iRhythm Technologies, Inc. (IRTC) Q1 2021 Earnings Report, Transcript and Summary

Welcome to the iRhythm Technologies, Inc. Q1 2021 Earnings Conference Call. My name is Erin, and I'll be your operator for today's call. [Operator Instructions] Later, we will conduct a question-and-answer session. [Operator Instructions] Please note that this conference is being recorded. I'll now turn the call over to Leigh Salvo. Leigh, you may begin.

Thank you all for participating in today's call. Joining me are Mike Coyle, CEO; Doug Devine, CFO; and Dan Wilson, EVP, Strategy, Corporate Development and Investor Relations. Earlier today, iRhythm released financial results for the first quarter ended March 31, 2021. 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, those statements related to the impact of COVID-19 on our business, expectations for recovery, market opportunity, product performance, market expansion and penetration, productivity improvements, reimbursement, release of clinical data, operating trends and our future financial expectations including revenue, gross margins, profitability and operating expenses 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. In addition, we will refer to adjusted EBITDA, which is defined as EBITDA, excluding stock-based compensation expense. Adjusted EBITDA is a non-GAAP measure that is used to help investors understand iRhythm's ongoing business performance. 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 annual and quarterly reports on Form 10-K and Form 10-Q, respectively, with the SEC. This conference call contains time-sensitive information and is accurate only as of the live broadcast today, May 6, 2021. 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. And with that, I'll turn the call over to Mike.

Thanks, Leigh. Good afternoon, and thank you all for joining us. During my prepared remarks today, I will provide an update on the actions under way with regard to Zio XT pricing and our support of Medicare patients. We will also review key highlights of our first quarter performance and discuss our strategic initiatives to continue to drive toward durable, profitable growth for the business. There's a lot to cover, so I want to start with five key points. First, Zio XT's innovation delivers superior clinical benefits in the way cardiac arrhythmias are diagnosed and managed, and there is strong market demand for the service. The clinical and economic benefits of Zio XT are underscored by the over 40 peer-reviewed studies supporting its superior diagnostic yield and customer preference of the Zio XT 14-day monitoring system is demonstrated by the consistently strong demand and positive feedback we have received both from physicians and patients. This strong demand continued throughout the first quarter with record volumes and has stayed strong as we enter the second quarter. I would, first and foremost, like to thank the iRhythm team for their dedication to serving our patients and their excellent execution in delivering this strong growth. Second, we are actively pursuing multiple paths to achieve pricing that is more in line with the benefits our technology provides. Since Novitas published updated rates on April 10 this year, we have had discussions with them to better understand their analysis and to propose an alternative costing method. The model we have shared with them has been successfully applied in other areas of the CMS physician fee schedule and we believe is a more appropriate methodology for establishing rates for the long-term continuous ECG category one codes. Novitas has been open to discussing this approach. However, we cannot provide certainty at this time on the potential outcome of those discussions or on the timing of any action taken following those discussions. In parallel, we are pursuing national pricing with CMS for the 2022 calendar year physician fee schedule and/or having conversations with [indiscernible.] Third, since the Novitas decision, our physicians and their patients have been outspoken in sharing the benefits they have experienced with Zio and their strong desire to have the service available to all of their patients who can benefit from it. It is core to our purpose as a company to provide access to innovative technology that benefits lives and lowers the cost of healthcare. Given the multiple avenues we see for obtaining revised pricing in Medicare, which I will discuss in a moment, we have decided to continue to ensure Zio XT is broadly available to all patients, and we will make no changes in access to the service for Medicare patients until the paths we are pursuing for more appropriate Medicare pricing have been fully explored. Fourth, we are committed to making the necessary adjustments to our business model to deliver operating efficiencies that support both profitability and growth. This is not an exercise in pure cost savings. We plan to drive more discipline in the business, so that we can have a solid operating foundation as we scale up to meet our market opportunities. This discipline will better position us to profitably operate at lower price points over the long term, and we can and will accelerate our plans to help us efficiently and cost effectively deliver the Zio service regardless of where Medicare reimbursement rates ultimately land. We have initiated several related projects in manufacturing, clinical operations, customer service and revenue cycle management areas of our business. This work is progressing well, and Doug will share more detail on the specific areas of focus later in the presentation. Lastly, iRhythm continues to have substantial opportunities to drive sustainable growth and value creation, including international expansion and expanding indications for use. In addition to the U.K., we have identified several other OUS markets that we believe are ripe for expansion due to clear clinician enthusiasm for the service and identified pathways to obtain regulatory approval and reimbursement. As previously discussed, we also see opportunities to extend our reach into additional indications for use. Positive clinical data continues to highlight the opportunity in asymptomatic AF patient populations, and we have initiated efforts to open up this market. Long term, we believe there are many other possibilities to leverage our technology platform. Importantly, we have the financial strength and flexibility we need to invest in these growth avenues and to also support our business as we work toward more reasonable Medicare pricing for Zio XT. With these major themes in mind, I will now start with an update of our efforts to establish more appropriate Medicare pricing for Zio XT. As you know, on April 10, Novitas posted updated rates for CPT codes 93243 and 93247. These rates are substantially below our historical rates and do not appropriately reflect the clinical and economic value that long-term continuous ECG monitoring offers patients and their care teams. Since our April 12 call with you, we have had the opportunity to talk directly with Novitas to learn more about how they derive these rates. Through our conversations, we have learned that Novitas used a valuation methodology based on assumed cost inputs. Unlike our experience with NICE in the U.K. or with our commercial payers, the overall impact on healthcare costs was not directly considered in this analysis. It is also important to recognize that the codes posted by Novitas cover monitoring periods from three days up to 15 days. We believe the assumed cost inputs that generated the rates posted by Novitas more accurately reflect costs for less sophisticated devices and services that are most commonly used for shorter-term monitoring. Unlike those devices and services, the Zio XT technology combines longer-term monitoring with sophisticated, proprietary, deep-learned advanced AI algorithms that enable sensitive and specific processing of the more than 20,000 minutes of ECG signals that go into a single patient's 14-day record. The value of Zio XT is not just in the device but in this analysis. Indeed, it is the output of the AI technology and the sophistication of the data curation process, carried out by our highly trained certified cardiographic technologists that has been demonstrated to enable higher diagnostic yields, better clinical outcomes and lower healthcare costs compared to less sophisticated and shorter monitoring services. And it is our unique implementation of this model that explains why Zio XT represented the vast majority of long-term continuous ECG monitoring claims filed under the previously existing temporary CPT codes. In our discussions with Novitas since April 12, we have outlined an alternative valuation methodology that we have seen applied successfully in other parts of the physician fee schedule, such as clinical diagnostics, that we believe are a more appropriate method for establishing the true cost to provide the Zio XT service. We are working to adapt these cost models to the long-term continuous ECG monitoring codes, which we believe will better demonstrate the true cost of delivering the service. Historical investments made in hardware and software that enable us to deliver the service efficiently and at scale can also be considered in this model. Novitas has given us preliminary indications that this model has been a methodology that has worked well in other areas, and they believe it could be appropriate for use in this case as well. While we are encouraged, I want to caveat that no commitment has been made by Novitas to accept this alternative costing approach and we have no clear indication as to the timing for completion of that work may be. In parallel with the Novitas discussions, we are also holding discussions with other MACs, both in geographies where we have existing independent diagnostic testing facilities as well as potentially new geographies. In these discussions, we will continue to reinforce the clinical and economic value of long-term ECG monitoring, and it is our intent to share the same cost model that is being developed for our Novitas discussions as the basis for establishing appropriate rates with these MACs. We expect the process with other MACs to take some time and do not yet have visibility as to whether we will ultimately be successful in establishing higher rates. As a third pathway, we continue to pursue national pricing with the CMS. National pricing is our ultimate aim given we are now operating under Category one CPT codes. We will aggressively continue to pursue national pricing for calendar year 2022 physician fee schedule through the final rule in the November-December time frame. As mentioned on April 12, we had the opportunity to meet with CMS in mid-March and present an alternative pricing methodology for valuing the long-term ECG monitoring codes. This alternative methodology utilize cost inputs from other advanced analytics and analysis platforms already existing in the CMS database as an alternative to the imputed methodology that had been used in the original AMA RUC analysis. We expect to have an initial indication of whether CMS will establish national pricing for calendar year 2022 when the physician fee schedule proposed rule is released in July or August. And longer term, we're seeking opportunities to engage with CMS to establish what we consider to be more appropriate pricing methodologies for digital health business models. Digital health and AI-based technologies and solutions are novel and underappreciated in our healthcare system. And new solutions may be necessary to get the value of the technology underlying our products recognized by CMS. We have been in discussions with several other industry participants with AI-based business models that are seeing the same inherent difficulties in achieving appropriate Medicare reimbursement. We will look to partner and join efforts with them and we'll embrace our role as a leader in the digital health space. All of these efforts are being supported by a comprehensive advocacy campaign, which is amplifying the voice of our physician customers, patients, physician societies, industry association and elected officials to influence decisions at Novitas and at CMS. This campaign is meant to ensure that the clinical value of long-term continuous monitoring is understood and recognized. More than 140 letters have been sent to Novitas that highlight the value of the Zio XT in providing the highest quality and life-saving cardiac care and how reducing reimbursement can negatively impact our physician customers and the patients that they serve. These letters have reinforced the strong recommendation of support provided by the American College of Cardiology and the Heart Rhythm Society during the Novitas rate review process. We'd like to offer our sincere thanks for the additional validation and support from our partners, our customers and other constituents. We will continue to work hard to reach a positive outcome on behalf of our patients and the industry. Now turning to commercial payor business. While we continue to pursue more appropriate Medicare reimbursement, we are also talking directly with commercial payors to reiterate the clinical and economic value of Zio XT. We expect that some of our commercial payors will reference Medicare pricing in their negotiations. However, we believe they will also consider the total clinical and economic value that the service provides. As previously communicated, the large majority of our commercial customers have recontracted the Zio XT service. Since the establishment of the Category one codes on January 1, 2021, with most cross walking to pre-existing rates. Overall, commercial pricing in the first quarter of 2021 was down low single digits on a percentage basis when compared to 2020 pricing. We have a handful of contracts that remain open or come up for renewal in July of this year. We will view these negotiations as an important indicator of our ability to separate ongoing negotiations with the MACs and the CMS from established commercial pricing, and we will be transparent about these trends. If we are unsuccessful in improving the Medicare rates before calendar year 2022, we believe it is prudent to expect that commercial rates may begin to more negatively be impacted next year. To mitigate this risk, we have and will continue to meet regularly with our commercial payors to review the utilization of the Zio XT service, the effectiveness of the service and identifying treatable arrhythmias and summarizing the efficiencies the service is bringing to their patient populations as a result of the high diagnostic yields that Zio offers relative to Holter monitors and event recorders. We plan to keep our commercial customers apprised of the multiple paths we are pursuing to obtain more appropriate Medicare pricing and will encourage our commercial payors to let us work through these paths before revisiting existing contractual rates. To close on reimbursement, we are disappointed in the outcome at this point, but remain steadfast in our pursuit of higher Medicare reimbursement. Our recent conversations with Novitas have been constructive, and we believe there are viable paths to more equitable rates and that it is appropriate to fully explore these paths before making any changes to the availability of the Zio XT service and the Medicare portion of our business. To the extent that more sustainable pricing cannot be achieved, we want to be prepared and we'll continue to examine operating plans and potential changes to our business model that will meaningfully drive down our costs to deliver the Zio XT service, and if necessary, begin to modify or limit access to the services and portions of our market that carry below cost reimbursement levels. However, it is our strong preference and that of our customers to achieve reasonable rates with Novitas, another MAC and/or CMS that ensures continued access for all patients. Now turning to our first quarter results. Revenue for the first quarter was $74.3 million, which represents year-over-year revenue growth of 17%. We estimate that the updated Novitas rates had a negative $13 million impact on revenue in the first quarter, and despite that, we were able to show meaningful year-over-year improvement reflecting our strong underlying volume growth. We saw continued strong growth from Zio AT, which has seen great traction as a best-in-class mobile cardiac telemetry service. We are confident in the outlook for Zio AT and the benefits that it offers to relative to traditional MCT technologies, including its unique value proposition of providing a comprehensive Zio XT report at the end of each patient wear cycle. Further, Zio AT leverages the same digital and clinical service that Zio XT is built on, which position customers have high confidence in. Selectively, the volume levels that we saw for both AT and XT in the quarter, which is significantly exceeding our initial expectations, and we experienced sequential volume growth of nearly 10% compared to the fourth quarter of 2020. We estimate that we are near 20% penetrated in our core market, with our continued growth we are driving toward becoming the new standard of care in cardiac arrhythmia monitoring. We also saw very strong volume growth in the United Kingdom, which outpaced overall company growth. On the heels of the AI award and NICE recommendation in the second half of last year, we have been making steady progress in opening up new NHS sites and ramping our service in the U.K. As we look forward, we are confident in the continued growth in demand for our service, but also realistic about what direction the reimbursement paths may take. It is clear that demand for our Zio service remains very strong. Our focus is increasingly on instilling greater operating discipline across our organization, capitalizing on our strengths in AI and operating with increased efficiency in our manufacturing, clinical operations, revenue cycle management, sales and marketing functions. In each of these areas, we have opportunities to lower our total cost of service, which will give us increased flexibility to reinvest in the business regardless of what direction reimbursement dynamics take. I want to emphasize that investing for the long-term growth of the business remains our top priority. And importantly, we have the financial resources to do so. Zio AT, international expansion and silent AF as well as building our manufacturing and clinical operations capacity all represent meaningful avenues to drive growth and value creation. As mentioned a moment ago, Zio AT is seeing great traction in the market and remains an important growth driver for the company. We remain less than 10% penetrated in the MCT market. We believe our focus on driving deeper penetration into high-volume MCT centers, growing new use cases and new sites of care and generating comparative clinical data will drive sustained growth and continued market share gains for Zio AT. On international expansion, we see tremendous long-term opportunity to drive a new standard of care in geographies outside of the U.S. and the U.K. We have been hard at work identifying a set of prioritized countries and developing a road map to begin market access initiatives in several new countries in the coming years. We are looking forward to sharing more details about these plans later this year. Within asymptomatic AF, we believe there is a clear value proposition and compelling clinical evidence to support targeted detection programs that identify and monitor high-risk but asymptomatic patients. We believe the evidence on the cost effectiveness of identifying high-risk patients with undetected atrial fibrillation before they experienced significant clinical complications, such as stroke and heart failure hospitalization, continues to build. And we expect we will provide a compelling case for payors and integrated payor providers to directly contract with the Zio XT service and risk-sharing business models over time. Now I will turn the call over to Doug to cover our first quarter results in more detail before providing my final remarks. Doug?

Thanks, Mike. Our first quarter results demonstrated steady growth in unit volumes and incremental improvement in sales metrics, offset by the headwinds of Medicare reimbursement. Total revenue in the first quarter was $74.3 million, reflecting year-on-year growth of 17% and a sequential decline of 5.7% over the fourth quarter. Gross margins were 68.4%, down 6.3% year-on-year and 5.6% quarter-on-quarter. Adjusted EBITDA, defined as EBITDA less stock-based compensation expense, was negative $5.2 million, an increase of $2.2 million year-on-year and down $11.7 million quarter-on-quarter. Cash and short-term investments were $262 million at quarter end, down $73 million from Q4 '20. Taking a more detailed look at the first quarter financial results. Volumes grew sequentially with quarter-on-quarter growth of slightly below 10%, and volumes were solidly above pre-COVID levels with first quarter 2021 volumes, 31% above volumes in the first quarter of 2020. Zio XT volume in the U.S. drove the majority of our growth in the first quarter, while Zio AT in the U.S. and Zio XT in the U.K. outpaced the overall company growth on a percentage basis. New account onboarding increased 11% compared to Q4 2020, reaching historically high levels. Looking at new store same-store mix. New store accounted for 28% of year-on-year growth, down from 39% in Q4 2020, primarily due to lower new account onboarding in Q2 2020. Home enrollment was steady at approximately 24% in the first quarter, down slightly from the fourth quarter 2020. Turning our attention to the rest of the P&L. Gross margin for the fourth quarter was 68.4%, a 5.6% decrease compared to the gross margin of 74% in Q4 of 2020. The decrease was primarily due to the Novitas, Medicare price decrease with limited impact of higher Zio AT volumes and COVID-related labor costs offset by volume benefits. Operating expenses for the first quarter of 2021 were $78.3 million, up 15.4% from Q4 of 2020 and up 38.3% year-over-year. The sequential increase in operating expenses included increases in stock-based compensation expense, primarily from executive retention programs and accelerated expense recognition associated with our prior CEO's retirement totaling $7.9 million. We also saw seasonal payroll and 401k costs of $4.6 million and hiring and other payroll expenses of $1.9 million, offset by the $4 million decrease in Verily milestone costs. Comparing year-on-year OpEx. Q1 2021 OpEx was up $21.7 million due primarily to stock-based compensation and payroll expense, offset by a decrease in Verily milestone expense. Quarterly adjusted EBITDA was negative $5.2 million in Q1 2021. Quarterly adjusted EBITDA was down $11.7 million sequential as compared to Q4 2020 due to the decrease in Novitas reimbursement for Zio XT. Cash and short-term investments decreased $73 million from the fourth quarter of 2020 to $262 million. $30 million of the decrease is related to accounts receivable increases due to the held Zio XT claims. This amount is expected to reverse over the next three to four months. $25 million of cash used resulted from historical practice of receiving employee shares to cover their RSU holding obligations and using corporate cash for withholding remittances. Cash used for RSU withholding obligations was higher in Q1 2021 due to the higher company stock price in January through early March period when RSU vesting occurred. This practice has been updated to require employees to sell shares or pay cash to the company to cover tax liabilities, which we expect will eliminate this category as a use of cash in the future. Finally, capital spending of $4 million, repayment of long-term debt of $3 million, EBITDA loss of negative $5.2 million and working capital increases or uses of cash in Q1 2021. Cash burn is expected to steadily improve over Q2 2021 and Q3 2021. We expect cash inflows to improve in Q2 2021 as we expect to make material progress on Zio XT claims processing and collections, while we expect Q2 2021 cash outflows to be approximately $30 million lower than Q1 2021 cash outflows. Finally, the net loss for the first quarter of 2021 was negative $27.8 million or a loss of $0.95 per share compared with a net loss of $9.1 million or $0.34 per share in the same period of the prior year. Updating on held claims. We are currently holding approximately 55% of 2021 year-to-date Zio XT claims, down from 70% as of quarter end. We have begun submitting held Novitas claims and expect to close the second quarter current on most initial claims submissions. As previously discussed, the delay in Zio XT claim filing is expected to delay some Q2 '21 revenue recognition to the second half 2021. Due to the shifts in timing for revenue recognition and business model alignments, we are only able to offer the following guidance. For the second quarter 2021, we expect sequential volume growth of approximately 4% over the first quarter of 2021 and OpEx to be approximately flat to Q1 2021 with reductions in stock-based compensation and payroll taxes, offset by increases in legal and consulting spending and hiring to support investments. To close, I'll spend a minute discussing the operating efficiencies that Mike briefly mentioned in his remarks. We have initiated a process of evaluating our operating profile, not only to develop additional capacity but to identify opportunities to scale more efficiently by increasing our revenue conversion per unit and to reduce our cost to serve. Key categories include using better design and more automation to reduce device manufacturing costs; reducing clinical scan times through increased artificial intelligence and workflow improvement; improving revenue cycle management through improved management of contractual allowances, cost of claims and bad debt; and finally, examining various go-to-market options that would reduce sales and marketing costs per unit. Collectively, we identified opportunities where we believe we can drive double-digit percentage reductions in our cost to serve, and as a result, build a strong, sustainable operating foundation that can profitably support a range of reimbursement levels. We are committed to improving operating efficiencies, and our financial strength provides the flexibility we need to appropriately develop and implement these programs as we also invest in the growth areas that Mike discussed. We look forward to providing more details as we progress. With that, I'd like to turn the call back over to Mike for closing remarks.

Thanks, Ed. There's a lot of work under way here at iRhythm, and the entire team is focused on meeting patients' needs while positioning the company for a profitable growth over the long term. While we do have some clear reimbursement-driven headwinds, I remain very enthusiastic about the disruptive nature of the Zio service, its value to our patients and physician customers and the numerous long-term growth drivers that will create long-term value for our shareholders. Let me close with a few observations. First, as I stated at the outset, Zio XT is the most innovative monitoring technology in the industry and there is significant ongoing strong market demand for it. I have high confidence in our technology platform, the clinical and economic value that Zio delivers to patients and healthcare systems and the complete service that we deliver for our customers. And most importantly, I have high confidence in the iRhythm team to continue driving toward a new standard of care in the U.S. and beyond. Second, we are committed to redoubling our efforts with Novitas, with the other MACs and with CMS to clearly demonstrate the value that our customers are realizing. Clearly, we have more work ahead of us to convince CMS and Novitas of this value. However, Novitas' openness to discussing an alternative costing model. It is an important step forward in this work. Third, the benefits of Zio XT, the value that should be recognized and the expectation for continued strong demand is validated by the advocacy from physicians and patients and their increasing utilization of the Zio service. We want to thank doctors and patients, who are making their voices heard. We will make no changes in access to the service for Medicare patients until the paths we are pursuing for more appropriate Medicare pricing have been fully explored. Fourth, I'm also realistic about the need to position the company to grow with lower assumed levels of reimbursement than had been in our previous plans. With that in mind, we have increased our focus on internal investments in the areas that will lower our overall cost to serve patients, targeting each of the areas that Doug outlined in his comments. And finally, despite the Medicare reimbursement headwinds, iRhythm continues to have many opportunities for growth and value creation that will benefit all of our stakeholders going forward, including international expansion and expanded indications for use. These opportunities will continue to be areas of investment for us in the months and years ahead. Thanks to all of you for your interest and support in the iRhythm program. And with that, we would like to open the call up for questions. Operator?

[Operator Instructions] Our first question comes from Robbie Marcus with JPMorgan.

This is actually Lili on for Robbie. So, one on the commercial side, I was hoping you could dig a little deeper into what your conversations with payors there have been like? What's been the feedback here since the update? And you mentioned that you have some contracts coming up for renewal in July. Do you have any sense for what sort of strategy those payors will take? And what percentage of sales do those payors represent?

So, thanks very much for the question. It's obviously, it's only been three weeks since the posting of the Novitas code, but we have had very constructive discussions with payors from the standpoint that, obviously, we've completed negotiations with about 90% of them and had them since the January one crossover date to CPT one codes. And as we mentioned, the vast majority of them have cross-walked their existing pricing. As I mentioned, 10% are still out to be completed in terms of negotiation, and we have had ample of them want to talk about the Medicare pricing and discuss, in some cases, linkage to Medicare pricing or the CPT one code or to just get in a discussion of our long-term approach to managing the Medicare pricing. And as I mentioned, we have had a small number -- small single-digit number who have talked about their -- coming up for renewal in the July time frame and wanting the end to discuss Medicare pricing. Our strategy with them has been basically to provide a clear indication that the Medicare pricing, as we've discussed on the call on the 12th and since, is well below our cost to be able to deliver the service, and as such, really can't represent a point of negotiation that, in fact, we have significant ongoing discussions to both with CMS and with Novitas and other MACs to be able to revisit that pricing and that we are essentially seeking kind of their patients to let that play out. When we mentioned to them that this 14-day service that they come to rely on, is below the reimbursements below cost, we get no pushback on that. They absolutely see the quality and cost inputs associated with providing that service. And so we're going to continue to do what we have been doing with these customers, which is to sit down with them usually for largest customers on a sort of quarterly basis, step them through the benefits they're realizing from using Zio in terms of the higher diagnostic yield, the elimination of the high number of patients who wind up with undetermined test if they're getting a Holter or event recorder and to remind them that alternatives such as MCT are significantly more expensive, mobile cardiac telemetry. So, that is how we expect things to play out here with as renewals come up to have those extensive discussions, and again, keep them very well tough to speed on the discussions we're having with CMS and the MACs in addressing Medicare pricing.

And your next question comes from Cecilia Furlong with Morgan Stanley.

Great. I guess I wanted to start off with just really what shifted in terms of what Novitas was looking at pre the rates coming on initially versus the conversations you've been able to have with them subsequent to that. Just really what kind of changed in how they were looking at this, what you were able to bring to the table show them now and kind of their acceptance and willingness to move forward?

So, thanks Celia for the question. The methodology that Novitas is using is very much rooted in sort of a pure cost analysis. And it's based really on what they view as direct product costs, which I think as you know that is just the start of the story for the Zio service and that there are significant sort of additional expenses that fall into the OpEx category that come along with things like the bad debt expense that we see with patients with the customer service side of actually having patients putting these applying the technology in the at-home setting, revenue cycle management investment in terms of processing of claims and dealing with levels of claims rejection. And so, what we've tried to do with them is basically identify the costs that they have acknowledged and then to bring into the picture of these other costs that have not been acknowledged, including and very importantly, the costs associated with the development of the deep learned algorithms that are key to being able to do this service from the standpoint that 20,000 minutes of electric cardiogram information cannot be done using traditional Holter approaches and brute force analysis of those waveforms. They've got to be processed in a way that really find the needle in the haystack and then allow the physician to see exactly what arrhythmias are taking place over that time period. And it's that, of course, benefit that turns what Holter's 24% diagnostic yield into something closer to 97% when you use the Zio system. So, that ability to have the patient identified the first time with the appropriate arrhythmias and then allow them to be treated without a lot of waste in the system is what we're kind of pointing them to. So, coming up with alternative methodologies that actually will look not just at those direct product costs, but the broader variable cost that go into providing the service and some of these important investments in technology, software, our 750,000-hour database that actually allows the deep-learned algorithms to develop and getting some cost allocations associated with that into the analysis. And we're this is not a unique issue for us. There are other areas of the physician fee schedule, and I would point to things like clinical diagnostics, genetic testing, where they have very similar issues, where there are very expensive capital investments made both in manufacturing as well as in the R&D activities that need to be reflected in the calculation of the cost. And there have, in fact, been alternative methodologies that have been generally accepted across the MACs in these areas that we are now suggesting would be appropriate models to relook at. And that's exactly where we are in discussions with them, that we think can take this first step and get us to a more reasonable representation of the true products and providing the service.

Great. And I guess if I could ask two. Just on guidance for 2Q, 4% versus almost 10% in Q1. I guess as you thought about guidance, just what was factored in from kind of the seasonality component, COVID or else just potential disruption given Novitas rates and anyone maybe pulling back service or anything like that associated with that? Just curious kind of what the inputs were in your guidance range.

Sure. I think probably the thing that we'd bring to your attention is that the strength of the business here in the first quarter was well above what we had projected. And so what we've seen is a bigger bounce back from COVID than we had anticipated. And of course, the important thing about our service is that we have to be staffed to be able to provide the analysis of the electrocardiogram information as it comes in. So, we are rapidly sort of expanding our -- the individual headcount involved in that specific part of our business. And so what we're seeing is continued strong demand, but we are likely to see some catch-up needed here to be able to actually get to the kind of posted growth rates that are in the market. So, we're just being a little conservative just because of the speed that one can bring up those individuals. We have a lot of activity going on in this area. But we don't want to overpromise and under deliver. So, this is pretty much in line with what we are looking at as our capacity to expand our service capability.

We have Margaret Kaczor with William Blair on the line.

So, a couple for me. One, I wanted to shore up some details on the new payment methodology that you shared with Novitas and a few others. So, have they reached back out since that meeting? Or have some of the other MACs reached out since kind of those original meetings? Are there future meetings on the books or more of a wait-and-see mode? And I guess, if you don't hear by year end, is that the time frame where you think you fully explored all paths? Or could it take longer than that?

So, it has been very interactive in the sense that based on this proposal, I think the Novitas has basically seen this as a viable path for being able to address what they want to get to, which is to make sure, a, the service is available to patients in the Medicare system. They've heard a lot of feedback that is valued very highly, and we would be expecting 250,000 patients in Medicare to be treated or to receive the service this year. And so they understand sort of the importance of it. And I think they have seen the application of this alternative approach in clinical diagnostics has been very appropriate. And so now the question in their mind will be, is it appropriate to this particular set of codes. And so that is where we sit right now, is not only engaging Novitas in that discussion, but also bringing the MACs who actually were involved in developing these methodologies and who were the original champions of them into support for these particular codes. And that activity is -- meetings are being scheduled -- have been scheduled, will be over the next several weeks, talking to multiple constituents both among the MACs as well as with the CMS.

Okay, great. Yes. And I guess a second question, Mike. You were brought on to commercialize Zio and push penetration higher. I know we're all spending time on reimbursement here. But what changes has reimbursement had on those initial plans that you had? And I guess, do you think you can grow at the same pace that you originally thought you would?

Well, I think you can see just from the demand for the service here in the first quarter that, in fact, it's very much on the trajectory we would have thought, in fact, that it's a bit ahead, as I mentioned, in terms of our forecasts for -- as we build capacity into our system. So, there's absolutely a strong demand for the service, and we're still at a 20% penetration rate. So, there's still a lot of opportunity to continue to expand the service. Obviously, that's not the issue. It's making sure that we have appropriate payment in Medicare to be able to not -- start segregating different patients with different insurance plans from getting different levels of service. And that obviously is our sort of Number one priority. But I would say the team has just done an excellent job of continuing to highlight the differentiation of the value creation, the improved workflow. Patients are happier with this approach versus the Holter monitors and event recorders. It's much less expensive than mobile cardiac telemetry in terms of its delivery of results. And so all of those portions of the value proposition are selling very well into the marketplace, and you could see just from the uptake in the technology.

Okay. So, you guys aren't changing any of the commercial plans that you came in to try to accomplish.

And our next question comes from Joanne Wuensch with Citi.

This is Matt Henriksson in for Joanne. First, with the U.K. performance. You talked about how it outpaced the overall company growth. But is there any way to kind of quantify that further, either in percentage of sales or even dollar amount?

Again, we haven't generally been breaking down the relative contributions of the three primary drivers, Zio XT, Zio AT and then the U.K. beyond the color that we've given you there. But clearly, because we were starting at a very small base, the growth profile is well above our company growth for the U.K. and we'll expect that to continue for quite some time.

Okay. And then moving to Verily. You guys talked about the costs, but how -- is there going to be any updates in the time line? I think with the kind of the previous question about commercialization, it sounds like things are kind of as they are. But just want to confirm that the time line is still as is and there's no changes there.

Let me ask Dan Wilson since he is actually leading that program to kind of comment.

Yes. Thanks Mike and thanks Matt for the question. So, related to the Verily program, as noted previously, our next milestone in that collaboration is regulatory submission of the end-to-end technology that we're developing. And we continue to expect to achieve that milestone this year, and we'll update everyone at the time we meet that milestone. And then as we've talked about previously as well, following clearance, we would expect to initiate a market evaluation phase to evaluate the performance of the technology in real-world settings and develop the clinical evidence and evaluate the business model. I would say the initiation of the market evaluation is obviously dependent on, first, getting the regulatory submission and then on regulatory clearance. So, those are the two timing requirements to get to that phase. But next milestone is regulatory submission, which we expect this year. And we'll update everyone when we reach that. I would also note that, as we've talked about previously, in the meantime, we are initiating early commercialization efforts within silent AF with Zio XT, as Mike mentioned, which will help inform our views on the business model and the strategy for the better lead technology.

That's helpful color. Actually, can I just squeeze one follow-up on the Verily. You guys talk about how you have initiatives to reduce the cost to serve. I would assume that the Verily product, once it's launched, would help that process. Is that the right assumption to make?

Yes. I think our view would be that the wearing of the watch would actually have a lower sort of cost per service than what we have typically seen with XT. And we think it needs to obviously be comfortably worn. It needs to be able to have downloads of information during the course of a period of, let's say, six months. But it needs to come in at sort of the lower overall cost of delivery than what we see with XT, and everything that we've developed here in our modeling would say that's exactly what will happen.

And our next question in queue comes from Kaila Krum from Truist Securities.

Can you just talk about next steps to a national coverage decision, and I guess, what you need to do on your end to support an NCD for next year? And then if Zio XT does end up in the proposed rule, I mean, what would be the likelihood in your view that CMS would take a different approach than the Novitas to determine their rate?

So, the process for the national coverage is pretty well laid out in terms of there being sort of comment periods for providing information, that happens sort of the March, late February, March kind of time frame. Then there is period where they essentially are digesting the information that they've had and can request additional information during that period. And we're right now in the period where, essentially, they're making their decisions about which codes are they going to prioritize and price, which ones they are going to leave as carrier pricing. And then what we would typically see is that there will be an announcement, say, in the late July or early August time frame that would highlight the preliminary rules. And then there would be a common period that would take place then until later in the year when we would expect a sort of announcement to be made in the November/December kind of time frame about what the effective codes will be for 2022. We took full advantage of that time period in the March time period, as I mentioned in our call here on the 12th, to basically propose this alternative approach to the valuing the code to offer an alternative to the RUC recommendations that had been sort of last year not chosen as the basis for doing the establishment of national pricing. So, in addition to that, we followed up based on questions in that session with additional information, and since then, have also provided some additional information from an administrative perspective into the process, such that if we get an announcement for the preliminary rulings that do actually price the codes, that will be fine. If in fact, they have not yet made a decision to price those codes, then there would be an alternative to provide additional input window between the preliminary rule and the final rule. And that is what we would then use to provide additional information that will be responsive to anything they may ask. So, those are kind of the steps that go into it. And as I said, the milestones will be here in the July/August time frame and then again at the end of the year in November/December.

Okay. That makes sense. And then I just want to touch on volumes. And specifically, would love to understand sort of how volumes have trended over the course of the quarter and into April. I guess, really did the Novitas news have any effect on volumes in the quarter?

Thanks, very much. It's been very steady and very strong, as you can see from the numbers that we posted, that there is a strong underlying demand. As you know, this is a funnel business. You spend time building up belief in the technology, and then there are conversions that take place over time in these accounts. So, we have not seen much of any negative impact of the Novitas decision. And of course, we continue to focus on not only demonstrating the value proposition, but encouraging our customer base that to the extent that they are seeing the benefits here in terms of better patient satisfaction, better clinical outcomes for their patients, better patient flow through their system with fewer patients coming back in for repeat tests because of ineffective Holters, that they make that known as being a really important sort of piece of their own inventory. And as I mentioned, we're now representing on the order of 20% of the market. And we said 250,000 patients in Medicare, so making sure that, that is recognized and understood among decision makers in CMS and beyond is important.

I guess, just one more if I can squeeze one in, I guess, tied to volumes. In terms of the competitive environment, can you guys just comment a little bit more about what you've seen there? Obviously, there's been a lot of consolidation in the space. And so I'm curious what you're seeing from a competitive standpoint.

Yes. Obviously, the transactions that led to the acquisitions of folks are relatively new, but what we're seeing is not so much the other companies trying to occupy the space of the 8-day to 14-day monitoring, and obviously, we concentrate really heavily in the 14-day monitoring, but to essentially sell a different value proposition where you can start with event recorders and then get traded up to MCT if you don't get an answer that you're happy with. And so it really is a distinct sort of value proposition that we're generally seeing from our competitors, from what we offer. And obviously, the downside of that value proposition is you see very low diagnostic yields with event recorders as well, in that 25% range, which means a lot of patients who are getting tests and then not getting definitive diagnosis. And then the alternative then becomes trading them up to mobile cardiac telemetry which carries with it very, very high cost. You're typically looking in the high $700, $800 price range for that technology versus what had been sort of $300 in Medicare. And now with the Novitas pricing, it is down in that 125% range. So, we are continuing to focus on the value proposition of the 14-day monitoring differentiation, and they are really focused on a different sort of value proposition.

And it looks like we have time for one more question. Your final question comes from Bill Plovanic from Canaccord.

Great. One of the challenges in time like these is always just keeping the organization together. And I'm just curious, what have you seen in terms of specifically sales force turnover? And then what are you doing in terms of retention for key -- I mean, customer-facing folks because that's probably one of the most important things outside of the people running things?

So yes, it's a great question. And obviously, because we have not limited access into Medicare, we have really not made changes to our overall compensation system here while we sort of focus our efforts on getting the pricing improvements. And because the service remains in very much in high demand in terms of growth, we've seen the rep base obviously continue to be very focused on penetrating the market. Obviously, there is concern about the long term if, in fact, we can't get pricing adjusted. And obviously, the way to deal with that is being very upfront on all the efforts that we are doing with our field sales organization. So, we're not in the headcount reduction mode for our direct sales activities. We're not really going after fundamental changes to compensation at this stage. And we're working real hard to basically get the value proposition to actually drive adjustments to what Medicare is providing. And our field has actually been very much responsive to their customers, saying they really want the service available to all their patients regardless of what their insurance carrying is. And it's really a tribute to our field implementation that our customers are so enamored not only with the technology and the report that we generate, but also the support they get from our sort of best-in-class field.

Yes, that's great to hear. And then just a follow-up. You mentioned the discipline in the organization. When do you implement that? Is that something you start now in the other areas? And then -- or is that something you kind of wait to see where Novitas or the national pricing rolls out? And those are my questions.

No. We actually are quite convinced that these sort of investments in our innovation stack pivoting toward driving the efficiency of the service is the right thing to do under any case because as you think about potential trends on reimbursement, but also expansion into international, we think the more efficient the services at delivering that report, the better off where we're going to be. And so we've been investing for a while and things like the deep-learned algorithms to actually improve the efficiency of our clinical operations folks, so that they can get a lot more help from the technology. So, it's less brute force analysis of the electrogram, and that is really starting to pay out in terms of new meaningful improvements in efficiency with new software. We've kind of pivoted within our product development area to look at cost reduction in the patch technology, not just focused on feature enhancement. And probably the most important thing is improving that registration experience such that we can actually have lower bad debt allotments, have more first-time claims being accepted by the insurance carriers without a lot of rework. All of those things take costs out of our system. They improve the service and actually allow us to do more at a lower cost. And the one thing we have really working for us is the number of cases being done is obviously growing very aggressively quarter-over-quarter, which lets us sort of spread these benefits as we just get the volume through the system.

And at this time, I would like to turn the call back over to Mike Coyle for closing remarks.

So, thank you all very much for joining us. We really appreciate your continued interest in the iRhythm program, and we're very much looking forward to continuing to report out on our progress as we get into Q2 and beyond. Thank you very much, and have a good afternoon.

Thank you ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect.