iRhythm Holdings, Inc. 10-K

Item 7. 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 financial statements and related notes included elsewhere in Item 8 of Part II of this Annual Report on Form 10-K. This discussion and other parts of this Annual Report on Form 10-K reflect the revisions disclosed in our Form 10-Q filed on December 23, 2019 and 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 Annual Report on Form 10-K entitled “Risk Factors.” The Company identified errors and made revisions to prior fiscal years as discussed in Note 1. Organization and Description of Business in our accompanying consolidated financial statements. Accordingly, this Management’s Discussion and Analysis of Financial Condition and Results of Operations reflects the effects of the revisions. Overvie w 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%, 47% and 39% of our revenue for the years ended December 31, 2020, 2019 and 2018, respectively. Approximately 27%, 27% and 27% of our total revenue for the years ended December 31, 2020, 2019 and 2018, respectively, 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%, 20% and 25% of our revenue for the years ended December 31, 2020, 2019, and 2018 respectively. Non-contracted third-party payors and self-pay accounted for 6%, 5%, and 8% of our total revenue for the years ended December 31, 2020, 2019, and 2018, 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 three million patients and have collected over 750 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. 66 Table of Contents 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. Beginning in mid-March 2020, we experienced decreasing levels in the Zio service patient registrations which impacted our revenues for the year ended December 31, 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 second half 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 67 Table of Contents 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 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 year ended December 31, 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. 68 Table of Contents 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 Years Ended December 31, 2020, and 2019 Years Ended December 31, 2020 2019 $ Change % Change (dollars in thousands) Revenue $ 265,166 $ 214,552 $ 50,614 24 % Cost of revenue 70,277 52,485 17,792 34 % Gross profit 194,889 162,067 32,822 20 % Gross margin 73 % 76 % Operating expenses: Research and development 41,329 37,299 4,030 11 % Selling, general and administrative 197,233 179,523 17,710 10 % Total operating expenses 238,562 216,822 21,740 10 % Loss from operations (43,673) (54,755) 11,082 20 % Interest expense (1,519) (1,643) 124 8 % Other income, net 1,591 1,895 (304) 16 % Loss before income taxes (43,601) (54,503) 10,902 20 % Income tax provision 229 65 164 252 % Net loss $ (43,830) $ (54,568) $ 10,738 20 % Revenue Revenue increased $50.6 million, or 24%, to $265.2 million during the year ended December 31, 2020 from $214.6 million during the year ended December 31, 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 $17.8 million, or 34%, to $70.3 million during the year ended December 31, 2020 from $52.5 million during the year ended December 31, 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. 69 Table of Contents Gross margin for the year ended December 31, 2020 decreased to 73%, compared to 76% for the year ended December 31, 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 $4.0 million, or 11%, to $41.3 million during the year ended December 31, 2020 from $37.3 million during the year ended December 31, 2019. The increase was primarily attributable to a $8.3 million increase in payroll and employee stock-based compensation as a result of increased headcount and an increase of $1.0 million Verily milestone expense. This was partially offset by $4.7 million increase in capitalization of internal use software. Selling, General and Administrative Expenses Selling, general and administrative expenses increased $17.7 million, or 10%, to $197.2 million during the year ended December 31, 2020 from $179.5 million during the year ended December 31, 2019. The increase was primarily attributable to a $29.5 million increase in payroll and employee stock-based compensation as a result of increased headcount to support the growth in our operations, a $2.9 million increase in facilities and rent due to expansion of the San Francisco headquarters and increased facility related costs, partially offset by decrease of $8.9 million in travel, entertainment and office meals as a result of the COVID-19 pandemic and a decrease of $4.4 million in professional services fees. A significant amount of selling, general, and administrative incremental spend can be directly attributed to our continued focus on salesforce expansion and its support infrastructure to support our growth strategy. Interest Expense Interest expense decreased $0.1 million to $1.5 million during the year ended December 31, 2020 from $1.6 million during the year ended December 31, 2019 due to principal re-payments on SVB Loan starting in November 2020 and decrease in interest rate in 2020. Other Income, Net Other income, decreased $0.3 million to $1.6 million for the year ended December 31, 2020, compared to $1.9 million for year ended December 31, 2019. The decrease in other income is primarily due to a decrease in amortization of investments, partially offset by increase in interest income, and prior year value added tax reclaims. 70 Table of Contents Comparison of the Year Ended December 31 2019, and 2018 Years Ended December 31, 2019 2018 $ Change % Change (dollars in thousands) Revenue $ 214,552 $ 147,277 $ 67,275 46 % Cost of revenue 52,485 38,795 13,690 35 % Gross profit 162,067 108,482 53,585 49 % Gross margin 76 % 74 % Operating expenses: Research and development 37,299 20,860 16,439 79 % Selling, general and administrative 179,523 133,313 46,210 35 % Total operating expenses 216,822 154,173 62,649 41 % Loss from operations (54,755) (45,691) (9,064) 20 % Interest expense (1,643) (3,115) 1,472 47 % Other income, net 1,895 1,501 394 26 % Loss on extinguishment of debt — (3,029) 3,029 n/a Loss before income taxes (54,503) (50,334) (4,169) 8 % Income tax provision 65 44 21 48 % Net loss $ (54,568) $ (50,378) (4,190) 8 % Revenue Revenue increased $67.3 million, or 46%, to $214.6 million during the year ended December 31, 2019 from $147.3 million during the year ended December 31, 2018. 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 $13.7 million, or 35%, to $52.5 million during the year ended December 31, 2019 from $38.8 million during the year ended December 31, 2018. The increase in cost of revenue was primarily due to increased Zio service volume in 2019. This increase was partially offset by the reduction in costs to provide the Zio service, which was achieved through manufacturing efficiencies in the production of our device and reductions in cardiographic technician labor costs through algorithm improvements and software driven workflow enhancements. Gross margin for the year ended December 31, 2019 increased to 76% compared to 74% for the year ended December 31, 2018. The increase was driven primarily by the reduction in the cost of the Zio service due to our continued efforts to lower manufacturing costs, fixed costs absorption and reduced labor costs per device through our algorithm improvements and software-driven and other workflow enhancements. In addition, we experienced some mix shift and average selling price growth driven by the success of our contracting efforts, which also improved our gross margin during the year ended December 31, 2019. Research and Development Expenses Research and development expenses increased $16.4 million, or 79%, to $37.3 million during the year ended December 31, 2019 from $20.9 million during the year ended December 31, 2018. The increase was primarily attributable to a $7.4 million increase in payroll and personnel-related expenses as a result of increased headcount, $6.0 million in Verily milestone and upfront payment expense, and $3.3 million for allocated facility-related expenses. This was partially offset by $3.3 million increase in capitalization of internal use software. 71 Table of Contents Selling, General and Administrative Expenses Selling, general and administrative expenses increased $46.2 million, or 35%, to $179.5 million during the year ended December 31, 2019 from $133.3 million during the year ended December 31, 2018. The increase was primarily attributable to a $19.8 million increase in payroll and personnel-related expenses and $9.9 million increase in employee stock-based compensation as a result of increased headcount to support the growth in our operations. The increase was also driven by an increase in professional services of $8.1 million. A significant amount of selling, general, and administrative incremental spend can be directly attributed to our continued focus on salesforce expansion and its support infrastructure to support our growth strategy. Interest Expense Interest expense decreased $1.5 million to $1.6 million during the year ended December 31, 2019 from $3.1 million during the year ended December 31, 2018 due to the extinguishment of the loan agreement with Biopharma Secured Investments III Holdings Cayman LP in October 2018. Other Income, Net Other income, increased to $1.9 million for the year ended December 31, 2019, compared to $1.5 million for the year ended December 31, 2018. The increase in other income is primarily due to an increase in our investment portfolio during the fourth quarter of 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 December 31, 2020, we had cash and cash equivalents of $88.6 million, short-term investments of $246.6 million, and an accumulated deficit of $304.7 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 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): Year Ended December 31, 2020 2019 2018 Net cash (used in) provided by: Operating activities $ (13,759) $ (21,863) $ (29,093) Investing activities (132,391) (89,274) 34,142 Financing activities 214,316 111,576 6,303 Net increase in cash, cash equivalents, and restricted cash $ 68,166 $ 439 $ 11,352 Cash Used in Operating Activities During the year ended December 31, 2020, cash used in operating activities was $13.8 million which consisted of a net loss of $43.8 million, adjusted by non-cash charges of $86.3 million and a net change of $56.2 million in our net operating assets and liabilities. The non-cash charges are primarily comprised of stock-based compensation expense of $41.5 million, as well as depreciation and amortization expense of $6.9 million and a change in allowance for doubtful accounts and contractual 72 Table of Contents allowance of $31.4 million and amortization of right of use assets of $6.0 million. The change in our net operating assets and liabilities compared to December 31, 2019 was primarily due to an increase of $38.0 million in the change in accounts receivable as a result of the increase in our revenue, an increase of $6.1 million in other assets, primarily related to increase in PCBA boards due to increased customer demand and sales, a decrease of $4.8 million in operating lease liability and a decrease of $3.9 million in accounts payable. During the year ended December 31, 2019 cash used in operating activities was $21.9 million, which consisted of a net loss of $54.6 million, adjusted by non-cash charges of $62.4 million and a net change of $29.7 million in our net operating assets and liabilities. The non-cash charges are primarily comprised of stock-based compensation expense of $26.2 million, as well as depreciation and amortization expense of $3.4 million and a change in allowance for doubtful accounts and contractual allowance of $24.6 million. The change in our net operating assets and liabilities compared to December 31, 2018 was primarily due to an increase of $28.7 million in the change in accounts receivable as a result of the increase in our revenue, and an increase of $6.0 million in accrued liabilities, primarily related to increased accrued payroll and related compensation accruals. During the year ended December 31, 2018 cash used in operating activities was $29.1 million, which consisted of a net loss of $50.4 million, adjusted by non-cash charges of $34.3 million and a net change of $13.0 million in our net operating assets and liabilities. The non-cash charges are primarily comprised of stock-based compensation expense of $16.3 million, as well as a change in allowance for doubtful accounts and contractual allowance of $16.4 million. The change in our net operating assets and liabilities compared to December 31, 2017 was primarily due to an increase of $21.7 million in the change in accounts receivable as a result of the increase in our revenue, and an increase of $10.5 million in accrued liabilities, primarily related to increased accrued payroll and related compensation accruals. Cash From Investing Activities Cash used in investing activities during the year ended December 31, 2020 was $132.4 million, which consisted primarily of $277.5 million in purchases of available for sale investments, $13.6 million of capital expenditures to purchase property and equipment and $1.9 million in repayment of long-term debt, partially offset by $144.1 million cash received from the maturities of available for sale investments and $14.5 million in cash received from sales of available for sale investments. Cash used in investing activities during the year ended December 31, 2019 was $89.3 million, which consisted primarily of $165.9 million in purchases of available for sale investments and $20.5 million of capital expenditures to purchase property and equipment partially offset by $95.6 million cash received from the maturities of available for sale investments and $1.5 million in cash received from sales of available for sale investments. Cash provided by investing activities during the year ended December 31, 2018 was $34.1 million, which consisted of $126.5 million cash received from the maturities of available for sale investments and $6.0 million in cash received from sales of available for sale investments partially offset by $93.1 million in purchases of investments and $5.2 million of capital expenditures to purchase property and equipment. Cash From Financing Activities During the year ended December 31, 2020, cash provided by financing activities was $214.3 million, primarily due to $206.0 million from the issuance of common stock in a public offering, net of discounts and issuance costs and $20.2 million in proceeds from the issuance of common stock in connection with employee option exercises and our Employee Stock Purchase Program. This was partially offset by $10.0 million in tax withholding upon the vesting of RSUs and $1.9 million in re-payment of long term debt. During the year ended December 31, 2019, cash provided by financing activities was $111.6 million, primarily due to $107.4 million from the issuance of common stock in a public offering, net of discounts and issuance costs and $9.5 million in proceeds from the issuance of common stock in connection with employee option exercises and our Employee Stock Purchase Program. This was partially offset by $5.3 million in tax withholding upon the vesting of RSUs. During the year ended December 31, 2018, cash provided by financing activities was $6.3 million, primarily due to proceeds from the issuance of debt of $35.0 million and $9.3 million in proceeds from the issuance of common stock in connection with employee option exercises and our Employee Stock Purchase Program, partially offset by repayment of debt of $31.5 million, $3.9 million in tax withholding upon the vesting of RSUs and $2.5 million in premiums paid on loss on extinguishment of debt. 73 Table of Contents Indebtedness In December 2015, we entered into a Loan Agreement with Biopharma Secured Investments III Holdings Cayman LP (the “Pharmakon Loan Agreement”). The Pharmakon Loan Agreement provided for up to $55.0 million in term loans split into two tranches as follows: (i) the Tranche A Loans were $30.0 million in term loans, and (ii) the Tranche B Loans were up to $25.0 million in term loans. The Tranche A Loans were drawn on December 4, 2015. The Tranche B Loans were available to be drawn prior to December 4, 2016. No additional draw was taken. The Tranche A Loans bore interest at a fixed rate equal to 9.50% per annum that was due and payable quarterly in arrears. During the first eight calendar quarters, 50% of the interest due and payable was added to the then outstanding principal. In December 2015, we used the proceeds from the Pharmakon Loan Agreement to repay $4.9 million of bank debt to SVB. The issuance costs and debt discount were netted against the borrowed funds on the balance sheet. On October 23, 2018, we repaid the principal amount of the Tranche A Loan of $30.0 million and related accrued interest of $3.3 million. We incurred a $3.0 million loss in connection with the early extinguishment of the Pharmakon Loan Agreement which included a prepayment premium fee of $1.0 million and additional consideration related to prepayment of $1.5 million. The debt balance as of December 31, 2017 was $32.5 million. 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 made 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 December 31, 2020 we were eligible to borrow up to $7.7 million and 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 December 31, 2020. The obligations under the Third Amended and Restated Loan Agreement are collateralized by substantially all of our assets. 74 Table of Contents Critical Accounting Policies and Estimates Our management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”). The preparation of these financial statements requires our management to make judgments and estimates that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenue generated and expenses incurred during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these judgments and estimates under different assumptions or conditions and any such differences may be material. We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management’s judgments and estimates. Revenue Recognition Our Zio XT monitor, a wearable patch-based biosensor, continuously records and stores ECG data from every patient heartbeat for up to 14 consecutive days. The Zio XT monitor is returned to our monitoring facility and the heartbeat data is curated and analyzed by our proprietary algorithms and reviewed by our certified cardiac technicians. The final step in the Zio service is the delivery of an electronic Zio Report to the prescribing physician with a summary of findings. Our Zio XT service is generally billable when the Zio Report is issued to the physician. Our Zio AT mobile cardiac telemetry monitor, a wearable patch-based biosensor, offers what our Zio XT offers plus the additional capability of transmissions during the wear period to assist physicians in diagnosing and treating the small percentage of the population requiring more timely action. During the wear period, physicians will receive notifications if there are significant events that meet predetermined arrhythmia detection criteria. Our Zio AT service revenue is recognized over the prescription period and delivery of an electronic Zio Report. 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. These estimates require significant judgment by management. In determining the amount to accrue for a delivered 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 (“CMS”) – We have received independent diagnostic testing facility approval from regional Medicare Administrative Contractors and will receive reimbursement per the relevant Current Procedural Terminology (“CPT”) code rate for the services rendered to the patient covered by CMS. • 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. 75 Table of Contents • Healthcare institutions – Healthcare institutions are typically hospitals or physician practices in which we have negotiated amounts for its monitoring services, including certain governmental agencies such as the Veteran’s Administration and Department of Defense. We are utilizing the portfolio approach practical expedient under ASC 606 for revenue recognition. 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. 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 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 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. Allowance for Doubtful Accounts and Contractual Allowance We establish an allowance for doubtful accounts for estimated uncollectible receivables based on our historical collections, review of specific outstanding claims, consideration of relevant qualitative factors and an established allowance percentage by aging category. We write off outstanding accounts against the allowance for doubtful accounts when they are deemed to be uncollectible. Increases and decreases in the allowance for doubtful accounts are included as a component of general and administrative expenses. We record reductions in revenue for estimated uncollectible amounts as contractual allowances. We review and update our estimates for the allowance for doubtful accounts and the contractual allowance periodically to reflect our experience regarding historical collections. If we were to make different judgments or utilize different estimates in the allowance for doubtful accounts and the contractual allowance, differences in both the amount of reported general and administrative expenses and revenue could result. Estimated Usage of the Printed Circuit Board Assembly We use a printed circuit board assembly (“PCBA”) in each Zio XT and Zio AT wearable device and a gateway board in Zio AT device. These boards are reused numerous times in multiple patients. Each time the PCBA and gateway board is used in a wearable Zio XT and Zio AT monitor, a portion of the cost of the PCBA and gateway board is recorded as a cost of revenue. We have based our estimates of how many times a PCBA and gateway board can be used on 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 estimate. 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 76 Table of Contents grant date fair value, and the resulting stock-based compensation expense for market condition awards using the Monte-Carlo option pricing model. 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 model, 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. We recorded stock-based compensation expense of $41.5 million, $26.2 million, and $16.3 million for the years ended December 31, 2020, 2019 and 2018, respectively. We expect to continue to grant RSUs and other equity-based awards in the future, and to the extent that we do, our stock-based compensation expense recognized in future periods will likely increase. 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. The Company 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. The Company 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 77 Table of Contents requires customers to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement. The Company adopted ASU No. 2018-15 on January 1, 2020, using the prospective transition method. The impact of adoption on the Company's 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. The Company elected to early adopt ASU 2019-12 effective as of January 1, 2020, and the impact of adoption on the Company's condensed consolidated financial statements was not material. 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 Payments Due by Period Less Than 1 Year 1 to 3 Years 3 to 5 Years More Than 5 Years Total Debt interest payments (1) $ 1,194 $ 883 $ — $ — $ 2,077 Debt principal payments $ 11,666 $ 21,389 $ — $ — $ 33,055 Operating leases $ 9,513 $ 23,214 $ 24,389 $ 75,420 $ 132,536 Total contractual obligations $ 22,373 $ 45,486 $ 24,389 $ 75,420 $ 167,668 ________________________________ (1) Debt interest payments calculated based on interest rates in effect as of December 31, 2020 The table above does not include approximately $4.4 million in non-cancelable purchase orders related to inventory and printed circuit board assemblies entered into in the normal course of operations, which we expect to be paid in less than one year. The table excludes unrecognized tax benefits of $2.3 million as of December 31, 2020 because these uncertain tax positions, if recognized, would be an adjustment to our net deferred tax assets.