UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

_______________________________________________________________________

Form 10-Q

_______________________________________________________________________

(Mark One)

☑ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2021

OR

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 001-37918

_______________________________________________________________________

iRhythm Technologies, Inc.

(Exact Name of Registrant as Specified in its Charter)

_______________________________________________________________________

Delaware		20-8149544
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)
699 8th Street Suite 600
San Francisco,	California	94103
(Address of Principal Executive Offices)		(Zip Code)

(415) 632-5700

(Registrant’s Telephone Number, Including Area Code)

_______________________________________________________________________

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☑    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☑    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	☑	Accelerated filer	☐
Non-accelerated filer	☐	Smaller reporting company	☐
Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☑ 

As of April 30, 2021, the number of outstanding shares of the registrant’s common stock, par value $0.001 per share, was 29,303,050.

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading Symbol	Name of each exchange on which registered
Common Stock, Par Value $.001 Per Share	IRTC	The Nasdaq Stock Market

IRHYTHM TECHNOLOGIES, INC.

TABLE OF CONTENTS

	Page No
PART I. FINANCIAL INFORMATION	1
Item 1. Financial Statements (Unaudited):	1
Condensed Consolidated Balance Sheets	1
Condensed Consolidated Statements of Operations	2
Condensed Consolidated Statements of Comprehensive Loss	3
Condensed Consolidated Statements of Cash Flows	4
Condensed Consolidated Statements of Stockholders’ Equity	5
Notes to Condensed Consolidated Financial Statements	6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
Item 3. Quantitative and Qualitative Disclosures About Market Risk	30
Item 4. Controls and Procedures	30
PART II. OTHER INFORMATION	33
Item 1. Legal Proceedings	30
Item 1A. Risk Factors	30
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	56
Item 3. Defaults Upon Senior Securities	56
Item 4. Mine Safety Disclosures	56
Item 5. Other Information	56
Item 6. Exhibits	56
Exhibit Index	67
Signatures	69

i

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements concerning our business, operations and financial performance and condition, as well as our plans, objectives and expectations for our business, operations and financial performance and condition. Any statements contained herein that are not statements of historical facts may be deemed to be forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “anticipate,” “assume,” “believe,” “contemplate,” “continue,” “could,” “due,” “estimate,” “expect,” “goal,” “intend,” “may,” “objective,” “plan,” “predict,” “potential,” “positioned,” “seek,” “should,” “target,” “will,” “would” and other similar expressions that are predictions of or indicate future events and future trends, or the negative of these terms or other comparable terminology. These forward-looking statements include, but are not limited to, statements about:

•the impact of the COVID-19 pandemic on our operations and financial results;

•plans to conduct further clinical studies;

•our plans to modify our current products, or develop new products, to address additional indications;

•the expected growth of our business and our organization;

•our expectations regarding government and third-party payor coverage and reimbursement;

•our expectations regarding the size of our sales organization and expansion of our sales and marketing efforts in international geographies;

•our expectations regarding revenue, cost of revenue, cost of service per device, operating expenses, including research and development expense, sales and marketing expense and general and administrative expenses;

•our ability to retain and recruit key personnel, including the continued development of a sales and marketing infrastructure;

•our ability to obtain and maintain intellectual property protection for our products;

•our estimates of our expenses, ongoing losses, future revenue, capital requirements and our needs for, or ability to obtain, additional financing;

•our ability to identify and develop new and planned products and acquire new products;

•our ability to remediate our material weaknesses over financial reporting;

•our financial performance; and

•developments and projections relating to our competitors or our industry.

We believe that it is important to communicate our future expectations to our investors. However, there may be events in the future that we are not able to accurately predict or control and that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. These forward-looking statements are based on management’s current expectations, estimates, forecasts and projections about our business and the industry in which we operate and management’s beliefs and assumptions and are not guarantees of future performance or development and involve known and unknown risks, uncertainties and other factors that are in some cases beyond our control. As a result, any or all of our forward-looking statements in this Quarterly Report on Form 10-Q may turn out to be inaccurate. Factors that may cause actual results to differ materially from current expectations include, among other things, those listed under “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Potential investors are urged to consider these factors carefully in evaluating the forward-looking statements. These forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q. We assume no obligation to update or revise these forward-looking statements for any reason, even if new information becomes available in the future.

You should not rely upon forward-looking statements as predictions of future events. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee that the future results, levels of activity, performance or events and circumstances reflected in the forward-looking statements will be achieved or occur. We undertake no obligation to update publicly any forward-looking statements for any reason after the date of this Quarterly Report on Form 10-Q to conform these statements to actual results or to changes in our expectations.

You should read this Quarterly Report on Form 10-Q and the documents that we reference in this Quarterly Report on Form 10-Q and have filed with the SEC as exhibits to the Quarterly Report on Form 10-Q with the understanding that our actual future results, levels of activity, performance and events and circumstances may be materially different from what we expect.

ii

PART I. FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

IRHYTHM TECHNOLOGIES, INC.

Condensed Consolidated Balance Sheets

(Unaudited)

(In thousands, except share and per share data)

	March 31, 2021		December 31, 2020
Assets
Current assets:
Cash and cash equivalents	$	137,375	$	88,628
Short-term investments	124,911		246,589
Accounts receivable, net of allowances for doubtful accounts of $12,760 and $12,711 as of March 31, 2021 and December 31, 2020, respectively	59,982		29,932
Inventory	6,863		5,313
Prepaid expenses and other current assets	6,975		7,363
Total current assets	336,106		377,825
Property and equipment, net	37,447		34,247
Operating lease right-of-use assets	89,206		84,714
Goodwill	862		862
Other assets	14,866		14,091
Total assets	$	478,487	$	511,739
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	5,152	$	4,365
Accrued liabilities	36,260		40,532
Deferred revenue	1,425		930
Debt, current portion	11,667		11,667
Operating lease liabilities, current portion	4,878		8,171
Total current liabilities	59,382		65,665
Debt, noncurrent portion	18,427		21,339
Other noncurrent liabilities	1,836		1,830
Operating lease liabilities, noncurrent portion	89,270		81,293
Total liabilities	168,915		170,127
Commitments and contingencies (Note 6)
Stockholders’ equity:
Preferred stock, $0.001 par value – 5,000,000 shares authorized at March 31, 2021 and December 31, 2020; and none issued and outstanding at March 31, 2021  and December 31, 2020	—		—
Common stock, $0.001 par value – 100,000,000 shares authorized at March 31, 2021 and December 31, 2020; 29,287,749 and 29,019,350 shares issued and outstanding at March 31, 2021 and December 31, 2020, respectively	27		27
Additional paid-in capital	641,996		646,258
Accumulated other comprehensive income	12		11
Accumulated deficit	(332,463)		(304,684)
Total stockholders’ equity	309,572		341,612
Total liabilities and stockholders’ equity	$	478,487	$	511,739

The accompanying notes are an integral part of these condensed consolidated financial statements.

1

IRHYTHM TECHNOLOGIES, INC.

Condensed Consolidated Statements of Operations

(Unaudited)

(In thousands, except share and per share data)

	Three Months Ended March 31,
	2021		2020
Revenue, net	$	74,311	$	63,535
Cost of revenue	23,458		16,063
Gross profit	50,853		47,472
Operating expenses:
Research and development	8,510		8,415
Selling, general and administrative	69,813		48,230
Total operating expenses	78,323		56,645
Loss from operations	(27,470)		(9,173)
Interest expense	(335)		(380)
Other income, net	124		505
Loss before income taxes	(27,681)		(9,048)
Income tax provision	98		17
Net loss	$	(27,779)	$	(9,065)
Net loss per common share, basic and diluted	$	(0.95)	$	(0.34)
Weighted-average shares, basic and diluted	29,164,430		26,839,870

The accompanying notes are an integral part of these condensed consolidated financial statements.

2

IRHYTHM TECHNOLOGIES, INC.

Condensed Consolidated Statements of Comprehensive Loss

(Unaudited)

(In thousands)

	Three Months Ended March 31,
	2021		2020
Net loss	$	(27,779)	$	(9,065)
Other comprehensive income:
Net change in unrealized gains on available-for-sale securities	1		282
Comprehensive loss	$	(27,778)	$	(8,783)

The accompanying notes are an integral part of these condensed consolidated financial statements.

3

IRHYTHM TECHNOLOGIES, INC.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)

	Three Months Ended March 31,
	2021		2020
Cash flows from operating activities
Net loss	$	(27,779)	$	(9,065)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	2,036		1,551
Stock-based compensation	20,230		305
Accretion of discounts on investments, net and other	498		(167)
Provision for doubtful accounts and contractual allowances	9,768		9,184
Amortization of operating lease right-of-use assets	1,555		1,495
Changes in operating assets and liabilities:
Accounts receivable	(39,818)		(9,989)
Inventory	(1,608)		(191)
Prepaid expenses and other current assets	387		114
Other assets	(775)		(2,002)
Accounts payable	673		(2,835)
Accrued liabilities	(6,140)		(9,467)
Deferred revenue	495		(136)
Operating lease liabilities	(1,364)		(1,163)
Net cash used in operating activities	(41,842)		(22,366)
Cash flows from investing activities
Purchases of property and equipment	(4,211)		(3,405)
Purchases of available-for-sale investments	(30,054)		(8,009)
Sales of available-for-sale investments	—		14,525
Maturities of available-for-sale investments	151,300		56,800
Net cash provided by investing activities	117,035		59,911
Cash flows from financing activities
Payment of long term debt	(2,917)		—
Proceeds from issuance of common stock in connection with employee equity incentive plans	1,576		2,969
Tax withholding upon vesting of restricted stock awards	(25,105)		(4,462)
Net cash used in financing activities	(26,446)		(1,493)
Net increase in cash and cash equivalents	48,747		36,052
Cash and cash equivalents beginning of period	88,628		20,462
Cash and cash equivalents end of period	$	137,375	$	56,514
Supplemental disclosures of cash flow information
Interest paid	$	331	$	394
Non-cash investing and financing activities
Property and equipment costs included in accounts payable and accrued liabilities	$	115	$	136
Right-of-use assets obtained in exchange for new operating lease liabilities	$	5,757	$	621
Capitalized stock-based compensation	$	911	$	—

The accompanying notes are an integral part of these condensed consolidated financial statements.

4

IRHYTHM TECHNOLOGIES, INC.

Condensed Consolidated Statement of Stockholders’ Equity

(Unaudited)

(In thousands, except share data)

	Common Stock							Accumulated Other		Total
	Shares	Amount		Additional Paid-In Capital		Accumulated Deficit		Comprehensive Income		Stockholders' Equity
Balances at December 31, 2019	26,682,720	$	25	$	395,695	$	(260,393)	$	82	$	135,409
Issuance of common stock in connection with employee equity incentive plans, net	344,255	—		2,969		—		—		2,969
Tax withholding upon vesting of restricted stock awards	—	—		(4,462)		—		—		(4,462)
Stock-based compensation expense	—	—		305		—		—		305
Accounting Standards Codification 326 cumulative effect adjustment upon adoption	—	—		—		(461)		—		(461)
Net loss	—	—		—		(9,065)		—		(9,065)
Net change in unrealized gain on investments	—	—		—		—		282		282
Balances at March 31, 2020	27,026,975	$	25	$	394,507	$	(269,919)	$	364	$	124,977

	Common Stock							Accumulated Other		Total
	Shares	Amount		Additional Paid-In Capital		Accumulated Deficit		Comprehensive Income		Stockholders' Equity
Balances at December 31, 2020	29,019,350	$	27	$	646,258	$	(304,684)	$	11	$	341,612
Issuance of common stock in connection with employee equity incentive plans, net	268,399	—		1,576		—		—		1,576
Tax withholding upon vesting of restricted stock awards	—	—		(25,105)		—		—		(25,105)
Stock-based compensation expense	—	—		19,267		—		—		19,267
Net loss	—	—		—		(27,779)		—		(27,779)
Net change in unrealized gain on investments	—	—		—		—		1		1
Balances at March 31, 2021	29,287,749	$	27	$	641,996	$	(332,463)	$	12	$	309,572

The accompanying notes are an integral part of these condensed consolidated financial statements.

5

IRHYTHM TECHNOLOGIES, INC.

Notes to the Unaudited Condensed Consolidated Financial Statements

1. Organization and Description of Business

iRhythm Technologies, Inc. (the “Company”) was incorporated in the state of Delaware in September 2006. The Company is a digital healthcare company redefining the way cardiac arrhythmias are clinically diagnosed by combining wearable biosensing technology with cloud-based data analytics and deep-learning capabilities. The Company began commercial operations in the United States in 2009 following clearance by the U.S. Food and Drug Administration.

    The Company is headquartered in San Francisco, California, which also serves as a clinical center. The Company has additional clinical centers in Lincolnshire, Illinois and Houston, Texas and a manufacturing facility in Cypress, California. In March 2016, the Company formed a wholly-owned subsidiary in the United Kingdom. The Company manages its operations as a single operating segment. Substantially all of the Company’s assets are maintained in the United States. The Company derives substantially all of its revenue from sales to customers in the United States.

On August 21, 2020, the Company issued and sold an aggregate of 1,257,142 shares (the “Shares”) of common stock, in a public offering at a price of $175.00 per share. The Shares included the full exercise of the underwriters’ option to purchase an additional 163,975 shares of common stock. Total proceeds received from the offering were $206.8 million, after deducting discounts and issuance costs.

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America, or U.S. GAAP, and applicable rules and regulations of the Securities and Exchange Commission, or SEC, regarding interim financial reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by GAAP have been condensed or omitted, and accordingly the balance sheet as of December 31, 2020, and related disclosures, have been derived from the audited consolidated financial statements at that date but do not include all of the information required by GAAP for complete consolidated financial statements. These unaudited condensed consolidated financial statements have been prepared on the same basis as the Company’s annual consolidated financial statements and, in the opinion of management, reflect all adjustments (consisting only of normal recurring adjustments) that are necessary for the fair statement of the Company’s condensed consolidated financial information. The results of operations for the three months ended March 31, 2021 are not necessarily indicative of the results to be expected for the year ending December 31, 2021, or for any other interim period or for any other future year.

The accompanying interim unaudited condensed consolidated financial statements and related financial information should be read in conjunction with the audited financial statements and the related notes thereto for the year ended December 31, 2020, included in the Company’s annual report on Form 10-K, filed with the SEC on February 26, 2021.

Risks and Uncertainties

COVID-19

As a result of the COVID-19 pandemic, the Company has experienced significant business disruptions, restrictions on its ability to travel, reduction in access to customers due to diverted resources at hospitals, and shortened business hours as governments institute prolonged shelter-in-place and/or self-quarantine mandates.

Governmental mandates related to the COVID-19 pandemic have impacted, and is expected to continue to impact, Company personnel and personnel at third-party manufacturing facilities in the United States and other countries, and the availability or cost of materials, which could disrupt our supply chain and reduce margins. For instance, on or about March 16, 2020, the Health Officers of the counties of San Francisco (where the Company's headquarters is located), Santa Clara, San Mateo, Marin, Contra Costa and Alameda, where many employees are located, issued mandatory shelter-in-place orders and all employees transitioned to a remote work environment. The Company is also subject to orders in Southern California that temporarily shut down its manufacturing and distribution facilities in Cypress, California. For a limited number of employees who continue to support essential operations, including those at our manufacturing facilities, the Company has instituted protective equipment policies and, to the degree practical, social distancing measures to protect the safety of its employees. While the Company has continued to deliver its Zio service by operating with remote employees and essential employees on site, an extended implementation of these governmental mandates could further impact the Company's ability to effectively provide its Zio service, and could impede progress of all ongoing initiatives. Appropriate social distancing techniques and other

6

IRHYTHM TECHNOLOGIES, INC.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

measures at the Company's facilities have been implemented for the limited number of employees who have returned to work to support essential operations, and will not return until the risk to employee health has meaningfully diminished.

While hospital systems and healthcare facilities shift their focus and resources to treating COVID-19 patients and combating the spread of the coronavirus, the Company has adapted its service to meet the immediate needs of physicians, customers, and patients and significantly increased the utilization of its home enrollment service which allows patients to receive and wear the single-use Zio device without going to a healthcare facility.

Given the disruption in demand and an uncertain length of time to recovery, the Company adjusted its operating plan in the second quarter of 2020 by taking steps to reduce operating spend. These steps included eliminating or delaying spending on non-essential programs, reducing spend on travel and consulting, implementing a hiring freeze, furloughing approximately 5% of employees, conducting a layoff of approximately 2% of employees and implementing temporary pay reductions for our salaried workforce. From May 2020 to July 2020, the Company’s Chief Executive Officer, other named executive officers and other senior executives agreed to temporary base salary reductions and the Board of Directors agreed to a reduction in its fees until business and economic conditions improve. The Company also increased it’s bad debt reserve in anticipation of a potential increase in uncollectible co-payments from patients using the Zio Service. In August 2020, the Company reinstated furloughed employees, removed pay reductions for its salaried employees, and resumed hiring for most positions.

During the second half of 2020, the Company saw recovery of patient registrations for the Zio service to pre-COVID levels of the first quarter of 2020 and during the three months ended March 31, 2021, the Company experienced increasing levels in the Zio service patient registrations. However, this may be due, in some part, to the re-opening of certain regions within the United States and may not represent sustainable levels of patient registrations in future time periods.

The Company is continuously reviewing its liquidity and anticipated capital requirements in light of the significant uncertainty created by the COVID-19 pandemic. The Company believes it will have adequate liquidity over the next 12 months to operate its business and to meet its cash requirements. As of March 31, 2021, the Company is in compliance with its financial covenants in its debt agreement.

On March 27, 2020, as a result of the COVID-19 pandemic, Congress enacted the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") to support businesses during the COVID-19 pandemic, including deferment of the employer portion of certain payroll taxes, refundable payroll tax credits, and technical amendments to tax depreciation methods for qualified improvement property. The primary provisions of the CARES Act which are potentially applicable to us include:

• certain amendments to the limitations on the deductibility of interest contained in Section 163(j) of the Internal Revenue Code of 1986, as amended, for taxable years beginning in 2019 and 2020; and

• an allowance of net operating loss carrybacks for taxable years beginning in 2018 and before 2021.

The Company did not qualify for the Paycheck Protection Program under the CARES Act due to the number of employees in our organization. The CARES Act did not have material impact on the Company’s overall consolidated financial statements.

The ultimate impact of the COVID-19 pandemic is highly uncertain and subject to change. This impact is having a material, adverse impact on liquidity, capital resources, operations and business and those of the third parties on which the Company relies, and could worsen over time. The extent to which the COVID-19 pandemic impacts the Company’s results will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of the COVID-19 pandemic and the actions to contain the COVID-19 pandemic or treat its impact, among others. The full extent of potential delays or impacts on the business, financial condition, cash flows and results of operations remains unknown. Additionally, while the potential economic impact brought by, and the duration of, the COVID-19 pandemic is difficult to assess or predict, the COVID-19 pandemic has resulted in, and may continue to result in, significant disruption of global financial markets, reducing the Company’s ability to raise additional capital through equity, equity-linked or debt financings, which could negatively impact short-term and long-term liquidity and the ability to operate on a timely basis, or at all.

Furthermore, capital markets and economies worldwide have been negatively impacted by the COVID-19 pandemic, which may result in a period of regional, national, and global economic slowdown or regional, national, or global recessions that could curtail or delay demand for the Zio service as well as increase the risk of customer defaults or delays in payments. COVID-19

7

IRHYTHM TECHNOLOGIES, INC.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

and the current financial, economic, and capital markets environment, and future developments in these and other areas present material uncertainty and risk with respect to the Company's performance, financial condition, volume of business, results of operations, and cash flows.

Reimbursement

Government payors may change their coverage and reimbursement policies, as well as payment amounts, in a way that would prevent or limit reimbursement for the Zio service, which would significantly harm the Company. Government and other third-party payors require the Company to report the service for which it is seeking reimbursement by using a Current Procedural Terminology (“CPT”) code-set maintained by the American Medical Association (“AMA”). For Zio XT, the Company had historically utilized temporary CPT codes (or Category III CPT codes) used for newly introduced technologies and specific to our category of diagnostic monitoring. The process to convert Category III CPT codes to Category I CPT codes is governed by the AMA and Centers for Medicare and Medicaid (“CMS”). On October 25, 2019, the AMA’s CPT Editorial Panel established two new Category I CPT codes which are applicable to the Zio service and took effect on January 1, 2021. In August 2020, CMS published the Calendar Year 2021 Medicare Physician Fee Schedule Proposed Rule which proposed reimbursement for the Category I CPT codes that were higher than their associated Category III CPT codes. Following a comment period through October 2020, CMS published its Calendar Year 2021 Medicare Physician Fee Schedule Final Rule (the “Final Rule”) in December 2020. In the Final Rule, CMS chose not to finalize national pricing for four of the eight Category I CPT codes, 93241, 93243, 93245 and 93247 which include the CPT codes that the Company will primarily use to seek reimbursement for Zio XT.

Determinations of which products or services will be reimbursed under Medicare can be developed at the national level through a national coverage determination (“NCD”) by CMS, or at the local level through a local coverage determination (“LCD”), by one or more of the regional Medicare Administrative Contractors (“MACs”) who are private contractors that process and pay claims on behalf of CMS for different regions. In the absence of a specific NCD, as is the case with Zio XT historically and for Calendar Year 2021 following the Final Rule, the MAC with jurisdiction over a specific geographic region will have the discretion to make an LCD. The Company is seeking to establish LCD pricing with one or more MACs to establish pricing for 2021 and will be subject to LCD pricing until such time CMS establishes a NCD.

On January 29, 2021, Novitas Solutions, the MAC which covers the region where the Company's Independent Diagnostic Testing Facility (“IDTF”) in Houston, Texas is located and where almost all Medicare services for Zio XT are processed, published rates for 2021 that were significantly below our historical Medicare rates for Zio XT. The Company believes that the published rates by Novitas on January 29, 2021, are based off of rates from CPT codes 93224 and 93226, which are existing CPT codes for external continuous electrocardiographic recording up to 48 hours, while the Zio service is capable of continuous monitoring for up to 14 days.

On April 10, 2021, Novitas published updated reimbursement rates for codes 93243 and 93247 at $103 and $115, respectively. The updated rates are retroactive to January 1, 2021 and replace rates initially published on January 29, 2021. The Company has accounted for this announcement as a recognized subsequent event and reflected the impact of this announcement in its condensed consolidated financial statements for the three months ended March 31, 2021. While these new rates represent an increase from the rates posted on January 29, 2021, the Company believes these rates do not appropriately reflect the clinical and economic value that long-term continuous ECG monitoring offers patients, their care teams and the Medicare system. Due to the cost of providing the service relative to the updated rates published by Novitas, the Company will not be able to provide the Zio service to the Medicare fee for service segment if these rates remain unchanged. However, the Company believes there are potential paths to more equitable rates which it plans to explore before making any changes to the availability of Zio XT in the Medicare portion of its business. It is the Company's strong preference that continued access to Zio XT is available to all patients.

The Company is currently holding a majority of Zio XT claims due to the CPT code transition. Claims are being held due to a combination of negotiations with payors and administrative delays with payors. The Company expects the level of held claims to remain high through the end of the second quarter of 2021. The high level of held claims has delayed most first quarter 2021 cash flows into the second quarter of 2021 or potentially beyond, and may impact the timing and accounting for various income statement items, particularly revenue recognition and bad debt expense. The Company has adequate balance sheet liquidity to manage through these delays in cash flow timing.

8

IRHYTHM TECHNOLOGIES, INC.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

If the published rates by Novitas remain unchanged or are not significantly improved for the CPT codes listed above, thereby allowing the Company to obtain adequate Medicare reimbursement for the Zio service in the future, the Company may be unable to provide the Zio service or would experience a significant loss of revenue, either of which would have a material adverse effect on our cash flows, results of operations and financial condition.

Further, a reduction in coverage by Medicare could cause some commercial third-party payors to implement similar reductions in their coverage or level of reimbursement of the Zio service. Given the evolving nature of the healthcare industry and on-going healthcare cost reforms, the Company will continue to be subject to changes in the level of Medicare coverage for its products, and unfavorable coverage determinations at the national or local level could adversely affect its results of operations. Although a large majority of commercial customers have re-contracted the Zio XT service since the establishment of the Category I codes on January 1, 2021 matching to pre-existing rates, if the Company is unsuccessful in improving the Medicare rates before calendar year 2022, it is prudent to expect that commercial rates may begin to be more negatively impacted next year. If published rates by Novitas are not increased to above the cost of revenue for the Zio service, and the Company is unable to achieve a level of revenues adequate to support its cost structure, this would raise substantial doubts about the Company's ability to continue as a going concern.

Use of Estimates

The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, management evaluates its estimates, including those related to revenue recognition, contractual allowances, allowance for doubtful accounts, the useful lives of property and equipment, the recoverability of long-lived assets including the estimated usage of the printed circuit board assemblies (“PCBAs”), the incremental borrowing rate for operating leases, accounting for income taxes, and various inputs used in estimating stock-based compensation. Certain of these estimates are impacted by uncertainties surrounding COVID-19 such as revenue recognition, contractual allowances for revenue, allowance for doubtful accounts, and stock based compensation. The Company bases these estimates on historical and anticipated results, trends, and various other assumptions that management believes are reasonable under the circumstances, including assumptions as to future events. Actual results may differ from those estimates.

Investments

Short-term investments consist of debt securities classified as available-for-sale and have maturities greater than 90 days, but less than one year as of the balance sheet date. Long-term investments have maturities greater than one year as of the balance sheet date. All investments are carried at fair value based upon quoted market prices.

The Company periodically assesses its portfolio of debt investments for impairment. For debt securities in an unrealized loss position, this assessment first takes into account the intent to sell, or whether it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis. If either of these criteria are met, the debt security’s amortized cost basis is written down to fair value through interest and other, net. For debt securities in an unrealized loss position that do not meet the aforementioned criteria, the Company assesses whether the decline in fair value has resulted from credit losses or other factors.

The Company evaluates expected credit losses by considering factors such as historical experience, market data, issuer-specific factors, and current economic conditions. Expected credit losses on available-for-sale debt securities are recognized in other income, net in the condensed consolidated statements of operations, and any remaining unrealized losses, net of taxes, are reported as a component of accumulated other comprehensive loss. The Company did not recognize any credit losses on its available-for-sale securities during the three months ended March 31, 2021 and there were no impairment charges for unrealized losses in the periods presented.

The cost of available-for-sale securities sold is based on the specific-identification method and realized gains and losses are included in earnings. Amortization of premiums and accretion of discounts are reported as a component of other income, net.

Accounts Receivable, Allowance for Doubtful Accounts and Contractual Allowances

Accounts receivable includes amounts due to the Company from healthcare institutions, third-party payors, and government payors and their related patients, as a result of the Company's normal business activities. Accounts receivable is reported on the consolidated balance sheets net of an estimated allowance for doubtful accounts and contractual allowances.

9

IRHYTHM TECHNOLOGIES, INC.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

The Company establishes an allowance for doubtful accounts for estimated uncollectible receivables based on its assessment of the collectability of customer accounts and recognizes the provision as a component of selling, general and administrative expenses.

The Company records a provision for contractual allowances based on the estimated differences between contracted amounts and expected collection rates. Such provisions are based on the Company's historical experience and are reported as a reduction of revenue.

The Company regularly reviews the allowances by considering factors such as historical experience, credit quality, the age of the accounts receivable balances, and current economic conditions that may affect a customer’s ability to pay.

The following table presents the changes in the allowance for doubtful accounts (in thousands):

	Three Months Ended March 31, 2021		Year Ended December 31, 2020		Three Months Ended March 31, 2020
Balance, beginning of period	$	12,711	$	9,049	$	9,049
Add: provision for doubtful accounts	3,095		10,515		4,592
Add: adoption of ASC 326	—		461		461
Less: write-offs, net of recoveries and other adjustments	(3,046)		(7,314)		(2,262)
Balance, end of period	$	12,760	$	12,711	$	11,840

The following table presents the changes in the contractual allowance (in thousands):

	Three Months Ended March 31, 2021		Year Ended December 31, 2020		Three Months Ended March 31, 2020
Balance, beginning of period	$	21,281	$	15,433	$	15,433
Add: provision for contractual allowances	6,673		20,916		4,592
Less: realized contractual adjustments	(3,185)		(15,068)		(3,477)
Balance, end of period	$	24,769	$	21,281	$	16,548

Concentrations of Risk

Credit Risk

Financial instruments that potentially subject the Company to a concentration of credit risk consist primarily of cash and cash equivalents, investments and accounts receivable. Cash balances are deposited in financial institutions which, at times may be in excess of federally insured limits. Cash equivalents are invested in highly-rated money market funds. The Company invests in a variety of financial instruments, such as, but not limited to, United States Government securities, corporate notes, commercial paper and, by policy, limits the amount of credit exposure with any one financial institution or commercial issuer. The Company has not experienced any material losses on its deposits of cash and cash equivalents or investments.

Concentrations of credit risk with respect to accounts receivable are limited due to the large number of customers comprising the Company’s customer base and their dispersion across many geographies. The Company does not require collateral. The Company records an allowance for doubtful accounts based on the assessment of the collectability of customer accounts, considering factors such as historical experience, credit quality, the age of the accounts receivable balances, and current economic conditions that may affect a customer’s ability to pay. Centers for Medicare and Medicaid Services (“CMS”), accounted for approximately 14% and 27% of the Company’s revenue for the three months ended March 31, 2021, and 2020, respectively. CMS accounted for 14% and 20% of accounts receivable at March 31, 2021 and December 31, 2020, respectively.

Revenue Recognition

The Company’s revenue is generated primarily from the provision of its cardiac rhythm monitoring service, the Zio XT service. The Zio XT is a cardiac rhythm monitoring service that has a patient wear period of up to 14 days and is billable when the monitoring reports are delivered to the healthcare provider, which is also when the service is complete and the Company recognizes revenue. The time from when the patient has the Zio XT device applied to the time the report is posted is generally around 20 days. The Company has concluded that the Zio XT service is one performance obligation on the basis that the

10

IRHYTHM TECHNOLOGIES, INC.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

customer cannot benefit from each component of the service on its own or together with other resources that are readily available to the customer.

The Zio AT mobile cardiac telemetry monitor, a wearable patch-based biosensor, offers what the Zio XT offers plus the additional capability of transmissions during the wear period to assist physicians in diagnosing and treating the small percentage of the population requiring more timely action. During the wear period, physicians will receive notifications if there are significant events that meet predetermined arrhythmia detection criteria. The Zio AT service revenue is recognized ratably over the prescription period.

The Company recognizes as revenue the amount of consideration to which it expects to be entitled in exchange for performing the service. The consideration the Company is entitled to varies by portfolio, as further defined below, and includes estimates that require significant judgment by management. A unique aspect of healthcare is the involvement of multiple parties to the service transaction. In addition to the patient, often a third-party, for example a commercial or governmental payor or healthcare institution, will pay the Company for some or all of the service on the patient’s behalf. Separate contractual arrangements exist between the Company and third-party payors that establish amounts the third-party payor will pay on behalf of a patient for covered services rendered.

A small portion of the Company’s transactions are covered by third-party payors with whom there is neither a contractual agreement nor an established amount that the third-party payor will pay. In determining the collectability and transaction price for its service, the Company considers factors such as insurance claims which are adjudicated as allowable under the applicable policy and payment history from both payors and patient out-of-pocket costs, payor coverage, whether there is a contract between the payor or healthcare institution and the Company, historical amount received for the service, and any current developments or changes that could impact reimbursement and healthcare institution payments. Certain of these factors are forms of variable consideration which are only included in the transaction price to the extent it is probable that a significant reversal of cumulative revenue will not occur when the uncertainty associated with the variable consideration is subsequently resolved.

A summary of the payment arrangements with third-party payors and healthcare institutions is as follows:

•Contracted third-party payors – The Company has contracts with negotiated prices for services provided to patients with commercial healthcare insurance coverage.

•CMS – The Company has received independent diagnostic testing facility approval from regional Medicare Administrative Contractors and will receive reimbursement per the relevant CPT code rates for the services rendered to the patient covered by CMS.

•Non-contracted third-party payors – Non-contracted commercial and government payors often reimburse out-of-network rates provided under the relevant CPT codes on a case-by-case basis. The transaction price used for determining revenue recognition is based on factors including an average of the Company’s historical collection experience for its non-contracted services. This rate is reviewed at least quarterly.

•Healthcare institutions – Healthcare institutions are typically hospitals or physician practices in which the Company has negotiated amounts for its monitoring services, including certain governmental agencies such as the Veterans Administration and Department of Defense.

The Company is utilizing the portfolio approach practical expedient under ASC 606 for revenue recognition whereby services provided under each of the above payor types form a separate portfolio. The Company accounts for the contracts within each portfolio as a collective group, rather than individual contracts. Based on history with these portfolios and the similar nature and characteristics of the patients within each portfolio, the Company has concluded that the financial statement effects are not materially different than if accounting for revenue on a contract-by-contract basis.

For contracted and CMS portfolios, the Company recognizes revenue, net of contractual allowances, and recognizes an allowance for doubtful accounts for uncollectible patient accounts receivable. The transaction price is determined based on negotiated rates, and the Company has historical experience of collecting substantially all of these contracted rates. These contracts also impose a number of obligations regarding billing and other matters, and the Company’s noncompliance with a material term of such contracts may result in a denial of the claim. The Company accounts for denied claims as a form of variable consideration that is included as a reduction to the transaction price recognized as revenue. The Company estimates the denied claims which require management judgment. The estimated denied claims are based on historical information and judgement includes the historical period utilized. The Company monitors the estimated denied claims against the latest available information, and subsequent changes to the estimated denied claims are recorded as an adjustment to revenue in the

11

IRHYTHM TECHNOLOGIES, INC.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

periods during which such changes occur. Historical cash collection indicates that it is probable that substantially all of the transaction price, less the estimate of denied claims, will be received. Contracted payors may require that we bill patient co-payments and deductibles and from time to time we may not be able to collect such amounts due to credit risk. The Company provides for estimates of uncollectible patient accounts receivable, based upon historical experience where judgment includes the historical period utilized, at the time revenue is recognized, with such provisions presented as bad debt expense within the selling, general and administrative line item of the consolidated statement of operations. Adjustments to these estimates for actual experience are also recorded as an adjustment to bad debt expense.

    For non-contracted portfolios, the Company is providing an implicit price concession due to the lack of a contracted rate with the underlying payor, the result of which requires the Company to estimate the transaction price based on historical cash collections utilizing the expected value method. All subsequent adjustments to the transaction price are recorded as an adjustment to revenue.

    For healthcare institutions, the transaction price is determined based on negotiated rates, and the Company has historical experience collecting substantially all of these contracted rates. Historical cash collection indicates that it is probable that substantially all of the transaction price will be received. As such, the Company is not providing an implicit price concession but, rather, has chosen to accept the risk of default, and any subsequent uncollected amounts are recorded as bad debt expense.

Disaggregation of Revenue

The Company disaggregates revenue from contracts with customers by payor type. The Company believes these categories aggregate the payor types by nature, amount, timing and uncertainty of its revenue streams. Disaggregated revenue by payor type and major service line for three months ended March 31, 2021 and March 31, 2020 were as follows (in thousands):

	Three Months Ended March 31,
	2021		2020
Contracted third-party payors	$	46,592	$	31,710
Non-contracted third-party payors	5,278		3,376
Centers for Medicare & Medicaid	10,177		17,316
Healthcare Institutions	12,264		11,133
Total	$	74,311	$	63,535

Contract Liabilities

ASC 606 requires an entity to present a revenue contract as a contract liability when the Company has an obligation to transfer goods or services to a customer for which the Company has received consideration from the customer, or an amount of consideration from the customer is due and unconditional (whichever is earlier).

Certain of the Company’s customers pay the Company directly for the Zio XT service upon shipment of devices. Such advance payments are contract liabilities and are recorded as deferred revenue on the Condensed Balance Sheets and revenue is recognized when reports are delivered to the healthcare provider. During the three months ended March 31, 2021, $0.9 million relating to the contract liability balance at the beginning of 2021 was recognized as revenue. Total revenue recognized during the three months ended March 31, 2020 that was included in the contract liability balance at the beginning of 2020 was $1.2 million.

Contract Costs

Under ASC 340, the incremental costs of obtaining a contract with a customer are recognized as an asset. Incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained.

The Company’s current commission programs are considered incremental. However, as a practical expedient, ASC 340 permits the Company to immediately expense contract acquisition costs, as the asset that would have resulted from capitalizing these costs will be amortized in one year or less.

12

IRHYTHM TECHNOLOGIES, INC.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

Stock-based Compensation

The Company measures its stock-based awards made to employees based on the estimated fair values of the awards as of the grant date. The fair value of market condition awards is determined using the Monte-Carlo option pricing model and the fair value of stock options is determined using the Black-Scholes option pricing model. Stock-based compensation expense is recognized over the requisite service period using the straight-line method and is based on the value of the portion of stock-based payment awards that is ultimately expected to vest. As such, the Company’s stock-based compensation is reduced for the estimated forfeitures at the date of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. For restricted stock, the compensation cost for these awards is based on the closing price of the Company’s common stock on the date of grant, and recognized as compensation expense on a straight-line basis over the requisite service period.

The Company recognizes compensation expense related to the Employee Stock Purchase Program (“ESPP”) based on the estimated fair value of the options on the date of grant, net of estimated forfeitures. The Company estimates the grant date fair value, and the resulting stock-based compensation expense, using the Black-Scholes option pricing model for each purchase period. The grant date fair value is expensed on a straight-line basis over the offering period.

3. Cash Equivalents and Investments

The fair value of cash equivalents and available-for-sale investments at March 31, 2021 and December 31, 2020, were as follows (in thousands):

	March 31, 2021
	Amortized Cost		Gross Unrealized				Estimated Fair Value
			Gains		Losses
Money market funds	$	111,827	$	—	$	—	$	111,827
U.S. government securities	70,436		22		—		70,458
Corporate notes	24,498		—		(10)		24,488
Commercial paper	29,965		—		—		29,965
Total cash equivalents and available-for-sale investments	$	236,726	$	22	$	(10)	$	236,738
Classified as:
Cash equivalents							$	111,827
Short-term investments							124,911
Total cash equivalents and available-for-sale investments							$	236,738
	December 31, 2020
	Amortized Cost		Gross Unrealized				Estimated Fair Value
			Gains		Losses
Money market funds	$	59,823	$	—	$	—	$	59,823
U.S. government securities	190,663		16		(2)		190,677
Corporate notes	26,426		2		(5)		26,423
Commercial paper	29,489		—		—		29,489
Total cash equivalents and available-for-sale investments	$	306,401	$	18	$	(7)	$	306,412
Classified as:
Cash equivalents							$	59,823
Short-term investments							246,589
Total cash equivalents and available-for-sale investments							$	306,412

The following table summarizes the fair value of the Company’s cash equivalents, short-term and long-term marketable securities classified by maturity (in thousands):

13

IRHYTHM TECHNOLOGIES, INC.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

	March 31, 2021		December 31, 2020
Due within one year	$	236,738	$	306,412
Due after one year through three years	—		—
Total cash equivalents and available-for-sale investments	$	236,738	$	306,412

There were no available-for-sale securities that were in an unrealized loss position for more than twelve months as of March 31, 2021. Unrealized losses as of March 31, 2021, and December 31, 2020, were not material. Available-for-sale securities held as of March 31, 2021 had a weighted average maturity of 86 days. At March 31, 2021, six investments were in an unrealized loss position and no investments have been in an unrealized loss position for more than one year.

4. Fair Value Measurements

The Company discloses and recognizes the fair value of its assets and liabilities using a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the reporting date. The hierarchy gives the highest priority to valuations based upon unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to valuations based upon unobservable inputs that are significant to the valuation (Level 3 measurements). The guidance establishes three levels of the fair value hierarchy as follows:

Level 1 - Inputs are unadjusted quoted prices in active markets for identical assets or liabilities at the measurement date.

Level 2 - Inputs (other than quoted market prices included in Level 1) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.

Level 3 - Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model. 

Assets and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires management to make judgments and consider factors specific to the asset or liability. The corporate notes, commercial paper and government securities are classified as Level 2 as they were valued based upon quoted market prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant inputs are observable in the market or can be corroborated by observable market data for substantially the full term of the assets.

The fair value of the Company’s outstanding interest-bearing obligations is estimated using the net present value of the future payments, discounted at an interest rate that is consistent with market interest rates, which is a Level 2 input. The carrying amount and the estimated fair value of the Company’s outstanding interest-bearing obligations at March 31, 2021 were $30.1 million and $30.8 million, respectively. The carrying amount and the estimated fair value of the Company’s outstanding interest-bearing obligations at December 31, 2020 were $33.0 million and $33.9 million, respectively.

The Company had no transfers between levels of the fair value hierarchy of its assets measured at fair value.

14

IRHYTHM TECHNOLOGIES, INC.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

The following tables present the fair value of the Company’s financial assets determined using the inputs defined above (in thousands).

	March 31, 2021
	Level 1		Level 2		Level 3		Total
Assets
Money market funds	$	111,827	$	—	$	—	$	111,827
U.S. government securities	—		70,458		—		70,458
Corporate notes	—		24,488		—		24,488
Commercial paper	—		29,965		—		29,965
Total	$	111,827	$	124,911	$	—	$	236,738

	December 31, 2020
	Level 1		Level 2		Level 3		Total
Assets
Money market funds	$	59,823	$	—	$	—	$	59,823
U.S. government securities	—		190,677		—		190,677
Corporate notes	—		26,423		—		26,423
Commercial paper	—		29,489		—		29,489
Total	$	59,823	$	246,589	$	—	$	306,412

5. Balance Sheet Components

Inventory and Other Assets

Inventory consisted of the following (in thousands):

	March 31, 2021		December 31, 2020
Raw materials	$	2,579	$	2,469
Finished goods	4,284		2,844
Total	$	6,863	$	5,313

    The Company uses PCBAs in each wearable Zio XT and Zio AT monitor as well as in the wireless gateway used in conjunction with the Zio AT monitor. The PCBAs are used numerous times and have useful lives beyond one year. Each time a PCBA is used in a wearable Zio XT monitor or Zio AT monitor, a portion of the cost of the PCBA is recorded as a cost of revenue. Each time a wireless gateway is used with a Zio AT monitor, a portion of the gateway is recorded as a cost of revenue. PCBAs which are recorded as other assets, were $12.9 million and $12.6 million as of March 31, 2021, and December 31, 2020, respectively.

15

IRHYTHM TECHNOLOGIES, INC.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

Property and Equipment, Net

Property and equipment, net consisted of the following (in thousands):

	March 31, 2021		December 31, 2020
Laboratory and manufacturing equipment	$	4,915	$	4,667
Computer equipment and software	2,005		2,005
Furniture and fixtures	3,793		3,794
Leasehold improvements	10,001		9,215
Internal-use software	32,619		28,416
Total property and equipment, gross	53,333		48,097
Less: accumulated depreciation and amortization	(15,886)		(13,850)
Total property and equipment, net	$	37,447	$	34,247

Depreciation and amortization expense was $2.0 million and $1.6 million for the three months ended March 31, 2021, and 2020, respectively.

Accrued Liabilities

Accrued liabilities consisted of the following (in thousands):

	March 31, 2021		December 31, 2020
Accrued vacation	$	6,959	$	6,007
Accrued payroll and related expenses	16,579		19,709
Accrued ESPP contribution	2,455		851
Accrued professional services fees	1,386		1,709
Accrued interest	110		121
Claims payable	3,559		4,757
Other	5,212		7,378
Total accrued liabilities	$	36,260	$	40,532

6. Commitments and Contingencies

Legal Proceedings

From time to time, the Company is involved in claims and legal proceedings or investigations, that arise in the ordinary course of business. Such matters could have an adverse impact on its reputation, business and the financial condition and divert the attention of its management from the operation of its business. These matters are subject to many uncertainties and outcomes that are not predictable.

On February 1, 2021, a putative class action lawsuit was filed in the United States District Court for the Northern District of California alleging that the Company and its former Chief Executive Officer violated Sections 10(b) and 20(a) of the Exchange Act and SEC Rule 10b-5 promulgated thereunder. The purported class includes all persons who purchased or acquired the Company's securities between August 4, 2020 and January 28, 2021. The complaint seeks unspecified damages purportedly sustained by the class. The Company believes the complaint to be without merit and plans to vigorously defend itself.

Development Agreement

On September 3, 2019, the Company entered into a Development Collaboration Agreement (the “Development Agreement”) with Verily Life Sciences LLC (“Verily”). The Development Agreement, which is over a 24 month term, involves joint development and production of intellectual property between the Company and Verily. Each participant has primary responsibility for certain aspects of development and approval, with all processes to be performed at each respective party’s own cost. Costs incurred by the Company in connection with the Development Agreement will be expensed as research and development expense in accordance with ASC 730, Research and Development.

16

IRHYTHM TECHNOLOGIES, INC.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

    The Company and Verily will develop certain next-generation atrial fibrillation (“AF”) screening, detection, or monitoring products pursuant to the Development Agreement, which products will involve combining Verily and the Company’s technology platforms and capabilities. Under the terms of the Development Agreement, the Company paid Verily an upfront fee of $5.0 million in 2019. In addition, the Company has agreed to make additional payments to Verily up to an aggregate of $12.75 million in milestone payments upon achievement of various development and regulatory milestones over the 24 months of the Development Agreement, which payments will be made in cash to Verily. During the year ended December 31, 2020, the Company recognized $7.0 million of research and development expense related to Verily milestones, of which $4.0 million is was paid during the three months ended March 31, 2021. No milestones were achieved during the three months ended March 31, 2021. The Company expects to incur additional expense of $3.0 million for the year ended December 31, 2021.

    The Development Agreement provides each party with licenses to use certain intellectual property of the other party for development activities in the field of AF screening, detection, or monitoring. Ownership of developed intellectual property will be allocated to the Company or Verily depending on the subject matter of the underlying developed intellectual property, and, for certain subject matter, shall be jointly owned.

Indemnifications

In the ordinary course of business, the Company enters into agreements pursuant to which it agrees to indemnify customers, vendors, lessors, business partners, and other parties with respect to certain matters, including losses arising out of the breach of such agreements, services to be provided by us, or from intellectual property infringement claims made by third parties. Pursuant to such agreements, the Company may indemnify, hold harmless and defend an indemnified party for losses suffered or incurred by the indemnified party. Some of the provisions will limit losses to those arising from third-party actions. In some cases, the indemnification will continue after the termination of the agreement. The maximum potential amount of future payments the Company could be required to make under these provisions is not determinable. The Company has also entered into indemnification agreements with its directors and officers that may require the Company to indemnify its directors and officers against liabilities that may arise by reason of their status or service as directors or officers to the fullest extent permitted by applicable law. The Company currently has directors’ and officers’ insurance. The Company has never incurred material costs to defend lawsuits or settle claims related to these indemnification provisions, and believes that the estimated fair value of these indemnification obligations is not material and it has not accrued any amounts for these obligations.

7. Debt

Bank Debt

In December 2015, the Company entered into a Second Amended and Restated Loan and Security Agreement (“Loan Agreement”) with Silicon Valley Bank (“SVB”). Under the SVB Loan Agreement, the Company could borrow, repay and reborrow under a revolving credit line, but not in excess of the maximum loan amount of $15.0 million, until December 4, 2018, when all outstanding principal and accrued interest became due and payable. Any principal amount outstanding under the SVB Loan Agreement shall bear interest at a floating rate per annum equal to the rate published by The Wall Street Journal as the “Prime Rate” plus 0.25%. The Company could borrow up to 80% of its eligible accounts receivable, up to the maximum of $15.0 million.

In October 2018, the Company entered into the Third Amended and Restated Loan and Security Agreement with SVB (“Third Amended and Restated SVB Loan Agreement”). This Agreement amends and restates the Second Amended and Restated Loan and Security Agreement between the Company and SVB dated December 4, 2015, as amended by the First Loan Modification Agreement between the Company and SVB dated August 22, 2016.

Pursuant to the Third Amended and Restated SVB Loan Agreement, the Company obtained a term loan (“SVB Term Loan”) for $35.0 million. Total proceeds from the SVB Term Loan were used to pay off the loan agreement with Biopharma Secured Investments III Holdings Cayman LP (“Pharmakon”), totaling $35.8 million. The Company made interest-only payments through October 31, 2020. Beginning in November 2020, the Company began monthly payments of principal plus interest, which will continue through October 31, 2024. Interest charged on the SVB Term Loan will be the greater of (a) a floating rate based on the “Prime Rate” published by The Wall Street Journal minus 0.75%, or (b) 4.25%.

17

IRHYTHM TECHNOLOGIES, INC.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

Under the Third Amended and Restated SVB Loan Agreement, the Company may borrow, repay, and reborrow under a revolving credit line, but not in excess of the maximum loan amount of $25.0 million, which includes an $11.0 million standby letter of credit sublimit availability. In October 2018, a $6.9 million standby letter of credit was obtained in connection with a lease for the Company’s San Francisco headquarters. Any principal amount outstanding under the Third Amended and Restated SVB Loan Agreement revolving credit line shall bear interest at an amount that is the greater of (a) a floating rate per annum equal to the rate published by The Wall Street Journal as the “Prime Rate” or (b) 5.00%. The Company may borrow up to 75% of eligible accounts receivable, up to the maximum of $25.0 million.

The Third Amended and Restated Loan Agreement requires the Company to maintain a minimum consolidated liquidity ratio or minimum adjusted Earnings Before Interest, Tax, Depreciation, and Amortization during the term of the loan facility. In addition, the SVB Loan Agreement contains customary affirmative and negative covenants and events of default. The Company was in compliance with loan covenants as of March 31, 2021. The obligations under the Third Amended and Restated Loan Agreement are collateralized by substantially all assets of the Company.

8. Income Taxes

The Company recorded a tax provision related to its U.S. state taxes and the U.K. subsidiary during the three months ended March 31, 2021 and March 31, 2020. Due to the uncertainties surrounding the realization of the U.S. deferred tax assets through future taxable income, the Company has provided a full valuation allowance and, therefore, no benefit has been recognized for the U.S. net operating loss carryforwards and other deferred tax assets.

9. Stockholders’ Equity

Common stock

The Company’s amended and restated certificate of incorporation dated October 25, 2016, as amended, authorizes the Company to issue 100,000,000 shares of common stock with a par value of $0.001 per share and 5,000,000 shares of preferred stock with a par value of $0.001 per share. The holders of common stock are entitled to receive dividends whenever funds and assets are legally available and when declared by the board of directors, subject to the prior rights of holders of all series of convertible preferred stock outstanding. No dividends were declared through March 31, 2021.

The Company had reserved shares of common stock for issuance as follows:

	March 31, 2021	December 31, 2020
Options issued and outstanding	553,064	609,881
Unvested restricted stock units	1,212,423	1,114,159
Shares available for grant under future stock plans	7,718,950	8,016,517
Shares available for future issuance	9,484,437	9,740,557

18

IRHYTHM TECHNOLOGIES, INC.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

10. Equity Incentive Plans

Equity Incentive Plan Activity

A summary of share-based awards available for grant under the 2016 Equity Incentive Plan is as follows:

	Awards Available for Grant
Balance at December 31, 2019	5,528,132
Additional awards authorized	1,333,928
Awards granted	(595,915)
Awards forfeited	156,623
Awards withheld for tax purposes	82,622
Balance at December 31, 2020	6,505,390
Awards granted	(470,959)
Awards forfeited	44,394
Awards withheld for tax purposes	128,998
Balance at March 31, 2021	6,207,823

During the three months ended March 31, 2021, 304,225 restricted stock units (“RSUs”) were granted, 202,336 RSUs vested, and 7,751 RSUs were forfeited.

The following table summarizes stock option activity under the 2006 and 2016 Equity Incentive Plans:

		Options Outstanding
	Options Outstanding	Weighted- Average Exercise Price Per Share		Weighted- Average Remaining Contractual Life (years)	Aggregate Intrinsic Value (in thousands)
Balance at December 31, 2019	1,503,247	$	27.40	6.43	$	62,401
Options exercised	(868,614)	$	17.31
Options forfeited	(24,752)	$	66.89
Balance at December 31, 2020	609,881	$	40.18	6.24	$	120,163
Options exercised	(56,111)	$	28.09
Options forfeited	(706)	$	78.89
Balances at March 31, 2021	553,064	$	41.36	6.05	$	53,923
Options exercisable – March 31, 2021	469,148	$	36.51	5.88	$	48,016
Options vested and expected to vest – March 31, 2021	550,842	$	41.24	6.05	$	53,774

The aggregate intrinsic values of options outstanding, exercisable, vested and expected to vest were calculated as the difference between the exercise price of the options and the closing price of the Company’s common stock.

The Company did not grant any options during the three months ended March 31, 2021, and 2020.

11. Stock-Based Compensation

Market-based RSU Valuation

The fair value of market based RSUs was estimated at the date of grant using the Monte-Carlo option pricing model with the assumptions below. Additional details on the Company's market based RSUs are included below.

	Three Months Ended March 31,
	2021
Expected term (in years)	0.74
Expected volatility	63.0	%
Risk-free interest rate	0.17	%
Dividend yield	—	%

19

IRHYTHM TECHNOLOGIES, INC.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

Stock-Based Compensation

The following table summarizes the total stock-based compensation expense included in the statements of operations and comprehensive loss for all periods presented (in thousands):

	Three Months Ended, March 31,
	2021		2020
Cost of revenue	$	423	$	—
Research and development	1,659		741
Selling, general and administrative	18,148		(436)
Total stock-based compensation expense	$	20,230	$	305

As of March 31, 2021, there was total unamortized compensation costs of $2.9 million, net of estimated forfeitures, related to unvested stock options which the Company expects to recognize over a period of approximately 1 year, $114.5 million, net of estimated forfeitures, related to unrecognized RSU expense, which the Company expects to recognize over a period of 2.7 years, and $1.0 million unrecognized ESPP expense, which the Company will recognize over 0.7 years.

Performance-based RSUs (“PRSU”) and Market-based RSUs

The Company grants PRSUs to key executives of the Company. PRSUs can be earned in accordance with the performance equity program for each respective grant.

2019 Awards

In February 2019, the company granted PRSU's ("2019 awards") to be earned based on the compound annual growth rate ("CAGR") of fiscal year 2020's revenue compared to fiscal year 2018's revenue.

Due to the impact of the COVID-19 pandemic, management determined that the Company’s achievement of its performance targets described above, was not probable in the first quarter of fiscal year 2020. PRSU expense of $4.8 million recognized in fiscal year 2019 related to the 2019 awards was reversed in the first quarter of fiscal year 2020.

On June 19, 2020, the Company modified the terms of the 2019 awards to vest based on the Company’s average stock price for the 60 days preceding January 1, 2021. The modification impacted all active recipients of the 2019 awards, a total of ten recipients. The total incremental compensation cost resulting from the modification of $13.6 million was recognized ratably through March of 2021. The Company recognized $2.2 million of compensation cost for the three months ended March 31, 2021 in connection with the 2019 awards.

February 2020 Awards

In February 2020, the company granted PRSU's ("February 2020 awards") for fiscal year 2022's annual unit volume CAGR compared to fiscal year 2019's annual unit volume CAGR, measuring a minimum performance threshold of 19.7% to earn 50% of target, and a maximum threshold of 29% achieved to earn 200% of target. A total of 133,834 PRSU shares were granted with grant date fair value of $11.0 million. The 2020 awards also include a service-based component.

Compensation cost in connection with the probable number of shares that will vest will be recognized ratably through March 31, 2023. During the three months ended March 31, 2021 the Company recognized $1.4 million of compensation cost in connection with the February 2020 awards.

January 2021 Awards

In January 2021, the Company granted PRSU's ("January 2021 awards") for fiscal year 2021's annual consolidated revenue compared to fiscal year 2020's annual consolidated revenue, measuring a performance threshold of 10.0% to earn 100% of target. A total of 53,862 PRSU shares were granted with a grant date fair value of $13.9 million. The January 2021 awards also include a service-based component.

Compensation cost in connection with the probable number of shares that will vest will be recognized ratably through March 31, 2022. During the three months ended March 31, 2021, the Company determined that it was probable that the January 2021 Awards would vest and recognized $2.2 million of compensation cost in connection with the January 2021 awards.

20

IRHYTHM TECHNOLOGIES, INC.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

February 2021 Awards

In February 2021, the Company granted PRSU's ("February 2021 awards") for fiscal year 2023's annual unit volume CAGR compared to fiscal year 2020's annual unit volume CAGR, measuring a minimum performance threshold of 19.7% to earn 50% of target, and a maximum threshold of 29% achieved to earn 200% of target. A total of 112,872 PRSU shares were granted with grant date fair value of $17.3 million. The February 2021 awards also include a service-based component.

Compensation cost in connection with the probable number of shares that will vest will be recognized ratably through March 31, 2024. During the three months ended March 31, 2021, the Company determined that it was probable that the February 2021 Awards would vest and recognized $0.4 million of compensation cost in connection with the February 2021 awards.

Non employee Stock-Based Compensation

On July 3, 2020, the Company’s Chief Financial Officer (“CFO”) resigned and entered into a Consulting and Professional Services Agreement (“CPSA”) with the Company to provide consulting services through July 2, 2021. Pursuant to the original terms of the awards, the CFO will continue to vest in outstanding awards as long as services are provided to the Company under the CPSA as a non-employee consultant. In accordance with ASC 718, the Company recognized expense related to all awards expected to vest over the duration of the CPSA in the current period as an equity- based severance cost as the consulting services are not substantive.

On January 12, 2021, the Company's Chief Executive Officer ("CEO") resigned and entered into a CPSA with the Company. Pursuant to the original terms of the awards, the CEO will continue to vest in outstanding awards as long as services are provided to the Company under the CPSA as a non-employee consultant or a member of the Company's Board of Directors. In accordance with ASC 718, the Company recognized expense related to all awards expected to vest over the duration of the CPSA in the current period as an equity- based severance cost as the consulting services are not substantive.

Total expense related to non-employee stock-based compensation recognized for the three months ended March 31, 2021 was $5.0 million.

21

IRHYTHM TECHNOLOGIES, INC.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

12. Net Loss Per Common Share

As the Company has net losses for the three months ended March 31, 2021, and 2020, all potential common shares were deemed to be anti-dilutive. The following table sets forth the computation of the basic and diluted net loss per share (in thousands, except share and per share data):

	Three Months Ended March 31,
	2021		2020
Numerator:
Net loss	$	(27,779)	$	(9,065)
Denominator:
Weighted-average shares used to compute net loss per common share, basic and diluted	29,164,430		26,839,870
Net loss per common share, basic and diluted	$	(0.95)	$	(0.34)

The following outstanding shares of potentially dilutive securities have been excluded from diluted net loss per common share for the three months ended March 31, 2021 and 2020, because their inclusion would be anti-dilutive:

	Three Months Ended March 31,
	2021	2020
Options to purchase common stock	553,064	1,221,621
PRSUs and RSUs unvested	1,212,423	947,101
Total	1,765,487	2,168,722

13. Subsequent Events

On April 10, 2021, Medicare Administrative Contractor (“MAC”) Novitas published updated reimbursement rates which affect reimbursement for the Company’s Zio XT service. Rates for codes 93243 and 93247 were announced at $103 and $115, respectively. The updated rates are retroactive to January 1, 2021 and replace rates initially published on January 29, 2021. As the publication of the updated rates represents a resolution to uncertainties that existed as of the balance sheet date, the Company has accounted for this announcement as a recognized subsequent event and reflected the impact of this announcement in its condensed consolidated financial statements for the three months ended March 31, 2021.

22

IRHYTHM TECHNOLOGIES, INC.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations together with the unaudited financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q. This discussion and other parts of this Quarterly Report on Form 10-Q contain forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section of this Quarterly Report on Form 10-Q entitled “Risk Factors".

Overview

We are a digital healthcare company redefining the way cardiac arrhythmias are clinically diagnosed by combining our wearable biosensing technology with cloud-based data analytics and deep-learning capabilities. Our goal is to be the leading provider of ambulatory electrocardiogram (“ECG”) monitoring for patients at risk for arrhythmias. We have created a full portfolio of ambulatory cardiac monitoring services on a unique platform, called the Zio service, which combines an easy-to-wear and unobtrusive biosensor that can be worn for up to 14 consecutive days with powerful proprietary algorithms that distill data from millions of heartbeats into clinically actionable information. The Zio service consists of:

•wearable patch-based biosensors, Zio XT and Zio AT monitors, which continuously record and store ECG data from every patient heartbeat for up to 14 consecutive days; Zio AT offers the option of timely transmission of data during the prescribed wear period;

•cloud-based analysis of the recorded cardiac rhythms using our proprietary, deep-learned algorithms;

•a final quality assessment review of the data by our certified cardiographic technicians; and

•an easy-to-read Zio report, a curated summary of findings that includes high quality and clinically-actionable information which is sent directly to a patient’s physician through ZioSuite and can be integrated into a patient’s electronic health record.

We receive revenue for the Zio service primarily from third-party payors, which include commercial payors and government agencies, such as CMS, Veterans Administration, and the military. In addition, a small percentage of institutions, which are typically hospitals or private physician practices, purchase the Zio service from us directly. Our revenue in the third-party commercial payor category is primarily contracted, which means we have entered into pricing contracts with these payors. Third-party contracted payors accounted for approximately 63% and 50% of our revenue for the three months ended March 31, 2021 and 2020, respectively. Approximately, 14% and 27% of our total revenue for the three months ended March 31, 2021 and 2020, respectively, is received from Centers for Medicare and Medicaid Services ("CMS"), which is under established reimbursement codes. Healthcare institutions, which are typically hospitals or private physician practices accounted for approximately 17% and 18% of our revenue for the three months ended March 31, 2021 and 2020, respectively. Non-contracted third party payors and self-pay accounted for 7% and 5% of our total revenue for the three months ended March 31, 2021 and March 31, 2020, respectively. We rely on a third-party billing partner, XIFIN, Inc., to submit patient claims and collect from commercial payors, certain government agencies, and patients.

Since our Zio service was cleared by the U.S. Food and Drug Administration (“FDA”), we have provided the Zio service to over three million patients and have collected over 750 million hours of curated heartbeat data. We believe the Zio service is well-positioned to disrupt an already-established $1.8 billion U.S. ambulatory cardiac monitoring market by offering a user-friendly device to patients, actionable information to physicians and value to payors.

    We market our ambulatory cardiac monitoring solution in the United States through a direct sales organization comprised of sales management, field billing specialists, quota-carrying sales representatives, and a customer service team. Our sales representatives focus on initial introduction into new customers, penetration across a sales region, driving adoption within existing accounts and conveying our message of clinical and economic value to service line managers and hospital administrators and other clinical departments. In addition, we will continue exploring sales and marketing expansion opportunities in international geographies.

23

COVID-19 Impact

We cannot currently predict the extent or duration of the ongoing impact to our financial results and have suspended forward-looking guidance. Although we cannot currently predict the extent or duration of the COVID-19 related impact to our financial results, we expect the impact of COVID-19 to be more significant in the near-term.

Beginning in mid-March 2020, we experienced decreasing levels in the Zio service patient registrations which impacted our revenues during the year ended December 31, 2020. This decrease in revenue is due to a variety of challenges associated with the COVID-19 pandemic in the United States, including, among others:

•reduction in physician prescriptions for our Zio service due to:

•cancellation and reduction of physician attendance at professional medical society meetings and trade shows and our decision not to attend them;

•travel restrictions and changing hospital policies that have limited access of our sales professionals to hospitals where the Zio services are prescribed and where patients have historically been enrolled;

•delays in receiving Zio XT back from patients with some patients not returning the device at all; and

•patients who have lost jobs, been furloughed, have reduced work hours or are worried about the continuation of medical insurance being unable to afford the Zio service.

During the second half of 2020, we saw recovery of patient registrations for the Zio service to pre-COVID levels of the first quarter of 2020 and during the three months ended March 31, 2021 we experienced increasing levels in the Zio service patient registrations. However, this may be due, in some part, to the re-opening of certain regions within the United States and may not represent sustainable levels of patient registrations in future time periods.

We are taking a variety of measures to promote the safety and security of our employees and customers. Our response to COVID-19 is focused on:

•Protecting and supporting the health and well-being of our employees, our communities and our customers by limiting the transmission of COVID-19. Following recommendations from federal and local government and healthcare agencies, we transitioned employees to a remote work environment beginning in early March 2020. For a small number of our employees who continue to support essential operations at our facilities, we have instituted social distancing and other measures to ensure the safety of our employees. We rapidly implemented business continuity protocols and have been able to transition to a remote operating environment while continuing to deliver our Zio service. We will continue to follow local and national guidelines to determine the appropriate time to resume in-office functions.

•Delivering uninterrupted patient care for both Zio XT and Zio AT and supporting efforts to monitor COVID-19 patients. While hospital systems and healthcare facilities shift their focus and resources to treating COVID-19 patients and combating the spread of COVID-19, we have adapted our service to meet the immediate needs of our physician customers and patients. Our digital service platform enables physician ordering, results reporting, data curation and patient support independent of location, across virtual or in-office care models. As an example, we have significantly increased the utilization of our “Home Enrollment” service. This service allows patients to receive and wear the single-use Zio monitor without going to a healthcare facility. Physicians can prescribe the Zio service for their patients, either in-office or through a virtual care setting, and we ship the Zio monitor directly to the patient’s residence. We pay for the costs of shipping the Zio monitor, which represents additional expense for us. We also guide patients through the patch application process and inform them of instructions for wear. Home enrollment also eliminates clinical staff exposure to patients, as well as application, cleaning or reusing traditional Holter and event monitors that may have been exposed to viruses or other pathogens. In addition, health systems with acute needs to facilitate a reduction in healthcare provider contact or for additional monitoring capacity can deploy Zio AT for in-patient monitoring. The FDA informed us that Zio AT usage for this application is consistent with the FDA COVID-19 Remote Monitoring guidance.

•Adjusting our operating plan as appropriate to ensure continued financial strength. We continue to maintain a strong cash position and have taken initiatives to adjust our operating plan to ensure we maintain appropriate liquidity

24

during these uncertain times. We have proactively taken steps to reduce spend, including eliminating or delaying project spend for non-essential programs, and reducing spend on travel and consulting. In addition, we raised $206.8 million in proceeds from a follow-on public offering in August 2020 to fund growth initiatives and for working capital and other general corporate purposes

Components of Results of Operations

Revenue

Substantially all of our revenue is derived from sales of our Zio service in the United States. We earn revenue from the provision of our Zio service primarily from contracted third-party payors, CMS, and healthcare institutions. In addition, a small percentage of institutions, which are typically hospitals or private physician practices, purchase the Zio service from us directly, and a very small percentage of commercial non-contracted payors.

We recognize revenue on an accrual basis based on estimates of the amount that will ultimately be realized, which is the difference between the amount submitted for payment and the amount received. These estimates require significant judgment by management. In determining the amount to accrue for a delivered report, and Zio service provided, we consider factors such as claim payment history from both payors and patient out-of-pocket costs, payor coverage, whether there is a contract between the payor or healthcare institution and the Company, historical amount received for the service, and any current developments or changes that could impact reimbursement and healthcare institution payments.

We are subject to seasonality similar to other companies in our field, as vacations by physicians and patients tend to affect enrollment in the Zio service more during the summer months and during the end of calendar year holidays compared to other times of the year.

Cost of Revenue and Gross Margin

Cost of revenue includes direct labor, material costs, equipment and infrastructure expenses, amortization of internal-use software, allocated overhead, and shipping and handling. Direct labor includes payroll and personnel-related costs including stock-based compensation involved in manufacturing, data analysis, and customer service. Material costs include both the disposable materials costs of the Zio monitors and amortization of the re-usable printed circuit board assemblies (“PCBAs”). Each Zio XT monitor includes a PCBA, and each Zio AT monitor includes a PCBA and gateway board, the cost of which is amortized over the anticipated number of uses of the board. We expect cost of revenue to increase in absolute dollars to the extent our revenue grows.

We calculate gross margin as gross profit divided by revenue. Our gross margin has been and will continue to be affected by a variety of factors, including increased contracting with third-party payors and institutional providers. We have in the past been able to increase our pricing as third-party payors become more familiar with the benefits of the Zio service and move to contracted pricing arrangements. We expect to continue to decrease the cost of service per device by obtaining volume purchase discounts for our material costs and implementing scan-time algorithm improvements and software-driven and other workflow enhancements to reduce labor costs.

Gross margin for the three months ended March 31, 2021 was negatively impacted due to the Novitas Medicare price decrease with limited impact of higher Zio AT volumes and COVID-related labor costs offset by volume benefits.

Although a large majority of our commercial customers have re-contracted the Zio XT service since the establishment of the Category I codes on January 1, 2021 matching to pre-existing rates, if we are unsuccessful in improving the Medicare rates before calendar year 2022, we believe it is prudent to expect that commercial rates may begin to be more negatively impacted next year which would have a negative impact on margins.

Research and Development Expenses

We expense research and development costs as they are incurred. Research and development expenses include payroll and personnel-related costs, including stock-based compensation, consulting services, clinical studies, laboratory supplies and allocated facility overhead costs. We expect our research and development costs to increase in absolute dollars as we hire additional personnel to develop new product and service offerings and product enhancements.

25

Selling, General and Administrative Expenses

Our sales and marketing expenses consist of payroll and personnel-related costs, including stock-based compensation, sales commissions, travel expenses, consulting, public relations costs, direct marketing, tradeshow and promotional expenses and allocated facility overhead costs.

Our general and administrative expenses consist primarily of payroll and personnel-related costs for executive, finance, legal and administrative personnel, including stock-based compensation. Other significant expenses include professional fees for legal and accounting services, consulting fees, recruiting fees, bad debt expense, third-party patient claims processing fees and travel expenses.

Interest Expense

Interest expense is attributable to borrowings under our loan agreements. Refer to Note 7. Debt, for further information on our loan agreements.

Other Income, Net

Other income, net consists primarily of interest income which consists of interest received on our cash, cash equivalents and investments balances.

Results of Operations

Comparison of the Three Months Ended March 31, 2021 and 2020

	Three Months Ended March 31,
	2021			2020			$ Change		% Change
Revenue	$	74,311		$	63,535		$	10,776	17	%
Cost of revenue	23,458			16,063			7,395		46	%
Gross profit	50,853			47,472			3,381		7	%
Gross margin	68		%	75		%
Operating expenses:
Research and development	8,510			8,415			95		1	%
Selling, general and administrative	69,813			48,230			21,583		45	%
Total operating expenses	78,323			56,645			21,678		38	%
Loss from operations	(27,470)			(9,173)			(18,297)		199	%
Interest expense	(335)			(380)			45		(12)	%
Other income, net	124			505			(381)		(75)	%
Loss before income taxes	(27,681)			(9,048)			(18,633)		206	%
Income tax provision	98			17			81		476	%
Net loss	$	(27,779)		$	(9,065)		$	(18,714)	206	%

Revenue

Revenue increased $10.8 million, or 17%, to $74.3 million during the three months ended March 31, 2021 from $63.5 million during the three months ended March 31, 2020. The increase in revenue was primarily attributable to the increase in volume of the Zio services as a result of increased demand from our customers, partially offset by a decrease in revenue recognized from CMS, based on the updated 2021 published rates.

Cost of Revenue and Gross Margin

Cost of revenue increased $7.4 million, or 46%, to $23.5 million during the three months ended March 31, 2021 from $16.1 million during the three months ended March 31, 2020. The increase in cost of revenue was primarily due to increased Zio service volume as well as costs incurred to support a larger cost structure in 2021.

26

Gross margin for the three months ended March 31, 2021 was 68%, compared to 75% for the three months ended March 31, 2020. The decrease in gross margin is primarily due to the updated reimbursement rates announced by Novitas in April 2021.

Research and Development Expenses

Research and development expenses increased $0.1 million, or 1%, to $8.5 million during the three months ended March 31, 2021 from $8.4 million during the three months ended March 31, 2020. The increase was primarily attributable to a $2.3 million increase in bonus and stock-based compensation, and a $1.8 million reduction of expense due to an increase in costs capitalized to internal use software, as well as a $0.2 million decrease in employee travel expense.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $21.6 million, or 45%, to $69.8 million during the three months ended March 31, 2021 from $48.2 million during the three months ended March 31, 2020. The increase was due to $18.6 million increase in stock-based compensation primarily due to increased headcount and a reversal of PRSU expense recorded during the three months ended March 31, 2020, $8.4 million increase in payroll as a result of increased headcount, and $0.9 million increase in facility expenses, partially offset by a $2.8 million reduction in employee travel expense, and a $2.3 million reduction in temporary consultants.

Interest Expense

Interest expense was $0.3 million for the three months ended March 31, 2021, compared to $0.4 million for the three months ended March 31, 2020. There were no significant changes in interest expense during the three months ended March 31, 2021 compared with the three months ended March 31, 2020.

Other Income, Net

Other income, net was $0.1 million for the three months ended March 31, 2021, compared to $0.5 million for the three months ended March 31, 2020. There were no significant changes in other income, net during the three months ended March 31, 2021 compared with the three months ended March 31, 2020.

Liquidity and Capital Expenditures

Overview

We are continuously reviewing our liquidity and anticipated capital requirements in light of the significant uncertainty created by the COVID-19 global pandemic. We believe we will have adequate liquidity over the next twelve months to operate our business and to meet our cash requirements.

As of March 31, 2021, we had cash and cash equivalents of $137.4 million, short-term investments of $124.9 million, and an accumulated deficit of $332.5 million.

Our expected future capital requirements may depend on many factors including expanding our customer base, the expansion of our salesforce, and the timing and extent of spending on the development of our technology to increase our product offerings.

If we raise additional funds by issuing equity securities, our stockholders may experience dilution. Any future debt financing into which we enter may impose upon us additional covenants that restrict our operations, including limitations on our ability to incur liens or additional debt, pay dividends, repurchase our common stock, make certain investments and engage in certain merger, consolidation or asset sale transactions. Any debt financing or additional equity that we raise may contain terms that are not favorable to us or our stockholders.

27

Cash Flows

The following table summarizes our cash flows for the periods indicated (in thousands):

	Three Months Ended March 31,
	2021		2020
Net cash (used in) provided by:
Operating activities	$	(41,842)	$	(22,366)
Investing activities	117,035		59,911
Financing activities	(26,446)		(1,493)
Net increase in cash and cash equivalents	$	48,747	$	36,052

Cash Used in Operating Activities

During the three months ended March 31, 2021, cash used in operating activities was $41.8 million, which consisted of a net loss of $27.8 million, adjusted by non-cash charges of $34.1 million and a net change of $48.2 million in our net operating assets and liabilities. The non-cash charges were primarily comprised of a change in stock-based compensation of $20.2 million, allowance for doubtful accounts and contractual allowances of $9.8 million, depreciation and amortization of $2.0 million and amortization of right of use assets of $1.6 million. The change in our net operating assets and liabilities was primarily due to an increase of $39.8 million in accounts receivable, a decrease of $6.1 million in accrued liabilities, a decrease of $0.7 million in accounts payable and a decrease of $1.4 million in operating lease liability.

We are currently holding a majority of Zio XT claims due to the CPT code transition. Claims are being held due to a combination of negotiations with payors and administrative delays with payors. We expect the level of held claims to remain high through the end of the second quarter of 2021 and potentially beyond. The high level of held claims will delay some second quarter 2021 cash flows into the second half of 2021 or potentially beyond. We expect cash inflows from accounts receivable to improve in the second quarter of 2021 as we make progress on Zio XT claims processing and collections that have been delayed.

During the three months ended March 31, 2020, cash used in operating activities was $22.4 million, which consisted of a net loss of $9.1 million, adjusted by non-cash charges of $12.4 million and a net change of $25.7 million in our net operating assets and liabilities. The non-cash charges were primarily comprised of a change in the allowance for doubtful accounts and contractual allowances of $9.2 million and depreciation and amortization of $1.6 million. The change in our net operating assets and liabilities was primarily due to an increase of $10.0 million in accounts receivable as a result of increased revenues and an increase of $9.5 million in accrued liabilities.

28

Cash Provided by Investing Activities

Cash provided by investing activities during the three months ended March 31, 2021 was $117.0 million, which consisted of $30.1 million in purchases of available for sale investments and $4.2 million of capital expenditures, partially offset by cash received from the maturities of available for sale investments of $151.3 million.

Cash provided by investing activities during the three months ended March 31, 2020 was $59.9 million, which consisted of cash received from the maturities of available for sale investments of $56.8 million and sales of available for sale investments of $14.5 million. This was partially offset by $8.0 million in purchases of available for sale investments and $3.4 million of capital expenditures associated with leasehold improvements and internal use software.

Cash Used in Financing Activities

During the three months ended March 31, 2021, cash used in financing activities was $26.4 million, primarily due to $25.1 million in tax withholding upon the vesting of RSUs. This practice will be updated to require employees to sell shares to cover tax liabilities and will not be a company use of cash beginning in June 2021. In addition, cash used in financing activities was due to repayment of debt of $2.9 million, partially offset by $1.6 million in proceeds from the issuance of common stock in connection with employee options exercises and our Employee Stock Purchase Program.

During the three months ended March 31, 2020, cash used in financing activities was $1.5 million, primarily due to $4.5 million in tax withholding upon the vesting of RSUs, partially offset by $3.0 million in proceeds from the issuance of common stock in connection with employee options exercises and our Employee Stock Purchase Plan.

Bank Debt

In December 2015, we entered into a Second Amended and Restated Loan and Security Agreement with SVB, (the “SVB Loan Agreement”). Under the SVB Loan Agreement, we could borrow, repay and reborrow under a revolving credit line, but not in excess of the maximum loan amount of $15.0 million, until December 4, 2018, when all outstanding principal and accrued interest became due and payable. Any principal amount outstanding under the SVB Loan Agreement shall bear interest at a floating rate per annum equal to the rate published by The Wall Street Journal as the “Prime Rate” plus 0.25%. We could borrow up to 80% of our eligible accounts receivable, up to the maximum of $15.0 million.

In October 2018, we entered into the Third Amended and Restated Loan and Security Agreement with SVB (“Third Amended and Restated SVB Loan Agreement”). This Agreement amends and restates the Second Amended and Restated Loan and Security Agreement between the Company and SVB dated December 4, 2015, as amended by the First Loan Modification Agreement between the Company and SVB dated August 22, 2016.

Pursuant to the Third Amended and Restated SVB Loan Agreement, we obtained a term loan (“SVB Term Loan”) for $35.0 million. Total proceeds from the SVB Term Loan were used to pay off the loan agreement with Biopharma Secured Investments III Holdings Cayman LP (“Pharmakon”), totaling $35.8 million. We will make interest-only payments through October 31, 2020, followed by 36 monthly payments of principal plus interest on the SVB Term Loan. Interest charged on the SVB Term Loan will be the greater of (a) a floating rate based on the “Prime Rate” published by The Wall Street Journal minus 0.75%, or (b) 4.25%.

Under the Third Amended and Restated SVB Loan Agreement, we may borrow, repay, and reborrow under a revolving credit line, but not in excess of the maximum loan amount of $25.0 million, which includes an $11.0 million standby letter of credit sublimit availability. In October 2018, a $6.9 million standby letter of credit was obtained in connection with a lease for our San Francisco headquarters. Any principal amount outstanding under the Third Amended and Restated SVB Loan Agreement revolving credit line shall bear interest at an amount that is the greater of (a) a floating rate per annum equal to the rate published by The Wall Street Journal as the “Prime Rate” or (b) 5.00%. We may borrow up to 75% of eligible accounts receivable, up to the maximum of $25.0 million. As of March 31, 2021 no amount was outstanding under the revolving credit line.

The Third Amended and Restated Loan Agreement requires us to maintain a minimum consolidated liquidity ratio or minimum adjusted Earnings Before Interest, Tax, Depreciation, and Amortization during the term of the loan facility. In addition, the SVB Loan Agreement contains customary affirmative and negative covenants and events of default. We were in compliance with loan covenants as of March 31, 2021. The obligations under the Third Amended and Restated Loan Agreement are collateralized by substantially all of our assets.

29

Off-Balance Sheet Arrangements

We have not entered into any off-balance sheet arrangements and do not have any holdings in variable interest entities.

Contractual Obligations

Our contractual obligations as of December 31, 2020 are presented in our Form 10-K filed with the SEC on February 26, 2021. There have been no material changes.

Critical Accounting Policies and Estimates

For a complete description of what we believe to be the critical accounting policies and estimates used in the preparation of our Unaudited Condensed Consolidated Financial Statements, refer to our Annual Report on Form 10-K for the year ended December 31, 2020 ("Annual Report"). Refer to Note 2. Summary of Significant Accounting Policies, in the Notes to Unaudited Condensed Consolidated Financial Statements in Item 1 of Part I of this Quarterly Report on Form 10-Q, for all significant accounting policies. With the exception of the accounting policy described below, there have been no significant changes to our critical accounting policies as described in our Annual Report.

ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risks in the ordinary course of our business. These risks primarily include risk related to interest rate sensitivities and foreign currency exchange rate sensitivity.

Interest Rate Sensitivity

We had cash, cash equivalents and investments of $262.3 million as of March 31, 2021, which consisted of bank deposits, money market funds, U.S. government securities, corporate notes, and commercial paper. Such interest-earning instruments carry a degree of interest rate risk; however, historical fluctuations in interest income have not been significant.