iRhythm Holdings, Inc. Q2 FY2024 Earnings Call

Hello all, and welcome to iRhythm Technologies Second Quarter 2024 Earnings Conference Call. My name is Lydia and I'll be your operator today. After the prepared remarks, there will be an opportunity to ask questions. I will now hand you over to Stephanie Zhadkevich, Director of Investor Relations, to begin. Please go ahead when you're ready.

Thank you all for participating in today's call. Earlier today, iRhythm released financial results for the second quarter ended June 30, 2024. 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 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. These are based on our current estimates and various assumptions and reflect management's intentions, beliefs, and expectations about future events, strategies, competition, products, operating plans, and performance. These statements involve risks and uncertainties that could cause actual results or events to materially differ from those anticipated or implied by these forward-looking statements. Accordingly, you should not place undue reliance on these statements. For a list and description of the risks and uncertainties associated with our business, please refer to the Risk Factors section of our most recent annual and quarterly reports on Form 10-K and Form 10-Q, respectively, filed with the Securities and Exchange Commission. Also during the call, we will discuss certain financial measures that have not been prepared in accordance with U.S. GAAP, with respect to our non-GAAP and cash-based results, including adjusted EBITDA, adjusted operating expenses, and adjusted net loss. Unless otherwise noted, all references to financial metrics are presented on a non-GAAP basis. The presentation of this additional information should not be considered in isolation or as a substitute for, or superior to results prepared in accordance with GAAP. Please refer to the tables in our earnings release and 10-Q for reconciliation of these measures to their most directly comparable GAAP financial measures. Unless otherwise indicated, all references to financial measures in this call, other than revenue, refer to non-GAAP results. This conference call contains time-sensitive information and is accurate only as of the live broadcast today, August 1, 2024. 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 will turn the call over to Quentin Blackford, iRhythm's President and CEO.

Thank you, Stephanie. Good afternoon and thank you all for joining us. Brice Bobzien, our Chief Financial Officer; and Dan Wilson, our EVP of Corporate Development and Investor Relations, join me on today's call. My prepared remarks today cover business updates during the second quarter of 2024, as well as our annual outlook. I'll then turn the call over to Brice to provide a detailed review of our second quarter financial results and updated 2024 guidance. Finally, Brice and Dan will both discuss the CFO transition that we announced earlier today before I close out with final remarks. Once again, we realized strong results in the second quarter from our core business as we achieved revenue of $148 million, representing 19.3% growth versus the prior year. This success was driven by another quarter of record volume demand, along with a slight improvement in average selling prices. Within our core business, our teams continued to drive growth from new accounts that were opened in the prior 12 months as well as penetration in existing accounts, and we have built a very strong pipeline, thanks to the growing recognition of Zio's value proposition. The compelling CAMELOT real-world evidence data demonstrating Zio's superiority both across categories and within category directly against competitors for highest diagnostic yield and lowest retest rate continues to provide traction with clinicians and health systems. Payers have also responded favorably to our health economic data in CAMELOT, enabling our market access team to drive favorable negotiations with greenfield contracts and to drive updates to several existing coverage policies for improved patient access. Our continued focus within the primary care channel has been successfully driving conversions from competitors as well as continued conversion of customers from traditional modalities, such as short-term Holter monitoring, with a steady stream of new evidence demonstrating the value of 14 days of monitoring for a range of arrhythmias, not only atrial fibrillation. In addition to winning competitive share and driving the mix shift towards long-term continuous monitoring, iRhythm is driving accelerated expansion of the total ACM market by expanding into primary care, where we estimate that there are more than 15 million patients with cardiac-related palpitations who visit their physicians each year. Zio's value proposition to address the quintuple aim of healthcare is clearly resonating with primary care providers in integrated delivery networks as well as large national primary care accounts, some of whom have begun to proactively monitor for arrhythmias even if a patient is not symptomatic. In large integrated delivery networks, cardiologists, electrophysiologists, and primary care physicians have begun to appreciate the utility of Zio as a workflow efficiency tool, enabling them to diagnose the right patient the first time and alleviate some of the capacity constraints facing many cardiologists in electrophysiology practices by helping identify the appropriate patients who should be seen by these specialty physicians. We believe that this trend towards pushing Zio earlier in the treatment care pathway will only accelerate with further appreciation of the Zio value proposition by primary care providers and with initiatives such as our Epic Aura EHR partnership, which will be introduced into the first accounts in the fourth quarter of this year and then launch more broadly in 2025. Additionally, we have found solid traction and product-market fit in the undiagnosed arrhythmia space, specifically in value-based primary care programs, which has been the culmination of several factors we have been driving over the past few years. The known increases in healthcare utilization and cost have been met with a focus on serving patients in lower-cost settings of care. The ease of use for physicians and patients alike of our Zio monitor, together with iRhythm's clinical evidence with mSToPS and other trials, demonstrates Zio's ability to identify undiagnosed arrhythmias and the cost-effectiveness of a proactive arrhythmia monitoring approach. In parallel, the CAMELOT data showed that long-term continuous monitoring is associated with the lowest healthcare utilization, with Zio specifically having the highest diagnostic yield and lowest retest rates compared to competitors. What we initially conceived as our Know Your Rhythm program for the payer channels has been instead organically adopted by innovative value-based care organizations over the past few quarters to encapsulate proactive monitoring strategies. We've been excited by the early progress in this area, as we've seen some of our top customer accounts during the second quarter prescribing Zio for proactive monitoring. Even more encouraging is that we signed a number of additional large national accounts during the second quarter with a strong pipeline that remains in place that we believe will be significant contributors to future growth. Turning to Zio AT, we continued to make progress on the remediation activities of the FDA warning letter during the quarter and submitted the first of our responses to the FDA regarding the two 510(k) submissions this week, with the second submission planned to be submitted shortly. Recall that we submitted two 510(k) files in January of this year. One is a catch-up for changes previously made to the Zio AT system as a letter to file, and a second 510(k) for design features and labeling updates to further address areas of focus noted in the FDA warning letter. The agency has requested data that includes incremental electromagnetic compatibility (EMC) testing and human factors testing around design changes made to satisfy their request. We look forward to having provided these responses in the near term, and will then wait to hear back from the FDA. Regarding the FDA, the agency was on-site at our San Francisco and Orange County facilities in the back half of July. The inspections concluded yesterday with several 483 observations noted. We are in the early stages of evaluating these and we intend to provide responses to the FDA in a timely fashion. At a high level, the observations were primarily focused on our quality system and regulatory compliance, including complaint handling and medical device reporting, risk analysis regarding the involvement of the company's certified technicians to prepare the ECG reports in the CAPA process. We remain committed to our customers' patient safety, quality, and compliance, and we will continue to work diligently and collaboratively to resolve the warning letter to the FDA's satisfaction. In parallel, our teams continue to work diligently to prepare for the subsequent filing of our next-generation MCT product, Zio MCT, and we continue to believe that the 510(k) submission for that product will be submitted late in the second half of 2024, following clearance of the two 510(k)s for Zio AT. Moving to our strategic pillars for future growth. We're also making significant strides to open up new opportunities outside of our core business, beginning in the back part of this year. In Western Europe, we remain on track to launch commercial activities in four countries: the Netherlands, Austria, Switzerland, and Spain, with first patient patching anticipated before year-end 2024. We could not be more excited for the culmination of this enormous cross-functional effort that demonstrates iRhythm's commitment to introducing a better way to monitor for arrhythmias to millions more patients globally. As we move into 2025 and beyond, the commercial launch in these countries could constitute an incremental market opportunity of 1.5 million patients who could potentially benefit from Zio each year and also represents an important lever for growth towards our $1 billion revenue target in our 2027 long-range plan. To support this broad commercial launch, we have completed two limited market evaluations in five top centers in Switzerland and Spain, continue to be very active at major European medical conferences with educational events and presentations, and have held an advisory board with 15 of Europe's leading key opinion leaders to drive physician awareness of Zio. In Japan, we continue to anticipate a regulatory decision by the PMDA in late 2024, representing the first step of our foray into the second-largest medical device market in the world, with approximately 1.6 million ACM tests being prescribed per year. Recall that we received a high medical needs designation from the Japanese MHLW last year and that this distinction is specific to Zio, granted at the recommendation of the Japanese Heart Rhythm Society. This designation has created significant interest with potential commercial partners and has also informed our regulatory submission with the PMDA. As we continue to engage with the Japanese PMDA, we have finalized our reimbursement dossier that would be submitted to the MHLW immediately following a regulatory decision. We are also pleased to note that we have now signed a letter of intent with our distribution partner in Japan. We are actively collaborating with them to prepare for a limited market launch in the first half of 2025 and look forward to sharing more details as we make progress in the coming months. In potential new indications, we plan to move forward with a market evaluation in obstructive sleep apnea in the United States in 2025, representing our initial foray into an adjacent indication with significant overlap in arrhythmias and a sizable unaddressed patient population. Thus far, early results from the Sleep Pilot that we launched in February have indicated that physician demand is high for a service that could streamline their workflow to decrease current pain points in the diagnostic journey for OSA, including insurance validation, patient facilitation, and comprehensive report delivery, all in an integrated digital platform. Market research performed to date associated with this project has confirmed that cardiologists are likely to be early adopters of a service that combines an OSA and ACM diagnostic. A frictionless ordering process, high-quality report with clear insights, and seamless integration between the two tests were cited as key features physicians would look for in this type of service. These learnings have validated our views of the value of a technology and service platform that can serve multiple patient indications. We plan to continue building a potential product and service offering that we can then launch into market evaluation beginning in 2025. With that, I'll now turn the call over to Brice to discuss our recent financial performance.

Thanks, Quentin. Before discussing the quarter, I wanted to briefly address my upcoming transition from the CFO role at iRhythm. I've resided in Southern California for the past 12-plus years, but I'm originally from the Midwest where much of my immediate and extended family currently resides. Like many of us, we have loved ones who are aging and have experienced health challenges. While working and residing out of the Midwest for the past couple of months, I've been able to help and support my family members directly. While providing this support, it became apparent that my family needs my focused ongoing attention firsthand. Trying to evaluate how I could continue to support family needs while also balancing the work here at iRhythm, it was clear I needed to make a decision. With the changing landscape of my life, I've decided to step away from iRhythm to focus my attention on family. For most of my life, I've prioritized career, but priorities shift, and I need to attend to personal family matters in the near to mid-term. Over the last couple of years, I have loved being a part of transforming and maturing this great company, and I'm so thankful for the truly world-class team we have built. There is so much opportunity here at iRhythm, and I am grateful to have been a part of it. I will be transitioning out of my role as CFO on August 31st, but will remain engaged for a period of time to ensure a seamless and effective transition. There are great days ahead here at iRhythm, and I plan to have a front-row seat to see us continue to be the leader in ambulatory cardiac monitoring. Turning to the quarter, as a reminder, unless otherwise noted, the financial metrics that I discuss today will be presented on a non-GAAP basis. Reconciliations to GAAP can be found in today's earnings release and on our investor relations website. Our second quarter 2024 results demonstrated continued traction in our core markets as we achieved revenue of $148 million, representing 19.3% year-over-year growth. These results were driven by strong revenue unit growth as well as expected improvement in our average selling price compared to the second quarter of 2023. New store growth, with new stores defined as accounts that have been open for less than 12 months, accounted for approximately 40% of our year-over-year volume growth and home enrollment for Zio services in the U.S. was approximately 22% of volume in the second quarter. As we enhance our revenue growth strategy, our health policy teams have continued to achieve key wins that will enable expanded patient access to Zio services. During the second quarter, our market access team drove favorable negotiations with six greenfield contracts that will open up coverage for Zio for an incremental 2.9 million covered lives and have also driven updates to a number of existing coverage policies to be optimized for MCT utilization. Additionally, our market access team, in collaboration with our Health Economics and Outcomes Research Group and supported by our CAMELOT data, successfully drove a major policy shift by a large national payer to provide favorable positions for our Zio service. This new policy now allows for 14-day, long-term, continuous monitoring or mobile cardiac telemetry as a step-through to implantable loop recorders and also removes the need for step therapy or prior authorization as a prerequisite for MCT coverage. This policy enables improved access to Zio products and services for over 25 million commercial and healthcare exchange members, which started June 1, 2024. In addition to being a testament to our team's tireless efforts and continued passion for supporting patients, these critical successes are an important recognition of the value that Zio products and services bring for patients and healthcare systems alike. Gross margin for the second quarter was 69.9% ahead of expectations. As anticipated, we have started to realize the benefit of optimized efficiency from our clinical operations team and specifically from our investments into our San Francisco Center of Excellence. Additionally, we realized favorability from a couple of one-time items that we do not necessarily believe will reoccur in the future, but contributed nicely in the second quarter. Furthermore, we achieved a significant operational milestone in May of 2024 with the launch of the initial phase of manufacturing automation. This project and subsequent phases of manufacturing automation will continue to enhance manufacturing scalability and margin improvement as well as set the stage for future growth and innovation in the second half of 2024 and beyond. Second quarter adjusted operating expenses were $125.2 million, down 0.4% sequentially and up 25.5% year-over-year in line with our expectations. Compared to the second quarter of 2023, this increase in adjusted operating expenses was primarily due to compensation-related costs, development work for Zio MCT as we move the product closer to our regulatory submission, software development efforts to further enhance the functionality of our current and future product offerings, EPIC Aura integration costs, and revenue cycle management claims processing fees. We believe that these incremental investments will continue to support our growth in future quarters. Please note that we continue to incur incremental legal and consulting fees as well as other company expenses related to the FDA warning letter and DOJ subpoena. Adjusted net loss in the second quarter of 2024 was approximately $18.8 million or a loss of $0.61 per share, compared to an adjusted net loss of $13.1 million or an adjusted net loss of $0.43 per share in the second quarter of 2023. Adjusted EBITDA in the second quarter of 2024 was $5 million or 3.4% of revenue compared to 3.5% in the second quarter of 2023 and -9.2% of revenue in the first quarter of 2024. This was ahead of the previously provided guidance and inclusive of funding important investments into projects that we believe will continue to drive future growth. Turning to guidance. We are also raising our 2024 revenue outlook as presented earlier this year and now anticipate full-year revenue to range between $580 million and $590 million. We continue to believe that the year will be driven by sustained volume growth in our core U.S. market as we continue to drive penetration in both existing and new customer accounts. As in previous years, we believe that third quarter 2024 revenue will be in line with normal summer seasonality of approximately 25% of expected full-year revenue. Turning to gross margin. We are raising our full-year 2024 gross margin guidance to a range of 68.5% to 69%, an improvement of approximately 150 basis points at midpoint compared to the full year of 2023. We made significant progress during the second quarter with regards to clinical operations and manufacturing efficiencies and believe these are sustainable over time. However, it is important to note that we will need to continue to invest to enable future growth and do not believe that the one-time items noted previously will repeat. As such, we anticipate third-quarter gross margin to be slightly down sequentially; however, we continue to believe this additional leverage will support our goal to reach over 70% gross margin as we exit 2024. We are also raising our adjusted EBITDA margin guidance to a range between 3.5% and 4% of revenues, which would represent a 450 basis point to 500 basis point improvement compared to 2023, in line with our stated path to adjusted EBITDA margin targets by 2027 and driven by our focus on sustainable operating leverage improvements throughout the P&L. Looking at the cadence of margin expansion in the second half of this year, we expect to see third-quarter adjusted EBITDA margin improve by approximately 150 to 250 basis points compared to the second quarter before expanding further in the fourth quarter. Along with anticipated progress in gross margin efficiency, operating expenses are historically more elevated in the first half of the year relative to revenue. As mentioned previously, we continue to believe that there will be approximately $8 million to $10 million of costs associated with the FDA warning letter and responses to the DOJ subpoena for the full year of 2024. As we navigate these two issues, the majority of these costs will come out of the P&L in the future. Finally, we ended the second quarter in a strong financial position with approximately $561.5 million in unrestricted cash and short-term investments. During the second quarter, we began to see improvements in working capital as anticipated. We were pleased to see cash collection improvements in the second quarter resulting from the recovery of delayed billings associated with the changed healthcare cybersecurity attack in the first quarter. We anticipate further improvements to cash collection and normalized levels of DSO as we exit 2024. I'd now like to turn the call over to Dan for a few remarks.

Thank you, Brice. I would like to start by expressing my excitement for the opportunity to step into the CFO role. I would like to thank Quentin, Brice, and the rest of the iRhythm team for positioning me for success and ensuring a smooth transition. In my five years with iRhythm, I have seen a tremendous amount of growth and progress, and I am more excited than ever about what's in front of us. I am honored and looking forward to contributing to our next phase of growth and transformation. As I step into the role, I am able to reflect on the engagement I have had with our investor base and covering analysts and have a good understanding of the strategic and financial expectations of iRhythm. My focus will be on supporting the company to drive continued top-line growth and doing so profitably. We have many initiatives in motion, and I'm excited to continue leading and supporting those efforts as we look to scale iRhythm and serve millions more patients in the future. Thank you, and I look forward to working with all of you in the new role.

Thank you, Dan. Before closing, I'd like to thank Brice for his many contributions in helping us to transform our company. While I'm disappointed to see Brice step down, just as we're beginning to see the financial benefits of the significant transformation efforts we've embarked on over the last 30 months, I respect his decision as he deals with unfortunate personal matters at this time. Importantly, he'll be nearby as we work through this transition to Dan. Succession planning is something that we spend a good amount of time on here at iRhythm, and Dan has long been seen as a potential successor to Brice. His strong strategic financial background, in-depth knowledge of our company and industry, together with a strong relationship to our investors, will allow for a seamless transition and ensure we remain on track to deliver on the long-term financial goals that we have laid out. That path forward is as clear as ever. The strong financial performance in the second quarter and our increasing financial guidance across all metrics demonstrate the building momentum and confidence in where we are headed. I'd like to thank Brice for his many contributions to iRhythm and look forward to continuing to build upon that progress with Dan. Finally, I'd like to address recent activity around the Department of Justice's inquiry into iRhythm. As you'll recall, on April 4, 2023, we received an inquiry from the civil division of the United States Department of Justice, or DOJ, seeking information and documents regarding the company's products and services. Since the DOJ's initial inquiry, we have been extremely responsive and collaborative, and we have produced a significant amount of materials with information responsive to their subpoena. In July, the DOJ filed a petition for Order to Show Cause, an application for enforcement of administrative subpoena seeking the production of certain documents that the company has withheld on the basis of legal privilege. The company disagrees with the DOJ's attempt to invade the attorney-client privilege and the protection afforded to attorney-work product. In partnership with our top-tier outside counsel, we determined that it is in the best interest of the company to continue to maintain our position that certain documents are privileged, not only as it pertains to this case, but for the precedent it sets and other outstanding and future matters. Our immediate next step in this process is to prepare our opposition to the DOJ's petition, and we have negotiated a briefing schedule with them directly that pushes this matter into the fall. iRhythm's opposition brief is due on August 16, 2024, and the DOJ's reply is due September 6, 2024. At this time, we cannot speak with certainty on the focus of their investigation and prefer not to speculate. In closing, we are very pleased with the results from the first half of this year and are incredibly excited for multiple milestones in the coming months that will enable us to capture the significant opportunities that lie ahead of us. As we work to transform the company, we're continuing to drive penetration in our core commercial markets while expanding the ACM market in the U.S. more broadly. We're launching internationally in multiple countries across the globe. We're driving operational efficiency and financial sustainability, all while keeping the patients we serve in focus at all times. As multiple vital signs and digital data assets are increasingly combined to generate clinical insights, we are excited to be a market leader in defining how monitoring could look in the next three, five, or ten years. iRhythm is building a digital healthcare portfolio of the future, and I could not be more pleased with our unique positioning to address the quintuple aim of healthcare in the years to come. With that, we would now like to open the call for questions. Operator?

Thank you. Our first question today comes from Margaret Andrew with William Blair. Please go ahead. Your line is open.

Hey, good afternoon, folks. Thanks for taking the questions. And first off, Brice, very sorry to hear you're leaving and wish you and your family the very best in the meantime. So wish you well. I guess just to start on the 483s, I know quite early, but anything that you can give us around what was in the observation? Is it a few smaller observations that you feel confident to characterize, maybe minor observations, anything new or surprising? And then how quickly, I know it's early again, but how quickly do you think that you can resolve those? Thanks.

Hey, Margaret, thanks for the question. Well, look, we will respond to those observations within 15 days. So it's got our full attention at this point in time. Obviously, where it goes from there, I can't speculate at this point, but let me try to give a little bit more clarity around it. I think it's clear that the FDA is trying to define, frankly, how to regulate this relatively new category. As a market leader, discussions like this will be ongoing for a period of time. Keep in mind, from the warning letter in these discussions as they continue to understand this category, a whole new code has been established as a result of those discussions. At the end of the day, I think the fundamental issue sort of comes down to whether the Independent Diagnostic Testing Facility (IDTF), the clinical technicians, are they part of the product or are they not? I think from the beginning, we have viewed those as separate items. I think the FDA has a bit of a different perspective right now that we're working through. But when you start to think about those two things differently, we land in different places when it comes to complaint handling or reporting, or process controls and how you document those controls or how you go about your statistical techniques. It's important to note that there are no conversations with the FDA around the overall safety or efficacy of our product. That's not being discussed. It's not like it was in the initial warning letter where there were questions around whether you are an MCT product or not. Those issues are behind us. This is really about how we go about identifying what complaints to report or not to report, how we document those things, and the processes set around it. So nothing is specific to the safety or efficacy of the product, whatsoever. It's more about how we continue to build and make our quality systems more robust.

Okay, that's helpful. Yes, and then as we look at revenue guidance, you raised a little bit more than the beat. How should we look at that outlook for the rest of the year on a sequential basis and then maybe walk through drivers of that increase? Is it TCP, is that big contract, or something else? Thanks, guys.

Yes, thanks, Margaret. This is Dan. I can start on that. So hopefully you heard from our prepared remarks that we feel really good about the momentum in the business, the trends we're seeing, and really seeing contributions from across the board. You heard new store growth being 40%, so we're seeing nice balanced contributions from new store, same-store growth both monitor, and AT contributing. Additionally, primary care continues to open up nicely for us. So all of that is really contemplated in guidance and we see that continuing to contribute through the course of the year. You heard our remarks on Q3 being 25% of full-year revenue, which reflects normal seasonality for us.

Thank you. Our next question comes from Allen Gong with JPMorgan. Please proceed.

Thanks for the question. I just want to echo my condolences for the situation with your family and I hope everything gets better. So I guess I'll bundle my two questions together. The first, starting with the financials, you mentioned that there were some one-timers that really helped gross margin. You still expect to end the year at around 70%, but it also looks like SG&A improved pretty significantly. What were the drivers of that and how should we think about the sustainability there? And then just a quick follow-up on the DOJ investigation, whether or not you can kind of give us a better idea, kind of the scope of that and we've all seen the filing by now, but just kind of the scope of what the DOJ is looking into? Thank you.

Hey, Allen, thanks for the question. I appreciate the kind words. So, first question on the one-timers that we talked about with regards to gross margins, it's really a couple of different things. We've talked to the investor community about just the focus and diligence that we've placed on procurement activities and indirect procurement efficiencies that we've been working to drive as an organization. The biggest thing was, frankly, some logistical savings that we were able to drive with regards to shipping vendors that we've been working with. We were able to get retrospective pricing that dated back into Q4 of 2023 that ultimately came through in the form of credit in the second quarter. So as you can imagine, that will sustain moving forward, but those couple of quarters of incremental benefit that we gained from that negotiation won't necessarily repeat moving forward. The other one that's relevant is the fact that we do have a component of our software organization that works on optimization and tweaks to the edges on the solutions that are used by our clinical technicians as well as our intake solution and manufacturing for that matter. Our full focus now from a software development standpoint has really been on the development of MCT and getting it ready for that submission that's right around the corner. We had very little of that work being done in Q2, so that reduced the cost profile a bit. We don't expect that to continue moving forward. We're going to continue to optimize those solutions that we have available to us. Both of those things contributed about 100 basis points of benefit in the quarter. I also mentioned that we will need to continue to hire resources as we scale volumes. As we saw in Q4, you hire those resources in preparation for future volumes, and it takes a little bit of time to get them up to speed. So those are things that aren't necessarily surprising or one-time in nature, but it's just investing ahead of the ultimate scale that you're going to get. We feel great about the progress that was made there. On the SG&A side, the biggest thing is that we do have some higher-level costs specific to Q1 regarding company meetings, some things that hit both selling as well as SG&A. Those don’t necessarily replicate, and we communicated that as we think about the first half being a little higher than that of the back half. So you're seeing that play out in Q2, and it's certainly sustainable for the rest of the year, though there is some seasonality that we'll have to continue to consider as we move forward from models in 2025 and beyond.

Hey, Allen, and with respect to the question on the scope of the DOJ, I don't think there's a whole lot more information, frankly, that we can provide you at this point. I think the set of questions or the documents they've requested are broad. We've indicated that we haven't seen anything different over the last several months. As a matter of fact, it has gone relatively quiet for a good period of time until they made the motion to compile these documents that we spoke to and to your point, with the filings being out there, those documents are around quality systems and design history files from the past back in '16, '17, '18, '19. We feel very strongly that we need to try to protect that client privilege, not only for this case but the precedent it sets with all other cases that are out there. We've been very cooperative with them, having produced many documents and all of them have topical matters that are the same as what's in the reports they've requested. So they have the information, but this is about protecting the attorney-client privilege that we believe we're entitled to. But I can't provide anything more specific than that right now; we would be speculating, and we're not going to speculate.

Our next question comes from Marie Thibault with BTIG LLC. Please go ahead.

Hi. Thanks for taking the questions. Brice, thanks for all your help the last couple of years, and best wishes to you and your family. Dan, congrats on the new seat. Wanted to use my one question here actually to latch onto what you talked about on the sleep space and efforts to launch into a market evaluation next year. Can you tell us a little bit more about what that looks like? Is that a reimbursable product? What parameters are being measured? And then is there spend or acquisition needed to get there into that market evaluation? Thanks for taking the questions.

Thanks, Marie. So I think we can get to the market evaluation without a lot of incremental investment or acquisition to make that happen. In the market evaluation phase, it's really about building a front-end capability that makes it entirely seamless for the physician to identify the patient, then order the product, and behind the scenes ensure the product gets to the patient. The data is received, we interpret it through an Independent Diagnostic Testing Facility (IDTF) capability and provide a report back through a single digital portal to the physician. So to the physician, customer, it's incredibly seamless. To the patient, it's a much more efficient workflow; they don't have to leave the cardiology office to see a sleep specialist or someone else. We introduce them to a virtual sleep capability or a home sleep test. Out of the gate, we will leverage a third-party sleep test while we continue to build our own capabilities to diagnose sleep disease independently. So at the outset, we'll procure a sleep device from a third party, make that part of the iRhythm package, ultimately provide that to the patient, collect the data, interpret the data, and give a report back to the physician that will be packaged as an iRhythm solution. All of that can be reimbursed, and the reimbursable rate is between $150 to $200 for that sleep test and the service we will provide back in the form of a report. That rate ranges between CMS and commercial payers, which is why there's a bit of a range between the $150 to $200 for two to three days of home sleep test service with report generation. But that's how to think about it in terms of the financial model. Over time, it's our intent to develop and deliver our own home sleep test capability directly off of our single platform, but that will take more time.

Our next question comes from David Rescott with Baird. Please go ahead.

Great. Thanks for taking the questions. Brice, obviously echoing kind of the best wishes to you and your family under these circumstances. Dan, congrats on the new role. I'm looking forward to working with you even more going forward. I wanted to follow up just on the 483 comments first and curious how these new observations impact the recently submitted 510(k). Whether or not that has any impact on the total kind of resolution of the warning letter or the ability to submit for Zio MCT. And then just related to that, plus the DOJ comments, I think I heard the comments around the $8 million to $10 million of the incremental spending or spending that's in the business today. I'm wondering if these drag on a little longer, whether or not that impacts the longer-term view around where the EBITDA margin can go.

Sure. Regarding the 483s and the inspections that took place here in the back part of July, there's nothing in those discussions that gave us any indication or direction to think differently around how we think about clearing the Zio AT product in those 510(k) submissions. Back to my prepared remarks, we did file the response to the catch-up 510(k) earlier this week. The response to the other 510(k) would have gone in as well had we not been addressing the inspection, so that got delayed just a little bit, but it's nearly ready to go. That will be filed likely by the end of next week or shortly thereafter, which puts us right on track for the September-October timeframe for the approval of Zio AT. I also want to note that for the Zio MCT, there has been no indication given that we should think differently regarding the Zio MCT product. We do need to see Zio AT clear or get the two clearances there, as that will be the predicate for Zio MCT. However, our expectation is that we will continue to submit Zio MCT for clearance before the end of the year. One thing I will add is that skin irritation is something that has come up. Our skin irritation rate is right around 2%, which is well below published literature of what's acceptable in wearable devices. We have seen it step up a bit over the last two years. The FDA proactively asked how quickly we can move from Zio XT onto Zio monitor or how quickly we could deploy Zio AT onto Zio MCT because we know that monitor has a much lower irritation rate. Again, that’s a favorable indication of moving towards these new products. Nothing has changed from our perspective, and we stay on track.

Yes, that's a good question. I appreciate that. From what we know now, we believe that the $8 million to $10 million is the appropriate way to think about it for 2024, so effectively, no deviation. With what that means moving forward, we'll certainly provide feedback. I don't see any indication that this is going to extend meaningfully longer. Now, should something creep into 2025, we'll certainly discuss that. However, over time, we absolutely believe this $8 million to $10 million comes out of the spending profile and becomes a meaningful contributor to adjusted EBITDA moving forward.

Our next question comes from Nathan Treybeck with Wells Fargo. Your line is open.

Hi. Thanks for taking the question. Brice, it has been a pleasure working with you and Dan, congrats on the new role. I just wanted to touch on the DOJ subpoena just one more time. The wording in the recent document that was posted seems to suggest that it might just relate to Zio AT. Is there anything in the documentation that was requested from you that would suggest the inquiry extends to Zio XT as well?

Nathan, we'd be speculating at best around it. From the very beginning, this seems to have been focused around the AT or even the MCT category. Keep in mind, competitors of ours who have MCT products received the subpoena at the same time. We don't know that for certain, but certainly, much of the documents that have been requested are focused on AT, including what you're referring to and what was produced in that filing. At the same time, I can't tell you with certainty that that's where it's focused. The request has been broad, and we've been very cooperative with them to produce everything they're asking for, so I can't speculate. That's where it seems to be focused initially.

Our next question comes from Joanne Wuensch with Citigroup. Please go ahead.

Hi, guys. This is actually Anthony on for Joanne, and I'll just echo the well wishes for you and your family, Brice; Dan, congrats on the new role. At a broker conference, I think back in June, you laid out some components in the back half of the year driving the gross margin expansion. It was 200 basis points from the clinical technicians coming up to speed, 100 basis points from ramping up monitor, and then another 100 basis points from automation. Is that still how you're thinking about contribution from these components for margin in the back half of the year?

Yes, Anthony. Yes, that is still our outlook. Obviously, the performance in the second quarter, that efficiency regarding the 200 basis points from the clinical operations team played through more quickly than we anticipated. We saw some incredibly nice work by that team and focused just operations from that team in the second quarter. We also saw that manufacturing efficiency contribute positively as well that quarter. However, that doesn't take away from the 400 basis points that we outlined, and where we expect to be as we exit 2024 and into 2025.

Our next question comes from Mike Polark with Wolfe Research. Your line is open.

Hi, good afternoon. If I could ask two questions, I would appreciate it. The first is about Research and Development. It appears to have increased in dollar terms and is a bit lumpier than usual. Is there something new contributing to this? Is the $20 million a quarter a sustainable rate, or do you anticipate a decrease in the second half? My second question concerns the significant policy change from a major national payer. I noted a couple of key points: the step-through for implantable loop recorders and the removal of step therapy. It seems different and noteworthy, and I'm wondering if you could clarify what is changing there. Thank you.

Hey, Mike, thanks for the questions. On the R&D side, there's really no major deviation from the trend moving forward. I will say the expenses were higher in the quarter, notably as we prepare the Zio MCT product for regulatory submission, working through human factors testing, and finalizing some work on the software solution side. That cost was a little higher in Q2, which we don't expect moving forward. We would expect to see that start to trend down in Q3 and then further in Q4 as we get beyond that submission.

I'm pleased to see the team achieve significant wins in payer and market access areas. This demonstrates the clinical and economic evidence we continue to produce, which is gaining recognition from payers. We identified several wins, including new coverage that adds approximately 2.9 million new covered lives, along with coverage policy decisions that simplify access to Zio for patients. While the impact of these wins won't be immediate, we anticipate they will positively influence our results, benefiting both volumes and average selling prices over time. Ultimately, these coverage policy victories will greatly facilitate patient access to Zio, leading to long-term advantages.

One thing I'll add is that it's encouraging to see the impact that CAMELOT continues to have in this space. Many policies in the past required up to 30 days of monitoring before you can get onto an implantable loop recorder. They are now proactively moving that down to 14 days directly in line with the Zio monitor's wear period. This resonates with providers and is leading to incremental access, reduced hurdles to product adoption, and is opening up new channels in our offering. But CAMELOT has been a wonderful asset for us.

Our next question comes from Ravi Misra with Truist. Please go ahead.

Hi, this is Ravi from Truist. Thanks for taking the questions. So just two questions on our end. First, Quentin, it sounds like the 483 observations are more around workflow issues and things like that. I was hoping you could maybe talk about what you envision around risk if the discussions don't go the way you think they will. They seem pretty benign so far, at least from the way you've described them. And what are you doing to kind of address these issues and risks? And also, regarding MCT strategy, CAMELOT really seems to be driving the plans and policy changes. Given the ASPs, how should we think about that from a future perspective? Is this a directional change, because of this data you're able to negotiate higher ASPs with the plans? Is that something you expect to continue in the future? Thanks.

Not so much, Ravi. So many of these plans establish a rate for a particular category code, and the broader industry is billing against that code. Take CMS, for example, we're all getting reimbursed at the same level. Encouragingly, you saw in the proposed rule that long-term cardiac monitoring was the only one that had a significant cost increase in this proposed rule. Some position fee adjustments and other adjusting factors might bring that down a bit, but net-net pricing remains stable. I do think, over time, where the opportunity presents itself is in these larger at-risk proactive monitoring programs. We have some ability to negotiate price differently in those situations because we may be selling directly into the payer plan at whatever price we negotiate with them. The more we can demonstrate the value that we're bringing them, the more they're going to be willing to pay. We’re in the process of collecting data to support this further, and again, the yield rates have been incredible, far surpassing what was initially targeted. That's why we're seeing pilots expand more broadly. So, in time, we expect to gain a bit of pricing power in some of these proactive monitoring programs that historically have just been billed against codes where the model is starting to evolve.

Our next question comes from David Saxon with Needham & Company. Please go ahead.

Great. Good afternoon. Thanks for taking my question. I wanted to ask on MCT. This is probably for Brice, but maybe Dan. It sounds like that can still launch in 2025, and maybe that can help you take share in the MCT market. But my understanding is that MCT as a product category is lower margin but higher dollars. So when that product does launch and ramps, how should we think about the impact on margins and dollar profitability? Will it be meaningfully different from what you're seeing with AT?

Yeah, it's a good question. I appreciate that. You are absolutely right. From a revenue perspective, it is a higher dollar-reimbursed product as it stands now. However, it is more, I would say, costly to service that product category. However, that was fully contemplated in the long-range plan as we designed it. We have efficiencies that we're working on from a gross margin perspective that is aimed not only to offset any ASP pressures over time but also to accommodate the shift into the MCT category. We talked about that low 70s gross margin over time being where we believe we're able to go. Obviously, that requires us to drive incremental efficiencies in and above that as we absorb some of the things that ultimately cause a bit of pressure, but we feel very good about the long-range plan we have presented to the investor community and we're still running to that level.

And our next question comes from Suraj Kalia with Oppenheimer. Please go ahead.

Good afternoon, everyone. Thanks for taking my question. Brice, it's been a pleasure working with you. Hope all is well on the family front. And Dan, congrats on the new seat. I echo this sentiment. So, gentlemen, a lot of questions have been asked. Quentin, I'll just throw a couple quickly your way. This policy change of Zio being a precursor to ILR, I'm curious, is that a trend toward more, I don't know if coordination is the right word, but the larger players with ILRs? How should we think about the relationship in the field? That is one question. And in terms of asymptomatic, the policy changes, you're working with some of the integrated delivery networks and so on. Should we consider a differential pricing system for asymptomatic versus symptomatic patients in the future?

Yes, great question, Suraj. Regarding coordination in the field around ILR and perhaps longer duration monitoring being a step-through into it, it'll be interesting to see how that plays out with respect to relationships in the field. We don't offer an ILR, so for us, we have one value proposition to physicians, which is our Zio product, and it doesn't compete against an ILR procedure. However, ILRs are quite expensive procedures for payers, and they're inclined to look for a cheaper alternative. I believe payers will continue to be interested in this space. Ultimately, how competitors with ILRs respond remains to be seen. The data is showing that 14 days of monitoring can deliver the insights needed without immediately resorting to ILR, so we will see how that plays out. Regarding pricing for asymptomatic versus symptomatic patients, it's currently too early to tell. We're diligently working to influence USPSTF to recommend proactive monitoring for asymptomatic patients, which remains a major hurdle. That said, continuing to work with commercial payers will influence the overall market and could lead to changes even before USPSTF makes a recommendation. The field is evolving, and we couldn't be more encouraged by the changes we are beginning to see.

Thank you. We have no further questions in the queue, so I'd like to turn the call back to management for any closing comments.

Well, thank you for joining us today. We couldn't be more pleased with the start of 2024, and we couldn't be more excited about the growing momentum in our business as we begin to explore opening new adjacencies like sleep or a continued expansion into the primary care channel. The second half of the year is set up to demonstrate significant financial leverage as we continue to progress towards becoming more operationally excellent as we grow. Additionally, we have multiple growth levers that remain in front of us which are yet to contribute to our success, including a new innovative Zio MCT solution, further entry into international markets, including the second largest ACM market in the world – Japan, and further expansion into primary care opportunities. So our future has never been brighter. We couldn't be more excited, and we look forward to talking to you again in the near future. With that, take care. Thank you.

This concludes today's call. Thank you for joining. You may now disconnect your line.