iRhythm Holdings, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS You should read the following discussion and analysis of our financial condition and results of operations together with the unaudited financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q. This discussion and other parts of this Quarterly Report on Form 10-Q contain forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section of this Quarterly Report on Form 10-Q entitled “Risk Factors". Overview We are a digital healthcare company redefining the way cardiac arrhythmias are clinically diagnosed by combining our wearable biosensing technology with cloud-based data analytics and deep-learning capabilities. Our goal is to be the leading provider of ambulatory electrocardiogram (“ECG”) monitoring for patients at risk for arrhythmias. We have created a full portfolio of ambulatory cardiac monitoring services on a unique platform, called the Zio service, which combines an easy-to-wear and unobtrusive biosensor that can be worn for up to 14 consecutive days with powerful proprietary algorithms that distill data from millions of heartbeats into clinically actionable information. The Zio service consists of: • wearable patch-based biosensors, Zio XT and Zio AT monitors, which continuously record and store ECG data from every patient heartbeat for up to 14 consecutive days; Zio AT offers the option of timely transmission of data during the prescribed wear period; • cloud-based analysis of the recorded cardiac rhythms using our proprietary, deep-learned algorithms; • a final quality assessment review of the data by our certified cardiographic technicians; and • an easy-to-read Zio report, a curated summary of findings that includes high quality and clinically-actionable information which is sent directly to a patient’s physician through ZioSuite and can be integrated into a patient’s electronic health record. We receive revenue for the Zio service primarily from third-party payors, which include commercial payors and government agencies, such as CMS, Veterans Administration, and the military. In addition, a small percentage of institutions, which are typically hospitals or private physician practices, purchase the Zio service from us directly. Our revenue in the third-party commercial payor category is primarily contracted, which means we have entered into pricing contracts with these payors. Third-party contracted payors accounted for approximately 51% and 47% of our revenue for the nine months ended September 30, 2020 and 2019, respectively. Approximately, 27% of our total revenue for each of the nine months ended September 30, 2020 and 2019, is received from Centers for Medicare and Medicaid Services ("CMS"), which is under established reimbursement codes. Healthcare institutions, which are typically hospitals or private physician practices accounted for approximately 16% and 20% of our revenue for the nine months ended September 30, 2020 and 2019, respectively. Non-contracted third party payors and self-pay accounted for 6% and 5% of our total revenue for the nine months ended September 30, 2020 and September 30, 2019, respectively. We rely on a third-party billing partner, XIFIN, Inc., to submit patient claims and collect from commercial payors, certain government agencies, and patients. Since our Zio service was cleared by the U.S. Food and Drug Administration (“FDA”), we have provided the Zio service to over two million patients and have collected over 600 million hours of curated heartbeat data. We believe the Zio service is well-positioned to disrupt an already-established $1.8 billion U.S. ambulatory cardiac monitoring market by offering a user-friendly device to patients, actionable information to physicians and value to payors. We market our ambulatory cardiac monitoring solution in the United States through a direct sales organization comprised of sales management, field billing specialists, quota-carrying sales representatives, and a customer service team. Our sales representatives focus on initial introduction into new customers, penetration across a sales region, driving adoption within existing accounts and conveying our message of clinical and economic value to service line managers and hospital administrators and other clinical departments. In addition, we will continue exploring sales and marketing expansion opportunities in international geographies. COVID-19 Impact We cannot currently predict the extent or duration of the ongoing impact to our financial results and have suspended forward-looking guidance. Although we cannot currently predict the extent or duration of the COVID-19 related impact to our financial results, we expect the impact of COVID-19 to be more significant in the near-term. 24 Beginning in mid-March 2020, we experienced decreasing levels in the Zio service patient registrations which impacted our revenues for the three and nine months ended September 30, 2020. This decrease in revenue is due to a variety of challenges associated with the COVID-19 pandemic in the United States, including, among others: • reduction in physician prescriptions for our Zio service due to: ◦ directives from the Centers for Disease Control and Prevention, CMS, various medical societies and other entities that suggested cancelling or deferring elective, non-essential procedures; ◦ a reduction in diagnostic testing outside of those tests related to severe respiratory distress; ◦ closure or reduction in the hours of most physicians’ offices; ◦ physicians and hospitals prioritizing the treatment of critically ill patients; and ◦ patient reluctance to visit physicians or hospitals for fear of contracting COVID-19; • cancellation and reduction of physician attendance at professional medical society meetings and trade shows and our decision not to attend them; • travel restrictions and changing hospital policies that have limited access of our sales professionals to hospitals where the Zio services are prescribed and where patients have historically been enrolled; • delays in receiving Zio XT back from patients with some patients not returning the device at all; and • patients who have lost jobs, been furloughed, have reduced work hours or are worried about the continuation of medical insurance being unable to afford the Zio service. During the third quarter of fiscal year 2020, we saw recovery of patient registrations for the Zio service to pre-COVID levels of the first quarter of 2020. However, it is expected that the challenges of the COVID-19 pandemic will potentially impact the number of patients who register for the Zio service for some period of time depending on the rate at which the number of COVID-19 cases increases or declines and the economy recovers. We are taking a variety of measures to promote the safety and security of our employees and customers. Our response to COVID-19 is focused on: • Protecting and supporting the health and well-being of our employees, our communities and our customers by limiting the transmission of COVID-19. Following recommendations from federal and local government and healthcare agencies, we transitioned employees to a remote work environment beginning in early March 2020. For a small number of our employees who continue to support essential operations at our facilities, we have instituted social distancing and other measures to ensure the safety of our employees. We rapidly implemented business continuity protocols and have been able to transition to a remote operating environment while continuing to deliver our Zio service. We will continue to follow local and national guidelines to determine the appropriate time to resume in-office functions. • Delivering uninterrupted patient care for both Zio XT and Zio AT and supporting efforts to monitor COVID-19 patients. While hospital systems and healthcare facilities shift their focus and resources to treating COVID-19 patients and combating the spread of COVID-19, we have adapted our service to meet the immediate needs of our physician customers and patients. Our digital service platform enables physician ordering, results reporting, data curation and patient support independent of location, across virtual or in-office care models. As an example, we have significantly increased the utilization of our “Home Enrollment” service. This service allows patients to receive and wear the single-use Zio monitor without going to a healthcare facility. Physicians can prescribe the Zio service for their patients, either in-office or through a virtual care setting, and we ship the Zio monitor directly to the patient’s residence. We pay for the costs of shipping the Zio monitor, which represents additional expense for us. We also guide patients through the patch application process and inform them of instructions for wear. Home enrollment also eliminates clinical staff exposure to patients, as well as application, cleaning or reusing traditional Holter and event monitors that may have been exposed to viruses or other pathogens. In addition, health systems with acute needs to facilitate a reduction in healthcare provider contact or for additional monitoring capacity can deploy Zio AT for in-patient monitoring. The 25 FDA informed us that Zio AT usage for this application is consistent with the FDA COVID-19 Remote Monitoring guidance. • Adjusting our operating plan as appropriate to ensure continued financial strength. We continue to maintain a strong cash position and have taken initiatives to adjust our operating plan to ensure we maintain appropriate liquidity during these uncertain times. We have proactively taken steps to reduce spend, including eliminating or delaying project spend for non-essential programs, and reducing spend on travel and consulting. In addition, we raised $206.8 million in proceeds from a follow-on public offering in August 2020 to fund growth initiatives and for working capital and other general corporate purposes Components of Results of Operations Revenue Substantially all of our revenue is derived from sales of our Zio service in the United States. We earn revenue from the provision of our Zio service primarily from contracted third-party payors, CMS, and healthcare institutions. In addition, a small percentage of institutions, which are typically hospitals or private physician practices, purchase the Zio service from us directly, and a very small percentage of commercial non-contracted 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 a delivered report, and Zio service provided, 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 the Company, historical amount received for the service, and any current developments or changes that could impact reimbursement and healthcare institution payments. We are subject to seasonality similar to other companies in our field, as vacations by physicians and patients tend to affect enrollment in the Zio service more during the summer months and during the end of calendar year holidays compared to other times of the year. 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 and personnel-related costs including stock-based compensation involved in manufacturing, data analysis, and customer service. Material costs include both the disposable materials costs of the Zio monitors and amortization of the re-usable printed circuit board assemblies (“PCBAs”). Each Zio XT monitor includes a PCBA, and each Zio AT monitor 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 to the extent our revenue grows. 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 service and move to contracted pricing arrangements. We expect to continue to decrease the cost of service per device by obtaining volume purchase discounts for our material costs and implementing scan-time algorithm improvements and software-driven and other workflow enhancements to reduce labor costs. Gross margin for the nine months ended September 30, 2020 was negatively impacted due to the COVID-19 pandemic and absorption of fixed costs. We expect this impact to continue in the near term. Research and Development Expenses We expense research and development costs as they are incurred. Research and development expenses include payroll and personnel-related costs, including stock-based compensation, consulting services, clinical studies, laboratory supplies and allocated facility overhead costs. We expect our research and development costs to increase in absolute dollars as we hire additional personnel to develop new product and service offerings and product enhancements. 26 Selling, General and Administrative Expenses Our sales and marketing expenses consist of payroll and personnel-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 and personnel-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. Interest Expense Interest expense is attributable to borrowings under our loan agreements. Refer to Note 7. Debt , for further information on our loan agreements. Other Income, Net Other income, net consists primarily of interest income which consists of interest received on our cash, cash equivalents and investments balances. Results of Operations Comparison of the Three Months Ended September 30, 2020 and 2019 Three Months Ended September 30, 2020 2019 $ Change % Change Revenue $ 71,944 $ 54,673 $ 17,271 32 % Cost of revenue 18,232 13,785 4,447 32 % Gross profit 53,712 40,888 12,824 31 % Gross margin 75 % 75 % Operating expenses: Research and development 8,768 13,499 (4,731) (35) % Selling, general and administrative 49,701 45,649 4,052 9 % Total operating expenses 58,469 59,148 (679) (1) % Loss from operations (4,757) (18,260) 13,503 (74) % Interest expense (384) (409) 25 (6) % Other income, net 569 396 173 44 % Loss before income taxes (4,572) (18,273) 13,701 (75) % Income tax provision 105 20 85 425 % Net loss $ (4,677) $ (18,293) $ 13,616 (74) % Revenue Revenue increased $17.3 million, or 32%, to $71.9 million during the three months ended September 30, 2020 from $54.7 million during the three months ended September 30, 2019. The increase in revenue was primarily attributable to the increase in volume of the Zio services as a result of increased in demand from our customers. Cost of Revenue and Gross Margin Cost of revenue increased $4.4 million, or 32%, to $18.2 million during the three months ended September 30, 2020 from $13.8 million during the three months ended September 30, 2019. The increase in cost of revenue was primarily due to increased Zio service volume as well as costs incurred to support a larger cost structure in 2020. Gross margin for the three months ended September 30, 2020 was 75%, compared to 75% for the three months ended September 30, 2019. 27 Research and Development Expenses Research and development expenses decreased $4.7 million, or 35%, to $8.8 million during the three months ended September 30, 2020 from $13.5 million during the three months ended September 30, 2019. The decrease was primarily attributable to a $5.0 million decrease related to the Verily milestone achievement in the third quarter of 2019 and a $1.3 million reduction of expense due to an increase in costs capitalized to internal use software, partially offset by a $2.0 million increase of employee related costs due to increased headcount and stock-based compensation. Selling, General and Administrative Expenses Selling, general and administrative expenses increased $4.1 million, or 9%, to $49.7 million during the three months ended September 30, 2020 from $45.6 million during the three months ended September 30, 2019. The increase was primarily attributable to a $12.3 million increase in payroll and stock-based compensation as a result of increased headcount, partially offset by a $2.6 million reduction in travel expenses, $2.4 million reduction in temporary consultants, and $0.8 million decrease in bad debt expense. Interest Expense Interest expense was $0.4 million for the three months ended September 30, 2020, compared to $0.4 million for the three months ended September 30, 2019. There were no significant changes in interest expense during the three months ended September 30, 2020 compared with the three months ended September 30, 2019. Other Income, Net Other income, net was $0.6 million for the three months ended September 30, 2020, compared to $0.4 million for the three months ended September 30, 2019. There were no significant changes in other income, net during the three months ended September 30, 2020 compared with the three months ended September 30, 2019. Results of Operations Comparison of the Nine Months Ended September 30, 2020 and 2019 Nine Months Ended September 30, 2020 2019 $ Change % Change Revenue $ 186,357 $ 155,448 $ 30,909 20 % Cost of revenue 49,779 38,570 11,209 29 % Gross profit 136,578 116,878 19,700 17 % Gross margin 73 % 75 % Operating expenses: Research and development 29,725 28,031 1,694 6 % Selling, general and administrative 140,945 125,876 15,069 12 % Total operating expenses 170,670 153,907 16,763 11 % Loss from operations (34,092) (37,029) 2,937 (8) % Interest expense (1,145) (1,258) 113 (9) % Other income, net 1,311 1,066 245 23 % Loss before income taxes (33,926) (37,221) 3,295 (9) % Income tax provision 253 47 206 438 % Net loss $ (34,179) $ (37,268) $ 3,089 (8) % 28 Revenue Revenue increased $30.9 million, or 20%, to $186.4 million during the nine months ended September 30, 2020 from $155.4 million during the nine months ended September 30, 2019. The increase in revenue was primarily attributable to the increase in volume of the Zio services as a result of increased in demand from our customers. Cost of Revenue and Gross Margin Cost of revenue increased $11.2 million, or 29%, to $49.8 million during the nine months ended September 30, 2020 from $38.6 million during the nine months ended September 30, 2019. The increase in cost of revenue was primarily due to increased Zio service volume and costs incurred to support a larger cost structure in 2020. Gross margin for the nine months ended September 30, 2020 decreased to 73%, compared to 75% for the nine months ended September 30, 2019. The decrease in gross margin was primarily driven by product mix, as well as fixed costs that we continue to incur, partially offset by increased volume. Research and Development Expenses Research and development expenses increased $1.7 million, or 6%, to $29.7 million during the nine months ended September 30, 2020 from $28.0 million during the nine months ended September 30, 2019. The increase was primarily attributable to a $5.5 million increase in employee related costs and stock-based compensation as a result of increased headcount, partially offset by a $3.1 million reduction of expense due to an increase in costs capitalized to internal use software and $2.0 million decrease related to the Verily milestone achievement in the third quarter of 2020. Selling, General and Administrative Expenses Selling, general and administrative expenses increased $15.1 million, or 12%, to $140.9 million during the nine months ended September 30, 2020 from $125.9 million during the nine months ended September 30, 2019. The increase was primarily attributable to a $16.8 million increase in payroll and stock-based compensation as a result of increased headcount, a $2.8 million in rent expense due to expansion of the San Francisco headquarters and increased facility related costs, partially offset by decrease of $5.2 million in travel and related expenses as a result of the COVID-19 pandemic. Interest Expense Interest expense was $1.1 million for the nine months ended September 30, 2020, compared to $1.3 million for the nine months ended September 30, 2019. There were no significant changes in interest expense during the nine months ended September 30, 2020 compared with the nine months ended September 30, 2019. Other Income, Net Other income, net was $1.3 million for the nine months ended September 30, 2020, compared to $1.1 million for the nine months ended September 30, 2019. There were no significant changes in other income, net during the nine months ended September 30, 2020 compared with the nine months ended September 30, 2019. Liquidity and Capital Expenditures Overview We are continuously reviewing our liquidity and anticipated capital requirements in light of the significant uncertainty created by the COVID-19 global pandemic. We believe we will have adequate liquidity over the next twelve months to operate our business and to meet our cash requirements. As of September 30, 2020, we had cash and cash equivalents of $95.3 million, short-term investments of $231.9 million, and an accumulated deficit of $295.0 million. Our expected future capital requirements may depend on many factors including expanding our customer base, the expansion of our salesforce, and the timing and extent of spending on the development of our technology to increase our product offerings. If we raise additional funds by issuing equity securities, our stockholders may experience dilution. Any future debt financing into which we enter may impose upon us additional covenants that restrict our operations, including limitations on 29 our ability to incur liens or additional debt, pay dividends, repurchase our common stock, make certain investments and engage in certain merger, consolidation or asset sale transactions. Any debt financing or additional equity that we raise may contain terms that are not favorable to us or our stockholders. Cash Flows The following table summarizes our cash flows for the periods indicated (in thousands): Nine Months Ended September 30, 2020 2019 Net cash (used in) provided by: Operating activities $ (21,577) $ (17,003) Investing activities (114,906) (76,766) Financing activities 211,357 108,380 Net increase in cash and cash equivalents $ 74,874 $ 14,611 Cash Used in Operating Activities During the nine months ended September 30, 2020, cash used in operating activities was $21.6 million, which consisted of a net loss of $34.2 million, adjusted by non-cash charges of $57.4 million and a net change of $44.8 million in our net operating assets and liabilities. The non-cash charges were primarily comprised of a change in stock-based compensation of $27.5 million, allowance for doubtful accounts and contractual allowances of $20.5 million, depreciation and amortization of $4.9 million and amortization of right of use assets of $4.5 million. The change in our net operating assets and liabilities was primarily due to an increase of $26.0 million in accounts receivable, a decrease of $5.4 million in accrued liabilities, an decrease of $4.7 million in accounts payable and a decrease of $3.5 million in operating lease liability. During the nine months ended September 30, 2019, cash used in operating activities was $17.0 million, which consisted of a net loss of $37.3 million, adjusted by non-cash charges of $45.8 million and a net change of $25.5 million in our net operating assets and liabilities. The non-cash charges were primarily comprised of a change in stock-based compensation of $19.1 million, allowance for doubtful accounts and contractual allowance of $17.6 million, and amortization of right of use assets of $7.5 million. The change in our net operating assets and liabilities was primarily due to an increase of $22.8 million in accounts receivable. Cash Provided by Investing Activities Cash used in investing activities during the nine months ended September 30, 2020 was $114.9 million, which consisted of $214.9 million in purchases of available for sale investments and $11.2 million of capital expenditures, partially offset by cash received from the maturities of available for sale investments of $96.6 million and sales of available for sale investments of $14.5 million. Cash provided by investing activities during the nine months ended September 30, 2019 was $76.8 million, which consisted primarily of purchases of available for sale investments of $146.0 million, and $8.6 million of capital expenditures to purchase property and equipment. This was partially offset by $77.9 million in cash received from the maturities of available for sale investments. Cash Provided by Financing Activities During the nine months ended September 30, 2020, cash provided by financing activities was $211.4 million, primarily due to $206.4 million from the issuance of common stock in connection with the follow-on public offering, net discounts and issuance costs, $13.7 million in proceeds from the issuance of common stock in connection with employee options exercises and our Employee Stock Purchase Program, partially offset by $8.7 million in tax withholding upon the vesting of RSUs. During the nine months ended September 30, 2019, cash provided by financing activities was $108.4 million, primarily due to $107.1 million from the issuance of common stock in a public offering, net discounts and issuance costs, $6.4 million in proceeds from the issuance of common stock in connection with employee options exercises and our Employee Stock Purchase Program, partially offset by $5.1 million in tax withholding upon the vesting of RSUs. 30 Bank Debt In December 2015, we entered into a Second Amended and Restated Loan and Security Agreement with SVB, (the “SVB Loan Agreement”). Under the SVB Loan Agreement, we could borrow, repay and reborrow under a revolving credit line, but not in excess of the maximum loan amount of $15.0 million, until December 4, 2018, when all outstanding principal and accrued interest became due and payable. Any principal amount outstanding under the SVB Loan Agreement shall bear interest at a floating rate per annum equal to the rate published by The Wall Street Journal as the “Prime Rate” plus 0.25%. We could borrow up to 80% of our eligible accounts receivable, up to the maximum of $15.0 million. In October 2018, we entered into the Third Amended and Restated Loan and Security Agreement with SVB (“Third Amended and Restated SVB Loan Agreement”). This Agreement amends and restates the Second Amended and Restated Loan and Security Agreement between the Company and SVB dated December 4, 2015, as amended by the First Loan Modification Agreement between the Company and SVB dated August 22, 2016. Pursuant to the Third Amended and Restated SVB Loan Agreement, we obtained a term loan (“SVB Term Loan”) for $35.0 million. Total proceeds from the SVB Term Loan were used to pay off the loan agreement with Biopharma Secured Investments III Holdings Cayman LP (“Pharmakon”), totaling $35.8 million. We will make interest-only payments through October 31, 2020, followed by 36 monthly payments of principal plus interest on the SVB Term Loan. Interest charged on the SVB Term Loan will be the greater of (a) a floating rate based on the “Prime Rate” published by The Wall Street Journal minus 0.75%, or (b) 4.25%. Under the Third Amended and Restated SVB Loan Agreement, we may borrow, repay, and reborrow under a revolving credit line, but not in excess of the maximum loan amount of $25.0 million, which includes an $11.0 million standby letter of credit sublimit availability. In October 2018, a $6.9 million standby letter of credit was obtained in connection with a lease for our San Francisco headquarters. Any principal amount outstanding under the Third Amended and Restated SVB Loan Agreement revolving credit line shall bear interest at an amount that is the greater of (a) a floating rate per annum equal to the rate published by The Wall Street Journal as the “Prime Rate” or (b) 5.00%. We may borrow up to 75% of eligible accounts receivable, up to the maximum of $25.0 million. As of September 30, 2020 no amount was outstanding under the revolving credit line. The Third Amended and Restated Loan Agreement requires us to maintain a minimum consolidated liquidity ratio or minimum adjusted Earnings Before Interest, Tax, Depreciation, and Amortization during the term of the loan facility. In addition, the SVB Loan Agreement contains customary affirmative and negative covenants and events of default. We were in compliance with loan covenants as of September 30, 2020. The obligations under the Third Amended and Restated Loan Agreement are collateralized by substantially all of our assets. Off-Balance Sheet Arrangements We have not entered into any off-balance sheet arrangements and do not have any holdings in variable interest entities. Contractual Obligations Our contractual obligations as of December 31, 2019 are presented in our Form 10-K filed with the SEC on March 2, 2020. There have been no material changes. 31 Critical Accounting Policies and Estimates For a complete description of what we believe to be the critical accounting policies and estimates used in the preparation of our Unaudited Condensed Consolidated Financial Statements, refer to our Annual Report on Form 10-K for the year ended December 31, 2019 ("Annual Report"). Refer to Note 2. Summary of Significant Accounting Policies , in the Notes to Unaudited Condensed Consolidated Financial Statements in Item 1 of Part I of this Quarterly Report on Form 10-Q, for all significant accounting policies. With the exception of the accounting policy described below, there have been no significant changes to our critical accounting policies as described in our Annual Report. Stock-Based Compensation We recognize compensation costs related to stock option grants, restricted stock unit grants (“RSUs”), and shares under the employee stock purchase program (“ESPP”), and market condition awards based on the estimated fair value of the awards on the date of grant, net of estimated forfeitures. We estimate the grant date fair value, and the resulting stock-based compensation expense for options and shares under the ESPP, using the Black-Scholes option pricing model. We estimate the grant date fair value, and the resulting stock-based compensation expense for market condition awards using the Monte-Carlo pricing mode. The RSU grant date fair value is based on the closing price on the date of the grant. The grant date fair value of stock-based awards is expensed on a straight-line basis over the period during which the employee is required to provide service in exchange for the award (generally the vesting period). We estimate the fair value of our stock-based awards using the Black-Scholes and Monte-Carlo option-pricing models, which requires the input of highly subjective assumptions. Our assumptions are as follows: • Expected term. The expected term represents the period that the stock-based awards are expected to be outstanding. We use the simplified method to determine the expected term, which is calculated as the average of the time to vesting and the contractual life of the options. • Expected volatility. The expected volatility is derived from the average implied volatility of our common stock. As our common stock has been publicly traded for a limited time, in some cases expected volatility is derived from the average historical volatilities of publicly traded companies within our industry that we consider to be comparable to our business over a period approximately equal to the expected term for employees’ options and the remaining contractual life for nonemployees’ options. • Risk-free interest rate. The risk-free interest rate is based on the U.S. Treasury yield with a maturity equal to the expected term of the option in effect at the time of grant. • Dividend yield. The expected dividend is assumed to be zero as we have never paid dividends and have no current plans to pay any dividends on our common stock. In addition to the assumptions used in the Black-Scholes and Monte-Carlo option-pricing models, we also estimate a forfeiture rate to calculate the stock-based compensation for our equity awards. We will continue to use judgment in evaluating the expected volatility, expected terms and forfeiture rates utilized for our stock-based compensation calculations on a prospective basis. We recognize compensation expense related to RSUs based on the grant date fair value on a straight-line basis over the period during which the employee is required to provide service in exchange for the award (generally the vesting period). Where there is a minimum performance condition required to vest in RSUs, we perform a probability assessment to estimate the number of shares that are probable to vest. We recognize compensation expense related to the Employee Stock Purchase Program (“ESPP”) based on the estimated fair value 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. 32 Recently Adopted Accounting Guidance In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost, including trade receivables. ASU No. 2016-13 replaces the existing incurred loss impairment model with an expected loss model that requires the use of forward-looking information to calculate credit loss estimates. It also eliminates the concept of other-than-temporary impairment and requires credit losses related to available-for-sale debt securities to be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. We adopted ASC 326 on January 1, 2020, using the modified retrospective transition method through a non-cash $0.5 million cumulative-effect increase to accumulated deficit and the allowance for doubtful accounts. We considered the current and expected future economic and market conditions surrounding the novel COVID-19 pandemic and recorded additional reserves that were not individually material to the estimate. Actual results may differ from these estimates. In August 2018, the FASB issued ASU No. 2018-15, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract, which amended its guidance for costs of implementing a cloud computing service arrangement to align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. This new standard also requires customers to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement. We adopted ASU No. 2018-15 on January 1, 2020, using the prospective transition method. The impact of adoption on our consolidated financial statements was not material. In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, which simplifies the accounting for income taxes by removing certain exceptions to the general principles for income taxes. We elected to early adopt ASU 2019-12 effective as of January 1, 2020, and the impact of adoption on our condensed consolidated financial statements was not material. 33