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Ladies and gentlemen, thank you for standing by, and welcome to the iRhythm Technologies Inc. Q4 2020 Earnings Conference Call. [Operator Instructions] Please be advised that today's call may be recorded. [Operator Instructions]
I would now like to hand the conference over to your speaker today, Leigh Salvo. Please go ahead.
Thank you, and thank you all for participating in today's call. Joining me are Mike Coyle, CEO; Doug Devine, CFO; and Dan Wilson, EVP Strategy, Corporate Development and Investor Relations.
Earlier today, iRhythm released financial results for the fourth quarter ended December 31, 2020. A copy of the press release is available on the company's website.
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, which are made 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 facts should be deemed to be forward-looking statements. All forward-looking statements, including, without limitation, those statements related to the impact of COVID-19 on our business, expectations for recovery, market opportunity, product performance, market expansion and penetration, productivity improvements, reimbursement, release of clinical data, operating trends and our future financial expectations, including revenue, gross margins, profitability and operating expenses are based upon our current estimates and various assumptions. These statements involve material 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.
In addition, we will refer to adjusted EBITDA, which is defined as EBITDA excluding stock-based compensation expense. Adjusted EBITDA is a non-GAAP measure that is used to help investors understand iRhythm's ongoing business performance. 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, with the SEC.
This conference call contains time-sensitive information and is accurate only as of the live broadcast today, February 25, 2021. iRhythm disclaims any intention or obligation, except as required by law, to update or revise financial projections or forward-looking statements, whether because of new information, future events or otherwise.
And with that, I'll turn the call over to Mike.
Thanks, Leigh. Good afternoon, and thank you all for joining us. I would like to start by reiterating how excited I am to join the iRhythm team. I've watched the company over many years as much of my career has been in the cardiovascular market and particularly in cardiac rhythm management. I have long been aware of the widespread under diagnosis and detection of life-threatening arrhythmias and the significant impact that disruptive technology can have given the well-known limitations of Holter monitors and cardiac event recorders. Appropriate diagnosis is paramount to getting the right patients to the right treatment at the right time.
iRhythm is a leader in bringing to market a differentiated platform for arrhythmia detection and patient management. We have been a pioneer in the category of long-term continuous ECG monitoring, and I truly believe that we are just getting started on the journey to change the way cardiac arrhythmias are diagnosed and managed. I see the opportunity for significant growth in our core symptomatic arrhythmia detection market, which we estimate to be a $1.8 billion opportunity and less than 20% penetrated. With this much of the market underpenetrated, we believe there is a very long runway for growth ahead. I'm equally excited about a number of other growth vectors that are rapidly emerging for our technology, including international expansion of our Zio platform and the development of the asymptomatic atrial fibrillation market. Both of these opportunities have a number of recent positive developments that are encouraging and give me confidence that this can be a material growth driver for the mid- and long-term growth.
In my prepared remarks today, I will cover recent highlights and accomplishments, developments related to our strategic initiatives, provide our current view of the market environment as we enter Q1 and provide an update on our reimbursement progress, given the recent unexpected dynamics that have risen in the Medicare segment of our business. Doug will go into more details on our financials, and then we will open the call for your questions.
Starting with our fourth quarter performance. Once again, the iRhythm team continued to rise to the challenges presented by the current environment and maintained high-quality patient care each day while building a stronger company for the future. In the short time that I've been on board, I've been very impressed by the ability of the team to innovate and adapt to ongoing uncertainties, and most importantly, the ability to deliver on the priorities established a year ago for increased market penetration of our Zio platform, increased operating leverage through continued productivity and automation improvements and expanding the addressable market into new indications and new geographies. While the COVID situation generally worsened through the quarter, we saw positive recovery trends at our accounts and the resiliency of our digital platform led to another quarter of significant growth, both sequentially and year-over-year.
In summary, total revenue in the fourth quarter was $78.8 million, reflecting year-over-year growth of 33.3% and sequential growth of 9.5% over the third quarter. As we saw in the third quarter, fourth quarter results were driven by further penetration of Zio XT in both existing and new accounts, continued ramp of Zio AT and continued utilization of our home enrollment service in telemedicine settings. We are very pleased with these results, given the challenges that remain in the market and believe that the results signify the strength of our platform and our capabilities.
The start of Q4 saw a continuation of the strong trends we saw in the prior quarter. And while parts of the United States saw a widespread surge of COVID cases in the latter half of the quarter, this had a much less significant impact on our business as our customers, our team and our business operations demonstrated resiliency and the ability to continue to provide high-quality patient care. Once again, home enrollment for our Zio service allowed physicians to deliver care in a flexible manner and partially insulated our business from negative impacts of COVID.
And through the first 2 months of 2021, we are pleased with the overall market environment and the continued demand for the Zio platform. Importantly, we are confident in our platform, our near-term -- near and midterm strategic priorities and our ability to continue to grow our share of the market. As we enter 2021, our strategic goals remain driving increased penetration of our Zio platform, increasing operating leverage while building the infrastructure to support our future growth and expanding our addressable market into new indications and geographies.
Starting with market penetration with our Zio platform. We saw significant adoption in 2020 and a continued appreciation by our customers of the meaningful clinical and economic benefits of long-term ECG monitoring and ZIO's ability to change the standard of care. The events over the past year brought to the forefront, the unique advantages of our platform relative to traditional Holter monitors. This includes being a single use, patient-friendly device, leading to high compliance rates, and of increasing importance, the ability to monitor and administer patient care remotely. Further, our 40-plus peer-reviewed publication demonstrates ZIO's superior clinical accuracy and higher diagnostic yield as well as the ability to diagnose patients earlier and more accurately, leading to reduced health care resource utilization. This body of evidence, which we continue to build on, has driven the adoption of our Zio platform across the health care ecosystem. And the flexibility of our digital platform allows for continuity of patient care, independent of patient and physician location, which has become even more important and valued by our customers throughout COVID.
Turning to Zio AT. We had another quarter of strong market traction and growth, which continues to exceed our expectations. Our single platform solution resonates with our customers and has shown important operational benefits and streamlined workflows, leading to increased patient throughput for usage of both Zio XT and Zio AT. We are focused on generating important clinical evidence to demonstrate the advantage of Zio AT relative to traditional MCT technologies and anticipate releasing data this year to help demonstrate Zio AT's clinical differentiation. In 2021, we continue to expect that Zio AT growth will outpace the growth of our overall business.
An important element of the market penetration is the continued innovation of our technology platform. Through these investments, we have continued to not only expand our competitive differentiation, but more importantly, to increase the value of the service we deliver to our customers. In 2020, we had a significant upgrade and rollout of our information system, ZioSuite, and are now live with that offering in 100% of our accounts.
Looking forward, we continue to make significant investments across our technology stack and expect to see meaningful updates within 2021. Our technology stack includes our patient database with over 750 million hours of curated ECG data, our FDA-cleared deep learned algorithm and artificial intelligence tools, our patented wearables and our clinical back end, all of which work together seamlessly to deliver a clinically superior and complete service to our customers. These elements also meaningfully differentiate our platform enabling us to maintain a strong competitive position. Through continued technology innovation, clinical evidence generation and delivering a high-quality service to our customers, we are well positioned to drive meaningful market share gains and to establish the new standard of care within ambulatory cardiac monitoring.
Our second strategic priority is around increasing our operating leverage through productivity improvements and automation, while building the infrastructure to support our future growth. For a second consecutive quarter, we delivered positive adjusted EBITDA. While we are pleased with the operating leverage demonstrated in the fourth quarter, it's important to note that our spending was adjusted in the middle of 2020 due to COVID, and is only now just starting to ramp back to levels we feel are appropriate to achieve our long-term objectives. Our focus remains on investing in the long-term growth of the business and building our infrastructure to scale the business efficiently. We plan to continue to scale and refine our commercial infrastructure to most efficiently grow our core business. In 2021, we expect to add additional territory managers to the sales organization, but at a slower rate than prior years as we expand investment to additional customer engagement modalities that can better leverage the effectiveness of our field footprint.
Along with our traditional territory manager expansion, we expect to build out important support functions, such as key account managers and EMR integration resources as we deploy strategies that provide leverage and support to our territory managers in their selling efforts. We believe these investments will further improve the productivity of our territory managers and our commercial organization and over time, lower the cost of sales.
Now turning to our third strategic priority, expanding our addressable market into new geographies and new indications. We remain excited about each of these opportunities and saw several positive developments in the last few months. I will start with our international expansion efforts and 2 positive developments within the U.K. On the heels of an important funding award as a winner of the Artificial Intelligence in Healthcare Award by the U.K.'s National Health System, we received notice in early December that Zio XT was the first technology to pass through a new digital health technology pilot, resulting in a successful recommendation for adoption from the National Institute for Health and Care Excellence or NICE. As a result, Zio XT has been included in NICE guidelines as an option for people with suspected cardiac arrhythmias who would benefit from ECG monitoring for longer than 24 hours.
In addition, we are very encouraged by the 3-year funding secured with the AI award and began contracting with and launching Zio into select NHS sites in Q4. We expect additional sites to come online in Q1. With this funding program, we will be focused on building out our commercial organization, our clinical service back end and our in-country technology platform to support the expected growth in the U.K. in 2021 and beyond. And importantly, the program will allow us to generate the clinical and economic evidence needed to achieve sustainable reimbursement in addition to offering a path to changing the standard of care within NHS. And lastly, the NICE recommendation is important validation of the cost effectiveness of the Zio XT. We plan to leverage the positive recommendation to not only drive growth of Zio in the U.K., but to selectively seek opportunities to drive into the rest of Europe and globally. We are actively developing a road map of international countries where we plan to begin market access initiatives during 2021. We are very encouraged by these recent developments and are increasingly confident that international expansion can be a meaningful contributor to growth over the long term.
Related to new indication expansion, we recently saw several important market development milestones related to asymptomatic AF. In mid-November, 3-year outcomes data from the mSToPS study designed to evaluate the detection of silent or previously undiagnosed atrial fibrillation in moderate risk individuals was presented at the American Heart Association meeting. We were very pleased with these results as the trial demonstrated that active monitoring with Zioled to a statistically significant increase in newly diagnosed AF as well as a statistically significant reduction in the incidence of major adverse cardiac events, including stroke, myocardial infarction, systemic embolism and death. In addition, it was determined that active monitoring with Zio led to fewer hospitalizations for bleeding and fewer total hospitalizations. Ultimately, the mSToPS study found that active screening for AF using Zio was associated with a significant improvement in clinical outcomes and safety at 3 years versus relative routine care. We believe these data are quite compelling and are actively engaging with payers and providers to develop real-world targeted AF detection demonstration programs.
In addition, 6-month clinical results from our SCREEN AF trial were presented at the European Stroke Organization and the World Stroke Organization 2020 Virtual Conference. Yesterday, we also announced a publication in JAMA Cardiology. The study found that Zio led to a tenfold increase in the detection of AF. 1 out of every 20 patients in the heart monitoring group was found to have a new diagnosis of AF. And as a result, 75% of those patients were subsequently prescribed oral anticoagulation medication for protection against strokes, which had been shown to reduce stroke risk in patients with confirmed AF by up to 80%. The study adds to growing evidence that Zio can be an effective screening tool for early detection of atrial fibrillation.
Clinical and economic evidence supporting the benefits of Zio monitoring in patients at elevated risk for AF continues to build across multiple studies. We continue to work with our clinical partners to see how this evidence can be pooled to draw conclusions about which patients benefit most from monitoring and how that evidence can help inform clinical practice and ultimately, practice guidelines.
Turning to our collaboration with Verily. We surpassed 2 more development milestones in Q4, and continue to make progress towards regulatory submission of our end-to-end solution. As of now, we anticipate regulatory submission midyear with regulatory clearance in late 2021 or early 2022. It is important to note that following regulatory clearance, there will be a period of market evaluation work, where we will be focused on validating the technology and the service clinically and testing the business model. We would expect these efforts to take us through at least 2022. In the meantime, we are working to make enrolled in the silent AF market with Zio, potentially laying the groundwork for the end-to-end service we are developing with Verily.
Now turning to an update on our reimbursement process. And our discussions to establish carrier pricing with the Medicare Administrative Contractors, or MACs, and commercial payers in 2021. As we have covered in prior calls, significant milestone was achieved last December, with the establishment of a category 1 permanent CPT code for extended monitoring. That is a big win for our technology and believe this will have a positive impact in patient access and physician willingness to adopt the technology over time. Last December, CMS published a decision not to apply a national price for the new category 1 codes and referred pricing decisions to the regional MACs. The MACs then separately established the rates for the category 1 codes in their regional jurisdiction.
As we announced in late January, Novitas, the MAC that oversees the region where the vast majority of our Medicare claims are processed, posted rates for the new categories 1 CPT codes that were meaningfully below the rates that have been established for our temporary category III CPT codes up until last year. The rates that Novitas published matched existing rates for CPT codes used for ECG monitoring of less than 48 hours, which are used to reimburse existing Holter technologies. Since the publishing of the rates in late January, we, along with other industry participants, have had the opportunity to meet with Novitas to provide a detailed overview of the clinical and economic benefits of long-term ECG monitoring relative to traditional Holter monitoring, the differentiated components of delivering this end-to-end service and the valuation work that formed the basis for the rough payment recommendations that were supported by AMA, ACC and HRS last year, along with our recommendation that these rates be adopted as the appropriate payment level for the new category 1 codes.
We believe the evidence that we presented was compelling, but can provide no assurances as to if and when Novitas will decide to change the proposed rates. We have greatly appreciated Novitas' level of engagement on the topic and we fully respect their evaluation process and time lines. Until we have final confirmation from Novitas as to what rates will be applied to the new codes, we will continue in the near term to deliver Zio services to Medicare patients, hold those claims pending final rates and importantly, not make any changes to our business model.
In conclusion on this topic, I'd like to say a few words about the value and importance of data in this process. Over the years, iRhythm has made substantial investment in clinical studies and cost effectiveness studies in order to demonstrate the outcomes benefits to patients and the value of the Zio XT to the health care system. The data generated in these studies validate the importance of Zio XT to the patient and to the health care system. We look forward to working with Novitas and our industry partners to ensure Medicare patients retain access to these proven benefits of long-term ECG technology and services.
Another important update I wanted to highlight is our recent completion of an extensive rebranding effort that incorporated an enhanced website and the publication of our environmental, social and governance policies. We recognize that these topics are appropriately becoming a greater focus for investors, and they have long been a part of our DNA as an organization. In our inaugural ESG report, we highlight our focus and commitment to patient safety and our customers' access to quality health care as well as our commitment to diversity and equal opportunity. We will be posting this report on our website tomorrow and are excited to share this with all of you. And most importantly, we are looking forward to further progress in our ongoing journey of being the best of corporate citizens possible.
Before I turn the call over to Doug to review our financial results in more detail, I'd like to close by discussing our outlook for 2021. While we are not in a position to provide financial guidance until we have resolution around the 2021 reimbursement, we expect to see continued strong volume growth for the business. We remain less than 20% penetrated in our core market and expect to see continued strong growth from Zio XT in new and existing accounts and even greater growth from Zio AT and from the U.K. The demand for our Zio service continues to be strong, and our customers are expanding their utilization of the service, driving Zio as the new standard of care in ambulatory cardiac monitoring.
And finally, I would like to thank the iRhythm team, our partners, our physician customers and the patients we serve for a very successful 2020 despite unprecedented challenges. Selectively, we ensure that patients have continued access to high-quality care when needed most, the resiliency and adaptability and responsiveness which is truly impressive and gives me confidence that 2021 will be another year of great accomplishments.
With that, I'd like to turn the call over to Doug. Doug?
Thanks, Mike. Our fourth quarter results demonstrated steady growth and stability. Sales metrics improved incrementally and home enrollment was once again a stable part of our mix. EBITDA remained positive.
First, let's take a look at financial highlights for the fourth quarter of 2020. Revenue increased 33.3% year-on-year and was up sequentially 9.5% quarter-on-quarter. Gross margins were 74%, down 2.5% year-on-year and 0.7% quarter-on-quarter. Adjusted EBITDA, defined as EBITDA less stock-based compensation, was $6.5 million, up $15.7 million year-on-year and down $8.3 million quarter-on-quarter. Finally, cash and short-term investments were $335 million at quarter end, up $8 million from Q3 2020.
Taking a more detailed look at the fourth quarter financial results, revenue grew incrementally in the fourth quarter with quarter-on-quarter growth of 9.5%, slightly exceeding the 2019 Q3 to Q4 growth of 8.1%. We saw less seasonal slowdown in December versus historical patterns. Revenue is now solidly above pre-COVID levels, with the fourth quarter 2020 revenue 24% above revenue in the first quarter of 2020. Zio XT volume drove the majority of our growth in the fourth quarter, while Zio AT growth continued to outpace total company revenue growth. New account onboarding improved to historical levels in Q4 compared to Q3 new account onboarding of approximately 90% of pre-COVID levels.
Looking at new store same-store mix. New store accounted 39% of year-on-year growth, down slightly from 45% in Q3, primarily due to lower new account onboarding in the second quarter of 2020. Home enrollment was steady at approximately 25% in the fourth quarter.
Turning our attention to the rest of the P&L. Gross margin in the fourth quarter of 2020 was 74%, a 0.7% decrease compared to gross margin of 74.7% in Q3 of 2020. The decrease was due to higher shipping cost to mitigate U.S. Postal Service delays and testing and overtime costs related to COVID. Comparing Q4 2020 gross margin to pre-COVID Q1 2020 gross margin of 74.7%, gross margin is down due to higher cost of home enrollment, the Zio AT ramp, expedited shipping costs and COVID-related labor and testing costs offset by cost reductions and volume benefits. Higher costs due to home enrollment decreased gross margin in Q4 2020 by 2% versus pre-COVID levels.
Operating expenses in the fourth quarter of 2020 were $67.9 million, up 16.1% from Q3 of 2020 and up 7.9% year-over-year. The sequential increase in operating expense was the result of Verily milestone costs of $4 million, restoration of the remaining COVID compensation reductions of $1.5 million, restoration of bad debt expense to normal levels, resulting in an increase of $2 million and hiring and restoration of programs, resulting in an increase of approximately $3 million, offset by reductions in stock-based compensation expenses. Comparing year-on-year OpEx, Q4 2020 OpEx was up 3.2% compared to Q4 2019, excluding Verily milestone expenses.
Verily costs included in OpEx were $4.6 million in Q4 2020 compared to $1 million in Q4 2019 and $0.5 million in Q3 2020. Verily expenses were higher in Q4 '20 due to milestone expenses of $4 million. The company expects the next Verily milestone to occur in Q2 2021.
Quarterly adjusted EBITDA was again positive in Q4 '20 at $6.5 million. Expenses reductions due to COVID were approximately $5.8 million in Q4 '20, thus EBITDA would still have been positive at $0.7 million without COVID impacts.
Finally, the net loss for the fourth quarter of 2020 was $9.7 million or a loss of $0.33 per share compared with a net loss of $17.3 million or a loss of $0.65 per share in the same period of the prior year.
Moving to internal controls. We are pleased to announce that 2 of the 3 material weaknesses from 2019 have been remediated related to the financial statement close process and accounting for revenue and related accounts receivables and reserves. We have made significant progress on the third material weakness related to the effective control environment, commensurate with our financial reporting requirements and expect to close that item in the coming quarters. The company remains committed and focused on continuing to improve our control environment and investing in our infrastructure, hiring and training to support the future growth of the company.
Turning our expectations to 2021. As Mike mentioned, due to the continuing uncertainties and reimbursement and the continued COVID-related uncertainties, we will not be issuing revenue, margin or operating expense guidance at this time. However, we can provide commentary on expected volume growth in the first quarter, gross margin puts and takes and changes in operating expenses that we have visibility to today. We intend to provide more complete guidance when reimbursement uncertainties are resolved, and we are fully able to assess the impact on our business.
For the first quarter of 2021, we expect volume growth of 5% over the fourth quarter of 2020. Gross margin is expected to continue to be impacted by the approximately 2% headwind from home enrollment costs and by COVID-related testing and overtime costs, assuming stable pricing. Additionally, we expect to launch a new manufacturing facility in 2021 to support capacity growth and future automation of our manufacturing processes. The new facility and planned automation will result in medium to long-term improvements in gross margin, but will decrease gross margin in the near term due to transition costs and initially lower facility utilization.
OpEx is expected to increase by $9 million to $11 million versus Q4 of '20 due to higher stock-based compensation expense related to the CEO transition, seasonal increases in bad debt and payroll taxes of $3 million and the ramp of hiring and investment programs, offset by the $4 million reduction in Verily milestone payments. For the full year, we expect stock-based compensation to increase by $20 million evenly throughout the year due to the CEO transition and the retention of key executives during the transition.
And finally, as an update on our claims processing, at the start of the year, as we transition to billing the new category 1 CPT codes, iRhythm is currently holding approximately 90% of 2021 year-to-date Zio XT claims. About half of these claims are being held due to ongoing negotiation with payers, with the remainder being held due to timing requirements for implementation of the new category 1 billing codes with payers. We expect the level of held claims to remain high through the end of Q1 '21. The high level of health claims will delay most Q1 '21 cash flows into Q2 '21 or potentially to Q3 '21. We have adequate balance sheet liquidity to manage through these delays and cash flow timing. The delay in commercial claims submission will most likely push some Q2 '21 revenue recognition into second half '21. Additionally, as noted previously, we are in discussions with Novitas on Medicare reimbursement levels. If these discussions do not result in updated pricing or if updated pricing is not made retroactive to January 1, 2021, we expect to recognize Medicare's Zio XT revenue at the Novitas pricing published on January 29, 2021, for the applicable time periods.
Mike, Dan and I would now like to open the call for questions. Operator?
[Operator Instructions] Our first question comes from David Lewis with Morgan Stanley.
Just maybe one for Doug, and then Mike, maybe one for you, but maybe you can pass these off a little bit here. So just on Novitas. I appreciate the commentary on the update there. When did the meeting occur? And can we roughly assume that 6 to 8 weeks is a reasonable time frame for a decision or update one way or the other from Novitas? And maybe for Doug, for you, it sounds like this Novitas decision will begin to impact kind of rev rec and bad debt around the time that you have to file the first quarter? And then I had a quick follow-up.
So thanks, David. On the question about the Novitas timing, the meetings have been relatively recent over the last 2 weeks. And in fact, there have been 2 meetings of the consortium members, industry members with Novitas. Very constructive in both meetings. We're basically not in a position to describe timing other than to say that we clearly are getting a lot of focus and attention from the Novitas team in terms of evaluating this question of the appropriate rates for these new codes. And so we expect them to be diligently working on it. So I don't have better visibility to the timing, but they seem to have a lot of effort going behind it right now.
Okay. And then Doug, that question on billing and then I have one quick follow-up after that.
Yes. So in general, our contractual allowances accounting, which impacts revenue and our bad debt expense accounting, they're 12-month averages, but they're offset by a quarter. So my comment on rev rec in Q2 is more based on that. That's -- when we close Q1, our period for averaging for doing accounting purposes is pretty much calendar year 2020. And then that rolls forward 1 quarter.
Okay. Very helpful. And then for first quarter, team, you're actually guiding above the Street for the first quarter. Just help us understand what assumptions are embedded in that number. Obviously, you have sort of a bit of a delayed billing cycle, which kind of changes how COVID impacts your business. I'm just kind of curious what assumptions you made here in the first quarter?
And then has there been any change either channel friction, tied to the reimbursement dynamics that are impacting volumes? Or any change in the competitive environment, Mike, in light of the reimbursement dynamics that are worth considering? So just broad assumptions on Q1 and then channel friction and reimbursement dynamics on the competitive environment.
Sure. Let me start with the second question, and I'll just ask Doug to comment on the assumptions in Q1. But obviously, the customers who are writing scripts for our product generally are not directly connected to the economics of it, that as we do direct bill, right, to the payers. And so it's been relatively invisible to them that this whole discussion is going on, other than the fact that they have become aware. So a number of our customers have become aware that the cross-reference pricing to Holter is a concern to them, given that clearly, they understand that, that would be below the cost of providing the service. So other than that concern, obviously, it's not hitting our volumes in any meaningful way, as you can see from the strong revenue performance during Q4 and the guidance that we're providing for Q1. Doug, you want to add anything?
Yes. Going to the other part. So the 5% volume up quarter-on-quarter, that is in reports posted, which is our standard trigger for revenue recognition. And is -- under our usual accounting flow, we recognize revenue when we post the report. And so even if you took the corner case of a normal flow of something that, say, the report posted on March 31, and we submitted to the payer 2 days into April, that would still be under our normal flow Q1 revenue. And so even though that time lag is going to be greater, we would still be recognizing any report we post in Q1 and 2Q on revenue.
Your next question comes from Robbie Marcus with JPMorgan.
Great. Maybe just to follow up on reimbursement. Mike, I was hoping when you had your discussions with Novitas, did you at least get an answer of why they decided to crosswalk to Holter monitor rates, the $310 CPT 3 code wasn't there anymore for them to crosswalk to. Is that the reason that they cross-walked it? Or anything you can give us on the rationale for choosing that rate?
It really wasn't a big focus of discussion in the meetings around why that mapping of the Holter rates went in. There -- clearly, there are administrative reasons why it was beneficial to them to have a number in there. And it's clear that the lack of the ability just to map to the existing codes because the temporary codes went away was a challenge.
But obviously, the level of attention that they are paying to understanding the differentiation of long-term ECG relative to Holter, the increased cost components that go into being able to provide that significant clinical and economic advantage relative to Holter monitoring and their interest in understanding fully the RUC recommendations and how they were based tell us that they are very clearly looking at what the right answer is for being able to put in sort of sustainable rates into those codes.
Got it. Okay. And you give us a little more detail on Verily and the rollout plans. When should we expect to be able to see a mockup of the product to get more information on the details and sensitivity of the product and a little more color into the new business model?
Well, as we said in the body of the prepared text, we expect to be seeing a regulatory submission here midyear and likely regulatory approval of both the form factor itself, so the sensor as well as the supporting AI-enabled diagnostic software by either late this calendar year or early next calendar year. And that would be the time for us to talk about the form factor and the design. But clearly, as we mentioned in the body of the text, the work that we will be doing clinically with that will be really to evaluate its applicability, its performance. This is a whole new way of doing detection of atrial fibrillation. We're going to want to assess the business model. And so the work that we will do clinically after the approval is really in support of just understanding the technology and understanding the economics and the business model so that we can support a reimbursement strategy.
Okay. So we won't see it or get any sort of insight into data versus Zio until around submission later this year?
Right. And then mostly, we're really just going to be focusing on doing the clinical evaluation. So we're not talking about a commercial rollout even after those approvals.
Our next question comes from Margaret Kaczor with William Blair.
This is Brandon on for Margaret. First, I just wanted to ask a question around guidance and reimbursement. Just to be specific, is the lack of guidance or the inability to provide guidance at this point due to uncertainty in rates with Medicare? Or is it also uncertainty in some rates with the private commercial side as well?
Well, the guidance that we have is a volume expectation, right, in terms of what we expect to see in terms of sort of registration growth, and so we are providing a view of what we see the primary demand for the product is. The question will be, of course, what rate to apply for the Medicare business, given where the current Novitas rates are. And obviously, when that is clarified, then we will be able to make an assessment of any potential [indiscernible] effect onto the commercial side of the business. But the open item here is the rates that will be applied to the Novitas business.
The other piece I would just point to is having some level of uncertainty to it as how quickly we emerge from the holding of the claims as we bring on these CPT 1 codes on the -- into customer contracts across our commercial direct bill customer base. This is a timing aspect from the standpoint that the whole process involves, obviously, having to take every one of those contracts and map them from the old codes into the new CPT 1 codes.
That process involves, obviously, agreeing on a price for those new contracts, it involves setting up the IT systems for the commercial payers to be able to accept our claims and then to do testing to make sure that before we send large numbers of claims into the system that everything is working the way it needs to work. And that is a multi-week process even after we get a signed agreement to actually bring up to speed each of these payers onto the new systems. And so the timing of that is going to be what determines when we essentially are able to completely have our claims submitted, and that will then normalize our revenue flow.
Okay. And just to clarify, part of, I guess, what I was trying to ask was, are you seeing any of the commercial payers follow the decision that Novitas had put out there a month or 2 ago?
So as we watch in our discussions of converting over to the CPT 1 code with the commercial payers, generally, what we're seeing is those conversions being done at essentially the same prices that we have today. So we do obviously see customers who are aware of the ongoing discussions with Novitas. Some of them have indicated that they're going to go ahead with these contracts, but they will be looking to see where those new rates come in to decide if they want to sort of reopen discussions. But the majority of the accounts that we have today are essentially very long-term relationships that we've had at existing pricing, and most of those conversions are taking place at essentially the same price levels.
Okay. And then the last one for me, maybe for Doug on the manufacturing facility. Are there any kind of qualitative benefits you can give us, maybe what will the output of the new facility be? What would the CapEx be on building this facility out? And maybe is there a meaningful headcount reduction? Anything like that to kind of get us a little bit of details on how meaningful the new facility could be?
Sorry. I unmuted the wrong phone. Okay. So going back to the comments that I made in the prepared remarks, this is going to be a bit of a cost drag decrease to margin structure in the short term, I mean, partially because we're going to be operating 2 facilities for a period of time. And partially, it will take time to ramp it up. We'll give you more details on the CapEx and the cost, although this is not a CapEx-intensive business. So the number is not going to be huge in terms of the CapEx.
In the longer term, this is going to -- the medium to long term, this is going to enable us, and we do plan to substantially -- introduce substantially greater automation into our workflow. As I emphasized before, that's medium to long term, that's not in the short term where that's going to happen. In terms of capacity sizing, you're talking the new facility, we're not going to build out the -- purchase all the capital to build out the new facility to its ultimate capacity immediately. Of course, we're going to bring on capacity and capital investments with our volume growth, but this facility will be able to go to ballpark 5x more volume than the current facility.
Our next question comes from Kaila Krum with Truist.
So I just want to be clear on the revenue recognition commentary. I mean, if Novitas doesn't update its rates by the end of March, it sounds like the plan is still to submit these claims to Novitas and recognize revenue at the $43 rate? First, is that right? Or could you and would you hold those claims into the second quarter?
Let me ask Doug, just to comment on the timing of the revenue recognition.
Yes. So first, on the claims piece, with Novitas and with most, but not all of our payers, we have up to 12 months to submit the claim. So there is no -- particularly with Novitas, there's no looming deadline to submit the claims. And then really -- and if we were to get a new price after March 31, but before we had closed the books on Q1 and that price was to be retroactive to some -- ideally to January 1, then we would be able to use the new price in those circumstances.
Got it. Okay. That makes sense. And then I just -- you guys mentioned your hospital customers are concerned about the lower reimbursement rate. So I guess, are you seeing hospitals step up as advocate here, too? I'm just curious how they're responding to this news.
So both the American College of Cardiology and the Heart Rhythm Society submitted letters to Novitas restating their support for the RUC recommendations on pricing. And obviously, in the process, all that -- also validating the importance of long-term ECG technology to their clinical practice. And that was a response from -- driven by multiple members in each of those societies reaching out to ACC and HRS to ask them to do that. So there is strong advocacy as there was in the RUC process from ACC and HRS, and we're very appreciative of our customers and those societies, in particular, for helping advocate for this important technology.
Great. No, that's super helpful color. And then just a last one for me. I mean it's -- quite a few of your competitors at this point have either been acquired or they're expected to be acquired with deals closing by mid year. So can you just speak to some of the opportunities and risks around the recent consolidation in this space? And just how you're thinking about the competitive environment evolving over the next 12 to 18 months?
Sure. Thanks, Kaila. Well, obviously, it was a bit of a surprise to see our 3 biggest competitors or 3 most important competitors all being acquired in a fairly short period of time. And what was particularly interesting is the commentary by the acquirers, all focusing on different reasons as to why they found the opportunity to be compelling. I think the one thing we take away from it is number one, it's a validation of the importance of the long-term ECG technologies as being a real sort of new standard relative to the very large Holter and event monitor shares that exist in the U.S. Also several of those acquirers indicated an interest in really helping to drive the adoption internationally. And that I think can only be helpful to a company like iRhythm with limited presences if we have much larger players advocating for why the Holter and event monitor market should be replaced with these much more diagnostically effective approaches to identifying arrhythmias. It can only be helpful to us. And then obviously, the -- I mean, that's true in the U.S. as well.
And then I think the other thing it does for us is by having more larger voices speaking to the fact that this conversion should take place more rapidly, the fact that we have a very clear lead, and I would almost call it a multiyear lead in terms of all the aspects of our innovation stack, I think it's going to be very helpful to us. Now I don't underestimate the fact that some of these acquirers have large footprint presence in things like the primary care market or with physicians, thought-leading physicians in the electrophysiology area. But I think the differentiation of our offering is such that I think we're going to really benefit from just having much more, let's say, time and attention being paid from a promotional standpoint to the space.
Our next question comes from Marie Thibault with BTIG.
I wanted to ask just one on the claims side, a little bit in the nitty-gritty in the weeds here, but I wanted to see if I could get a sense of how likely it is that Novitas would be willing to make this retroactive, if you have any insight into their past experience there? And then one for Doug. What is the latest that iRhythm is able to close their books for Q1? I know that's very detailed.
Doug, you want to take the second one and then I'll...
It's -- I mean, you'd have to back up about 2 weeks from the Q filing.
Okay. And then on the question relative to Novitas in terms of -- I'm sorry, could you just repeat the?
Yes. The possibility of new pricing being retroactive. Do they do that typically? Or would that be unconventional? Any insight into that?
It's our understanding that they have full flexibility to implement pricing changes into their schedules at any point and make it retroactive if they choose to do so. And it's been clear in our interactions with Novitas. What they're interested in is making sure that Medicare patients get served with the right technology at a fair price to the Medicare system. So to the extent they think that they've arrived at a fair price, it would not be outside of what they have indicated to us to make it sort of appropriate for the time period. But I have to stress that that's completely at their discretion. And while they have the capacity to do that, we have no way of knowing now whether they would choose to do that when they arrive at final pricing.
Okay. That's very helpful and understood. And then one on the business here. I was pleased to hear that December, you were less impacted than some other businesses. And I know you cited home enrollment is one of the reasons for that. Any other drivers of that volume growth that sequential volume growth despite the COVID headwinds?
Well, of course, that is a continuation of a trend that we've had in terms of sort of an improving situation around new account openings. I think we mentioned that we were very encouraged by the fact that we now had new account openings back to pre-COVID levels, after some pretty significant declines in new -- or a lack of opening of new accounts in Q2 and then Q3. So obviously, that momentum is helping us. And of course, that this is a pipeline business. So as we're able to open those new accounts, it pays dividends to us out 2, 3 and 4 quarters down the road.
But I think the primary opportunity here is that there is just a lot of customer enthusiasm for the benefits, the clinical and economic benefits of long-term ECG versus Holter monitoring. And that's just a continuation of the trend that got a little interrupted for COVID for a very short period of time, but just continues to now drive adoption of the technology, where we remain less than 20% penetrated into the market.
Your next question comes from Bill Plovanic with Canaccord.
First is just to level set us. I just want to be clear that Novitas pricing, CMS is about 25% of your business. And then secondly, on the Level 1 CPT code, that impacts the other contracts because they need to be renegotiated because you have the new level CP -- 1 level CPT code. So all your other commercial contracts and other types of contracts. Is that -- am I -- is that level set? Am I correct in those statements?
That is correct. Roughly 25% of our business is in Medicare. And that is what the Novitas discussion is about. On the CPT 1 code conversion, all of our direct bill private customers, so private payers have to reset their contracts because now this new code exists and is what is being built under. So each one of them has to essentially adopt a new contract with us that recognizes those codes or how we're going to be doing the billing.
And then just I want to make sure I understood the statement of -- in terms of the billing and using 12-month averages, that's offset by a quarter. So if you haven't gotten the final payment rate from Novitas by the end of the quarter, you would use the 2020 average payment rate for all your contracts, including CMS, for the first quarter? Is that accurate? Or would you use the new lower rate if you didn't get it by the time you need to close the books to close the first quarter? And I understand that you don't -- you wouldn't send the invoices out because you book revenues when you post the reports?
So let me ask Doug to take that.
Sorry, there was a little bit of a mixing of apples and oranges there. There's 2 different components here. I mean, so the first is we invoice our payers at an agreed-upon rate. For various reasons, which are all grouped together as contractual allowances, our payers either adjudicate to a lower amount or in some cases, they will deny the claim for more information, for medical necessity, et cetera. And so as I was talking about the impacts of the delayed claims on revenue recognition, it's on that latter part of what percentage of our revenue basically is taken away from these contractual allowances. And if we don't submit the claims -- if we're very delayed in submitting the claims, then obviously, there's the initial amount that is adjudicated on the first submission of the claims and then in a substantial number of our cases, we resubmit with more information to address the payers' concern.
But the issue with contractual allowances and the delayed claims is that you're not going to -- if you submit the claim a month -- I mean, a quarter late, because of these various issues, you don't have time to work those contractual allowances issues. And so we could be facing temporarily until we get caught up on claims, a significantly larger contractual allowance percentage than has been our historical average. So that's -- so separate the 2 from when we can invoice and the impact to contractual allowances, the percentage of our revenue -- commercial revenue that contractual allowances reduce that revenue by.
I understand. But I guess the simple thing, I'm trying to ask, I'm sorry if I'm not understanding it is when you -- for Q1, if you don't have the final Novitas number, would you book revenue under the assumption that it's the lower number for Q1 for -- in terms of just closing the books? Is that how you'd move forward and then you -- when you do finally kind of collect it or it all gets fixed, you would just adjust it in the future? I'm just trying to understand -- trying to figure out Q1 is what I'm just trying to figure out.
So we switched from a category 3 code to a category 1 code, January 1. We cannot, under any circumstances, continue to bill Novitas for the category 3 code. That one is no longer in service. So as we talked about before, if Novitas -- Novitas has published an official price. So that price is what we would have to recognize revenue at, unless they publish a new price, as we are certainly hoping they will. And then when they publish the new price, if they make it retroactive to January 1 or some other date, then we would be able to use that new price to recognize revenue. And then even if the quarter has ended, we would be able to go back and do the catch-up transaction in the second quarter in that case. But in the absence of a new -- as I said in my prepared comments, in the absence of a new price, there is an official Novitas price for the new category 1 code. And that is the price we would have to use in the absence of a new price -- that price being updated.
Great. And then does -- in terms of the discussions, and I don't know if you can answer this or expand on this. But is there a discussion with less than 7 days versus greater than 7 days of re separating that out? And then lastly, just with the SCREEN AF published, does that have any impact on the payer discussions? And that's all I have.
Yes. So on the question of SCREEN AF, that is new data on the asymptomatic AF opportunity. So it's not particularly relevant to the payer discussions other than the fact that clearly, linking to the mSToPS data, we're able to show clinical outcome benefits associated with long-term ECG that simply aren't available from the Holter technologies. And then I'm sorry, could you just repeat the first question you had?
In the discussions with Novitas, they basically gave 1 rate for less than 7 days and greater than 7 days. In terms of the discussions, do you think that, that -- as you go through this, are they looking at under 7 days and greater 7 days? Or is it looked at 1 bucket? Any color would be helpful.
So certainly, there are 2 codes that have to be assigned a rate, right? So we basically presented data during the discussion that showed higher resource intensity associated with the longer-term code, right? So you have essentially more than twice the level of data that you're having to adjudicate. It's much more complex with the longer runs of data. And so the oversight of the certified cardiac technologies is actually greater in those longer codes.
And so we highlighted the cost differential associated with just providing that service for the longer code. Now whether that winds up resulting from -- in 2 different rates for those 2 different codes, will be entirely up to Novitas, but it clearly was discussed in our meetings as 2 sort of distinct code requirements.
Our next question comes from Suraj Kalia with Oppenheimer.
Mike, Doug, can you hear me all right?
Yes, we can.
Perfect. So Mike, Doug, forgive me for belaboring this. It's been a -- quite a confusing set of commentaries. So I'm just trying to get my head wrapped around. So Mike, let's do it this way. Just piggybacking on what Bill's question was. If we don't have updated rates from Novitas by April, let's say, is it safe to say we are headed towards the CMS proposal then? It's essentially too late and there is a chance now we are headed into that CMS cycle. Is that even a possibility?
Well, I think it's fair to look at these 2 as 2 distinct work streams, right? Novitas is basically looking at the pricing of codes that are in their system, and they have full autonomy to decide how they want to determine, what methodologies they want to use to determine, what the appropriate rates should be for those 2 new codes. And obviously, they've engaged with us as an industry consortium to discuss it in detail. So that's a work stream we would expect they are going to pursue and then decide what the answer is, whether they leave the code where it is, whether they accept the recommendations of the RUC process or whether they arrive at a different methodology for arriving at their rates. That seems to be a distinct work stream.
The second, obviously, is the CMS work stream around the potential for a national price to these codes. And that's a process that is really now entering into a meaningful comment period in March where we will avail ourselves of the opportunity to provide additional data and methodologies for being able to revisit the question of whether a national price can be established. And we will do that independent of the Novitas activities. Now whether there's interaction between those 2 things after Novitas rate has been set, I don't know, but we are certainly pursuing them as 2 very distinct work streams.
Got it. Mike, you mentioned about a consortium you met with Novitas, I believe, a couple of weeks ago. Forgive me if I got that wrong. The fundamental question, I think, so all of us are trying to figure out were any invoices provided by any of the participants in this -- in these meetings? That seems to be sort of the hiccup in this whole process that could yield tangible results pretty quickly. I'd love to get your comments on that.
Sure. I think one of the benefits of having the 4 largest producers of the -- or suppliers of the service available, and the 4 companies who are involved in these discussions represent about 97% of the billing under the old temporary code with iRhythm, frankly, representing about 85% of that. But all of the major players who actually provide the service has called out for the code were there. And all of us were able to identify the key components of being able to successfully deliver that service, as inclusive of a patch technology that can reliably provide 14-day data with high patient compliance and is labeled as such by the FDA. That when you start to talk about that length of a period of time for collecting, what is essentially 1.5 million cardiac cycles that then have to be analyzed. Doing that in the manual process or with a base Holter-like software approach simply doesn't work because of the complexity and massive amount of data that's being analyzed.
So having an advanced analytic platform, and in our case, driven by AI and machine learned algorithms is critical to being able to have an efficient identification in a sensitive way of where there could be potentially risk -- high-risk rhythms in that 14 days of code. You may only be looking for 5 or 8 minutes of time over that entire period. And being able to find it with high sensitivity requires these advanced analytics.
And then once those areas of potential risk or of concerned parts of the electrogram, you need a team of highly trained individuals who could then look at those data and make conclusions about, in our case, 13 different potential arrhythmias that could exist versus what you would typically see with a Holter, which is about 4. So the idea of a patch being identified at some cost point that is in part of a fully integrated system. It isn't going to get you the fundamental report that is what becomes useful for the physician enable in determining whether there is actionable rhythms there and what that action should be. And obviously, that's where the fully integrated long-term ECG technology comes in. And all of the players in the space would point to the fact that having these fully integrated systems is what's important to be able to get the outcome that the code is looking for.
Got it. Doug, one final question and I'll hop back in queue. Again, please forgive me. Just trying to get my arms around all the commentary. So there are a sort of percent of direct commercial contracts that are indexed to Medicare, and you all are holding back claims on that also. Did I get that right? Or no?
So I mean first, there's 2 reasons that we're holding back claims. I mean, one is that the contract is in negotiation. And the other one is that at least hasn't been signed. I mean there's cases where we're in verbal agreement but haven't inked the agreement. But then after that, the payer IT has to implement this, payer IT's are -- that's not a matter of days. That's often a matter of weeks, even months for payer IT departments to implement the new contract. And then we go through a testing process because we, of course, will send through like a half a dozen claims and make sure they adjudicate properly before -- if we've got thousands of claims rather than risk there being a glitch. So it's roughly evenly split between the 2 of those of places where we're in agreement, but we're still going through that administrative and IT portion and places where we're holding the claims because we haven't reached an agreement yet although Novitas being the larger fraction of that.
Doug, would this approach be more -- I mean, it comes across as a negotiating tool in terms of holding back claims, right? The reverse would also be true. Let's say, I agree on your $43 price target, right, to file a claim today. I get a certain revenue level, fine. I fundamentally don't like the dollar amount but then when I argued on the same premise that what you all are doing today, but then let's say, whatever time frame it gets reset then you can come back and do it retroactively also. Am I right in thinking the reason -- and rightfully so should be -- if I accept the price right now, my negotiating leverage in essence, it gets weakened?
Let me say that there's -- that's not an angle here. This is purely administrative that if they change the price, I mean even if we -- I could go ahead and submit all the claims at the current price. And if they change the price and make it retroactive to Jan 1, I will be able to resubmit the claims at the new higher price and collect the differential. So I'm not losing or gaining anything by holding other than the fact that it's administratively much more time-consuming and resource consuming to submit the claim twice versus once.
And the one thing I would just point out is that what's going on here is a good faith negotiation between Novitas and the industry around what the appropriate level of these payments should be for these new codes. I mean there's nothing else going on, and we're very focused on respecting the process that Novitas has and providing them all the information they need to be able to make the decision as timely a fashion as we can all have it. So that's really all that's going on.
I would now like to turn the call back over to Mike Coyle for any further remarks.
Thank you all very much. Obviously, very exciting for me for my first earnings call to be with you all and we appreciate all the time and attention you focused on the company, and we look forward to our future communications that will be coming up in future months. So thank you all very much.
Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.