46% to 47%, demonstrating our continued competence in our ability to scale the organization as we continue to produce benchmark top line growth. We anticipate gross margins will reverse Q3 trends and maintain our previous range guidance of 75.5% to 76.5%. We continue to anticipate some AT drag for the foreseeable future as we operationalize our work streams and more broadly launch the service over the next few quarters.

And finally, we are raising operation expenses guidance slightly, reflecting the increases in bad debt expense, incremental commission, bonus accruals and non-cash stock expense. The new range of $202 million to $206 million is up from $198 million to $204 million, including $29 million to $31 million for research and development and $173 million to $175 million for SG&A. Inclusive of Verily development costs, we project annual OpEx in the range of $210 million to $214 million, including $36 million to $38 million for research and development and $174 million to $176 million for SG&A. These figures assume one additional milestone payment of $1 million and some amount of developmental costs in the fourth quarter related to the Verily collaboration.

With that Kevin, Dan, and I would love to open the call up for your questions. Turn it back over to the operator.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question is from Robbie Marcus from JPMorgan. Your nine is now open.

Allen Gong

Hey guys, this is actually Allen on for Robbie, congratulations on the good quarter. I just had one question on the RUC process and then a follow-up. I guess my first one is, we know that you're moving from four, I believe to eight codes, but this was I think the first time that you've really highlighted that it's two different code sets. So I guess, could you clarify like what the differences between these two code sets, and under which circumstances you would use one or the other?

Kevin King

Hey Allen, it's Kevin. The only thing that's been published right now is that the separation of the code sets is along the lines of duration of where, we've not been allowed to talk about the amount of wear times. Compared to what we have today, a single code spans three days to 21 days. And within that code set there are four codes, a global code, patient hookup code, a technical component and a physician interpretation. Those same four code sets will be replicated twice in the new code set arrangement.

Allen Gong

Got it. And then kind of like, I guess a broader question, hopefully if you can talk around it a bit. But – regardless of what the decision is, in terms of like the value of these codes. Can you walk us through kind of the rollout once we do hit January 2021, like how much time will it take for whatever price changes implemented to kind of really start impacting the business and what does that rollout look like along kind of the different mix, and a mix of consumers that you have? Thank you.

Kevin King

Sure. So this code set change affects our payment with CMS, which is about 26% or 27% of our revenue, that code change would go into effect in January of 2021, unless it were delayed for some reason or if it were appealed. Our expectation is that it would go into effect at that timeframe. And so whatever the decision is in the July timeframe to either accept or modify or to change the relative values that are being assigned here in the February the timeframe that will go into effect at that period of time.

Operator

Your next question is from David Lewis. Your line is now open.

Unidentified Analyst

Good afternoon. This is [Jay Chado] on for David. Kevin, I had two quick questions and then a follow-up. I was wondering if you could talk about the underlying momentum in the business. If you look at guidance into the fourth quarter, it may be implies a little bit weaker quarter-over-quarter growth into the fourth. And in light of the full AT launch, I was wondering if you could talk about, how we should think about the incremental pull-through either AT or XT? Now the device is fully underway and then I had a quick follow-up for Matt.

Kevin King

Sure. Okay, I would start-off by saying from a momentum standpoint, I don't think we could be in a better off position right now. We have a large number of positive growth drivers. I think everyone understands and accepts that we're really well positioned competitively and got a very, very long runway ahead of us here. And growing salesforce, competitive differentiation, abundance of clinical evidence on, that's allowed us to raise our estimates throughout the year. I think relative to the fourth quarter here and looking forward, it's important to note that, changes in growth rates don't imply less opportunity or imply weaker execution, it really implies the segment that we're targeting is different now than the segment that we targeted in the past.

And I like to think about it from the standpoint of when we study our opportunity funnel, we now are characterizing ourselves as having transitioned from let's call it early adopters, where those early adopters were in order to change their status quo were largely looking for a demonstrated clinical benefit. And we did that really well and we continue to do that well in terms of an unsurpassed assurance of accuracy, proven ability to change medical managements and the 30 plus peer review publications that we have, that show that we're superior.

Today, I think we're more in the middle market, the middle majority of the market and there those customers are asking us not only for the clinical benefit, but they're asking for productivity gains, gains that help them to be world class in terms of delivering clinical, operational and financial value. And I said in our prepared remarks that we've got comparative customer data that confirms that we measure and diagnose patients in fewer – in less time with fewer unnecessary repeat tests with fewer resources and lower costs, that's what people want. And that takes a lot of energy for us to work with these large accounts in order to get them over the hurdle to change their status quo.

Their overwork, their pressed for time and in order for them adopt they have to have, not only the proven clinical superiority, but the completeness of the platform. And so I like in our trajectory that we're on right now more related to the segment of the market that we're addressing, it's certainly as large and growing, but it's a little bit harder to tap because of the requirements that those customers have for us. I wouldn't read into it, I wouldn't read anything into it other than that.

As far as XT and AT pull through, maybe Matt can address that. We continue to see very strong XT pull through and AT accounts. Matt, I think you said a few things on your prepared remarks, there maybe you want to go into that.

Matthew Garrett

Yes. Well, I think that that's right, Kevin, before we dive into that everyone has to understand that the AT product is a completely different workflow and work. Our excitement of launching that product and the feedback we've gotten from the field has been outstanding and we've provided updates for I guess three quarters now on pull-through that we see in those pilot accounts.

But again, those pilot accounts are extremely limited and we're just now starting to launch it. So I think there's going to be some learning curve here as we move into November, December as relates to providing change of our guidance around AT.

So I think what I would strongly suggest is that we will continue to provide feedback as we move to this broader commercial opportunity around the XT pull through, particularly as it relates to new accounts or Greenfield accounts, I think that's going to have some interesting outcomes for us. So I'll just leave it that for now.

Unidentified Analyst

I have another question here?

Kevin King

Yes. You want to follow-up with me on another question?

Unidentified Analyst

Yes, thank you. And either for Matt or Kevin. As you think about the recent capital raise, how should we think about incremental investment into commercial infrastructure? Any potential adds into the fourth quarter or earlier in 2020 next year?

Kevin King

No, I don't think so. I think everything is maybe one small caveat, I think everything is exactly the same as we've talked about on the raise. We just highlighted, we've already spent about $5.5 million on Verily development, obviously a significant portion that was the initial milestone payment and that's certainly going to be a good portion of it.

The other two areas that we talked about are consistent with where I think our thinking is now as we move into kind of the budget planning season, and that is the sales force expansion as well as some dollars related to international expansion. I think those are absolutely still front and center in our minds.

I did mention that although it's not going to be material moving forward, the amount required for bad debt expense is probably going to go up slightly. I think we've guided in the past at 4%, that is probably leaning more towards 5%, maybe 5.5% as we're just seeing a significant increase in deductibles and an incremental amount owed by the patient that's coming with the environmental territory that we're presiding. And so other than that small adjustment, I think everything else is exactly as we laid it out with the follow-on.

Unidentified Analyst

Thank you.

Operator

Your next question is from Jason Mills from Canaccord Genuity. Your line is now open.

Jason Mills

Hi, Kevin. Matt and Dan, thanks for the questions. I wanted to go follow up on a few metrics that seem to be important in the model. So you talked a lot about, Kevin on this call, the larger health networks and IBMs, in the past you’ve been under-penetrated and relative to the amount of the market that they preside over. Could you talk about sequentially your success in penetrating those – that particular account base. And how AT may help you in fourth quarter and 2020, not only vis-à-vis the sale of AT, but the XT pull-through. I think you alluded to it to some extent.

But, is that one – I guess a follow-up to that question is, is that one potential area that could drive upside to your revised guidance? Is that an area that perhaps is underappreciated in terms of the growth potential near-term?

Kevin King

Hi Jason, this is Kevin. So maybe just make sure that I got all those. So our first one was relative to same-store, new store how did new store do in the quarter, Matt will cover that. AT upsize, I think the answer is yes, our XT upsize as well. I mean, the AT numbers are small number from starting, but nonetheless, I think the pull through is probably more significant than the actual AT volume. And then the other one was…

Matthew Garrett

Yes. Jason, I think what you were going for is from our strategy of these large systems, what does that sizing compared to the overall market? And we have not, done a deep dive into that number since last quarter, but based upon guidance since new store, same store sales, the answer is exactly the same. And that is the overall opportunity in those accounts as it relates to our market penetration, it’s almost on par with the broader market.

So however you guys are defining the market, whether it's $1 billion in three quarters or $2 billion with some of these add-on indications, whatever, 10% or 15% penetrated in the broader market, we're also still 10% or 15% penetrated in these large integrated systems. So again, we think that bodes extremely well for us moving forward. Does that help?

Jason Mill

Yes, it does. That's exactly where I was going with that, Matt. Thank you. And then just a few other metrics. In the past you've talked about not yet seeing the peak level of your productivity level, you've added more ramps this year than you originally thought, perhaps that – some of the productivity gains, I'm just curious if your – I you at this point, been able to identify a peak productivity level per your increasing sales force.

Matthew Garrett

Yes. Jason. I mean, good question. We weren't trying to hide that obviously with a quarter that didn't – doesn't see as much growth because of the summer, right. there was not a huge change to those numbers and that’s we weren't calling out a higher a productivity level at this time. I think the last one we've called out is about 2.5 million, although we have talked about the ability to pull that in.

I think the genesis of the question and the genesis of the answer is that, I don't believe any of us in the room feel as though we've reached peak productivity. And I think with the onboarding of these large integrated systems and the potential volume that comes with them, clearly would indicate that we haven't reached peak productivity. I just don't think that we're ready to call out anything higher right now, given what Kevin just talked about in terms of the strategy, given the AT launch and given that, we're a quarter away from guidance on 2020.

So long story short we're, we're still guiding that 2.5 million, but I don't think any of us feel that we've achieved the top of that threshold yet.

Jason Mills

Thank you.

Kevin King

Jason. I might add to that and just say that, we've added 40 people a year for the last two years, that would imply that roughly 60% of our sales force is with us less than two full years, this year and last year. And Matt's peak productivity number is when people are with us three to four years.

Matthew Garrett

Three to four. Correct.

Kevin King

So we feel like, we’ve got an opportunity to grow there, but that peak productivity number, that's peak of the peak productivity number is still rather elusive for us to define.

Jason Mills

Okay. Understood. Thank you.

Kevin King

You bet.

Operator

I am showing no further question at this time. I would now like to turn the conference back to Kevin King, CEO for some closing remarks.

Kevin King

Great. Thanks everyone. Thank you for joining our third quarter earnings call. We look forward to updating you on our year-end results and outlook for next year on our fourth quarter earnings called early next year. Thanks very much.

Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation and have a wonderful day. You may all disconnect.