iRhythm Technologies, Inc. (NASDAQ:IRTC) Q2 2019 Earnings Conference Call July 31, 2019 4:30 PM ET

Company Participants

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

Conference Call Participants

David Lewis – Morgan Stanley

Operator

Good afternoon, my name is Sylvia and I will be your conference operator today. At this time I’d like to welcome everyone to the iRhythm Technologies Second Quarter 2019 Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host Ms. Lynn Lewis from Gilmartin Group, please go ahead.

Lynn Lewis

Thank you. Thank you all for participating in today's call. Joining me are Kevin King, CEO and Matthew Garrett, CFO. Earlier today, iRhythm released financial results for the second quarter ended June 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 includes forward-looking statements within the meaning of federal securities laws, which are made pursuant to the safe harbor provision of 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 margin and operating expenses in 2019 are based upon our current estimates and various assumptions. These statements involve material risks and uncertainties that could cause actual results or events to materially differ from those 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, July 31, 2019.

iRhythm disclaims any intention or obligation, except as required by law, to update or revise any financial projections or forward-looking statements, whether because of new information, future events or otherwise. With that, I'll now turn the call over to Kevin.

Kevin King

Thanks Lynn. Good afternoon and thanks for joining us. Our second quarter results demonstrated continued strong company-wide execution and increased market penetration. We achieved second quarter year-over-year revenue growth of 50% reaching $53.3 million and second quarter gross margins increased by 2.8 points to 76%.

Our business continues to strengthen on many fronts driven by accelerated adoption of our highly differentiated Zio platform within existing and new accounts. The continued strength we see on our fundamentals combined with a growing market opportunity gives us the confidence to increase our 2019 revenue guidance to $212 million to $216 million up from $206 million to $211 million which represents annual revenue growth of 44% to 47%.

The three primary components of our short and long term growth strategy remain unchanged. Sales team expansion and continued productivity improvements, increased penetration within our single Zio platform strategy and expanding our addressable market into new indications. I'll highlight our progress on each of these objectives as well as our priorities for the remainder of the year and then turn the call over to Matt for a detailed financial review of the quarter and additional annual guidance.

Before doing so, I want to provide a status update on our CPT code renewal process. On July 26, the AMA published the agenda for its upcoming CPT Editorial Panel Meeting which will be taking place September 25 through September 28. As we anticipated the CPT code change application was accepted by AMA and will be reviewed for Category 1 status at the September meeting. We were aware of, and support the ACC and HRSs recommendation to replace the existing four temporary codes with eight permanent codes. At this point in time, we cannot comment further on the code application, we are in construction of the codes.

After code application is submitted to the AMA, the AMA has very strict and appropriate rules to prohibit any lobbying or public statements meant to influence the process. As such, we will be limited in the information we can share with you as we go through the process. We will however make every effort to update you on any new developments and we expect the meeting notes for the September CPT Editorial Panel Meeting to be available to the public in late October.

In summary, we remain extremely confident in the value of our Zio service and our outlook has not changed. We're looking forward to the September meeting as the next step and we're excited to highlight the differentiated value of our Zio service as we go through the process.

Let's move to our commercial organization, sales force expansion continues to contribute to 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. Our 2019 goal was to add a similar number of sales positions and bring our total sales head count to 130 to 140. As we've done in prior years, we did complete the majority of our 2019 hiring plan in the first half of the year. To support the increased headcount, we have also created several new sales management positions and most of these positions were filled in the first half as well.

I do want to remind everyone that it takes time for new sales reps to complete their on-boarding, training and to contribute meaningfully to productivity. We also caution that we have historically experienced significant summer seasonality in the months of July and August. Longer term, we expect to continue to manage the commercial team headcount to meet the most cost effective size required to capture the full and untapped market potential that lies in front of us.

Turning to account penetration, to fuel our rapid growth, we've been focusing on commercial strategy on growing our share of the large health system customers, which represents about 60% to 70% of the addressable market. As we noted on our recent Investor Day presentation, while much of our growth is coming from the segment, we also believe that we are under penetrated with less than 20% overall share and that set plenty of opportunity for additional expansion.

The proven superiority and completeness of our Zio platform, which now includes both Zio XT and. Zio AT is enabling our customers to measurably diagnose patients in less time with fewer unnecessary repeat tests and at lower cost. Zio also delivers a platform that requires significantly reduced resources compared to other approaches. During the first half of the year, we continued to experience increased velocity within existing accounts. We saw a seven-fold increase in year-over-year, first month adoption from new large accounts. This demonstrates our ability to meet our customer's demand as we change the standard of care across the enterprise.

The outlook for the remainder of the year is favorable due to a significant pipeline of large accounts, successful expansion of our sales force and the highly differentiated value of our proven and complete Zio service that now includes Zio XT and Zio AT. It's important to note that settling into larger accounts is highly complex and includes an array of decision makers across a variety of care settings, all with priorities that encompass patient satisfaction, operational efficiency, and standardization that can be lengthy and unpredictable.

On the back of this new approach, we have invested in training programs for our commercial teams, which has in turn further improved the productivity of our tenured reps. We expect that our commercial efforts in expanding service capabilities will continue to drive adoption in these larger accounts for the foreseeable future to ultimately become the standard of care for monitoring.

I'd like to add a few words on our recent launch of Zio AT. As a reminder, Zio AT offers real time reporting for use in detecting and diagnosing arrhythmias associated with conditions such as syncope or fainting that require a more immediate notification and actions. Zio XT and Zio AT form factors, application processes, reporting platforms and workflow tools are identical. This similarity across devices has reduced the burden on clinicians to learn and adopt the new capability. As we've shared previously, Zio AT addresses approximately 10% of the total ambulatory monitoring market or about 400,000 tests per year.

In May, we began a targeted rollout out of Zio AT into to the market. As we've highlighted in the past, we took a very thoughtful approach to Zio AT’s introduction and are encouraged by its impact within its early customer’s sites. Feedback has been extremely positive with customers noting, the accuracy of our analysis as well as the consistency and reliability of the platform. With the launch now underway, we're delighted to see the strength of our platform based approach delivering a more complete solution for ambulatory cardiac monitoring.

Regarding market expansion opportunities, silent AF remains our near-term primary market expansion priority. We estimate that there is a population of more than 10 million patients who have risk factors such as age, hypertension, and diabetes and possibly undiagnosed atrial fibrillation. We published last year the first phase of the mSToPS study that demonstrated the utility of Zio in diagnosing AF, the most asymptomatic population.

At the annual meeting of the ACC one year healthcare resource utilization data was presented, which showed that patients who were diagnosed with AF in the Zio monitoring group had significantly lower rates of hospitalizations and emergency room visits, compared to the nonmonetary control group. Evidence such as this continues to build the case for the targeted detection of AF by Zio in the asymptomatic population.

In 2020, we will continue to expect the three year clinical outcome and healthcare utilization data from mSToPS to be published, which would be an important data point for clinicians and payers in opening up this market. As is the case with the rest of our business, clinical evidence remains a key pillar not only in our discussions with payers, but also as a driver for competitive differentiation. In addition to mSToPS, we continue to invest in clinical trials and partnerships to open up this large market opportunity.

In closing, it's clear our market opportunity is large and growing and that demand for Zio platform is increasing. The iRhythm team continues to deliver and I'm proud of our success in sales force expansion, the traction we are achieving together in new and existing accounts, the recent launch of Zio AT and a potential benefits that our scalable platform provides our customers. We look forward to continuing this success for the remainder of the year and beyond.

Before I turn the call over to Matt, I'd like to welcome Dan Wilson to iRhythm, as our Executive Vice President of Strategy, Corporate Development and Investor Relations. For those of you who haven't met Dan, he is a highly accomplished medical technology and financial executive with deep industry and investment community relationships. We're delighted to have him join our team and confident he'll be a significant contributor to our long-term goals as our business grows.

With that, I'd like to turn it over to Matt Garrett, our CFO for a review of our second quarter financials and guidance for 2019.

Matthew Garrett

Thanks, Kevin. Our ability to staff up in the sales organization while continuing to onboard the large integrated systems, where two of the three key areas that focus in the quarter. Our continued ability to deeply penetrate existing accounts was the third, which continues to pay dividends on delivering consistent top line growth.

Encouragingly, we made significant progress in all three of these deliverables. Highlights for the second quarter of 2019 include, revenue growth of 50% year-over-year and sequential growth of 13%, gross margins of 76% an increase of 2.8 percentage points over the prior year. Continued mix shift away from non-contracted and legacy client bill claims towards contracted claims and finally success with Zio AT pilot accounts, which has accelerated adoption of Zio XT in those accounts, demonstrating iRhythm's capability of being in the full service solution offering.

Taking a more detailed look at the quarter, revenue for the three months ended June 30th, 2019 was $53.3 million an increase of 50% year-over-year and 13% sequentially. We continue to see sales force productivity levels rise, as we penetrate these large integrated systems and as the reps hired over the past year achieved meaningful productivity levels. Some of the trends we continue to monitor and communicate to investors include, same-store new store revenue growth for the fourth consecutive quarter, posted a mixed split of approximately 60% to 40%. We view this mix in a positive light as we continue to deeply penetrate existing networks, while maintaining a strong target pipeline, creating true productivity scale within our sales force.

In a related item, we continue to see material growth in our largest accounts, were our top 25 accounts grew approximately 50% over the prior year. As we mentioned last quarter, improved brand awareness, EHR implementations and overall workflow enhancements enabled by our comprehensive Zio service, not only accelerate growth, but can also lead to greater volumes than were originally forecast within these large integrated systems. We've also been able to aggressively hire most of the new sales reps for the year, bringing us to within our guidance target of 130 reps to 140 reps in the first half of the year. Our attention will now turn to onboarding and training for multiple product lines, where we continue to see sales reps getting productive at a faster pace.

And finally, in accounts where we have piloted Zio AT, we continue to see double-digit volume expansion for Zio XT in the months after AT launch. As we approach a broader AT market launch, we view this as a positive indicator for the rapid expansion of XT and AT launched accounts, whether the account was using XT before or not.

Turning our attention to the rest of the P&L. Gross margins for the second quarter of 2019 was 76%, compared to 73.2%, a 2.8 percentage point improvement over the same period in 2018. Operating expenses for the second quarter of 2019 were $51.8 million, compared to $37.7 million an increase of $12.3 million or growth of 38% over the same period in the prior year. We continued to see operating scale improvements, where for the third straight quarter OpEx growth has been materially lower than revenue growth, as we move the business towards cash flow breakeven while maintaining minimal cash burn during this transition.

For the quarter, the year-over-year spending increases continue to be driven by heavy first half investment in sales force expansion, organizational support for our network sales strategy, expansion of R&D activities and the impact of increasing stock compensation expense. Net loss for the second quarter 2019 was $11.5 million or a loss of $0.46 per share, compared with a net loss of $12.2 million or a loss of $0.51 per share for the same period of the prior year.

Turning to our guidance for the remainder of 2019, and as Kevin noted earlier, given the strong start to the first half of the year and the ongoing strength in the business, we are raising revenue guidance for the full year 2019 to $212 million to $216 million from $206 million to $211 million. This represents annual revenue growth of 44% to 47%, demonstrating our continued confidence and our ability to scale the organization as we continue to produce benchmark top line growth.

We once again take this opportunity to remind investors who are modeling the second half of the year that we are a services business that faces material summer seasonality. In addition to our typical vacation slowdown, we faced the added challenges this year related to the preparation for the commercial launch of our AT service offering and despite our robust pipeline, the added lumpiness of onboarding new integrated systems with their vacation scheduling issues. Thus we encourage investors to weight the impact of our improved guidance towards the fourth quarter.

Gross margin guidance for the year has also been raised by 0.5 percentage point to arrange a 75.5% to 76.5%. While we see the continued scale in our margins and remain bullish on long-term gross margins approaching 80%, we do anticipate some Zio AT drag in the near-term, as we more broadly launch the service later this year. And finally we are raising operating expense guidance, reflecting incremental commission, bonus accruals and non-cash stock expense due to better-than-anticipated performance in the business.

The new range of $198 million to $204 million is up from $193 million to $199 million, including $29 million to $31 million for research and development and $169 million to $173 million for SG&A. Finally, this range reflects our expectation that OpEx will continue to trend downward over time, even as we continue to scale the business.

With that, Kevin, Dan and I would now like to open the call up for questions, operator?

Question-and-Answer Session

Operator

[Operator Instructions] First question comes from the line of David Lewis with Morgan Stanley. Your line is open.

David Lewis

Hello, good afternoon. Sorry about that. I was on mute. Couple questions here. Kevin, we start with you, just – or Matt. Just guidance, thinking about the back half of the year, you've been conservative all year with the guidance, guidance in the back half of the year does imply some deceleration. Can you sort of talk about how you see commercial traction in the back half versus the first half? Just that back half guidance suggests some level of conservatism or any change in sort of how you see the underlying business? And I had a couple quick follow-ups.

Kevin King

David, I would say aside from the seasonality that we see in the months of July and August, really not much difference in trend or trajectory in terms of first half, second half. And as Matt noted, we tend to perform better in the fourth quarter than we do in the third quarter as a result of that seasonality.

David Lewis

Okay. And then just, cash flow trends year-to-date, maybe talk about how they've been year-to-date. What you specifically saw this quarter in terms of the burn rate in the second quarter versus the first? And how you see cash flow into the second half of the year and how you're feeling about the cash position? And then one last one for Kevin after that.

Matthew Garrett

Sure, David. I mean, as you know, we don't give specific cash flow or EBITDA guidance. But as I said in the prepared remarks, we do continue to point towards decreasing OpEx growth levels below revenue growth. And I think the third consecutive quarter of that, and our belief that we are appropriately spending as we to say out in front of that revenue growth, right. So I believe it was 50% revenue growth and 38% OpEx growth. And this comes despite the fact that we've had a significant amount of sales and marketing pull-in related to getting to our target in the first half of the year for the reps, the stock comp expense and so on and so forth.

But to answer your specific question, yes, look we don't, again, don't talk about EBITDA, but if you back out the non-cash EBITDA items, our Q1 EBITDA was roughly $3.5 million, Q2 is just slightly higher, still in the $3 million range and we actually had a cash flow breakeven quarter, with cash actually up slightly, obviously, that trend can't continue if we continue to burn a little bit more than we bring in from an oping perspective. But as I think the key point here is that we track this very carefully and we continue to see over time this continuing a decrease in the burn which as you can tell from Q1 and Q2 was actually quite small.

As it relates to the rest of the year, we are going to see a relative increase in cash burning Q3 and that's because we are actually moving locations here in San Francisco and there was a good portion of TI expense that we're going to have to pay up front. So that would be the one mitigating item I think you would see on the other half of the year. But other than that from a P&L perspective, I would tend to think that we're going to continue to trend in that very low burn rate.

David Lewis

Okay. Kevin, just last one for me, just the XT traction. What are you specifically seeing? Is it when you adopt the AT platform, people are using the system more broadly, so they’re converting their Holter business to far more comfortable, converting the Holter business, are you’re actually seeing customers say, look, there's enough value in XT where I don't have to rely on alternate forms like MCOT. I wonder how much of this is sort of XT in replace of MCOT? Or is it really more specifically driving AT in replacement of MCOT? Thanks so much.

Kevin King

I think it may be a little bit of both, David. But in those accounts that have not been using AT or XT oftentimes MCT is used as a surrogate for low performing Holter or low performing Event monitors. And when we see accounts adopt XT, I think you know that the diagnostic yield of XT is close to 76%, it clearly replaces whatever you might be doing with Holter or Event. And if you are using MCT to augment those deficiencies with Holter and Event, you can now go to XT. And so I think that's where we're getting a lot of the lift and a lot of the Holter if you will.

In those accounts that are now using AT, it's just a more streamlined operation for them. They no longer have to deal with multiple disparate systems or platforms they can use, iRhythm as a single turnkey. And as a result, I think the rising tide lifts all boats and we get the benefit of both AT and XT in that case.

Operator

Our next question comes from the line of Robbie Marcus from J.P Morgan. Your line is open.

Unidentified Analyst

Hi, this is actually Alan on for Robbie. Congratulations on the good quarter. I just had a question on the indication or I guess the clinical trial pipeline. So you mentioned obviously silent AF is the major opportunity that you guys have ahead of you that's a bit further out. But the one that maybe benefited you in the quarter and maybe will benefit you in the back half of the year is really KP-RHYTHM and paroxysmal AF. So I just was curious what kind of traction you're getting from that, whether or not it's a meaningful contribution to your growth that you're seeing.

Matthew Garrett

I think the traction we're getting is a little bit broader than just the KP-RHYTHM study. For example, the remap study that was published earlier in the year, compared iRhythm to multiple technologies, where we were all compared to a gold standard pacemaker. And iRhythm outperformed competitive patch products, traditionally Event monitoring products and Holter like products and the marketplace is increasingly aware of that and that's building upon my comment to David on the earlier question.

I think AF burden is increasingly – physicians are increasingly aware of the importance of AF burdens, I think it's still rather early days in terms of educating the market. And I would say there are some pull-through from that study, but I don't think we've come anywhere near the point of fully educating the market on the benefits of understanding that 11% atrial fibrillation burden confers an increased risk of stroke over patients that have less than that. I think we're still in the early days of educating the market.

Nonetheless, it has gotten a lot of press and AF burden has increasingly been written about not only in editorials, but also in other discussion forums and in conferences. So we’re pleased with the traction, but I think it's early days.

Unidentified Analyst

Got it. And then I guess a question on rep productivity. I think you've called that in the past that prior – compared to previous expectations, you're now seeing your most tenured reps are averaging around – I want to say 3 million, a year in terms of rep productivity. And that's with AT in very limited launch. So now that you're preparing to ramp AT into a full launch, when we think about peak rep productivity and even beyond, like how much higher I guess, do you think that can go?

Matthew Garrett

Yes, I think that it's not 3 million. The number that we've provided guidance on was $2.5 million, but the average was right. So you could certainly have reps that are above $3 million number. I think the thing that we've talked about most recently in the last couple of calls, isn't a change to the $2.5 million as much as it's been that the reps that are younger or newer to the company are coming online quicker and they're coming online and being more productive faster.

So I think when we gave original guidance back few years ago, it took three to four quarters for them to get to a level of any productivity and now they're able to do it in a matter of a couple of quarters. So that was probably the big change. And as we've said in the past that has a lot to do with better training, better on-boarding, brand awareness, contract things better all the usual suspects there. And obviously when you tap into some of these larger integrated systems, you have a chance to get productive considerably faster. So that's obviously the strategy moving forward.

To answer your specific question, I don't think that we've ever said the cap is 2.5. I think we just said that we feel comfortable with 2.5 for now and as Zio AT launches, as we get more traction over the next two to three quarters with these larger integrated systems, I think we're going to be able to provide – we'll update our guidance accordingly.

Unidentified Analyst

Thanks guys.

Operator

Our next question comes from the line of Joanne Wuensch. Your line is open.

Unidentified Analyst

Hi, this is Steve for Joanne.

Kevin King

Hi Steve.

Unidentified Analyst

Hey guys. This is more of a big picture question for you, but given that you said roughly less than 20% penetrated today in the clinical and economic benefits of Zio are quite clear verse Holters. So what takes you meaningfully higher to say greater than 50% range? I mean, can you even get there? Does it require significantly larger sales force or much more clinical data that we'll see in 2020?

Kevin King

Steve, this is Kevin. I think it's more time to get physicians and accounts to change what we call their status quo. I'm sure you're well aware of that change in health care takes place over long periods of time. I was at a conference recently and people were talking about that Warfarin as an anticoagulant is still about 40% market share despite all the benefits of oral anticoagulation therapy and all the marketing, healthcare changes quite slowly.

That said I don't see any reason why we can't be a very, very high percentage of the market over time. And it's a multi-pronged effort if you will, certainly technology, sales force expansion, continued deep clinical evidence, strengthening our innovation stack that we've described previously, the five layers of our innovation stack, new indications. I mean all of those things are investments for us that will drive greater share, greater awareness and higher levels of adoption.

Unidentified Analyst

Okay. Thank you. And then can you just give us an update on your efforts internationally? How is that sales force build going, will there just indirect efforts there? Can you mind us what countries you'll be targeting aside from the UK and maybe when we can expect some you to report revenue there?

Kevin King

Yes, Steve, we've not publicly disclosed any of our market access efforts outside of the U.S. and the UK, we do have initiatives underway, but it's a highly competitive market and would rather not disclose that right now. I would say that the traction in the UK is increasing and it's on plan, now we are still small, as I've mentioned on previous calls, nearly all, if not all outside the U.S. markets are single payer systems and so it can take many years to gain market access, meaning remuneration for your service and that's where our investment is right now.

We firmly believe that the markets are attractive. We firmly believe that the markets are large and we firmly believe our clinical evidence is transferable outside the U.S. to these new markets. So with that time will tell and – but we will be addressing other markets.

Unidentified Analyst

Okay, great. Thanks. Congrats on the nice quarter.

Kevin King

Great, thanks Steve.

Operator

[Operator Instructions] Your next question comes from line of Jason Mills from Canaccord. Your line is open.

Unidentified Analyst

Hey, it’s David on for Jason.

Kevin King

Hey David? Yes, it is just fine.

Unidentified Analyst

I want to start first on guidance for 2019. I know you provided some commentary around the Q3 versus Q4 breakup rows, wondering if whether or not the increased guidance is coming more from increased confidence that you've seen in the Zio AT rollout so far this year, based on what's happened in the first half of the year, whether it's kind of more overall business confidence and general trends there?

Kevin King

Yes. I don't think that we've really given any guidance or break out between Zio AT and Zio XT, I think I would just state it as that the growth is in line with our strategy for our penetrating not just Zio XT but Zio AT over time in these large markets. So I think internally, we look at it as we're just beating our own internal estimates, maybe not quite weighted evenly but pretty close to that. It's not coming from one source over the other I guess is the way to say it.

Unidentified Analyst

Okay, thanks. And then looking and thinking about margins for the first half of the year and second half of year in 2020, could you provide some detail around the kind of bad as well as what type of impact do you think we could see or have seen thus far with Zio AT as well, once Zio AT hits the full scale?

Matthew Garrett

Yes, I don't really think I have much else to offer on that particular front today other than what we shared on the guidance, which is that we are raising the 76.5%. And internally our expectation is that we will over time continue to guide and raise eventually towards the 80% gross margins, I don't think there's anything internally that has changed our minds really – again, back to my previous answer, the mix between Zio AT and Zio XT from a margin perspective, we think that they're both very attractive gross margins and even with the added costs associated with Zio AT those being offset obviously by higher price point that they blend in very well together. So again, we still feel very good over time about that 80% gross margin.

Unidentified Analyst

Okay. Thanks for taking the questions. And good progress in the quarter.

Kevin King

You're welcome. Thanks David.

Operator

There are no further questions at this time. I will now turn the call back over to Mr. Kevin King, CEO.

Kevin King

Great. Thanks everyone. We really appreciate you for dialing into our second quarter earnings call and look forward to updating you on our third quarter results in the near future.

Operator

This concludes today's conference call. You may now disconnect.