# iRhythm Holdings, Inc. (IRTC) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from iRhythm Holdings, Inc.'s 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1388658/000138865823000007/irtc-20221231.htm
Accession: 0001388658-23-000007
Filing date: 2023-02-23
Report date: 2022-12-31
Extracted from a substantive MD&A body after the formal Item 7 span was a TOC or reference stub.
Confidence: high

Company profile: /company/IRTC/
All MD&A years: /company/IRTC/mda/
Previous year: /company/IRTC/mda/fy2021/ (FY 2021)
Next year: /company/IRTC/mda/fy2023/ (FY 2023)

Overview

We are a leading digital healthcare company that creates trusted solutions that detect, predict, and prevent disease. Our principal business is the design, development, and commercialization of device-based technology to provide remote cardiac monitoring services that we believe allow clinicians to diagnose certain arrhythmias quicker and with greater efficiency than other services that rely on traditional technology.

Each Zio System combines FDA-cleared and CE-marked, wire-free, patch-based, 14-day wearable biosensor that continuously records ECG data with a proprietary cloud-based data analytic software to help physicians monitor patients and diagnose arrhythmias. Since receiving FDA clearance, we have provided the Zio Services to over five million patients and have collected over one billion hours of curated heartbeat data.

Since first receiving clearance from the FDA for our technology in 2009, we have supported physician and patient use of our technology and provided remote cardiac monitoring services from our Medicare-enrolled IDTFs and our qualified technicians. We have provided our Zio Services using our Zio Systems.

We receive revenue for the Zio Services primarily from third-party payors, which include contracted third-party payors and the CMS. The remainder of our revenue comes from healthcare institutions, which are typically hospitals or private physician practices, who purchase the Zio Services from us directly. We rely on third-party billing partners to submit patient claims and collect from commercial payors, certain government agencies, and patients.

The following are Zio Services shown as a percentage of revenue:

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2022","","2021","","2020"],["Contracted third-party payors","","55","%","","60","%","","51","%"],["Centers for Medicare and Medicaid","","25","%","","14","%","","27","%"],["Healthcare institutions","","14","%","","18","%","","16","%"],["Non-contracted third party payors","","6","%","","8","%","","6","%"]]
[[/GREPCENT_TABLE]]

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Key Business Metric

Non-GAAP Financial Measure

Adjusted EBITDA is a key measure we use to assess our financial performance and it is also used for internal planning and forecasting purposes. We believe Adjusted EBITDA is helpful to investors, analysts and other interested parties because it can assist in providing a more consistent and comparable overview of our operations across our historical financial periods. In addition, this measure is frequently used by analysts, investors and other interested parties to evaluate and assess performance.

We define Adjusted EBITDA for a particular period as net loss or income before interest, taxes, depreciation and amortization, interest expense and interest income and as further adjusted for stock-based compensation expense, impairment and restructuring charges and transformation costs.

Adjusted EBITDA is a non-GAAP financial measure and is presented for supplemental informational purposes only and should not be considered as an alternative or substitute to financial information presented in accordance with GAAP. This measure has certain limitations in that it does not include the impact of certain expenses that are reflected in our consolidated statements of operations that are necessary to run our business. Other companies, including other companies in our industry, may not use this measure or may calculate this measures differently than as presented in this Annual Report on Form 10-K, limiting their usefulness as a comparative measure.

The following table presents a reconciliation of net loss, the most directly comparable financial measure calculated in accordance with GAAP, to Adjusted EBITDA (in thousands):

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2022","","2021","","2020"],["Net loss","","$","(116,155)","","","$","(101,361)","","","$","(43,830)"],["Income tax provision","","269","","","367","","","229"],["Depreciation and amortization","","13,405","","","9,842","","","6,900"],["Interest expense","","4,138","","","1,169","","","1,519"],["Interest income","","(2,350)","","","(249)","","","(1,138)"],["Stock-based compensation","","57,740","","","54,527","","","41,515"],["Impairment and restructuring charges","","26,608","","","\u2014","","","\u2014"],["Transformation costs","","5,082","","","\u2014","","","\u2014"],["Adjusted EBITDA","","$","(11,263)","","","$","(35,705)","","","$","5,195"]]
[[/GREPCENT_TABLE]]

Macroeconomic Factors and the Effects of COVID-19

Our future results of operations and liquidity could be materially adversely affected by macroeconomic factors contributing to delays in payments of outstanding receivables, supply chain disruptions, including shortages and inflationary pressure, uncertain or reduced demand, and the impact of any initiatives or programs that we may undertake to address financial and operational challenges faced by our customers.

We have experienced business disruptions affecting the availability and cost of materials, which has impacted our supply chain and reduced margins, from the COVID-19 pandemic. In addition, we have continued to deliver our Zio Services by operating with remote employees and essential employees on site.

The current macroeconomic environment is impacting our customers, both financially and operationally. Hospitals are experiencing staffing shortages and supply chain issues that could affect their ability to provide patient care. Additionally, hospitals are facing significant financial pressure as supply chain constraints and inflation drive up operating costs, rising interest rates make access to credit more expensive, unrealized losses decrease available cash reserves, and fiscal stimulus programs enacted during the COVID-19 pandemic wind down. As a consequence of the financial pressures and decreased profitability, some hospitals have indicated that they are lowering their capital investment plans and tightening their operational budgets.

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We have adapted our Zio Services to meet the immediate needs of physicians, customers, and patients and significantly increased the utilization of our home enrollment service, which allows patients to receive and wear the single-use Zio patch without going to a healthcare facility.

In the first quarter of 2022, we re-opened our offices for use and certain groups of employees have begun returning to work in our offices across the United States. We continue to monitor developments regarding health pandemics or other health concerns, including COVID-19, and will implement any additional safety protocols that may become necessary in the future.

Our remote work arrangements subsequent decision to pursue a sublease for the 5th floor of our San Francisco headquarters caused us to recognize an impairment on our right of use asset and related leasehold improvements and furniture and fixtures and we believe we may incur additional impairment charges related to our real property lease agreements.

Revenue

The majority of our revenue is derived from provision of our Zio Services to customers in the United States. We earn revenue from the provision of our Zio Services primarily from contracted third-party payors, CMS and healthcare institutions. A small percentage of our revenue is from non-contracted third-party payors.

We recognize revenue on an accrual basis based on estimates of the amount that will ultimately be realized, which is the difference between the amount submitted for payment and the amount received. These estimates require significant judgment by management. In determining the amount to accrue for the Zio Services (including a delivered report), we consider factors such as claim payment history from both payors and patient, available reimbursement, including whether there is a contract between us and the payor or healthcare institution and historical amount received for the service, and any current developments or changes that could impact reimbursement and healthcare institution payments.

We typically experience reduced revenue during the third quarter, as well as during the year-end holiday season. We believe this is the result of physicians and patients taking vacations and patients electing to delay our monitoring services during the summer months or holidays. Revenue may be impacted by the outcome of adjudications with contracted and non-contracted payors, as well as changes in CMS reimbursement rates like we experienced with final rates being established for our Zio Services as of January 1, 2023. Clinical capacity limitations may also restrict our ability to complete the performance obligations to achieve revenue recognition.

Cost of Revenue and Gross Margin

Cost of revenue includes direct labor, material costs, equipment and infrastructure expenses, amortization of internal-use software, allocated overhead, and shipping and handling. Direct labor includes payroll-related costs including stock-based compensation involved in manufacturing, clinical data curation, and customer service. Material costs include both the disposable materials costs of the Zio patches and amortization of the re-usable printed circuit board assemblies (“PCBAs”). Each Zio XT patches includes a PCBA, and each Zio AT patch includes a PCBA and gateway board, the cost of which is amortized over the anticipated number of uses of the board. We expect cost of revenue to increase in absolute dollars as our revenue increases due to increased direct labor, direct materials, and variable spending, partially offset by economies of scale in relation to fixed costs such as overhead, depreciation and amortization, and facilities costs.

We calculate gross margin as gross profit divided by revenue. Our gross margin has been and will continue to be affected by a variety of factors, including increased contracting with third-party payors and institutional providers. We have in the past been able to increase our pricing as third-party payors become more familiar with the benefits of the Zio Services and move to contracted pricing arrangements. We expect to continue to decrease the cost of revenue per device by obtaining volume purchase discounts for our material costs, implementing scan-time algorithms and process improvements, automating manufacturing assembly and packaging, and through software-driven and other workflow enhancements to reduce labor costs. These decreases may be offset by increases to materials and electronics components pricing, labor rates, shipping rates, depreciation and amortization of investments, and increases in the general level of inflation.

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Research and Development Expenses

We expense research and development costs as they are incurred. Research and development expenses include payroll-related costs, including stock-based compensation, consulting services, clinical studies, laboratory supplies and allocated facility overhead costs. In addition, we expense milestone payments, when probable, for the development agreement with Verily. We expect our research and development costs to increase in absolute dollars as we hire additional personnel to develop new product and service offerings, product enhancements, and clinical evidence.

Selling, General and Administrative Expenses

Our sales and marketing expenses consist of payroll-related costs, including stock-based compensation, sales commissions, travel expenses, consulting, public relations costs, direct marketing, tradeshow and promotional expenses, and allocated facility overhead costs.

Our general and administrative expenses consist primarily of payroll-related costs for executive, finance, legal and administrative personnel, including stock-based compensation. Other significant expenses include professional fees for legal and accounting services, consulting fees, recruiting fees, bad debt expense, third-party patient claims processing fees, and travel expenses. In addition, we incurred transformation costs to scale our organization during the year and expect to incur additional transformation costs throughout 2023 with the restructuring activities to be substantially complete by mid-2024. Upon completion, we expect to achieve operational efficiencies in our administrative expenses.

Interest expense is attributable to borrowings under our loan agreements. See Note 9, Debt, in the Notes to our consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K (the “Consolidated Financial Statements”) for further information on our loan agreements.

Other Income (Expense), Net

Other income, net consists primarily of interest income which consists of interest received on our cash and cash equivalents and short-term investments and foreign exchange gain or loss from our UK subsidiary.

Results of Operations

The following table sets forth, for the years indicated, certain Consolidated Statements of Income information (in thousands, except percentages):

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2022","","% Revenue","","2021","","% Revenue","","2020","","% Revenue"],["","(dollars in thousands, except percentages)"],["Revenue","$","410,921","","","100","%","","$","322,825","","","100","%","","$","265,166","","","100","%"],["Cost of revenue","129,289","","","31","%","","109,258","","","34","%","","70,277","","","27","%"],["Gross profit","281,632","","","69","%","","213,567","","","66","%","","194,889","","","73","%"],["Operating expenses:"],["Research and development","46,610","","","11","%","","38,671","","","12","%","","41,329","","","16","%"],["Selling, general and administrative","322,198","","","78","%","","274,839","","","85","%","","197,233","","","74","%"],["Impairment and restructuring charges","26,608","","","6","%","","\u2014","","","\u2014","%","","\u2014","","","\u2014","%"],["Total operating expenses","395,416","","","96","%","","313,510","","","97","%","","238,562","","","90","%"],["Loss from operations","(113,784)","","","(28)","%","","(99,943)","","","(31)","%","","(43,673)","","","(16)","%"],["Interest expense","(4,138)","","","(1)","%","","(1,169)","","","\u2014","%","","(1,519)","","","(1)","%"],["Other income (expense), net","2,036","","","\u2014","%","","118","","","\u2014","%","","1,591","","","1","%"],["Loss before income taxes","(115,886)","","","(28)","%","","(100,994)","","","(31)","%","","(43,601)","","","(16)","%"],["Income tax provision","269","","","\u2014","%","","367","","","\u2014","%","","229","","","\u2014","%"],["Net loss","$","(116,155)","","","(28)","%","","$","(101,361)","","","(31)","%","","$","(43,830)","","","(17)","%"]]
[[/GREPCENT_TABLE]]

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Comparison of the Years Ended December 31, 2021, and 2020

For discussion related to the results of operations and changes in financial condition for fiscal 2021 compared to fiscal 2020 refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our 2021 Annual Report on Form 10-K, which was filed with the SEC on February 28, 2022.

Comparison of the Years Ended December 31, 2022, and 2021

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2022","","2021","","Change","","% Change"],["","(dollars in thousands, except percentages)"],["Revenue","$","410,921","","","$","322,825","","","$","88,096","","","27","%"],["Cost of revenue","129,289","","","109,258","","","20,031","","","18","%"],["Gross profit","281,632","","","213,567","","","68,065","","","32","%"],["Operating expenses:"],["Research and development","46,610","","","38,671","","","7,939","","","21","%"],["Selling, general and administrative","322,198","","","274,839","","","47,359","","","17","%"],["Impairment and restructuring charges","26,608","","","\u2014","","","26,608","","","100","%"],["Total operating expenses","395,416","","","313,510","","","81,906","","","26","%"],["Loss from operations","(113,784)","","","(99,943)","","","(13,841)","","","14","%"],["Interest expense","(4,138)","","","(1,169)","","","(2,969)","","","254","%"],["Other income (expense), net","2,036","","","118","","","1,918","","","1625","%"],["Loss before income taxes","(115,886)","","","(100,994)","","","(14,892)","","","15","%"],["Income tax provision","269","","","367","","","(98)","","","(27)","%"],["Net loss","$","(116,155)","","","$","(101,361)","","","$","(14,794)","","","15","%"]]
[[/GREPCENT_TABLE]]

Revenue

Revenue increased $88.1 million, or 27%, to $410.9 million during the year ended December 31, 2022 from $322.8 million during the year ended December 31, 2021. The increase in revenue was primarily attributable to the increase in volume of the Zio Services provided as a result of increased demand and improved CMS reimbursement rates, partially offset by an increase in contractual allowance with contracted and non-contracted payors.

Cost of Revenue and Gross Margin

Cost of revenue increased $20.0 million, or 18%, to $129.3 million during the year ended December 31, 2022 from $109.3 million during the year ended December 31, 2021. The increase in cost of revenue was primarily due to higher volume of Services provided, higher material and freight costs, and an increase in amortization for capitalized internal-use software.

Gross margin for the year ended December 31, 2022 increased to 69%, compared to 66% for the year ended December 31, 2021. The increase in gross margin was primarily due to higher per unit average selling prices and lower fixed costs per unit driven by higher unit volumes, partially offset by higher material and freight costs.

Research and Development Expenses

Research and development expenses increased $7.9 million, or 21%, to $46.6 million during the year ended December 31, 2022 from $38.7 million during the year ended December 31, 2021. The increase was primarily attributable to an increase of $13.6 million in payroll-related costs, including stock-based compensation, an increase of $1.8 million in consulting fees, partially offset by an increase of $6.8 million in costs capitalized for internal-use software and a decrease of $3.0 million from a milestone payment pursuant to the Development Agreement with Verily incurred during the year ended December 31, 2021 and none incurred during the year ended December 31, 2022.

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Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $47.4 million, or 17%, to $322.2 million during the year ended December 31, 2022 from $274.8 million during the year ended December 31, 2021. The increase was primarily attributable to an increase of $16.7 million in professional service fees, an increase of $13.6 million in payroll related costs, including employee stock-based compensation as a result of increased headcount and executive hires to support the growth in our operations, an increase of $7.6 million of bad debt expense related to revenue growth.$7.5 million of travel, and general office expenses and an increase of $1.8 million related to software and hardware costs.

Impairment and Restructuring Charges

In February 2022, our board of directors (the “Board”) approved reducing our leased space for our headquarters in San Francisco, California. As a result, we recognized an impairment of our right-of-use ("ROU") asset and related leasehold improvements and furniture and fixtures in the amount of $23.2 million during the year ended December 31, 2022. Also in February 2022, the Board approved a restructuring plan to allow the Company to effectively and efficiently scale its business, which resulted in severance and other employment related costs of $3.4 million during the year ended December 31, 2022.

Interest expense and other income (expense), net

Interest expense increased by $3.0 million to $4.1 million during the year ended December 31, 2022 from $1.2 million during the year ended December 31, 2021 due to the additional financing fees of $1.75 million related to the payment of the original loans as well as higher interest expense from the higher term loans balance in 2022 and due to higher interest rates.

Other income (expense), net increased by $1.9 million to $2.0 million for the year ended December 31, 2022, compared to $0.1 million for the year ended December 31, 2021. The increase is primarily due to higher interest earned because of rising interest rates from our cash and cash equivalents and short-term investments during the year ended December 31, 2022.

Liquidity and Capital Expenditures

Overview

As of December 31, 2022, we had cash and cash equivalents of $78.8 million, short-term investments of $134.3 million, and accounts receivable of $49.9 million. In addition, we have term loans facility of $40.0 million and a revolving credit line of $25.0 million available. We are continuously reviewing our liquidity and anticipated capital requirements in light of the significant uncertainty created by the current macroeconomic environment, including inflation and rising interest rates, and the COVID-19 global pandemic. We believe that our current cash, cash equivalents, short-term investment balances, and term loans facility, together with income to be derived from the sales of our Zio Services, will be sufficient to meet our liquidity requirements for the foreseeable future.

Our expected future capital requirements may depend on many factors, including the expansion of our customer base, the expansion of our sales force, and the timing and extent of spending on the development of our technology to increase our service offerings. We expect the next Verily milestone payment of $1.75 million to be due in 2023.

The following table summarizes our cash flows for the years indicated (in thousands):

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2022","","2021","","2020"],["Net cash (used in) provided by:"],["Operating activities","$","(23,012)","","","$","(37,753)","","","$","(13,759)"],["Investing activities","(52,434)","","","105,264","","","(132,391)"],["Financing activities","26,716","","","(28,577)","","","214,316"],["Net (decrease) increase in cash and cash equivalents","$","(48,730)","","","$","38,934","","","$","68,166"]]
[[/GREPCENT_TABLE]]

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Operating Activities

During the year ended December 31, 2022, cash used in operating activities was $23.0 million and consisted of a net loss of $116.2 million, adjusted by non-cash charges of $158.7 million and a net change of $65.5 million in our net operating assets and liabilities. The non-cash charges are primarily comprised of stock-based compensation expense of $57.7 million, a change in allowance for doubtful accounts and contractual allowance of $58.3 million, depreciation and amortization expense of $13.4 million and amortization of ROU assets of $6.2 million. The change in our net operating assets and liabilities was primarily due to an increase of $61.8 million in accounts receivable, an increase of $5.1 million in inventory, and a decrease in accounts payable of $3.0 million, partially offset by an increase in accrued liabilities of $14.5 million due to increased compensation and benefit accruals as a result of increased head count.

During the year ended December 31, 2021, cash used in operating activities was $37.8 million and consisted of a net loss of $101.4 million, adjusted by non-cash charges of $109.8 million and a net change of $46.2 million in our net operating assets and liabilities. The non-cash charges are primarily comprised of stock-based compensation expense of $54.5 million, a change in allowance for doubtful accounts and contractual allowance of $37.1 million, depreciation and amortization expense of $9.8 million, and amortization of ROU assets of $6.8 million. The change in our net operating assets and liabilities was primarily due to an increase of $53.6 million in accounts receivable, an increase of $5.0 million in inventory and an increase of $4.1 million in prepaid assets and other assets, partially offset by a decrease of $7.9 million in accrued liabilities and a decrease of $6.1 million in accounts payable.

Investing Activities

During the year ended December 31, 2022, cash used in investing activities was $52.4 million, and consisted primarily of $188.6 million in purchases of short-term investments and $29.8 million of capital expenditures to purchase property and equipment, partially offset by $166.0 million received from the sale and maturities of short-term investments.

During the year ended December 31, 2021, cash provided by investing activities was $105.3 million, which consisted primarily of $255.5 million in maturities of short-term investments, partially offset by $122.2 million in purchases of short-term investments and $28.1 million of capital expenditures to purchase property and equipment.

Financing Activities

During the year ended December 31, 2022, cash provided by financing activities was $26.7 million, primarily due to $35.0 million proceeds of a term loans and $13.2 million in proceeds from the issuance of common stock in connection with employee option exercises and our Employee Stock Purchase Plan, partially offset by a $21.4 million repayment of a long-term debt.

During the year ended December 31, 2021, cash used in financing activities was $28.6 million, primarily due to $25.9 million in tax withholding upon the vesting of restricted stock units (“RSUs”) and $11.7 million in repayment of long-term debt, partially offset by $8.9 million in proceeds from the issuance of common stock in connection with employee option exercises and our Employee Stock Purchase Plan.

Indebtedness

Bank Debt

In October 2018, we entered into the Third Amended and Restated Loan and Security Agreement with SVB. Under the SVB Loan Agreement, we had borrowed $35.0 million and had made repayments through March 2022, at which time the outstanding balance was $18.5 million.

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On March 28, 2022, we entered into a Second Amendment (the “2022 Amendment”) to our SVB Loan Agreement which provided for a term loans facility in the aggregate principal amount of up to $75.0 million (the “2022 Term Loans”), of which $35.0 million was borrowed at closing and a portion of the proceeds was used to pay in full the outstanding balance of $18.5 million under the SVB Loan Agreement. The remaining $40.0 million of 2022 Term Loans may be borrowed from time to time at our option, in increments of at least $10.0 million, through December 31, 2023. We will pay interest only on the 2022 Term Loans until April 1, 2025, when we will commence repaying the 2022 Term Loans in 24 equal consecutive monthly installments, with all obligations under the 2022 Term Loans maturing on March 1, 2027. Interest charged on the 2022 Term Loans will accrue at a floating per annum rate equal to the greater of: (A) the Prime Rate plus 0.25%; and (B) 3.50%. We are also required to pay fees on any prepayment of the 2022 Term Loans, ranging from 3.0% to 1.0% depending on the date of prepayment, and a final payment equal to 5.0% of the principal amount of the 2022 Term Loans drawn. Once repaid or prepaid, the 2022 Term Loans may not be reborrowed.

The 2022 Amendment also amended the terms of the revolving credit line under the SVB Loan Agreement, which provided for an aggregate principal amount of $25.0 million, to: (i) extend the maturity date from August 1, 2023 to March 1, 2027, (ii) increase the letters of credit sublimit to $15.0 million and (iii) increase the cash management services sublimit to $15.0 million. Interest charged on the principal amount outstanding under the revolving credit line will accrue at a floating per annum rate equal to the greater of (A) the Prime Rate plus 0.25% and (B) 3.50%. We are required to pay an annual fee equal to 0.15% of the revolving credit line. As of December 31, 2022, no loans were outstanding under the revolving credit line.

The 2022 Amendment also amended the SVB Loan Agreement to require us to comply, as of the last day of each fiscal quarter, with a quick ratio of at least 1.15 to 1.0 or minimum adjusted EBITDA trailing six months of at least $15.0 million We were in compliance with its loan covenants as of December 31, 2022.

Critical Accounting Policies and Estimates

Our Consolidated Financial Statements are prepared in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”), which requires us to make judgments, estimates, and assumptions. See Note 2, Summary of Significant Accounting Policies, in the Notes to the Consolidated Financial Statements, which describes our significant accounting policies and methods used in the preparation of our Consolidated Financial Statements. The methods, estimates, and judgments that we use in applying our accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates regarding matters that are inherently uncertain. Our most critical accounting estimates include:

•Revenue recognition;

•Assessment of collectability of accounts receivable which results in uncollectible allowance for doubtful accounts and contractual allowances;

•How many times a PCBA can be used for testing in research and development, loss rates, product obsolescence, and the amount of time it takes the device to go through the manufacturing, shipping, customer shelf, and patient wear time and upload process;

•Stock-based compensation; and

•Lease impairment.

Revenue Recognition

We have developed a proprietary system that combines an FDA-cleared and CE-marked wire-free, patch-based, 14-day wearable biosensor that continuously records ECG data, with a proprietary cloud-based data analytic platform to help physicians monitor patients and diagnose arrhythmias. We currently offer three Zio System options—the Zio XT System, the Zio AT System, and the Zio Monitor System.

The Zio XT System is a prescription-only, remote ECG monitoring system that consists of the Zio XT patch that records the electric signal from the heart continuously for up to 14 days and the ZEUS System, which supports the capture and analysis of ECG data recorded by the Zio XT patch at the end of the wear period, including specific arrhythmia events detected by the ZEUS algorithm. The final step in the Zio Services is the delivery of an electronic Zio report to the prescribing physician with a summary of findings. Our Zio XT services are generally billable when the Zio report is issued to the physician.

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The Zio Monitor System is the next generation of the Zio XT System, and is a prescription-only, remote ECG monitoring system that consists of the Zio Monitor patch that records the electric signal from the heart continuously for up to 14 days and the ZEUS System, which supports the capture and analysis of ECG data recorded by the Zio Monitor patch at the end of the wear period, including specific arrhythmia events detected by the ZEUS algorithm.

The Zio AT System is a prescription-only, remote ECG monitoring system that similarly consists of the Zio AT patch that records the electric signal from the heart continuously for up to 14 days and the ZEUS System, but which also incorporates the Zio AT wireless gateway that provides connectivity between the patch and the ZEUS System during the patient wear period. The wireless gateway, slightly larger than a smart phone, is provided to the patient at the time of Zio AT patch application and collects and transmits data from the Zio AT patch to the cloud via a LTE protocol. The Zio AT service revenue is recognized over the patient wear period and delivery of electronic Zio reports with two performance obligations.

We account for contract revenue with a customer when there is a legally enforceable contract between us and the customer, the rights of the parties are identified, the contract has commercial substance, and collectability of the contract consideration is probable. Our revenue is measured based on consideration specified in the contract with each customer. A unique aspect of healthcare is the involvement of multiple parties to the service transaction. In addition to the patient, often a third-party, for example a commercial or governmental payor or healthcare institution, like a hospital or clinic, will pay us for some or all of the service on the patient’s behalf. Separate contractual arrangements exist between us and many third-party payors that establish amounts the third-party payor will pay on behalf of a patient for covered services rendered and should be considered in determining collectability and the transaction price for services provided to a patient covered by that third-party payor.

We recognize revenue on an accrual basis based on estimates of the amount that will ultimately be realized, which is the difference between the amount submitted for payment and the amount received. Revenue recognition is subject to uncertainty because these estimates require significant judgment by management. In determining the amount to accrue for a delivered Zio report, we consider factors such as claim payment history from both payors and patient out-of-pocket costs, payor coverage, whether there is a contract between the payor or healthcare institution and us, historical amount received for the service, and any current developments or changes that could impact reimbursement and healthcare institution payments.

A summary of the payment arrangements with third-party payors and healthcare institutions is as follows:

•Contracted third-party payors – We have contracts with negotiated prices for services provided for patients with commercial healthcare insurance carriers.

•Centers for Medicare and Medicaid Services – We have received IDTF approval from regional Medicare Administrative Contractors and will receive reimbursement per the relevant CPT code rate for the services rendered to the patient covered by CMS.

•Healthcare institutions – Healthcare institutions are typically hospitals or physician practices in which we have negotiated amounts for our monitoring services, including certain governmental agencies such as the Veteran’s Administration and Department of Defense.

•Non-contracted third-party payors – Non-contracted commercial and government payors often reimburse out-of-network rates provided under the relevant CPT codes on a case-by-case basis. The transaction price used for determining revenue recognition is based on factors including an average of our historical collection experience for our non-contracted services. This rate is reviewed at least quarterly.

We are utilizing the portfolio approach practical expedient under Accounting Standard Codification (“ASC”) 606, Revenue from Contracts with Customers. We account for the contracts within each portfolio as a collective group, rather than individual contracts. Based on history with these portfolios and the similar nature and characteristics of the patients within each portfolio, we have concluded that the financial statement effects are not materially different than if accounting for revenue on a contract-by-contract basis.

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For contracted and CMS portfolios, we are providing an implicit price concession because, while we have a contract with the underlying payor, we expect to accept a lower amount of consideration when claims are adjudicated and allowable claims are determined by the commercial payor. The implicit price concession is recorded as variable consideration to the transaction price and recorded as an adjustment to revenue as a contractual allowance. Historical cash collection indicates that it is probable that substantially all of the contracted claim amount will be received. We provide for estimates of uncollectible patient accounts receivable, based upon historical experience, at the time revenue is recognized, with such provisions presented as bad debt expense within the selling, general and administrative line item of the consolidated statement of operations. Adjustments to these estimates for actual experience are also recorded as an adjustment to bad debt expense.

For the healthcare institutions, we have historical experience of collecting substantially all of the negotiated contractual rates and determined at contract inception that these customers, and or their related third-party payor that pays us on their behalf, have the intention and ability to pay the promised consideration. As such, we have not provided an implicit price concession but, rather, have chosen to accept the risk of default, and adjustments to the transaction price are recorded as bad debt expense.

For non-contracted portfolios, we are providing an implicit price concession because we do not have a contract with the underlying payor, the result of which requires us to estimate transaction price based on historical cash collections utilizing the expected value method. Subsequent adjustments to the transaction price are recorded as an adjustment to revenue and not as bad debt expense.

Accounts Receivable, Allowance for Doubtful Accounts and Contractual Allowances

Accounts receivable includes amounts due to us from healthcare institutions, third-party payors, and government payors and our related patients as a result of our normal business activities. Accounts receivable is reported on the consolidated balance sheets net of an estimated allowance for doubtful accounts and contractual allowances.

We establish an allowance for doubtful accounts for estimated uncollectible receivables based on our assessment of the collectability of customer accounts and recognize the provision as a component of selling, general and administrative expenses. We record a provision for contractual allowances based on the estimated differences between contracted amounts and expected collection rates. Such provisions are based on our historical experience and are reported as a reduction of revenue.

We regularly review the allowances by considering factors such as historical experience, credit quality, the age of the accounts receivable balances, and current economic conditions that may affect a customer’s ability to pay.

PCBA Valuation

We use PCBAs in each wearable Zio AT patch, Zio XT patch and the Zio Monitor, as well as the wireless gateway used in conjunction with the Zio AT patch. The PCBAs are used numerous times and have useful lives beyond one year. Each time a PCBA is used in a wearable Zio AT patch, the Zio XT patch, or the Zio Monitor or a wireless gateway is used with a Zio AT patch a portion of the cost of the PCBA and/or gateway is recorded as a cost of revenue. We have based our estimate of how many times a PCBA can be used in testing in research and development, loss rates, product obsolescence, and the amount of time it takes the device to go through the manufacturing, shipping, customer shelf, and patient wear time and upload process. We periodically evaluate the use of these estimates. The fair value of our PCBAs is included in Other Assets on the Consolidated Balance Sheets.

Stock-Based Compensation

We measure the estimated fair values of our restricted stock units based on the closing price of our stock on the grant date. For performance-based restricted stock units, we estimate the fair value based on the closing price of our stock on the grant date and, if the award includes a market condition, a Monte Carlo simulation model. In addition, for performance-based restricted stock units, we apply a probability assessment to determine the probable achievement of the performance-based metrics.

Stock-based compensation expense is recognized over the requisite service period using the straight-line method and is based on the value of the portion of stock-based payment awards that is ultimately expected to vest. As such, our stock-based compensation is reduced for the estimated forfeitures at the date of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. For restricted stock, the compensation cost for these awards is based on the closing price of the Company’s common stock on the date of grant, and recognized as compensation expense on a straight-line basis over the requisite service period.

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We recognize compensation expense related to the Employee Stock Purchase Plan based on the estimated fair value of the options on the date of grant, net of estimated forfeitures. We estimate the grant date fair value, and the resulting stock-based compensation expense, using the Black-Scholes option pricing model for each purchase period. The grant date fair value is expensed on a straight-line basis over the offering period.

Lease Impairment

We account for the impairment of long-lived assets in accordance with ASC 360, Impairment or Disposal of Long-Lived Assets. An impairment loss is recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying value. If an asset is determined to be impaired, the impairment is measured by the amount that the carrying value of the asset exceeds its fair value.

We estimated undiscounted future cash flows from our vacant office lease based on our intent and ability to sub-lease the vacant office space which we had ceased using and estimated future sub-lease income considering the local real estate market conditions. We also factored into the estimate the amount of time to identify a tenant and to enter into an agreement. We estimated the fair value of the ROU asset related to the vacant office lease by discounting the estimated undiscounted future cash flows using the average lease capitalization rate, plus average inflation rate, for other lease transactions in the local area during the year.

Material Cash Requirements

Our material cash requirements include the following contractual and other obligations.

•Purchase commitments - From time to time in the ordinary course of business, we enter into a variety of purchase arrangements including but not limited to, purchase arrangements related to components used in manufacturing our products. See Note 8, Commitments and Contingencies, to the Consolidated Financial Statements for more information.

•Operating leases - We lease our facilities under non-cancelable operating leases. See Note 8, Commitments and Contingencies, to the Consolidated Financial Statements for more information.

•Debt interest and principal payments - On March 28, 2022, we entered into the 2022 Amendment to our SVB Loan Agreement which provided for a term loans facility in the aggregate principal amount of up to $75.0 million, of which $35.0 million was borrowed at closing. See Note 9, Debt, to the Consolidated Financial Statements for more information.

Recent Accounting Guidance

For a description of recently issued accounting guidance that is applicable to our financial statements, see Note 2 Significant Accounting Policies, to the Consolidated Financial Statements.