iRhythm Technologies - Q2 2024

Transcript

Operator (participant)

Hello all, and welcome to iRhythm Technologies' Q2 2024 earnings conference call. My name is Lydia, and I'll be your operator today. After the prepared remarks, there'll be an opportunity to ask questions. If you'd like to ask a question during this time, you can do so by pressing star followed by one on your telephone keypad. I'll now hand you over to Stephanie Zhadkevich, Director of Investor Relations, to begin. Please go ahead when you're ready.

Stephanie Zhadkevich (Director of Investor Relations)

Thank you all for participating in today's call. Earlier today, iRhythm released financial results for the Q2 ended June 30, 2024. Before we begin, I'd like to remind you that management will make statements during this call that include forward-looking statements within the meaning of federal securities laws pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Any statements contained in this call that are not statements of historical fact should be deemed to be forward-looking statements. These are based upon our current estimates and various assumptions and reflect management's intentions, beliefs, and expectations about future events, strategies, competition, products, operating plans, and performance. These statements involve risks and uncertainties that could cause actual results or events to materially differ from those anticipated or implied by these forward-looking statements. Accordingly, you should not place undue reliance on these statements.

For a list and description of the risks and uncertainties associated with our business, please refer to the Risk Factors section of our most recent annual and quarterly reports on Form 10-K and Form 10-Q, respectively, filed with the Securities and Exchange Commission. Also during the call, we will discuss certain financial measures that have not been prepared in accordance with US GAAP. With respect to our non-GAAP and cash-based results, including Adjusted EBITDA, adjusted operating expenses, and adjusted net loss. Unless otherwise noted, all references to financial metrics are presented on a non-GAAP basis. The presentation of this additional information should not be considered in isolation of, as a substitute for, or superior to results prepared in accordance with GAAP. Please refer to the tables in our earnings release and 10-Q for a reconciliation of these measures to their most directly comparable GAAP financial measures.

Unless otherwise indicated, all references to financial measures in this call other than revenue refer to non-GAAP results. This conference call contains time-sensitive information and is accurate only as of the live broadcast today, August 1, 2024. iRhythm disclaims any intention or obligation, except as required by law, to update or revise any financial projections or forward-looking statements, whether because of new information, future events, or otherwise. With that, I will turn the call over to Quentin Blackford, iRhythm's President and CEO.

Quentin Blackford (President and CEO)

Thank you, Stephanie. Good afternoon, and thank you all for joining us. Brice Bobzien, our Chief Financial Officer, and Dan Wilson, our EVP of Corporate Development and Investor Relations, join me on today's call. My prepared remarks today cover business updates during the Q2 of 2024, as well as our annual outlook. I'll then turn the call over to Brice to provide a detailed review of our Q2 financial results and updated 2024 guidance. Finally, Brice and Dan will both discuss the CFO transition that we announced earlier today before I close out with final remarks. Once again, we realized strong results in the Q2 from our core business as we achieved revenue of $148 million, representing 19.3% growth versus the prior year.

This success was driven by another quarter of record volume demand, along with a slight improvement in average selling prices. Within our core business, our teams continued to drive growth from new accounts that were opened in the prior twelve months, as well as penetration in existing accounts. We have built a very strong pipeline, thanks to the growing recognition of Zio's value proposition. The compelling CAMELOT real-world evidence data demonstrating Zio's superiority, both across categories and within category directly against competitors for highest diagnostic yield and lowest retest rate, continues to provide traction with clinicians and health systems. Payers have also responded favorably to our health economic data in CAMELOT, enabling our market access team to drive favorable negotiations with greenfield contracts and to drive updates to several existing coverage policies for improved patient access.

Our continued focus within the primary care channel has been successfully driving conversions from competitors, as well as continued conversion of customers from traditional modalities such as short-term Holter monitoring, with a steady stream of new evidence demonstrating the value of 14 days of monitoring for a range of arrhythmias, not only AFib. In addition to winning competitive share and driving the mix shift towards long-term continuous monitoring, iRhythm is driving accelerated expansion of the total ACM market by expanding into primary care, where we estimate that there are more than 15 million patients with cardiac-related palpitations who visit their physicians each year. Zio's value proposition to address the Quintuple Aim of healthcare is clearly resonating with primary care providers in integrated delivery networks, as well as large national primary care accounts, some of whom have begun to proactively monitor for arrhythmias, even if a patient is not symptomatic.

In large IDNs, cardiologists, EPs, and primary care physicians have begun to appreciate the utility of Zio as a workflow efficiency tool, enabling them to diagnose the right patient the first time and alleviate some of the capacity constraints facing many cardiologists in EP practices by helping to identify the appropriate patients who should be seen by these specialty physicians. We believe that this trend towards pushing Zio earlier in the treatment care pathway will only accelerate with further appreciation of the Zio value proposition by primary care providers and with initiatives such as our Epic Aura EHR partnership, which will be introduced into the first accounts in the Q4 of this year and then launched more broadly in 2025.

Additionally, we have found solid traction and product-market fit in the undiagnosed arrhythmia space, specifically in value-based primary care programs, which has been the culmination of several factors we have been driving over the past few years. The known increases in healthcare utilization and cost have been met with a focus on serving patients in lower-cost settings of care. The ease of use for physicians and patients alike of our Zio monitor, together with iRhythm's clinical evidence with mSToPS and other trials, demonstrate Zio's ability to identify undiagnosed arrhythmias and the cost-effectiveness of a proactive arrhythmia monitoring approach. In parallel, the CAMELOT data showed that long-term continuous monitoring is associated with the lowest healthcare utilization, with Zio specifically having the highest diagnostic yield and lowest retest rates compared to competitors.

What we initially conceived as our Know Your Rhythm program for the payer channels, has been instead organically adopted by innovative value-based care organizations over the past few quarters to encapsulate proactive monitoring strategies. We've been excited by the early progress in this area as we've seen some of our top customer accounts during the Q2 prescribing Zio for proactive monitoring. Even more encouraging is that we signed a number of additional large national accounts during the Q2 with a strong pipeline that remains in place that we believe will be nice contributors of future growth. Turning to Zio AT, we continued to make progress on the remediation activities of the FDA warning letter during the quarter and submitted the first of our responses to the FDA on the two 510(k)s this week, with the second plan to be submitted shortly.

Recall that we submitted two 510(k) files in January of this year. One is a catch-up for changes previously made to the Zio AT system as a letter to file, and a second 510(k) for design features and labeling updates to further address areas of focus noted in the FDA warning letter. The agency came back with a request for data that included incremental electromagnetic compatibility or EMC testing and human factors testing around design changes made to satisfy their request. We look forward to having provided these responses in the near term and will then wait to hear back from the FDA. With respect to the FDA, the agency was on-site at our San Francisco and Orange County facilities in the back half of July. The inspections concluded yesterday with several 483 observations noted.

We are in the early stages of evaluating these, and we intend to provide responses to the FDA in a timely fashion. At a high level, the observations were primarily focused on our quality system and regulatory compliance, including complaint handling and medical device reporting, risk analysis regarding the involvement of the company's certified technicians to prepare the ECG reports, and the CAPA process. We remain committed to our customers, patient safety, quality, and compliance, and we will continue to work diligently and collaboratively to resolve the warning letter to the FDA's satisfaction. In parallel, our teams continue to work diligently to prepare for the subsequent filing of our next-generation MCT product, Zio MCT, and we continue to believe that 510(k) submission for that product will be submitted late in the H2 of 2024, following clearance of the two 510(k)s for Zio AT.

Moving to our strategic pillars for future growth, we are also making significant strides to open up new opportunities outside of our core business, beginning in the back part of this year. In Western Europe, we remain on track to launch commercial activities in four countries: the Netherlands, Austria, Switzerland, and Spain, with first patient patching anticipated before year-end 2024. We could not be more excited for the culmination of this enormous cross-functional effort that demonstrates iRhythm's commitment to introducing a better way to monitor for arrhythmias to millions more patients globally.

As we move into 2025 and beyond, commercial launch in these countries could constitute an incremental market opportunity of 1.5 million patients who could potentially benefit from Zio each year, and also represents an important lever for growth towards our $1 billion revenue target in our 2027 long-range plan. To support this broad commercial launch, we have completed 2 limited market evaluations in 5 top centers in Switzerland and Spain, continue to be very active at major European medical conferences with educational events and presentations, and have held an advisory board with 15 of Europe's leading KOLs to drive physician awareness of Zio.

In Japan, we continue to anticipate a regulatory decision by the PMDA in late 2024, representing the first step of our foray into the second-largest medical device market in the world, with approximately 1.6 million ACM tests being prescribed per year. Recall that we received a high medical needs designation from the Japanese MHLW last year and that this distinction is specific to Zio. Granted, at the recommendation of the Japanese Heart Rhythm Society, this designation has created significant interest with potential commercial partners and also has informed our regulatory submission with the PMDA. As we continue to engage with the Japanese PMDA, we have finalized our reimbursement dossier that would be submitted to the MHLW immediately following a regulatory decision. We are also pleased to note that we have now signed a letter of intent with our distribution partner in Japan.

We are actively collaborating with them to prepare for a limited market launch in the H1 of 2025 and look forward to sharing more details as we make progress in the coming months. In potential new indications, we plan to move forward with a market evaluation in obstructive sleep apnea in the United States in 2025, representing our initial foray into an adjacent indication with significant overlap in arrhythmias and a sizable unaddressed patient population. Thus far, early results from the sleep pilot that we launched in February have indicated that physician demand is high for a service that could streamline their workflow to decrease current pain points in the diagnostic journey for OSA, including insurance validation, patient facilitation, and comprehensive report delivery, all in an integrated digital platform.

Market research performed to date associated with this project has confirmed that cardiologists are likely to be early adopters of a service that combines an OSA and ACM diagnostic. A frictionless ordering process, high-quality report with clear insights, and seamless integration between the two tests were cited as key features physicians would look for in this type of service. These learnings have validated our views of the value of a technology and service platform that can serve multiple patient indications. We plan to continue building a potential product and service offering that we can then launch into market evaluation beginning in 2025. With that, I'll now turn the call over to Brice to discuss our recent financial performance.

Brice Bobzien (CFO)

Thanks, Quentin. Before discussing the quarter, I wanted to briefly address my upcoming transition from the CFO role at iRhythm. I have resided in Southern California for the past 12+ years, but I'm originally from the Midwest, where much of my immediate and extended family currently reside. Like many of us, we have loved ones who are aging and have experienced health challenges. While working and residing out of the Midwest for the past couple months, I've been able to help and support my family members directly. While providing this support, it became apparent that my family needs my focused, ongoing support firsthand. Trying to evaluate how I could continue to support family needs while also balancing the work here at iRhythm, it was clear I needed to make a decision.

With the changing landscape of my life, I've decided to step away from iRhythm to focus my attention on family. For most of my life, I've prioritized career, but priorities shift, and I need to attend to personal family matters in the near to midterm. Over the last couple of years, I have loved being a part of transforming and maturing this great company, and I'm so thankful for the truly world-class team we have built. There is so much opportunity here at iRhythm, and I am grateful to have been a part of it. I will be transitioning out of my role as CFO on August 31st, but will remain engaged for a period of time to ensure a seamless and effective transition.

There are great days ahead here at iRhythm, and I plan to have a front row seat to see us continue to be the leader in ambulatory cardiac monitoring. Turning to the quarter, as a reminder, unless otherwise noted, the financial metrics that I discussed today will be presented on a non-GAAP basis. Reconciliations to GAAP can be found in today's earnings release and on our IR website. Our Q2 2024 results demonstrated continued traction in our core markets as we achieved revenue of $148 million, representing 19.3% year-over-year growth. These results were driven by strong revenue unit growth, as well as expected improvement in our average selling price compared to the Q2 of 2023.

New store growth, with new store defined as accounts that have been open for less than 12 months, accounted for approximately 40% of our year-over-year volume growth, and home enrollment for Zio Services in the U.S. was approximately 22% of volume in the Q2. As we enhance our revenue growth strategy, our health policy teams have continued to achieve key wins that will enable expanded patient access to Zio Services. During the Q2, our market access team drove favorable negotiations with six greenfield contracts that will open up coverage for Zio for an incremental 2.9 million covered lives and have also driven updates to a number of existing coverage policies to be optimized for MCT utilization.

Additionally, our market access team, in collaboration with our health economics and outcomes research group, and supported by our CAMELOT data, successfully drove a major policy shift by a large national payer to provide favorable position for our Zio service. This new policy now allows for a 14-day long-term continuous monitoring or mobile cardiac telemetry as a step through to implantable loop recorders, and also removes the need for step therapy or prior authorization as a prerequisite for MCT coverage. This policy enables improved access to Zio products and services for over 25 million commercial and healthcare exchange members, which started June 1, 2024. In addition to being a testament to our team's tireless efforts and continued passion for supporting patients, these critical successes are an important recognition of the value that Zio products and services bring for patients and healthcare systems alike.

Gross margin for the Q2 was 69.9% ahead of expectations. As anticipated, we have started to realize the benefit of optimized efficiency from our clinical operations team and specifically from our investments into our San Francisco Center of Excellence. Additionally, we realized favorability from a couple of one-time items that we do not necessarily believe will reoccur in the future, but contributed nicely in the Q2. Furthermore, we achieved a significant operational milestone in May of 2024 with the launch of our initial phase of manufacturing automation. This project and subsequent phases of manufacturing automation will continue to enhance manufacturing scalability and margin improvement, as well as set the stage for future growth and innovation in the H2 of 2024 and beyond.

Q2 adjusted operating expenses were $125.2 million, down 0.4% sequentially and up 25.5% year-over-year, in line with our expectations. Compared to the Q2 of 2023, this increase in adjusted operating expenses was primarily due to compensation-related costs, development work for Zio MCT as we move the product closer to our regulatory submission, software development efforts to further enhance the functionality of our current and future product offerings, Epic Aura integration costs, and revenue cycle management claims processing fees. We believe that these incremental investments will continue to support our growth in future quarters. Please note that we continue to incur incremental legal and consulting fees, as well as other company expenses related to the FDA warning letter and DOJ subpoena.

Adjusted net loss in the Q2 of 2024 was approximately $18.8 million, or a loss of $0.61 per share, compared to an adjusted net loss of $13.1 million, or an adjusted net loss of $0.43 per share in the Q2 of 2023. Adjusted EBITDA in the Q2 of 2024 was $5 million, or 3.4% of revenue, compared to 3.5% in the Q2 of 2023 and -9.2% of revenue in the Q1 of 2024. This was ahead of the previously provided guidance and inclusive of funding important investments into projects that we believe will continue to drive future growth.

Turning to guidance, we are also raising our 2024 revenue outlook as presented earlier this year, and now anticipate full year revenue to range between $580 million and $590 million. We continue to believe that the year will be driven by sustained volume growth in our core US market as we continue to drive penetration in both existing and new customer accounts. As in previous years, we believe that Q3 2024 revenue will be in line with normal summer seasonality of approximately 25% of expected full year revenue. Turning to gross margin, we are raising our full year 2024 gross margin guidance to a range of 68.5%-69%, an improvement of approximately 150 basis points at midpoint compared to the full year of 2023.

We made significant progress during the Q2 with regards to clinical operations and manufacturing efficiencies and believe these are sustainable over time. However, it is important to note that we will need to continue to invest to enable future growth and do not believe that the one-time items noted previously will repeat. As such, we anticipate Q3 gross margin to be slightly down sequentially. However, we continue to believe this additional leverage will support our goal to reach 70%+ gross margin as we exit 2024.

We are also raising our adjusted EBITDA margin guidance to range between 3.5%-4% of revenues, which would represent a 450-500 basis point improvement compared to 2023, in line with our stated path to adjusted EBITDA margin targets by 2027, and driven by our focus on sustainable operating leverage improvements throughout the P&L. Looking at the cadence of margin expansion in the back half of this year, we expect to see Q3 adjusted EBITDA margin improve by approximately 150-250 basis points compared to the Q2, before expanding further in the Q4. Along with anticipated progress in gross margin efficiency, operating expenses are historically more elevated in the H1 of the year relative to revenue.

As mentioned previously, we continue to believe that there will be approximately $8 million-$10 million of costs associated with the FDA warning letter and responses to the DOJ subpoena for the full year of 2024. As we navigate these two issues, the majority of these costs will come out of the P&L in the future. Finally, we ended the Q2 in a strong financial position, with approximately $561.5 million in unrestricted cash and short-term investments. During the Q2, we began to see improvements in working capital, as anticipated. We were pleased to see cash collection improvements in the Q2, resulting from the recovery of delayed billings associated with the Change Healthcare cybersecurity attack in the Q1. We anticipate further improvements to cash collection and normalized levels of DSO as we exit 2024.

I'd now like to turn the call over to Dan for a few remarks. Dan?

Dan Wilson (EVP of Corporate Development and Investor Relations)

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

We have many initiatives in motion, and I'm excited to continue leading and supporting those efforts as we look to scale iRhythm and serve millions more patients in the future. Thank you, and I look forward to working with all of you in the new role.

Quentin Blackford (President and CEO)

Thank you, Dan. Before closing, I'd like to thank Brice for his many contributions in helping us to transform our company. While disappointed to see Brice step down, just as we're beginning to see the financial benefits of the significant transformation efforts we've embarked on over the last 30 months, I respect his decision as he deals with unfortunate personal matters at this time. Importantly, he'll be nearby as we work through this transition to Dan. Succession planning is something that we spend a good amount of time with here at iRhythm, and Dan has long been seen as a potential successor to Brice. His strong strategic financial background, in-depth knowledge of our company and industry, together with a strong relationship to our investors, will allow for a seamless transition and ensure we remain on track to delivering on the long-term financial goals that we have laid out.

That path forward is as clear as ever. The strong financial performance in the Q2 and increasing our financial guidance across all metrics demonstrate the building momentum and confidence in where we are headed. I'd like to thank Brice for his many contributions to iRhythm, and look forward to continuing to build upon that progress with Dan. Finally, I'd like to address recent activity around the Department of Justice's inquiry into iRhythm. As you'll recall, on April fourth, two thousand twenty-three, we received an inquiry from the Civil Division of the United States Department of Justice, or DOJ, seeking information and documents regarding the company's products and services. Since the DOJ's initial inquiry, we have been extremely responsive and collaborative, and we have produced a significant amount of materials with information responsive to their subpoena.

In July, the DOJ filed a petition for order to show cause, an application for enforcement of administrative subpoena, seeking the production of certain documents that the company has withheld on the basis of legal privilege. The company disagrees with the DOJ's attempt to invade the attorney-client privilege and the protection afforded to attorney work product. In partnership with our top-tier outside counsel, we determined that it is in the best interest of the company to continue to maintain our position that certain documents are privileged, not only as it pertains to this case, but for the precedent it sets in other outstanding and future matters. Our immediate next step in this process is to prepare our opposition to the DOJ's petition, and we have negotiated a briefing schedule with them directly that pushes this matter into the fall.

iRhythm's opposition brief is due on August 16, 2024, and the DOJ's reply is due September 6, 2024. At this time, we cannot speak with certainty on the focus of their investigation and prefer not to speculate. In closing, we are very pleased with the results from the H1 of this year and are incredibly excited for multiple milestones in the coming months that will enable capture of the significant opportunities that lie ahead of us. As we work to transform the company, we're continuing to drive penetration in our core commercial markets while expanding the ACM market in the U.S. more broadly. We're launching internationally in multiple countries across the globe. We're driving operational efficiency and financial sustainability, all while keeping the patients we serve in focus at all times.

As multiple vital signs and digital data assets are increasingly combined to generate clinical insights, we are excited to be a market leader in defining how monitoring could look in the next three, five, or 10 years. iRhythm is building a digital healthcare portfolio of the future, and I could not be more pleased with our unique positioning to address the Quintuple Aim of healthcare in the years to come. With that, we would now like to open the call for questions. Operator?

Operator (participant)

Thank you. Please press star followed by the number 1 if you'd like to ask a question, and ensure your device is on mute locally when it's your turn to speak. If you change your mind or your question has already been answered, you can withdraw your question by pressing star followed by the number 2. Please ask one question only, and then rejoin the queue for any additional questions. Our first question today comes from Margaret Andrew with William Blair. Please go ahead. Your line is open.

Margaret Andrew (Senior Research Analyst)

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

Brice Bobzien (CFO)

Hey, Margaret, thanks for the question. Well, look, we will respond to those observations within 15 days, so, it's got our full attention at this point in time, and obviously, where it goes from there, I can't speculate at this point in time. But, let me try to give a little bit more clarity around it. I think it's clear that the FDA is trying to define, frankly, how to regulate this relatively new category. And I think as a market leader, discussions like this are gonna be ongoing for a period of time. Keep in mind, from the warning letter, you know, in these discussions, as they continue to understand this category, a whole new code has been established as a result of those discussions.

At the end of the day, I think the fundamental issue sort of comes down to whether the IDTF, the CCTs, if you will, the clinical technicians, are they part of the product or are they not? And I think from the beginning of time, we've viewed those as separate items. And I think the FDA has a bit of a different perspective right now that we're working through. But when you start to think about those two things differently, meaning ourselves versus how the FDA may be looking at it, you start to land in different places when it comes to complaint handling or reporting or process controls and how you document those controls or how you go about your statistical techniques.

I think it's important to note, like, there is no conversations in here with the FDA, in the course of these inspections around, you know, the overall safety or efficacy of our product. That's not being discussed. It's not like it was in the initial warning letter, where there were questions around: Are you an MCT product or are you not? Or is AT a legally marketed product as a result of your letter to file approach or not? Those issues are behind us. That's not being discussed any further. This is really about how we go about identifying what complaints to report or not to report, how we document those things, and the processes set around it. So, nothing specific to safety or efficacy of the product whatsoever.

It's more about, you know, how we continue to build and make our quality systems more robust.

Margaret Andrew (Senior Research Analyst)

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

Dan Wilson (EVP of Corporate Development and Investor Relations)

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

Operator (participant)

Thank you. As a kind reminder, please limit yourself to one question and then rejoin the queue if you have any further follow-ups. Our next question comes from Allen Gong with JPMorgan. Please go ahead.

Allen Gong (VP of Equity Research)

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

You know, we've all seen the, you know, the filing by now, but just kind of the scope of what the DOJ is looking into. Thank you.

Quentin Blackford (President and CEO)

Hey, Allen, thanks for the question, and I appreciate the kind words. So first question on the one-timers that we talked about with regards to gross margins. Really a couple of different things. We've talked to the investor community about just the focus and diligence that we've placed on procurement activities and indirect procurement efficiencies that we've been drawing, you know, trying to drive as an organization. And the biggest thing was, frankly, some logistical savings that we were able to drive with regards to shipping vendors that we've been working with. We were able to get retrospective pricing dating back into Q4 of 2023, that ultimately came through in the way of a credit in the Q2.

So as you can imagine, that will sustain moving forward, but those couple of quarters of incremental benefit that we gained from that, negotiation won't necessarily repeat moving forward. And then the other one, I think that's relevant of talking about is the fact that we do have a component of our software organization that works on optimization and frankly, you know, tweaks to the edges on the solutions that are used by CCTs, as well as our intake solution, and frankly, manufacturing for that matter.

Our full focus now from a software development standpoint has really been on the development of MCT and frankly, getting it ready for that submission that is right around the corner. So we had very little of that work being done in Q2, so that reduced the cost profile a bit. We don't expect that to continue moving forward, but we're gonna continue to optimize those solutions that we have available to us. Both of those things contributed about 100 basis points of benefit in the quarter. And then I talked about the fact that we will need to continue to hire resources as we continue to scale volumes. And as we saw in Q4, you hire those resources in preparation for future volumes, and it takes a little bit of time to get them up to speed.

So those are things that aren't necessarily anything to be surprised of or one time in nature, but it's just investing ahead of the ultimate scale that you're gonna get. So that's what was going on in the quarter, and we feel great about the progress that was made there. On the SG&A side, the biggest thing is, and we talked about this, we do have some higher level costs specific to Q1 with regards to company meetings and some things that hit both selling as well as G&A. Those things don't necessarily replicate, and we communicated that as we think about, you know, H1 being a little bit higher than that of the back half.

And so you're seeing that play through in Q2, and certainly sustainable for the rest of the year, though there is some seasonality that we'll have to continue to consider as we move forward from models in 2025 and beyond.

Brice Bobzien (CFO)

Hey, Allen, and, with respect to the question on the, the scope of the DOJ, I don't think there's a whole lot more information, frankly, that we can provide you at this point. I think, you know, the set of questions or the documents they've requested are, are broad. Like we've always indicated, we haven't seen anything different, over the last, you know, several months. As a matter of fact, it had gone relatively quiet for a good period of time until they made the motion to compel these documents that we spoke to. And, to your point, with the filings being out there, you know, those documents are around quality systems, sort of design history files, of the past, you know, back in the 2016, 2017, 2018, 2019.

So, we feel very strongly that, you know, we need to try to protect that attorney-client privilege, not only for this case, but the precedent it sets with all other cases that are out there. But we've been very cooperative with them, and we've produced many, many, many, many documents, you know, everything that they've requested. And all of them, frankly, have topical, you know, matters that are the same as what's in the reports that they've requested as well. So they have this information, but this is about protecting the attorney-client privilege that we think we're entitled to. But I can't give you anything more specific than that right now. We'd be speculating, and we're not gonna speculate.

Operator (participant)

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

Marie Thibault (Managing Director and BTIG Medical Technology and Digital Health Analyst)

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

Quentin Blackford (President and CEO)

Thanks, Marie. So I think we can get to the market evaluation without a lot of incremental investment or acquisition to make that happen. In the market evaluation phase, it's really about building a front-end capability that makes it entirely seamless for the physician to ultimately identify the patient, then order the product, and behind the scenes, ensure the product gets to the patient, the data is received, we interpret it through an IDTF capability, and provide a report back through a single digital portal to the physician. So to the physician customer, it's incredibly seamless. To the patient, it's a much more efficient workflow. They don't have to leave, you know, the cardiology, go see a sleep specialist or somebody else. We introduce them to a virtual sleep capability or a home sleep test.

Out of the gate, we will leverage a third-party sleep test while we continue to build our own capabilities to diagnose sleep disease on our own. So out of the gate, we'll leverage procuring a sleep device from a third party, make that part of the iRhythm package, and ultimately, you know, provide that to the patient, collect the data, interpret the data, and provide a report back to the physician that will be packaged up as an iRhythm solution. All of that can be reimbursed, and the reimbursable rate is somewhere between $150-$200 for that sleep test and the service that we'll be providing back in the way of a report. That rate sort of ranges between CMS and commercial payers.

That's why there's a bit of a range between the $150-$200. So that's for 2-3 days of, call it, home sleep test service and the report generation. But that's how to think about it in terms of, you know, the financial model. Over time, it's our intent to continue to develop and ultimately deliver our own home sleep test capability right off of our single platform. So that'll come further down the road, and we'll step into that and really verticalize that entire offering in time, but that's not gonna hold us up in the near term.

Operator (participant)

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

David Rescott (Senior Research Analyst)

Oh, great. Thanks for taking the questions. Brice, obviously echoing kind of the best wishes to you and your family under these circumstances. Dan, congrats on the new role. I'm looking forward to working with you, even more going forward. I wanted to follow up just on the 483 comments, you know, first and curious on, you know, how these new observations impact the recently submitted 510(k)s, whether or not that has any impact on the total kind of resolution of the warning letter or the ability to, you know, submit for Zio MCT.

Then, you know, just related to that, plus the DOJ comments, I think I heard the comments around the $8 million-$10 million of the incremental spend or the spend that's in the business today. Wondering if these, you know, drag on a little bit longer, if that's the case, whether or not that impacts the longer-term view around where the EBITDA margin can go longer term. Thank you.

Quentin Blackford (President and CEO)

Sure. So, let me hit on the, the 483s, and Brice or Dan, you guys could speak to longer term view around, sort of the expense associated with this. But, with respect to the 483s, and the inspections that took place here in the back part of July, there's nothing in those discussions at all that gave us any indication or any direction to think differently around how we think about clearing the Zio AT product in those 510(k)s. So, back to my prepared remarks, we did file the response to the, the catch-up 510(k) earlier this week, and, frankly, the, the other response to the other 510(k) would have gone in as well had we not been addressing the inspection. So that got delayed just a little bit, but it's, it's nearly ready to go.

So that will get on file likely by the end of next week, or shortly thereafter, and that puts us right on track for sort of that September, October timeframe in terms of the approval of Zio AT. So nothing has changed from that perspective. And the same with Zio MCT. There's been no indication given at all that we should think differently around the Zio MCT product. Of course, we do need to see Zio AT clear or get the two clearances there, as that will be the predicate for Zio MCT. But our expectation is that we continue to get Zio MCT on file before the end of the year. One of the things that I would note, you know, skin irritation is something that has come up, you know, the investors have asked about it.

It's something that we pay close attention to, and frankly, we even had a discussion with the FDA around it. Overall, our skin irritation rate is right around 2%, which is well below published literature of what's acceptable in wearable devices. But we have seen it step up just a little bit over the last two years. You know, one of the things the FDA proactively asked us about is, you know, How quickly can you move from Zio XT on to Zio Monitor? Or once Zio MCT gets approved, how quickly could you move Zio AT on to Zio MCT? Because we know that monitor, which will be the platform for MCT, has a much lower irritation rate. So again, that's a favorable indication of moving towards these new products.

We've not been given any indication to think differently around the timeframe at this point in time. If that changes, of course, we'll have those conversations with you, but, from our perspective, nothing changes there, and we stay on track.

Brice Bobzien (CFO)

Yeah. Hey, James, question on the, or the $8 million-$10 million. You know, based on everything we know now, we, we believe that $8 million-$10 million is the appropriate way to think about it for 2024, so effectively, no deviation. With regards to what that means moving forward, we'll certainly provide feedback. As of now, I don't see any indication that this is going to extend meaningfully longer. Now, should the something, you know, creep into 2025, we'll certainly talk about that. But over time, we absolutely believe this $8 million-$10 million comes out of the spend profile and becomes a meaningful contributor to adjusted EBITDA moving forward.

Operator (participant)

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

Nathan Treybeck (Equity Research VP)

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

Quentin Blackford (President and CEO)

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

That's where it seemed to be focused, you know, to begin with, but at the same time, the document request has been broad, so we can't- I can't tell you for certainly, or for certain that that's where it's at.

Operator (participant)

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

Anthony Occhiogrosso (Equity Research Senior Associate)

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

Quentin Blackford (President and CEO)

Yeah, Anthony. Yeah, it is. That's the way we're thinking about it. Obviously, the performance in the Q2, that efficiency with regards to the 200 basis points from the clinical operations team actually played through much more quickly than what we anticipated. We saw some incredibly nice work by that team and focused just operations from that team in the Q2, and we saw that play through a bit earlier than we thought. The other thing that we saw was the manufacturing efficiency component, and not so much pure automation, but the efficiencies component play through as well in the quarter. I alluded to the fact that there were a couple of things that contributed to the benefit in the Q2.

However, that doesn't take away that 400 basis points that we laid out and where we expect to be as we exit 2024, and frankly, as we move into 2025.

Operator (participant)

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

Mike Polark (Senior Equity Research Analyst)

Hi, good afternoon. If I could sneak in, too, I'd appreciate it. The easy one is R&D. It looked to be in dollar terms, just a little lumpy than-- little higher than it has been. What is-- Is there something new in there? Is that $20 million a quarter the good run rate, or would you expect to step back down in 2H? And then the second question is, you know, my ears perked up around major policy shift from a large national payer. I heard a couple of things in there, step through for ILRs, and removing step therapy. I guess it sounds different, new, you're calling it out. Can you maybe spoon feed us what's going on there and what's changing? Thank you so much.

Quentin Blackford (President and CEO)

Hey, Mike, thanks for the questions. On the R&D side, really no major deviation from trend moving forward. I will say the expenses were higher in the quarter, most notably as we get the product ready, that being Zio MCT, ready for regulatory submission, working through human factors testing, you know, finalization of some work on the software solution side, and basically just getting in a position to ultimately file that regulatory submission. The cost was a little bit higher in the Q2. That's not something that we anticipate moving forward. We would expect to see that start to trend down in Q3 and then even further in Q4 as we get beyond that submission.

Dan Wilson (EVP of Corporate Development and Investor Relations)

Hey, Mike, it's Dan. I'll take the second question. So, glad you captured the nice wins the team drove there, on the payer side and market access side. I think it highlights, you know, the clinical and economic evidence we continue to generate and that getting recognition from the payers. There was a few different wins lumped in there, right? Some new coverage, and we sized that up to be 2.9 million new covered lives, and then some coverage policy decisions that essentially make it easier for patients to get onto Zio. So some really nice wins there.

You know, those the impact of that doesn't necessarily show up immediately, but, you know, we will see that start to show up in results, and really benefit both, you know, volumes and ASPs, you know, through time. But ultimately, those coverage policy wins absolutely make it easier for patients to get access to Zio, and that will have a long-term benefit.

Quentin Blackford (President and CEO)

Hey, Mike, one thing that I'll, I'll add to it, because I just think it, it's encouraging to see the impact that CAMELOT continues to have in this space. So many, you know, policies and time have required up to 30 days of, of monitoring before you can get onto an ILR. They are proactively moving that down to 14 days, directly in line with the Zio monitor's wear period, and that comes back to the data that's being presented in these CAMELOT studies. Again, I think it's resonating, it's leading to incremental access, it's leading to reduced hurdles to get, you know, onto the product, and it's opening up new channels. CAMELOT's been a wonderful thing for us.

Operator (participant)

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

Ravi Misra (Associate Analyst and Medtech Equity Research VP)

Hi, this is Ravi on for Rich. Thanks for taking the questions. So just two questions on our end. First, just Quentin, it sounds like the 483 observations are more kind of around workflow issues and things like that. I was hoping you could maybe talk about what you envision around risk, you know, in terms of if the discussions don't go the way you think they will. They seem pretty benign so far, at least the way you've described them. What could that mean? And then secondly, just on undiagnosed arrhythmia, I think it's something that you talked-