iRhythm Technologies, Inc. (IRTC) Q3 2017 Earnings Report, Transcript and Summary

Good day ladies and gentlemen and welcome to iRhythm Technologies Inc. Q3 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will have a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today’s conference, Leigh Salvo of Investor Relations. You may begin.

Thank you, Nova, and thank you all for participating in today’s call. Joining me are Kevin King, President and CEO; and Matt Garrett, CFO. Earlier today, iRhythm released financial results for the quarter ended September 30, 2017. 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 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 includes expectations for hiring, growth in our organization and reimbursement, guidance for revenue, gross margins and operating expenses in 2017 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 risks factor section of our most recent Quarterly Report on Form 10-Q with the Securities and Exchange Commission. 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. This conference call contains time-sensitive information and is accurate only as of the live broadcast today, November 1, 2017. And with that, I like to turn the call over to Kevin.

Thanks Lynn, good afternoon and thanks everyone for joining us today. Third quarter and year-to-date results strongly support the progress we’re making and establishing our Zio Service as the new standard for care in ambulatory cardiac monitoring. Revenues for the quarter were $25 million, reflecting growth of 49% over the prior year. We had strong growth in both existing and new accounts and made further progress in our in-network payer contracting during the quarter. We believe the hurricanes that struck Houston, Puerto Rico and the Southeast states had a non-material impact on revenue. However, the widespread devastation from these events, as well as the fires in Northern California impacted the lives of many of our employees and our hearts and thoughts continue to go out to each of them. We’re so proud of their continued commitments to our company during this period of time and despite their personal hardships, we did not see any significant disruption to our internal operations. We are raising our 2017 revenue guidance to a range of $96 million to $97 million, representing a year-over-year growth in the range of 50%. Matt will go into more details on weather-related impacts, our Q3 financials, and our 2017 annual guidance in his section. Let me begin - at the beginning of this year, we highlighted the importance of two growth initiatives, expanding our sales channel to meet the growing demand for our Zio Service and increasing our in-network health plan contracting. I’d like to take a few minutes to provide an update on the notable progress in each of these strategic areas starting with our sales organization. The consistent growth and demand of our service has enabled us to confidently pursue a path of sales force and infrastructure expansion throughout the year. And during the first half of 2017, we invested heavily in the expansion of our sales leadership team through the addition of new area and regional managers. Entering the second half, we quickly transition to the next step in our expansion process, the recruitment of an additional 15 to 20 quota-carrying reps. We made substantial progress in hiring in Q3 and are confident we will meet overstated year-end target of 81 to 86 sales reps with a total sales force of over 100, including sales management. Our new hire on boarding process, including training is extensive and the time for new reps to reach productivity takes several quarters. As a result, we feel it is prudent to model minimal impact from these hires for at least several quarters. We continue to make progress and laying the groundwork for international expansion with the UK as our first target market. During the third quarter, we began hiring a small sales team in that region. As previously mentioned, our primary focus outside of the US is establishing appropriate reimbursement with national players. The timing of which is difficult to predict. Until those payment milestones are reached, we will be focused primarily on key opinion leader in market development work with some nominal opportunities within the private sector. As such we do not expect international sales to be a meaningful contributor to our revenue at this time. Turning to our second strategic objective, growth of in-network contracts is vitally important to us that the millions of patients who experience cardiac arrhythmia symptoms or suffer from cardiac arrhythmias have cost-effective access to our service through their health plans. Positive coverage decisions and policies are the first step and our Zio Service is covered by the vast majority of health plans. The next step is gaining in-network or contracted status, which can take anywhere from 6 to 24 months, depending upon the type of health plan. If patients are eligible for in-network coverage, it is more likely they will be prescribed our Zio Service. During the quarter, we made further progress on our in-network contracting efforts with health plans across the country and continue to expect by year-end we will have grown our in-network lives by 20% to 25% over the prior year allowing for a majority of the US populations be in network for Zio XT. In the third quarter, our non-contracted revenue was less than 10% of our total business. We continue to invest in developing evidence to expand the indications in clinical uses for our Zio Service. A clinical use case that we remain excited about is the monitoring of asymptomatic or silent Atrial Fibrillation in high-risk patients. These are patients who have not yet been diagnosed with AF, but have risk factors such as age, diabetes, or hypertension which may predispose them to AF. Early diagnosis in these patients would allow them to be medically managed through therapies such as anticoagulation that would significantly reduce their risk of stroke. We estimate that there were over 3 million high-risk patients in the U.S. who could potentially be candidates to be monitored for silent AF. On November 14, we expect preliminary results from the mSToPS study to be presented at the American Heart Association scientific sessions and Anaheim, California. As a reminder, the mSToPS study is being conducted by Scripps Translational Science Institute and is in partnership with the major payer, Aetna, as well as the drug company, Janssen. The primary purpose of this randomized controlled study is to evaluate the detection of silent AF using the Zio Service in over 2000 Aetna members who were at potentially increased risk for undiagnosed Atrial Fibrillation. The Zio monitor patients will also be compared to an observational case matched cohort of patients to evaluate long-term clinical and health economic outcomes. We expect the poster presentation at AHA to provide a preliminary readout of data from the Zio monitor patients. Importantly, full results from both the monitored and observational cohorts are expected to be available in the first half of 2018. Lastly, there are 3-year clinical and health economic endpoints that remain ongoing. We see silent AF as having the potential to significantly expand the total addressable market for the Zio Service as we develop supporting clinical evidence over time. In the meantime, we remain focused on aggressively driving penetration into the existing symptomatic arrhythmia market in which we are less than 10% penetrated. Early access for our Zio AT, our next generation connected offering began shortly after receiving FDA clearance in June 2017. Zio AT offers the full benefits of our Zio XT Service with the addition of real-time data transmission and notification of actionable clinical events. During the third quarter, we began the rollout of our Zio AT service among a limited number of sites with the goal of demonstrating a level of clinical robustness, patient end-user acceptance on par with Zio XT. I am pleased to report that the feedback is very positive and increases our confidence to bring on more sites in the fourth quarter. In particular, physicians have noticed the benefits of using a single share platform with our Zio XT offering, including the biosensor design, workflow tools, and comprehensive final reporting. I’m very pleased that we’re making meaningful progress to establish Zio AT Service as an in-network service among health plans. It is important to note that utilization of mobile cardiac telemetry has traditionally been highly constrained by payers with policies often limiting its use to a specific set of clinical indications such as syncope, pre-syncope, or ventricular tachycardia and most often requires prior use of a first line test such as Zio XT. Many plans provide no coverage policy for the technology at all. Although this segment represents less than 15% of the total market, our new offering is important that it fills out a gap and our product portfolio enables us to fully meet the ambulatory monitoring needs of the market. I’ll update you on our progress and plans as we move into the new year. With that, I like to turn it over to Matt Garrett, our CFO for a more detailed review of our financial results and guidance. Matt?

Thank you, Kevin. Despite both traditional summer seasonality in our business and weather-related challenges, we were very pleased with our overall financial results for the third quarter 2017 and remain encouraged with our Zio XT and Zio AT contracting efforts and expanding sales force footprint exiting September. Highlights for the third quarter include revenue growth of 49%, with sequential growth of 5%, gross margins of 72.4%, a better-than-expected start to our AT contracting efforts and being on track to exit the year with 81 to 86 sales reps. Taking a more detailed look at the third quarter results, we achieved strong revenue growth despite the traditional impact of December seasonality and with the occurrences of the hurricanes. As it relates to the storms, while we did see some registration pullback in the affected states, we have estimated the impact to be immaterial to the overall business. And in addition, we have seen a full recovery and do not believe there will be any material carryforward impact into Q4. Revenue growth remains predominantly volume driven as a result of the growth in both new and existing accounts and continued success in our in-network contracting efforts. Given the traditionally slow summer season, we were very pleased with several large institutional accounts coming online in the third quarter that demonstrated rapid adoption of the Zio service. We can in-part attribute these successes to our improving on boarding capabilities, registration workflow improvements, and continued reduction in patient friction as we establish contracts with previously non-contracted payers. Revenue trends also remain encouraging with volume growth coming from all key sectors and an only slight increase in our same-store versus new store sales during the period attributable to summer seasonality. Moving forward, we would continue to guide investors towards an even split of new store same-store sales and the 80/20 volume to price mix for this foreseeable future. Turning our attention to the rest of the P&L, gross margin for the third quarter 2017 was 72.4%, compared to 68.5%, a 3.9 percentage point improvement over the same period in 2016. Margin expansion continues to be driven by three variables; productivity gains through our machine-learned algorithms, associated with report generation, the impact from the mix shift to contracted claims, and continued reduction of device related manufacturing cost. To further elaborate on Kevin's comments regarding the hurricanes, iRhythm has a significant clinical operation located in Houston. We are extremely grateful to that team who performed well above expectations given the circumstances and despite great personal challenges and sacrifice. Our organization’s ability to react to an otherwise damaging financial event for the company is a testament to our cloud-based systems, diversified operational centers, and all of our people. Because of these efforts and with no physical damage to our facility, we have estimated the financial impact of the storm to our gross margin in Q3 2017 to be immaterial and we project no impact on gross margins moving forward. Operational expenses for the third quarter 2017 were $24.1 million, an increase of 70%, compared to $14.2 million for the same period of the prior year. The increase in operating expenses was primarily driven by three factors. First, we continue to accelerate investment in our sales force expansion, including the completion of our sales management hires, and higher commission expenses, due to incremental topline growth. Second, due in large part to the increase in our share price since the October 2016 IPO, we’ve had a material increase in stock-based compensation expense beyond our forecasted estimates and guidance. We remind investors that this is a non-cash expense and it will be adjusted in our guidance for 2018 when we announced those figures in early February. Finally, the company triggered SOX 404(b) external attestation requirements as of June 30, 2017. Thus, we have significantly increased cost associated with third-party testing during the third quarter in order for the company to be compliant by year's end. The net loss for the third quarter 2017 was $6.5 million or a loss of $0.29 per share, compared with net loss of $4.1 million or a loss of $2.80 per share for the same period of the prior year. Cash burn for the quarter was $2.4 million. Turning to our guidance for the remainder of 2017, based on our continued confidence in the adoption trends of our Zio Service, as Kevin noted earlier, we are raising our expected 2017 revenue to a range of $96 million to $97 million, up from $94 million to $96 million provided on our last earnings call. The continued upward revisions on guidance can be summarized by the various factors we have articulated throughout the year. In particular, our continued success in obtaining coverage and contracting policies increase sales productivity levels and improved account onboarding activities. Moving forward, these key variables that impact our growth will be augmented by management's focus on rapidly expanding sales representation in the field. We reiterate our goal of exiting the year between 81 and 86 quota-carrying sales reps and total sales organizational headcount inclusive of sales management and sales operations of more than 100 people. For gross margin, we maintain our guidance of exiting the year at 71.5% to 72.5%, which includes some start-up costs associated with our Zio AT Service. Due to the AT launch, we caution investors that there may be some near-term drag on our gross margin. Over the long run, we do not expect the Zio AT Service to be dilutive to our gross margins at scale. Operating expenses are projected to range from $93 million to $95 million, up from $89 million to $92 million, including $13 million to $14 million for research and development and $80 million to $81 million for SG&A. Again, this increase in guidance is primarily attributable to the sales force expansion acceleration efforts associated commissions for over performance through expectations stock-based compensation, and 404(b) related cost. Our overriding focus on executing of our strategy gives us confidence as we enter the fourth quarter of 2017 and as we prepare for our continued sales force expansion in 2018. We now like to open the call for questions. Joining me for Q&A is Kevin King, President and CEO; and Derrick Sung, our Executive Vice President of Strategy and Corporate Development. Operator?

Thank you. [Operator Instructions] Our first question comes from the line of David Lewis of Morgan Stanley.

Hi David, we are unable to hear you.

David your line is open.

Maybe we could go to the second call and we could put David back in queue there.

Yes sir. Our next question comes from the line of Jason Mills of Canaccord.

Kevin can you hear me?

Yes, I can. Hi Jason.

Good afternoon guys. Congratulations on another great quarter. So, I guess just to start Kevin, another quarter of 50% topline growth that’s obviously among the best in Med-Tech, could you talk about the single greatest or maybe couple of things that are allowing you to continue to drive that kind of robust expansion, adoption really converting accounts from Holter to Zio, I presume one is the sales force because you are investing so much in it and perhaps you can give us an idea - if you could reiterate your guidance with respect to adding sales reps in the near-term, maybe update us on where do you think that sales force can go over the medium term, and whether or not there is a possibility that you would expedite hiring even a little faster than you have guided in the near term?

Sure. Maybe two-part question. I think one is, what are the drivers for that we observed in Q3 and then how do we feel about hiring of the people and where are we. So, I would say Jason, the points that Matt made relative to his prepared remarks, certainly sales force hiring, certainly the contribution of increased payer contracting our primary drivers here. And then just we have gotten a whole lot better over time with driving, what we call, account onboarding, bringing on new prescribers to the service, bringing on new accounts, the rate at which we do that, now that we have a broader infrastructure of customer service revenue cycle management and other folks to help the sales team all of those things, I think are net contributors to the strength that we’re seeing as it relates to the 50% growth number. Relative to the sales headcount, we are extremely confident and achieving the year-end targets, the 81 to 86, we made substantial progress in the third quarter, we didn’t give a number, but you can probably think about it as splitting the goal post if you will, between where we fed and where we are going to, pretty much in-line with what we spoke about in the past. And then in our recent, as far as looking forward in a recent conference where I spoke at, we spoke about our view that this adding of roughly 10 a quarter going into next year feels about right for us in terms of numbers. And so that’s kind of an estimate of where we are, I’m not so sure that we will call that guidance at this point, but adding about 10 per quarter feels pretty good to us.

Okay that's helpful and then…

We're trying to build towards about 120 to 125 plus type sales organization here to cover the country.

Okay. That's very helpful. That is helpful. So as a follow-up, Matt, you gave us some good guidance with respect to the growth mix and 80/20 mix between volume and price. I guess, may be a two-part question on that as you look forward. I understand you haven't given 2018 guidance yet, but as we think about AT becoming at least part of the mix at some level and obviously seemingly at a higher price, how do you see that 80/20 mix changing, if at all, over the next say 18 to 24 months? And then something - a third one I'll get back in queue, maybe for Derrick on mSToPS, I want to make sure I understand what we are going to see at AHA relative to what we're going to see next year, early next year may be at ACC, and whether or not there is, it sounded like perhaps things might have been expedite in terms of data release, but I want to make sure I was reading in something into it that isn’t there? Thanks guys.

Sure. Good to hear from you Jason, this is Matt, I’ll answer your question first. Look, as it relates to the overall - the indicators that we provided to you, I think we feel pretty good for, I said the foreseeable future so that would mean the next say 4 to 5 quarters through 2018 that we would continue that 50/50 new store, same-store split. We feel pretty good about that. As it relates to the 80/20 volume prize, we are maintaining that sort of guidance to the end of next year as well at this point. It could be a little higher, it could be a little lower, but it is just, it is way too early days to understand the potential impact that AT might have to change that mix significantly. So, for the time being we’re pretty comfortable stating that to 80/20 will continue through the next four to give quarters as well. I’ll turn it over to Derrick for the second question.

Sure. Thanks Jason. So, on mSToPS, there is going to be a poster that’s being presented, it will be presented on Tuesday, November 14 at a poster session at 1:30 and our understanding is that at this poster session, preliminary results from the study will be presented. Now the protocol for the study kind of has two parts to it. So, there is a randomized component in which about 2,000 patients are randomized to either a delayed or immediate monitoring with our Zio Service and our understanding is that the preliminary results from this randomized component are what’s going to be presented at the poster session at AHA. We continue to expect that the full results, which also include comparison of the Zio monitored patients to an observational cohort of additional 4,000 patients to look at long-term clinical and health economic endpoints. We expect that those four results will still be presented sometime in the first half of next year as we’ve been discussing.

Okay. That's super helpful. Derrick, before I get back in the queue, could you remind us as we go to that poster and look at the data, sort of how should we think about the data relative to the pilot study, maybe you could remind us those on the call about the pilot study and just, sort of what would be viewed as a positive result, just sort of at high-levels? Thank you and I will promise to get back in queue this time.

Sure. So, the feasibility study was the study that we published back in May of 2015 in the Journal of clinical cardiology and that was a smaller study in a similar subset of high-risk patients in which we found about 5% previously undetected Atrial Fibrillation and that compares to 1% to 2% AFS sound in kind of the general population, and I think the way to think about what is the successful result and how we would think about it is, at the end of the day our objectives around the market development for silent AF - and the initial objective is around establishing kind of payer coverage and demonstrating the cost-effectiveness if you will of screening for AF in this high-risk population. And we know that there is - we know that the cost of stroke is about $140,000 per patient, the medical cost to treat stroke in these types so in patients. So, you can kind of do the math yourself, but I think if you - I think in the range of our feasibility study results would, in our view provide a cost-effective argument to capture these patients. So, I think that’s kind of how we would think about the results. If that’s helpful.

Very helpful. Thank you.

[Operator Instructions] Our next question comes from the line of David Lewis from Morgan Stanley.

Good afternoon guys. Sorry about that [indiscernible] on this evening. Matt, just a couple of questions on 2018, I’ll be brief. Just thinking about the two specific things, gross margin expansion has been much better than we expected this year, a lot of the drivers that are driving that this year should be present next year. So, is it safe to assume we should expect continued progression on gross margins in the next year and then similar question OpEx, this year is an interesting year, as you have taken up revenue, you’ve always taken up your spending, so you’re basically growing OpEx in-line with spending, our sense is next year you would start to get some leverage on your incremental revenue dollars, that being said, you are also going to expand the sales force next year more dramatically in 2018 and 2017. So, just trying to get a sense of GM and OpEx for 2018?

Yes, David, look, you know as we have said in the past it is a little bit tricky and that we haven't given guidance out for 2018, but I can try to give a couple of high-level things. Frist up on gross margins, yes, we have done a little better than even our own internal expectations I think related to the three variables that I’ve mentioned in the past. There is no reason to think that they won't continue, but we do have a little bit of headwind related to AT launch. I won’t go into specific quantitative numbers, but I will qualitatively walk you through two items. One, with our initial launch, or pilot if you will in initial commercial ramp, we’ve used some boards that are being amortized over a much shorter period of time, and that is something that could have a near-term drag and we're going to see how that impacts us. So, we would caution on that point and the other is, we’re turning on a clinical operation center that’s working 24-hours a day, seven days a week on unit number one. So, you can imagine that there will be some absorption issues as we begin that more broader launch, which in effect over time will lower our cost per unit's, but on the smaller number of units to come out of the gate it will be impactful. So, I’m not saying that in a way that we would - in any way lower guidance, but I'm just saying we want to be cautious at this point about any dramatic increase in guidance for next year, and of course we will be able to give you much more detail on that on the call more likely in early February.

And then that just… I’m sorry go ahead.

I was going to say the long-term range that you have provided to David and others for gross margins, does that still hold?

Yes, absolutely, the 75% to 80% absolutely still holds.

Okay.

David, I think you had a second question on spend. Yes, I think you are kind of sport on with the fact that we are aggressively hiring in our own internal estimates related to the sales force expansion getting people on board in some situations two to three quarters earlier and in previous guidance, you know saying that we would be hiring throughout the year and instead may be pulling some of those headcount in. We’re not giving specific guidance at this point, but again if we exit the year and 80 - somewhere between 81 and 86 and we stay on Kevin's 10 to 15 sort of range for at least the first couple of quarters, you could imagine that we will have some expense expansion as it relates to that activity.

Okay, sure you're going to see some leveraged next year, but you may not be seeing kind of the numbers that maybe some of the [indiscernible] imply, so we will take a look at that. And Matt I think I may have missed this question, you kind of went there, but is there anything from a payer mix perspective as we look into 2018 that we should be thinking about or any other headwinds or tailwinds are from a qualitative perspective we should be thinking about for 2018 guidance?

I don't think so David. I mean, our belief internally is that we will continue to drive down that noncontracted portion of our business into the lower single digits from the high single digits where we currently are. There could be a little bit as again as it relates to as we launch AT. We were going to have to get our variance in terms of what the mix will be between the various revenue streams that might have a little bit of an up or down balance, but again it is a little bit of early days there. Nothing that we think is going to materially impact the way we think about the business at this point.

Great, thanks so much.

Our next question comes from the line of Michael Weinstein of JPMorgan.

Hi guys. This is actually Allen on for Mike. Just wanted to say congratulations on the first quarter, and a great quarter to start. But first question, just really related to kind of Zio AT launch, I know it's still kind of early days yet, but just in terms of the kind of adoption. I know you said, it's very positive right now, but just in terms of training physicians’ kind of getting them up to speed, is it all still kind of on track? And what kind of ramp should we expect to see, like, going into 2018 when you really kind of get your feet under you?

It’s very early days Allen forward Zio AT. That said all indicators relative to product performance, relative to the quality of the service offering being on par with what we do with Zio XT turnaround times, patient satisfaction and others are all pointing in the right direction. The most difficult challenge in this particular market segment is on the payor side. And in the prepared remarks, I was alluding to this where many health plans have no coverage policy or have strong restrictions and that’s something that needs to be, you know the technology - this space has been around for 10 years, so a lot of people know about this, but it’s very different from the XT space where we have near universal coverage policies. And so, physicians are not necessarily thinking, is this a cover technology or not. They have to think more about it with Zio AT as they do with any other MCOT. And that’s the area that we’re really being thoughtful about, particularly when it comes to our existing base of customers, as well as those new customers that we’re interacting with where we haven't had prior relationships. So, we’re just continuing to tread lightly there till we gain more experience.

Okay. So, I guess, with that in mind, obviously, you have the mSToPS data coming out at the end of this year and you're also going to be looking for other indication expansions into kind of these actionable event markets. Are you kind of expecting to have this kind of reimbursement challenge like pass you by the time you pursue more reimbursement challenges, or do you think this will be kind of like a longer battle?

On the AT side, we’ve message that this is more like a 3 to 4 quarter ramp. I think the question came on our last call, was this like a 2 to 4 or was this an 8 to 10 ramp, month ramp or quarter ramp and we guided kind of more towards the lower end of the 3 to 4 quarters in order to get full AT contracts. And as Matt indicated, we came out of the box pretty strong here in and so we're feeling good about the status or the position that we are up right now.

And Alan I would add on the mSToPS front. That is an effort in terms of some screening for silent AF. That’s an effort in its early days, right. So, I think you should think about the data coming out from mSToPS, which, some will - some will come out obviously next month, some early in the first half of next year and there is also longer-term kind of three-year end points on clinical and health economic outcomes that are being tracked as well. That’s kind of the first step in the process of establishing reimbursement for that used case. So, even there, I think it’s much earlier days and it will take some time.

Got it, thanks.

And I’m showing no further questions in the queue at this time. I’d like to turn the call back to Kevin King CEO for closing remarks.

Thank you, operator. This concludes our call for today. We thank you very much for your attention and interest in iRhythm and look forward to talking to you next quarter.

Ladies and gentlemen, thank you for participating in today's call. This does conclude the conference. You may now disconnect. Everyone have a wonderful day.