Good day, ladies and gentlemen, and welcome to the iRhythm Technologies Q4 2017 Earnings 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, Lynn Lewis, Investor Relations. You may begin.

Thank you, Andrew. Thank you all for participating in today's call. Joining me are Kevin King, President and Chief Executive Officer; and Matthew Garrett, Chief Financial Officer. Earlier today, iRhythm released financial results for the quarter ended December 31, 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 2018, 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 these risks and uncertainties associated with our business, please refer to the Risk Factors 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, February 14, 2018. And with that, I'll turn the call over to Kevin.

Thank you, Lynn. Good afternoon, and thanks for joining us. Our team made great progress in achieving and, in many cases, surpassing the goals we set for the fourth quarter and 2017. I'm especially proud of how our ZIO XT service is rapidly becoming the standard of care in the diagnosis and management of patients with cardiac arrhythmias. Fourth quarter revenue was $28.2 million, up 51% when compared to the prior year period, and gross margins increased 3.6 points to nearly 73%. For the full year, revenues grew 54% over 2016, demonstrating the success of two growth initiatives we focused on throughout the year, expanding our sales channel to meet the growing demand for our ZIO Service and increasing our in-network health plan contracting. We continue to see increased customer acceptance trends, and our business outlook remains very positive for 2018. The 2017 investments made in channel expansion and increasing our payer contracting gives us a solid and confident platform to project 2018 year-over-year revenue growth in the range of 35% to 40%. This guidance is inclusive of new accounting procedures that the company adopted as of January 1, 2018, resulting from the update made by the Financial Accounting Standards Board referred to as Topic 606. Matt will discuss the accounting rule changes to iRhythm's financials in his remarks momentarily. A reconciliation table is available in the earnings release that was issued today. I'd like to take a few minutes to briefly summarize our progress on several key initiatives in 2017 and then offer some thoughts on milestones and goals for 2018 and beyond. Our sales channel expansion took place in two phases. Phase I built out our sales leadership team and reconfigured our regional structure from six regions to 18 regions. This phase took nearly two quarters to complete…

Thanks, Kevin. As Kevin mentioned, we are very pleased with our overall financial results for the fourth quarter 2017 and remain encouraged with the fundamentals of our business, including our strong contracting success, expanding product portfolio and rapid but coordinated investment into our infrastructure, inclusive of sales force hiring. Highlights for the fourth quarter include, revenue growth of 51% year-over-year and sequential growth of 13%; gross margins of 72.7%; continued success in new XT and AT payer contracts; a significant increase in investments into operations, most notably in sales rep expansion, exiting the year with 86 quota-carrying reps; and lastly, for the full year 2017, revenues were $98.5 million and gross margins were $71.9 million. Taking a more detailed look at fourth quarter results. Revenue for the three months ended December 31, 2017, was $28.2 million, an increase of 51% year-over-year and 13% sequentially. Growth remains predominantly volume-driven as a result of both new and existing accounts, along with continued success in our in-network contracting efforts. Overall revenue trends also remained very encouraging. We can point to success in large integrated networks as an ongoing catalyst for our growth as our ZIO reports information system continues to improve account onboarding and physician workflow, which also reduces patient friction. These trends, in large part, give us confidence in our continued guidance of an even split in revenue growth from new store and same-store sales and in volume-to-price mix of 80:20 through 2018. Turning our attention to the rest of the P&L. Gross margins for the fourth quarter of 2017 were 72.7% compared to 69.1% a year ago, a 3.6 percentage point improvement. Margin expansion continues to be driven by increased contract claims mix, productivity gains through our machine-learned algorithms associated with report generation and continued reduction of device-related manufacturing costs. We…

[Operator Instructions]. Our first question comes from Mike Weinstein with JPMorgan.

I think probably the first question people have and maybe want to touch on is the 606 adoption and why do it now? The FASB standard was in May, 2014. And then maybe explain to people why the impact was a lot greater in 2017 than it would have been in prior years. Why did it scale up and become more meaningful in '17?

Want to take that?

Yes, Mike, so this is Matt. To answer the first part of your question, we're required as of 2018 to make this change. The reason that -- we actually didn't have to do that until the end of the Q1 time frame, but we decided to do it now because we're providing you guys with guidance for 2018. And clearly, the adjustments would have impacted our growth rates. So the way to think about this is that we had this $5.2 million revenue adjustment for '17, and what we didn't say in the transcript or the call or in the earnings release was that our expectation of the impact on 2019 will be roughly the same, about $5 million. So when you take that into account, the overall growth rates remain in that 35% to 40% that we have kind of come to provide you guys for guidance in the past. In terms of the year-over-year, I'd have to go back and look to see what specifically was going on. But for the most part, the difference is that the way to think about it is, when we book a claim, it takes literally 12 to 18 months for us to get full payments for that, the cash receipts. There can be a denial of the claim. There can be a contesting of the claim. The co-pay portion or the patient portion can take 12 to 18 months to pay, so there's a tail. It's an inverse tail. Meaning that, over time, you can build up, if you will, the cash receipts that we were booking on a quarterly basis. Now what's happened and why it's increased, why it's not going to be a big significant impact moving forward is because our overall direct non-contracted direct bill mix is in the single digits and getting smaller and thus that tail is working itself out. So over time, that the ACR portion of this impact will be zero. The only ongoing impact to revenue will be that bad debt expense, and that will be in the low 1 to maybe 2 percentage points as you look at the overall revenue. We would stop there and see if that is helpful.

Yes, that's actually very helpful. So that's very clear to be on what's playing out there. Much everybody is going understand the move to direct and why that -- why there's the tail, but that is pretty clear. Also, let's talk on two topics, if you don't mind. One, Kevin, I'd like you to opine on kind of the big picture adoption question. With where you are now at that 80% level on contracted lives, you've made, obviously, this great progress the last few years in getting coverage and contracting. What, in your view, is the primary obstacle to adoption going forward, given what you've achieved on the coverage and contracting side? And then second, can you guys give us your updated thoughts on timing of profitability? I know that's not the primary focus of the company right now. It's to drive adoption and drive revenue growth. But how are you thinking about the time line to profitability with the revenue run rate that you think about when you turn profitable?

Sure. I can take the first one. Matt can take the profitability. So on obstacles that we still face, Mike, I think there are two. One is the need to continue to grow out the sales force. We did a great job last year. We reached the upper level of the headcount that we have projected the 86. And as we said here, we've got another 20 to 30 to build out this year. That's a pretty big number. That's almost a 30% increase in sales force. So that has to do with -- we still have relatively low brand awareness of ZIO across the country. Given that we're only 10% player, we don't have enough sales reps. That's one obstacle that's in our control, and we're going as aggressively as we possibly can. I think the other one is the physician landscape. We spoke about this at your conference, the JPMorgan Conference. We're competing with status quo in that physicians have been using holter monitors for 40 to 50 years, and our ability to change that behavior takes time. The clinical evidence that we have, the increase in payer contracting, the increased headcount, all of those things add to it. But nonetheless, physicians are overloaded, and we have to get their attention and get them to adopt the product, and that's our primary competition right now is status quo, right? Changing the landscape for how physicians prescribe test for their symptomatic population of patients. I think those are the two primary ones right now, and the payer one, it's certainly not a tailwind, but it's certainly not a headwind any longer. Matt, on the timing of profitability, how would you describe that for the...?

Yes. A couple of things here, Mike. I'll take this opportunity to reiterate that we achieved cash flow breakeven in Q2 of the prior year. And probably what you really want to hear though is, secondly, I'm very comfortable with our burn in '18. As we continue to see how this investment or these investments, I should say, the in sales force, the operational teams, the payer relation, the customer service has really supported and continue to support our top line growth. I think this is the third time now that we have raised sales force productivity, and a lot of that is based upon that infrastructure that we're building around that. So that really is helpful from our perspective on growth. And I guess, finally, while I wouldn't say that we're ready to put a specific date at some point in 2019 on cash flow breakeven, we will continue to monitor that very carefully, and I think what's most important to say here is that we feel very confident in our ability with the cash we have on hand to support this operation. There's no internal thoughts around a burn that would be significantly higher than what you see here. And hopefully, if we can continue to drive that top line the way we think so internally, it's not going to be an issue. So maybe a non-answer to the specific question, but I think we'd be looking at some point in '19 is the appropriate time to potentially make that transition, pending our ability to continue to invest in that top line growth.

Understand and recognize that the priority for the Street is that you continue to build out your business and drive revenue growth, but that context is helpful.

Our next question comes from David Lewis with Morgan Stanley.

Kevin and Matt, I wanted to focus on interiors. There are two components that you gave on this call. It's sort of get a little worse near term, but your conviction, if they get stronger long term, was notable. So just I'll start with the first and maybe, Kevin, for you. You start to build out the sales force back half of '17. Your guidance for '18 is, sort of, adding something around 20, 26 reps. That's sort of below the trend line on the margin that you saw in the back half of '17. So why is that rep number, Kevin, 20, 26 the right number for 2018? And sort of just for the accounting in that rep number, it implies revenue per rep probably declines in the low single digits in 2018, but yet you're very, very confident that rev rep number is going a lot higher in the out years. So can you just talk about the first part of the question? Why is that the right rep count this year in light of all the opportunity in front of you? Is our math right, that still implies rev rep goes down, and if so, why the conviction that those numbers go a lot higher in the future? Then I have a quick follow-up.

Sure. Look, David, I would say that the view here is based on the tenure of nearly 50% of the people that we hired in the last 12 months, right? So if you go back to early 2017 with roughly 66 people, the vast majority of the people that we have in the company last year and going into this year who will be with us are less than 50%. And from a management attention standpoint, we're always trying to balance what's best in terms of driving productivity of the people that we just hired or having to add more people. And it's a fine balance. Management attention, our ability to get people to focus leads us to this target number that we have for this year of 106 to 112. That number should not be confused, as you fully understand, with our lack of confidence in the business. It doesn't take us off our goal of having between 125 and 150 people is what we've spoken about in the past. And as the year unfolds, if the productivity levels of our reps or the performance of these reps is better than expected, we will add more. But I don't want to give you guys a number that we're not going to be able to achieve, and it really comes down to the balancing between focusing on the increasing the productivity of the new people, which are roughly half, versus just spending time adding new people. Not much more complicated than that.

Okay. That's very clear. And Matt, for you, same kind of structural question though. If you think about one of the key divestments you made in the company is the algorithm. The engine gets more scalable over time. I think your gross margins in fact have improved sequentially every quarter for 12 quarters. Yet you're sort of implying that based on some of the investments in the fourth quarter, gross margins actually could be flattish in 2018. Just given the scalability of the algorithm and what you've seen in the last 12 quarters, is it likely GMs could prove to be flattish in 2018? How could that occur? But yet, you're very bullish that this number is still going to 75 kind of longer term.

Yes. David, again, I think before we could have a discussion on any sort of impact on the new reps and AT, you have to take into consideration the impact of Topic 606. And maybe I didn't do a good enough job articulating that. But again, the adjustment would imply that our guidance would have been roughly $5 million higher if not for Topic 606. So our 125 to 130 would have been 130 to 135, split evenly roughly between the impact of the cash receipts and the impact of bad debt expense. So that, in and of itself -- and heavily impacted in the first of the year on the ACR portion because, again, of that tail that goes away over time. So I think that, in and of itself, is a percentage point, if not more, on any given quarter. After that comes into play, then there is a little bit of a drag related to the AT launch. And any time that we're bringing on a significant number of new scan text that aren't as productive, there's going to be a little bit of a wall. But overall, there's no change in my mind in terms of our bullishness around gross margin, cost improvement on a per unit basis as well as continued improvement on the top line for ASP where we, again, gave guidance at the end of the year of 80:20.

Our next question comes from Jason Mills with Canaccord Genuity.

Matt, I want to start, or Kevin, with sales force/operating expense guidance that you gave. Kevin, I think I heard you slip in that your longer-term expectations were still in the $125 million to $150 million range. And I guess the first question has to do with as you build to that level, how does the time allocation get split among the reps between the core business of XT and these new targeted addressable markets of second-line therapy in AT. And then perhaps you could talk about how you'll weave in the asymptomatic or silent AF marketing effort. Will it be with the significant sales force? Or will there be some other means of going after that market? Maybe talk a little bit about the allocation of time as you're building up the sales resources across that continuum of care.

Sure. Jason, I think maybe the easiest way to wrap one's thinking around our sales channel and where they spend their time is to think about them being more geography-bound than to be segment-bound, right? So when we have a sales rep in a particular city or a number of sales reps in a particular city, they are responsible for a fixed number of accounts. And as we add capabilities, whether it's ZIO XT and a ZIO AT or a new indication like cryptogenic stroke, where a patient may be in the emergency room or in neurology, it's really the sales rep's time to penetrate that account as deeply as possible. So our modeling basically starts with that 4.6 million, 4.7 million procedures. We add to it the number of procedures based upon the new indications. So in the case of AT, as I said, it's about 400,000. I think in the stroke case, it's about 360,000 a year. Those numbers are folded into the territory targets. As far as other people selling products, no, we don't envision anything beyond initial startup that we have here for AT in terms of duplicative sales forces or redundant sales forces. I described in, I think the -- in an earlier call, it might have been the last call when we first started talking about ZIO AT, that we have a launch team, if you will, that is responsible for helping us to target counts, train people, et cetera. But the long-term plan is we just turn all that over to sales reps, to the regular sales reps that we have. We didn't want to distract the core team with "the shiny new object", if you will, given that the XT business is 90% of the market opportunity for us.

Yes. That's very helpful. Just a couple follow-ups, and I'll get back in queue. Matt, you talked about, and David asked a little bit about rev rep or rev per rep expectations going up. But in the near term, with the additions of some of your new reps, that could perhaps go down a little bit. I understand that from the standpoint of a newer reps taking 3 to 4 years to get fully productive. But as you're cutting territories, are you modeling into the algorithm the assumption that existing reps productivity perhaps take a dip before going and setting a new high vis-a-vis the fact that you're cutting their territory? Just wondering how you're thinking about that. And then, I guess, a stronger follow-up maybe for Derrick, maybe expectations for the mSToPS data or what we should be looking for in terms of key aspects of those data? What physicians will look at and really pay attention to coming out of those data in a couple of weeks?

Jason, this is Matt. I'll answer your first question and turn it over to Derrick. Jason, I think I'd first reiterate to you guys that investors need to understand, we are extremely bullish on our sales force productivity levels. Again, these investments that we have made to support this team is really taking effect. As it relates to -- we get the question, are we splitting territories? Does that impact sales productivity? And the answer from our perspective is, it's not an issue. And I'll give you an example. If you have a rep that is currently covering all of South Florida and also is responsible for, I don't know, Orlando, and you split that territory, there's no impact on that person's ability to be productive in either one of those capacities, simply because there's just too much land to cover. Again, 8% or 9% penetrated in the overall market, so we're not at a point where we think that there's any kind of dip or challenge as it relates to splitting those territories and/or opening new territories. I would argue with more of the opening a new territory or actually putting someone in who has the time and effort to cover it than it is of splitting. So hopefully that answers your question. Derrick, you want to follow up on mSToPS?

Sure, thanks, Matt, and thanks for the question, Jason. So with regards to mSToPS, you recall that at the AHA Annual Meeting last year in November, preliminary results represented from that study. And those preliminary results looked at the rate of AF detection, and only about 1.5 of the approximately 2,000 patients who are randomized to be monitored with our ZIO Service. So what's going to be presented -- and those results showed about a 5% AF detection in that group, which we were quite pleased with. What's going to be presented at the ACC conference are the full one-year results. And so those will show the results of new AF diagnosis in the entire ZIO-monitored group of approximately 2,000 patients as compared to a risk match observational cohort of about 4,000 patients who did not receive any monitoring. So we would be looking for ideally a confirmation of some of those preliminary results and this much larger subset as compared to the full 4,000 observational cohort control group. The second piece of additional information that will be presented, which I think is going to be impactful, is a look at the therapy decisions that were made around those patients who were diagnosed with undetected atrial fibrillation by our ZIO Service. So this gets to the notion of, if our ZIO Service is able to detect AF in the subgroup of high-risk asymptomatic patients, how are they then treated as a result of this detection procedure? So that is, I think, going to be another key point that we'll be looking at. And then I would remind you, too, to keep in mind that there is an important three-year endpoint that will not be presented, and that will ultimately look at the clinical and health economic outcomes between the monitored and non-monitored groups. And this will obviously be presented at a later point in a couple of years.

Our next question comes from Glenn Novarro with RBC Capital Markets.

Two questions. First, a follow-up on mSToPS. Kevin, can you help us understand, assuming the data is all good at ACC, how this data will impact your business going forward? And the reason I'm asking is in other cardiovascular markets that we cover, when we get real positive data, we see an uptick in adoption. So maybe help us understand, when we do get the mSToPS data, when the cardiologists at ACC see the data, what's next and how does this impact your business over the next several years? And then as a follow-up question, for all the reps that you are hiring for 2018, are there any specific regions of the country that you're targeting? Or are these reps going to be placed across the country?

Sure. No, let me take the second one first. I think that's the easier one. The rep expansion continues to be somewhat uniform across the country. We have a slightly greater density in the West Coast given that when we started our commercial effort back in 2012, 2013, we started there. So the 8 or 10 or 12 reps, whatever we had, were starting to be placed in that part of the country. But most of the open positions are pretty uniformly distributed, and they kind of follow the pattern of large metropolitan areas where there are large academic medical centers and physicians and populations and so forth. So the uniformity is -- follows the population more than it does the geography. Some states, Montana doesn't have a lot of people, so there aren't a lot of sales reps to be added there. That kind of makes a lot of sense. As far as the impact on mSToPS, this is still early days. The results, as you say, if they're good, will allow us to begin to affect guidelines, and those guidelines would then allow us to translate that into policy work with health plans. And some health plans may be quicker than others, but we still have to go down through the kind of remuneration path, if you will. We are screening for atrial fibrillation, so we have to make sure that there are coverage policies in place for dealing with asymptomatic patients versus symptomatic patients. Nearly all policies today are associated with symptomatic patients. So there's still a fair amount of market development work. I think the study that we've done here is one of the most powerful studies to be doing because it is randomized and it is prospective and as quite large in size. And if the results are favorable, the health economics associated with our reducing the risk of costly strokes is quite beneficial. So we're hopeful people will move quickly. But that said, there's still some work to do, and it's certainly not an instant on application, if you will. It's a completely new indication to a new population of patients.

And two quick follow-ups. MSToPS, does that get published on the day of announcement in any big cardiovascular journal? And then guidelines, getting into ACC, AHA guidelines, for example, usually takes 1 to 2 years. So should we assume mSToPS really has an impact maybe in 2019 and 2020 versus at any point in 2018?

Sure, Glenn. I'll take those. This is Derrick. So any publication plans have not yet been released for mSToPS. So we wouldn't be able to comment on that. As far as guidelines, I think the gist of your question is right in that, in general, guidelines do take a long time to impact and to influence or they take a considerable amount of time. We haven't specifically targeted a specific set of guidelines at this point. We'll be able to start those conversations with professional societies hopefully once we have some data. I would also just add, too, to your primary question, just to make clear, that this study is not about expanding the labeling for an indicated use for our ZIO Service. We already are on label and have labeling for the monitoring and detection of asymptomatic arrhythmias. So really, as Kevin talked about, this whole study and the data coming out from it is all about impacting professional guidelines, clinical practice and payer coverage. And so that's what takes some time.

Our next question comes from Gene Mannheimer with Dougherty & Company.

Matt, did you give the stock-based comp number in the quarter?

No. We haven't given that level of information, Gene.

Okay. Is it included though in the EPS you reported today though, right?

That is correct.

Yes, okay. I appreciate the color around the geographical spread of the sales force. Can you talk a little bit about the pedigree of the folks you're hiring? What companies you're recruiting them from? And what their backgrounds tend to be?

Sure. I can tell you where we don't recruit from and I can tell you the types of people. So we don't consider ourselves a medical device company. So the traditional sources of med tech or med device recruiting is not really where we're at. We think of ourselves as an information services company and a company that is focused on trying to change the behavior of physicians. So you can think about companies like, say, Intuitive Surgical, where our head of sales came from a number of years ago. An application or a delivery model that changed the behavior of a surgeon was quite important to do, and we've got a number of people from those types of industries, software-as-a-service industries, services industries, things that are around changing physician behavior, changing account behavior in adoption of new technologies, more so than understanding the practice of cardiology and things of that nature. We feel we can teach people cardiology, but we can't teach people how to change behavior that effectively.

And that does conclude our question-and-answer session. I would now like to turn the call back to Kevin King for any further remarks.

Great. Thank you, Operator. Thanks, everyone, for joining our fourth quarter call. We're very appreciative of your interest in the company, and I'm very proud of our results and look forward to updating you as the year goes on. Thank you so much.