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".
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 each patient’s heart rhythm ECG data for up to 14 consecutive days; Zio AT offers the option of fast, sensing-based data transmission during the prescribed wear period;
• Cloud-based analysis of recorded heart rhythms using our proprietary deep-learned algorithms;
•a final data quality assessment review by our certified cardiograph technicians; and
•An easy-to-read Zio Report, an organized summary of results that includes high-quality, clinically actionable information that is sent directly to a patient’s physician via 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 56% and 63% of our revenue for the three months ended March 31, 2022and 2021, respectively. Approximately 22% and 14% of our total revenue for the three months ended March 31, 2022and 2021, 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% and 17% of our revenue for each of the three months ended March 31, 2022and 2021, respectively. Non-contracted third party payors and self-pay accounted for 6% and 7% of our total revenue for the three months ended March 31, 2022and March 31, 2021, 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 four million patients and have collected over one billion hours of curated heartbeat data. We believe the Zio service is well-positioned to penetrate an already-established approximately $2.0 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 Statesthrough 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. 25
Impact of COVID-19
•a reduction in physician prescriptions for our Zio service due to: •a reduction in diagnostic testing outside of those tests related to severe respiratory distress; •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;
• the cancellation and reduction of physician attendance at professional medical society meetings and trade shows and our decision not to attend;
•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 patients receiving Zio XT, 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. As of
March 31, 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. Appropriate social distancing techniques and other measures at our facilities have been implemented for the employees who have returned to work. While hospital systems and healthcare facilities shift their focus and resources to treating COVID-19 patients and combating the spread of the coronavirus, we have adapted our service 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 device without going to a healthcare facility. Our remote work arrangements resulting from the COVID-19 pandemic and subsequent decision to pursue a sublease for our San Franciscoheadquarters 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.
Components of operating results
The majority of our revenue is derived from provision of our Zio service to customers 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. Revenue may be impacted by the outcome of adjudications with contracted and non-contracted payors, as well as changes in the CMS reimbursement rates. Clinical capacity limitations may also restrict our ability to complete the performance obligations to achieve revenue recognition. 26 --------------------------------------------------------------------------------
Revenue Cost and Gross Margin
Cost of revenue includes direct labor, material costs, equipment and infrastructure expenses, device scrap and loss, 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, clinical data curation, and customer service. Material costs include both the disposable materials costs of the Zio monitors and amortization of the reusable 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 the 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 service 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 algorithm and process improvements, automating manufacturing assembly and packaging, and software-driven and other workflow enhancements to reduce labor costs. These decreases have been 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. Although a large majority of our commercial customers have renewed their contracts for the Zio XT service since the establishment of the Category I codes on
January 1, 2021matching to pre-existing rates, if we are unsuccessful in improving the Medicare rates, we believe that commercial rates may begin to be more negatively impacted, which would have a negative impact on our gross margins.
Research and development costs
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, product enhancements and clinical evidence.
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.
Impairment and restructuring charges
Our impairment and restructuring expenses consist of impairment charges on our
San Franciscoright-of-use asset and severance charges in connection with our 2022 restructuring plan. Interest Expense
Interest expense is attributable to borrowings under our loan agreements. See Note 8. Debt, for more information on our loan agreements.
Other income, net
Other income, net, mainly includes interest income which consists of interest received on our cash equivalents and investments.
Comparison of the three months ended
Three Months Ended March 31, 2022 2021 $ Change % Change Revenue
$ 92,378 $ 74,311 $ 18,06724 % Cost of revenue 30,619 23,458 7,161 31 % Gross profit 61,759 50,853 10,906 21 % Gross margin 67 % 68 % Operating expenses: Research and development 10,542 8,510 2,032 24 % Selling, general and administrative 73,158 69,813 3,345 5 % Impairment and restructuring charges 26,608 - 26,608 - Total operating expenses 110,308 78,323 31,985 41 % Loss from operations (48,549) (27,470) (21,079) 77 % Interest expense (2,029) (335) (1,694) 506 % Other income, net 16 124 (108) (87) % Loss before income taxes (50,562) (27,681) (22,881) 83 % Income tax provision 47 98 (51) (52) % Net loss $ (50,609) $ (27,779) $ (22,830)82 % Revenue Revenue increased $18.1 million, or 24%, to $92.4 millionduring the three months ended March 31, 2022from $74.3 millionduring the three months ended March 31, 2021. The increase in revenue was primarily attributable to the increase in volume of the Zio services as a result of increased demand from our customers and in improved CMS reimbursement rates. Revenue was also impacted by improvements in adjudication performance with contracted and non-contracted payors.
Revenue Cost and Gross Margin
Cost of revenue increased
$7.2 million, or 31%, to $30.6 millionduring the three months ended March 31, 2022from $23.5 millionduring the three months ended March 31, 2021. The increase in cost of revenue was primarily due to increased Zio service volume, and an increase in costs resulting from capacity limitations associated with clinical operations. Gross margin for the three months ended March 31, 2022was 67%, compared to 68% for the three months ended March 31, 2021. The decrease in gross margin is primarily due to increased costs associated with capacity constraints, with limited impact of higher Zio AT volumes and COVID-related labor costs, offset by volume benefit and increase in average selling price.
Research and development costs
Research and development expenses increased
$2.0 million, or 24%, to $10.5 millionduring the three months ended March 31, 2022from $8.5 millionduring the three months ended March 31, 2021. The increase was primarily attributable to a $3.4 millionincrease in compensation expense, partially offset by a $1.4 millionreduction of expense due to an increase in costs capitalized to internal use software.
Selling, general and administrative expenses
Selling, general and administrative expenses increased
$3.3 million, or 5%, to $73.2 millionduring the three months ended March 31, 2022from $69.8 millionduring the three months ended March 31, 2021. The increase was due to a $8.0 millionincrease in compensation costs as a result of increased headcount and corporate bonus, an increase in bad debt expense of $1.3 million, partially offset by a $6.0 milliondecrease in stock based compensation expense. 28 --------------------------------------------------------------------------------
Impairment and restructuring charges
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 impairment of our right of use asset and related leasehold improvements and furniture and fixtures in the amount of $23.2 million. In February 2022, the board approved a restructuring plan to allow the Company to effectively and efficiently scale its business. The 2022 Restructuring Plan resulted in severance and other employment related costs. We recorded $3.4 millionin charges under the 2022 Restructuring plan during the three months ended March 31, 2022. Interest Expense Interest expense was $2.0 millionfor the three months ended March 31, 2022, compared to $0.3 millionfor the three months ended March 31, 2021. The increase was due to additional financing fees of $1.75 millionrelated to our term loan paid in the three months ended March 31, 2022, compared with the three months ended March 31, 2021. Other Income, Net Other income, net was immaterial for the three months ended March 31, 2022and 2021. There were no significant changes in other income, net during the three months ended March 31, 2022, compared with the three months ended March 31, 2021.
Cash and capital expenditure
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.
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. We expect the next Verily milestone to be met in 2023. Additionally, we will complete the build out of our new manufacturing facility and our new
Deerfield Illinoisfacility in the first half of 2022. 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. 29 --------------------------------------------------------------------------------
The following table summarizes our cash flows for the periods indicated (in thousands): Three months ended March 31, 2022 2021 Net cash (used in) provided by: Operating activities
$ (38,885) $ (41,842)Investing activities (8,527) 117,035 Financing activities 14,636 (26,446) Net increase in cash and cash equivalents $ (32,776)
Cash flows used in operating activities
During the three months ended
March 31, 2022, cash used in operating activities was $38.9 million, which consisted of a net loss of $50.6 million, adjusted by non-cash charges of $61.2 millionand a net change of $49.5 millionin our net operating assets and liabilities. The non-cash charges were primarily comprised of impairment charges of $23.2 million, stock-based compensation expense of $13.9 million, allowance for doubtful accounts and contractual allowances of $14.0 million, depreciation and amortization of $3.1 millionand amortization of right of use assets of $6.5 million. The change in our net operating assets and liabilities was primarily due to an increase of $22.9 millionin accounts receivable, an increase of $2.4 millionin inventory, a decrease of $9.4 millionin accrued liabilities, an increase of $5.3 millionin accounts payable and a decrease of $6.2 millionin operating lease liability. The number of claims from the first half of 2021 which contained differences between the submitted price and reimbursement and overall denials increased significantly compared to our historical experience as a result of CPT code transition issues with the payors. We continue to work with the payors to collect on these claims and the collection cycle for these claims is significantly longer than usual. While we believe we have properly estimated the impact to our contractual allowances and allowance for doubtful accounts, the inherent uncertainty caused by longer collection cycle and claims adjudication process could result in additional provisions for contractual allowances and doubtful accounts which would negatively impact our results of operations in future periods. As of March 31, 2022, uncollected claims as a result of the CPT code transition were $12.9 million. We believe we have adequate balance sheet liquidity to manage through these delays During the three months ended March 31, 2021, cash used in operating activities was $41.8 million, which consisted of a net loss of $27.8 million, adjusted by non-cash charges of $34.1 millionand a net change of $48.2 millionin our net operating assets and liabilities. The non-cash charges were primarily comprised of a change in stock-based compensation of $20.2 million, allowance for doubtful accounts and contractual allowances of $9.8 million, depreciation and amortization of $2.0 millionand amortization of right of use assets of $1.6 million. The change in our net operating assets and liabilities was primarily due to an increase of $39.8 millionin accounts receivable, a decrease of $6.1 millionin accrued liabilities, a decrease of $0.7 millionin accounts payable and a decrease of $1.4 millionin operating lease liability.
Cash from investing activities
Cash used in investing activities during the three months ended
March 31, 2022was $8.5 million, which primarily consisted of $46.0 millionin purchases of available for sale investments and $5.6 millionof capital expenditures, partially offset by cash received from the maturities of available for sale investments of $28.0 million, and sales of available for sale investments of $15.0 million. Cash provided by investing activities during the three months ended March 31, 2021was $117.0 million, which consisted of cash received from the maturities of available for sale investments of $151.3 million, partially offset by $30.1 millionin purchases of available for sale investments and $4.2 millionof capital expenditures. 30 --------------------------------------------------------------------------------
Cash used in financing activities
During the three months ended
March 31, 2022, cash provided by financing activities was $14.6 million, primarily due $35.0 millionin proceeds received from the closing of our Second Amendment to our SVB Loan Agreement, partially offset by $21.4 millionof repayment of the outstanding balance under the existing SVB term loan. During the three months ended March 31, 2021, cash used in financing activities was $26.4 million, primarily due to $25.1 millionin tax withholding upon the vesting of RSUs. This practice has been updated to require employees to sell shares to cover tax liabilities. In addition, cash used in financing activities was due to repayment of debt of $2.9 million, partially offset by $1.6 millionin proceeds from the issuance of common stock in connection with employee options exercises and our Employee Stock Purchase Plan.
October 2018, we entered into a Third Amended and Restated Loan and Security Agreement with SVB ("SVB Loan Agreement"). Under the SVB Loan Agreement, we had borrowed $35.0 millionand had made repayments through March 2022at which time the outstanding balance was $18.5 million. On March 28, 2022, we entered into a Second Amendment ("2022 Amendment") to the SVB Loan Agreement which provided for a term loan facility in the aggregate principal amount of up to $75.0 million(the "2022 Term Loans"), of which $35.0 millionaggregate principal amount was borrowed at closing and a portion of the proceeds of which were used to pay in full the outstanding balance of $18.5 millionof the SVB Loan Agreement. The remaining $40.0 millionof 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 shall 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 accrues 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 made. 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, 2023to March 1, 2027, (ii) increase the letters of credit sublimit to $15.0 millionand (iii) increase the cash management services sublimit to $15.0 million. Interest charged on the principal amount outstanding under the revolving credit line shall 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 March 31, 2022, no loans were outstanding under the revolving credit line.
Off-balance sheet arrangements
We have no off-balance sheet arrangements and do not hold any interests in variable interest entities.
Our contractual obligations from
Significant 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, 2021("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. There have been no significant changes to our critical accounting policies as described in our Annual Report.
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